Halliburton Company
Annual Report 2002

Plain-text annual report

H A L L I B U R T O N 2 0 0 2 A N N U A L R E P O R T H A L L I B U R T O N T O D AY The Energy Services Group offers the broadest array of products and services to the upstream petroleum industry worldwide. These services include decision support services for locating hydrocarbons and managing digital data; creation and evaluation of the wellbore; creation of infrastructure to move hydrocarbons; and optimization of hydrocarbon production. KBR, the Engineering and Construction Group, serves the energy industry by designing, building and providing operations and maintenance services for liquefied natural gas plants, refining and processing plants, production facilities and pipelines both onshore and offshore. The non-energy business of the group meets the engineering and construction needs of governments and civil infrastructure customers. C O M PA R AT I V E H I G H L I G H T S Millions of dollars and shares except per share data 2002 Diluted income (loss) per share from continuing operations $ (0.80) $ Diluted net income (loss) per share Cash dividends per share Shareholders’ equity per share Revenues Operating income (loss) Income (loss) from continuing operations Net income (loss) Long-term debt (including current maturities) Shareholders’ equity Capital expenditures Depreciation and amortization Diluted average shares outstanding (2.31) 0.50 8.16 12,572 (112) (346) (998) 1,476 3,558 764 505 432 2001 1.28 1.88 0.50 10.95 13,046 1,084 551 809 1,484 4,752 797 531 430 $ 2000 0.42 1.12 0.50 9.20 11,944 462 188 501 1,057 3,928 578 503 446 Net income in 2001 includes a gain on disposal of discontinued operations of $299 million or $0.70 per diluted share. Net income in 2000 includes a gain on disposal of discontinued operations of $215 million or $0.48 per diluted share. C O N T E N T S Letter to Shareholders Operations Overview Board of Directors Corporate Information Financial Information 2 6 30 32 33 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 1 O U R M I S S I O N : D E L I V E R I N G S E R V I C E Q U A L I T Y 2 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T D A V I D J . L E S A R L E T T E R T O S H A R E H O L D E R S David J. Lesar, Chairman of the Board, President and Chief Executive Officer of Halliburton 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 3 DEAR FELLOW SHAREHOLDERS, And it is through their efforts, and the increased pricing pressures in 2002 efforts of thousands more like them, resulted in a 12 percent drop in In 2001, Real Time technology began that Halliburton has achieved good revenues for the Energy Services transforming Halliburton into a faster, financial performance in 2002 – even Group. Yet, in spite of the decline in smarter, more responsive service during a difficult environment. rig activity, Sperry-Sun had record company. This year, we took the next Looking back, 2001 gave rise to a new revenues of $1 billion, and Landmark step and made Service Quality a and frightening world with fear of Graphics again had excellent revenues Company-wide campaign. terrorism, the war in Afghanistan, a and operating income increases. At Halliburton, we’ve always prided global recession and growing geopoliti- Higher revenues on the Engineering ourselves on our ability to perform cal instability. That atmosphere has & Construction side of the business under the most extreme conditions or persisted, making many companies offset the Energy Services Group’s constraints. But with the economy hesitant to increase their investments decreased revenues. The Engineering laboring under the strain of geopolitical because of concerns of what might & Construction Group’s onshore and tensions and uncertainties, the market- happen in the future. Yet, despite all offshore business revenues increased place demands even more. We believe this, and the cloud of asbestos litiga- by 25 percent or more, while the that Service Quality, or knowing what tion, 2002 was a very good year for Infrastructure business experienced a customers expect and delivering it Halliburton. While revenues were down 22 percent rise. right the first time, will give us the slightly for the year, we are very With large contract wins in Algeria, edge. Companies that can consistently pleased with our performance relative Egypt and Nigeria, KBR continues to deliver exceptional Service Quality to our peers in this very difficult perform extremely well in the liquefied will win on every front – customer environment. I’d like to thank the natural gas (LNG) market. Government satisfaction, employee motivation and management team and hard-working Services also experienced significant shareholder value. Halliburton people everywhere. successes, including a site support serv- Throughout these pages, you’re going Certainly, one of the biggest news ices contract with the U.S. Department to see and read stories of Halliburton items for Halliburton this year has of Energy’s Los Alamos National people achieving Service Quality been the progress we have made toward Laboratory in New Mexico, and a beyond expectations. You’ll see them resolving our asbestos litigation problem. design-build contract for the new U.S. on job sites in remote and demanding We still have a long way to go and may Embassy compound in Kabul, places, in laboratories and manufactur- not get there, but we are working Afghanistan. ing facilities around the world. You’ll toward a resolution that we believe will A continuing bright spot for both meet teams, individuals, old hands result in a fair and equitable settlement business groups was the international and newcomers. And what you’re going with the asbestos claimants and free us market. Halliburton’s international to notice is how much pride they to concentrate on the future. revenues increased in 2002 to 67 percent have in what they do. They are excited Overall, we had solid results from of total revenues from 62 percent about where they work and how the Energy Services Group. Following a a year ago. Another positive was hard they work. They’re proud of their record year for the Energy Services the dispositions of non-core business years of experience and their loyalty Group in 2001, reduced drilling activity assets that bolstered our liquidity. to the Company. They are Halliburton. in the United States and Canada and Last year, our message was of 4 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T transformation. The transformation • There have been fundamental business with our customers to improve overall continues, sweeping through every changes, with the Engineering & efficiency. This could mean a restruc- part of the Company: Construction Group making a bold turing of traditional relationships. Or • There have been major organizational move in deciding it will no longer it could mean collaborative relation- changes, as the Energy Services pursue lump-sum engineering, ships yielding more focused, effective Group (ESG) and Engineering & procurement, installation and com- products and services. At Halliburton, Construction Group (KBR) became missioning (EPIC) projects for the different times call for fresh thinking. two independent business units in offshore oil and gas industry until and Innovation is the means by which 2002. There were many reasons for unless the current business model companies exploit change as an oppor- this restructuring: liquidity pressures improves to allow for reasonable profits tunity for growth, and technology will in a more difficult global business at reasonable risks. continue to be a major thrust of our environment; competitive pressures to The oil and gas industry is historically strategy. Over the past five years, have the best possible cost structure; boom or bust. Since the collapse in Halliburton has invested more than pressure on the stock price due to prices in late 1998, oil prices have been $1 billion developing game-changing asbestos litigation; and the increasingly even more unstable than in past decades. technologies in almost every product different business drivers, business The tight energy supply-and-demand line. Instead of designing products to cycles and customers of the Energy balance in the industry these days compete head-to-head with others in Services Group and Engineering & means that even small shifts can lead the market, our aim is to create products Construction Group. But the overriding to large swings in prices. that optimize assets, solve problems reason? Restructuring will enable both Clearly, we are at a point in time and deliver long-term value for ourselves companies to strengthen their busi- where we must redesign our Company and our customers. nesses and go head-to-head with our for short commodity price cycles and Today at the ESG, new technology most powerful competitors, many of position ourselves technologically, accounts for more than 20 percent of them companies that have an emphasis operationally and culturally to respond our total revenues. But innovation can on one core competency. This will, in as the energy industry is evolving. also be achieved by integrating existing turn, position Halliburton to achieve That means looking beyond what will technologies to provide new or improved sustained growth and profitability. make us successful this year, and for- offerings, and we are pursuing opportuni- • There have been management changes. ward into the next 10 years. ties to do this. Edgar Ortiz, the chief executive We’re working hard to increase our At the same time, we are shifting our officer of the ESG, retired Dec. 31 productivity so that we can accomplish economic resources into areas of higher after a distinguished 33-year career more with a smaller core group. productivity and greater yields. The in the industry, and Halliburton Programs that align employee perform- Energy Services Group and Engineering Energy Services President John Gibson ance and compensation with our busi- & Construction Group currently hold the succeeded him. KBR continues under ness objectives are an important first No. 1 or No. 2 positions in most of their the leadership of Randy Harl. Doug step. Our intense Service Quality focus product lines. The Energy Services Group Foshee is now our chief operating will produce more efficiencies, as well derives more than 75 percent of its officer, and C. Christopher Gaut has as a competitive advantage. revenue today from product service lines joined us as chief financial officer. We’re also finding ways to work where it holds a No. 1 or No. 2 position. 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 5 In the months ahead, you will see us burn, back in 1994. It’s still considered and drive. They are welcome additions developing strategies and investing to the industry standard. But as good as to the Halliburton family. sustain and grow those positions in all it is, the result is still significant ther- The next 10 years will require diligence of our product lines because that’s what mal releases that are suspected to add and imagination. And despite current will generate the profitability to sustain to global warming. Now, we’re working industry conditions, I am very encour- us, boom or bust. on technologies that will eliminate aged. We are transforming our internal I’ve said before how important Health, flaring altogether, such as open-hole processes. We’re improving our execution Safety and Environment (HSE) is to test techniques, formation testing while and our products. Everywhere you Halliburton. Respect for the environment drilling and under-balanced drilling look, the Energy Services Group and and for the health and safety of our methods that enable us to evaluate the Engineering & Construction Group are employees and others that we work with reservoir in real time while drilling. being re-energized. is a core value, and we are a leader in All of these technologies are environ- We’re evolving in our industry from this arena. HSE is really about good mentally responsible, but none of them having value in fixed assets to having business practices. Take, for instance, will be truly successful unless they are value in intellectual capital, which Company-mandated driver safety more cost-efficient and effective. It’s makes us very rich indeed. Because initiatives. There’s a clear correlation entirely achievable, too, as we learned Halliburton people are the finest that between not wearing seat belts and from developing our new Accolade™ the industry has to offer. As I walk the cell phone use while driving and the drilling fluid system. Designed to conform hallways and visit job sites, the feeling quantity and severity of incidents to stricter regulatory standards in the I get from managers to field personnel that impact the health and safety of our Gulf of Mexico, Accolade dramatically is that we are entering the most exciting employees. Adverse incidents have a increased the rate of penetration over period in our history. They are pleased negative impact on insurance rates traditional fluids while significantly to be here at this point in time, with all and worker productivity, which increase reducing fluid losses from as many as its risks and opportunities, because for our cost of operations. A zero incidents 5,000 barrels to a few hundred barrels. the companies that can think clearly and objective is not just a good idea, it’s It’s a great example of how creativity act quickly, the rewards will be great. good business. within guidelines resulted in cost and I’d like to thank the people of Protecting the environment as we go performance breakthroughs. Halliburton for their spirit, dedication forward in the next decades is another As we look into the future, we can see and sense of adventure. I’m proud to good business practice – management that challenges abound in every area work with you. of environmental risks saves money of our industry. Our industry’s workforce today and demonstrates our commitment in North America and Europe is aging, to a better environment. Halliburton and few young people are entering the is developing new technologies that will ranks. But Halliburton is finding and help our customers address some of their training talented young professionals most pressing environmental needs. at our locations around the world. For instance, Halliburton developed Engineers from countries like Malaysia, the Sea Emerald Burner for well testing, Angola, Russia and the Caspian Sea which produces a 99.9 percent clean region are bringing fresh perspectives David J. Lesar Chairman of the Board, President and Chief Executive Officer 6 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 7 8 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 9 W O R L D ’ S B E S T F R A C C R E W S “YOU CALL, WE HAUL.” Crews like this one in Mission are a big reason why Halliburton is the “go-to” supplier of frac services to South Texas. That, and the right tools: our one- of-a-kind HT-2000 pump, the only 2000 HHP pump designed to work at 20,000 psi; our high-tech, temperature-busting SiroccoSM fracturing system and Expedite SM XT proppant flowback control. Five wells treated with these technologies increased production revenues some $1.5 million in eight days. Halliburton’s “you call, we haul” tradition meets the 21st century. 10 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 11 A R E C O R D R U N THE NEW BENCHMARK. The result of a collaboration between Sperry-Sun and Japan National Oil Corporation (JNOC), the Geo-Pilot system introduces a new approach to rotary steerable drilling – point the bit. Using Security DBS’ FullDrift™ extended-gauge bits, the Geo-Pilot system produces unparalleled borehole quality, improved drilling efficiency and reliability, and lower drilling costs – even under extreme North Slope conditions where wellheads must be housed in special buildings (see above). Coupled with the Geo-Span downlink system™ that provides full-time, two-way communication, the Geo-Pilot system can change directions on-the-fly while on bottom drilling. It’s the new benchmark in rotary steerable technology. 12 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 13 G E T T I N G G R E E N GREAT FOR THE ENVIRONMENT, GREAT FOR BUSINESS. Accolade’s exceptional properties provide minimized swab and surge pressures, one of the most desired qualities in deepwater drilling fluids. It reduces lost circulation, supplies better hole-cleaning efficiency and stability, and provides superior rates of penetration. It also dramatically cuts fluid losses and consumption – in some cases by 80 percent. For one customer, Accolade saved $3.8 million in reduced mud costs and rig time. That’s great for the environment. Great for business. 14 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 15 B E T T I N G O N B A K U FIRST OIL IN 2005. With four offshore platforms, a major onshore terminal expansion, 600 kilometers of subsea pipelines and the biggest water injection pumps ever manufactured, Azeri is among the world’s largest infrastructure projects. Materials must be brought in through canals that are frozen during winter. Local fabrication yards and marine equipment/vessels have required major upgrades. Topsides weighing 15,000 tonnes must be barge loaded and floated over four platform jackets constructed from launch frames, like the one above. Despite the challenges, KBR Engineering is on schedule, with first oil expected in early 2005. 16 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T S T E P C H A N G E R S THE ULTIMATE VISION. For years, it has been a goal within the oilfield services industry to drill a mono-diameter well. A wellbore with the same diameter top to bottom would allow operators to drill deeper, faster, more cost effectively – and with much less impact on system, the ultimate application of SET tech- the environment. Enventure’s MonoDiameter™ nology, along with Halliburton’s PoroFlex™ expandable screens, VersaFlex™ expandable in the printout, left) and the ChannelSeal™ liner hangers (a section of which is shown selective-set cementing system, brings the reality even closer. At right, parts of an expansion assembly of the SET system. 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 17 18 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T G I A N T I N T H E D E S E R T WHAT KBR DOES BEST. Many of KBR’s activities may seem surprising for an E&C company. Like teaching people to make bricks and build homes, running a health clinic, or enabling home loans. But the client is committed to responsible development. Meanwhile, with 270 well sites, miles of gathering lines and related facilities, and an ambitious schedule, it’s an immense undertaking, and KBR must deliver. So far, KBR has achieved 25 million incident-free work hours – and counting. 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 19 20 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T A D R I V E F O R S A F E T Y THE TRIPLE BOTTOM LINE. A winner of Halliburton’s HSE Award this year, Halliburton de Mexico has an incredible safety record. After starting a driver safety program in 1997, the vehicle accident rate plunged. But the team members weren’t satisfied. They started training families covered by Halliburton’s employee medical insurance plan. Now, they’re training drivers who interact with Halliburton every day, reducing the accident rate and serving the community at the same time – the bottom line of a successful HSE policy. 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 21 22 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T T H E Y E A R O F S E R V I C E Q U A L I T Y Value for service, or Service Quality, were already a significant number of ESG’s Service Quality strategy, a key isn’t a new concept. It is the age-old Halliburton employees who had been part of our business strategy and our expectation of every buyer, and it’s dedicated to these principles for years. mantra. Poor Service Quality costs at the heart of every service transac- To strengthen this dedication, we made companies millions of dollars every tion. But how do you define it? Is it HSE a focus of our business objectives year and can end up costing some- cost, or timeliness, or convenience? Is it with a strong commitment – from thing more valuable – a customer’s shiny new technology introduced the Board of Directors on down – and trust. While our end-of-job customer every year? systems to measure our progress. surveys say that 97 percent of our At Halliburton, we believe that Today, HSE is ingrained into the customers are satisfied with the job Service Quality comes from knowing culture at Halliburton and is a core we do, we aim for nothing less than what our customers need and deliv- value. We are one of the industry 100 percent. To do that takes refo- ering it, when they need it and how leaders in safety performance. In 2002, cusing on what great customer satis- they need it. Service Quality is not we had a remarkable 30 percent faction really means. simply executing a job, but rather decrease in the United States in our doing it to meet or exceed our Occupational Safety and Health customers’ expectations. It’s results, Administration (OSHA) recordable pure and simple. incident rate, and this has been This is the story of how Halliburton reflected in our global operations. made Service Quality a business If we can accomplish so much in a strategy and a passionate focus – short amount of time, who knows what starting where it counts, from within. we can achieve with the same focus S E R V I C E Q U A L I T Y A N D P E O P L E on Service Quality? One thing that we know with certain- ty: Important organizational change S E R V I C E Q U A L I T Y A N D T H E E N E R GY S E R V I C E S G R O U P A year ago, we said that Halliburton was transforming the way we deliver solutions in order to help our customers maximize the economic recovery of their hydrocarbon reservoirs. By that standard, Service Quality involves more than excellent job execution. It’s about using our resources and experi- ence to help our customers optimize reservoirs and produce a profitable well – without significant failures or down time, and with environmental requires a cultural change. We’re not For years, Halliburton has been known compliance and zero incidents. just changing actions; we’re changing as the hardest-working, most-reliable It’s about delivering the best solutions a belief system. energy services company in the oil in four areas that are of particular Halliburton has experience doing patch. “You call, we haul, that’s all.” concern to our customers: locating hydro- that. In 1997, the Energy Services But is it? After all, as an energy carbons, creating the hole, putting in- Group (ESG) and KBR made a com- services company, it’s our responsibility frastructure into the hole to move fluids mitment to be the industry leaders in to find out what challenges our cus- and gases, and optimizing production. Health, Safety and the Environment tomers are facing and give them the In this context, Service Quality (HSE). At the time, most people agreed means to meet them. doesn’t necessarily mean designing a that HSE was a good idea. And there This year, “Done Right” became the new drill bit, but rather finding the 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 23 best way to get our customers to the S E R V I C E Q U A L I T Y A N D Halliburton’s Innovative Product reservoir. Whatever way that might T E C H N O L O GY Commercialization (IPC) provides a be. So we’re challenging the notion of In 2002, the ESG spent $247 million on clear path for identifying, developing what it means to be an energy services technology development. Halliburton and commercializing new technologies. company and to become what the was awarded 194 patents in the U.S. The IPC framework enables industry needs us to be. That may Due to this commitment, Halliburton Halliburton to look into the future and mean partnering with our customers ranks among the top 100 U.S. technol- uncover innovative, new ideas and when we develop a special technology ogy development companies. Our tech- opportunities that will help us solve for them, or getting involved in project nologies are boosting our customers’ customer needs and profitably grow planning upfront and taking more production, increasing reserves, and our business. The underlying purpose responsibility for results. Service reducing capital and operating of IPC is to help us identify, develop done right. expenses. Can we do better? and commercialize technology quickly ... the Service Quality that we deliver today with our existing technology is what foreshadows the delivery of technology for tomorrow ... AN ENVIABLE RECORD. Enventure employees continue to demonstrate their commit- ment to safety by completing a fourth year without a lost-time injury, a safety-performance level they take pride in. SAFETY MEETING. Before leaving for the job site, the Mission, Texas, frac crew gathers for its first safety meeting of the day. Such meetings help reinforce safe behavior and cut down on recordable incidents. 24 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T and effectively in order to bring value Landmark led the oil and gas industry Landmark is currently developing to Halliburton and our customers: the by making its entire suite of integrated technologies in the areas of prospect right technology for right now. software technology available to run generation, field development and plan- It takes a world-class organization on Linux systems. Not only are they ning, well design, and drilling and pro- to consistently deliver the finest appli- providing customers with greater duction optimization. When combined cations of technology to the well site. platform choice and independence, with leading-edge technologies from And because customers vote “yes” or but the cost-effective Linux platforms Halliburton, these products will further “no” in the marketplace, the Service are producing measurable boosts in increase the percentage of recoverable Quality that we deliver today with our performance of 10 times or more reserves from new and existing reser- existing technology is what foreshadows and creating a significant customer voirs, while significantly reducing the delivery of technology for tomorrow. advantage by lowering costs and finding and lifting costs. In 2002, the ESG introduced some reducing cycle times. Halliburton is also creating a new truly ground-breaking technologies. Throughout the world, nine out of generation of drilling, completion and But it’s technology with a purpose. 10 leading oil and gas companies are production enhancement products that Such is the case at Landmark using Landmark products to dramati- Graphics, where the first criterion of cally compress many business-critical solve an entire range of needs. One SM , of them, Halliburton Micropolymer any new technology is: How will it workflows while increasing efficiencies. is a non-surfactant based fluid system. help our customers find, develop and Tasks that used to take days or weeks Using polymer chains 20 to 30 times produce their oil and gas resources can now be done in a matter of hours smaller than conventional polymers, more quickly and efficiently? Last year, or even minutes. these micropolymer systems greatly RELIABILITY CHECK. A Sperry-Sun technician puts away the electronics insert from a Logging-While-Drilling tool. After every use, inserts are cleaned and inspected for signs of wear before being stored in a laboratory-controlled environment. DEEP FREEZE. To lessen the footprint, future North Slope drill sites will be inaccessible by roads. Equipment and personnel must be flown in by airplanes, or use temporary ice roads built to last from November until the spring thaw. 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 25 ... Performance Excellence is driven by implementing innovative ideas submitted by KBR employees. Their ideas help us work faster and more efficiently ... improve conductivity and increase The idea of Performance Excellence E X A M P L E S O F I N N OVAT I O N initial hydrocarbon production rates seems natural to a company like by up to 67 percent. Better still, KBR. After all, we are known for Halliburton Micropolymer is the our ability to execute some of the industry’s first and only reusable most complex and exacting projects frac fluid, making it much more cost anywhere. Whether it’s designing efficient and environmentally and building a billion-dollar liquefied responsible, too. That’s technology natural gas (LNG) plant in Algeria Years ago, we dreamed of the 24-hours-a-day, seven-days-a-week virtual project. After all, sharing work is shortening time to market in the motor and aircraft industries. Why not global work sharing in the world of process plant design? done right. or rebuilding the U.S. Embassy in Today, technology is providing this Maximum profitability today has Kabul, Afghanistan, KBR delivers. a new definition. Companies in But in the engineering and con- the 21st century need to be socially struction industry these days, the capability, and KBR has embraced it. In a recent project, KBR and its German joint venture partner collabo- responsible and environmentally margins are thinner, room for error rated over a common 3-D CAD system conscious because their profitability is narrower, the landing zone smaller. to design a phenol and acetone plant. depends on it, and it’s the right thing It can take three to five years from The teams worked concurrently, to do. Successful services companies contract to completion, and there sharing files between offices on two will deliver the products and services are hundreds of chances for a project continents and delivering a fully that make this possible. to fail. Our customers, our investors integrated and successful design on S E R V I C E Q U A L I T Y A N D K B R and the marketplace demand pre- a very aggressive schedule. dictability and certainty. This is also taking place in KBR’s Service Quality is referred to at KBR Performance Excellence is driven Infrastructure business product line, as Performance Excellence. A different by implementing innovative ideas where design and engineering work name, but the meaning is the same: submitted by KBR employees. Their transcend geographical boundaries. innovation and knowledge manage- ideas help us work faster and more On one of KBR’s large U.K. road ment, excellent execution, predictable efficiently, without compromising concessions involving the upgrade of results and customer value. project integrity. a major road to motorway standard, 26 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T MOVING OIL. Workers finish construction on Pump Station Three at the Belabo site in Cameroon. ... Halliburton has a workforce of 83,000 people in more than 100 countries. With so many chances to do good or harm, we choose to do what is right ... 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 27 bridge design and the development of business processes, and to submit can assess their skills and provide the CAD design model are being ideas for transforming work through training where there are gaps. carried out in Australia, while the an online Idea Zone. Employees will use the critical skills road design is undertaken in the U.K. Innovation is becoming part of we’ve identified for all levels of man- KBR’s Engineering Excellence the KBR psyche, and Knowledge agement, from first-time managers to Group is working to make these break- Management goes hand in hand with the executive team, as a fast track for through scenarios routine. A laboratory it. Using Knowledge Management career development. KBR’s executive for purposeful engineering innovation, techniques, we are capturing the very team will assess its senior and middle the group is blending process engi- best of our expertise and our practices managers through the Leadership neers, layout engineers and cost and making it accessible to our people Performance Program. Already, KBR’s engineers to create a new engineer – through knowledge portals – providing president and CEO met personally the concept engineer – and improving the right information at the right time. with more than 100 senior managers how a project gets done. We are also connecting people to evaluate their direct reports, guide One approach being studied is using through global discipline teams and them in succession planning and object-oriented data dynamically. communities of practice to systemati- identify high-potential employees to Project teams around the globe will cally capture, share and integrate be the KBR leaders of tomorrow. access warehoused data through a information throughout KBR. The Nurturing young talent is our invest- secure Web-based portal and provide effective utilization of our intellectual ment in the future. IMPACT, the global input to its development as it moves capital enables us to achieve Perfor- network for KBR’s young engineers, through the system. This multi-dis- mance Excellence and to produce value was founded last year and now has ciplinary involvement at every stage for our shareholders and customers. more than 1,000 members. Committed helps to enhance overall knowledge, Like the ESG, KBR believes that to career and personal development eliminate rework, compress schedules by improving our people’s skills, and making an “impact” on the compa- and deliver a better project – the very Performance Excellence will follow. ny’s future, these enthusiastic young definition of Performance Excellence. A key piece – our Company-wide professionals are, in turn, visiting area P E O P L E E X C E L L E N C E People, Performance, Results pro- schools, colleges and universities, talk- gram – aligns performance goals ing to students and planting the seeds “Entrepreneurs innovate,” writes Peter and career objectives with business for KBR’s next generation. Drucker. But innovation isn’t only strategy and ties compensation to Our Performance Excellence focus technical. Throughout KBR, innovation accomplishment. began just a little over a year ago. champions are helping people apply Also taking aim at people excellence, But the idea has caught on, and it’s creative problem-solving techniques a worldwide taskforce is presently quickly becoming our way of life. and tools to daily tasks. Employees defining the competencies needed for Evidence of our success rests in our are encouraged to challenge the existing every job at KBR. By evaluating new and repeat business. KBR business model and remake critical employees against this standard, we booked an average of $1 billion in new 28 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T business each quarter of 2002. pressure and cholesterol. Our office in reduce waste; we’re removing toxic It’s also evident as you walk our Chad is helping to fund a center to components from our formulations hallways and hear the buzz. E&C study tropical diseases that shorten and eliminating flaring; and we’re firms, especially the size and scope lives and affect the quality of life for researching solutions that will allow of KBR, aren’t expected to have this that country’s citizens. us to clean and re-use water while kind of excitement. But our aim is to refashion KBR into a different kind of company that will be a model for the new millennium. And it’s working. S E R V I C E Q U A L I T Y B E YO N D P R O F I T S As human beings and citizens of this planet, we are inextricably linked. While we understand that as a com- pany we cannot expect to solve all the world’s problems, we also believe that we have a responsibility to make our world a better place. To Halliburton, Service Quality also means service to a greater good. We also believe that every employee drilling. Our real time technologies has the right to expect a safe, healthy for remote monitoring of reservoirs workplace. We begin meetings with are reducing our footprint at the well an HSE or safety moment, dis- site, and by reducing travel, we’re cussing specific on-the-job risks and also reducing our emissions. how to mitigate them. Everywhere we Halliburton is a company of people, operate, drivers receive safety training, and it is to them that we owe our seatbelts are mandatory, and the use best effort. We have a 91 percent of business cell phones while driving nationalized workforce. We provide is prohibited. jobs to local people, fair trade oppor- It’s the norm that during booming tunities to local companies and markets in our industry, increased support to local communities. We’re activity makes accident rates go up. encouraging young people to enter Yet, Halliburton’s incident rate has our industry by subsidizing student actually dropped for the last several membership dues in professional Halliburton has a workforce of years in a row, including during the organizations so they have a practical 83,000 people in more than 100 coun- strong market of 2001. We are proud and university education. Halliburton tries. With so many chances to do that our incident rate is much lower people commit thousands of hours to good or harm, we choose to do what than the industry average because community outreach projects – sup- is right. We conduct business ethics of our commitment to safety and our porting schools, cleaning beaches and training and have a strong code of processes. In 2002 at Halliburton, deserts, planting trees – because that’s conduct that applies to all employees we drove more than 400 million miles what it means to be a good neighbor. since we highly value principled busi- – that’s about twice around the planet We do these things because we ness practices. every hour – and we did it without a understand that we are – all of us – Health is the first word of our HSE single employee driving-related dependent on each other for the initiative, and we take a proactive fatality. survival of our planet, and we realize approach to health management. We’re We’re also creating technologies that our actions have consequences. teaching workers in Africa about that are reusable, sustainable and We are keenly aware that to lead is AIDS and mosquito-borne diseases, environmentally responsible. We’ve more than to make the most money. and office workers about high blood developed drilling systems that We know that to lead is to serve. 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 29 … Halliburton people commit thousands of hours to community outreach projects – supporting schools, cleaning beaches and deserts, planting trees – because that’s what it means to be a good neighbor … MAKING A CONTRIBUTION. A mother and her young child stand outside their home in a Chadian village. Around the world, families like this one often benefit from the employment opportunities and community involvement that Halliburton brings to their homelands. ABCs. Chadian children start their day in the new village school. The one-room schoolhouse was built with donated materials and assistance from KBR and its joint venture partners, and holds around 30 students. 30 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T H A L L I B U R T O N B O A R D O F D I R E C T O R S R O B E R T L . C R A N D A L L ( 1 9 8 6 ) (a), (b), (c) K E N N E T H T. D E R R ( 2 0 0 1 ) (a), (c), (e) C H A R L E S J . D I B O N A ( 1 9 9 7 ) (a), (b), (d) Chairman Emeritus AMR Corporation/American Airlines, Inc. Irving, Texas Retired Chairman of the Retired President and Board Chevron Corporation San Francisco, California Chief Executive Officer American Petroleum Institute Great Falls, Virginia L A W R E N C E S . E A G L E B U R G E R ( 1 9 9 8 ) (a), (c), (e) Senior Foreign Policy Advisor Baker, Donelson, Bearman & Caldwell Washington, D.C. J . L A N D I S M A R T I N ( 1 9 9 8 ) (a), (d), (e) President and J AY A . P R E C O U R T ( 1 9 9 8 ) (a), (b), (d) Chairman of the Board and Chief Executive Officer Scissor Tail Energy, LLC Vail, Colorado Chief Executive Officer NL Industries, Inc. Houston, Texas Chairman and Chief Executive Officer Titanium Metals Corporation Denver, Colorado D E B R A L . R E E D ( 2 0 0 1 ) (a), (d), (e) President and Chief Financial Officer Southern California Gas Company and San Diego Gas & Electric Company San Diego, California C . J . S I L A S ( 1 9 9 3 ) (a), (b), (c) Retired Chairman of the Board and Chief Executive Officer Phillips Petroleum Company Bartlesville, Oklahoma 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 31 W. R . H O W E L L ( 1 9 9 1 ) (a), (b), (c) Chairman Emeritus J.C. Penney Company, Inc. Dallas, Texas R AY L . H U N T ( 1 9 9 8 ) (a), (c), (e) D AV I D J . L E S A R ( 2 0 0 0 ) AY LW I N B . L E W I S ( 2 0 0 1 ) (a), (b), (d) Chairman of the Board Chairman of the Board, President, Chief Multibranding and Chief Executive Officer Hunt Oil Company Dallas, Texas President and Chief Executive Officer Halliburton Company Houston, Texas & Operating Officer YUM! Brands, Inc. Louisville, Kentucky (a) Member of the Management Oversight Committee (b) Member of the Compensation Committee (c) Member of the Audit Committee (d) Member of the Health, Safety and Environment Committee (e) Member of the Nominating and Corporate Governance Committee 32 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T M A N A G E M E N T A N D C O R P O R A T E I N F O R M A T I O N C O R P O R AT E O F F I C E R S E N E R GY S E R V I C E S G R O U P S H A R E H O L D E R I N F O R M AT I O N D AV I D J . L E S A R Chairman of the Board, President and Chief Executive Officer J O H N W. G I B S O N J R . President and Chief Executive Officer E N G I N E E R I N G A N D C O N S T R U C T I O N G R O U P KBR A L B E R T J . S TA N L E Y Chairman R O B E R T R . H A R L President and Chief Executive Officer D O U G L A S L . F O S H E E Executive Vice President and Chief Operating Officer C . C H R I S T O P H E R G A U T Executive Vice President and Chief Financial Officer A L B E R T O . C O R N E L I S O N J R . Executive Vice President and General Counsel J E R R Y H . B L U R T O N Vice President and Treasurer C E D R I C W. B U R G H E R Vice President, Investor Relations W E L D O N J . M I R E Vice President, Human Resources C H A R L E S E . D O M I N Y Vice President, Government Relations A R T H U R D . H U F F M A N Vice President and Chief Information Officer M A R G A R E T E . C A R R I E R E Vice President, Secretary and Corporate Counsel R . C H A R L E S M U C H M O R E J R . Vice President and Controller D AV I D R . S M I T H Vice President, Tax Corporate Office 5 Houston Center 1401 McKinney, Suite 2400 Houston, TX 77010 S H A R E S L I S T E D New York Stock Exchange Swiss Exchange Symbol: HAL T R A N S F E R A G E N T A N D R E G I S T R A R Mellon Investor Services LLC 85 Challenger Road Ridgefield Park New Jersey 07660-2104 1-800-279-1227 www.melloninvestor.com F O R M 1 0- K R E P O R T Shareholders can obtain a copy of the Company’s annual report to the Securities and Exchange Commission Form 10-K by contacting: Vice President, Investor Relations Halliburton Company 5 Houston Center 1401 McKinney, Suite 2400 Houston, TX 77010 For up-to-date information on Halliburton Company, shareholders may use the Company’s toll-free telephone-based information service available 24 hours a day at 1-888-669-3920 or contact the Halliburton Company homepage on the Internet’s World Wide Web at www.halliburton.com. 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 33 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S In this section, we discuss the business environment, of our business activities reduces the risk that loss of operating results and general financial condition of business in any one country would be material to our Halliburton Company and its subsidiaries. We explain: consolidated results of operations. • factors and risks that impact our business; • why our earnings and expenses for the year 2002 vary from 2001 and why our earnings and expenses for 2001 vary from 2000; • capital expenditures; • factors that impacted our cash flows; and • other items that materially affect our financial condition or earnings. B U S I N E S S E N V I R O N M E N T Our business is organized in the following two business segments: • Energy Services Group; and • Engineering and Construction Group. H a l l i b u r t o n C o m p a n y Activity levels within our two business segments are significantly impacted by the following: • spending on upstream exploration, development and production programs by major, national and independent oil and gas companies; • capital expenditures for downstream refining, processing, petrochemical and marketing facilities by major, national and independent oil and gas companies; and • government spending levels. Also impacting our activity is the status of the global economy, which indirectly impacts oil and gas consumption, demand for petrochemical products and investment in infrastructure projects. We currently operate in over 100 countries throughout the Some of the more significant barometers of current and world, providing a comprehensive range of discrete and future spending levels of oil and gas companies are oil and integrated products and services to the energy industry and gas prices, exploration and production drilling prospects, the to other industrial and governmental customers. The majority of our consolidated revenues is derived from the sale of services and products, including engineering and construction activities to major, national and independent world economy and global stability which together drive worldwide drilling activity. As measured by rig count, high levels of worldwide drilling activity during the first half of 2001 began to decline in the latter part of that year. Drilling oil and gas companies. These services and products are used levels reached a low, particularly in the United States for throughout the energy industry from the earliest phases gas drilling, in April 2002. The decline was partially due to of exploration, development and production of oil and gas general business conditions caused by global economic resources through refining, processing and marketing. The industries we serve are highly competitive with uncertainty which was accelerated by the terrorist attacks on September 11, 2001. An abnormally warm 2001/2002 many substantial competitors for each segment. In 2002, the winter season in the United States also resulted in United States represented 33% of our total revenue and the increased working gas in storage. The high level of gas in United Kingdom represented 12%. No other country storage put pressure on gas prices, which resulted in accounted for more than 10% of our operations. Unsettled reduced gas drilling activity particularly in the Western political conditions, social unrest, acts of terrorism, force portion of the United States. majeure, war or other armed conflict, expropriation or other For the year 2002, natural gas prices at Henry Hub governmental actions, inflation, exchange controls or averaged $3.33 per million cubic feet, commonly referred to currency devaluation may result in increased business risk as mcf, compared to $4.07 per mcf in 2001. Gas prices in any one country. We believe the geographic diversification continued to decline during the first two months of 2002 and 34 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S then steadily increased throughout the year ending at an supply disruption as a result of the armed conflict in the average of $4.65 per mcf in December. Based upon data from Middle East. OPEC, on January 12, 2003, agreed to raise its a leading research association at the end of 2002, the gas output ceiling by 1.5 million barrels per day or 6.5% to 24.5 price at Henry Hub was expected to average slightly above million barrels per day. Prices for the first and second $3.73 per mcf for all of 2003 and $4.00 per mcf for the 2003 quarters of 2003 will be impacted by the length of disruption first quarter. However, actual prices have been of Venezuelan crude oil supplies, the ability of OPEC to significantly higher averaging $6.33 per mcf during manage country production quotas, political tensions in the January and February. These higher gas prices have not Middle East, global demand and the level of production by translated into significantly increased gas drilling rig major non-OPEC countries, including Norway, Russia and activity as of the end of February. other members of the former Soviet Union. Natural gas prices have been impacted by an abnormally cold 2002/2003 winter season thus far in the United States, resulting in reduced gas storage levels. As of January 31, 2003, working gas in storage was 1,521 billion cubic feet, commonly referred to as bcf, according to Energy Information Administration estimates. These stocks were 811 bcf less than last year at this time and 287 bcf below the 5-year average of 1,808 bcf. At 1,521 bcf, total working gas in storage is within the 5-year historical range. While gas prices in the United States have historically varied somewhat geographically, this winter we have seen significantly higher fluctuations in regional gas prices in the United States. For example, while the price averaged $4.27 per mcf in the fourth quarter at Henry Hub, it was less than $2.00 per mcf in various parts of the Western United States. This is resulting in significant variation in gas drilling activity by region in the United States and E n e r g y S e r v i c e s G r o u p Lower natural gas and crude oil drilling activity since the 2001 third quarter has resulted in decreased demand for the services and products provided by the Energy Services Group. The yearly average and quarterly average rig count based on the Baker Hughes Incorporated rig count information is as follows: Average Rig Counts United States Canada International (excluding Canada) Worldwide Total 2002 831 266 732 2001 1,155 342 745 2000 916 344 652 1,829 2,242 1,912 Average Rig Counts United States Canada International Third Fourth First Quarter Quarter Quarter Quarter 2002 Second 2002 2002 2002 847 283 753 853 250 718 806 147 725 818 383 731 Fourth Quarter 2001 Third Quarter 2001 1,004 1,241 278 748 320 757 much lower drilling and stimulation activity in the gas (excluding Canada) basins of the Western United States. Worldwide Total 1,883 1,821 1,678 1,932 2,030 2,318 Crude oil prices for West Texas Intermediate, commonly referred to as WTI, averaged $25.92 per barrel for all of 2002 compared to $26.02 per barrel for 2001. Oil prices have continued to trend upward since the beginning of 2002. Quarterly average WTI increased from $20.52 in the 2001 fourth quarter, to $28.23 in the 2002 third quarter and increased slightly to $28.34 during the 2002 fourth quarter. We believe that current oil prices reflect the disruption of supplies from Venezuela due to political unrest related to the national strike and a war premium due to the risk of Worldwide rig activity started to decline in the latter part of the third quarter 2001 and averaged 1,829 rigs in 2002 as compared to 2,242 in 2001. The decline in rig activity was most severe in North America, particularly the United States, where the rig count dropped 28% from an average of 1,155 in 2001 to 831 in 2002, with the majority of this decline due to reduced gas drilling. In the past, there has 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 35 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S generally been a good correlation between the price of oil for most product and service lines on average between 2% and gas in the United States and rig activity. However, this and 12%. In January 2001, as a result of continued labor has not been the case in recent months where the rig count shortages and increased labor and materials costs, we has declined as compared to the fourth quarter 2001, while increased prices in the United States on average between WTI oil and Henry Hub gas prices have increased. We 5% and 12%. In July 2001, as a result of continuing believe this is due to economic uncertainty, which we expect personnel and consumable material cost increases, we to continue into at least the next quarter or two, created by increased prices on average between 6% and 15%. the following: • volatility of oil and gas prices; • disruption of oil supplies from Venezuela; • differences in gas prices geographically in the United States; • less spending due to current uncertain global economic environment; • the armed conflict in the Middle East; • budgetary constraints of some of our customers; The decreased rig activity in 2002 from 2001 in the United States has increased pressure on the oilfield services product service lines to discount prices. The price increases we implemented last year have mostly been eroded by additional discounts. Our pressure pumping product service line has been significantly impacted by the current economic slowdown due to its dependence on United States gas drilling. Our deepwater activity has not been as adversely impacted as land activity by the downturn in the energy industry, due to the level of investment and the long-term • focus on debt reduction by some of our customers; nature of contracts. Our drilling systems product service • lack of quality drilling prospects by exploration and line, which currently has a large percentage of its business production companies; and outside the United States and is currently heavily involved • level of United States working gas in storage during the in deepwater oil and gas exploration and development winter heating season. It is common practice in the United States oilfield services industry to sell services and products based on a price book and then apply discounts to the price book based upon a variety of factors. The discounts applied typically increase to partially or substantially offset price book increases in the weeks immediately following a price increase. The discount applied normally decreases over time if the activity levels remain strong. During periods of reduced activity, discounts normally increase, reducing the net revenue for our services and conversely during periods of higher activity, discounts normally decline resulting in net revenue increasing for our services. During 2000 and 2001, we implemented several price book increases. In July 2000, as a result of increased drilling and longer term contracts, has remained relatively strong despite the overall decline in the energy industry. Our operations have also been impacted by political and economic instability in Indonesia and in Latin America. In Latin America, the impact was primarily in Argentina in the earlier part of 2002 and then in Venezuela toward the end of 2002, due to political unrest related to the national strike. We also experienced disruptions due to Tropical Storm Isidore and Hurricane Lili in the Gulf of Mexico. Based upon data from Spears and Associates, drilling activity in the United States and Canada in 2003 is expected to increase compared to overall 2002 levels and compared to the fourth quarter 2002. This reflects the current level of oil and gas prices and tight supplies. International drilling activity is expected to remain constant with fourth quarter consumable materials costs and a tight labor market causing 2002 levels. higher labor costs, we increased prices in the United States 36 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S At the end of 2002, two brokerage firms released manufacturing. A number of large-scale gas and liquefied exploration and production expenditure surveys for 2003. natural gas development, offshore deepwater, government Salomon Smith Barney reported that worldwide exploration and infrastructure projects are being awarded or actively and production spending is expected to increase 3.8% in considered. However, in light of terrorist threats, the armed 2003. North America spending was forecasted to rise 1.5%. conflict and increasing instability in the Middle East and The report also noted that a lack of quality drilling the modest growth of the global economy, many customers prospects and uncertainty over Iraq have also contributed are delaying some of their capital commitments and to a weaker initial spending forecast. Lehman Brothers international investments. made similar predictions. They are projecting a 4.2% We expect growth opportunities to exist for additional increase in worldwide exploration and production security and defense support to government agencies in the expenditures for 2003, but a slight decrease in United States United States and other countries. Demand for these spending. Canadian exploration and production spending services is expected to grow as a result of the armed conflict is estimated to increase 7.2%. International exploration and in the Middle East and as governmental agencies seek to production expenditures are estimated to grow 5.5% in control costs and promote efficiencies by outsourcing these 2003, led by national oil companies and European majors. functions. We also expect growth due to new demands According to the Lehman report, exploration and created by increased efforts to combat terrorism and production company budgets were based upon an average enhance homeland security. oil price estimate of $23.22 per barrel (WTI) and $3.42 per Engineering and construction contracts can be broadly mcf for natural gas (Henry Hub). categorized as fixed-price, sometimes referred to as lump Until economic and political uncertainties impacting sum, or cost reimbursable contracts. Some contracts can customer spending become clearer, we expect oilfield involve both fixed-price and cost reimbursable elements. services activity to be essentially flat in the short-term and Fixed-price contracts are for a fixed sum to cover all costs improve in the second half of 2003. The armed conflict in and any profit element for a defined scope of work. Fixed- the Middle East could disrupt our operations in the region price contracts entail more risk to us as we must pre- and elsewhere for the duration of the conflict. In the determine both the quantities of work to be performed and longer-term, we expect increased global demand for oil and the costs associated with executing the work. The risks to us natural gas, additional customer spending to replace arise, among other things, from: depleting reserves and our continued technological advances to provide growth opportunities. • having to judge the technical aspects and effort involved to accomplish the work within the contract schedule; E n g i n e e r i n g a n d C o n s t r u c t i o n G r o u p • labor availability and productivity; and Our engineering and construction projects are longer term • supplier and subcontractor pricing and performance. in nature than our energy services projects and are not Fixed-price engineering, procurement and construction and significantly impacted by short-term fluctuations in oil and fixed-price engineering, procurement, installation and gas prices. We believe that the global economy’s recovery commissioning contracts involve even greater risks including: is continuing, but its strength and sustainability are not assured. Based on the uncertain economic recovery and continuing excess capacity in petrochemical supplies, customers have continued to delay project awards or reduce the scope of projects involving hydrocarbons and • bidding a fixed-price and completion date before detailed engineering work has been performed; • bidding a fixed-price and completion date before locking in price and delivery of significant procurement 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 37 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S components (often items which are specifically designed and fabricated for the project); through a variety of other contracting forms. We have seven fixed-price engineering, procurement, installation and • bidding a fixed-price and completion date before finalizing subcontractors terms and conditions; • subcontractors individual performance and combined interdependencies of multiple subcontractors (the majority of all construction and installation work is performed by subcontractors); commissioning offshore projects underway and we are fully committed to successful completion of these projects, several of which are substantially complete. We plan to retain our offshore engineering and services capabilities. The approximate percentages of revenues attributable to fixed-price and cost reimbursable engineering and • contracts covering long periods of time; construction segment contracts are as follows: • contract values generally for large amounts; and • contracts containing significant liquidated damages provisions. Cost reimbursable contracts include contracts where the price is variable based upon actual costs incurred for time and materials, or for variable quantities of work priced at defined unit rates. Profit elements on cost reimbursable contracts may be based upon a percentage of costs incurred and/or a fixed amount. Cost reimbursable contracts are generally less risky, since the owner retains many of the risks. While fixed-price contracts involve greater risk, they also potentially are more profitable for the contractor, since the owner pays a premium to transfer many risks to the contractor. After careful consideration, we have decided no longer to pursue riskier fixed-price engineering, procurement, installation and commissioning contracts for the offshore oil and gas industry. An important aspect of our 2002 reorganization was to look closely at each of our businesses to ensure that they are self-sufficient, including their use of capital and liquidity. In that process, we found that the engineering, procurement, installation and commissioning offshore business was using a disproportionate share of our bonding and letter of credit capacity relative to its profit contribution. The risk/reward relationship in that segment is no longer attractive to us. We provide a range of engineering, fabrication and project management services to the offshore industry, which we will continue to service 2002 2001 2000 Fixed-Price Cost Reimbursable 47% 41% 47% 53% 59% 53% R e o r g a n i z a t i o n o f B u s i n e s s O p e ra t i o n s We have substantially completed a corporate reorganization commenced in 2002 intended to restructure our businesses into two operating subsidiary groups, the Energy Services Group and KBR, representing the Engineering and Construction Group. As part of this reorganization, we are separating and consolidating the entities in our Energy Services Group together as direct and indirect subsidiaries of Halliburton Energy Services, Inc. We are also separating and consolidating the entities in our Engineering and Construction Group together as direct and indirect subsidiaries of the former Dresser Industries Inc., which became a limited liability company during the second quarter of 2002 and was renamed DII Industries, LLC. The reorganization of business operations facilitated the separation, organizationally, financially and operationally, of our two business segments, which we believe will significantly improve operating efficiencies in both, while streamlining management and easing manpower requirements. In addition, many support functions that were previously shared were moved into the two business groups. Although we have no specific plans currently, the reorganization would facilitate separation of the ownership of the two businesses in the future if we identify an opportunity that produces greater value for our shareholders than continuing to own both businesses. 38 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S We expect only a minimal amount of restructuring costs recoveries resulting in a total of $2.1 billion as of December to be incurred in 2003. In 2002, we incurred approximately 31, 2002 and recorded a net pretax charge of $799 million $107 million in restructuring charges consisting of ($675 million after-tax) in the fourth quarter of 2002. the following: • $64 million in personnel related expense; • $17 million of asset related write-downs; • $20 million in professional fees related to the restructuring; and • $6 million related to contract terminations. We anticipate annualized cost savings of $200 million compared to costs prior to the corporate reorganization. As a part of the reorganization, we decided that the operations of Major Projects, Granherne and Production Services were better aligned with KBR in the current business environment and these businesses were moved from the Energy Services Group to the Engineering and Construction Group during the second quarter of 2002. All prior period segment results have been restated to reflect this change. Major Projects, which currently consists of the Should the proposed global settlement become probable under Statement of Financial Accounting Standards No. 5, we would adjust our accrual for probable and reasonably estimable liabilities for current and future asbestos and silica claims. The settlement amount initially would be up to $4.0 billion, consisting of up to $2.775 billion in cash, 59.5 million Halliburton shares of common stock and notes with a net present value expected to be less than $100 million. Assuming the revised liability would be $4.0 billion, we would also increase our probable insurance recoveries to $2.3 billion. The impact on our income statement would be an additional pretax charge of $322 million ($288 million after-tax). This accrual (which values our stock to be contributed at $1.1 billion using our stock price at December 31, 2002 of $18.71) would then be adjusted periodically based on changes in the market price of our common stock until the common stock was contributed to a trust for the Barracuda-Caratinga project in Brazil, is now reported benefit of the claimants. through the Offshore operations product line, Granherne is now reported in the Onshore operations product line, and Production Services is now reported under the Operations R E S U LT S O F O P E R AT I O N S I N 2 0 0 2 C O M PA R E D T O 2 0 0 1 and Maintenance product line. A s b e s t o s a n d S i l i c a On December 18, 2002, we announced that we had reached an agreement in principle that, if and when consummated, would result in a global settlement of all asbestos and silica personal injury claims. The agreement in principle covers all current and future personal injury asbestos claims against DII Industries, Kellogg, Brown & Root and their current and former subsidiaries, as well as all current silica claims asserted presently or in the future. We revised our best estimate of our asbestos and silica liability based on information obtained while negotiating the agreement in principle, and adjusted our asbestos and silica liability to $3.425 billion, recorded additional probable insurance R E V E N U E S Millions of dollars 2002 2001 Increase/ (Decrease) Energy Services Group $ 6,836 $ 7,811 $(975) Engineering and Construction Group 5,736 5,235 501 Total revenues $12,572 $13,046 $(474) Consolidated revenues for 2002 were $12.6 billion, a decrease of 4% compared to 2001. International revenues comprised 67% of total revenues in 2002 and 62% in 2001. International revenues increased $298 million in 2002 partially offsetting a $772 million decline in the United States where oilfield services drilling activity declined 28%, putting pressure on pricing. E n e r g y S e r v i c e s G r o u p revenues declined 12%, or $975 million, in 2002 from 2001. International revenues were 60% of total revenues for 2002 as compared to 54% for 2001. 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 39 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S Revenues from our oilfield services product service lines • revenues increased in Europe/Africa, the Middle East, were $6.2 billion for 2002 compared to $6.8 billion for 2001. and Asia Pacific due to increased activity. The decline in revenue is attributable to lower levels of activity in North America across all product service lines, putting pressure on pricing of work in the United States. The decrease in North America revenue was offset by 8% higher international revenue. The change in revenues in oilfield services is shown by product service line as follows: Revenues for the remainder of the segment decreased $308 million year-over-year. We account for our 50% ownership interest in Subsea 7, which began operations in May 2002, on the equity method of accounting. Prior to the formation of Subsea 7, the revenue of our subsea operations was included in our consolidated results. Had it • pressure pumping revenue declined 13% due to reduced not been for the change to the equity method of accounting rig counts and activity in North America, partially offset by increased activity internationally in Algeria, Nigeria, Mexico, Brazil, Saudi Arabia, Oman, Egypt and China; • logging revenue was down 13% due to lower North American activity, partially offset by increased activity in Nigeria, Mexico, Saudi Arabia and China; • completion products revenue was down 10% due to lower North American activity, partially offset by increased activity in the UK, Nigeria, Indonesia and Malaysia; • drilling fluids revenue was down 10%, principally in North America, partially offset by increased sales in Nigeria, Angola, Mexico, Saudi Arabia and Indonesia; • drill bits revenue was down 12% principally due to lower North American activity, partially offset by increased sales in Algeria, UK, Angola, Mexico, Brazil, Saudi Arabia and Indonesia; and • drilling systems revenue was up 8% due to increased activity in Saudi Arabia, Thailand, Mexico, Brazil and the United Arab Emirates, offset by lower North American activity. On a geographic basis, our oilfield services revenues were as follows: • North American revenue decreased 24% across all product service lines due to lower rig activity; • Latin American revenue decreased 8% primarily as a result of decreases in Argentina due to currency devaluation and in Venezuela due to lower activity brought on by uncertain market and political conditions and the national strike; and in connection with the transaction, revenues for the balance of the segment would have decreased $79 million for 2002 as compared to 2001 due to lower subsea activity. Partially offsetting the lower subsea activity, Landmark revenues increased 12% compared to 2001 due to increased software and professional services revenues. E n g i n e e r i n g a n d Co n s t r u c t i o n G ro u p revenues increased $501 million, or 10%, in 2002 compared to 2001. Year-over- year revenues were 10% higher in North America and 9% higher outside North America. Our revenue comparison by product line is as follows: • Offshore revenues increased 26% due to progress on the Barracuda-Caratinga project in Brazil and the Belenak project in Indonesia; • Infrastructure revenues increased by 22% due to increased progress on the Alice Springs to Darwin Rail Line project in Australia and revenues from Europe/Africa; • Onshore revenues increased by 25% primarily due to progress on several new projects in 2002 including gas and LNG projects in Algeria, Nigeria, Chad, Cameroon and Egypt; • Government Operations revenues were 15% lower due to completion of a major project at our shipyard in the United Kingdom and lower volumes of logistical support in the Balkans; and • Operations and Maintenance revenue declined 3% primarily due to reduced downstream maintenance activity. 40 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S O P E R AT I N G I N C O M E Millions of dollars Energy Services Group Engineering and Construction Group General corporate Operating income (loss) 2002 2001 Increase/ (Decrease) $ 638 $1,036 $ (398) (685) (65) 111 (63) (796) (2) $(112) $1,084 $(1,196) E n e r g y S e r v i c e s G r o u p operating income for 2002 declined $398 million, or 38%, as compared to 2001. Excluding a $79 million loss on the sale of our 50% interest in the Bredero-Shaw joint venture, a $108 million gain on the sale of our interest in European Marine Contractors, a $98 million accrual related to the BJ Services litigation and Consolidated operating loss was $112 million for 2002 $64 million in restructuring charges in 2002, and goodwill compared to operating income of $1.1 billion in 2001. In amortization of $24 million in 2001, operating income 2002, our results of operations included: declined 27%. On the same basis, operating margin for 2002 • $107 million in pretax expense related to restructuring charges, of which $64 million related to the Energy Services Group, $18 million related to the Engineering and Construction Group and $25 million related to General corporate; was 11% compared to 14% for 2001. Operating income in our oilfield services product service line declined $469 million or 46% compared to 2001. Excluding the above-noted items, the decline was $323 million or 32%, reflecting lower rig activity primarily • $117 million pretax loss in the Engineering and in North America and net pretax losses of $51 million on Construction Group on the Barracuda-Caratinga project in Brazil; integrated solutions properties. The change in operating income in oilfield services is detailed by product service line • $564 million pretax expense in the Engineering and as follows: Construction Group related to asbestos and silica liabilities; • $79 million pretax loss in the Energy Services Group on the sale of our 50% equity investment in the Bredero- Shaw joint venture; • $108 million pretax gain in the Energy Services Group on the sale of our 50% interest in European Marine Contractors; • $98 million pretax expense in the Energy Services Group related to patent infringement litigation; • $80 million pretax expense resulting from write-off of billed and accrued receivables related to the Highlands Insurance Company litigation in the Engineering and Construction Group, formerly reported in General corporate; and • $29 million pretax gain for the value of stock received from the demutualization of an insurance provider in General corporate. In 2002, we recorded no amortization of goodwill due to the adoption of SFAS No. 142. For the year ended 2001, we recorded $42 million in goodwill amortization, of which $24 million related to the Energy Services Group and $18 million related to the Engineering and Construction Group. • pressure pumping operating income decreased 35%, as a result of reduced oil and gas drilling in North America, offset by increased international activity; • our logging, drilling fluids and drill bits product services lines were also affected by the reduced oil and gas drilling in North America with operating income declining 64% in logging, 42% in drilling fluids and 30% in drill bits; • our drilling systems product service line operating income increased 19%, benefiting from improved international activity; and • our completion products and services product service line had a 6% increase in operating income. We also recorded impairments of $66 million on integrated solutions properties primarily in the United States, Indonesia and Colombia, net of gains of $45 million on disposals of integrated solutions properties in the United States. Operating income in the United States for our oilfield services product service line decreased $459 million due to lower activity levels and pricing pressures. International 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 41 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S operating income decreased $10 million where losses on G e n e ra l c o r p o ra t e e x p e n s e s were $65 million for 2002 integrated solutions properties of $37 million offset improved as compared to $63 million in 2001. Excluding restructuring operating results of Sperry-Sun, pressure pumping and charges and gain from the value of stock received from completion products and services. demutualization of an insurance provider, expenses would Operating income for the remainder of the segment have been $69 million. increased $71 million in 2002 compared to 2001. Excluding the $79 million loss on the sale of our 50% interest in the Bredero-Shaw joint venture, a $108 million gain on the sale of our interest in European Marine Contractors and $9 million in restructuring charges in 2002, and goodwill amortization of $17 million in 2001, operating income for the remainder of the segment increased $34 million due to improved profitability in software sales and professional services at Landmark and in our subsea operations. E n g i n e e r i n g a n d C o n s t r u c t i o n G r o u p operating income declined by $796 million compared to 2001. Excluding the $117 million loss on the Barracuda-Caratinga project in Brazil, $644 million of expenses related to net asbestos and silica liabilities, $18 million in restructuring costs, goodwill amortization in 2001 of $18 million and asbestos charges for 2001 of $11 million, operating income declined $46 million. On the same basis, operating margin for 2002 was 2% as compared to 3% for 2001. Operating income in Offshore operations decreased $40 million in 2002 compared to 2001 primarily due to a $36 million loss on a project in the Philippines. Operating income decreased in Onshore operations by $30 million in 2002 compared to 2001 due to lower results in the construction segment and completion of a project in Algeria. Offsetting the declines was increased operating income of $21 million in Infrastructure primarily due to the Alice Springs to Darwin Rail Line project, and in Government operations where operating income increased $22 million due to improved results from projects in Asia Pacific, Europe/Africa and in the Americas. Recognizing income due to an increase in our total probable unapproved claims during 2002 reduced reported losses by approximately $158 million. N O N O P E R AT I N G I T E M S I n t e r e s t e x p e n s e of $113 million for 2002 decreased $34 million compared to 2001. The decrease is due to repayment of debt and lower average borrowings in 2002, partially offset by the $5 million in interest related to the patent infringement judgment which we are appealing. I n t e r e s t i n c o m e was $32 million in 2002 compared to $27 million in 2001. The increased interest income is for interest on a note receivable from a customer which had been deferred until collection. Fo r e i g n c u r r e n c y l o s s e s , n e t were $25 million in 2002 compared to $10 million in 2001. The increase is due to negative developments in Brazil, Argentina and Venezuela. O t h e r, n e t was a loss of $10 million in 2002, which includes a $9.1 million loss on the sale of ShawCor Ltd. common stock acquired in the sale of our 50% interest in Bredero-Shaw. P r o v i s i o n f o r i n c o m e t a x e s was $80 million in 2002 compared to a provision for income taxes of $384 million in 2001. Exclusive of the tax effect on the asbestos and silica accrual (net of insurance recoveries) and the loss on sale of Bredero-Shaw, our 2002 effective tax rate from continuing operations was 38.9% for 2002 compared to 40.3% in 2001. The asbestos and silica accrual generates a United States Federal deferred tax asset which was not fully benefited because we anticipate that a portion of the asbestos and silica deduction will displace foreign tax credits and those credits will expire unutilized. As a result, we have recorded a $114 million valuation allowance in continuing operations and $119 million in discontinued operations associated with the asbestos and silica accrual, net of insurance recoveries. In addition, continuing operations has recorded a valuation allowance of $49 million related to potential excess foreign 42 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S tax credit carryovers. Further, our impairment loss on R E S U LT S O F O P E R AT I O N S I N 2 0 0 1 Bredero-Shaw cannot be fully benefited for tax purposes due C O M PA R E D T O 2 0 0 0 to book and tax basis differences in that investment and the R E V E N U E S limited benefit generated by a capital loss carryback. Millions of dollars 2001 2000 Increase/ (Decrease) Settlement of unrealized prior period tax exposures had a favorable impact to the overall tax rate. M i n o r i t y i n t e r e s t i n n e t i n c o m e o f s u b s i d i a r i e s in Energy Services Group $ 7,811 $ 6,233 $1,578 Engineering and Construction Group 5,235 5,711 (476) Total revenues $13,046 $11,944 $1,102 2002 was $38 million as compared to $19 million in 2001. Consolidated revenues for 2001 were $13.0 billion, an The increase was primarily due to increased activity in increase of 9% compared to 2000. International revenues Devonport Management Limited. comprised 62% of total revenues in 2001 and 66% in 2000 as L o s s f r o m c o n t i n u i n g o p e ra t i o n s was $346 million in activity and pricing increased in our Energy Services Group 2002 compared to income from continuing operations of more rapidly in the United States and internationally $551 million in 2001. particularly in the first half of 2001. Our Engineering and L o s s f r o m d i s c o n t i n u e d o p e ra t i o n s was $806 million Construction Group revenues, which did not benefit from pretax, $652 million after-tax, or $1.51 per diluted share in the positive factors contributing to the growth of the Energy 2002 compared to a loss of $62 million pretax, $42 million Services Group, decreased 8%. Engineering and construction after-tax, or $0.10 per diluted share in 2001. The loss in projects are long-term in nature and customers continued 2002 was due primarily to charges recorded for asbestos to delay major projects with the slowdown in the economy and silica liabilities. The pretax loss for 2001 represents occurring in the latter part of 2001. operating income of $37 million from Dresser Equipment E n e r g y S e r v i c e s G r o u p revenues increased by $1.6 Group through March 31, 2001 offset by a $99 million pretax billion, or 25%, in 2001 from 2000. International revenues asbestos accrual primarily related to Harbison-Walker. were 54% of the total segment revenues in 2001 compared G a i n o n d i s p o s a l o f d i s c o n t i n u e d o p e ra t i o n s of to 59% in 2000. Revenues in 2001 from our oilfield services $299 million after-tax, or $0.70 per diluted share, in 2001 product service lines were $6.8 billion. Our oilfield services resulted from the sale of our remaining businesses in the product service lines experienced revenue growth of 29% Dresser Equipment Group in April 2001. despite a 14% decline in oil prices and a 3% decrease in C u m u l a t i v e e f f e c t o f a c c o u n t i n g c h a n g e , n e t in 2001 natural gas prices between December 2000 and December of $1 million reflects the impact of adoption of Statement of 2001. The revenue increase was primarily due to higher Financial Accounting Standards No. 133, “Accounting for drilling activity, as measured by the annual average oil and Derivative Instruments and for Hedging Activities.” After gas rig counts, and pricing improvements, particularly in the recording the cumulative effect of the change our estimated United States. Revenues increased across all product annual expense under Financial Accounting Standards service lines in 2001 compared to 2000 as follows: No. 133 is not expected to be materially different from • pressure pumping product service lines experienced amounts expensed under the prior accounting treatment. growth of 34% in 2001; N e t l o s s for 2002 was $998 million, or $2.31 per diluted share. Net income for 2001 was $809 million, or $1.88 per diluted share. • logging, drilling services and drilling fluids revenues increased approximately 28%; • drill bit revenues were 19% higher in 2001; and • completion products revenues increased 13%. 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 43 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S Logging and drilling services revenues increases occurred primarily due to the completion of a major project in primarily in the United States, as the product service lines Norway and lower activity on the logistical support contract benefited from higher prices and increased drilling activity. in the Balkans which moved to the sustainment phase, Geo-Pilot TM and other new products introduced in the drilling which involved providing support at the facilities which were services product service line improved revenue in 2001 by constructed during the initial phase of the contract. The approximately $50 million. We design and assemble the decline was partially offset by increases in activities at our Geo-Pilot TM tool from parts manufactured to our specifications shipyard in the United Kingdom of approximately $67 by third parties. Drilling fluid revenues increased in 2001 million which related to a contract with the United Kingdom with higher activity levels in the Gulf of Mexico. Ministry of Defense. North American revenues declined in Geographically, all regions within the oilfield services 2001 partially due to the completion of highway and paving product service lines prospered with North America construction jobs and the baseball stadium in Houston. revenues increasing 37% from 2000 to 2001 as follows: These declines in North America were partially offset by a • pressure pumping revenues in North America were 48% higher in 2001 primarily due to higher levels of drilling activity; • revenues from Latin America increased 27% with significant increases in Venezuela and Brazil; and • Europe/Africa and Middle East revenues were about 20% higher in 2001 than 2000, arising primarily in Russia and Egypt. Revenues for the remainder of the segment of $980 million increased by $58 million, or 6%, primarily due to Landmark. slight increase in operations and maintenance revenues as our customers focused on maintaining current facilities and plant operations rather than adding new facilities. These declines were partially offset by increases in revenue in Latin America due to the Barracuda-Caratinga project in Brazil which began in the third quarter of 2000. O P E R AT I N G I N C O M E Millions of dollars Energy Services Group Engineering and Construction Group 2001 Increase/ 2000 (Decrease) $1,036 $589 $447 111 (63) (54) (73) 165 10 $1,084 $462 $622 Landmark revenues were higher by 19% partially due to the General corporate acquisition of PGS Data Management as well as growth in Operating income software sales and professional services. E n g i n e e r i n g a n d Co n s t r u c t i o n G ro u p revenues decreased $476 million, or 8%, from 2000 to 2001. The decline was primarily due to the completion of several large international onshore and offshore projects which had not yet been fully replaced with new project awards and delays in the awards of new projects. International revenues were approximately 75% in 2001 as compared to 73% in 2000. Revenues for the Asia/Pacific region were down nearly 40% due to the effects of completing two major projects, partially offset by a new liquefied natural gas project and the start-up of construction on the Alice Springs to Darwin Rail Line project. In Europe/Africa, revenues were down 6%. The decline was Consolidated operating income increased $622 million, or 135%, from 2000 to 2001. In 2000 our results of operations include two significant items: an $88 million pretax gain on the sale of marine vessels and a pretax charge of $36 million related to the restructuring of the engineering and construction businesses. Excluding these items, operating income increased by more than 160%. E n e r g y S e r v i c e s G r o u p operating income increased $447 million, or 76%, in 2001 over 2000. Excluding the sale of marine vessels, operating income increased more than 100% compared to 2000. Increased operating income reflects increased activity levels, higher equipment utilization and improved pricing, particularly in the United States in the first nine months of 2001. Our oilfield services product 44 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S service lines operating income in 2001 exceeded $1 billion, N O N O P E R AT I N G I T E M S more than double from 2000. Operating margins for our I n t e r e s t e x p e n s e of $147 million in 2001 was $1 million oilfield services product service lines increased from 8.6% in higher than in 2000. Our outstanding short-term debt 2000 to 14.8% in 2001, resulting in an incremental margin was substantially higher in the first part of 2001 due to of 37%. Incremental margins are calculated by taking the repurchases of our common stock in the fourth quarter of change in operating income over the applicable periods and 2000 under our repurchase program and borrowings dividing by the change in revenues over the same period. associated with the acquisition of PGS Data Management Operating income was higher in 2001 as compared to 2000 in March 2001. Cash proceeds of $1.27 billion received in in all product service lines and geographic regions. The April 2001 from the sale of the remaining businesses within largest increase was in pressure pumping in North America, the Dresser Equipment Group were used to repay our which rose by over 130%. Substantial increases in operating short-term borrowings; however, our average borrowings for income were also made in the logging, drill bits and drilling 2001 were slightly higher than in 2000. The impact of services product service lines. Operating income in North higher average borrowings was mostly offset by lower interest America was higher by 72% in 2001 as compared to 2000. rates on short-term borrowings. International regions, particularly Latin America and I n t e r e s t i n c o m e was $27 million in 2001, an increase of Europe/Africa, made significant improvements in operating $2 million from 2000. income. Excluding the sale of marine vessels in 2000, Fo r e i g n c u r r e n c y l o s s e s , n e t were $10 million in 2001 operating income for the remainder of the segment decreased as compared to $5 million in 2000. Argentina’s financial $27 million, primarily due to lower operating margins in crisis accounted for $4 million of the $5 million increase. our Surface/Subsea product service line. O t h e r, n e t was a loss of $1 million in 2000 and less than E n g i n e e r i n g a n d C o n s t r u c t i o n G r o u p operating income a $1 million gain in 2001. increased $165 million from 2000 to 2001. Operating P r o v i s i o n f o r i n c o m e t a x e s was $384 million for margins improved to 2.1% in 2001. This increase was an effective tax rate of 40.3% in 2001 compared to 38.5% primarily due to the $167 million recorded in the fourth in 2000. quarter of 2000 as a result of higher than estimated costs on M i n o r i t y i n t e r e s t i n n e t i n c o m e o f s u b s i d i a r i e s in specific jobs and unfavorable claims negotiations on other 2001 was $19 million as compared to $18 million in 2000. jobs. We also recorded a restructuring charge of $36 million I n c o m e ( l o s s ) f r o m d i s c o n t i n u e d o p e r a t i o n s in 2001 in the fourth quarter of 2000 related to the reorganization of was a $42 million loss, or $0.10 per diluted share, due to the engineering and construction businesses under Kellogg, accrued expenses associated with asbestos claims of Brown & Root. Excluding these fourth quarter 2000 disposed businesses. See Note 3. The loss was partially offset charges, operating income decreased $38 million, or 26%, by net income for the first quarter of 2001 from Dresser consistent with the decline in revenues and due to a revised Equipment Group of $0.05 per diluted share. Income from profit estimate on the Barracuda-Caratinga project. discontinued operations of $98 million, or $0.22 per diluted G e n e ra l c o r p o ra t e e x p e n s e s were $63 million for 2001 share, represents the net income of Dresser Equipment as compared to $73 million in 2000. In 2000 general corporate Group for the full year of 2000. expenses included $9 million of costs related to the early G a i n o n d i s p o s a l o f d i s c o n t i n u e d o p e ra t i o n s in retirement of our previous chairman and chief executive 2001 was $299 million after-tax, or $0.70 per diluted share. officer, which was recorded in the third quarter of 2000. The 2001 gain resulted from the sale of our remaining businesses within the Dresser Equipment Group in April 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 45 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S 2001. The gain of $215 million after-tax, or $0.48 per diluted to Halliburton Energy Services, for fracturing equipment and share, in 2000 resulted from the sale of our 51% interest in directional and logging-while-drilling equipment. In Dresser-Rand, formerly a part of Dresser Equipment Group, addition, we invested $60 million in an integrated solutions in January 2000. project. Included in sales of property, plant and equipment C u m u l a t i v e e f f e c t o f a c c o u n t i n g c h a n g e , n e t of is $130 million collected from the sale of integrated solutions $1 million reflects the adoption of SFAS No. 133 “Accounting properties and cash collected from other asset sales. for Derivative Instruments and Hedging Activities” in the Dispositions of businesses in 2002 include $134 million first quarter of 2001. collected from the sale of our European Marine Contractors N e t i n c o m e for 2001 was $809 million, or $1.88 per Ltd. joint venture. Proceeds from the sale of securities of diluted share, as compared to net income of $501 million, or $62 million was for the sale of ShawCor shares. Included in $1.12 per diluted share in 2000. the restricted cash balance for 2002 are the following: L I Q U I D I T Y A N D C A P I TA L R E S O U R C E S We ended 2002 with cash and cash equivalents of $1.1 billion compared with $290 million at the end of 2001 and $231 million at the end of 2000. C a s h f l o w s f r o m o p e r a t i n g a c t i v i t i e s provided $1.6 billion for 2002 compared to providing $1.0 billion in 2001 and using $57 million in 2000. The net loss in 2002 was due to an after-tax asbestos and silica charge of $1.1 billion which has no effect on 2002 cash flows. Some factors which accounted for cash flows from operations for 2002 were as follows: • we collected large milestone payments on several long- term contracts; • $107 million deposit that collateralizes a bond for a patent infringement judgment and interest, which judgment is on appeal; • $57 million as collateral for potential future insurance claim reimbursements; and • $26 million primarily related to cash collateral agreements for outstanding letters of credit for several construction projects. In March 2001, we acquired the PGS Data Management division of Petroleum Geo-Services ASA for $164 million cash. In addition we spent $56 million for various other acquisitions in 2001. C a s h f l o w s f r o m f i n a n c i n g a c t i v i t i e s used $248 million in 2002, $1.4 billion in 2001 and $584 million in 2000. • we collected several large receivables during 2002 in our Proceeds from exercises of stock options provided cash flows Energy Services Group; • we sold an undivided ownership interest to unaffiliated companies under the accounts receivable securitization agreement for a net cash inflow of $180 million (see Note 6 to the financial statements); and of less than $1 million in 2002, $27 million in 2001 and $105 million in 2000. We paid dividends of $219 million to our shareholders in 2002, $215 million in 2001 and $221 million in 2000. Included in payments on long-term borrowings of $81 • we managed inventory at lower levels during 2002. million in 2002 is a repayment of a $75 million medium- C a s h f l o w s f r o m i n v e s t i n g a c t i v i t i e s used $473 million term note. In the fourth quarter of 2002, our 51% owned for 2002, $858 million for 2001 and $411 million for 2000. and consolidated subsidiary, Devonport Management Capital expenditures of $764 million in 2002 were about 4% Limited, signed an agreement for a credit facility of £80 lower than in 2001 and about 32% higher than in 2000. million ($126 million as of December 31, 2002) maturing Capital spending in 2002 continued to be primarily directed in September 2009. Devonport Management Limited drew down $66 million from this facility in the fourth quarter. 46 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S Proceeds from the sale of the remaining businesses in with proceeds from the sales of Ingersoll-Dresser Pump and Dresser Equipment Group in April 2001, the sale of Dresser- Dresser-Rand joint ventures early in the year. We increased Rand in early 2000 and the collection of a note from the short-term debt in the third quarter of 2000 to fund share fourth quarter 1999 sale of Ingersoll-Dresser Pump received repurchases. At December 31, 2002, we had $190 million in in early 2000 were used to reduce short-term debt. On July restricted cash included in “Other assets.” See Note 5 to the 12, 2001, we issued $425 million in two and five year financial statements. In addition on April 15, 2002, we medium-term notes under our medium-term note program. entered into an agreement to sell accounts receivable to The notes consist of $275 million of 6% fixed rate notes due provide additional liquidity. See Note 6 to the financial August 1, 2006 and $150 million of floating rate notes due statements. Currently, we expect capital expenditures in July 16, 2003. Net proceeds from the two medium-term note 2003 to be about $700 million. We have not finalized our offerings were also used to reduce short-term debt. Net capital expenditures budget for 2004 or later periods. repayments of short-term debt in 2001 used $1.5 billion. P r o p o s e d g l o b a l s e t t l e m e n t . On December 18, 2002, On April 25, 2000, our Board of Directors approved plans we announced that we had reached an agreement in principle to implement a share repurchase program for up to 44 that, if and when consummated, would result in a global million shares. We repurchased 1.2 million shares at a cost settlement of all asbestos and silica personal injury claims of $25 million in 2001 and 20.4 million shares at a cost of against DII Industries, Kellogg, Brown & Root and their $759 million in 2000. We currently have no plan to current and former subsidiaries. The agreement in principle repurchase the remaining shares under the approved plan. provides that: In addition, we repurchased $4 million of common stock in 2002, $9 million in 2001 and $10 million in 2000 from employees to settle their income tax liabilities primarily for restricted stock lapses. C a s h f l o w s f r o m d i s c o n t i n u e d o p e r a t i o n s provided $1.3 billion in 2001 and $826 million in 2000. No cash flows from discontinued operations were provided in 2002. Cash flows for 2001 included proceeds from the sale of Dresser Equipment Group of approximately $1.27 billion. Cash flows for 2000 include proceeds from the sale of Dresser- Rand and Ingersoll-Dresser Pump of $913 million. C a p i t a l r e s o u r c e s from internally generated funds and access to capital markets are sufficient to fund our working capital requirements and investing activities. Our combined short-term notes payable and long-term debt was 30% of total capitalization at the end of 2002, 24% at the end of 2001, and 40% at the end of 2000. Short-term debt was reduced significantly in the second quarter of 2001 with the proceeds from the sale of Dresser Equipment Group and in the third quarter from the issuance of $425 million of • up to $2.775 billion in cash, 59.5 million Halliburton shares (valued at $1.1 billion using the stock price at December 31, 2002 of $18.71) and notes with a net present value expected to be less than $100 million will be paid to a trust for the benefit of current and future asbestos personal injury claimants and current silica personal injury claimants upon receiving final and non- appealable court confirmation of a plan of reorganization; • DII Industries and Kellogg, Brown & Root will retain rights to the first $2.3 billion of any insurance proceeds with any proceeds received between $2.3 billion and $3.0 billion going to the trust; • the agreement is to be implemented through a pre- packaged Chapter 11 filing for DII Industries and Kellogg, Brown & Root, and some of their subsidiaries; and • the funding of the settlement amounts would occur upon receiving final and non-appealable court confirmation of a plan of reorganization of DII Industries and Kellogg, Brown & Root and their subsidiaries in the Chapter 11 proceeding. Subsequently, as of March 2003, DII Industries and medium-term notes. In 2000 we reduced our short-term debt Kellogg, Brown & Root have entered into definitive written 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 47 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S agreements finalizing the terms of the agreement in • obtaining final and non-appealable bankruptcy court principle. The proposed global settlement also includes silica claims as a result of current or past exposure. These silica approval and federal district court confirmation of the plan of reorganization. claims are less than 1% of the personal injury claims included Many of these prerequisites are subject to matters and in the proposed global settlement. We have approximately uncertainties beyond our control. There can be no assurance 2,500 open silica claims. that we will be able to satisfy the prerequisites for Among the prerequisites for reaching a conclusion of the completion of the settlement. If we were unable to complete settlement are: • agreement on the amounts to be contributed to the trust the proposed settlement, we would be required to resolve current and future asbestos claims in the tort system or, in for the benefit of silica claimants; the case of Harbison-Walker claims (see Note 12 to the • our review of the more than 347,000 current claims to financial statements), possibly through the Harbison-Walker establish that the claimed injuries are based on exposure to products of DII Industries, Kellogg, Brown & Root, their subsidiaries or former businesses or subsidiaries; • completion of our medical review of the injuries alleged to have been sustained by plaintiffs to establish a medical basis for payment of settlement amounts; • finalizing the principal amount of the notes to be contributed to the trust; • agreement with a proposed representative of future claimants and attorneys representing current claimants on procedures for distribution of settlement funds to individuals claiming personal injury; • definitive agreement with the attorneys representing current asbestos claimants and a proposed representative of future claimants on a plan of reorganization for the Chapter 11 filings of DII Industries, Kellogg, Brown & Root and some of their subsidiaries; and agreement with the attorneys representing current asbestos claimants with respect to, and completion and mailing of, a disclosure statement explaining the pre-packaged plan of reorganization to the more than 347,000 current claimants; • arrangement of financing on terms acceptable to us to fund the cash amounts to be paid in the settlement; • Halliburton board approval; • obtaining affirmative votes to the plan of reorganization from at least the required 75% of known present asbestos claimants and from a requisite number of silica claimants needed to complete the plan of reorganization; and bankruptcy proceedings. The template settlement agreement with attorneys representing current claimants grants the attorneys a right to terminate the definitive settlement agreement on ten days’ notice if DII Industries does not file a plan of reorganization on or before April 1, 2003. We are conducting due diligence on the asbestos claims, which is not expected to be completed by April 1, 2003. Therefore, we do not expect DII Industries to file a plan of reorganization prior to April 1. Although there can be no assurances, we do not believe the claimants’ attorneys will terminate the settlement agreements on April 1, 2003 as long as adequate progress is being made toward a Chapter 11 filing. We have begun our due diligence review of current asbestos claims. While these results are preliminary and not necessarily indicative of the eventual results of a completed review of all current asbestos claims, it appears that a substantial portion of the records for claims reviewed to date do not provide detailed product identification. We expect that many of these records could be supplemented by attorneys representing the claimants to provide additional information on product identification. However, no assurance can be given that the additional product identification documentation will be timely provided or sufficient for us or the plaintiffs to proceed with the proposed global settlement. In addition, although the medical information in the files we preliminarily reviewed appears 48 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S significantly more complete, if a material number of claims May, August and November, beginning after certain ultimately do not meet the medical criteria for alleged conditions are met, until the earlier of the date that the injuries, no assurance can be given that a sufficient number $450 million is paid or the date the proposed settlement is of plaintiffs would vote to ratify the plan of reorganization abandoned. that would implement the global settlement. In such case, P r o p o s e d b a n k r u p t c y o f D I I I n d u s t r i e s , Ke l l o g g , we would not proceed with a Chapter 11 filing. B r o w n & R o o t a n d s u b s i d i a r i e s . Under the terms of the In March 2003, we agreed with Harbison-Walker and proposed global settlement, the settlement would be the asbestos creditors committee in the Harbison-Walker implemented through a pre-packaged Chapter 11 filing for bankruptcy to consensually extend the period of the stay DII Industries, Kellogg, Brown & Root and some of their contained in the Bankruptcy Court’s temporary restraining subsidiaries. Other than those debtors, none of the order until July 21, 2003. The court’s temporary restraining subsidiaries of Halliburton (including Halliburton Energy order, which was originally entered on February 14, 2002, Services) or Halliburton itself will be a debtor in the stays more than 200,000 pending asbestos claims against Chapter 11 proceedings. We anticipate that Halliburton, DII Industries. The agreement provides that if the pre- Halliburton Energy Services and each of the debtors’ non- packaged Chapter 11 filing by DII Industries, Kellogg, Brown debtor affiliates will continue normal operations and & Root and their subsidiaries is not made by July 14, 2003, continue to fulfill all of their respective obligations in the the Bankruptcy Court will hear motions to lift the stay on ordinary course as they become due. July 21, 2003. The asbestos creditors committee also As part of any proposed plan of reorganization, the reserves the right to monitor progress toward the filing of debtors intend to seek approval of the bankruptcy court the Chapter 11 proceeding and seek an earlier hearing for debtor-in-possession financing to provide for operating to lift the stay if satisfactory progress toward the Chapter 11 needs and to provide additional liquidity during the filing is not being made. pendency of the Chapter 11 proceeding. We currently are Of the up to $2.775 billion cash amount included as part negotiating with several banks and non-bank lenders of the proposed global settlement, approximately $450 over the terms of such facility. See “ – Financing the million primarily relates to claims previously settled but proposed settlement”. Obtaining a commitment for debtor- unpaid by Harbison-Walker (see Note 12 to the financial in-possession financing is a condition precedent to the filing statements), but not previously agreed to by us. As part of of any Chapter 11 proceeding. the proposed settlement, we have agreed that, if a Chapter Any plan of reorganization will provide that all of the 11 filing by DII Industries, Kellogg, Brown & Root and debtors’ obligations under letters of credit, surety bonds, their subsidiaries were to occur, we would pay this amount corporate guaranties and indemnity agreements (except for within four years if not paid sooner pursuant to a final agreements relating to asbestos claims or silica claims) will bankruptcy court approved plan of reorganization for DII be unimpaired. In addition, the Bankruptcy Code allows a Industries, Kellogg, Brown & Root and their subsidiaries. debtor to assume most executory contracts without regard to Effective November 30, 2002, we are making cash bankruptcy default provisions, and it is the intention of payments in lieu of interest at a rate of 5% per annum to DII Industries, Kellogg, Brown & Root and the other filing the holders of these claims. These cash payments in lieu entities to assume and continue to perform all such of interest are being made in arrears at the end of February, executory contracts. Representatives of DII Industries, Kellogg, Brown & Root and their subsidiaries have advised their customers of this intention. 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 49 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S After filing any Chapter 11 proceeding, the debtors would that has jurisdiction over the case. After the expiration of the seek an order of the bankruptcy court scheduling a hearing time for appeal of the order, the injunction becomes valid to consider confirmation of the plan of reorganization. In and enforceable. order to be confirmed, the Bankruptcy Code requires that an The debtors believe that, if they proceed with a Chapter impaired class of creditors vote to accept the plan of 11 filing, they will be able to satisfy all the requirements reorganization submitted by the debtors. In order to carry a of Section 524(g), so long as the requisite number of holders class, approval of over one-half in number and at least of asbestos claims vote in favor of the plan of reorganization. two-thirds in amount are required. In addition, to obtain an If the 524(g) and 105 injunctions are issued, all unsettled injunction under Section 524(g) of the Bankruptcy Code, at current asbestos claims, all future asbestos claims and all least 75% of current asbestos claimants must vote to accept silica claims based on exposure that has already occurred the plan of reorganization. In addition to obtaining the will be channeled to a trust for payment, and the debtors required votes, the requirements for a bankruptcy court to and related parties (including Halliburton, Halliburton approve a plan of reorganization include, among other Energy Services and other subsidiaries and affiliates of judicial findings, that: • the plan of reorganization complies with applicable provisions of the Bankruptcy Code; • the debtors have complied with the applicable provisions of the Bankruptcy Code; • the trust will value and pay similar present and future claims in substantially the same manner; • the plan of reorganization has been proposed in good faith and not by any means forbidden by law; and • any payment made or promised by the debtors to any person for services, costs or expenses in or in connection with the Chapter 11 proceeding or the plan of reorganization has been or is reasonable. Section 524(g) of the Bankruptcy Code authorizes the bankruptcy court to enjoin entities from taking action to collect, recover or receive payment or recovery with respect to any asbestos claim or demand that is to be paid in whole or in part by a trust created by a plan of reorganization that satisfies the requirements of the Bankruptcy Code. Section 105 of the Bankruptcy Code authorizes a similar injunction for silica claims. The injunction also may bar any action based on such claims or demands against the debtors that are directed at third parties. The order confirming the plan must be issued or affirmed by the federal district court Halliburton and the debtors) will be released from any further liability under the plan of reorganization. A prolonged Chapter 11 proceeding could adversely affect the debtor’s relationships with customers, suppliers and employees, which in turn could adversely affect the debtors’ competitive position, financial condition and results of operations. A weakening of the debtors’ financial condition and results of operations could adversely affect the debtors’ ability to implement the plan of reorganization. F i n a n c i n g t h e p r o p o s e d s e t t l e m e n t . The plan of reorganization through which the proposed settlement will be implemented will require us to contribute up to $2.775 billion in cash to the Section 524(g)/105 trust established for the benefit of claimants, which we will need to finance on terms acceptable to us. We are pursuing a number of financing alternatives for the cash amount to be contributed to the trust. The availability of these alternatives depend in large part on market conditions. We are currently negotiating with several banks and non-bank lenders over the terms of multiple credit facilities. A proposed banking syndicate is currently performing due diligence in an effort to make a funding commitment before the bankruptcy filing. We will not proceed with the Chapter 11 filing for DII Industries, Kellogg, Brown & Root and some of their subsidiaries until financing commitments are in place. 50 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S The anticipated credit facilities include: under consideration for possible downgrade pending the • debtor-in-possession financing to provide for the operating needs of the filing entities; • a revolving line of credit for general working capital purposes; • a master letter of credit facility intended to ensure that existing letters of credit supporting our contracts remain in place during the filing; and • a delayed-draw term facility to be available for funding of up to $2.775 billion to the trust for the benefit of claimants. The delayed-draw term facility is intended to eliminate uncertainty the capital markets might have concerning our ability to meet our funding requirement once final and non- appealable court confirmation of a plan of reorganization has been obtained. None of these credit facilities are currently in place, and there can be no assurances that we will complete these facilities. We are not obligated to enter into these facilities if the terms are not acceptable to us. Moreover, these facilities would only be available for limited periods of time. As a result, if we were delayed in filing the Chapter 11 proceeding or delayed in completing the plan of reorganization after a Chapter 11 filing, the credit facilities may expire and no longer be available. In such circumstances, we would have to terminate the proposed settlement if replacement financing were not available on acceptable terms. We have sufficient authorized and unrestricted shares to issue 59.5 million shares to the trust. No shareholder approval is required for issuance of the shares. C r e d i t ra t i n g s . Late in 2001 and early in 2002, Moody’s Investors’ Services lowered its ratings of our long-term senior unsecured debt to Baa2 and our short-term credit and commercial paper ratings to P-2. In addition, Standard & Poor’s lowered its ratings of our long-term senior unsecured debt to A- and our short-term credit and commercial paper ratings to A-2 in late 2001. In December 2002, Standard & Poor’s lowered these ratings to BBB and A-3. These ratings were lowered primarily due to our asbestos exposure, and both agencies have indicated that the ratings continue results of the proposed global settlement. Although our long-term ratings continue at investment grade levels, the cost of new borrowing is higher and our access to the debt markets is more volatile at the new rating levels. Investment grade ratings are BBB- or higher for Standard & Poor’s and Baa3 or higher for Moody’s Investors’ Services. Our current ratings are one level above BBB- on Standard & Poor’s and one level above Baa3 on Moody’s Investors’ Services. We have $350 million of committed lines of credit from banks that are available if we maintain an investment grade rating. This facility expires on August 16, 2006. As of December 31, 2002, no amounts have been borrowed under these lines. If our debt ratings fall below investment grade, we would also be in technical breach of a bank agreement covering $160 million of letters of credit at December 31, 2002, which might entitle the bank to set-off rights. In addition, a $151 million letter of credit line, of which $121 million has been issued, includes provisions that allow the banks to require cash collateralization for the full line if debt ratings of either rating agency fall below the rating of BBB by Standard & Poor’s or Baa2 by Moody’s Investors’ Services, one downgrade from our current ratings. These letters of credit and bank guarantees generally relate to our guaranteed performance or retention payments under our long-term contracts and self-insurance. In the event the ratings of our debt by either agency fall, we may have to issue additional debt or equity securities or obtain additional credit facilities in order to satisfy the cash collateralization requirements under the instruments referred to above and meet our other liquidity needs. We anticipate that any such new financing would not be on terms as attractive as those we have currently and that we would also be subject to increased borrowing costs and interest rates. Our Halliburton Elective Deferral Plan has a provision which states that if the Standard & Poor’s rating 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 51 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S falls below BBB the amounts credited to the participants’ into term loans. However, this letter of credit facility is not accounts will be paid to the participants in a lump-sum currently in place, and, if we were required to cash within 45 days. At December 31, 2002 this was approximately collateralize letters of credit prior to obtaining the facility, $49 million. we would be required to use cash on hand or existing credit L e t t e r s o f c r e d i t . In the normal course of business, we facilities. We will not enter into the pre-packaged Chapter 11 have agreements with banks under which approximately filing without having this credit facility in place. In $1.4 billion of letters of credit or bank guarantees were addition, representatives of DII Industries, Kellogg, Brown & issued, including at least $204 million which relate to our Root and their subsidiaries have been in discussions with joint ventures’ operations. The agreements with these their customers in order to reduce the possibility that any banks contain terms and conditions that define when the material draw on the existing letters of credit will occur banks can require cash collateralization of the entire line. due to the anticipated Chapter 11 proceedings. Agreements with banks covering at least $150 million of Effective October 9, 2002, we amended an agreement letters of credit allow the bank to require cash collaterali- with banks under which $261 million of letters of credit zation for the full line for any reason, and agreements have been issued on the Barracuda-Caratinga project. The covering another at least $890 million of letters of credit amended agreement removes the provision that previously allow the bank to require cash collateralization for the allowed the banks to require collateralization if ratings of entire line in the event of a bankruptcy or insolvency event Halliburton debt fell below investment grade ratings. The involving one of our subsidiaries. revised agreement includes provisions that require us to Our letters of credit also contain terms and conditions maintain ratios of debt to total capital and of total earnings that define when they may be drawn. At least $230 million before interest, taxes, depreciation and amortization to of letters of credit permit the beneficiary of such letters of interest expense. The definition of debt includes our asbestos credit to draw against the line for any reason and another at liability. The definition of total earnings before interest, least $560 million of letters of credit permit the beneficiary taxes, depreciation and amortization excludes any non-cash of such letters of credit to draw against the line in the event charges related to the proposed global settlement through of a bankruptcy or insolvency event involving one of our December 31, 2003. subsidiaries who will be party to the proposed reorganization. In the past, no significant claims have been made against Our anticipated credit facilities described above would letters of credit issued on our behalf. include a master letter of credit facility intended to replace B a r r a c u d a - C a r a t i n g a P r o j e c t . In June 2000, KBR any cash collateralization rights of issuers of substantially entered into a contract with the project owner, Barracuda all our existing letters of credit during the pendency of the & Caratinga Leasing Company B.V., to develop the anticipated Chapter 11 proceedings by DII Industries and Barracuda and Caratinga crude oil fields, which are located Kellogg, Brown & Root. The master letter of credit facility is off the coast of Brazil. The project manager and owner also intended to provide reasonably sufficient credit lines representative is Petrobras, the Brazilian national oil for us to be able to fund any such cash requirements. If any company. See Note 12 to the financial statements. of such existing letters of credit are drawn during the KBR’s performance under the contract is secured by: bankruptcy and we are required to provide cash to collateralize or reimburse for such draws, it is anticipated that the letter of credit facility would provide the cash needed for such draws, with any borrowings being converted • two performance letters of credit, which together have an available credit of approximately $261 million 52 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S and which represent approximately 10% of the contract amount, as amended to date by change orders; but excluding consequential damages) against KBR for up to $500 million plus the return of up to $300 million in advance • a retainage letter of credit in an amount equal to $121 payments that would otherwise have been credited back million as of December 31, 2002 and which will increase in order to continue to represent 10% of the cumulative cash amounts paid to KBR; and • a guarantee of KBR’s performance of the contract by Halliburton Company in favor of the project owner. to the project owner had the contract not been terminated. In addition, although the project financing includes borrowing capacity in excess of the original contract amount, only $250 million of this additional borrowing capacity is reserved for increases in the contract amount payable to As of December 31, 2002, the project was approximately KBR and its subcontractors other than Petrobras. Because 63% complete and KBR had recorded a loss of $117 million our claims, together with change orders that are currently related to the project. The probable recovery from unapproved under negotiation, exceed this amount, we cannot give claims included in determining the loss on the project was assurance that there is adequate funding to cover current or $182 million as of December 31, 2002. future KBR claims. Unless the project owner provides The project owner has procured project finance funding additional funding or permits us to defer repayment of the obligations from various banks to finance the payments due $300 million advance, and assuming the project owner to KBR under the contract. The project owner currently has does not allege default on our part, we may be obligated to no other committed source of funding on which we can fund operating cash flow shortages over the remaining necessarily rely other than the project finance funding for project life in an amount we currently estimate to be up to the project. While we believe the banks have an incentive to approximately $400 million. complete the financing of the project, there is no assurance The possible Chapter 11 pre-packaged bankruptcy filing that they would do so. If the banks ceased funding the by Kellogg, Brown & Root in connection with the project, we believe that Petrobras would provide for or secure settlement of its asbestos and silica claims would constitute other funding to complete the project, although there is no an event of default under the loan documents with the assurance that it will do so. To date, the banks have made banks unless waivers are obtained. KBR believes that it is funds available, and the project owner has continued to unlikely that the banks will exercise any right to cease disburse funds to KBR as payment for its work on the funding given the current status of the project and the fact project, even though the project completion has been delayed. that a failure to pay KBR may allow KBR to cease work In the event that KBR is alleged to be in default under on the project without Petrobras having a readily available the contract, the project owner may assert a right to draw substitute contractor. upon the letters of credit. If the letters of credit were drawn, C u r r e n t m a t u r i t i e s . We have approximately $295 million KBR would be required to fund the amount of the draw to of current maturities of long-term debt as of December 31, the issuing bank. In the event that KBR was determined 2002. This includes a repayment of a $139 million senior after an arbitration proceeding to have been in default note due April 2003 and a $150 million medium-term note under the contract, and if the project was not completed by due July 2003. KBR as a result of such default (i.e., KBR’s services are C a s h a n d c a s h e q u i v a l e n t s . We ended 2002 with cash terminated as a result of such default), the project owner and equivalents of $1.1 billion. may seek direct damages (including completion costs in excess of the contract price and interest on borrowed funds, 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 53 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S C R I T I C A L A C C O U N T I N G E S T I M AT E S • amounts of any probable unapproved claims and change The preparation of financial statements requires the use of orders included in revenues. judgments and estimates. Our critical accounting policies At the onset of each contract, we prepare a detailed are described below to provide a better understanding of analysis of our estimated cost to complete the project. Risks how we develop our judgments about future events and relating to service delivery, usage, productivity and other related estimations and how they can impact our financial factors are considered in the estimation process. Our project statements. A critical accounting policy is one that requires personnel periodically evaluate the estimated costs, claims our most difficult, subjective or complex estimates and and change orders, and percentage of completion at the assessments and is fundamental to our results of operations. project level. The recording of profits and losses on long-term We identified our most critical accounting policies to be: contracts requires an estimate of the total profit or loss • percentage of completion accounting for our long-term over the life of each contract. This estimate requires engineering and construction contracts; consideration of contract revenue, change orders and claims, • allowance for bad debts; • forecasting our effective tax rate, including our ability to utilize foreign tax credits and the realizability of deferred tax assets; and • loss contingencies, primarily related to: – asbestos litigation; and – other litigation. We base our estimates on historical experience and on various other assumptions we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. This discussion and analysis should be read in conjunction with our consolidated financial statements and related notes included in this report. P e r c e n t a g e o f c o m p l e t i o n We account for our revenues on long-term engineering and construction contracts on the percentage-of-completion method. This method of accounting requires us to calculate job profit to be recognized in each reporting period for each job based upon our predictions of future outcomes which include: • estimates of the total cost to complete the project; • estimates of project schedule and completion date; less costs incurred and estimated costs to complete. Anticipated losses on contracts are recorded in full in the period in which they become evident. Profits are recorded based upon the total estimated contract profit times the current percentage complete for the contract. When calculating the amount of total profit or loss on a long-term contract, we include unapproved claims as revenue when the collection is deemed probable based upon the four criteria for recognizing unapproved claims under the American Institute of Certified Public Accountants’ Statement of Position 81-1 “Accounting for Performance of Construction-Type and Certain Production-Type Contracts.” Including probable unapproved claims in this calculation increases the operating income or decreases the operating loss that would otherwise be recorded without consideration of the probable unapproved claims. Probable unapproved claims are recorded to the extent of costs incurred and include no profit element. In substantially all cases, the probable unapproved claims included in determining contract profit or loss are less than the actual claim that will be or has been presented to the customer. We actively engage in claims negotiations with our customers and the success of claims negotiations have a direct impact on the profit or loss recorded for any related long-term contract. Unsuccessful claims negotiations could result in decreases in estimated • estimates of the percentage the project is complete; and contract profits or additional contract losses and successful claims negotiations could result in increases in 54 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S estimated contract profits or recovery of previously recorded the current year; and an asset and liability approach in contract losses. recognizing the amount of deferred tax liabilities and assets Significant projects are reviewed in detail by senior for the future tax consequences of events that have been engineering and construction management at least quarterly. recognized in our financial statements or tax returns. We Preparing project cost estimates and percentages of apply the following basic principles in accounting for our completion is a core competency within our engineering and income taxes at the date of the financial statements: construction businesses. We have a long history of dealing with multiple types of projects and in preparing cost estimates. However, there are many factors that impact • a current tax liability or asset is recognized for the estimated taxes payable or refundable on tax returns for the current year; future costs, including but not limited to weather, inflation, labor disruptions and timely availability of materials, and other factors as outlined in our “Forward- Looking Information” section. These factors can affect the accuracy of our estimates and materially impact our future reported earnings. A l l o wa n c e f o r b a d d e b t s We evaluate our accounts receivable through a continuous process of assessing our portfolio on an individual customer and overall basis. This process comprises a thorough review of historical collection experience, current aging status of the customer accounts, financial condition of our customers, and other factors such as whether the receivables involve retentions or billing disputes. We also consider the economic environment of our customers, both from a marketplace and geographic perspective, in evaluating the need for an allowance. Based on our review of these factors, we establish or adjust allowances for specific customers and the accounts receivable portfolio as a whole. This process involves a high degree of judgment and estimation and frequently involves significant dollar amounts. Accordingly, our results of operations can be affected by adjustments to the allowance due to actual write-offs that differ from estimated amounts. Ta x a c c o u n t i n g We account for our income taxes in accordance with Statement of Financial Accounting Standards No. 109 “Accounting for Income Taxes”, which requires the • a deferred tax liability or asset is recognized for the estimated future tax effects attributable to temporary differences and carryforwards; • the measurement of current and deferred tax liabilities and assets is based on provisions of the enacted tax law and the effects of potential future changes in tax laws or rates are not considered; and • the value of deferred tax assets is reduced, if necessary, by the amount of any tax benefits that, based on available evidence, are not expected to be realized. We determine deferred taxes separately for each tax-paying component (an entity or a group of entities that is consolidated for tax purposes) in each tax jurisdiction. That determination includes the following procedures: • identify the types and amounts of existing temporary differences; • measure the total deferred tax liability for taxable temporary differences using the applicable tax rate; • measure the total deferred tax asset for deductible temporary differences and operating loss carryforwards using the applicable tax rate; • measure the deferred tax assets for each type of tax credit carryforward; and • reduce the deferred tax assets by a valuation allowance if, based on available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized prior to expiration, or that future deductibility is uncertain. recognition of the amount of taxes payable or refundable for This methodology requires a significant amount of judgment regarding assumptions and the use of estimates, 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 55 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S which can create significant variances between actual • epidemiological studies to estimate the number of people results and estimates. Examples include the forecasting of who might allege exposure to products. our effective tax rate and the potential realization of deferred tax assets in the future, such as utilization of foreign tax credits. This process involves making forecasts of current and future years’ United States taxable income, foreign taxable income and related taxes in order to estimate the foreign tax credits. Unforeseen events, such as the timing of asbestos or silica settlements, and other tax timing issues may significantly affect these estimates. These factors can affect the accuracy of our tax account balances and impact our future reported earnings. L o s s c o n t i n g e n c i e s A s b e s t o s . Prior to June 2002, we provided for known out- standing asbestos and silica claims because we did not have sufficient information to make a reasonable estimate of future unknown asbestos claims liability. DII Industries retained Dr. Francine F. Rabinovitz of Hamilton, Rabinovitz & Alschuler, Inc. to estimate the probable number and value, including defense costs, of unresolved current and future asbestos and silica related bodily injury claims asserted against DII Industries and its subsidiaries. Dr. Rabinovitz’s estimates are based on historical data supplied by DII Industries, KBR and Harbison-Walker and publicly available studies, including annual surveys by the National Institutes of Health concerning the incidence of mesothelioma deaths. In her analysis, Dr. Rabinovitz projected that the elevated and historically unprecedented rate of claim filings of the last two years (particularly in 2000 and 2001), especially as expressed by the ratio of nonmalignant claim filings to malignant claim filings, would continue into the future for five more years. After that, Dr. Rabinovitz projected that the ratio of nonmalignant claim filings to malignant claim filings will gradually decrease for a 10 year period ultimately returning to the historical claiming rate and claiming ratio. In making her calculation, Dr. Rabinovitz alternatively assumed a somewhat lower rate of claim filings, based on an average of the last five years of claims experience, would continue into the future for five more years and decrease thereafter. Other important assumptions utilized in Dr. Rabinovitz’s estimates, which we relied upon in making our accrual are: Dr. Rabinovitz is a nationally renowned expert in conducting • an assumption that there will be no legislative or other such analyses. systemic changes to the tort system; The methodology utilized by Dr. Rabinovitz to project • that we will continue to aggressively defend against DII Industries and its subsidiaries’ asbestos and silica asbestos and silica claims made against us; related liabilities and defense costs relied upon and included: • an inflation rate of 3% annually for settlement payments • an analysis of historical asbestos and silica settlements and defense costs; • an analysis of the pending inventory of asbestos and and an inflation rate of 4% annually for defense costs; and • we would receive no relief from our asbestos obligation due to actions taken in the Harbison-Walker bankruptcy. silica related claims; Through 2052, Dr. Rabinovitz estimated the current and • an analysis of the claims filing history for asbestos and future total undiscounted liability for personal injury silica related claims since January 2000 (two-year claim history) and alternatively since January 1997 (five-year claim history); • an analysis of the population likely to have been exposed or claim exposure to specific products or construction and renovation projects; and asbestos and silica claims, including defense costs, would be a range between $2.2 billion and $3.5 billion as of June 30, 2002 (which includes payments related to the approximately 347,000 claims currently pending). The lower end of the range is calculated by using an average of the last five years of asbestos and silica claims experience and the upper end of the range is calculated using the more recent two-year 56 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S elevated rate of asbestos and silica claim filings in projecting the case of Harbison-Walker claims (See Note 12 to the the rate of future claims. financial statements), possibly through the Harbison- P r o p o s e d G l o b a l S e t t l e m e n t . On December 18, 2002, Walker bankruptcy proceedings. Given the uncertainties we announced that we had reached an agreement surrounding the completion of the global settlement and in principle that, if and when consummated, would result the uncertainty as to the amounts that could be paid under in a global settlement of all asbestos and silica personal the proposed global settlement, we believe Dr. Rabinovitz’s injury claims against DII Industries, Kellogg, Brown & Root study continues to provide the best possible range of and their current and former subsidiaries. The agreement in estimated loss associated with known and future asbestos principle provides that: • up to $2.775 billion in cash, 59.5 million Halliburton shares (valued at $1.1 billion using the stock price at December 31, 2002 of $18.71) and notes with a net present value expected to be less than $100 million will be paid to a trust for the benefit of current and future asbestos personal injury claimants and current silica personal injury claimants upon receiving final and non- appealable court confirmation of a plan of reorganization; • DII Industries and Kellogg, Brown & Root will retain rights to the first $2.3 billion of any insurance proceeds with any proceeds received between $2.3 billion and $3.0 billion going to the trust; • the agreement is to be implemented through a pre- packaged Chapter 11 filing for DII Industries, Kellogg, Brown & Root, and some of their subsidiaries; and • the funding of the settlement amounts would occur upon receiving final and non-appealable court confirmation of a plan of reorganization of DII Industries, Kellogg, Brown & Root and their subsidiaries on the Chapter 11 proceeding. and silica claims liabilities. As a result of negotiating the proposed global settlement, we have determined that the best estimate of the probable loss is $3.4 billion ($3.5 billion estimate as of June 30, 2002 in Dr. Rabinovitz’s study less $50 million in payments in the third and fourth quarter of 2002) and we have adjusted our liability to this amount at December 31, 2002. I n s u ra n c e R e c o v e r i e s . In 2002, we retained Peterson Consulting, a nationally-recognized consultant in liability and insurance, to work with us to project the amount of probable insurance recoveries using the current and future asbestos and silica liabilities recorded by us at December 31, 2002. Using Dr. Rabinovitz’s estimate of liabilities through 2052 using the two-year elevated rate of asbestos and silica claim filings, Peterson Consulting assisted us in conducting an analysis to determine the amount of insurance that we estimate is probable that we will recover in relation to the projected claims and defense costs. In conducting this analysis, Peterson Consulting: Subsequently, as of March 2003, DII Industries and • reviewed DII Industries’ historical course of dealings Kellogg, Brown & Root have entered into definitive written agreements finalizing the terms of the agreement in principle. Please see “Liquidity and Capital Resources” for a discussion of the prerequisites to reaching a conclusion of the settlement. Asbestos and Silica Liability Estimate as of December 31, 2 0 0 2 . We currently do not believe that completion of the proposed global settlement is probable as defined by State- ment of Financial Accounting Standards No. 5. If the proposed global settlement is not completed, we will continue to resolve asbestos and silica claims in the tort system or, in with its insurance companies concerning the payment of asbestos and silica related claims, including DII Industries’ 15 year litigation and settlement history; • reviewed the terms of DII Industries’ prior and current coverage-in-place settlement agreements; • reviewed the status of DII Industries’ and Kellogg, Brown & Root’s current insurance-related lawsuits and the various legal positions of the parties in those lawsuits in relation to the developed and developing case law and the historic positions taken by insurers in the earlier filed and settled lawsuits; • engaged in discussions with our counsel; and 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 57 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S • analyzed publicly-available information concerning • the continuing solvency of various insurance companies. the ability of the DII Industries’ insurers to meet their obligations. Based on these reviews, analyses and discussions, Peterson Consulting assisted us in making judgments concerning insurance coverage that we believe are reasonable and consistent with our historical course of dealings with our insurers and the relevant case law to determine the probable insurance recoveries for asbestos and silica liabilities. This analysis factored in the probable effects of self-insurance features, such as self-insured retentions, policy exclusions, liability caps and the financial status of applicable insurers, and various judicial determinations relevant to DII Industries’ insurance programs. Based on Peterson Consulting analysis of the probable insurance recoveries, we increased our insurance receivable to $2.1 billion at December 31, 2002. The insurance receivable recorded by us does not assume any recovery from insolvent carriers and assumes that those carriers which are currently solvent will continue to be solvent through- out the period of the applicable recoveries in the projections. However, there can be no assurance that these assumptions will be accurate. The insurance receivables recorded at December 31, 2002 do not exhaust applicable insurance coverage for asbestos and silica related liabilities. Projecting future events is subject to many uncertainties that could cause the asbestos and silica related liabilities and insurance recoveries to be higher or lower than those projected and accrued, such as: P o s s i b l e A d d i t i o n a l A c c r u a l s . Should the proposed global settlement become probable as defined by Statement of Financial Accounting Standards No. 5, we would adjust our accrual for probable and reasonably estimable liabilities for current and future asbestos and silica claims. The settlement amount would be up to $4.0 billion, consisting of up to $2.775 billion in cash, 59.5 million Halliburton shares and notes with a net present value expected to be less than $100 million. Assuming the revised liability would be $4.0 billion, we would also increase our probable insurance recoveries to $2.3 billion. The impact on our income statement would be an additional pretax charge of $322 million ($288 million after-tax). This accrual (which values our stock to be contributed at $1.1 billion using our stock price at December 31, 2002 of $18.71) would then be adjusted periodically based on changes in the market price of our common stock until the common stock is contributed to a trust for the benefit of the claimants. C o n t i n u i n g R e v i e w. Given the inherent uncertainty in making future projections, we plan to have the projections periodically reexamined, and update them based on our experience and other relevant factors such as changes in the tort system, the resolution of the bankruptcies of various asbestos defendants, and our proposed global settlement. Similarly, we will re-evaluate our projections concerning our probable insurance recoveries in light of any updates to Dr. Rabinovitz’s projections, developments in DII Industries’ and Kellogg, Brown & Root’s various lawsuits against their • the number of future asbestos and silica related insurance companies, factors related to the global lawsuits to be filed against DII Industries and Kellogg, Brown & Root; settlement, if consummated, and other developments that may impact the probable insurance recoveries. • the average cost to resolve such future lawsuits; L i t i g a t i o n . We are currently involved in other legal • coverage issues among layers of insurers issuing different policies to different policyholders over extended periods of time; proceedings not involving asbestos and silica. As discussed in Note 12 of our consolidated financial statements, as of December 31, 2002, we have accrued an estimate of the • the impact on the amount of insurance recoverable in probable costs for the resolution of these claims. Attorneys light of the Harbison-Walker and Federal-Mogul bankruptcies; and 58 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S in our legal department specializing in litigation claims, undivided ownership interests. No additional amounts were monitor and manage all claims filed against us. The estimate received from our accounts receivable facility since the of probable costs related to these claims is developed in second quarter of 2002. The total amount outstanding under consultation with outside legal counsel representing us in this facility was $180 million as of December 31, 2002. We the defense of these claims. Our estimates are based upon continue to service, administer and collect the receivables on an analysis of potential results, assuming a combination of behalf of the purchaser. The amount of undivided ownership litigation and settlement strategies. We attempt to resolve interest in the pool of receivables sold to the unaffiliated claims through mediation and arbitration where possible. If companies is reflected as a reduction of accounts receivable the actual settlement costs and final judgments, after in our consolidated balance sheet and as an increase in cash appeals, differ from our estimates, our future financial flows from operating activities in our consolidated statement results may be adversely affected. of cash flows. O F F B A L A N C E S H E E T R I S K L O N G -T E R M C O N T R A C T U A L O B L I G AT I O N S A N D On April 15, 2002, we entered into an agreement to sell certain of our accounts receivable to a bankruptcy-remote C O M M E R C I A L C O M M I T M E N T S The following table summarizes our various long-term limited-purpose funding subsidiary. Under the terms of the contractual obligations: agreement, new receivables are added on a continuous basis Millions of dollars 2003 2004 2005 2006 2007 Thereafter Total Payments due to the pool of receivables, and collections reduce previously Long-term debt $295 $ 21 $ 20 $293 $ 8 $ 826 $1,463 sold accounts receivable. This funding subsidiary sells an undivided ownership interest in this pool of receivables to Operating leases Capital leases Total contractual 119 1 83 1 63 55 40 1 — — 249 — 609 3 entities managed by unaffiliated financial institutions under obligations $415 $105 $ 84 $348 $48 $1,075 $2,075 another agreement. Sales to the funding subsidiary have been structured as “true sales” under applicable bankruptcy laws, and the assets of the funding subsidiary are not available to pay any creditors of Halliburton or of its subsidiaries or affiliates, until such time as the agreement with the unaffiliated companies is terminated following sufficient collections to liquidate all outstanding undivided ownership interests. The funding subsidiary retains the interest in the pool of receivables that are not sold to the unaffiliated companies, and is fully consolidated and reported in our financial statements. The amount of undivided interests, which can be sold under the program, varies based on the amount of eligible Energy Services Group receivables in the pool at any given time and other factors. The funding subsidiary sold a $200 million undivided ownership interest to the unaffiliated companies, and may from time to time sell additional Included in long-term debt is an additional $13 million at December 31, 2002 related to the terminated interest rate swaps. We also have $350 million of committed lines of credit from banks that are available if we maintain an investment grade rating. Investment grade ratings are BBB- or higher for Standard & Poor’s and Baa3 or higher for Moody’s Investors’ Services and we are currently above these levels. In the normal course of business we have agreements with banks under which approximately $1.4 billion of letters of credit or bank guarantees were issued, including $204 million which relate to our joint ventures’ operations. Effective October 9, 2002, we amended an agreement with banks under which $261 million of letters of credit have been issued. The amended agreement removes the provision that previously allowed the banks to require collateralization if ratings of Halliburton debt fell below investment grade ratings. The revised agreements include provisions that 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 59 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S require us to maintain ratios of debt to total capital and of We do not use derivative instruments for trading total earnings before interest, taxes, depreciation and purposes. We do not consider any of these risk management amortization to interest expense. The definition of debt activities to be material. See Note 1 to the financial includes our asbestos and silica liability. The definition of statements for additional information on our accounting total earnings before interest, taxes, depreciation and policies on derivative instruments. See Note 19 to the amortization excludes any non-cash charges related to the financial statements for additional disclosures related to proposed global settlement through December 31, 2003. derivative instruments. If our debt ratings fall below investment grade, we would I n t e r e s t ra t e r i s k . We have exposure to interest rate risk also be in technical breach of a bank agreement covering from our long-term debt and related interest rate swaps. another $160 million of letters of credit at December 31, The following table represents principal amounts of our 2002, which might entitle the bank to set-off rights. In long-term debt at December 31, 2002 and related weighted addition, a $151 million letter of credit line, of which $121 average interest rates by year of maturity for our long- million has been issued, includes provisions that allow the term debt. banks to require cash collateralization for the full line if Millions of dollars 2003 2004 2005 2006 2007 Thereafter Total debt ratings of either rating agency fall below the rating of Long-term debt: BBB by Standard & Poor’s or Baa2 by Moody’s Investors’ Services, one downgrade from our current ratings. These Fixed rate debt $140 $ 2 $ 1 $274 $ — $825 $1,242 Weighted average interest rate 8.0% 7.7% 7.0% 6.0% — 7.4% 7.1% letters of credit and bank guarantees generally relate to our Variable rate debt $155 $ 19 $ 19 $ 19 $ 8 $ 1 $ 221 guaranteed performance or retention payments under our Weighted average long-term contracts and self-insurance. interest rate 2.3% 5.4% 5.4% 5.4% 5.4% 5.8% 3.2% F I N A N C I A L I N S T R U M E N T M A R K E T R I S K We are exposed to financial instrument market risk from changes in foreign currency exchange rates, interest rates and to a limited extent, commodity prices. We selectively manage these exposures through the use of derivative instruments to mitigate our market risk from these exposures. The objective of our risk management program is to protect our cash flows related to sales or purchases of goods or services from market fluctuations in currency rates. Our use of derivative instruments includes the following types of market risk: • volatility of the currency rates; • time horizon of the derivative instruments; • market cycles; and • the type of derivative instruments used. Fair market value of long-term debt was $1.3 billion as of December 31, 2002. In the second quarter 2002, we terminated our interest rate swap agreement on our 8% senior note. The notional amount of the swap agreement was $139 million. This interest rate swap was designated as a fair value hedge under SFAS No. 133. Upon termination, the fair value of the interest rate swap was $0.5 million. In the fourth quarter 2002, we terminated our interest rate swap agreement on our 6% fixed rate medium-term notes. The notional amount of the swap agreement was $150 million. This interest rate swap was designated as a fair value hedge under SFAS No. 133. Upon termination, the fair value of the interest rate swap was $13 million. These swaps had previously been classified in “Other assets” on the balance sheet. The fair value adjustment to these debt instruments that were hedged will remain and be amortized as a reduction in interest expense using the “Effective Yield Method” over the remaining life of the notes. 60 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S R E O R G A N I Z AT I O N O F B U S I N E S S O P E R AT I O N S reorganization would facilitate separation of the ownership On March 18, 2002 we announced plans to restructure our of the two businesses in the future if we identify an businesses into two operating subsidiary groups, the Energy opportunity that produces greater value for our shareholders Services Group and KBR, representing the Engineering and than continuing to own both businesses. See Note 14 to the Construction Group. As part of this reorganization, we are financial statements. separating and consolidating the entities in our Energy In the fourth quarter of 2000 we approved a plan to Services Group together as direct and indirect subsidiaries reorganize our engineering and construction businesses into of Halliburton Energy Services, Inc. We are also separating one business unit. This restructuring was undertaken and consolidating the entities in our Engineering and Construction Group together as direct and indirect because our engineering and construction businesses continued to experience delays in customer commitments for subsidiaries of the former Dresser Industries, Inc., which new upstream and downstream projects. With the exception became a limited liability company during the second of deepwater projects, short-term prospects for increased quarter of 2002 and was renamed DII Industries, LLC. The engineering and construction activities in either the reorganization of business operations facilitated the upstream or downstream businesses were not positive. As a separation, organizationally, financially, and operationally, of result of the reorganization of the engineering and our two business segments, which we believe will construction businesses, we took actions to rationalize our significantly improve operating efficiencies in both, while operating structure, including write-offs of equipment and streamlining management and easing manpower licenses of $10 million, engineering reference designs of $4 requirements. In addition, many support functions, which million and capitalized software of $6 million, and recorded were previously shared, were moved into the two business severance costs of $16 million. Of these charges, $30 million groups. As a result, we took actions during 2002 to reduce was reflected under the captions cost of services and $6 our cost structure by reducing personnel, moving previously million as general and administrative in our 2000 shared support functions into the two business groups and consolidated statements of income. Severance and related realigning ownership of international subsidiaries by group. costs of $16 million were for the reduction of approximately In 2002, we incurred approximately $107 million for the year 30 senior management positions. In January 2002, the last of personnel reduction costs and asset related write-offs. Of of the personnel actions was completed and we have no this amount, $8 million remains in accruals for severance remaining accruals related to the 2000 restructuring. See arrangements and approximately $2 million for other items. Note 14 to the financial statements. We expect these remaining payments will be made during 2003. Reorganization charges for 2002 consisted of the following: • $64 million in personnel related expense; • $17 million of asset related write-downs; E N V I R O N M E N TA L M AT T E R S We are subject to numerous environmental, legal and regulatory requirements related to our operations worldwide. In the United States, these laws and regulations include the Comprehensive Environmental Response, • $20 million in professional fees related to the Compensation and Liability Act, the Resources Conservation restructuring; and and Recovery Act, the Clean Air Act, the Federal Water • $6 million related to contract terminations. Pollution Control Act and the Toxic Substances Control Act, Although we have no specific plans currently, the among others. In addition to the federal laws and regulations, states where we do business may have equivalent laws and 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 61 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S regulations by which we must also abide. actual results to differ from our forward-looking statements We evaluate and address the environmental impact of our and potentially adversely affect our financial condition and operations by assessing and remediating contaminated results of operations, including risks relating to: properties in order to avoid future liabilities and comply with environmental, legal and regulatory requirements. On occasion we are involved in specific environmental litigation and claims, including the remediation of properties we A s b e s t o s • completion of the proposed global settlement, prerequisites to which include: own or have operated as well as efforts to meet or correct – agreement on the amounts to be contributed to the trust compliance-related matters. for the benefit of current silica claimants; We do not expect costs related to these remediation – our due diligence review for product exposure and requirements to have a material adverse effect on our medical basis for claims; consolidated financial position or our results of operations. – agreement on procedures for distribution of settlement We have subsidiaries that have been named as potentially funds to individuals claiming personal injury; responsible parties along with other third parties for ten – definitive agreement on a plan of reorganization and federal and state superfund sites for which we have disclosure statement relating to the proposed settlement; established a liability. As of December 31, 2002, those ten – arrangement of acceptable financing to fund the sites accounted for $8 million of our total $48 million proposed settlement; liability. See Note 12 to the financial statements. – Board of Directors approval; F O R WA R D - L O O K I N G I N F O R M AT I O N The Private Securities Litigation Reform Act of 1995 provides safe harbor provisions for forward-looking information. Forward-looking information is based on projections and estimates, not historical information. Some statements in this Form 10-K are forward-looking and use words like “may,” “may not,” “believes,” “do not believe,” “expects,” “do not expect,” “do not anticipate,” and other expressions. We may also provide oral or written forward-looking information in other materials we release to the public. Forward- looking information involves risks and uncertainties and reflects our best judgment based on current information. Our results of operations can be affected by inaccurate assumptions we make or by known or unknown risks and uncertainties. In addition, other factors may affect the accuracy of our forward-looking information. As a result, no forward-looking information can be guaranteed. Actual events and the results of operations may vary materially. While it is not possible to identify all factors, we continue to face many risks and uncertainties that could cause – obtaining approval from 75% of current asbestos claimants to the plan of reorganization implementing the proposed global settlement; and – obtaining final and non-appealable bankruptcy court approval and federal district court confirmation of the plan of reorganization; • the results of being unable to complete the proposed global settlement, including: – continuing asbestos and silica litigation against us, which would include the possibility of substantial adverse judgments, the timing of which could not be controlled or predicted, and the obligation to provide appeals bonds pending any appeal of any such judgment, some or all of which may require us to post cash collateral; – current and future asbestos claims settlement and defense costs, including the inability to completely control the timing of such costs and the possibility of increased costs to resolve personal injury claims; – the possibility of an increase in the number and type of asbestos and silica claims against us in the future; 62 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S – future events in the Harbison-Walker bankruptcy proceeding, including the possibility of discontinuation of the temporary restraining order entered by the Harbison-Walker bankruptcy court that applies to over 200,000 pending claims againt DII Industries; and • liquidity risks resulting from being unable to complete a global settlement or timely recovery of insurance reimbursement for amounts paid, each as discussed further below; and • an adverse effect on our financial condition or results of – any adverse changes to the tort system allowing operations as a result of any of the foregoing; additional claims or judgments against us; • the results of being unable to recover, or being delayed in recovering, insurance reimbursement in the amounts anticipated to cover a part of the costs incurred defending asbestos and silica claims, and amounts paid to settle claims or as a result of court judgments, due to: – the inability or unwillingness of insurers to timely reimburse for claims in the future; – disputes as to documentation requirements for DII Industries in order to recover claims paid; – the inability to access insurance policies shared with, or the dissipation of shared insurance assets by, Harbison-Walker Refractories Company or Federal- Mogul Products, Inc.; – the insolvency or reduced financial viability of insurers; – the cost of litigation to obtain insurance reimbursement; and – adverse court decisions as to our rights to obtain insurance reimbursement; • the results of recovering, or agreeing in settlement of litigation to recover, less insurance reimbursement than the insurance receivable recorded in our financial statements; L i q u i d i t y • adverse financial developments that could affect our available cash or lines of credit, including: – the effects described above of not completing the proposed global settlement or not being able to timely recover insurance reimbursement relating to amounts paid as part of a global settlement or as a result of judgments against us or settlements paid in the absence of a global settlement; – our inability to provide cash collateral for letters of credit or any bonding requirements from customers or as a result of adverse judgments that we are appealing; and – a reduction in our credit ratings as a result of the above or due to other adverse developments; • requirements to cash collateralize letters of credit and surety bonds by issuers and beneficiaries of these instruments in reaction to: – our plans to place DII Industries, Kellogg, Brown & Root and some of their subsidiaries into a pre-packaged Chapter 11 bankruptcy as part of the proposed global settlement; – in the absence of a global settlement, one or more • continuing exposure to liability even after the proposed substantial adverse judgments; settlement is completed, including exposure to: – not being able to timely recover insurance – any claims by claimants exposed outside of the United reimbursement; or States; – a reduction in credit ratings; – possibly any claims based on future exposure to silica; • our ability to secure financing on acceptable terms to fund – property damage claims as a result of asbestos and our proposed global settlement; silica use; or – any claims against any other subsidiaries or business units of Halliburton that would not be released in the Chapter 11 proceeding through the 524(g) injunction; • defaults that could occur under our and our subsidiaries’ debt documents as a result of a Chapter 11 filing unless we are able to obtain consents or waivers to those events of default, which events of default could cause defaults under other of our credit facilities and possibly result in 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 63 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S an obligation to immediately pay amounts due thereunder; • actions by issuers and beneficiaries of current letters of credit to draw under such letters of credit prior to our completion of a new letter of credit facility that is intended to provide reasonably sufficient credit lines for us to be able to fund any such cash requirements; • restrictions on our ability to provide products and services to Iran, Iraq and Libya, all of which are significant producers of oil and gas; • protective government regulation in many of the countries where we operate, including, for example, regulations that: – encourage or mandate the hiring of local contractors; • obtaining debtor-in-possession financing for DII Industries, and Kellogg, Brown & Root and their subsidiaries prior to filing a Chapter 11 proceeding; • reductions in our credit ratings by rating agencies, which could result in: – the unavailability of borrowing capacity under our existing $350 million line of credit facility, which is only available to us if we maintain an investment grade credit rating; – reduced access to lines of credit, credit markets and credit from suppliers under acceptable terms; – borrowing costs in the future; and – inability to issue letters of credit and surety bonds with or without cash collateral; • debt and letter of credit covenants; • volatility in the surety bond market; • availability of financing from the United States Export/Import Bank; • ability to raise capital via the sale of stock; and – require foreign contractors to employ citizens of, or purchase supplies from, a particular jurisdiction; • potentially adverse reaction, and time and expense responding to, the increased scrutiny of Halliburton by regulatory authorities, the media and others; • potential liability and adverse regulatory reaction in Nigeria to the theft from us of radioactive material used in wireline logging operations; • environmental laws and regulations, including, for example, those that: – require emission performance standards for facilities; and – the potential regulation in the United States of our Energy Services Group’s hydraulic fracturing services and products as underground injection; and • the proposed excise tax in the United States targeted at heavy equipment of the type we own and use in our operations would negatively impact our Energy Services Group operating income; • an adverse effect on our financial condition or results of E f f e c t o f C h a p t e r 1 1 P r o c e e d i n g s operations as a result of any of the foregoing; L e g a l • litigation, including, for example, class action shareholder and derivative lawsuits, contract disputes, patent infringements, and environmental matters; • any adverse outcome of the SEC’s current investigation into Halliburton’s accounting policies, practices and procedures that could result in sanctions and the payment of fines or penalties, restatement of financials for years under review or additional shareholder lawsuits; • trade restrictions and economic embargoes imposed by the United States and other countries; • the adverse effect on the ability of the subsidiaries that are proposed to file a Chapter 11 proceeding to obtain new orders from current or prospective customers; • the potential reluctance of current and prospective customers and suppliers to honor obligations or continue to transact business with the Chapter 11 filing entities; • the potential adverse effect of the Chapter 11 filing of negotiating favorable terms with customers, suppliers and other vendors; • a prolonged Chapter 11 proceeding that could adversely affect relationships with customers, suppliers and employees, which in turn could adversely affect our 64 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S competitive position, financial condition and results of operations and our ability to implement the proposed plan of reorganization; and • the adverse affect on our financial condition or results of operations as a result of the foregoing; G e o p o l i t i c a l • armed conflict in the Middle East that could: – impact the demand and pricing for oil and gas; – disrupt our operations in the region and elsewhere; and – increase our costs for security worldwide; – weather related damage to our facilities; – inability to deliver materials to jobsites in accordance with contract schedules; and – loss of productivity; and • demand for natural gas in the United States drives a disproportionate amount of our Energy Services Group’s United States business. As a result, warmer than normal winters in the United States are detrimental to the demand for our services to gas producers. Conversely, colder than normal winters in the United States result in increased demand for our services to gas producers; • unsettled political conditions, consequences of war or C u s t o m e r s other armed conflict, the effects of terrorism, civil unrest, strikes, currency controls and governmental actions in many oil producing countries and countries in which we provide governmental logistical support that could adversely affect our revenues and profit. Countries where we operate which have significant amounts of political risk include Afghanistan, Algeria, Angola, Colombia, Indonesia, Libya, Nigeria, Russia, and Venezuela. For example, the national strike in Venezuela as well as seizures of offshore oil rigs by protestors and cessation of operations by some of our customers in Nigeria have disrupted our Energy Services Group’s ability to provide services and products to our customers in these countries during 2002 and likely will continue to do so in 2003; and • changes in foreign exchange rates and exchange controls as were experienced in Argentina in late 2001 and early 2002. For example, the changes in Argentina exchange rates in late 2001 and early 2002 were detrimental to results of our Energy Services Group operations in Argentina; We a t h e r r e l a t e d • severe weather that impacts our business, particularly in the Gulf of Mexico where we have significant operations. Impacts may include: – evacuation of personnel and curtailment of services; – weather related damage to offshore drilling rigs resulting in suspension of operations; • the magnitude of governmental spending and outsourcing for military and logistical support of the type that we provide, including, for example, support services in the Balkans; • changes in capital spending by customers in the oil and gas industry for exploration, development, production, processing, refining, and pipeline delivery networks; • changes in capital spending by governments for infrastructure projects of the sort that we perform; • consolidation of customers including, for example, the merger of Conoco and Phillips Petroleum, has caused customers to reduce their capital spending which has negatively impacted the demand for our services and products; • potential adverse customer reaction, including potential draws upon letters of credit, due to their concerns about our plans to place DII Industries, Kellogg, Brown & Root and some of their subsidiaries into a pre-packaged bankruptcy as part of the global settlement; • customer personnel changes due to mergers and consolidation which impacts the timing of contract negotiations and settlements of claims; • claim negotiations with engineering and construction customers on cost and schedule variances and change orders on major projects, including, for example, the Barracuda-Caratinga project in Brazil; and • ability of our customers to timely pay the amounts due us; 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 65 M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S I n d u s t r y P e r s o n n e l a n d m e r g e r s /r e o r g a n i z a t i o n s /d i s p o s i t i o n s • changes in oil and gas prices, among other things, • integration of acquired businesses into Halliburton, result from: including: – the armed conflict in the Middle East; – standardizing information systems or integrating data – OPEC’s ability to set and maintain production levels from multiple systems; and prices for oil; – maintaining uniform standards, controls, procedures, – the level of oil production by non-OPEC countries; and policies; and – the policies of governments regarding exploration for and production and development of their oil and natural gas reserves; and – the level of demand for oil and natural gas, especially natural gas in the United States; • obsolescence of our proprietary technologies, equipment and facilities, or work processes; • changes in the price or the availability of commodities that we use; – combining operations and personnel of acquired businesses with ours; • effectively restructuring operations and personnel within Halliburton including, for example, the segregation of our business into two operating subsidiary groups under Halliburton; • ensuring acquisitions and new products and services add value and complement our core businesses; and • successful completion of planned dispositions. • our ability to obtain key insurance coverage on acceptable In addition, future trends for pricing, margins, revenues terms; • nonperformance, default or bankruptcy of joint venture and profitability remain difficult to predict in the industries we serve. We do not assume any responsibility to publicly partners, key suppliers or subcontractors; update any of our forward-looking statements regardless of • performing fixed-price projects, where failure to meet schedules, cost estimates or performance targets could result in reduced profit margins or losses; • entering into complex business arrangements for technically demanding projects where failure by one or more parties could result in monetary penalties; and • the use of derivative instruments of the sort that we use which could cause a change in value of the derivative instruments as a result of: whether factors change as a result of new information, future events or for any other reason. You should review any additional disclosures we make in our press releases and Forms 10-K, 10-Q and 8-K filed with the United States Securities and Exchange Commission. We also suggest that you listen to our quarterly earnings release conference calls with financial analysts. No assurance can be given that our financial condition or results of operations would not be materially and adversely – adverse movements in foreign exchange rates, interest affected by some of the events described above, including: rates, or commodity prices; or – the value and time period of the derivative being different than the exposures or cash flows being hedged; Sy s t e m s • the successful identification, procurement and installation of a new financial system to replace the current system for the Engineering and Construction Group; • the inability to complete a global settlement; • in the absence of a global settlement, adverse developments in the tort system, including adverse judgments and increased defense and settlement costs relating to claims against us; • liquidity issues resulting from failure to complete a global settlement, adverse developments in the tort system, including adverse judgments and increased defense and settlement costs, and resulting or concurrent credit 66 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T M A N A G E M E N T ’ S D I S C U S S I O N A N D A N A L Y S I S ratings downgrades and/or demand for cash collateral- ization of letters of credit or surety bonds; termination costs and some employee severance costs that are associated with a restructuring, discontinued operation, • the filing of Chapter 11 proceedings by some of our plant closing, or other exit or disposal activity. SFAS No. subsidiaries or a prolonged Chapter 11 proceeding; and 146 is to be applied prospectively to exit or disposal • adverse geopolitical developments, including armed activities initiated after December 31, 2002 and would only conflict, civil disturbance and unsettled political conditions in foreign countries in which we operate. N E W A C C O U N T I N G P R O N O U N C E M E N T S In August 2001, the Financial Accounting Standards Board issued SFAS No. 143, “Accounting for Asset Retirement affect the timing of charges associated with any future exit or disposal activity. In November 2002, the Financial Accounting Standards Board issued FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” Obligations” which addresses the financial accounting and (FIN 45). This statement requires that a liability be reporting for obligations associated with the retirement of recorded in the guarantor’s balance sheet upon issuance of a tangible long-lived assets and the associated assets’ guarantee. In addition, FIN 45 requires disclosures about retirement costs. SFAS No. 143 requires that the fair value the guarantees that an entity has issued, including a of a liability associated with an asset retirement be rollforward of the entity’s product warranty liabilities. We recognized in the period in which it is incurred if a reasonable will apply the recognition provisions of FIN 45 prospectively estimate of fair value can be made. The associated retirement costs are capitalized as part of the carrying to guarantees issued after December 31, 2002. The disclosure provisions of FIN 45 are effective for financial statements of amount of the long-lived asset and subsequently depreciated interim and annual periods ending December 15, 2002. over the life of the asset. We currently account for liabilities associated with asset retirement obligations under existing accounting standards, such as SFAS 19, SFAS 5, SOP 96-1, and EITF 89-30, which do not require The adoption of FIN 45 will not have a material effect on our consolidated financial position and results of operations. In January 2003, the Financial Accounting Standards Board issued FASB Interpretation No. 46, “Consolidation of the asset retirement obligations to be recorded at fair value Variable Interest Entities, an Interpretation of ARB No. 51” and in some instances do not require the costs to be recognized in the carrying amount of the related asset. The new standard is effective for us beginning January 1, 2003, and the effects of this standard will be immaterial to our (FIN 46). This statement requires specified variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not future financial condition and we estimate will require a have sufficient equity at risk for the entity to finance its charge of less than $10 million after tax as a cumulative activities without additional subordinated financial support effect of a change in accounting principle. from other parties. FIN 46 is effective for all new variable In July 2002 the Financial Accounting Standards Board interest entities created or acquired after January 31, 2003 issued SFAS No. 146, “Accounting for Costs Associated with and beginning July 1, 2003 for variable interest entities Exit or Disposal Activities”. The standard requires created or acquired prior to February 1, 2003. Our exposure companies to recognize costs associated with exit or disposal to variable interest entities is limited and, therefore, the activities when the liabilities are incurred rather than at adoption of FIN 46 is not expected to have a material the date of a commitment to an exit or disposal plan. impact on our consolidated financial position and results Examples of costs covered by the standard include lease of operations. 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 67 R E S P O N S I B I L I T Y F O R F I N A N C I A L R E P O R T I N G We are responsible for the preparation and integrity of our are taken to address control deficiencies and other published financial statements. The financial statements opportunities for improving the system as they are have been prepared in accordance with accounting principles identified. In accordance with the Securities and Exchange generally accepted in the United States of America and, Commission’s rules to improve the reliability of financial accordingly, include amounts based on judgments and statements, our 2002 interim financial statements were estimates made by our management. We also prepared the reviewed by KPMG LLP. other information included in the annual report and There are inherent limitations in the effectiveness of any are responsible for its accuracy and consistency with the system of internal control, including the possibility of human financial statements. error and the circumvention or overriding of controls. Our 2002 financial statements have been audited by the Accordingly, even an effective internal control system can independent accounting firm, KPMG LLP. KPMG LLP provide only reasonable assurance with respect to the was given unrestricted access to all financial records and reliability of our financial statements. Also, the effectiveness related data, including minutes of all meetings of of an internal control system may change over time. stockholders, the Board of Directors and committees of the We have assessed our internal control system in relation Board. Halliburton’s Audit Committee of the Board of to criteria for effective internal control over financial Directors consists of directors who, in the business judgment reporting described in “Internal Control-Integrated of the Board of Directors, are independent under the Framework” issued by the Committee of Sponsoring New York Stock Exchange listing standards. The Board of Organizations of the Treadway Commission. Based upon Directors, operating through its Audit Committee, that assessment, we believe that, as of December 31, 2002, provides oversight to the financial reporting process. Integral our system of internal control over financial reporting met to this process is the Audit Committee’s review and those criteria. discussion with management and the external auditors of the quarterly and annual financial statements prior to their respective filing. We maintain a system of internal control over financial reporting, which is intended to provide reasonable assurance HALLIBURTON COMPANY by to our management and Board of Directors regarding the David J. Lesar reliability of our financial statements. The system includes: Chairman of the Board, • a documented organizational structure and division of responsibility; President and Chief Executive Officer • established policies and procedures, including a code of conduct to foster a strong ethical climate which is communicated throughout the company; and • the careful selection, training and development of our people. Internal auditors monitor the operation of the internal control system and report findings and recommendations to management and the Board of Directors. Corrective actions Douglas L. Foshee Executive Vice President and Chief Financial Officer 68 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T I N D E P E N D E N T A U D I T O R ’ S R E P O R T T O T H E S H A R E H O L D E R S A N D B O A R D O F D I R E C T O R S O F H A L L I B U R T O N C O M PA N Y: We have audited the accompanying consolidated balance sheet of Halliburton Company and subsidiaries as of December 31, 2002, and the related consolidated statements of operations, shareholders’ equity, and cash flows for the year then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit. The accompanying 2001 and 2000 consolidated financial statements of Halliburton Company and subsidiaries were audited by other auditors who have ceased operations. Those auditors expressed an unqualified opinion on those consolidated financial statements, before the restatement described in Note 4 to the consolidated financial statements and before the revision described in Note 22 to the consolidated financial statements, in their report dated January 23, 2002 (except with respect to matters discussed in Note 9 to those financial statements, as to which the date was February 21, 2002). We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the 2002 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Halliburton Company and subsidiaries as of December 31, 2002, and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. As discussed above, the 2001 and 2000 consolidated financial statements of Halliburton Company and subsidiaries were audited by other auditors who have ceased operations. As described in Note 4, the Company changed the composition of its reportable segments in 2002, and the amounts in the 2001 and 2000 consolidated financial statements relating to reportable segments have been restated to conform to the 2002 composition of reportable segments. We audited the adjustments that were applied to restate the disclosures for reportable segments reflected in the 2001 and 2000 consolidated financial statements. In our opinion, such adjustments are appropriate and have been properly applied. Also, as described in Note 22, these consolidated financial statements have been revised to include the transitional disclosures required by Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, which was adopted by the Company as of January 1, 2002. In our opinion, the disclosures for 2001 and 2000 in Note 22 are appropriate. However, we were not engaged to audit, review, or apply any procedures to the 2001 and 2000 consolidated financial statements of Halliburton Company and subsidiaries other than with respect to such adjustments and revisions and, accordingly, we do not express an opinion or any other form of assurance on the 2001 and 2000 consolidated financial statements taken as a whole. K P M G L L P Houston, Texas March 13, 2003 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 69 R E P O R T O F I N D E P E N D E N T P U B L I C A C C O U N T A N T S This report is a copy of a previously issued report, the predecessor auditor has not reissued this report, the previously issued report refers to financial statements not physically included in this document, and the prior-period financial statements have been revised or restated. T O T H E S H A R E H O L D E R S A N D B O A R D O F D I R E C T O R S O F H A L L I B U R T O N C O M PA N Y: management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Halliburton Company and subsidiary companies as of December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three We have audited the accompanying consolidated balance years in the period ended December 31, 2001, in sheets of Halliburton Company (a Delaware corporation) conformity with accounting principles generally accepted in and subsidiary companies as of December 31, 2001 and the United States of America. 2000, and the related consolidated statements of income, cash flows, and shareholders’ equity for each of the three years in the period ended December 31, 2001. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by A R T H U R A N D E R S E N L L P Dallas, Texas January 23, 2002 (Except with respect to certain matters discussed in Note 9, as to which the date is February 21, 2002.) 70 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T C O N S O L I D A T E D S T A T E M E N T S O F O P E R A T I O N S Years ended December 31 (Millions of dollars and shares except per share data) REVENUES: Services Product sales Equity in earnings of unconsolidated affiliates Total revenues OPERATING COSTS AND EXPENSES: Cost of services Cost of sales General and administrative Gain on sale of marine vessels Gain on sale of business assets Total operating costs and expenses OPERATING INCOME (LOSS) Interest expense Interest income Foreign currency losses, net Other, net INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES, MINORITY INTEREST, AND CHANGE IN ACCOUNTING METHOD, NET Provision for income taxes Minority interest in net income of subsidiaries INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE CHANGE IN ACCOUNTING METHOD, NET DISCONTINUED OPERATIONS: Income (loss) from discontinued operations, net of tax (provision) benefit of $154, $20, and ($60) Gain on disposal of discontinued operations, net of tax provision of $0, $199, and $141 Income (loss) from discontinued operations, net Cumulative effect of change in accounting method, net NET INCOME (LOSS) BASIC INCOME (LOSS) PER SHARE: Income (loss) from continuing operations before change in accounting method, net Income (loss) from discontinued operations Gain on disposal of discontinued operations Net income (loss) DILUTED INCOME (LOSS) PER SHARE: Income (loss) from continuing operations before change in accounting method, net Income (loss) from discontinued operations Gain on disposal of discontinued operations Net income (loss) Basic average common shares outstanding Diluted average common shares outstanding See notes to annual financial statements. 2002 2001 2000 $10,658 1,840 74 $12,572 $10,737 1,642 335 — (30) $12,684 (112) (113) 32 (25) (10) (228) (80) (38) (346) (652) — ( 652) — $ (998) $ (0.80) (1.51) — $ (2.31) $ (0.80) (1.51) — $ (2.31) 432 432 $10,940 1,999 107 $13,046 $ 9,831 1,744 387 — — $11,962 1,084 (147) 27 (10) — 954 (384) (19) 551 (42) 299 257 1 809 1.29 (0.10) 0.70 1.89 1.28 (0.10) 0.70 1.88 428 430 $ $ $ $ $ $10,185 1,671 88 $11,944 $ 9,755 1,463 352 (88) — $11,482 462 (146) 25 (5) (1) 335 (129) (18) 188 98 215 313 — 501 0.42 0.22 0.49 1.13 0.42 0.22 0.48 1.12 442 446 $ $ $ $ $ 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 71 C O N S O L I D A T E D B A L A N C E S H E E T S December 31 (Millions of dollars and shares except per share data) ASSETS CURRENT ASSETS: Cash and equivalents Receivables: Notes and accounts receivable (less allowance for bad debts of $157 and $131) Unbilled work on uncompleted contracts TOTAL RECEIVABLES Inventories Current deferred income taxes Other current assets TOTAL CURRENT ASSETS Net property, plant and equipment Equity in and advances to related companies Goodwill Noncurrent deferred income taxes Insurance for asbestos and silica related liabilities Other assets TOTAL ASSETS LIABILITIES AND SHAREHOLDERS’ EQUITY CURRENT LIABILITIES: Short-term notes payable Current maturities of long-term debt Accounts payable Accrued employee compensation and benefits Advance billings on uncompleted contracts Deferred revenues Income taxes payable Other current liabilities TOTAL CURRENT LIABILITIES Long-term debt Employee compensation and benefits Asbestos and silica related liabilities Other liabilities Minority interest in consolidated subsidiaries TOTAL LIABILITIES SHAREHOLDERS’ EQUITY: Common shares, par value $2.50 per share – authorized 600 shares, issued 456 and 455 shares Paid-in capital in excess of par value Deferred compensation Accumulated other comprehensive income Retained earnings Less 20 and 21 shares of treasury stock, at cost TOTAL SHAREHOLDERS’ EQUITY TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY See notes to annual financial statements. 2002 2001 $ 1,107 $ 290 2,533 724 3,257 734 200 262 5,560 2,629 413 723 607 2,059 853 $12,844 $ 49 295 1,077 370 641 100 148 592 3,272 1,181 756 3,425 581 71 9,286 1,141 293 (75) (281) 3,110 4,188 630 3,558 $12,844 3,015 1,080 4,095 787 154 247 5,573 2,669 551 720 410 612 431 $10,966 $ 44 81 917 357 611 99 194 605 2,908 1,403 570 737 555 41 6,214 1,138 298 (87) (236) 4,327 5,440 688 4,752 $10,966 72 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T C O N S O L I D A T E D S T A T E M E N T S O F S H A R E H O L D E R S ’ E Q U I T Y Years ended December 31 (Millions of dollars and shares) COMMON STOCK (NUMBER OF SHARES): Balance at beginning of year Shares issued under compensation and incentive stock plans, net of forfeitures Shares issued for acquisition Balance at end of year COMMON STOCK (DOLLARS): Balance at beginning of year Shares issued under compensation and incentive stock plans, net of forfeitures Shares issued for acquisition Balance at end of year PAID-IN CAPITAL IN EXCESS OF PAR VALUE: Balance at beginning of year Shares issued under compensation and incentive stock plans, net of forfeitures Tax benefit Shares issued for acquisition, net Balance at end of year DEFERRED COMPENSATION: Balance at beginning of year Current year awards, net of tax Balance at end of year ACCUMULATED OTHER COMPREHENSIVE INCOME: Cumulative translation adjustment Pension liability adjustment Unrealized loss on investments and derivatives Balance at end of year CUMULATIVE TRANSLATION ADJUSTMENT: Balance at beginning of year Sales of subsidiaries Current year changes Balance at end of year * Actual shares issued in 2002 were 357,000. See notes to annual financial statements. 2002 2001 2000 455 — * 1 456 453 1 1 455 448 4 1 453 $ 1,138 $1,132 $1,120 1 2 $ 1,141 2 4 $1,138 9 3 $1,132 $ 298 $ 259 $ 68 (24) (5) 24 $ 293 $ $ (87) 12 (75) $ (121) (157) (3) $ (281) $ (205) 15 69 $ (121) 30 (2) 11 $ 298 $ $ (63) (24) (87) $ (205) (27) (4) $ (236) $ (275) 102 (32) $ (205) 109 38 44 $ 259 $ (51) (12) $ (63) $ (275) (12) (1) $ (288) $ (185) 11 (101) $ (275) 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 73 C O N S O L I D A T E D S T A T E M E N T S O F S H A R E H O L D E R S ’ E Q U I T Y ( c o n t ’ d ) Years ended December 31 (Millions of dollars and shares) PENSION LIABILITY ADJUSTMENT: Balance at beginning of year Sale of subsidiary Current year change, net of tax Balance at end of year UNREALIZED GAIN (LOSS) ON INVESTMENTS: Balance at beginning of year Current year unrealized gain (loss) on investments and derivatives Balance at end of year $ $ (4) 1 (3) RETAINED EARNINGS: Balance at beginning of year Net income (loss) Cash dividends paid Balance at end of year TREASURY STOCK (NUMBER OF SHARES): Beginning of year Shares issued under benefit, dividend reinvestment plan and incentive stock plans, net Shares issued for acquisition Shares purchased Balance at end of year TREASURY STOCK (DOLLARS): $ 4,327 (998) (219) $ 3,110 21 (2) — 1 20 2002 2001 2000 $ (27) — (130) $ (157) $ $ $ $ (12) 12 (27) (27) (1) (3) (4) $3,733 809 (215) $4,327 26 (2) (4) 1 21 $ (19) 7 — $ (12) $ — (1) (1) $ $3,453 501 (221) $3,733 6 — — 20 26 Beginning of year Shares issued under benefit, dividend reinvestment plan and $ 688 $ 845 $ 99 incentive stock plans, net Shares issued for acquisition Shares purchased Balance at end of year COMPREHENSIVE INCOME (LOSS): Net income (loss) Cumulative translation adjustment, net of tax Less reclassification adjustments for losses included in net income Net cumulative translation adjustment Current year adjustment to minimum pension liability, net of tax Unrealized gain/(loss) on investments and derivatives Total comprehensive income (loss) See notes to annual financial statements. (62) — 4 630 $ $ (998) 69 15 84 (130) 1 $ (1,043) (51) (140) 34 $ 688 $ 809 (32) 102 70 (15) (3) $ 861 (23) — 769 $ 845 $ 501 (101) 11 (90) 7 (1) $ 417 74 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T C O N S O L I D A T E D S T A T E M E N T S O F C A S H F L O W S Years ended December 31 (Millions of dollars) CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) Adjustments to reconcile net income to net cash from operations: Loss (income) from discontinued operations Depreciation, depletion and amortization Provision (benefit) for deferred income taxes Distributions from (advances to) related companies, net of equity in (earnings) losses Change in accounting method, net Gain on sale of assets Gain on option component of joint venture sale Asbestos and silica related liabilities, net Accrued special charges Other non-cash items Other changes, net of non-cash items: Receivables and unbilled work on uncompleted contracts Sale of receivables, net Inventories Accounts payable Other working capital, net Other operating activities Total cash flows from operating activities CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures Sales of property, plant and equipment Acquisitions of businesses, net of cash acquired Dispositions of businesses, net of cash disposed Proceeds from sale of securities Investments – restricted cash Other investing activities Total cash flows from investing activities CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from long-term borrowings Payments on long-term borrowings (Repayments) borrowings of short-term debt, net Payments of dividends to shareholders Proceeds from exercises of stock options Payments to reacquire common stock Other financing activities Total cash flows from financing activities Effect of exchange rate changes on cash Net cash flows from discontinued operations (1) Increase (decrease) in cash and equivalents Cash and equivalents at beginning of year CASH AND EQUIVALENTS AT END OF YEAR SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash payments during the year for: Interest Income taxes Non-cash investing and financing activities: Liabilities assumed in acquisitions of businesses Liabilities disposed of in dispositions of businesses 2002 2001 2000 $ (998) $ 809 $ 501 652 505 (151) 3 — (22) (3) 588 — 101 675 180 62 71 (78) (23) 1,562 (764) 266 — 170 62 (187) (20) (473) 66 (81) (2) (219) — (4) (8) (248) (24) — 817 290 $ 1,107 $ 104 94 $ $ — $ — (257) 531 26 8 (1) — — 96 (6) (3) (199) — (91) 118 122 (124) 1,029 (797) 120 (220) 61 — 4 (26) (858) 425 (13) (1,528) (215) 27 (34) (17) (1,355) (20) 1,263 59 231 $ 290 $ 132 $ 382 $ 92 $ 500 (313) 503 (6) (64) — — — 4 (63) (22) (896) — 8 170 155 (34) (57) (578) 209 (10) 19 — 5 (56) (411) — (308) 629 (221) 105 (769) (20) (584) (9) 826 (235) 466 $ 231 $ 144 $ 310 $ 95 $ 499 (1) Net cash flows from discontinued operations in 2001 include proceeds of $1.27 billion from the sale of the remaining businesses in Dresser Equipment Group and in 2000 proceeds of $913 million from the sales of Dresser-Rand in 2000 and Ingersoll-Dresser Pump in 1999. See Note 3. See notes to annual financial statements. 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 75 N O T E S T O A N N U A L F I N A N C I A L S T A T E M E N T S N O T E 1 . S I G N I F I C A N T A C C O U N T I N G P O L I C I E S transactions are eliminated. Investments in companies in which we own a 50% interest or less and have a significant We employ accounting policies that are in accordance with influence are accounted for using the equity method and if accounting principles generally accepted in the United we do not have significant influence we use the cost method. States of America. The preparation of financial statements Prior year amounts have been reclassified to conform to the in conformity with accounting principles generally accepted current year presentation. in the United States of America requires us to make R e v e n u e r e c o g n i t i o n . We recognize revenues as estimates and assumptions that affect: services are rendered or products are shipped. Generally the • the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements; and date of shipment corresponds to the date upon which the customer takes title to the product and assumes all risk and rewards of ownership. The distinction between services • the reported amounts of revenues and expenses during and product sales is based upon the overall activity of the the reporting period. Ultimate results could differ from those estimates. D e s c r i p t i o n o f C o m p a n y. Halliburton Company’s predecessor was established in 1919 and incorporated under the laws of the State of Delaware in 1924. Halliburton Company provides a variety of services, products, maintenance, engineering and construction to energy, industrial and governmental customers. We operate in two business segments: • Energy Services Group; and • Engineering and Construction Group. particular business operation. Training and consulting service revenues are recognized as the services are performed. Sales of perpetual software licenses, net of deferred maintenance fees, are recorded as revenue upon shipment. Sales of use licenses are recognized as revenue over the license period. Post-contract customer support agreements are recorded as deferred revenues and recognized as revenue ratably over the contract period of generally one year’s duration. E n g i n e e r i n g a n d c o n s t r u c t i o n c o n t ra c t s . Revenues from engineering and construction contracts are reported on the percentage of completion method of accounting using The Energy Services Group segment provides discrete measurements of progress toward completion appropriate services and products and integrated solutions ranging from for the work performed. Progress is generally based upon the initial evaluation of producing formations to drilling, physical progress, man-hours or costs incurred based upon completion, production and well maintenance. In addition, the appropriate method for the type of job. When revenue the segment is the leading supplier of integrated exploration and costs are recorded from engineering and construction and production software information systems as well as contracts, we comply with paragraph 81 of American Institute professional and data management services for the upstream of Certified Public Accountants Statement of Position 81-1, oil and gas industry. The Engineering and Construction also known as SOP 81-1. Under this method, revenues are Group segment, operating as KBR, provides a wide range of recognized as the sum of costs incurred during the period services to energy and industrial customers and government plus the gross profit earned, measured using the percentage entities worldwide. of completion method of accounting. All known or P r i n c i p l e s o f c o n s o l i d a t i o n . The consolidated financial anticipated losses on contracts are provided for when they statements include the accounts of our company and all of become evident in accordance with paragraph 85 of SOP our subsidiaries in which we own greater than 50% interest 81-1. Claims and change orders which are in the process or control. All material intercompany accounts and of being negotiated with customers, for extra work or changes in the scope of work, are included in revenue when 76 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T N O T E S T O A N N U A L F I N A N C I A L S T A T E M E N T S collection is deemed probable. For more details of revenue bulk materials are recorded using the last-in, first-out recognition, including other aspects of engineering and method. The cost of over 90% of the remaining inventory is construction accounting, including billings, claims and change recorded on the average cost method, with the remainder orders and liquidated damages, see Note 8 and Note 12. on the first-in, first-out method. See Note 7. R e s e a r c h a n d d e v e l o p m e n t . Research and development P r o p e r t y, p l a n t a n d e q u i p m e n t . Property, plant and expenses are charged to income as incurred. See Note 4 equipment are reported at cost less accumulated for research and development expense by business segment. depreciation, which is generally provided on the straight- S o f t wa r e d e v e l o p m e n t c o s t s . Costs of developing line method over the estimated useful lives of the assets. software for sale are charged to expense when incurred, as Some assets are depreciated on accelerated methods. research and development, until technological feasibility Accelerated depreciation methods are also used for tax has been established for the product. Once technological purposes, wherever permitted. Upon sale or retirement of an feasibility is established, software development costs are asset, the related costs and accumulated depreciation are capitalized until the software is ready for general release to removed from the accounts and any gain or loss is customers. We capitalized costs related to software recognized. When events or changes in circumstances developed for resale of $11 million in 2002, $19 million in indicate that assets may be impaired, an evaluation is 2001 and $7 million in 2000. Amortization expense of performed. The estimated future undiscounted cash flows software development costs was $19 million for 2002, $16 associated with the asset are compared to the asset’s million for 2001 and $12 million for 2000. Once the carrying amount to determine if a write-down to fair value software is ready for release, amortization of the software is required. We follow the successful efforts method of development costs begins. Capitalized software accounting for oil and gas properties. See Note 9. development costs are amortized over periods which do not M a i n t e n a n c e a n d r e p a i r s . Expenditures for maintenance exceed five years. and repairs are expensed; expenditures for renewals and I n c o m e p e r s h a r e . Basic income per share is based improvements are generally capitalized. We use the accrue- on the weighted average number of common shares in-advance method of accounting for major maintenance outstanding during the year. Diluted income per share and repair costs of marine vessel dry docking expense and includes additional common shares that would have been major aircraft overhauls and repairs. Under this method outstanding if potential common shares with a dilutive we anticipate the need for major maintenance and repairs effect had been issued. See Note 13 for a reconciliation of and charge the estimated expense to operations before the basic and diluted income per share. actual work is performed. At the time the work is C a s h e q u i v a l e n t s . We consider all highly liquid performed, the actual cost incurred is charged against the investments with an original maturity of three months or amounts that were previously accrued with any deficiency less to be cash equivalents. or excess charged or credited to operating expense. I n v e n t o r i e s . Inventories are stated at the lower of cost or G o o d w i l l . For acquisitions occurring prior to July 1, 2001, market. Cost represents invoice or production cost for new goodwill was amortized on a straight-line basis over periods items and original cost less allowance for condition for used not exceeding 40 years through December 31, 2001. material returned to stock. Production cost includes Effective July 1, 2001, we adopted SFAS No. 141, “Business material, labor and manufacturing overhead. Some United Combinations” and SFAS No. 142, “Goodwill and Other States manufacturing and field services finished products Intangible Assets”, which precludes amortization of goodwill and parts inventories for drill bits, completion products and related to acquisitions completed subsequent to June 30, 2001. Additionally, SFAS No. 142 precludes the amortization 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 77 N O T E S T O A N N U A L F I N A N C I A L S T A T E M E N T S of existing goodwill related to acquisitions completed prior No. 133 requires that we recognize all derivatives on the to July 1, 2001 for periods beginning January 1, 2002. See balance sheet at fair value. Derivatives that are not hedges Note 22 for discussion of this accounting change. SFAS No. must be adjusted to fair value and reflected immediately 142 requires an entity to segregate its operations into through the results of operations. If the derivative is “reporting units,” which we have determined to be the same designated as a hedge under SFAS No. 133, depending on as our reportable operating segments, or the Energy the nature of the hedge, changes in the fair value of Services Group and Engineering and Construction Group. derivatives are either offset against: Additionally, all goodwill has been assigned to one of these • the change in fair value of the hedged assets, liabilities or reporting units for purposes of determining impairment of firm commitments through earnings; or the goodwill. Because goodwill and some intangible assets • recognized in other comprehensive income until the are no longer amortized, the reported amounts of goodwill hedged item is recognized in earnings. and intangible assets are reviewed for impairment on an annual basis and more frequently when negative conditions such as significant current or projected operating losses exist. The annual impairment test is a two-step process and involves comparing the estimated fair value of each reporting unit to the reporting unit’s carrying value, including goodwill. If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is not considered impaired, and the second step of the impairment test is unnecessary. If the carrying amount of a reporting unit exceeds its fair value, the second step of the goodwill impairment test would be performed to measure the amount of impairment loss to be recorded, if any. I n c o m e t a x e s . Deferred tax assets and liabilities are recognized for the expected future tax consequences of events that have been recognized in the financial statements or tax returns. A valuation allowance is provided for deferred tax assets if it is more likely than not that these items will either expire before we are able to realize their benefit, or that future deductibility is uncertain. D e r i v a t i v e i n s t r u m e n t s . We enter into derivative financial transactions to hedge existing or projected exposures to changing foreign currency exchange rates, interest rates and commodity prices. We do not enter into derivative transactions for speculative or trading purposes. Effective January 1, 2001, we adopted SFAS No. 133 “Accounting for Derivative Instruments and Hedging Activities.” SFAS The ineffective portion of a derivative’s change in fair value is immediately recognized in earnings. Recognized gains or losses on derivatives entered into to manage foreign exchange risk are included in foreign currency gains and losses on the consolidated statements of operations. Gains or losses on interest rate derivatives are included in interest expense and gains or losses on commodity derivatives are included in operating income. During the three years ended December 31, 2002, we did not enter into any significant transactions to hedge commodity prices. See Note 11 for discussion of interest rate swaps and Note 19 for further discussion of foreign currency exchange derivatives. Fo r e i g n c u r r e n c y t r a n s l a t i o n . Foreign entities whose functional currency is the United States dollar translate monetary assets and liabilities at year-end exchange rates, and non-monetary items are translated at historical rates. Income and expense accounts are translated at the average rates in effect during the year, except for depreciation, cost of product sales and revenues, and expenses associated with non-monetary balance sheet accounts which are translated at historical rates. Gains or losses from changes in exchange rates are recognized in consolidated income in the year of occurrence. Foreign entities whose functional currency is the local currency translate net assets at year-end rates and income and expense accounts at average exchange rates. Adjustments resulting from these translations are reflected in the consolidated statements of shareholders’ equity under “Cumulative translation adjustment”. 78 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T N O T E S T O A N N U A L F I N A N C I A L S T A T E M E N T S L o s s c o n t i n g e n c i e s . We accrue for loss contingencies N O T E 2 . based upon our best estimates in accordance with SFAS A C Q U I S I T I O N S A N D D I S P O S I T I O N S No. 5, “Accounting for Contingencies”. See Note 12 for M a g i c E a r t h a c q u i s i t i o n . We acquired Magic Earth, Inc., a discussion of our significant loss contingencies. 3-D visualization and interpretation technology company S t o c k- B a s e d C o m p e n s a t i o n . At December 31, 2002, we with broad applications in the area of data interpretation in have six stock-based employee compensation plans, which are November 2001 for common shares with a value of $100 described more fully in Note 17. We account for those plans million. At the consummation of the transaction, we issued under the recognition and measurement principles of APB 4.2 million shares, valued at $23.93 per share, to complete Opinion No. 25, “Accounting for Stock Issued to Employees”, the purchase. Magic Earth became a wholly-owned and related Interpretations. No cost for stock options granted subsidiary and is reported within our Energy Services is reflected in net income, as all options granted under our Group segment. We recorded goodwill of $71 million, all of plans have an exercise price equal to the market value of the which is nondeductible for tax purposes. In addition, we underlying common stock on the date of grant. recorded intangible assets of $19 million, which are being The fair value of options at the date of grant was estimated amortized based on a five-year life. using the Black-Scholes option pricing model. The weighted P E S a c q u i s i t i o n . In February 2000, we acquired the average assumptions and resulting fair values of options remaining 74% of the shares of PES (International) Limited granted are as follows: Assumptions Risk-Free Interest Rate Expected Dividend Yield Expected Life (in years) Expected Volatility 2.9% 4.5% 5.2% 2.7% 2.3% 1.3% 5 5 5 63% 58% 54% Weighted Average Fair Value of Options Granted $ 6.89 $ 19.11 $ 21.57 2002 2001 2000 The following table illustrates the effect on net income and earnings per share if we had applied the fair value recognition provisions of FASB Statement No. 123, “Accounting for Stock-Based Compensation”, to stock-based employee compensation. Years ended December 31 Millions of dollars except per share data 2002 2001 2000 that we did not already own for a value of $126.7 million. This was based on 3.3 million shares of Halliburton common stock valued at $37.75 per share which was the closing stock price on January 12, 2000. PES is based in Aberdeen, Scotland, and has developed technology that complements Halliburton Energy Services’ real time reservoir solutions. To acquire the remaining 74% of PES, we issued 1.2 million shares of Halliburton common stock in February 2002, and we also issued rights that resulted in the issuance of 2.1 million additional shares of Halliburton common stock between February 2001 and February 2002. We issued 1 million shares in February 2001; 400,000 shares in June 2001; and the remaining 700,000 shares in February 2002 under these rights. These shares were included in the Net income (loss), as reported $ (998) $ 809 $ 501 cost of the acquisition as a contingent liability. We recorded Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects Net income (loss), pro forma Basic earnings (loss) per share: As reported Pro forma Diluted earnings (loss) per share: As reported Pro forma $115 million of goodwill, all of which is non-deductible for tax purposes. (26) (42) $ (1,024) $ 767 (41) $ 460 During the second quarter of 2001, we contributed the majority of PES’ assets and technologies, including $130 $ (2.31) $1.89 $ ( 2.37) $1.79 $1.13 $1.04 $ ( 2.31) $1.88 $ ( 2.37) $1.77 $1.12 $1.03 million of goodwill associated with the purchase of PES, to a newly formed joint venture with Shell Technology Ventures BV, WellDynamics. We received $39 million in cash as an equity equalization adjustment, which we recorded as a 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 79 N O T E S T O A N N U A L F I N A N C I A L S T A T E M E N T S reduction in our investment in the joint venture. We own approximately $94 million. The $12 million difference is 50% of WellDynamics and account for this investment using being amortized over ten years representing the average the equity method. The formation of WellDynamics resulted remaining useful life of the assets contributed. We own 50% in a difference of $90 million between the carrying amount of Subsea 7 and account for this investment using the equity of our investment and our equity in the underlying net assets method. The remaining 50% is owned by DSND Subsea ASA. of the joint venture, which has been recorded as goodwill B r e d e r o - S h a w d i s p o s i t i o n . On September 30, 2002 we under “Equity in and advances to related companies”. The sold our 50% interest in the Bredero-Shaw joint venture to remaining assets and goodwill of PES relating to completions our partner ShawCor Ltd. The purchase price of $149 and well intervention products have been combined with our million is comprised of $53 million in cash, a short-term existing completion products product service line. note for $25 million and 7.7 million of ShawCor Class A P G S D a t a M a n a g e m e n t a c q u i s i t i o n . In March 2001, we Subordinate shares. In addition to our second quarter acquired the PGS Data Management division of Petroleum impairment charge of $61 million ($0.14 per diluted share Geo-Services ASA (PGS) for $164 million in cash. The after-tax) related to the pending sale of Bredero-Shaw, we acquisition agreement also calls for Landmark to provide, for recorded a third quarter pretax loss on sale of $18 million, a fee, strategic data management and distribution services or $0.04 per diluted share. Included in this loss was $15 to PGS for three years from the date of acquisition. We million of cumulative translation adjustment loss which was recorded intangible assets of $14 million and goodwill of $149 realized upon the disposition of our investment in Bredero- million in our Energy Services Group segment, $9 million of Shaw. During the 2002 fourth quarter, we recorded in “Other, which is non-deductible for tax purposes. The intangible net” a $9.1 million loss on the sale of ShawCor shares, or assets are being amortized based on a three-year life. $0.02 per diluted share. E u r o p e a n M a r i n e C o n t ra c t o r s L t d . d i s p o s i t i o n . In D r e s s e r E q u i p m e n t G r o u p d i s p o s i t i o n . In April 2001, January 2002, we sold our 50% interest in European Marine we disposed of the remaining businesses in the Dresser Contractors Ltd., an unconsolidated joint venture reported Equipment Group. See Note 3. within our Energy Services Group, to our joint venture partner, Saipem. At the date of sale, we received $115 million in cash and a contingent payment option valued at $16 million resulting in a pretax operating income gain of $108 million. The contingent payment option was based on a formula linked to performance of the Oil Service Index. In February 2002, we exercised our option receiving an additional $19 million and recorded a pretax gain of $3 million in “Other, net” in the statement of operations as a result of the increase in value of this option. The total transaction resulted in an after-tax gain of $68 million, or $0.16 per diluted share. S u b s e a 7 f o r m a t i o n . In May 2002, we contributed substantially all of our Halliburton Subsea assets to a newly formed company, Subsea 7, Inc. We contributed assets with a book value of approximately $82 million. The contributed assets were recorded by the new company at a fair value of N O T E 3 . D I S C O N T I N U E D O P E R AT I O N S For the twelve months ended December 31, 2002, we recorded a $806 million pretax charge in discontinued operations. The $806 million charge is primarily comprised of the following: • a $567 million charge during the fourth quarter due to a revision of our best estimate of our asbestos and silica liability based upon knowledge gained throughout the development of the agreement in principle for our proposed global settlement. The charge consisted of $1,047 million related to the asbestos and silica claims gross liability, which was offset by $480 million in anticipated related insurance recoveries; 80 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T N O T E S T O A N N U A L F I N A N C I A L S T A T E M E N T S • a $153 million charge during the second quarter in connection with our econometric study. The charge consisted of $1,176 million related to the gross liability on our asbestos and silica claims, which was offset by $1,023 million in anticipated insurance recoveries; • a $40 million payment associated with the Harbison- Walker bankruptcy filing recorded in the first quarter; and • $46 million in costs primarily related to the negotiation of the agreement in principle. During the second and third quarters of 2001, we recorded a $95 million pretax expense to discontinued operations. This amount was comprised of a $632 million charge related to the gross liability on Harbison-Walker asbestos claims, I n c o m e ( L o s s) f r o m O p e ra t i o n s o f D i s c o n t i n u e d B u s i n e s s e s Years ended December 31 Millions of dollars Revenues Operating income Asbestos litigation claims, net of insurance recoveries Tax benefit (expense) Net income (loss) 2002 2001 2000 $ — $359 $1,400 $ — $ 37 $ 158 (806) 154 (99) 20 — (60) $(652) $ (42) $ 98 Gain on disposal of discontinued operations reflects the gain on the sale of the remaining businesses within the Dresser Equipment Group in the second quarter of 2001 and the gain on the sale of Dresser-Rand in February 2000. which was offset by $537 million in anticipated related G a i n o n D i s p o s a l o f D i s c o n t i n u e d O p e ra t i o n s insurance recoveries. See Note 12. In late 1999 and early 2000 we sold our interest in two joint ventures that were a significant portion of our Dresser Equipment Group. These sales prompted a strategic review of the remaining businesses within the Dresser Equipment Group. As a result of this review, we determined that these remaining businesses did not closely fit with our core businesses, long-term goals and strategic objectives. In April 2000, our Board of Directors approved plans to sell all the remaining businesses within the Dresser Equipment Group. We sold these businesses on April 10, 2001 and we recognized a pretax gain of $498 million ($299 million after- tax) during the second quarter of 2001. The financial results of the Dresser Equipment Group through March 31, 2001 are presented as discontinued operations in our financial statements. As part of the terms of the transaction, we retained a 5.1% equity interest of Class A common stock in the Dresser Equipment Group, which has been renamed Dresser, Inc. In July 2002, Dresser, Inc. announced a reorganization, and we have exchanged our shares for shares of Dresser Ltd. Our equity interest is accounted for under the cost method. Millions of dollars 2001 2000 Proceeds from sale, less intercompany settlement Net assets disposed Gain before taxes Income taxes $1,267 $ 536 (769) (180) 498 356 (199) (141) Gain on disposal of discontinued operations $ 299 $ 215 N O T E 4 . B U S I N E S S S E G M E N T I N F O R M AT I O N We operate in two business segments – the Energy Services Group and the Engineering and Construction Group. Dresser Equipment Group is presented as part of discontinued operations through March 31, 2001 as a result of the sale in April 2001 of the remaining businesses within Dresser Equipment Group. See Note 3. Our segments are organized around the products and services provided to our customers. During the first quarter of 2002, we announced plans to restructure our businesses into two operating subsidiary groups. One group is focused on energy services and the other is focused on engineering and construction. As part of this restructuring, many support functions that were previously shared were moved into the two business groups. We also decided that the operations of Major Projects, Granherne and Production Services better aligned with our Kellogg Brown & Root subsidiary, or KBR, in the current 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 81 N O T E S T O A N N U A L F I N A N C I A L S T A T E M E N T S business environment. These businesses were moved for • Other product service lines provide installation and management and reporting purposes from the Energy Services Group segment to the Engineering and Construction Group segment during the second quarter of 2002. Major Projects, which consisted of the Barracuda-Caratinga project in Brazil, is now reported through the Offshore Operations product line, Granherne is now reported in the Onshore product line, and Production Services is now reported under the Operations and Maintenance product line. In addition, during the fourth quarter of 2000, we combined all engineering, construction, fabrication and project management operations into one segment, reporting as our Engineering and Construction Group. This restructuring resulted in some activities moving from the Energy Services Group to the Engineering and Construction Group, effective January 1, 2001. All prior period segment results have been restated to reflect these changes. E n e r g y S e r v i c e s G r o u p . The Energy Services Group provides a wide range of discrete services and products and integrated solutions to customers for the exploration, development, and production of oil and gas. The customers for this segment are major, national and independent oil and gas companies. This segment consists of: • Halliburton Energy Services provides oilfield services and products including discrete products and services and integrated solutions ranging from the initial evaluation of producing formations to drilling, completion, production and well maintenance. Products and services include pressure pumping equipment and services, logging and perforating, drilling systems and services, drilling fluids systems, drill bits, specialized completion and production equipment and services, well control and integrated solutions; • Landmark Graphics provides integrated exploration and production software information systems, data management services, and professional services for the upstream oil and gas industry; and servicing of subsea facilities and pipelines. In January 2002, we sold to Saipem, our joint venture partner, our 50% interest in European Marine Contractors Ltd., a joint venture that provided pipeline services for offshore customers. In May 2002, we contributed substantially all of our Halliburton Subsea assets to a newly formed company, Subsea 7, Inc. We own 50% of Subsea 7, Inc. and DSND Subsea ASA owns the other 50%. In September 2002, we sold our 50% interest in Bredero- Shaw, a pipecoating joint venture, to our partner ShawCor Ltd. See Note 2. E n g i n e e r i n g a n d C o n s t r u c t i o n G r o u p . The Engineering and Construction Group provides engineering, procurement, construction, project management, and facilities operation and maintenance for oil and gas and other industrial and governmental customers. The Engineering and Construction Group, operating as KBR, offers the following five product lines: • Onshore operations consist of engineering and construction activities, including engineering and construction of liquefied natural gas, ammonia and crude oil refineries and natural gas plants; • Offshore operations include specialty offshore deepwater engineering and marine technology and worldwide fabrication capabilities; • Government operations provide operations, construction, maintenance and logistics activities for government facilities and installations; • Operations and maintenance services include plant operations, maintenance, and start-up services for both upstream and downstream oil, gas and petrochemical facilities as well as operations, maintenance and logistics services for the power, commercial and industrial markets; and • Infrastructure provides civil engineering, consulting and project management services. 82 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T N O T E S T O A N N U A L F I N A N C I A L S T A T E M E N T S G e n e ra l c o r p o ra t e . General corporate represents assets O p e ra t i o n s b y G e o g ra p h i c A r e a not included in a business segment and is primarily composed of cash and cash equivalents, deferred tax assets and insurance for asbestos and silica litigation claims. Intersegment revenues included in the revenues of the Years ended December 31 Millions of dollars R E V E N U E S : United States United Kingdom Other areas (numerous countries) business segments and revenues between geographic areas Total are immaterial. Our equity in pretax earnings and losses of L O N G - L I V E D A S S E T S : 2002 2001 2000 $ 4,139 $ 4,911 $ 4,073 1,521 6,912 1,800 6,335 1,512 6,359 $12,572 $13,046 $11,944 unconsolidated affiliates that are accounted for on the equity method is included in revenues and operating income of the applicable segment. The tables below present information on our continuing operations business segments. United States United Kingdom Other areas (numerous countries) Total $ 4,617 $ 3,030 $ 2,068 691 711 617 744 525 776 $ 6,019 $ 4,391 $ 3,369 N O T E 5 . R E S T R I C T E D C A S H O p e ra t i o n s b y B u s i n e s s S e g m e n t At December 31, 2002, we had restricted cash of $190 million 2002 2001 2000 included in “Other assets”. Restricted cash consists of: Years ended December 31 Millions of dollars R E V E N U E S : Energy Services Group $ 6,836 $ 7,811 $ 6,233 Engineering and Construction Group 5,736 5,235 5,711 • $107 million deposit that collateralizes a bond for a patent infringement judgment on appeal; $12,572 $13,046 $11,944 • $57 million as collateral for potential future insurance Total O P E R AT I N G I N C O M E ( L O S S ) : General corporate Total C A P I TA L E X P E N D I T U R E S : Energy Services Group $ 638 $ 1,036 $ 589 Engineering and Construction Group (685) (65) 111 (63) $ (112) $ 1,084 Energy Services Group $ 603 $ 743 Engineering and Construction Group General corporate Total 161 — 54 — $ 764 $ 797 D E P R EC I AT I O N , D E P L E T I O N A N D A M O R T I Z AT I O N : Energy Services Group $ 475 $ 474 Engineering and Construction Group General corporate Total TOTA L A S S E T S : 29 1 56 1 claim reimbursements; and • $26 million primarily related to cash collateral agreements for outstanding letters of credit for various construction projects. At December 31, 2001, we had $3 million of restricted cash in “Other assets”. N O T E 6 . R E C E I VA B L E S Our receivables are generally not collateralized. Included in notes and accounts receivable are notes with varying $ $ $ $ (54) (73) 462 533 44 1 578 435 65 3 $ 505 $ 531 $ 503 interest rates totaling $53 million at December 31, 2002 and Energy Services Group $ 5,944 $ 6,564 $ 5,964 Engineering and Construction Group 3,104 3,187 2,885 Net assets of discontinued operations — — General corporate Total 3,796 1,215 $12,844 $10,966 $10,192 R E S E A R C H A N D D E V E L O P M E N T: Energy Services Group Engineering and Construction Group Total $ $ 228 5 233 $ $ 226 7 233 $ $ 224 7 231 $19 million at December 31, 2001. On April 15, 2002, we entered into an agreement to sell 690 653 accounts receivable to a bankruptcy-remote limited-purpose funding subsidiary. Under the terms of the agreement, new receivables are added on a continuous basis to the pool of receivables, and collections reduce previously sold accounts receivable. This funding subsidiary sells an undivided ownership interest in this pool of receivables to entities managed by unaffiliated financial institutions under 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 83 N O T E S T O A N N U A L F I N A N C I A L S T A T E M E N T S another agreement. Sales to the funding subsidiary have method had been used, total inventories would have been been structured as “true sales” under applicable bankruptcy $17 million higher than reported at December 31, 2002 and laws, and the assets of the funding subsidiary are not $20 million higher than reported at December 31, 2001. available to pay any creditors of Halliburton or of its Over 90% of remaining inventory is recorded on the subsidiaries or affiliates, until such time as the agreement average cost method, with the remainder on the first-in, with the unaffiliated companies is terminated following first-out method. sufficient collections to liquidate all outstanding undivided Inventories at December 31, 2002 and December 31, 2001 ownership interests. The funding subsidiary retains the are composed of the following: interest in the pool of receivables that are not sold to the unaffiliated companies, and is fully consolidated and reported in our financial statements. December 31 Millions of dollars Finished products and parts Raw materials and supplies The amount of undivided interests, which can be sold Work in process under the program, varies based on the amount of eligible Total Energy Services Group receivables in the pool at any given time and other factors. The funding subsidiary sold a $200 N O T E 8 . million undivided ownership interest to the unaffiliated U N A P P R OV E D C L A I M S A N D L O N G -T E R M 2002 2001 $ 545 $ 520 141 48 192 75 $ 734 $ 787 companies, and may from time to time sell additional undivided ownership interests. No additional amounts were received from our accounts receivable facility since the second quarter of 2002. The total amount outstanding under this facility was $180 million as of December 31, 2002. We continue to service, administer and collect the receivables on behalf of the purchaser. The amount of undivided ownership interest in the pool of receivables sold to the unaffiliated companies is reflected as a reduction of accounts receivable in our consolidated balance sheet and as an increase in cash flows from operating activities in our consolidated statement of cash flows. N O T E 7. I N V E N T O R I E S Inventories are stated at the lower of cost or market. Some United States manufacturing and field service finished products and parts inventories for drill bits, completion products and bulk materials are recorded using the last-in, first-out method, totaling $43 million at December 31, 2002 and $54 million at December 31, 2001. If the average cost C O N S T R U C T I O N C O N T R A C T S Billing practices for engineering and construction projects are governed by the contract terms of each project based upon costs incurred, achievement of milestones or pre-agreed schedules. Billings do not necessarily correlate with revenues recognized under the percentage of completion method of accounting. Billings in excess of recognized revenues are recorded in “Advance billings on uncompleted contracts”. When billings are less than recognized revenues, the difference is recorded in “Unbilled work on uncompleted contracts”. With the exception of claims and change orders which are in the process of being negotiated with customers, unbilled work is usually billed during normal billing pro- cesses following achievement of the contractual requirements. Recording of profits and losses on long-term contracts requires an estimate of the total profit or loss over the life of each contract. This estimate requires consideration of contract revenue, change orders and claims reduced by costs incurred and estimated costs to complete. Anticipated losses on contracts are recorded in full in the period they become evident. Profits are recorded based upon the total estimated contract profit multiplied by the current percentage complete for the contract. 84 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T N O T E S T O A N N U A L F I N A N C I A L S T A T E M E N T S When calculating the amount of total profit or loss on a probable unapproved claim in arbitration is $2 million. The long-term contract, we include unapproved claims as largest claim relates to the Barracuda-Caratinga contract revenue when the collection is deemed probable based upon which was approximately 63% complete at the end of 2002. the four criteria for recognizing unapproved claims under The probable unapproved claims included in determining the American Institute of Certified Public Accountants this contract’s loss were $182 million at December 31, 2002 Statement of Position 81-1, “Accounting for Performance of and $43 million at December 31, 2001. As the claim for this Construction-Type and Certain Production-Type Contracts.” contract most likely will not be settled within one year, Including unapproved claims in this calculation increases amounts in unbilled work on uncompleted contracts of $115 the operating income (or reduces the operating loss) that million at December 31, 2002 and $10 million at December would otherwise be recorded without consideration of the 31, 2001 included in the table above have been recorded probable unapproved claims. Unapproved claims are to long-term unbilled work on uncompleted contracts which recorded to the extent of costs incurred and include no profit is included in “Other assets” on the balance sheet. All other element. In substantially all cases, the probable unapproved claims included in the table above have been recorded to claims included in determining contract profit or loss are “Unbilled work on uncompleted contracts” included in the less than the actual claim that will be or has been presented “Total receivables” amount on the balance sheet. to the customer. A summary of unapproved claims activity for the years When recording the revenue and the associated unbilled ended December 31, 2002 and 2001 is as follows: receivable for unapproved claims, we only accrue an amount equal to the costs incurred related to probable unapproved claims. Therefore, the difference between the probable unapproved claims included in determining contract profit Millions of dollars Beginning balance Additions or loss and the probable unapproved claims recorded in Costs incurred during period unbilled work on uncompleted contracts relates to forecasted costs which have not yet been incurred. The amounts Approved claims Write-offs Other * Total Probable Unapproved Claims Probable Unapproved Claims Accrued Revenue 2002 $ 137 158 — (4) (7) (5) 2001 $ 93 92 — (15) (33) — 2002 $102 105 19 (4) (7) (5) 2001 $ 92 58 — (15) (33) — included in determining the profit or loss on contracts, and Ending balance $ 279 $137 $210 $102 the amounts booked to “Unbilled work on uncompleted * Other primarily relates to claims in which the customer has agreed to a change order relating to the scope of work. contracts” for each period are as follows: Years ended December 31 Millions of dollars Probable unapproved claims (included in In addition, our unconsolidated related companies include 2002 2001 probable unapproved claims as revenue to determine the determining contract profit or loss) $ 279 $ 137 amount of profit or loss for their contracts. Our “Equity in Unapproved claims in unbilled work on earnings of unconsolidated affiliates” includes our equity uncompleted contracts $ 210 $ 102 The claims at December 31, 2002 listed in the above table relate to ten contracts, most of which are complete or substantially complete. We are actively engaged in claims negotiation with the customer in all but one case, and in that case we have initiated the arbitration process. The percentage of unapproved claims related to unconsolidated projects. Amounts for unapproved claims from our related companies are included in “Equity in and advances to related companies” and totaled $9 million at December 31, 2002 and $0.3 million at December 31, 2001. 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 85 N O T E S T O A N N U A L F I N A N C I A L S T A T E M E N T S N O T E 9. P R O P E R T Y, P L A N T A N D E Q U I P M E N T Property, plant and equipment at December 31, 2002 and 2001 are composed of the following: Millions of dollars Land Buildings and property improvements Machinery, equipment and other Total Less accumulated depreciation 2002 86 $ 2001 $ 82 1,024 4,842 5,952 3,323 942 4,926 5,950 3,281 Net property, plant and equipment $2,629 $2,669 Buildings and property improvements are depreciated over 5-40 years; machinery, equipment and other are depreciated over 3-25 years. Machinery, equipment and other includes oil and gas investments of $356 million at December 31, 2002 and $423 million at December 31, 2001. N O T E 1 0 . R E L AT E D C O M PA N I E S C o m b i n e d F i n a n c i a l P o s i t i o n December 31 Millions of dollars Current assets Noncurrent assets Total Current liabilities Noncurrent liabilities Minority interests Shareholders’ equity Total 2002 2001 $1,404 $1,818 1,876 1,672 $3,280 $3,490 $1,155 $1,522 1,367 1,272 — 758 2 694 $3,280 $3,490 N O T E 1 1 . L I N E S O F C R E D I T, N O T E S PAYA B L E A N D L O N G -T E R M D E B T At December 31, 2002, we had committed lines of credit totaling $350 million which expire in August 2006. There were no borrowings outstanding under these lines of credit. These lines are not available if our senior unsecured long-term debt is rated lower than BBB- by Standard & Poor’s Ratings Service Group or lower than Baa3 by Moody’s Investors’ Services. Fees for committed lines of We conduct some of our operations through various joint credit were immaterial. ventures which are in partnership, corporate and other Short-term debt at December 31, 2002 consists primarily business forms, and are principally accounted for using the of $37 million in overdraft facilities and $12 million of other equity method. Financial information pertaining to related facilities with varying rates of interest. companies for our continuing operations is set out below. Long-term debt at the end of 2002 and 2001 consists of This information includes the total related company the following: balances and not our proportional interest in those balances. Millions of dollars Our larger unconsolidated entities include Subsea 7, 7.6% debentures due August 2096 Inc., a 50% owned subsidiary, formed in May of 2002 and the partnerships created to construct the Alice Springs 8.75% debentures due February 2021 8% senior notes due April 2003 Variable interest credit facility maturing to Darwin rail line in Australia. During 2002, we sold our September 2009 50% interest in European Marine Contractors and Medium-term notes due 2002 through 2027 Bredero-Shaw. See Note 2. Combined summarized financial information for all jointly Effect of interest rate swaps Term loans at LIBOR (GBP) plus 0.75% payable in semiannual installments through March 2002 owned operations that are not consolidated is as follows: Other notes with varying interest rates C o m b i n e d O p e ra t i n g R e s u l t s Years ended December 31 Millions of dollars Revenues Operating income Net income 2002 2001 2000 $1,948 $1,987 $3,098 $ 200 $ 159 $ 231 $ 169 $ 192 $ 169 Total long-term debt Less current portion Noncurrent portion of long-term debt $1,181 $1,403 The 7.6% debentures due 2096, 8.75% debentures due 2021, and 8% senior notes due 2003 may not be redeemed prior to maturity and do not have sinking fund requirements. 2002 2001 $ 300 $ 300 200 139 66 750 13 — 8 1,476 295 200 139 — 825 3 4 13 1,484 81 86 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T N O T E S T O A N N U A L F I N A N C I A L S T A T E M E N T S In the fourth quarter of 2002, our 51% owned and the swap agreement was $150 million. This interest rate consolidated subsidiary, Devonport Management Limited swap was designated as a fair value hedge under SFAS No. (DML), signed an agreement for a credit facility of £80 133. Upon termination, the fair value of the interest rate million ($126 million as of December 31, 2002) maturing swap was $13 million. These swaps had previously been in September 2009. This credit facility has a variable classified in “Other assets” on the balance sheet. The fair interest rate that was equal to 5.375% on December 31, value adjustment to these debt instruments that were 2002. There are various financial covenants which must hedged will remain and be amortized as a reduction in be maintained by DML. DML has drawn down an initial interest expense using the “Effective Yield Method” over amount of $66 million as of December 31, 2002. Under the remaining life of the notes. this agreement, payments of approximately $4.5 million Our debt, excluding the effects of our interest rate swaps, are due in quarterly installments. As of December 31, matures as follows: $295 million in 2003; $21 million in 2002, the available credit under this facility was 2004; $20 million in 2005; $293 million in 2006; $8 million approximately $60 million. in 2007; and $826 million thereafter. On July 12, 2001, we issued $425 million of two and five- year notes under our medium-term note program. The notes consist of $275 million 6% fixed rate notes due August 2006 and $150 million LIBOR + 0.15% floating rate notes due July 2003. At December 31, 2002, we have outstanding notes under our medium-term note program as follows: Amount $150 million $275 million $150 million $ 50 million $125 million Due Rate 07/2003 Floating % 08/2006 12/2008 05/2017 02/2027 6.00% 5.63% 7.53% 6.75% Issue Price Par 99.57% 99.97% Par 99.78% Each holder of the 6.75% medium-term notes has the right to require us to repay the holder’s notes in whole or in part on February 1, 2007. We may redeem the 5.63% and 6.00% medium-term notes in whole or in part at any time. Other notes issued under the medium-term note program may not be redeemed prior to maturity. The medium-term notes do not have sinking fund requirements. In the second quarter of 2002, we terminated our interest rate swap agreement on our 8% senior note. The notional amount of the swap agreement was $139 million. This interest rate swap was designated as a fair value hedge under SFAS No. 133. Upon termination, the fair value of the interest rate swap was $0.5 million. In the fourth quarter N O T E 1 2 . C O M M I T M E N T S A N D C O N T I N G E N C I E S L e a s e s . At year-end 2002, we were obligated under noncancelable operating leases, principally for the use of land, offices, equipment, field facilities and warehouses. Total rentals, net of sublease rentals, for noncancelable leases in 2002, 2001 and 2000 were as follows: Millions of dollars Rental expense 2002 $ 149 2001 $ 172 2000 $149 Future total rentals on noncancelable operating leases are as follows: $119 million in 2003; $83 million in 2004; $63 million in 2005; $55 million in 2006; $40 million in 2007; and $249 million thereafter. A s b e s to s l i t i g a t i o n . Several of our subsidiaries, particularly DII Industries, LLC (DII Industries) and Kellogg, Brown & Root, Inc. (Kellogg, Brown & Root), are defendants in a large number of asbestos-related lawsuits. The plaintiffs allege injury as a result of exposure to asbestos in products manufactured or sold by former divisions of DII Industries or in materials used in construction or maintenance projects of Kellogg, Brown & Root. These claims are in three general categories: • refractory claims; 2002, we terminated the interest rate swap agreement on • other DII Industries claims; and our 6% fixed rate medium-term note. The notional amount of • construction claims. 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 87 N O T E S T O A N N U A L F I N A N C I A L S T A T E M E N T S R e f ra c t o r y c l a i m s . Asbestos was used in a small number not be able to fulfill its indemnification obligation to DII of products manufactured or sold by Harbison-Walker Industries. Accordingly, DII Industries took up the defense Refractories Company, which DII Industries acquired in of unsettled post spin-off refractory claims that name it 1967. The Harbison-Walker operations were conducted as a as a defendant in order to prevent Harbison-Walker from division of DII Industries (then named Dresser Industries, unnecessarily eroding the insurance coverage both Inc.) until those operations were transferred to another then- companies access for these claims. These claims are now existing subsidiary of DII Industries in preparation for a stayed in the Harbison-Walker bankruptcy proceeding. spin-off. Harbison-Walker was spun-off by DII Industries in As of December 31, 2002, there were approximately July 1992. At that time, Harbison-Walker assumed liability 6,000 open and unresolved pre-spin-off refractory claims for asbestos claims filed after the spin-off and it agreed to against DII Industries. In addition, there were defend and indemnify DII Industries from liability for those approximately 142,000 post spin-off claims that name DII claims, although DII Industries continues to have direct Industries as a defendant. liability to tort claimants for all post spin-off refractory O t h e r D I I I n d u s t r i e s c l a i m s . As of December 31, 2002, claims. DII Industries retained responsibility for all there were approximately 147,000 open and unresolved asbestos claims pending as of the date of the spin-off. claims alleging injuries from asbestos used in other products The agreement governing the spin-off provided that formerly manufactured by DII Industries. Most of these Harbison-Walker would have the right to access DII claims involve gaskets and packing materials used in pumps Industries’ historic insurance coverage for the asbestos- and other industrial products. related liabilities that Harbison-Walker assumed in the C o n s t r u c t i o n c l a i m s . Our Engineering and Construction spin-off. After the spin-off, DII Industries and Harbison- Group includes engineering and construction businesses Walker jointly negotiated and entered into coverage-in-place formerly operated by The M.W. Kellogg Company and Brown agreements with a number of insurance companies that & Root, Inc., now combined as Kellogg, Brown & Root. As of had issued historic general liability insurance policies which December 31, 2002, there were approximately 52,000 open both DII Industries and Harbison-Walker had the right and unresolved claims alleging injuries from asbestos in to access for, among other things, bodily injury occurring materials used in construction and maintenance projects, between 1963 and 1985. These coverage-in-place most of which were conducted by Brown & Root, Inc. agreements provide for the payment of defense costs, Approximately 2,200 of these claims are asserted against settlements and court judgments paid to resolve refractory The M.W. Kellogg Company. We believe that Kellogg, Brown asbestos claims. & Root has a good defense to these claims, and a prior As Harbison-Walker’s financial condition worsened in late owner of The M.W. Kellogg Company provides Kellogg, 2000 and 2001, Harbison-Walker began agreeing to pay Brown & Root a contractual indemnification for claims more in settlement of the post spin-off refractory claims against The M.W. Kellogg Company. than it historically had paid. These increased settlement H a r b i s o n -Wa l k e r C h a p t e r 1 1 b a n k r u p t c y. On February amounts led to Harbison-Walker making greater demands 14, 2002, Harbison-Walker filed a voluntary petition for on the shared insurance asset. By July 2001, DII Industries reorganization under Chapter 11 of the United States determined that the demands that Harbison-Walker was Bankruptcy Code in the Bankruptcy Court in Pittsburgh, making on the shared insurance policies were not acceptable Pennsylvania. In its bankruptcy-related filings, Harbison- to DII Industries and that Harbison-Walker probably would Walker said that it would seek to utilize Sections 524(g) and 105 of the Bankruptcy Code to propose and seek 88 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T N O T E S T O A N N U A L F I N A N C I A L S T A T E M E N T S confirmation of a plan of reorganization that would provide the benefits of an injunction channeling to a Section for distributions for all legitimate, pending and future 524(g)/105 trust all present and future asbestos claims, asbestos claims asserted directly against Harbison-Walker including with respect to DII Industries, Kellogg, Brown & or asserted against DII Industries for which Harbison- Root and Halliburton, claims that do not relate to the Walker is required to indemnify and defend DII Industries. Harbison-Walker business or share insurance with Harbison-Walker’s failure to fulfill its indemnity Harbison-Walker. obligations, and its erosion of insurance coverage shared Harbison-Walker has not yet submitted a proposed plan of with DII Industries, required DII Industries to assist reorganization to the Bankruptcy Court. Moreover, Harbison-Walker in its bankruptcy proceeding in order to although possible, at this time we do not believe it likely protect the shared insurance from dissipation. At the time that Harbison-Walker will propose or ultimately there would that Harbison-Walker filed its bankruptcy, DII Industries be confirmed a plan of reorganization in its bankruptcy agreed to provide up to $35 million of debtor-in-possession proceeding that is acceptable to DII Industries. In general, financing to Harbison-Walker during the pendency of the in order for a Harbison-Walker plan of reorganization Chapter 11 proceeding, of which $5 million was advanced involving a Section 524(g)/105 trust to be confirmed, among during the first quarter of 2002. On February 14, 2002, in other things the creation of the trust would require the accordance with the terms of a letter agreement, DII approval of 75% of the asbestos claimant creditors of Industries also paid $40 million to Harbison-Walker’s Harbison-Walker. There can be no assurance that any plan United States parent holding company, RHI Refractories proposed by Harbison-Walker would obtain the necessary Holding Company. This payment was charged to approval or that it would provide for an injunction discontinued operations in our financial statements in the channeling to a Section 524(g)/105 trust all present and first quarter of 2002. future asbestos claims against DII Industries arising out of The terms of the letter agreement also requires DII the Harbison-Walker business or that share insurance with Industries to pay to RHI Refractories an additional $35 Harbison-Walker. million if a plan of reorganization is proposed in the In addition, we anticipate that a significant financial Harbison-Walker bankruptcy proceedings, and an additional contribution to the Harbison-Walker estate could be $85 million if a plan is confirmed in the Harbison-Walker required from DII Industries to obtain confirmation of a bankruptcy proceedings, in each case acceptable to DII Harbison-Walker plan of reorganization if that plan were to Industries in its sole discretion. The letter agreement include an injunction channeling to a Section 524(g)/105 provides that a plan acceptable to DII Industries must trust all present and future asbestos claims against DII include an injunction channeling to a Section 524(g)/105 Industries arising out of the Harbison-Walker business or trust all present and future asbestos claims against DII that have claims to shared insurance with the Harbison- Industries, arising out of the Harbison-Walker business or Walker business. This contribution to the estate would be in other DII Industries’ businesses that share insurance with addition to DII Industries’ contribution of its interest to Harbison-Walker. insurance coverage for refractory claims to the Section By contrast, the global settlement being pursued by 524(g)/105 trust. At this time, we are not able to quantify Halliburton contemplates that DII Industries and Harbison- the amount of this contribution in light of numerous Walker, among others including Halliburton, would receive uncertainties. These include the amount of Harbison-Walker in a DII Industries and Kellogg, Brown & Root bankruptcy 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 89 N O T E S T O A N N U A L F I N A N C I A L S T A T E M E N T S assets available to satisfy its asbestos and trade creditors Walker, or that any plan that is confirmed will provide relief and the results of negotiations that must be completed to DII Industries. among Harbison-Walker, the asbestos claims committee The stayed asbestos claims are those covered by insurance under its Chapter 11 proceeding, a legal representative for that DII Industries and Harbison-Walker each access to future asbestos claimants (which has not yet been appointed pay defense costs, settlements and judgments attributable to by the Bankruptcy Court), DII Industries and the relevant both refractory and non-refractory asbestos claims. The insurance companies. stayed claims include approximately 142,000 post-1992 Whether or not Halliburton has completed, is still spin-off refractory claims, 6,000 pre-spin-off refractory claims pursuing or has abandoned its previously announced global and approximately 135,000 other types of asbestos claims settlement, DII Industries would be under no obligation pending against DII Industries. Approximately 51,000 of the to make a significant financial contribution to the Harbison- claims in the third category are claims made against DII Walker estate, although Halliburton intends to consider Industries based on more than one ground for recovery and all of its options if in the future it ceased pursuing the the stay affects only the portion of the claim covered by the global settlement. shared insurance. The stay prevents litigation from For the reasons outlined above among others, we do not proceeding while the stay is in effect and also prohibits the believe it probable that DII Industries will be obligated to filing of new claims. One of the purposes of the stay is to make either of the additional $35 million and $85 million allow Harbison-Walker and DII Industries time to develop payments to RHI Refractories described above. During and propose a plan of reorganization. February 2003, representatives of RHI A.G., the ultimate A s b e s t o s i n s u r a n c e c o v e r a g e . DII Industries has corporate parent of RHI Refractories, met with represen- substantial insurance for reimbursement for portions of tatives of DII Industries and indicated that they believed the costs incurred defending asbestos and silica claims, as that DII Industries would be obligated to pay RHI well as amounts paid to settle claims and court judgments. Refractories the $35 million and the $85 million described This coverage is provided by a large number of insurance above in the event that our proposed global settlement policies written by dozens of insurance companies. The were to be consummated. For a number of reasons, DII insurance companies wrote the coverage over a period of Industries believes that the global settlement would not be more than 30 years for DII Industries, its predecessors or its the cause of a failure of a Harbison-Walker plan to be subsidiaries and their predecessors. Large amounts of this acceptable to DII Industries, and intends vigorously to coverage are now subject to coverage-in-place agreements defend against this claim if formally asserted. that resolve issues concerning amounts and terms of In connection with the Chapter 11 filing by Harbison- coverage. The amount of insurance available to DII Walker, the Bankruptcy Court on February 14, 2002 issued Industries and its subsidiaries depends on the nature and a temporary restraining order staying all further litigation time of the alleged exposure to asbestos or silica, the of more than 200,000 asbestos claims currently pending specific subsidiary against which an asbestos or silica claim against DII Industries in numerous courts throughout the is asserted and other factors. United States. The period of the stay contained in the R e f ra c t o r y c l a i m s i n s u ra n c e . DII Industries has temporary restraining order has been extended to July 21, approximately $2.1 billion in aggregate limits of insurance 2003. Currently, there is no assurance that a stay will coverage for refractory asbestos and silica claims, of which remain in effect beyond July 21, 2003, that a plan of over one-half is with Equitas or other London-based reorganization will be proposed or confirmed for Harbison- insurance companies. Most of this insurance is shared with 90 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T N O T E S T O A N N U A L F I N A N C I A L S T A T E M E N T S Harbison-Walker. Many of the issues relating to the majority Bankruptcy Court’s mediation order remains in effect. of this coverage have been resolved by coverage-in-place Given the early stages of these negotiations, DII Industries agreements with dozens of companies, including Equitas cannot predict whether a negotiated resolution of this and other London-based insurance companies. Coverage-in- dispute will occur or, if such a resolution does occur, the place agreements are settlement agreements between precise terms of such a resolution. policyholders and the insurers specifying the terms and Prior to the Harbison-Walker bankruptcy, on August 7, conditions under which coverage will be applied as claims 2001, DII Industries filed a lawsuit in Dallas County, Texas, are presented for payment. These agreements in an asbestos against a number of these insurance companies asserting claims context govern such things as what events will be DII Industries rights under an existing coverage-in-place deemed to trigger coverage, how liability for a claim will be agreement and under insurance policies not yet subject to allocated among insurers and what procedures the coverage-in-place agreements. The coverage-in-place policyholder must follow in order to obligate the insurer to agreements allow DII Industries to enter into settlements pay claims. Recently, however, Equitas and other London- for small amounts without requiring claimants to produce based companies have attempted to impose new restrictive detailed documentation to support their claims, when DII documentation requirements on DII Industries and other Industries believes the settlements are an effective claims insureds. Equitas and the other London-based companies management strategy. DII Industries believes that the new have stated that the new requirements are part of an effort documentation requirements are inconsistent with the to limit payment of settlements to claimants who are truly current coverage-in-place agreements and are unenforceable. impaired by exposure to asbestos and can identify the The insurance companies that DII Industries has sued have product or premises that caused their exposure. not refused to pay larger claim settlements where documen- On March 21, 2002, Harbison-Walker filed a lawsuit in tation is obtained or where court judgments are entered. the United States Bankruptcy Court for the Western On May 10, 2002, the London-based insuring entities and District of Pennsylvania in its Chapter 11 bankruptcy companies removed DII Industries’ Dallas County State proceeding. This lawsuit is substantially similar to DII Court Action to the United States District Court for the Industries’ lawsuit filed in Texas State Court in 2001 and Northern District of Texas alleging that federal court seeks, among other relief, a determination as to the rights of jurisdiction existed over the case because it is related to the DII Industries and Harbison-Walker to the shared general Harbison-Walker bankruptcy. DII Industries has filed an liability insurance. The lawsuit also seeks damages against opposition to that removal and has asked the federal court specific insurers for breach of contract and bad faith, and a to remand the case back to the Dallas County state court. declaratory judgment concerning the insurers’ obligations On June 12, 2002, the London-based insuring entities and under the shared insurance. Although DII Industries is also companies filed a motion to transfer the case to the federal a defendant in this lawsuit, it has asserted its own claim court in Pittsburgh, Pennsylvania. DII Industries has filed to coverage under the shared insurance and is cooperating an opposition to that motion to transfer. The federal court with Harbison-Walker to secure both companies’ rights to in Dallas has yet to rule on any of these motions. Regardless the shared insurance. The Bankruptcy Court has ordered of the outcome of these motions, because of the similar the parties to this lawsuit to engage in non-binding insurance coverage lawsuit filed by Harbison-Walker in its mediation. The first mediation session was held on July 26, bankruptcy proceeding, it is unlikely that DII Industries’ 2002 and additional sessions have since taken place and case will proceed independently of the bankruptcy. further sessions are scheduled to take place, provided the 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 91 N O T E S T O A N N U A L F I N A N C I A L S T A T E M E N T S O t h e r D I I I n d u s t r i e s c l a i m s i n s u ra n c e . DII Industries Inc. and a large number of its affiliated companies filed a has substantial insurance to cover other non-refractory voluntary petition for reorganization under Chapter 11 of asbestos claims. Two coverage-in-place agreements cover the Bankruptcy Code in the Bankruptcy Court in DII Industries for companies or operations that DII Wilmington, Delaware. Industries either acquired or operated prior to November 1, In response to Federal-Mogul’s allegations, on December 1957. Asbestos claims that are covered by these 7, 2001, DII Industries filed a lawsuit in the Delaware agreements are currently stayed by the Harbison-Walker Bankruptcy Court asserting its rights to insurance coverage bankruptcy because the majority of this coverage also under historic general liability policies issued to applies to refractory claims and is shared with Harbison- Studebaker-Worthington, Inc. and its successor for asbestos- Walker. Other insurance coverage is provided by a number related liabilities arising from, among other operations, of different policies that DII Industries acquired rights to Worthington’s and its successors’ historic operations. This access when it acquired businesses from other companies. lawsuit also seeks a judicial declaration concerning the Three coverage-in-place agreements provide reimbursement competing rights of DII Industries and Federal-Mogul, if for asbestos claims made against DII Industries’ former any, to this insurance coverage. DII Industries recently filed Worthington Pump division. There is also other substantial a second amended complaint in that lawsuit and the parties insurance coverage with approximately $2.0 billion in are now beginning the discovery process. The parties to aggregate limits that has not yet been reduced to coverage- this litigation, including Federal-Mogul, have agreed to in-place agreements. mediate this dispute. The first mediation session is On August 28, 2001, DII Industries filed a lawsuit in the scheduled for April 2, 2003. Unlike the Harbison-Walker 192nd Judicial District of the District Court for Dallas insurance coverage litigation, in which the litigation is County, Texas against specific London-based insuring stayed while the mediation proceeds, the insurance coverage entities that issued insurance policies that provide coverage litigation concerning the Worthington-related asbestos to DII Industries for asbestos-related liabilities arising out liabilities has not been stayed and such litigation will proceed of the historical operations of Worthington Corporation or its simultaneously with the mediation. successors. This lawsuit raises essentially the same issue as At the same time, DII Industries filed its insurance to the documentation requirements as the August 7, 2001 coverage action in the Federal-Mogul bankruptcy, DII Harbison-Walker lawsuit filed in the same court. The Industries also filed a second lawsuit in which it has filed a London-based insuring entities filed a motion in that case motion for preliminary injunction seeking a stay of all seeking to compel the parties to binding arbitration. The Worthington asbestos-related lawsuits against DII trial court denied that motion and the London-based Industries that are scheduled for trial within the six months insuring entities appealed that decision to the state appellate following the filing of the motion. The stay that DII court. The state appellate courts denied the appeal and, Industries seeks, if granted, would remain in place until the most recently, the London-based insuring entities have competing rights of DII Industries and Federal-Mogul to removed the case from the state court to the federal court. the allegedly shared insurance are resolved. The Court has DII Industries was successful in remanding the case back to yet to schedule a hearing on DII Industries’ motion for the state court. preliminary injunction. A significant portion of the insurance coverage applicable A number of insurers who have agreed to coverage-in- to Worthington claims is alleged by Federal-Mogul Products, place agreements with DII Industries have suspended Inc. to be shared with it. In 2001, Federal-Mogul Products, 92 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T N O T E S T O A N N U A L F I N A N C I A L S T A T E M E N T S payment under the shared Worthington policies until the historic insurers that issued these excess insurance policies. Federal-Mogul Bankruptcy Court resolves the insurance In the lawsuit, Kellogg, Brown & Root seeks to establish issues. Consequently, the effect of the Federal-Mogul the specific terms under which it can seek reimbursement for bankruptcy on DII Industries’ rights to access this shared costs it incurs in settling and defending asbestos claims insurance is uncertain. from its historic construction operations. On January 6, 2003, C o n s t r u c t i o n c l a i m s i n s u ra n c e . Nearly all of our this lawsuit was transferred to the 11th Judicial District of construction asbestos claims relate to Brown & Root, Inc. the District Court of Harris County, Texas. Until this lawsuit operations before the 1980s. Our primary insurance is resolved, the scope of the excess insurance will remain coverage for these claims was written by Highlands uncertain. We do not expect the excess insurers will Insurance Company during the time it was one of our reimburse us for asbestos claims until this lawsuit is resolved. subsidiaries. Highlands was spun-off to our shareholders in S i g n i f i c a n t a s b e s t o s j u d g m e n t s o n a p p e a l . During 1996. On April 5, 2000, Highlands filed a lawsuit against us 2001, there were several adverse judgments in trial court in the Delaware Chancery Court. Highlands asserted that proceedings that are in various stages of the appeal process. the insurance it wrote for Brown & Root, Inc. that covered All of these judgments concern asbestos claims involving construction asbestos claims was terminated by agreements Harbison-Walker refractory products. Each of these appeals, between Halliburton and Highlands at the time of the 1996 however, has been stayed by the Bankruptcy Court in the spin-off. In March 2001, the Chancery Court ruled that a Harbison-Walker Chapter 11 bankruptcy. termination did occur and that Highlands was not obligated On November 29, 2001, the Texas District Court in Orange, to provide coverage for Brown & Root, Inc.’s asbestos Texas, entered judgments against Dresser Industries, Inc. claims. This decision was affirmed by the Delaware Supreme (now DII Industries) on a $65 million jury verdict rendered in Court on March 13, 2002. As a result of this ruling, we September 2001 in favor of five plaintiffs. The $65 million wrote-off approximately $35 million in accounts receivable amount includes $15 million of a $30 million judgment for amounts paid for claims and defense costs and $45 million against DII Industries and another defendant. DII Industries of accrued receivables in relation to estimated insurance is jointly and severally liable for $15 million in addition to recoveries claims settlements from Highlands in the first $65 million if the other defendant does not pay its share of quarter 2002. In addition, we dismissed the April 24, 2000 this judgment. Based upon what we believe to be controlling lawsuit we filed against Highlands in Harris County, Texas. precedent, which would hold that the judgment entered is As noted in our 2001 Form 10-K, the amount of the billed void, we believe that the likelihood of the judgment being insurance receivable related to Highlands Insurance affirmed in the face of DII Industries’ appeal is remote. Company included in “Accounts receivable” was $35 million. As a result, we have not accrued any amounts for this As a consequence of the Delaware Supreme Court’s judgment. However, a favorable outcome from the appeal decision, Kellogg, Brown & Root no longer has primary is not assured. insurance coverage from Highlands for asbestos claims. On November 29, 2001, the same District Court in Orange, However, Kellogg, Brown & Root has significant excess Texas, entered three additional judgments against Dresser insurance coverage. The amount of this excess coverage that Industries, Inc. (now DII Industries) in the aggregate will reimburse us for an asbestos claim depends on a variety amount of $35.7 million in favor of 100 other asbestos of factors. On March 20, 2002, Kellogg, Brown & Root filed plaintiffs. These judgments relate to an alleged breach of a lawsuit in the 172nd Judicial District of the District Court purported settlement agreements signed early in 2001 by of Jefferson County, Texas, against Kellogg, Brown & Root’s 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 93 N O T E S T O A N N U A L F I N A N C I A L S T A T E M E N T S a New Orleans lawyer hired by Harbison-Walker, which had which we are named as a defendant along with a number of been defending DII Industries pursuant to the agreement other defendants, often exceeding 100 unaffiliated defendant by which Harbison-Walker was spun-off by DII Industries in companies in total. During the fourth quarter of 2002, 1992. These settlement agreements expressly bind we received approximately 32,000 new claims and we closed Harbison-Walker Refractories Company as the obligated approximately 13,000 claims. The number of open claims party, not DII Industries, which is not a party to the pending against us is as follows: agreements. For that reason, and based upon what we believe to be controlling precedent which would hold that the judgment entered is void, we believe that the likelihood of the judgment being affirmed in the face of DII Industries’ appeal is remote. As a result, we have not accrued any amounts for this judgment. However, a favorable outcome from the appeal is not assured. On December 5, 2001, a jury in the Circuit Court for Baltimore County, Maryland, returned verdicts against Period Ending December 31, 2002 September 30, 2002 June 30, 2002 March 31, 2002 December 31, 2001 September 30, 2001 June 30, 2001 March 31, 2001 December 31, 2000 Total Open Claims 347,000 328,000 312,000 292,000 274,000 146,000 145,000 129,000 117,000 Dresser Industries, Inc. (now DII Industries) and other The claims include approximately 142,000 at December defendants following a trial involving refractory asbestos 31, 2002 and September 30, 2002, 139,000 at June 30, 2002, claims. Each of the five plaintiffs alleges exposure to 133,000 at March 31, 2002 and 125,000 at December 31, Harbison-Walker products. DII Industries’ portion of the 2001 of post spin-off Harbison-Walker refractory related verdicts was approximately $30 million, which we have fully claims that name DII Industries as a defendant. All such accrued at December 31, 2002. DII Industries intends to claims have been factored into the calculation of our appeal the judgment to the Maryland Supreme Court. While asbestos liability. we believe we have a valid basis for appeal and intend to We manage asbestos claims to achieve settlements of vigorously pursue our appeal, any favorable outcome from valid claims for reasonable amounts. When reasonable that appeal is not assured. settlement is not possible, we contest claims in court. Since On October 25, 2001, in the Circuit Court of Holmes 1976, we have closed approximately 231,000 claims County, Mississippi, a jury verdict of $150 million was through settlements and court proceedings at a total cost of rendered in favor of six plaintiffs against Dresser Industries, approximately $202 million. We have received or expect to Inc. (now DII Industries) and two other companies. DII receive from our insurers all but approximately $93 million Industries’ share of the verdict was $21.3 million which of this cost, resulting in an average net cost per closed we have fully accrued at December 31, 2002. The award was claim of about $403. for compensatory damages. The jury did not award any punitive damages. The trial court has entered judgment on the verdict. While we believe we have a valid basis for appeal and intend to vigorously pursue our appeal, any favorable outcome from that appeal is not assured. A s b e s t o s c l a i m s h i s t o r y. Since 1976, approximately 578,000 asbestos claims have been filed against us. Almost all of these claims have been made in separate lawsuits in A s b e s t o s s t u d y a n d t h e v a l u a t i o n o f u n r e s o l v e d c u r r e n t a n d f u t u r e a s b e s t o s c l a i m s . A s b e s t o s S t u d y. In late 2001, DII Industries retained Dr. Francine F. Rabinovitz of Hamilton, Rabinovitz & Alschuler, Inc. to estimate the probable number and value, including defense costs, of unresolved current and future asbestos and silica-related bodily injury claims asserted 94 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T N O T E S T O A N N U A L F I N A N C I A L S T A T E M E N T S against DII Industries and its subsidiaries. Dr. Rabinovitz is • an analysis of the population likely to have been exposed a nationally renowned expert in conducting such analyses, has been involved in a number of asbestos-related and other toxic tort-related valuations of current and future liabilities, has served as the expert for three representatives of future claimants in asbestos related bankruptcies and has had her valuation methodologies accepted by numerous courts. Further, the methodology utilized by Dr. Rabinovitz is the same methodology that is utilized by the expert who is routinely retained by the asbestos claimants committee in asbestos-related bankruptcies. Dr. Rabinovitz estimated the probable number and value of unresolved current and future asbestos and silica-related bodily injury claims asserted against DII Industries and its subsidiaries over a 50 year period. The report took approximately seven months to complete. M e t h o d o l o g y. The methodology utilized by Dr. Rabinovitz to project DII Industries’ and its subsidiaries’ asbestos- or claim exposure to products manufactured by DII Industries, its predecessors and Harbison-Walker or to Brown & Root construction and renovation projects; and • epidemiological studies to estimate the number of people who might allege exposure to products manufactured by DII Industries, its predecessors and Harbison-Walker or to Brown & Root construction and renovation projects that would be likely to develop asbestos-related diseases. Dr. Rabinovitz’s estimates are based on historical data supplied by DII Industries, Kellogg, Brown & Root and Harbison-Walker and publicly available studies, including annual surveys by the National Institutes of Health concerning the incidence of mesothelioma deaths. In her estimates, Dr. Rabinovitz relied on the source data provided by our management; she did not independently verify the accuracy of the source data. The source data provided by us was based on our 24-year history in gathering claimant information and defending and settling related liabilities and defense costs relied upon and included: asbestos claims. • an analysis of DII Industries, Kellogg, Brown & Root’s and Harbison-Walker Refractories Company’s historical asbestos settlements and defense costs to develop average settlement values and average defense costs for specific asbestos-related diseases and for the specific business operation or entity allegedly responsible for the asbestos-related diseases; • an analysis of DII Industries’, Kellogg, Brown & Root’s and Harbison-Walker Refractories Company’s pending inventory of asbestos-related claims by specific asbestos- related diseases and by the specific business operation or entity allegedly responsible for the asbestos-related disease; • an analysis of the claims filing history for asbestos- related claims against DII Industries, Kellogg, Brown & Root and Harbison-Walker Refractories Company for the approximate two-year period from January 2000 to May 31, 2002, and for the approximate five-year period from January 1997 to May 31, 2002 by specific asbestos- related disease and by business operation or entity allegedly responsible for the asbestos-related disease; In her analysis, Dr. Rabinovitz projected that the elevated and historically unprecedented rate of claim filings of the last several years (particularly in 2000 and 2001), especially as expressed by the ratio of nonmalignant claim filings to malignant claim filings, would continue into the future for five more years. After that, Dr. Rabinovitz projected that the ratio of nonmalignant claim filings to malignant claim filings will gradually decrease for a 10 year period ultimately returning to the historical claiming rate and claiming ratio. In making her calculation, Dr. Rabinovitz alternatively assumed a somewhat lower rate of claim filings, based on an average of the last five years of claims experience, would continue into the future for five more years and decrease thereafter. Other important assumptions utilized in Dr. Rabinovitz’s estimates, which we relied upon in making our accrual are: • there will be no legislative or other systemic changes to the tort system; • that we will continue to aggressively defend against asbestos claims made against us; 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 95 N O T E S T O A N N U A L F I N A N C I A L S T A T E M E N T S • an inflation rate of 3% annually for settlement against us. The proposed settlement provides that up to payments and an inflation rate of 4% annually for defense costs; and $2.775 billion in cash, 59.5 million shares of our common stock (with a value of $1.1 billion using the stock price at • we would receive no relief from our asbestos obligation December 31, 2002 of $18.71) and notes with a net present due to actions taken in the Harbison-Walker bankruptcy. value expected to be less than $100 million would be R a n g e o f L i a b i l i t i e s . Based upon her analysis, Dr. paid to a trust for the benefit of current and future asbestos Rabinovitz estimated total, undiscounted asbestos and silica personal injury claimants and current silica personal injury liabilities, including defense costs, of DII Industries, claimants. Under the proposed agreement, Kellogg, Brown Kellogg, Brown & Root and some of their current and & Root and DII Industries will retain the rights to the first former subsidiaries. Through 2052, Dr. Rabinovitz estimated $2.3 billion of any insurance proceeds with any proceeds the current and future total undiscounted liability for received between $2.3 billion and $3.0 billion going to the personal injury asbestos and silica claims, including defense trust. The proposed settlement will be implemented through costs, would be a range between $2.2 billion and $3.5 billion a pre-packaged Chapter 11 filing of DII Industries and as of June 30, 2002 (which includes payments related to Kellogg, Brown & Root as well as some other DII the claims currently pending). The lower end of the range is Industries and Kellogg, Brown & Root subsidiaries with calculated by using an average of the last five years of U.S. operations. The funding of the settlement amounts asbestos claims experience and the upper end of the range is would occur upon receiving final and non-appealable court calculated using the more recent two-year elevated rate of confirmation of a plan of reorganization of DII Industries asbestos claim filings in projecting the rate of future claims. and Kellogg, Brown & Root and their subsidiaries in the 2 n d Q u a r t e r 2 0 0 2 A c c r u a l . Based on that estimate, in Chapter 11 proceeding. the second quarter of 2002, we accrued asbestos and silica Subsequently, as of March 2003, DII Industries and claims liability and defense costs for both known outstanding Kellogg, Brown & Root have entered into definitive written and future refractory, other DII Industries, and construction agreements finalizing the terms of the agreement in asbestos and silica claims using the low end of the range of principle. The proposed global settlement also includes Dr. Rabinovitz’s study, or approximately $2.2 billion. In silica claims as a result of current or past exposure. These establishing our liability for asbestos, we included all post silica claims are less than 1% of the personal injury spin-off claims against Harbison-Walker that name DII claims included in the proposed global settlement. We have Industries as a defendant. Our accruals are based on an approximately 2,500 open silica claims. estimate of personal injury asbestos claims through 2052 The agreement contemplated that we would conduct due based on the average claims experience of the last five diligence on the claims, and that we and attorneys for the years. At the end of the second quarter of 2002, we did not claimants would use reasonable efforts to execute definitive believe that any point in the expert’s range was better settlement agreements. While all the required settlement than any other point, and accordingly, based our accrual on agreements have not yet been executed, we and attorneys the low end of the range in accordance with FIN 14. for some of the asbestos claimants have now reached A g r e e m e n t R e g a r d i n g P r o p o s e d G l o b a l S e t t l e m e n t . agreement on what they believe will be a template for such In December 2002, we announced that we had reached an settlement agreements. These agreements are subject to a agreement in principle that could result in a global number of conditions, including agreement on a Chapter 11 settlement of all personal injury asbestos and silica claims plan of reorganization for DII Industries, Kellogg, Brown & Root and some of their subsidiaries, approval by 75% of 96 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T N O T E S T O A N N U A L F I N A N C I A L S T A T E M E N T S current asbestos claimants to the plan of reorganization, R e v i e w o f A c c r u a l s . As a result of the proposed the negotiation of financing acceptable to us, approval by settlement, in the fourth quarter of 2002, we re-evaluated Halliburton’s Board of Directors, and confirmation of the our accruals for known outstanding and future asbestos plan of reorganization by a bankruptcy court. The template claims. Although we have reached an agreement in principle settlement agreement also grants the claimants’ attorneys a with respect to a proposed settlement, we do not believe the right to terminate the definitive settlement agreement on settlement is “probable” under SFAS No. 5 at the current ten days’ notice if Halliburton’s DII Industries subsidiary time. Among the prerequisites to reaching a conclusion of does not file a plan of reorganization under the bankruptcy the settlement are: code on or before April 1, 2003. • agreement on the amounts to be contributed to the trust We are conducting due diligence on the asbestos claims, for the benefit of silica claimants; which is not expected to be completed by April 1, 2003. Therefore, we do not expect DII Industries, Kellogg, Brown & Root and some of their subsidiaries to file a plan of reorganization prior to April 1. Although there can be no assurances, we do not believe the claimants’ attorneys will terminate the settlement agreements on April 1, 2003 as long as adequate progress is being made toward a Chapter 11 filing. In March 2003, we agreed with • our review of the more than 347,000 current claims to establish that the claimed injuries are based on exposure to products of DII Industries, Kellogg, Brown & Root, their subsidiaries or former businesses or subsidiaries; • completion of our medical review of the injuries alleged to have been sustained by plaintiffs to establish a medical basis for payment of settlement amounts; • finalizing the principal amount of the notes to be contri- Harbison-Walker and the asbestos creditors committee in buted to the trust; the Harbison-Walker bankruptcy to consensually extend the period of the stay contained in the Bankruptcy Court’s temporary restraining order until July 21, 2003. The court’s temporary restraining order, which was originally entered • agreement with a proposed representative of future claimants and attorneys representing current claimants on procedures for distribution of settlement funds to individuals claiming personal injury; on February 14, 2002, stays more than 200,000 pending • definitive agreement with the attorneys representing asbestos claims against DII Industries. The agreement provides that if the pre-packaged Chapter 11 filing by DII Industries, Kellogg, Brown & Root and their subsidiaries is not made by July 14, 2003, the Bankruptcy Court will hear motions to lift the stay on July 21, 2003. The asbestos creditors committee also reserves the right to monitor progress toward the filing of the Chapter 11 proceeding and seek an earlier hearing to lift the stay if satisfactory progress toward the Chapter 11 filing is not being made. current asbestos claimants and a proposed representative of future claimants on a plan of reorganization for the Chapter 11 filings of DII Industries, Kellogg, Brown & Root and some of their subsidiaries; and agreement with the attorneys representing current asbestos claimants with respect to, and completion and mailing of, a disclosure statement explaining the pre-packaged plan of reorganization to the more than 347,000 current claimants; • arrangement of financing on terms acceptable to us to fund the cash amounts to be paid in the settlement; • Halliburton board approval; • obtaining affirmative votes to the plan of reorganization from at least the required 75% of known present asbestos claimants and from a requisite number of silica claimants needed to complete the plan of reorganization; and 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 97 N O T E S T O A N N U A L F I N A N C I A L S T A T E M E N T S • obtaining final and non-appealable bankruptcy court • reviewed our insurance coverage policy database approval and federal district court confirmation of the plan of reorganization. containing information on key policy terms as provided by outside counsel; Because we do not believe the settlement is currently • reviewed the terms of DII Industries’ prior and current probable as defined by Statement of Financial Standards coverage-in-place settlement agreements; No. 5, we have continued to establish our accruals in • reviewed the status of DII Industries’ and Kellogg, Brown accordance with the analysis performed by Dr. Rabinovitz. However, as a result of the settlement and the payment amounts contemplated thereby, we believed it appropriate to adjust our accrual to use the upper end of the range of probable and reasonably estimable liabilities for current and future asbestos liabilities contained in Dr. Rabinovitz’s study, which estimated liabilities through 2052 and assumed the more recent two-year elevated rate of claim filings in projecting the rate of future claims. & Root’s current insurance-related lawsuits and the various legal positions of the parties in those lawsuits in relation to the developed and developing case law and the historic positions taken by insurers in the earlier filed and settled lawsuits; • engaged in discussions with our counsel; and • analyzed publicly-available information concerning the ability of the DII Industries’ insurers to meet their obligations. As a result, in the fourth quarter of 2002, we have Based on that review, analyses and discussions, Peterson determined that the best estimate of the probable loss is the Consulting assisted us in making judgments concerning $3.5 billion estimate in Dr. Rabinovitz’s study, and insurance coverage that we believe are reasonable and accordingly, we have increased our accrual for probable and consistent with our historical course of dealings with our reasonably estimable liabilities for current and future insurers and the relevant case law to determine the asbestos and silica claims to $3.4 billion. probable insurance recoveries for asbestos liabilities. This I n s u ra n c e . In 2002, we retained Peterson Consulting, a analysis factored in the probable effects of self-insurance nationally-recognized consultant in asbestos liability and features, such as self-insured retentions, policy exclusions, insurance, to work with us to project the amount of liability caps and the financial status of applicable insurers, insurance recoveries probable in light of the projected and various judicial determinations relevant to the current and future liabilities accrued by us. Using applicable insurance programs. The analysis of Peterson Dr. Rabinovitz’s projection of liabilities through 2052 using Consulting is based on its best judgment and information the two-year elevated rate of asbestos claim filings, provided by us. Peterson Consulting assisted us in conducting an analysis to P r o b a b l e I n s u ra n c e R e c o v e r i e s . Based on this analysis determine the amount of insurance that we estimate is of the probable insurance recoveries, in the second quarter probable that we will recover in relation to the projected of 2002, we recorded a receivable of $1.6 billion for probable claims and defense costs. In conducting this analysis, insurance recoveries. Peterson Consulting: • reviewed DII Industries’ historical course of dealings with its insurance companies concerning the payment of asbestos-related claims, including DII Industries’ 15 year litigation and settlement history; In connection with our adjustment of our accrual for asbestos liability and defense costs in the fourth quarter of 2002, Peterson Consulting assisted us in re-evaluating our receivable for insurance recoveries deemed probable through 2052, assuming $3.5 billion of liabilities for current and future asbestos claims using the same factors cited above through that date. Based on Peterson Consulting analysis of 2002 $ 737 $ 2,820 (132) 2001 80 696 (39) $ 3,425 $ 737 $ (45) $ — 45 — — (39) (18) — 12 (45) (12) 98 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T N O T E S T O A N N U A L F I N A N C I A L S T A T E M E N T S the probable insurance recoveries, we increased our December 31 Millions of dollars insurance receivable to $2.1 billion as of the fourth quarter Gross liability – beginning balance of 2002. The insurance receivable recorded by us does not assume any recovery from insolvent carriers and assumes that those carriers which are currently solvent will continue Accrued liability Payments on claims Gross liability – ending balance Estimated insurance recoveries: to be solvent throughout the period of the applicable Highlands Insurance Company – recoveries in the projections. However, there can be no assurance that these assumptions will be correct. These beginning balance Accrued insurance recoveries Write-off of recoveries insurance receivables do not exhaust the applicable insurance Insurance billings coverage for asbestos-related liabilities. C u r r e n t A c c r u a l s . The current accrual of $3.4 billion for probable and reasonably estimable liabilities for current and future asbestos and silica claims and the $2.1 billion in insurance receivables are included in noncurrent assets and liabilities due to the extended time periods involved to settle claims. In the second quarter of 2002, we recorded a pretax Highlands Insurance Company – ending balance Other insurance carriers – beginning balance $ (567) $ Accrued insurance recoveries Insurance billings (1,530) (563) 38 8 Other insurance carriers – ending balance $(2,059) $ (567) Total estimated insurance recoveries Net liability for known asbestos claims $(2,059) $ (612) $ 1,366 $ 125 charge of $483 million, and, in the fourth quarter of 2002, Accounts receivable for billings to insurance companies we recorded a pretax charge of $799 million ($675 million for payments made on asbestos claims were $44 million at after-tax). December 31, 2002, and $18 million at December 31, 200l, In the fourth quarter of 2002, we recorded pretax charges excluding $35 million in accounts receivable written off at of $232 million ($212 million after-tax) for claims related the conclusion of the Highlands litigation. to Brown & Root construction and renovation projects under P o s s i b l e A d d i t i o n a l A c c r u a l s . When and if the the Engineering and Construction Group segment. The currently proposed global settlement becomes balance of $567 million ($463 million after-tax) related to probable under SFAS No. 5, we would increase our accrual claims associated with businesses no longer owned by for probable and reasonably estimable liabilities for current us and was recorded as discontinued operations. The low and future asbestos claims up to $4.0 billion, reflecting effective tax rate on the asbestos charge is due to the the amount in cash and notes we would pay to fund the recording of a valuation allowance against the United States settlement combined with the value of 59.5 million shares of Federal deferred tax asset associated with the accrual as Halliburton common stock using $18.71, which was trading the deferred tax asset may not be fully realizable based upon value of the stock at the end of the fourth quarter of 2002. future taxable income projections. In addition, at such time as the settlement becomes The total estimated claims through 2052, including the probable, we would adjust our accrual for liabilities for 347,000 current open claims, are approximately one million. current and future asbestos claims and we would expect A summary of our accrual for all claims and corresponding to increase the amount of our insurance receivables to $2.3 insurance recoveries is as follows: billion. As a result, we would record at such time an additional pretax charge of $322 million ($288 million after- tax). Beginning in the first quarter in which the settlement 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 99 N O T E S T O A N N U A L F I N A N C I A L S T A T E M E N T S becomes probable, the accrual would then be adjusted company. When completed, the project will consist of two from period to period based on positive and negative converted supertankers which will be used as floating changes in the market price of our common stock until the production, storage and offloading platforms, or FPSO’s, 33 payment of the shares into the trust. hydrocarbon production wells, 18 water injection wells, C o n t i n u i n g R e v i e w. Projecting future events is subject to and all sub-sea flow lines and risers necessary to connect the many uncertainties that could cause the asbestos-related underwater wells to the FPSO’s. liabilities and insurance recoveries to be higher or lower KBR’s performance under the contract is secured by: than those projected and booked such as: • the number of future asbestos-related lawsuits to be filed against DII Industries, and Kellogg, Brown & Root; • the average cost to resolve such future lawsuits; • coverage issues among layers of insurers issuing different policies to different policyholders over extended periods of time; • the impact on the amount of insurance recoverable in light of the Harbison-Walker and Federal-Mogul bankruptcies; and • the continuing solvency of various insurance companies. Given the inherent uncertainty in making future projections, we plan to have the projections of current and future asbestos and silica claims periodically reexamined, and we will update them if needed based on our experience and other relevant factors such as changes in the tort system, the resolution of the bankruptcies of various asbestos defendants and the probability of our settlement of all claims becoming effective. Similarly, we will re-evaluate our projections concerning our probable insurance recoveries in light of any updates to Dr. Rabinovitz’s projections, developments in DII Industries’ and Kellogg, Brown & Root’s various lawsuits against its insurance companies and other developments that may impact the probable insurance. B a r ra c u d a - C a ra t i n g a P r o j e c t . In June 2000, KBR entered into a contract with the project owner, Barracuda & Caratinga Leasing Company B.V., to develop the Barracuda and Caratinga crude oil fields, which are located off the coast of Brazil. The project manager and owner representative is Petrobras, the Brazilian national oil • two performance letters of credit, which together have an available credit of approximately $261 million and which represent approximately 10% of the contract amount, as amended to date by change orders; • a retainage letter of credit in an amount equal to $121 million as of December 31, 2002 and which will increase in order to continue to represent 10% of the cumulative cash amounts paid to KBR; and • a guarantee of KBR’s performance of the agreement by Halliburton Company in favor of the project owner. The project owner has procured project finance funding obligations from various banks to finance the payments due to KBR under the contract. As of December 31, 2002, the project was approximately 63% complete and KBR had recorded a loss of $117 million related to the project. The probable unapproved claims included in determining the loss on the project were $182 million as of December 31, 2002. The claims for the project most likely will not be settled within one year. Accordingly, probable unapproved claims of $115 million at December 31, 2002 have been recorded to long-term unbilled work on uncompleted contracts. Those amounts are included in “Other assets” on the balance sheet. KBR has asserted claims for compensation substantially in excess of $182 million. The project owner, through its project manager, Petrobras, has denied responsibility for all such claims. Petrobras has, however, agreed in principle to the scope, but not yet the amount, of issues valued by KBR approximately $29 million which are not related to the $182 million in probable unapproved claims. Additionally we are in discussion with Petrobras about responsibility for $78 million of new tax costs that were not foreseen in the contract price. 100 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T N O T E S T O A N N U A L F I N A N C I A L S T A T E M E N T S KBR expects the project will likely be completed more is no assurance that it would do so. To date, the banks have than 12 months later than the original contract completion made funds available, and the project owner has continued to date. KBR believes that the project’s delay is due primarily disburse funds to KBR as payment for its work on the to the actions of Petrobras. In the event that any portion of project even though the project completion has been delayed. the delay is determined to be attributable to KBR and any In the event that KBR is alleged to be in default under phase of the project is completed after the milestone dates the contract, the project owner may assert a right to draw specified in the contract, KBR could be required to pay upon the letters of credit. If the letters of credit were drawn, liquidated damages. These damages would be calculated on KBR would be required to fund the amount of the draw to an escalating basis of up to $1 million per day of delay the issuing bank. In the event that KBR was determined caused by KBR subject to a total cap on liquidated damages after an arbitration proceeding to have been in default of 10% of the final contract amount (yielding a cap of under the contract, and if the project was not completed by approximately $263 million as of December 31, 2002). We are KBR as a result of such default (i.e., KBR’s services are in discussions with Petrobras regarding a settlement of the terminated as a result of such default), the project owner amount of unapproved claims. There can be no assurance may seek direct damages (including completion costs in that we will reach any settlement regarding these excess of the contract price and interest on borrowed funds, claims. We expect any settlement, if reached, will result in a but excluding consequential damages) against KBR for schedule extension that would eliminate liability for up to $500 million plus the return of up to $300 million in liquidated damages based on the currently forecasted advance payments that would otherwise have been schedule. We have not accrued any amounts for liquidated credited back to the project owner had the contract not damages, since we consider the imposition of liquidated been terminated. damages to be unlikely. In addition, although the project financing includes The project owner currently has no other committed borrowing capacity in excess of the original contract source of funding on which we can necessarily rely other amount, only $250 million of this additional borrowing than the project finance funding for the project. If the banks capacity is reserved for increases in the contract amount cease to fund the project, the project owner may not have payable to KBR and its subcontractors other than the ability to continue to pay KBR for its services. The Petrobras. Because our claims, together with change original bank documents provide that the banks are not orders that are currently under negotiation, exceed this obligated to continue to fund the project if the project has amount, we cannot give assurance that there is adequate been delayed for more than 6 months. In November 2002, funding to cover current or future KBR claims. Unless the the banks agreed to extend the 6-month period to 12 months. project owner provides additional funding or permits us to Other provisions in the bank documents may provide for defer repayment of the $300 million advance, and assuming additional time extensions. However, delays beyond 12 the project owner does not allege default on our part, we months may require bank consent in order to obtain may be obligated to fund operating cash flow shortages over additional funding. While we believe the banks have an the remaining project life in an amount we currently incentive to complete the financing of the project, there is no estimate to be up to approximately $400 million. assurance that they would do so. If the banks did not The possible Chapter 11 pre-packaged bankruptcy filing consent to extensions of time or otherwise ceased funding the by KBR in connection with the settlement of its asbestos project, we believe that Petrobras would provide for or claims would constitute an event of default under the loan secure other funding to complete the project, although there 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 101 N O T E S T O A N N U A L F I N A N C I A L S T A T E M E N T S documents with the banks unless waivers are obtained. American Institute of Certified Public Accountants’ KBR believes that it is unlikely that the banks will exercise Statement of Position 81-1, “Accounting for Performance of any right to cease funding given the current status of the Construction-Type and Certain Production-Type project and the fact that a failure to pay KBR may allow KBR Contracts,” and satisfied the relevant criteria for accruing to cease work on the project without Petrobras having a this revenue, although the SEC may conclude otherwise. readily available substitute contractor. On December 21, 2001, the SEC’s Division of Corporation KBR and Petrobras are currently attempting to resolve Finance announced that it would review the annual reports any disputes through ongoing negotiations between of all Fortune 500 companies that file periodic reports with the parties and each has appointed a high-level team for the SEC. We received the SEC’s initial comments in letter this purpose. form dated September 20, 2002 and responded on October 31, S e c u r i t i e s a n d E x c h a n g e C o m m i s s i o n ( “ S EC ” ) 2002. Since then, we have received and responded to three I n v e s t i g a t i o n a n d Fo r t u n e 5 0 0 R e v i e w. In late May 2002, follow-up sets of comments, most recently in March 2003. we received a letter from the Fort Worth District Office of S e c u r i t i e s a n d r e l a t e d l i t i g a t i o n . On June 3, 2002, a the Securities and Exchange Commission stating that it was class action lawsuit was filed against us in the United initiating a preliminary inquiry into some of our accounting States District Court for the Northern District of Texas on practices. In mid-December 2002, we were notified by the behalf of purchasers of our common stock alleging SEC that a formal order of investigation had been issued. violations of the federal securities laws. After that date, Since that time, the SEC has issued subpoenas calling for approximately twenty similar class actions were filed the production of documents and requiring the appearance against us in that or other federal district courts. Several of of a number of witnesses to testify regarding those those lawsuits also named as defendants Arthur Andersen, accounting practices, which relate to the recording of LLP (“Arthur Andersen”), our independent accountants for revenues associated with cost overruns and unapproved the period covered by the lawsuit, and several of our claims on long-term engineering and construction projects. present or former officers and directors. Those lawsuits Throughout the informal inquiry and during the allege that we violated federal securities laws in failing to pendency of the formal investigation, we have provided disclose a change in the manner in which we accounted for approximately 300,000 documents to the SEC. The revenues associated with unapproved claims on long-term production of documents is essentially complete and the engineering and construction contracts, and that we process of providing witnesses to testify is ongoing. To our overstated revenue by accruing the unapproved claims. One knowledge, the SEC’s investigation has focused on the such action was subsequently dismissed voluntarily, without compliance with generally accepted accounting principles prejudice, upon motion by the filing plaintiff. The federal of our recording of revenues associated with cost overruns securities fraud class actions have all been transferred to and unapproved claims for long-term engineering and the U.S. District Court for the Northern District of Texas construction projects, and the disclosure of our accrual and consolidated before the Honorable Judge David Godbey. practice. Accrual of revenue from unapproved claims is an The amended consolidated class action complaint in that accepted and widely followed accounting practice for case, styled Richard Moore v. Halliburton, was scheduled to companies in the engineering and construction business. be filed in February 2003, but that date has been extended Although we accrued revenue related to unapproved by agreement of the parties. It is unclear as of this time claims in 1998, we first made disclosures regarding the when the amended consolidated class action complaint will accruals in our 1999 Annual Report on Form 10-K. We believe we properly applied the required methodology of the 102 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T N O T E S T O A N N U A L F I N A N C I A L S T A T E M E N T S be filed. However, we believe that we have meritorious plus pre-judgment interest, which was less than one-quarter defenses to the claims and intend to vigorously defend of BJ’s claim at the beginning of the trial. A total of $102 against them. million was accrued in the first quarter, which was Another case, also filed in the United States District comprised of the $98 million judgment and $4 million in Court for the Northern District of Texas on behalf of three pre-judgment interest costs. The jury also found that there individuals, and based upon the same revenue recognition was no intentional infringement by Halliburton Energy practices and accounting treatment that is the subject of the Services. As a result of the jury’s determination of securities class actions, alleges only common law and infringement, the court has enjoined us from further use of statutory fraud in violation of Texas state law. We moved to our Phoenix fracturing fluid. We have posted a supersedeas dismiss that action on October 24, 2002, as required by bond in the amount of approximately $107 million to the court’s scheduling order, on the bases of lack of federal cover the damage award, pre-judgment and post-judgment subject matter jurisdiction and failure to plead with that interest, and awardable costs. We timely appealed the degree of particularity required by the rules of procedure. judgment and the appeal has now been fully briefed and we That motion has now been fully briefed and is before the are awaiting notice of a date of hearing before the United court awaiting ruling. States Court of Appeals for the Federal Circuit, which hears In addition to the securities class actions, one additional all appeals of patent cases. While we believe we have a class action, alleging violations of ERISA in connection with valid basis for appeal and intend to vigorously pursue our the Company’s Benefits Committee’s purchase of our stock appeal, any favorable outcome from that appeal is not for the accounts of participants in our 401 (k) retirement assured. We have alternative products to use in our plan during the period we allegedly knew or should have fracturing operations, and do not expect the loss of the use known that our revenue was overstated as a result of the of the Phoenix fracturing fluid to have a material adverse accrual of revenue in connection with unapproved claims, impact on our overall energy services business. was filed and subsequently voluntarily dismissed. A n g l o - D u t c h ( Te n g e) . We have been sued in the District Finally, on October 11, 2002, a shareholder derivative Court of Harris County, Texas by Anglo-Dutch (Tenge) action against present and former directors and our former L.L.C. and Anglo-Dutch Petroleum International, Inc. for CFO was filed alleging breach of fiduciary duty and allegedly breaching a confidentiality agreement related to corporate waste arising out of the same events and an investment opportunity we considered in the late 1990s circumstances upon which the securities class actions are in an oil field in the former Soviet republic of Kazakhstan. based. We have moved to dismiss that action and a hearing While we believe the claims raised in that lawsuit are on that motion has taken place in March 2003. We believe without merit and are vigorously defending against them, the action is without merit and we intend to vigorously the plaintiffs have announced their intention to seek defend it. approximately $680 million in damages. We have moved for B J S e r v i c e s C o m p a n y p a t e n t l i t i g a t i o n . On April 12, summary judgment and a hearing on that motion was 2002, a federal court jury in Houston, Texas, returned a held on March 12 of 2003. The court’s ruling on this motion verdict against Halliburton Energy Services, Inc. in a patent is still pending. Trial is set for April 21, 2003. infringement lawsuit brought by BJ Services Company, or I m p r o p e r p a y m e n t s r e p o r t e d t o t h e S e c u r i t i e s a n d BJ. The lawsuit alleged that our Phoenix fracturing fluid E x c h a n g e C o m m i s s i o n . We have reported to the SEC that infringed a patent issued to BJ in January 2000 for a one of our foreign subsidiaries operating in Nigeria made method of well fracturing using a specific fracturing fluid. The jury awarded BJ approximately $98 million in damages, 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 103 N O T E S T O A N N U A L F I N A N C I A L S T A T E M E N T S improper payments of approximately $2.4 million to an million as of December 31, 2002 and $49 million as of entity owned by a Nigerian national who held himself out as December 31, 2001. The liability covers numerous properties a tax consultant when in fact he was an employee of a local and no individual property accounts for more than 10% of tax authority. The payments were made to obtain favorable the current liability balance. In some instances, we have tax treatment and clearly violated our Code of Business been named a potentially responsible party by a regulatory Conduct and our internal control procedures. The payments agency, but in each of those cases, we do not believe we have were discovered during an audit of the foreign subsidiary. any material liability. We have subsidiaries that have We have conducted an investigation assisted by outside been named as potentially responsible parties along with legal counsel. Based on the findings of the investigation we other third parties for ten federal and state superfund sites have terminated several employees. None of our senior for which we have established liabilities. As of December 31, officers were involved. We are cooperating with the SEC in 2002, those ten sites accounted for $8 million of our total its review of the matter. We plan to take further action to $48 million liability. ensure that our foreign subsidiary pays all taxes owed in L e t t e r s o f c r e d i t . In the normal course of business, we Nigeria, which may be as much as an additional $3 million, have agreements with banks under which approximately which amount was fully accrued as of March 31, 2002. $1.4 billion of letters of credit or bank guarantees were The integrity of our Code of Business Conduct and our issued, including $204 million which relate to our joint internal control procedures are essential to the way we ventures’ operations. Effective October 9, 2002, we amended conduct business. an agreement with banks under which $261 million of E n v i r o n m e n t a l . We are subject to numerous letters of credit have been issued. The amended agreement environmental, legal and regulatory requirements related to removes the provision that previously allowed the banks to our operations worldwide. In the United States, these laws require collateralization if ratings of Halliburton debt fell and regulations include the Comprehensive Environmental below investment grade ratings. The revised agreements Response, Compensation and Liability Act, the Resources include provisions that require us to maintain ratios of Conservation and Recovery Act, the Clean Air Act, the debt to total capital and of total earnings before interest, Federal Water Pollution Control Act and the Toxic Substances taxes, depreciation and amortization to interest expense. Control Act, among others. In addition to the federal laws The definition of debt includes our asbestos liability. The and regulations, states where we do business may have definition of total earnings before interest, taxes, depreciation equivalent laws and regulations by which we must also and amortization excludes any non-cash charges related abide. We evaluate and address the environmental impact of to the proposed global asbestos settlement through our operations by assessing and remediating contaminated December 31, 2003. properties in order to avoid future liabilities and comply If our debt ratings fall below investment grade, we would with environmental, legal and regulatory requirements. On be in technical breach of a bank agreement covering another occasion, we are involved in specific environmental litigation $160 million of letters of credit at December 31, 2002, which and claims, including the remediation of properties we own might entitle the bank to set-off rights. In addition, a $151 or have operated as well as efforts to meet or correct million letter of credit line, of which $121 million has been compliance-related matters. issued, includes provisions that allow the bank to require We do not expect costs related to these remediation cash collateralization for the full line if debt ratings of either requirements to have a material adverse effect on our rating agency fall below the rating of BBB by Standard & consolidated financial position or our results of operations. Our accrued liabilities for environmental matters were $48 104 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T N O T E S T O A N N U A L F I N A N C I A L S T A T E M E N T S Poor’s or Baa2 by Moody’s Investors’ Services. These letters N O T E 1 3 . of credit and bank guarantees generally relate to our guaranteed performance or retention payments under our long-term contracts and self-insurance. In the past, no significant claims have been made against letters of credit we have issued. We do not I N C O M E ( L O S S ) P E R S H A R E Millions of dollars and shares except per share data Income (loss) from continuing operations before change in accounting method, net Basic weighted average shares anticipate material losses to occur as a result of these Effect of common stock equivalents 2002 2001 2000 $ (346) $ 551 $ 188 432 — 432 428 2 430 442 4 446 financial instruments. L i q u i d a t e d d a m a g e s . Many of our engineering and construction contracts have milestone due dates that must be met or we may be subject to penalties for liquidated damages if claims are asserted and we were responsible for the delays. These generally relate to specified activities within a project by a set contractual date or achievement of a specified level of output or throughput of a plant we construct. Each contract defines the conditions under which a customer may make a claim for liquidated damages. In most instances, liquidated damages are never asserted by the customer but the potential to do so is used in negotiating claims and closing out the contract. We had not accrued a liability for $364 million at December 31, 2002 and $97 million at December 31, 2001 of possible liquidated damages as we consider the imposition of liquidated damages to be unlikely. We believe we have valid claims for schedule extensions against the customers which would eliminate any liability for liquidated damages. Of the total liquidated damages, $263 million at December 31, 2002 and $77 million at December 31, 2001 relate to unasserted liquidated damages for the Barracuda-Caratinga project. The estimated schedule impact of change orders requested by the customer is expected to cover approximately one-half Diluted weighted average shares Income (loss) per common share from continuing operations before change in accounting method, net: Basic Diluted $(0.80) $1.29 $0.42 $(0.80) $1.28 $0.42 Basic income (loss) per share is based on the weighted average number of common shares outstanding during the period. Diluted income (loss) per share includes additional common shares that would have been outstanding if potential common shares with a dilutive effect had been issued. For 2002, we have used the basic weighted average shares in the calculation as the effect of the common stock equivalents would be antidilutive based upon the net loss from continuing operations. Included in the computation of diluted income per share in 2001 and 2000 are rights we issued in connection with the PES acquisition for between 850,000 and 2.1 million shares of Halliburton common stock. Excluded from the computation of diluted income per share are options to purchase 10 million shares of common stock in 2001 and 1 million shares in 2000. These options were outstanding during these years, but were excluded because the option exercise price was greater than the average market price of the common shares. of the $263 million exposure at December 31, 2002 and N O T E 1 4 . claims for schedule extension are expected to cover the remaining exposure. R E O R G A N I Z AT I O N O F B U S I N E S S O P E R AT I O N S On March 18, 2002 we announced plans to restructure our O t h e r. We are a party to various other legal proceedings. businesses into two operating subsidiary groups, the Energy We expense the cost of legal fees related to these Services Group and the Engineering and Construction proceedings as incurred. We believe any liabilities we may Group. As part of this reorganization, we separated and have arising from these proceedings will not be material to our consolidated financial position or results of operations. consolidated the entities in our Energy Services Group together as direct and indirect subsidiaries of Halliburton 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 105 N O T E S T O A N N U A L F I N A N C I A L S T A T E M E N T S Energy Services, Inc. We also separated and consolidated the continued to experience delays in customer commitments for entities in our Engineering and Construction Group new upstream and downstream projects. With the exception together as direct and indirect subsidiaries of the former of deepwater projects, short-term prospects for increased Dresser Industries, Inc., which became a limited liability engineering and construction activities in either the company during the second quarter of 2002 and was upstream or downstream businesses were not positive. As a renamed DII Industries. The reorganization of business result of the reorganization of the engineering and operations facilitated the separation, organizationally, construction businesses, we took actions to rationalize our financially, and operationally, of our two business segments, operating structure including write-offs of equipment and which we believe will significantly improve operating licenses of $10 million, engineering reference designs of $4 efficiencies in both, while streamlining management and million, capitalized software of $6 million, and recorded easing manpower requirements. In addition, many support severance costs of $16 million. Of these charges, $30 million functions, which were previously shared, were moved into was reflected under the captions Cost of services and $6 the two business groups. As a result, we took actions during million as General and administrative in our 2000 2002 to reduce our cost structure by reducing personnel, consolidated statements of income. Severance and related moving previously shared support functions into the two costs of $16 million were for the reduction of approximately business groups and realigning ownership of international 30 senior management positions. In January 2002, the subsidiaries by group. last of the personnel actions was completed and we have no In 2002, we incurred costs related to the restructuring of remaining accruals related to the 2000 restructuring. approximately $107 million which consisted of the following: • $64 million in personnel related expense; • $17 million of asset related write-downs; N O T E 1 5 . C H A N G E I N A C C O U N T I N G M E T H O D In July 2001, the Financial Accounting Standards Board • $20 million in professional fees related to the issued SFAS No. 142, “Goodwill and Other Intangible restructuring; and Assets.” Effective January 1, 2002, goodwill is no longer • $6 million related to contract terminations. amortized but is tested for impairment as set forth in the Of this amount, $8 million remains in accruals for severance arrangements and approximately $2 million for other items. We expect these remaining payments will be made during 2003. Although we have no specific plans currently, the reorganization would facilitate separation of the ownership of the two businesses in the future if we identify an opportunity that produces greater value for our shareholders than continuing to own both businesses. In the fourth quarter of 2000 we approved a plan to reorganize our engineering and construction businesses into one business unit. This restructuring was undertaken because our engineering and construction businesses statement. We now perform our goodwill impairment test for each of our reporting units in accordance with SFAS No. 142 and those tests indicate that none of the goodwill we currently have recorded is impaired. Amortization of goodwill for 2001 totaled $42 million pretax and $38 million after-tax. In July 2001, the Financial Accounting Standards Board issued SFAS No. 141, “Business Combinations” which requires the purchase method of accounting for business combination transactions initiated after June 30, 2001. The statement requires that goodwill recorded on acquisitions completed prior to July 1, 2001 be amortized through December 31, 2001. Goodwill amortization is precluded on acquisitions completed after June 30, 2001. We ceased amortization of goodwill on December 31, 2001. 106 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T N O T E S T O A N N U A L F I N A N C I A L S T A T E M E N T S N O T E 1 6 . I N C O M E TA X E S December 31 Millions of dollars Gross deferred tax assets: 2002 2001 The components of the (provision) benefit for income taxes are: Employee compensation and benefits $ 282 $ 214 Years ended December 31 Millions of dollars Current income taxes: Federal Foreign State Total Deferred income taxes: Federal Foreign and state Total 2002 2001 2000 $ 71 $(146) $ (16) (173) (157) (114) 4 (20) (5) (98) (323) (135) (11) 29 18 (58) (3) (61) (20) 26 6 Total continuing operations $ (80) $(384) $(129) Discontinued operations: Current income taxes Deferred income taxes Disposal of discontinued operations Total 21 133 — (15) 35 (60) — (199) (141) $ 74 $(563) $(330) Included in the current (provision) benefit for income taxes are foreign tax credits of $89 million in 2002, $106 million in 2001 and $113 million in 2000. The United States and foreign components of income before income taxes, Capitalized research and experimentation Accrued liabilities Insurance accruals Construction contract accounting methods Inventory 75 102 78 114 46 Asbestos and silica related liabilities 1,201 Intercompany profit Net operating loss carryforwards Foreign tax credit carryforward AMT credit carryforward Intangibles Allowance for bad debt Other Total Gross deferred tax liabilities: 46 121 82 100 53 258 54 44 — — 18 36 41 32 81 49 5 6 40 23 $ 2,134 $1,067 Insurance for asbestos and silica related liabilities $ 724 $ 214 Depreciation and amortization Nonrepatriated foreign earnings All other Total Valuation allowances: 188 36 13 106 36 101 $ 961 $ 457 Net operating loss carryforwards $ 77 $ 38 Future tax attributes related to asbestos Foreign tax credit limitation All other Total 233 49 7 366 — — 8 46 minority interests, discontinued operations, and change in litigation accounting method are as follows: Years ended December 31 Millions of dollars United States Foreign Total 2002 2001 2000 $(537) $565 $ 128 309 389 207 $(228) $954 $ 335 Net deferred income tax asset $ 807 $ 564 We have $158 million of net operating loss carryforwards that expire from 2003 through 2011 and net operating loss The primary components of our deferred tax assets and carryforwards of $71 million with indefinite expiration liabilities and the related valuation allowances, including dates. The federal alternative minimum tax credits are federal deferred tax assets of discontinued operations are available to reduce future U.S. federal income taxes on an as follows: indefinite basis. We have accrued for the potential repatriation of undistributed earnings of our foreign subsidiaries and consider earnings above the amounts on which tax has been provided to be permanently reinvested. While these additional earnings could become subject to additional tax if repatriated, repatriation is not anticipated. Any additional amount of tax is not practicable to estimate. 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 107 N O T E S T O A N N U A L F I N A N C I A L S T A T E M E N T S We have established a $49 million valuation allowance potential excess foreign tax credit carryovers. Further, our against the 2002 foreign tax credit carryovers, on the basis impairment loss on Bredero-Shaw cannot be fully benefited that we believe these credits will not be utilized in the for tax purposes due to book and tax basis differences in statutory carryover period. We also have recorded a $233 that investment and the limited benefit generated by a million valuation allowance on the asbestos liabilities based capital loss carryback. Settlement of unrealized prior period on the anticipated impact of the future asbestos deductions tax exposures had a favorable impact to the overall tax rate. on our ability to utilize future foreign tax credits. We Exclusive of the asbestos and silica charges net of anticipate that a portion of the asbestos deductions will insurance recoveries and the impairment loss on displace future foreign tax credits and those credits will Bredero-Shaw, our 2002 effective tax rate from continuing expire unutilized. operations would be 38.9% for fiscal 2002 compared to Pension liability adjustment included in Other 40.3% in 2001. comprehensive income is net of a tax benefit of $69 million in 2002, and $15 million in 2001. Reconciliations between the actual provision for income taxes and that computed by applying the United States statutory rate to income from continuing operations before income taxes and minority interest are as follows: N O T E 1 7. C O M M O N S T O C K Our 1993 Stock and Long-Term Incentive Plan provides for the grant of any or all of the following types of awards: • stock options, including incentive stock options and non- qualified stock options; 2002 2001 2000 • stock appreciation rights, in tandem with stock options or Years ended December 31 Millions of dollars (Provision) benefit computed at statutory rate $ 80 $ (334) $ (117) Reductions (increases) in taxes resulting from: Rate differentials on foreign earnings (4) (32) (14) State income taxes, net of federal income tax benefit Prior years 2 33 Loss on disposals of equity method investee (28) (13) — — (3) — — Non-deductible goodwill Valuation allowance Other items, net Total continuing operations Discontinued operations Disposal of discontinued operations — (163) — (80) 154 — — 6 (384) 20 (199) — 16 (129) (60) (141) Total $ 74 $ (563) $ (330) We have recognized a $114 million valuation allowance in continuing operations and $119 million in discontinued operations associated with the asbestos charges net of insurance recoveries. In addition, continuing operations has recorded a valuation allowance of $49 million related to (11) (11) have been reserved for issuance to key employees. The plan freestanding; • restricted stock; • performance share awards; and • stock value equivalent awards. Under the terms of the 1993 Stock and Long-Term Incentive Plan as amended, 49 million shares of common stock specifies that no more than 16 million shares can be awarded as restricted stock. At December 31, 2002, 19 million shares were available for future grants under the 1993 Stock and Long-Term Incentive Plan of which 10 million shares remain available for restricted stock awards. In connection with the acquisition of Dresser Industries, Inc. in 1998, we assumed the outstanding stock options under the stock option plans maintained by Dresser Industries, Inc. Stock option transactions summarized below include amounts for the 1993 Stock and Long-Term Incentive Plan and stock plans of Dresser Industries, Inc. and other acquired companies. No further awards are being made under the stock plans of acquired companies. 108 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T N O T E S T O A N N U A L F I N A N C I A L S T A T E M E N T S The following table represents our stock options granted, Stock options generally expire 10 years from the grant exercised and forfeited during the past three years: date. Stock options under the 1993 Stock and Long-Term Stock Options Outstanding at December 31, 1999 Granted Exercised Forfeited Outstanding at December 31, 2000 Granted Exercised Forfeited Outstanding at Number of Shares (in millions) Exercise Price per Share Weighted Average Exercise Price per Share Incentive Plan vest ratably over a three or four year period. Other plans have vesting periods ranging from three to 10 years. Options under the Non-Employee Directors’ Plan vest 17.1 1.7 (3.6) (0.5) 14.7 3.6 (0.7) (0.5) $ 3.10 – 61.50 $ 32.03 after six months. 34.75 – 54.00 3.10 – 45.63 12.20 – 54.50 41.61 25.89 37.13 Restricted shares awarded under the 1993 Stock and Long-Term Incentive Plan were 1,706,643 in 2002, 1,484,034 in 2001, and 695,692 in 2000. The shares awarded are net $ 8.28 – 61.50 $ 34.54 of forfeitures of 46,894 in 2002, 170,050 in 2001, and 69,402 12.93 – 45.35 8.93 – 40.81 12.32 – 54.50 35.56 25.34 36.83 in 2000. The weighted average fair market value per share at the date of grant of shares granted was $14.95 in 2002, $30.90 in 2001, and $42.25 in 2000. December 31, 2001 17.1 $ 8.28 – 61.50 $ 35.10 Our Restricted Stock Plan for Non-Employee Directors Granted Exercised Forfeited Outstanding at 2.6 — * (1.2) 9.10 – 19.75 8.93 – 17.21 8.28 – 54.50 12.57 11.39 31.94 December 31, 2002 18.5 $9.10 – 61.50 $32.10 * Actual exercises for 2002 were approximately 30,000 shares. allows for each non-employee director to receive an annual award of 400 restricted shares of common stock as a part of compensation. We reserved 100,000 shares of common stock for issuance to non-employee directors. Under this plan we issued 4,400 restricted shares in 2002, 4,800 restricted Options outstanding at December 31, 2002 are composed of shares in 2001, and 3,600 restricted shares in 2000. At the following: December 31, 2002, 38,000 shares have been issued to non- Range of Exercise Prices $ 9.10 – 19.27 $ 19.28 – 30.14 $ 30.15 – 39.54 $ 39.55 – 61.50 Number of Shares (in millions) 3.2 5.1 6.3 3.9 $ 9.10 – 61.50 18.5 Outstanding Weighted Average Remaining Contractual Life 7.4 4.8 6.5 6.7 6.2 Exercisable employee directors under this plan. The weighted average Weighted Average Exercise Price $13.41 27.50 37.30 45.28 Number of Shares (in millions) 0.7 4.8 4.8 2.2 Weighted Average Exercise Price $16.96 27.79 38.55 48.34 fair market value per share at the date of grant of shares granted was $12.56 in 2002, $34.35 in 2001, and $46.81 in 2000. Our Employees’ Restricted Stock Plan was established for employees who are not officers, for which 200,000 shares $32.10 12.5 $34.98 of common stock have been reserved. At December 31, 2002, There were 10.7 million options exercisable with a weighted average exercise price of $34.08 at December 31, 2001, and 8.8 million options exercisable with a weighted average exercise price of $32.81 at December 31, 2000. All stock options under the 1993 Stock and Long-Term Incentive Plan, including options granted to employees of Dresser Industries, Inc. since its acquisition, are granted at the fair market value of the common stock at the grant date. 152,650 shares (net of 42,750 shares forfeited) have been issued. Forfeitures were 400 in 2002, 800 in 2001, and 6,450 in 2000. No further grants are being made under this plan. Under the terms of our Career Executive Incentive Stock Plan, 15 million shares of our common stock were reserved for issuance to key officers and key employees at a purchase price not to exceed par value of $2.50 per share. At December 31, 2002, 11.7 million shares (net of 2.2 million shares forfeited) have been issued under the plan. No further grants will be made under the Career Executive Incentive Stock Plan. 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 109 N O T E S T O A N N U A L F I N A N C I A L S T A T E M E N T S Restricted shares issued under the 1993 Stock and Long- N O T E 1 8 . Term Incentive Plan, Restricted Stock Plan for Non- Employee Directors, Employees’ Restricted Stock Plan and the Career Executive Incentive Stock Plan are limited as to sale or disposition. These restrictions lapse periodically over an extended period of time not exceeding 10 years. Restrictions may also lapse for early retirement and other conditions in accordance with our established policies. Upon termination of employment, shares in which restrictions have not lapsed must be returned to us, resulting in restricted stock forfeitures. The fair market value of the stock, on the date of issuance, is being amortized and charged to income (with similar credits to paid-in capital in excess of par value) generally over the average period during which the restrictions lapse. At December 31, 2002, the unamortized amount is $75 million. We recognized compensation costs of $38 million in 2002, $23 million in 2001, and $18 million in 2000. During 2002, our Board of Directors approved the 2002 Employee Stock Purchase Plan (ESPP) and reserved 12 million shares for issuance. Under the ESPP, eligible employees may have up to 10% of their earnings withheld, subject to some limitations, to be used to purchase shares of our common stock. Unless the Board of Directors shall determine otherwise, each 6-month offering period commences on January 1 and July 1 of each year. The price at which common stock may be purchased under the ESPP is equal to 85% of the lower of the fair market value S E R I E S A J U N I O R PA R T I C I PAT I N G P R E F E R R E D S T O C K We previously declared a dividend of one preferred stock purchase right on each outstanding share of common stock. The dividend is also applicable to each share of our common stock that was issued subsequent to adoption of the Rights Agreement entered into with Mellon Investor Services LLC. Each preferred stock purchase right entitles its holder to buy one two-hundredth of a share of our Series A Junior Participating Preferred Stock, without par value, at an exercise price of $75. These preferred stock purchase rights are subject to anti-dilution adjustments, which are described in the Rights Agreement entered into with Mellon. The preferred stock purchase rights do not have any voting rights and are not entitled to dividends. The preferred stock purchase rights become exercisable in limited circumstances involving a potential business combination. After the preferred stock purchase rights become exercisable, each preferred stock purchase right will entitle its holder to an amount of our common stock, or in some circumstances, securities of the acquirer, having a total market value equal to two times the exercise price of the preferred stock purchase right. The preferred stock purchase rights are redeemable at our option at any time before they become exercisable. The preferred stock purchase rights expire on December 15, 2005. No event during 2002 made the preferred stock purchase rights exercisable. of the common stock on the commencement date or last N O T E 1 9. trading day of each offering period. There were approximately F I N A N C I A L I N S T R U M E N T S A N D R I S K M A N A G E M E N T 541,000 shares sold through the ESPP in 2002. In June 1998, the Financial Accounting Standards Board On April 25, 2000, our Board of Directors approved plans to issued SFAS No. 133 “Accounting for Derivative Instruments implement a share repurchase program for up to 44 million and for Hedging Activities”, subsequently amended by SFAS shares. No shares were repurchased in 2002. We repurchased No. 137 and SFAS No. 138. This standard requires entities 1.2 million shares at a cost of $25 million in 2001 and 20.4 to recognize all derivatives on the balance sheet as assets or million shares at a cost of $759 million in 2000. liabilities and to measure the instruments at fair value. Accounting for gains and losses from changes in those fair values is specified in the standard depending on the intended use of the derivative and other criteria. We adopted 110 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T N O T E S T O A N N U A L F I N A N C I A L S T A T E M E N T S SFAS No. 133 effective January 2001 and recorded a $1 The use of some contracts may limit our ability to benefit million after-tax credit for the cumulative effect of adopting from favorable fluctuations in foreign exchange rates. the change in accounting method. We do not expect future Foreign currency contracts are not utilized to manage measurements at fair value under the new accounting exposures in some currencies due primarily to the lack of method to have a material effect on our financial condition available markets or cost considerations (non-traded or results of operations. currencies). We attempt to manage our working capital Fo r e i g n e x c h a n g e r i s k . Techniques in managing foreign position to minimize foreign currency commitments in non- exchange risk include, but are not limited to, foreign traded currencies and recognize that pricing for the currency borrowing and investing and the use of currency services and products offered in these countries should cover derivative instruments. We selectively manage significant the cost of exchange rate devaluations. We have historically exposures to potential foreign exchange losses considering incurred transaction losses in non-traded currencies. current market conditions, future operating activities and A s s e t s , l i a b i l i t i e s a n d f o r e c a s t e d c a s h f l o w s the associated cost in relation to the perceived risk of loss. d e n o m i n a t e d i n f o r e i g n c u r r e n c i e s . We utilize the The purpose of our foreign currency risk management derivative instruments described above to manage the activities is to protect us from the risk that the eventual foreign currency exposures related to specific assets and dollar cash flows resulting from the sale and purchase of liabilities, which are denominated in foreign currencies; products and services in foreign currencies will be adversely however, we have not elected to account for these affected by changes in exchange rates. We do not hold instruments as hedges for accounting purposes. Additionally, or issue derivative financial instruments for trading or we utilize the derivative instruments described above to speculative purposes. manage forecasted cash flows denominated in foreign We manage our currency exposure through the use of currencies generally related to long-term engineering and currency derivative instruments as it relates to the major construction projects. While we enter into these instruments currencies, which are generally the currencies of the to manage the foreign currency risk on these projects, countries for which we do the majority of our international we have chosen not to seek hedge accounting treatment for business. These contracts generally have an expiration these contracts. The fair value of these contracts was date of two years or less. Forward exchange contracts, which immaterial as of the end of 2002 and 2001. are commitments to buy or sell a specified amount of a N o t i o n a l a m o u n t s a n d fa i r m a r k e t v a l u e s . The notional foreign currency at a specified price and time, are generally amounts of open forward contracts and options for used to manage identifiable foreign currency commitments. continuing operations were $609 million at December 31, Forward exchange contracts and foreign exchange option 2002 and $505 million at December 31, 2001. The notional contracts, which convey the right, but not the obligation, to amounts of our foreign exchange contracts do not generally sell or buy a specified amount of foreign currency at a represent amounts exchanged by the parties, and thus, are specified price, are generally used to manage exposures not a measure of our exposure or of the cash requirements related to assets and liabilities denominated in a foreign relating to these contracts. The amounts exchanged are currency. None of the forward or option contracts are calculated by reference to the notional amounts and by other exchange traded. While derivative instruments are subject terms of the derivatives, such as exchange rates. to fluctuations in value, the fluctuations are generally offset C r e d i t r i s k . Financial instruments that potentially by the value of the underlying exposures being managed. subject us to concentrations of credit risk are primarily cash equivalents, investments and trade receivables. It is our 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 111 N O T E S T O A N N U A L F I N A N C I A L S T A T E M E N T S practice to place our cash equivalents and investments in N O T E 2 0 . high-quality securities with various investment institutions. R E T I R E M E N T P L A N S We derive the majority of our revenues from sales and Our Company and subsidiaries have various plans which services, including engineering and construction, to the cover a significant number of their employees. These plans energy industry. Within the energy industry, trade include defined contribution plans, which provide retirement receivables are generated from a broad and diverse group of contributions in return for services rendered, provide an customers. There are concentrations of receivables in the individual account for each participant and have terms that United States and the United Kingdom. We maintain an specify how contributions to the participant’s account are to allowance for losses based upon the expected collectibility of be determined rather than the amount of pension benefits all trade accounts receivable. the participant is to receive. Contributions to these plans There are no significant concentrations of credit risk with are based on pretax income and/or discretionary amounts any individual counterparty related to our derivative contracts. We select counterparties based on their profitability, balance sheet and a capacity for timely determined on an annual basis. Our expense for the defined contribution plans for both continuing and discontinued operations totaled $80 million in 2002 compared to $129 payment of financial commitments which is unlikely to be million in 2001 and $140 million in 2000. Other retirement adversely affected by foreseeable events. plans include defined benefit plans, which define an amount I n t e r e s t ra t e r i s k . We have several debt instruments of pension benefit to be provided, usually as a function of age, outstanding which have both fixed and variable interest years of service or compensation. These plans are funded to rates. We manage our ratio of fixed to variable-rate debt operate on an actuarially sound basis. Plan assets are through the use of different types of debt instruments and primarily invested in cash, short-term investments, real derivative instruments. estate, equity and fixed income securities of entities domiciled Fa i r m a r k e t v a l u e o f f i n a n c i a l i n s t r u m e n t s . The in the country of the plan’s operation. Plan assets, expenses estimated fair market value of long-term debt at year-end and obligations for retirement plans in the following tables for both 2002 and 2001 was $1.3 billion as compared to the include both continuing and discontinued operations. Millions of dollars U.S. Int’l. U.S. Int’l. 2002 2001 carrying amount of $1.5 billion at year-end for both 2002 and 2001. The fair market value of fixed rate long-term debt is based on quoted market prices for those or similar instruments. The carrying amount of variable rate long-term debt approximates fair market value because these instruments reflect market changes to interest rates. See CHANGE IN BENEFIT OBLIGATION Benefit obligation at beginning of year Service cost Interest cost Note 11. The carrying amount of short-term financial Plan participants’ contributions instruments, cash and equivalents, receivables, short-term Effect of business combinations notes payable and accounts payable, as reflected in the consolidated balance sheets approximates fair market value due to the short maturities of these instruments. The currency derivative instruments are carried on the balance sheet at fair value and are based upon third-party quotes. The fair market values of derivative instruments used for and new plans Amendments Divestitures Settlements/curtailments Currency fluctuations Actuarial gain/(loss) Benefits paid Benefit obligation at $140 $1,968 $ 288 $1,670 1 9 — — 1 — (1) — 5 (11) 72 102 14 70 (4) (5) (1) 102 (27) (52) 2 13 — — — (111) (46) — 8 (14) 60 89 14 — — (90) — 15 270 (60) fair value hedging and cash flow hedging were immaterial. end of year $144 $2,239 $ 140 $1,968 112 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T N O T E S T O A N N U A L F I N A N C I A L S T A T E M E N T S Millions of dollars U.S. Int’l. U.S. Int’l. 2002 2001 Assumed long-term rates of return on plan assets, CHANGE IN PLAN ASSETS Fair value of plan assets at beginning of year $130 $1,827 $ 313 $2,165 Actual return on plan assets Employer contribution Settlements Plan participants’ contributions Effect of business combinations and new plans Divestitures Currency fluctuations Benefits paid Fair value of plan assets at end of year Funded status Unrecognized transition (6) 1 (1) — — — — (11) (69) (22) (294) 36 — 14 45 7 (46) 1 — (5) (109) 89 (51) — (14) 30 — 14 — (45) 15 (58) $113 $1,886 $ 130 $1,827 $ (31) $ (353) $ (10) $ (141) obligation/(asset) — (2) (1) (3) Unrecognized actuarial (gain)/loss 56 477 34 308 Unrecognized prior service cost/(benefit) 1 (70) (2) (96) Net amount recognized $ 26 $ 52 $ 21 $ 68 We recognized an additional minimum pension liability for the underfunded defined benefit plans. The additional minimum liability is equal to the excess of the accumulated benefit obligation over plan assets and accrued liabilities. A discount rates for estimating benefit obligations and rates of compensation increases vary for the different plans according to the local economic conditions. The rates used are as follows: Weighted-average assumptions 2002 2001 2000 Expected return on plan assets: United States plans International plans 9.0% 5.5% to 8.16% 9.0% 5.5% to 9.0% 9.0% 3.5% to 9.0% Discount rate: United States plans International plans 7.0% 5.25% to 20.0% 7.25% 5.0% to 8.0% 7.5% 4.0% to 8.0% Rate of compensation increase: United States plans International plans 4.5% 3.0% to 21.0% 4.5% 3.0% to 7.0% 4.5% 3.0% to 7.6% Millions of dollars U.S. Int’l. U.S. Int’l. U.S. Int’l. 2002 2001 2000 COMPONENTS OF NET PERIODIC BENEFIT COST Service cost Interest cost $ 1 $ 72 $ 2 $ 60 $ 4 $ 57 9 102 13 89 20 87 Expected return on plan assets (13) (106) Transition amount — (2) (18) — (95) (2) (26) (99) — — Amortization of prior service cost Settlements/ (2) (6) (2) (6) (1) (6) curtailments — (2) 16 — 10 — Recognized actuarial corresponding amount is recognized as either an intangible (gain)/loss 1 3 (1) (9) — (10) asset or a reduction of shareholders’ equity. For the year Net periodic benefit ended December 31, 2002 we recognized $212 million in additional minimum pension liability of which $130 million was recorded as Other comprehensive income, net of tax. (income) cost $ (4) $ 61 $ 10 $ 37 $ 7 $ 29 The projected benefit obligation, accumulated benefit obligation, and fair value of plan assets for the pension 2002 2001 U.S. Int’l. U.S. Int’l. plans with accumulated benefit obligations in excess of plan assets as of December 31, 2002 and 2001 are as follows: Millions of dollars AMOUNTS RECOGNIZED IN THE CONSOLIDATED BALANCE SHEETS Prepaid benefit cost $ 30 $ 102 $ 7 $ 85 Accrued benefit liability including additional minimum liability (59) (250) (10) (36) Intangible asset 2 12 1 1 Millions of dollars Projected benefit obligation Accumulated benefit obligation Fair value of plan assets 2002 2001 $ 2,319 $ 2,121 $ 1,942 $ 235 $ 215 $ 175 Accumulated other comprehensive income, net of tax Deferred tax asset Net amount recognized 35 18 122 66 15 8 12 6 P o s t r e t i r e m e n t m e d i c a l p l a n . We offer postretirement medical plans to specific eligible employees. For some plans, $ 26 $ 52 $ 21 $ 68 our liability is limited to a fixed contribution amount for each participant or dependent. The plan participants share the total cost for all benefits provided above our fixed 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 113 N O T E S T O A N N U A L F I N A N C I A L S T A T E M E N T S contribution and participants’ contributions are adjusted as Millions of dollars 2002 2001 required to cover benefit payments. We have made no commitment to adjust the amount of our contributions; therefore, the computed accumulated postretirement benefit obligation amount is not affected by the expected future health care cost inflation rate. Other postretirement medical plans are contributory but we generally absorb the majority of the costs. We may elect AMOUNTS RECOGNIZED IN THE CONSOLIDATED BALANCE SHEETS Accrued benefit liability Net amount recognized $(162) $ (166) $(162) $ (166) Weighted-average assumptions Discount rate 2002 2001 2000 7.0% 7.25% 7.50% to adjust the amount of our contributions for these plans. As Millions of dollars 2002 2001 2000 a result, the expected future health care cost inflation rate affects the accumulated postretirement benefit obligation amount. These plans have assumed health care trend rates (weighted based on the current year benefit obligation) for 2002 of 13% which are expected to decline to 5% by 2007. Obligations and expenses for postretirement medical plans in the following tables include both continuing and discontinued operations. Millions of dollars 2002 2001 CHANGE IN BENEFIT OBLIGATION COMPONENTS OF NET PERIODIC BENEFIT COST Service cost Interest cost Amortization of prior service cost Settlements/curtailments Recognized actuarial gain Net periodic benefit cost $ 1 $ 11 — — (1) 2 15 (3) (221) (1) $ 3 20 (7) — (1) $11 $ (208) $15 Assumed health care cost trend rates have a significant effect on the amounts reported for the total of the health care plans. A one-percentage-point change in assumed Benefit obligation at beginning of year $ 157 $ 296 health care cost trend rates would have the following effects: Service cost Interest cost Plan participants’ contributions Settlements/curtailments Actuarial gain Benefits paid 1 11 11 — 33 (27) 2 15 12 (144) 5 (29) Millions of dollars Effect on total of service and interest cost components Effect on the postretirement benefit obligation One-Percentage-Point (Decrease) Increase $ 1 $ 10 $ (1) $ (9) Benefit obligation at end of year $ 186 $ 157 CHANGE IN PLAN ASSETS Fair value of plan assets at beginning of year $ — $ — Employer contribution Plan participants’ contributions Benefits paid Fair value of plan assets at end of year Funded status Employer contribution Unrecognized actuarial gain Unrecognized prior service cost Net amount recognized 16 11 17 12 (27) (29) $ — $ — $(186) $ (157) 2 20 2 2 (14) 3 $(162) $ (166) N O T E 2 1 . D R E S S E R I N D U S T R I E S , I N C . F I N A N C I A L I N F O R M AT I O N Since becoming a wholly owned subsidiary of Halliburton, DII Industries (formerly Dresser Industries, Inc.) has ceased filing periodic reports with the United States Securities and Exchange Commission. DII Industries 8% guaranteed senior notes, which were initially issued by Baroid Corporation, remain outstanding and are fully and unconditionally guaranteed by Halliburton. Under the terms of a Fourth Supplemental Indenture, Halliburton Company in December 2002 assumed as co-obligor the payment of principle and interest on the notes, and the performance of all of the covenants and conditions of the related indenture. 114 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T N O T E S T O A N N U A L F I N A N C I A L S T A T E M E N T S N O T E 2 2 . G O O D W I L L A N D O T H E R I N TA N G I B L E A S S E T S Years ended December 31 Millions of dollars except per share data Reported net income (loss) 2002 2001 2000 $ (998) $ 809 $ 501 We adopted the SFAS No. 142, “Goodwill and Other Goodwill amortization, net of tax — 38 36 Intangible Assets”, and in accordance with the statement, amortization of goodwill has been discontinued. Our Adjusted net income (loss) $ (998) $ 847 $ 537 Basic earnings (loss) per share: Reported net income (loss) $(2.31) $1.89 $1.13 reporting units as defined under SFAS No. 142 are the same Goodwill amortization, net of tax — 0.09 0.08 as our reportable operating segments: Energy Services Adjusted net income (loss) $(2.31) $1.98 $1.21 Group and Engineering and Construction Group. Goodwill for the Energy Services Group was $402 million (net of $118 Diluted earnings (loss) per share: Reported net income (loss) $(2.31) $1.88 $1.12 Goodwill amortization, net of tax — 0.09 0.08 million accumulated amortization) in 2002, $386 million (net Adjusted net income (loss) $(2.31) $1.97 $1.20 of $118 million accumulated amortization) in 2001, and $310 million (net of $97 million accumulated amortization) in 2000. Goodwill for the Engineering and Construction Group was $321 million (net of $152 million accumulated amortization) in 2002, $334 million (net of $151 million accumulated amortization) in 2001, and $287 million (net of $134 million accumulated amortization) in 2000. Had we been accounting for our goodwill under SFAS No. 142 for all periods presented, our net income (loss) and earnings (loss) per share would have been as follows: 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 115 S E L E C T E D F I N A N C I A L D A T A ( U N A U D I T E D ) Years ended December 31 Millions of dollars and shares except per share and employee data OPERATING RESULTS Net revenues Energy Services Group Engineering and Construction Group Total revenues OPERATING INCOME (LOSS) Energy Services Group Engineering and Construction Group Special charges and credits (1) General corporate Total operating income (1) Nonoperating income (expense), net (2) INCOME/(LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES AND MINORITY INTEREST Provision for income taxes (3) Minority interest in net income of consolidated subsidiaries Income (loss) from continuing operations Income (loss) from discontinued operations Net income (loss) BASIC INCOME (LOSS) PER COMMON SHARE 2002 2001 2000 1999 1998 $ 6,836 5,736 $12,572 $ 7,811 5,235 $13,046 $ 6,233 5,711 $11,944 $ 5,402 6,911 $ 12,313 $ 7,258 7,246 $ 14,504 $ 638 (685) — (65) (112) (116) (228) (80) (38) $ (346) $ (652) $ (998) $ $ $ $ 1,036 111 — (63) 1,084 (130) 954 (384) (19) 551 257 809 $ $ $ $ 589 (54) — (73) 462 (127) 335 (129) (18) 188 313 501 $ $ $ $ $ 241 184 47 (71) 401 (94) 307 (116) (17) 174 283 438 0.40 1.00 $ $ $ $ $ 934 274 (959) (79) 170 (115) 55 (155) (20) (120) 105 (15) (0.27) (0.03) (0.27) (0.03) 0.50 (0.35)% Continuing operations Net income (loss) $ (0.80) (2.31) $ 1.29 1.89 $ 0.42 1.13 DILUTED INCOME (LOSS) PER COMMON SHARE Continuing operations Net income (loss) Cash dividends per share Return on average shareholders’ equity FINANCIAL POSITION Net working capital Total assets Property, plant and equipment, net Long-term debt (including current maturities) Shareholders’ equity Total capitalization Shareholders’ equity per share Average common shares outstanding (basic) Average common shares outstanding (diluted) OTHER FINANCIAL DATA Capital expenditures Long-term borrowings (repayments), net Depreciation, depletion and amortization expense Goodwill amortization included in depreciation, depletion and amortization expense: Energy Services Group Engineering and Construction Group Payroll and employee benefits (4) Number of employees (4) (5) (continued on next page) (0.80) (2.31) 0.50 (24.02)% 1.28 1.88 0.50 18.64% 0.42 1.12 0.50 12.20% 0.39 0.99 0.50 10.49% $ 2,288 12,844 2,629 1,476 3,588 5,083 8.16 432 432 $ 2,665 10,966 2,669 1,484 4,752 6,280 10.95 428 430 $ 1,742 10,192 2,410 1,057 3,928 6,555 9.20 442 446 $ 2,329 9,639 2,390 1,364 4,287 6,590 9.69 440 443 $ 2,129 10,072 2,442 1,426 4,061 5,990 9.23 439 439 $ (764) (15) 505 $ (797) 412 531 $ (578) (308) 503 $ (520) (59) 511 $ (841) 122 500 — — (4,875) 83,000 24 18 (4,818) 85,000 19 25 (5,260) 93,000 12 21 (5,647) 103,000 22 14 (5,880) 107,800 116 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T S E L E C T E D F I N A N C I A L D A T A ( U N A U D I T E D ) ( c o n t i n u e d ) Years ended December 31 Millions of dollars and shares except per share and employee data OPERATING RESULTS Net revenues Energy Services Group Engineering and Construction Group Total revenues OPERATING INCOME Energy Services Group Engineering and Construction Group Special charges and credits (1) General corporate Total operating income (1) Nonoperating income (expense), net (2) INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES AND MINORITY INTEREST Provision for income taxes (3) Minority interest in net income of consolidated subsidiaries Income (loss) from continuing operations Income from discontinued operations Net income (loss) BASIC INCOME (LOSS) PER COMMON SHARE Continuing operations Net income (loss) DILUTED INCOME (LOSS) PER COMMON SHARE Continuing operations Net income (loss) Cash dividends per share Return on average shareholders’ equity FINANCIAL POSITION Net working capital Total assets Property, plant and equipment, net Long-term debt (including current maturities) Shareholders’ equity Total capitalization Shareholders’ equity per share Average common shares outstanding (basic) Average common shares outstanding (diluted) OTHER FINANCIAL DATA Capital expenditures Long-term borrowings (repayments), net Depreciation, depletion and amortization expense Goodwill amortization included in depreciation, depletion and amortization expense: Energy Services Group Engineering and Construction Group Payroll and employee benefits (4) Number of employees (4), (5) (continued on next page) 1997 1996 1995 1994 1993 $ 7,152 6,346 $ 13,498 $ 5,696 5,540 $11,236 $ 4,838 4,207 $ 9,045 $ 4,548 3,992 $ 8,540 $ 5,065 4,080 $ 9,145 $ $ $ $ $ 959 279 11 (71) 1,178 (82) 1,096 (406) (30) 660 112 772 1.53 1.79 1.51 1.77 0.50 19.16% $ $ $ $ $ 644 188 (86) (72) 674 (70) 604 (158) — 446 112 558 1.04 1.30 $ $ $ $ $ 552 89 (8) (71) 562 (34) 528 (167) (1) 360 36 381 $ $ $ $ 411 66 (19) (56) 402 333 735 (275) (14) 446 97 543 $ $ $ $ 395 95 (419) (63) 8 (61) (53) (18) (24) (95) 81 (14) 0.83 0.88 $ 1.04 1.26 $ (0.23) (0.04) 1.03 1.29 0.50 15.25% 0.83 0.88 0.50 10.44% 1.03 1.26 0.50 15.47% (0.23) (0.04) 0.50 (0.43)% $ 1,985 9,657 2,282 1,303 4,317 5,647 9.86 431 436 $ 1,501 8,689 2,047 957 3,741 4,828 8.78 429 432 $ 1,477 7,723 1,865 667 3,577 4,378 8.29 431 432 $ 2,197 7,774 1,631 1,119 3,723 4,905 8.63 431 432 $ 1,563 8,087 1,747 1,129 3,296 4,746 7.70 422 422 $ (804) 285 465 $ (612) 286 405 $ (474) (481) 380 $ (358) (120) 387 $ (373) 192 574 20 12 (5,479) 102,000 19 7 (4,674) 93,000 17 7 (4,188) 89,800 14 7 (4,222) 86,500 11 7 (4,429) 90,500 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T 117 S E L E C T E D F I N A N C I A L D A T A ( U N A U D I T E D ) ( c o n t i n u e d ) (1) Operating income includes the following special charges and credits: 1999 – $47 million: reversal of a portion of the 1998 special charges. 1998 – $959 million: asset related charges ($491 million), personnel reductions ($234 million), facility consolidations ($124 million), merger transaction costs ($64 million), and other related costs ($46 million). 1997 – $11 million: merger costs ($9 million), write-downs on impaired assets and early retirement incentives ($10 million), losses from the sale of assets ($12 million), and gain on extension of joint venture ($42 million). 1996 – $86 million: merger costs ($13 million), restructuring, merger and severance costs ($62 million), and write-off of acquired in-process research and development costs ($11 million). 1995 – $8 million: restructuring costs ($5 million) and write-off of acquired in-process research and development costs ($3 million). 1994 – $19 million: merger costs ($27 million), litigation ($10 million), and litigation and insurance recoveries ($18 million). 1993 – $419 million: loss on sale of business ($322 million), merger costs ($31 million), restructuring ($5 million), litigation ($65 million), and gain on curtailment of medical plan ($4 million). (2) Nonoperating income in 1994 includes a gain of $276 million from the sale of an interest in Western Atlas International, Inc. and a gain of $102 million from the sale of our natural gas compression business. (3) Provision for income taxes in 1996 includes tax benefits of $44 million due to the recognition of net operating loss carryforwards and the settlement of various issues with the Internal Revenue Service. (4) Includes employees of Dresser Equipment Group which is accounted for as discontinued operations for the years 1993 through 2000. (5) Does not include employees of less than 50%-owned affiliated companies. 118 2 0 0 2 H A L L I B U R T O N A N N U A L R E P O R T Q U A R T E R L Y D A T A A N D M A R K E T P R I C E I N F O R M A T I O N ( U N A U D I T E D ) Millions of dollars except per share data 2002 Revenues Operating income (loss) Income (loss) from continuing operations Loss from discontinued operations Net income (loss) Earnings per share: Basic income (loss) per common share: Income (loss) from continuing operations Loss from discontinued operations Net income (loss) Diluted income (loss) per common share: Income (loss) from continuing operations Loss from discontinued operations Net income (loss) Cash dividends paid per share Common stock prices (1) High Low 2001 Revenues Operating income Income from continuing operations before change in accounting method, net Income (loss) from discontinued operations Gain on disposal of discontinued operations Change in accounting method, net Net income Earnings per share: Basic income (loss) per common share: Income from continuing operations Income (loss) from discontinued operations Gain on disposal of discontinued operations Net income Diluted income (loss) per common share: Income from continuing operations Income (loss) from discontinued operations Gain on disposal of discontinued operations Net income Cash dividends paid per share Common stock prices (1) High Low Quarter First Second Third Fourth Year $3,007 123 50 (28) 22 $3,235 (405) (358) (140) (498) $2,982 191 94 — 94 $3,348 (21) (132) (484) (616) $12,572 (112) (346) (652) (998) 0.12 (0.07) 0.05 0.12 (0.07) 0.05 0.125 18.00 8.60 (0.83) (0.32) (1.15) (0.83) (0.32) (1.15) 0.125 19.63 14.60 0.22 — 0.22 0.22 — 0.22 0.125 16.00 8.97 (0.30) (1.12) (1.42) (0.30) (1.12) (1.42) 0.125 21.65 12.45 (0.80) (1.51) (2.31) (0.80) (1.51) (2.31) 0.50 21.65 8.60 $3,144 198 $3,339 272 $3,391 342 $3,172 272 $13,046 1,084 86 22 — 1 109 0.20 0.05 — 0.25 0.20 0.05 — 0.25 0.125 45.91 34.81 143 (60) 299 — 382 0.34 (0.14) 0.70 0.90 0.33 (0.14) 0.70 0.89 0.125 49.25 32.20 181 (2) — — 179 0.42 — — 0.42 0.42 — — 0.42 0.125 36.79 19.35 141 (2) — — 139 0.33 (0.01) — 0.32 0.33 (0.01) — 0.32 0.125 28.90 10.94 551 (42) 299 1 809 1.29 (0.10) 0.70 1.89 1.28 (0.10) 0.70 1.88 0.50 49.25 10.94 (1) New York Stock Exchange – composite transactions high and low intraday price. P R O D U C T I O N Halliburton Communications C O R P O R A T E O F F I C E : 5 H O U S T O N C E N T E R 1 4 0 1 M c K I N N E Y , S U I T E 2 4 0 0 H O U S T O N , T E X A S 7 7 0 1 0 U S A W W W . H A L L I B U R T O N . C O M H 0 3 4 1 8 

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