B u i l d i n g a S u s t a i n a b l e F u t u r e 2 0 0 3 A n n u a l R e p o r t C O M P A R A T I V E H I G H L I G H T S Millions of dollars and shares except per share data 2003 2002 2001 Diluted income (loss) per share from continuing operations before change in accounting principle $ 0.78 $ (0.80) $ 1.28 Diluted net income (loss) per share Cash dividends per share Revenues Operating income (loss) Income (loss) from continuing operations before change in accounting principle Net income (loss) Working capital1 Long-term debt (including current maturities) (1.88) 0.50 (2.31) 0.50 16,271 12,572 720 (112) 339 (820) 3,884 3,437 (346) (998) 2,288 1,476 1.88 0.50 13,046 1,084 551 809 2,665 1,484 Net debt to total capitalization2 39.2% 10.5% 20.7% Capital expenditures Depreciation and amortization Diluted average shares outstanding 515 518 437 764 505 432 797 531 430 1Calculated as current assets minus current liabilities which exclude the current portion of the asbestos and silica liability of $2,507 million in 2003. 2Calculated as total debt less cash divided by total debt less cash plus shareholders’ equity. Contents Halliburton Today Letter to Shareholders Operations Overview 2 6 Financial Information 17 Corporate Information 129 The Energy Services Group (ESG) offers the broadest array of products 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, construction and services needs of governments and civil infrastructure customers. Everywhere we look we see a world in transition. Geographies are being redrawn. Boundaries are dissolving. Our world is linked in ways we previously could not have imagined. As companies find themselves competing in a global marketplace, the old business rules no longer apply. For an 84-year-old company, change is nothing new. But as we look back on 2003, the transitions we have experienced have been truly profound. Major challenges to our business are close to resolution. The Energy Services Group (ESG) and KBR, our Engineering and Construction Group, have transformed their businesses. At all levels of our Company, we have set the systems in motion to unleash our enormous potential. This is the story of a year of transition and the beginning of our journey toward a sustainable future. L E T T E R T O S H A R E H O L D E R S Dear Fellow Shareholders Halliburton was started in 1919 in the oil fields of Texas by one man with a homemade cement mixer and a borrowed pump. Today, we are a world leader in oilfield services, engineering and construction, with over 100,000 employees and operations in more than 100 countries. Throughout the course and Production Optimization – the ESG maintains a leading presence. About 75 percent of its revenues are being generated from product lines where it holds a No. 1 or No. 2 market share. One of our biggest success stories of 2003 has been within the Drilling and Formation Evaluation division with a product that holds the No. 3 position in its market. of our history, we have experienced great transitions In last year’s annual report, we introduced you to and every kind of business cycle more times than we Geo-Pilot® point-the-bit rotary steerable technology. can count. We have been here this long and come this far because of our ability to adapt to change. The product was deployed in 2001, and by 2002, our market share went from 0 percent to 9 percent. That ability has been tested over the past few years, During 2003, our market share jumped to 15 but as I look back on our accomplishments in 2003, percent and is still growing. We have also seen I’m extremely proud and optimistic about the future. growth in our international revenues across all We have made significant progress toward resolving of our businesses. our asbestos liability that has consumed so much of There has been solid progress on the engineering, our resources. Despite some pretty big challenges, construction and services side of Halliburton’s busi- including a sluggish U.S. economy, our Energy ness as well. Since KBR made the decision in 2002 Services Group (ESG) and KBR, our Engineering to no longer enter into undifferentiated offshore and Construction Group, have both had a successful lump-sum, turnkey Engineering, Procurement, year, posting significantly improved revenues. Installation and Commissioning (EPIC) contracts, One day, I believe, we will look back on 2003 as we have continued to rebalance our portfolio a watershed year when we took steps to become a by drawing upon KBR’s Centers of Excellence, leaner, tougher organization and continued to put or core business strengths, to grow the services ourselves in position to win in the years ahead. and program management part of the business. We reorganized the ESG into four P&L divisions The strategy is already yielding significant contract addressing four core customer needs. In addition, wins, including the Kashagan oilfield development four new regional and 10 sub-regional organizations Project Management Contract (PMC) for offshore have been established, centered around natural and onshore Kazakhstan, and the reimbursable geographic markets and aimed at further extending Engineering, Procurement and Construction the ESG’s global growth. For the first time, we have Management (EPCM) contract for a major floating broken out the ESG’s financials by divisions and production offloading and storage vessel offshore regions to provide greater transparency to the Angola. KBR was also awarded the Program financial community, and this move is being hailed Management Contract to restructure and modernize by many analysts as a model for the industry. the U.K. National Health Service’s information In three of the ESG’s divisions – Fluids, Landmark technology systems. 2 Most of the major international oil companies have targeted clean-burning natural gas as a key area of their growth strategies. KBR continues to hold a David J. Lesar Chairman of the Board, President and Chief Executive Officer of Halliburton leading market position in constructing plants for the logistical support and infrastructure for Army Liquefied Natural Gas (LNG), and is responsible for bases in Iraq, Uzbekistan, Afghanistan, Kuwait, building 56 percent of the world’s LNG capacity over Djibouti, Jordan, the Republic of Georgia and the last 30 years. As worldwide demand for LNG Turkey. KBR provides everything from food, beds continues to increase, more than doubling current and mail service to laundry, sanitation and utilities. levels by 2010, KBR will be right there, developing Under a separate contract for the U.S. Army Corps new technology, building on its know-how and of Engineers known as Restore Iraqi Oil (RIO), delivering the projects that customers need. KBR, with assistance from ESG reservoir and data KBR also has much to be proud of for the work management experts, has restored the country’s it is doing in support of various military troops in oil production to pre-war levels, working with the locations across the globe. KBR was recently awarded Iraqi Ministry of Oil. a contract by the U.S. Army Corps of Engineers to The work in southern Iraq was competitively support military operations, federal agencies and bid and a new contract has been awarded for two governments throughout the U.S. Central Command’s years, with three one-year optional extensions. 25-country region that extends from the Horn of We will provide a range of services and support – Africa to Central Asia. from extinguishing oil well fires and providing As part of its competitively bid Logistics Civil environmental assessments and cleanup at oil sites, Augmentation Program III (LOGCAP III) contract to supplying design and construction of infrastructure with the U.S. Army, KBR employees are providing and technical assistance, as well as consulting 3 services to the Iraqi oil companies – that will help problems. Recently, we posted a representative to a Iraq build a sustainable future for its people. We’re two-year assignment with the World Bank to work assisting Iraqis in their daily lives, too, by importing on the Global Gas Flaring Reduction team and to and delivering massive amounts of fuel for driving, help it develop alternatives for harmful gas flaring cooking and heating. practices, encouraging the use of saved gas as a These are tough, demanding assignments in a cheap and clean fuel for local communities. dangerous region. Just 72 hours after the first troops Since the earliest times, a long and prosperous entered Iraq, KBR followed with water and meals. future has been the hope of almost everyone on this Our people have been under fire and some have lost planet. The secret of longevity is one of humankind’s their lives. To all of the brave men and women who greatest quests. Building a Sustainable Future is a put their lives on the line to get the job done, I give process that requires everyone in the organization my thanks and sincerest admiration. working together to improve efficiencies. It requires What it takes to be successful in the 21st century our will and the courage to adapt to an ever-changing is different than it was even a decade ago. The and challenging future by understanding and continuing consolidation of the super majors, the responding to the needs of customers in diverse growing power of the national oil companies, cost- markets; by identifying and exploiting opportunities cutting issues and globalization are challenges that all without succumbing to market volatility and risk; of us face. We are no longer accountable only to local by committing to continuous innovation; and by or national interests; we are a citizen of the world. understanding that a company thrives not just by That’s not a new concept for Halliburton. capturing markets, but by developing its people. Throughout our 84-year history, we have contributed I couldn’t end this message without a big thank to the economic development of communities around you to our shareholders who have stayed with us the planet by assisting in delivering oil and gas and continue to believe in our Company. And most revenues to host governments; building roads, of all I want to thank our wonderful Halliburton tracks, tunnels and bridges for moving freight; employees. In a year of transitions, and in the face and providing local employment and trade. Our of some pretty big challenges, you have kept your commitment to real time technology has created heads down, worked hard and performed magnifi- a new way of working that allows us to maximize cently, providing excellent customer service, strong limited resources – whether it’s hydrocarbon returns and good profits. You never, ever gave up. resources or human ones. This, more than anything, is what gives me hope for Our commitment to Service Quality, along with our future. Just imagine what we can accomplish Health, Safety and Environment (HSE), is elimi- together once our full power is unleashed. I am nating health, safety and environmental incidents proud to work alongside you. at the job site, as well as the waste of precious resources and capital. The technologies we’ve devel- oped are helping customers develop their assets in less time for lower costs and with fewer risks. We’re participating with many of our customers and host governments to create global solutions to energy David J. Lesar Chairman of the Board, President and Chief Executive Officer of Halliburton 4 “One day, I believe, we will look back on 2003 as a watershed year when we took steps to become a leaner, tougher organization and continued to put ourselves in position to win in the years ahead.” O P E R A T I O N S O V E R V I E W The Energy Services Group Doing the Right Thing. (HSE) performance which, at the very least, is what our customers and employees should expect. As a result of our efforts and diligent practice, we have In 1997, the Energy Services Group (ESG) intro- one of the best safety records in the business. This duced its Vision 2003 of becoming the Real Time year, we again saw improvements in our lost-time Knowledge Company serving the energy industry. incident rate, from 0.56 in 2002 to 0.37 in 2003. Our This radical shift in thinking signaled our intention recordable incident rate dropped from 1.36 to 1.08. to forge a technological future based on the reser- Our vehicle incident rate went from 0.95 to 0.87. voir and the wellbore. This year, we expanded that The ESG has played a leading role, participating vision to position the ESG as a company that helps in and supporting industry initiatives to promote its customers succeed – not only by executing HSE practices in places where we live and work. the job, but by understanding and meeting their Recently, the ESG initiated a pilot project with business objectives. That’s the only way to ensure Repsol, a Spanish international oil company operat- our own sustainability. ing in Venezuela, to implement a web-based tool To do this, we have centered our beliefs and used successfully by Halliburton Latin America to values on doing the right thing for our customers, capture, track and analyze HSE-related behavioral our shareholders and our employees. Doing the performance of drilling activities. The ESG will also right thing has always been an unwritten rule at the provide Repsol with HSE training and consulting, ESG and a hallmark of how we do business. Today, to help them achieve a safer, healthier and more it is a business focus, and we manage it with the environmentally friendly workplace. same discipline and competitive fervor that we apply In 2003, Service Quality became a core value for to technology development or sales. the ESG. Done Right, Done Once became our rally- Doing things right ing cry, and with it came a radical new concept – the idea of delivering a perfect job whose purpose is Doing the right thing has its starting point in a achieved, leaving the customer completely satisfied basic creed for how we conduct ourselves wherever and without any HSE incidents, lost time or cost we work. It starts with job execution, the founda- of poor quality. tion of customer relationships. Doing the right Though a perfect job may seem like an unattain- thing means expecting every job to be done right able dream, it’s becoming a reality at the ESG. We’re the first time, every time. But it also includes using our real time capabilities to monitor job data respect for others and the belief that a company’s so that we can recognize and avoid potential prob- success should be measured by higher standards lems. We’ve developed metrics that allow us not than its business accomplishments. only to measure our progress toward meeting our Now these things may sound like vague goals, customers’ expectations, but also to establish an but we have made them tangible. For instance, in industry standard for Service Quality. The Done Right 1997, we began applying business principles to the Job Index challenges Halliburton and our competi- delivery of superior Health, Safety and Environment tors to always deliver nothing less than the best. 6 Halliburton de Mexico: Making the case for sustainability. In just four years, Halliburton de Mexico has become a shining success story and an example of how to build a sustainable business. Lesson 1: Align your business with your customer’s objectives. Halliburton has worked in Mexico since 1939, providing oilfield services to the national oil company Petroleos Mexicanos, or Pemex. Since 1999, Halliburton managers have approached the business differently: in addition to discrete services, they would provide solutions to Pemex’s business challenges. It took time to build trust, but the strategy has worked. Engineers of Halliburton’s product lines now meet with Pemex to plan jobs and put together solutions to achieve performance goals. Together, the two companies have introduced advanced technology – the Sigma process, MRIL Prime, and the world’s first certified stimulation boat, the Cape Hawke – that have significantly increased reservoir and other performance. Service quality has improved, along with customer satisfaction. With Pemex beginning an aggressive program to produce natural gas, the company recently signed a five-year contract with Landmark for software and consulting services, the largest contract Landmark has signed with a single client. Lesson 2: Be relentless in pursuit of HSE performance. Leave each place you work as good as, or better than, you found it. That’s Halliburton’s motto, beginning with its own operations. Facilities are clean and well-maintained. Uniforms are neat and pressed. It’s obvious that employees are proud of where they work. And they are just as meticulous when it comes to meeting safety and environmental standards. Each employee is given extensive HSE training that’s reinforced with an active Performance Improvement Initiative. Halliburton also has a strong commitment to the environment. Residues and spills, even as small as a liter of oil, are handled according to Company and Mexican regulations. In 2003, Halliburton’s Ciudad del Carmen base was awarded a clean industry certification from the Mexican government, the first in the oil services industry to achieve this designation. The Company used this opportunity to sponsor Expo Halliburton 2003 in Ciudad del Carmen. University students, high school students, city and state government officials, and client representatives were invited to the three-day event, which featured presentations on environmental issues in hopes of sharing knowledge and improving community environmental standards. Doing right by our customers Much of the technology that we produce, especially Doing the right thing for our customers means in Landmark, is designed to take the guesswork out being the company to which our customers look to of exploration and reservoir development. Using find solutions to their business concerns – whether 3-D reservoir models and simulations, we help our it’s increasing production, reducing cycle time, clients take appropriate actions to mitigate risk. decreasing risk or lowering costs. Today, along with Landmark’s Asset Performance GroupSM, a consulting established products and services, every product and project management operation, gives customers line within Halliburton has introduced technologies access to some of the world’s best oil and gas engi- that are delivering real and sustainable value neering talents to achieve sustainable performance for our customers. improvement from their energy assets. Take, for instance, recovery from mature The ESG invests about $220 million each year in reservoirs, an area of vital and ever-increasing research and development to stay at the forefront importance. The world’s demand for oil is expected of technology development and ensure a sustainable to grow 58 percent in the next 25 years; new giant, future. Most of our research budget is spent on easily accessible discoveries seem unlikely. That staying competitive – developing new, leading means we must improve recovery from known technology and making improvements to established reserves where the current average global rate technologies that meet the needs of our customers of recovery is only about 35 percent. now and in the near future. The rest is earmarked What if technology could be developed that for longer-term strategic technology and research would ultimately allow us to recover twice that at the frontiers of scientific development, aimed amount safely and responsibly? We could double at meeting our customers’ and their customers’ the world energy reserve without making future needs. a single new discovery. That’s sustain- ability, and the ESG is hard at work Doing right by our people developing solutions. “The world’s demand A single piece of technology, no matter Our reservoir description and for oil is expected to how innovative, will not guarantee that visualization capabilities allow us to grow 58 percent in we will be a viable entity in the future. place wells in the optimal location. the next 25 years; Our people will, though. Doing right Utilizing Geo-Pilot® point-the-bit rotary steerable technology with SlickBore®, we can drill complex well trajectories with pinpoint accuracy and reduce drilling time by as much as 30 percent. Using real-time monitoring, Halliburton helps customers make real-time decisions about how to optimize their underbalanced drilling process and increase production rates by up to 50 percent. new giant, easily accessible discoveries seem unlikely. That means we must improve recovery from known reserves where the current average global rate of recovery is only about 35 percent.” by our people means making a commit- ment to create a well-trained, educated, energetic and engaged workforce in every country in which we work. In the old way of thinking, many companies working internationally would import competency into other countries and use nationals for jobs that didn’t require skills and certainly didn’t create them. That approach simply doesn’t work 9 anymore. These days, our customers’ customers, the national oil companies and their governments, want much more than oil revenues. They want the very real benefits that oil and gas development can provide – jobs, “The ESG has already come a long way toward developing a localized workforce. and quality standards that give them entry into the global marketplace. Doing right for our investors In the end, doing the right thing means building a sustainable company, a com- training, a better way of life. But they Seven out of 10 ESG pany that will last for generations to aren’t willing to allow development to regional vice presidents come. This year, we have strengthened take place at the cost of harming their are from their respective our commitment to deliver superior people or their environment. The benefits go both ways. A diverse and highly skilled global workforce is critical to building a sustainable future. It’s more efficient and responsible to have a supply of readily available local talent instead of having to bring in project managers and supervisors. It’s regions, and so are many of our country vice presidents. We’re hiring and training locally.” returns to our shareholders and have backed it with sustainable business practices that ensure profits in the future, as well as today. We have improved our capital and operational efficiency in the short term, while taking care not to compromise our ability to serve new growth markets also a good investment, since a key ingredient in the future. We are working hard to achieve this for global market success is local passion. If local balance and will continue to fine-tune it in line managers take ownership in the company, they with the growth of the markets and our capabilities. will have a greater interest in maintaining its With our processes in place, and with the signifi- long-term success. cant pipeline of technologies and opportunities The ESG has already come a long way toward available to us, we believe that the ESG is uniquely developing a localized workforce. Seven out of positioned to capture a significant share of the huge 10 ESG regional vice presidents are from their projected capital investment that will be made in the respective regions, and so are many of our country energy industry over the next 5 to 10 years. vice presidents. We’re hiring and training locally. Building a sustainable future also means creating And we’re helping to establish community colleges a culture that values sustainable principles in in emerging countries to train the next generation everything we do. It means putting our customers’ of oilfield workers so they can contribute to the success first, with the knowledge that their success vitality of our business. fuels our own. It means attracting and motivating Within the past three years, Halliburton has also the best workforce in the world. It means building made a significant commitment to developing local relationships based on the highest business ethics, sourcing for equipment, material and operations sup- as well as on conduct, transparency, accountability, port. This year, we spent approximately $1.5 billion honesty and respect. These values are at the very with third-party providers outside the U.S. Not only is heart of what it means to do the right thing, and this practice more cost-competitive, but it also has they are the foundation for a company that lasts. huge sustainability implications. Halliburton is partnering with local suppliers to implement HSE 10 Lesson 3: Give back to the community that has given to you. Halliburton de Mexico was incorporated in 1956 as a Mexican company. Today, approximately 95 percent of the 1200-person workforce, including managers, is Mexican. The community considers Halliburton one of its own and the Company honors that trust. Giving back to the community is a Halliburton way of life. Halliburton’s safety and driver training programs have become local mainstays, teaching family members and neighbors to drive responsibly and avoid accidents. In 2003, after only a year, Halliburton’s workforce made the Company the No. 1 contributor per capita to Mexico’s United Way. Over 70 percent of workers contributed; the goal is 100 percent. But the programs closest to employees’ hearts are the ones in their communities that they manage and fund. Some employees raise money for schools and homes for the elderly. Others sponsor a school for special education and provide maintenance, repairs and mentoring in a local orphanage. For Halliburton de Mexico’s volunteers, these are more than just community projects. Reaching out to their neighbors is simply the right thing to do. KBR We Deliver. Iraq, where we’re working to restore oil production, is our biggest challenge. If, when we complete our work there, the Iraqi people are self-sufficient As a company that builds massive facilities and with the chance for a solid future then, from our infrastructure around the world, we have the poten- perspective, that project has been a success. tial to leave lasting footprints wherever we go. In the Sustainability is such an important issue for our fifth century B.C., a Chinese philosopher posed the clients and for KBR that we’ve made it one of our question, “What is the way of universal love and values for 2004. Backed by systems and processes mutual benefit?” His answer? To treat other people’s that encompass every aspect of our business, it also countries with the same respect as one’s own. includes a commitment to robust profitability over It is a philosophy that KBR has always used the long term because a sustainable company is, as our guide. We focus on Health, Safety and ultimately, a company that lasts. Environment (HSE), because the price of doing business should never mean that people are Delivering a sustainable business model harmed, land is ruined, and air and rivers spoiled. We took the first step toward building a sustainable We have always believed in leaving a place as good future when we made the decision more than a as, or even better than, we found it, because it’s the year ago to no longer pursue undifferentiated lump- right thing to do. Delivering sustainable projects sum Engineering, Procurement, Installation and Commissioning (EPIC) projects, and began to concentrate on growing our services business. It would be very easy to operate behind a chain The services market is generally low-risk, link fence. To complete a project and then simply reimbursable and cash generating. It’s also where pack up and leave. But this doesn’t serve the best our decades-long experience and skill at project interests of the host country, or KBR. If we can execution technology, delivered in integrated, provide training, make workers self-sufficient and collaborative partnership with the client, really put plant operations into the hands of the people come into play. The services industry truly depends whose resources built it, we all profit – the country on the skill of its people. because we’ve helped them create sustainable KBR’s contract to deliver a deepwater floating, wealth, and KBR because we’re more likely to production, storage and offloading system including be invited back again. associated subsea infrastructure off the coast of We’ve seen this happen in Bonny Island, Nigeria, Angola is an excellent example of our new business where we’ve just started work on two new trains for model. We initially won the Front-End, Engineering their Liquefied Natural Gas (LNG) facility, and and Design (FEED) contract three years ago. Due recently completed the third train. We’ve seen it in to the project’s deepwater technological, environ- Malaysia, where KBR built the country’s first LNG mental and geographic complexities, and the plant 20 years ago and has just completed trains client’s need to have a greater involvement in the 7 and 8. Not coincidentally, we recently reached a development of the project, KBR has moved to an safety milestone on MLNG-Tiga – 51 million work Engineering, Procurement and Construction hours without a lost-time incident. Customer Management (EPCM) services contract where we loyalty and repeat business is one of KBR’s work with the client as part of a highly integrated biggest success stories, and an affirmation of team, providing our full range of Engineering, how we do business. Procurement and Construction (EPC) skills in a 12 Fueling Sustainability: Bonny Island, Nigeria To get to Bonny Island takes a one-hour boat ride up a river. It’s a remote place in a nation that happens to be sitting on the world’s tenth-largest proven gas reserves. Since we arrived here in 1996 with a consortium to build the Nigeria LNG plant, there have been changes. The island currently has over 100,000 residents. Streets are busy with automobiles, taxis and motorcycles. Now beginning the fourth and fifth train expansions, KBR has worked closely with Nigeria LNG to make sure our community relations meet long-term needs. We’ve created a crafts school – probably the best in the country. We’ve trained 2,100 workers in crafts and computer skills, with plans to train up to 3,000 more. We’ve built and repaired roads, brought in clean water, sponsored immunization programs, donated schoolbooks, conducted health classes and disease control programs. The project is helping Nigeria harness its gas reserves and reduce gas flaring, as well as providing opportunity for its people. Bonny Island’s future is looking bright. Restoring Hope: The Middle East. Almost everything we do in the Middle East is on a massive scale. We support 185,000 Coalition soldiers in some 98 locations. We build camps, service equipment, transport fuel, deliver mail, do laundry, cook meals and serve them – several hundred thousand meals a day in more than 50 dining facilities. We’re also working with the Iraqi Oil Ministry to increase production and restore the delivery system. As we carry out all of this complicated and challenging work, KBR understands and respects the fact that our contracts are subject to oversight and accountability. We have put people and processes in place to assure internal accountability and that funds are spent wisely, with taxpayers receiving full value. Any way you look at it, what KBR is doing in the Middle East is the model for our business future. It is services, pure and simple, and we provide a lot of them in one of the most dangerous places anywhere. KBR has a strong brand name in the Middle East, and both M.W. Kellogg and Brown & Root have a long history here. When workers arrived in the southern Iraq oil fields earlier this year, they spotted an older Iraqi man wearing a worn Brown & Root cap from the 1970s. “Are you going to help us start our oil business up again?” he asked the KBR foreman. “And will you have training programs like when I was a young man? I have a son who’s 18 now and I want you to teach him.” From one generation to another, KBR is working with its community partners to deliver hope and self-sufficiency to this land. cooperative contractual environment that balances Delivering a vital and motivated workforce risk and reward. We do business these days in an increasingly The area where we see the greatest opportunity competitive world, where the gap between success is in Program Management, a traditional KBR and failure can be narrow and the challenge of strength. In this contractual arrangement, KBR maintaining a competitive advantage never ends. It represents the client and manages various subcon- is people that make the difference – the quality of tractors to execute the project or program. Over the their skills and experience, and our ability to attract, years, KBR has provided program management on motivate, develop and deploy them. The people who numerous offshore oil and gas projects, and on come in our front doors every day are the founda- high-profile work like the construction of Johnson tion of our sustainable future and we always treat Space Center. We currently provide program them with respect, taking responsibility for their management through our logistics support contracts health, safety and professional development. for the U.S. Military. We’ve now secured contracts At KBR everybody, from the CEO down, keeps to provide program management for projects where a close eye on promising employees and makes sure the work being managed is in excess of $10 billion. their managers are giving them what they need Our strategy is working. to become contributors by assessing, coaching, KBR will continue to pursue EPC contracts, mentoring and developing them into the future but only if the project is highly differentiated, or leadership of our company. if we can create a clear advantage because of our Strict adherence to strong Health, Safety and commercial offering. Environment (HSE) principles is one of KBR’s main For example, our LNG business has strong differentiators and a core value. Our safety record differentiators. We’re responsible for building 56 is something we are very proud of. Some of our job percent of the world’s LNG capacity over the past 30 sites have achieved 23 years without a lost-time years and are considered one of the industry’s most accident. Last year, 236 projects were injury-free. innovative leaders. Our LNG execution technology And we received several important awards, includ- and our experience in delivering these complex, ing the Safe Contractor of the Year award from remotely located plants are also big differentiators. ExxonMobil for our work on a complicated $3.5 Similarly, our financial credibility and our years billion oilfield development and pipeline project, of project management and operations and main- which included about 9,000 workers of more than tenance experience helped to secure the $1 billion 10 nationalities, many of whom initially lacked Alice Springs to Darwin rail project in Australia. This knowledge of the most basic safe work practices. 880-mile railway line, which completes the national We finished the year with a total of 64 million work rail network, is perhaps one of the last pieces of hours without a lost-time incident. pioneering infrastructure in the developed world. Building a sustainable company is a process that’s This complex private finance initiative package never-ending. It requires a clear communication of included project financing, design and construction, our expectations and our values, large investments maintenance and a 50-year freight operations concession – a combination that the KBR-led con- in training and a strong commitment from all levels of management. But we are all citizens of the world; sortium was uniquely equipped to deliver. Railroad it’s the right thing to do. And for a company to construction was completed five months ahead of schedule, and the new line promises to expand opportunities to a range of Australian industries and communities situated along the rail corridor. ensure its continued admission in today’s global marketplace, there’s really no other choice. 15 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 F F I N A N C I A L C O N D I T I O N A N D R E S U L T S O F O P E R A T I O N S EXECUTIVE OVERVIEW Halliburton and its affiliates from those claims. We have also During 2003, we made progress toward resolving our asbestos recently entered into a settlement with Equitas, the largest and silica liabilities. Our revenues grew nearly 30% to $16 insurer of our asbestos and silica claims. The settlement calls for billion, largely as a result of our increased government services Equitas to pay us $575 million (representing approximately 60% work in the Middle East. We reduced our exposure related to of applicable limits of liability that DII Industries had substantial unapproved claims and liquidated damages related to our likelihood of recovering from Equitas) provided that we receive challenging Barracuda-Caratinga construction project. We confirmation of our plan of reorganization and the current addressed the substantial expected future demands on our funds United States Congress does not pass national asbestos litigation by securing financing, managing working capital and strictly reform legislation. following our reduced capital spending plan. We achieved all of Government services in the Middle East. Our government this while continuing to effectively run our day-to-day business services revenue related to Iraq totaled $3.6 billion in 2003. by delivering quality, on-time services to our customers. The work we perform includes providing construction and Asbestos and silica. Having reached definitive settlements services (among other things): with almost all of our asbestos and silica personal injury - to support deployment, site preparation, operations and claimants, certain of our subsidiaries filed Chapter 11 proceed- maintenance and transportation for United States troops; and ings on December 16, 2003. A pre-approved proposed plan of - to restore the Iraqi petroleum industry, such as extinguishing reorganization was filed as part of the Chapter 11 proceedings. oil well fires, environmental assessments and cleanup at oil The confirmation hearing is currently scheduled in May 2004. sites, oil infrastructure condition assessments, oilfield, If the plan is approved by the bankruptcy court, in addition to pipeline and refinery maintenance, and the procurement and the $311 million paid to claimants in December 2003, we will importation of fuel products. contribute the following to trusts established for the benefit The accelerated ramp up in services in a war zone brought of the claimants: with it several challenges, including keeping our people safe, - up to approximately $2.5 billion in cash; recruiting and retaining qualified personnel, identifying and - 59.5 million shares of Halliburton common stock; retaining appropriate subcontractors, establishing the necessary - notes currently valued at approximately $52 million; and internal control procedures associated with this type of business - insurance proceeds, if any, between $2.3 billion and and funding the increased working capital demands. We have $3.0 billion received by DII Industries and Kellogg Brown received and expect to continue to receive heightened media, & Root. legislative and regulatory attention regarding our work in Iraq, Upon confirmation of the plan of reorganization, current including the preliminary results of various audits by the and future asbestos and silica personal injury claims against Defense Contract Audit Agency (DCAA) related to our invoicing Halliburton and its subsidiaries will be channeled into trusts practices and our self-reporting of possible improper conduct by established for the benefit of claimants, thus releasing one or two of our former employees. 17 Barracuda-Caratinga project. In recent years we have faced the near-term should we need them, including, but not limited numerous problems related to our Barracuda-Caratinga project, a to, approximately $200 million in availability under our United multi-year construction project to build two converted super- States accounts receivable securitization facility. In addition, as tankers, which will be used as floating production, storage and early as January 2005, we may receive $500 million of the funds offloading units (FPSOs), 32 hydrocarbon production wells, 22 that would be provided by the Equitas settlement described water injection wells and all sub-sea flow lines, umbilicals and above. In 2003, we implemented programs to improve our risers necessary to connect the underwater wells to the FPSOs. working capital and to limit our spending on capital projects to The project will be used to develop the Barracuda and Caratinga those critical to serving our customers. We continue to maintain crude oil fields, which are located off the coast of Brazil. The our investment grade credit ratings and have sufficient cash and project is significantly behind its original schedule and in a financing capacity to fund our asbestos and silica settlement financial loss position. In November 2003, we entered into an obligations in 2004 and continue to grow our business. agreement with the project owner which settled a portion of our Business focus. In 2003, we continued to focus on providing claims and also extended the project completion dates. quality service to our customers and developing new technolo- Financing activities. The anticipated cash contribution into gies to effectively compete in a challenging market. Early in the the asbestos and silica trusts in 2004, the increased work in Iraq year, we realigned our Energy Services Group into four new and potential additional delays of certain billings related to work segments, allowing us to better align ourselves with how our in Iraq have required us to raise substantial funds and could customers procure our services and to capture new business and require us to raise additional funds in order to meet our current achieve better integration. Our Energy Services Group business and potential future liabilities and working capital requirements. is largely affected by worldwide drilling activity and oil and gas As a result, between June 2003 and January 2004, we issued prices. In 2003 we were negatively impacted by the decline in $1.2 billion in convertible notes and $1.6 billion in fixed and the Gulf of Mexico offshore rig count and the reduction in deep floating rate senior notes. In addition, in anticipation of the pre- water activity by a number of our key customers in that area. We packaged Chapter 11 filing, in the fourth quarter of 2003 we reacted to this change in the market and put into place various entered into: measures in order to “right size” our business serving that area. - a delayed-draw term facility that would currently provide for Our continued emphasis on research and development resulted draws of up to $500 million to be available for cash funding in growth in new products and services in 2003, such as rotary of the trusts for the benefit of asbestos and silica claimants, if steerables and data center technologies. Besides the growth in required conditions are met; government services work at KBR, including the recent awarding - a master letter of credit facility intended to ensure that of the two-year $1.2 billion contract for the RIO program and existing letters of credit supporting our contracts remain in the five-year up to $1.5 billion military support contract, we place during the Chapter 11 filing; and continue to differentiate ourselves as a leader in the liquefied - a $700 million three-year revolving credit facility for general natural gas industry by being a preferred engineer and construc- working capital purposes which expires in October 2006. tor of liquification plants and receiving terminals throughout the We have other significant sources of funds available to us in world. We also recently completed the construction of the 1,420 18 kilometer Alice Springs to Darwin Rail Road in Australia, one over 99% of voting silica claimants voted to accept the proposed of the largest and most complex infrastructure projects ever plan of reorganization, meeting the voting requirements of undertaken in that country, five months ahead of schedule. Chapter 11 of the Bankruptcy Code for approval of the proposed Following is a more detailed discussion of each of these plan. The pre-approved proposed plan of reorganization was subjects. filed as part of the Chapter 11 proceedings. Asbestos and Silica Obligations and Insurance Recoveries The proposed plan of reorganization, which is consistent with the definitive settlement agreements reached with our asbestos Pre-packaged Chapter 11 proceedings. DII Industries, LLC and silica personal injury claimants in early 2003, provides that, (DII Industries), Kellogg Brown & Root, Inc. (Kellogg Brown & if and when an order confirming the proposed plan of reorgani- Root) and our other affected subsidiaries filed Chapter 11 zation becomes final and non-appealable, in addition to the proceedings on December 16, 2003 in bankruptcy court in $311 million paid to claimants in December 2003, the following Pittsburgh, Pennsylvania. With the filing of the Chapter 11 will be contributed to trusts for the benefit of current and future proceedings, all asbestos and silica personal injury claims and asbestos and silica personal injury claimants: related lawsuits against Halliburton and our affected subsidiaries - up to approximately $2.5 billion in cash; have been stayed. - 59.5 million shares of Halliburton common stock (valued at Our subsidiaries sought Chapter 11 protection because approximately $1.6 billion for accrual purposes using a stock Sections 524(g) and 105 of the Bankruptcy Code may be used to price of $26.17 per share, which is based on the average discharge current and future asbestos and silica personal injury trading price for the five days immediately prior to and claims against us and our subsidiaries. Upon confirmation of the including December 31, 2003); plan of reorganization, current and future asbestos and silica - a one-year non-interest bearing note of $31 million for the claims against us and our affiliates will be channeled into trusts benefit of asbestos claimants; established for the benefit of claimants under Sections 524(g) - a silica note with an initial payment into a silica trust of and 105 of the Bankruptcy Code, thus releasing Halliburton and $15 million. Subsequently the note provides that we will its affiliates from those claims. contribute an amount to the silica trust balance at the end A pre-packaged Chapter 11 proceeding is one in which a of each year for the next 30 years to bring the silica trust debtor seeks approval of a plan of reorganization from affected balance to $15 million, $10 million or $5 million, based creditors before filing for Chapter 11 protection. Prior to upon a formula which uses average yearly disbursements proceeding with the Chapter 11 filing, our affected subsidiaries from the trust to determine that amount. The note also solicited acceptances from known present asbestos and silica provides for an extension of the note for 20 additional years claimants to a proposed plan of reorganization. In the fourth under certain circumstances. We have estimated the amount quarter of 2003, valid votes were received from approximately of this note to be approximately $21 million. We will 364,000 asbestos claimants and approximately 21,000 silica periodically reassess our valuation of this note based upon claimants, representing substantially all known claimants. Of our projections of the amounts we believe we will be the votes validly cast, over 98% of voting asbestos claimants and required to fund into the silica trust; and 19 - insurance proceeds, if any, between $2.3 billion and our products. We have reviewed substantially all medical claims $3.0 billion received by DII Industries and Kellogg Brown received. During the fourth quarter of 2003, we received & Root. significant numbers of the product identification due diligence In connection with reaching an agreement with representatives files. Based on our review of these files, we received the of asbestos and silica claimants to limit the cash required to necessary information to allow us to proceed with the pre- settle pending claims to $2.775 billion, DII Industries paid packaged Chapter 11 proceedings. As of December 31, 2003, $311 million on December 16, 2003. Halliburton also agreed to approximately 63% of the value of claims passing medical due guarantee the payment of an additional $156 million of the diligence have submitted satisfactory product identification. remaining approximately $2.5 billion cash amount, which must We expect the percentage to increase as we receive additional be paid on the earlier to occur of June 17, 2004 or the date on plaintiff files. Based on these results, we found that substantially which an order confirming the proposed plan of reorganization all of the asbestos and silica liability relates to claims filed against becomes final and non-appealable. As a part of the definitive our former operations that have been divested and included settlement agreements, we have been accruing cash payments in in discontinued operations. Consequently, all 2003 changes lieu of interest at a rate of five percent per annum for these in our estimates related to the asbestos and silica liability were amounts. We recorded approximately $24 million in pretax recorded through discontinued operations. charges in 2003 related to the cash in lieu of interest. On Our proposed plan of reorganization calls for a portion of our December 16, 2003, we paid $22 million to satisfy a portion of total asbestos and silica liability to be settled by contributing our cash in lieu of interest payment obligations. 59.5 million shares of Halliburton common stock into the trusts. As a result of the filing of the Chapter 11 proceedings, we We will continue to adjust our asbestos and silica liability related adjusted the asbestos and silica liability to reflect the full amount to the shares if the average value of Halliburton stock for the five of the proposed settlement and certain related costs, which days immediately prior to and including the end of each fiscal resulted in a before tax charge of approximately $1.016 billion to quarter has increased by five percent or more from the most discontinued operations in the fourth quarter 2003. The tax recent valuation of the shares. At December 31, 2003, the value effect on this charge was minimal, as a valuation allowance was of the shares to be contributed is classified as a long-term established for the net operating loss carryforward created by the liability on our consolidated balance sheet, and the shares have charge. We also reclassified a portion of our asbestos and silica not been included in our calculation of basic or diluted earnings related liabilities from long-term to short-term, resulting in an per share. If the shares had been included in the calculation as of increase of short-term liabilities by approximately $2.5 billion, the beginning of the fourth quarter, our diluted earnings per because we believe we will be required to fund these amounts share from continuing operations for the year ended December within one year. 31, 2003 would have been reduced by $0.03. When and if we In accordance with the definitive settlement agreements receive final and non-appealable confirmation of our proposed entered in early 2003, we have been reviewing plaintiff files to plan of reorganization, we will: establish a medical basis for payment of settlement amounts and - increase or decrease our asbestos and silica liability to value to establish that the claimed injuries are based on exposure to the 59.5 million shares of Halliburton common stock based 20 on the value of Halliburton stock on the date of final and its insurance companies concerning the payment of asbestos- non-appealable confirmation of our proposed plan of related claims, including DII Industries’ 15-year litigation reorganization; and settlement history; - reclassify from a long-term liability to shareholders’ equity - reviewed our insurance coverage policy database containing the final value of the 59.5 million shares of Halliburton information on key policy terms as provided by outside common stock; and counsel; - include the 59.5 million shares in our calculations of - reviewed the terms of DII Industries’ prior and current earnings per share on a prospective basis. coverage-in-place settlement agreements; We understand that the United States Congress may consider - reviewed the status of DII Industries’ and Kellogg Brown & adopting legislation that would establish a national trust fund as Root’s current insurance-related lawsuits and the various the exclusive means for recovery for asbestos-related disease. We legal positions of the parties in those lawsuits in relation to are uncertain as to what contributions we would be required to the developed and developing case law and the historic make to a national trust, if any, although it is possible that they positions taken by insurers in the earlier filed and settled could be substantial and that they could continue for several lawsuits; years. It is also possible that our level of participation and - engaged in discussions with our counsel; and contribution to a national trust could be greater than it otherwise - analyzed publicly-available information concerning the ability of would have been as a result of having subsidiaries that have filed the DII Industries insurers to meet their obligations. Chapter 11 proceedings due to asbestos liability. Navigant Consulting’s analysis assumed that there will be no Recent insurance developments. Concurrent with the recoveries from insolvent carriers and that those carriers which remeasurement of our asbestos and silica liability due to the pre- are currently solvent will continue to be solvent throughout the packaged Chapter 11 filing, we evaluated the appropriateness of period of the applicable recoveries in the projections. Based on the $2.0 billion recorded for asbestos and silica insurance its review, analysis and discussions, Navigant Consulting’s recoveries. In doing so, we separately evaluated two types analysis assisted us in making our judgments concerning of policies: insurance coverage that we believe are reasonable and consistent - policies held by carriers with which we had either settled or with our historical course of dealings with our insurers and the which were probable of settling and for which we could relevant case law to determine the probable insurance recoveries reasonably estimate the amount of the settlement; and for asbestos liabilities. This analysis included the probable effects - other policies. of self-insurance features, such as self-insured retentions, policy In December 2003, we retained Navigant Consulting exclusions, liability caps and the financial status of applicable (formerly Peterson Consulting), a nationally-recognized insurers, and various judicial determinations relevant to the consultant in asbestos and silica liability and insurance, to assist applicable insurance programs. The analysis of Navigant us. In conducting their analysis, Navigant Consulting performed Consulting is based on information provided by us. the following with respect to both types of policies: In January 2004, we reached a comprehensive agreement with - reviewed DII Industries’ historical course of dealings with Equitas to settle our insurance claims against certain 21 Underwriters at Lloyd’s of London, reinsured by Equitas. The already recorded as of December 31, 2003, causing us not to settlement will resolve all asbestos-related claims made against significantly adjust our recorded insurance asset at that time. Lloyd’s Underwriters by us and by each of our subsidiary and Our estimate was based on a comprehensive analysis of the affiliated companies, including DII Industries, Kellogg Brown & situation existing at that time which could change significantly in Root and their subsidiaries that have filed Chapter 11 proceed- the both near- and long-term period as a result of: ings as part of our proposed settlement. Our claims against our - additional settlements with insurance companies; other London Market Company Insurers are not affected by this - additional insolvencies of carriers; and settlement. Provided that there is final confirmation of the plan - legal interpretation of the type and amount of coverage of reorganization in the Chapter 11 proceedings and the current available to us. United States Congress does not pass national asbestos litigation Currently, we cannot estimate the time frame for collection of reform legislation, Equitas will pay us $575 million, representing this insurance receivable, except as described earlier with regard approximately 60% of the applicable limits of liability that DII to the Equitas settlement. Industries had substantial likelihood of recovering from Equitas. United States Gover nment Contract Work The first payment of $500 million will occur within 15 working days of the later of January 5, 2005 or the date on which the order of the bankruptcy court confirming DII Industries’ plan of reorganization becomes final and non-appealable. A second payment of $75 million will be made eighteen months after the first payment. As of December 31, 2003, we developed our best estimate of the asbestos and silica insurance receivables as follows: - included $575 million of insurance recoveries from Equitas based on the January 2004 comprehensive agreement; - included insurance recoveries from other specific insurers with whom we had settled; - estimated insurance recoveries from specific insurers that we We provide substantial work under our government contracts business to the United States Department of Defense and other governmental agencies, including under world-wide United States Army logistics contracts, known as LogCAP, and under contracts to rebuild Iraq’s petroleum industry, known as RIO. Our units operating in Iraq and elsewhere under government contracts such as LogCAP and RIO consistently review the amounts charged and the services performed under these contracts. Our operations under these contracts are also regularly reviewed and audited by the Defense Contract Audit Agency, or DCAA, and other governmental agencies. When issues are found during the governmental agency audit process, these issues are typically discussed and reviewed with us in order to reach are probable of settling with and for which we could a resolution. reasonably estimate the amount of the settlement. When appropriate, these estimates considered prior settlements with insurers with similar facts and circumstances; and - estimated insurance recoveries for all other policies with the assistance of the Navigant Consulting study. The estimate we developed as a result of this process was consistent with the amount of asbestos and silica receivables The results of a preliminary audit by the DCAA in December 2003 alleged that we may have overcharged the Department of Defense by $61 million in importing fuel into Iraq. After a review, the Army Corps of Engineers, which is our client and oversees the project, concluded that we obtained a fair price for the fuel. However, Department of Defense officials have referred the matter to the agency’s inspector general with a request for 22 additional investigation by the agency’s criminal division. We already credited) being questioned by the DCAA. The issues understand that the agency’s inspector general has commenced relate to whether invoicing should be based on the number of an investigation. We have also in the past had inquiries by the meals ordered by the Army Materiel Command or whether DCAA and the civil fraud division of the United States invoicing should be based on the number of personnel served. Department of Justice into possible overcharges for work under a We have been invoicing based on the number of meals ordered. contract performed in the Balkans, which is still under review The DCAA is contending that the invoicing should be based on with the Department of Justice. the number of personnel served. We believe our position is On January 22, 2004, we announced the identification by our correct, but have undertaken a comprehensive review of its internal audit function of a potential over billing of approxi- propriety and the views of the DCAA. However, we cannot mately $6 million by one of our subcontractors under the predict when the issue will be resolved with the DCAA. In the LogCAP contract in Iraq. In accordance with our policy and meantime, we may withhold all or a portion of the payments to government regulation, the potential overcharge was reported to our subcontractors relating to the withheld invoices pending the Department of Defense Inspector General’s office as well as to resolution of the issues. Except for the $36 million in credits and our customer, the Army Materiel Command. On January 23, the $141 million of withheld invoices, all our invoicing in Iraq 2004, we issued a check in the amount of $6 million to the and Kuwait for other food services and other matters are being Army Materiel Command to cover that potential over billing processed and sent to the Army Materiel Command for payment while we conduct our own investigation into the matter. We are in the ordinary course. also continuing to review whether third-party subcontractors All of these matters are still under review by the applicable paid, or attempted to pay, one or two former employees in government agencies. Additional review and allegations are connection with the potential $6 million over billing. possible, and the dollar amounts at issue could change signifi- The DCAA has raised issues relating to our invoicing to the cantly. We could also be subject to future DCAA inquiries for Army Materiel Command for food services for soldiers and other services we provide in Iraq under the current LogCAP supporting civilian personnel in Iraq and Kuwait. We have taken contract or the RIO contract. For example, as a result of an two actions in response. First, we have temporarily credited $36 increase in the level of work performed in Iraq or the DCAA’s million to the Department of Defense until Halliburton, the review of additional aspects of our services performed in Iraq, it DCAA and the Army Materiel Command agree on a process to is possible that we may, or may be required to, withhold be used for invoicing for food services. Second, we are not additional invoicing or make refunds to our customer, some of submitting $141 million of additional food services invoices which could be substantial, until these matters are resolved. This until an internal review is completed regarding the number of could materially and adversely affect our liquidity. meals ordered by the Army Materiel Command and the number Barracuda-Caratinga Project of soldiers actually served at dining facilities for United States In June 2000, KBR entered into a contract with Barracuda & troops and supporting civilian personnel in Iraq and Kuwait. Caratinga Leasing Company B.V., the project owner, to develop The $141 million amount is our “order of magnitude” estimate the Barracuda and Caratinga crude oil fields, which are located of the remaining amounts (in addition to the $36 million we off the coast of Brazil. The construction manager and owner’s 23 representative is Petroleo Brasilero SA (Petrobras), the Brazilian - extend the original project completion dates and other national oil company. When completed, the project will consist milestone dates, reducing our exposure to liquidated of two converted supertankers, Barracuda and Caratinga, which damages. will be used as floating production, storage and offloading units, Accordingly, as of December 31, 2003: commonly referred to as FPSOs, 32 hydrocarbon production - the project was approximately 83% complete; wells, 22 water injection wells and all sub-sea flow lines, - we have recorded an inception to date pretax loss of $355 umbilicals and risers necessary to connect the underwater wells million related to the project, of which $238 million was to the FPSOs. The project is significantly behind the original recorded in 2003 and $117 million was recorded in 2002; schedule, due in large part to change orders from the project - the probable unapproved claims included in determining the owner, and is in a financial loss position. As a result, we have loss were $114 million; and asserted numerous claims against the project owner and are - we have an exposure to liquidated damages of up to ten subject to potential liquidated damages. We continue to engage percent of the contract value. Based upon the current in discussions with the project owner in an attempt to settle schedule forecast, we would incur $96 million in liquidated issues relating to additional claims, completion dates and damages if our claim for additional time is not successful. liquidated damages. Unapproved claims. We have asserted claims for compensa- Our performance under the contract is secured by: tion substantially in excess of the $114 million of probable - performance letters of credit, which together have an unapproved claims recorded as noncurrent assets as of available credit of approximately $266 million as of December 31, 2003, as well as claims for additional time to December 31, 2003 and which will continue to be adjusted complete the project before liquidated damages become to represent approximately 10% of the contract amount, as applicable. The project owner and Petrobras have asserted claims amended to date by change orders; against us that are in addition to the project owner’s potential - retainage letters of credit, which together have available claims for liquidated damages. In the November 2003 agree- credit of approximately $160 million as of December 31, ments, the parties have agreed to arbitrate these remaining 2003 and which will increase in order to continue to disputed claims. In addition, we have agreed to cap our financial represent 10% of the cumulative cash amounts paid to recovery to a maximum of $375 million, and the project owner us; and and Petrobras have agreed to cap their recovery to a maximum - a guarantee of Kellogg Brown & Root’s performance under of $380 million plus liquidated damages. the agreement by Halliburton Company in favor of the Liquidated damages. The original completion date for the project owner. Barracuda vessel was December 2003, and the original comple- In November 2003, we entered into agreements with the tion date for the Caratinga vessel was April 2004. We expect that project owner in which the project owner agreed to: the Barracuda vessel will likely be completed at least 16 months - pay $69 million to settle a portion of our claims, thereby later than its original contract determination date, and the reducing the amount of probable unapproved claims to Caratinga vessel will likely be completed at least 14 months later $114 million; and than its original contract determination date. However, there can 24 be no assurance that further delays will not occur. In the event liquidated damages. We have not accrued for this exposure that any portion of the delay is determined to be attributable to because we consider the imposition of such liquidated damages us and any phase of the project is completed after the milestone to be unlikely. dates specified in the contract, we could be required to pay Value added taxes. On December 16, 2003, the State of Rio liquidated damages. These damages were initially calculated on de Janeiro issued a decree recognizing that Petrobras is entitled an escalating basis rising ultimately to approximately $1 million to a credit for the value added taxes paid on the project. The per day of delay caused by us, subject to a total cap on liqui- decree also provided that value added taxes that may have dated damages of 10% of the final contract amount (yielding a become due on the project, but which had not yet been paid, cap of approximately $272 million as of December 31, 2003). could be paid in January 2004 without penalty or interest. In Under the November 2003 agreements, the project owner response to the decree, we have entered into an agreement with granted an extension of time to the original completion dates Petrobras whereby Petrobras agreed to: and other milestone dates that average approximately 12 - directly pay the value added taxes due on all imports on months. In addition, the project owner agreed to delay any the project (including Petrobras’ January 2004 payment of attempt to assess the original liquidated damages against us for approximately $150 million); and project delays beyond 12 months and up to 18 months and - reimburse us for value added taxes paid on local purchases, delay any drawing of letters of credit with respect to such of which approximately $100 million will become due liquidated damages until the earliest of December 7, 2004, the during 2004. completion of any arbitration proceedings or the resolution of Since the credit to Petrobras for these value added taxes is on all claims between the project owner and us. Although the a delayed basis, the issue of whether we must bear the cost of November 2003 agreements do not delay the drawing of letters money for the period from payment by Petrobras until receipt of of credit for liquidated damages for delays beyond 18 months, the credit has not been determined. our master letter of credit facility (see Note 13 to the consoli- The validity of the December 2003 decree has now been dated financial statements) will provide funding for any such challenged in court in Brazil. Our legal advisers in Brazil believe draw while it is in effect. The November 2003 agreements also that the decree will be upheld. If it is overturned or rescinded, or provide for a separate liquidated damages calculation of the Petrobras credits are lost for any other reason not due to $450,000 per day for each of the Barracuda and the Caratinga Petrobras, the issue of who must ultimately bear the cost of the vessels if delayed beyond 18 months from the original schedule. value added taxes will have to be determined based upon the That amount is subject to the total cap on liquidated damages of law prior to the December 2003 decree. We believe that the 10% of the final contract amount. Based upon the November value added taxes are reimbursable under the contract and prior 2003 agreements and our most recent estimates of project law, but, until the December 2003 decree was issued, Petrobras completion dates, which are April 2005 for the Barracuda vessel and the project owner had been contesting the reimbursability and May 2005 for the Caratinga vessel, we estimate that if of up to $227 million of value added taxes. There can be no we were to be completely unsuccessful in our claims for assurance that we will not be required to pay all or a portion of additional time, we would be obligated to pay $96 million in these value added taxes. In addition, penalties and interest of 25 $40 million to $100 million could be due if the December 2003 of such default), the project owner may seek direct damages. decree is invalidated. We have not accrued any amounts for Those damages could include completion costs in excess of the these taxes, penalties or interest. contract price and interest on borrowed funds, but would Default provisions. Prior to the filing of the pre-packaged exclude consequential damages. The total damages could be up Chapter 11 proceedings in connection with the proposed to $500 million plus the return of up to $300 million in advance settlement of our asbestos and silica claims, we obtained a payments previously received by us to the extent they have not waiver from the project owner (with the approval of the lenders been repaid. The original contract terms require repayment of financing the project) so that the filing did not constitute an the $300 million in advance payments by crediting the last $350 event of default under the contract. In addition, the project million of our invoices related to the contract by that amount, owner also obtained a waiver from the lenders so that the but the November 2003 agreements delay the repayment of any Chapter 11 filing did not constitute an event of default under the of the $300 million in advance payments until at least December project owner’s loan agreements with the lenders. The waiver 7, 2004. A termination of the contract by the project owner received by the project owner from the lenders is subject to could have a material adverse effect on our financial condition certain conditions that have thus far been fulfilled. Included as a and results of operations. condition is that the pre-packaged plan of reorganization be Cash flow considerations. The project owner has procured confirmed by the bankruptcy court within 120 days of the filing project finance funding obligations from various lenders to of the Chapter 11 proceedings. The currently scheduled hearing finance the payments due to us under the contract. The project date for confirmation of the plan of reorganization is not within owner currently has no other committed source of funding on the 120-day period. We understand that the project owner is which we can necessarily rely. In addition, the project financing seeking, and expects to receive, an extension of the 120-day includes borrowing capacity in excess of the original contract period, but can give no assurance that it will be granted. In the amount. However, only $250 million of this additional borrow- event that the conditions do not continue to be fulfilled, the ing capacity is reserved for increases in the contract amount lenders , among other things, could exercise a right to suspend payable to us and our subcontractors. the project owner’s use of advances made, and currently Under the loan documents, the availability date for loan draws escrowed, to fund the project. We believe it is unlikely that the expired December 1, 2003 and therefore, the project owner lenders will exercise any right to suspend funding the project drew down all remaining available funds on that date. As a given the current status of the project and the fact that a failure condition to the draw down of the remaining funds, the project to pay may allow us to cease work on the project without owner was required to escrow the funds for the exclusive use of Petrobras having a readily available substitute contractor. paying project costs. The availability of the escrowed funds can However, there can be no assurance that the lenders will be suspended by the lenders if applicable conditions are not continue to fund the project. met. With limited exceptions, these funds may not be paid to In the event that we were determined to be in default under Petrobras or its subsidiary (which is funding the drilling costs of the contract, and if the project was not completed by us as a the project) until all amounts due to us, including amounts due result of such default (i.e., our services are terminated as a result for the claims, are liquidated and paid. While this potentially 26 reduces the risk that the funds would not be available for increased by approximately $880 million due to the start-up of payment to us, we are not party to the arrangement between the our government services work in Iraq. The activities in Iraq will lenders and the project owner and can give no assurance that continue to require this significant amount of working capital, there will be adequate funding to cover current or future claims and therefore the timing of the realization of this working capital and change orders. is uncertain. We currently expect the working capital require- We have now begun to fund operating cash shortfalls on the ments related to Iraq will increase through the first half of 2004. project and would be obligated to fund such shortages over An increase in the amount of services we are engaged to perform the remaining project life in an amount we currently estimate could place additional demands on our working capital. It is to be approximately $480 million. That funding level assumes possible that we may, or may be required to, withhold additional generally that neither we nor the project owner are successful in invoicing or make refunds to our customer related to the DCAA’s recovering claims against the other and that no liquidated review of additional aspects of our services, some of which could damages are imposed. Under the same assumptions, except be substantial, until these matters are resolved. This could assuming that we recover unapproved claims in the amounts materially and adversely affect our liquidity. currently recorded, the cash shortfall would be approximately On December 16, 2003, a partial payment of $311 million $360 million. We have already funded approximately $85 was made immediately prior to the Chapter 11 filing of our million of such shortfall and expect that our funded shortfall subsidiaries related to asbestos and silica personal injury claims. amount will increase to approximately $416 million by We have also agreed to guarantee the payment of an additional December 2004, of which approximately $225 million would be $156 million of the remaining approximately $2.5 billion cash paid to the project owner in December 2004 as part of the amount, which must be paid on the earlier to occur of June 17, return of the $300 million in advance payments. The remainder 2004 or the date on which an order confirming the proposed of the advance payments would be returned to the project owner plan of reorganization becomes final and non-appealable. When over the remaining life of the project after December 2004. and if we receive final and non-appealable confirmation of our There can be no assurance that we will recover the amount of plan of reorganization, we will be required to fund the remain- unapproved claims we have recognized, or any amounts in der of the cash amount to be contributed to the asbestos and excess of that amount. silica trusts. LIQUIDITY AND CAPITAL RESOURCES We ended 2003 with cash and cash equivalents of $1.8 billion compared to $1.1 billion at the end of 2002. Significant uses of cash. Our liquidity and cash balance As a result of capital discipline throughout the year, we have reduced capital expenditures from $764 million in 2002 to $515 million in 2003. We expect to continue this level of expenditures with capital outlays currently being estimated at approximately during 2003 have been significantly affected by our government $540 million in 2004. We have not finalized our capital services work in Iraq, our asbestos and silica liabilities, $296 million in scheduled debt maturities and a $180 million expenditures budget for 2005 or later periods. We currently have been paying annual dividends to our shareholders of approxi- reduction of receivables in our securitization program. Our mately $219 million. working capital position (excluding cash and equivalents) 27 The following table summarizes our long-term contractual which included $136 million collected from the sale of obligations as of December 31, 2003: Payments due Wellstream, $33 million collected from the sale of Halliburton Millions of dollars 2004 2005 2006 2007 2008 Thereafter Total Measurement Systems, $25 million collected on a note receivable Long-term debt (1) $ 22 $324 $296 $10 $151 $2,625 $3,428 Operating leases Capital leases Pension funding 143 1 obligations (2) 67 Purchase obligations (3) 241 96 1 - 4 80 58 45 267 - - 4 - - 3 - - 3 - - 1 689 2 67 256 Total long-term contractual obligations that was received as a portion of the payment for Bredero-Shaw and $23 million collected from the sale of Mono Pumps. In contemplation of the anticipated cash contribution into the asbestos and silica trusts in 2004 and to help fund our working capital needs in Iraq, we increased our long-term borrowings by $474 $425 $380 $71 $199 $2,893 $4,442 approximately $2.2 billion during 2003 through the issuance of (1) Long-term debt excludes the effect of an interest rate swap of approximately $9 million. See Note 10 to the consolidated financial statements for further discussion. (2) Congress is expected to consider pension funding relief legislation when they reconvene in 2004. The actual contributions we make during 2004 may be impacted by the final legislative outcome. (3) The purchase obligations disclosed above do not include purchase obligations that KBR enters into with its vendors in the normal course of business that support existing contracting arrangements with its customers. The purchase obligations with their vendors can span several years depending on the duration of the projects. In general, the costs associated with the purchase obligations are expensed as the revenue is earned on the related projects. convertible bonds and fixed and floating rate senior notes. Also, in January of 2004, we issued senior notes due 2007 totaling $500 million, which will primarily be used to fund the asbestos and silica settlement liability. Our combined short-term notes payable and long-term debt was 58% of total capitalization at the end of 2003, compared to 30% at the end of 2002 and 24% at the end of 2001. In addition, we have received adverse judgments on two Future sources of cash. We have available to us significant cases: BJ Services Company patent litigation and Anglo-Dutch sources of cash in the near-term should we need it. (Tenge). (See Note 13 to the consolidated financial statements Asbestos and silica liability financing. In the fourth quarter for more information.) We could be required to pay approxi- of 2003, we entered into a delayed-draw term facility for up mately $107 million during 2004 to BJ Services Company, which to $1.0 billion. This facility was reduced in January 2004 to has been escrowed and is included in the restricted cash balance approximately $500 million by the net proceeds of our recent in “Other current assets”. We are currently appealing the Anglo- issuance of senior notes due 2007. This facility is subject to Dutch (Tenge) judgment but could be required to pay as much further reduction and could be available for cash funding of the as $106 million (although we have only accrued $77 million) to trusts for the benefit of asbestos and silica claimants. There are a Anglo-Dutch Petroleum International, Inc. We have posted number of conditions that must be met before the delayed-draw security in the amount of $25 million in order to postpone term facility will become available for our use, including final execution of the judgment until all appeals have been exhausted. and non-appealable confirmation of our plan of reorganization Significant sources of cash. After consideration of the and confirmation of the rating of Halliburton’s long-term senior increase in working capital needs related to work in Iraq, unsecured debt at BBB or higher by Standard & Poor’s and asbestos and silica claims payments, and the reduction of $180 Baa2 or higher by Moody’s Investors Service. In addition, we million under our accounts receivable securitization facility, our entered into a $700 million three-year revolving credit facility operations provided approximately $600 million in cash flow in for general working capital purposes, which replaced our $350 2003. In addition, our cash flow was supplemented by cash million revolving credit facility. At the time of its replacement, no from the sale of non-core businesses totaling $224 million, amounts had been drawn against the $350 million revolver. The 28 $700 million revolving credit facility is now effective and 2001. In December 2002, Standard & Poor’s lowered these undrawn. ratings to BBB and A-3. These ratings were lowered primarily Asbestos and silica settlements with insurers. In January due to our asbestos and silica exposure. In December 2003, 2004, we reached a comprehensive agreement with Equitas to Moody’s Investors Service confirmed our ratings with a positive settle our insurance claims against certain Underwriters at outlook and Standard & Poor’s revised its credit watch listing for Lloyd’s of London, reinsured by Equitas. The settlement will us from “negative” to “developing” in response to our announce- resolve all asbestos-related claims made against Lloyd’s ment that DII Industries and Kellogg Brown & Root and other of Underwriters by us and by each of our subsidiary and affiliated our subsidiaries filed Chapter 11 proceedings to implement the companies, including DII Industries, Kellogg Brown & Root and proposed asbestos and silica settlement. their subsidiaries that have filed Chapter 11 proceedings as part Although our long-term unsecured debt ratings continue at of our proposed settlement. Our claims against our other investment grade levels, the cost of new borrowing is relatively London Market Company Insurers are not affected by this higher and our access to the debt markets is more volatile at settlement. Provided that there is final confirmation of the plan these new rating levels. Investment grade ratings are BBB- or of reorganization in the Chapter 11 proceedings and the current higher for Standard & Poor’s and Baa3 or higher for Moody’s United States Congress does not pass national asbestos litigation Investors Service. Our current long-term unsecured debt ratings reform legislation, Equitas will pay us $575 million, representing are one level above BBB- on Standard & Poor’s and one level approximately 60% of the applicable limits of liability that DII above Baa3 on Moody’s Investors Service. Several of our credit Industries had substantial likelihood of recovering from Equitas. facilities or other contractual obligations require us to maintain a The first payment of $500 million will occur within 15 working certain credit rating as follows: days of the later of January 5, 2005 or the date on which the - our $700 million revolving credit facility would require us to order of the bankruptcy court confirming DII Industries’ plan of provide additional collateral if our long-term unsecured debt reorganization becomes final and non-appealable. A second rating falls below investment grade; payment of $75 million will be made eighteen months after the - our Halliburton Elective Deferral Plan contains a provision first payment. which states that, if the Standard & Poor’s rating for our Other sources of cash. We also have available our accounts long-term unsecured debt falls below BBB, the amounts receivable securitization facility. See “Off Balance Sheet Risk” for credited to the participants’ accounts will be paid to the a further discussion. participants in a lump-sum within 45 days. At December 31, Other factors af fecting liquidity Credit ratings. Late in 2001 and early in 2002, Moody’s Investors Service lowered its ratings of our long-term senior unsecured debt to Baa2 and our short-term credit and commer- cial paper ratings to P-2. In addition, Standard & Poor’s lowered 2003 this was approximately $51 million; and - certain of our letters of credit have ratings triggers that could require cash collateralization or give the banks set-off rights. These contingencies would be funded under the senior secured master letter of credit facility (see below) while it its ratings of our long-term senior unsecured debt to A- and our remains available. short-term credit and commercial paper ratings to A-2 in late Letters of credit. In the normal course of business, we have 29 agreements with banks under which approximately $1.2 billion of letters of credit or bank guarantees were outstanding as of BUSINESS ENVIRONMENT AND RESULTS OF OPERATIONS December 31, 2003, including $252 million which relate to our joint ventures’ operations. Certain of these letters of credit have triggering events (such as the filing of Chapter 11 proceedings by some of our subsidiaries or reductions in our credit ratings) that would allow the banks to require cash collateralization or allow the holder to draw upon the letter of credit. In the fourth quarter of 2003, we entered into a senior secured master letter of credit facility (Master LC Facility) with a syndicate of banks which covers at least 90% of the face amount of our existing letters of credit. Under the Master LC Facility, each participating bank has permanently waived any right that it had to demand cash collateral as a result of the filing of Chapter 11 proceedings. In addition, the Master LC Facility provides for the issuance of new letters of credit, so long as the total facility does not exceed an amount equal to the amount of the facility at closing plus $250 million, or approximately $1.5 billion. The purpose of the Master LC Facility is to provide an advance for letter of credit draws, if any, as well as to provide collateral for the reimbursement obligations for the letters of credit. Advances under the Master LC Facility will remain available until the earlier of June 30, 2004 or when an order confirming the proposed plan of reorganization becomes final and non-appealable. At that time, all advances outstanding under the Master LC Facility, if any, will become term loans payable in full on November 1, 2004, and all other letters of credit shall cease to be subject to the terms of the Master LC Facility. As of December 31, 2003, there were no outstanding advances under the Master LC Facility. We currently operate in over 100 countries throughout the world, providing a comprehensive range of discrete and integrated products and services to the energy industry and to other industrial and governmental customers. The majority of our consolidated revenues are derived from the sale of services and products, including engineering and construction activities. We sell services and products primarily to major, national and independent oil and gas companies and the United States government. These products and services are used throughout the energy industry from the earliest phases of exploration, development and production of oil and gas resources through refining, processing and marketing. Our five business segments are organized around how we manage the business: Drilling and Formation Evaluation, Fluids, Production Optimization, Landmark and Other Energy Services, and the Engineering and Construction Group. We sometimes refer to the combination of Drilling and Formation Evaluation, Fluids, Production Optimization, and Landmark and Other Energy Services segments as the Energy Services Group. The industries we serve are highly competitive, with many substantial competitors for each segment. In 2003, based upon the location of the services provided and products sold, 27% of our total revenue was from the United States and 15% was from Iraq. In 2002, 33% of our total revenue was from the United States and 12% of our total revenue was from the United Kingdom. No other country accounted for more than 10% of our revenues during these periods. Unsettled political condi- tions, social unrest, acts of terrorism, force majeure, war or other armed conflict, expropriation or other governmental actions, inflation, exchange controls or currency devaluation may result in increased business risk in any one country. We believe the geographic diversification of our business activities reduces the 30 risk that loss of business in any international country would be Our customers’ cash flow, in many instances, depends upon material to our consolidated results of operations. the revenue they generate from sale of oil and gas. With higher Hallibur ton Company Activity levels within our business segments are significantly impacted by the following: - spending on upstream exploration, development and prices, they may have more cash flow, which usually translates into higher exploration and production budgets. Higher prices may also mean that oil and gas exploration in marginal areas can become attractive, so our customers may consider investing in production programs by major, national and independent oil such properties when prices are high. When this occurs, it and gas companies; means more potential work for us. The opposite is true for lower - capital expenditures for downstream refining, processing, oil and gas prices. petrochemical and marketing facilities by major, national and The expectation in 2003 was that world oil prices would begin to somewhat soften, but prices have continued to increase. United States oil prices continued to increase due to low inventory levels as a result of Iraqi crude oil production still being below pre-war levels and higher natural gas prices adding pressure to switch to competing heating fuel oils. Natural gas demand showed a decline in 2003 largely due to high prices discouraging demand in the industrial and electric power sectors. However, expected growth in the economy, along with somewhat lower projected annual average prices, are expected to increase demand by two percent in 2004. Natural gas production slightly increased in 2003, but is expected to fall back somewhat in 2004 as drilling intensity declines. In 2004, the projected supply gap between demand and production is offset by the expectation that storage injection requirements will be less than those in 2003, when stocks after the winter of 2002- 2003 were at record lows. 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. Energy Ser vices Group Some of the more significant barometers of current and future spending levels of oil and gas companies are oil and gas prices, exploration and production expenditures by international and national oil companies, the world economy and global stability, which together drive worldwide drilling activity. Our Energy Services Group financial performance is significantly affected by oil and gas prices and worldwide rig activity which are summa- rized in the following tables. This table shows the average oil and gas prices for West Texas Intermediate crude oil and Henry Hub natural gas prices: Average Oil and Gas Prices 2003 2002 2001 West Texas Intermediate (WTI) oil prices (dollars per barrel) $31.14 $25.92 $26.02 Henry Hub gas prices (dollars per million cubic feet) $ 5.63 $ 3.33 $ 4.07 31 The yearly average rig counts based on the Baker Hughes periods of reduced activity, discounts normally increase, Incorporated rig count information are as follows: reducing the net revenue for our services and conversely, during Average Rig Counts Land vs. Offshore United States: Land Offshore Total Canada: Land Offshore Total International (excluding Canada): Land Offshore Total Worldwide total Land total Offshore total Average Rig Counts Oil vs. Gas United States: Oil Gas Total Canada:* International (excluding Canada): Oil Gas Total 2003 2002 2001 periods of higher activity, discounts normally decline resulting 924 108 1,032 368 4 372 544 226 770 2,174 1,836 338 718 113 831 260 6 266 507 225 732 1,829 1,485 344 1,002 153 1,155 337 5 342 525 220 745 2,242 1,864 378 in net revenue increasing for our services. The United States rig count increase in 2003 was primarily in gas drilling as gas prices remained high and operators continued to build gas storage levels before the 2003/2004 winter heating season. The overall increased North American rig count is being driven by higher oil and gas prices and demand for natural gas to replace working gas in storage for the 2003/2004 winter heating season. Overall outlook. For 2003, high commodity prices resulted in improved activity levels, with average global rig counts up 19%. 2003 2002 2001 Nonetheless, reduced reinvestment rates by our customers meant 157 875 1,032 372 576 194 770 137 694 831 266 561 171 732 217 938 1,155 342 571 174 745 Worldwide total 2,174 1,829 2,242 * Canadian rig counts by oil and gas were not available. Most of our work in Energy Services Group closely tracks the number of active rigs. As rig count increases or decreases, so does the total available market for our services and products. Further, our margins associated with services and products for offshore rigs are generally higher than those associated with land rigs. 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 immedi- ately following a price increase. The discount applied normally decreases over time if the activity levels remain strong. During 32 that overall activity growth and offshore activity in particular failed to meet broader expectations of the market. The Energy Services Group experienced strong performance in Canada, the Middle East and Latin America in 2003. Mexico’s performance was particularly strong as operating income there more than doubled. The Gulf of Mexico was an overall disappointment. The industry experienced a five percent year-over-year decline in the offshore Gulf of Mexico rig count and a reduction in deep water activity with a number of our key customers. As a result, we have started the process of reducing our cost structure in the Gulf of Mexico region and are refocusing our efforts towards more successful new products. Equally important, we have redeployed a number of people and assets to higher growth regions internationally, including Latin America and Asia. Our Drilling and Formation Evaluation segment saw excellent performance in logging, but our drilling services performance was adversely affected in the second half of the year by downturns of activity in the Gulf of Mexico and the United Kingdom sector of the North Sea. As a result, we are currently executing a plan to remove approximately $50 million of annual predicting an average of 362 rigs in 2004. Growth in interna- operating costs from drilling services. We expect to see a tional drilling activity is expected to remain positive over the recovery of margins during 2004. coming year. The international rig count is expected by Spears to The Energy Services Group also achieved significant growth in average 795 rigs in 2004 with 9,874 new wells forecasted to be our new products and services in 2003. Overall, revenues drilled. We will be focused in 2004 on our operational efficiency associated with new technologies were higher than those of 2002 and capital discipline, without compromising our ability to serve across a wide range of customers and geographies. We were new growth markets in the future. particularly successful in our rotary steerables products, where Engineering and Constr uction Group we increased our revenues by 80% with an increase in our tool fleet of 25%. The signing of contracts for national data centers with the governments of Nigeria and Indonesia reinforces the successes we have had with national oil companies and their governments over the last few years, and is something we wish to build upon in 2004. Together with the data centers in Pakistan, the United Kingdom, Brazil, Norway, Australia, Canada and Houston, as well as the recent selection of Landmark as an operator of the Kazakhstan National Data Bank, we believe Halliburton is emerging as the clear leader for data center technology. We have also reexamined various joint ventures and recently announced an agreement to restructure two significant joint ventures with Shell, WellDynamics B.V. (an intelligent well Our Engineering and Construction Group, operating as KBR, provides a wide range of services to energy and industrial customers and government entities worldwide. Engineering and construction projects are generally longer term in nature than our Energy Services Group work and are impacted by more diverse drivers than short-term fluctuations in oil and gas prices. Our government services opportunities are strong in the Middle East, United States, United Kingdom and Australia. Spending on defense and security programs has been increasing in each of the major markets. These include support to military forces, security assessments and upgrades at military and government facilities, and disaster and contingency relief at home and abroad. We believe governments will continue to look to the private sector to perform work traditionally done by those completion joint venture), and Enventure Global Technologies government agencies. LLC (an expandable casing joint venture). For Enventure, we elected to reduce our interests and transfer part of our interests to Shell. In return, we received significantly enhanced marketing and distribution rights for sand screens and liner hangers, which we believe are central to our business and offer major opportunities for profitable growth. In a similar strategic vein, we believe the majority stake we will secure in WellDynamics is better aligned The drive to monetize gas reserves in the Middle East, West Africa, Asia Pacific, Eurasia and Latin America, combined with strong demand for gas and liquefied natural gas (LNG) in the United States, Japan, Korea, Taiwan, China and India, has led to numerous gas to liquid, LNG liquefaction and gas development projects in the exporting regions as well as onshore or floating LNG terminals, and gas processing plants in the importing with the core “Real Time Knowledge” strategy of our company. countries. As we look forward, we see modest growth in the global market during 2004. Spears and Associates expects the United States rig count to average 1,050 rigs. For Canada, they are Outsourcing of operations and maintenance work has been increasing worldwide, and we expect this trend to continue. An increasing number of independent oil companies are acquiring 33 mature oilfield assets from major oil companies and are looking (often items which are specifically designed and fabricated to outsource operations and maintenance capabilities. KBR is for the project); investing in technologies to optimize asset performance in both - bidding a fixed-price and completion date before finalizing upstream and downstream oil and gas markets. subcontractors’ terms and conditions; We are also seeing significant business opportunities in the - subcontractor’s individual performance and combined United Kingdom for major public infrastructure projects, which interdependencies of multiple subcontractors (the majority have been dominated for almost a decade by privately financed of all construction and installation work is performed by projects, and now account for 10% of the country’s infrastruc- subcontractors); ture capital spending. We have been involved with a significant - contracts covering long periods of time; number of these projects, and we expect to build on that - contract values generally for large amounts; and business using our experience with pulling together complex - contracts containing significant liquidated damages project financing arrangements and managing partnerships. provisions. Engineering and construction contracts can be broadly Cost reimbursable contracts include contracts where the categorized as either fixed-price (sometimes referred to as lump price is variable based upon actual costs incurred for time and sum) or cost reimbursable contracts. Some contracts can involve materials, or for variable quantities of work priced at defined both fixed-price and cost reimbursable elements. Fixed-price unit rates. Profit elements on cost reimbursable contracts may contracts are for a fixed sum to cover all costs and any profit be based upon a percentage of costs incurred and/or a fixed element for a defined scope of work. Fixed-price contracts entail amount. Cost reimbursable contracts are generally less risky, more risk to us as we must pre-determine both the quantities of since the owner retains many of the risks. While fixed-price work to be performed and the costs associated with executing contracts involve greater risk, they also potentially are more the work. The risks to us arise from, among other things: profitable for the contractor, since the owners pay a premium to - uncertainty in estimating the technical aspects and effort transfer many risks to the contractor. involved to accomplish the work within the contract The approximate percentages of revenues attributable to fixed- schedule; price and cost reimbursable engineering and construction - labor availability and productivity; and segment contracts are as follows: - supplier and subcontractor pricing and performance. Fixed-price engineering, procurement and construction and fixed-price engineering, procurement, installation and 2003 2002 2001 Fixed-Price Cost Reimbursable 24% 47% 41% 76% 53% 59% commissioning contracts involve even greater risks including: An important aspect of our 2002 reorganization was to look - bidding a fixed-price and completion date before detailed closely at each of our products and services to ensure that risks engineering work has been performed; can be properly evaluated and that they are self-sufficient, - bidding a fixed-price and completion date before locking in including their use of capital and liquidity. In that process, price and delivery of significant procurement components we found that the engineering, procurement, installation 34 and commissioning, or EPIC, of offshore projects involved a disproportionate risk and were using a large share of our bonding and letter of credit capacity relative to profit contribution. Accordingly, we determined to not pursue those types of projects in the future. We have six fixed-price EPIC offshore projects underway, and we are fully committed to successful completion of these projects, several of which are substantially complete. The reshaping of our offshore business away from lump-sum EPIC contracts to cost reimbursement services has been marked by some significant new work. During the first quarter of 2004 we signed a major reimbursable engineering, procurement and construction management, or EPCM, contract for a West African oilfield development. This is a major award under our new EPCM strategy. We are also pursuing program management opportunities in deep-water locations around the world. These efforts, implemented under our new strategy, are allowing us to utilize our global resources to continue to be a leader in the offshore business. 35 RESULTS OF OPERATIONS IN 2003 COMPARED TO 2002 REVENUES: Millions of dollars Drilling and Formation Evaluation Fluids Production Optimization Landmark and Other Energy Services Total Energy Services Group Engineering and Construction Group Total revenues Geographic – Energy Services Group segments only: Drilling and Formation Evaluation: North America Latin America Europe/Africa Middle East/Asia Subtotal Fluids: North America Latin America Europe/Africa Middle East/Asia Subtotal Production Optimization: North America Latin America Europe/Africa Middle East/Asia Subtotal Landmark and Other Energy Services: North America Latin America Europe/Africa Middle East/Asia Subtotal Total Energy Services Group revenues 2003 $ 1,643 2,039 2,766 547 6,995 9,276 $16,271 $ 558 261 312 512 1,643 990 258 452 339 2,039 1,345 317 562 542 2,766 192 71 116 168 547 $ 6,995 2002 $ 1,633 1,815 2,554 834 6,836 5,736 $12,572 $ 549 251 344 489 1,633 934 216 381 284 1,815 1,264 277 556 457 2,554 284 102 297 151 834 $ 6,836 Increase/ (Decrease) $ 10 224 212 (287) 159 3,540 $3,699 $ 9 10 (32) 23 10 56 42 71 55 224 81 40 6 85 212 (92) (31) (181) 17 (287) $ 159 Percentage Change 0.6% 12.3 8.3 (34.4) 2.3 61.7 29.4% 1.6% 4.0 (9.3) 4.7 0.6 6.0 19.4 18.6 19.4 12.3 6.4 14.4 1.1 18.6 8.3 (32.4) (30.4) (60.9) 11.3 (34.4) 2.3% 36 OPERATING INCOME (LOSS): Millions of dollars Drilling and Formation Evaluation Fluids Production Optimization Landmark and Other Energy Services Total Energy Services Group Engineering and Construction Group General corporate Operating income (loss) Geographic – Energy Services Group segments only: Drilling and Formation Evaluation: North America Latin America Europe/Africa Middle East/Asia Subtotal Fluids: North America Latin America Europe/Africa Middle East/Asia Subtotal Production Optimization: North America Latin America Europe/Africa Middle East/Asia Subtotal Landmark and Other Energy Services: North America Latin America Europe/Africa Middle East/Asia Subtotal Total Energy Services Group operating income NM - Not Meaningful 2003 $ 177 251 421 (23) 826 (36) (70) $ 720 $ 60 30 30 57 177 104 52 48 47 251 202 75 52 92 421 (60) 8 17 12 (23) $ 826 2002 $ 160 202 384 (108) 638 (685) (65) $ (112) $ 70 29 (6) 67 160 119 33 20 30 202 228 41 46 69 384 (218) 5 118 (13) (108) $ 638 Increase/ (Decrease) $ 17 49 37 85 188 649 (5) $832 $ (10) 1 36 (10) 17 (15) 19 28 17 49 (26) 34 6 23 37 158 3 (101) 25 85 $188 Percentage Change 10.6% 24.3 9.6 78.7 29.5 94.7 (7.7) NM (14.3)% 3.4 NM (14.9) 10.6 (12.6) 57.6 140.0 56.7 24.3 (11.4) 82.9 13.0 33.3 9.6 72.5 60.0 (85.6) NM 78.7 29.5% 37 The increase in consolidated revenues for 2003 compared increased $34 million compared to 2002 as contracts that were to 2002 was largely attributable to activity in our government expiring were more than offset by new contracts, primarily in services projects, primarily work in the Middle East. West Africa, the Middle East and Ecuador. Also impacting International revenues were 73% of total revenues in 2003 drilling services were significant price discounts in the fourth and 67% of total revenues in 2002, with the increase attributable quarter of 2003 on basic drilling services and rotary steerables to our government services projects. The United States in the United Kingdom. International revenues were 72% of Government has become a major customer of ours with total total segment revenues in both 2003 and 2002. revenues of approximately $4.2 billion, or 26% of total consoli- The increase in operating income for the segment was dated revenues, for 2003. Revenues from the United States primarily driven by logging and perforating services, which Government during 2002 represented less than 10% of total increased operating income by $32 million, a result of increased consolidated revenues. The consolidated operating income rig counts internationally, lower discounts in the United States increase in 2003 compared to 2002 was again largely attributa- and the absence of start-up costs incurred in 2002. Operating ble to our government services projects and the absence of the income for 2003 also included a $36 million gain ($24 million $644 million in asbestos and silica charges and restructuring in North America and $12 million in Europe/Africa) on the sale charges which occurred in 2002. During 2003, Iraq related of Mono Pumps. Operating income for drilling services work contributed approximately $3.6 billion in consolidated decreased by $49 million and $9 million for drill bits compared revenues and $85 million in consolidated operating income, to 2002 due to lower activity in Venezuela, pricing pressures in a 2.4% margin before corporate costs and taxes. In addition, the United States, severance expense, and facility consolidation we recorded a loss on the Barracuda-Caratinga project of expenses. Drilling services operating income for 2003 was $238 million in 2003 as compared to a $117 million loss negatively impacted by $5 million compared to 2002 due to in 2002. Our Energy Services Group segments accounted for the sale of Mono Pumps. approximately $188 million of the increase. Fluids increase in revenues was driven by drilling fluids sales Following is a discussion of our results of operations by increase of $101 million and cementing activities increase of reportable segment. $121 million compared to 2002. Cementing benefited from Drilling and Formation Evaluation revenues were essentially higher land rig counts in the United States. Both drilling fluids flat. Logging and perforating services revenues increased $25 and cementing revenues benefited from increased activity in million, primarily due to higher average year-over-year rig Mexico, primarily with PEMEX, which offset lower activity in counts in the United States and Mexico, partially offset by Venezuela. Drilling fluids also benefited from price improve- lower sales in China and reduced activity in Venezuela. Drill ments on certain contracts in Europe/Africa. International bits revenues increased $21 million, benefiting from the revenues were 56% of total revenues in 2003 compared to 52% increased rig counts in the United States and Canada. Drilling in 2002. services revenue for 2003 was negatively impacted by $79 The Fluids segment operating income increase was a result million compared to 2002 due to the sale of Mono Pumps in of drilling fluids increasing $29 million and cementing services January 2003. The remainder of drilling services revenue increasing $24 million compared to 2002, partially offset by 38 lower results of $4 million from Enventure. Drilling fluids Landmark and Other Energy Services decrease in revenues benefited from higher sales of biodegradable drilling fluids and compared to 2002 was primarily due to the contribution of most improved contract terms. Those benefits were partially offset by of the assets of Halliburton Subsea to Subsea 7, Inc. which, contract losses in the Gulf of Mexico and United States pricing beginning in May 2002, was reported on an equity basis. This pressures in 2003. Cementing operating income primarily accounted for approximately $200 million of the decrease. The increased in Middle East/Asia due to collections on previously sale of Wellstream in March 2003 also contributed $49 million reserved receivables, certain start-up costs in 2002, and higher to the decrease. Revenues for Landmark Graphics were down margin work. All regions showed improved segment operating $13 million compared to 2002 due to the general weakness in income in 2003 compared to 2002, except North America, information technology spending. International revenues were which was impacted by the decrease in activity from the higher 68% of segment revenues in 2003 compared to 74% in 2002. margin offshore business in the Gulf of Mexico. The decrease is the result of the contribution of the Halliburton Production Optimization increase in revenues was mainly Subsea assets to Subsea 7, Inc. which mainly conducts opera- attributable to production enhancement services, which tions in the North Sea. increased $187 million compared to 2002, driven by higher Segment operating loss was $23 million in 2003 compared to activity in the Middle East following the end of the war in a loss of $108 million in 2002. Included in 2003 were a $15 Iraq and increased rig count in Mexico and North America. In million loss on the sale of Wellstream ($11 million in North addition, sales of tools and testing services increased $40 million America and $4 million in Europe/Africa) and a $77 million compared to 2002 due primarily to increased land rig counts in charge related to the October 2003 verdict in the Anglo-Dutch North America, increased activity in Brazil due to higher activity lawsuit, which impacted North America results. The significant with national and international oil companies in deepwater and items affecting operating income in 2002 included: increased rig activity in Mexico. These increases were partially - $108 million gain on the sale of European Marine offset by lower sales of completion products and services of $5 Contractors Ltd in Europe/Africa; million, primarily in the United States due to lower activity in - $98 million charge for BJ Services patent infringement the Gulf of Mexico and the United Kingdom. The May 2003 sale lawsuit accrual in North America; of Halliburton Measurement Systems had a $24 million negative - $79 million loss on the impairment of our 50% equity impact on segment revenues in 2003 compared to 2002. The investment in the Bredero-Shaw joint venture in North improvement in revenues more than offset the $9 million in America; and equity losses from the Subsea 7, Inc. joint venture. International - $64 million in expense related to restructuring charges ($51 revenues were 56% of segment revenues in 2003 compared to million in North America, $3 million in Latin America, $7 53% in 2002 as activity picked up in the Middle East following million in Europe/Africa and $3 million in Middle East/Asia). the end of the war in Iraq. During 2003, Landmark Graphics achieved its highest The Production Optimization operating income increase included operating income and highest operating margins since we a $24 million gain on the sale of Halliburton Measurement acquired it, as operating income increased $8 million or 18% Systems in North America, offset by inventory write-downs. over 2002. 39 Engineering and Construction Group increase in revenues on the $1.2 billion convertible notes issued in June 2003 and compared to 2002 was due to increased activity in Iraq for the the $1.05 billion senior floating and fixed notes issued in United States government, and, to a lesser extent, a $264 October 2003. The increase was partially offset by $5 million million increase on other government projects and a $161 in pre-judgment interest recorded in 2002 related to the BJ million increase on LNG and oil and gas projects in Africa. Services patent infringement judgment and $296 million of Partially offsetting the revenue increases are lower revenues scheduled debt repayments in 2003. earned on the Barracuda-Caratinga project in Brazil and a $111 Foreign currency losses, net for 2003 included gains in million decrease on industrial services projects in the United Canada offset by losses in the United Kingdom and Brazil. States and production services projects globally. Losses in 2002 were due to negative developments in Brazil, Engineering and Construction Group operating loss improve- Argentina and Venezuela. ment in 2003 was due to government related activities, partially Provision for income taxes of $234 million resulted in an related to operations in the Middle East for Iraq related work effective tax rate on continuing operations of 38.2% in 2003. and a $14 million increase in income from other government The provision was $80 million in 2002 on a net loss from projects. Also contributing to the improved results were income continuing operations. The inclusion of asbestos accruals in from liquefied natural gas projects in Africa and $18 million in continuing operations for 2002 was the primary cause of the favorable adjustments to insurance reserves as a result of revised unusual 2002 effective tax rate on continuing operations. actuarial valuations and other changes in estimates in 2003. There are no asbestos charges or related tax accruals included Partially offsetting the 2003 improvement are losses recognized in continuing operations for 2003. Our impairment loss on on the Barracuda-Caratinga project in Brazil of $238 million, Bredero-Shaw during 2002 could not be benefited for tax losses on a hydrocarbon project in Belgium and lower income purposes due to book and tax basis differences in that on a liquefied natural gas project in Malaysia due to project investment and the limited benefit generated by a capital completion. Included in the 2002 loss was a charge of loss carryback. However, due to changes in circumstances $644 million for asbestos and silica liabilities, $18 million of regarding prior years, we are now able to carry back a portion restructuring charges and a Barracuda-Caratinga project loss of the capital loss, which resulted in an $11 million benefit of $117 million. in 2003. General corporate in 2002 included a $29 million pretax Loss from discontinued operations, net of tax of $1.151 gain for the value of stock received from the demutualization billion in 2003 was due to the following: of an insurance provider, partially offset by 2002 restructuring - asbestos and silica liability was increased to reflect the full charges of $25 million. The higher 2003 expenses also relate to amount of the proposed settlement as a result of the Chapter preparations for the certifications required under Section 404 11 proceeding; of the Sarbanes-Oxley Act. NONOPERATING ITEMS Interest expense increased $26 million in 2003 compared to 2002. The increase was due primarily to $30 million in interest - charges related to our July 2003 funding of $30 million for the debtor-in-possession financing to Harbison-Walker in connection with its Chapter 11 proceedings that is expected to be forgiven by Halliburton on the earlier of the effective 40 date of a plan of reorganization for DII Industries or the effective date of a plan of reorganization for Harbison-Walker RESULTS OF OPERATIONS IN 2002 COMPARED TO 2001 acceptable to DII Industries; - $10 million allowance for an estimated portion of uncol- REVENUES Millions of dollars Drilling and 2002 2001 Increase/ (Decrease) Percentage Change lectible amounts related to the insurance receivables Formation Evaluation $ 1,633 $ 1,643 $ (10) (0.6)% purchased from Harbison-Walker; - professional fees associated with the due diligence, printing Fluids Production Optimization Landmark and 1,815 2,554 2,065 2,803 (250) (249) (12.1) (8.9) Other Energy Services 834 1,300 (466) (35.8) and distribution cost of the disclosure statement and other Total Energy aspects of the proposed settlement for asbestos and silica liabilities; and - a release of environmental and legal reserves related to indemnities that were part of our disposition of the Dresser Equipment Group and are no longer needed. The loss of $652 million in 2002 was due primarily to charges recorded for asbestos and silica liabilities and a $40 million Services Group 6,836 7,811 (975) (12.5) Engineering and Construction Group 5,736 5,235 501 9.6 Total revenues $12,572 $13,046 $ (474) (3.6)% OPERATING INCOME (LOSS) Millions of dollars Drilling and 2002 2001 Increase/ (Decrease) Percentage Change Formation Evaluation $ 160 $ 171 $ (11) (6.4)% Fluids Production Optimization Landmark and 202 384 308 528 (106) (144) (34.4) (27.3) payment associated with the Harbison-Walker Chapter 11 filing. Other Energy Services (108) 29 (137) NM The provision for income taxes on discontinued operations was $6 million in 2003 compared to a tax benefit of $154 million in 2002. We established a valuation allowance for the net General corporate operating loss carryforward created by the 2003 asbestos and silica charges resulting in a minimal tax effect. In 2002, we Total Energy Services Group 638 1,036 (398) (38.4) Engineering and Construction Group (685) (65) 111 (63) (796) (2) NM (3.2) NM Operating income (loss) $ (112) $ 1,084 $(1,196) NM - Not Meaningful Consolidated revenues for 2002 were $12.6 billion, a decrease recorded a $119 million valuation allowance in discontinued of 4% compared to 2001. International revenues comprised operations related to the asbestos and silica accrual. 67% of total revenues in 2002 and 62% in 2001. International Cumulative effect of change in accounting principle, net revenues increased $298 million in 2002, partially offsetting a was an $8 million after-tax charge, or $0.02 per diluted share, $772 million decline in the United States where oilfield services related to our January 1, 2003 adoption of Financial Accounting drilling activity declined 28%, putting pressure on pricing. Standards Board Statement No. 143, “Accounting for Asset Drilling and Formation Evaluation revenues declined slightly Retirement Obligations.” in 2002 compared to 2001. Approximately $62 million of the decrease was in logging and perforating services primarily due to lower North American activity. An additional $21 million of the change resulted from decreased drill bit revenue principally in North America. These decreases were offset by $74 million of increased drilling systems activity primarily in international locations such as Saudi Arabia, Thailand, Mexico, Brazil, and 41 the United Arab Emirates. On a geographic basis, the decline Operating income for the segment decreased 34% in 2002 in revenue is attributable to lower levels of rig activity in compared to 2001. Drilling fluids contributed $35 million of the North America, putting pressure on pricing of work in the decrease, primarily due to the reduced level of oil and gas United States. Latin America revenues decreased 1% as a result drilling in North America. In addition, the cementing business, of decreases in Argentina due to currency devaluation and in which was also affected by reduced oil and gas drilling in North Venezuela due to lower activity brought on by uncertain market America, represented $70 million of the decline. On a and political conditions and the national strike. International geographic basis, the decline in operating income is attributable revenues were 72% of Drilling and Formation Evaluation’s to lower levels of activity and pricing pressures in North revenues in 2002 as compared to 66% in 2001. America. The decrease in North America operating income was Operating income for the segment declined 6% in 2002 partially offset by higher operating income from Mexico, Algeria, compared to 2001. Approximately $37 million of the decrease Angola, the United Kingdom, and Saudi Arabia. related to reduced operating income in logging and perforating Production Optimization revenues decreased 9% in 2002 and $8 million related to the drill bits business, both affected compared to 2001. Approximately $197 million of the decrease by the reduced oil and gas drilling activity in North America. related to reduced production enhancement sales, primarily due Offsetting these declines was a $22 million increase in drilling to decreased rig counts in North America. Further, $56 million systems operating income due to improved international activity. of the decrease resulted from lower completion products and On a geographic basis, the decline in operating income is services sales primarily in North America. Production attributable to lower levels of rig activity and pricing pressures Optimization includes our 50% ownership interest in Subsea 7, in North America. The decrease in North America operating Inc., which began operations in May 2002 and is accounted for income was partially offset by higher operating income from on the equity method of accounting. On a geographic basis, the international sources in Brazil, Mexico, Algeria, Angola, Egypt, decline in revenue is attributable to lower levels of activity in China, and Saudi Arabia. North America, putting pressure on pricing of work in the Fluids revenues decreased 12% in 2002 compared to 2001. United States. Latin America revenues decreased five percent as a Approximately $89 million related to a decrease in drilling fluids result of decreases in Argentina due to currency devaluation and revenues primarily in North America. An additional $160 million in Venezuela due to lower activity brought on by uncertain related to decreases in cementing sales arising primarily from political conditions and a national strike. International revenues reduced rig counts in North America. On a geographic basis, the were 53% of Production Optimization’s revenues in 2002 as decline in revenue is attributable to lower levels of activity in North compared to 44% in 2001. America, putting pressure on pricing of work in the United States. Operating income for the segment decreased 27% in 2002 Latin America revenues decreased 13% as a result of decreases in compared to 2001. Production enhancement results contributed Argentina due to currency devaluation and in Venezuela due to $149 million of the decrease and tools and testing services lower activity brought on by uncertain market and political contributed $5 million, both affected primarily by the reduced conditions and the national strike. International revenues were oil and gas drilling in North America. Offsetting these decreases 52% of Fluids revenues in 2002 as compared to 45% in 2001. was an $11 million increase in completion products and services 42 operating income due to higher international activity which in improved profitability on sales of software and professional more than offset reduced oil and gas drilling in North America. services. On a geographic basis, the decline in operating income is due Engineering and Construction Group revenues increased to reduced rig counts and activity and pricing pressures in $501 million, or 10%, in 2002 compared to 2001. Year-over- North America, partially offset by higher operating income year revenues were $150 million higher in North America and from international sources in Brazil, Mexico, Algeria, Angola, $351 million higher outside North America. Several major Egypt, the United Kingdom, China, Oman, and Saudi Arabia. projects were awarded in 2001 and 2002, which, combined Landmark and Other Energy Services revenues declined with other major ongoing projects, resulted in approximately 36% in 2002 compared to 2001. Approximately $117 million of $756 million of increased revenue, including: the decline is from lower revenues from integrated solutions - liquefied natural gas and gas projects in Algeria, Nigeria, projects as a result of the sale of several properties during 2002. Chad, Cameroon and Egypt; and In addition, approximately $353 million of the decline is due to - the Belenak offshore project in Indonesia. lower revenues from the remaining subsea operations. Most of Activities in the Barracuda-Caratinga project in Brazil were the assets of Halliburton Subsea were contributed to the also increasing in 2002, which generated higher revenue in formation of Subsea 7, Inc. (which was formed in May 2002 and comparison to 2001. Partially offsetting the increasing activities is accounted for under the equity method in our Production in the new projects was a $446 million reduction in revenue due Optimization segment). Offsetting the decline is a $40 million to reduced activity of a major project at our shipyard in the increase in software and professional services revenues due to United Kingdom, a gas project in Algeria, lower volumes of strong 2002 sales in all geographic areas by Landmark Graphics. United States government logistical support in the Balkans and Operating loss for the segment was $108 million in 2002 reduced downstream maintenance work. compared to $29 million in operating income in 2001. Operating loss for the segment of $685 million in 2002 Significant factors influencing the results included: compared to operating income of $111 million in 2001. - $108 million gain on the sale of our 50% interest in Significant factors influencing the results included: European Marine Contractors in 2002; - $644 million of expenses related to net asbestos and silica - $98 million charge recorded in 2002 related to patent liabilities recorded in 2002 compared to $11 million in infringement litigation; asbestos charges recorded in 2001; - $79 million loss on the sale of our 50% equity investment in - an increase in our total probable unapproved claims during the Bredero-Shaw joint venture in 2002; 2002 which reduced reported losses by approximately $158 - $66 million of impairments recorded in 2002 on integrated million as compared to 2001; solutions projects primarily in the United States, Indonesia - $18 million in 2002 restructuring costs; and and Colombia, partially offset by net gains of $45 million on - goodwill amortization in 2001 of $18 million. 2002 disposals of properties in the United States; and Further, operating income in 2002 was negatively impacted - $64 million in 2002 restructuring charges. by loss provisions on offshore engineering, procurement, In addition, Landmark Graphics experienced $32 million installation and commissioning work in Brazil ($117 million on 43 Barracuda-Caratinga) and the Philippines ($36 million). The acquired in the sale of our 50% interest in Bredero-Shaw. 2002 operating income was also negatively impacted by the Provision for income taxes was $80 million in 2002 completion of a gas project in Algeria during 2002 and construc- compared to a provision for income taxes of $384 million in tion work in North America. Partially offsetting the declines was 2001. In 2002, the effective tax rate was impacted by our increased income levels on an ongoing liquefied natural gas asbestos and silica accrual recorded in continuing operations and project in Nigeria, the Alice Springs to Darwin Rail Line project losses on our Bredero-Shaw disposition. The asbestos and silica in Australia, and government projects in the United States, the accrual generates a United States Federal deferred tax asset United Kingdom and Australia. which was not fully benefited because we anticipate that a In 2002, we recorded no amortization of goodwill due to portion of the asbestos and silica deduction will displace foreign the adoption of SFAS No. 142. For 2001, we recorded $42 tax credits and those credits will expire unutilized. As a result, million in goodwill amortization ($18 million in Engineering we have recorded a $114 million valuation allowance in and Construction Group, $17 million in Landmark and Other continuing operations and $119 million in discontinued Energy Services, $5 million in Production Optimization, and operations associated with the asbestos and silica accrual, net of $2 million in Drilling and Formation Evaluation). insurance recoveries. In addition, continuing operations has General corporate expenses were $65 million for 2002 as recorded a valuation allowance of $49 million related to compared to $63 million in 2001. Expenses in 2002 include potential excess foreign tax credit carryovers. Further, our restructuring charges of $25 million and a gain from the value impairment loss on Bredero-Shaw cannot be fully benefited for of stock received from demutualization of an insurance provider tax purposes due to book and tax basis differences in that of $29 million. investment and the limited benefit generated by a capital loss NONOPERATING ITEMS carryback. Settlement of unrealized prior period tax exposures Interest expense of $113 million for 2002 decreased $34 had a favorable impact to the overall tax rate. 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 Minority interest in net income of subsidiaries in 2002 was $38 million as compared to $19 million in 2001. The increase was primarily due to increased activity in Devonport judgment which we are appealing. Management Limited. Interest income was $32 million in 2002 compared to $27 million in 2001. The increased interest income is for interest on Loss from continuing operations was $346 million in 2002 compared to income from continuing operations of $551 million a note receivable from a customer which had been deferred until in 2001. collection. Foreign currency losses, net were $25 million in 2002 compared to $10 million in 2001. The increase is due to negative developments in Brazil, Argentina and Venezuela. Other, net was a loss of $10 million in 2002, which includes a $9.1 million loss on the sale of ShawCor Ltd. common stock Loss from discontinued operations was $806 million pretax, $652 million after tax, or $1.51 per diluted share in 2002 compared to a loss of $62 million pretax, $42 million after tax, or $0.10 per diluted share in 2001. The loss in 2002 was due primarily to charges recorded for asbestos and silica liabilities. The pretax loss for 2001 represents operating income of $37 44 million from Dresser Equipment Group through March 31, 2001 - asbestos and silica insurance recoveries; and offset by a $99 million pretax asbestos accrual primarily related - litigation matters. to Harbison-Walker. We base our estimates on historical experience and on various Gain on disposal of discontinued operations of $299 million other assumptions we believe to be reasonable under the after tax, or $0.70 per diluted share, in 2001 resulted from the circumstances, the results of which form the basis for making sale of our remaining businesses in the Dresser Equipment judgments about the carrying values of assets and liabilities that Group in April 2001. are not readily apparent from other sources. This discussion and Cumulative effect of accounting change, net in 2001 of analysis should be read in conjunction with our consolidated $1 million reflects the impact of adoption of Statement of financial statements and related notes included in this report. Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and for Hedging Activities.” After recording the cumulative effect of the change, our estimated annual expense under Financial Accounting Standards No. 133 is not expected to be materially different from amounts expensed under the prior accounting treatment. Net loss for 2002 was $998 million, or $2.31 per diluted share. Net income for 2001 was $809 million, or $1.88 per diluted share. Percentage of completion 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; - estimates of the percentage the project is complete; and CRITICAL ACCOUNTING ESTIMATES - 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 are At the onset of each contract, we prepare a detailed analysis of described below to provide a better understanding of how we our estimated cost to complete the project. Risks relating to develop our judgments about future events and related estima- service delivery, usage, productivity and other factors are tions and how they can impact our financial statements. A considered in the estimation process. Our project personnel critical accounting estimate is one that requires our most periodically evaluate the estimated costs, claims and change difficult, subjective or complex estimates and assessments and is orders, and percentage of completion at the project level. The fundamental to our results of operations. We identified our most recording of profits and losses on long-term contracts requires an critical accounting estimates to be: estimate of the total profit or loss over the life of each contract. - percentage-of-completion accounting for our long-term This estimate requires consideration of contract revenue, change engineering and construction contracts; orders and claims, less costs incurred and estimated costs to - accounting for government contracts; complete. Anticipated losses on contracts are recorded in full in - allowance for bad debts; the period in which they become evident. Profits are recorded - forecasting our effective tax rate, including our ability to utilize based upon the total estimated contract profit times the current foreign tax credits and the realizability of deferred tax assets; percentage complete for the contract. 45 When calculating the amount of total profit or loss on a long- Accounting for gover nment contracts term contract, we include unapproved claims as revenue when Most of the services provided to the United States government the collection is deemed probable based upon the four criteria are governed by cost-reimbursable contracts. Generally, these for recognizing unapproved claims under the American Institute contracts contain both a base fee (a guaranteed percentage of Certified Public Accountants Statement of Position 81-1, applied to our estimated costs to complete the work, adjusted “Accounting for Performance of Construction-Type and Certain for general, administrative and overhead costs) and a maximum Production-Type Contracts.” Including probable unapproved award fee (subject to our customer’s discretion and tied to the claims in this calculation increases the operating income (or specific performance measures defined in the contract). The reduces the operating loss) that would otherwise be recorded general, administrative and overhead fees are estimated periodi- without consideration of the probable unapproved claims. cally in accordance with government contract accounting Probable unapproved claims are recorded to the extent of costs regulations and may change based on actual costs incurred or incurred and include no profit element. In all cases, the probable based upon the volume of work performed. Award fees are unapproved claims included in determining contract profit or generally evaluated and granted by our customer periodically. loss are less than the actual claim that will be or has been Similar to many cost-reimbursable contracts, these government presented to the customer. We are actively engaged in claims contracts are typically subject to audit and adjustment by our negotiations with our customers and the success of claims customer. Services under our RIO, LogCAP and Balkans support negotiations have a direct impact on the profit or loss recorded contracts are examples of these types of arrangements. for any related long-term contract. Unsuccessful claims negotia- For these contracts, base fee revenues are recorded at the time tions could result in decreases in estimated contract profits or services are performed based upon the amounts we expect to additional contract losses, and successful claims negotiations realize upon completion of the contracts. Revenues may be could result in increases in estimated contract profits or recovery adjusted for our estimate of costs that may be categorized of previously recorded contract losses. as disputed or unallowable as a result of cost overruns or the Significant projects are reviewed in detail by senior engineer- audit process. ing and construction management at least quarterly. Preparing For contracts entered into prior to June 30, 2003, all award project cost estimates and percentages of completion is a core fees are recognized during the term of the contract based on our competency within our engineering and construction businesses. estimate of amounts to be awarded. Our estimates are often We have a long history of dealing with multiple types of projects based on our past award experience for similar types of work. As and in preparing cost estimates. However, there are many factors a result of our adoption of Emerging Issues Task Force Issue No. that impact future costs, including but not limited to weather, 00-21 (EITF 00-21), “Revenue Arrangements with Multiple inflation, labor disruptions and timely availability of materials, Deliverables,” for contracts entered into subsequent to June 30, and other factors as outlined in our “Forward-Looking 2003, we will not recognize award fees for the services portion Information and Risk Factors.” These factors can affect the of the contract based on estimates. Instead, they will be accuracy of our estimates and materially impact our future recognized only when awarded by the customer. Award fees on reported earnings. the construction portion of the contract will still be recognized 46 based on estimates in accordance with SOP 81-1. There were no - the measurement of current and deferred tax liabilities and government contracts affected by EITF 00-21 in 2003. assets is based on provisions of the enacted tax law and the Allowance for bad debts effects of potential future changes in tax laws or rates are not We evaluate our accounts receivable through a continuous considered; and process of assessing our portfolio on an individual customer and overall basis. This process consists of 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 - 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 of our customers, both from a marketplace and geographic includes the following procedures: perspective, in evaluating the need for an allowance. Based on - identifying the types and amounts of existing temporary our review of these factors, we establish or adjust allowances for differences; 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 - measuring the total deferred tax liability for taxable tempo- rary differences using the applicable tax rate; - measuring the total deferred tax asset for deductible temporary differences and operating loss carryforwards using adjustments to the allowance due to actual write-offs that the applicable tax rate; differ from estimated amounts. Tax accounting We account for our income taxes in accordance with Statement of Financial Accounting Standards No. 109, - measuring the deferred tax assets for each type of tax credit carryforward; and - reducing 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 “Accounting for Income Taxes,” which requires the recognition of the amount of taxes payable or refundable for the current year be realized. and an asset and liability approach in recognizing the amount of deferred tax liabilities and assets for the future tax consequences of events that have been recognized in our financial statements or tax returns. We apply the following basic principles in accounting for our income taxes: - a current tax liability or asset is recognized for the estimated taxes payable or refundable on tax returns for the current year; - a deferred tax liability or asset is recognized for the estimated future tax effects attributable to temporary differences and carryforwards; 47 The valuation allowance recorded on tax benefits arising from asbestos and silica liabilities attributable to displaced foreign tax credits is determined quarterly based on an estimate of the future foreign taxes that would be creditable but for the asbestos and silica liabilities, the tax loss carryforwards that these deductions will generate in the future and future estimated taxable income. Any changes to these estimates, which could be material, are recorded in the quarter they arise, if they relate to future years, and/or by adjusting the annual effective tax rate, if they relate to the current year. Our methodology for recording income taxes requires a information on key policy terms as provided by outside significant amount of judgment regarding assumptions and the counsel; use of estimates, including determining our annual effective tax - reviewed the terms of DII Industries’ prior and current rate and the valuation of deferred tax assets, which can create coverage-in-place settlement agreements; large variances between actual results and estimates. The process - reviewed the status of DII Industries’ and Kellogg Brown & involves making forecasts of current and future years’ United Root’s current insurance-related lawsuits and the various States and foreign taxable income, estimating foreign tax credit legal positions of the parties in those lawsuits in relation utilization and evaluating the feasibility of implementing certain to the developed and developing case law and the historic tax planning strategies. Unforeseen events, such as the timing positions taken by insurers in the earlier filed and of asbestos and silica settlements and other tax timing issues, settled lawsuits; may significantly affect these estimates. Those factors, among - engaged in discussions with our counsel; and others, could have a material impact on our provision or benefit - analyzed publicly-available information concerning for income taxes related to both continuing and discontinued the ability of the DII Industries insurers to meet operations. their obligations. Asbestos and silica insurance recoveries Concurrent with the remeasurement of our asbestos and silica liability due to the pre-packaged Chapter 11 filing, we evaluated the appropriateness of the $2 billion recorded for asbestos and silica insurance recoveries. In doing so, we separately evaluated two types of policies: - policies held by carriers with which we had either settled or which were probable of settling and for which we could reasonably estimate the amount of the settlement; and - other policies. In December 2003 we retained Navigant Consulting (formerly Peterson Consulting), a nationally-recognized consultant in asbestos and silica liability and insurance, to assist us. In conducting their analysis, Navigant Consulting performed the following with respect to both types of policies: Navigant Consulting’s analysis assumed that there will be no recoveries from insolvent carriers and that those carriers which are currently solvent will continue to be solvent throughout the period of the applicable recoveries in the projections. Based on its review, analysis and discussions, Navigant Consulting’s analysis assisted us in making our 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 liabilities. This analysis included 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 the applicable insurance programs. The analysis of Navigant Consulting is based on information provided by us. - reviewed DII Industries’ historical course of dealings with its In January 2004, we reached a comprehensive agreement with insurance companies concerning the payment of asbestos- related claims, including DII Industries’ 15-year litigation and settlement history; - reviewed our insurance coverage policy database containing Equitas to settle our insurance claims against certain Underwriters at Lloyd’s of London, reinsured by Equitas. The settlement will resolve all asbestos-related claims made against Lloyd’s Underwriters by us and by each of our subsidiary and 48 affiliated companies, including DII Industries, Kellogg Brown & situation existing at that time which could change significantly Root and their subsidiaries that have filed Chapter 11 proceed- in the both near- and long-term period as a result of: ings as part of our proposed settlement. Our claims against our - additional settlements with insurance companies; other London Market Company Insurers are not affected by this - additional insolvencies of carriers; and settlement. Provided that there is final confirmation of the plan - legal interpretation of the type and amount of coverage of reorganization in the Chapter 11 proceedings and the current available to us. United States Congress does not pass national asbestos litigation Currently, we cannot estimate the time frame for collection of reform legislation, Equitas will pay us $575 million, representing this insurance receivable, except as described earlier with regard approximately 60% of the applicable limits of liability that DII to the Equitas settlement. Industries had substantial likelihood of recovering from Equitas. Projecting future events is subject to many uncertainties that The first payment of $500 million will occur within 15 working could cause the asbestos and silica insurance recoveries to be days of the later of January 5, 2005 or the date on which the higher or lower than those projected and accrued, such as: order of the bankruptcy court confirming DII Industries’ plan of - future settlements with insurance carriers; reorganization becomes final and non-appealable. A second - coverage issues among layers of insurers issuing different payment of $75 million will be made eighteen months after the policies to different policyholders over extended periods first payment. of time; As of December 31, 2003, we developed our best estimate of - the impact on the amount of insurance recoverable in light the asbestos and silica insurance receivables as follows: of the Harbison-Walker and Federal-Mogul bankruptcies. - included $575 million of insurance recoveries from Equitas See Note 11 to our consolidated financial statements; and based on the January 2004 comprehensive agreement; - the continuing solvency of various insurance companies. - included insurance recoveries from other specific insurers We could ultimately recover, or may agree in settlement of with whom we had settled; litigation to recover, less insurance reimbursement than the - estimated insurance recoveries from specific insurers that insurance receivable recorded in our consolidated financial we are probable of settling with and for which we could statements. In addition, we may enter into agreements with all or reasonably estimate the amount of the settlement. When some of our insurance carriers to negotiate an overall accelerated appropriate, these estimates considered prior settlements payment of insurance proceeds. If we agree to any such with insurers with similar facts and circumstances; and settlements, we likely would recover less than the recorded - estimated insurance recoveries for all other policies with amount of insurance receivables, which would result in an the assistance of the Navigant Consulting study. additional charge to our consolidated statement of operations. The estimate we developed as a result of this process was Litigation. We are currently involved in other legal proceed- consistent with the amount of asbestos and silica receivables ings not involving asbestos and silica. As discussed in Note 13 of already recorded as of December 31, 2003, causing us not to our consolidated financial statements, as of December 31, 2003, significantly adjust our recorded insurance asset at that time. we have accrued an estimate of the probable costs for the Our estimate was based on a comprehensive analysis of the resolution of these claims. Attorneys in our legal department 49 specializing in litigation claims monitor and manage all claims Services Group receivables in the pool at any given time and filed against us. The estimate of probable costs related to these other factors. The funding subsidiary initially sold a $200 claims is developed in consultation with outside legal counsel million undivided ownership interest to the unaffiliated representing us in the defense of these claims. Our estimates are companies, and could from time to time sell additional based upon an analysis of potential results, assuming a combina- undivided ownership interests. In July 2003, however, the tion of litigation and settlement strategies. We attempt to resolve balance outstanding under this facility was reduced to zero. The claims through mediation and arbitration proceedings where total amount outstanding under this facility continued to be zero possible. If the actual settlement costs and final judgments, after as of December 31, 2003. appeals, differ from our estimates, our future financial results FINANCIAL INSTRUMENT MARKET RISK may be adversely affected. We are exposed to financial instrument market risk from OFF-BALANCE SHEET RISK changes in foreign currency exchange rates, interest rates and, to On April 15, 2002, we entered into an agreement to sell a limited extent, commodity prices. We selectively manage these accounts receivable to a bankruptcy-remote limited-purpose exposures through the use of derivative instruments to mitigate funding subsidiary. Under the terms of the agreement, new our market risk from these exposures. The objective of our risk receivables are added on a continuous basis to the pool management program is to protect our cash flows related to sales of receivables. Collections reduce previously sold accounts or purchases of goods or services from market fluctuations in receivable. This funding subsidiary sells an undivided currency rates. Our use of derivative instruments includes the ownership interest in this pool of receivables to entities following types of market risk: managed by unaffiliated financial institutions under another - volatility of the currency rates; agreement. Sales to the funding subsidiary have been structured - time horizon of the derivative instruments; as “true sales” under applicable bankruptcy laws. While the - market cycles; and funding subsidiary is wholly-owned by us, its assets are not - the type of derivative instruments used. available to pay any creditors of ours or of our subsidiaries or We do not use derivative instruments for trading purposes. affiliates, until such time as the agreement with the unaffiliated We do not consider any of these risk management activities to be companies is terminated following sufficient collections to material. See Note 1 to the consolidated financial statements for liquidate all outstanding undivided ownership interests. The additional information on our accounting policies on derivative undivided ownership interest in the pool of receivables sold to instruments. See Note 18 to the consolidated financial statements the unaffiliated companies, therefore, is reflected as a reduction for additional disclosures related to derivative instruments. of accounts receivable in our consolidated balance sheets. The Interest rate risk. We have exposure to interest rate risk from funding subsidiary retains the interest in the pool of receivables our long-term debt. that are not sold to the unaffiliated companies and is fully The following table represents principal amounts of our long- consolidated and reported in our financial statements. term debt at December 31, 2003 and related weighted average The amount of undivided interests which can be sold under interest rates by year of maturity for our long-term debt. the program varies based on the amount of eligible Energy 50 Millions of dollars 2004 2005 2006 2007 2008 Thereafter Total financial position or our results of operations. We have Fixed rate debt $ 1 $ 3 $284 $ - $150 $2,625 $3,063 Weighted average interest rate 9.5% 10.9% 6.0% - 5.6% 5.0% 5.1% Variable rate debt $ 21 $321 $ 21 $ 10 $ 1 $ - $ 374 subsidiaries that have been named as potentially responsible parties along with other third parties for nine federal and state Weighted average superfund sites for which we have established a liability. As of interest rate 4.8% 2.8% 4.8% 4.8% 5.6% - 3.1% The fair market value of long-term debt was $3.6 billion as of December 31, 2003, those nine sites accounted for approxi- mately $7 million of our total $31 million liability. See Note 13 December 31, 2003. ENVIRONMENTAL MATTERS We are subject to numerous environmental, legal and to the consolidated financial statements. FORWARD-LOOKING INFORMATION AND RISK FACTORS regulatory requirements related to our operations worldwide. The Private Securities Litigation Reform Act of 1995 In the United States, these laws and regulations include, among provides safe harbor provisions for forward-looking information. others: Forward-looking information is based on projections and - the Comprehensive Environmental Response, Compensation estimates, not historical information. Some statements in this and Liability Act; Form 10-K are forward-looking and use words like “may,” “may - the Resources Conservation and Recovery Act; not,” “believes,” “do not believe,” “expects,” “do not expect,” - the Clean Air Act; “anticipates,” “do not anticipate,” and other expressions. We may - the Federal Water Pollution Control Act; and also provide oral or written forward-looking information in other - the Toxic Substances Control Act. materials we release to the public. Forward-looking information In addition to the federal laws and regulations, states and involves risks and uncertainties and reflects our best judgment other countries where we do business may have numerous based on current information. Our results of operations can be environmental, legal and regulatory requirements by which we affected by inaccurate assumptions we make or by known or must abide. unknown risks and uncertainties. In addition, other factors may We evaluate and address the environmental impact of our affect the accuracy of our forward-looking information. As a operations by assessing and remediating contaminated properties result, no forward-looking information can be guaranteed. Actual in order to avoid future liabilities and comply with environmen- events and the results of operations may vary materially. tal, legal and regulatory requirements. On occasion, we are We do not assume any responsibility to publicly update any involved in specific environmental litigation and claims, of our forward-looking statements regardless of whether factors including the remediation of properties we own or have operated change as a result of new information, future events or for any as well as efforts to meet or correct compliance-related matters. other reason. You should review any additional disclosures we Our Health, Safety and Environment group has several programs make in our press releases and Forms 10-Q and 8-K filed with in place to maintain environmental leadership and to prevent the the United States Securities and Exchange Commission. We also occurrence of environmental contamination. suggest that you listen to our quarterly earnings release confer- We do not expect costs related to these remediation require- ence calls with financial analysts. ments to have a material adverse effect on our consolidated While it is not possible to identify all factors, we continue to 51 face many risks and uncertainties that could cause actual results The bankruptcy court presiding over the Chapter 11 proceed- to differ from our forward-looking statements and potentially ings has scheduled a hearing on confirmation of the proposed materially and adversely affect our financial condition and results plan of reorganization for May 10 through 12, 2004. Some of the of operations, including risks relating to: insurance carriers of DII Industries and Kellogg Brown & Root Asbestos and Silica Liability Our ability to complete our proposed settlement and plan of reorganization As contemplated by our proposed settlement of asbestos and silica personal injury claims, DII Industries, Kellogg Brown & Root and our other affected subsidiaries (collectively referred to herein as the “debtors”) filed Chapter 11 proceedings on December 16, 2003 in bankruptcy court in Pittsburgh, Pennsylvania. Although the debtors have filed Chapter 11 proceedings and we are proceeding with the proposed settle- ment, completion of the settlement remains subject to several conditions, including the requirements that the bankruptcy court confirm the plan of reorganization and the federal district court affirm such confirmation, and that the bankruptcy court and federal district court orders become final and non-appeal- able. Completion of the proposed settlement is also conditioned on continued availability of financing on terms acceptable to us in order to allow us to fund the cash amounts to be paid in the settlement. There can be no assurance that such conditions will be met. The requirements for a bankruptcy court to approve a plan of reorganization include, among other judicial findings, that: - the plan of reorganization complies with applicable provi- sions of the United States Bankruptcy Code; have filed various motions in and objections to the Chapter 11 proceedings in an attempt to seek dismissal of the Chapter 11 proceedings or to delay the proposed plan of reorganization. The motions and objections filed by the insurance carriers include a request that the court grant the insurers standing in the Chapter 11 proceedings to be heard on a wide range of matters, a motion to dismiss the Chapter 11 proceedings and a motion objecting to the proposed legal representative for future asbestos and silica claimants. On February 11, 2004, the bankruptcy court presiding over the Chapter 11 proceedings issued a ruling holding that the insurance carriers lack standing to bring motions seeking to dismiss the pre-packaged plan of reorganiza- tion and denying standing to the insurance carriers to object to the appointment of the proposed legal representative for future asbestos and silica claimants. Notwithstanding the bankruptcy court ruling, we expect the insurance carriers to object to confirmation of the pre-packaged plan of reorganization. In addition, we believe that these insurance carriers will take additional steps to prevent or delay confirmation of a plan of reorganization, including appealing the rulings of the bankruptcy court, and there can be no assurance that the insurance carriers would not be successful or that such efforts would not result in delays in the reorganization process. There can be no assurance that we will obtain the required judicial approval of the - the debtors have complied with the applicable provisions of proposed plan of reorganization or any revised plan of reorgani- the United States Bankruptcy Code; zation acceptable to us. - the trusts will value and pay similar present and future claims in substantially the same manner; and Effect of inability to complete a plan of reorganization If the currently proposed plan of reorganization is not - the plan of reorganization has been proposed in good faith confirmed by the bankruptcy court and the Chapter 11 and not by any means forbidden by law. proceedings are not dismissed, the debtors could propose an 52 alternative plan of reorganization. Chapter 11 permits a - any adverse changes to the tort system allowing additional company to remain in control of its business, protected by a stay claims or judgments against us. of all creditor action, while that company attempts to negotiate Substantial adverse judgments or substantial claims settlement and confirm a plan of reorganization with its creditors. If the and defense costs could materially and adversely affect our debtors are unsuccessful in obtaining confirmation of the liquidity, especially if combined with a lowering of our credit currently proposed plan of reorganization or an alternative plan ratings or other events. If an adverse judgment were entered of reorganization, the assets of the debtors could be liquidated in against us, we may be required to post a bond in order to perfect the Chapter 11 proceedings. In the event of a liquidation of the an appeal of that judgment. If the bonds were not available debtors, Halliburton could lose its controlling interest in DII because of uncertainties in the bonding market or if, as a result Industries and Kellogg Brown & Root. Moreover, if the plan of of our financial condition or credit rating, bonding companies reorganization is not confirmed and the debtors have insufficient would not provide a bond on our behalf, we could be required assets to pay the creditors, Halliburton’s assets could be drawn to provide a cash bond in order to perfect any appeal. As a into the liquidation proceedings because Halliburton guarantees result, a substantial judgment or judgments could require a certain of the debtors’ obligations. substantial amount of cash to be posted by us in order to appeal, If the Chapter 11 proceedings are dismissed without confir- which we may not be able to provide from cash on hand or mation of a plan of reorganization, we could be required to borrowings, or which we may only be able to provide by resolve current and future asbestos claims in the tort system or, incurring high borrowing costs. In such event, our ability to in the case of the Harbison-Walker Refractories Company claims, pursue our legal rights to appeal could be materially and possibly through the Harbison-Walker Chapter 11 proceedings. adversely affected. If we were required to resolve asbestos claims in the tort There can be no assurance that our financial condition and system, we would be subject to numerous uncertainties, results of operations, our stock price or our debt ratings would including: not be materially and adversely affected in the absence of a - continuing asbestos and silica litigation against us, which completed plan of reorganization. would include the possibility of substantial adverse Proposed federal legislation may affect our liability judgments, the timing of which could not be controlled or and agreements predicted, and the obligation to provide appeals bonds We understand that the United States Congress may consider pending any appeal of any such judgment, some or all of adopting legislation that would set up a national trust fund as which may require us to post cash collateral; the exclusive means for recovery for asbestos-related disease. - current and future asbestos claims settlement and defense We are uncertain as to what contributions we would be required costs, including the inability to completely control the to make to a national trust, if any, although it is possible that timing of such costs and the possibility of increased costs to they could be substantial and that they could continue for resolve personal injury claims; several years. It is also possible that our level of participation - the possibility of an increase in the number and type of and contribution to a national trust could be greater than it asbestos and silica claims against us in the future; and otherwise would have been as a result of having subsidiaries that 53 have filed Chapter 11 proceedings due to asbestos liabilities. 524(g) of the Bankruptcy Code has not been tested in a court of It is a condition to the effectiveness of our settlement with law. We can provide no assurance that, if the constitutionality is Equitas that no law shall be passed by the United States challenged, the injunction would be upheld. In addition, Congress that relates to, regulates, limits or controls the although we would have other significant affirmative defenses, prosecution of asbestos claims in United States state or federal the injunctions issued under the Bankruptcy Code may not courts or any other forum. If national asbestos litigation cover all silica personal injury claims arising as a result of future legislation is passed by the United States Congress on or before silica exposure. Moreover, the proposed settlement does not January 5, 2005, we would not receive the $575 million in cash resolve claims for property damage as a result of materials provided by the Equitas settlement, but we would retain the containing asbestos. Accordingly, although we have historically rights we currently have against our insurance carriers. received no such claims, claims could still be made as to damage Possible remaining asbestos and silica exposure to property or property value as a result of asbestos-containing Our proposed settlement of asbestos and silica claims includes products having been used in a particular property or structure. asbestos and silica personal injury claims against DII Industries, Insurance recoveries Kellogg Brown & Root and their current and former subsidiaries, We have substantial insurance intended to reimburse us for as well as Halliburton and its subsidiaries and the predecessors portions of the costs incurred in defending asbestos and silica and successors of them. However, the proposed settlement is claims and amounts paid to settle claims and to satisfy court subject to bankruptcy court approval as well as federal district judgments. We had $2 billion in probable insurance recoveries court confirmation. No assurance can be given that the court accrued as of December 31, 2003. We may be unable to recover, reviewing and approving the plan of reorganization that is being or we may be delayed in recovering, insurance reimbursements used to implement the proposed settlement will grant relief as in the amounts accrued to cover a part of the costs incurred broad as contemplated by the proposed settlement. in defending asbestos and silica claims and amounts paid to In addition, a Chapter 11 proceeding and injunctions under settle claims or as a result of court judgments due to, among Section 524(g) and Section 105 of the Bankruptcy Code may not other things: apply to protect against all asbestos and silica claims. For - the inability or unwillingness of insurers to timely reimburse example, while we have historically not received a significant for claims in the future; number of claims outside the United States, any such future - disputes as to documentation requirements for DII claims would be subject to the applicable legal system of the Industries, Kellogg Brown & Root or other subsidiaries in jurisdiction where the claim was made. In addition, the Section order to recover claims paid; 524(g) injunction would not apply to some claims under - the inability to access insurance policies shared with, or the worker’s compensation arrangements. Although we do not dissipation of shared insurance assets by, Harbison-Walker believe that we have material exposure to foreign or worker’s Refractories Company or others; compensation claims, there can be no assurance that material - the possible insolvency or reduced financial viability of claims would not be made in the future. Further, to our our insurers; knowledge, the constitutionality of an injunction under Section - the cost of litigation to obtain insurance reimbursement; and 54 - possible adverse court decisions as to our rights to obtain result of the Chapter 11 proceedings, some current and insurance reimbursement. prospective customers, suppliers and other vendors may assume If the proposed plan of reorganization is completed, we would that our subsidiaries are financially weak and will be unable to be required to contribute up to an aggregate of approximately honor obligations, making those customers, suppliers and other $2.5 billion in cash, but may be delayed in receiving reimburse- vendors reluctant to do business with our subsidiaries. In ment from our insurance carriers because of extended negotia- particular, some governments may be unwilling to conduct tions or litigation with those insurance carriers. If we were business with a subsidiary in Chapter 11 or having recently filed unable to recover from a substantial number of our insurance a Chapter 11 proceeding. The Chapter 11 proceedings also carriers, or if we were delayed significantly in our recoveries, could materially and adversely affect the subsidiary’s ability to it could have a material adverse effect on our consolidated negotiate favorable terms with customers, suppliers and other financial condition. vendors. DII Industries’ and Kellogg Brown & Root’s financial We could ultimately recover, or may agree in settlement of condition and results of operations could be materially and litigation to recover, less insurance reimbursement than the adversely affected if they cannot attract customers, suppliers insurance receivable recorded in our consolidated financial and other vendors or obtain favorable terms from customers, statements. In addition, we may enter into agreements with all or suppliers or other vendors. Consequently, our financial some of our insurance carriers to negotiate an overall accelerated condition and results of operations could be materially and payment of insurance proceeds. If we agree to any such adversely affected. settlements, we likely would recover less than the recorded Further, prolonged Chapter 11 proceedings could materially amount of insurance receivables, which would result in an and adversely affect the relationship that DII Industries, Kellogg additional charge to the consolidated statement of operations. Brown & Root and their subsidiaries involved in the Chapter 11 Effect of Chapter 11 proceedings on our business and proceedings have with their customers, suppliers and employees, operations which in turn could materially and adversely affect their Because Halliburton’s financial condition and its results of competitive positions, financial conditions and results of operations depend on distributions from its subsidiaries, the operations. A weakening of their financial conditions and results Chapter 11 filing of some of them, including DII Industries of operations could materially and adversely affect their ability to and Kellogg Brown & Root, may have a negative impact on implement the plan of reorganization. Halliburton’s cash flow and distributions from those subsidiaries. These subsidiaries will not be able to make distributions to Halliburton during the Chapter 11 proceedings without court approval. The Chapter 11 proceedings may also hinder the subsidiaries’ ability to take actions in the ordinary course. In addition, the Chapter 11 filing could materially and adversely affect the ability of our subsidiaries in Chapter 11 proceedings to obtain new orders from current or prospective customers. As a Legal Matters SEC investigation We are currently the subject of a formal investigation by the SEC, which we believe is focused on the accuracy, adequacy and timing of our disclosure of the change in our accounting practice for revenues associated with estimated cost overruns and unapproved claims for specific long-term engineering and construction projects. The resolution of this investigation could 55 have a material adverse effect on us and result in: On January 22, 2004, we announced the identification by our - the institution of administrative, civil or injunctive internal audit function of a potential over billing of approxi- proceedings; mately $6 million by one of our subcontractors under the - sanctions and the payment of fines and penalties; and LogCAP contract in Iraq. In accordance with our policy and - increased review and scrutiny of us by regulatory authorities, government regulation, the potential overcharge was reported to the media and others. the Department of Defense Inspector General’s office as well as to Audits and inquiries about government contracts work our customer, the Army Materiel Command. On January 23, We provide substantial work under our government contracts 2004, we issued a check in the amount of $6 million to the business to the United States Department of Defense and other Army Materiel Command to cover that potential over billing governmental agencies, including under world-wide United while we conduct our own investigation into the matter. We are States Army logistics contracts, known as LogCAP, and under continuing to review whether third party subcontractors paid, or contracts to rebuild Iraq’s petroleum industry, known as RIO. attempted to pay, one or two former employees in connection Our units operating in Iraq and elsewhere under government with the potential $6 million over billing. contracts such as LogCAP and RIO consistently review the The DCAA has raised issues relating to our invoicing to the amounts charged and the services performed under these Army Materiel Command for food services for soldiers and contracts. Our operations under these contracts are also regularly supporting civilian personnel in Iraq and Kuwait. We have taken reviewed and audited by the Defense Contract Audit Agency, or two actions in response. First, we have temporarily credited $36 DCAA, and other governmental agencies. When issues are found million to the Department of Defense until Halliburton, the during the governmental agency audit process, these issues are DCAA and the Army Materiel Command agree on a process to typically discussed and reviewed with us in order to reach a be used for invoicing for food services. Second, we are not resolution. submitting $141 million of additional food services invoices The results of a preliminary audit by the DCAA in December until an internal review is completed regarding the number of 2003 alleged that we may have overcharged the Department of meals ordered by the Army Materiel Command and the number Defense by $61 million in importing fuel into Iraq. After a review, of soldiers actually served at dining facilities for United States the Army Corps of Engineers, which is our client and oversees the troops and supporting civilian personnel in Iraq and Kuwait. project, concluded that we obtained a fair price for the fuel. The $141 million amount is our “order of magnitude” estimate However, Department of Defense officials have referred the matter of the remaining amounts (in addition to the $36 million we to the agency’s inspector general with a request for additional already credited) being questioned by the DCAA. The issues investigation by the agency’s criminal division. We understand that relate to whether invoicing should be based on the number of the agency’s inspector general has commenced an investigation. We meals ordered by the Army Materiel Command or whether have also in the past had inquiries by the DCAA and the civil fraud invoicing should be based on the number of personnel served. division of the United States Department of Justice into possible We have been invoicing based on the number of meals ordered. overcharges for work under a contract performed in the Balkans, The DCAA is contending that the invoicing should be based on which is still under review with the Department of Justice. the number of personnel served. We believe our position is 56 correct, but have undertaken a comprehensive review of its asked to reimburse payments made to us and that are deter- propriety and the views of the DCAA. However, we cannot mined to be in excess of those allowed by the applicable predict when the issue will be resolved with the DCAA. In the contract, or we could agree to delay billing for an indefinite meantime, we may withhold all or a portion of the payments to period of time for work we have performed until any billing and our subcontractors relating to the withheld invoices pending cost issues are resolved. Our ability to secure future government resolution of the issues. Except for the $36 million in credits and contracts business or renewals of current government contracts the $141 million of withheld invoices, all our invoicing in Iraq business in the Middle East or elsewhere could be materially and and Kuwait for other food services and other matters are being adversely affected. In addition, we may be required to expend a processed and sent to the Army Materiel Command for payment significant amount of resources explaining and/or defending in the ordinary course. actions we have taken under our government contracts. All of these matters are still under review by the applicable Nigerian joint venture investigation government agencies. Additional review and allegations are It has been reported that a French magistrate is investigating possible, and the dollar amounts at issue could change signifi- whether illegal payments were made in connection with the cantly. We could also be subject to future DCAA inquiries for construction and subsequent expansion of a multi-billion dollar other services we provide in Iraq under the current LogCAP gas liquification complex and related facilities at Bonny Island, in contract or the RIO contract. For example, as a result of an Rivers State, Nigeria. TSKJ and other similarly-owned entities increase in the level of work performed in Iraq or the DCAA’s have entered into various contracts to build and expand the review of additional aspects of our services performed in Iraq, liquefied natural gas project for Nigeria LNG Limited, which is it is possible that we may, or may be required to, withhold owned by the Nigerian National Petroleum Corporation, additional invoicing or make refunds to our customer, some Shell Gas B.V., Cleag Limited (an affiliate of Total) and Agip of which could be substantial, until these matters are resolved. International B.V. TSKJ is a private limited liability company This could materially and adversely affect our liquidity. registered in Madeira, Portugal whose members are Technip SA of To the extent we or our subcontractors make mistakes in France, Snamprogetti Netherlands B.V., which is an affiliate of our government contracts operations, even if unintentional, ENI SpA of Italy, JGC Corporation of Japan and Kellogg Brown & insignificant or subsequently self-reported to the applicable Root, each of which owns 25% of the venture. The United States government agency, we will likely be subject to intense scrutiny. Department of Justice and the SEC have met with Halliburton to Some of this scrutiny is a result of the Vice President of the discuss this matter and have asked Halliburton for cooperation United States being a former chief executive officer of and access to information in reviewing this matter in light of the Halliburton. This scrutiny has recently centered on our govern- requirements of the United States Foreign Corrupt Practices Act. ment contracts work, especially in Iraq and the Middle East. In Halliburton has engaged outside counsel to investigate any part because of the heightened level of scrutiny under which we allegations and is cooperating with the government’s inquiries. operate, audit issues between us and government auditors like Office of Foreign Assets Control inquiry the DCAA or the inspector general of the Department of Defense We have a Cayman Islands subsidiary with operations in Iran, may arise and are more likely to become public. We could be and other European subsidiaries that manufacture goods 57 destined for Iran and/or render services in Iran, and we own resolved. This could materially and adversely affect our liquidity. several non-United States subsidiaries and/or non-United States Credit facilities joint ventures that operate in or manufacture goods destined for, The plan of reorganization through which the proposed or render services in, Libya. The United States imposes trade settlement would be implemented will require us to contribute restrictions and economic embargoes that prohibit United States up to approximately $2.5 billion in cash to the trusts established incorporated entities and United States citizens and residents for the benefit of asbestos and silica claimants pursuant to the from engaging in commercial, financial or trade transactions with Bankruptcy Code. We may need to finance additional amounts some foreign countries, including Iran and Libya, unless in connection with the settlement. authorized by the Office of Foreign Assets Control, or OFAC, of In connection with the plan of reorganization contemplated the United States Treasury Department or exempted by statute. by the proposed asbestos and silica settlement, in the fourth We received and responded to an inquiry in mid-2001 from quarter of 2003 we entered into: OFAC with respect to the operations in Iran by a Halliburton - a delayed-draw term facility that would currently provide for subsidiary that is incorporated in the Cayman Islands. The draws of up to $500 million to be available for cash funding OFAC inquiry requested information with respect to compliance of the trusts for the benefit of asbestos and silica claimants, if with the Iranian Transaction Regulations. Our 2001 written required conditions are met; response to OFAC stated that we believed that we were in full - a master letter of credit facility intended to ensure that compliance with applicable sanction regulations. In January existing letters of credit supporting our contracts remain in 2004, we received a follow-up letter from OFAC requesting place during the Chapter 11 filing; and additional information. We are responding to questions raised in - a $700 million three-year revolving credit facility for general the most recent letter. We have been asked to and could be working capital purposes, which expires in October 2006. required to respond to other questions and inquiries about Although the master letter of credit facility and the $700 operations in countries with trade restrictions and economic million revolving credit facility are now effective, there are a embargoes. Liquidity Working capital requirements related to Iraq work number of conditions that must be met before the delayed-draw term facility will become effective and available for our use, including bankruptcy court approval and federal district court We currently expect the working capital requirements related confirmation of the plan of reorganization. Moreover, these to Iraq will increase through the first half of 2004. An increase in the amount of services we are engaged to perform could place additional demands on our working capital. As described in “Legal Matters: Audits and inquiries about government contracts work” above, it is possible that we may, or may be required to, withhold additional invoicing or make refunds to our customer related to the DCAA’s review of additional aspects of our services, some of which could be substantial, until these matters are facilities are only available for limited periods of time: advances under our master letter of credit facility are available until the earlier of June 30, 2004 or when an order confirming the proposed plan of reorganization becomes final and non- appealable, and our delayed-draw term facility currently expires on June 30, 2004 if not drawn by that time. As a result, if the debtors are delayed in completing the plan of reorganization, these credit facilities may not provide us with the necessary 58 financing to complete the proposed settlement. Additionally, cash collateral obligations on us and/or our subsidiaries. there may be other conditions to funding that we may be unable Uncertainty may also hinder our ability to access new letters to satisfy. In such circumstances, we would be unable to of credit in the future. This could impede our liquidity and/or complete the proposed settlement if replacement financing were our ability to conduct normal operations. not available on acceptable terms. Credit ratings In addition, we experience increased working capital Late in 2001 and early in 2002, Moody’s Investors Service requirements from time to time associated with our business. An lowered its ratings of our long-term senior unsecured debt to increased demand for working capital could affect our liquidity Baa2 and our short-term credit and commercial paper ratings to needs and could impair our ability to finance the proposed P-2. In addition, Standard & Poor’s lowered its ratings of our settlement on acceptable terms. long-term senior unsecured debt to A- and our short-term credit Letters of credit and commercial paper ratings to A-2 in late 2001. In December We entered into a master letter of credit facility in the fourth 2002, Standard & Poor’s lowered these ratings to BBB and A-3. quarter of 2003 that is intended to replace any cash collateraliza- These ratings were lowered primarily due to our asbestos tion rights of issuers of substantially all our existing letters of exposure. In December 2003, Moody’s Investors Service credit during the pendency of the Chapter 11 proceedings of DII confirmed our ratings with a positive outlook and Standard & Industries and Kellogg Brown & Root and our other filing Poor’s revised its credit watch listing for us from “negative” to subsidiaries. The master letter of credit facility is now in effect “developing” in response to our announcement that DII and governs at least 90% of the face amount of our existing Industries and Kellogg Brown & Root and other of our letters of credit. subsidiaries filed Chapter 11 proceedings to implement the Under the master letter of credit facility, if any letters of credit proposed asbestos and silica settlement. that are covered by the facility are drawn on or before June 30, Although our long-term unsecured debt ratings continue at 2004, the facility will provide the cash needed for such draws, as investment grade levels, the cost of new borrowing is relatively well as for any collateral or reimbursement obligations in respect higher and our access to the debt markets is more volatile at these thereof, with any such borrowings being converted into term new rating levels. Investment grade ratings are BBB- or higher loans. However, with respect to the letters of credit that are not for Standard & Poor’s and Baa3 or higher for Moody’s Investors subject to the master letter of credit facility, we could be subject Service. Our current ratings are one level above BBB- on Standard to reimbursement and cash collateral obligations. In addition, if & Poor’s and one level above Baa3 on Moody’s Investors Service. an order confirming our proposed plan of reorganization has not If our debt ratings fall below investment grade, we will be become final and non-appealable by June 30, 2004 and we are required to provide additional collateral to secure our new unable to negotiate a renewal or extension of the master letter of master letter of credit facility and our new revolving credit credit facility, the letters of credit that are now governed by that facility. With respect to the outstanding letters of credit that are facility will be governed by the arrangements with the banks that not subject to the new master letter of credit facility, we may be in existed prior to the effectiveness of the facility. In many cases, technical breach of the bank agreements governing those letters those pre-existing arrangements impose reimbursement and/or of credit and we may be required to reimburse the bank for any 59 draws or provide cash collateral to secure those letters of credit. Geopolitical and Inter national Events In addition, if an order confirming our proposed plan of International and Political Events reorganization has not become final and non-appealable by June A significant portion of our revenue is derived from our non- 30, 2004 and we are unable to negotiate a renewal or extension United States operations, which exposes us to risks inherent in of the terms of the master letter of credit facility, advances under doing business in each of the more than 100 other countries in our master letter of credit facility will no longer be available and which we transact business. The occurrence of any of the risks will no longer override the reimbursement, cash collateral or described below could have a material adverse effect on our other agreements or arrangements relating to any of the letters of consolidated results of operations and consolidated financial credit that existed prior to the effectiveness of the master letter of condition. credit facility. In that event, we may be required to provide Our operations in more than 100 countries other than the reimbursement for any draws or cash collateral to secure our or United States accounted for approximately 73% of our consoli- our subsidiaries’ obligations under arrangements in place prior to dated revenues during 2003, 67% of our consolidated revenues our entering into the master letter of credit facility. during 2002 and 62% of our consolidated revenues during In addition, our elective deferral compensation plan has 2001. Operations in countries other than the United States are a provision which states that if the Standard & Poor’s credit rating subject to various risks peculiar to each country. With respect to falls below BBB, the amounts credited to participants’ accounts any particular country, these risks may include: will be paid to participants in a lump-sum within 45 days. At - expropriation and nationalization of our assets in that December 31, 2003, this amount was approximately $51 million. country; In the event our debt ratings are lowered by either agency, we - political and economic instability; may have to issue additional debt or equity securities or obtain - social unrest, acts of terrorism, force majeure, war or other additional credit facilities in order to meet our liquidity needs. armed conflict; We anticipate that any such new financing or credit facilities - inflation; would not be on terms as attractive as those we have currently - currency fluctuations, devaluations and conversion and that we would also be subject to increased costs of capital restrictions; and interest rates. We also may be required to provide cash - confiscatory taxation or other adverse tax policies; collateral to obtain surety bonds or letters of credit, which would - governmental activities that limit or disrupt markets, restrict reduce our available cash or require additional financing. payments or limit the movement of funds; Further, if we are unable to obtain financing for our proposed - governmental activities that may result in the deprivation of settlement on terms that are acceptable to us, we may be unable contract rights; and to complete the proposed settlement. - trade restrictions and economic embargoes imposed by the United States and other countries, including current restrictions on our ability to provide products and services to Iran and Libya, both of which are significant producers of oil and gas. 60 Due to the unsettled political conditions in many oil produc- materially and adversely affect us in ways we cannot predict at ing countries and countries in which we provide governmental this time. logistical support, our revenues and profits are subject to the Taxation adverse consequences of war, the effects of terrorism, civil We have operations in more than 100 countries other than unrest, strikes, currency controls and governmental actions. the United States and as a result are subject to taxation in many Countries where we operate that have significant amounts of jurisdictions. Therefore, the final determination of our tax political risk include Algeria, Argentina, Afghanistan, Indonesia, liabilities involves the interpretation of the statutes and require- Iran, Iraq, Libya, Nigeria, Russia and Venezuela. For example, ments of taxing authorities worldwide. Foreign income tax continued economic unrest in Venezuela, as well as the social, returns of foreign subsidiaries, unconsolidated affiliates and economic and political climate in Nigeria, could affect our related entities are routinely examined by foreign tax authorities. business and operations in these countries. In addition, military These tax examinations may result in assessments of additional action or continued unrest in the Middle East could impact the taxes or penalties or both. Additionally, new taxes, such as the demand and pricing for oil and gas, disrupt our operations in proposed excise tax in the United States targeted at heavy the region and elsewhere, and increase our costs for security equipment of the type we own and use in our operations, could worldwide. negatively affect our results of operations. Military Action, Other Armed Conflicts or Terrorist Attacks Foreign Exchange and Currency Risks Military action in Iraq and increasing military tension A sizable portion of our consolidated revenues and consoli- involving North Korea, as well as the terrorist attacks of dated operating expenses are in foreign currencies. As a result, September 11, 2001 and subsequent threats of terrorist attacks we are subject to significant risks, including: and unrest, have caused instability in the world’s financial and - foreign exchange risks resulting from changes in foreign commercial markets, and have significantly increased political exchange rates and the implementation of exchange controls and economic instability in some of the geographic areas in such as those experienced in Argentina in late 2001 and which we operate. Acts of terrorism and threats of armed early 2002; and conflicts in or around various areas in which we operate, such - limitations on our ability to reinvest earnings from opera- as the Middle East and Indonesia, could limit or disrupt markets tions in one country to fund the capital needs of our and our operations, including disruptions resulting from the operations in other countries. evacuation of personnel, cancellation of contracts or the loss of We do business in countries that have non-traded or “soft” personnel or assets. currencies which, because of their restricted or limited trading Such events may cause further disruption to financial and markets, may be more difficult to exchange for “hard” currency. commercial markets generally and may generate greater political We may accumulate cash in soft currencies and we may be and economic instability in some of the geographic areas in limited in our ability to convert our profits into United States which we operate. In addition, any possible reprisals as a dollars or to repatriate the profits from those countries. consequence of the war with and ongoing military action in Iraq, We selectively use hedging transactions to limit our exposure such as acts of terrorism in the United States or elsewhere, could to risks from doing business in foreign currencies. For those 61 currencies that are not readily convertible, our ability to hedge natural gas include: our exposure is limited because financial hedge instruments for - governmental regulations; those currencies are nonexistent or limited. Our ability to hedge - global weather conditions; is also limited because pricing of hedging instruments, where - worldwide political, military and economic conditions, they exist, is often volatile and not necessarily efficient. including the ability of OPEC to set and maintain produc- In addition, the value of the derivative instruments could be tion levels and prices for oil; impacted by: - the level of oil production by non-OPEC countries; - adverse movements in foreign exchange rates; - the policies of governments regarding the exploration for - interest rates; - commodity prices; or and production and development of their oil and natural gas reserves; - the value and time period of the derivative being different - the cost of producing and delivering oil and gas; and than the exposures or cash flows being hedged. - the level of demand for oil and natural gas, especially Customers and Business Exploration and Production Activity Demand for our services and products depends on oil and natural gas industry activity and expenditure levels that are directly affected by trends in oil and natural gas prices. A prolonged downturn in oil and gas prices could have a material adverse effect on our consolidated results of operations and consolidated financial condition. demand for natural gas in the United States. Historically, the markets for oil and gas have been volatile and are likely to continue to be volatile in the future. Spending on exploration and production activities and capital expenditures for refining and distribution facilities by large oil and gas companies have a significant impact on the activity levels of our businesses. Barracuda-Caratinga Project Demand for our products and services is particularly sensitive See Note 3 to the consolidated financial statements and to the level of development, production and exploration activity of, and the corresponding capital spending by, oil and natural “Fixed-Price Engineering and Construction Projects” below for a discussion of the risk factors associated with this project. gas companies, including national oil companies. Prices for oil Governmental and Capital Spending and natural gas are subject to large fluctuations in response to relatively minor changes in the supply of and demand for oil and natural gas, market uncertainty and a variety of other factors that are beyond our control. Any prolonged reduction in oil and natural gas prices will depress the level of exploration, develop- ment and production activity, often reflected as changes in rig counts. Lower levels of activity result in a corresponding decline in the demand for our oil and natural gas well services and products that could have a material adverse effect on our revenues and profitability. Factors affecting the prices of oil and Our business is directly affected by changes in governmental spending and capital expenditures by our customers. Some of the changes that may materially and adversely affect us include: - a decrease in the magnitude of governmental spending and outsourcing for military and logistical support of the type that we provide. For example, the current level of govern- ment services being provided in the Middle East may not continue for an extended period of time; - an increase in the magnitude of governmental spending and outsourcing for military and logistical support, which can 62 materially and adversely affect our liquidity needs as a result - any disposition would not result in decreased earnings, of additional or continued working capital requirements to revenue or cash flow; support this work; - any dispositions, investments, acquisitions or integrations - a decrease in capital spending by governments for infrastruc- would not divert management resources; or ture projects of the type that we undertake; - any dispositions, investments, acquisitions or integrations - the consolidation of our customers, which has (1) caused would not have a material adverse effect on our results of customers to reduce their capital spending, which has in operations or financial condition. turn reduced the demand for our services and products, and We conduct some operations through joint ventures, where (2) resulted in customer personnel changes, which in turn control may be shared with unaffiliated third parties. As with any affects the timing of contract negotiations and settlements of joint venture arrangement, differences in views among the joint claims and claim negotiations with engineering and venture participants may result in delayed decisions or in failures construction customers on cost variances and change orders to agree on major issues. We also cannot control the actions of on major projects; our joint venture partners, including any nonperformance, - adverse developments in the business and operations of our default or bankruptcy of our joint venture partners. These customers in the oil and gas industry, including write-downs factors could potentially materially and adversely affect the of reserves and reductions in capital spending for explo- business and operations of the joint venture and, in turn, our ration, development, production, processing, refining and business and operations. pipeline delivery networks; and Fixed-Price Engineering and Construction Projects - ability of our customers to timely pay the amounts due us. We contract to provide services either on a time-and-materials Acquisitions, Dispositions, Investments and Joint Ventures basis or on a fixed-price basis, with fixed-price (or lump sum) We may actively seek opportunities to maximize efficiency and contracts accounting for approximately 24% of KBR’s revenues value through various transactions, including purchases or sales for the year ended December 31, 2003 and 47% of KBR’s of assets, businesses, investments or contractual arrangements or revenues for the year ended December 31, 2002. We bear the joint ventures. These transactions would be intended to result in risk of cost over-runs, operating cost inflation, labor availability the realization of savings, the creation of efficiencies, the and productivity and supplier and subcontractor pricing and generation of cash or income, or the reduction of risk. performance in connection with projects covered by fixed-price Acquisition transactions may be financed by additional borrowings contracts. Our failure to estimate accurately the resources and or by the issuance of our common stock. These transactions may time required for a fixed-price project, or our failure to complete also affect our consolidated results of operations. our contractual obligations within the time frame and costs These transactions also involve risks and we cannot assure committed, could have a material adverse effect on our business, you that: results of operations and financial condition. - any acquisitions would result in an increase in income; Environmental Requirements - any acquisitions would be successfully integrated into our Our businesses are subject to a variety of environmental laws, operations; rules and regulations in the United States and other countries, 63 including those covering hazardous materials and requiring arising as a result of environmental laws could be substantial and emission performance standards for facilities. For example, our could have a material adverse effect on our consolidated results well service operations routinely involve the handling of of operations. significant amounts of waste materials, some of which are Changes in environmental requirements may negatively classified as hazardous substances. Environmental requirements impact demand for our services. For example, activity by oil and include, for example, those concerning: natural gas exploration and production may decline as a result of - the containment and disposal of hazardous substances, environmental requirements (including land use policies oilfield waste and other waste materials; responsive to environmental concerns). Such a decline, in turn, - the use of underground storage tanks; and could have a material adverse effect on us. - the use of underground injection wells. Intellectual Property Rights Environmental requirements generally are becoming increas- We rely on a variety of intellectual property rights that we use ingly strict. Sanctions for failure to comply with these require- in our products and services. We may not be able to successfully ments, many of which may be applied retroactively, may include: preserve these intellectual property rights in the future and - administrative, civil and criminal penalties; these rights could be invalidated, circumvented or challenged. - revocation of permits; and In addition, the laws of some foreign countries in which our - corrective action orders, including orders to investigate products and services may be sold do not protect intellectual and/or clean up contamination. property rights to the same extent as the laws of the United Failure on our part to comply with applicable environmental States. Our failure to protect our proprietary information and requirements could have a material adverse effect on our any successful intellectual property challenges or infringement consolidated financial condition. We are also exposed to costs proceedings against us could materially and adversely affect our arising from environmental compliance, including compliance competitive position. with changes in or expansion of environmental requirements, Technology such as the potential regulation in the United States of our The market for our products and services is characterized by Energy Services Group’s hydraulic fracturing services and continual technological developments to provide better and products as underground injection, which could have a material more reliable performance and services. If we are not able to adverse effect on our business, financial condition, operating design, develop and produce commercially competitive products results or cash flows. and to implement commercially competitive services in a timely We are exposed to claims under environmental requirements manner in response to changes in technology, our business and and from time to time such claims have been made against us. In revenues could be materially and adversely affected and the the United States, environmental requirements and regulations value of our intellectual property may be reduced. Likewise, typically impose strict liability. Strict liability means that in some if our proprietary technologies, equipment and facilities or situations we could be exposed to liability for cleanup costs, work processes become obsolete, we may no longer be natural resource damages and other damages as a result of our competitive and our business and revenues could be materially conduct that was lawful at the time it occurred or the conduct and adversely affected. of prior operators or other third parties. Liability for damages 64 Systems Because demand for natural gas in the United States drives a Our business could be materially and adversely affected by disproportionate amount of our Energy Services Group’s United problems encountered in the installation of a new financial States business, warmer than normal winters in the United States system to replace the current systems for our Engineering and are detrimental to the demand for our services to gas producers. Construction Group. Technical Personnel Many of the services that we provide and the products that we sell are complex and highly engineered and often must perform or be performed in harsh conditions. We believe that our success depends upon our ability to employ and retain technical personnel with the ability to design, utilize and enhance these products and services. In addition, our ability to expand our operations depends in part on our ability to increase our skilled labor force. The demand for skilled workers is high and the supply is limited. A significant increase in the wages paid by competing employers could result in a reduction of our skilled labor force, increases in the wage rates that we must pay or both. If either of these events were to occur, our cost structure could increase, our margins could decrease and our growth potential could be impaired. Weather Our business could be materially and adversely affected by severe weather, particularly in the Gulf of Mexico where we have significant operations. Repercussions of severe weather condi- tions may include: - evacuation of personnel and curtailment of services; - weather related damage to offshore drilling rigs resulting in suspension of operations; - weather related damage to our facilities; - inability to deliver materials to jobsites in accordance with contract schedules; and - loss of productivity. 65 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 Internal auditors monitor the operation of the internal control published financial statements. The financial statements have system and report findings and recommendations to manage- been prepared in accordance with accounting principles ment and the Audit Committee. Corrective actions are taken generally accepted in the United States of America and, to address control deficiencies and other opportunities for accordingly, include amounts based on judgments and improving the system as they are identified. In accordance estimates made by our management. We also prepared the with the Securities and Exchange Commission’s rules to improve other information included in the annual report and are the reliability of financial statements, our 2003 interim financial responsible for its accuracy and consistency with the statements were reviewed by KPMG LLP. financial statements. There are inherent limitations in the effectiveness of any Our 2003 financial statements have been audited by the system of internal control, including the possibility of human independent accounting firm, KPMG LLP. KPMG LLP was error and the circumvention or overriding of controls. given unrestricted access to all financial records and related Accordingly, even an effective internal control system can data, including minutes of all meetings of stockholders, the provide only reasonable assurance with respect to the reliability Board of Directors and committees of the Board. Halliburton’s of our financial statements. Also, the effectiveness of an internal Audit Committee of the Board of Directors consists of directors control system may change over time. who, in the business judgment of the Board of Directors, are We have assessed our internal control system in relation to independent under the New York Stock Exchange listing criteria for effective internal control over financial reporting standards. The Board of Directors, operating through its Audit described in “Internal Control-Integrated Framework” issued by Committee, provides oversight to the financial reporting process. the Committee of Sponsoring Organizations of the Treadway Integral to this process is the Audit Committee’s review and Commission. Based upon that assessment, we believe that, as of discussion with management and the external auditors of the December 31, 2003, our system of internal control over financial quarterly and annual financial statements prior to their respec- reporting met those criteria. tive filing. HALLIBURTON COMPANY We maintain a system of internal control over financial by reporting, which is intended to provide reasonable assurance to our management and Board of Directors regarding the reliability of our financial statements. The system includes: - a documented organizational structure and division of responsibility; - established policies and procedures, including a code of conduct to foster a strong ethical climate which is communi- cated throughout the company; and - the careful selection, training and development of our people. David J. Lesar Chairman of the Board, President, and Chief Executive Officer C. Christopher Gaut Executive Vice President and Chief Financial Officer 66 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 TO THE SHAREHOLDERS AND BOARD OF DIRECTORS OF HALLIBURTON COMPANY: We have audited the accompanying consolidated balance conformity with accounting principles generally accepted in the United States of America. As described in Note 5 to the consolidated financial state- sheets of Halliburton Company and subsidiaries as of December ments, the Company changed the composition of its reportable 31, 2003 and December 31, 2002, and the related consolidated segments in 2003. The amounts in the 2002 and 2001 consoli- statements of operations, shareholders’ equity, and cash flows for dated financial statements related to reportable segments have the years then ended. These consolidated financial statements are been restated to conform to the 2003 composition of reportable the responsibility of the Company’s management. Our responsi- segments. bility is to express an opinion on these consolidated financial statements based on our audits. The accompanying 2001 As discussed above, the 2001 consolidated financial state- ments of Halliburton Company and subsidiaries were audited by consolidated financial statements of Halliburton Company and other auditors who have ceased operations. As described above, subsidiaries were audited by other auditors who have ceased the Company changed the composition of its reportable operations. Those auditors expressed an unqualified opinion on those consolidated financial statements, before the restatement segments in 2003, and the amounts in the 2001 consolidated financial statements relating to reportable segments have been described in Note 5 to the consolidated financial statements and restated. We audited the adjustments that were applied to restate before the revision related to goodwill and other intangibles the disclosures for reportable segments reflected in the 2001 described in Note 1 to the consolidated financial statements, in consolidated financial statements. In our opinion, such adjust- their report dated January 23, 2002 (except with respect to ments are appropriate and have been properly applied. Also, as matters discussed in Note 9 to those financial statements, as to described in Note 1, these consolidated financial statements have which the date was February 21, 2002). We conducted our audits in accordance with auditing been revised to include the transitional disclosures required by Statement of Financial Accounting Standards No. 142, Goodwill standards generally accepted in the United States of America. and Other Intangible Assets, which was adopted by the Those standards require that we plan and perform the audit to Company as of January 1, 2002. In our opinion, the disclosures obtain reasonable assurance about whether the financial for 2001 in Note 1 are appropriate. However, we were not statements are free of material misstatement. An audit includes engaged to audit, review, or apply any procedures to the 2001 examining, on a test basis, evidence supporting the amounts and consolidated financial statements of Halliburton Company and disclosures in the financial statements. An audit also includes subsidiaries other than with respect to such adjustments and assessing the accounting principles used and significant estimates revisions and, accordingly, we do not express an opinion or any made by management, as well as evaluating the overall financial other form of assurance on the 2001 consolidated financial statement presentation. We believe that our audits provide a statements taken as a whole. reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Halliburton Company and subsidiaries as of December 31, 2003 and December 31, 2002, and the results of their operations and their cash flows for the years then ended in KPMG LLP Houston, Texas February 18, 2004 67 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. TO THE SHAREHOLDERS AND BOARD OF DIRECTORS OF HALLIBURTON COMPANY: We have audited the accompanying consolidated balance In our opinion, the financial statements referred to above sheets of Halliburton Company (a Delaware corporation) and present fairly, in all material respects, the financial position of subsidiary companies as of December 31, 2001 and 2000, and Halliburton Company and subsidiary companies as of December the related consolidated statements of income, cash flows, and 31, 2001 and 2000, and the results of their operations and their shareholders’ equity for each of the three years in the period cash flows for each of the three years in the period ended ended December 31, 2001. These financial statements are the December 31, 2001, in conformity with accounting principles responsibility of the Company’s management. Our responsibility generally accepted in the United States of America. 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. Arthur Andersen LLP Those standards require that we plan and perform the audit to Dallas, Texas obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes January 23, 2002 (Except with respect to certain matters examining, on a test basis, evidence supporting the amounts and discussed in Note 9, as to which the date is February 21, 2002.) 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 audits provide a reasonable basis for our opinion. 68 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 2003 2002 2001 $14,383 1,863 25 16,271 13,589 1,679 330 (47) 15,551 720 (139) 30 - 1 612 (234) (39) 339 (1,151) - (1,151) $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) $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 (8) $ (820) - $ (998) 1 $ 809 $ 0.78 (2.65) - (0.02) $ (1.89) $ 0.78 (2.64) - (0.02) $ (1.88) 434 437 $ (0.80) (1.51) - - $ (2.31) $ (0.80) (1.51) - - $ (2.31) 432 432 $ 1.29 (0.10) 0.70 - $ 1.89 $ 1.28 (0.10) 0.70 - $ 1.88 428 430 (Millions of dollars and shares except per share data) Revenues: Services Product sales Equity in earnings of unconsolidated affiliates, net Total revenues Operating costs and expenses: Cost of services Cost of sales General and administrative 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 principle Provision for income taxes Minority interest in net income of subsidiaries Income (loss) from continuing operations before change in accounting principle Discontinued operations: Loss from discontinued operations, net of tax (provision) benefit of $(6), $154 and $20 Gain on disposal of discontinued operations, net of tax provision of $199 Income (loss) from discontinued operations, net Cumulative effect of change in accounting principle, net of tax benefit of $5, $0 and $0 Net income (loss) Basic income (loss) per share: Income (loss) from continuing operations before change in accounting principle Loss from discontinued operations, net Gain on disposal of discontinued operations, net Cumulative effect of change in accounting principle, net Net income (loss) Diluted income (loss) per share: Income (loss) from continuing operations before change in accounting principle Loss from discontinued operations, net Gain on disposal of discontinued operations, net Cumulative effect of change in accounting principle, net Net income (loss) Basic weighted average common shares outstanding Diluted weighted average common shares outstanding See notes to consolidated financial statements. 69 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 (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 $175 and $157) 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 Current asbestos and silica related liabilities 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 Total liabilities Minority interest in consolidated subsidiaries Shareholders’ equity: Common shares, par value $2.50 per share – authorized 600 shares, issued 457 and 456 shares Paid-in capital in excess of par value Deferred compensation Accumulated other comprehensive income Retained earnings Less 18 and 20 shares of treasury stock, at cost Total shareholders’ equity Total liabilities and shareholders’ equity See notes to consolidated financial statements. 70 December 31 2003 2002 $ 1,815 $ 1,107 3,005 1,760 4,765 695 188 456 7,919 2,526 579 670 738 2,038 993 $15,463 $ 18 22 1,776 2,507 400 741 104 236 738 6,542 3,415 801 1,579 479 12,816 100 1,142 273 (64) (298) 2,071 3,124 577 2,547 $15,463 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 9,215 71 1,141 293 (75) (281) 3,110 4,188 630 3,558 $12,844 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 (Millions of dollars) Balance at January 1 Dividends and other transactions with shareholders Comprehensive income (loss): Net income (loss) Cumulative translation adjustment Realization of losses included in net income Net cumulative translation adjustment Pension liability adjustments Unrealized gains (losses) on investments and derivatives Total comprehensive income (loss) Balance at December 31 See notes to consolidated financial statements. 2003 $3,558 (174) (820) 43 15 58 (88) 13 (837) $2,547 2002 $4,752 (151) (998) 69 15 84 (130) 1 (1,043) $3,558 2001 $3,928 (37) 809 (32) 102 70 (15) (3) 861 $4,752 71 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 2003 2002 2001 $ (820) $ (998) $ 809 1,151 - 518 (86) 13 8 (52) (311) (1,442) (180) 7 676 (257) (775) (515) 107 - 224 57 (18) (51) (196) 2,192 (296) (32) (219) (9) 1,636 43 - 708 1,107 $1,815 $ 114 $ 173 652 564 505 (151) 3 - (25) - 675 180 62 71 24 1,562 (764) 266 - 170 62 (187) (20) (473) 66 (81) (2) (219) (12) (248) (24) - 817 290 $1,107 $ 104 $ 94 (257) 11 531 26 8 (1) - - (199) - (91) 118 74 1,029 (797) 120 (220) 61 - 4 (26) (858) 425 (13) (1,528) (215) (24) (1,355) (20) 1,263 59 231 $ 290 $ 132 $ 382 (Millions of dollars) Cash flows from operating activities: Net income (loss) Adjustments to reconcile net income (loss) to net cash from operations: Loss (income) from discontinued operations Asbestos and silica charges not included in discontinued operations, net Depreciation, depletion and amortization Provision (benefit) for deferred income taxes, including $27, $(133) and $(35) related to discontinued operations Distributions from related companies, net of equity in (earnings) losses Change in accounting principle, net Gain on sale of assets Asbestos and silica liability payment prior to Chapter 11 filing Other changes: Receivables and unbilled work on uncompleted contracts Sale (reduction) of receivables in securitization program Inventories Accounts payable Other 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 of short-term debt, net of borrowings Payments of dividends to shareholders Other financing activities Total cash flows from financing activities Effect of exchange rate changes on cash Net cash flows from discontinued operations, including $1.27 billion proceeds from the Dresser Equipment Group sale Increase 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 See notes to consolidated financial statements. 72 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S Note 1. Description of Company and Significant Accounting Policies Description of Company. Halliburton Company’s predecessor was established in 1919 and incorporated under the laws of the less and have a significant influence are accounted for using the equity method, and if we do not have significant influence we use the cost method. The consolidated financial statements also include the accounts of all of our subsidiaries currently in State of Delaware in 1924. We are one of the world’s largest Chapter 11 proceedings. oilfield services companies and a leading provider of engineering Prior year amounts have been reclassified to conform to the and construction services. We have five business segments that current year presentation. are organized around how we manage our business: Drilling and Formation Evaluation, Fluids, Production Optimization, and Landmark and Other Energy Services, collectively, the Energy Services Group; and the Engineering and Construction Group, known as KBR. Through our Energy Services Group, we provide a comprehensive range of discrete and integrated products and services for the exploration, development and production of oil Pre-packaged Chapter 11 proceedings. DII Industries, LLC, Kellogg Brown & Root, Inc. and our other affected subsidiaries filed Chapter 11 proceedings on December 16, 2003 in bankruptcy court in Pittsburgh, Pennsylvania. With the filing of the Chapter 11 proceedings, all asbestos and silica personal injury claims and related lawsuits against Halliburton and our affected subsidiaries have been stayed. See Note 11 and Note 12 and gas. We serve major national and independent oil and gas for a more detailed discussion. companies throughout the world. Our Engineering and Construction Group provides a wide range of services to energy and industrial customers and governmental entities worldwide. Use of estimates. Our financial statements are prepared in conformity with accounting principles generally accepted in the United States, requiring us to make estimates and assumptions that affect: The proposed plan of reorganization, which is consistent with the definitive settlement agreements reached with our asbestos and silica personal injury claimants in early 2003, provides that, if and when an order confirming the proposed plan of reorgani- zation becomes final and non-appealable, in addition to the $311 million paid to claimants in December 2003, the following will be contributed to trusts for the benefit of current and future - the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial asbestos and silica personal injury claimants: - up to approximately $2.5 billion in cash; statements; and - the reported amounts of revenues and expenses during the reporting period. Ultimate results could differ from those estimates. - 59.5 million shares of Halliburton common stock; - notes currently valued at approximately $52 million; and - insurance proceeds, if any, between $2.3 billion and $3.0 billion received by DII Industries and Kellogg Brown & Basis of presentation. The consolidated financial statements Root. include the accounts of our company and all of our subsidiaries in which we own greater than 50% interest or control. All material intercompany accounts and transactions are eliminated. Investments in companies in which we own a 50% interest or Upon confirmation of the plan of reorganization, current and future asbestos and silica personal injury claims against Halliburton and its subsidiaries will be channeled into trusts 73 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S established for the benefit of claimants, thus releasing costs to complete the work adjusted for general, administrative Halliburton and its affiliates from those claims. and overhead costs) and a maximum award fee (subject to our Revenue recognition. We generally recognize revenues as customer’s discretion and tied to the specific performance services are rendered or products are shipped. Usually the date measures defined in the contract). The general, administrative of shipment corresponds to the date upon which the customer and overhead fees are estimated periodically in accordance with takes title to the product and assumes all risks and rewards government contract accounting regulations and may change of ownership. The distinction between services and product based on actual costs incurred or based upon the volume of sales is based upon the overall activity of the particular work performed. Award fees are generally evaluated and granted business operation. Training and consulting service revenues by our customer periodically. Similar to many cost-reimbursable are recognized as the services are performed. As a result of our contracts, these government contracts are typically subject to adoption of Emerging Issues Task Force Issue No. 00-21 (EITF audit and adjustment by our customer. Services under our RIO, No. 00-21), “Revenue Arrangements with Multiple Deliverables,” LogCAP and Balkans support contracts are examples of these for contracts entered into after June 30, 2003 that contain types of arrangements. performance awards, such award fees are recognized when they For these contracts, base fee revenues are recorded at the time are awarded by our customer. For contracts entered into prior to services are performed based upon the amounts we expect to June 30, 2003, these award fees are recognized as services are realize upon completion of the contracts. Revenues may be performed based on our estimate of the amount to be awarded. adjusted for our estimate of costs that may be categorized as Revenue recognition for specialized products and services is disputed or unallowable as a result of cost overruns or the as follows: audit process. Engineering and construction contracts. Revenues from engineer- For contracts entered into prior to June 30, 2003, all award ing and construction contracts are reported on the percentage-of- fees are recognized during the term of the contract based on our completion method of accounting. Progress is generally based estimate of amounts to be awarded. Our estimates are often upon physical progress, man-hours or costs incurred, depending based on our past award experience for similar types of work. As on the type of job. All known or anticipated losses on contracts a result of our adoption of EITF 00-21 for contracts entered into are provided for when they become evident. Claims and change subsequent to June 30, 2003, we will not recognize award fees orders which are in the process of being negotiated with for the services portion of the contract based on estimates. customers for extra work or changes in the scope of work are Instead, they will be recognized only when awarded by the included in revenue when collection is deemed probable. customer. Award fees on the construction portion of the contract Accounting for government contracts. Most of the services will still be recognized based on estimates in accordance with provided to the United States government are governed by cost- SOP 81-1. There were no government contracts affected by EITF reimbursable contracts. Generally, these contracts contain both 00-21 in 2003. a base fee (a guaranteed percentage applied to our estimated Software sales. Software sales of perpetual software licenses, net 74 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S of deferred maintenance fees, are recorded as revenue upon inventory is recorded on the average cost method, with the shipment. Sales of use licenses are recognized as revenue over remainder on the first-in, first-out method. the license period. Post-contract customer support agreements Property, plant and equipment. Other than those assets that are recorded as deferred revenues and recognized as revenue have been written down to their fair values due to impairment, ratably over the contract period of generally one year’s duration. property, plant and equipment are reported at cost less accumu- Research and development. Research and development lated depreciation, which is generally provided on the straight- expenses are charged to income as incurred. Research and line method over the estimated useful lives of the assets. Some development expenses were $221 million in 2003 and $233 assets are depreciated on accelerated methods. Accelerated million in 2002 and 2001. depreciation methods are also used for tax purposes, wherever Software development costs. Costs of developing software permitted. Upon sale or retirement of an asset, the related costs for sale are charged to expense when incurred, as research and and accumulated depreciation are removed from the accounts development, until technological feasibility has been established and any gain or loss is recognized. We follow the successful for the product. Once technological feasibility is established, efforts method of accounting for oil and gas properties. software development costs are capitalized until the software is Maintenance and repairs. Expenditures for maintenance and ready for general release to customers. We capitalized costs repairs are expensed; expenditures for renewals and improve- related to software developed for resale of $17 million in 2003, ments are generally capitalized. We use the accrue-in-advance $11 million in 2002 and $19 million in 2001. Amortization method of accounting for major maintenance and repair costs of expense of software development costs was $17 million for marine vessel dry docking expense and major aircraft overhauls 2003, $19 million for 2002 and $16 million for 2001. Once the and repairs. Under this method we anticipate the need for major software is ready for release, amortization of the software maintenance and repairs and charge the estimated expense to development costs begins. Capitalized software development operations before the actual work is performed. At the time the costs are amortized over periods which do not exceed five years. work is performed, the actual cost incurred is charged against Cash equivalents. We consider all highly liquid investments the amounts that were previously accrued, with any deficiency with an original maturity of three months or less to be cash or excess charged or credited to operating expense. equivalents. Goodwill and other intangibles. Prior to 2002, for acquisi- Inventories. Inventories are stated at the lower of cost or tions that occurred before July 1, 2001, goodwill was amortized market. Cost represents invoice or production cost for new items on a straight-line basis over periods not exceeding 40 years. and original cost less allowance for condition for used material Effective January 1, 2002, we ceased the amortization of returned to stock. Production cost includes material, labor and goodwill. The reported amounts of goodwill for each reporting manufacturing overhead. Some domestic manufacturing and unit (segment) and intangible assets are reviewed for impairment field service finished products and parts inventories for drill bits, on an annual basis and more frequently when negative condi- completion products and bulk materials are recorded using the tions such as significant current or projected operating losses last-in, first-out method. The cost of over 90% of the remaining exist. The annual impairment test for goodwill is a two-step 75 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S process and involves comparing the estimated fair value of each In assessing the realizability of deferred tax assets, manage- reporting unit to the reporting unit’s carrying value, including ment considers whether it is more likely than not that some goodwill. If the fair value of a reporting unit exceeds its carrying portion or all of the deferred tax assets will not be realized. The amount, goodwill of the reporting unit is not considered ultimate realization of deferred tax assets is dependent upon the impaired, and the second step of the impairment test is generation of future taxable income during the periods in which unnecessary. If the carrying amount of a reporting unit exceeds those temporary differences become deductible. Management its fair value, the second step of the goodwill impairment test considers the scheduled reversal of deferred tax liabilities, would be performed to measure the amount of impairment loss projected future taxable income and tax planning strategies in to be recorded, if any. Our annual impairment tests resulted in making this assessment. Based upon the level of historical no goodwill or intangible asset impairment. taxable income and projections for future taxable income over In 2001, we recorded $42 million pretax ($38 million after- the periods in which the deferred tax assets are deductible, tax), or $0.09 per basic and diluted earnings per share, in management believes it is more likely than not that we will goodwill amortization. If we had not amortized goodwill during realize the benefits of these deductible differences, net of the 2001, our net income would have been $847 million, our basic existing valuation allowances. earnings per share would have been $1.98 and our diluted Derivative instruments. At times, we enter into derivative earnings per share would have been $1.97. financial transactions to hedge existing or projected exposures to Evaluating impairment of long-lived assets. When events or changing foreign currency exchange rates, interest rates and changes in circumstances indicate that long-lived assets other commodity prices. We do not enter into derivative transactions than goodwill may be impaired, an evaluation is performed. for speculative or trading purposes. We recognize all derivatives For an asset classified as held for use, the estimated future on the balance sheet at fair value. Derivatives that are not hedges undiscounted cash flows associated with the asset are compared must be adjusted to fair value and reflected immediately through to the asset’s carrying amount to determine if a write-down to the results of operations. If the derivative is designated as a fair value is required. When an asset is classified as held for sale, hedge, depending on the nature of the hedge, changes in the the asset’s book value is evaluated and adjusted to the lower of fair value of derivatives are either offset against: its carrying amount or fair value less cost to sell. In addition, - the change in fair value of the hedged assets, liabilities or depreciation (amortization) is ceased while it is classified as held firm commitments through earnings; or for sale. - recognized in other comprehensive income until the hedged Income taxes. Deferred tax assets and liabilities are recognized item is recognized in earnings. for the expected future tax consequences of events that have The ineffective portion of a derivative’s change in fair value is been recognized in the financial statements or tax returns. A immediately recognized in earnings. Recognized gains or losses valuation allowance is provided for deferred tax assets if it is on derivatives entered into to manage foreign exchange risk are more likely than not that these items will not be realized. included in foreign currency gains and losses in the consolidated 76 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S statements of income. Gains or losses on interest rate derivatives Plan is reflected in net income because it is not considered a are included in interest expense and gains or losses on commod- compensatory plan. ity derivatives are included in operating income. The fair value of options at the date of grant was estimated Foreign currency translation. Foreign entities whose using the Black-Scholes option pricing model. The weighted functional currency is the United States dollar translate monetary average assumptions and resulting fair values of options granted assets and liabilities at year-end exchange rates, and non- are as follows: 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 Assumptions Risk-Free Interest Rate Expected Dividend Yield Expected Life (in years) Expected Volatility Weighted Average Fair Value of Options Granted 2003 2002 2001 3.2% 2.9% 4.5% 1.9% 2.7% 2.3% 5 5 5 59% 63% 58% $12.37 $ 6.89 $19.11 and revenues, and expenses associated with non-monetary The following table illustrates the effect on net income and balance sheet accounts which are translated at historical rates. earnings per share if we had applied the fair value recognition Gains or losses from changes in exchange rates are recognized in provisions of SFAS No. 123, “Accounting for Stock-Based consolidated income in the year of occurrence. Foreign entities Compensation,” to stock-based employee compensation. whose functional currency is not the United States dollar Millions of dollars except per share data 2003 2002 2001 Years ended December 31 translate net assets at year-end rates and income and expense Net income (loss), as reported $ (820) $ (998) $ 809 accounts at average exchange rates. Adjustments resulting from these translations are reflected in the consolidated statements of Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects (30) (26) (42) shareholders’ equity as cumulative translation adjustments. Net income (loss), pro forma $ (850) $(1,024) $ 767 Loss contingencies. We accrue for loss contingencies based Basic income (loss) per share: upon our best estimates in accordance with Statement of As reported Pro forma Financial Accounting Standards (SFAS) No. 5, “Accounting for Diluted income (loss) per share: Contingencies.” See Note 13 for discussion of our significant As reported Pro forma $(1.89) $ (2.31) $(1.96) $ (2.37) $1.89 $1.79 $(1.88) $ (2.31) $(1.95) $ (2.37) $1.88 $1.77 loss contingencies. Stock-based compensation. At December 31, 2003, we have six stock-based employee compensation plans. We account for these plans under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations. No cost for stock options granted is reflected in net income, as all options granted under our plans have an exercise price equal to the market value of the underlying common stock on the date of grant. In addition, no cost for the Employee Stock Purchase Note 2. Long-Ter m Constr uction Contracts Revenues from engineering and construction contracts are reported on the percentage-of-completion method of accounting using measurements of progress toward completion appropriate for the work performed. Commonly used measurements are physical progress, man-hours and costs incurred. 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 77 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S under the percentage-of-completion method of accounting. unapproved claims are recorded to the extent of costs incurred Billings in excess of recognized revenues are recorded in and include no profit element. In all cases, the probable “Advance billings on uncompleted contracts.” When billings are unapproved claims included in determining contract profit or less than recognized revenues, the difference is recorded in loss are less than the actual claim that will be or has been “Unbilled work on uncompleted contracts.” With the exception presented to the customer. of claims and change orders which are in the process of being When recording the revenue and the associated unbilled negotiated with customers, unbilled work is usually billed receivable for unapproved claims, we only accrue an amount during normal billing processes following achievement of the equal to the costs incurred related to probable unapproved contractual requirements. claims. Therefore, the difference between the probable Recording of profits and losses on long-term contracts requires unapproved claims included in determining contract profit or an estimate of the total profit or loss over the life of each loss and the probable unapproved claims recorded in unbilled contract. This estimate requires consideration of contract work on uncompleted contracts relates to forecasted costs which revenue, change orders and claims reduced by costs incurred have not yet been incurred. The amounts included in determin- and estimated costs to complete. Anticipated losses on contracts ing the profit or loss on contracts and the amounts booked to are recorded in full in the period they become evident. Except “Unbilled work on uncompleted contracts” for each period are where we, because of uncertainties in the estimation of costs on as follows: a limited number of projects, deem it prudent to defer income recognition, we do not delay income recognition until projects have reached a specified percentage of completion. Profits are recorded from the commencement date of the contract based Total Probable Unapproved Claims (included in determining contract profit or loss) Probable Unapproved Claims Accrued Revenue (unbilled work on uncompleted contracts) Millions of dollars 2003 2002 2001 2003 2002 2001 Beginning balance $279 $137 Additions Costs incurred 63 158 $93 92 $210 $102 105 61 $92 58 upon the total estimated contract profit multiplied by the current during period - - - 63 19 - percentage complete for the contract. Settled/Other (109) (16) (48) Ending balance $233 $279 $137 (16) (109) (48) $225 $210 $102 When calculating the amount of total profit or loss on a long- The probable unapproved claims recorded in 2003 relate to term contract, we include unapproved claims as revenue when seven contracts, most of which are complete or substantially the collection is deemed probable based upon the four criteria complete. We are actively engaged in claims negotiation with our for recognizing unapproved claims under the American Institute customers. The largest claim relates to the Barracuda-Caratinga of Certified Public Accountants Statement of Position 81-1, contract which was approximately 83% complete at December “Accounting for Performance of Construction-Type and Certain 31, 2003. There are probable unapproved claims that will likely Production-Type Contracts.” Including unapproved claims in this not be settled within one year totaling $204 million at December calculation increases the operating income (or reduces the 31, 2003 included in the table above that are reflected as “Other operating loss) that would otherwise be recorded without assets” on the consolidated balance sheet. All other probable consideration of the probable unapproved claims. Probable unapproved claims included in the table above have been 78 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S recorded to “Unbilled work on uncompleted contracts” included asserted numerous claims against the project owner and are in the “Total receivables” amount on the consolidated balance subject to potential liquidated damages. We continue to engage sheet. In addition, we are negotiating change orders to the in discussions with the project owner in an attempt to settle contract scope where we have agreed upon the scope of work issues relating to additional claims, completion dates and but not the price. These have a total value of $97 million at liquidated damages. December 31, 2003 of which $78 million is unlikely to be Our performance under the contract is secured by: settled within one year. - performance letters of credit, which together have an Our unconsolidated related companies include probable available credit of approximately $266 million as of unapproved claims as revenue to determine the amount of profit December 31, 2003 and which will continue to be adjusted or loss for their contracts. Amounts for unapproved claims are to represent approximately 10% of the contract amount, as included in “Equity in and advances to related companies” and amended to date by change orders; totaled $10 million at December 31, 2003 and $9 million at - retainage letters of credit, which together have available December 31, 2002. In addition, our unconsolidated related credit of approximately $160 million as of December 31, companies are negotiating change orders to the contract scope 2003 and which will increase in order to continue to where we have agreed upon the scope of work but not the price. represent 10% of the cumulative cash amounts paid to us; Our share is valued at $59 million at December 31, 2003 of and which $36 million is unlikely to be settled within one year. - a guarantee of Kellogg Brown & Root’s performance under Note 3. Barracuda-Caratinga Project the agreement by Halliburton Company in favor of the In June 2000, KBR entered into a contract with Barracuda & project owner. Caratinga Leasing Company B.V., the project owner, to develop In November 2003 we entered into agreements with the the Barracuda and Caratinga crude oil fields, which are located project owner in which the project owner agreed to: off the coast of Brazil. The construction manager and owner’s representative is Petroleo Brasilero SA (Petrobras), the Brazilian - pay $69 million to settle a portion of our claims, thereby reducing the amount of probable unapproved claims to national oil company. When completed, the project will consist $114 million; and of two converted supertankers, Barracuda and Caratinga, which will be used as floating production, storage and offloading units, - extend the original project completion dates and other milestone dates, reducing our exposure to liquidated commonly referred to as FPSOs, 32 hydrocarbon production damages. wells, 22 water injection wells and all sub-sea flow lines, umbilicals and risers necessary to connect the underwater wells to the FPSOs. The project is significantly behind the original schedule, due in large part to change orders from the project owner, and is in a financial loss position. As a result, we have Accordingly, as of December 31, 2003: - the project was approximately 83% complete; - we have recorded an inception to date pretax loss of $355 million related to the project, of which $238 million was recorded in 2003 and $117 million was recorded in 2002; 79 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S - the probable unapproved claims included in determining the per day of delay caused by us, subject to a total cap on liqui- loss were $114 million; and dated damages of 10% of the final contract amount (yielding a - we have an exposure to liquidated damages of up to ten cap of approximately $272 million as of December 31, 2003). percent of the contract value. Based upon the current Under the November 2003 agreements, the project owner schedule forecast, we would incur $96 million in liquidated granted an extension of time to the original completion dates damages if our claim for additional time is not successful. and other milestone dates that average approximately 12 Unapproved claims. We have asserted claims for compensa- months. In addition, the project owner agreed to delay any tion substantially in excess of the $114 million of probable attempt to assess the original liquidated damages against us for unapproved claims recorded as noncurrent assets as of project delays beyond 12 months and up to 18 months and December 31, 2003, as well as claims for additional time to delay any drawing of letters of credit with respect to such complete the project before liquidated damages become liquidated damages until the earliest of December 7, 2004, the applicable. The project owner and Petrobras have asserted claims completion of any arbitration proceedings or the resolution of all against us that are in addition to the project owner’s potential claims between the project owner and us. Although the claims for liquidated damages. In the November 2003 agree- November 2003 agreements do not delay the drawing of letters ments, the parties have agreed to arbitrate these remaining of credit for liquidated damages for delays beyond 18 months, disputed claims. In addition, we have agreed to cap our financial our master letter of credit facility (see Note 13) will provide recovery to a maximum of $375 million, and the project owner funding for any such draw while it is in effect. The November and Petrobras have agreed to cap their recovery to a maximum 2003 agreements also provide for a separate liquidated damages of $380 million plus liquidated damages. calculation of $450,000 per day for each of the Barracuda and Liquidated damages. The original completion date for the the Caratinga vessels if delayed beyond 18 months from the Barracuda vessel was December 2003, and the original comple- original schedule. That amount is subject to the total cap on tion date for the Caratinga vessel was April 2004. We expect that liquidated damages of 10% of the final contract amount. Based the Barracuda vessel will likely be completed at least 16 months upon the November 2003 agreements and our most recent later than its original contract determination date, and the estimates of project completion dates, which are April 2005 for Caratinga vessel will likely be completed at least 14 months later the Barracuda vessel and May 2005 for the Caratinga vessel, we than its original contract determination date. However, there can estimate that if we were to be completely unsuccessful in our be no assurance that further delays will not occur. In the event claims for additional time, we would be obligated to pay $96 that any portion of the delay is determined to be attributable to million in liquidated damages. We have not accrued for this us and any phase of the project is completed after the milestone exposure because we consider the imposition of such liquidated dates specified in the contract, we could be required to pay damages to be unlikely. liquidated damages. These damages were initially calculated on Value added taxes. On December 16, 2003, the State of Rio an escalating basis rising ultimately to approximately $1 million de Janeiro issued a decree recognizing that Petrobras is entitled 80 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S to a credit for the value added taxes paid on the project. The Default provisions. Prior to the filing of the pre-packaged decree also provided that value added taxes that may have Chapter 11 proceedings in connection with the proposed become due on the project but which had not yet been paid settlement of our asbestos and silica claims, we obtained a waiver could be paid in January 2004 without penalty or interest. In from the project owner (with the approval of the lenders response to the decree, we have entered into an agreement with financing the project) so that the filing did not constitute an event Petrobras whereby Petrobras agreed to: of default under the contract. In addition, the project owner also - directly pay the value added taxes due on all imports on obtained a waiver from the lenders so that the Chapter 11 filing the project (including Petrobras’ January 2004 payment of did not constitute an event of default under the project owner’s approximately $150 million); and loan agreements with the lenders. The waiver received by the - reimburse us for value added taxes paid on local purchases, project owner from the lender is subject to certain conditions of which approximately $100 million will become due which have thus far been fulfilled. Included as a condition is that during 2004. the pre-packaged plan of reorganization be confirmed by the Since the credit to Petrobras for these value added taxes is on bankruptcy court within 120 days of the filing of the Chapter 11 a delayed basis, the issue of whether we must bear the cost of proceedings. The currently scheduled hearing date for confirma- money for the period from payment by Petrobras until receipt of tion of the plan of reorganization is not within the 120-day the credit has not been determined. period. We understand that the project owner is seeking, and The validity of the December 2003 decree has now been expects to receive, an extension of the 120-day period, but can challenged in court in Brazil. Our legal advisers in Brazil believe give no assurance that it will be granted. In the event that the that the decree will be upheld. If it is overturned or rescinded, or conditions do not continue to be fulfilled the lenders, among the Petrobras credits are lost for any other reason not due to other things, could exercise a right to suspend the project Petrobras, the issue of who must ultimately bear the cost of the owner’s use of advances made, and currently escrowed, to fund value added taxes will have to be determined based upon the the project. We believe it is unlikely that the lenders will exercise law prior to the December 2003 decree. We believe that the any right to stop funding the project given the current status of value added taxes are reimbursable under the contract and prior the project and the fact that a failure to pay may allow us to cease law, but, until the December 2003 decree was issued, Petrobras work on the project without Petrobras having a readily available and the project owner had been contesting the reimbursability substitute contractor. However, there can be no assurance that the of up to $227 million of value added taxes. There can be no lenders will continue to fund the project. assurance that we will not be required to pay all or a portion of In the event that we were determined to be in default under these value added taxes. In addition, penalties and interest of the contract, and if the project was not completed by us as a $40 million to $100 million could be due if the December 2003 result of such default (i.e., our services are terminated as a result decree is invalidated. We have not accrued any amounts for of such default), the project owner may seek direct damages. these taxes, penalties or interest. Those damages could include completion costs in excess of 81 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S the contract price and interest on borrowed funds, but would reduces the risk that the funds would not be available for exclude consequential damages. The total damages could be up payment to us, we are not party to the arrangement between the to $500 million plus the return of up to $300 million in advance lenders and the project owner and can give no assurance that payments previously received by us to the extent they have not there will be adequate funding to cover current or future claims been repaid. The original contract terms require repayment of and change orders. the $300 million in advance payments by crediting the last $350 We have now begun to fund operating cash shortfalls on the million of our invoices related to the contract by that amount, project and would be obligated to fund such shortages over the but the November 2003 agreements delay the repayment of any remaining project life in an amount we currently estimate to be of the $300 million in advance payments until at least December approximately $480 million. That funding level assumes 7, 2004. A termination of the contract by the project owner generally that neither we nor the project owner are successful in could have a material adverse effect on our financial condition recovering claims against the other and that no liquidated and results of operations. damages are imposed. Under the same assumptions, except Cash flow considerations. The project owner has procured assuming that we recover unapproved claims in the amounts project finance funding obligations from various lenders to currently recorded, the cash shortfall would be approximately finance the payments due to us under the contract. The project $360 million. We have already funded approximately $85 owner currently has no other committed source of funding on million of such shortfall and expect that our funded shortfall which we can necessarily rely. In addition, the project financing amount will increase to approximately $416 million by includes borrowing capacity in excess of the original contract December 2004, of which approximately $225 million would be amount. However, only $250 million of this additional borrow- paid to the project owner in December 2004 as part of the ing capacity is reserved for increases in the contract amount return of the $300 million in advance payments. The remainder payable to us and our subcontractors. of the advance payments would be returned to the project owner Under the loan documents, the availability date for loan draws over the remaining life of the project after December 2004. expired December 1, 2003 and therefore, the project owner There can be no assurance that we will recover the amount of drew down all remaining available funds on that date. As a unapproved claims we have recognized, or any amounts in condition to the draw down of the remaining funds, the project excess of that amount. owner was required to escrow the funds for the exclusive use of Note 4. Acquisitions and Dispositions paying project costs. The availability of the escrowed funds can be suspended by the lenders if applicable conditions are not met. With limited exceptions, these funds may not be paid to Enventure and WellDynamics. In January 2004, Halliburton and Shell Technology Ventures (Shell, an unrelated party) agreed to restructure two joint venture companies, Enventure Global Petrobras or its subsidiary (which is funding the drilling costs of Technologies LLC (Enventure) and WellDynamics B.V. the project) until all amounts due to us, including amounts due for the claims, are liquidated and paid. While this potentially (WellDynamics), in an effort to more closely align the ventures with near-term priorities in the core businesses of the venture 82 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S owners. Enventure and WellDynamics were owned equally by segment. Included in the pretax loss is the write-off of the Halliburton and Shell. Shell acquired an additional 33.5% of cumulative translation adjustment related to Wellstream of Enventure, leaving us with 16.5% ownership in return for approximately $9 million. The cumulative translation adjustment enhanced and extended agreements and licenses with Shell for could not be tax benefited and therefore the effective tax benefit its Poroflex™ expandable sand screens and a distribution for the loss on disposition of Wellstream was only 20%. agreement for its Versaflex™ expandable liner hangers. Mono Pumps. In January 2003, we sold our Mono Pumps Halliburton acquired an additional one percent of WellDynamics business to National Oilwell, Inc. The sale price of approxi- from Shell, giving Halliburton 51% ownership and control of mately $88 million was paid with $23 million in cash and 3.2 day-to-day operations. In addition, Shell received an option to million shares of National Oilwell common stock, which were obtain Halliburton’s remaining interest in Enventure by giving valued at $65 million on January 15, 2003. We recorded a Halliburton an additional 14% interest in WellDynamics. The pretax gain of $36 million ($21 million after tax, or $0.05 per transaction required no cash, except for the cash necessary to diluted share) on the sale, which is included in our Drilling and adjust and re-balance the current and projected working capital Formation Evaluation segment. Included in the pretax gain is the positions. write-off of the cumulative translation adjustment related to Halliburton Measurement Systems. In May 2003, we sold Mono Pumps of approximately $5 million. The cumulative certain assets of Halliburton Measurement Systems, which translation adjustment could not be tax benefited and therefore provides flow measurement and sampling systems, to NuFlo the effective tax rate for this disposition was 42%. In February Technologies, Inc. for approximately $33 million in cash, subject 2003, we sold 2.5 million of our 3.2 million shares of the to post-closing adjustments. The pretax gain on the sale of National Oilwell common stock for $52 million, which resulted Halliburton Measurement Systems assets was $24 million ($14 in a gain of $2 million pretax, or $1 million after tax, which was million after tax, or $0.03 per diluted share) and is included in recorded in “Other, net.” In February 2004, we sold the our Production Optimization segment. remaining shares for $20 million, resulting in a gain of $6 Wellstream. In March 2003, we sold the assets relating to our million. Wellstream business, a global provider of flexible pipe products, Subsea 7 formation. In May 2002, we contributed substan- systems and solutions, to Candover Partners Ltd. for $136 tially all of our Halliburton Subsea assets, with a book value of million in cash. The assets sold included manufacturing plants approximately $82 million, to a newly formed company, Subsea in Newcastle upon Tyne, United Kingdom, and Panama City, 7, Inc. The contributed assets were recorded by the new Florida, as well as certain assets and contracts in Brazil. In company at a fair value of approximately $94 million. The $12 addition, Wellstream had $34 million in goodwill recorded at the million difference is being amortized over ten years representing disposition date. The transaction resulted in a pretax loss of $15 the average remaining useful life of the assets contributed. We million ($12 million after tax, or $0.03 per diluted share), which own 50% of Subsea 7, Inc. and account for this investment is included in our Landmark and Other Energy Services using the equity method in our Production Optimization 83 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S segment. The remaining 50% is owned by DSND Subsea ASA. November 2001 for common shares with a value of $100 Bredero-Shaw. In the second quarter of 2002, we incurred an million. At the consummation of the transaction, we issued 4.2 impairment charge of $61 million ($0.14 per diluted share) million shares, valued at $23.93 per share, to complete the related to our then-pending sale of Bredero-Shaw. On September purchase. Magic Earth became a wholly-owned subsidiary and is 30, 2002, we sold our 50% interest in the Bredero-Shaw joint reported within our Landmark and Other Energy Services venture to our partner ShawCor Ltd. The sale price of $149 segment. We recorded goodwill of $71 million, all of which is million was comprised of $53 million in cash, a short-term note nondeductible for tax purposes. In addition, we recorded of $25 million and 7.7 million of ShawCor Class A Subordinate intangible assets of $19 million, which are being amortized shares. Consequently, we recorded a 2002 third quarter pretax based on a five-year life. loss on the sale of $18 million, or $0.04 per diluted share, which PGS Data Management acquisition. In March 2001, we is reflected in our Landmark and Other Energy Services segment. acquired the PGS Data Management division of Petroleum Geo- Included in this loss was $15 million of cumulative translation Services ASA (PGS) for $164 million in cash. The acquisition adjustment loss which was realized upon the disposition of our agreement also calls for Landmark to provide, for a fee, strategic investment in Bredero-Shaw. During the 2002 fourth quarter, we data management and distribution services to PGS for three recorded in “Other, net” a $9 million pretax loss on the sale of years from the date of acquisition. We recorded intangible assets ShawCor shares. of $14 million and goodwill of $149 million in our Landmark European Marine Contractors Ltd. In January 2002, we sold and Other Energy Services segment, $9 million of which is non- our 50% interest in European Marine Contractors Ltd., an deductible for tax purposes. The intangible assets are being unconsolidated joint venture reported within our Landmark and amortized based on a three-year life. Other Energy Services segment, to our joint venture partner, Dresser Equipment Group disposition. In April 2001, we Saipem. At the date of sale, we received $115 million in cash and disposed of the remaining businesses in the Dresser Equipment a contingent payment option valued at $16 million, resulting in a Group, which is reflected in discontinued operations. See Note 21. pretax gain of $108 million, or $0.15 per diluted share after tax. Note 5. Business Segment Infor mation The contingent payment option was based on a formula linked to During the second quarter of 2003, we restructured our performance of the Oil Service Index. In February 2002, we exercised our option and received an additional $19 million and recorded a pretax gain of $3 million, or $0.01 per diluted share after tax, in “Other, net” in the statement of operations as a result of the increase in value of this option. Energy Services Group into four divisions and our Engineering and Construction Group into one, which is the basis for the five segments we now report. We grouped product lines in order to better align ourselves with how our customers procure our services, and to capture new business and achieve better Magic Earth acquisition. We acquired Magic Earth, Inc., a 3- integration, including joint research and development of new D visualization and interpretation technology company with broad applications in the area of data interpretation, in products and technologies and other synergies. The new segments mirror the way our chief executive officer (our chief 84 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S operating decision maker) now regularly reviews the operating directional drilling and measurement-while-drilling/logging- results, assesses performance and allocates resources. while-drilling; logging services; and drill bits. Included in this Our five business segments are now organized around how business segment are Sperry-Sun, logging and perforating and we manage the business: Drilling and Formation Evaluation, Security DBS. Also included is our Mono Pumps business, which Fluids, Production Optimization, Landmark and Other Energy we disposed of in the first quarter of 2003. Services, and the Engineering and Construction Group. Fluids. The Fluids segment focuses on fluid management and We sometimes refer to the combination of Drilling and technologies to assist in the drilling and construction of oil and Formation Evaluation, Fluids, Production Optimization, and gas wells. Drilling fluids are used to provide for well control and Landmark and Other Energy Services segments as the Energy drilling efficiency, and as a means of removing wellbore cuttings. Services Group. Cementing services provide zonal isolation to prevent fluid The amounts in the 2002 and 2001 notes to the consolidated movement between formations, ensure a bond to provide financial statements related to segments have been restated to support for the casing, and provide wellbore reliability. Our conform to the 2003 composition of reportable segments. Baroid and cementing product lines, along with our equity During the first quarter of 2002, we announced plans to method investment in Enventure, an expandable casing joint restructure our businesses into two operating subsidiary venture, are included in this segment. groups. One group is focused on energy services and the other Production Optimization. The Production Optimization is focused on engineering and construction. As part of this segment primarily tests, measures and provides means to restructuring, many support functions that were previously shared manage and/or improve well production once a well is drilled were moved into the two business groups. We also decided that the and, in some cases, after it has been producing. This segment operations of Major Projects (which currently consists of the consists of: Barracuda-Caratinga project in Brazil), Granherne and Production - production enhancement services (including fracturing, Services better aligned with KBR in the current business environ- acidizing, coiled tubing, hydraulic workover, sand control, ment. These businesses were moved for management and reporting and pipeline and process services); purposes from the Energy Services Group to the Engineering and - completion products and services (including well completion Construction Group during the second quarter of 2002. equipment, slickline and safety systems); Following is a summary of our new segments. - tools and testing services (including underbalanced Drilling and Formation Evaluation. The Drilling and applications, tubular conveyed perforating and testing Formation Evaluation segment is primarily involved in drilling services); and and evaluating the formations related to bore-hole construction - subsea operations conducted in our 50% owned company, and initial oil and gas formation evaluation. The products and Subsea 7, Inc. services in this segment incorporate integrated technologies, which offer synergies related to drilling activities and data gathering. The segment consists of drilling services, including 85 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S Landmark and Other Energy Services. This segment Intersegment revenues and revenues between geographic areas represents integrated exploration and production software are immaterial. Our equity in pretax earnings and losses of information systems, consulting services, real-time operations, unconsolidated affiliates that are accounted for on the equity smartwells and other integrated solutions. Included in this method is included in revenues and operating income of the business segment are Landmark Graphics, integrated solutions, applicable segment. Real Time Operations and our equity method investment in Total revenues for 2003 include $4.2 billion, or 26% of total WellDynamics, an intelligent well completions joint venture. consolidated revenues, from the United States Government, Also included are Wellstream, Bredero-Shaw and European which are derived almost entirely from our Engineering and Marine Contractors Ltd., all of which have been sold. Construction Group. Revenues from the United States Engineering and Construction Group. The Engineering and Government during 2002 and 2001 represented less than 10% Construction Group provides engineering, procurement, of total consolidated revenues. No other customer represented construction, project management, and facilities operation and more than 10% of consolidated revenues in any period maintenance for oil and gas and other industrial and governmen- presented. tal customers. Our Engineering and Construction Group offers: - onshore engineering and construction activities, including engineering and construction of liquefied natural gas, ammonia and crude oil refineries and natural gas plants; - offshore deepwater engineering, marine technology, project management, and worldwide construction capabilities; - government operations, construction, maintenance and logistics activities for government facilities and installations; - 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 - civil engineering, consulting and project management services. General corporate. General corporate represents assets 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. 86 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S The tables below present information on our continuing Operations by Business Segment (continued) operations business segments. Operations by Business Segment Millions of dollars Revenues: Years ended December 31 2003 2002 2001 Drilling and Formation Evaluation Fluids $ 1,643 $ 1,633 $ 1,643 2,065 1,815 2,039 Production Optimization 2,766 2,554 Landmark and Other Energy Services 547 834 Total Energy Services Group 6,995 6,836 2,803 1,300 7,811 Engineering and Construction Group Total 9,276 5,736 5,235 $16,271 $12,572 $13,046 Operating income (loss): Drilling and Formation Evaluation Fluids Production Optimization Landmark and Other Energy Services Total Energy Services Group Engineering and Construction Group $ 177 $ 160 202 251 421 (23) 826 (36) 384 (108) 638 (685) $ 171 308 528 29 1,036 111 General corporate Total Capital expenditures: (70) (63) $ 720 $ (112) $ 1,084 (65) Millions of dollars Depreciation, depletion and amortization: Drilling and Formation Evaluation Fluids Production Optimization Landmark and Other Energy Services Shared energy services Total Energy Services Group Engineering and Construction Group General corporate Total Total assets: Drilling and Formation Evaluation Fluids Production Optimization Landmark and Other Energy Services Shared energy services Total Energy Services Group Engineering and Construction Group General corporate Total Operations by Geographic Area Drilling and Formation Evaluation Fluids $ 145 $ 190 55 54 Production Optimization 124 Landmark and Other Energy Services Group 27 Shared energy services Total Energy Services Group Engineering and Construction Group Total 103 453 62 54 $ 515 $ 764 $ 797 161 $ 225 92 209 105 112 743 Millions of dollars Revenues: United States Iraq United Kingdom 118 149 91 603 Within the Energy Services Group, not all assets are associated with specific segments. Those assets specific to segments include Other areas (numerous countries) Total Long-lived assets: United States United Kingdom Other areas (numerous countries) receivables, inventories, certain identified property, plant and Total equipment (including field service equipment), equity in and Note 6. Receivables Years ended December 31 2003 2002 2001 $ 144 $ 137 $ 126 50 50 48 104 77 92 467 50 99 112 79 475 29 95 137 66 474 56 1 1 $ 518 $ 505 $ 531 1 $ 1,074 $ 1,163 $ 1,253 1,071 1,402 830 1,365 1,558 1,030 895 1,240 5,797 5,082 1,399 1,187 5,944 3,104 1,766 1,072 6,564 3,187 4,584 1,215 3,796 $15,463 $12,844 $10,966 Years ended December 31 2003 2002 2001 $ 4,415 $ 4,139 $ 4,911 2 2,399 1 1,473 1,521 1,800 7,984 6,333 6,911 $16,271 $12,572 $13,046 $ 4,461 $ 4,617 $ 3,030 617 630 691 917 744 $ 6,008 $ 6,019 $ 4,391 711 advances to related companies, and goodwill. The remaining assets, such as cash and the remaining property, plant and equipment (including shared facilities), are considered to be shared among the segments within the Energy Services Group. For segment operating income presentation the depreciation expense associated with these shared Energy Services Group assets is allocated to the Energy Services Group segments and general corporate. Our receivables are generally not collateralized. Included in notes and accounts receivable are notes with varying interest rates totaling $11 million at December 31, 2003 and $53 million at December 31, 2002. At December 31, 2003, 41% of our total receivables related to our United States government contracts, primarily for projects in the Middle East. Receivables from the United States government at December 31, 2002 were less than 10% of consolidated receivables. 87 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S On April 15, 2002, we entered into an agreement to sell parts inventories for drill bits, completion products, bulk accounts receivable to a bankruptcy-remote limited-purpose materials, and other tools that are recorded using the last-in, funding subsidiary. Under the terms of the agreement, new first-out method totaling $38 million at December 31, 2003 receivables are added on a continuous basis to the pool of and $43 million at December 31, 2002. If the average cost receivables. Collections reduce previously sold accounts receiv- method had been used, total inventories would have been able. This funding subsidiary sells an undivided ownership $17 million higher than reported at December 31, 2003 and interest in this pool of receivables to entities managed by December 31, 2002. unaffiliated financial institutions under another agreement. Sales Inventories at December 31, 2003 and December 31, 2002 are to the funding subsidiary have been structured as “true sales” composed of the following: under applicable bankruptcy laws. While the funding subsidiary is wholly-owned by us, its assets are not available to pay any creditors of ours or of our 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 undivided ownership interest in the pool of receivables sold to the unaffili- ated companies, therefore, is reflected as a reduction of accounts receivable in our consolidated balance sheets. The funding Millions of dollars Finished products and parts Raw materials and supplies Work in process Total December 31 2002 $545 141 48 $734 2003 $503 159 33 $695 Finished products and parts are reported net of obsolescence reserves of $117 million at December 31, 2003 and $140 million at December 31, 2002. Note 8. Restricted Cash At December 31, 2003, we had restricted cash of $259 subsidiary retains the interest in the pool of receivables that are million. Restricted cash consists of: not sold to the unaffiliated companies and is fully consolidated and reported in our financial statements. - $107 million deposit that collateralizes a bond for a patent infringement judgment on appeal, included in “Other The amount of undivided interests which can be sold under current assets” (see Note 13); 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 initially sold a $200 million undivided ownership interest to the unaffiliated companies, and - $78 million as collateral for potential future insurance claim reimbursements, included in “Other assets”; - $37 million ordered by the bankruptcy court to be set aside as part of the reorganization proceedings, included in “Other could from time to time sell additional undivided ownership current assets”; and interests. In July 2003, however, the balance outstanding under this facility was reduced to zero. The total amount outstanding - $37 million ($22 million in “Other assets” and $15 million in “Other current assets”) primarily related to cash collateral under this facility continued to be zero as of December 31, 2003. agreements for outstanding letters of credit for various Note 7. Inventories Inventories are stated at the lower of cost or market. We manufacture in the United States certain finished products and construction projects. At December 31, 2002, we had $190 million in restricted cash in “Other assets”. 88 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S Note 9. Proper ty, Plant and Equipment obligations ranking equally with all of our existing and future Property, plant and equipment at December 31, 2003 and senior unsecured indebtedness. 2002 are composed of the following: The notes are convertible into our common stock under any Millions of dollars Land Buildings and property improvements Machinery, equipment and other Total Less accumulated depreciation 2003 $ 80 1,065 4,921 6,066 3,540 2002 $ 86 1,024 4,842 5,952 3,323 of the following circumstances: - during any calendar quarter (and only during such calendar quarter) if the last reported sale price of our common stock for at least 20 trading days during the period of Net property, plant and equipment $2,526 $2,629 30 consecutive trading days ending on the last trading day Buildings and property improvements are depreciated over 5- of the previous quarter is greater than or equal to 120% of 40 years; machinery, equipment and other are depreciated over the conversion price per share of our common stock on 3-25 years. such last trading day; Machinery, equipment and other includes oil and gas - if the notes have been called for redemption; investments of $359 million at December 31, 2003 and $356 - upon the occurrence of specified corporate transactions that million at December 31, 2002. Note 10. Debt are described in the indenture relating to the offering; or - during any period in which the credit ratings assigned to the Short-term notes payable consist primarily of overdraft notes by both Moody’s Investors Service and Standard & facilities and other facilities with varying rates of interest. Long- Poor’s are lower than Ba1 and BB+, respectively, or the notes term debt at the end of 2003 and 2002 consists of the following: are no longer rated by at least one of these rating services or Millions of dollars 2003 2002 their successors. 3.125% convertible senior notes due July 2023 $1,200 $ - The initial conversion price is $37.65 per share and is subject 5.5% senior notes due October 2010 1.5% plus LIBOR senior notes due October 2005 Medium-term notes due 2006 through 2027 7.6% debentures of Halliburton due August 2096 8.75% debentures due February 2021 7.6% debentures of DII Industries, LLC 748 300 600 294 200 due August 2096 6 Variable interest credit facility maturing September 2009 69 - 8% senior notes which matured April 2003 Effect of interest rate swaps Other notes with varying interest rates Total long-term debt Less current portion 9 11 3,437 22 - - 750 - 200 300 66 139 13 8 1,476 295 Noncurrent portion of long-term debt $3,415 $1,181 Convertible notes. In June 2003, we issued $1.2 billion of 3.125% convertible senior notes due July 15, 2023, with interest payable semi-annually. The notes are our senior unsecured to adjustment. Upon conversion, we will have the right to deliver, in lieu of shares of our common stock, cash or a combination of cash and common stock. The notes are redeemable for cash at our option on or after July 15, 2008. Holders may require us to repurchase the notes for cash on July 15 of 2008, 2013 or 2018 or, prior to July 15, 2008, in the event of a fundamental change as defined in the underlying indenture. In each case, we will pay a purchase price equal to 100% of the principal amount plus accrued and unpaid interest and additional amounts owed, if any. Floating and fixed rate senior notes. In October 2003, we completed an offering of $1.05 billion of floating and fixed rate 89 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S unsecured senior notes. The fixed rate notes, with an aggregate exchange offer in which Halliburton issued its new 7.6% principal amount of $750 million, will mature on October 15, debentures due 2096 in exchange for a like amount of outstand- 2010 and bear interest at a rate equal to 5.5%, payable semi- ing 7.6% debentures due 2096 of DII Industries was completed. annually. The fixed rate notes were initially offered on a Following the exchange offer, approximately $6 million of the discounted basis at 99.679% of their face value. The discount is 7.6% debentures due 2096 of DII Industries remained outstand- being amortized to interest expense over the life of the bond. ing and, prior to the completion of the exchange offer, The floating rate notes, with an aggregate principal amount of Halliburton became a co-obligor on the remaining DII Industries $300 million, will mature on October 17, 2005 and bear interest debentures. at a rate equal to three-month LIBOR (London interbank offered Variable interest credit facility. In the fourth quarter 2002, rates) plus 1.5%, payable quarterly. our 51% owned consolidated subsidiary, Devonport Medium-term notes. At December 31, 2003, we had outstand- Management Limited (DML), signed an agreement for a credit ing notes under our medium-term note program as follows: facility of £80 million maturing in September 2009. This credit Amount $275 million $150 million $ 50 million $125 million Due 08/2006 12/2008 05/2017 02/2027 Rate 6.00% 5.63% 7.53% 6.75% facility has a variable interest rate that was equal to 4.73% on December 31, 2003. There are various financial covenants which must be maintained by DML. DML has drawn down $69 million Each holder of the 6.75% medium-term notes has the right to as of December 31, 2003. Under this agreement, annual require us to repay their notes in whole or in part on February payments of approximately $20 million are due in quarterly 1, 2007. We may redeem the 5.63% and 6.00% medium-term installments. As of December 31, 2003, the available credit notes in whole or in part at any time. The 7.53% notes may not under this facility was approximately $57 million. be redeemed prior to maturity. The medium-term notes do not Interest rate swaps. In the second quarter of 2002, we have sinking fund requirements. terminated our interest rate swap agreement on our 8% senior Exchange of DII Industries debentures. In October 2003, notes. The notional amount of the swap agreement was $139 DII Industries commenced a consent solicitation in which it million. This interest rate swap was designated as a fair value requested consents to amend the indenture governing its $300 hedge. Upon termination, the fair value of the interest rate swap million aggregate principal amount of 7.6% debentures due was not material. In the fourth quarter 2002, we terminated the 2096 to, among other things, eliminate the bankruptcy-related interest rate swap agreement on our 6.00% medium-term note. events of default. Halliburton commenced an exchange offer in The notional amount of the swap agreement was $150 million. which it offered to issue its new 7.6% debentures due 2096 in This interest rate swap was designated as a fair value hedge. exchange for a like amount of outstanding 7.6% debentures due Upon termination, the fair value of the interest rate swap was 2096 of DII Industries held by holders qualified to participate in $13 million. These swaps had previously been classified in the exchange offer. On December 15, 2003, the consents to “Other assets” on the balance sheet. The fair value adjustments amend the DII Industries indenture became effective and the to the hedged 6.00% medium-term note are being amortized as 90 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S a reduction in interest expense using the “effective yield method” Halliburton from the issuance of debt securities, asset sales and over the remaining life of the medium-term note. the settlement of asbestos and silica insurance claims reduce Maturities. Our debt, excluding the effects of our interest rate commitments under the Senior Unsecured Credit Facility. swaps, matures as follows: $22 million in 2004; $324 million in Borrowings under the Revolving Credit Facility will be 2005; $296 million in 2006; $10 million in 2007; $151 million secured by certain of our assets until: in 2008; and $2,625 million thereafter. - final and non-appealable confirmation of our proposed plan Senior notes due 2007. On January 26, 2004, we issued of reorganization; $500 million aggregate principal amount of senior notes due - our long-term senior unsecured debt is rated BBB or higher 2007 bearing interest at a floating rate equal to three-month (stable outlook) by Standard & Poor’s and Baa2 or higher LIBOR plus 0.75%, payable quarterly. On January 26, 2005, or (stable outlook) by Moody’s Investors Service; on any interest payment date thereafter, we have the option to - there is no material adverse change in our business redeem all or a portion of the outstanding notes. condition; Chapter 11-related financing activities. In anticipation - we are not in default under the Revolving Credit Facility; of the pre-packaged Chapter 11 filing, in the fourth quarter of and 2003 we entered into: - there are no court proceedings pending or threatened which - a delayed-draw term facility (Senior Unsecured Credit could have a material adverse affect on our business. Facility) that would currently provide for draws of up to To the extent that the aggregate principal amount of all $500 million to be available for cash funding of the trusts for secured indebtedness exceeds five percent of the consolidated the benefit of asbestos and silica claimants, if required net tangible assets of Halliburton and its subsidiaries, all conditions are met; and collateral will be shared pro rata with holders of Halliburton’s - a $700 million three-year revolving credit facility (Revolving 8.75% notes due 2021, 3.125% convertible senior notes due Credit Facility) for general working capital purposes, which 2023, senior notes due 2005, 5.5% senior notes due 2010, expires in October 2006. medium-term notes, 7.6% debentures due 2096, senior notes At December 31, 2003, there were no borrowings outstanding issued in January 2004 due 2007 and any other new issuance to under these facilities. the extent that the issuance contains a requirement that the Drawings under the Senior Unsecured Credit Facility are holders thereof be equally and ratably secured with Halliburton’s subject to satisfaction of certain conditions, including confirma- other secured creditors. Security to be provided includes: tion of the proposed plan of reorganization, maintenance of - 100% of the stock of Halliburton Energy Services, Inc. certain financial covenants and the long-term senior unsecured (a wholly-owned subsidiary of Halliburton); debt of Halliburton shall have been confirmed at BBB or higher - 100% of the stock or other equity interests held by (stable outlook) by Standard & Poor’s and Baa2 or higher (stable Halliburton and Halliburton Energy Services, Inc. in certain outlook) by Moody’s Investors Service. Proceeds received by of their first-tier domestic subsidiaries; 91 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S - 66% of the stock or other equity interests of Halliburton we anticipate resolving all open and future claims in the pre- Affiliates LLC (a wholly-owned subsidiary of Halliburton); packaged Chapter 11 proceedings of DII Industries, Kellogg and Brown & Root and other of our subsidiaries, which were filed - 66% of the stock or other equity interests of certain on December 16, 2003. The following tables summarize the foreign subsidiaries of Halliburton or Halliburton various charges we have incurred over the past three years and Energy Services, Inc. a rollforward of our asbestos- and silica-related liabilities and Note 11. Asbestos and Silica Obligations and Insurance Recoveries Summary Several of our subsidiaries, particularly DII Industries and Kellogg Brown & Root, have been named as defendants in a large number of asbestos- and silica-related lawsuits. The plaintiffs allege injury primarily as a result of exposure to: - asbestos used in products manufactured or sold by former divisions of DII Industries (primarily refractory materials, gaskets and packing materials used in pumps and other industrial products); - asbestos in materials used in our construction and mainte- nance projects of Kellogg Brown & Root or its subsidiaries; and - silica related to sandblasting and drilling fluids operations. We have substantial insurance to reimburse us for portions of the costs of judgments, settlements and defense costs for these insurance receivables. 2003 2002 2001 Cont’d. Discont’d. Cont’d. Discont’d. Cont’d. Discont’d. Millions of dollars Oper. Oper. Oper. Oper. Oper. Oper. Asbestos and silica charges: Pre-packaged Chapter 11 proceedings 2002 Rabinovitz Study Liabilities for Harbison-Walker claims Subtotal Asbestos and silica insurance write-off/(receivables): - Navigant Study Write-off of Highlands accounts receivable Insurance recoveries for Harbison-Walker claims Subtotal - - - Other Costs: Harbison-Walker matters - - Professional fees - Cash in lieu of interest 5 Other costs 5 Subtotal 6 - - 6 51 58 24 - 133 $- $1,016 $ - 564 - - $ - 2,256 $ - - $ - - - - - 1,016 - 564 - 2,256 - - - - - - - (1,530) 80 - - 80 - (1,530) - - - - - 45 35 - - 80 - - - 11 11 632 632 - - (537) (537) - 4 - - 4 Pretax asbestos & silica charges Tax (provision) benefit Total asbestos & silica 5 (2) 1,155 644 5 (114) 806 (154) 11 (4) 99 (35) asbestos and silica claims. Since 1976, approximately 683,000 charges, net of tax $3 $1,160 $530 $ 652 $ 7 $ 64 asbestos claims have been filed against us and approximately 238,000 asbestos claims have been closed through settlements in court proceedings at a total cost of approximately $227 million. Almost all of these claims have been made in separate lawsuits in which we are named as a defendant along with a number of other defendants, often exceeding 100 unaffiliated defendant companies in total. In 2001, we were subject to several large adverse judgments in trial court proceedings. At December 31, 2003, approximately 445,000 asbestos claims were open, and 92 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S Millions of dollars Asbestos and silica related liabilities: Beginning balance Accrued liability Payments on claims December 31 2003 2002 $ 3,425 1,016 (355) $ 737 2,820 (132) creditors before filing for Chapter 11 protection. Prior to proceeding with the Chapter 11 filing, our affected subsidiaries solicited acceptances from known present asbestos and silica Asbestos and silica related liabilities – ending balance claimants to a proposed plan of reorganization. In the fourth (of which $2,507 and $0 is current) Insurance for asbestos and silica related liabilities: $ 4,086 $ 3,425 Beginning balance (Accrual)/write-off of insurance recoveries Write-off of Highlands receivable Insurance billings $(2,059) $ (612) (1,530) 45 38 6 - 15 Insurance for asbestos and silica related liabilities - quarter of 2003, valid votes were received from approximately 364,000 asbestos claimants and approximately 21,000 silica claimants, representing substantially all known claimants. Of the ending balance $(2,038) $(2,059) votes validly cast, over 98% of voting asbestos claimants and Accounts receivable for billings to insurance companies: Beginning balance Billed insurance recoveries Purchase of Harbison-Walker receivable, net of allowance Write-off of Highlands receivable Payments received $ (44) $ (53) (38) (15) (40) - 3 - 35 12 over 99% of voting silica claimants voted to accept the proposed plan of reorganization, meeting the voting requirements of Chapter 11 of the Bankruptcy Code for approval of the proposed Accounts receivable for billings to insurance companies - plan. The pre-approved proposed plan of reorganization was ending balance $ (96) $ (44) Pre-packaged Chapter 11 proceedings and recent insurance developments Pre-packaged Chapter 11 proceedings. DII Industries, Kellogg Brown & Root and our other affected subsidiaries filed Chapter 11 proceedings on December 16, 2003 in bankruptcy court in Pittsburgh, Pennsylvania. With the filing of the Chapter 11 proceedings, all asbestos and silica personal injury claims and related lawsuits against Halliburton and our affected subsidiaries have been stayed. See Note 12. Our subsidiaries sought Chapter 11 protection because Sections 524(g) and 105 of the Bankruptcy Code may be used to discharge current and future asbestos and silica personal injury claims against us and our subsidiaries. Upon confirmation of the plan of reorganization, current and future asbestos and silica personal injury claims against us and our affiliates will be channeled into trusts established for the benefit of claimants under Section 524(g) and 105 of the Bankruptcy Code, thus releasing Halliburton and its affiliates from those claims. A pre-packaged Chapter 11 proceeding is one in which a debtor seeks approval of a plan of reorganization from affected 93 filed as part of the Chapter 11 proceedings. The proposed plan of reorganization, which is consistent with the definitive settlement agreements reached with our asbestos and silica personal injury claimants in early 2003, provides that, if and when an order confirming the proposed plan of reorgani- zation becomes final and non-appealable, in addition to the $311 million paid to claimants in December 2003, the following will be contributed to trusts for the benefit of current and future asbestos and silica personal injury claimants: - up to approximately $2.5 billion in cash; - 59.5 million shares of Halliburton common stock (valued at approximately $1.6 billion for accrual purposes using a stock price of $26.17 per share, which is based on the average trading price for the five days immediately prior to and including December 31, 2003); - a one-year non-interest bearing note of $31 million for the benefit of asbestos claimants; - a silica note with an initial payment into a silica trust of $15 million. Subsequently the note provides that we will contribute an amount to the silica trust balance at the end N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S of each year for the next 30 years to bring the silica trust effect on this charge was minimal, as a valuation allowance was balance to $15 million, $10 million or $5 million, based established for the net operating loss carryforward created by the upon a formula which uses average yearly disbursements charge. We also reclassified a portion of our asbestos and silica from the trust to determine that amount. The note also related liabilities from long-term to short-term, resulting in an provides for an extension of the note for 20 additional increase of short-term liabilities by approximately $2.5 billion, years under certain circumstances. We have estimated the because we believe we will be required to fund these amounts amount of this note to be approximately $21 million. within one year. We will periodically reassess our valuation of this note In accordance with the definitive settlement agreements based upon our projections of the amounts we believe entered in early 2003, we have been reviewing plaintiff files to we will be required to fund into the silica trust; and establish a medical basis for payment of settlement amounts and - insurance proceeds, if any, between $2.3 billion and $3.0 to establish that the claimed injuries are based on exposure to billion received by DII Industries and Kellogg Brown & Root. our products. We have reviewed substantially all medical claims In connection with reaching an agreement with representa- received. During the fourth quarter of 2003, we received tives of asbestos and silica claimants to limit the cash required significant numbers of the product identification due diligence to settle pending claims to $2.775 billion, DII Industries paid files. Based on our review of these files, we received the $311 million on December 16, 2003. Halliburton also agreed necessary information to allow us to proceed with the pre- to guarantee the payment of an additional $156 million of the packaged Chapter 11 proceedings. As of December 31, 2003, remaining approximately $2.5 billion cash amount, which must approximately 63% of the value of claims passing medical due be paid on the earlier to occur of June 17, 2004 or the date on diligence have submitted satisfactory product identification. which an order confirming the proposed plan of reorganization We expect the percentage to increase as we receive additional becomes final and non-appealable. As a part of the definitive plaintiff files. Based on these results, we found that substantially settlement agreements, we have been accruing cash payments in all of the asbestos and silica liability relates to claims filed lieu of interest at a rate of five percent per annum for these against our former operations that have been divested and amounts. We recorded approximately $24 million in pretax included in discontinued operations. Consequently, all 2003 charges in 2003 related to the cash in lieu of interest. On changes in our estimates related to the asbestos and silica December 16, 2003, we paid $22 million to satisfy a portion of liability were recorded through discontinued operations. our cash in lieu of interest payment obligations. Our proposed plan of reorganization calls for a portion of our As a result of the filing of the Chapter 11 proceedings, we total asbestos and silica liability to be settled by contributing adjusted the asbestos and silica liability to reflect the full amount 59.5 million shares of Halliburton common stock into the trusts. of the proposed settlement and certain related costs, which We will continue to adjust our asbestos and silica liability related resulted in a before tax charge of approximately $1.016 billion to the shares if the average value of Halliburton stock for the five to discontinued operations in the fourth quarter 2003. The tax days immediately prior to and including the end of each fiscal 94 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S quarter has increased by five percent or more from the most surement of our asbestos and silica liability due to the pre-packaged recent valuation of the shares. At December 31, 2003, the value Chapter 11 filing, we evaluated the appropriateness of the $2.0 of the shares to be contributed is classified as a long-term billion recorded for asbestos and silica insurance recoveries. In liability on our consolidated balance sheet, and the shares have doing so, we separately evaluated two types of policies: not been included in our calculation of basic or diluted earnings - policies held by carriers with which we had either settled or per share. If the shares had been included in the calculation as of which were probable of settling and for which we could the beginning of the fourth quarter, our diluted earnings per reasonably estimate the amount of the settlement; and share from continuing operations for the year ended December - other policies. 31, 2003 would have been reduced by $0.03. When and if we In December 2003, we retained Navigant Consulting receive final and non-appealable confirmation of our proposed (formerly Peterson Consulting), a nationally-recognized plan of reorganization, we will: consultant in asbestos and silica liability and insurance, to assist - increase or decrease our asbestos and silica liability to value us. In conducting their analysis, Navigant Consulting performed the 59.5 million shares of Halliburton common stock based the following with respect to both types of policies: on the value of Halliburton stock on the date of final and - reviewed DII Industries’ historical course of dealings with its non-appealable confirmation of our proposed plan of insurance companies concerning the payment of asbestos- reorganization; related claims, including DII Industries’ 15-year litigation - reclassify from a long-term liability to shareholders’ equity and settlement history; the final value of the 59.5 million shares of Halliburton - reviewed our insurance coverage policy database containing common stock; and information on key policy terms as provided by outside - include the 59.5 million shares in our calculations of counsel; earnings per share on a prospective basis. - reviewed the terms of DII Industries’ prior and current We understand that the United States Congress may consider coverage-in-place settlement agreements; adopting legislation that would establish a national trust fund as - reviewed the status of DII Industries’ and Kellogg Brown & the exclusive means for recovery for asbestos-related disease. We Root’s current insurance-related lawsuits and the various legal are uncertain as to what contributions we would be required to positions of the parties in those lawsuits in relation to the make to a national trust, if any, although it is possible that they developed and developing case law and the historic positions could be substantial and that they could continue for several taken by insurers in the earlier filed and settled lawsuits; years. It is also possible that our level of participation and - engaged in discussions with our counsel; and contribution to a national trust could be greater than it otherwise - analyzed publicly-available information concerning would have been as a result of having subsidiaries that have filed the ability of the DII Industries insurers to meet Chapter 11 proceedings due to asbestos liability. their obligations. Recent insurance developments. Concurrent with the remea- Navigant Consulting’s analysis assumed that there will be no 95 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S recoveries from insolvent carriers and that those carriers which reorganization becomes final and non-appealable. A second are currently solvent will continue to be solvent throughout the payment of $75 million will be made eighteen months after the period of the applicable recoveries in the projections. Based on first payment. its review, analysis and discussions, Navigant Consulting’s As of December 31, 2003, we developed our best estimate of analysis assisted us in making our judgments concerning the asbestos and silica insurance receivables as follows: insurance coverage that we believe are reasonable and consistent - included $575 million of insurance recoveries from Equitas with our historical course of dealings with our insurers and the based on the January 2004 comprehensive agreement; relevant case law to determine the probable insurance recoveries - included insurance recoveries from other specific insurers for asbestos liabilities. This analysis included the probable effects with whom we had settled; of self-insurance features, such as self-insured retentions, policy - estimated insurance recoveries from specific insurers that we exclusions, liability caps and the financial status of applicable are probable of settling with and for which we could insurers, and various judicial determinations relevant to the reasonably estimate the amount of the settlement. When applicable insurance programs. The analysis of Navigant appropriate, these estimates considered prior settlements Consulting is based on information provided by us. with insurers with similar facts and circumstances; and In January 2004, we reached a comprehensive agreement - estimated insurance recoveries for all other policies with the with Equitas to settle our insurance claims against certain assistance of the Navigant Consulting study. Underwriters at Lloyd’s of London, reinsured by Equitas. The The estimate we developed as a result of this process was settlement will resolve all asbestos-related claims made against consistent with the amount of asbestos and silica receivables Lloyd’s Underwriters by us and by each of our subsidiary and recorded as of December 31, 2003, causing us not to signifi- affiliated companies, including DII Industries, Kellogg Brown & cantly adjust our recorded insurance asset at that time. Our Root and their subsidiaries that have filed Chapter 11 proceed- estimate was based on a comprehensive analysis of the situation ings as part of our proposed settlement. Our claims against our existing at that time which could change significantly in both the other London Market Company Insurers are not affected by this near- and long-term period as a result of: settlement. Provided that there is final confirmation of the plan - additional settlements with insurance companies; of reorganization in the Chapter 11 proceedings and the current - additional insolvencies of carriers; and United States Congress does not pass national asbestos litigation - legal interpretation of the type and amount of coverage reform legislation, Equitas will pay us $575 million, representing available to us. approximately 60% of the applicable limits of liability that DII Currently, we cannot estimate the time frame for collection of Industries had substantial likelihood of recovering from Equitas. this insurance receivable, except as described earlier with regard The first payment of $500 million will occur within 15 working to the Equitas settlement. days of the later of January 5, 2005 or the date on which the order of the bankruptcy court confirming DII Industries’ plan of 96 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S Asbestos and silica obligations and receivables based upon 2002 outside studies Rabinovitz study. 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 against DII Industries and its subsidiaries. Dr. Rabinovitz’s estimates are based on historical data supplied by us and publicly available studies, including annual surveys by the National Institutes of Health concerning the incidence of mesothelioma deaths. In addition, Dr. Rabinovitz used the following assumptions in her estimates: - there will be no legislative or other systemic changes to the tort system; - we will continue to aggressively defend against asbestos claims made against us; - an inflation rate of 3% annually for settlement payments 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 Chapter 11 proceedings (see below). 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 report took approximately seven months to complete. Dr. Rabinovitz estimated the current and future total undis- counted liability for personal injury asbestos and silica claims through 2052, including defense costs, would be a range between $2.2 billion and $3.5 billion. The lower end of the range was calculated by using an average of the last five years of asbestos claims experience and the upper end of the range was calculated using the more recent two-year elevated rate of 97 asbestos claim filings in projecting the rate of future claims. As a result of reaching an agreement in principle in December of 2002 (which was the basis of the definitive settlement agree- ments entered in early 2003) for the settlement of all of our asbestos and silica claims, we believed it was appropriate to adjust our accrual to use the upper end of the range contained in Dr. Rabinovitz’s study. Therefore in 2002 we recorded a pretax charge of $2.820 billion to increase our asbestos and silica liability to the upper end of the range. Navigant study. In 2002, we retained Navigant Consulting (formerly Peterson Consulting) to work with us to project the amount of insurance recoveries probable at that time. In conducting this analysis, Navigant Consulting used the Rabinovitz Study to project liabilities through 2052 using the two-year elevated rate of asbestos claim filings. The methodology used by Navigant Consulting for that study was consistent with the methodology employed in December 2003. Based on our analysis of the probable insurance recoveries, we recorded a receivable of $1.530 billion. Other insurance matters Harbison-Walker Chapter 11 proceedings. A large portion of our asbestos claims relate to alleged injuries from asbestos used in a small number of products manufactured or sold by Harbison-Walker Refractories Company, whose operations DII Industries acquired in 1967 and spun off in 1992. At the time of the spin-off, Harbison-Walker assumed liability for asbestos claims filed after the spin-off, and it agreed to defend and indemnify DII Industries from liability for those claims, although DII Industries continues to have direct liability to tort claimants for all post spin-off refractory asbestos claims. DII Industries retained responsibility for all asbestos claims pending as of the date of the spin-off. The agreement governing the spin-off N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S provided that Harbison-Walker would have the right to access 2003); and DII Industries’ historic insurance coverage for the asbestos- - during 2003, DII Industries purchased $50 million of related liabilities that Harbison-Walker assumed in the spin-off. Harbison-Walker’s outstanding insurance receivables, of In July 2001, DII Industries determined that the demands that which $10 million were estimated to be uncollectible. Harbison-Walker was making on the shared insurance policies In 2003, DII Industries entered into a definitive agreement were not acceptable to DII Industries and that Harbison-Walker with Harbison-Walker. This agreement is subject to court probably would not be able to fulfill its indemnification approval in Harbison-Walker’s Chapter 11 proceedings and obligations to DII Industries. Accordingly, DII Industries took up would channel all asbestos and silica personal injury claims the defense of unsettled post spin-off refractory claims that name against Harbison-Walker and certain of its affiliates to the trusts it as a defendant in order to prevent Harbison-Walker from created in DII Industries’ and Kellogg Brown & Root’s Chapter unnecessarily eroding the insurance coverage both companies 11 proceedings. Our asbestos and silica obligations and related access for these claims. As a result, in 2001 we recorded a charge insurance recoveries recorded as of December 31, 2003 reflect of $632 million to increase our asbestos and silica liability to the terms of this definitive agreement. cover the Harbison-Walker asbestos and silica claims and $537 DII Industries also agreed to pay RHI Refractories an million in anticipated insurance recoveries. additional $35 million if a plan of reorganization were proposed On February 14, 2002, Harbison-Walker filed a voluntary in the Harbison-Walker Chapter 11 proceedings and an petition for reorganization under Chapter 11 of the Bankruptcy additional $85 million if a plan is confirmed in the Harbison- Code. In its initial Chapter 11 filings, Harbison-Walker stated it Walker Chapter 11 proceedings, in each case acceptable to DII would seek to utilize Sections 524(g) and 105 of the Bankruptcy Industries in its sole discretion. This plan must include an Code to propose and seek confirmation of a plan of reorganiza- injunction channeling to Section 524(g)/105 trusts all present tion that would provide for distributions for all legitimate, and future asbestos and silica claims against DII Industries pending and future asbestos and silica claims asserted directly arising out of the Harbison-Walker business or other DII against Harbison-Walker or asserted against DII Industries. In Industries businesses that share insurance with Harbison-Walker. order to protect the shared insurance from dissipation, DII The proposed plan of reorganization filed by Harbison-Walker Industries began to assist Harbison-Walker in its Chapter 11 on July 31, 2003 did not provide for a Section 524(g)/105 proceedings as follows: injunction. We do not believe it is likely that Harbison-Walker - on February 14, 2002, DII Industries paid $40 million to will propose or will be able to confirm a plan of reorganization Harbison-Walker’s United States parent holding company, in its Chapter 11 proceedings that is acceptable to DII Industries. RHI Refractories Holding Company (RHI Refractories); In early 2004, we entered into an agreement with RHI - DII Industries agreed to provide up to $35 million in debtor- Refractories to settle the $35 million and $85 million potential in-possession financing to Harbison-Walker ($5 million was payments. The agreement calls for a $10 million payment to RHI paid in 2002 and the remaining $30 million was paid in and a $1 million payment to our asbestos and silica trusts on 98 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S behalf of RHI Refractories. These amounts were expensed If the bankruptcy court approves our settlement agreement during 2003. with Equitas, we will seek to dismiss Equitas from the litigation London-based insurers. Equitas and other London-based we currently have with the London-based insurers. companies have attempted to impose more restrictive documen- Federal-Mogul. A significant portion of the insurance tation requirements on DII Industries and its affiliates than are coverage applicable to Worthington Pump (a former division currently required under existing coverage-in-place agreements of DII Industries) is alleged by Federal-Mogul Products, Inc. related to certain asbestos claims. Coverage-in-place agreements (Federal-Mogul) to be shared with it. In 2001, Federal-Mogul are settlement agreements between policyholders and the and a large number of its affiliated companies filed a voluntary insurers specifying the terms and conditions under which petition for reorganization under Chapter 11 of the Bankruptcy coverage will be applied as claims are presented for payment. Code in the bankruptcy court in Wilmington, Delaware. In These agreements in an asbestos claims context govern such response to Federal-Mogul’s allegations, DII Industries filed a things as what events will be deemed to trigger coverage, how lawsuit on December 7, 2001 in Federal-Mogul’s Chapter 11 liability for a claim will be allocated among insurers and what proceedings asserting DII Industries’ rights to asbestos insurance procedures the policyholder must follow in order to obligate coverage under historic general liability policies issued to the insurer to pay claims. These insurance carriers stated that Studebaker-Worthington, Inc. and its successor. The parties the new restrictive requirements are part of an effort to limit to this litigation have agreed to mediate this dispute. A number payment of settlements to claimants who are truly impaired by of insurers who have agreed to coverage-in-place agreements exposure to asbestos and can identify the product or premises with DII Industries have suspended payment under the shared that caused their exposure. Worthington Pump policies until the Federal-Mogul bankruptcy DII Industries is a plaintiff in two lawsuits against a number of court resolves the insurance issues. Consequently, the effect of London-based insurance companies asserting DII Industries’ the Federal-Mogul Chapter 11 proceedings on DII Industries’ rights under an existing coverage-in-place agreement and rights to access this shared insurance is uncertain. under insurance policies not yet subject to coverage-in-place Highlands litigation. Highlands Insurance Company agreements. DII Industries believes that the more restrictive (Highlands) was our wholly-owned insurance company until it documentation requirements are inconsistent with the current was spun off to our shareholders in 1996. Highlands wrote the coverage-in-place agreements and are unenforceable. The primary insurance coverage for the construction claims related to insurance companies that DII Industries has sued continue Brown & Root, Inc. prior to 1980. On April 5, 2000, Highlands to pay larger claim settlements where the more restrictive filed a lawsuit against Halliburton in the Delaware Chancery documentation is obtained or where court judgments Court asserting that the construction claims insurance it wrote are entered. Likewise, they continue to pay previously for Brown & Root, Inc. was terminated by agreements between agreed amounts of defense costs that DII Industries incurs Halliburton and Highlands at the time of the 1996 spin-off. In defending claims. March 2001, the Chancery Court ruled that a termination did 99 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S occur and that Highlands was not obligated to provide coverage - Kellogg Brown & Root International, Inc. (a Panamanian for Brown & Root, Inc.’s construction claims. This decision was corporation); and affirmed by the Delaware Supreme Court on March 13, 2002. - BPM Minerals, LLC. As a result of this ruling in the first quarter 2002, we wrote off The bankruptcy court has scheduled a hearing on confirma- approximately $35 million in accounts receivable for amounts tion of the proposed plan of reorganization for May 10 through paid for claims and defense costs and $45 million of accrued 12, 2004. The affected subsidiaries will continue to be wholly- receivables in relation to estimated insurance recoveries claims owned by Halliburton Company under the proposed plan. settlements from Highlands. Halliburton Company (the registrant), Halliburton’s Energy Excess insurance on construction claims. As a result of the Services Group or Kellogg Brown & Root’s government services Highlands litigation, Kellogg Brown & Root no longer has businesses are not included in the Chapter 11 filing. Upon primary insurance coverage related to construction claims. confirmation of the plan of reorganization, current and future However, excess insurance coverage policies with other insurers asbestos and silica personal injury claims filed against us and our were in place during those periods. On March 20, 2002, Kellogg subsidiaries will be channeled into trusts established under Brown & Root filed a lawsuit against the insurers that issued Sections 524(g) and 105 of the Bankruptcy Code for the benefit these excess insurance policies, seeking to establish the specific of claimants, thus releasing Halliburton and its affiliates from terms under which it can obtain reimbursement for costs such claims. incurred in settling and defending construction claims. Until this A pre-packaged Chapter 11 proceeding such as that of the lawsuit is resolved, the scope of the excess insurance coverage Debtors is one in which approval of a plan of reorganization is will remain uncertain, and as such we have not recorded any sought from affected creditors before filing for Chapter 11 recoveries related to excess insurance coverage. protection. Prior to proceeding with the Chapter 11 filing, the Note 12. Chapter 11 Reorganization Proceedings Debtors solicited acceptances from known present asbestos and On December 16, 2003, the following wholly-owned subsidiaries of Halliburton (collectively, the Debtors or Debtors- in-Possession) filed Chapter 11 proceedings in bankruptcy court in Pittsburgh, Pennsylvania: - DII Industries, LLC; - Kellogg Brown & Root, Inc.; - Mid-Valley, Inc.; - KBR Technical Services, Inc.; - Kellogg Brown & Root Engineering Corporation; - Kellogg Brown & Root International, Inc. (a Delaware corporation); 100 silica claimants to a proposed plan of reorganization. In the fourth quarter of 2003, valid votes were received from approxi- mately 364,000 asbestos claimants and approximately 21,000 silica claimants, representing substantially all known claimants. Of the votes validly cast, over 98% of voting asbestos claimants and over 99% of voting silica claimants voted to accept the proposed plan of reorganization, meeting the voting require- ments of Chapter 11 of the Bankruptcy Code for approval of the proposed plan. The pre-approved proposed plan of reorganiza- tion was filed as part of the Chapter 11 proceedings. Debtors-in-Possession financial statements. Under the N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S Bankruptcy Code, we are required to file periodically with the professional fees, realized gains and losses and provisions for losses, bankruptcy court various documents, including financial are included in both our consolidated financial statements and the statements of the Debtors-in-Possession. These financial condensed combined financial statements of the Debtors-in- statements are prepared according to requirements of the Possession as discontinued operations. During 2003, we recorded a Bankruptcy Code. While these financial statements accurately total of $27 million as reorganization items, all of which consisted provide information required by the Bankruptcy Code, they of professional fees, including $16 million which was paid in 2003, are unconsolidated, unaudited, and prepared in a format with the balance expected to be paid in 2004. different from that used in our consolidated financial statements Furthermore, certain claims against the Debtors existing filed under the securities laws and from that used in the before the Chapter 11 filing are considered liabilities subject to condensed combined financial statements that follow. compromise. The principal categories of claims subject to Accordingly, we believe the substance and format do not allow compromise at December 31, 2003 included the following: meaningful comparison with the following condensed combined - $2,507 million current asbestos and silica related liabilities; financial statements. and Basis of presentation. We continue to consolidate the Debtors - $1,579 million long-term asbestos and silica related in our consolidated financial statements. While generally it is liabilities. appropriate to de-consolidate a subsidiary during its Chapter 11 Prior to the filing of the Chapter 11 proceedings, DII proceedings on the basis that control no longer rests with the Industries was the parent for all Energy Services Group and KBR parent, the facts and circumstances particular to our situation operations. As part of a pre-filing corporate restructuring, support the continued consolidation of these subsidiaries. immediately prior to Chapter 11 filing, DII Industries distributed Specifically: the Energy Services Group operations to Halliburton Company, - substantially all affected creditors have approved the terms of while the operations of KBR continued to be conducted through the plan of reorganization and related transactions; subsidiaries of DII Industries. The condensed combined financial - the duration of the Chapter 11 proceedings are likely to be statements of the Debtors-in-Possession were prepared as if this very short (anticipated to be approximately six months); distribution had taken place as of January 1, 2003. - the Debtors were solvent and filed Chapter 11 proceedings to resolve asbestos and silica claims rather than as a result of insolvency; and - the plan of reorganization provides that we will continue to own 100% of the equity of the Debtors upon completion of the plan of reorganization. As such, the plan of reorganiza- tion will not impact our equity ownership of the Debtors. All reorganization items, including but not limited to all 101 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S Debtors-in-Possession Condensed Combined Statement of Operations (Millions of dollars) (Unaudited) Revenues Equity in earnings of majority owned subsidiaries Total revenues Operating costs and expenses Operating loss Nonoperating expenses, net Loss from continuing operations before income taxes Income tax benefit Loss from continuing operations Loss from discontinued operations, net of tax benefit of $5 Net loss Year Ended December 31, 2003 $ 2,040 70 2,110 2,328 (218) (26) (244) 88 (156) (1,160) $(1,316) The subsidiaries of DII Industries that are not included in the Chapter 11 filing are presented in the condensed combined Debtors-in-Possession Condensed Combined Balance Sheet (Millions of dollars) (Unaudited) Assets Current assets: Cash and equivalents Receivables: Trade, net Intercompany, net Unbilled work on uncompleted contracts Other, net Total receivables, net Inventories Right to Halliburton shares (1) Other current assets Total current assets Property, plant and equipment, net Goodwill, net Investments in majority owned subsidiaries Insurance for asbestos and silica related liabilities financial statements using the equity method of accounting. Noncurrent deferred income taxes These subsidiaries had revenues of $7,053 million and operating income of $233 million for the year ended December 31, 2003. Other assets Total assets Liabilities and Shareholders’ Equity Current liabilities: These subsidiaries had assets of $2,283 million and liabilities of Accounts payable $2,303 million as of December 31, 2003. Accrued employee compensation and benefits Advance billings on uncompleted contracts Prepetition liabilities not subject to compromise Current prepetition asbestos and silica related liabilities subject to compromise Other current liabilities Total current liabilities Prepetition liabilities not subject to compromise Noncurrent prepetition asbestos and silica related liabilities subject to compromise Other liabilities Total liabilities Shareholders’ equity Total liabilities and shareholders’ equity December 31, 2003 $ 108 191 50 60 75 376 23 1,547 80 2,134 91 188 1,567 2,038 436 257 $6,711 $ 13 30 23 834 2,507 14 3,421 137 1,579 2 5,139 1,572 $6,711 (1) This line item represents an option for DII Industries to acquire 59.5 million shares of Halliburton common stock at no cost and was valued at $26 based upon the closing price on December 31, 2003. 102 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S Debtors-in-Possession Condensed Combined Statement of Cash Flows (Millions of dollars) (Unaudited) Total cash flows from operating activities Total cash flows from investing activities Total cash flows from activities with Halliburton Effect of exchange rate changes on cash Increase (decrease) in cash and equivalents Cash and equivalents at beginning of year Year Ended December 31, 2003 $(1,226) 2 1,306 (5) 77 31 There can be no assurance that we will obtain the required judicial approval of the proposed plan of reorganization or any revised plan of reorganization acceptable to us. In such event, a prolonged Chapter 11 proceeding could adversely affect the Debtors’ relationships with customers, suppliers and employees, which in turn could adversely affect the Debtors’ competitive position, financial condition and results of operations. In Cash and equivalents at end of year $ 108 addition, if the Debtors are unsuccessful in obtaining confirma- Some of the insurers of DII Industries and Kellogg Brown & Root have filed various motions in and objections to the Chapter tion of a plan of reorganization, the assets of the Debtors could be liquidated in the Chapter 11 proceedings, which could have a 11 proceedings in an attempt to seek dismissal of the Chapter 11 material adverse effect on Halliburton. proceedings or to delay the proposed plan of reorganization. The Note 13. Other Commitments and Contingencies motions and objections filed by the insurers include a request United States government contract work. We provide that the court grant the insurers standing in the Chapter 11 substantial work under our government contracts business to the proceedings to be heard on a wide range of matters, a motion to United States Department of Defense and other governmental dismiss the Chapter 11 proceedings and a motion objecting to agencies, including under world-wide United States Army the proposed legal representative for future asbestos and silica logistics contracts, known as LogCAP, and under contracts to claimants. On February 11, 2004, the bankruptcy court rebuild Iraq’s petroleum industry, known as RIO. Our units presiding over the Chapter 11 proceedings issued a ruling operating in Iraq and elsewhere under government contracts holding that the insurers lack standing to bring motions seeking such as LogCAP and RIO consistently review the amounts to dismiss the pre-packaged plan of reorganization and denying charged and the services performed under these contracts. Our standing to insurers to object to the appointment of the operations under these contracts are also regularly reviewed and proposed legal representative for future asbestos and silica audited by the Defense Contract Audit Agency, or DCAA, and claimants. Notwithstanding the bankruptcy court ruling, we other governmental agencies. When issues are found during the expect the insurers to object to confirmation of the pre-packaged governmental agency audit process, these issues are typically plan of reorganization. In addition, we believe that these insurers discussed and reviewed with us in order to reach a resolution. will take additional steps to prevent or delay confirmation of a The results of a preliminary audit by the DCAA in December plan of reorganization, including appealing the rulings of the 2003 alleged that we may have overcharged the Department of bankruptcy court, and there can be no assurance that the Defense by $61 million in importing fuel into Iraq. After a insurers would not be successful or that such efforts would not review, the Army Corps of Engineers, which is our client and result in delays in the reorganization process. oversees the project, concluded that we obtained a fair price for the fuel. However, Department of Defense officials have referred 103 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S the matter to the agency’s inspector general with a request for troops and supporting civilian personnel in Iraq and Kuwait. additional investigation by the agency’s criminal division. We The $141 million amount is our “order of magnitude” estimate understand that the agency’s inspector general has commenced of the remaining amounts (in addition to the $36 million we an investigation. We have also in the past had inquiries by already credited) being questioned by the DCAA. The issues the DCAA and the civil fraud division of the United States relate to whether invoicing should be based on the number of Department of Justice into possible overcharges for work under meals ordered by the Army Materiel Command or whether a contract performed in the Balkans, which is still under review invoicing should be based on the number of personnel served. with the Department of Justice. We have been invoicing based on the number of meals ordered. On January 22, 2004, we announced the identification by our The DCAA is contending that the invoicing should be based on internal audit function of a potential over billing of approxi- the number of personnel served. We believe our position is mately $6 million by one of our subcontractors under the correct, but have undertaken a comprehensive review of its LogCAP contract in Iraq. In accordance with our policy and propriety and the views of the DCAA. However, we cannot government regulation, the potential overcharge was reported to predict when the issue will be resolved with the DCAA. In the the Department of Defense Inspector General’s office as well as to meantime, we may withhold all or a portion of the payments to our customer, the Army Materiel Command. On January 23, our subcontractors relating to the withheld invoices pending 2004, we issued a check in the amount of $6 million to the resolution of the issues. Except for the $36 million in credits and Army Materiel Command to cover that potential over billing the $141 million of withheld invoices, all our invoicing in Iraq while we conduct our own investigation into the matter. We are and Kuwait for other food services and other matters are being also continuing to review whether third party subcontractors processed and sent to the Army Materiel Command for payment paid, or attempted to pay, one or two former employees in in the ordinary course. connection with the potential $6 million over billing. All of these matters are still under review by the applicable The DCAA has raised issues relating to our invoicing to the government agencies. Additional review and allegations are Army Materiel Command for food services for soldiers and possible, and the dollar amounts at issue could change signifi- supporting civilian personnel in Iraq and Kuwait. We have taken cantly. We could also be subject to future DCAA inquiries for two actions in response. First, we have temporarily credited $36 other services we provide in Iraq under the current LogCAP million to the Department of Defense until Halliburton, the contract or the RIO contract. For example, as a result of an DCAA and the Army Materiel Command agree on a process to increase in the level of work performed in Iraq or the DCAA’s be used for invoicing for food services. Second, we are not review of additional aspects of our services performed in Iraq, submitting $141 million of additional food services invoices it is possible that we may, or may be required to, withhold until an internal review is completed regarding the number of additional invoicing or make refunds to our customer, some of meals ordered by the Army Materiel Command and the number which could be substantial, until these matters are resolved. This of soldiers actually served at dining facilities for United States could materially and adversely affect our liquidity. 104 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S Securities and Exchange Commission (SEC) investigation. 2003. In early May 2003, we announced that we had entered The SEC investigation into our recognition of revenue from into a written memorandum of understanding setting forth the unapproved claims and change orders on long-term construction terms upon which the consolidated cases would be settled. The projects, which began in late May 2002 as an informal inquiry, memorandum of understanding called for Halliburton to pay $6 was converted to a formal investigation in December 2002. Since million, which is to be funded by insurance proceeds. After that that time, the SEC has issued subpoenas calling for the produc- announcement, one of the lead plaintiffs announced that it was tion of documents and requiring the appearance of a number of dissatisfied with the lead plaintiffs’ counsel’s handling of witnesses to testify regarding those accounting practices. To our settlement negotiations and what the dissident plaintiff regarded knowledge, the SEC is now focused on the accuracy, adequacy as inadequate communications by the lead plaintiffs’ counsel. It and timing of our disclosure of the change in our accounting is unclear whether this dispute within the ranks of the lead practice for revenues associated with estimated cost overruns plaintiffs will have any impact upon the process of approval of and unapproved claims for specific long-term engineering and the settlement and whether the dissident plaintiff will object to construction projects. the settlement at the time of the fairness hearing or opt out of Securities and related litigation. On June 3, 2002, a class the class action for settlement purposes. The process by which action lawsuit was filed against us in federal court on behalf of the parties will seek approval of the settlement is ongoing. The purchasers of our common stock alleging violations of the attorneys representing the dissident plaintiff filed yet another federal securities laws. After that date, approximately twenty class action case in August 2003 raising, in addition to allega- similar class actions were filed against us. Several of those tions similar to those raised in the earlier filed actions, claims lawsuits also named as defendants Arthur Andersen, LLP, our growing out of the September 1998 Dresser merger. We believe independent accountants for the period covered by the lawsuits, that the allegations in that action, styled Kimble v. Halliburton and several of our present or former officers and directors. Those Company, et al., are without merit and we intend to vigorously lawsuits allege that we violated federal securities laws in failing defend against them. We also believe that those new allegations to disclose a change in the manner in which we accounted for fall within the scope of the memorandum of understanding and revenues associated with unapproved claims on long-term that the settlement, if approved and consummated, will dispose engineering and construction contracts, and that we overstated of those claims in their entirety. The parties are awaiting an order revenue by accruing the unapproved claims. On March 12, from the court consolidating that action with the others. 2003, another shareholder derivative action arising out of the As of the date of this filing, the $6 million settlement amount same events and circumstances was filed in federal court against for the consolidated actions and the federal court derivative certain of our present and former officers and directors. The action was fully covered by our directors’ and officers’ insurance class action cases were later consolidated and the amended carrier. As such, we have accrued a contingent liability for the $6 consolidated class action complaint, styled Richard Moore v. million settlement and a $6 million insurance receivable from Halliburton, was filed and served upon us on or about April 11, the insurance carrier. 105 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S BJ Services Company patent litigation. On April 12, 2002, a includes approximately $25 million in prejudgment interest on federal court jury in Houston, Texas, returned a verdict against future lost profits damages which we believe was awarded Halliburton Energy Services, Inc. in a patent infringement contrary to law. A charge in the amount of $77 million was lawsuit brought by BJ Services Company, or BJ. The lawsuit recorded in the third quarter of 2003 related to this matter. In alleged that our Phoenix fracturing fluid infringed a patent February 2004, the court ordered the parties to appear on issued to BJ in January 2000 for a method of well fracturing March 8, 2004 at which time the court will rehear our motions. using a specific fracturing fluid. The jury awarded BJ approxi- We have posted cash in lieu of a bond in the amount of $25 mately $98 million in damages, plus pre-judgment interest, and million and intend to vigorously prosecute our appeal in the the court enjoined us from further use of our Phoenix fracturing event that the court upholds the jury verdict at the conclusion fluid. BJ Services’ judgment against us was affirmed by the of the March 8, 2004 hearing. federal appellate court in August 2003. Thereafter, we filed a Newmont Gold. In July 1998, Newmont Gold, a gold mining petition for rehearing before the full federal circuit court. That and extraction company, filed a lawsuit over the failure of a petition was denied by order dated October 17, 2003. In mid- blower manufactured and supplied to Newmont by Roots, a January 2004 we filed a petition for writ of certiorari requesting former division of Dresser Equipment Group. The plaintiff that the United States Supreme Court review and reverse the alleges that during the manufacturing process, Roots had judgment. In light of the trial court’s decision in April 2002, a reversed the blades on a component of the blower known as the total of $102 million was accrued in the first quarter of 2002, inlet guide vane assembly, resulting in the blower’s failure and which was comprised of the $98 million judgment and $4 the shutdown of the gold extraction mill for a period of million in pre-judgment interest costs. We do not expect the loss approximately a month during 1996. In January 2002, a Nevada of the use of the Phoenix fracturing fluid to have a material trial court granted summary judgment to Roots on all counts adverse impact on our overall energy services business. We have and Newmont appealed. In February 2004, the Nevada Supreme alternative products to use in our fracturing operations and have Court reversed the summary judgment and remanded the case to not been using the Phoenix fracturing fluid since April 2002. the trial court, holding that fact issues existed which would Anglo-Dutch (Tenge). On October 24, 2003, a Texas require trial. We believe our exposure is no more than $40 district court jury returned a verdict finding a subsidiary of million; however, we believe that we have valid defenses to Halliburton liable to Anglo-Dutch (Tenge) L.L.C. and Anglo- Newmont’s claims and intend to vigorously defend the matter. Dutch Petroleum International, Inc. for breaching a confidential- As of December 31, 2003, we had not accrued any amounts ity agreement related to an investment opportunity we related to this matter. considered in the late 1990s in an oil field in the former Soviet Improper payments reported to the Securities and Republic of Kazakhstan. On January 20, 2004, the judge in that Exchange Commission. During the second quarter 2002, case entered judgment against us and our co-defendants, Ramco we reported to the SEC that one of our foreign subsidiaries Oil & Gas, Ltd. and Ramco Energy, PLC (collectively, “Ramco”), operating in Nigeria made improper payments of approximately jointly and severally for the total sum of $106 million. That sum $2.4 million to entities owned by a Nigerian national who held 106 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S himself out as a tax consultant when in fact he was an employee reviewing this matter in light of the requirements of the United of a local tax authority. The payments were made to obtain States Foreign Corrupt Practices Act. Halliburton has engaged favorable tax treatment and clearly violated our Code of Business outside counsel to investigate any allegations and is cooperating Conduct and our internal control procedures. The payments with the government’s inquiries. As of December 31, 2003, we were discovered during an audit of the foreign subsidiary. We had not accrued any amounts related to this investigation. conducted an investigation assisted by outside legal counsel and, Operations in Iran. We received and responded to an inquiry based on the findings of the investigation, we terminated several in mid-2001 from the Office of Foreign Assets Control, or employees. None of our senior officers were involved. We are OFAC, of the United States Treasury Department with respect to cooperating with the SEC in its review of the matter. We took operations in Iran by a Halliburton subsidiary that is incorpo- further action to ensure that our foreign subsidiary paid all taxes rated in the Cayman Islands. The OFAC inquiry requested owed in Nigeria. A preliminary assessment was issued by the information with respect to compliance with the Iranian Nigerian Tax Authorities in the second quarter of 2003 of Transaction Regulations. These regulations prohibit United approximately $4 million. We are cooperating with the Nigerian States persons from engaging in commercial, financial or trade Tax Authorities to determine the total amount due as quickly transactions with Iran, unless authorized by OFAC or exempted as possible. by statute. Our 2001 written response to OFAC stated that we Nigerian joint venture. It has been reported that a French believed that we were in full compliance with applicable magistrate is investigating whether illegal payments were made sanction regulations. In January 2004, we received a follow-up in connection with the construction and subsequent expansion letter from OFAC requesting additional information. We are of a multi-billion dollar gas liquification complex and related responding to questions raised in the most recent letter. As of facilities at Bonny Island, in Rivers State, Nigeria. TSKJ and other December 31, 2003, we had not accrued any amounts related to similarly-owned entities have entered into various contracts to this investigation. build and expand the liquefied natural gas project for Nigeria Environmental. We are subject to numerous environmental, LNG Limited, which is owned by the Nigerian National legal and regulatory requirements related to our operations Petroleum Corporation, Shell Gas B.V., Cleag Limited (an affiliate worldwide. In the United States, these laws and regulations of Total) and Agip International B.V. TSKJ is a private limited include, among others: liability company registered in Madeira, Portugal whose - the Comprehensive Environmental Response, Compensation members are Technip SA of France, Snamprogetti Netherlands and Liability Act; B.V., which is an affiliate of ENI SpA of Italy, JGC Corporation of - the Resources Conservation and Recovery Act; Japan and Kellogg Brown & Root, each of which owns 25% of - the Clean Air Act; the venture. The United States Department of Justice and the - the Federal Water Pollution Control Act; and SEC have met with Halliburton to discuss this matter and have - the Toxic Substances Control Act. asked Halliburton for cooperation and access to information in In addition to the federal laws and regulations, states and 107 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S other countries where we do business may have numerous In the fourth quarter of 2003, we entered into a senior environmental, legal and regulatory requirements by which we secured master letter of credit facility (Master LC Facility) with a must abide. We evaluate and address the environmental impact syndicate of banks which covers at least 90% of the face amount of our operations by assessing and remediating contaminated of our existing letters of credit. The Master LC Facility became properties in order to avoid future liabilities and comply with effective in December 2003. Each bank has permanently waived environmental, legal and regulatory requirements. On occasion, any right that it had to demand cash collateral as a result of the we are involved in specific environmental litigation and claims, filing of Chapter 11 proceedings. In addition, the Master LC including the remediation of properties we own or have operated Facility provides for the issuance of new letters of credit, so as well as efforts to meet or correct compliance-related matters. long as the total facility does not exceed an amount equal to Our Health, Safety and Environment group has several programs the amount of the facility at closing plus $250 million, or in place to maintain environmental leadership and to prevent the approximately $1.5 billion. occurrence of environmental contamination. The purpose of the Master LC Facility is to provide an We do not expect costs related to these remediation require- advance for letter of credit draws, if any, as well as to provide ments to have a material adverse effect on our consolidated collateral for the reimbursement obligations for the letters of financial position or our results of operations. Our accrued credit. Advances under the Master LC Facility will remain liabilities for environmental matters were $31 million as of available until the earlier of June 30, 2004 or when an order December 31, 2003 and $48 million as of December 31, 2002. confirming the proposed plan of reorganization becomes final The liability covers numerous properties, and no individual and non-appealable. At that time, all advances outstanding property accounts for more than $5 million of the liability under the Master LC Facility, if any, will become term loans balance. In some instances, we have been named a potentially payable in full on November 1, 2004 and all other letters of responsible party by a regulatory agency, but in each of those credit shall cease to be subject to the terms of the Master LC cases, we do not believe we have any material liability. We have Facility. As of December 31, 2003, there were no outstanding subsidiaries that have been named as potentially responsible advances under the Master LC Facility. parties along with other third parties for nine federal and state The Master LC Facility requires the same asset collateralization superfund sites for which we have established a liability. As of and is subject to similar terms and conditions as our Revolving December 31, 2003, those nine sites accounted for approxi- Credit Facility. See Note 10. mately $7 million of our total $31 million liability. Liquidated damages. Many of our engineering and construction Letters of credit. In the normal course of business, we contracts have milestone due dates that must be met or we may be have agreements with banks under which approximately $1.2 subject to penalties for liquidated damages if claims are asserted billion of letters of credit or bank guarantees were outstanding as and we were responsible for the delays. These generally relate to of December 31, 2003, including $252 million which relate to specified activities within a project by a set contractual date or our joint ventures’ operations. achievement of a specified level of output or throughput of a plant 108 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S we construct. Each contract defines the conditions under which a from continuing operations before income taxes, minority customer may make a claim for liquidated damages. In most interest and change in accounting principle are as follows: instances, liquidated damages are not asserted by the customer but the potential to do so is used in negotiating claims and closing out the contract. We had not accrued liabilities for $243 million at December 31, 2003 and $364 million at December 31, 2002 of liquidated damages we could incur based upon completing the projects as forecasted, 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 our liability for liquidated damages. Millions of dollars United States Foreign Total Years ended December 31 2003 2002 $254 358 $612 $(537) 309 $(228) 2001 $565 389 $954 The reconciliations between the actual provision for income taxes on continuing operations and that computed by applying the United States statutory rate to income from continuing operations before income taxes, minority interest and change in accounting principle are as follows: Leases. We are obligated under noncancelable operating United States Statutory rate leases, principally for the use of land, offices, equipment, field Rate differentials on foreign earnings facilities, and warehouses. Total rentals, net of sublease rentals, for noncancelable leases were as follows: Millions of dollars Rental expense 2003 2002 2001 $ 193 $ 149 $ 172 Future total rentals on noncancelable operating leases are as follows: $143 million in 2004; $96 million in 2005; $80 million State income taxes, net of federal income tax benefit Prior years Dispositions Valuation allowance Other items, net Total effective tax rate on continuing operations Years ended December 31 2003 2002 2001 35.0% 0.8) 0.9) 1.6) (1.6) - 1.5) 35.0% 35.0% (1.8) 0.9) 14.5) (12.3) (71.5) - 3.4 1.4 - - - 0.5 38.2% (35.2)% 40.3% in 2006; $58 million in 2007; $45 million in 2008; and $267 The asbestos accruals, the losses on the Bredero-Shaw million thereafter. Note 14. Income Taxes disposition and the associated tax benefits net of valuation allowances in continuing operations during 2002 are the The components of the (provision)/benefit for income taxes on primary causes of the unusual 2002 effective tax rate on continuing operations are: Millions of dollars Current income taxes: Federal Foreign State Total Current Deferred income taxes: Federal Foreign State Total Deferred Years ended December 31 2003 2002 2001 $(167) (181) 1 (347) 80 25 8 113 $ 71 (173) 4 (98) (11) 11 18 18 $(146) (157) (20) (323) (58) (8) 5 (61) continuing operations. There were no significant asbestos charges or related tax accruals included in continuing operations for 2001 or 2003. Our impairment loss on Bredero-Shaw during 2002 could not be benefited for tax purposes due to book and tax basis differences in that investment and the limited benefit generated by a capital loss carryback. However, due to changes in circumstances regarding prior years, we are now able to carry Provision for Income Taxes $(234) $ (80) $(384) back a portion of the capital loss, which resulted in an $11 The United States and foreign components of income (loss) million benefit in 2003. 109 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S The primary components of our deferred tax assets and become subject to additional tax if repatriated, repatriation is liabilities and the related valuation allowances, including not anticipated. Any additional amount of tax is not practicable deferred tax accounts associated with discontinued operations, to estimate. are as follows: We have established a valuation allowance against foreign tax Millions of dollars Gross deferred tax assets: December 31 2003 2002 credit carryovers and certain foreign operating loss carryforwards on the basis that we believe these assets will not be utilized in the statutory carryover period. We also have recorded a valuation allowance on the asbestos and silica liabilities based on the anticipated impact of the future asbestos and silica deductions on our ability to utilize future foreign tax credits. We anticipate that a portion of the asbestos and silica deductions will displace future foreign tax credits and those credits will expire unutilized. Asbestos and silica related liabilities $1,463 $1,201 Employee compensation and benefits Foreign tax credit carryforward Capitalized research and experimentation Accrued liabilities Construction contract accounting Net operating loss carryforwards Insurance accruals Alternative minimum tax credit carryforward Other 275 113 100 100 94 83 77 30 191 282 49 75 102 114 81 78 5 147 Total $2,526 $2,134 Gross deferred tax liabilities: Insurance for asbestos and silica related liabilities Depreciation and amortization Nonrepatriated foreign earnings Other Total Valuation allowances: $ 631 $ 724 129 36 11 188 36 13 $ 807 $ 961 Future tax attributes related to asbestos and silica litigation $ 624 $ 233 Foreign tax credit limitation Net operating loss carryforwards Other Total Net deferred income tax asset 113 56 - $ 793 $ 926 49 77 7 $ 366 $ 807 We have $190 million of net operating loss carryforwards that expire from 2004 through 2012 and net operating loss carryforwards of $62 million with indefinite expiration dates. The federal alternative minimum tax credits are available to reduce future United States federal income taxes on an indefinite basis. We have accrued for the potential repatriation of undistrib- uted 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 110 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S Note 15. Shareholders’ Equity and Stock Incentive Plans The following tables summarize our common stock and other shareholders’ equity activity: (Millions of dollars) Balance at December 31, 2000 Cash dividends paid Reissuance of treasury stock for: Stock purchase, compensation and incentive plans, net Acquisition Treasury stock purchased Current year awards, net of tax Tax benefit from exercise of options Total dividends and other transactions with shareholders Comprehensive income: Net income Other comprehensive income, net of tax: Cumulative translation adjustments Realization of losses included in net income Minimum pension liability adjustment, net of income taxes of $13 Unrealized (loss) on investments and derivatives Total comprehensive income (loss) Balance at December 31, 2001 Cash dividends paid Reissuance of treasury stock for: Stock purchase, compensation and incentive plans, net Stock issued for acquisition Treasury stock purchased Current year awards, net of tax Tax benefit from exercise of options Total dividends and other transactions with shareholders Comprehensive income: Net loss Other comprehensive income, net of tax: Cumulative translation adjustments Realization of losses included in net income Minimum pension liability adjustment, net of income taxes of $70 Unrealized gain on investments and derivatives Total comprehensive income (loss) Balance at December 31, 2002 Common Stock $1,132 - Capital in Excess of Par Value $259 - Treasury Stock $(845) - Deferred Compensation $(63) - Retained Earnings $3,733 (215) Accumulated Other Comprehensive Income $(288) - 2 4 - - - 6 - - - 30 11 - - (2) 39 - - - 51 140 (34) - - 157 - - - - - - $1,138 - - - $298 - - - $(688) - 1 2 - - - 3 - - - - (24) 24 - - (5) (5) - - - - 62 - (4) - - 58 - - - - - - (24) - (24) - - - - - - $(87) - - - - 12 - 12 - - - - - - - - (215) 809 - - - - 809 $4,327 (219) - - - - - (219) (998) - - - - - $1,141 - - - $293 - - - $(630) - - - $(75) - - (998) $3,110 - - - - - - - (32) 102 (15) (3) 52 $(236) - - - - - - - - 69 15 (130) 1 (45) $(281) 111 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S (Millions of dollars) Balance at December 31, 2002 Cash dividends paid Reissuance of treasury stock for: Stock purchase, compensation and incentive plans, net Treasury stock purchased Current year awards, net of tax Tax benefit from exercise of options Total dividends and other transactions with shareholders Comprehensive income: Net loss Other comprehensive income, net of tax: Cumulative translation adjustments Realization of losses included in net income Minimum pension liability adjustment, net of income taxes of $25 Unrealized gain on investments and derivatives Common Stock $1,141 - 1 - - - 1 - - - - - Capital in Excess of Par Value $293 - (19) - - (1) (20) - - - - - Treasury Stock $(630) Deferred Compensation $(75) - 60 (7) - - 53 - - - - - - - - 11 - 11 - - - - - Retained Earnings $3,110 (219) - - - - (219) (820) - - - - Total comprehensive income (loss) Balance at December 31, 2003 - $1,142 - $273 - $(577) - $(64) (820) $2,071 Accumulated Other Comprehensive Income $(281) - - - - - - - 43 15 (88) 13 (17) $(298) 112 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S Accumulated other comprehensive income for the 1993 Stock and Incentive Plan and stock plans of December 31 Millions of dollars 2003 2002 2001 Cumulative translation adjustments $ (63) $(121) $(205) Pension liability adjustments Unrealized gains (losses) on (245) (157) (27) investments and derivatives 10 (3) (4) Dresser Industries, Inc. and other acquired companies. No further awards are being made under the stock plans of acquired companies. The following table represents our stock options granted, $(298) $(281) $(236) exercised and forfeited during the past three years: Total accumulated other comprehensive income Shares of common stock Millions of shares Issued In treasury 2003 457 (18) December 31 2002 456 (20) 436 2001 455 (21) 434 Total shares of common stock outstanding 439 Our 1993 Stock and 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; - stock appreciation rights, in tandem with stock options or freestanding; - restricted stock; - performance share awards; and - stock value equivalent awards. Stock Options Outstanding at December 31, 2000 Granted Exercised Forfeited Outstanding at December 31, 2001 Granted Exercised Forfeited Outstanding at December 31, 2002 Granted Exercised Forfeited Outstanding at Number of Shares (in millions) Exercise Price per Share Weighted Average Exercise Price per Share 14.7 3.6 (0.7) (0.5) 17.1 2.6 -* (1.2) 18.5 2.4 (0.4) (1.0) $8.28 - 61.50 12.93 - 45.35 8.93 - 40.81 12.32 - 54.50 $34.54 35.56 25.34 36.83 $8.28 - 61.50 $35.10 9.10 - 19.75 8.93 - 17.21 8.28 - 54.50 $9.10 - 61.50 18.60 - 24.76 8.28 - 23.52 9.10 - 54.50 12.57 11.39 31.94 $32.10 23.45 14.75 32.07 December 31, 2003 19.5 $9.10 - 61.50 $31.34 *Actual exercises for 2002 were approximately 30,000 shares. Options outstanding at December 31, 2003 are composed of Under the terms of the 1993 Stock and Incentive Plan, the following: as amended, 49 million shares of common stock have been reserved for issuance to key employees. The plan specifies that no more than 16 million shares can be awarded as restricted stock. At December 31, 2003, 17 million shares were available for future grants under the 1993 Stock and Incentive Plan of which nine million shares remain available for restricted stock awards. Range of Exercise Prices $ 9.10 - 23.79 $23.80 - 32.40 $32.41 - 39.54 $39.55 - 61.50 Outstanding Exercisable Weighted Average Weighted Number of Remaining Average Exercise Contractual Price Life Shares (in millions) Number of Shares (in millions) 5.6 5.4 4.9 3.6 7.2 5.0 5.4 5.7 5.9 $18.30 28.82 38.44 45.57 1.8 4.3 4.8 2.9 Weighted Average Exercise Price $17.57 28.85 38.44 46.90 $ 9.10 - 61.50 19.5 $31.34 13.8 $34.59 There were 12.5 million options exercisable with a weighted In connection with the acquisition of Dresser Industries, Inc. average exercise price of $34.98 at December 31, 2002, and in 1998, we assumed the outstanding stock options under 10.7 million options exercisable with a weighted average exercise the stock option plans maintained by Dresser Industries, Inc. price of $34.08 at December 31, 2001. Stock option transactions summarized below include amounts All stock options under the 1993 Stock and Incentive Plan, 113 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S including options granted to employees of Dresser Industries, Under the terms of our Career Executive Incentive Stock Inc. (now DII Industries) since its acquisition, are granted at the Plan, 15 million shares of our common stock were reserved fair market value of the common stock at the grant date. for issuance to officers and key employees at a purchase price Stock options generally expire 10 years from the grant date. not to exceed par value of $2.50 per share. At December 31, Stock options under the 1993 Stock and Incentive Plan vest 2003, 11.7 million shares (net of 2.2 million shares forfeited) ratably over a three or four year period. Other plans have vesting have been issued under the plan. No further grants will be periods ranging from three to 10 years. Options under the Non- made under the Career Executive Incentive Stock Plan. Employee Directors’ Plan vest after six months. Restricted shares issued under the 1993 Stock and Incentive Restricted shares awarded under the 1993 Stock and Incentive Plan, Restricted Stock Plan for Non-Employee Directors, Plan were 431,865 in 2003, 1,706,643 in 2002 and 1,484,034 Employees’ Restricted Stock Plan and the Career Executive in 2001. The shares awarded are net of forfeitures of 248,620 Incentive Stock Plan are limited as to sale or disposition. in 2003, 46,894 in 2002 and 170,050 in 2001. The weighted These restrictions lapse periodically over an extended period average fair market value per share at the date of grant of shares of time not exceeding 10 years. Restrictions may also lapse for granted was $22.94 in 2003, $14.95 in 2002 and $30.90 early retirement and other conditions in accordance with our in 2001. established policies. Upon termination of employment, shares Our Restricted Stock Plan for Non-Employee Directors allows in which restrictions have not lapsed must be returned to us, for each non-employee director to receive an annual award of resulting in restricted stock forfeitures. The fair market value 400 restricted shares of common stock as a part of compensa- of the stock, on the date of issuance, is being amortized and tion. We reserved 100,000 shares of common stock for issuance charged to income (with similar credits to paid-in capital in to non-employee directors. Under this plan we issued 4,000 excess of par value) generally over the average period during restricted shares in 2003, 4,400 restricted shares in 2002 and which the restrictions lapse. At December 31, 2003, the 4,800 restricted shares in 2001. At December 31, 2003, 42,000 unamortized amount is $64 million. We recognized compensa- shares have been issued to non-employee directors under this tion costs of $20 million in 2003, $38 million in 2002 and plan. The weighted average fair market value per share at the $23 million in 2001. date of grant of shares granted was $22.24 in 2003, $12.56 in During 2002, our Board of Directors approved the 2002 2002 and $34.35 in 2001. Employee Stock Purchase Plan (ESPP) and reserved 12 million Our Employees’ Restricted Stock Plan was established for shares for issuance. Under the ESPP, eligible employees may employees who are not officers, for which 200,000 shares of have up to 10% of their earnings withheld, subject to some common stock have been reserved. At December 31, 2003, limitations, to be used to purchase shares of our common stock. 151,850 shares (net of 43,550 shares forfeited) have been issued. Unless the Board of Directors shall determine otherwise, each 6- Forfeitures were 800 in 2003, 400 in 2002 and 800 in 2001. No month offering period commences on January 1 and July 1 of further grants are being made under this plan. each year. The price at which common stock may be purchased 114 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S under the ESPP is equal to 85% of the lower of the fair market The preferred stock purchase rights become exercisable value of the common stock on the commencement date or last in limited circumstances involving a potential business trading day of each offering period. Through the ESPP, there combination. After the preferred stock purchase rights become were approximately 1.3 million shares sold in 2003 and exercisable, each preferred stock purchase right will entitle its approximately 541,000 shares sold in 2002. holder to an amount of our common stock, or in some circum- We account for these plans under the recognition and stances, securities of the acquirer, having a total market value measurement principles of APB Opinion No. 25, “Accounting equal to two times the exercise price of the preferred stock for Stock Issued to Employees,” and related Interpretations. No purchase right. The preferred stock purchase rights are cost for stock options granted is reflected in net income, as all redeemable at our option at any time before they become options granted under our plans have an exercise price equal to exercisable. The preferred stock purchase rights expire on the market value of the underlying common stock on the date of December 15, 2005. No event during 2003 made the preferred grant. In addition, no cost for the Employee Stock Purchase Plan stock purchase rights exercisable. is reflected in net income because it is not considered a Note 17. Income (Loss) Per Share compensatory plan. On April 25, 2000, our Board of Directors approved plans to implement a share repurchase program for up to 44 million shares. No shares were repurchased in 2003 or 2002. We repurchased 1.2 million shares at a cost of $25 million in 2001. 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 (consisting primarily of stock options) with a dilutive Note 16. Series A Junior Par ticipating effect had been issued. The effect of common stock equivalents Preferred Stock 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. on basic weighted average shares outstanding was an additional three million shares in 2003 and an additional two million shares in 2001. Excluded from the computation of diluted income (loss) per share are options to purchase 16 million shares of common stock in 2003 and 10 million shares in 2001. 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. The shares issuable upon conversion of the 3.125% convertible senior notes due 2023 (see Note 10) were not included in the computation of diluted income (loss) per share since the conditions for conversion had not been met as of December 31, 2003. Loss per share for discontinued operations and net loss for the year ended 115 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S December 31, 2003 were antidilutive, as the control number buy or sell a specified amount of a foreign currency at a specified used to determine whether to include any common stock price and time, are generally used to manage identifiable foreign equivalents in the weighted shares outstanding for the period is currency commitments. Forward exchange contracts and foreign income from continuing operations. exchange option contracts, which convey the right, but not the For 2002, we used the basic weighted average shares in the obligation, to sell or buy a specified amount of foreign currency calculation of diluted loss per share, as the effect of the common at a specified price, are generally used to manage exposures stock equivalents (which totaled two million shares for this related to assets and liabilities denominated in a foreign currency. period) would be antidilutive based upon the net loss from None of the forward or option contracts are exchange traded. continuing operations. While derivative instruments are subject to fluctuations in value, Included in the computation of diluted income per common the fluctuations are generally offset by the value of the underly- share in 2001 are rights we issued in connection with the PES ing exposures being managed. The use of some contracts may (International) Limited acquisition in 2000 for between 850,000 limit our ability to benefit from favorable fluctuations in foreign and 2.1 million shares of Halliburton common stock. exchange rates. Note 18. Financial Instr uments and Risk Management Foreign currency contracts are not utilized to manage exposures in some currencies due primarily to the lack of Foreign exchange risk. Techniques in managing foreign available markets or cost considerations (non-traded currencies). exchange risk include, but are not limited to, foreign currency We attempt to manage our working capital position to minimize borrowing and investing and the use of currency derivative foreign currency commitments in non-traded currencies and instruments. We selectively manage significant exposures to recognize that pricing for the services and products offered in potential foreign exchange losses considering current market these countries should cover the cost of exchange rate devalua- conditions, future operating activities and the associated cost in tions. We have historically incurred transaction losses in non- relation to the perceived risk of loss. The purpose of our foreign traded currencies. currency risk management activities is to protect us from the risk Assets, liabilities and forecasted cash flows denominated that the eventual dollar cash flows resulting from the sale and in foreign currencies. We utilize the derivative instruments purchase of products and services in foreign currencies will be described above to manage the foreign currency exposures adversely affected by changes in exchange rates. related to specific assets and liabilities, which are denominated We manage our currency exposure through the use of in foreign currencies; however, we have not elected to account currency derivative instruments as it relates to the major for these instruments as hedges for accounting purposes. currencies, which are generally the currencies of the countries Additionally, we utilize the derivative instruments described for which we do the majority of our international business. above to manage forecasted cash flows denominated in foreign These contracts generally have an expiration date of two years or currencies generally related to long-term engineering and less. Forward exchange contracts, which are commitments to construction projects. Beginning in 2003, we designated these 116 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S contracts related to engineering and construction projects as cash Credit risk. Financial instruments that potentially subject us flow hedges. The ineffective portion of these hedges are included to concentrations of credit risk are primarily cash equivalents, in operating income in the accompanying consolidated statement investments and trade receivables. It is our practice to place our of operations and was not material in the year ended 2003. The cash equivalents and investments in high-quality securities with unrealized net gains on these cash flow hedges were approxi- various investment institutions. We derive the majority of our mately $10 million as of December 31, 2003 and are included in revenues from sales and services, including engineering and other comprehensive income in the accompanying consolidated construction, to the energy industry. Within the energy industry, balance sheet. We expect approximately $10 million of the trade receivables are generated from a broad and diverse group unrealized net gain on these cash flow hedges to be reclassified of customers. There are concentrations of receivables in the into earnings within a year as most of these cash flow hedges United States and the United Kingdom. We maintain an settle in the next 12 months. Changes in the timing or amount allowance for losses based upon the expected collectibility of all of the future cash flows being hedged could result in hedges trade accounts receivable. In addition, see Note 6 for further becoming ineffective and, as a result, the amount of unrealized discussion of United States government receivables. gain or loss associated with that hedge would be reclassified There are no significant concentrations of credit risk with any from other comprehensive income into earnings. At December individual counterparty related to our derivative contracts. We 31, 2003, the maximum length of time over which we are select counterparties based on their profitability, balance sheet hedging our exposure to the variability in future cash flows and a capacity for timely payment of financial commitments associated with foreign currency forecasted transactions is two which is unlikely to be adversely affected by foreseeable events. years. In 2002, we did not designate these derivative contracts Interest rate risk. We have several debt instruments outstand- related to engineering and construction projects as cash flow ing which have both fixed and variable interest rates. We hedges. The fair value of these contracts was immaterial as of the manage our ratio of fixed to variable-rate debt through the end of 2003 and 2002. use of different types of debt instruments and derivative Notional amounts and fair market values. The notional amounts instruments. As of December 31, 2003, we held no interest of open forward contracts and options contracts for operations rate derivative instruments. were $1.1 billion at December 31, 2003 and $609 million at Fair market value of financial instruments. The estimated fair December 31, 2002. The notional amounts of our foreign market value of long-term debt was $3.6 billion at December 31, exchange contracts do not generally represent amounts 2003 and $1.3 billion at December 31, 2002, as compared to exchanged by the parties, and thus are not a measure of our the carrying amount of $3.4 billion at December 31, 2003 and exposure or of the cash requirements relating to these contracts. $1.5 billion at December 31, 2002. The fair market value of The amounts exchanged are calculated by reference to the fixed rate long-term debt is based on quoted market prices for notional amounts and by other terms of the derivatives, such as those or similar instruments. The carrying amount of variable exchange rates. rate long-term debt approximates fair market value because these 117 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S instruments reflect market changes to interest rates. The plans, our liability is limited to a fixed contribution amount carrying amount of short-term financial instruments, cash for each participant or dependent. The plan participants and equivalents, receivables, short-term notes payable and share the total cost for all benefits provided above our fixed accounts payable, as reflected in the consolidated balance contribution. Participants’ contributions are adjusted as sheets, approximates fair market value due to the short required to cover benefit payments. We have made no maturities of these instruments. The currency derivative commitment to adjust the amount of our contributions; instruments are carried on the balance sheet at fair value and therefore, the computed accumulated postretirement benefit are based upon third-party quotes. The fair market values of obligation amount is not affected by the expected future derivative instruments used for fair value hedging and cash health care cost inflation rate. For another postretirement flow hedging were immaterial. medical plan we have generally absorbed the majority of Note 19. Retirement Plans Our company and subsidiaries have various plans which cover a significant number of their employees. These plans include the costs; however, an amendment was made to this plan in 2003 to limit the company’s share of costs. Total amend- ments made in 2003 decreased the accumulated benefit defined contribution plans, defined benefit plans and other obligation by $93 million. postretirement plans: On December 8, 2003, the President signed into law the - our defined contribution plans provide retirement contribu- Medicare Prescription Drug Improvement and Modernization tions in return for services rendered. These plans provide an individual account for each participant and have terms that specify how contributions to the participant’s account are to be determined rather than the amount of pension benefits the participant is to receive. Contributions to these plans are based on pretax income and/or discretionary amounts determined on an annual basis. Our expense for the defined contribution plans for both continuing and discontinued operations totaled $87 million, $80 million and $129 million in 2003, 2002 and 2001, respectively; - our defined benefit plans include both funded and unfunded pension plans, which define an amount of pension benefit to be provided, usually as a function of age, years of service or compensation; and Act of 2003. Because the Act was passed after the measurement date used for our retirement plans, its impact has not been reflected in any amounts disclosed in the financial statements or accompanying notes. We are currently reviewing the effects the Act will have on our plans and expect to complete that review during 2004. In addition, we are waiting for guidance from the United States Department of Health and Human Services on how the employer subsidy provision will be administered and from the Financial Accounting Standards Board on how the impact of the Act should be recognized in our financial statements. Plan assets, expenses and obligation for retirement plans in the following tables include both continuing and discontinued operations. We use a September 30 measurement date for our international plans and an October 31 measurement date for our - our postretirement medical plans are offered to specific domestic plans. eligible employees. These plans are contributory. For some 118 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S Benefit obligations Millions of dollars Change in benefit obligation Benefit obligation at beginning of year Service cost Interest cost Plan participants’ contributions Effect of business combinations and new plans Amendments Divestitures Settlements/curtailments Currency fluctuations 1 10 - - - - - - Actuarial gain/(loss) Benefits paid Benefit obligation 18 (13) Pension Benefits U.S. Int’l U.S. Int’l. Other Postretirement Benefits 2003 2002 2003 2002 Our pension plan weighted-average asset allocations at December 31, 2003 and 2002 and the target allocations for 2004, by asset category are as follows: $144 $2,239 $140 $1,968 $186 $157 Target Allocation 2004 Percentage of Plan Assets at Year End U.S. Int’l U.S. Int’l. 2003 2002 72 120 17 12 - (56) 4 54 107 (68) 1 9 - - 1 - (1) - 5 (11) 72 102 14 70 (4) (5) (1) 102 (27) (52) 1 12 13 - (93) - - - 4 (26) 1 11 11 - - - - - 33 (27) Asset category Equity securities Debt securities Real estate Other – STIF Total 45% - 70% 45% 63% 30% - 55% 23% 34% 0% 0% 0% 0% - 5% 32% 3% 44% 26% 0% 30% 61% 37% 0% 2% 100% 100% 100% 100% Our investment strategy varies by country depending on the circumstances of the underlying plan. Typically less mature plan benefit obligations are funded by using more equity securities, as they are expected to achieve long-term growth while exceeding inflation. More mature plan benefit obligations are funded using more fixed income securities, as they are expected to produce at end of year $160 $2,501 $144 $2,239 $ 97 $186 Accumulated benefit obligation at end of year $158 $2,230 $142 $2,032 $ - $ - current income with limited volatility. Risk management Pension Benefits U.S. Int’l U.S. Int’l. Other Postretirement Benefits 2003 2002 2003 2002 a Plan ssets Millions of dollars Change in plan assets Fair value of plan assets at beginning of year $113 $1,886 $130 $1,827 $ - $ - practices include the use of multiple asset classes and investment managers within each asset class for diversification purposes. Specific guidelines for each asset class and investment manager are implemented and monitored. Actual return on plan assets Employer contributions Settlements and transfers Plan participants’ contributions Effect of business combinations and new plans Divestitures 8 2 - 3 - - Currency fluctuations Benefits paid Fair value of plan - (13) 152 53 (6) 1 (69) 36 (33) (1) - - 13 - - 16 - 17 - (47) 43 - - - - 14 13 11 45 (5) 89 - - - (26) - - - (27) (68) (11) (51) assets at end of year $113 $2,003 $113 $1,886 $ - $ - 119 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S Funded status We recognized an additional minimum pension liability for The funded status of the plans, reconciled to the amount the underfunded defined benefit plans of $107 million in 2003 reported on the statement of financial position, is as follows: and $212 million in 2002, of which $88 million was recorded as Pension Benefits U.S. Int’l U.S. Int’l. Other Postretirement Benefits “Other comprehensive income” in 2003 and $130 million was recorded as “Other comprehensive income” in 2002. The End of year (millions of dollars) 2003 2002 2003 2002 additional minimum liability is equal to the excess of the Fair value of plan assets at end of year Benefit obligation $113 $2,003 $113 $1,886 $ - $ - accumulated benefit obligation over plan assets and accrued liabilities. A corresponding amount is recognized as either an at end of year 160 2,501 144 2,239 97 186 intangible asset or a reduction of shareholders’ equity. Funded status Employer contribution Unrecognized transition $ (47) $ (498) $ (31) $ (353) $ (97) $(186) 2 5 2 - - - The projected benefit obligation, accumulated benefit obligation, and fair value of plan assets for the pension plans with accumulated benefit obligations in excess of plan assets as obligation/(asset) (1) (1) - (2) - - Unrecognized of December 31, 2003 and 2002 are as follows: actuarial (gain)/loss 76 594 56 477 23 20 Unrecognized prior service cost/(benefit) Purchase accounting adjustment Net amount 1 - (1) (77) 1 - - (90) (70) - 2 - Millions of dollars Projected benefit obligation Accumulated benefit obligation Fair value of plan assets recognized $ 29 $ 22 $ 26 $ 52 $(162) $(162) Expected cash flows Pension Benefits 2003 $2,630 $2,363 $2,087 2002 $2,319 $2,121 $1,942 Amounts recognized in the statement of financial position are as follows: Pension Benefits U.S. Int’l U.S. Int’l. Other Postretirement Benefits End of year (millions of dollars) 2003 2002 2003 2002 Amounts recognized in the consolidated balance sheets Prepaid benefit cost $31 $ 95 $ 30 $ 102 $ 0- - $ - Accrued benefit liability including additional Funding requirements for each plan are determined based on the local laws of the country where such plan resides. In certain countries the funding requirements are mandatory while in other countries they are discretionary. We currently expect to contribute $64 million to our international pension plans in 2004. For our domestic plans we expect our contributions to be in the range of $1 million to $3 million in 2004. We may make additional discretionary contributions, which will be minimum liability (76) (361) (59) (250) 162 162 determined after the actuarial valuations are complete. The Intangible asset Accumulated other comprehensive income, net of tax Deferred tax asset Net amount - 8 2 12 48 26 197 83 35 18 122 66 - - - - - - United States Congress is expected to consider pension funding relief legislation when they reconvene for 2004. The actual contributions we make during 2004 may be impacted by the recognized $29 $ 22 $26 $ 52 $ 162 $ 162 final legislative outcome, but the impact cannot be reasonably estimated at this time. 120 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S Net periodic c ost End of year ( m illions of dollars) Components of net periodic benefit cost Service cost Interest cost Expected return on plan assets Transition amount Amortization of prior service cost Settlements/curtailments Recognized actuarial (gain)/loss Net periodic benefit (income)/cost Assumptions U.S. Int’l U.S. Int’l. U.S. Int’l. Pension Benefits Other Postretirement Benefits 2003 2002 2001 2003 2002 2001 $1 10 (12) - - 2 1 $2 $72 120 (136) (1) - - 18 $73 $ 1 9 (13) - (2) - 1 $(4) $ 72 102 (106) (2) (6) (2) 3 $ 61 $ 2 13 (18) - (2) 16 (1) $10 $ 60 89 $ 1 12 $ 1 $ 2 11 15 (95) (2) (6) - (9) $ 37 - - - - 1 $14 - - - - (1) $ 11 - - (3) (221) (1) $(208) Assumed long-term rates of return on plan assets, 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 used to determine benefit obligations at December 31 U.S. Int’l U.S. Int’l. U.S. Int’l. Pension Benefits Other Postretirement Benefits 2003 2002 2001 2003 2002 2001 Discount rate Rate of compensation increase 6.25% 4.5% 2.5-18.0% 2.0-15.5% 7.0% 4.5% 5.25-20.0% 7.25% 3.0-21.0% 4.5% 5.0-8.0% 6.25% N/A 3.0-7.0% 7.0% 7.25% N/A N/A Weighted-average assumptions used to determine net periodic benefit cost for years ended December 31 U.S. Int’l U.S. Int’l. U.S. Int’l. Pension Benefits Other Postretirement Benefits 2003 2002 2001 2003 2002 2001 Discount rate 7.0% Expected return on plan assets 8.75% Rate of compensation increase 4.5% 2.5-20.0% 5.5-8.0% 2.0-21.0% 7.25% 9.0% 4.5% 5.0-20.0% 5.5-9.0% 3.0-21.0% 7.5% 9.0% 4.5% 5.0-8.0% 5.5-9.0% 3.0-7.0% 7.0% 7.25% 7.50% N/A N/A N/A N/A N/A N/A The overall expected long-term rate of return on assets is determined based upon an evaluation of our plan assets, historical trends and experience taking into account current and expected market conditions. Assumed health care cost trend rates at December 31 Health care cost trend rate assumed for next year Rate to which the cost trend rate is assumed to decline (the ultimate trend rate) Year that the rate reached the ultimate trend rate 2003 13.0% 5.0% 2008% 2002 13.0% 5.0% 2007% 2001 11.0% 5.0% 2005% Assumed health care cost trend rates are not expected to have a significant impact on the amounts reported for the total of the health care plans. A one-percentage-point change in assumed health care cost trend rates would have the following effects: 121 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S One-Percentage-Point Increase (Decrease) Combined Financial Position December 31 Millions of dollars Effect on total of service and interest cost components Effect on the postretirement benefit obligation $ - $ 1 $ - $(1) Note 20. Related Companies We conduct some of our operations through joint ventures which are in partnership, corporate and other business forms Total Millions of dollars Current assets Noncurrent assets Total Current liabilities Noncurrent liabilities Minority interests Shareholders’ equity 2003 $1,355 3,044 $4,399 $1,332 2,277 3 787 $4,399 2002 $1,404 1,876 $3,280 $1,155 1,367 - 758 $3,280 and are principally accounted for using the equity method. Financial information pertaining to related companies for our continuing operations is set out below. This information includes the total related company balances and not our proportional interest in those balances. Our larger unconsolidated entities include Subsea 7, Inc., a 50% owned subsidiary, formed in May 2002 (whose results are Note 21. Other Discontinued Operations In addition to the asbestos and silica items recorded in discontinued operations for 2003, 2002 and 2001 (see Note 11), discontinued operations for 2003 also includes a $10 million pretax release of environmental and legal accruals. The accruals are no longer required as they related to indemnities associated with the 2001 disposition of Dresser Equipment Group. The tax reported in our Production Optimization segment) and the effect of the release is $1 million. partnerships created to construct the Alice Springs to Darwin rail line in Australia (whose results are reported in our Engineering and Construction segment). Combined summarized financial information for all jointly owned operations that are accounted for under the equity method is as follows: Combined Operating Results Millions of dollars Revenues Operating income Net income Years ended December 31 2003 $2,576 $ 124 $ 74 2002 $1,948 $ 200 $ 159 2001 $1,987 $ 231 $ 169 In late 1999 and early 2000, we sold our interest in two joint ventures that were a significant portion of our Dresser Equipment Group. In April 2001, we sold the remaining Dresser Equipment Group businesses. We recorded $37 million of income (or $22 million, net of tax effect of $15 million) for the financial results of Dresser Equipment Group through March 31, 2001 as discontinued operations. Gain on disposal of discontinued operations. As a result of the sale of Dresser Equipment Group, we recognized a pretax gain of $498 million ($299 million after tax). 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. 122 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S Gain on disposal of discontinued operations reflects the approximately $107 million which consisted of the following: gain on the sale of the remaining businesses within the Dresser - $64 million in personnel related expense; Equipment Group in the second quarter of 2001. - $17 million of asset related write-downs; Gain on Disposal of Discontinued Operations - $20 million in professional fees related to the restructuring; Millions of dollars Proceeds from sale, less intercompany settlement Net assets disposed Gain before taxes Income taxes Gain on disposal of discontinued operations 2001 $1,267 (769) 498 (199) $ 299 Note 22. Reorganization of Business Operations in 2002 and - $6 million related to contract terminations. Of this amount, $8 million remained in accruals for severance arrangements and approximately $2 million for other items at December 31, 2002. During 2003, we charged $9 million of severance and other reorganization costs against the restructur- ing reserve, leaving a balance in the reserve as of December 31, On March 18, 2002 we announced plans to restructure our 2003 of approximately $1 million. businesses into two operating subsidiary groups, the Energy Although we have no specific plans currently, the reorganiza- Services Group and the Engineering and Construction Group. As tion would facilitate separation of the ownership of the two part of this reorganization, we separated and consolidated the business groups in the future if we identify an opportunity that entities in our Energy Services Group together as direct and produces greater value for our shareholders than continuing to indirect subsidiaries of Halliburton Energy Services, Inc. We also own both business groups. separated and consolidated 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 subsidiaries facilitated the separation, organizationally and financially, of our business groups, which we believe will significantly improve operating efficiencies in both, while streamlining management and easing manpower requirements. In addition, many support functions, which were previously shared, were moved into the two business groups. As a result, we took actions during 2002 to reduce our cost structure by reducing personnel, moving previously shared support functions into the two business groups and realigning ownership of international subsidiaries by group. In 2002, we incurred costs related to the restructuring of Note 23. New Accounting Pronouncements On January 1, 2003 we adopted the Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standard (SFAS) No. 143, “Accounting for Asset Retirement Obligations” which addresses the financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated assets’ retirement costs. SFAS No. 143 requires that the fair value of a liability associated with an asset retirement be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated retirement costs are capitalized as part of the carrying amount of the long-lived asset and subsequently depreciated over the life of the asset. The adoption of this standard resulted in a charge of $8 million after tax as a cumulative effect of a change in accounting principle. The 123 N O T E S T O C O N S O L I D A T E D F I N A N C I A L S T A T E M E N T S asset retirement obligations primarily relate to the removal of assets extends through 2023. The proceeds from the debt leasehold improvements upon exiting certain lease arrangements financing are being used to construct the assets and will be and restoration of land associated with the mining of bentonite. paid down with cash flows generated during the operation The total liability recorded at adoption and at December 31, and service phase of the contract with the third party. As 2003 for asset retirement obligations and the related accretion of December 31, 2003, the joint venture had total assets of and depreciation expense for all periods presented is immaterial $157 million and total liabilities of $155 million. Our to our consolidated financial position and results of operations. aggregate exposure to loss as a result of our involvement The FASB issued FASB Interpretation No. 46, “Consolidation with this joint venture is limited to our equity investment of Variable Interest Entities, an Interpretation of ARB No. 51” and subordinated debt of $11 million and any future losses (FIN 46), in January 2003. In December 2003, the FASB issued related to the construction and operation of the assets. FIN 46R, a revision which supersedes the original interpretation We are not the primary beneficiary. The joint venture is and includes: accounted for under the equity method of accounting in - the deferral of the effective date for certain variable interests our Engineering and Construction Group segment; and until the first quarter of 2004; - our Engineering and Construction Group is involved in - additional scope exceptions for certain other variable three projects executed through joint ventures to design, interests; and build, operate and maintain roadways for certain govern- - additional guidance on what constitutes a variable interest ment agencies. We have a 25% ownership interest in these entity. joint ventures and account for them under the equity FIN 46 requires the consolidation of entities in which a method. These joint ventures are considered variable company absorbs a majority of another entity’s expected losses, interest entities as they were initially formed with little receives a majority of the other entity’s expected residual returns, equity contributed by the partners. The joint ventures have or both, as a result of ownership, contractual or other financial obtained financing through third parties which is not interests in the other entity. Currently, entities are generally guaranteed by us. We are not the primary beneficiary of consolidated based upon a controlling financial interest through these joint ventures and will, therefore, continue to account ownership of a majority voting interest in the entity. for them using the equity method. As of December 31, We have identified the following variable interest entities: 2003, these joint ventures had total assets of $1.3 billion - during 2001, we formed a joint venture in which we own a and total liabilities of $1.3 billion. Our maximum exposure 50% equity interest with two other unrelated partners, each to loss is limited to our equity investments in and loans to owning a 25% equity interest. This variable interest entity the joint ventures (totaling $40 million at December 31, was formed to construct, operate and service certain assets 2003) and our share of any future losses related to the for a third party and was funded with third-party debt. The construction of these roadways. construction of the assets is expected to be completed in 2004, and the operating and service contract related to the 124 S E L E C T E D F I N A N C I A L D A T A (Unaudited) Millions of dollars and shares except per share and employee data Total revenues Total operating income (loss) Nonoperating expense, net Income (loss) from continuing operations before income taxes and minority interest Provision for income taxes 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 share Continuing operations Net income (loss) Diluted income (loss) per 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 Payroll and employee benefits Number of employees 2003 $16,271 720 (108) 612 (234) (39) $339 $(1,151) $ (820) $ 0.78 (1.89) Years ended December 31 2002 $12,572 (112) (116) (228) (80) (38) $ (346) $ (652) $ (998) 2001 $13,046 1,084 (130) 954 (384) (19) $ 551 $ 257 $ 809 2000 $11,944 462 (127) 335 (129) (18) $ 188 $ 313 $ 501 1999 $12,313 401 (94) 307 (116) (17) $ 174 $ 283 $ 438 $ (0.80) (2.31) $ 1.29 1.89 $ 0.42 1.13 $ 0.40 1.00 0.78 (1.88) 0.50 (26.86)% (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% $ 1,377 15,463 2,526 3,437 2,547 6,002 5.80 434 437 $ (515) 1,896 518 - (5,154) 101,381 $2,288 12,844 2,629 1,476 3,558 5,083 8.16 432 432 $ (764) (15) 505 - (4,875) 83,000 $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 $ (797) 412 531 $ (578) (308) 503 $ (520) (59) 511 42 (4,818) 85,000 44 (5,260) 93,000 33 (5,647) 103,000 125 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 (Unaudited) Millions of dollars except per share data 2003 Revenues Operating income Income from continuing operations Loss from discontinued operations Cumulative effect of change in accounting principle, net of tax benefit of $5 Net income (loss) Earnings per share: Basic income (loss) per share: Income (loss) from continuing operations Loss from discontinued operations Cumulative effect of change in accounting principle, net of tax benefit Net income (loss) Diluted income (loss) per share: Income (loss) from continuing operations Loss from discontinued operations Cumulative effect of change in accounting principle, net of tax benefit Net income (loss) Cash dividends paid per share Common stock prices (1) High Low 2002 Revenues Operating income (loss) Income (loss) from continuing operations Loss from discontinued operations Net income (loss) Earnings per share: Basic income (loss) per share: Income (loss) from continuing operations Loss from discontinued operations Net income (loss) Diluted income (loss) per share: Income (loss) from continuing operations Loss from discontinued operations Net income (loss) Cash dividends paid per share Common stock prices (1) High Low First Second Third Fourth Year Quar ter $3,060 142 59 (8) (8) 43 0.14 (0.02) (0.02) 0.10 0.14 (0.02) (0.02) 0.10 0.125 21.79 17.20 $3,007 123 50 (28) 22 0.12 (0.07) 0.05 0.12 (0.07) 0.05 0.125 18.00 8.60 $3,599 71 42 (16) - 26 0.09 (0.03) - 0.06 0.09 (0.03) - 0.06 0.125 24.97 19.98 $3,235 (405) (358) (140) (498) (0.83) (0.32) (1.15) (0.83) (0.32) (1.15) 0.125 19.63 14.60 $4,148 204 92 (34) - 58 0.21 (0.08) - 0.13 0.21 (0.08) - 0.13 0.125 25.90 20.50 $2,982 191 94 - 94 0.22 - 0.22 0.22 - 0.22 0.125 16.00 8.97 $5,464 303 146 (1,093) - (947) 0.34 (2.52) - (2.18) 0.34 (2.51) - (2.17) 0.125 27.20 22.80 $3,348 (21) (132) (484) (616) (0.30) (1.12) (1.42) (0.30) (1.12) (1.42) 0.125 21.65 12.45 $16,271 720 339 (1,151) (8) (820) 0.78 (2.65) (0.02) (1.89) 0.78 (2.64) (0.02) (1.88) 0.50 27.20 17.20 $12,572 (112) (346) (652) (998) (0.80) (1.51) (2.31) (0.80) (1.51) (2.31) 0.50 21.65 8.60 (1) New York Stock Exchange – composite transactions high and low intraday price. 126 I R A N R E P O R T October 21, 2003 To: The Managers of the New York City Police Pension Fund and the New York City Fire Pension Fund Re: Halliburton Business in Iran – Global Overview Preface This report is being submitted to the Halliburton Company Board of Directors pursuant to an agreement worked out with Mr. William Thompson Jr.’s Office of the Comptroller, which represents the New York City Police Pension Fund and the New York City Fire Department Pension Fund, which are Halliburton stockholders (approximately 318,540 shares). The Fund’s stated concern was that the Halliburton Board of Directors have actual knowledge of operations conducted in Iran or for Iranian entities by the various worldwide elements of the Company. As the Board is aware, Iran is the subject of special sanctions administered by the U.S. Treasury, through the U.S. Office of Foreign Assets Control. In general, all “U.S. Persons,” both corporate and individual, are prohibited to enter into transac- tions with Iran or entities working on behalf of Iran, and are further prohibited to “approve or facilitate” transactions by foreign persons. The sanctions leave open however, the possibility for “independent foreign subsidiaries” of U.S. corporations, which are not considered to be “U.S. Persons,” to conduct such business. Many U.S. corporations have foreign subsidiaries active in Iran, including our major competitors. , Halliburton has taken care to isolate its entities that continue to work in Iran from contact with U.S. citizens or managers of U.S. companies, so as to ensure that all work in Iran is under- taken independently, without any facilitation, authorization or approval from U.S. citizen managers. The Board should be assured, however, that the U.S. sanctions do not prohibit them as individuals, or as the Halliburton Company Board of Directors, from having knowledge of the activity there. All of the activities described below have been intensively reviewed by the Law Department for the purpose of determining compliance. The activities are fully compliant with applicable requirements of United States sanctions. For simplicity of understanding, the report is presented in the format of a discussion of the separate activities of each of the foreign subsidiaries involved in Iran. For the most part, the activities of the different companies are quite independent of one another, and there is no coordinated direction of the activity. Hallibur ton Products & Ser vices Limited Principal activity in Iran occurs through the operations of Halliburton Products & Services Limited, a Cayman Islands company headquartered in Dubai, U.A.E. (hereinafter HPSL). HPSL performs between $30 and $40 million annually in oilfield service work in Iran, consisting of cementing, completions work, downhole tools and well testing, stimulation services, PDC drilling bits, coring bits, fluids logging and the provision of drilling fluids. More specifically, revenues for the separate Product Service Lines operated within HPSL are shown in this chart for the completed year 2002 and as projected for 2003. HPSL Business (Unaudited) Completion Products & Services Tools & Testing Production Enhancement Sperry-Sun Drilling Services Security DBS Drill Bits Baroid Drilling Fluids Zonal Isolation (Cementing) Bundled Services TOTALS 2002 $ (000’s) 7,722 3,346 4,763 2003 $ (000’s) 10,274 4,197 4,029 1,060 2,659 4,383 5,190 946 1,690 5,989 8,275 142 $29,265 3,665 $39,065 The operation is profitable, and as shown in the chart, revenues are increasing generally across the board. Customers in Iran include local and international oil companies. All of HPSL’s customers are sound financially, and there is very little risk of non-payment so long as the work is performed correctly. The wells themselves on which HPSL performs services in Iran are all of moderate depths and pressures, and do not present any unique technical challenge. Environmental condi- tions in the Persian Gulf and onshore Iran present little risk. Consequently, there is very little risk of technical failure connected with the operations there. HPSL’s activities are parallel to and competitive with the activities of the foreign affiliates of Schlumberger, Baker-Hughes, Smith International, Weatherford, ABB Vetco Gray, FMC and Cooper-Cameron, as well as those of other U.S. and foreign competitors. The business represents 100% of the revenues of HPSL. Hallibur ton Manufacturing and Ser vices Limited Halliburton Manufacturing and Services Limited, a U.K. corporation headquartered in Aberdeen, Scotland, with manufacturing facilities in Arbroath, Scotland, produces (and/or procures) a small array of products to support Halliburton Products & Services Limited operations in Iran. Those products manufactured include cementing tools (floats, shoes and guides – all items which are inserted into the well bore in connection with cementing of the well) and completion products (Packers / Travel joints / Landing nipples / Flow couplings / Crossovers / Pup joints / Lock mandrels / Ratch latches / Specialized flow control components / Couplings / Wire line retrievable safety valves and actuators – all products used to complete the well and regulate the flow of oil or gas during the production phase). The chemicals for Baroid drilling fluids are various additives and basic drilling fluids; these are purchased from several European and other non-U.S. suppliers. 127 I R A N R E P O R T HMSL Business for Iran (Unaudited) Completion Products & Services Baroid Drilling Fluids Cementing Tools TOTALS 2002 $ (000’s) 2,686 53 909 3,648 2003 $ (000’s) 5,168 718 327 6,213 The only sales of these products for Iran by HMSL are to Halliburton Products & Services Limited in Dubai. The figures above are thus essentially duplicated in the revenues of Halliburton Products & Services Limited shown above. Given that these sales are to a sister Halliburton affiliate there is no financial risk of non-payment. All of these products have been manufactured by HMSL since well before the imposition of Iranian sanctions by the U.S. in 1995. The products represent quite standard technology, and there is little technical risk. The business represents only about 1% of the revenues of HMSL. MWKL M.W. Kellogg Limited (hereinafter MWKL), a U.K. corporation headquartered in London, England, is a 55 - 45 joint venture company between KBR and JGC Corporation. MWKL performs occasional engineering work for energy installations in Iran, typically related to oil and gas processing and petrochemical plants. MWKL is currently a subcontractor to an international company to provide engineering services and the license of ammonia technology for the implementation of an ammonia plant in Iran. The total contract value is about $5.4 million, of which about $4.4 million was billed in 2002. Only $28 thousand was billed in 2003. The remaining $1 million is expected to be billed in 2004. Collections to date more than cover the cost of the work billed, and thus there is no financial risk. The technology is well understood, and MWKL does not see any significant technical risk. MWKL has worked as a subcontractor to an international company for the front end design of plants for the conversion of natural gas to liquid fuels for another international company, the first two of which were expected to be built in Iran and Qatar. For basic design package work on the Iranian portion, approxi- mately $7.4 million was billed by MWKL in 2002 and about $3.9 million in 2003. No further work is expected in 2003 or 2004. Collections to date cover the work billed, and thus there is no financial risk. MWKL is working for an international company to provide engineering services, procurement services and a technology license for a proposed ammonia plant in Iran. Heads of Agreement are in place. The total size of the contract is expected to be in the $17 million range. Billings on this contract were about $3.6 million in 2002 and $10 million in 2003. Collections to date cover the cost of the work billed, and thus there is no financial risk. The technology is well understood, and MWKL does not see any significant technical risk. All of the above work has been done by MWKL in the U.K. MWKL has investigated other projects in Iran, but none are active at this time. The business represents approximately 3% of the revenues of MWKL. Granher ne Limited Granherne Limited, a U.K. corporation headquartered in Leatherhead, England, performs limited scope consulting engineering assignments in the U.K. for entities which have potential or actual interests in projects located in sanctioned countries. Such work for Iran for 2002 was approximately $1 million. Work for 2003 declined to just under $500 thousand. 2004 is expected to be similar. All of the work is well within Granherne’s technical expertise. Customers included interna- tional companies. They are large and financially secure entities, and there is no real financial risk associated with the work. The business represents approximately 5% of the revenues of Granherne. GVA Consultants GVA Consultants (GVA), a Swedish corporation headquartered in Goteborg, Sweden, performs engineering work relating to oilfield activity in Iran, typically related to the design of vessels and offshore platform structures. The project currently underway, to perform engineering and design work for a semisubmersible offshore platform being constructed in Iran, was undertaken before GVA’s acquisition by Halliburton Company in the fall of 2001. Revenues for work on this project in 2002 were about $6.6 million. 2003 revenues are expected to be approximately $3.8 million through year end. 2004 revenues are expected to be in the range of $2 million. Work on this project will likely continue at a reduced level into 2005. Collections to date have covered costs, and there are no significant remaining financial risks. The design is a relatively standard one, and there are no unusual technical or engineering risks. A tender was recently submitted by GVA for the design of one or two tanker vessels; if obtained, such additional work would amount to about $2.8 million, assuming the Iranian entity involved chose to take two vessels. No order has been received as of the time of this report. The business represents approximately 15% of the revenues of GVA. Total Revenues in Iran The total revenues from Iran of all Halliburton affiliates represent approximately one-half of one percent of the revenue of Halliburton Company and do not appear to be material to the Company from a revenue or revenue risk perspective. SH issue Report for NYC 128 C O R P O R A T E I N F O R M A T I O N Board of Directors Robert L. Crandall (1986) (a), (b), (c) Chairman Emeritus AMR Corporation/American Airlines, Inc. Irving, Texas Jay A. Precourt (1998) (a), (b), (d) Chairman of the Board and Chief Executive Officer Scissor Tail Energy, LLC Vail, Colorado Kenneth T. Derr (2001) (a), (c), (e) Retired Chairman of the Board Chevron Corporation San Francisco, California Charles J. DiBona (1997) (a), (d), (e) Retired President and Chief Executive Officer American Petroleum Institute Great Falls, Virginia W. R. Howell (1991) (a), (b), (c) Chairman Emeritus J.C. Penney Company, Inc. Dallas, Texas Ray L. Hunt (1998) (a), (c), (e) Chairman of the Board and Chief Executive Officer Hunt Oil Company Dallas, Texas David J. Lesar (2000) Chairman of the Board, President and Chief Executive Officer Halliburton Company Houston, Texas Aylwin B. Lewis (2001) (a), (b), (d) President, Chief Multibranding and Operating Officer YUM! Brands, Inc. Louisville, Kentucky J. Landis Martin (1998) (a), (d) Chairman of the Board, President and Chief Executive Officer Titanium Metals Corporation Denver, Colorado Debra L. Reed (2001) (a), (d), (e) President and Chief Financial Officer Southern California Gas Company and San Diego Gas & Electric Company San Diego, California C. J. Silas (1993) (a), (b), (c) Retired Chairman of the Board and Chief Executive Officer Phillips Petroleum Company Bartlesville, Oklahoma (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 Corporate Officers David J. Lesar Chairman of the Board, President and Chief Executive Officer C. Christopher Gaut Executive Vice President and Chief Financial Officer Albert O. Cornelison, Jr. Executive Vice President and General Counsel Mark A. McCollum Senior Vice President and Chief Accounting Officer Jerry H. Blurton Vice President and Treasurer Cedric W. Burgher Vice President, Investor Relations Margaret E. Carriere Vice President, Secretary and Corporate Counsel Charles E. Dominy Vice President, Government Relations Weldon J. Mire Vice President, Human Resources David R. Smith Vice President, Tax Energy Services Group (ESG) John W. Gibson, Jr. President and Chief Executive Officer Engineering and Construction Group (KBR) Robert R. Harl President and Chief Executive Officer Shareholder Information Corporate Office 5 Houston Center 1401 McKinney, Suite 2400 Houston, Texas 77010 Shares Listed New York Stock Exchange Swiss Exchange Symbol: HAL Transfer Agent and Registrar Mellon Investor Services LLC 85 Challenger Road Ridgefield Park, New Jersey 07660-2104 1-800-279-1227 www.melloninvestor.com Form 10-K Report Shareholders can obtain a copy of the Company’s Annual Report on Form 10-K by contacting: Vice President, Investor Relations Halliburton Company 5 Houston Center 1401 McKinney, Suite 2400 Houston, Texas 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. 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 , Te 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