EXECUTIVE OVERVIEW

Organization
We are a leading provider of products and services to the energy industry. We serve the upstream oil and gas industry throughout the lifecycle of the reservoir, from locating hydrocarbons and managing geological data, to drilling and formation evaluation, well construction and completion, and optimizing production through the life of the field. Activity levels within our operations are significantly impacted by spending on upstream exploration, development, and production programs by major, national, and independent oil and natural gas companies. We report our results under two segments, Completion and Production and Drilling and Evaluation:
- our Completion and Production segment delivers cementing, stimulation, intervention, and completion services. The segment consists of production enhancement services, completion tools and services, and cementing services; and

- our Drilling and Evaluation segment provides field and reservoir modeling, drilling, evaluation, and precise well-bore placement solutions that enable customers to model, measure, and optimize their well construction activities. The segment consists of fluid services, drilling services, drill bits, wireline and perforating services, Landmark software and consulting services, and project management services.

The business operations of our segments are organized around four primary geographic regions: North America, Latin America, Europe/Africa/CIS, and Middle East/Asia. We have significant manufacturing operations in various locations, including, but not limited to, the United States, Canada, the United Kingdom, Continental Europe, Malaysia, Mexico, Brazil, and Singapore. With more than 53,000 employees, we operate in approximately 70 countries around the world, and our corporate headquarters are in Houston, Texas and Dubai, United Arab Emirates.
Financial results
During the first half of 2008, we produced revenue of $8.5 billion and operating income of $1.8 billion, reflecting an operating margin of 21%. Revenue increased $1.4 billion or 19% over the first half of 2007, while operating income improved $115 million or 7% over the first half of 2007. Consistent with our initiative to grow our non-North America operations, we experienced 25% revenue growth and 23% operating income growth outside of North America in the first six months of 2008 compared to the first six months of 2007. Revenue from our Latin America region increased 30% to $1.1 billion, and operating income increased 39% to $235 million in the first six months of 2008 compared to the first six months of 2007. Our Middle East/Asia and Europe/Africa/CIS regions also returned revenue growth in excess of 20% in the first six months of 2008 compared to the first six months of 2007.
Business outlook
The outlook for our business remains generally favorable barring significant demand declines due to high commodity prices. During 2007, the North America region experienced challenging market conditions as a result of downward pressure on the pricing of our services, as well as reduced activity in Canada. During the first six months of 2008, operating margins in the region continued to decline from prior period levels, primarily as a result of lower effective pricing for our United States fracturing services and cost inflation for fuel and other materials used in our operations. However, we saw signs of prices stabilizing for fracturing services near the end of the second quarter, and we negotiated fuel surcharges with many of our customers. We expect to see the positive impacts of these negotiations starting in the third quarter of 2008. In addition, we believe pricing has now stabilized for product lines outside of fracturing, with the exception of some weakness in cementing. Canada has also recovered from its seasonal decline in activity, and we expect stronger activity in this market in the second half of 2008. Our customers announced increases to their capital programs for the remainder of 2008 and 2009. This potential increased activity with tightening of supply capacity provides us with an improved outlook for our fracturing volumes and pricing. We also see unconventional drilling activity, such as emerging shale plays, increasing in the second half of 2008, which could create additional demand for our services.

Outside of North America, our outlook also remains positive. Worldwide demand for hydrocarbons continues to grow, and the reservoirs are becoming more complex. The trend toward exploration and exploitation of more complex reservoirs bodes well for the mix of our product line offerings and degree of service intensity on a per rig basis. Therefore, we have been investing and will continue to invest in infrastructure, capital, and technology predominantly outside of North America, consistent with our initiative to grow our operations in that part of the world and balance our geographic portfolio. As our customers award larger tranches of work, pricing competition in the international arena has intensified. However, we expect this price competition to be offset partially with continued expansion of our margins driven by value created through the introduction of new technologies, consistency of execution, and fixed cost leverage. In addition, we believe our Latin America region will continue to experience the highest growth rate of all our regions, driven by contract awards in Mexico and higher activity in Colombia, Brazil, and Venezuela.
In 2008, we are focusing on:
- maintaining optimal utilization of our equipment and resources;

- managing pricing, particularly in our North America operations;

- hiring and training additional personnel to meet the increased demand for our services;

- continuing the globalization of our manufacturing and supply chain processes;

- balancing our United States operations by capitalizing on the trend toward horizontal drilling;

- leveraging our technologies to provide our customers with the ability to more efficiently drill and complete their wells and to increase their productivity. To that end, we opened one international research and development center with global technology and training missions in 2007 and opened another in the first quarter of 2008;

- maximizing our position to win meaningful international tenders, especially in deepwater fields, complex reservoirs, and high-pressure/high-temperature environments;

- expanding our business with national oil companies, including preparing for a shift to more demand for our integrated project management services;

- pursuing strategic acquisitions that enhance our technological position and our product and service portfolio in key geographic areas such as:

- in June 2008, we entered into a definitive agreement with Shell Technology Ventures Fund 1 B.V. to acquire its remaining 49% equity interest in WellDynamics B.V. (WellDynamics). Upon completion of the transaction in July 2008, we now own 100% of WellDynamics;

- in June 2008, we acquired all the intellectual property and assets of Protech Centerform. Protech Centerform is a provider of casing centralization service; and

- in May 2008, we acquired all intellectual property, assets, and existing business of Knowledge Systems Inc. (KSI). KSI is a leading provider of combined geopressure and geomechanical analysis software and services; and

- directing our capital spending primarily toward non-North America operations for service equipment additions and infrastructure. During the second quarter of 2008, we increased our capital spending forecast to provide for equipment placements on coming offshore rigs and to meet the growing demand of our customers in the emerging shale plays in North America. Capital spending for 2008 is expected to be approximately $1.9 billion to $2.0 billion.

Our operating performance is described in more detail in "Business Environment and Results of Operations."
Foreign Corrupt Practices Act (FCPA) investigations The Securities and Exchange Commission (SEC) is conducting a formal investigation into whether improper payments were made to government officials in Nigeria. The Department of Justice (DOJ) is also conducting a related criminal investigation. See Note 8 to our condensed consolidated financial statements for further information.

LIQUIDITY AND CAPITAL RESOURCES

We ended the second quarter of 2008 with cash and equivalents of $1.9 billion compared to $1.8 billion at December 31, 2007. Significant sources of cash
Cash flows from operating activities contributed $985 million to cash in the first six months of 2008. Growth in revenue and operating income in the first half of 2008 compared to the first half of 2007 is attributable to higher customer demand and increased service intensity due to a trend toward exploration and exploitation of more complex reservoirs.
During the first six months of 2008, we sold approximately $388 million of marketable securities, consisting of auction-rate securities and variable-rate demand notes.
Further available sources of cash. We have an unsecured $1.2 billion five-year revolving credit facility to provide commercial paper support, general working capital, and credit for other corporate purposes. There were no cash drawings under the facility as of June 30, 2008.
We entered into an unsecured, $2.5 billion, 364-day revolving credit facility in July 2008 in order to ensure we will have sufficient cash available to pay off 100% of our convertible notes. When added to our pre-existing unsecured, five-year, revolving credit facility, this provides $3.7 billion of committed bank credit to support any commercial paper we subsequently issue. We expect to refinance all or a portion of any commercial paper issued or any other borrowings under these credit facilities through the issuance of long-term senior notes.
Significant uses of cash
Capital expenditures were $837 million in the first six months of 2008, with increased focus toward building infrastructure and adding service equipment in support of our expanding operations outside of North America. Capital expenditures were predominantly made in the drilling services, production enhancement, cementing, and wireline and perforating product service lines. During the first six months of 2008, we repurchased approximately 10 million shares of our common stock under our share repurchase program at a cost of approximately $360 million at an average price of $37.26 per share.
We paid $158 million in dividends to our shareholders in the first six months of 2008.
Future uses of cash. We have approximately $2.0 billion remaining available under our share repurchase authorization, which may be used for open market purchases or to settle the conversion premium over the face amount of our 3.125% convertible senior notes.
Capital spending for 2008 is expected to be approximately $1.9 billion to $2.0 billion. The capital expenditures plan for 2008 is primarily directed toward our drilling services, production enhancement, cementing, and wireline and perforating product service lines. We will continue to explore opportunities for acquisitions that will enhance or augment our current portfolio of products and services, including those with unique technologies or distribution networks in areas where we do not already have large operations. Further, as market conditions change, we will continue to evaluate the allocation of our cash between acquisitions and stock buybacks.
Our 3.125% convertible senior notes due July 2023 became redeemable at our option on July 15, 2008. If we choose to redeem the notes prior to their maturity or if the holders choose to convert the notes, we must settle the principal amount of the notes, which totaled $1.2 billion at June 30, 2008, plus any applicable accrued interest in cash. We have the option to settle any amounts due in excess of the principal, which has ranged between $1.6 billion to $2.0 billion since June 30, 2008, by delivering shares of our common stock, cash, or a combination of common stock and cash.

Subject to Board of Directors approval, we expect to pay dividends of approximately $80 million per quarter for the remainder of 2008.
We are currently evaluating possible acquisitions that may result in additional borrowings and a significant use of cash.
While the timing is not necessarily under our control, any potential settlements entered into with the SEC or DOJ related to the Foreign Corrupt Practices Act investigations may lead to cash payments relating to the indemnity provided to KBR and for any matters deemed to relate to us directly. See Notes 2 and 8 to our condensed consolidated financial statements for more information. Other factors affecting liquidity
Letters of credit. In the normal course of business, we have agreements with banks under which approximately $2.3 billion of letters of credit, surety bonds, or bank guarantees were outstanding as of June 30, 2008, including $1.0 billion that relate to KBR. These KBR letters of credit, surety bonds, or bank guarantees are being guaranteed by us in favor of KBR's customers and lenders. KBR has agreed to compensate us for these guarantees and indemnify us if we are required to perform under any of these guarantees. Some of the outstanding letters of credit have triggering events that would entitle a bank to require cash collateralization.
Credit ratings. The credit ratings for our long-term debt are A2 with Moody's Investors Service and A with Standard & Poor's. The credit ratings on our short-term debt are P-1 with Moody's Investors Service and A-1 with Standard & Poor's.

BUSINESS ENVIRONMENT AND RESULTS OF OPERATIONS

We operate in approximately 70 countries throughout the world to provide a comprehensive range of discrete and integrated services and products to the energy industry. The majority of our consolidated revenue is derived from the sale of services and products to major, national, and independent oil and gas companies worldwide. We serve the upstream oil and natural gas industry throughout the lifecycle of the reservoir: from locating hydrocarbons and managing geological data, to drilling and formation evaluation, well construction and completion, and optimizing production throughout the life of the field. Our two business segments are the Completion and Production segment and the Drilling and Evaluation segment. The industries we serve are highly competitive with many substantial competitors in each segment. In the first six months of 2008, based upon the location of the services provided and products sold, 42% of our consolidated revenue was from the United States. In the first six months of 2007, 45% of our consolidated revenue was from the United States. No other country accounted for more than 10% of our revenue during these periods.
Operations in some countries may be adversely affected by unsettled political conditions, acts of terrorism, civil unrest, force majeure, war or other armed conflict, expropriation or other governmental actions, inflation, exchange control problems, and highly inflationary currencies. We believe the geographic diversification of our business activities reduces the risk that loss of operations in any one country would be material to our consolidated results of operations.
Activity levels within our business segments are significantly impacted by spending on upstream exploration, development, and production programs by major, national, and independent oil and natural gas companies. Also impacting our activity is the status of the global economy, which impacts oil and natural gas consumption.

Some of the more significant barometers of current and future spending levels of oil and natural gas companies are oil and natural gas prices, the world economy, and global stability, which together drive worldwide drilling activity. Our financial performance is significantly affected by oil and natural gas prices and worldwide rig activity, which are summarized in the following tables. This table shows the average oil and natural gas prices for West Texas Intermediate (WTI) and United Kingdom Brent crude oil, and Henry Hub natural gas:

                                                        Three Months Ended          Year Ended
                                                              June 30              December 31
Average Oil Prices (dollars per barrel)                 2008           2007            2007
West Texas Intermediate                              $    123.42     $   64.59     $      71.91
United Kingdom Brent                                      120.90         68.63            72.21

Average United States Gas Prices (dollars per
million British
thermal units, or mmBtu)
Henry Hub                                            $     11.14     $    7.65     $       6.97

The quarterly and year-to-date average rig counts based on the Baker Hughes Incorporated rig count information were as follows:

                                      Three Months Ended          Six Months Ended
                                            June 30                    June 30
Land vs. Offshore                      2008          2007         2008         2007
United States:
Land                                     1,799        1,679         1,755       1,665
Offshore                                    66           77            63          80
Total                                    1,865        1,756         1,818       1,745
Canada:
Land                                       168          136           337         333
Offshore                                     1            3             1           3
Total                                      169          139           338         336
International (excluding Canada):
Land                                       776          710           769         705
Offshore                                   308          292           296         287
Total                                    1,084        1,002         1,065         992
Worldwide total                          3,118        2,897         3,221       3,073
Land total                               2,743        2,525         2,861       2,703
Offshore total                             375          372           360         370

                                      Three Months Ended          Six Months Ended
                                            June 30                    June 30
Oil vs. Natural Gas                    2008          2007         2008         2007
United States:
Oil                                        373          284           352         279
Natural Gas                              1,492        1,472         1,466       1,466
Total                                    1,865        1,756         1,818       1,745
Canada:
Oil                                         81           65           147         130
Natural Gas                                 88           74           191         206
Total                                      169          139           338         336
International (excluding Canada):
Oil                                        842          781           822         772
Natural Gas                                242          221           243         220
Total                                    1,084        1,002         1,065         992
Worldwide total                          3,118        2,897         3,221       3,073
Oil total                                1,296        1,130         1,321       1,181
Natural Gas total                        1,822        1,767         1,900       1,892

Our customers' cash flows, in many instances, depend upon the revenue they generate from the sale of oil and natural gas. Higher oil and natural gas prices usually translate into higher exploration and production budgets. Higher prices also improve the economic attractiveness of unconventional reservoirs. This promotes additional investment by our customers. The opposite is true for lower oil and natural gas prices.
WTI oil spot prices averaged $72 per barrel in 2007 and are expected to increase to an average of $127 per barrel in 2008, according to the Energy Information Administration (EIA). From mid-December 2007 through June 2008, the WTI crude oil price increased $42 per barrel from an average of $90 per barrel to an average of $132 per barrel as a result of rising world oil consumption and low surplus production capacity. We expect that oil prices will remain at levels sufficient to sustain, and likely grow, our customers' current levels of spending due to a combination of the following factors:
- continued growth in worldwide petroleum demand, barring any significant demand reduction due to higher commodity prices;

- projected production growth in non-Organization of Petroleum Exporting Countries (non-OPEC) supplies is not expected to accommodate world wide demand growth;

- OPEC's commitment to control production;

- modest increases in OPEC's current and forecasted production capacity; and

- geopolitical tensions in major oil-exporting nations.

According to the International Energy Agency's (IEA) July 2008 "Oil Market Report," the outlook for world oil demand remains strong, with Asia, the Middle East, and Latin America accounting for nearly all of the expected demand growth in 2008. Excess oil production capacity is expected to remain constrained with OPEC producers' continuing reluctance to supply additional crude oil to the market. This constraint, along with a strong refined product market, a weaker dollar, and geopolitical tensions, is expected to keep supplies tight. Thus, any unexpected supply disruption or change in demand could lead to fluctuating prices. The IEA forecasts world petroleum demand growth in 2008 to increase 2% over 2007.
North America operations. Volatility in natural gas prices has the potential to impact our customers' drilling and production activities, particularly in North America. During 2007, we experienced a significant decline in activity from 2006 levels in our North America operations, especially in Canada. This decline caused us to move equipment and personnel from Canada to other areas in 2007. Canada has now recovered from its decline, and all indications point to stronger than anticipated activity in the second half of 2008. With continued strong natural gas fundamentals, our customers have reevaluated and appear to be increasing their North American capital programs for the remainder of 2008 and 2009. In July 2008, the EIA noted that the Henry Hub spot price averaged $7.17 per thousand cubic feet (mcf) in 2007 and was projected to increase to an average of $11.86 per mcf in 2008.

We experienced increased pricing pressure from our customers in the North American market in 2007 and in the first quarter of 2008, particularly in Canada and in our United States well stimulation operations. However, more recently, pricing declines in the transactional market are easing in areas where activity is increasing and where job and basin complexity favors our differentiated fracturing technologies. In addition, except for some weakness in cementing, we believe prices for all other product lines have stabilized. We continue to experience cost inflation for fuel and materials, which is putting additional downward pressure on operating margins. Recently, we have negotiated fuel surcharges with many of our customers, and we expect to see the impact of these negotiations starting in the third quarter of 2008. We have also begun discussions regarding material cost recoveries with our customers. We believe the improved outlook for all our businesses enhances our ability to modestly increase prices to help cover cost inflation. We also see unconventional drilling activity, such as emerging shale plays, increasing in the second half of 2008, which could create additional demand for our services. Focus on international growth. Consistent with our strategy to grow our operations outside of North America, we expect to continue to invest capital and increase manufacturing capacity to bring new tools online to serve the high demand for our services. As our customers award larger tranches of work, pricing competition in the international arena has intensified. However, we expect this to be offset partially with continued expansion of our margins driven by introduction of new technologies, consistency of execution, and fixed cost leverage. Following is a brief discussion of some of our current initiatives:
- in order to continue to supply our customers with leading-edge services and products, we have increased our technology spending and are making our research and development efforts more geographically diverse. To that end, we opened a technology center in India in 2007, and we opened another in Singapore in the first quarter of 2008;

- we have expanded our manufacturing capability and capacity to meet the increasing demands for our services and products and to support our planned growth. In 2007 and 2008, we opened four new regional manufacturing facilities in Asia and Latin America. These new centers will enable us to be more responsive to our international customers while, building regional supply networks that support local economies;

- as our workforce becomes more global, the need for regional training centers increases. As a result, we have expanded our number of regional training centers to meet this need. We now have 12 training centers worldwide that integrate new workers and advance the technical skills of our workforce; and

- expanding our business with national oil companies, including preparing for a shift to more demand for our integrated project management services; and

- part of our growth strategy includes acquisitions that will enhance or augment our current portfolio of products and services, including those with unique technologies or distribution networks in areas where we do not already have large operations;

- in June 2008, we entered into a definitive agreement with Shell Technology Ventures Fund 1 B.V. to acquire its 49% equity interest in WellDynamics. Upon completion of the transaction in July 2008, we now own 100% of WellDynamics. WellDynamics is the world's leading provider of intelligent well completion technology;

- in June 2008, we acquired all the intellectual property and assets of Protech Centerform in Houston, Ravenna, Italy, and Aberdeen, Scotland. Protech Centerform is a provider of casing centralization service; and

- in May 2008, we acquired all intellectual property, assets, and existing business of KSI, a leading provider of combined geopressure and geomechanical analysis software and services.

Recent contract wins positioning us to grow our international operations over the coming years include:
- a contract to manage the drilling and completion of 58 onshore wells in the southern region of Mexico;

- a contract to perform workover and sidetrack services in the United Kingdom;

- a contract to provide completion equipment and services, tubing conveyed perforating services and SmartWellŽ completion technology for numerous oil and natural gas fields on the Norwegian continental shelf. The contract also allows for the provision of other products and services;

- a three-year contract to provide directional drilling, logging-while-drilling, cementing, wireline and perforating, coiled tubing, and stimulation services in support of the offshore portion of the Manifa mega-project in Saudi Arabia; and

. . .