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 55,000 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 nine months of 2008, we produced revenue of $13.4 billion and operating income of $2.8 billion, reflecting an operating margin of 21%. Revenue increased $2.3 billion or 21% over the first nine months of 2007, while operating income improved $256 million or 10% over the first nine months of 2007. Consistent with our initiative to grow our non-North America operations, we experienced 25% revenue growth and 22% operating income growth outside of North America in the first nine months of 2008 compared to the first nine months of 2007. Revenue from our Latin America region increased 34% to $1.8 billion, and operating income increased 47% to $369 million in the first nine months of 2008 compared to the first nine months of 2007. Our Middle East/Asia and Europe/Africa/CIS regions also returned revenue growth in excess of 20% in the first nine months of 2008 compared to the first nine months of 2007. Business outlook
The long-term outlook for our business remains generally favorable despite the recent volatility in the equity and credit markets and the likelihood of a global decrease in hydrocarbon demand. We believe that any major macroeconomic disruptions may ultimately correct themselves as the underlying trends of smaller and more complex reservoirs, high depletion rates, and the need for continual reserve replacement should drive the long-term need for our services.

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, as of the third quarter of 2008, prices have stabilized and margins have improved due to increased activity in the United States, recovery in Canada from its seasonal decline, and the positive impacts of fuel surcharges that we negotiated with many of our customers earlier in the year. In addition, we continue to see revenue growth from our customers' development of more complex reservoirs that benefit from our differentiated technologies. Recently, a drop in natural gas prices is creating some uncertainty on future activity levels and has caused some of our customers to adjust the level of their future capital expenditures. However, we believe we may have opportunities to grow our market share in this environment, as our customers' capital expenditure cuts appear to be directed primarily toward conventional and shallower drilling activity; preserving the focus on unconventional plays where we generally have a stronger position. These more complex, unconventional developments, as noted above, represent the majority of our business. Our strategy of deploying our equipment and services to our larger customers, who normally have longer-term drilling plans and are involved in the more complex developments, should mitigate the effect of short-term fluctuations in commodity prices. In addition, access to capital, with the recent volatility in the credit market, may constrain the growth of industry capacity. We believe that the inability of some service providers to raise capital could lead to a tightening of supply and this, along with the continued shift to more complex, service-intensive developments, may create the opportunity for us to compete effectively for additional market share.
Outside of North America, our international business has not yet experienced any significant impact from the weakening of commodity prices. If a slowdown occurs, history indicates that the effects may be more muted compared to that of North America. While macroeconomic uncertainties could cloud our view, we still believe that growth will continue in 2009. It is likely we may experience delay or curtailing of some new projects, notably new heavy oil and potentially some gas-to-liquids projects. We are monitoring the activities of our customers and are ready to react to any changes in customer spending. In addition, as noted above, 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 technology and appropriate levels of capital and infrastructure 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 are working to partially offset this price competition by value created through the introduction of new technologies, consistency of execution, and fixed cost leverage. In addition, we believe our Latin America region should continue to experience the highest growth rate of all our regions, driven by contract awards in Mexico and higher activity in Brazil and Colombia. 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 need 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, one in the first quarter of 2008, and another in the third quarter of 2008;

- 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 October 2008, we acquired the assets of Pinnacle Technologies, Inc. (Pinnacle), including the Pinnacle brand from CARBO Ceramics Inc. Pinnacle is a provider of microseismic fracture mapping services and tiltmeter mapping services;

- in July 2008, we acquired the remaining 49% equity interest in WellDynamics B.V. (WellDynamics) from Shell Technology Ventures Fund 1 B.V (STV Fund). We now own 100% of WellDynamics, a provider of intelligent well completion technology;

- 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;

- directing our capital spending primarily toward non-North America operations for service equipment additions and infrastructure. During the third quarter of 2008, we lowered our capital spending forecast marginally due to the temporary cessation of manufacturing in our Houston-area plants because of the hurricane. However, we continue to provide for equipment placements on 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 $1.8 billion to $1.9 billion.

Our operating performance is described in more detail in "Business Environment and Results of Operations."
Financial markets, liquidity and capital resources In October 2008, the equity, credit, and commodity markets saw unprecedented volatility. While this created certain additional risks for our business, we have invested our cash balances conservatively, reduced our leverage, and secured sufficient short-term credit capacity to help mitigate any negative impact on our operations. During the third quarter of 2008, we issued an aggregate amount of $1.2 billion in senior notes and settled the principal and conversion premium on our 3.125% convertible senior notes. For additional information, see "Liquidity and Capital Resources", "Risk Factors", Note 6 to our condensed consolidated financial statements, and "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 and "Risk Factors" for further information.

LIQUIDITY AND CAPITAL RESOURCES

We ended the third quarter of 2008 with cash and equivalents of $973 million compared to $1.8 billion at December 31, 2007.

Significant sources of cash
Cash flows from operating activities contributed $1.6 billion to cash in the first nine months of 2008. Growth in revenue and operating income in the first nine months of 2008 compared to the first nine months of 2007 is attributable to higher customer demand and increased service intensity due to a trend toward exploration and exploitation of more complex reservoirs.
In September 2008, we issued senior notes due 2038 totaling $800 million and senior notes due 2018 totaling $400 million, which were used to pay the principal amount of our 3.125% convertible senior notes.
Early in 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 September 30, 2008.
On September 25, 2008 we terminated the $2.5 billion, 364-day revolving credit facility agreement, which we entered into in July 2008 to provide short-term financing to pay for the settlement of the convertible notes. On October 10, 2008, we entered into an unsecured, six-month revolving credit facility, with current commitments of $400 million, in order to give us additional liquidity and for other general corporate purposes. Significant uses of cash
Our 3.125% convertible senior notes due July 2023 became redeemable at our option on July 15, 2008. On July 30, 2008, we gave notice of redemption on the convertible notes. In lieu of redemption, the holders of the convertible notes could convert each $1,000 principal amount of convertible notes into 53.4069 shares of our common stock. Substantially all of the holders timely elected to convert during the third quarter of 2008. Upon conversion, we settled the principal amount of our convertible notes in cash and the premium on our notes with a combination of $693 million in cash and approximately $840 million, or 20 million shares, of our treasury stock.
Capital expenditures were $1.3 billion in the first nine 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 nine months of 2008, we repurchased approximately 13 million shares of our common stock under our share repurchase program at a cost of approximately $481 million at an average price of $36.61 per share. We paid $239 million in dividends to our shareholders in the first nine months of 2008.
Future uses of cash. We have approximately $1.8 billion remaining available under our share repurchase authorization, which may be used for open market share purchases. However, at the present time, we are not repurchasing additional shares in order to maintain our liquidity.
We will repay $150 million of medium term notes, which will mature in December 2008.
Capital spending for 2008 is expected to be approximately $1.8 billion to $1.9 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 are currently exploring 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.
Subject to Board of Directors approval, we expect to pay dividends of approximately $80 million in the fourth quarter of 2008.
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 September 30, 2008, including approximately $900 million 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.
Financial position in current market. In recent years, we have reduced our leverage and improved our liquidity by focusing on debt reduction and improvement to our credit profile. Our debt maturities extend over a long period of time. We have no financial covenants or material adverse change provisions in our bank agreements, and we are working to continue to improve our short-term credit capacity. For example, we recently entered into an additional revolving credit facility, as discussed above, providing us with a total of $1.6 billion of committed bank credit to support our operations. These revolving credit facilities also support any commercial paper we may issue in the future. Currently, there are no borrowings under these revolving credit facilities.
In addition, we conservatively manage our cash investments by investing principally in United States Treasury securities and repurchase agreements collateralized by United States Treasury securities.
Credit ratings. Our conservatively-managed balance sheet is evidenced by the strong credit ratings assigned to us by the rating agencies. Credit ratings for our long-term debt remain A2 with Moody's Investors Service and A with Standard & Poor's. The credit ratings on our short-term debt remain 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 nine months of 2008, based upon the location of the services provided and products sold, 43% of our consolidated revenue was from the United States. In the first nine 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, economic recessions, 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 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
                                                           September 30            December 31
Average Oil Prices (dollars per barrel)                 2008           2007            2007
West Texas Intermediate                              $    117.88     $   75.16     $      71.91
United Kingdom Brent                                      114.83         74.62            72.21

Average United States Gas Prices (dollars per
million British
thermal units, or mmBtu)
Henry Hub                                            $      9.09     $    6.00     $       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          Nine Months Ended
                                         September 30                September 30
Land vs. Offshore                      2008          2007          2008         2007
United States:
      Land                               1,910        1,716          1,807       1,682
Offshore                                    68           72             64          78
Total                                    1,978        1,788          1,871       1,760
Canada:
Land                                       431          346            369         337
Offshore                                     1            2              1           3
Total                                      432          348            370         340
International (excluding Canada):
Land                                       796          733            778         714
Offshore                                   299          287            297         287
Total                                    1,095        1,020          1,075       1,001
Worldwide total                          3,505        3,156          3,316       3,101
Land total                               3,137        2,795          2,954       2,733
Offshore total                             368          361            362         368



                                      Three Months Ended          Nine Months Ended
                                         September 30                September 30
Oil vs. Natural Gas                    2008          2007          2008         2007
United States:
Oil                                        398          298            367         285
Natural Gas                              1,580        1,490          1,504       1,475
Total                                    1,978        1,788          1,871       1,760
Canada:
Oil                                        177          122            158         127
Natural Gas                                255          226            212         213
Total                                      432          348            370         340
International (excluding Canada):
Oil                                        849          798            831         780
Natural Gas                                246          222            244         221
Total                                    1,095        1,020          1,075       1,001
Worldwide total                          3,505        3,156          3,316       3,101
Oil total                                1,424        1,218          1,356       1,192
Natural Gas total                        2,081        1,938          1,960       1,909

Our customers' cash flows, in many instances, depend upon the revenue they generate from the sale of oil and natural gas. Lower oil and natural gas prices usually translate into lower exploration and production budgets. The opposite is true for higher oil and natural gas prices.

WTI oil spot prices averaged $72 per barrel in 2007 and are expected to average $112 per barrel in 2008, according to the Energy Information Administration (EIA). However, the current slowdown in economic growth and the more recent financial markets crisis have contributed to a sharp decline from record crude oil prices in July of approximately $145 per barrel to approximately $74 per barrel as of October 20, 2008. Despite the recent market volatility, decline in crude oil prices, and reduction in some of our customers' capital spending, we believe that any major macroeconomic disruptions may ultimately correct themselves as the underlying trends of smaller and more complex reservoirs, high depletion rates, and the need for continual reserve replacement should drive the long-term need for our services.
According to the International Energy Agency's (IEA) October 2008 "Oil Market Report," the outlook for world oil demand is still positive, but has been lowered for both 2008 and 2009 from earlier 2008 estimates, with Asia, the Middle East, and Latin America accounting for nearly all of the expected demand growth in 2008. The IEA forecasts world petroleum demand in 2008 to increase 1% over 2007.
North America operations. Volatility in natural gas prices can 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 we expect some increase in activity throughout the remainder of 2008 from 2007 levels. Natural gas prices have fallen from the levels seen during early parts of the summer, but are above levels seen in 2006. The announced reduction in some of our customers' capital spending could result in a decline in rig counts below those previously anticipated. However, we believe we may have opportunities to grow our market share in this environment as our customers' capital expenditure cuts appear to be directed primarily toward conventional and shallower drilling activity; preserving the focus on unconventional plays where we generally have a stronger position. The services we provide to our customers related to these more complex, unconventional developments represent the majority of our business. Our strategy of deploying our equipment and services to our larger customers, who normally have longer-term drilling plans and are involved in the more complex developments, should mitigate the effect of short-term fluctuations in commodity prices. In addition, access to capital, with the recent volatility in the credit market, may constrain growth of industry capacity. We believe that the inability of some service providers to raise capital could lead to a tightening of supply and this, along with the continued shift to more complex, service-intensive developments, may create the opportunity for us to compete effectively for additional market share. In early October 2008, the EIA noted that the Henry Hub spot price averaged $7.17 per thousand cubic feet (mcf) in 2007, is projected to average $9.67 per mcf in 2008, and then is expected to decrease to an average of $8.17 per mcf in 2009.
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, prices and margins have stabilized. In addition, we have seen a positive impact in the third quarter of 2008 from fuel surcharges we negotiated with many of our customers earlier in the year. As noted above, we also continue to see a shift in our customers' drilling plans to more unconventional drilling activity, such as emerging shale plays, that favors our differentiated technologies. . . .