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 wellbore 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, testing and subsea, software and asset solutions, and integrated 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 approximately 54,000 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 quarter of 2009, we produced revenue of $3.9 billion and operating income of $616 million, reflecting an operating margin of 16%. Revenue decreased $122 million or 3% from the first quarter of 2008, while operating income decreased $231 million or 27% from the first quarter of 2008. These decreases were caused by a decline in our customers' capital spending as a result of the global recession and its impact on commodity prices, which resulted in severe margin contraction compared to the first quarter of 2008. Business outlook
We continue to believe in the strength of the long-term fundamentals of our business. However, due to the financial crisis that developed in mid-2008, the ensuing negative impact on credit availability, and the current excess supply of oil and natural gas, the near- and mid-term outlook for our business and the industry remains uncertain. Forecasting the depth and length of the current cycle is challenging as it is different from past cycles due to the overlay of the global credit crisis in combination with broad demand weakness. In North America, the industry experienced an unprecedented decline in drilling activity during the first quarter of 2009. United States rig counts have continued to fall and as of April 17, 2009 are approximately 50% below 2008 highs, with no certainty as to when the decline in activity will bottom out. We have also seen pricing erosion and severe margin contraction in all of our service offerings in North America, and we believe that pricing for our services will remain under pressure until drilling activity stabilizes. As noted, when this stabilization may occur is uncertain, and we expect our customers to continue to adjust their spending plans until natural gas supply-demand fundamentals improve.
Outside of North America, rig count has declined approximately 10% from 2008 highs, and there is a risk of a further decline in activity. This is in line with the behavior of past cycles, where international cycles tend to be shallower and longer in duration and follow North America cycles by one to two quarters. Our business has started to see the deferral of several projects, and certain markets are already exhibiting particular weakness in activity due to the lack of access to external financing to fund development projects. In addition, operators are focusing their efforts on removing service cost inflation on their projects by seeking to secure cost concessions from their supply chain. Although international margin pressure was modest during the first quarter of 2009, we expect pressure to intensify in coming quarters.

In 2009, we will focus on:
- minimizing discretionary spending;

- lowering our costs from vendors by negotiating price reductions;

- negotiating with our customers to trade an expansion of scope and a lengthening of duration with contract renegotiation milestones for price concessions;

- reducing headcount in locations experiencing significant activity declines;

- improving working capital, operating within our cash flow, and managing our balance sheet to maximize our financial flexibility;

- leveraging our technologies to provide our customers with the ability to more efficiently drill and complete their wells, especially in service intensive environments such as deepwater and shale plays;

- continuing to deploy our packaged services strategy while creating an efficiency model for our customers in the development of their assets;

- continuing the globalization of our manufacturing and supply chain processes, preserving work at our lower-cost manufacturing centers, and utilizing our international infrastructure to lower costs from our supply chain through delivery;

- expanding our business with national oil companies; and

- protecting our market share by enhancing our technological position and our product and service portfolio in key areas.

Our operating performance is described in more detail in "Business Environment and Results of Operations."
Financial markets, liquidity, and capital resources So far in 2009, the equity, credit, and commodity markets continue to be volatile. While this has created additional risks for our business, we believe we have invested our cash balances conservatively and secured sufficient financing to help mitigate any near- and mid-term negative impact on our operations. To provide additional liquidity and flexibility in the current environment, we issued $2 billion in senior notes during the first quarter of 2009. For additional information, see "Liquidity and Capital Resources", "Risk Factors", "Business Environment and Results of Operations", and Note 5 to the condensed consolidated financial statements.

LIQUIDITY AND CAPITAL RESOURCES

We ended the first quarter of 2009 with cash and equivalents of $3 billion compared to $1.1 billion at December 31, 2008. Significant sources of cash
Cash flows from operating activities contributed $381 million to cash in the first quarter of 2009.
In March 2009, we issued senior notes due 2039 totaling $1 billion and senior notes due 2019 totaling $1 billion. We intend to use the net proceeds of this offering for general corporate purposes.
Further available sources of cash. We have an unsecured $1.2 billion five-year revolving credit facility expiring in 2012 to provide commercial paper support, general working capital, and credit for other corporate purposes. There were no cash drawings under the facility as of March 31, 2009.
Future sources of cash. We expect to receive payment of approximately $85 million in insurance recoveries for our asbestos-related insurance settlements during the second half of 2009.
Significant uses of cash
Capital expenditures were $518 million in the first quarter of 2009 and were predominantly made in the production enhancement, drilling services, cementing, and wireline and perforating product service lines.
We paid $274 million to the Department of Justice (DOJ) and Securities and Exchange Commission (SEC) in the first quarter of 2009 related to the settlements with them and under the indemnity provided to KBR upon separation. We paid $81 million in dividends to our shareholders in the first quarter of 2009.

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.
In 2009, we believe we will maintain our capital expenditures up to 2008 levels but will monitor our customers' activity and make reductions as necessary. The capital expenditures plan for 2009 is primarily directed toward our production enhancement, drilling services, wireline and perforating, and cementing product service lines and toward retiring old equipment to replace it with new equipment to improve our fleet reliability and efficiency. 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. As a result of the resolution of the DOJ and SEC Foreign Corrupt Practices Act (FCPA) investigations, we will pay $285 million in equal installments over the next six quarters for the settlement with the DOJ and under the indemnity provided to KBR upon separation. See Notes 2 and 7 to our condensed consolidated financial statements for more information.
We currently expect to contribute an additional $87 million to our pension plans in 2009.
Subject to Board of Directors approval, we expect to pay dividends of approximately $80 million per quarter in 2009. Other factors affecting liquidity
Letters of credit. In the normal course of business, we have agreements with banks under which approximately $2 billion of letters of credit, surety bonds, or bank guarantees were outstanding as of March 31, 2009, including $657 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. Our recent $2 billion long-term debt offering provides sufficient liquidity and flexibility, given the current market environment. Our debt maturities extend over a long period of time. We currently have a total of $1.2 billion of committed bank credit under revolving credit facilities to support our operations and any commercial paper we may issue in the future. We have no financial covenants or material adverse change provisions in our bank agreements. Currently, there are no borrowings under the revolving credit facility.
In addition, we manage our cash investments by investing principally in United States Treasury securities and repurchase agreements collateralized by United States Treasury securities.
Credit ratings. 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.
Customer receivables. In line with industry practice, we bill our customers for our services in arrears and are, therefore, subject to our customers delaying or failing to pay our invoices. In weak economic environments, we may experience increased delays and failures due to, among other reasons, a reduction in our customer's cash flow from operations and their access to the credit markets. For example, we have seen an increased delay in receiving payment on our receivables from one of our significant national oil company customers in Latin America due to the economic recession and decrease in commodity prices. If our customers delay in paying or fail to pay us a significant amount of our outstanding receivables, it could have a material adverse effect on our liquidity, consolidated results of operations, and consolidated financial condition.

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 quarter of 2009, based upon the location of the services provided and products sold, 40% of our consolidated revenue was from the United States. In the first quarter of 2008, 42% 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 gas companies. Also impacting our activity is the status of the global economy, which impacts oil and natural gas consumption. See "Risk Factors-Worldwide recession and effect on exploration and production activity" for further information related to the effect of the current recession.
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, the availability of credit, 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), United Kingdom Brent crude oil, and Henry Hub natural gas:

                                                           Three Months Ended          Year Ended
                                                                March 31              December 31
Average Oil Prices (dollars per barrel)                    2009           2008            2008
West Texas Intermediate                                 $    42.91      $   97.94     $      99.57
United Kingdom Brent                                         44.43          96.94            96.85

Average United States Natural Gas Prices (dollars per
thousand cubic feet, or mcf)
Henry Hub                                               $     4.71      $    8.92     $       9.13

The quarterly and yearly average rig counts based on the Baker Hughes Incorporated rig count information were as follows:

                                             Three Months Ended         Year Ended
                                                  March 31             December 31
       Land vs. Offshore                      2009          2008           2008
       United States:
       Land                                     1,270        1,711            1,812
       Offshore                                    56           59               65
       Total                                    1,326        1,770            1,877
       Canada:
       Land                                       327          506              378
       Offshore                                     1            1                1
       Total                                      328          507              379
       International (excluding Canada):
       Land                                       743          763              784
       Offshore                                   282          284              295
       Total                                    1,025        1,047            1,079
       Worldwide total                          2,679        3,324            3,335
       Land total                               2,340        2,980            2,974
       Offshore total                             339          344              361

                                             Three Months Ended         Year Ended
                                                  March 31             December 31
       Oil vs. Natural Gas                    2009          2008           2008
       United States:
       Oil                                        281          332              384
       Natural gas                              1,045        1,438            1,493
       Total                                    1,326        1,770            1,877
       Canada:
       Oil                                        125          213              160
       Natural gas                                203          294              219
       Total                                      328          507              379
       International (excluding Canada):
       Oil                                        807          803              825
       Natural gas                                218          244              254
       Total                                    1,025        1,047            1,079
       Worldwide total                          2,679        3,324            3,335
       Oil total                                1,213        1,348            1,369
       Natural gas total                        1,466        1,976            1,966

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 have fallen from an average of $100 per barrel in 2008 to an average of $48 per barrel in the month of March 2009. As of April 21, 2009 the WTI oil spot price was $46.65 per barrel. According to the International Energy Agency's (IEA) April 2009 "Oil Market Report," the pace of global demand contraction is approaching rates last seen in the 1980s. Amid weaker than expected global economic indicators, the IEA revised its world petroleum demand forecast for 2009 downward from 1% less than 2008 demand levels to approximately 3% less than 2008 demand levels. WTI and United Kingdom Brent crude oil prices exceeded $50 per barrel in late March for the first time in four months, but the IEA warned that pervasively weak supply-demand fundamentals could limit a sustained recovery from materializing until 2010. Despite the decline in oil and gas prices and reduction in our customers' capital spending, we believe that, over the long term, 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.
North America operations. Volatility in natural gas prices can impact our customers' drilling and production activities, particularly in North America. In the first quarter of 2009, we experienced an unprecedented decline in drilling activity as the United States rig count, as of April 17, 2009, dropped approximately 50% from 2008 highs. Correlating with this decline, the Henry Hub spot price decreased from an average of $9.13 per mcf in 2008 to $4.08 per mcf in March 2009. As of April 21, 2009, the Henry Hub spot price had fallen to $3.54 per mcf. We have also seen pricing erosion and severe margin contraction in all of our service offerings in North America, and we anticipate that pricing for our services will remain under pressure until drilling activity stabilizes. When this stabilization may occur is uncertain, and we expect our customers to continue to adjust their spending plans until natural gas supply-demand fundamentals improve.
Focus on international operations. Consistent with our long-term strategy to grow our operations outside of North America, we expect to continue to invest capital related to our international operations. However, rig count has declined approximately 10% from 2008 highs and there is a risk of a further decline in activity. This is in line with the behavior of past cycles, where international cycles tend to be shallower and longer in duration and follow North America cycles by one to two quarters. Our business has started to see the deferral of several projects, and certain markets are already exhibiting particular weakness in activity due to the lack of access to external financing to fund development projects. In addition, operators are focusing their efforts on removing service cost inflation on their projects by seeking to secure cost concessions from their supply chain. Although international margin pressure was modest in the first quarter of 2009, we expect pressure to intensify in coming quarters. Following is a brief discussion of some of our recent and current initiatives:
- minimizing discretionary spending;

- lowering our costs from vendors by negotiating price reductions;

- negotiating with our customers to trade an expansion of scope and a lengthening of duration with contract renegotiation milestones for price concessions;

- reducing headcount in locations experiencing significant activity declines;

- improving working capital, operating within our cash flow, and managing our balance sheet to maximize our financial flexibility;

- leveraging our technologies to provide our customers with the ability to more efficiently drill and complete their wells, especially in service intensive environments such as deepwater and shale plays;

- continuing to deploy our packaged services strategy while creating an efficiency model for our customers in the development of their assets;

- continuing the globalization of our manufacturing and supply chain processes, preserving work at our lower-cost manufacturing centers, and utilizing our international infrastructure to lower costs from our supply chain through delivery;

- expanding our business with national oil companies; and

- protecting our market share by enhancing our technological position and our product and service portfolio in key areas.

Recent contract wins positioning us to grow our international operations over the long term include:
- a four-year contract to provide directional-drilling, measurement-while-drilling, and logging-while-drilling, along with drilling fluids and cementing services in Russia; and

- a multi-year contract scheduled to commence in 2010 to provide completion products and services and drilling and completion fluids in the deepwater, offshore fields of Angola.

RESULTS OF OPERATIONS IN 2009 COMPARED TO 2008

Three Months Ended March 31, 2009 Compared with Three Months Ended March 31,
2008

                                  Three Months Ended
    REVENUE:                           March 31              Increase        Percentage
    Millions of dollars            2009          2008       (Decrease)         Change
    Completion and Production   $    2,028      $ 2,122     $       (94 )             (4 )%
    Drilling and Evaluation          1,879        1,907             (28 )             (1 )
    Total revenue               $    3,907      $ 4,029     $      (122 )             (3 )%



By geographic region:
Completion and Production:
North America                $ 1,071     $ 1,164     $  (93 )      (8 )%
Latin America                    232         217         15         7
Europe/Africa/CIS                426         413         13         3
Middle East/Asia                 299         328        (29 )      (9 )
Total                          2,028       2,122        (94 )      (4 )
Drilling and Evaluation:
North America                    612         698        (86 )     (12 )
Latin America                    324         292         32        11
Europe/Africa/CIS                542         545         (3 )      (1 )
Middle East/Asia                 401         372         29         8
Total                          1,879       1,907        (28 )      (1 )
Total revenue by region:
North America                  1,683       1,862       (179 )     (10 )
Latin America                    556         509         47         9
Europe/Africa/CIS                968         958         10         1
Middle East/Asia                 700         700          -         -

                                  Three Months Ended
   OPERATING INCOME:                   March 31               Increase        Percentage
   Millions of dollars           2009            2008        (Decrease)         Change
   Completion and Production   $     363       $     504     $      (141 )            (28 )%
   Drilling and Evaluation           304             409            (105 )            (26 )
   Corporate and other               (51 )           (66 )            15               23
   Total operating income      $     616       $     847     $      (231 )            (27 )%



By geographic region:
Completion and Production:
North America                      $ 166     $ 321     $ (155 )     (48 )%
Latin America                         54        53          1         2
Europe/Africa/CIS                     77        64         13        20
Middle East/Asia                      66        66          -         -
Total                                363       504       (141 )     (28 )
Drilling and Evaluation:
North America                         64       170       (106 )     (62 )
Latin America                         54        54          -         -
Europe/Africa/CIS                     91       111        (20 )     (18 )
Middle East/Asia                      95        74         21        28
Total                                304       409       (105 )     (26 )
Total operating income by region
(excluding Corporate and other):
North America                        230       491       (261 )     (53 )
Latin America                        108       107          1         1
Europe/Africa/CIS                    168       175         (7 )      (4 )
Middle East/Asia                     161       140         21        15

Note - All periods presented reflect the movement of
certain operations from the Completion and Production segment to the
Drilling and Evaluation segment.

The 3% decline in consolidated revenue in the first quarter of 2009 compared to the first quarter of 2008 was primarily due to pricing declines and lower demand . . .