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 52,000 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 2009, we produced revenue of $7.4 billion and operating income of $1.1 billion, reflecting an operating margin of 15%. Revenue decreased $1.1 billion or 13% from the first half of 2008, while operating income decreased $704 million or 39% from the first half 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.
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 financial crisis in combination with broad demand weakness.
In North America, the industry experienced an unprecedented decline in drilling activity during the first half of 2009. United States rig counts have continued to fall and as of July 17, 2009 are approximately 55% below 2008 highs. Working natural gas storage continues to be ahead of its normal seasonal patterns, which suggests that despite reduced drilling activity, the supply curtailment in gas production has not yet caught up with lower demand levels. Further, the expectation that gas storage will potentially reach record levels by the end of the injection period indicates that any recovery in gas drilling activity is likely to be relatively modest for the remainder of 2009. 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.

Outside of North America, rig count has declined approximately 13% from 2008 highs, and there is still a risk of a further decline in activity. Although we are seeing some projects move forward and have recently won a number of contract awards, we still continue to see certain markets exhibit weakness in activity. The depth of the decline in international markets is unknown, and operators have maintained their focus on lowering project costs. Given the continued pricing negotiations, we expect to see margin compression over the remainder of 2009 and throughout 2010.
In 2009, we are focusing on:
- leveraging our technologies to deploy our packaged-services strategy 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;
- retaining key investments in technology and capital to accelerate growth opportunities;
- increasing our market share in unconventional markets by enhancing our technological position and leveraging our technical expertise and wide portfolio of products and services;
- lowering our input costs from vendors by negotiating price reductions for both materials used in our operations and those utilized in the manufacturing of capital equipment;
- negotiating with our customers to trade an expansion of scope and a lengthening of contract duration 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;
- 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
- minimizing discretionary spending.

Our operating performance is described in more detail in "Business Environment and Results of Operations."
Financial markets, liquidity, and capital resources 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 and invested $1.5 billion in United States Treasury securities during the second quarter of 2009. For additional information, see "Liquidity and Capital Resources," "Risk Factors," "Business Environment and Results of Operations," and Notes 5 and 9 to the condensed consolidated financial statements.

LIQUIDITY AND CAPITAL RESOURCES

We ended the second quarter of 2009 with cash and equivalents of $1.6 billion compared to $1.1 billion at December 31, 2008. Significant sources of cash
Cash flows from operating activities contributed $1 billion to cash in the first six months 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.
We received payment of $79 million for our asbestos-related insurance settlements in July 2009.
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, 2009. In addition, we have $1.5 billion in United States Treasury securities that will be maturing at various dates through September 2010.

Significant uses of cash
Capital expenditures were $950 million in the first six months of 2009 and were predominantly made in the drilling services, production enhancement, wireline and perforating, and cementing product service lines.
We purchased $1.5 billion in United States Treasury securities with both short- and long-term maturity dates during the second quarter of 2009. We paid $322 million to the Department of Justice (DOJ) and Securities and Exchange Commission (SEC) in the first six months of 2009 related to the settlements with them and under the indemnity provided to KBR, Inc. (KBR) upon separation.
We paid $162 million in dividends to our shareholders in the first six months of 2009.
We contributed an additional $66 million to an international pension plan in July 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 of $1.8 billion but will monitor our customers' activity and make reductions as necessary. The capital expenditures plan for 2009 is primarily directed toward our drilling services, production enhancement, 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 a total of $237 million in equal installments over the next five 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.
Subject to Board of Directors approval, we expect to pay dividends of approximately $80 million per quarter for the remainder of 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 June 30, 2009, including approximately $400 million of surety bonds related to Venezuela. In addition, $627 million of the total $2 billion relates to KBR letters of credit, surety bonds, or bank guarantees that 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 our revolving credit facility 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 primary customers in Venezuela. Recently, this customer requested a discount on the receivables. No agreement has been reached. 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 six months of 2009, based upon the location of the services provided and products sold, 37% of our consolidated revenue was from the United States. In the first six months 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 materially adverse 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
                                                              June 30              December 31
Average Oil Prices (dollars per barrel)                 2009           2008            2008
West Texas Intermediate                              $    59.44      $  123.42     $      99.57
United Kingdom Brent                                      58.70         120.90            96.85

Average United States Gas Prices (dollars per
thousand cubic
feet, or mcf)
Henry Hub                                            $     3.83      $   11.73     $       9.13

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                      2009          2008         2009         2008
    United States:
    Land                                       886        1,799         1,078       1,755
    Offshore                                    50           66            53          63
    Total                                      936        1,865         1,131       1,818
    Canada:
    Land                                        90          168           209         337
    Offshore                                     1            1             1           1
    Total                                       91          169           210         338
    International (excluding Canada):
    Land                                       711          776           727         769
    Offshore                                   271          308           277         296
    Total                                      982        1,084         1,004       1,065
    Worldwide total                          2,009        3,118         2,345       3,221
    Land total                               1,687        2,743         2,014       2,861
    Offshore total                             322          375           331         360



                                          Three Months Ended          Six Months Ended
                                                June 30                    June 30
    Oil vs. Natural Gas                    2009          2008         2009         2008
    United States:
    Oil                                        201          373           242         352
    Natural Gas                                735        1,492           889       1,466
    Total                                      936        1,865         1,131       1,818
    Canada:
    Oil                                         40           81            82         147
    Natural Gas                                 51           88           128         191
    Total                                       91          169           210         338
    International (excluding Canada):
    Oil                                        757          842           783         822
    Natural Gas                                225          242           221         243
    Total                                      982        1,084         1,004       1,065
    Worldwide total                          2,009        3,118         2,345       3,221
    Oil total                                  998        1,296         1,107       1,321
    Natural Gas total                        1,011        1,822         1,238       1,900

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 $69.64 per barrel in the month of June 2009. As of July 21, 2009 the WTI oil spot price was $64.81 per barrel. According to the International Energy Agency's (IEA) July 2009 "Oil Market Report," growing concerns over the path of economic recovery and current weak demand contribute to an unlikely rebound in crude prices during the second half of 2009. The IEA's forecasted world petroleum demand for the remainder of 2009 is 3% less than 2008 demand levels. In June 2009, the IEA reduced its five-year forecast for global crude demand, predicting that consumption may not regain 2008 levels until 2012. 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 six months of 2009, we experienced an unprecedented decline in drilling activity as the United States rig count, as of July 17, 2009, dropped approximately 55% from 2008 highs. Correlating with this decline, the Henry Hub spot price decreased from an average of $9.13 per mcf in 2008 to $3.91 per mcf in June 2009. As of July 21, 2009, the Henry Hub spot price had fallen to $3.59 per mcf. A high sequential decline in rig count from the first quarter of 2009 led to a more severe margin compression in the industry than previously anticipated. Working natural gas storage continues to be ahead of its normal seasonal patterns, which suggests that despite reduced drilling activity, the supply curtailment in gas production has not yet caught up with lower demand levels. Further, the expectation that gas storage will potentially reach record levels by the end of the injection period indicates that any recovery in gas drilling activity is likely to be relatively modest for the remainder of 2009. 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.
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, as of June 30, 2009, rig count had declined approximately 13% from 2008 highs, and there is a risk of a further decline in activity. Although we are seeing some projects move forward and have recently won a number of contract awards, we still continue to see certain markets exhibit weakness in activity. The depth of the decline in international markets is unknown, and operators have maintained their focus on lowering project costs. Given the continued pricing negotiations, we expect to see margin compression over the remainder of 2009 and throughout 2010.
Following is a brief discussion of some of our recent and current initiatives:
- leveraging our technologies to deploy our packaged-services strategy 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;
- retaining key investments in technology and capital to accelerate growth opportunities;
- increasing our market share in unconventional markets by enhancing our technological position and leveraging our technical expertise and wide portfolio of products and services;
- lowering our input costs from vendors by negotiating price reductions for both materials used in our operations and those utilized in the manufacturing of capital equipment;
- negotiating with our customers to trade an expansion of scope and a lengthening of contract duration 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;
- 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
- minimizing discretionary spending.

Recent contract wins positioning us to grow our operations over the long term include:
- a five-year, $1.5 billion contract to provide a broad base of products and services to an international oil company for its work associated with North America;
- several wins totaling $1 billion, including $700 million to provide deepwater drilling fluid services in the Gulf of Mexico, Brazil, Indonesia, Angola, and other countries, which solidifies our position in the deepwater drilling fluids market and $300 million for shelf- and land-related work;
- a two-year contract extension, estimated to be valued at $450 million, to provide cementing services and completion and drilling fluids for StatoilHydro in offshore fields on the Norwegian continental shelf;
- a five-year, $190 million contract to provide drilling fluid, completion fluid, and drilling waste management services for Petrobras in the offshore markets of Brazil;
- a five-year, $100 million contract to provide directional-drilling and logging-while-drilling services in the Middle East;
- a contract award in Algeria to provide integrated project management services for a number of delineation wells initially with the potential to expand to 120 wells for full field development.
- 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 June 30, 2009 Compared with Three Months Ended June 30, 2008

                                  Three Months Ended
    REVENUE:                            June 30              Increase        Percentage
    Millions of dollars            2009          2008       (Decrease)         Change
    Completion and Production   $    1,752      $ 2,357     $      (605 )            (26 )%
    Drilling and Evaluation          1,742        2,130            (388 )            (18 )
    Total revenue               $    3,494      $ 4,487     $      (993 )            (22 )%



By geographic region:
Completion and Production:
North America                $   795     $ 1,265     $ (470 )     (37 )%
Latin America                    227         232         (5 )      (2 )
Europe/Africa/CIS                439         509        (70 )     (14 )
Middle East/Asia                 291         351        (60 )     (17 )
Total                          1,752       2,357       (605 )     (26 )
Drilling and Evaluation:
North America                    464         725       (261 )     (36 )
Latin America                    317         365        (48 )     (13 )
Europe/Africa/CIS                532         607        (75 )     (12 )
Middle East/Asia                 429         433         (4 )      (1 )
Total                          1,742       2,130       (388 )     (18 )
Total revenue by region:
North America                  1,259       1,990       (731 )     (37 )
Latin America                    544         597        (53 )      (9 )
Europe/Africa/CIS                971       1,116       (145 )     (13 )
Middle East/Asia                 720         784        (64 )      (8 )

. . .