10-K/A 1 body_10ka.htm HALLIBURTON 10-K/A 12/31/2003 Unassociated Document
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A
(Amendment No. 2)

 
(Mark One)
 
 
x
Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
 
For the fiscal year ended December 31, 2003
 
 
 
 
 
 
OR
 
 
 
 
 
 
o
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from __ to __
 
       
  Commission File Number 1-3492  
 
HALLIBURTON COMPANY
(Exact name of registrant as specified in its charter)

 
Delaware
 
75-2677995
 
 
(State or other jurisdiction of
 
(I.R.S. Employer
 
 
incorporation or organization)
 
Identification No.)
 

5 Houston Center
1401 McKinney, Suite 2400
Houston, Texas 77010
(Address of principal executive offices)
Telephone Number - Area code (713)759-2600

Securities registered pursuant to Section 12(b) of the Act:

 
Title of each class
 
Name of each Exchange on which registered
 
 
Common Stock par value $2.50 per share
 
New York Stock Exchange
 

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).
Yes x No o

The aggregate market value of Common Stock held by nonaffiliates on June 30, 2003, determined using the per share closing price on the New York Stock Exchange Composite tape of $23.00 on that date was approximately $10,022,000,000.

As of February 27, 2004, there were 439,713,236 shares of Halliburton Company Common Stock, $2.50 par value per share, outstanding.

Portions of the Halliburton Company Proxy Statement dated March 23, 2004 (File No. 1-3492), are incorporated by reference into Part III of this report.

 
     
 
 
EXPLANATORY NOTE

This Amendment No. 2 is being filed primarily to reflect:
-
additional detail regarding internal control issues identified in the fourth quarter of 2003 in Item 9(a); and
-
additional information in the “United States Government Contract Work” section of “Management’s Discussion and Analysis of Financial Condition and Results of Operations: and conforming changes elsewhere in the Form 10-K related to “United States Government Contract Work.”
In order to preserve the nature and character of the disclosures set forth in such Items as originally filed, this report speaks as of the date of the original filing, and we have not updated the disclosures in this report to speak as of a later date. While this report primarily relates to the historical periods covered, events may have taken place since the original filing that might have been reflected in this report if they had taken place prior to the original filing. All information contained in this Amendment No. 2 is subject to updating and supplementing as provided in our reports filed with the Securities and Exchange Commission subsequent to the date of the original filing of the Annual Report on Form 10-K.

 
     
 
 
PART I

Item 1. Business.
General description of business. Halliburton Company’s predecessor was established in 1919 and incorporated under the laws of the State of Delaware in 1924. Halliburton Company provides a variety of services, products, maintenance, engineering and construction to energy, industrial and governmental customers.
Our five business segments are organized around how we manage the business: Drilling and Formation Evaluation, Fluids, Production Optimization, Landmark and Other Energy Services and the Engineering and Construction Group. We sometimes refer to the combination of Drilling and Formation Evaluation, Fluids, Production Optimization and Landmark and Other Energy Services segments as our Energy Services Group. See Note 5 to the consolidated financial statements for financial information about our business segments.
Dresser Equipment Group is presented as discontinued operations through March 31, 2001 as a result of the sale in April 2001 of this business unit.
Proposed Asbestos and Silica Settlement and Pre-packaged Chapter 11 proceedings. DII Industries, LLC, Kellogg Brown & Root, Inc. and our other affected subsidiaries filed Chapter 11 proceedings on December 16, 2003. With the filing of the Chapter 11 proceedings, all asbestos and silica personal injury claims and related lawsuits against Halliburton and our affected subsidiaries have been stayed. See Note 11 and Note 12 to the consolidated financial statements for a more detailed discussion.
The proposed plan of reorganization, which is consistent with the definitive settlement agreements reached with our asbestos and silica personal injury claimants in early 2003, provides that, if and when an order confirming the proposed plan of reorganization becomes final and non-appealable, in addition to the $311 million paid to claimants in December 2003, the following will be contributed to trusts for the benefit of current and future asbestos and silica personal injury claimants:
-
up to approximately $2.5 billion in cash;
-
59.5 million shares of Halliburton common stock;
-
notes currently valued at approximately $52 million; and
-
insurance proceeds, if any, between $2.3 billion and $3.0 billion received by DII Industries and Kellogg Brown & Root.
Upon confirmation of the plan of reorganization, current and future asbestos and silica personal injury claims against Halliburton and its subsidiaries will be channeled into trusts established for the benefit of claimants, thus releasing Halliburton and its affiliates from those claims. We have also recently entered into a settlement with Equitas, the largest insurer of our asbestos and silica claims. The settlement calls for Equitas to pay us $575 million (representing approximately 60% of applicable limits of liability that DII Industries had substantial likelihood of recovering from Equitas) provided that we receive confirmation of our plan of reorganization and the current United States Congress does not pass national asbestos litigation reform legislation.
Description of services and products. We offer a broad suite of products and services through our five business segments. The following summarizes our services and products for each business segment.
ENERGY SERVICES GROUP
Our Energy Services Group provides a wide range of discrete services and products, as well as integrated solutions to customers for the exploration, development and production of oil and gas. The Energy Services Group serves major, national and independent oil and gas companies throughout the world.
Drilling and Formation Evaluation
Our Drilling and Formation Evaluation segment is primarily involved in drilling and evaluating the formations related to bore-hole construction and initial oil and gas formation evaluation. Major products and services offered include:

 
  1  
 

-
drilling systems and services;
-
drill bits; and
-
logging and perforating.
Our Sperry-Sun business line provides drilling systems and services. These services include directional and horizontal drilling, measurement-while-drilling, logging-while-drilling, multilateral wells and related completion systems, and rig site information systems. Our drilling systems feature bit stability, directional control, borehole quality, low vibration and high rates of penetration while drilling directional wells.
Drill bits, offered by our Security DBS business line, include roller cone rock bits, fixed cutter bits, coring equipment and services and other downhole tools used to drill wells.
Logging and perforating products and services include our Magnetic Resonance Imaging Logging (MRIL®) and high-temperature logging, as well as traditional open-hole and cased-hole logging tools. MRIL® tools apply magnetic resonance imaging technology to the evaluation of subsurface rock formations in newly drilled oil and gas wells. Open-hole tools provide information on well visualization, formation evaluation (including resistivity, porosity, lithology and temperature), rock mechanics and sampling. Cased-hole tools provide cementing evaluation, reservoir monitoring, pipe evaluation, pipe recovery and perforating.
Fluids
Our Fluids segment focuses on fluid management and technologies to assist in the drilling and construction of oil and gas wells. This segment offers cementing and drilling fluids systems.
Cementing is the process used to bond the well and well casing while isolating fluid zones and maximizing wellbore stability. Cement and chemical additives are pumped to fill the space between the casing and the side of the wellbore. Our cementing service line also provides casing equipment and services.
Our Baroid business line provides drilling fluid systems and performance additives for oil and gas drilling, completion and workover operations. In addition, Baroid sells products to a wide variety of industrial customers. Drilling fluids usually contain bentonite or barite in a water or oil base. Drilling fluids primarily improve wellbore stability and facilitate the transportation of cuttings from the bottom of a wellbore to the surface. Drilling fluids also help cool the drill bit, seal porous well formations and assist in pressure control within a wellbore. Drilling fluids are often customized by onsite engineers for optimum stability and enhanced oil production.
Also included in this segment is our equity method investment in Enventure Global Technology, LLC (Enventure), which is an expandable casing joint venture. In January 2004, Halliburton and Shell Technology Ventures (Shell, an unrelated party) agreed to restructure two joint venture companies, Enventure and WellDynamics B.V. (WellDynamics), in an effort to more closely align the ventures with near-term priorities in the core businesses of the venture owners. Enventure was owned equally by Halliburton and Shell. Shell acquired an additional 33.5% of Enventure, leaving us with 16.5% ownership in return for enhanced and extended agreements and licenses with Shell for its Poroflex™ expandable sand screens and a distribution agreement for its Versaflex™ expandable liner hangers, in addition to a one percent increase in our ownership of WellDynamics.
Production Optimization
Our Production Optimization segment primarily tests, measures and provides means to manage and/or improve well production once a well is drilled and, in some cases, after it has been producing. This segment consists of:
-
production enhancement;
-
completion products; and
-
tools and testing services.

 
  2  
 

Production enhancement optimizes oil and gas reservoirs through a variety of pressure pumping services, including fracturing and acidizing, sand control, coiled tubing, hydraulic workover and pipeline and process services. These services are used to clean out a formation or to fracture formations to allow increased oil and gas production.
Completion products include subsurface safety valves and flow control equipment, surface safety systems, packers and specialty completion equipment, production automation, well screens, and slickline equipment and services.
Tools and testing services include underbalanced applications, tubing-conveyed perforating products and services, drill stem and other well testing tools, data acquisition services and production applications.
Also included in this segment are our subsea operations conducted in our 50% owned company, Subsea 7, Inc.
Landmark and Other Energy Services
Our Landmark and Other Energy Services segment provides integrated exploration and production software information systems, consulting services, real-time operations, smartwells and other integrated solutions.
Landmark Graphics is the leading supplier of integrated exploration and production software information systems as well as professional and data management services for the upstream oil and gas industry. Landmark Graphics software transforms vast quantities of seismic, well log and other data into detailed computer models of petroleum reservoirs. The models are used by our customers to achieve optimal business and technical decisions in exploration, development and production activities. Landmark Graphics’ broad range of professional services enables our worldwide customers to optimize technical, business and decision processes. Data management services provides efficient storage, browsing and retrieval of large volumes of exploration and petroleum data. The products and services offered by Landmark Graphics integrate data workflows and operational processes across disciplines, including geophysics, geology, drilling, engineering, production, economics, finance and corporate planning, and key partners and suppliers.
This segment also provides value-added oilfield project management and integrated solutions to independent, integrated and national oil companies. Integrated solutions enhance field deliverability and maximize a customer’s return on investment. These services make use of all of our products and technologies, as well as project management capabilities. Other services provide installation and servicing of subsea facilities and pipelines.
Also included in this segment is our equity method investment in WellDynamics, an intelligent well completions joint venture. As discussed above, in January 2004, Halliburton and Shell agreed to restructure the WellDynamics joint venture. We acquired an additional one percent of WellDynamics from Shell, giving us 51% ownership. With our resulting control of day-to-day operations, we believe we will be able to achieve more natural opportunities to leverage existing complementary businesses, reduce costs, and ensure global availability.
ENGINEERING AND CONSTRUCTION GROUP
Our Engineering and Construction Group segment, operating as KBR, provides a wide range of services to energy and industrial customers and government entities worldwide.
KBR offers the following:
-
onshore engineering and construction activities, including engineering and construction of liquefied natural gas, ammonia and crude oil refineries and natural gas plants;
-
offshore deepwater engineering, marine technology, project management, and related worldwide fabrication capabilities;
-
government operations, construction, maintenance and logistics activities for government facilities and installations;

 
  3  
 

-
plant operations, maintenance and start-up services for both upstream and downstream oil, gas and petrochemical facilities as well as operations, maintenance and logistics services for the power, commercial and industrial markets; and
-
civil engineering, consulting and project management services.
Dispositions in 2003. During 2003, we disposed of the following non-core businesses:
-
in January 2003, we sold our Mono Pumps business, which was reported in our Drilling and Formation Evaluation segment, to National Oilwell, Inc.;
-
in March 2003, we sold the assets relating to our Wellstream business, a global provider of flexible pipe products, systems and solutions, which was reported in our Landmark and Other Energy Services segment, to Candover Partners Ltd.; and
-
in May 2003, we sold certain assets of Halliburton Measurement Systems, which provides flow measurement and sampling systems and was reported in our Production Optimization segment, to NuFlo Technologies.
These dispositions will have an immaterial impact on our future operations. See Note 4 to the consolidated financial statements for additional information related to 2003 dispositions.
Business strategy. Our business strategy is to maintain global leadership in providing energy services and products and engineering and construction services. We provide these services and products to our customers as discrete services and products and, when combined with project management services, as integrated solutions. Our ability to be a global leader depends on meeting four key goals:
-
establishing and maintaining technological leadership;
-
achieving and continuing operational excellence;
-
creating and continuing innovative business relationships; and
-
preserving a dynamic workforce.
Markets and competition. We are one of the world’s largest diversified energy services and engineering and construction services companies. We believe that our future success will depend in large part upon our ability to offer a wide array of services and products on a global scale. Our services and products are sold in highly competitive markets throughout the world. Competitive factors impacting sales of our services and products include:
-
price;
-
service delivery (including the ability to deliver services and products on an “as needed, where needed” basis);
-
service quality;
-
product quality;
-
warranty; and
-
technical proficiency.
While we provide a wide range of discrete services and products, a number of customers have indicated a preference for integrated services and solutions. In the case of the Energy Services Group, integrated services and solutions relate to all phases of exploration, development and production of oil, natural gas and natural gas liquids. In the case of the Engineering and Construction Group, integrated services and solutions relate to all phases of design, procurement, construction, project management and maintenance of facilities primarily for energy and government customers.
We conduct business worldwide in over 100 countries. In 2003, based on the location of services provided and products sold, 27% of our total revenue was from the United States and 15% of our total revenue was from Iraq, primarily related to our work for the United States government. In 2002, 33% of our total revenue was from the United States and 12% of our total revenue was from the United Kingdom. No other country accounted for more than 10% of our total revenue during these periods. Since the markets for our services and products are vast and cross numerous geographic lines, a meaningful estimate of the total number of competitors cannot be made. The industries we serve are highly competitive and we

 
  4  
 

have many substantial competitors. Substantially all of our services and products are marketed through our servicing and sales organizations.
Operations in some countries may be adversely affected by unsettled political conditions, acts of terrorism, civil unrest, expropriation or other governmental actions and exchange control and currency problems. We believe the geographic diversification of our business activities reduces the risk that loss of operations in any one country would be material to the conduct of our operations taken as a whole. While Venezuela accounted for less than one percent of our 2003 revenues, the continuing economic and political instability will continue to negatively impact our business activities in Venezuela until resolved. The currency devaluation in Venezuela in February 2004 did not materially impact our operations, but further devaluations could negatively impact our operations in 2004. Due to continuing levels of civil disturbance and the social, economic and political climate, a number of our customers have ceased operations in the Nigerian Delta region and our operations could be negatively impacted. Energy Services Group operations in Nigeria accounted for approximately 2% of our revenues in 2003, and these developments could negatively impact our operations in 2004. Information regarding our exposures to foreign currency fluctuations, risk concentration and financial instruments used to minimize risk is included in Management’s Discussion and Analysis of Financial Condition and Results of Operations - Financial Instrument Market Risk and in Note 18 to the consolidated financial statements.
Customers and backlog. Our revenues during the past three years were mainly derived from the sale of services and products to the energy industry, including 66% in 2003, 86% in 2002 and 85% in 2001. Revenues from the United States government (which resulted primarily from the work performed in the Middle East by our Engineering and Construction Group) represented 26% of our 2003 consolidated revenues. Revenues from the United States government during 2002 and 2001 represented less than 10% of total consolidated revenues. No other customer represented more than 10% of consolidated revenues in any period presented.
The following schedule summarizes our project backlog at December 31, 2003 and 2002:

Millions of dollars
  

2003

 

2002

  
Firm orders
  
$
8,928
  
$
8,704
  
Government orders firm but not yet funded;
letters of intent and contracts awarded
but not signed
    
1,138
    
1,330
  
Total
  
$
10,066
  
$
10,034
  

Of the total backlog at December 31, 2003, $9,745 million relates to KBR operations with the remainder arising from our Energy Services Group. The entire Energy Services Group 2003 backlog relates to subsea operations. We estimate that 73% of the total backlog existing at December 31, 2003 will be completed during 2004. Approximately 72% of total backlog relates to cost reimbursable contracts with the remaining 28% relating to fixed-price contracts. In addition, backlog relating to engineering, procurement, installation and commissioning contracts for the offshore oil and gas industry totaled $432 million at December 31, 2003. For contracts that are not for a specific amount, backlog is estimated as follows:
-
operations and maintenance contracts that cover multiple years are included in backlog based upon an estimate of the work to be provided over the next twelve months; and
-
government contracts that cover a broad scope of work up to a maximum value are included in backlog at the estimated amount of work to be completed under the contract based upon periodic consultation with the customer.
For projects where we act as project manager, we only include our scope of each project in backlog. For projects related to unconsolidated joint ventures, we only include our percentage ownership

 
  5  
 

of each joint venture’s backlog, which totaled $1.9 billion at December 31, 2003. Our backlog excludes contracts for recurring hardware and software maintenance and support services offered by Landmark Graphics. Backlog is not indicative of future operating results because backlog figures are subject to substantial fluctuations. Arrangements included in backlog are in many instances extremely complex, nonrepetitive in nature and may fluctuate in contract value and timing. Many contracts do not provide for a fixed amount of work to be performed and are subject to modification or termination by the customer. The termination or modification of any one or more sizeable contracts or the addition of other contracts may have a substantial and immediate effect on backlog.
Not included in the above backlog numbers for December 31, 2003 are two new government contracts awarded in January 2004. KBR was awarded the five year United States Army Corps of Engineers’ CENTCOM contract for up to $1.5 billion and the competitively bid $1.2 billion Restore Iraqi Oil, or RIO, continuation contract, which will run for up to two years. As KBR receives task orders on these contracts, the amount of the task order will be included in backlog.
Raw materials. Raw materials essential to our business are normally readily available. Where we rely on a single supplier for materials essential to our business, we are confident that we could make satisfactory alternative arrangements in the event of an interruption in supply.
Research and development costs. We maintain an active research and development program. The program improves existing products and processes, develops new products and processes and improves engineering standards and practices that serve the changing needs of our customers. Our expenditures for research and development activities totaled $221 million in 2003 and $233 million in both 2002 and 2001.
Patents. We own a large number of patents and have pending a substantial number of patent applications covering various products and processes. We are also licensed to utilize patents owned by others. Included in “Other assets” is the cost associated with our patents, net of accumulated amortization, totaling $49 million as of December 31, 2003 and $58 million as of December 31, 2002. We do not consider any particular patent or group of patents to be material to our business operations.
Seasonality. On an overall basis, our operations are not generally affected by seasonality. Weather and natural phenomena can temporarily affect the performance of our services, but the widespread geographical locations of our operations serve to mitigate those effects. Examples of how weather can impact our business include:
-
the severity and duration of the winter in North America can have a significant impact on gas storage levels and drilling activity for natural gas;
-
the timing and duration of the spring thaw in Canada directly affects activity levels due to road restrictions;
-
typhoons and hurricanes can disrupt offshore operations; and
-
severe weather during the winter months normally results in reduced activity levels in the North Sea.
Due to higher spending near the end of the year on capital expenditures by its customers for software, Landmark Graphics results of operations are generally stronger in the fourth quarter of the year than at the beginning of the year.
Employees. At December 31, 2003, we employed approximately 101,000 people worldwide compared to 83,000 at December 31, 2002. The large increase is primarily due to KBR’s expanded operations in the Middle East during 2003. At December 31, 2003, approximately seven percent of our employees were subject to collective bargaining agreements. Based upon the geographic diversification of these employees, we believe any risk of loss from employee strikes or other collective actions would not be material to the conduct of our operations taken as a whole.
Environmental regulation. We are subject to numerous environmental, legal and regulatory requirements related to our operations worldwide. In the United States, these laws and regulations include, among others:

 
  6  
 

-
the Comprehensive Environmental Response, Compensation and Liability Act;
-
the Resources Conservation and Recovery Act;
-
the Clean Air Act;
-
the Federal Water Pollution Control Act; and
-
the Toxic Substances Control Act.
In addition to the federal laws and regulations, states and other countries where we do business may have numerous environmental, legal and regulatory requirements by which we must abide.
We evaluate and address the environmental impact of our operations by assessing and remediating contaminated properties in order to avoid future liabilities and comply with environmental, legal and regulatory requirements. On occasion, we are involved in specific environmental litigation and claims, including the remediation of properties we own or have operated as well as efforts to meet or correct compliance-related matters. Our Health, Safety and Environment group has several programs in place to maintain environmental leadership and to prevent the occurrence of environmental contamination.
We do not expect costs related to these remediation requirements to have a material adverse effect on our consolidated financial position or our results of operations. We have subsidiaries that have been named as potentially responsible parties along with other third parties for nine federal and state superfund sites for which we have established a liability. As of December 31, 2003, those nine sites accounted for approximately $7 million of our total $31 million liability. See Note 13 to the consolidated financial statements.
Website access. The Company's annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act of 1934 are made available free of charge on the Company's internet website at www.halliburton.com as soon as reasonably practicable after the Company has electronically filed the material with, or furnished it to, the Securities and Exchange Commission. Also posted on our website is our Code of Business Conduct, which applies to all our employees and also serves as a code of ethics for our chief executive officer, chief financial officer, chief accounting officer and persons performing similar functions.

 
  7  
 

Item 2. Properties.
We own or lease numerous properties in domestic and foreign locations. The following locations represent our major facilities:

Location
 
Owned/Leased
 
Sq. Footage
 
Description
Energy Services Group
North America
 
 
 
 
 
 
Drilling and Formation
 
 
 
 
 
 
Evaluation Segment:
 
 
 
 
 
 
 
 
 
 
 
 
 
Dallas, Texas
 
Owned
 
352,000
 
Manufacturing facility includes office, laboratory and warehouse space that primarily produces roller cone drill bits. In December 2003, we moved the production from this facility to our new facility in The Woodlands, Texas. The facility is currently for sale.
 
The Woodlands, Texas
 
Leased
 
256,000
 
Manufacturing facility including warehouses, engineering and sales, testing, training and research. The manufacturing plant produces roller cone and rotary type drill bits.
 
Production Optimization Segment:
 
Carrollton, Texas
 
Owned
 
649,000
 
Manufacturing facility including warehouses, engineering and sales, testing, training and research. The manufacturing plant produces equipment for the Production Optimization segment, including surface and subsurface safety valves and packer assemblies.
 
Shared Facilities:
 
Duncan, Oklahoma
 
Owned
 
1,275,000
 
Four locations which include manufacturing capacity totaling 655,000 square feet. The manufacturing facility is the main manufacturing site for the cementing, fracturing and acidizing equipment. The Duncan facilities also include a technology and research center, training facility, administrative offices and warehousing. These facilities service our Drilling and Formation Evaluation, Fluids and Production Optimization segments.
 

 
  8  
 

Location
 
Owned/Leased
 
Sq. Footage
 
Description
Shared Facilities (continued):
 
Houston, Texas
 
Owned
 
638,000
 
Two suburban campus locations utilized by our Drilling and Formation Evaluation and Fluids segments. One campus is on 89 acres consisting of office, training, test well, warehouse, manufacturing and laboratory facilities. The manufacturing facility, which occupies 115,000 square feet, produces highly specialized downhole equipment for our Drilling and Formation Evaluation segment. The other campus is a manufacturing facility with limited office, laboratory and warehouse space that primarily produces fixed cutter drill bits.
 
Houston, Texas
 
Owned
 
564,000
 
A campus facility that is the home office for the Energy Services Group.
 
Alvarado, Texas
 
Owned
 
238,000
 
Manufacturing facility including some office and warehouse space. The manufacturing facility produces perforating products and exploratory and formation evaluation tools for our Drilling and Formation Evaluation and Production Optimization segments.
 
Europe/Africa
 
 
 
 
 
 
Shared Facilities:
 
 
 
 
 
 
 
Aberdeen, United Kingdom
 
Owned
Leased
 
1,216,000
365,000
 
A total of 26 sites including 866,000 square feet of manufacturing capacity used by various business segments.
 
Tananger, Norway
 
Leased
 
319,000
 
Service center with workshops, testing facilities, warehousing and office facilities supporting the Norwegian North Sea operations.
 
Engineering and Construction Group
North America
 
 
 
 
 
 
 
Houston, Texas
 
Leased
 
740,000
 
Engineering and project support center which occupies 31 full floors in 2 office buildings. One of these buildings is owned by a joint venture in which we have a 50% ownership. The remaining 50% of the joint venture is owned by a subsidiary of Trizec Properties Inc. (NYSE: TRZ). Trizec is not affiliated with Halliburton Company or any of its directors or executive officers.
 

 
  9  
 

Location
 
Owned/Leased
 
Sq. Footage
 
Description
North America (continued)
 
 
 
 
 
 
 
Houston, Texas
 
Owned
 
977,000
 
A campus facility occupying 135 acres utilized primarily for administrative and support personnel. Approximately 221,000 square feet is dedicated to maintenance and warehousing of construction equipment. This campus also serves as office facilities for KBR.
 
Europe/Africa
 
 
 
 
 
 
 
Leatherhead, United Kingdom
 
Owned
 
262,000
 
Engineering and project support center on 55 acres in suburban London.
 
Corporate
 
 
 
 
 
 
 
Houston, Texas
 
Leased
 
30,000
 
Corporate executive offices.
 

In addition, we have 173 international and 106 United States field camps from which the Energy Services Group delivers its products and services. We also have numerous small facilities that include sales offices, project offices and bulk storage facilities throughout the world. We own or lease marine fabrication facilities covering approximately 761 acres in Texas, England and Scotland which are used by the Engineering and Construction Group.
We have mineral rights to proven and probable reserves of barite and bentonite. These rights include leaseholds, mining claims and owned property. We process barite and bentonite for supply to many industrial markets worldwide in addition to using it in our Fluids segment. Based on the number of tons of bentonite consumed in fiscal year 2003, we estimate our 19 million tons of proven reserves in areas of active mining are sufficient to fulfill our internal and external needs for the next 15 years. We estimate that our 2.7 million tons of proven reserves of barite in areas of active mining equate to a 17 year supply based on current rates of production. These estimates are subject to change based on periodic updates to reserve estimates and to the extent future consumption differs from current levels of consumption.
We believe all properties that we currently occupy are suitable for their intended use.

Item 3. Legal Proceedings.
Information relating to various commitments and contingencies is described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Forward-Looking Information and Risk Factors” and in Notes 11, 12 and 13 to the consolidated financial statements.

Item 4. Submission of Matters to a Vote of Security Holders.
There were no matters submitted to a vote of security holders during the fourth quarter of 2003.

 
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Executive Officers of the Registrant.

The following table indicates the names and ages of the executive officers of the registrant as of February 1, 2004, along with a listing of all offices held by each during the past five years:

Name and Age
 
Offices Held and Term of Office
 
Jerry H. Blurton
(Age 59)
 
 
Vice President and Treasurer of Halliburton Company, since July 1996
*
Albert O. Cornelison, Jr.
(Age 54)
 
Executive Vice President and General Counsel of Halliburton Company, since December 2002
Vice President and General Counsel of Halliburton Company, May 2002 to December 2002
Vice President and Associate General Counsel of Halliburton Company, October 1998 to May 2002
 
*
C. Christopher Gaut
(Age 47)
 
Executive Vice President and Chief Financial Officer of Halliburton Company, since March 2003
Senior Vice President, Chief Financial Officer and Member – Office of the President and Chief Operating Officer of ENSCO International Incorporated, January 2002 to February 2003
Senior Vice President and Chief Financial Officer of ENSCO International Incorporated, December 1987 to December 2001
 
*
John W. Gibson, Jr.
(Age 46)
 
President and Chief Executive Officer of Energy Services Group, since January 2003
President of Halliburton Energy Services, March 2002 to December 2002
President and Chief Executive Officer of Landmark, May 2000 to February 2002
Chief Operating Officer of Landmark, July 1999 to April 2000
Executive Vice President of Integrated Products Group, February 1996 to June 1999
 
*
Robert R. Harl
(Age 53)
 
Chief Executive Officer of Kellogg Brown & Root, Inc., since March 2001
President of Kellogg Brown & Root, Inc., since October 2000
Vice President of Kellogg Brown & Root, Inc., March 1999 to October 2000
Chief Executive Officer and President of Brown & Root Energy Services Division of Kellogg Brown & Root, Inc., April 2000 to February 2001
Chief Executive Officer of Brown & Root Services Division of Kellogg Brown & Root, Inc., January 1999 to April 2000
Chief Executive Officer and President of Brown & Root Services Corporation, November 1996 to January 1999
 

 
  11  
 

Executive Officers of the Registrant (continued)

Name and Age
 
Offices Held and Term of Office
*
David J. Lesar
(Age 50)
 
Chairman of the Board, President and Chief Executive Officer of Halliburton Company, since August 2000
Director of Halliburton Company, since August 2000
President and Chief Operating Officer of Halliburton Company, May 1997 to August 2000
Executive Vice President and Chief Financial Officer of Halliburton Company, August 1995 to May 1997
Chairman of the Board of Kellogg Brown & Root, Inc., January 1999 to August 2000
 
 
Mark A. McCollum
(Age 44)
 
Senior Vice President and Chief Accounting Officer, since August 2003
Senior Vice President and Chief Financial Officer, Tenneco Automotive, Inc., November 1999 to August 2003
Vice President, Global Finance of Tenneco Automotive, September 1998 to November 1999
 
*
Weldon J. Mire
(Age 56)
 
Vice President – Human Resources of Halliburton Company, since May 2002
Division Vice President of Halliburton Energy Services, January 2001 to May 2002 (Country Vice President Indonesia)
Asia Pacific Sales Manager of Halliburton Energy Services, November 1999 to January 2001
Director of Business Development, September 1999 to November 1999
Global Director of Strategic Business Development, January 1999 to November 1999
Senior Shared Service Manager Houston, November 1998 to January 1999
 
 
David R. Smith
(Age 57)
 
Vice President – Tax of Halliburton Company, since May 2002
Vice President – Tax of Halliburton Energy Services, Inc., September 1998 to May 2002
 

* Members of the Policy Committee of the registrant.

There are no family relationships between the executive officers of the registrant or between any director and any executive officer of the registrant.

 
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PART II

Item 5. Market for the Registrant’s Common Stock and Related Stockholder Matters.
Halliburton Company’s common stock is traded on the New York Stock Exchange and the Swiss Exchange. Information relating to the high and low market prices of common stock and quarterly dividend payments is included under the caption “Quarterly Data and Market Price Information” on page 124 of this annual report. Cash dividends on common stock for 2003 and 2002 in the amount of $0.125 per share were paid in March, June, September, and December of each year. Our Board of Directors intends to consider the payment of quarterly dividends on the outstanding shares of our common stock in the future. The declaration and payment of future dividends, however, will be at the discretion of the Board of Directors and will depend upon, among other things, future earnings, general financial condition and liquidity, success in business activities, capital requirements, and general business conditions.
At December 31, 2003, there were approximately 24,143 shareholders of record. In calculating the number of shareholders, we consider clearing agencies and security position listings as one shareholder for each agency or listing.

Item 6. Selected Financial Data.
Information relating to selected financial data is included on page 123 of this annual report.

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Information relating to Management’s Discussion and Analysis of Financial Condition and Results of Operations is included on pages 16 through 62 of this annual report.

Item 7(a). Quantitative and Qualitative Disclosures About Market Risk.
Information relating to market risk is included in Management’s Discussion and Analysis of Financial Condition and Results of Operations under the caption “Financial Instrument Market Risk” on pages 47 and 48 of this annual report.
 
 
  13  
 
 
Item 8. Financial Statements and Supplementary Data.

 
 
Page No.
Responsibility for Financial Reporting
 
63
Independent Auditors’ Report
 
64-65
Consolidated Statements of Operations for the years ended
December 31, 2003, 2002 and 2001
 
66
Consolidated Balance Sheets at December 31, 2003 and 2002
 
67
Consolidated Statements of Shareholders’ Equity for the years ended
December 31, 2003, 2002 and 2001
 
68
Consolidated Statements of Cash Flows for the years ended
December 31, 2003, 2002 and 2001
 
69
Notes to Consolidated Financial Statements
 
70-122
Selected Financial Data (Unaudited)
 
123
Quarterly Data and Market Price Information (Unaudited)
 
124

The related financial statement schedules are included under Part IV, Item 15 of this annual report.

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.

Item 9(a). Controls and Procedures.
In accordance with Exchange Act Rules 13a-15 and 15d-15, we carried out an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of December 31, 2003 to provide reasonable assurance that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Our disclosure controls and procedures include controls and procedures designed to ensure that information required to be disclosed in reports filed or submitted under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial officer, as appropriate, to allow timely decisions regarding required disclosure.
During the fourth quarter of 2003, it became apparent to us that the existing infrastructure for our LogCAP and RIO contracts to support activities in Iraq was being strained. Specifically, these projects are being performed in a war zone with operations spread across 60 different site locations in Kuwait and Iraq, and we have had to carefully balance the priority of keeping our people safe against the demand for significant resources in forward areas. Once deployed in forward areas, our people often have had difficulty communicating due to very poor telephone or computer infrastructure. Additionally, these projects have had to ramp up very quickly to respond to customer demands. Revenues on these projects increased from $320 million in the second quarter of 2003 to $900 million in the third quarter of 2003 and to $2.2 billion in the fourth quarter of 2003. The accelerated and significant ramp up in services, concerns for the security of our employees and subcontractors, as well as the complexity and scale of these projects, have created unique challenges in establishing and maintaining a process and procedural environment that controls these projects as well as we would normally expect.
With respect to the fourth quarter of 2003, control issues were identified under our LogCAP and RIO contracts to support activities in Iraq as a result of work done by our internal and external auditors, and actions were immediately taken to address the issues. Specifically,

 
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-
our internal auditors identified that petty cash and bank accounts were not being reconciled to the general ledger in a timely manner. These accounts were properly reconciled prior to completing our year-end closing process;
-
our internal auditors identified that non-labor costs were not being reconciled between the project controls subledger and the general ledger in a timely manner. These costs were properly reconciled prior to completing our year-end closing process; and
-
KPMG LLP identified non-labor costs not yet entered into the project controls subledger (including goods and services that had been received but not invoiced) had not been fully accrued. An extensive review followed and additional resources were deployed, resulting in the identification of and accounting for the accrual of all such costs prior to completing our year-end closing process.
We believe that none of these internal control issues constituted significant deficiencies or material weaknesses in our internal controls over financial reporting. All of these issues were project specific to the LogCAP and RIO contracts to support activities in Iraq and related to the fourth quarter of 2003. These issues were identified and addressed promptly such that our fourth quarter results and financial statements were not affected. Neither were any prior periods affected.
We also identified procurement process issues under our LogCAP contract during the fourth quarter of 2003. Our internal auditors identified the need to complete the customer-required documentation in a number of procurement and subcontractor files. In response, we sent a task force into Kuwait to assist personnel in the project office in updating and formalizing procurement documentation, which had been delayed due to insufficient resources. The project procurement staff has also been significantly increased. As part of on-going audits by the Defense Contract Audit Agency (DCAA), several similar contract procurement process issues have been raised. See Note 13 to the consolidated financial statements. Recently, the DCAA has also issued a deficiency report related to the procurement process in Iraq, largely due to the procurement documentation issues mentioned above. It is likely that this will result in a formal audit by the DCAA in this area in the near future. Issues the DCAA raised are related to documentation of subcontractor selection and cost and evidence of an approved/preferred supplier listing. We do not believe the issues identified by the DCAA or us to be significant deficiencies or material weaknesses in internal controls over financial reporting. We are working with the DCAA and our customer, the Army Materiel Command, to complete the documentation files so that we receive the proper payments from our customer.
In order to strengthen our control environment for these contracts, we are implementing several improvements, including:
-
strengthening the procurement management for government operations within KBR;
-
adding procurement resources on the project;
-
mobilizing a task force to assist on procurement processes and documentation until sufficient resources have been hired and trained;
-
reinforcing requirements and adding resources to materials management and property control reconciliations;
-
reinforcing requirements and adding resources related to reconciliation of bank and petty cash accounts; and
-
revising and reinforcing procedures for identification of and accounting for accruals for goods and services received but not invoiced.
There have been no other changes in our internal controls over financial reporting that occurred during the quarter ended December 31, 2003 that materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

 
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HALLIBURTON COMPANY
Management’s Discussion and Analysis of Financial Condition and Results of Operations


EXECUTIVE OVERVIEW

During 2003, we made progress toward resolving our asbestos and silica liabilities. Our revenues grew nearly 30% to $16 billion, largely as a result of our increased government services work in the Middle East. We reduced our exposure related to unapproved claims and liquidated damages related to our challenging Barracuda-Caratinga construction project. We addressed the substantial expected future demands on our funds by securing financing, managing working capital and strictly following our reduced capital spending plan. We achieved all of this while continuing to effectively run our day-to-day business by delivering quality, on-time services to our customers.
Asbestos and silica. Having reached definitive settlements with almost all of our asbestos and silica personal injury claimants, certain of our subsidiaries filed Chapter 11 proceedings on December 16, 2003. A pre-approved proposed plan of reorganization was filed as part of the Chapter 11 proceedings. The confirmation hearing is currently scheduled in May 2004. If the plan is approved by the bankruptcy court, in addition to the $311 million paid to claimants in December 2003, we will contribute the following to trusts established for the benefit of the claimants:
-
up to approximately $2.5 billion in cash;
-
59.5 million shares of Halliburton common stock;
-
notes currently valued at approximately $52 million; and
-
insurance proceeds, if any, between $2.3 billion and $3.0 billion received by DII Industries and Kellogg Brown & Root.
Upon confirmation of the plan of reorganization, current and future asbestos and silica personal injury claims against Halliburton and its subsidiaries will be channeled into trusts established for the benefit of claimants, thus releasing Halliburton and its affiliates from those claims. We have also recently entered into a settlement with Equitas, the largest insurer of our asbestos and silica claims. The settlement calls for Equitas to pay us $575 million (representing approximately 60% of applicable limits of liability that DII Industries had substantial likelihood of recovering from Equitas) provided that we receive confirmation of our plan of reorganization and the current United States Congress does not pass national asbestos litigation reform legislation.
Government services in the Middle East. Our government services revenue related to Iraq totaled $3.6 billion in 2003. The work we perform includes providing construction and services (among other things):
-
to support deployment, site preparation, operations and maintenance and transportation for United States troops; and
-
to restore the Iraqi petroleum industry, such as extinguishing oil well fires, environmental assessments and cleanup at oil sites, oil infrastructure condition assessments, oilfield, pipeline and refinery maintenance and the procurement and importation of fuel products.
The accelerated ramp up in services in a war zone brought with it several challenges, including keeping our people safe, recruiting and retaining qualified personnel, identifying and retaining appropriate subcontractors, establishing the necessary internal control procedures associated with this type of business and funding the increased working capital demands. We have received and expect to continue to receive heightened media, legislative and regulatory attention regarding our work in Iraq, including the preliminary results of various audits by the Defense Contract Audit Agency (DCAA) related to our invoicing practices and our self-reporting of possible improper conduct by one or two of our former employees.

 
  16  
 

Barracuda-Caratinga project. In recent years we have faced numerous problems related to our Barracuda-Caratinga project, a multi-year construction project to build two converted supertankers, which will be used as floating production, storage and offloading units (FPSOs), 32 hydrocarbon production wells, 22 water injection wells and all sub-sea flow lines, umbilicals and risers necessary to connect the underwater wells to the FPSOs. The project will be used to develop the Barracuda and Caratinga crude oil fields, which are located off the coast of Brazil. The project is significantly behind its original schedule and in a financial loss position. In November 2003, we entered into an agreement with the project owner which settled a portion of our claims and also extended the project completion dates.
Financing activities. The anticipated cash contribution into the asbestos and silica trusts in 2004, the increased work in Iraq and potential additional delays of certain billings related to work in Iraq have required us to raise substantial funds and could require us to raise additional funds in order to meet our current and potential future liabilities and working capital requirements. As a result, between June 2003 and January 2004, we issued $1.2 billion in convertible notes and $1.6 billion in fixed and floating rate senior notes. In addition, in anticipation of the pre-packaged Chapter 11 filing, in the fourth quarter of 2003 we entered into:
-
a delayed-draw term facility that would currently provide for draws of up to $500 million to be available for cash funding of the trusts for the benefit of asbestos and silica claimants, if required conditions are met;
-
a master letter of credit facility intended to ensure that existing letters of credit supporting our contracts remain in place during the Chapter 11 filing; and
-
a $700 million three-year revolving credit facility for general working capital purposes which expires in October 2006.
We have other significant sources of funds available to us in the near-term should we need them, including, but not limited to, approximately $200 million in availability under our United States accounts receivable securitization facility. In addition, as early as January 2005, we may receive $500 million of the funds that would be provided by the Equitas settlement described above. In 2003, we implemented programs to improve our working capital and to limit our spending on capital projects to those critical to serving our customers. We continue to maintain our investment grade credit ratings and have sufficient cash and financing capacity to fund our asbestos and silica settlement obligations in 2004 and continue to grow our business.
Business focus. In 2003, we continued to focus on providing quality service to our customers and developing new technologies to effectively compete in a challenging market. Early in the year, we realigned our Energy Services Group into four new segments, allowing us to better align ourselves with how our customers procure our services and to capture new business and achieve better integration. Our Energy Services Group business is largely affected by worldwide drilling activity and oil and gas prices. In 2003 we were negatively impacted by the decline in the Gulf of Mexico offshore rig count and the reduction in deep water activity by a number of our key customers in that area. We reacted to this change in the market and put into place various measures in order to “right size” our business serving that area. Our continued emphasis on research and development resulted in growth in new products and services in 2003, such as rotary steerables and data center technologies. Besides the growth in government services work at KBR, including the recent awarding of the two-year $1.2 billion contract for the RIO program and the five-year up to $1.5 billion military support contract, we continue to differentiate ourselves as a leader in the liquefied natural gas industry by being a preferred engineer and constructor of liquification plants and receiving terminals throughout the world. We also recently completed the construction of the 1,420 kilometer Alice Springs to Darwin railroad in Australia, one of the largest and most complex infrastructure projects ever undertaken in that country, five months ahead of schedule.
Following is a more detailed discussion of each of these subjects.

 
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Asbestos and Silica Obligations and Insurance Recoveries
Pre-packaged Chapter 11 proceedings. DII Industries, LLC (DII Industries), Kellogg Brown & Root, Inc. (Kellogg Brown & Root) and our other affected subsidiaries filed Chapter 11 proceedings on December 16, 2003 in bankruptcy court in Pittsburgh, Pennsylvania. With the filing of the Chapter 11 proceedings, all asbestos and silica personal injury claims and related lawsuits against Halliburton and our affected subsidiaries have been stayed.
Our subsidiaries sought Chapter 11 protection because Sections 524 (g) and 105 of the Bankruptcy Code may be used to discharge current and future asbestos and silica personal injury claims against us and our subsidiaries. Upon confirmation of the plan of reorganization, current and future asbestos and silica claims against us and our affiliates will be channeled into trusts established for the benefit of claimants under Sections 524(g) and 105 of the Bankruptcy Code, thus releasing Halliburton and its affiliates from those claims.
A pre-packaged Chapter 11 proceeding is one in which a debtor seeks approval of a plan of reorganization from affected creditors before filing for Chapter 11 protection. Prior to proceeding with the Chapter 11 filing, our affected subsidiaries solicited acceptances from known present asbestos and silica claimants to a proposed plan of reorganization. In the fourth quarter of 2003, valid votes were received from approximately 364,000 asbestos claimants and approximately 21,000 silica claimants, representing substantially all known claimants. Of the votes validly cast, over 98% of voting asbestos claimants and over 99% of voting silica claimants voted to accept the proposed plan of reorganization, meeting the voting requirements of Chapter 11 of the Bankruptcy Code for approval of the proposed plan. The pre-approved proposed plan of reorganization was filed as part of the Chapter 11 proceedings.
The proposed plan of reorganization, which is consistent with the definitive settlement agreements reached with our asbestos and silica personal injury claimants in early 2003, provides that, if and when an order confirming the proposed plan of reorganization becomes final and non-appealable, in addition to the $311 million paid to claimants in December 2003, the following will be contributed to trusts for the benefit of current and future asbestos and silica personal injury claimants:
-
up to approximately $2.5 billion in cash;
-
59.5 million shares of Halliburton common stock (valued at approximately $1.6 billion for accrual purposes using a stock price of $26.17 per share, which is based on the average trading price for the five days immediately prior to and including December 31, 2003);
-
a one-year non-interest bearing note of $31 million for the benefit of asbestos claimants;
-
a silica note with an initial payment into a silica trust of $15 million. Subsequently the note provides that we will contribute an amount to the silica trust balance at the end of each year for the next 30 years to bring the silica trust balance to $15 million, $10 million or $5 million based upon a formula which uses average yearly disbursements from the trust to determine that amount. The note also provides for an extension of the note for 20 additional years under certain circumstances. We have estimated the amount of this note to be approximately $21 million. We will periodically reassess our valuation of this note based upon our projections of the amounts we believe we will be required to fund into the silica trust; and
-
insurance proceeds, if any, between $2.3 billion and $3.0 billion received by DII Industries and Kellogg Brown & Root.
In connection with reaching an agreement with representatives of asbestos and silica claimants to limit the cash required to settle pending claims to $2.775 billion, DII Industries paid $311 million on December 16, 2003. Halliburton also agreed to guarantee the payment of an additional $156 million of the remaining approximately $2.5 billion cash amount, which must be paid on the earlier to occur of June 17, 2004 or the date on which an order confirming the proposed plan of reorganization becomes final and non-appealable. As a part of the definitive settlement agreements, we have been accruing cash payments in lieu

 
  18  
 

of interest at a rate of five percent per annum for these amounts. We recorded approximately $24 million in pretax charges in 2003 related to the cash in lieu of interest. On December 16, 2003, we paid $22 million to satisfy a portion of our cash in lieu of interest payment obligations.
As a result of the filing of the Chapter 11 proceedings, we adjusted the asbestos and silica liability to reflect the full amount of the proposed settlement and certain related costs, which resulted in a before tax charge of approximately $1.016 billion to discontinued operations in the fourth quarter 2003. The tax effect on this charge was minimal, as a valuation allowance was established for the net operating loss carryforward created by the charge. We also reclassified a portion of our asbestos and silica related liabilities from long-term to short-term, resulting in an increase of short-term liabilities by approximately $2.5 billion, because we believe we will be required to fund these amounts within one year.
In accordance with the definitive settlement agreements entered in early 2003, we have been reviewing plaintiff files to establish a medical basis for payment of settlement amounts and to establish that the claimed injuries are based on exposure to our products. We have reviewed substantially all medical claims received. During the fourth quarter of 2003, we received significant numbers of the product identification due diligence files. Based on our review of these files, we received the necessary information to allow us to proceed with the pre-packaged Chapter 11 proceedings. As of December 31, 2003, approximately 63% of the value of claims passing medical due diligence have submitted satisfactory product identification. We expect the percentage to increase as we receive additional plaintiff files. Based on these results, we found that substantially all of the asbestos and silica liability relates to claims filed against our former operations that have been divested and included in discontinued operations. Consequently, all 2003 changes in our estimates related to the asbestos and silica liability were recorded through discontinued operations.
Our proposed plan of reorganization calls for a portion of our total asbestos and silica liability to be settled by contributing 59.5 million shares of Halliburton common stock into the trusts. We will continue to adjust our asbestos and silica liability related to the shares if the average value of Halliburton stock for the five days immediately prior to and including the end of each fiscal quarter has increased by five percent or more from the most recent valuation of the shares. At December 31, 2003, the value of the shares to be contributed is classified as a long-term liability on our consolidated balance sheet, and the shares have not been included in our calculation of basic or diluted earnings per share. If the shares had been included in the calculation as of the beginning of the fourth quarter, our diluted earnings per share from continuing operations for the year ended December 31, 2003 would have been reduced by $0.03. When and if we receive final and non-appealable confirmation of our proposed plan of reorganization, we will:
-
increase or decrease our asbestos and silica liability to value the 59.5 million shares of Halliburton common stock based on the value of Halliburton stock on the date of final and non-appealable confirmation of our proposed plan of reorganization;
-
reclassify from a long-term liability to shareholders’ equity the final value of the 59.5 million shares of Halliburton common stock; and
-
include the 59.5 million shares in our calculations of earnings per share on a prospective basis.
We understand that the United States Congress may consider adopting legislation that would establish a national trust fund as the exclusive means for recovery for asbestos-related disease. We are uncertain as to what contributions we would be required to make to a national trust, if any, although it is possible that they could be substantial and that they could continue for several years. It is also possible that our level of participation and contribution to a national trust could be greater than it otherwise would have been as a result of having subsidiaries that have filed Chapter 11 proceedings due to asbestos liability.

 
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Recent insurance developments. Concurrent with the remeasurement of our asbestos and silica liability due to the pre-packaged Chapter 11 filing, we evaluated the appropriateness of the $2.0 billion recorded for asbestos and silica insurance recoveries. In doing so, we separately evaluated two types of policies:
-
policies held by carriers with which we had either settled or which were probable of settling and for which we could reasonably estimate the amount of the settlement; and
-
other policies.
In December 2003, we retained Navigant Consulting (formerly Peterson Consulting), a nationally-recognized consultant in asbestos and silica liability and insurance, to assist us. In conducting their analysis, Navigant Consulting performed the following with respect to both types of policies:
-
reviewed DII Industries’ historical course of dealings with its insurance companies concerning the payment of asbestos-related claims, including DII Industries’ 15-year litigation and settlement history;
-
reviewed our insurance coverage policy database containing information on key policy terms as provided by outside counsel;
-
reviewed the terms of DII Industries’ prior and current coverage-in-place settlement agreements;
-
reviewed the status of DII Industries’ and Kellogg Brown & Root’s current insurance-related lawsuits and the various legal positions of the parties in those lawsuits in relation to the developed and developing case law and the historic positions taken by insurers in the earlier filed and settled lawsuits;
-
engaged in discussions with our counsel; and
-
analyzed publicly-available information concerning the ability of the DII Industries insurers to meet their obligations.
Navigant Consulting’s analysis assumed that there will be no recoveries from insolvent carriers and that those carriers which are currently solvent will continue to be solvent throughout the period of the applicable recoveries in the projections. Based on its review, analysis and discussions, Navigant Consulting’s analysis assisted us in making our judgments concerning insurance coverage that we believe are reasonable and consistent with our historical course of dealings with our insurers and the relevant case law to determine the probable insurance recoveries for asbestos liabilities. This analysis included the probable effects of self-insurance features, such as self-insured retentions, policy exclusions, liability caps and the financial status of applicable insurers, and various judicial determinations relevant to the applicable insurance programs. The analysis of Navigant Consulting is based on information provided by us.
In January 2004, we reached a comprehensive agreement with Equitas to settle our insurance claims against certain Underwriters at Lloyd's of London, reinsured by Equitas. The settlement will resolve all asbestos-related claims made against Lloyd's Underwriters by us and by each of our subsidiary and affiliated companies, including DII Industries, Kellogg Brown & Root and their subsidiaries that have filed Chapter 11 proceedings as part of our proposed settlement. Our claims against our other London Market Company Insurers are not affected by this settlement. Provided that there is final confirmation of the plan of reorganization in the Chapter 11 proceedings and the current United States Congress does not pass national asbestos litigation reform legislation, Equitas will pay us $575 million, representing approximately 60% of the applicable limits of liability that DII Industries had substantial likelihood of recovering from Equitas. The first payment of $500 million will occur within 15 working days of the later of January 5, 2005 or the date on which the order of the bankruptcy court confirming DII Industries' plan of reorganization becomes final and non-appealable. A second payment of $75 million will be made eighteen months after the first payment.
As of December 31, 2003, we developed our best estimate of the asbestos and silica insurance receivables as follows:

 
  20  
 

-
included $575 million of insurance recoveries from Equitas based on the January 2004 comprehensive agreement;
-
included insurance recoveries from other specific insurers with whom we had settled;
-
estimated insurance recoveries from specific insurers that we are probable of settling with and for which we could reasonably estimate the amount of the settlement. When appropriate, these estimates considered prior settlements with insurers with similar facts and circumstances; and
-
estimated insurance recoveries for all other policies with the assistance of the Navigant Consulting study.
The estimate we developed as a result of this process was consistent with the amount of asbestos and silica receivables already recorded as of December 31, 2003, causing us not to significantly adjust our recorded insurance asset at that time. Our estimate was based on a comprehensive analysis of the situation existing at that time which could change significantly in the both near- and long-term period as a result of:
-
additional settlements with insurance companies;
-
additional insolvencies of carriers; and
-
legal interpretation of the type and amount of coverage available to us.
Currently, we cannot estimate the time frame for collection of this insurance receivable, except as described earlier with regard to the Equitas settlement.

United States Government Contract Work
We provide substantial work under our government contracts business to the United States Department of Defense and other governmental agencies, including under world-wide United States Army logistics contracts, known as LogCAP, and under contracts to rebuild Iraq’s petroleum industry, known as RIO. Our government services revenue related to Iraq totaled approximately $3.6 billion in 2003. Our units operating in Iraq and elsewhere under government contracts such as LogCAP and RIO consistently review the amounts charged and the services performed under these contracts. Our operations under these contracts are also regularly reviewed and audited by the Defense Contract Audit Agency, or DCAA, and other governmental agencies. When issues are found during the governmental agency audit process, these issues are typically discussed and reviewed with us in order to reach a resolution.
The results of a preliminary audit by the DCAA in December 2003 alleged that we may have overcharged the Department of Defense by $61 million in importing fuel into Iraq. After a review, the Army Corps of Engineers, which is our client and oversees the project, concluded that we obtained a fair price for the fuel. However, Department of Defense officials thereafter referred the matter to the agency’s inspector general, which we understand has commenced an investigation. We have recently been advised by the Criminal Division of the United States Department of Justice that it too may decide to investigate this matter. If criminal wrongdoing were found, criminal penalties could range up to the greater of $500,000 in fines per count for a corporation, or twice the gross pecuniary gain or loss. During 2003, we recognized revenues and received full payment related to these services. We have also in the past had inquiries by the DCAA and the civil fraud division of the United States Department of Justice into possible overcharges for work performed during 1996 through 2000 under a contract in the Balkans, which inquiry has not yet been completed by the Department of Justice. Based on an internal investigation, we credited our customer approximately $2 million during 2000 and 2001 related to our work in the Balkans as a result of billings for which support was not readily available. We believe that the preliminary Department of Justice inquiry relates to potential overcharges in connection with a part of the Balkans contract under which approximately $100 million in work was done. The Department of Justice has not alleged any overcharges, and we believe that any allegation of overcharges would be without merit.

 
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The DCAA has raised issues relating to our invoicing to the Army Materiel Command for food services for soldiers and supporting civilian personnel in Iraq and Kuwait during 2003. We believe these issues raised by the DCAA are issues of contractual interpretation and not issues that relate to our internal controls over financial reporting. We have taken two actions in response to the issues raised by the DCAA. First, we have temporarily credited $36 million to the Department of Defense until Halliburton, the DCAA and the Army Materiel Command agree on a process to be used for invoicing for food services. We have recognized revenues and related costs associated with these services, and the $36 million is reflected in “Notes and accounts receivable” in our December 31, 2003 consolidated balance sheet. Second, we are not submitting $141 million of additional food services invoices until an internal review is completed regarding the number of meals ordered by the Army Materiel Command and the number of soldiers actually served at dining facilities for United States troops and supporting civilian personnel in Iraq and Kuwait. The $141 million amount is our “order of magnitude” estimate of the remaining amounts (in addition to the $36 million we already temporarily credited) being questioned by the DCAA. We have recognized revenues and related costs associated with these services, and the $141 million is reflected in “Unbilled work on uncompleted contracts” in our December 31, 2003 consolidated balance sheet. The issues relate to whether invoicing should be based on the number of meals ordered by the Army Materiel Command or whether invoicing should be based on the number of personnel served. We have been invoicing based on the number of meals ordered. The DCAA is contending that the invoicing should be based on the number of personnel served. We believe our position is correct, but have undertaken a comprehensive review of its propriety and the views of the DCAA. However, we cannot predict when the issue will be resolved with the DCAA. In the meantime, we may withhold all or a portion of the payments to our subcontractors relating to the withheld invoices pending resolution of the issues. Except for the $36 million in credits and the $141 million of withheld invoices, all our invoicing in Iraq and Kuwait for other food services and other matters are being processed and sent to the Army Materiel Command for payment in the ordinary course.
 
Barracuda-Caratinga Project
In June 2000, KBR entered into a contract with Barracuda & Caratinga Leasing Company B.V., the project owner, to develop the Barracuda and Caratinga crude oil fields, which are located off the coast of Brazil. The construction manager and owner's representative is Petroleo Brasilero SA (Petrobras), the Brazilian national oil company. When completed, the project will consist of two converted supertankers, Barracuda and Caratinga, which will be used as floating production, storage and offloading units, commonly referred to as FPSOs, 32 hydrocarbon production wells, 22 water injection wells and all sub-sea flow lines, umbilicals and risers necessary to connect the underwater wells to the FPSOs. The project is significantly behind the original schedule due in large part to change orders from the project owner and is in a financial loss position. As a result, we have asserted numerous claims against the project owner and

 
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are subject to potential liquidated damages. We continue to engage in discussions with the project owner in an attempt to settle issues relating to additional claims, completion dates and liquidated damages.
Our performance under the contract is secured by:
-
performance letters of credit, which together have an available credit of approximately $266 million as of December 31, 2003 and which will continue to be adjusted to represent approximately 10% of the contract amount, as amended to date by change orders;
-
retainage letters of credit, which together have available credit of approximately $160 million as of December 31, 2003 and which will increase in order to continue to represent 10% of the cumulative cash amounts paid to us; and
-
a guarantee of Kellogg Brown & Root's performance under the agreement by Halliburton Company in favor of the project owner.
In November 2003, we entered into agreements with the project owner in which the project owner agreed to:
-
pay $69 million to settle a portion of our claims, thereby reducing the amount of probable unapproved claims to $114 million; and
-
extend the original project completion dates and other milestone dates, reducing our exposure to liquidated damages.
Accordingly, as of December 31, 2003:
-
the project was approximately 83% complete;
-
we have recorded an inception to date pretax loss of $355 million related to the project, of which $238 million was recorded in 2003 and $117 million was recorded in 2002;
-
the probable unapproved claims included in determining the loss were $114 million; and
-
we have an exposure to liquidated damages of up to ten percent of the contract value. Based upon the current schedule forecast, we would incur $96 million in liquidated damages if our claim for additional time is not successful.
Unapproved Claims. We have asserted claims for compensation substantially in excess of the $114 million of probable unapproved claims recorded as noncurrent assets as of December 31, 2003, as well as claims for additional time to complete the project before liquidated damages become applicable. The project owner and Petrobras have asserted claims against us that are in addition to the project owner’s potential claims for liquidated damages. In the November 2003 agreements, the parties have agreed to arbitrate these remaining disputed claims. In addition, we have agreed to cap our financial recovery to a maximum of $375 million, and the project owner and Petrobras have agreed to cap their recovery to a maximum of $380 million plus liquidated damages.
Liquidated Damages. The original completion date for the Barracuda vessel was December 2003, and the original completion date for the Caratinga vessel was April 2004. We expect that the Barracuda vessel will likely be completed at least 16 months later than its original contract determination date, and the Caratinga vessel will likely be completed at least 14 months later than its original contract determination date. However, there can be no assurance that further delays will not occur. In the event that any portion of the delay is determined to be attributable to us and any phase of the project is completed after the milestone dates specified in the contract, we could be required to pay liquidated damages. These damages were initially calculated on an escalating basis rising ultimately to approximately $1 million per day of delay caused by us, subject to a total cap on liquidated damages of 10% of the final contract amount (yielding a cap of approximately $272 million as of December 31, 2003).
Under the November 2003 agreements, the project owner granted an extension of time to the original completion dates and other milestone dates that average approximately 12 months. In addition, the project owner agreed to delay any attempt to assess the original liquidated damages against us for project delays beyond 12 months and up to 18 months and delay any drawing of letters of credit with respect to

 
  23  
 

such liquidated damages until the earliest of December 7, 2004, the completion of any arbitration proceedings or the resolution of all claims between the project owner and us. Although the November 2003 agreements do not delay the drawing of letters of credit for liquidated damages for delays beyond 18 months, our master letter of credit facility (see Note 13 to the consolidated financial statements) will provide funding for any such draw while it is in effect. The November 2003 agreements also provide for a separate liquidated damages calculation of $450,000 per day for each of the Barracuda and the Caratinga vessels if delayed beyond 18 months from the original schedule. That amount is subject to the total cap on liquidated damages of 10% of the final contract amount. Based upon the November 2003 agreements and our most recent estimates of project completion dates, which are April 2005 for the Barracuda vessel and May 2005 for the Caratinga vessel, we estimate that if we were to be completely unsuccessful in our claims for additional time, we would be obligated to pay $96 million in liquidated damages. We have not accrued for this exposure because we consider the imposition of such liquidated damages to be unlikely.
Value added taxes. On December 16, 2003, the State of Rio de Janeiro issued a decree recognizing that Petrobras is entitled to a credit for the value added taxes paid on the project. The decree also provided that value added taxes that may have become due on the project, but which had not yet been paid could be paid in January 2004 without penalty or interest. In response to the decree, we have entered into an agreement with Petrobras whereby Petrobras agreed to:
-
directly pay the value added taxes due on all imports on the project (including Petrobras’ January 2004 payment of approximately $150 million); and
-
reimburse us for value added taxes paid on local purchases, of which approximately $100 million will become due during 2004.
Since the credit to Petrobras for these value added taxes is on a delayed basis, the issue of whether we must bear the cost of money for the period from payment by Petrobras until receipt of the credit has not been determined.
The validity of the December 2003 decree has now been challenged in court in Brazil. Our legal advisers in Brazil believe that the decree will be upheld. If it is overturned or rescinded, or the Petrobras credits are lost for any other reason not due to Petrobras, the issue of who must ultimately bear the cost of the value added taxes will have to be determined based upon the law prior to the December 2003 decree. We believe that the value added taxes are reimbursable under the contract and prior law, but, until the December 2003 decree was issued, Petrobras and the project owner had been contesting the reimbursability of up to $227 million of value added taxes. There can be no assurance that we will not be required to pay all or a portion of these value added taxes. In addition, penalties and interest of $40 million to $100 million could be due if the December 2003 decree is invalidated. We have not accrued any amounts for these taxes, penalties or interest.
Default provisions. Prior to the filing of the pre-packaged Chapter 11 proceedings in connection with the proposed settlement of our asbestos and silica claims, we obtained a waiver from the project owner (with the approval of the lenders financing the project) so that the filing did not constitute an event of default under the contract. In addition, the project owner also obtained a waiver from the lenders so that the Chapter 11 filing did not constitute an event of default under the project owner’s loan agreements with the lenders. The waiver received by the project owner from the lenders is subject to certain conditions that have thus far been fulfilled. Included as a condition is that the pre-packaged plan of reorganization be confirmed by the bankruptcy court within 120 days of the filing of the Chapter 11 proceedings. The currently scheduled hearing date for confirmation of the plan of reorganization is not within the 120-day period. We understand that the project owner is seeking, and expects to receive, an extension of the 120-day period, but can give no assurance that it will be granted. In the event that the conditions do not continue to be fulfilled, the lenders, among other things, could exercise a right to suspend the project owner’s use of advances made, and currently escrowed, to fund the project. We believe it is unlikely that the lenders will exercise any right to suspend funding the project given the current status of the project and

 
  24  
 

the fact that a failure to pay may allow us to cease work on the project without Petrobras having a readily available substitute contractor. However, there can be no assurance that the lenders will continue to fund the project.
In the event that we were determined to be in default under the contract, and if the project was not completed by us as a result of such default (i.e., our services are terminated as a result of such default), the project owner may seek direct damages. Those damages could include completion costs in excess of the contract price and interest on borrowed funds, but would exclude consequential damages. The total damages could be up to $500 million plus the return of up to $300 million in advance payments previously received by us to the extent they have not been repaid. The original contract terms require repayment of the $300 million in advance payments by crediting the last $350 million of our invoices related to the contract by that amount, but the November 2003 agreements delay the repayment of any of the $300 million in advance payments until at least December 7, 2004. A termination of the contract by the project owner could have a material adverse effect on our financial condition and results of operations.
Cash flow considerations. The project owner has procured project finance funding obligations from various lenders to finance the payments due to us under the contract. The project owner currently has no other committed source of funding on which we can necessarily rely. In addition, the project financing includes borrowing capacity in excess of the original contract amount. However, only $250 million of this additional borrowing capacity is reserved for increases in the contract amount payable to us and our subcontractors.
Under the loan documents, the availability date for loan draws expired December 1, 2003 and therefore, the project owner drew down all remaining available funds on that date. As a condition to the draw down of the remaining funds, the project owner was required to escrow the funds for the exclusive use of paying project costs. The availability of the escrowed funds can be suspended by the lenders if applicable conditions are not met. With limited exceptions, these funds may not be paid to Petrobras or its subsidiary (which is funding the drilling costs of the project) until all amounts due to us, including amounts due for the claims, are liquidated and paid. While this potentially reduces the risk that the funds would not be available for payment to us, we are not party to the arrangement between the lenders and the project owner and can give no assurance that there will be adequate funding to cover current or future claims and change orders.
We have now begun to fund operating cash shortfalls on the project and would be obligated to fund such shortages over the remaining project life in an amount we currently estimate to be approximately $480 million. That funding level assumes generally that neither we nor the project owner are successful in recovering claims against the other and that no liquidated damages are imposed. Under the same assumptions, except assuming that we recover unapproved claims in the amounts currently recorded, the cash shortfall would be approximately $360 million. We have already funded approximately $85 million of such shortfall and expect that our funded shortfall amount will increase to approximately $416 million by December 2004, of which approximately $225 million would be paid to the project owner in December 2004 as part of the return of the $300 million in advance payments. The remainder of the advance payments would be returned to the project owner over the remaining life of the project after December 2004. There can be no assurance that we will recover the amount of unapproved claims we have recognized, or any amounts in excess of that amount.

LIQUIDITY AND CAPITAL RESOURCES

We ended 2003 with cash and cash equivalents of $1.8 billion compared to $1.1 billion at the end of 2002.
Significant uses of cash. Our liquidity and cash balance during 2003 have been significantly affected by our government services work in Iraq, our asbestos and silica liabilities, $296 million in scheduled debt maturities and a $180 million reduction of receivables in our securitization program. Our

 
  25  
 

working capital position (excluding cash and equivalents) increased by approximately $880 million due to the start-up of our government services work in Iraq. The activities in Iraq will continue to require this significant amount of working capital, and therefore the timing of the realization of this working capital is uncertain. We currently expect the working capital requirements related to Iraq will increase through the first half of 2004. An increase in the amount of services we are engaged to perform could place additional demands on our working capital. It is possible that we may, or may be required to, withhold additional invoicing or make refunds to our customer related to the DCAA’s review of additional aspects of our services, some of which could be substantial, until these matters are resolved. This could materially and adversely affect our liquidity.
On December 16, 2003, a partial payment of $311 million was made immediately prior to the Chapter 11 filing of our subsidiaries related to asbestos and silica personal injury claims. We have also agreed to guarantee the payment of an additional $156 million of the remaining approximately $2.5 billion cash amount, which must be paid on the earlier to occur of June 17, 2004 or the date on which an order confirming the proposed plan of reorganization becomes final and non-appealable. When and if we receive final and non-appealable confirmation of our plan of reorganization, we will be required to fund the remainder of the cash amount to be contributed to the asbestos and silica trusts.
As a result of capital discipline throughout the year, we have reduced capital expenditures from $764 million in 2002 to $515 million in 2003. We expect to continue this level of expenditures with capital outlays currently being estimated at approximately $540 million in 2004. We have not finalized our capital expenditures budget for 2005 or later periods. We currently have been paying annual dividends to our shareholders of approximately $219 million.
The following table summarizes our long-term contractual obligations as of December 31, 2003:

 
  

Payments due

    
 
    
 
  
   
             
Millions of dollars
  

2004

  

2005

  

2006

  

2007

  

2008

  

Thereafter

  

Total

  
Long-term debt (1)
  
$
22
  
$
324
  
$
296
  
$
10
  
$
151
  
$
2,625
  
$
3,428
  
Operating leases
    
143
    
96
    
80
    
58
    
45
    
267
    
689
  
Capital leases
    
1
    
1
    
-
    
-
    
-
    
-
    
2
  
Pension funding
obligations (2)
    
67
    
-
    
-
    
-
    
-
    
-
    
67
  
Purchase obligations (3)
    
241
    
4
    
4
    
3
    
3
    
1
    
256
  
Total long-term
   
 
    
 
    
 
    
 
    
 
    
 
    
 
  
contractual obligations
  
$
474
  
$
425
  
$
380
  
$
71
  
$
199
  
$
2,893
  
$
4,442
  
(1) Long-term debt excludes the effect of an interest rate swap of approximately $9 million. See Note 10 to the consolidated financial statements for further discussion.
(2) Congress is expected to consider pension funding relief legislation when they reconvene in 2004. The actual contributions we make during 2004 may be impacted by the final legislative outcome.
(3) The purchase obligations disclosed above do not include purchase obligations that KBR enters into with its vendors in the normal course of business that support existing contracting arrangements with its customers. The purchase obligations with their vendors can span several years depending on the duration of the projects. In general, the costs associated with the purchase obligations are expensed as the revenue is earned on the related projects.

In addition, we have received adverse judgments on two cases: BJ Services Company patent litigation and Anglo-Dutch (Tenge). (See Note 13 to the consolidated financial statements for more information.) We could be required to pay approximately $107 million during 2004 to BJ Services Company, which has been escrowed and is included in the restricted cash balance in “Other current assets”. We are currently appealing the Anglo-Dutch (Tenge) judgment but could be required to pay as much as

 
  26  
 

$106 million (although we have only accrued $77 million) to Anglo-Dutch Petroleum International, Inc. We have posted security in the amount of $25 million in order to postpone execution of the judgment until all appeals have been exhausted.
Significant sources of cash. After consideration of the increase in working capital needs related to work in Iraq, asbestos and silica claims payments, and the reduction of $180 million under our accounts receivable securitization facility, our operations provided approximately $600 million in cash flow in 2003. In addition, our cash flow was supplemented by cash from the sale of non-core businesses totaling $224 million, which included $136 million collected from the sale of Wellstream, $33 million collected from the sale of Halliburton Measurement Systems, $25 million collected on a note receivable that was received as a portion of the payment for Bredero-Shaw and $23 million collected from the sale of Mono Pumps.
In contemplation of the anticipated cash contribution into the asbestos and silica trusts in 2004 and to help fund our working capital needs in Iraq, we increased our long-term borrowings by approximately $2.2 billion during 2003 through the issuance of convertible bonds and fixed and floating rate senior notes. Also, in January of 2004, we issued senior notes due 2007 totaling $500 million, which will primarily be used to fund the asbestos and silica settlement liability. Our combined short-term notes payable and long-term debt was 58% of total capitalization at the end of 2003, compared to 30% at the end of 2002 and 24% at the end of 2001.
Future sources of cash. We have available to us significant sources of cash in the near-term should we need it.
Asbestos and silica liability financing. In the fourth quarter of 2003, we entered into a delayed-draw term facility for up to $1.0 billion. This facility was reduced in January 2004 to approximately $500 million by the net proceeds of our recent issuance of senior notes due 2007. This facility is subject to further reduction and could be available for cash funding of the trusts for the benefit of asbestos and silica claimants. There are a number of conditions that must be met before the delayed-draw term facility will become available for our use, including final and non-appealable confirmation of our plan of reorganization and confirmation of the rating of Halliburton’s long-term senior unsecured debt at BBB or higher by Standard & Poor’s and Baa2 or higher by Moody’s Investors Service. In addition, we entered into a $700 million three-year revolving credit facility for general working capital purposes, which replaced our $350 million revolving credit facility. At the time of its replacement, no amounts had been drawn against the $350 million revolver. The $700 million revolving credit facility is now effective and undrawn.
Asbestos and silica settlements with insurers. In January 2004, we reached a comprehensive agreement with Equitas to settle our insurance claims against certain Underwriters at Lloyd's of London, reinsured by Equitas. The settlement will resolve all asbestos-related claims made against Lloyd's Underwriters by us and by each of our subsidiary and affiliated companies, including DII Industries, Kellogg Brown & Root and their subsidiaries that have filed Chapter 11 proceedings as part of our proposed settlement. Our claims against our other London Market Company Insurers are not affected by this settlement. Provided that there is final confirmation of the plan of reorganization in the Chapter 11 proceedings and the current United States Congress does not pass national asbestos litigation reform legislation, Equitas will pay us $575 million, representing approximately 60% of the applicable limits of liability that DII Industries had substantial likelihood of recovering from Equitas. The first payment of $500 million will occur within 15 working days of the later of January 5, 2005 or the date on which the order of the bankruptcy court confirming DII Industries' plan of reorganization becomes final and non-appealable. A second payment of $75 million will be made eighteen months after the first payment.
Other Sources of cash. We also have available our accounts receivable securitization facility. See “Off Balance Sheet Risk” for a further discussion.
Other factors affecting liquidity
Credit ratings. Late in 2001 and early in 2002, Moody’s Investors Service lowered its ratings of our long-term senior unsecured debt to Baa2 and our short-term credit and commercial paper ratings to P-2. In addition, Standard & Poor’s lowered its ratings of our long-term senior unsecured debt to A- and our

 
  27  
 

short-term credit and commercial paper ratings to A-2 in late 2001. In December 2002, Standard & Poor’s lowered these ratings to BBB and A-3. These ratings were lowered primarily due to our asbestos and silica exposure. In December 2003, Moody’s Investors Service confirmed our ratings with a positive outlook and Standard & Poor’s revised its credit watch listing for us from “negative” to “developing” in response to our announcement that DII Industries and Kellogg Brown & Root and other of our subsidiaries filed Chapter 11 proceedings to implement the proposed asbestos and silica settlement.
Although our long-term unsecured debt ratings continue at investment grade levels, the cost of new borrowing is relatively higher and our access to the debt markets is more volatile at these new rating levels. Investment grade ratings are BBB- or higher for Standard & Poor’s and Baa3 or higher for Moody’s Investors Service. Our current long-term unsecured debt ratings are one level above BBB- on Standard & Poor’s and one level above Baa3 on Moody’s Investors Service. Several of our credit facilities or other contractual obligations require us to maintain a certain credit rating as follows:
-
our $700 million revolving credit facility would require us to provide additional collateral if our long-term unsecured debt rating falls below investment grade;
-
our Halliburton Elective Deferral Plan contains a provision which states that, if the Standard & Poor’s rating for our long-term unsecured debt falls below BBB, the amounts credited to the participants’ accounts will be paid to the participants in a lump-sum within 45 days. At December 31, 2003 this was approximately $51 million; and
-
certain of our letters of credit have ratings triggers that could require cash collateralization or give the banks set-off rights. These contingencies would be funded under the senior secured master letter of credit facility (see below) while it remains available.
Letters of credit. In the normal course of business, we have agreements with banks under which approximately $1.2 billion of letters of credit or bank guarantees were outstanding as of December 31, 2003, including $252 million which relate to our joint ventures’ operations. Certain of these letters of credits have triggering events (such as the filing of Chapter 11 proceedings by some of our subsidiaries or reductions in our credit ratings) that would allow the banks to require cash collateralization or allow the holder to draw upon the letter of credit.
In the fourth quarter of 2003, we entered into a senior secured master letter of credit facility (Master LC Facility) with a syndicate of banks which covers at least 90% of the face amount of our existing letters of credit. Under the Master LC Facility, each participating bank has permanently waived any right that it had to demand cash collateral as a result of the filing of Chapter 11 proceedings. In addition, the Master LC Facility provides for the issuance of new letters of credit, so long as the total facility does not exceed an amount equal to the amount of the facility at closing plus $250 million, or approximately $1.5 billion.
The purpose of the Master LC Facility is to provide an advance for letter of credit draws, if any, as well as to provide collateral for the reimbursement obligations for the letters of credits. Advances under the Master LC Facility will remain available until the earlier of June 30, 2004 or when an order confirming the proposed plan of reorganization becomes final and non-appealable. At that time, all advances outstanding under the Master LC Facility, if any, will become term loans payable in full on November 1, 2004, and all other letters of credit shall cease to be subject to the terms of the Master LC Facility. As of December 31, 2003, there were no outstanding advances under the Master LC Facility.

BUSINESS ENVIRONMENT AND RESULTS OF OPERATIONS

We currently operate in over 100 countries throughout the world, providing a comprehensive range of discrete and integrated products and services to the energy industry and to other industrial and governmental customers. The majority of our consolidated revenues are derived from the sale of services and products, including engineering and construction activities. We sell services and products primarily to

 
  28  
 

major, national and independent oil and gas companies and the United States government. These products and services are used throughout the energy industry from the earliest phases of exploration, development and production of oil and gas resources through refining, processing and marketing. Our five business segments are organized around how we manage the business: Drilling and Formation Evaluation, Fluids, Production Optimization, Landmark and Other Energy Services and the Engineering and Construction Group. We sometimes refer to the combination of Drilling and Formation Evaluation, Fluids, Production Optimization and Landmark and Other Energy Services segments as the Energy Services Group.
The industries we serve are highly competitive with many substantial competitors for each segment. In 2003, based upon the location of the services provided and products sold, 27% of our total revenue was from the United States and 15% was from Iraq. In 2002, 33% of our total revenue was from the United States and 12% of our total revenue was from the United Kingdom. No other country accounted for more than 10% of our revenues during these periods. Unsettled political conditions, social unrest, acts of terrorism, force majeure, war or other armed conflict, expropriation or other governmental actions, inflation, exchange controls or currency devaluation may result in increased business risk in any one country. We believe the geographic diversification of our business activities reduces the risk that loss of business in any international country would be material to our consolidated results of operations.
Halliburton Company
Activity levels within our business segments are significantly impacted by the following:
-
spending on upstream exploration, development and production programs by major, national and independent oil and gas companies;
-
capital expenditures for downstream refining, processing, petrochemical and marketing facilities by major, national and independent oil and gas companies; and
-
government spending levels.
Also impacting our activity is the status of the global economy, which indirectly impacts oil and gas consumption, demand for petrochemical products and investment in infrastructure projects.
Energy Services Group
Some of the more significant barometers of current and future spending levels of oil and gas companies are oil and gas prices, exploration and production expenditures by international and national oil companies, the world economy and global stability, which together drive worldwide drilling activity. Our Energy Services Group financial performance is significantly affected by oil and gas prices and worldwide rig activity which are summarized in the following tables.
This table shows the average oil and gas prices for West Texas Intermediate crude oil and Henry Hub natural gas prices:

Average Oil and Gas Prices
  

2003

  

2002

  

2001

  
West Texas Intermediate (WTI)
oil prices (dollars per barrel)
  
$
31.14
  
$
25.92
  
$
26.02
  
Henry Hub Gas Prices (dollars per
million cubic feet)
  
$
5.63
  
$
3.33
  
$
4.07
  

Our customers’ cash flow, in many instances, depends upon the revenue they generate from sale of oil and gas. With higher prices, they may have more cash flow, which usually translates into higher exploration and production budgets. Higher prices may also mean that oil and gas exploration in marginal areas can become attractive, so our customers may consider investing in such properties when prices are high. When this occurs, it means more potential work for us. The opposite is true for lower oil and gas prices.

 
  29  
 

The expectation in 2003 was that world oil prices would begin to somewhat soften, but prices have continued to increase. United States oil prices continued to increase due to low inventory levels as a result of Iraqi crude oil production still being below pre-war levels and higher natural gas prices adding pressure to switch to competing heating fuel oils.
Natural gas demand showed a decline in 2003 largely due to high prices discouraging demand in the industrial and electric power sectors. However, expected growth in the economy, along with somewhat lower projected annual average prices, are expected to increase demand by two percent in 2004. Natural gas production slightly increased in 2003, but is expected to fall back somewhat in 2004 as drilling intensity declines. In 2004, the projected supply gap between demand and production is offset by the expectation that storage injection requirements will be less than those in 2003, when stocks after the winter of 2002-2003 were at record lows.
The yearly average rig counts based on the Baker Hughes Incorporated rig count information are as follows:

Average Rig Counts
  

2003

  

2002

  

2001

  
Land vs. Offshore
    
 
    
 
    
 
  
United States:
    
 
    
 
    
 
  
Land
   
924
    
718
    
1,002
  
Offshore
    
108
    
113
    
153
  
Total
    
1,032
    
831
    
1,155
  
Canada:
    
 
    
 
    
 
  
Land
   
368
    
260
    
337
  
Offshore
    
4
    
6
    
5
  
Total
    
372
    
266
    
342
  
International (excluding Canada):
    
 
    
 
    
 
  
Land
   
544
    
507
    
525
  
Offshore
    
226
    
225
    
220
  
Total
    
770
    
732
    
745
  
Worldwide total
    
2,174
    
1,829
    
2,242
  
Land total
    
1,836
    
1,485
    
1,864
  
Offshore total
    
338
    
344
    
378
  

Average Rig Counts
  

2003

  

2002

  

2001

  
Oil vs. Gas
    
 
    
 
    
 
  
United States:
    
 
    
 
    
 
  
   
157
    
137
    
217
  
Gas
    
875
    
694
    
938
  
Total
    
1,032
    
831
    
1,155
  
* Canada:
    
372
    
266
    
342
  
International (excluding Canada):
    
 
    
 
    
 
  
Oil
   
576
    
561
    
571
  
Gas
    
194
    
171
    
174
  
Total
    
770
    
732
    
745
  
Worldwide total
    
2,174
    
1,829
    
2,242
  
* Canadian rig counts by oil and gas were not available.

 
  30  
 

Most of our work in Energy Services Group closely tracks the number of active rigs. As rig count increases or decreases, so does the total available market for our services and products. Further, our margins associated with services and products for offshore rigs are generally higher than those associated with land rigs.
It is common practice in the United States oilfield services industry to sell services and products based on a price book and then apply discounts to the price book based upon a variety of factors. The discounts applied typically increase to partially or substantially offset price book increases in the weeks immediately following a price increase. The discount applied normally decreases over time if the activity levels remain strong. During periods of reduced activity, discounts normally increase, reducing the net revenue for our services and conversely, during periods of higher activity, discounts normally decline resulting in net revenue increasing for our services.
The United States rig count increase in 2003 was primarily in gas drilling as gas prices remained high and operators continued to build gas storage levels before the 2003/2004 winter heating season. The overall increased North American rig count is being driven by higher oil and gas prices and demand for natural gas to replace working gas in storage for the 2003/2004 winter heating season.
Overall outlook. For 2003, high commodity prices resulted in improved activity levels with average global rig counts up 19%. Nonetheless, reduced reinvestment rates by our customers meant that overall activity growth and offshore activity in particular failed to meet broader expectations of the market.
The Energy Services Group experienced strong performance in Canada, the Middle East and Latin America in 2003. Mexico’s performance was particularly strong as operating income there more than doubled.
The Gulf of Mexico was an overall disappointment. The industry experienced a five percent year-over-year decline in the offshore Gulf of Mexico rig count and a reduction in deep water activity with a number of our key customers. As a result, we have started the process of reducing our cost structure in the Gulf of Mexico region and are refocusing our efforts towards more successful new products. Equally important, we have redeployed a number of people and assets to higher growth regions internationally, including Latin America and Asia.
Our Drilling and Formation Evaluation segment saw excellent performance in logging, but our drilling services performance was adversely affected in the second half of the year by downturns of activity in the Gulf of Mexico and the United Kingdom sector of the North Sea. As a result, we are currently executing a plan to remove approximately $50 million of annual operating costs from drilling services. We expect to see a recovery of margins during 2004.
The Energy Services Group also achieved significant growth in our new products and services in 2003. Overall, revenues associated with new technologies were higher than those of 2002 across a wide range of customers and geographies. We were particularly successful in our rotary steerables products, where we increased our revenues by 80% with an increase in our tool fleet of 25%.
The signing of contracts for national data centers with the governments of Nigeria and Indonesia reinforces the successes we have had with national oil companies and their governments over the last few years, and is something we wish to build upon in 2004. Together with the data centers in Pakistan, the United Kingdom, Brazil, Norway, Australia, Canada and Houston, as well as the recent selection of Landmark as an operator of the Kazakhstan National Data Bank, we believe Halliburton is emerging as the clear leader for data center technology.
We have also reexamined various joint ventures and recently announced an agreement to restructure two significant joint ventures with Shell, WellDynamics B.V. (an intelligent well completion joint venture), and Enventure Global Technologies LLC (an expandable casing joint venture). For Enventure, we elected to reduce our interests and transfer part of our interests to Shell. In return, we received significantly enhanced marketing and distribution rights for sand screens and liner hangers, which

 
  31  
 

we believe are central to our business and offer major opportunities for profitable growth. In a similar strategic vein, we believe the majority stake we will secure in WellDynamics is better aligned with the core “Real Time Knowledge” strategy of our company.
As we look forward, we see modest growth in the global market during 2004. Spears and Associates expects the United States rig count to average 1,050 rigs. For Canada, they are predicting an average of 362 rigs in 2004. Growth in international drilling activity is expected to remain positive over the coming year. The international rig count is expected by Spears to average 795 rigs in 2004 with 9,874 new wells forecasted to be drilled. We will be focused in 2004 on our operational efficiency and capital discipline, without compromising our ability to serve new growth markets in the future.
Engineering and Construction Group
Our Engineering and Construction Group, operating as KBR, provides a wide range of services to energy and industrial customers and government entities worldwide. Engineering and construction projects are generally longer term in nature than our Energy Services Group work and are impacted by more diverse drivers than short term fluctuations in oil and gas prices.
Our government services opportunities are strong in the Middle East, United States, United Kingdom, and Australia. Spending on defense and security programs has been increasing in each of the major markets. These include support to military forces, security assessments and upgrades at military and government facilities and disaster and contingency relief at home and abroad. We believe governments will continue to look to the private sector to perform work traditionally done by those government agencies.
The drive to monetize gas reserves in the Middle East, West Africa, Asia Pacific, Eurasia and Latin America, combined with strong demand for gas and liquefied natural gas (LNG) in the United States, Japan, Korea, Taiwan, China and India, has led to numerous gas to liquid, LNG liquefaction and gas development projects in the exporting regions as well as onshore or floating LNG terminals, and gas processing plants in the importing countries.
Outsourcing of operations and maintenance work has been increasing worldwide, and we expect this trend to continue. An increasing number of independent oil companies are acquiring mature oilfield assets from major oil companies and are looking to outsource operations and maintenance capabilities. KBR is investing in technologies to optimize asset performance in both upstream and downstream oil and gas markets.
We are also seeing significant business opportunities in the United Kingdom for major public infrastructure projects, which have been dominated for almost a decade by privately financed projects, and now account for 10% of the country’s infrastructure capital spending. We have been involved with a significant number of these projects, and we expect to build on that business using our experience with pulling together complex project financing arrangements and managing partnerships.
Engineering and construction contracts can be broadly categorized as either fixed-price (sometimes referred to as lump sum) or cost reimbursable contracts. Some contracts can involve both fixed-price and cost reimbursable elements. Fixed-price contracts are for a fixed sum to cover all costs and any profit element for a defined scope of work. Fixed-price contracts entail more risk to us as we must pre-determine both the quantities of work to be performed and the costs associated with executing the work. The risks to us arise, from among other things:
-
uncertainty in estimating the technical aspects and effort involved to accomplish the work within the contract schedule;
-
labor availability and productivity; and
-
supplier and subcontractor pricing and performance.
Fixed-price engineering, procurement and construction and fixed-price engineering, procurement, installation and commissioning contracts involve even greater risks including:
-
bidding a fixed-price and completion date before detailed engineering work has been performed;

 
  32  
 

-
bidding a fixed-price and completion date before locking in price and delivery of significant procurement components (often items which are specifically designed and fabricated for the project);
-
bidding a fixed-price and completion date before finalizing subcontractors’ terms and conditions;
-
subcontractor’s individual performance and combined interdependencies of multiple subcontractors (the majority of all construction and installation work is performed by subcontractors);
-
contracts covering long periods of time;
-
contract values generally for large amounts; and
-
contracts containing significant liquidated damages provisions.
Cost reimbursable contracts include contracts where the price is variable based upon actual costs incurred for time and materials, or for variable quantities of work priced at defined unit rates. Profit elements on cost reimbursable contracts may be based upon a percentage of costs incurred and/or a fixed amount. Cost reimbursable contracts are generally less risky, since the owner retains many of the risks. While fixed-price contracts involve greater risk, they also potentially are more profitable for the contractor, since the owners pay a premium to transfer many risks to the contractor.
The approximate percentages of revenues attributable to fixed-price and cost reimbursable engineering and construction segment contracts are as follows:

 
Fixed-Price
Cost Reimbursable
2003
24%
76%
2002
47%
53%
2001
41%
59%

An important aspect of our 2002 reorganization was to look closely at each of our products and services to ensure that risks can be properly evaluated and that they are self-sufficient, including their use of capital and liquidity. In that process, we found that the engineering, procurement, installation and commissioning, or EPIC, of offshore projects involved a disproportionate risk and were using a large share of our bonding and letter of credit capacity relative to profit contribution. Accordingly, we determined to not pursue those types of projects in the future. We have six fixed-price EPIC offshore projects underway, and we are fully committed to successful completion of these projects, several of which are substantially complete.
The reshaping of our offshore business away from lump-sum EPIC contracts to cost reimbursement services has been marked by some significant new work. During the first quarter of 2004 we signed a major reimbursable engineering, procurement, and construction management, or EPCM, contract for a West African oilfield development. This is a major award under our new EPCM strategy. We are also pursuing program management opportunities in deep-water locations around the world. These efforts, implemented under our new strategy, are allowing us to utilize our global resources to continue to be a leader in the offshore business.

 
  33  
 

RESULTS OF OPERATIONS IN 2003 COMPARED TO 2002

REVENUES:
    
 
    
 
  

Increase/

  

Percentage

  
Millions of dollars
  

2003

  

2002

  

(Decrease)
 

Change

  
Drilling and Formation Evaluation
  
$
   1,643
  
$
   1,633
  
$
   10
    
   0.6
%
Fluids
    
   2,039
    
   1,815
    
   224
    
   12.3
  
Production Optimization
    
   2,766
    
   2,554
    
   212
    
   8.3
  
Landmark and Other Energy Services
    
   547
    
   834
    
   (287
)
  
   (34.4
)
Total Energy Services Group
    
   6,995
    
   6,836
    
   159
    
   2.3
  
Engineering and Construction Group
    
   9,276
    
   5,736
    
   3,540
    
   61.7
  
Total revenues
  
$
   16,271
  
$
   12,572
  
$
   3,699
    
   29.4
%
 
    
 
    
 
    
 
    
 
  
Geographic – Energy Services Group segments only:
  
 
    
 
  
Drilling and Formation Evaluation:
    
 
    
 
    
 
    
 
  
North America
  
$
   558
  
$
   549
  
$
   9
    
   1.6
%
Latin America
    
   261
    
   251
    
   10
    
   4.0
  
Europe/Africa
    
   312
    
   344
    
   (32
)
  
   (9.3
)
Middle East/Asia
    
   512
    
   489
    
   23
    
   4.7
  
Subtotal
    
   1,643
    
   1,633
    
   10
    
   0.6
  
Fluids:
    
 
    
 
    
 
    
 
  
North America
    
   990
    
   934
    
   56
    
   6.0
  
Latin America
    
   258
    
   216
    
   42
    
   19.4
  
Europe/Africa
    
   452
    
   381
    
   71
    
   18.6
  
Middle East/Asia
    
   339
    
   284
    
   55
    
   19.4
  
Subtotal
    
   2,039
    
   1,815
    
   224
    
   12.3
  
Production Optimization:
    
 
    
 
    
 
    
 
  
North America
    
   1,345
    
   1,264
    
   81
    
   6.4
  
Latin America
    
   317
    
   277
    
   40
    
   14.4
  
Europe/Africa
    
   562
    
   556
    
   6
    
   1.1
  
Middle East/Asia
    
   542
    
   457
    
   85
    
   18.6
  
Subtotal
    
   2,766
    
   2,554
    
   212
    
   8.3
  
Landmark and Other Energy Services:
    
 
    
 
    
 
    
 
  
North America
    
   192
    
   284
    
   (92
)
  
   (32.4
)
Latin America
    
   71
    
   102
    
   (31
)
  
   (30.4
)
Europe/Africa
    
   116
    
   297
    
   (181
)
  
   (60.9
)
Middle East/Asia
    
   168
    
   151
    
   17
    
   11.3
  
Subtotal
    
   547
    
   834
    
   (287
)
  
   (34.4
)
Total Energy Services Group revenues
  
$
   6,995
  
$
   6,836
  
$
   159
    
   2.3
%

 
  34  
 

OPERATING INCOME (LOSS):
  
 
    
 
  

Increase/

  

Percentage

  
Millions of dollars
  

2003

  

2002

  

(Decrease)
 

Change

  
Drilling and Formation Evaluation
  
$
   177
  
$
   160
  
$
   17
    
   10.6
%
Fluids
    
   251
    
   202
    
   49
    
   24.3
  
Production Optimization
    
   421
    
   384
    
   37
    
   9.6
  
Landmark and Other Energy Services
    
   (23
)
  
   (108
)
  
   85
    
   78.7
  
Total Energy Services Group
    
   826
    
   638
    
   188
    
   29.5
  
Engineering and Construction Group
    
   (36
)
  
   (685
)
  
   649
    
   94.7
  
General corporate
    
   (70
)
  
   (65
)
  
   (5
)
  
   (7.7
)
Operating income (loss)
  
$
   720
  
$
   (112
)
$
   832
    
   NM
  

Geographic – Energy Services Group segments only:
                
 
    
 
  
Drilling and Formation Evaluation:
    
 
    
 
    
 
    
 
  
North America
  
$
   60
  
$
   70
  
$
   (10
)
  
   (14.3)
%
Latin America
    
   30
    
   29
    
   1
    
   3.4
  
Europe/Africa
    
   30
    
   (6
)
  
   36
    
   NM
  
Middle East/Asia
    
   57
    
   67
    
   (10
)
  
   (14.9
)
Subtotal
    
   177
    
   160
    
   17
    
   10.6
  
Fluids:
    
 
    
 
    
 
    
 
  
North America
    
   104
    
   119
    
   (15
)
  
   (12.6
)
Latin America
    
   52
    
   33
    
   19
    
   57.6
  
Europe/Africa
    
   48
    
   20
    
   28
    
   140.0
  
Middle East/Asia
    
   47
    
   30
    
   17
    
   56.7
  
Subtotal
    
   251
    
   202
    
   49
    
   24.3
  
Production Optimization:
    
 
    
 
    
 
    
 
  
North America
    
   202
    
   228
    
   (26
)
  
   (11.4
)
Latin America
    
   75
    
   41
    
   34
    
   82.9
  
Europe/Africa
    
   52
    
   46
    
   6
    
   13.0
  
Middle East/Asia
    
   92
    
   69
    
   23
    
   33.3
  
Subtotal
    
   421
    
   384
    
   37
    
   9.6
  
Landmark and Other Energy Services:
    
 
    
 
    
 
    
 
  
North America
    
   (60
)
  
   (218
)
  
   158
    
   72.5
  
Latin America
    
   8
    
   5
    
   3
    
   60.0
  
Europe/Africa
    
   17
    
   118
    
   (101
)
  
   (85.6
)
Middle East/Asia
    
   12
    
   (13
)
  
   25
    
   NM
  
Subtotal
    
   (23
)
  
   (108
)
  
   85
    
   78.7
  
Total Energy Services Group
    
 
    
 
    
 
    
 
  
operating income
  
$
   826
  
$
   638
  
$
   188
    
   29.5
%
NM – Not Meaningful

The increase in consolidated revenues for 2003 compared to 2002 was largely attributable to activity in our government services projects, primarily work in the Middle East. International revenues were 73% of total revenues in 2003 and 67% of total revenues in 2002, with the increase attributable to our government services projects. The United States Government has become a major customer of ours with total revenues of approximately $4.2 billion, or 26% of total consolidated revenues, for 2003. Revenues from the United States Government during 2002 represented less than 10% of total consolidated revenues. The consolidated operating income increase in 2003 compared to 2002 was again largely attributable to our government services projects and the absence of the $644 million in asbestos and silica charges and restructuring charges which occurred in 2002. During 2003, Iraq related work contributed approximately $3.6 billion in consolidated revenues and $85 million in consolidated operating income, a 2.4% margin

 
  35  
 

before corporate costs and taxes. In addition, we recorded a loss on the Barracuda-Caratinga project of $238 million in 2003 as compared to a $117 million loss in 2002. Our Energy Services Group segments accounted for approximately $188 million of the increase.
Following is a discussion of our results of operations by reportable segment.
Drilling and Formation Evaluation revenues were essentially flat. Logging and perforating services revenues increased $25 million, primarily due to higher average year-over-year rig counts in the United States and Mexico, partially offset by lower sales in China and reduced activity in Venezuela. Drill bits revenues increased $21 million, benefiting from the increased rig counts in the United States and Canada. Drilling services revenue for 2003 was negatively impacted by $79 million compared to 2002 due to the sale of Mono Pumps in January 2003. The remainder of drilling services revenue increased $34 million compared to 2002 as contracts that were expiring were more than offset by new contracts, primarily in West Africa, the Middle East and Ecuador. Also impacting drilling services were significant price discounts in the fourth quarter of 2003 on basic drilling services and rotary steerables in the United Kingdom. International revenues were 72% of total segment revenues in both 2003 and 2002.
The increase in operating income for the segment was primarily driven by logging and perforating services, which increased operating income by $32 million, a result of increased rig counts internationally, lower discounts in the United States and the absence of start-up costs incurred in 2002. Operating income for 2003 also included a $36 million gain ($24 million in North America and $12 million in Europe/Africa) on the sale of Mono Pumps. Operating income for drilling services decreased by $49 million and $9 million for drill bits compared to 2002 due to lower activity in Venezuela, pricing pressures in the United States, severance expense, and facility consolidation expenses. Drilling services operating income for 2003 was negatively impacted by $5 million compared to 2002 due to the sale of Mono Pumps.
Fluids increase in revenues was driven by drilling fluids sales increase of $101 million and cementing activities increase of $121 million compared to 2002. Cementing benefited from higher land rig counts in the United States. Both drilling fluids and cementing revenues benefited from increased activity in Mexico, primarily with PEMEX, which offset lower activity in Venezuela. Drilling fluids also benefited from price improvements on certain contracts in Europe/Africa. International revenues were 56% of total revenues in 2003 compared to 52% in 2002.
The Fluids segment operating income increase was a result of drilling fluids increasing $29 million and cementing services increasing $24 million compared to 2002, partially offset by lower results of $4 million from Enventure. Drilling fluids benefited from higher sales of biodegradable drilling fluids and improved contract terms. Those benefits were partially offset by contract losses in the Gulf of Mexico and United States pricing pressures in 2003. Cementing operating income primarily increased in Middle East/Asia due to collections on previously reserved receivables, certain start-up costs in 2002, and higher margin work. All regions showed improved segment operating income in 2003 compared to 2002, except North America, which was impacted by the decrease in activity from the higher margin offshore business in the Gulf of Mexico.
Production Optimization increase in revenues was mainly attributable to production enhancement services, which increased $187 million compared to 2002, driven by higher activity in the Middle East following the end of the war in Iraq and increased rig count in Mexico and North America. In addition, sales of tools and testing services increased $40 million compared to 2002 due primarily to increased land rig counts in North America, increased activity in Brazil due to higher activity with national and international oil companies in deepwater and increased rig activity in Mexico. These increases were partially offset by lower sales of completion products and services of $5 million, primarily in the United States due to lower activity in the Gulf of Mexico and the United Kingdom. The May 2003 sale of Halliburton Measurement Systems had a $24 million negative impact on segment revenues in 2003 compared to 2002. The improvement in revenues more than offset the $9 million in equity losses from the Subsea 7, Inc. joint venture. International revenues were 56% of segment revenues in 2003 compared to 53% in 2002 as activity picked up in the Middle East following the end of the war in Iraq.

 
  36  
 

The Production Optimization operating income increase included a $24 million gain on the sale of Halliburton Measurement Systems in North America, offset by inventory write-downs.
Landmark and Other Energy Services decrease in revenues compared to 2002 was primarily due to the contribution of most of the assets of Halliburton Subsea to Subsea 7, Inc. which, beginning in May 2002, was reported on an equity basis. This accounted for approximately $200 million of the decrease. The sale of Wellstream in March 2003 also contributed $49 million to the decrease. Revenues for Landmark Graphics were down $13 million compared to 2002 due to the general weakness in information technology spending. International revenues were 68% of segment revenues in 2003 compared to 74% in 2002. The decrease is the result of the contribution of the Halliburton Subsea assets to Subsea 7, Inc. which mainly conducts operations in the North Sea.
Segment operating loss was $23 million in 2003 compared to a loss of $108 million in 2002. Included in 2003 were a $15 million loss on the sale of Wellstream ($11 million in North America and $4 million in Europe/Africa) and a $77 million charge related to the October 2003 verdict in the Anglo-Dutch lawsuit, which impacted North America results. The significant items affecting operating income in 2002 included:
-
$108 million gain on the sale of European Marine Contractors Ltd in Europe/Africa;
-
$98 million charge for BJ Services patent infringement lawsuit accrual in North America;
-
$79 million loss on the impairment of our 50% equity investment in the Bredero-Shaw joint venture in North America; and
-
$64 million in expense related to restructuring charges ($51 million in North America, $3 million in Latin America, $7 million in Europe/Africa, and $3 million in Middle East/Asia).
During 2003, Landmark Graphics achieved its highest operating income and highest operating margins since we acquired it as operating income increased $8 million or 18% over 2002.
Engineering and Construction Group increase in revenues compared to 2002 was due to increased activity in Iraq for the United States government, and, to a lesser extent, a $264 million increase on other government projects and a $161 million increase on LNG and oil and gas projects in Africa. Partially offsetting the revenue increases are lower revenues earned on the Barracuda-Caratinga project in Brazil and a $111 million decrease on industrial services projects in the United States and production services projects globally.
Engineering and Construction Group operating loss improvement in 2003 was due to government related activities, partially related to operations in the Middle East for Iraq related work and a $14 million increase in income from other government projects. Also contributing to the improved results were income from liquefied natural gas projects in Africa and $18 million in favorable adjustments to insurance reserves as a result of revised actuarial valuations and other changes in estimates in 2003. Partially offsetting the 2003 improvement are losses recognized on the Barracuda-Caratinga project in Brazil of $238 million, losses on a hydrocarbon project in Belgium and lower income on a liquefied natural gas project in Malaysia due to project completion. Included in the 2002 loss was a charge of $644 million for asbestos and silica liabilities, $18 million of restructuring charges, and a Barracuda-Caratinga project loss of $117 million.
General corporate in 2002 included a $29 million pretax gain for the value of stock received from the demutualization of an insurance provider, partially offset by 2002 restructuring charges of $25 million. The higher 2003 expenses also relate to preparations for the certifications required under Section 404 of the Sarbanes-Oxley Act.

NONOPERATING ITEMS

Interest expense increased $26 million in 2003 compared to 2002. The increase was due primarily to $30 million in interest on the $1.2 billion convertible notes issued in June 2003 and the $1.05 billion senior floating and fixed notes issued in October 2003. The increase was partially offset by $5

 
  37  
 

million in pre-judgment interest recorded in 2002 related to the BJ Services patent infringement judgment and $296 million of scheduled debt repayments in 2003.
Foreign currency losses, net for 2003 included gains in Canada offset by losses in the United Kingdom and Brazil. Losses in 2002 were due to negative developments in Brazil, Argentina and Venezuela.
Provision for income taxes of $234 million resulted in an effective tax rate on continuing operations of 38.2% in 2003. The provision was $80 million in 2002 on a net loss from continuing operations. The inclusion of asbestos accruals in continuing operations for 2002 was the primary cause of the unusual 2002 effective tax rate on continuing operations. There are no asbestos charges or related tax accruals included in continuing operations for 2003. Our impairment loss on Bredero-Shaw during 2002 could not be benefited for tax purposes due to book and tax basis differences in that investment and the limited benefit generated by a capital loss carryback. However, due to changes in circumstances regarding prior years, we are now able to carry back a portion of the capital loss, which resulted in an $11 million benefit in 2003.
Loss from discontinued operations, net of tax of $1.151 billion in 2003 was due to the following:
-
asbestos and silica liability was increased to reflect the full amount of the proposed settlement as a result of the Chapter 11 proceeding;
-
charges related to our July 2003 funding of $30 million for the debtor-in-possession financing to Harbison-Walker in connection with its Chapter 11 proceedings that is expected to be forgiven by Halliburton on the earlier of the effective date of a plan of reorganization for DII Industries or the effective date of a plan of reorganization for Harbison-Walker acceptable to DII Industries;
-
$10 million allowance for an estimated portion of uncollectible amounts related to the insurance receivables purchased from Harbison-Walker;
-
professional fees associated with the due diligence, printing and distribution cost of the disclosure statement and other aspects of the proposed settlement for asbestos and silica liabilities; and
-
a release of environmental and legal reserves related to indemnities that were part of our disposition of the Dresser Equipment Group and are no longer needed.
The loss of $652 million in 2002 was due primarily to charges recorded for asbestos and silica liabilities and a $40 million payment associated with the Harbison-Walker Chapter 11 filing.
The provision for income taxes on discontinued operations was $6 million in 2003 compared to a tax benefit of $154 million in 2002. We established a valuation allowance for the net operating loss carryforward created by the 2003 asbestos and silica charges resulting in a minimal tax effect. In 2002, we recorded a $119 million valuation allowance in discontinued operations related to the asbestos and silica accrual.
Cumulative effect of change in accounting principle, net was an $8 million after-tax charge, or $0.02 per diluted share, related to our January 1, 2003 adoption of Financial Accounting Standards Board Statement No. 143, “Accounting for Asset Retirement Obligations.”
 
 
  38  
 
 
RESULTS OF OPERATIONS IN 2002 COMPARED TO 2001

REVENUES