UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the quarterly period ended June 30, 2003
OR
[ ] 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
(a Delaware Corporation)
75-2677995
5 Houston Center
1401 McKinney, Suite 2400
Houston, Texas 77010
(Address of Principal Executive Offices)
Telephone Number - Area Code (713) 759-2600
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
----- ----
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes X No
----- ----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common stock, par value $2.50 per share:
Outstanding at July 24, 2003 - 437,927,577
HALLIBURTON COMPANY
Index
Page No.
--------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements 2-33
- Condensed Consolidated Statements of Operations 2
- Condensed Consolidated Balance Sheets 3
- Condensed Consolidated Statements of Cash Flows 4
- Notes to Quarterly Condensed Consolidated Financial Statements 5-33
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 34-61
Item 3. Quantitative and Qualitative Disclosures about Market Risk 62
Item 4. Controls and Procedures 62
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds 63
Item 4. Submission of Matters to a Vote of the Security Holders 63-64
Item 6. Exhibits and Reports on Form 8-K 64-66
Signatures 67
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
-----------------------------
HALLIBURTON COMPANY
Condensed Consolidated Statements of Operations
(Unaudited)
(Millions of dollars and shares except per share data)
Three Months Six Months
Ended June 30 Ended June 30
-----------------------------------------------------
2003 2002 2003 2002
-------------------------------------------------------------- ------------ ----------------------------------------
Revenues:
Services $ 3,106 $ 2,750 $ 5,735 $ 5,279
Product sales 476 457 924 917
Equity in earnings of unconsolidated affiliates 17 28 - 46
--------------------------------------------------------------------------------------------------------------------
Total revenues $ 3,599 $ 3,235 $ 6,659 $ 6,242
--------------------------------------------------------------------------------------------------------------------
Operating costs and expenses:
Cost of services $ 3,050 $ 3,075 $ 5,504 $ 5,605
Cost of sales 425 407 829 816
General and administrative 80 97 161 150
(Gain) loss on sale of business assets, net (27) 61 (48) (47)
--------------------------------------------------------------------------------------------------------------------
Total operating costs and expenses $ 3,528 $ 3,640 $ 6,446 $ 6,524
--------------------------------------------------------------------------------------------------------------------
Operating income (loss) 71 (405) 213 (282)
Interest expense (25) (30) (52) (62)
Interest income 7 12 15 16
Foreign currency gains (losses), net 19 (5) 13 (13)
Other, net 2 (2) 2 2
--------------------------------------------------------------------------------------------------------------------
Income (loss) from continuing operations before income
taxes, minority interest, and change in accounting
principle, net 74 (430) 191 (339)
(Provision) benefit for income taxes (29) 77 (79) 41
Minority interest in net income of subsidiaries, net of tax (3) (5) (11) (10)
--------------------------------------------------------------------------------------------------------------------
Income (loss) from continuing operations
before change in accounting principle, net 42 (358) 101 (308)
Loss from discontinued operations, net of tax
benefit of $26, $19, $30 and $34 (16) (140) (24) (168)
Cumulative effect of change in accounting principle,
net of tax benefit of $5 - - (8) -
--------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 26 $ (498) $ 69 $ (476)
====================================================================================================================
Basic income (loss) per share:
Income (loss) from continuing operations before change in
accounting principle, net $ 0.09 $ (0.83) $ 0.23 $ (0.71)
Loss from discontinued operations, net (0.03) (0.32) (0.05) (0.39)
Cumulative effect of change in accounting principle, net - - (0.02) -
--------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 0.06 $ (1.15) $ 0.16 $ (1.10)
====================================================================================================================
Diluted income (loss) per share:
Income (loss) from continuing operations before change in
accounting principle, net $ 0.09 $ (0.83) $ 0.23 $ (0.71)
Loss from discontinued operations, net (0.03) (0.32) (0.05) (0.39)
Cumulative effect of change in accounting principle, net - - (0.02) -
--------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 0.06 $ (1.15) $ 0.16 $ (1.10)
====================================================================================================================
Cash dividends per share $ 0.125 $ 0.125 $ 0.25 $ 0.25
Basic weighted average common shares outstanding 434 432 434 432
Diluted weighted average common shares outstanding 436 432 436 432
See notes to quarterly condensed consolidated financial statements.
2
HALLIBURTON COMPANY
Condensed Consolidated Balance Sheets
(Unaudited)
(Millions of dollars and shares except per share data)
June 30 December 31
--------------------------------
2003 2002
------------------------------------------------------------------------------------------------
Assets
Current assets:
Cash and equivalents $ 1,859 $ 1,107
Receivables:
Notes and accounts receivable, net 2,656 2,533
Unbilled work on uncompleted contracts 1,010 724
------------------------------------------------------------------------------------------------
Total receivables 3,666 3,257
Inventories 747 734
Current deferred income taxes 212 200
Other current assets 291 262
------------------------------------------------------------------------------------------------
Total current assets 6,775 5,560
Property, plant and equipment, net of accumulated
depreciation of $3,403 and $3,323 2,498 2,629
Equity in and advances to related companies 412 413
Goodwill, net 669 723
Noncurrent deferred income taxes 670 607
Insurance for asbestos and silica related liabilities 2,059 2,059
Other assets, net 939 853
------------------------------------------------------------------------------------------------
Total assets $ 14,022 $ 12,844
================================================================================================
Liabilities and Shareholders' Equity
Current liabilities:
Short-term notes payable $ 16 $ 49
Current maturities of long-term debt 166 295
Accounts payable 1,056 1,077
Accrued employee compensation and benefits 353 370
Advanced billings on uncompleted contracts 715 641
Deferred revenues 86 100
Income taxes payable 129 148
Estimated loss on uncompleted contracts 276 82
Other current liabilities 520 510
------------------------------------------------------------------------------------------------
Total current liabilities 3,317 3,272
Long-term debt 2,374 1,181
Employee compensation and benefits 713 756
Asbestos and silica related liabilities 3,396 3,425
Other liabilities 580 581
Minority interest in consolidated subsidiaries 83 71
------------------------------------------------------------------------------------------------
Total liabilities 10,463 9,286
================================================================================================
Shareholders' equity:
Common shares, par value $2.50 per share - authorized
600 shares, issued 457 and 456 shares 1,142 1,141
Paid-in capital in excess of par value 287 293
Deferred compensation (67) (75)
Accumulated other comprehensive income (260) (281)
Retained earnings 3,070 3,110
------------------------------------------------------------------------------------------------
4,172 4,188
Less 19 and 20 shares of treasury stock, at cost 613 630
------------------------------------------------------------------------------------------------
Total shareholders' equity 3,559 3,558
------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 14,022 $ 12,844
================================================================================================
See notes to quarterly condensed consolidated financial statements.
3
HALLIBURTON COMPANY
Condensed Consolidated Statements of Cash Flows
(Unaudited)
(Millions of dollars)
Six Months
Ended June 30
-------------------------------------
2003 2002
--------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income (loss) $ 69 $ (476)
Adjustments to reconcile net income (loss) to net cash from operations:
Loss from discontinued operations, net 24 168
Depreciation, depletion and amortization 252 266
Benefit for deferred income taxes (77) (73)
Distributions from (advances to) related companies, net of
equity in (earnings) losses 47 14
Change in accounting principle, net 8 -
Gain on sale of assets, net (53) (50)
Asbestos and silica related liabilities, net (29) 477
Other non-cash items (6) 72
Other changes, net of non-cash items:
Receivables and unbilled work on uncompleted contracts (417) 227
Sale of receivables - 200
Inventories (45) (24)
Accounts payable (50) 169
Other working capital, net 139 (239)
Other operating activities (75) (111)
--------------------------------------------------------------------------------------------------------------------
Total cash flows from operating activities (213) 620
--------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Capital expenditures (229) (404)
Sales of property, plant and equipment 49 54
Dispositions (acquisitions) of businesses, net of cash disposed (acquired) 224 134
Proceeds from sale of securities 57 -
Investments - restricted cash (22) (188)
Other investing activities (29) (10)
--------------------------------------------------------------------------------------------------------------------
Total cash flows from investing activities 50 (414)
--------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Proceeds from long-term borrowings, net of offering costs 1,178 -
Payments on long-term borrowings (140) (4)
Borrowings (repayments) of short-term debt, net (34) 14
Payments of dividends to shareholders (109) (109)
Other financing activities (2) (2)
--------------------------------------------------------------------------------------------------------------------
Total cash flows from financing activities 893 (101)
--------------------------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash 22 (12)
--------------------------------------------------------------------------------------------------------------------
Increase in cash and equivalents 752 93
Cash and equivalents at beginning of period 1,107 290
--------------------------------------------------------------------------------------------------------------------
Cash and equivalents at end of period $ 1,859 $ 383
====================================================================================================================
Supplemental disclosure of cash flow information:
Cash payments during the period for:
Interest $ 48 $ 53
Income taxes $ 100 $ 98
See notes to quarterly condensed consolidated financial statements.
4
HALLIBURTON COMPANY
Notes to Quarterly Condensed Consolidated Financial Statements
(Unaudited)
Note 1. Management Representations
Our accounting policies are in accordance with generally accepted
accounting principles in the United States of America. The preparation of
financial statements in conformity with accounting principles generally accepted
in the United States of America requires us to make estimates and assumptions
that affect:
- the reported amounts of assets and liabilities and disclosure
of contingent assets and liabilities at the date of the
financial statements; and
- the reported amounts of revenues and expenses during the
reporting period.
Ultimate results could differ from those estimates.
The accompanying unaudited condensed consolidated financial statements
were prepared using generally accepted accounting principles for interim
financial information and the instructions to Form 10-Q and Regulation S-X.
Accordingly, these financial statements do not include all information or
footnotes required by generally accepted accounting principles for complete
financial statements and should be read together with our 2002 Annual Report on
Form 10-K. Certain prior period amounts have been reclassified to be consistent
with the current presentation.
In our opinion, the condensed consolidated financial statements
included here contain all adjustments necessary to present fairly our financial
position as of June 30, 2003, the results of our operations for the three and
six months ended June 30, 2003 and 2002 and our cash flows for the six months
ended June 30, 2003 and 2002. Such adjustments are of a normal recurring nature.
The results of operations for the six months ended June 30, 2003 and 2002 may
not be indicative of results for the full year.
Note 2. Business Segment Information
During the second quarter of 2003, we restructured our Energy Services
Group into four divisions, which is the basis for the four segments we now
report within the Energy Services Group. We grouped product lines in order to
better align ourselves with how our customers procure our services, and to
capture new business and achieve better integration, including joint research
and development of new products and technologies and other synergies. The new
segments mirror the way our chief executive officer (our chief operating
decision maker) now regularly reviews the operating results, assesses
performance and allocates resources. Our Engineering and Construction Group
(known as KBR) segment remains unchanged.
All prior period segment results have been restated to reflect these
changes.
Our five business segments are organized around how we manage the
business. These segments are:
- Drilling and Formation Evaluation;
- Fluids;
- Production Optimization;
- Landmark and Other Energy Services; and
- Engineering and Construction Group.
Drilling and Formation Evaluation. The 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. The products and services in this segment incorporate integrated
technologies, which offer synergies related to drilling activities and data
gathering. The segment consists of drilling services, including directional
drilling and measurement-while-drilling/logging-while-drilling; logging
services; and drill bits. Included in this business segment are our Sperry-Sun,
Logging and Perforating and Security DBS product lines. Also included is our
Mono Pumps business, which we disposed of in the first quarter of 2003.
Fluids. The Fluids segment focuses on fluid management and technologies
to assist in the drilling and construction of oil and gas wells. Drilling fluids
are used to provide for well control, drilling efficiency, and as a means of
removing wellbore cuttings. Cementing services provide zonal isolation to
prevent fluid movement between formations, ensure a bond to provide support for
the casing, and provide wellbore reliability. Our Baroid and Cementing product
lines, along with our equity method investment in Enventure Global Technology,
LLC, an expandable casing joint venture, are included in this business segment.
5
Production Optimization. The 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 services (including fracturing,
acidizing, coiled tubing, hydraulic workover, sand control,
and pipeline and process services);
- completion products and services (including well completion
equipment, slickline and safety systems);
- tools and testing services (including underbalanced
applications and tubular conveyed perforating testing
services); and
- subsea operations conducted in our 50% owned company, Subsea
7, Inc.
Landmark and Other Energy Services. This segment represents integrated
exploration and production software information systems, consulting services,
real-time operations, smartwells, subsea operations not contributed to Subsea 7,
Inc. and non-core businesses. Included in this business segment are Landmark
Graphics, Integrated Solutions, Real Time Operations and our equity method
investment in WellDynamics B.V., an intelligent well completions joint venture.
Also included are Wellstream, Bredero-Shaw and European Marine Contractors Ltd.,
all of which have been sold.
Engineering and Construction Group. The Engineering and Construction
Group provides engineering, procurement, construction, project management and
facilities operation and maintenance for oil and gas and other industrial and
governmental customers. The Engineering and Construction Group offers the
following types of products and services:
- Onshore operations consist of engineering and construction
activities, including engineering and construction of
liquefied natural gas, ammonia and natural gas plants, and
crude oil refineries;
- Offshore operations include offshore deepwater engineering and
marine technology and worldwide construction capabilities;
- Government Services provide engineering, operations,
construction, maintenance and logistics activities for
government facilities and installations;
- Operations and Maintenance services include plant operations,
construction maintenance and start-up services for both
upstream and downstream oil, gas and petrochemical facilities
as well as engineering, operations, maintenance and logistics
services for the power, commercial and industrial markets; and
- Infrastructure provides civil engineering, construction,
consulting and project management services.
6
The tables below present revenues, operating income (loss) and total
assets by business segment on a comparable basis.
Three Months Six Months
Ended June 30 Ended June 30
----------------------------------------------------
Millions of dollars 2003 2002 2003 2002
------------------------------------------------------------------------------------------------------
Revenues:
Drilling and Formation Evaluation $ 414 $ 413 $ 793 $ 812
Fluids 518 450 998 903
Production Optimization 693 634 1,322 1,246
Landmark and Other Energy Services 155 259 278 484
------------------------------------------------------------------------------------------------------
Total Energy Services Group 1,780 1,756 3,391 3,445
Engineering and Construction Group 1,819 1,479 3,268 2,797
------------------------------------------------------------------------------------------------------
Total $ 3,599 $ 3,235 $ 6,659 $ 6,242
======================================================================================================
Operating income (loss):
Drilling and Formation Evaluation $ 49 $ 42 $ 115 $ 80
Fluids 68 49 123 100
Production Optimization 113 106 183 189
Landmark and Other Energy Services 5 (127) (6) (130)
------------------------------------------------------------------------------------------------------
Total Energy Services Group 235 70 415 239
Engineering and Construction Group (148) (450) (167) (508)
General corporate (16) (25) (35) (13)
------------------------------------------------------------------------------------------------------
Total $ 71 $ (405) $ 213 $ (282)
======================================================================================================
Millions of dollars June 30, 2003 December 31, 2002
--------------------------------------------------------------------------------------------
Total Assets:
Drilling and Formation Evaluation $ 1,101 $ 1,163
Fluids 855 830
Production Optimization 1,425 1,365
Landmark and Other Energy Services 1,124 1,399
Shared Energy Services Assets 1,180 1,187
--------------------------------------------------------------------------------------------
Total Energy Services Group 5,685 5,944
Engineering and Construction Group 3,773 3,104
General Corporate 4,564 3,796
--------------------------------------------------------------------------------------------
Total $ 14,022 $ 12,844
============================================================================================
Within the Energy Services Group, only certain assets are associated
with specific segments. Those assets include receivables, inventories, certain
identified property, plant and equipment (including field service equipment),
equity in and advances to related companies and goodwill. The remaining assets,
such as cash and the remaining property, plant and equipment (including shared
facilities) are not associated with a segment but are considered to be shared
among the segments within the Energy Services Group.
Intersegment revenues are immaterial.
Note 3. Dispositions
Halliburton Measurement Systems. In May 2003, we sold certain assets of
Halliburton Measurement Systems, which provides flow measurement and sampling
systems, to NuFlo Technologies, Inc. for approximately $33 million in cash,
subject to post-closing adjustments. The pretax gain on the sale of Halliburton
Measurement Systems assets was $24 million ($14 million after tax, or $0.03 per
diluted share) and is included in our Production Optimization segment.
Wellstream. In March 2003, we sold the assets relating to our
Wellstream business, a global provider of flexible pipe products, systems and
solutions to Candover Partners Ltd. for $136 million in cash. The assets sold
included manufacturing plants in Newcastle on the Tyne, United Kingdom, and
Panama City, Florida, as well as certain assets and contracts in Brazil. The
transaction resulted in a pretax loss of $15 million ($12 million after tax, or
7
$0.03 per diluted share), which is included in our Landmark and Other Energy
Services segment. Included in the pretax loss is the write-off of the cumulative
translation adjustment related to Wellstream of approximately $9 million. The
cumulative translation adjustment could not be tax benefited and therefore the
effective tax benefit for this loss on disposition was only 20%.
Mono Pumps. In January 2003, we sold our Mono Pumps business to
National Oilwell, Inc. (NYSE: NOI). The sale price of approximately $88 million
was paid with $23 million in cash and 3.2 million shares of National Oilwell
common stock, which were valued at $65 million on January 15, 2003. We recorded
a pretax gain of $36 million ($21 million after tax, or $0.05 per diluted share)
on the sale, which is included in our Drilling and Formation Evaluation segment.
Included in the pretax gain is the write-off of the cumulative translation
adjustment related to Mono Pumps of approximately $5 million. The cumulative
translation adjustment could not be tax benefited and therefore the effective
tax rate for this disposition was 42%. In February 2003, we sold 2.5 million of
our 3.2 million shares of the National Oilwell common stock for $52 million,
which resulted in a gain of $2 million pretax, or $1 million after tax, that was
recorded in "Other, net".
Subsea 7 formation. In May 2002, we contributed substantially all of
our Halliburton Subsea assets, with a book value of approximately $82 million,
to a newly formed company, Subsea 7, Inc. The contributed assets were recorded
by the new company at a fair value of approximately $94 million. The $12 million
difference is being amortized over ten years representing the average remaining
useful life of the assets contributed. We own 50% of Subsea 7, Inc. and account
for this investment using the equity method in our Production Optimization
segment. The remaining 50% is owned by DSND Subsea ASA.
Bredero-Shaw. In the second quarter of 2002, we incurred an impairment
charge of $61 million ($0.14 per diluted share after tax) related to our then
pending sale of Bredero-Shaw. On September 30, 2002, we sold our 50% interest in
the Bredero-Shaw joint venture to our partner ShawCor Ltd. The sale price of
$149 million was comprised of $53 million in cash, a short-term note of $25
million and 7.7 million of ShawCor Class A Subordinate shares. Consequently, we
recorded a 2002 third quarter pretax loss on the sale of $18 million, or $0.04
per diluted share after tax, which is reflected in our Landmark and Other Energy
Services segment. Included in this loss was $15 million of cumulative
translation adjustment loss which was realized upon the disposition of our
investment in Bredero-Shaw. During the 2002 fourth quarter, we recorded in
"Other, net" a $9 million pretax loss on the sale of ShawCor shares.
European Marine Contractors Ltd. In January 2002, we sold our 50%
interest in European Marine Contractors Ltd., an unconsolidated joint venture
reported within our Landmark and Other Energy Services, to our joint venture
partner, Saipem. At the date of sale, we received $115 million in cash and a
contingent payment option valued at $16 million, resulting in a pretax gain of
$108 million. The contingent payment option was based on a formula linked to
performance of the Oil Service Index. In February 2002, we exercised our option
and received an additional $19 million and recorded a pretax gain of $3 million
in "Other, net" in the statement of operations as a result of the increase in
value of this option.
Note 4. Discontinued Operations
During the second quarter of 2003, we recorded a pretax loss from
discontinued operations of $42 million. This loss reflects a $30 million charge
for the debtor-in-possession financing provided to Harbison-Walker in connection
with their Chapter 11 bankruptcy proceeding which was funded on July 31, 2003
and is expected to be forgiven by us 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. In addition,
discontinued operations included professional fees associated with the due
diligence and other aspects of the proposed settlement for asbestos liabilities
offset by a release of environmental and legal accruals related to indemnities
associated with our 2001 disposition of Dresser Equipment Group that are no
longer required.
During the first quarter of 2003, we recorded as pretax expense to
discontinued operations $12 million for professional fees associated with due
diligence and other aspects of the proposed settlement for asbestos and silica
liabilities.
8
During the second quarter of 2002, in connection with our asbestos
econometric study, we recorded a pretax expense of $153 million to discontinued
operations for existing and future asbestos claims and defense costs related to
businesses disposed of, net of anticipated insurance recoveries. See Note 11. We
also recorded pretax expense of $6 million associated with the Harbison-Walker
bankruptcy filing.
During the first quarter of 2002, we recorded as pretax expense to
discontinued operations $3 million for asbestos claims and defense costs related
to businesses disposed of, net of anticipated insurance recoveries for asbestos
claims. We also recorded pretax expense for a $40 million payment associated
with the Harbison-Walker bankruptcy filing.
Note 5. Income (Loss) Per Share
Three Months Six Months
Ended June 30 Ended June 30
Millions of dollars and shares except ---------------------------------------------------
per share data 2003 2002 2003 2002
--------------------------------------------------------------------------------------------------------------
Income (loss) from continuing operations before
change in accounting principle, net $ 42 $ (358) $ 101 $ (308)
==============================================================================================================
Basic weighted average common shares outstanding 434 432 434 432
Effect of common stock equivalents 2 - 2 -
--------------------------------------------------------------------------------------------------------------
Diluted weighted average common shares outstanding 436 432 436 432
==============================================================================================================
Income (loss) per common share from continuing
operations before change in accounting
principle, net:
Basic $ 0.09 $ (0.83) $ 0.23 $ (0.71)
==============================================================================================================
Diluted $ 0.09 $ (0.83) $ 0.23 $ (0.71)
==============================================================================================================
Basic income (loss) per common share is based on the weighted average
number of common shares outstanding during the period. Diluted income (loss) per
common share includes additional common shares that would have been outstanding
if potential common shares with a dilutive effect had been issued. Excluded from
the computation of diluted income (loss) per common share are options to
purchase 15 million shares of common stock which were outstanding during the
three and six months ended June 30, 2003. These options were outstanding during
the applicable period, but were excluded because the option exercise price was
greater than the average market price of the common shares. The shares issuable
upon conversion of the 3.125% convertible senior notes due 2023 (see Note 15)
were not included in the computation of diluted income (loss) per common share
since the conditions for conversion had not been met as of June 30, 2003.
For the three and the six months ended June 30, 2002, we used the basic
weighted average shares in the calculation of diluted loss per common share, as
the effect of the common stock equivalents (which totaled two million shares for
each period) would be anti-dilutive based upon the net loss from continuing
operations.
Note 6. Comprehensive Income (Loss)
The components of other comprehensive income adjustments to net income
include the following:
Three Months Six Months
Ended June 30 Ended June 30
--------------------------------------------------------
Millions of dollars 2003 2002 2003 2002
--------------------------------------------------------------------------------------------------------------
Net income (loss) $ 26 $ (498) $ 69 $ (476)
Cumulative translation adjustment 25 32 12 35
Realization of losses included in net income 1 - 15 -
--------------------------------------------------------------------------------------------------------------
Net cumulative translation adjustment 26 32 27 35
Pension liability adjustments (7) - (7) -
Unrealized losses on investments and derivatives 2 - 1 -
--------------------------------------------------------------------------------------------------------------
Total comprehensive income (loss) $ 47 $ (466) $ 90 $ (441)
==============================================================================================================
9
Accumulated other comprehensive income consisted of the following:
June 30 December 31
--------------------------------
Millions of dollars 2003 2002
-------------------------------------------------------------------------------------
Cumulative translation adjustments $ (94) $ (121)
Pension liability adjustments (164) (157)
Unrealized losses on investments and derivatives (2) (3)
-------------------------------------------------------------------------------------
Total accumulated other comprehensive income $ (260) $ (281)
=====================================================================================
Note 7. Restricted Cash
At June 30, 2003 we had restricted cash of $212 million included in
"Other assets, net". Restricted cash consists of:
- $108 million deposit that collateralizes a bond for a patent
infringement judgment on appeal;
- $78 million as collateral for potential future insurance claim
reimbursements; and
- $26 million primarily related to cash collateral agreements
for outstanding letters of credit for various projects.
At December 31, 2002 we had restricted cash of $190 million, consisting
of similar items.
Note 8. Receivables
Included in notes and accounts receivable are notes with varying
interest rates totaling $23 million at June 30, 2003 and $53 million at December
31, 2002.
On April 15, 2002, we entered into an agreement to sell accounts
receivable to a bankruptcy-remote limited-purpose funding subsidiary. Under the
terms of the agreement, new receivables are added on a continuous basis to the
pool of receivables, and collections reduce previously sold accounts receivable.
This funding subsidiary sells an undivided ownership interest in this pool of
receivables to entities managed by unaffiliated financial institutions under
another agreement. Sales to the funding subsidiary have been structured as "true
sales" under applicable bankruptcy laws. The assets of the funding subsidiary
are not available to pay any creditors of ours or of our subsidiaries or
affiliates, until such time as the agreement with the unaffiliated companies is
terminated following sufficient collections to liquidate all outstanding
undivided ownership interests. The funding subsidiary retains the interest in
the pool of receivables that are not sold to the unaffiliated companies and is
fully consolidated and reported in our financial statements.
The amount of undivided interests which can be sold under the program
varies based on the amount of eligible Energy Services Group receivables in the
pool at any given time and other factors. The funding subsidiary initially sold
a $200 million undivided ownership interest to the unaffiliated companies, and
may from time to time sell additional undivided ownership interests. The total
amount outstanding under this facility was $180 million as of June 30, 2003. The
undivided ownership interest in the pool of receivables sold to the unaffiliated
companies is reflected as a reduction of accounts receivable in our consolidated
balance sheets. In July 2003, the balance outstanding under this facility was
reduced to zero.
Note 9. Inventories
Inventories are stated at the lower of cost or market. We manufacture
in the United States certain finished products and parts inventories for drill
bits, completion products and bulk materials that are recorded using the
last-in, first-out method and totaled $45 million at June 30, 2003 and $43
million at December 31, 2002. If the average cost method had been used, total
inventories would have been $18 million higher than reported at June 30, 2003
and $17 million higher than reported at December 31, 2002.
Over 90% of remaining inventory is recorded on the average cost method,
with the remainder on the first-in, first-out method.
10
Inventories at June 30, 2003 and December 31, 2002 are composed of the
following:
June 30 December 31
--------------------------------
Millions of dollars 2003 2002
-----------------------------------------------------------------
Finished products and parts $ 505 $ 545
Raw materials and supplies 179 141
Work in process 63 48
-----------------------------------------------------------------
Total $ 747 $ 734
=================================================================
Note 10. Long-Term Construction Contracts and Unapproved Claims
Revenues from engineering and construction contracts are reported on
the percentage of completion method of accounting using measurements of progress
toward completion appropriate for the work performed. Progress is generally
based upon physical progress, man-hours or costs incurred based upon the
appropriate method for the type of job.
Billing practices for engineering and construction projects are
governed by the contract terms of each project based upon costs incurred,
achievement of milestones or pre-agreed schedules. Billings do not necessarily
correlate with revenues recognized under the percentage of completion method of
accounting. Billings in excess of recognized revenues are recorded in "Advanced
billings on uncompleted contracts". When billings are less than recognized
revenues, the difference is recorded in "Unbilled work on uncompleted
contracts". With the exception of claims and change orders which are in the
process of being negotiated with customers, unbilled work is usually billed
during normal billing processes following achievement of the contractual
requirements.
Recording of profits and losses on long-term contracts requires an
estimate of the total profit or loss over the life of each contract. This
estimate requires consideration of contract revenue, change orders and claims
reduced by costs incurred and estimated costs to complete. Anticipated losses on
contracts are recorded in full in the period they become evident. Except where
we, because of uncertainties in the estimation of costs on a limited number of
projects, deem it prudent to defer income recognition, we do not delay income
recognition until projects have reached a specified percentage of completion. We
have not done so during the periods presented, although we followed such a
practice for some offshore projects prior to the periods presented herein.
Otherwise, profits are recorded from the commencement date of the contract based
upon the total estimated contract profit multiplied by the current percentage
complete for the contract.
When calculating the amount of total profit or loss on a long-term
contract, we include unapproved claims as revenue when the collection is deemed
probable based upon the four criteria for recognizing unapproved claims under
the American Institute of Certified Public Accountants Statement of Position
81-1, "Accounting for Performance of Construction-Type and Certain
Production-Type Contracts". Including unapproved claims in this calculation
increases the operating income (or reduces the operating loss) that would
otherwise be recorded without consideration of the probable unapproved claims.
Unapproved claims are recorded to the extent of costs incurred and include no
profit element. In substantially all cases, the probable unapproved claims
included in determining contract profit or loss are less than the actual claim
that will be or has been presented to the customer.
When recording the revenue and the associated unbilled receivable for
unapproved claims, we only accrue an amount up to the costs incurred related to
probable unapproved claims. The difference between the probable unapproved
claims included in determining contract profit or loss and the probable
unapproved claims recorded in "Unbilled work on uncompleted contracts" relates
to forecasted costs which have not yet been incurred. The amounts included in
determining the profit or loss on contracts, and the amounts booked to "Unbilled
work on uncompleted contracts" for each period are as follows:
June 30 December 31
--------------------------------
Millions of dollars 2003 2002
------------------------------------------------------------------------------
Probable unapproved claims (included
in determining contract profit or loss) $ 335 $ 279
Unapproved claims in unbilled work on
uncompleted contracts $ 285 $ 210
==============================================================================
11
Our claims at June 30, 2003 are listed in the table above. These claims
relate to ten contracts, most of which are complete or substantially complete.
We are actively engaged in claims negotiation with the customers. The largest
claim relates to the Barracuda-Caratinga contract which was approximately 75%
complete at June 30, 2003. The probable unapproved claims included in
determining this contract's loss were $182 million at June 30, 2003 and at
December 31, 2002. As most of the claim elements for this contract will likely
not be settled within one year, related amounts in unbilled work on uncompleted
contracts of $134 million at June 30, 2003 and $115 million at December 31, 2002
included in the table above have been recorded to long-term unbilled work on
uncompleted contracts which is included in "Other assets, net" on the balance
sheet. All other claims included in the table above have been recorded to
"Unbilled work on uncompleted contracts" included in the "Total receivables"
amount on the balance sheet.
A summary of unapproved claims activity for the three and six months
ended June 30, 2003 is as follows:
Total Probable Unapproved Probable Unapproved Claims
Claims Unbilled Work
--------------------------------------------------------------------
Three Months Six Months Three Months Six Months
Ended Ended Ended Ended
Millions of dollars June 30, 2003 June 30, 2003 June 30, 2003 June 30, 2003
---------------------------------------------------------------------------------------------------------
Beginning balance $ 298 $ 279 $ 237 $ 210
Additions 42 62 41 61
Costs incurred during period - - 12 20
Other (5) (6) (5) (6)
---------------------------------------------------------------------------------------------------------
Ending balance $ 335 $ 335 $ 285 $ 285
=========================================================================================================
In addition, our unconsolidated related companies include probable
unapproved claims as revenue to determine the amount of profit or loss for their
contracts. Our "Equity in earnings of unconsolidated affiliates" includes our
equity percentage of unapproved claims related to unconsolidated projects
totaling $11 million at June 30, 2003 and $9 million at December 31, 2002.
Note 11. Commitments and Contingencies - Asbestos and Silica
Asbestos litigation. Several of our subsidiaries, particularly DII
Industries, LLC (DII Industries) and Kellogg Brown & Root, Inc. (Kellogg Brown &
Root), are defendants in a large number of asbestos-related lawsuits. The
plaintiffs allege injury as a result of exposure to asbestos in products
manufactured or sold by former divisions of DII Industries or in materials used
in construction or maintenance projects of Kellogg Brown & Root.
These claims are in three general categories:
- refractory claims;
- other DII Industries claims; and
- construction claims.
Refractory claims. Asbestos was used in a small number of products
manufactured or sold by Harbison-Walker Refractories Company, which DII
Industries acquired in 1967. The Harbison-Walker operations were conducted as a
division of DII Industries (then named Dresser Industries, Inc.) until those
operations were transferred to another then-existing subsidiary of DII
Industries in preparation for a spin-off. Harbison-Walker was spun-off by DII
Industries in July 1992. At that time, Harbison-Walker assumed liability for
asbestos claims filed after the spin-off and it agreed to defend and indemnify
DII Industries from liability for those claims, although DII Industries
continues to have direct liability to tort claimants for all post spin-off
refractory asbestos claims. DII Industries retained responsibility for all
asbestos claims pending as of the date of the spin-off. The agreement governing
the spin-off provided that Harbison-Walker would have the right to access DII
Industries historic insurance coverage for the asbestos-related liabilities that
Harbison-Walker assumed in the spin-off. After the spin-off, DII Industries and
Harbison-Walker jointly negotiated and entered into coverage-in-place agreements
with a number of insurance companies that had issued historic general liability
insurance policies which both DII Industries and Harbison-Walker had the right
to access for, among other things, bodily injury occurring between 1963 and
1985. These coverage-in-place agreements provide for the payment of defense
costs, settlements and court judgments paid to resolve refractory asbestos
claims.
12
As Harbison-Walker's financial condition worsened in late 2000 and
2001, Harbison-Walker began agreeing to pay more in settlement of the post
spin-off refractory claims than it historically had paid. These increased
settlement amounts led to Harbison-Walker making greater demands on the shared
insurance asset. By July 2001, DII Industries determined that the demands that
Harbison-Walker was making on the shared insurance policies were not acceptable
to DII Industries and that Harbison-Walker probably would not be able to fulfill
its indemnification obligation to DII Industries. Accordingly, DII Industries
took up the defense of unsettled post spin-off refractory claims that name it as
a defendant in order to prevent Harbison-Walker from unnecessarily eroding the
insurance coverage both companies access for these claims. These claims are now
stayed in the Harbison-Walker bankruptcy proceeding.
As of June 30, 2003, there were approximately 6,000 open and unresolved
pre-spin-off refractory claims against DII Industries. In addition, there were
approximately 153,000 post spin-off claims that name DII Industries as a
defendant.
Other DII Industries claims. As of June 30, 2003, there were
approximately 185,000 open and unresolved claims alleging injuries from asbestos
used in other products formerly manufactured by DII Industries or its
predecessors. Most of these claims involve gaskets and packing materials used in
pumps and other industrial products.
Construction claims. Our Engineering and Construction Group includes
engineering and construction businesses formerly operated by The M.W. Kellogg
Company and Brown & Root, Inc., now combined as Kellogg Brown & Root. As of June
30, 2003, there were approximately 81,000 open and unresolved claims alleging
injuries from asbestos in materials used in construction and maintenance
projects, most of which were conducted by Brown & Root, Inc. Approximately 6,000
of these claims are asserted against The M.W. Kellogg Company. We believe that
Kellogg Brown & Root has a good defense to these claims, and a prior owner of
The M.W. Kellogg Company provides Kellogg Brown & Root a contractual
indemnification for claims against The M.W. Kellogg Company.
Harbison-Walker Chapter 11 bankruptcy. On February 14, 2002,
Harbison-Walker filed a voluntary petition for reorganization under Chapter 11
of the United States Bankruptcy Code in the Bankruptcy Court in Pittsburgh,
Pennsylvania. In its initial bankruptcy-related filings, Harbison-Walker said
that it would seek to utilize Sections 524(g) and 105 of the Bankruptcy Code to
propose and seek confirmation of a plan of reorganization that would provide for
distributions for all legitimate, pending and future asbestos claims asserted
directly against Harbison-Walker or asserted against DII Industries for which
Harbison-Walker is required to indemnify and defend DII Industries.
Harbison-Walker's failure to fulfill its indemnity obligations, and its
erosion of insurance coverage shared with DII Industries, required DII
Industries to assist Harbison-Walker in its bankruptcy proceeding in order to
protect the shared insurance from dissipation. At the time that Harbison-Walker
filed its bankruptcy, DII Industries agreed to provide up to $35 million of
debtor-in-possession financing to Harbison-Walker during the pendency of the
Chapter 11 proceeding, of which $5 million was advanced during the first quarter
of 2002. Halliburton funded the remaining $30 million on July 31, 2003. We
recorded a pretax charge of $30 million in "Loss from discontinued operations"
in our condensed consolidated statements of operations for the second quarter
2003, as the debtor-in-possession financing is expected to be forgiven 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. On February 14, 2002, in accordance with the terms of a letter
agreement, DII Industries paid $40 million to Harbison-Walker's United States
parent holding company, RHI Refractories Holding Company. This payment was
charged to discontinued operations in our financial statements in the first
quarter of 2002.
The terms of the letter agreement also require DII Industries to pay to
RHI Refractories an additional $35 million if a plan of reorganization is
proposed in the Harbison-Walker bankruptcy proceedings, and an additional $85
million if a plan is confirmed in the Harbison-Walker bankruptcy proceedings, in
each case acceptable to DII Industries in its sole discretion. The letter
agreement provides that a plan acceptable to DII Industries must include an
injunction channeling to a Section 524(g)/105 trust all present and future
asbestos claims against DII Industries arising out of the Harbison-Walker
business or other DII Industries' businesses that share insurance with
Harbison-Walker.
13
Harbison-Walker filed a proposed plan of reorganization on July 31,
2003. However, the proposed plan does not provide for a Section 524(g)/105
injunction for the benefit of DII Industries and other DII Industries businesses
that share insurance with Harbison-Walker, and DII Industries has not consented
to the plan. Although possible, at this time we do not believe it likely that
Harbison-Walker will propose or will be able to confirm a plan of reorganization
in its bankruptcy proceeding that is acceptable to DII Industries within the
meaning of the letter agreement with RHI Refractories.
In general, in order for a Harbison-Walker plan of reorganization
involving a Section 524(g)/105 trust to be confirmed, the plan would need, among
other things, to be structured to provide substantially similar treatment to
current and future asbestos claimants and the creation of the trust would
require the approval of 75% of those asbestos claimant creditors of
Harbison-Walker voting on the plan. A plan also would be subject to completion
of negotiations of material terms and definitive plan documentation with the
asbestos claimants committee, a futures representative for asbestos claimants in
the Harbison-Walker bankruptcy cases and DII Industries. There can be no
assurance that any plan proposed by Harbison-Walker would be structured to meet
the requirements for obtaining an injunction or that Harbison-Walker could
obtain the necessary approval.
As an alternative, DII Industries has entered into a settlement in
principle with Harbison-Walker which would resolve substantially all of the
issues between them. This agreement is subject to negotiation of definitive
documentation and court approval in Harbison-Walker's bankruptcy case. If
approved by the court in Harbison-Walker's bankruptcy case, this agreement would
provide for:
- channeling of asbestos and silica personal injury claims
against Harbison-Walker and certain of its affiliates to the
trusts created in the Chapter 11 cases being contemplated for
DII Industries and Kellogg Brown & Root;
- release by Harbison-Walker and its affiliates of any rights in
insurance shared with DII Industries on occurrence of the
effective date of the plan of reorganization for DII
Industries;
- release by DII Industries of any right to be indemnified by
Harbison-Walker for asbestos or silica personal injury claims;
- forgiveness by DII Industries of all of Harbison-Walker's
obligations under the debtor-in-possession financing provided
by DII Industries 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;
- purchase by DII Industries of Harbison-Walker's outstanding
insurance receivables for an amount of approximately $50
million on the earliest of the effective date of a plan of
reorganization for DII Industries, the effective date of a
plan of reorganization for Harbison-Walker acceptable to DII
Industries or December 31, 2003. It is expected that a portion
of this receivable would require a reserve for
uncollectibility due to the insolvency of the insurance
carriers. This receivable and related allowance will be
recorded in the third quarter 2003;
- guarantee of the insurance receivable purchase price by
Halliburton on a subordinated basis; and
- negotiation between the parties on a mutually-agreeable
structure for resolving other products or tort claims.
We do not believe it probable that DII Industries will be obligated to
make either of the additional $35 million or $85 million payments to RHI
Refractories described above because the plan of reorganization filed by
Harbison-Walker on July 31, 2003 in its bankruptcy proceeding would not, if
confirmed, create a Section 524(g) and/or 105 channeling injunction in favor of
DII Industries and because the plan of reorganization filed by Harbison-Walker
is not acceptable to DII Industries within the meaning of the February 14, 2002
letter agreement. RHI A.G., the ultimate corporate parent of RHI Refractories,
has indicated that it believes otherwise, and has announced an intent to take
legal action against us to recover $35 million they believe is presently owing.
On August 8, 2003, we filed a declaratory judgment lawsuit against RHI
Refractories in the District Court of Harris County, Texas, 80th Judicial
District seeking a declaration from the court that we do not owe RHI
Refractories any money pursuant to the letter agreement.
14
In connection with the Chapter 11 filing by Harbison-Walker, the
Bankruptcy Court on February 14, 2002 issued a temporary restraining order
staying all further litigation of more than 200,000 asbestos claims currently
pending against DII Industries in numerous courts throughout the United States.
The period of the stay contained in the temporary restraining order has been
extended through September 30, 2003. At present, the stay will terminate at
close of business on September 30, 2003, but DII Industries does have the
ability, provided the asbestos claimants committee in the Harbison-Walker
bankruptcy agrees, to request that the Court extend the stay further. Currently,
there is no assurance that a stay will remain in effect beyond September 30,
2003, that a plan of reorganization will be confirmed for Harbison-Walker, or
that any plan that is confirmed will provide relief to DII Industries. Should
the stay expire on September 30, 2003, the Bankruptcy Court established that
discovery on the claims that had been stayed cannot begin until November 1, 2003
and that trials on any of the claims that had been stayed cannot commence before
January 1, 2004.
The stayed asbestos claims are those covered by insurance that DII
Industries and Harbison-Walker each access to pay defense costs, settlements and
judgments attributable to both refractory and non-refractory asbestos claims.
The stayed claims include approximately 153,000 post-1992 spin-off refractory
claims, 6,000 pre-spin-off refractory claims and approximately 135,000 other
types of asbestos claims pending against DII Industries. Approximately 51,000 of
the claims in the third category are claims made against DII Industries based on
more than one ground for recovery and the stay affects only the portion of the
claim covered by the shared insurance. The stay prevents litigation from
proceeding while the stay is in effect and also prohibits the filing of new
claims. One of the purposes of the stay is to allow Harbison-Walker and DII
Industries time to develop and propose a plan of reorganization.
Asbestos insurance coverage. DII Industries has substantial insurance
for reimbursement for portions of the costs incurred defending asbestos and
silica claims, as well as amounts paid to settle claims and court judgments.
This coverage is provided by a large number of insurance policies written by
dozens of insurance companies. The insurance companies wrote the coverage over a
period of more than 30 years for DII Industries, its predecessors or its
subsidiaries and their predecessors. Large amounts of this coverage are now
subject to coverage-in-place agreements that resolve issues concerning amounts
and terms of coverage. The amount of insurance available to DII Industries and
its subsidiaries depends on the nature and time of the alleged exposure to
asbestos or silica, the specific subsidiary against which an asbestos or silica
claim is asserted and other factors.
Refractory claims insurance. DII Industries has approximately $2.1
billion in aggregate limits of insurance coverage for refractory asbestos and
silica claims, of which over one-half is with Equitas or other London-based
insurance companies. Most of this insurance is shared with Harbison-Walker. Many
of the issues relating to the majority of this coverage have been resolved by
coverage-in-place agreements with dozens of companies, including Equitas and
other London-based insurance companies. Coverage-in-place agreements are
settlement agreements between policyholders and the insurers specifying the
terms and conditions under which coverage will be applied as claims are
presented for payment. These agreements in an asbestos claims context govern
such things as what events will be deemed to trigger coverage, how liability for
a claim will be allocated among insurers and what procedures the policyholder
must follow in order to obligate the insurer to pay claims. Beginning in 2001
however, Equitas and other London-based companies have attempted to impose new
restrictive documentation requirements on DII Industries and other insureds.
Equitas and the other London-based companies have stated that the new
requirements are part of an effort to limit payment of settlements to claimants
who are truly impaired by exposure to asbestos and can identify the product or
premises that caused their exposure.
On March 21, 2002, Harbison-Walker filed a lawsuit in the United States
Bankruptcy Court for the Western District of Pennsylvania in its Chapter 11
bankruptcy proceeding. This lawsuit is substantially similar to DII Industries
lawsuit filed in Texas State Court in 2001 and seeks, among other relief, a
determination as to the rights of DII Industries and Harbison-Walker to the
shared general liability insurance. The lawsuit also seeks damages against
specific insurers for breach of contract and bad faith, and a declaratory
judgment concerning the insurers' obligations under the shared insurance.
Although DII Industries is also a defendant in this lawsuit, it has asserted its
own claim to coverage under the shared insurance and is cooperating with
Harbison-Walker to secure both companies' rights to the shared insurance. The
Bankruptcy Court has ordered the parties to this lawsuit to engage in
non-binding mediation. The first mediation session was held on July 26, 2002 and
additional sessions have since taken place and further sessions will be
scheduled to take place, provided the Bankruptcy Court's mediation order remains
15
in effect. Given the early stages of these negotiations, DII Industries cannot
predict whether a negotiated resolution of this dispute will occur or, if such a
resolution does occur, the precise terms of such a resolution.
Prior to the Harbison-Walker bankruptcy, on August 7, 2001, DII
Industries filed a lawsuit in Dallas County, Texas, against a number of these
insurance companies asserting DII Industries rights under an existing
coverage-in-place agreement and under insurance policies not yet subject to
coverage-in-place agreements. The coverage-in-place agreements allow DII
Industries to enter into settlements for small amounts without requiring
claimants to produce detailed documentation to support their claims, when DII
Industries believes the settlements are an effective claims management strategy.
DII Industries believes that the new documentation requirements are inconsistent
with the current coverage-in-place agreements and are unenforceable. The
insurance companies that DII Industries has sued have not refused to pay larger
claim settlements where documentation is obtained or where court judgments are
entered.
On May 10, 2002, the London-based insuring entities and companies
removed DII Industries' Dallas County State Court Action to the United States
District Court for the Northern District of Texas alleging that federal court
jurisdiction existed over the case because it is related to the Harbison-Walker
bankruptcy. DII Industries has filed an opposition to that removal and has asked
the federal court to remand the case back to the Dallas County state court. On
June 12, 2002, the London-based insuring entities and companies filed a motion
to transfer the case to the federal court in Pittsburgh, Pennsylvania. DII
Industries has filed an opposition to that motion to transfer. The federal court
in Dallas has yet to rule on any of these motions. Regardless of the outcome of
these motions, because of the similar insurance coverage lawsuit filed by
Harbison-Walker in its bankruptcy proceeding, it is unlikely that DII
Industries' case will proceed simultaneously with the insurance coverage case
filed by Harbison-Walker in its bankruptcy.
Other DII Industries claims insurance. DII Industries has substantial
insurance to cover other non-refractory asbestos claims. Two coverage-in-place
agreements cover DII Industries for companies or operations that DII Industries
either acquired or operated prior to November 1, 1957. Asbestos claims that are
covered by these agreements are currently stayed by the Harbison-Walker
bankruptcy because the majority of this coverage also applies to refractory
claims and is shared with Harbison-Walker. Other insurance coverage is provided
by a number of different policies that DII Industries acquired rights to access
when it acquired businesses from other companies. Three coverage-in-place
agreements provide reimbursement for asbestos claims made against DII
Industries' former Worthington Pump division. There is also other substantial
insurance coverage with approximately $2.0 billion in aggregate limits that has
not yet been reduced to coverage-in-place agreements.
On August 28, 2001, DII Industries filed a lawsuit in the 192nd
Judicial District of the District Court for Dallas County, Texas against
specific London-based insuring entities that issued insurance policies that
provide coverage to DII Industries for asbestos-related liabilities arising out
of the historical operations of Worthington Corporation or its successors. This
lawsuit raises essentially the same issue as to the documentation requirements
as the August 7, 2001 Harbison-Walker lawsuit filed in the same court. The
London-based insuring entities filed a motion in that case seeking to compel the
parties to binding arbitration. The trial court denied that motion and the
London-based insuring entities appealed that decision to the state appellate
court. The state appellate court denied the appeal and, most recently, the
London-based insuring entities have removed the case from the state court to the
federal court. DII Industries was successful in remanding the case back to the
state court.
A significant portion of the insurance coverage applicable to
Worthington claims is alleged by Federal-Mogul Products, Inc. to be shared with
it. In 2001, Federal-Mogul Products, Inc. and a large number of its affiliated
companies filed a voluntary petition for reorganization under Chapter 11 of the
Bankruptcy Code in the Bankruptcy Court in Wilmington, Delaware.
In response to Federal-Mogul's allegations, on December 7, 2001, DII
Industries filed a lawsuit in the Delaware Bankruptcy Court asserting its rights
to insurance coverage under historic general liability policies issued to
Studebaker-Worthington, Inc. and its successor for asbestos-related liabilities
arising from, among other operations, Worthington's and its successors' historic
operations. This lawsuit also seeks a judicial declaration concerning the
competing rights of DII Industries and Federal-Mogul, if any, to this insurance
coverage. DII Industries recently filed a third amended complaint in that
lawsuit and the parties are engaged in the discovery process and summary
judgment briefing. The parties to this litigation, including Federal-Mogul, have
16
agreed to mediate this dispute. Unlike the Harbison-Walker insurance coverage
litigation, in which the litigation is stayed while the mediation proceeds, the
insurance coverage litigation concerning the Worthington-related asbestos
liabilities has not been stayed and such litigation is proceeding simultaneously
with the mediation.
At the same time, DII Industries filed its insurance coverage action in
the Federal-Mogul bankruptcy, DII Industries also filed a second lawsuit in
which it has filed a motion for preliminary injunction seeking a stay of all
Worthington asbestos-related lawsuits against DII Industries that are scheduled
for trial within the six months following the filing of the motion. The stay
that DII Industries seeks, if granted, would remain in place until the competing
rights of DII Industries and Federal-Mogul to the allegedly shared insurance are
resolved. The Court has yet to schedule a hearing on DII Industries' motion for
preliminary injunction.
A number of insurers who have agreed to coverage-in-place agreements
with DII Industries have suspended payment under the shared Worthington policies
until the Federal-Mogul Bankruptcy Court resolves the insurance issues.
Consequently, the effect of the Federal-Mogul bankruptcy on DII Industries
rights to access this shared insurance is uncertain.
Construction claims insurance. Nearly all of our construction asbestos
claims relate to Brown & Root, Inc. operations before the 1980s. Our primary
insurance coverage for these claims was written by Highlands Insurance Company
during the time it was one of our subsidiaries. Highlands was spun-off to our
shareholders in 1996. On April 5, 2000, Highlands filed a lawsuit against us in
the Delaware Chancery Court. Highlands asserted that the insurance it wrote for
Brown & Root, Inc. that covered construction asbestos claims was terminated by
agreements between Halliburton and Highlands at the time of the 1996 spin-off.
In March 2001, the Chancery Court ruled that a termination did occur and that
Highlands was not obligated to provide coverage for Brown & Root, Inc.'s
asbestos claims. This decision was affirmed by the Delaware Supreme Court on
March 13, 2002. As a result of this ruling, we wrote-off approximately $35
million in accounts receivable for amounts paid for claims and defense costs and
$45 million of accrued receivables in relation to estimated insurance recoveries
claims settlements from Highlands in the first quarter 2002. In addition, we
dismissed the April 24, 2000 lawsuit we filed against Highlands in Harris
County, Texas.
As a consequence of the Delaware Supreme Court's decision, Kellogg
Brown & Root no longer has primary insurance coverage from Highlands for
asbestos claims. However, Kellogg Brown & Root has significant excess insurance
coverage. The amount of this excess coverage that will reimburse us for an
asbestos claim depends on a variety of factors. On March 20, 2002, Kellogg Brown
& Root filed a lawsuit in the 172nd Judicial District of the District Court of
Jefferson County, Texas, against Kellogg Brown & Root's historic insurers that
issued these excess insurance policies. In the lawsuit, Kellogg Brown & Root
seeks to establish the specific terms under which it can seek reimbursement for
costs it incurs in settling and defending asbestos claims from its historic
construction operations. On January 6, 2003, this lawsuit was transferred to the
11th Judicial District of the District Court of Harris County, Texas, and the
parties are engaged in the discovery process. Until this lawsuit is resolved,
the scope of the excess insurance will remain uncertain, and as such we have not
assumed any recoveries from excess insurance coverage. We do not expect the
excess insurers will reimburse us for asbestos claims until this lawsuit is
resolved.
Significant asbestos judgments on appeal. During 2001, there were
several adverse judgments in trial court proceedings that are in various stages
of the appeal process. All of these judgments concern asbestos claims involving
Harbison-Walker refractory products. Each of these appeals, however, has been
stayed by the Bankruptcy Court in the Harbison-Walker Chapter 11 bankruptcy.
On November 29, 2001, the Texas District Court in Orange, Texas,
entered judgments against Dresser Industries, Inc. (now DII Industries) on a $65
million jury verdict rendered in September 2001 in favor of five plaintiffs. The
$65 million amount includes $15 million of a $30 million judgment against DII
Industries and another defendant. DII Industries is jointly and severally liable
for $15 million in addition to $65 million if the other defendant does not pay
its share of this judgment. Based upon what we believe to be controlling
precedent, which would hold that the judgment entered is void, we believe that
the likelihood of the judgment being affirmed in the face of DII Industries'
appeal is remote. As a result, we have not accrued any amounts for this
judgment. However, a favorable outcome from the appeal is not assured.
On November 29, 2001, the same District Court in Orange, Texas, entered
three additional judgments against Dresser Industries, Inc. (now DII Industries)
in the aggregate amount of $35.7 million in favor of 100 other asbestos
plaintiffs. These judgments relate to an alleged breach of purported settlement
17
agreements signed early in 2001 by a New Orleans lawyer hired by
Harbison-Walker, which had been defending DII Industries pursuant to the
agreement by which Harbison-Walker was spun-off by DII Industries in 1992. These
settlement agreements expressly bind Harbison-Walker Refractories Company as the
obligated party, not DII Industries, which is not a party to the agreements. For
that reason, and based upon what we believe to be controlling precedent, which
would hold that the judgment entered is void, we believe that the likelihood of
the judgment being affirmed in the face of DII Industries' appeal is remote. As
a result, we have not accrued any amounts for this judgment. However, a
favorable outcome from the appeal is not assured.
On December 5, 2001, a jury in the Circuit Court for Baltimore County,
Maryland, returned verdicts against Dresser Industries, Inc. (now DII
Industries) and other defendants following a trial involving refractory asbestos
claims. Each of the five plaintiffs alleges exposure to Harbison-Walker
products. DII Industries portion of the verdicts was approximately $30 million,
which we fully accrued in 2002. DII Industries intends to appeal the judgment to
the Maryland Supreme Court. While we believe we have a valid basis for appeal
and intend to vigorously pursue our appeal, any favorable outcome from that
appeal is not assured.
On October 25, 2001, in the Circuit Court of Holmes County,
Mississippi, a jury verdict of $150 million was rendered in favor of six
plaintiffs against Dresser Industries, Inc. (now DII Industries) and two other
companies. DII Industries share of the verdict was $21.3 million which we fully
accrued in 2002. The award was for compensatory damages. The jury did not award
any punitive damages. The trial court has entered judgment on the verdict. While
we believe we have a valid basis for appeal and intend to vigorously pursue our
appeal, any favorable outcome from that appeal is not assured.
Asbestos claims history. Since 1976, approximately 661,000 asbestos
claims have been filed against us. Almost all of these claims have been made in
separate lawsuits in which we are named as a defendant along with a number of
other defendants, often exceeding 100 unaffiliated defendant companies in total.
The approximate number of open claims pending against us is as follows:
Total Open
Period Ending Claims
---------------------------------------------------
June 30, 2003 425,000
March 31, 2003 389,000
December 31, 2002 347,000
September 30, 2002 328,000
June 30, 2002 312,000
March 31, 2002 292,000
December 31, 2001 274,000
===================================================
During the second quarter of 2003, we received approximately 37,000 new
claims and we closed approximately 1,000 claims. We believe that in many cases,
single claimants are filing claims against multiple Halliburton entities, and we
believe that the actual number of additional claimants is about half of the
number of new claims. If and when we confirm duplicate claims, we will adjust
our data accordingly. We believe of the 425,000 open claims as of June 30, 2003,
these represent claims made by approximately 345,000 separate claimants.
The total open claims include post spin-off Harbison-Walker refractory
related claims that name DII Industries as a defendant. All such claims have
been factored into the calculation of our asbestos liability. The approximate
number of post spin-off Harbison-Walker claims included in total open claims
pending against us is as follows:
18
Post Spin-off
Harbison-Walker
Period Ending Claims
------------------------------------------------------
June 30, 2003 153,000
March 31, 2003 152,000
December 31, 2002 142,000
September 30, 2002 142,000
June 30, 2002 139,000
March 31, 2002 133,000
December 31, 2001 125,000
======================================================
We manage asbestos claims to achieve settlements of valid claims for
reasonable amounts. When reasonable settlement is not possible, we contest
claims in court. Since 1976, we have closed approximately 236,000 claims through
settlements and court proceedings at a total cost of approximately $217 million.
We have received or expect to receive from our insurers all but approximately
$105 million of this cost, resulting in an average net cost per closed claim of
about $445.
Asbestos study and the valuation of unresolved current and future
asbestos claims.
Asbestos Study. In late 2001, DII Industries retained Dr. Francine F.
Rabinovitz of Hamilton, Rabinovitz & Alschuler, Inc. to estimate the probable
number and value, including defense costs, of unresolved current and future
asbestos and silica-related bodily injury claims asserted against DII Industries
and its subsidiaries. Dr. Rabinovitz is a nationally renowned expert in
conducting such analyses, has been involved in a number of asbestos-related and
other toxic tort-related valuations of current and future liabilities, has
served as the expert for three representatives of future claimants in asbestos
related bankruptcies and has had her valuation methodologies accepted by
numerous courts. Further, the methodology utilized by Dr. Rabinovitz is the same
methodology that is utilized by the expert who is routinely retained by the
asbestos claimants committee in asbestos-related bankruptcies. Dr. Rabinovitz
estimated the probable number and value of unresolved current and future
asbestos and silica-related bodily injury claims asserted against DII Industries
and its subsidiaries over a 50 year period. The report took approximately seven
months to complete.
Methodology. The methodology utilized by Dr. Rabinovitz to project DII
Industries and its subsidiaries' asbestos- and silica-related liabilities and
defense costs relied upon and included:
- an analysis of DII Industries, Kellogg Brown & Root's and
Harbison-Walker Refractories Company's historical asbestos and
silica settlements and defense costs to develop average
settlement values and average defense costs for specific
asbestos- and silica-related diseases and for the specific
business operation or entity allegedly responsible for the
asbestos- and silica-related diseases;
- an analysis of DII Industries, Kellogg Brown & Root's and
Harbison-Walker Refractories Company's pending inventory of
asbestos- and silica-related claims by specific diseases and
by the specific business operation or entity allegedly
responsible for the disease;
- an analysis of the claims filing history for asbestos- and
silica-related claims against DII Industries, Kellogg Brown &
Root and Harbison-Walker Refractories Company for the
approximate two-year period from January 2000 to May 31, 2002,
and for the approximate five-year period from January 1997 to
May 31, 2002 by specific disease and by business operation or
entity allegedly responsible for the disease;
- an analysis of the population likely to have been exposed or
claim exposure to products manufactured by DII Industries, its
predecessors and Harbison-Walker or to Brown & Root
construction and renovation projects; and
- epidemiological studies to estimate the number of people who
might allege exposure to products manufactured by DII
Industries, its predecessors and Harbison-Walker or to Brown &
Root construction and renovation projects that would be likely
to develop asbestos-related diseases. Dr. Rabinovitz's
estimates are based on historical data supplied by DII
Industries, Kellogg Brown & Root and Harbison-Walker and
19
publicly available studies, including annual surveys by the
National Institutes of Health concerning the incidence of
mesothelioma deaths.
In her estimates, Dr. Rabinovitz relied on the source data provided by
our management; she did not independently verify the accuracy of the source
data. The source data provided by us was based on our 24-year history in
gathering claimant information and defending and settling asbestos and silica
claims.
In her analysis, Dr. Rabinovitz projected that the elevated and
historically unprecedented rate of claim filings of the last several years
(particularly in 2000 and 2001), especially as expressed by the ratio of
nonmalignant claim filings to malignant claim filings, would continue into the
future for five more years. After that, Dr. Rabinovitz projected that the ratio
of nonmalignant claim filings to malignant claim filings will gradually decrease
for a 10 year period ultimately returning to the historical claiming rate and
claiming ratio. In making her calculation, Dr. Rabinovitz alternatively assumed
a somewhat lower rate of claim filings, based on an average of the last five
years of claims experience, would continue into the future for five more years
and decrease thereafter.
Other important assumptions utilized in Dr. Rabinovitz's estimates,
which we relied upon in making our accrual are:
- there will be no legislative or other systemic changes to the
tort system;
- that we will continue to aggressively defend against asbestos
and silica claims made against us;
- an inflation rate of 3% annually for settlement payments and
an inflation rate of 4% annually for defense costs; and
- we would receive no relief from our asbestos obligation due to
actions taken in the Harbison-Walker bankruptcy.
Range of Liabilities. Based upon her analysis, Dr. Rabinovitz estimated
total, undiscounted asbestos and silica liabilities, including defense costs, of
DII Industries, Kellogg Brown & Root and some of their current and former
subsidiaries. Through 2052, Dr. Rabinovitz estimated the current and future
total undiscounted liability for personal injury asbestos and silica claims,
including defense costs, would be a range between $2.2 billion and $3.5 billion
as of June 30, 2002 (which includes payments related to the claims currently
pending). The lower end of the range is calculated by using an average of the
last five years of asbestos claims experience and the upper end of the range is
calculated using the more recent two-year elevated rate of asbestos claim
filings in projecting the rate of future claims.
2nd Quarter 2002 Accrual. Based on that estimate, in the second quarter
of 2002, we accrued asbestos and silica claims liability and defense costs for
both known outstanding and future refractory, other DII Industries, and
construction asbestos and silica claims using the low end of the range of Dr.
Rabinovitz's study, or approximately $2.2 billion. In establishing our liability
for asbestos, we included all post spin-off claims against Harbison-Walker
that name DII Industries as a defendant. Our accruals were based on an estimate
of personal injury asbestos claims through 2052 based on the average claims
experience of the last five years. At the end of the second quarter of 2002, we
did not believe that any point in the expert's range was better than any other
point, and accordingly, based our accrual on the low end of the range in
accordance with FIN 14.
Agreement regarding proposed asbestos and silica settlement. In
December 2002, we announced that we had reached an agreement in principle that,
if and when consummated, would result in a settlement of asbestos and silica
personal injury claims against our subsidiaries DII Industries and Kellogg Brown
& Root and their current and former subsidiaries with United States operations.
Subsequently, DII Industries and Kellogg Brown & Root entered into definitive
written agreements finalizing the terms of the agreements in principle with
attorneys representing more than 90% of the current asbestos claimants. We have
also reached agreements in principle with 48% of current silica claimants.
The definitive agreements provide that:
- up to $2.775 billion in cash, 59.5 million Halliburton shares
(valued at $1.4 billion using the stock price at June 30, 2003
of $23.00) and notes with a net value expected to be less than
$100 million will be paid to one or more trusts for the
benefit of current and future asbestos and silica personal
injury claimants upon receiving final and non-appealable court
confirmation of a plan of reorganization;
20
- DII Industries and Kellogg Brown & Root will retain rights to
the first $2.3 billion of any insurance proceeds with any
proceeds received between $2.3 billion and $3 billion going to
the trust;
- the agreement is to be implemented through a pre-packaged
filing under Chapter 11 of the United States Bankruptcy Code
for DII Industries, Kellogg Brown & Root and some of the
subsidiaries with United States operations; and
- the funding of the settlement amounts would occur upon
receiving final and non-appealable court confirmation of a
plan of reorganization for DII Industries and Kellogg Brown &
Root and some of their subsidiaries with United States
operations in the Chapter 11 proceeding.
Among the prerequisites for concluding the proposed settlement are:
- agreement on the amounts to be contributed to the trusts for
the benefit of silica claimants;
- completion of our review of the current claims to establish
that the claimed injuries resulted from exposure to products
of DII Industries, Kellogg Brown & Root or their
subsidiaries or former businesses or subsidiaries;
- completion of our medical review of the injuries alleged to
have been sustained by plaintiffs to establish a medical basis
for payment of settlement amounts;
- finalizing the principal amount and terms of the notes to be
contributed to the trusts;
- agreement with a proposed representative of future claimants
and attorneys representing current claimants on procedures for
the distribution of settlement funds to individuals claiming
personal injury;
- definitive agreement with a proposed representative of future
claimants and the attorneys representing current asbestos
claimants on a plan of reorganization for the Chapter 11
filing of DII Industries, Kellogg Brown & Root and some of
their subsidiaries with United States operations; and
agreement with the attorneys representing current asbestos and
silica claimants with respect to a disclosure statement
explaining the pre-packaged plan of reorganization to the
current claimants;
- arrangement of financing, in addition to the proceeds of our
recent offering of $1.2 billion principal amount of
convertible senior notes, for the proposed settlement on terms
acceptable to us to fund the cash amounts to be paid in the
settlement;
- Halliburton board approval;
- distribution of a disclosure statement and obtaining approval
of a plan of reorganization from at least the required 75% of
known present asbestos claimants and from a majority of known
present silica claimants in order to complete the plan of
reorganization; and
- obtaining final and non-appealable bankruptcy court approval
and federal district court confirmation of the plan of
reorganization.
Many of these prerequisites are subject to matters and uncertainties
beyond our control. There can be no assurance that we will be able to satisfy
the prerequisities for completion of the settlement.
We are currently continuing our due diligence review of current
asbestos claims to be included in the proposed settlement. We have now received
in excess of 75% of the necessary files related to medical evidence and we have
reviewed substantially all of the information provided. In regards to the
product identification due diligence, the process is moving at a steady pace,
but not as rapidly as the medical due diligence. In addition, we have not yet
commenced any due diligence in regards to silica claims. While no assurance can
be given, if we continue to receive documentation that is consistent with the
recent quantity and quality of the documentation received to date, we expect
that this documentation will provide an acceptable basis on which to proceed
with the proposed settlement.
One result of our due diligence review is the preliminary
identification of more claims than contemplated by the proposed settlement.
However, until the more recently identified claims are subject to a complete due
diligence review, we will not be able to determine if these claims would be
appropriately included under the proposed settlement. Many of these recently
identified claims may be duplicative of previously submitted claims or may
otherwise not be appropriately included under the proposed settlement. In the
event that more claims are identified and validated than contemplated by the
proposed settlement, the cash required to fund the settlement may modestly
21
exceed $2.775 billion. If it does, we would need to decide whether to propose to
adjust the settlement matrices to reduce the overall amounts, or increase the
amounts we would be willing to pay to resolve the asbestos and silica
liabilities.
If we attempt to adjust the settlement matrices or otherwise attempt to
renegotiate the terms of the proposed settlement, the attorneys representing the
current asbestos claimants may not proceed with the settlement or may attempt to
renegotiate the settlement amount to increase the aggregate amount of the
settlement. Conversely, an increase in the amount of cash required may make
completing the proposed settlement more difficult.
In the event we elect to adjust the settlement matrices to reduce the
average amounts per claim, a supplemental disclosure statement may be required,
and if so, the claimants potentially adversely affected by the adjustment may
have an opportunity to change their votes. The additional time to make such
supplemental disclosure and opportunity to change votes may result in a delay in
the Chapter 11 filing.
Included in the next steps to complete the proposed settlement are (1)
an agreement on the procedures for the distribution of settlement funds to
individuals claiming personal injury and (2) an agreement on a plan of
reorganization for Kellogg Brown & Root and DII Industries and some of the
subsidiaries with United States operations and the related disclosure statement.
We cannot predict the exact timing of the completion of these steps, but we
expect that these prerequisites to making the Chapter 11 filing could be
completed on a timeline that would allow the Chapter 11 filing to be made late
in the third quarter or very early in the fourth quarter of 2003.
The settlement agreements with attorneys representing current asbestos
and silica claimants grant the attorneys a right to terminate their definitive
agreement on 10 days' notice. While no right to terminate any settlement
agreement has been exercised to date, there can be no assurance that claimants'
attorneys will not exercise their right to terminate the settlement agreements.
We continue to track legislative proposals for asbestos reform pending
in the United States Congress. In determining whether to approve the proposed
settlement and proceed with the Chapter 11 filing of DII Industries and Kellogg
Brown & Root and some of their subsidiaries with United States operations, the
Halliburton Board of Directors will take into account the then-current status of
these legislative initiatives.
Review of accruals. As a result of the proposed settlement, in the
fourth quarter of 2002, we re-evaluated our accruals for known outstanding and
future asbestos claims. Although we have reached an agreement in principle with
respect to a proposed settlement, we do not believe the settlement is "probable"
under Statement of Financial Standards ("SFAS") No. 5 at the current time.
Because we do not believe the settlement is currently probable as
defined by SFAS No. 5, we have continued to establish our accruals in accordance
with the analysis performed by Dr. Rabinovitz. However, as a result of the
settlement and the payment amounts contemplated thereby, we believed it
appropriate to adjust our accrual to use the upper end of the range of probable
and reasonably estimable liabilities for current and future asbestos liabilities
contained in Dr. Rabinovitz's study, which estimated liabilities through 2052
and assumed the more recent two-year elevated rate of claim filings in
projecting the rate of future claims.
As a result, in the fourth quarter of 2002, we determined that the best
estimate of the probable loss is the $3.5 billion estimate in Dr. Rabinovitz's
study, and accordingly, we increased our accrual for probable and reasonably
estimable liabilities for current and future asbestos and silica claims to $3.4
billion.
Insurance. In 2002, we retained Peterson Consulting, a
nationally-recognized consultant in asbestos liability and insurance, to work
with us to project the amount of insurance recoveries probable in light of the
projected current and future liabilities accrued by us. Using Dr. Rabinovitz's
projection of liabilities through 2052 using the two-year elevated rate of
asbestos claim filings, Peterson Consulting assisted us in conducting an
analysis to determine the amount of insurance that we estimate is probable that
we will recover in relation to the projected claims and defense costs. In
conducting this analysis, Peterson Consulting:
- 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;
22
- 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.
Based on review, analyses and discussions, Peterson Consulting
assisted us in making 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 factored in 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 Peterson Consulting is based on its best judgment and
information provided by us.
Probable insurance recoveries. Based on our analysis of the probable
insurance recoveries, in the second quarter of 2002, we recorded a receivable of
$1.6 billion for probable insurance recoveries.
In connection with our adjustment of our accrual for asbestos liability
and defense costs in the fourth quarter of 2002, Peterson Consulting assisted us
in re-evaluating our receivable for insurance recoveries deemed probable through
2052, assuming $3.5 billion of liabilities for current and future asbestos
claims using the same factors cited above through 2052. Based on Peterson
Consulting analysis of the probable insurance recoveries, we increased our
insurance receivable to $2.1 billion as of the fourth quarter of 2002. The
insurance receivable recorded by us does not assume any recovery from insolvent
carriers and assumes that those carriers which are currently solvent will
continue to be solvent throughout the period of the applicable recoveries in the
projections. However, there can be no assurance that these assumptions will be
correct. These insurance receivables do not exhaust the applicable insurance
coverage for asbestos-related liabilities.
Current accruals. The current accrual of $3.4 billion for probable and
reasonably estimable liabilities for current and future asbestos and silica
claims and the $2.1 billion in insurance receivables are included in noncurrent
assets and liabilities due to the extended time periods involved to settle
claims. In the second quarter of 2002, we recorded a pretax charge of $483
million ($391 million after tax), and, in the fourth quarter of 2002, we
recorded a pretax charge of $799 million ($675 million after tax).
In the fourth quarter of 2002, we recorded pretax charges of $232
million ($212 million after tax) for claims related to Brown & Root construction
and renovation projects under the Engineering and Construction Group segment.
The balance of $567 million ($463 million after tax) related to claims
associated with businesses no longer owned by us and was recorded as
discontinued operations. The low effective tax rate on the asbestos charge is
due to the recording of a valuation allowance against the United States Federal
deferred tax asset associated with the accrual as the deferred tax asset may not
be fully realizable based upon future taxable income projections.
The total estimated claims through 2052, including the 425,000 current
open claims, are approximately one million. A summary of our accrual for all
claims and corresponding insurance recoveries is as follows:
23
Six Months Ended Year Ended
Millions of dollars June 30, 2003 December 31, 2002
-------------------------------------------------------------------------------------------------------
Gross liability - beginning balance $ 3,425 $ 737
Accrued liability - 2,820
Payments on claims (29) (132)
-------------------------------------------------------------------------------------------------------
Gross liability - ending balance $ 3,396 $ 3,425
=======================================================================================================
Estimated insurance recoveries:
Highlands Insurance Company - beginning balance $ - $ (45)
Write-off of recoveries - 45
-------------------------------------------------------------------------------------------------------
Highlands Insurance Company - ending balance $ - $ -
=======================================================================================================
Other insurance carriers - beginning balance $(2,059) $ (567)
Accrued insurance recoveries - (1,530)
Insurance billings - 38
-------------------------------------------------------------------------------------------------------
Other insurance carriers - ending balance $(2,059) $ (2,059)
=======================================================================================================
Total estimated insurance recoveries $(2,059) $ (2,059)
=======================================================================================================
Net liability for asbestos claims $ 1,337 $ 1,366
=======================================================================================================
Accounts receivable for billings to insurance companies for payments
made on asbestos claims were $44 million at June 30, 2003 and December 31, 2002.
The $44 million at December 31, 2002 excludes $35 million in accounts receivable
written off at the conclusion of the Highlands litigation.
Possible additional accruals. When and if the currently proposed
settlement becomes probable under SFAS No. 5, we would increase our accrual for
probable and reasonably estimable liabilities for current and future asbestos
claims up to $4.3 billion, reflecting the amount in cash and notes we would pay
to fund the settlement combined with the value of 59.5 million shares of
Halliburton common stock, a value of $1.4 billion, using the stock price at June
30, 2003 of $23.00. In addition, at such time as the settlement becomes
probable, we would adjust our accrual for liabilities for current and future
asbestos claims and we would expect to increase the amount of our insurance
receivables to $2.3 billion. As a result, we would record at such time an
additional pretax charge of $606 million ($493 million after tax). Beginning in
the first quarter in which the settlement becomes probable, the accrual would
then be adjusted from period to period based on positive and negative changes in
the market price of our common stock until contribution of the shares into the
trust. We may enter into agreements with all or some of our insurance carriers
to negotiate an overall accelerated payment of anticipated insurance proceeds.
If this were to happen, we would expect to recover less than the $2.3 billion of
anticipated insurance receivables which would result in an additional charge to
income.
Continuing review. Projecting future events is subject to many
uncertainties that could cause the asbestos-related liabilities and insurance
recoveries to be higher or lower than those projected and booked such as:
- the number of future asbestos- and silica-related lawsuits to
be filed against DII Industries and Kellogg Brown & Root;
- the average cost to resolve such future lawsuits;
- coverage issues among layers of insurers issuing different
policies to different policyholders over extended periods of
time;
- the impact on the amount of insurance recoverable in light of
the Harbison-Walker and Federal-Mogul bankruptcies; and
- the continuing solvency of various insurance companies.
Given the inherent uncertainty in making future projections, we plan to
have the projections of current and future asbestos and silica claims
periodically reexamined, and we will update them if needed based on our
experience and other relevant factors such as changes in the tort system, the
resolution of the bankruptcies of various asbestos defendants and the
probability of our settlement of all claims becoming effective. Similarly, we
will re-evaluate our projections concerning our probable insurance recoveries in
light of any updates to Dr. Rabinovitz's projections, developments in DII
Industries and Kellogg Brown & Root's various lawsuits against its insurance
companies and other developments that may impact the probable insurance.
24
Note 12. Commitments and Contingencies - Excluding Asbestos and Silica
Barracuda-Caratinga Project. In June 2000, KBR entered into a contract
with the project owner, Barracuda & Caratinga Leasing Company B.V., to develop
the Barracuda and Caratinga crude oil fields, which are located off the coast of
Brazil. The project 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 which will be used as floating
production, storage and offloading platforms, or FPSOs, 33 hydrocarbon
production wells, 18 water injection wells and all sub-sea flow lines and risers
necessary to connect the underwater wells to the FPSOs.
KBR's performance under the contract is secured by:
- three performance letters of credit, which together have an
available credit of approximately $266 million as of June 30,
2003 and which represent approximately 10% of the contract
amount, as amended to date by change orders;
- a retainage letter of credit in an amount equal to $141
million as of June 30, 2003 and which will increase in order
to continue to represent 10% of the cumulative cash amounts
paid to KBR; and
- a guarantee of KBR's performance of the agreement by
Halliburton Company in favor of the project owner.
In the event that KBR is alleged to be in default under the contract,
the project owner may assert a right to draw upon the letters of credit. If the
letters of credit were to be drawn, KBR would be required to fund the amount of
the draw to the issuing banks. To the extent KBR cannot fund the amount of the
draw, Halliburton would be required to do so, which could have a material
adverse effect on Halliburton's financial condition and results of operations.
In addition, the proposed Chapter 11 pre-packaged bankruptcy filing by
KBR in connection with the proposed settlement of its asbestos claims would
constitute an event of default under the contract that would allow the owner
(with the approval of the lenders financing the project) to assert a right to
draw the letters of credit unless waivers are obtained. The proposed Chapter 11
filing would also constitute an event of default under the owner's loan
agreements with the lenders that would allow the lenders to cease funding the
project. We believe that it is unlikely that the owner will make a draw on the
letters of credit as a result of the proposed Chapter 11 filing. We also believe
it is unlikely that the lenders will exercise any right to cease funding the
project given the current status of the project and the fact that a failure to
pay KBR may allow KBR 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 or that the owner will not require
funding of the letters of credit by KBR.
In the event that KBR was determined after an arbitration proceeding to
have been in default under the contract with Petrobras, and if the project was
not completed by KBR as a result of such default (i.e., KBR's services are
terminated as a result of such default), the project owner may seek direct
damages (including completion costs in excess of the contract price and interest
on borrowed funds, but excluding consequential damages) against KBR for up to
$500 million plus the return of up to $300 million in advance payments
previously received by KBR to the extent they have not been repaid.
In addition to the amounts described above, KBR may have to pay
liquidated damages if the project is delayed beyond the original contract
completion date. KBR expects that the project will likely be completed at least
16 months later than the original contract completion date. Although KBR
believes that the project's delay is due primarily to the actions of the project
owner, in the event that any portion of the delay is determined to be
attributable to KBR and any phase of the project is completed after the
milestone dates specified in the contract, KBR could be required to pay
liquidated damages. These damages would be calculated on an escalating basis of
approximately $1 million per day of delay caused by KBR, subject to a total cap
on liquidated damages of 10% of the final contract amount (yielding a cap of
approximately $266 million as of June 30, 2003).
As of June 30, 2003, the project was approximately 75% complete and KBR
had recorded a pretax loss of $345 million related to the project, of which $173
million was recorded in the second quarter of 2003. The second quarter 2003
charge was due to higher cost estimates, schedule extensions, increased project
contingencies and other factors identified during the quarterly review of the
project. The probable unapproved claims included in determining the loss on the
project were $182 million as of June 30, 2003. The claims for the project most
likely will not be settled within one year. Accordingly, based upon the contract
being approximately 75% complete, probable unapproved claims of $134 million at
25
June 30, 2003 have been recorded to long-term unbilled work on uncompleted
contracts. Those amounts are included in "Other assets, net" on the balance
sheet. KBR has asserted claims for compensation substantially in excess of $182
million. The project owner, through its project manager, Petrobras, has denied
responsibility for all such claims. Petrobras has, however, issued formal change
orders worth approximately $61 million which are not included in the $182
million in probable unapproved claims.
In June 2003, Halliburton, KBR and Petrobras, on behalf of the project
owner, entered into a non-binding heads of agreement that would resolve some of
the disputed issues between the parties, subject to final agreement and lender
approval. The original completion date for the Barracuda project was December
2003 and the original completion date for the Caratinga project was April 2004.
Under the heads of agreement, the project owner would grant an extension of time
to the original completion dates and other milestone dates that averages
approximately 12 months, delay any attempt to assess the original liquidated
damages against KBR for project delays beyond 12 months and up to 18 months,
delay any drawing of letters of credit with respect to such liquidated damages
and delay the return of any of the $300 million in advance payments until after
arbitration. The heads of agreement also provides for a separate liquidated
damages calculation of $450,000 per day for each of the Barracuda and the
Caratinga vessels for a delay from the original schedule beyond 18 months
(subject to the total cap on liquidated damages of 10% of the final contract
amount). The heads of agreement does not delay the drawing of letters of credit
for these liquidated damages. The extension of the original completion dates and
other milestones would significantly reduce the likelihood of KBR incurring
liquidated damages on the project. Nevertheless, KBR continues to have exposure
for substantial liquidated damages for delays in the completion of the project.
Under the heads of agreement, the project owner has agreed to pay $59
million of KBR's disputed claims (which are included in the $182 million of
probable unapproved claims as of June 30, 2003) and to arbitrate additional
claims. The maximum recovery from the claims to be arbitrated would be capped at
$375 million. The heads of agreement also allows the project owner or Petrobras
to arbitrate additional claims against KBR, not including liquidated damages,
the maximum recovery from which would be capped at $380 million. KBR believes
the claims made to date by the project owner are based on a delay in project
completion. KBR's contract with the project owner excludes consequential damages
and, as indicated above, provides for liquidated damages in the event of delay
in completion of the project. While there can be no assurance that the
arbitrator will agree, KBR believes if it is determined that KBR is liable
for delays, the project owner would be entitled to liquidated damages in
amounts up to those referred to above and not to an additional $380 million.
The finalization of the heads of agreement is subject to project lender
approval. The parties have had discussions with the lenders and based on these
discussions have agreed to certain modifications to the original terms of the
heads of agreement to conform to the lenders' requirements. They have agreed
that the $300 million in advance payments would be due on the earliest of
December 7, 2004, the completion of any arbitration or the resolution of all
claims between the project owner and KBR. Likewise, the project owner's
obligation to defer drawing letters of credit with respect to liquidated damages
for the delays between 12 and 18 months would extend only until December 7,
2004. The discussions with the lenders are not yet complete, and no agreement
for their approval has yet been obtained. While we believe the lenders have an
incentive to approve the heads of agreement and complete the financing of the
project, and the parties have agreed to the modifications described above to the
heads of agreement to secure the lenders' approval, there is no assurance that
they will do so. If the lenders do not consent to the heads of agreement,
Petrobras may be forced to secure other funding to complete the project. There
is no assurance that Petrobras will pursue or will be able to secure such
funding.
Absent lender approval of the heads of agreement, KBR could be subject
to additional liquidated damages and other claims, be subject to the letters of
credit being drawn and be required to return the $300 million in advance
payments in accordance with the original contract terms. The original contract
terms require repayment through $300 million of credits to the last $350 million
of invoices on the contract. No assurance can be given that the heads of
agreement will be finalized or that the lenders will approve the heads of
agreement or that the lenders will approve the heads of agreement without
revisions that could adversely affect KBR.
The project owner has procured project finance funding obligations from
various lenders to finance the payments due to KBR under the contract. The
project owner currently has no other committed source of funding on which we can
necessarily rely other than the project finance funding for the project. If the
lenders cease to fund the project, the project owner may not have the ability to
continue to pay KBR for its services. The original loan documents provide that
26
the lenders are not obligated to continue to fund the project if the project has
been delayed for more than 6 months. In November 2002, the lenders agreed to
extend the 6-month period to 12 months. Other provisions in the loan documents
may provide for additional time extensions. However, delays beyond 12 months may
require lender consent in order to obtain additional funding. While we believe
the lenders have an incentive to complete the financing of the project, there is
no assurance that they would do so. If the lenders did not consent to extensions
of time or otherwise ceased funding the project, we believe that Petrobras would
provide for or secure other funding to complete the project, although there is
no assurance that it would do so. To date, the lenders have made funds
available, and the project owner has continued to disburse funds to KBR as
payment for its work on the project even though the project completion has been
delayed.
In addition, although the project financing includes borrowing capacity
in excess of the original contract amount, only $250 million of this additional
borrowing capacity is reserved for increases in the contract amount payable to
KBR and its subcontractors. Under the loan documents, the availability date for
loan draws expires December 1, 2003. As a condition to approving the heads of
agreement, the lenders will require the project owner to draw all remaining
available funds prior to December 1, 2003, and to escrow the funds for the
exclusive use of paying project costs. No funds may be paid to Petrobras or its
subsidiary (which is funding the drilling costs of the project) until all
amounts due to KBR, including amounts due for the claims, are liquidated and
paid. While this potentially increases the funds available for payment to KBR,
KBR is 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 KBR claims and change orders.
Securities and Exchange Commission ("SEC") Investigation and Fortune
500 Review. In late May 2002, we received a letter from the Fort Worth District
Office of the Securities and Exchange Commission stating that it was initiating
a preliminary inquiry into some of our accounting practices. In mid-December
2002, we were notified by the SEC that a formal order of investigation had been
issued. Since that time, the SEC has issued subpoenas calling for the production
of documents and requiring the appearance of a number of witnesses to testify
regarding those accounting practices, which relate to the recording of revenues
associated with cost overruns and unapproved claims on long-term engineering and
construction projects. Throughout the informal inquiry and during the pendency
of the formal investigation, we have provided approximately 300,000 documents to
the SEC. The production of documents is essentially complete and the process of
providing witnesses to testify is ongoing. To our knowledge, the SEC's
investigation has focused on the compliance with generally accepted accounting
principles of our recording of revenues associated with cost overruns and
unapproved claims for long-term engineering and construction projects, and the
disclosure of our accrual practices. Accrual of revenue from unapproved claims
is an accepted and widely followed accounting practice for companies in the
engineering and construction business. Although we accrued revenue related to
unapproved claims in 1998, we first made disclosures regarding the accruals in
our 1999 Annual Report on Form 10-K. We believe we properly applied the required
methodology of the American Institute of Certified Public Accountants' Statement
of Position 81-1, "Accounting for Performance of Construction-Type and Certain
Production-Type Contracts", and satisfied the relevant criteria for accruing
this revenue, although the SEC may conclude otherwise.
On December 21, 2001, the SEC's Division of Corporation Finance
announced that it would review the annual reports of all Fortune 500 companies
that file periodic reports with the SEC. We received the SEC's initial comments
in letter form dated September 20, 2002 and responded on October 31, 2002. Since
then, we have received and responded to several follow-up sets of comments.
Securities and related litigation. On June 3, 2002, a class action
lawsuit was filed against us in the United States District Court for the
Northern District of Texas on behalf of purchasers of our common stock alleging
violations of the federal securities laws. After that date, approximately twenty
similar class actions were filed against us in that or other federal district
courts. Several of those lawsuits also named as defendants Arthur Andersen, LLP
("Arthur Andersen"), our independent accountants for the period covered by the
lawsuits, and several of our present or former officers and directors. Those
lawsuits allege that we violated federal securities laws in failing to disclose
a change in the manner in which we accounted for revenues associated with
unapproved claims on long-term engineering and construction contracts, and that
we overstated revenue by accruing the unapproved claims. One such action was
subsequently dismissed voluntarily, without prejudice, upon motion by the filing
plaintiff. The federal securities fraud class actions have all been transferred
to the United States District Court for the Northern District of Texas and
27
consolidated before the Honorable Judge David Godbey. The amended consolidated
class action complaint in that case, styled Richard Moore v. Halliburton, was
filed and served upon us on or about April 11, 2003. In early May 2003, we
announced that we had entered into a written memorandum of understanding setting
forth the terms upon which the consolidated cases would be settled. The
memorandum of understanding calls for Halliburton to pay $6 million, which is to
be funded by insurance proceeds. After that announcement, one of the lead
plaintiffs announced that it was dissatisfied with the lead plaintiffs'
counsel's handling of settlement negotiations and what the dissident plaintiff
regarded as inadequate communications by the lead plaintiffs' counsel. The
dissident plaintiff has since filed a motion for an order to show cause why the
lead plaintiffs' counsel should not be held to have breached his fiduciary
duties to the class and be replaced as lead plaintiffs' counsel. It is unclear
whether this dispute within the ranks of the lead plaintiffs will have any
impact upon the process of approval of the settlement and whether the dissident
plaintiff will object to the settlement at the time of the fairness hearing or
opt out of the class action for settlement purposes. The process by which the
parties will seek approval of the settlement is ongoing.
Another case, also filed in the United States District Court for the
Northern District of Texas on behalf of three individuals, and based upon the
same revenue recognition practices and accounting treatment that is the subject
of the securities class actions, alleges only common law and statutory fraud in
violation of Texas state law. We moved to dismiss that action on October 24,
2002, as required by the court's scheduling order, on the bases of lack of
federal subject matter jurisdiction and failure to plead with the degree of
particularity required by the rules of procedure. That motion has now been fully
briefed and oral argument on it was held on July 29, 2003. No ruling has yet
been announced.
In addition to the securities class actions, one additional class
action, alleging violations of the Employee Retirement Income Security Act of
1974 ("ERISA") in connection with the Company's Benefits Committee's purchase of
our stock for the accounts of participants in our 401(k) retirement plan during
the period we allegedly knew or should have known that our revenue was
overstated as a result of the accrual of revenue in connection with unapproved
claims, was filed and subsequently voluntarily dismissed.
On October 11, 2002, a shareholder derivative action against present
and former directors and our former CFO was filed in the District Court of
Harris County, Texas alleging breach of fiduciary duty and corporate waste
arising out of the same events and circumstances upon which the securities class
actions are based. We moved to dismiss that action and, after hearings on that
motion, the court dismissed the action.
On March 12, 2003, another shareholder derivative action arising out of
the same events and circumstances was filed in the United States District Court
for the Northern District of Texas against certain of our present and former
officers and directors. Like the case filed in the state court in Harris County,
we believe that this action is without merit and we intend to vigorously defend
it. Settlement of this action is included in the memorandum of understanding in
the consolidated actions discussed above.
As of the date of this filing, the $6 million settlement amount for the
consolidated actions and the federal court derivative action was fully covered
by the Company's directors' and officers' insurance carrier. As such, we have
accrued a contingent liability for the $6 million settlement and a $6 million
insurance receivable from the insurance carrier. We have not accrued a
contingent liability as of June 30, 2003 for any other shareholder derivative
action or class action lawsuit discussed above.
BJ Services Company patent litigation. On April 12, 2002, a federal
court jury in Houston, Texas, returned a verdict against Halliburton Energy
Services, Inc. in a patent infringement lawsuit brought by BJ Services Company,
or BJ. The lawsuit alleged that our Phoenix fracturing fluid infringed a patent
issued to BJ in January 2000 for a method of well fracturing using a specific
fracturing fluid. The jury awarded BJ approximately $98 million in damages, plus
pre-judgment interest, and the court enjoined us from further use of our Phoenix
fracturing fluid. The United States Court of Appeals for the Federal Circuit
in Washington D.C. affirmed BJ Services' judgment against us in August 2003. We
currently anticipate filing a petition for rehearing before the full federal
circuit court on August 20, 2003. In light of the trial court's decision in
April 2002, a total of $102 million was accrued in the first quarter of 2002,
which was comprised of the $98 million judgment and $4 million in pre-judgment
interest costs. We do not expect the loss of the use of the Phoenix fracturing
fluid to have a material adverse impact on our overall energy services business.
We have alternative products to use in our fracturing operations and have not
been using the Phoenix fracturing fluid since April 2002.
28
Anglo-Dutch (Tenge). We have been sued in the District Court of Harris
County, Texas by Anglo-Dutch (Tenge) L.L.C. and Anglo-Dutch Petroleum
International, Inc. for allegedly breaching a confidentiality agreement related
to an investment opportunity we considered in the late 1990s in an oil field in
the former Soviet Republic of Kazakhstan. While we believe the claims raised in
that lawsuit are without merit and are vigorously defending against them, the
plaintiffs have announced their intention to seek approximately $680 million in
damages. Since we believe the probability of loss is remote, we have not accrued
a contingent liability for this matter as of June 30, 2003. In mid-July, the
court granted portions of our motions for summary judgment and on July 24, 2003
granted another portion as well and invited the parties to request
reconsideration of any other portions of the motions that have thus far been
denied. As of this date, it appears likely that the case will proceed to trial
as scheduled on August 18, 2003 on plaintiffs' claims of breach of contract,
misappropriation and misappropriation of trade secrets. In the event of an
adverse judgment, we could be called upon to post security not to exceed $25
million in the form of cash or a bond in order to postpone execution on the
judgment until after all appeals have been exhausted.
Improper payments reported to the Securities and Exchange Commission.
During the second quarter 2002, we reported to the SEC and disclosed in our
first quarter 2002 Form 10-Q that one of our foreign subsidiaries operating in
Nigeria made improper payments of approximately $2.4 million to entities owned
by a Nigerian national who held himself out as a tax consultant when in fact he
was an employee of a local tax authority. The payments were made to obtain
favorable tax treatment and clearly violated our Code of Business Conduct and
our internal control procedures. The payments were discovered during an audit of
the foreign subsidiary. We have conducted an investigation assisted by outside
legal counsel. Based on the findings of the investigation we have terminated
several employees. None of our senior officers were involved. We are cooperating
with the SEC in its review of the matter. We plan to take further action to
ensure that our foreign subsidiary pays all taxes owed in Nigeria, which may be
as much as $5 million, which has been fully accrued. A preliminary assessment
was issued by the Nigerian Tax Authorities in June of 2003 for approximately $3
million. Payment of that assessment has been made, and we are cooperating with
the Nigerian Tax Authorities to determine the total amount due as quickly as
possible.
Environmental. We are subject to numerous environmental, legal and
regulatory requirements related to our operations worldwide. In the United
States, these laws and regulations include 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, among others. In addition to the federal laws and
regulations, states where we do business may have equivalent laws and
regulations by which we must also 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.
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. Our accrued liabilities for environmental matters were
$36 million as of June 30, 2003 and $48 million as of December 31, 2002. The
liability covers numerous properties, and no individual property accounts for
more than $5 million of the liability balance. In some instances, we have been
named a potentially responsible party by a regulatory agency, but in each of
those cases, we do not believe we have any material liability. 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 liabilities. As of June 30, 2003, those nine sites accounted for
approximately $7 million of our total $36 million liability.
Letters of credit. In the normal course of business, we have agreements
with banks under which approximately $1.3 billion of letters of credit or bank
guarantees were issued as of June 30, 2003, including $195 million which relate
to our joint ventures' operations. Effective October 9, 2002, we amended an
agreement with banks under which $261 million of letters of credit had been
issued. The amended agreement removed the provision that previously allowed the
banks to require collateralization if ratings of Halliburton debt fell below
investment grade ratings. The revised agreements include provisions that require
us to maintain ratios of debt to total capital and of total earnings before
interest, taxes, depreciation and amortization to interest expense. The
definition of debt includes our asbestos liability. The definition of total
earnings before interest, taxes, depreciation and amortization excludes any
non-cash charges related to the proposed asbestos settlement through December
31, 2003.
29
If our debt ratings fall below investment grade, we would be in
technical breach of a bank agreement covering another $52 million of letters of
credit at June 30, 2003, which might entitle the bank to set-off rights. In
addition, a $151 million letter of credit line, of which $141 million has been
issued, includes provisions that allow the bank to require cash
collateralization for the full line if debt ratings fall below either the rating
of BBB by Standard & Poor's or Baa2 by Moody's Investors' Services. These
letters of credit and bank guarantees generally relate to our guaranteed
performance or retention payments under our long-term contracts and
self-insurance.
In the past, no significant claims have been made against letters of
credit we have issued. We do not anticipate material losses to occur as a result
of these financial instruments.
Liquidated damages. Many of our engineering and construction contracts
have milestone due dates that must be met or we may be subject to penalties for
liquidated damages if claims are asserted and we were responsible for the
delays. These generally relate to specified activities within a project by a set
contractual date or achievement of a specified level of output or throughput of
a plant we construct. Each contract defines the conditions under which a
customer may make a claim for liquidated damages. In most instances, liquidated
damages are not asserted by the customer but the potential to do so is used in
negotiating claims and closing out the contract. We had not accrued a liability
for $431 million at June 30, 2003 and $364 million at December 31, 2002 of
possible liquidated damages as we consider the imposition of liquidated damages
to be unlikely. We believe we have valid claims for schedule extensions against
the customers which would eliminate our liability for liquidated damages. Of the
total liquidated damages, $266 million at June 30, 2003 and $263 million at
December 31, 2002 relate to unasserted liquidated damages for the
Barracuda-Caratinga project.
Other. We are a party to various other legal proceedings. We expense
the cost of legal fees related to these proceedings as incurred. We believe any
liabilities we may have arising from these proceedings will not be material to
our consolidated financial position or results of operations.
Note 13. Accounting for Stock-Based Compensation
We have six stock-based employee compensation plans. We account for
those plans under the recognition and measurement principles of Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees", and
related interpretations. No cost for stock options granted is reflected in net
income, as all options granted under our plans have an exercise price equal to
the market value of the underlying common stock on the date of grant. In
addition, no cost for the Employee Stock Purchase Plan is reflected in net
income because it is not considered a compensatory plan.
The fair value of options at the date of grant was estimated using the
Black-Scholes option pricing model. For the three and six months ended June 30,
2003 and June 30, 2002, the weighted average assumptions and resulting fair
values of options granted are as follows:
Three Months Six Months
Ended June 30 Ended June 30
-------------------------------------------------------
2003 2002 2003 2002
----------------------------------------------------------------------------------------------------------
Assumptions:
Risk-free interest rate 2.4% 4.1% 2.4% 4.1%
Expected dividend yield 2.2% 3.1% 2.2% 3.1%
Expected life (in years) 5 5 5 5
Expected volatility 62.0% 60.0% 62.0% 60.0%
Weighted average fair value of options granted $ 12.68 $ 9.15 $ 12.55 $ 6.92
============================================================================================================
The following table illustrates the effect on net income and income per
share if we had applied the fair value recognition provisions of FASB Statement
No. 123, "Accounting for Stock-Based Compensation", to stock-based employee
compensation.
30
Three Months Six Months
Ended June 30 Ended June 30
-------------------------------------------------------
Millions of dollars except per share data 2003 2002 2003 2002
----------------------------------------------------------------------------------------------------------
Net income (loss), as reported $ 26 $ (498) $ 69 $ (476)
Total stock-based employee compensation
expense determined under fair value
based method for all awards, net of
related tax effects (7) (6) (13) (12)
----------------------------------------------------------------------------------------------------------
Net income (loss), pro forma $ 19 $ (504) $ 56 $ (488)
==========================================================================================================
Basic income (loss) per share:
As reported $ 0.06 $ (1.15) $ 0.16 $ (1.10)
Pro forma $ 0.04 $ (1.16) $ 0.13 $ (1.12)
Diluted income (loss) per share:
As reported $ 0.06 $ (1.15) $ 0.16 $ (1.10)
Pro forma $ 0.04 $ (1.16) $ 0.12 $ (1.12)
==========================================================================================================
Note 14. Change in Accounting Principle
In August 2001, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standard ("SFAS") No. 143, "Accounting
for Asset Retirement Obligations" which addresses the financial accounting and
reporting for obligations associated with the retirement of tangible long-lived
assets and the associated assets' retirement costs. SFAS No. 143 requires that
the fair value of a liability associated with an asset retirement be recognized
in the period in which it is incurred if a reasonable estimate of fair value can
be made. The associated retirement costs are capitalized as part of the carrying
amount of the long-lived asset and subsequently depreciated over the life of the
asset. The new standard was effective for us beginning January 1, 2003, and the
adoption of this standard resulted in a charge of $8 million after tax as a
cumulative effect of a change in accounting principle. The asset retirement
obligations primarily relate to the removal of leasehold improvements upon
exiting certain lease arrangements and restoration of land associated with the
mining of bentonite. The total liability recorded at adoption and at June 30,
2003 for asset retirement obligations and the related accretion and depreciation
expense for all periods presented is immaterial to our consolidated financial
position and results of operations.
In November 2002, the FASB issued FASB Interpretation No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others" ("FIN 45"). This statement
requires that a liability be recorded in the guarantor's balance sheet upon
issuance of a guarantee. In addition, FIN 45 requires disclosures about the
guarantees that an entity has issued. The disclosure provisions of FIN 45 were
effective for financial statements of interim and annual periods ended after
December 15, 2002. We adopted the recognition provisions of FIN 45 as of January
1, 2003. The adoption of FIN 45 did not have a material effect on our
consolidated financial position or results of operations.
The FASB issued FASB Interpretation No. 46, "Consolidation of Variable
Interest Entities, an Interpretation of ARB No. 51" ("FIN 46"), in January 2003.
FIN 46, which we adopted effective July 1, 2003, requires the consolidation of
entities in which a company absorbs a majority of another entity's expected
losses, receives a majority of the other entity's expected residual returns, or
both, as a result of ownership, contractual or other financial interests in the
other entity. Currently, entities are generally consolidated based upon a
controlling financial interest through ownership of a majority voting interest
in the entity. At this time, we have identified the following variable interest
entities:
- during 2001, we formed a joint venture under which we own a
50% equity interest with two other unrelated partners, each
owning a 25% equity interest. We have determined that the
joint venture is a variable interest entity and that we are
the primary beneficiary. We will consolidate the entity in our
Engineering and Construction Group business segment effective
July 1, 2003. The joint venture was formed to construct,
operate and service certain assets for a third party and was
31
funded with third party debt. The construction of the assets
is expected to be completed in 2004, and the operating and
service contract related to the assets will extend for 20
years beginning in 2003. The proceeds from the debt financing
are being used to construct the assets and will be paid down
with cash flows generated during the operation and service
phase of the contract with the third party. Our aggregate
exposure to loss is immaterial. The consolidation of this
joint venture will increase total assets by approximately
$139 million and long-term debt by approximately $143
million, with corresponding decreases in equity of $2
million and minority interest of $2 million as of July 1,
2003. The joint venture is currently accounted for under
the equity method of accounting and the future
consolidation will have no impact on net income;
- during the second quarter of 2001, we formed a joint venture
with an unrelated party in which we have a 50% equity interest
and account for this investment using the equity method in our
Landmark and Other Energy Services business segment. The joint
venture was established for the further development and
deployment of new technologies related to completions and well
intervention products and services. The joint venture is
considered a variable interest entity under FIN 46. However,
we are not the primary beneficiary of the entity and will
continue to apply the equity method of accounting. Our
maximum exposure to loss as a result of our involvement in the
joint venture is $100 million as of June 30, 2003, which is
the sum of our current investment and our share of the
balance outstanding under the joint venture's revolving loan
agreement with the equity partners. We are also at risk for
our share of any future losses the joint venture may incur;
and
- our Engineering and Construction Group is involved in three
joint ventures formed to design, build, operate and maintain
roadways for certain government agencies. We have a 25%
ownership interest in these joint ventures and account for
them under the equity method. These joint ventures are
considered variable interest entities as they were
initially formed with little equity contributed by the
partners. The joint ventures have obtained financing through
third parties which is not guaranteed by us. We are not the
primary beneficiary of these joint ventures and will,
therefore, continue to account for them using the equity
method. As of June 30, 2003, these joint ventures had
total assets of $911 million and total liabilities of $906
million. Our maximum exposure to loss is limited to our
equity investments in and loans to the joint ventures
(totaling $38 million at June 30, 2003) and our share of any
future losses related to the construction, operation and
maintenance of these roadways.
Note 15. Convertible Senior Notes
In June 2003, we issued $1.2 billion of 3.125% convertible senior notes
due July 15, 2023. The notes were offered and sold in accordance with Rule 144A
under the Securities Act of 1933. The notes are our senior unsecured obligations
ranking equally with all of our existing and future senior unsecured
indebtedness. We will pay interest on the notes on January 15 and July 15 of
each year.
The notes are convertible into our common stock under any of the
following circumstances:
- during any calendar quarter (and only during such calendar
quarter) if the last reported sale price of our common stock
for at least 20 trading days during the period of 30
consecutive trading days ending on the last trading day of the
previous quarter is greater than or equal to 120% of the
conversion price per share of our common stock on such last
trading day;
- if the notes have been called for redemption;
- upon the occurrence of specified corporate transactions that
are described in the indenture relating to the offering; or
- during any period in which the credit ratings assigned to the
notes by both Moody's and Standard & Poor's are lower than Ba1
and BB+, respectively, or the notes are no longer rated by at
least one of these rating services or their successors.
32
The initial conversion price is $37.65 per share and is subject to
adjustment. Upon conversion, we will have the right to deliver, in lieu of
shares of our common stock, cash or a combination of cash and common stock.
The notes are redeemable for cash at our option on or after July 15,
2008. Holders may require us to repurchase the notes for cash on July 15 of
2008, 2013 or 2018 or, prior to July 15, 2008, in the event of a fundamental
change as defined in the indenture. In each case, we will pay a purchase price
equal to 100% of the principal amount plus accrued and unpaid interest and
additional amounts owed, if any.
We have agreed to file a shelf registration statement with the SEC with
respect to the notes and the common stock issuable upon conversion of the notes.
If we fail to fulfill this obligation within the specified time period, we will
pay additional amounts on the notes and the common stock issuable upon
conversion of the notes.
Note 16. Income Taxes
Our effective tax rate for the second quarter 2003 was 39% as compared
to 18% for the second quarter 2002. The effective tax rate was lower in 2002
due to the impact of the impairment loss on Bredero-Shaw and charges associated
with our asbestos exposure. The Bredero-Shaw loss created a capital loss for
which we have no capital gains to offset and therefore no tax benefit was
recorded for the loss as future realization of the benefit was questionable. The
asbestos accrual generates a United States Federal deferred tax asset which may
not be fully realizable based upon future taxable income projections and thus we
have recorded a partial valuation allowance.
33
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
--------------------------------------------------------------------------------
In this section, we discuss the business environment, operating results
and general financial condition of Halliburton Company and its subsidiaries. We
explain:
- factors and risks that impact our business;
- why our revenues and operating income for the second quarter
2003 and six months ended June 30, 2003 vary from the
second quarter 2002 and six months ended June 30, 2002;
- capital expenditures;
- factors that impacted our cash flows; and
- other items that materially affect our financial condition or
earnings.
BUSINESS ENVIRONMENT
During the second quarter of 2003, we restructured our Energy Services
Group into four divisions, which is the basis for the four segments we now
report within the Energy Services Group. We grouped product lines in order to
better align ourselves with how our customers procure our services, and to
capture new business and achieve better integration, including joint research
and development of new products and technologies and other synergies. The new
segments mirror the way our chief executive officer (our chief operating
decision maker) now regularly reviews the operating results, assesses
performance and allocates resources. Our Engineering and Construction Group
(known as KBR) segment remains unchanged.
All prior period segment results have been restated to reflect these
changes.
Our five business segments are organized around how we manage the
business. These segments are:
- Drilling and Formation Evaluation;
- Fluids;
- Production Optimization;
- Landmark and Other Energy Services; and
- Engineering and Construction Group.
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, to major, national
and independent oil and gas companies. These services and products 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.
The industries we serve are highly competitive with many substantial
competitors for each segment. In the first half of 2003, the United States
represented 33% of our total revenue and the United Kingdom represented 11%. No
other country accounted for more than 10% of our operations. 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 one country would be
material to our consolidated results of operations.
Activity levels within our five 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 outsourcing and spending levels.
The state of the global economy also impacts our activity, which
indirectly impacts oil and gas consumption, demand for petrochemical products
and investment in infrastructure projects.
34
Energy Services Group
Some of the more significant measures of current and future spending
levels of oil and gas companies which drive worldwide exploration and production
activity and investment are the following:
- oil and gas prices;
- the quality of exploration and production drilling prospects;
and
- world economic conditions and the degree of global political
stability.
In early 2002, a surplus in working gas in storage contributed to low
prices and reduced drilling activities. Working gas in storage is the volume of
gas in underground reservoirs above the level of base gas (cushion gas) intended
as permanent inventory in a storage reservoir to maintain adequate pressure and
deliverability rates throughout the winter withdrawal season. The reduced
drilling, combined with an abnormally cold 2002/2003 winter season, drove the
working gas in storage at January 31, 2003 to 1,521 billion cubic feet,
commonly referred to as bcf, which was 287 bcf below the five year average.
This low level of working natural gas in storage in the United States
has increased the demand for natural gas resulting in Henry Hub prices averaging
above $5.00 per million cubic feet, commonly referred to as mcf, throughout the
second quarter 2003. For the second quarter 2003, natural gas prices at Henry
Hub averaged $5.63 per mcf compared to $3.40 per mcf in the second quarter 2002.
The level of natural gas storage continues to be a key driver of North American
activity. As of July 4, 2003 there was 1,773 bcf in working gas in storage in
the United States according to an Energy Information Administration (EIA)
estimate which was 580 bcf lower than a year ago and 317 bcf lower than the five
year average.
High natural gas prices tend to depress industrial demand for the gas,
which occurred during the second quarter 2003. As a result, a definite
improvement in the supply situation has occurred and the probability of reaching
adequate storage levels by November has risen.
Crude oil prices for West Texas Intermediate averaged $29.16 per barrel
for the second quarter of 2003 compared to $25.75 per barrel for the second
quarter 2002. Crude oil inventories in the United States have consistently
remained below the lower end of the normal range, which in turn has supported
crude oil prices in the United States. The situation worsened in December 2002
when oil imports from Venezuela were reduced due to strikes in that country
which created supply disruptions during most of the first quarter 2003. Despite
imports from Venezuela returning close to normal levels, United States
commercial crude oil inventories (excluding crude oil stored in the Strategic
Petroleum Reserve) have remained more than 15 million barrels below the lower
end of the normal range since the end of January, 2003. Until commercial crude
oil inventory deficits are eliminated, United States oil markets are expected to
remain tight, which should help support prices at or near current levels.
The yearly average and quarterly average rig counts based on the Baker
Hughes Incorporated rig count information are as follows:
Average Rig Counts 2002 2001
----------------------------------------------------------------------
United States 831 1,155
Canada 266 342
International (excluding Canada) 732 745
----------------------------------------------------------------------
Worldwide Total 1,829 2,242
======================================================================
Second First Fourth Third Second First
Quarter Quarter Quarter Quarter Quarter Quarter
Average Rig Counts 2003 2003 2002 2002 2002 2002
--------------------------------------------------------------------------------------------------------------
United States 1,028 901 847 853 806 818
Canada 203 493 283 250 147 383
International
(excluding Canada) 765 744 753 718 725 731
--------------------------------------------------------------------------------- ----------------------------
Worldwide Total 1,996 2,138 1,883 1,821 1,678 1,932
==============================================================================================================
35
Worldwide rig activity has increased since the second quarter of 2002
from an average of 1,678 rigs at the end of the second quarter 2002 to 1,996
rigs at the end of the second quarter 2003. The increase in rig activity has
been most pronounced in the United States with a 28% increase in rig counts from
806 in the second quarter 2002 to 1,028 rigs in the second quarter 2003. The
majority of this increase is related to rigs drilling for natural gas to
replenish working gas in storage for the upcoming 2003/2004 heating season. The
Canadian rig count decreased from 493 rigs in the first quarter 2003 to 203 rigs
in the second quarter 2003. Canadian rig counts decreased as a result of the
normal spring break up and thaw season, but increased 38% from 147 rigs in the
second quarter 2002 to 203 rigs in the second quarter 2003 on a comparative
basis. The international rig count increased six percent from 725 rigs in the
second quarter 2002 to 765 rigs in the second quarter 2003. The majority of this
increase was in Mexico and Argentina which was offset slightly by lower rig
counts in Venezuela and in the United Kingdom sector of the North Sea. We
believe the increased drilling activity and rig counts since the second quarter
of 2002 are due to the following factors:
- higher oil and gas prices;
- low oil inventories in the Organization for Economic
Co-operation and Development consuming countries;
- low natural gas inventories in the United States for the
upcoming winter season;
- cessation of armed conflict in Iraq;
- perception that the global economy is improving; and
- increased spending by our customers.
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. Discounts are typically applied
to partially or substantially offset price book increases immediately following
a price increase. Discounts normally decrease over time if the activity levels
remain strong. During periods of reduced activity, discounts normally increase,
reducing the net revenue for our products and services. Conversely, during
periods of higher activity, discounts normally decline resulting in net revenue
increasing for our products and services.
During 2000 and 2001, we implemented several price book increases. In
July 2000, as a result of increased consumable materials costs and a tight labor
market causing higher labor costs, we increased prices in the United States for
most product lines on average between 2% and 12%. In January 2001, as a result
of continued labor shortages and increased labor and materials costs, we
increased prices in the United States on average between 5% and 12%. In July
2001, as a result of continuing personnel and consumable material cost
increases, we increased prices on average between 6% and 15%.
Decreased rig activity in the United States in 2002 from 2001 caused
the Energy Services Group's product lines to discount prices. Although rig
activity in the United States has increased over the last twelve months,
discounts have still not decreased, particularly in some of the Western states.
Price increases that we implemented in 2000 and 2001 have mostly been eroded by
additional discounts.
Engineering and Construction Group
Our engineering and construction projects are longer term in nature
than our energy services projects and are not as significantly impacted by
short-term fluctuations in oil and gas prices. We believe that the global
economic recovery is continuing, but its strength and sustainability are not
assured. Based on the uncertain economic recovery, continuing excess capacity in
petrochemical supplies and rising unemployment, customers have continued to
delay project awards or reduce the scope of projects involving hydrocarbons and
manufacturing until growth in consumer spending is evident. A number of
large-scale gas and liquefied natural gas (LNG) development, offshore deepwater,
government and infrastructure projects are being awarded or actively considered.
However, due to the inconsistent economic growth in certain areas of the world
and the overall limited growth of the global economy, many customers continue to
delay some of their capital commitments and international investments.
We see an emerging drive to monetize gas reserves in the Middle East,
West Africa and parts of the Pacific Basin, combined with strong demand for gas
and LNG in the United States, Japan, Korea, Taiwan, China and India. The
developments have led to numerous gas-to-liquids (GTL), LNG liquefaction and gas
development projects in the three exporting regions as well as onshore or
floating regasification terminals and gas processing plants in the importing
countries. With LNG set to play a larger role as a new supply source, the shift
36
from fuel served by exclusively domestic resources to a market increasingly
served with international resources heralds a change in the United States gas
business. This will lead to an increasing internationalization of the natural
gas industry, bringing with it the integration of North America into a growing
world market.
We expect growth opportunities to exist for additional security and
defense support to government agencies in the United States and other countries.
Demand for these services is expected to grow as a result of the reconstruction
efforts in Iraq and as governmental agencies seek to control costs and promote
efficiencies by outsourcing these functions. We also expect growth due to new
demands created by increased efforts to combat terrorism and enhance homeland
security.
Engineering and construction contracts can be broadly categorized as
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, among
other things, from:
- uncertainties 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;
- 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;
- subcontractors' 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 are potentially more profitable for the contractor,
since the owners pay a premium to transfer many risks to the contractor.
After careful consideration, we have decided to no longer pursue
fixed-price engineering, procurement, installation and commissioning contracts
for the offshore oil and gas industry. An important aspect of our 2002
reorganization was to look closely at each of our businesses to ensure that they
are self-sufficient, including their use of capital and liquidity. In that
process, we found that the engineering, procurement, installation and
commissioning offshore business was using a disproportionate share of our
bonding and letter of credit capacity relative to its profit contribution. The
risk/reward relationship in that business is no longer attractive to us. We
provide a range of engineering, fabrication and project management services to
the offshore industry, which we will continue to service through a variety of
other contracting forms. We have seven fixed-price engineering, procurement,
installation and commissioning offshore projects underway and we are fully
committed to successful completion of these projects, all but two of which are
substantially complete. The two projects are approximately 75% complete. We plan
to retain our offshore engineering and services capabilities.
The approximate percentages of revenues attributable to fixed-price and
cost reimbursable engineering and construction segment contracts are as follows:
37
Fixed-Price Cost Reimbursable
--------------------------------------------------------------------------
Second Quarter ended June 30, 2003 40% 60%
Year ended December 31, 2002 47% 53%
==========================================================================
Backlog
Our backlog at June 30, 2003, was $10.2 billion, comprised of $9.9
billion for the Engineering and Construction Group and $299 million for the
Energy Services Group. Our total backlog at December 31, 2002, was $10 billion.
Reorganization of Business Operations
As a part of the 2002 reorganization, we decided that the operations of
major projects, Granherne and Production Services were better aligned with KBR,
and these businesses were moved from the Energy Services Group to the
Engineering and Construction Group during the second quarter of 2002. All prior
period segment results have been restated to reflect this change. Major
projects, which currently consists of the Barracuda-Caratinga project in Brazil,
is now reported through the offshore product line, Granherne is now reported in
the onshore product line and production services is now reported under the
operations and maintenance product line.
Asbestos and Silica
In December 2002, we announced that we had reached an agreement in
principle that, if and when consummated, would result in a settlement of
asbestos and silica personal injury claims against our subsidiaries DII
Industries and Kellogg Brown & Root and their current and former subsidiaries
with United States operations. Subsequently, in 2003, DII Industries and Kellogg
Brown & Root entered into definitive written agreements finalizing the terms of
the agreements in principle with attorneys representing more than 90% of the
current asbestos claimants. We revised our best estimate of our asbestos and
silica liability based on information obtained while negotiating the agreement
in principle, and adjusted our asbestos and silica liability to $3.4 billion,
recorded additional probable insurance recoveries resulting in a total of $2.1
billion as of December 31, 2002 and recorded a net pretax charge of $799 million
($675 million after tax) in the fourth quarter of 2002.
Should the proposed settlement become probable under Statement of
Financial Accounting Standards No. 5, we would adjust our accrual for probable
and reasonably estimable liabilities for current and future asbestos and silica
claims. The settlement amount initially would be up to $4.3 billion, consisting
of up to $2.775 billion in cash, the value of 59.5 million Halliburton shares of
common stock and notes with a net present value expected to be less than $100
million. Assuming the adjusted liability would be $4.3 billion, we would also
increase our probable insurance recoveries to $2.3 billion. The impact on our
statement of operations would be an additional pretax charge of $606 million
($493 million after tax). This accrual (which values our stock to be contributed
at $1.4 billion using our stock price at June 30, 2003 of $23.00) would then be
adjusted periodically based on changes in the market price of our common stock
until the common stock is contributed to a trust for the benefit of the
claimants. We may enter into agreements with all or some of our insurance
carriers to negotiate an overall accelerated payment of anticipated insurance
proceeds. If this were to happen, we would expect to recover less than the $2.3
billion of anticipated insurance receivables which would result in an additional
charge to income.
38
RESULTS OF OPERATIONS IN 2003 COMPARED TO 2002
Second Quarter of 2003 Compared with the Second Quarter of 2002
REVENUES
Second Quarter
----------------------- Increase
Millions of dollars 2003 2002 (decrease)
-----------------------------------------------------------------------------------
Drilling and Formation Evaluation $ 414 $ 413 $ 1
Fluids 518 450 68
Production Optimization 693 634 59
Landmark and Other Energy Services 155 259 (104)
-----------------------------------------------------------------------------------
Total Energy Services Group 1,780 1,756 24
-----------------------------------------------------------------------------------
Engineering and Construction Group 1,819 1,479 340
-----------------------------------------------------------------------------------
Total revenues $ 3,599 $ 3,235 $ 364
===================================================================================
Consolidated revenues in the 2003 second quarter of $3.6 billion
increased $364 million compared to the 2002 second quarter. International
revenues were 67% of total revenues for the second quarters of both 2003 and
2002.
Drilling and Formation Evaluation segment revenues were $414 million
for the 2003 second quarter, up slightly from the 2002 second quarter.
International revenues were 72% of total revenues in both the second quarter
2003 and the second quarter 2002. Mono Pumps, which was sold in January 2003,
contributed approximately $20 million in revenues in the second quarter of 2002
to our drilling services product line. The loss of Mono Pumps revenues was
partially offset by revenues in the remainder of our drilling services product
line as contracts that were expiring in the United Kingdom were more than offset
by new contracts, primarily in West Africa and Ecuador. Drill bits revenue
increased by 6% due mainly to sales in Continental Europe.
On a geographic basis, the Middle East/Asia region's revenue for the
segment increased $3 million in all product lines, while revenues for the
segment in Latin America declined $3 million due to decreased activity in
Venezuela as activity was slow to pick up after the recent civil unrest,
partially offset by an increase in Mexico.
Fluids segment revenues were $518 million for the second quarter 2003,
an increase of 15% from the second quarter 2002. International revenues were 55%
of total revenues in the 2003 second quarter compared to 52% in the 2002 second
quarter. The increase in Fluids segment revenue was spread almost equally
between cementing and drilling fluids reflecting higher rig counts in the United
States and increased activity with PEMEX in Mexico. In addition, drilling fluids
benefited from higher activity in Angola, Canada and Algeria.
On a geographic basis, Europe/Africa revenues for the segment increased
$21 million primarily due to increased activity in Norway and Angola. North
America revenues for the segment increased $24 million primarily due to the
higher land rig count in the United States. Similar to the Drilling and
Formation Evaluation and Production Optimization segments, Latin America
revenues for the segment were impacted by decreased activity in Venezuela, but
this was more than offset by the increases in Mexico. This resulted in an
overall increase in Latin America revenue of $3 million.
Production Optimization segment revenues were $693 million for the 2003
second quarter, an increase of 9% from the 2002 second quarter. International
revenues were 55% of total revenues in the second quarter 2003 compared to 51%
in the second quarter 2002 as activity picked up in the Middle East following
the end of the war in Iraq. Our production enhancement product line was up 11%,
due to an increase in activity in the United States as a result of higher land
rig counts. In addition, Subsea 7, Inc. accounted for $11 million of the
increase due to higher activity in the North Sea. Further, the 2002 second
quarter did not include all three months of activity for Subsea 7, Inc., as it
was not formed until May 23, 2002. The sale of Halliburton Measurement Systems
during the second quarter of 2003 had a $3 million negative impact on segment
revenue.
On a geographic basis, Middle East/Asia revenues for the segment were
up $25 million due to higher sales to Kazakhstan, and higher activity in the
former Soviet Union , Australia, Brunei and Iraq. Revenues for the segment were
$10 million higher in Latin America due to increased work with PEMEX in Mexico
partially offset by lower activity in Venezuela and Brazil.
39
Landmark and Other Energy Services segment revenues were $155 million
for the second quarter 2003, a decrease of 40% from the second quarter 2002. The
decrease is due to most of our subsea activities being moved into Subsea 7, Inc.
in May 2002 plus the impact of the sale of Wellstream during the first quarter
of 2003. Revenues for Landmark Graphics were flat with the prior year quarter.
International revenues for the segment were 72% of total revenues in the second
quarter 2003 compared to 75% in the second quarter 2002.
Engineering and Construction Group revenues of $1.8 billion in the 2003
second quarter were 23% higher than in the 2002 second quarter. The improvement
was due to revenue increases in government services and onshore projects,
partially offset by declines in offshore projects. Revenues from government
related activities more than doubled on increased work in the Middle East for
the United States and the United Kingdom governments, offset slightly by lower
activity levels on the Balkans project. Onshore revenues were up by 21%,
primarily due to several new projects in Algeria, Egypt, Chad and Cameroon that
began during 2002. Offshore revenues decreased 23% reflecting reduced activity
on the Barracuda-Caratinga project in Brazil and projects in the Philippines and
Nigeria that are nearing the completion phase. Operations and maintenance
revenues were down 12% compared to the second quarter of 2002 due to the
loss of several contracts that have not been replaced.
OPERATING INCOME
Second Quarter
-------------------------- Increase
Millions of dollars 2003 2002 (decrease)
----------------------------------------------------------------------------------
Drilling and Formation Evaluation $ 49 $ 42 $ 7
Fluids 68 49 19
Production Optimization 113 106 7
Landmark and Other Energy Services 5 (127) 132
----------------------------------------------------------------------------------
Total Energy Services Group 235 70 165
----------------------------------------------------------------------------------
Engineering and Construction Group (148) (450) 302
General corporate (16) (25) 9
-------------------------------------------------------------------- -------------
Total operating income $ 71 $ (405) $ 476
==================================================================================
Consolidated operating income of $71 million was $476 million higher in
the second quarter 2003 compared to the second quarter 2002. This change is
attributable to several significant items which occurred during the second
quarter of 2003 and 2002.
The significant items for the 2003 second quarter included:
- $173 million loss in the Engineering and Construction Group
related to the Barracuda-Caratinga project due to recently
identified higher cost trends and some actual and committed
costs exceeding estimated costs. In addition, schedule delays
have added to the costs of the project during the quarter; and
- $24 million gain in the Production Optimization segment
related to the sale of Halliburton Measurement Systems.
The net effect of these second quarter 2003 items was a loss of $149 million.
The significant items for the 2002 second quarter included:
- $56 million in expense related to restructuring charges;
- $119 million loss in the Engineering and Construction Group
related to the Barracuda-Caratinga project in Brazil;
- $330 million loss in the Engineering and Construction Group
related to asbestos exposures; and
- $61 million loss in the Landmark and Other Energy Services
segment for the impairment of our 50% equity investment in the
Bredero-Shaw joint venture.
The net effect of these second quarter 2002 items was a loss of $566 million.
Drilling and Formation Evaluation segment operating income for the 2003
second quarter increased $7 million, or 17%, from the second quarter 2002,
primarily due to improved logging results, where margins increased from 7% in
2002 to 13% in 2003. The improved logging results were primarily in Nigeria,
Indonesia, India and Mexico. Drilling services decreased by $2 million primarily
due to higher equipment maintenance costs and the impact from the sale of Mono
Pumps in the first quarter 2003.
40
Fluids segment operating income for the second quarter 2003 increased
$19 million, or 39%, from the second quarter 2002. Both drilling fluids and
cementing had incremental margins of about 30%.
Operating income was up in all geographic regions, as a result of
increased revenues. Drilling fluids results in the United States improved due to
a change in product mix and shift to newer environmental-friendly products.
Production Optimization segment operating income for the second quarter
2003 of $113 million increased $7 million from the second quarter 2002,
including the gain on the sale of Halliburton Measurement Systems of $24
million. Subsea 7, Inc. operating income increased $12 million from increased
activities in Norway and the United Kingdom. Also the 2002 second quarter did
not include all three months of activity for Subsea 7, Inc., as it was not
formed until May 23, 2002. Completion products and services operating income
decreased $13 million as margins were primarily affected by contract delays in
Indonesia and inventory obsolescence accruals. The production enhancement
product line decreased by $8 million as a result of increased discounts in the
United States, partially offset by increased activity in Mexico and Iraq. The
increased inventory obsolescence accruals in all product service lines decreased
segment operating income by $7 million.
Geographically, operating income in North America decreased $24 million
in the second quarter 2003 compared to the second quarter 2002 due to lower
pricing in spite of increased rig count and higher activity, which was offset by
the $24 million gain on the sale of Halliburton Measurement Systems.
Landmark and Other Energy Services segment operating income for the
second quarter 2003 was $5 million, a $132 million increase from the second
quarter 2002 reflecting the $61 million impairment of our equity investment in
Bredero-Shaw, the $37 million in restructuring charges and the $32 million of
impairment charges in integrated solutions projects in the second quarter of
2002.
Engineering and Construction Group operating loss of $148 million in
the second quarter 2003 decreased $302 million compared to the second quarter
2002. The second quarter of 2002 included a $330 million asbestos charge and a
$10 million restructuring charge. Income from government-related activities
improved by $18 million from the second quarter 2002, mainly related to
operations in the Middle East and at our shipyard in the United Kingdom. The
Barracuda-Caratinga project recognized $173 million of additional losses in the
second quarter 2003 compared to a $119 million loss in the 2002 second quarter.
The $173 million charge resulted from higher cost estimates, schedule
extensions, increased project contingencies as well as other factors. Onshore
results declined $11 million due mainly to a $29 million charge for schedule
delays on a project in Europe, which was partly offset by higher profits on LNG
projects.
General corporate expenses for the second quarter 2003 were $16 million
compared to $25 million for the 2002 second quarter, or a decrease in costs of
$9 million. The improved second quarter 2003 results reflect the $9 million of
restructuring charges incurred in the second quarter 2002.
NONOPERATING ITEMS
Interest expense of $25 million for the second quarter 2003 decreased
$5 million compared to the second quarter 2002. The decrease is due to lower
average borrowings in 2003 primarily from the reduction in debt prior to the
issuance of $1.2 billion in convertible notes at the end of the second quarter
2003.
Foreign exchange gains, net were $19 million in the current year
quarter compared to a $5 million loss in the second quarter of last year. The
increase was due to foreign exchange gains in the United Kingdom and Canada in
the second quarter 2003 and lower foreign exchange losses primarily in Argentina
as compared to the second quarter 2002.
Provision for income taxes of $29 million resulted in an effective tax
rate of 39% in the second quarter 2003, compared to a benefit for income taxes
in the second quarter 2002 of $77 million, resulting in an effective tax rate of
18%. The second quarter 2002 effective rate was low due to the tax impact of the
impairment loss on Bredero-Shaw and charges associated with our asbestos
exposure. The asbestos accrual generated a United States Federal deferred tax
asset in 2002 which may not be fully realizable based upon future taxable income
projections and thus we recorded a partial valuation allowance. The Bredero-Shaw
loss created a capital loss for which we have no capital gains to offset and
therefore no tax benefit was booked for the loss as future realization of the
benefit was questionable.
41
Loss from discontinued operations, net of tax was $16 million, or $0.03
per diluted share, for the second quarter 2003 compared to $140 million, or
$0.32 per diluted share, for the second quarter 2002. The loss in the second
quarter of 2003 reflects a $30 million pretax charge related to our July 2003
funding of the debtor-in-possession financing to Harbison-Walker in connection
with their Chapter 11 bankruptcy proceeding 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. In addition, discontinued
operations included professional fees associated with the due diligence and
other aspects of the proposed settlement for asbestos and silica liabilities
offset by a release of environmental and legal reserves related to indemnities
that were part of our disposition of Dresser Equipment Group and are no longer
needed. The loss in the second quarter 2002 was due primarily to charges of $153
million pretax, $123 million after tax, booked on asbestos exposures. We also
recorded pretax expense of $6 million associated with the Harbison-Walker
bankruptcy filing.
RESULTS OF OPERATIONS IN 2003 COMPARED TO 2002
First Six Months of 2003 Compared with the First Six Months of 2002
REVENUES
First Six Months
------------------------ Increase
Millions of dollars 2003 2002 (decrease)
---------------------------------------------------------------------------------
Drilling and Formation Evaluation $ 793 $ 812 $ (19)
Fluids 998 903 95
Production Optimization 1,322 1,246 76
Landmark and Other Energy Services 278 484 (206)
---------------------------------------------------------------------------------
Total Energy Services Group 3,391 3,445 (54)
---------------------------------------------------------------------------------
Engineering and Construction Group 3,268 2,797 471
---------------------------------------------------------------------------------
Total revenues $ 6,659 $ 6,242 $ 417
=================================================================================
Consolidated revenues in the first six months of 2003 of $6.7 billion
increased 7% compared to the first six months of 2002 primarily due to increased
revenues in the Engineering and Construction Group. International revenues were
67% of total revenues for the first six months of both 2003 and 2002.
Drilling and Formation Evaluation segment revenues for the first half
of 2003 declined $19 million compared to the first half of 2002. International
revenues were 72% of total revenues in the first six months of 2003 and 2002.
Mono Pumps, which was sold in January 2003, contributed approximately $40
million in revenues in the first six months of 2002 to our drilling services
product line. The loss of Mono Pumps revenue was partially offset by revenues in
the remainder of our drilling services product line as contracts that were
expiring in the United Kingdom were more than offset by new contracts, primarily
in West Africa and Ecuador. Logging services revenues decreased by $9 million
due to lower sales in China and reduced activity in Venezuela.
On a geographic basis, the sale of Mono Pumps negatively impacted
segment revenues in North America by $17 million, in Europe/Africa by $11
million, and in Middle East/Asia by $12 million for the first six months of
2003 compared to the first six months of 2002. Increased logging services
activity in the United States and higher drill bit sales in the United States
and Canada accounted for a $10 million increase in revenues. Middle East/Asia
revenues for the segment were positively impacted by increased drilling services
activity. Revenues were $6 million lower in Latin America where an increase in
activity in Mexico was more than offset by reductions in Venezuela, as activity
was slow to pick up after the recent civil unrest, and Brazil.
Fluids segment revenues were higher by $95 million in the first half
of 2003, an increase of 11% from the first six months of 2002. International
revenues were 55% of total revenues in the first six months of 2003 compared to
52% in the first six months of 2002. Drilling fluids, which was up 12%,
contributed to the majority of the increase due to higher land rig counts in the
United States.
42
On a geographic basis, all regions had increases in segment revenue
due to increased activity in both drilling fluids and cementing. On a percentage
basis the largest increase in revenues was in Middle East/Asia due to increased
activity in the former Soviet Union, Caspian and Indonesia. In addition, Latin
America revenues were slightly higher due to increased work in Mexico which was
offset by lower activity in Venezuela.
Production Optimization segment revenues were $1.3 billion for the
first six months of 2003, an increase of $76 million, or 6% from the first six
months of 2002. International revenues were 54% of total revenues in the first
half of 2003 compared to 51% in the first half of 2002 as activity picked up in
the Middle East following the end of the war in Iraq. The sale of Halliburton
Measurement Systems had a $3 million negative impact on segment revenues during
the first half of 2003. Our production enhancement product line was up 9%,
where United States revenue was up as a result of higher land rig counts.
On a geographic basis, Middle East/Asia revenues for the segment were
up $50 million due to higher sales to Kazakhstan, and higher activity in
Australia, Brunei and Iraq offset by lower activity in Indonesia. Revenues were
$12 million higher in Latin America where an increase in Mexico was partially
offset by reductions in activity in Brazil and Venezuela.
Landmark and Other Energy Services segment revenues were $278 million
for the first six months of 2003, a decrease of $206 million, or 43%, from the
first half of 2002. International revenues were 70% of total revenues in the
2003 first half compared to 77% in the first half of 2002. Lower segment
revenues were 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 in the Production Optimization segment. The sale of
Wellstream in March 2003 and the sale of integrated solutions projects in August
2002 also contributed to the decrease.
Engineering and Construction Group revenues for the six months ended
June 30, 2003 of $3.3 billion were 17% higher than in the six months ended June
30, 2002. The improvement was due to revenue increases in government related
activities and onshore projects, partially offset by declines in offshore
projects. Revenues from government services were up 78% on increased work in the
Middle East for the United States and the United Kingdom governments, offset
slightly by lower revenues on the Balkans project, which is in its final stages.
Onshore revenues were up 17%, primarily due to increases on a project in Nigeria
and progress on several new projects. The 16% decrease in offshore project
revenue reflects reduced activity on the Barracuda-Caratinga project in Brazil
and projects in the Philippines and Nigeria that are nearing the completion
phase. Operations and maintenance revenues were down 9% compared to the first
six months of 2002 due to the loss of several contracts that have not been
replaced.
OPERATING INCOME
First Six Months
-------------------------- Increase
Millions of dollars 2003 2002 (decrease)
----------------------------------------------------------------------------------
Drilling and Formation Evaluation $ 115 $ 80 $ 35
Fluids 123 100 23
Production Optimization 183 189 (6)
Landmark and Other Energy Services (6) (130) 124
----------------------------------------------------------------------------------
Total Energy Services Group 415 239 176
----------------------------------------------------------------------------------
Engineering and Construction Group (167) (508) 341
General corporate (35) (13) (22)
----------------------------------------------------------------------------------
Total operating income $ 213 $ (282) $ 495
==================================================================================
Consolidated operating income of $213 million was $495 million higher
in the first six months of 2003 compared to the first half of 2002. This change
is attributable to several significant items incurred during the first half of
2003 and 2002.
The significant items for the first six months of 2003 included:
- $228 million loss in the Engineering and Construction Group
related to the Barracuda-Caratinga project in Brazil;
- $15 million loss in the Landmark and Other Energy Services
segment on the sale of Wellstream;
43
- $24 million gain in the Production Optimization segment on the
sale of Halliburton Measurement Systems; and
- $36 million gain in the Drilling and Formation Evaluation
segment on the sale of Mono Pumps.
The net effect of these second quarter 2003 items was a loss of $183 million.
The significant items for the first six months of 2002 included:
- $67 million in expense related to restructuring charges, of
which $42 million related to Landmark and Other Energy
Services, $14 million related to the Engineering and
Construction Group, and $11 million related to General
corporate;
- $119 million loss in the Engineering and Construction Group
related to the Barracuda-Caratinga project in Brazil;
- $410 million loss in the Engineering and Construction Group
related to asbestos exposures;
- $61 million loss in the Landmark and Other Energy Services
segment on the impairment of our 50% equity investment in the
Bredero-Shaw joint venture; and
- $108 million gain in the Landmark and Other Energy Services
segment on the sale of European Marine Contractors Ltd.
The net effect of these second quarter 2002 items was a loss of $549 million.
Drilling and Formation Evaluation segment operating income totaled $115
million for the first six months of 2003 compared to $80 million in the first
six months of 2002. Operating income decreased $10 million in drilling services
partly due to the $5 million impact of having less than a month of Mono Pumps'
operations in 2003 due to the sale of Mono Pumps in January 2003. Drill bits
operating income was down $3 million primarily due to lower activity in the
Middle East and pricing pressures in the United States while logging benefited
from lower discounts in the United States. Operating income also included a $36
million gain on the sale of Mono Pumps in January of 2003.
Geographically, segment operating income decreased $4 million in Latin
America due to lower activity across the segment in Venezuela and Brazil offset
by increased activity for logging services and drill bits in Mexico and due to a
new drilling systems contract in Ecuador. A $12 million gain on the United
Kingdom portion of the sale of Mono Pumps positively impacted segment operating
income in Europe/Africa, along with higher activity in the North Sea and West
Africa.
Fluids segment operating income for the first six months of 2003 was
up $23 million, or 23%, from the first six months of 2002. The increase was
mostly in drilling fluids.
Geographically, all regions showed improved segment operating income
in the first six months of 2003 compared to the first six months of 2002 except
North America, which was flat with increased operating income for drilling
fluids offset by lower operating income in cementing. Pricing pressures
contributed to lower operating income in cementing in North America. Drilling
fluids benefited from higher sales of environmentally friendly fluids and
improved contract terms.
Production Optimization segment operating income for the first half
of 2003 decreased $6 million from the first half of 2002 with decreases across
all product lines. Operating income included a $24 million gain on the sale of
Halliburton Measurement Systems in the second quarter 2003. Operating income and
margins decreased in all product lines due to continued pricing pressures
throughout the six months combined with higher inventory adjustments and higher
operating costs in the North American region. The largest decreases came in
completion products and services which declined $14 million and tools and
testing which declined $9 million. Subsea 7, Inc. declined $2 million for the
period due to operating losses in the first quarter of 2003.
Segment operating income was down in the first half of 2003 compared
to the first half of 2002 in all geographic regions except Latin America, which
showed a $13 million increase reflecting increased activity in Mexico offset by
lower results in Brazil. Europe/Africa had a $6 million decrease compared to the
first six months of 2002 due to higher inventory obsolescence and equipment
mobilization costs as well as costs associated with early termination of a
contract in Norway.
44
Landmark and Other Energy Services segment operating income for the
first half of 2003 increased $124 million from the first six months of 2002 due
to the following:
- improved 2003 results in integrated solutions projects in the
United States, Indonesia and Iraq;
- a $61 million impairment in our 50% equity investment in
Bredero-Shaw in the second quarter 2002;
- $42 million of restructuring charges incurred in 2002;
- BJ Services litigation damage award of $98 million accrued in
2002;
- impairment charges in the second quarter of 2002 for
integrated solutions projects of $32 million, which were
partially offset by:
- $108 million gain on the sale of European Marine Contractors
Ltd. in the first quarter of 2002; and
- loss of $15 million on the sale of our Wellstream business in
March 2003.
Engineering and Construction Group operating loss of $167 million in
the first six months of 2003 decreased $341 million compared to the first half
of 2002. The improvement in operating results was due to $410 million in
asbestos charges and a $14 million restructuring charge that impacted the first
six months of 2002 compared to a $2 million asbestos charge and no restructuring
charges in the first six months of 2003. Income from government related
activities improved by $29 million from the first half of 2002, mainly related
to operations in the Middle East and our shipyard in the United Kingdom. The
Barracuda-Caratinga project recognized a $228 million loss in the first half of
2003 compared to a $119 million loss in the first six months of 2002. The losses
on the Barracuda-Caratinga project in 2003 are due to identified higher cost
trends and some actual and committed costs exceeding estimated costs. In
addition, schedule delays have added to the costs of the project during the
first half of the year. Onshore results declined $29 million due mainly to
schedule delays on a project in Europe and a project in Malaysia nearing
completion.
General corporate expenses for the first six months of 2003 were $35
million compared to $13 million for the first six months of 2002. General
corporate expenses were higher in 2003 as the first six months of 2002 included
a $28 million pretax gain for the value of stock received from the
demutualization of an insurance provider offset by 2002 restructuring charges of
$11 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 of $52 million for the first six months of 2003
decreased $10 million compared to the first six months of 2002. The decrease is
due to $4 million in pre-judgment interest recorded in the 2002 second quarter
related to the BJ Services patent infringement judgment and lower average
borrowings in the first six months of 2003.
Foreign exchange gains, net were $13 million in the current year
compared to a $13 million loss in the first half of last year. The increase was
due to a $15 million gain in the United Kingdom and an $8 million gain in Canada
in 2003 combined with the absence of foreign exchange losses in 2002 stemming
from the economic crisis in Argentina.
Provision for income taxes of $79 million resulted in an effective tax
rate of 41% in the first half of 2003, versus a benefit for income taxes in the
first half of 2002 of $41 million and an effective tax rate of 12%. The first
half of 2002 effective rate was low due to the tax impact of the impairment loss
on Bredero-Shaw and charges associated with our asbestos exposure. The asbestos
accrual generated a United States Federal deferred tax asset which may not be
fully realizable based upon future taxable income projections. As a result we
recorded a partial valuation allowance. The Bredero-Shaw loss created a capital
loss for which we had no capital gains to offset and therefore no tax benefit
was booked for the loss.
Loss from discontinued operations, net of tax was a $24 million loss,
or $0.05 per diluted share, for the first half of 2003 compared to $168 million,
or $0.39 per diluted share, for 2002. The loss in the first half of 2003 was due
to charges related to our July 2003 funding of the debtor-in-possession
financing to Harbison-Walker in connection with their Chapter 11 bankruptcy
proceeding 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. In addition, discontinued operations included professional fees
associated with the due diligence and other aspects of the proposed settlement
for asbestos liabilities offset by a release of environmental and legal reserves
45
related to indemnities that were part of our disposition of the Dresser
Equipment Group that are no longer needed. The loss in the first half of 2002
was due primarily to charges recorded for asbestos exposures. We also recorded
pretax expense of $6 million associated with the Harbison-Walker bankruptcy
filing.
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".
LIQUIDITY AND CAPITAL RESOURCES
We ended the second quarter of 2003 with cash and equivalents of $1.9
billion, an increase of $752 million from the end of 2002.
Cash flows from operating activities used $213 million in the first six
months of 2003 compared to providing $620 million in the first half of 2002.
Working capital items, which include receivables, sale of receivables,
inventories, accounts payable and other working capital, net, used $373 million
of cash in the first six months of 2003 compared to providing $333 million in
the same period of 2002. The major uses of working capital during the first half
of 2003 included the commencement of the Los Alamos contract by KBR and
increased activity in the Middle East due to new work related to Iraq. Our
government services activities could continue to use significant amounts of
working capital in the short term. Included in changes to other operating
activities for the first six months of 2002 is a $40 million payment related to
the Harbison-Walker bankruptcy filing.
Cash flows from investing activities provided $50 million in the first
six months of 2003 and used $414 million in the same period of 2002. Capital
expenditures of $229 million in the first half of 2003 were about 43% lower than
in the first six months of 2002. We have emphasized increased capital discipline
in 2003 and expect our full year capital spending to be approximately $600
million, down compared to 2002. Capital spending in the first half of 2003
continued to be mainly attributable to the Energy Services Group primarily for
directional and logging-while-drilling tools used in the Drilling and Formation
Evaluation segment. In addition, in the first quarter of 2002, we invested $60
million in integrated solutions projects. Cash from dispositions of businesses
in the first half of 2003 includes $136 million collected from the sale of
Wellstream, $33 million collected from the sale of Halliburton Measurement
Systems, and $23 million collected from the sale of Mono Pumps. Also included in
cash from dispositions is $25 million collected on a note receivable that was
received as a portion of the payment for Bredero-Shaw. Dispositions of
businesses in the first half of 2002 included $134 million collected from the
sale of our European Marine Contractors, Ltd. joint venture. The change in
restricted cash for the first half of 2003 is primarily collateral for potential
future insurance claim reimbursements. Included in the change in restricted cash
for the first half of 2002 is a $106 million deposit that collateralized an
appeal bond for a patent infringement judgment on appeal and $56 million as
collateral for potential future insurance claim reimbursements. Also included in
changes in restricted cash is $26 million primarily related to cash collateral
agreements for letters of credit outstanding on several construction projects.
Proceeds from the sale of securities in the first six months of 2003 of $57
million primarily relate to the sale of 2.5 million of National Oilwell common
shares that were received in the disposition of Mono Pumps.
Cash flows from financing activities provided $893 million in the first
six months of 2003. In the first six months of 2002, financing activities used
$101 million. Proceeds from long-term borrowings include $1.2 billion in
proceeds from the issuance of convertible senior notes, net of $24 million of
debt issuance costs. We also repaid our $139 million senior unsecured notes in
the first six months of 2003. Dividends to shareholders used $109 million of
cash in the first half of 2003 and 2002.
Capital resources from internally generated funds and access to capital
markets are sufficient to fund our working capital requirements and investing
activities. We will have to raise additional funding for the proposed asbestos
and silica settlement described below. Our combined short-term notes payable and
long-term debt was 42% of total capitalization at June 30, 2003 and 30% at
December 31, 2002. At June 30, 2003, we had $212 million in restricted cash
included in "Other assets, net". See Note 7 to the financial statements. In
addition, on April 15, 2002, we entered into an agreement to sell accounts
receivable to provide additional liquidity. Subsequent to the end of the second
46
quarter 2003, we reduced the balance on our accounts receivable securitization
facility to zero. This facility remains available to us for future use. See Note
8 to the financial statements. Currently, we expect capital expenditures in 2003
to be about $600 million. We have not finalized our capital expenditures budget
for 2004 or later periods.
Proposed asbestos and silica settlement. In December 2002, we reached
an agreement in principle that, if and when consummated, would result in a
settlement of asbestos and silica personal injury claims against our
subsidiaries DII Industries, Kellogg Brown & Root and their current and former
subsidiaries with United States operations. Subsequently, in 2003, DII
Industries and Kellogg Brown & Root entered into definitive written agreements
finalizing the terms of the agreements in principle with attorneys representing
more than 90% of the current asbestos claimants. We have also reached agreements
in principle with 48% of current silica claimants.
The definitive agreements provide that:
- up to $2.775 billion in cash, 59.5 million Halliburton shares
(valued at $1.4 billion using the stock price at June 30, 2003
of $23.00) and notes with a net present value expected to be
less than $100 million will be paid to one or more trusts for
the benefit of current and future asbestos and silica personal
injury claimants upon receiving final and non-appealable court
confirmation of a plan of reorganization;
- DII Industries and Kellogg Brown & Root will retain rights to
the first $2.3 billion of any insurance proceeds with any
proceeds received between $2.3 billion and $3.0 billion going
to the trust;
- the agreement is to be implemented through a pre-packaged
filing under Chapter 11 of the United States Bankruptcy Code
for DII Industries and Kellogg Brown & Root, and some of their
subsidiaries with United States operations; and
- the funding of the settlement amounts would occur upon
receiving final and non-appealable court confirmation of a
plan of reorganization for DII Industries and Kellogg Brown &
Root and some of their subsidiaries with United States
operations in the Chapter 11 proceeding.
Among the prerequisites for concluding the proposed settlement are:
- agreement on the amounts to be contributed to the trust for
the benefit of silica claimants;
- completion of our review of the current claims to establish
that the claimed injuries are based on exposure to products of
DII Industries, Kellogg Brown & Root, their subsidiaries or
former businesses or subsidiaries;
- completion of our medical review of the injuries alleged to
have been sustained by plaintiffs to establish a medical basis
for payment of settlement amounts;
- finalizing the principal amount and terms of the notes to be
contributed to the trust;
- agreement with a proposed representative of future claimants
and attorneys representing current claimants on procedures for
distribution of settlement funds to individuals claiming
personal injury;
- definitive agreement with the attorneys representing current
asbestos claimants and a proposed representative of future
claimants on a plan of reorganization for the Chapter 11
filings of DII Industries, Kellogg Brown & Root and some of
their subsidiaries with United States operations; and
agreement with the attorneys representing current asbestos and
silica claimants with respect to a disclosure statement
explaining the pre-packaged plan of reorganization to the
current claimants;
- arrangement of financing, in addition to the proceeds of our
recent offering of $1.2 billion principal amount of
convertible senior notes, for the proposed settlement on terms
acceptable to us to fund the cash amounts to be paid in the
settlement;
- Halliburton board approval;
- distribution of a disclosure statement and obtaining approval
of a plan of reorganization from at least the required 75% of
known present asbestos claimants and from a majority of known
present silica claimants in order to complete the plan of
reorganization; and
- obtaining final and non-appealable bankruptcy court approval
and federal district court confirmation of the plan of
reorganization.
47
Many of these prerequisites are subject to matters and uncertainties
beyond our control. There can be no assurance that we will be able to satisfy
the prerequisites for completion of the settlement. If we were unable to
complete the proposed settlement, we would be required to resolve current and
future asbestos claims in the tort system or, in the case of Harbison-Walker
claims (see Note 11 to the financial statements), possibly through the
Harbison-Walker bankruptcy proceedings.
We are currently continuing our due diligence review of current
asbestos claims to be included in the proposed settlement. We have now received
in excess of 75% of the necessary files related to medical evidence and we have
reviewed substantially all of the information provided. In regards to the
product identification due diligence, the process is moving at a steady pace,
but not as rapidly as the medical due diligence. In addition, we have not yet
commenced any due diligence in regards to silica claims. While no assurance can
be given, if we continue to receive documentation that is consistent with the
recent quantity and quality of the documentation received to date, we expect
that this documentation will provide an acceptable basis on which to proceed
with the proposed settlement. One result of our due diligence review is the
preliminary identification of more claims than contemplated by the proposed
settlement. However, until the more recently identified claims are subject to a
complete due diligence review, we will not be able to determine if these claims
would be appropriately included under the proposed settlement. Many of these
recently identified claims may be duplicative of previously submitted claims or
may otherwise not be appropriately included under the proposed settlement. In
the event that more claims are identified and validated than contemplated by the
proposed settlement, the cash required to fund the settlement may modestly
exceed $2.775 billion. If it does, we would need to decide whether to propose to
adjust the settlement matrices to reduce the overall amounts, or increase the
amounts we would be willing to pay to resolve the asbestos and silica
liabilities.
If we attempt to adjust the settlement matrices or otherwise attempt to
renegotiate the terms of the proposed settlement, the attorneys representing the
current asbestos claimants may not proceed with the settlement or may attempt to
renegotiate the settlement amount to increase the aggregate amount of the
settlement. Conversely, an increase in the amount of cash required may make
completing the proposed settlement more difficult.
In the event we elect to adjust the settlement matrices to reduce the
average amounts per claim, a supplemental disclosure statement may be required,
and if so, the claimants potentially adversely affected by the adjustment may
have an opportunity to change their votes. The additional time to make such
supplemental disclosure and opportunity to change votes may result in a delay in
the Chapter 11 filing.
Included in the next steps to complete the proposed settlement are (1)
an agreement on the procedures for the distribution of settlement funds to
individuals claiming personal injury and (2) an agreement on a plan of
reorganization for Kellogg Brown & Root and DII Industries and some of their
subsidiaries with United States operations and the related disclosure statement.
We cannot predict the exact timing of the completion of these steps, but we
expect that these prerequisites to making the Chapter 11 filing could be
completed on a timeline that would allow the Chapter 11 filing to be made late
in the third quarter or very early in the fourth quarter of 2003.
The settlement agreements with attorneys representing current asbestos
and silica claimants grant the attorneys a right to terminate their definitive
agreement on 10 days' notice. While no right to terminate any settlement
agreement has been exercised to date, there can be no assurance that claimants'
attorneys will not exercise their right to terminate the settlement agreements.
In connection with the Chapter 11 filing by Harbison-Walker, the
Bankruptcy Court on February 14, 2002 issued a temporary restraining order
staying all further litigation of more than 200,000 asbestos claims currently
pending against DII Industries in numerous courts throughout the United States.
The period of the stay contained in the temporary restraining order has been
extended through September 30, 2003. Currently, there is no assurance that a
stay will remain in effect beyond September 30, 2003, that a plan of
reorganization will be proposed or confirmed for Harbison-Walker, or that any
plan that is confirmed will provide relief to DII Industries. Should the stay
expire on September 30, 2003, the Bankruptcy Court established that discovery on
the stayed claims cannot begin until November 1, 2003 and trial dates cannot be
set before January 1, 2004.
Harbison-Walker filed a proposed plan of reorganization on July 31,
2003. However, the proposed plan does not provide for a Section 524(g)/105
injunction for the benefit of DII Industries and other DII Industries businesses
that share insurance with Harbison-Walker, and DII Industries has not consented
to the plan. Although possible, at this time we do not believe it likely that
48
Harbison-Walker will propose or will be able to confirm a plan of reorganization
in its bankruptcy proceeding that is acceptable to DII Industries within the
meaning of the letter agreements with RHI Refractories.
As an alternative, DII Industries has entered into a settlement in
principle with Harbison-Walker which would resolve substantially all of the
issues between them. This agreement is subject to negotiation of definitive
documentation and court approval in Harbison-Walker's bankruptcy case. If
approved by the court in Harbison-Walker's bankruptcy case, this agreement would
provide for:
- channeling of asbestos and silica personal injury claims
against Harbison-Walker and certain of its affiliates to the
trusts created in the Chapter 11 cases being contemplated for
DII Industries and Kellogg Brown & Root;
- release by Harbison-Walker and its affiliates of any rights in
insurance shared with DII Industries on occurrence of the
effective date of plan of reorganization for DII Industries;
- release by DII Industries of any right to be indemnified by
Harbison-Walker for asbestos or silica personal injury claims;
- forgiveness by DII Industries of all of Harbison-Walker's
obligations under the debtor-in-possession financing provided
by DII Industries 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;
- purchase by DII Industries of Harbison-Walker's outstanding
insurance receviables for an amount of approximately $50
million on the earliest of the effective date of a plan of
reorganization for DII Industries, the effective date of a
plan of reorganization for Harbison-Walker acceptable to DII
Industries or December 31, 2003. It is expected that a portion
of this receivable could require a reserve for
uncollectibility due to the insolvency of insurance carriers.
This receivable and related allowance will be recorded in the
third quarter 2003;
- guarantee of the insurance receivable purchase price by
Halliburton on a subordinated basis; and
- negotiation between the parties on a mutually-agreeable
structure for resolving other products or mass tort claims.
Of the up to $2.775 billion cash amount included as part of the
proposed settlement, approximately $450 million primarily relates to claims
previously settled but unpaid by Harbison-Walker (see Note 11 to the financial
statements), but not previously agreed to by us. As part of the proposed
settlement, we have agreed that, if a Chapter 11 filing by DII Industries,
Kellogg Brown & Root and their subsidiaries were to occur, we would pay this
amount within four years if not paid sooner pursuant to a final bankruptcy court
approved plan of reorganization for DII Industries, Kellogg Brown & Root and
their subsidiaries with United States operations. Effective November 30, 2002,
we are making cash payments in lieu of interest at a rate of 5% per annum to the
holders of these claims. These cash payments in lieu of interest will be made in
arrears at the end of February, May, August and November, beginning after
certain conditions are met, until the earlier of the date that the $450 million
is paid or the date the proposed settlement is abandoned.
We continue to track legislative proposals for asbestos reform pending
in the United States Congress. We understand that the United States Senate is
currently working on draft legislation that would set up a national trust fund
as the exclusive means for recovery for asbestos-related disease. We are not
certain as to what contributions we would be required to make to such a trust,
although we anticipate that they would be substantial and that they would
continue for a significant number of years. In determining whether to approve
the proposed settlement and proceed with the Chapter 11 filing of DII Industries
and Kellogg Brown & Root and some of their subsidiaries with United States
operations, the Halliburton Board of Directors will take into account the
then-current status of these legislative initiatives.
Proposed bankruptcy of DII Industries, Kellogg Brown & Root and
subsidiaries. Under the terms of the proposed settlement, the settlement would
be implemented through a pre-packaged Chapter 11 filing for DII Industries,
Kellogg Brown & Root and some of their subsidiaries with United States
operations. Other than those debtors, none of the subsidiaries of Halliburton
(including Halliburton Energy Services) or Halliburton itself will be a debtor
49
in the Chapter 11 proceedings. We anticipate that Halliburton, Halliburton
Energy Services and each of the debtors' non-debtor affiliates will continue
normal operations and continue to fulfill all of their respective obligations in
the ordinary course as they become due.
As part of any proposed plan of reorganization, the debtors intend to
seek approval of the bankruptcy court for debtor-in-possession financing to
provide for operating needs and to provide additional liquidity during the
pendency of the Chapter 11 proceeding. Halliburton intends, with the
understanding of its lenders, to provide the debtor-in-possession financing to
DII Industries and Kellogg Brown & Root. Arranging for debtor-in-possession
financing is a condition precedent to the filing of any Chapter 11 proceeding.
Any plan of reorganization will provide that all of the debtors'
obligations under letters of credit, surety bonds, corporate guaranties and
indemnity agreements (except for agreements relating to asbestos claims or
silica claims) will be unimpaired. In addition, the Bankruptcy Code allows a
debtor to assume most executory contracts without regard to bankruptcy default
provisions, and it is the intention of DII Industries, Kellogg Brown & Root and
the other filing entities to assume and continue to perform all such executory
contracts. Representatives of DII Industries, Kellogg Brown & Root and their
subsidiaries have advised their customers of this intention.
After filing any Chapter 11 proceeding, the debtors would seek an order
of the bankruptcy court scheduling a hearing to consider confirmation of the
plan of reorganization. In order to be confirmed, the Bankruptcy Code requires
that impaired classes of creditors vote to accept the plan of reorganization
submitted by the debtors. In order to carry a class, approval of over one-half
in number and at least two-thirds in amount are required. In addition, to obtain
an injunction under Section 524(g) of the Bankruptcy Code, at least 75% of
voting current asbestos claimants must vote to accept the plan of
reorganization. In addition to obtaining the required votes, the requirements
for a bankruptcy court to approve a plan of reorganization include, among other
judicial findings, that:
- the plan of reorganization complies with applicable provisions
of the Bankruptcy Code;
- the debtors have complied with the applicable provisions of
the Bankruptcy Code;
- the trust will value and pay similar present and future claims
in substantially the same manner;
- the plan of reorganization has been proposed in good faith and
not by any means forbidden by law; and
- any payment made or promised by the debtors to any person for
services, costs or expenses in or in connection with the
Chapter 11 proceeding or the plan of reorganization has been
or is reasonable.
Section 524(g) of the Bankruptcy Code authorizes the bankruptcy court
to enjoin entities from taking action to collect, recover or receive payment or
recovery with respect to any asbestos claim or demand that is to be paid in
whole or in part by a trust created by a plan of reorganization that satisfies
the requirements of the Bankruptcy Code. Section 105 of the Bankruptcy Code
authorizes a similar injunction for silica claims. The injunction also may bar
any action based on such claims or demands against the debtors that are directed
at third parties. The order confirming the plan must be issued or affirmed by
the federal district court that has jurisdiction over the case. After the
expiration of the time for appeal of the order, the injunction becomes valid and
enforceable.
The debtors believe that, if they proceed with a Chapter 11 filing,
they will be able to satisfy all the requirements of Section 524(g), so long as
the requisite number of holders of asbestos claims vote in favor of the plan of
reorganization. If the 524(g) and 105 injunctions are issued, all unsettled
current asbestos claims, all future asbestos claims and all silica claims based
on exposure that has already occurred will be channeled to a trust for payment,
and the debtors and related parties (including Halliburton, Halliburton Energy
Services and other subsidiaries and affiliates of Halliburton and the debtors)
will be released from any further liability under the plan of reorganization.
A prolonged Chapter 11 proceeding could adversely affect the debtors'
relationships with customers, suppliers and employees, which in turn could
adversely affect the debtors' competitive position, financial condition and
results of operations. A weakening of the debtors' financial condition and
results of operations could adversely affect the debtors' ability to implement
the plan of reorganization.
Financing the proposed asbestos and silica settlement. The plan of
reorganization through which the proposed settlement will be implemented will
require us to contribute approximately $2.775 billion in cash to the Section
524(g)/105 trust established for the benefit of claimants, which we will need to
finance on terms acceptable to us. On June 30, 2003, we issued $1.2 billion of
50
3.125% convertible senior notes due July 15, 2023. We intend to use a portion of
the net proceeds from the offering to fund a portion of the cash contribution
required by the proposed settlement. In addition, we are pursuing a number of
additional financing alternatives for the cash amount to be contributed to the
trust. The availability of these alternatives depends in large part on market
conditions. We are currently negotiating with several banks and non-bank lenders
over the terms of multiple credit facilities. A proposed banking syndicate is
currently performing due diligence in an effort to make a funding commitment
before the bankruptcy filing. We will not proceed with the Chapter 11 filing for
DII Industries, Kellogg Brown & Root and some of their subsidiaries until
financing commitments are in place.
The anticipated credit facilities include:
- a revolving line of credit for general working capital
purposes;
- a master letter of credit facility intended to ensure that
existing letters of credit supporting our contracts remain in
place during the filing; and
- a delayed-draw term facility to be available for cash funding
of the trust for the benefit of claimants.
The delayed-draw term facility is intended to eliminate uncertainty the
capital markets might have concerning our ability to meet our funding
requirement once final and non-appealable court confirmation of a plan of
reorganization has been obtained.
None of these credit facilities are currently in place, and there can
be no assurances that we will complete these facilities. We are not obligated to
enter into these facilities if the terms are not acceptable to us. Moreover,
these facilities would only be available for limited periods of time. As a
result, if the debtors were delayed in filing the Chapter 11 proceeding or
delayed in completing the plan of reorganization after a Chapter 11 filing, the
credit facilities may expire and no longer be available. In such circumstances,
we would have to terminate the proposed settlement if replacement financing were
not available on acceptable terms.
We have sufficient authorized and unrestricted shares to issue 59.5
million shares to the trust. No shareholder approval is required for issuance of
the shares.
Credit ratings. Late in 2001 and early in 2002, Moody's Investors'
Services 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 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 exposure, and both agencies
have indicated that the ratings continue under consideration for possible
downgrade pending the results of the proposed settlement. Although our long-term
ratings continue at investment grade levels, the cost of new borrowing is higher
and our access to the debt markets is more volatile at the current rating
levels. Investment grade ratings are BBB- or higher for Standard & Poor's and
Baa3 or higher for Moody's Investors' Services. Our current ratings are one
level above BBB- on Standard & Poor's and one level above Baa3 on Moody's
Investors' Services.
We have $350 million of committed lines of credit from banks that are
available if we maintain an investment grade rating. This facility expires on
August 16, 2006. As of June 30, 2003, no amounts have been borrowed under these
lines. If our credit ratings were to fall below investment grade, our credit
line would be unavailable absent a successful renegotiation with our banks. In
such event, we must also enter into good faith negotiations to amend our
accounts receivable facility. Absent an agreed amendment within 60 days, amounts
outstanding would be declared due and payable. As of June 30, 2003, the
outstanding balance of our accounts receivable facility was $180 million, which
was subsequently reduced to zero in July 2003.
If our debt ratings fall below investment grade, we would also be in
technical breach of a bank agreement covering $52 million of letters of credit
at June 30, 2003, which might entitle the bank to set-off rights. In addition, a
$151 million letter of credit line, of which $141 million has been issued,
includes provisions that allow the banks to require cash collateralization for
the full line if debt ratings of either rating agency fall below the rating of
BBB by Standard & Poor's or Baa2 by Moody's Investors' Services. These letters
of credit and bank guarantees generally relate to our guaranteed performance or
retention payments under our long-term contracts and self-insurance.
51
Our Halliburton Elective Deferral Plan has a provision which states
that if the Standard & Poor's rating falls below BBB the amounts credited to the
participants' accounts will be paid to the participants in a lump-sum within 45
days. At June 30, 2003 this was approximately $48 million.
In the event the ratings of our debt by either agency fall, we may have
to issue additional debt or equity securities or obtain additional credit
facilities in order to satisfy the cash collateralization requirements under the
instruments referred to above and meet our other liquidity needs. We anticipate
that any such new financing would not be on terms as attractive as those we have
currently and that we would also be subject to increased borrowing costs and
interest rates.
Letters of credit. In the normal course of business, we have agreements
with banks under which approximately $1.3 billion of letters of credit or bank
guarantees were issued, including at least $195 million which relate to our
joint ventures' operations. The agreements with these banks contain terms and
conditions that define when the banks can require cash collateralization of the
entire line. Agreements with banks covering at least $150 million of letters of
credit allow the bank to require cash collateralization for any reason, and
agreements covering another at least $890 million of letters of credit allow the
bank to require cash collateralization for the entire line in the event of a
bankruptcy or insolvency event involving one of our subsidiaries that will be a
party to the proposed Chapter 11.
Our letters of credit also contain terms and conditions that define
when they may be drawn. At least $230 million of letters of credit permit the
beneficiary of such letters of credit to draw against the line for any reason
and another at least $560 million of letters of credit permit the beneficiary of
such letters of credit to draw against the line in the event of a bankruptcy or
insolvency event involving one of our subsidiaries who will be party to the
proposed reorganization proceedings.
Effective October 9, 2002, we amended an agreement with banks under
which $261 million of letters of credit had been issued on the
Barracuda-Caratinga project. The amended agreement removes the provision that
previously allowed the banks to require collateralization if ratings of
Halliburton debt fell below investment grade ratings. The revised agreement
includes provisions that require us to maintain ratios of debt to total capital
and of total earnings before interest, taxes, depreciation and amortization to
interest expense. The definition of debt includes our asbestos liability. The
definition of total earnings before interest, taxes, depreciation and
amortization excludes any non-cash charges related to the proposed settlement
through December 31, 2003.
As such, requirements for us to cash collateralize letters of credit
and surety bonds by issuers and beneficiaries of these instruments could be
caused by:
- our plans to place DII Industries, Kellogg Brown & Root and
some of their subsidiaries with United States operations into
a pre-packaged Chapter 11 proceeding as part of the proposed
settlement;
- in the absence of the proposed settlement, one or more
substantial adverse judgments;
- not being able to recover on a timely basis insurance
reimbursement; or
- a reduction in credit ratings.
Uncertainty may also hinder our ability to access new letters of credit
in the future. This could impede our liquidity and/or our ability to conduct
normal operations.
Our anticipated credit facilities related to the proposed asbestos and
silica settlement would include a master letter of credit facility intended to
replace any cash collateralization rights of issuers of substantially all our
existing letters of credit during the pendency of the anticipated Chapter 11
proceedings by DII Industries and Kellogg Brown & Root and some of their
subsidiaries with United States operations. The master letter of credit facility
would also provide collateral for issuers of our existing letters of credit if
such letters of credit are drawn and the issuing bank provides cash for
collateral or reimbursement. If any of such existing letters of credit are drawn
during the bankruptcy and the bank issuing the letter of credit provides cash to
collateralize or reimburse for such draws, it is anticipated that the letter of
credit facility would provide the cash needed for such draws, with any
borrowings being converted into term loans. However, this master letter of
credit facility is not currently in place, and, if we were required to cash
collateralize letters of credit prior to obtaining the facility, we would be
required to use cash on hand or existing credit facilities. Substantial cash
collateralization requirements prior to our being able to enter into a new
master letter of credit facility may have a material adverse effect on our
financial condition. We will not enter into the pre-packaged Chapter 11 filing
without having this credit facility in place. There can be no assurance that we
52
will be able to enter into such a facility on reasonable terms or on terms
acceptable to us or at all. In addition, representatives of DII Industries,
Kellogg Brown & Root and their subsidiaries are having continuing discussions
with their customers in order to reduce the possibility that any material draw
on the existing letters of credit will occur due to the anticipated Chapter 11
proceedings.
In the past, no significant claims have been made against letters of
credit issued on our behalf.
Barracuda-Caratinga Project. In June 2000, KBR entered into a contract
with the project owner, Barracuda & Caratinga Leasing Company B.V., to develop
the Barracuda and Caratinga crude oil fields, which are located off the coast of
Brazil. The project 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 which will be used as floating
production, storage and offloading platforms, or FPSOs, 33 hydrocarbon
production wells, 18 water injection wells and all sub-sea flow lines and risers
necessary to connect the underwater wells to the FPSOs.
KBR's performance under the contract is secured by:
- three performance letters of credit, which together have an
available credit of approximately $266 million as of June 30,
2003 and which represent approximately 10% of the contract
amount, as amended to date by change orders;
- a retainage letter of credit in an amount equal to $141
million as of June 30, 2003 and which will increase in order
to continue to represent 10% of the cumulative cash amounts
paid to KBR; and
- a guarantee of KBR's performance of the agreement by
Halliburton Company in favor of the project owner.
In the event that KBR is alleged to be in default under the contract,
the project owner may assert a right to draw upon the letters of credit. If the
letters of credit were to be drawn, KBR would be required to fund the amount of
the draw to the issuing banks. To the extent KBR cannot fund the amount of the
draw, Halliburton would be required to do so, which could have a material
adverse effect on Halliburton's financial condition and results of operations.
In addition, the proposed Chapter 11 pre-packaged bankruptcy filing by
KBR in connection with the proposed settlement of its asbestos claims would
constitute an event of default under the contract that would allow the owner
(with the approval of the lenders financing the project) to assert a right to
draw the letters of credit unless waivers are obtained. The proposed Chapter 11
filing would also constitute an event of default under the owner's loan
agreements with the lenders that would allow the lenders to cease funding the
project. We believe that it is unlikely that the owner will make a draw on the
letters of credit as a result of the proposed Chapter 11 filing. We also believe
it is unlikely that the lenders will exercise any right to cease funding the
project given the current status of the project and the fact that a failure to
pay KBR may allow KBR 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 or that the owner will not require
funding of the letters of credit by KBR.
In the event that KBR was determined after an arbitration proceeding to
have been in default under the contract with Petrobras, and if the project was
not completed by KBR as a result of such default (i.e., KBR's services are
terminated as a result of such default), the project owner may seek direct
damages (including completion costs in excess of the contract price and interest
on borrowed funds, but excluding consequential damages) against KBR for up to
$500 million plus the return of up to $300 million in advance payments
previously received by KBR to the extent they have not been repaid.
In addition to the amounts described above, KBR may have to pay
liquidated damages if the project is delayed beyond the original contract
completion date. KBR expects that the project will likely be completed at least
16 months later than the original contract completion date. Although KBR
believes that the project's delay is due primarily to the actions of the project
owner, in the event that any portion of the delay is determined to be
attributable to KBR and any phase of the project is completed after the
milestone dates specified in the contract, KBR could be required to pay
liquidated damages. These damages would be calculated on an escalating basis of
approximately $1 million per day of delay caused by KBR, subject to a total cap
on liquidated damages of 10% of the final contract amount (yielding a cap of
approximately $266 million as of June 30, 2003).
53
As of June 30, 2003, the project was approximately 75% complete and KBR
had recorded a pretax loss of $345 million related to the project, of which $173
million was recorded in the second quarter of 2003. The second quarter 2003
charge was due to higher cost estimates, schedule extensions, increased project
contingencies and other factors identified during the quarterly review of the
project. The probable unapproved claims included in determining the loss on the
project were $182 million as of June 30, 2003. The claims for the project most
likely will not be settled within one year. Accordingly, based upon the contract
being approximately 75% complete, probable unapproved claims of $134 million at
June 30, 2003 have been recorded to long-term unbilled work on uncompleted
contracts. Those amounts are included in "Other assets, net" on the balance
sheet. KBR has asserted claims for compensation substantially in excess of $182
million. The project owner, through its project manager, Petrobras, has denied
responsibility for all such claims. Petrobras has, however, issued formal change
orders worth approximately $61 million which are not included in the $182
million in probable unapproved claims.
In June 2003, Halliburton, KBR and Petrobras, on behalf of the project
owner, entered into a non-binding heads of agreement that would resolve some of
the disputed issues between the parties, subject to final agreement and lender
approval. The original completion date for the Barracuda project was December
2003 and the original completion date for the Caratinga project was April 2004.
Under the heads of agreement, the project owner would grant an extension of time
to the original completion dates and other milestone dates that averages
approximately 12 months, delay any attempt to assess the original liquidated
damages against KBR for project delays beyond 12 months and up to 18 months,
delay any drawing of letters of credit with respect to such liquidated damages
and delay the return of any of the $300 million in advance payments until after
arbitration. The heads of agreement also provides for a separate liquidated
damages calculation of $450,000 per day for each of the Barracuda and the
Caratinga vessels for a delay from the original schedule beyond 18 months
(subject to the total cap on liquidated damages of 10% of the final contract
amount). The heads of agreement does not delay the drawing of letters of credit
for these liquidated damages. The extension of the original completion dates and
other milestones would significantly reduce the likelihood of KBR incurring
liquidated damages on the project. Nevertheless, KBR continues to have exposure
for substantial liquidated damages for delays in the completion of the project.
Under the heads of agreement, the project owner has agreed to pay $59
million of KBR's disputed claims (which are included in the $182 million of
probable unapproved claims as of June 30, 2003) and to arbitrate additional
claims. The maximum recovery from the claims to be arbitrated would be capped at
$375 million. The heads of agreement also allows the project owner or Petrobras
to arbitrate additional claims against KBR, not including liquidated damages,
the maximum recovery from which would be capped at $380 million. KBR believes
the claims made to date by the project owner are based on a delay in project
completion. KBR's contract with the project owner excludes consequential damages
and, as indicated above, provides for liquidated damages in the event of delay
in completion of the project. While there can be no assurance that the
arbitrator will agree, KBR believes if it is determined that KBR is liable for
delays, the project owner would be entitled to liquidated damages in amounts up
to those referred to above, and not to an additional $380 million.
The finalization of the heads of agreement is subject to project lender
approval. The parties have had discussions with the lenders and based on these
discussions have agreed to certain modifications to the original terms of the
heads of agreement to conform to the lenders' requirements. They have agreed
that the $300 million in advance payments would be due on the earliest of
December 7, 2004, the completion of any arbitration or the resolution of all
claims between the project owner and KBR. Likewise, the project owner's
obligation to defer drawing letters of credit with respect to liquidated damages
for delays between 12 and 18 months would extend only until December 7, 2004.
The discussions with the lenders are not yet complete, and no agreement for
their approval has yet been obtained. While we believe the lenders have an
incentive to approve the heads of agreement and complete the financing of the
project, and the parties have agreed to the modifications described above to the
heads of agreement to secure the lenders' approval, there is no assurance that
they will do so. If the lenders do not consent to the heads of agreement,
Petrobras may be forced to secure other funding to complete the project. There
is no assurance that Petrobras will pursue or will be able to secure such
funding.
Absent lender approval of the heads of agreement, KBR could be subject
to additional liquidated damages and other claims, be subject to the letters of
credit being drawn and be required to return the $300 million in advance
payments in accordance with the original contract terms. The original contract
terms require repayment through $300 million of credits to the last $350 million
54
of invoices on the contract. No assurance can be given that the heads of
agreement will be finalized or that the lenders will approve the heads of
agreement or that the lenders will approve the heads of agreement without
revisions that could adversely affect KBR.
The project owner has procured project finance funding obligations from
various lenders to finance the payments due to KBR under the contract. The
project owner currently has no other committed source of funding on which we can
necessarily rely other than the project finance funding for the project. If the
lenders cease to fund the project, the project owner may not have the ability to
continue to pay KBR for its services. The original loan documents provide that
the lenders are not obligated to continue to fund the project if the project has
been delayed for more than 6 months. In November 2002, the lenders agreed to
extend the 6-month period to 12 months. Other provisions in the loan documents
may provide for additional time extensions. However, delays beyond 12 months may
require lender consent in order to obtain additional funding. While we believe
the lenders have an incentive to complete the financing of the project, there is
no assurance that they would do so. If the lenders did not consent to extensions
of time or otherwise ceased funding the project, we believe that Petrobras would
provide for or secure other funding to complete the project, although there is
no assurance that it would do so. To date, the lenders have made funds
available, and the project owner has continued to disburse funds to KBR as
payment for its work on the project even though the project completion has been
delayed.
In addition, although the project financing includes borrowing capacity
in excess of the original contract amount, only $250 million of this additional
borrowing capacity is reserved for increases in the contract amount payable to
KBR and its subcontractors. Under the loan documents, the availability date for
loan draws expires December 1, 2003. As a condition to approving the heads of
agreement, the lenders will require the project owner to draw all remaining
available funds prior to December 1, 2003, and to escrow the funds for the
exclusive use of paying project costs. No funds may be paid to Petrobras or its
subsidiary (which is funding the drilling costs of the project) until all
amounts due to KBR, including amounts due for the claims, are liquidated and
paid. While this potentially increases the funds available for payment to KBR,
KBR is 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 KBR claims and change orders.
KBR has 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 $500 million (assuming
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 KBR recovers unapproved claims in the
amounts currently recorded on our books, the cash shortfall would be
approximately $320 million. While KBR believes it will recover amounts in excess
of the amount of unapproved claims on its books, there can be no assurance that
it will do so.
Current maturities. We had $166 million of current maturities of
long-term debt as of June 30, 2003. Subsequent to second quarter 2003, we repaid
a $150 million medium-term note due July 2003.
Cash and cash equivalents. We ended June 30, 2003 with cash and
equivalents of $1.9 billion.
OFF BALANCE SHEET RISK
On April 15, 2002, we entered into an agreement to sell accounts
receivable to a bankruptcy-remote limited-purpose funding subsidiary. Under the
terms of the agreement, new receivables are added on a continuous basis to the
pool of receivables, and collections reduce previously sold accounts receivable.
This funding subsidiary sells an undivided ownership interest in this pool of
receivables to entities managed by unaffiliated financial institutions under
another agreement. Sales to the funding subsidiary have been structured as "true
sales" under applicable bankruptcy laws. The assets of the funding subsidiary
are not available to pay any creditors of ours or of our subsidiaries or
affiliates, until such time as the agreement with the unaffiliated companies is
terminated following sufficient collections to liquidate all outstanding
undivided ownership interests. The funding subsidiary retains the interest in
the pool of receivables that are not sold to the unaffiliated companies and is
fully consolidated and reported in our financial statements.
55
The amount of undivided interests, which can be sold under the program,
varies based on the amount of eligible Energy Services Group receivables in the
pool at any given time and other factors. The funding subsidiary initially sold
a $200 million undivided ownership interest to the unaffiliated companies, and
may from time to time sell additional undivided ownership interests. The total
amount outstanding under this facility was $180 million as of June 30, 2003. The
amount of undivided ownership interest in the pool of receivables sold to the
unaffiliated companies is reflected as a reduction of accounts receivable in our
consolidated balance sheet. In July 2003, the balance outstanding under this
facility was reduced to zero.
ENVIRONMENTAL MATTERS
We are subject to numerous environmental, legal and regulatory
requirements related to our operations worldwide. In the United States, these
laws and regulations include 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, among others. In addition to the federal laws and regulations,
states where we do business may have equivalent laws and regulations by which we
must also 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.
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 June 30, 2003,
those nine sites accounted for approximately $7 million of our total $36 million
liability. See Note 12 to the financial statements.
FORWARD-LOOKING INFORMATION
Looking ahead, we believe United States activity levels will increase
modestly in the second half of this year. In particular, we expect continued
strong drilling activity onshore in North America provided natural gas or oil
prices do not decline significantly from current levels. Activity in the United
States Gulf of Mexico has been disappointing in the first half of this year and
we expect only a modest improvement through year end. Outside of North America,
we expect rig counts will be flat to up slightly for the balance of the year.
Mexico has also shown a significant increase in drilling activity, and we expect
this high level of activity to continue in the near term. Pricing on new
contracts for certain of our products and services began to improve in the
second quarter. We expect that the pricing environment will gradually improve
for the balance of the year. We are currently implementing price increases and
discount reductions in selected product lines and geographies.
In the longer-term, we expect increased global demand for oil and
natural gas, additional customer spending to replace depleting reserves and our
continued technological advances to provide growth opportunities.
The Private Securities Litigation Reform Act of 1995 provides safe
harbor provisions for forward-looking information. Forward-looking information
is based on projections and estimates, not historical information. Some
statements in this Form 10-Q are forward-looking and use words like "may", "may
not", "believes", "do not believe", "expects", "do not expect", "plans", "does
not plan", "anticipate", "do not anticipate", and other expressions. We may also
provide oral or written forward-looking information in other materials we
release to the public. Forward-looking information involves risks and
uncertainties and reflects our best judgment based on current information. Our
results of operations can be affected by inaccurate assumptions we make or by
known or unknown risks and uncertainties. In addition, other factors may affect
the accuracy of our forward-looking information. As a result, no forward-looking
information can be guaranteed. Actual events and the results of operations may
vary materially.
56
While it is not possible to identify all factors, we continue to face
many risks and uncertainties that could cause actual results to differ from our
forward-looking statements and potentially adversely affect our financial
condition and results of operations, including risks relating to:
Asbestos
- completion of the proposed settlement, prerequisites which
include:
- agreement on the total number of current asbestos and
silica personal injury claims and the aggregate
compensation for such claims within the parameters of
the proposed settlement;
- agreement on the amounts to be contributed to the
trust for the benefit of current silica claimants;
- our due diligence review for product exposure and
medical basis for claims;
- agreement on procedures for distribution of settlement
funds to individuals claiming personal injury;
- determining whether, after diligence and the
identification of duplicate claims, payment of the
claims submitted would exceed the $2.775 billion cash
portion of the asbestos settlement, and the manner
in which we and the claimants respond to these
matters;
- definitive agreement on a plan of reorganization and
disclosure statement relating to the proposed
settlement;
- arrangement of acceptable financing to fund the
proposed settlement;
- Board of Directors approval;
- obtaining approval from 75% of current asbestos
claimants and the requisite silica claimants to the
plan of reorganization implementing the proposed
settlement;
- obtaining final and non-appealable bankruptcy court
approval and federal district court confirmation of
the plan of reorganization;
- finalizing the settlement agreement with
Harbison-Walker and obtaining bankruptcy court
approval thereof; and
- Harbison-Walker obtaining approval of its proposed
plan of reorganization in a form satisfactory to us;
- the results of being unable to complete the proposed
settlement, including:
- continuing asbestos and silica litigation against us,
which would include the possibility of substantial
adverse judgments, the timing of which could not be
controlled or predicted, and the obligation to
provide appeals bonds pending any appeal of any such
judgment, some or all of which may require us to post
cash collateral;
- current and future asbestos claims settlement and
defense costs, including the inability to completely
control the timing of such costs and the possibility
of increased costs to resolve personal injury claims;
- the possibility of an increase in the number and type
of asbestos and silica claims against us in the
future;
- future events in the Harbison-Walker bankruptcy
proceeding, including the possibility of
discontinuation of the temporary restraining order
entered by the Harbison-Walker bankruptcy court that
applies to over 200,000 pending claims against DII
Industries; and
- any adverse changes to the tort system allowing
additional claims or judgments against us;
- the results of being unable to recover, or being delayed in
recovering, insurance reimbursement in the amounts anticipated
to cover a part of the costs incurred defending asbestos and
silica claims, and amounts paid to settle claims or as a
result of court judgments, due to:
- the inability or unwillingness of insurers to timely
reimburse for claims in the future;
- disputes as to documentation requirements for DII
Industries in order to recover claims paid;
57
- the inability to access insurance policies shared
with, or the dissipation of shared insurance assets
by, Harbison-Walker Refractories Company or
Federal-Mogul Products, Inc.;
- the insolvency or reduced financial viability of
insurers;
- the cost of litigation to obtain insurance
reimbursement; and
- adverse court decisions as to our rights to obtain
insurance reimbursement;
- the results of recovering, or agreeing in settlement of
litigation to recover, less insurance reimbursement than the
insurance receivable recorded in our financial statements;
- continuing exposure to liability even after the proposed
settlement is completed, including exposure to:
- any claims by claimants exposed outside of the United
States;
- possibly any claims based on future exposure to
silica;
- property damage claims as a result of asbestos and
silica use; or
- any claims against any other subsidiaries or business
units of Halliburton that would not be released in
the Chapter 11 proceeding through the 524(g)
injunction;
- liquidity risks resulting from being unable to complete a
settlement or timely recovery of insurance reimbursement for
amounts paid, each as discussed further below; and
- an adverse effect on our financial condition or results of
operations as a result of any of the foregoing;
Liquidity
- adverse financial developments that could affect our available
cash or lines of credit, including:
- the effects described above of not completing the
proposed settlement or not being able to timely
recover insurance reimbursement relating to amounts
paid as part of a settlement or as a result of
judgments against us or settlements paid in the
absence of a settlement;
- our inability to provide cash collateral for letters
of credit or any bonding requirements from customers
or as a result of adverse judgments that we are
appealing; and
- a reduction in our credit ratings as a result of the
above or due to other adverse developments;
- requirements to cash collateralize letters of credit and
surety bonds by issuers and beneficiaries of these instruments
in reaction to:
- our plans to place DII Industries, Kellogg Brown &
Root and some of their subsidiaries into a
pre-packaged Chapter 11 bankruptcy as part of the
proposed settlement;
- in the absence of a settlement, one or more
substantial adverse judgments;
- not being able to timely recover insurance
reimbursement; or
- a reduction in credit ratings;
- our ability to secure financing on acceptable terms to fund
our proposed settlement;
- defaults that could occur under our and our subsidiaries' debt
documents as a result of a Chapter 11 filing unless we are
able to obtain consents or waivers to those events of default,
which events of default could cause defaults under other of
our credit facilities and possibly result in an obligation to
immediately pay amounts due;
- actions by issuers and beneficiaries of current letters of
credit to draw under such letters of credit prior to our
completion of a new letter of credit facility that is intended
to provide reasonably sufficient credit lines for us to be
able to fund any such cash requirements;
- reductions in our credit ratings by rating agencies, which
could result in:
- the unavailability of borrowing capacity under our
existing $350 million line of credit facility, which
is only available to us if we maintain an investment
grade credit rating;
- reduced access to lines of credit, credit markets and
credit from suppliers under acceptable terms;
- borrowing costs in the future; and
- inability to issue letters of credit and surety bonds
with or without cash collateral;
- working capital requirements from time to time;
58
- debt and letter of credit covenants;
- volatility in the surety bond market;
- availability of financing from the United States Export/Import
Bank;
- ability to raise capital via the sale of stock; and
- an adverse effect on our financial condition or results of
operations as a result of any of the foregoing;
Legal
- litigation, including, for example, class action shareholder
and derivative lawsuits, contract disputes, patent
infringements, and environmental matters;
- any adverse outcome of the SEC's current investigation into
Halliburton's accounting policies, practices and procedures
that could result in sanctions and the payment of fines or
penalties, restatement of financials for years under review or
additional shareholder lawsuits;
- trade restrictions and economic embargoes imposed by the
United States and other countries;
- restrictions on our ability to provide products and services
to Iran, Iraq and Libya, all of which are significant
producers of oil and gas;
- protective government regulation in many of the countries
where we operate, including, for example, regulations that:
- encourage or mandate the hiring of local
contractors; and
- require foreign contractors to employ citizens of, or
purchase supplies from, a particular jurisdiction;
- potentially adverse reaction, and time and expense responding
to, the increased scrutiny of Halliburton by regulatory
authorities, the media and others;
- potential liability and adverse regulatory reaction in Nigeria
to the theft from us of radioactive material used in wireline
logging operations;
- environmental laws and regulations, including, for example,
those that:
- require emission performance standards for
facilities; and
- the potential regulation in the United States of our
Energy Services Group's hydraulic fracturing services
and products as underground injection; and
- the proposed excise tax in the United States targeted at heavy
equipment of the type we own and use in our operations would
negatively impact our Energy Services Group operating income;
Effect of Chapter 11 Proceedings
- the adverse effect on the ability of the subsidiaries that are
proposed to file a Chapter 11 proceeding to obtain new orders
from current or prospective customers;
- the potential reluctance of current and prospective customers
and suppliers to honor obligations or continue to transact
business with the Chapter 11 filing entities;
- the potential adverse effect of the Chapter 11 filing of
negotiating favorable terms with customers, suppliers and
other vendors;
- a prolonged Chapter 11 proceeding that could adversely affect
relationships with customers, suppliers and employees, which
in turn could adversely affect our competitive position,
financial condition and results of operations and our ability
to implement the proposed plan of reorganization; and
- the adverse affect on our financial condition or results of
operations as a result of the foregoing;
Geopolitical
- unrest in the Middle East that could:
- impact the demand and pricing for oil and gas;
- disrupt our operations in the region and elsewhere;
and
- increase our costs for security worldwide;
- unsettled political conditions, consequences of war or other
armed conflict, the effects of terrorism, civil unrest,
strikes, currency controls and governmental actions in many
oil producing countries and countries in which we provide
governmental logistical support that could adversely affect
our revenues and profit. Countries where we operate which have
significant amounts of political risk include Afghanistan,
59
Algeria, Angola, Colombia, Indonesia, Iraq, Libya, Nigeria,
Russia, and Venezuela. For example, the national strike in
Venezuela as well as seizures of offshore oil rigs by
protestors and cessation of operations by some of our
customers in Nigeria disrupted our Energy Services Group's
ability to provide services and products to our customers in
these countries during first quarter 2003 and likely will
continue to do so throughout the remainder of 2003; and
- changes in foreign exchange rates and exchange controls as
were experienced in Argentina in late 2001 and early 2002 and
in Venezuela in fourth quarter 2002;
Weather related
- severe weather that impacts our business, particularly in the
Gulf of Mexico where we have significant operations. Impacts
may include:
- evacuation of personnel and curtailment of services;
- weather related damage to offshore drilling rigs
resulting in suspension of operations;
- weather related damage to our facilities;
- inability to deliver materials to jobsites in
accordance with contract schedules; and
- loss of productivity; and
- demand for natural gas in the United States drives a
disproportionate amount of our Energy Services Group's United
States business. As a result, warmer than normal winters in
the United States are detrimental to the demand for our
services to gas producers. Conversely, colder than normal
winters in the United States result in increased demand for
our services to gas producers;
Customers
- the magnitude of governmental spending and outsourcing for
military and logistical support of the type that we provide,
including, for example, support services in the Balkans and
Iraq;
- changes in capital spending by customers in the oil and gas
industry for exploration, development, production, processing,
refining, and pipeline delivery networks;
- changes in capital spending by governments for infrastructure
projects of the sort that we perform;
- consolidation of customers including, for example, the merger
of Conoco and Phillips Petroleum, has caused customers to
reduce their capital spending which has negatively impacted
the demand for our services and products;
- potential adverse customer reaction, including potential draws
upon letters of credit, due to their concerns about our plans
to place DII Industries, Kellogg Brown & Root and some of
their subsidiaries into a pre-packaged bankruptcy as part of
the proposed settlement;
- customer personnel changes due to mergers and consolidation
which impacts the timing of contract negotiations and
settlements of claims;
- claim negotiations with engineering and construction customers
on cost and schedule variances and change orders on major
projects, including, for example, the Barracuda-Caratinga
project in Brazil;
- delay in customer spending due to consolidation and strategic
changes such as sales of the shallow water properties in the
Gulf of Mexico and recent sale of properties in the North Sea.
Spending is typically delayed when new operators take over;
and
- ability of our customers to timely pay the amounts due us;
Industry
- changes in oil and gas prices, among other things, result
from:
- the uncertainty as to the timing of return of Iraqi
oil production;
- OPEC's ability to set and maintain production levels
and prices for oil;
- the level of oil production by non-OPEC countries;
- the policies of governments regarding exploration for
and production and development of their oil and
natural gas reserves;
- the level of demand for oil and natural gas,
especially natural gas in the United States; and
- the level of gas storage in the northeast United
States;
60
- obsolescence of our proprietary technologies, equipment and
facilities, or work processes;
- changes in the price or the availability of commodities that
we use;
- our ability to obtain key insurance coverage on acceptable
terms;
- non-performance, default or bankruptcy of joint venture
partners, key suppliers or subcontractors;
- performing fixed-price projects, where failure to meet
schedules, cost estimates or performance targets could result
in reduced profit margins or losses;
- entering into complex business arrangements for technically
demanding projects where failure by one or more parties could
result in monetary penalties; and
- the use of derivative instruments of the sort that we use
which could cause a change in value of the derivative
instruments as a result of:
- adverse movements in foreign exchange rates, interest
rates, or commodity prices; or
- the value and time period of the derivative being
different than the exposures or cash flows being
hedged;
Systems
- the successful identification, procurement and installation of
a new financial system to replace the current system for the
Engineering and Construction Group;
Personnel and mergers/reorganizations/dispositions
- ensuring acquisitions and new products and services add value
and complement our core businesses; and
- successful completion of dispositions.
In addition, future trends for pricing, margins, revenues and
profitability remain difficult to predict in the industries we serve. We do not
assume any responsibility to publicly update any of our forward-looking
statements regardless of whether factors change as a result of new information,
future events or for any other reason. You should review any additional
disclosures we make in our press releases and Forms 10-K, 10-Q and 8-K filed
with the United States Securities and Exchange Commission. We also suggest that
you listen to our quarterly earnings release conference calls with financial
analysts.
No assurance can be given that our financial condition or results of
operations would not be materially and adversely affected by some of the events
described above, including:
- the inability to complete a settlement;
- in the absence of a settlement, adverse developments in the
tort system, including adverse judgments and increased defense
and settlement costs relating to claims against us;
- liquidity issues resulting from failure to complete a
settlement, adverse developments in the tort system, including
adverse judgments and increased defense and settlement costs,
and resulting or concurrent credit ratings downgrades and/or
demand for cash collateralization of letters of credit or
surety bonds;
- the filing of Chapter 11 proceedings by some of our
subsidiaries or a prolonged Chapter 11 proceeding; and
- adverse geopolitical developments, including armed conflict,
civil disturbance and unsettled political conditions in
foreign countries in which we operate.
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Item 3. Quantitative and Qualitative Disclosures about Market Risk
-------------------------------------------------------------------
We are exposed to financial instrument market risk from changes in
foreign currency exchange rates, interest rates and to a limited extent,
commodity prices. We selectively manage these exposures through the use of
derivative instruments to mitigate our market risk from these exposures. The
objective of our risk management is to protect our cash flows related to sales
or purchases of goods or services from market fluctuations in currency rates.
Our use of derivative instruments includes the following types of market risk:
- volatility of the currency rates;
- time horizon of the derivative instruments;
- market cycles; and
- the type of derivative instruments used.
We do not use derivative instruments for trading purposes. We do not
consider any of these risk management activities to be material.
Item 4. 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 June 30, 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.
There has been no change in our internal controls over financial
reporting that occurred during the three months ended June 30, 2003 that has
materially affected, or is reasonably likely to materially affect, our internal
controls over financial reporting.
62
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds
--------------------------------------------------
On June 30, 2003, we issued $1.2 billion of 3.125% convertible senior
notes due July 15, 2023. Citigroup Global Markets Inc., Goldman, Sachs & Co.,
J.P. Morgan Securities Inc., ABN AMRO Incorporated, HSBC and The Royal Bank of
Scotland plc, the initial purchasers of the notes, agreed to sell the notes only
to persons whom they reasonably believe are "qualified institutional buyers" in
reliance on Rule 144A under the Securities Act of 1933. The initial purchasers
offered the notes at 100% of the principal amount thereof. The initial
purchasers purchased the notes from us at 98% of the principal amount thereof.
The notes are convertible into our common stock under any of the
following circumstances:
- during any calendar quarter (and only during such calendar
quarter) if the last reported sale price of our common stock
for at least 20 trading days during the period of 30
consecutive trading days ending on the last trading day of the
previous quarter is greater than or equal to 120% of the
conversion price per share of our common stock on such last
trading day;
- if the notes have been called for redemption;
- upon the occurrence of certain corporate transactions; or
- during any period in which the credit ratings assigned to the
notes by both Moody's and Standard & Poor's are lower than Ba1
and BB+, respectively, or the notes are no longer rated by at
least one of these rating services or their successors.
The initial conversion price is $37.65 per share and is subject to
adjustment. Upon conversion, we will have the right to deliver, in lieu of
shares of our common stock, cash or a combination of cash and common stock.
Item 4. Submission of Matters to a Vote of Security Holders
------------------------------------------------------------
At our Annual Meeting of Stockholders held on May 21, 2003,
stockholders were asked to consider and act upon:
(1) the election of Directors for the ensuing year;
(2) ratification of the selection of KPMG LLP as independent
accountants to examine the financial statements and books and
records of Halliburton for the year 2003;
(3) a proposal to amend and restate the Halliburton Company 1993 Stock
and Incentive Plan; and
(4) a stockholder proposal on executive severance agreements.
The following table sets out, for each matter where applicable, the
number of votes cast for, against or withheld, as well as the number of
abstentions and broker non-votes.
(1) Election of Directors:
Name of Nominee Votes For Votes Withheld
Robert L. Crandall 357,966,842 10,979,634
Kenneth T. Derr 358,416,648 10,529,828
Charles J. DiBona 359,872,432 9,074,044
W. R. Howell 358,195,287 10,751,189
Ray L. Hunt 358,394,321 10,552,155
David J. Lesar 357,989,553 10,956,923
Aylwin B. Lewis 359,982,433 8,964,043
J. Landis Martin 359,981,448 8,965,028
Jay A. Precourt 360,122,772 8,823,704
Debra L. Reed 360,079,926 8,866,550
C. J. Silas 358,308,083 10,638,393
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(2) Ratification of KPMG LLP as independent accountants:
Number of Votes For 356,903,869
Number of Votes Against 9,486,518
Number of Votes Abstain 2,556,089
Number of Broker Non-Votes 0
(3) Proposal to amend and restate the Halliburton Company 1993 Stock
and Incentive Plan:
Number of Votes For 268,381,549
Number of Votes Against 27,714,726
Number of Votes Abstain 3,472,864
Number of Broker Non-Votes 69,377,337
(4) Stockholder proposal on executive severance agreements:
Number of Votes For 109,768,116
Number of Votes Against 181,647,039
Number of Votes Abstain 7,000,984
Number of Broker Non-Votes 70,530,337
Item 6. Exhibits and Reports on Form 8-K
-----------------------------------------
(a) Exhibits
* 4.1 Senior Indenture dated as of June 30, 2003 between Halliburton
and JPMorgan Chase Bank, as Trustee.
* 4.2 Form of note of 3.125% Convertible Senior Notes due July 15,
2023 (included as Exhibit A to Exhibit 4.1 above).
* 10.1 Halliburton Company 1993 Stock and Incentive Plan, as amended
and restated effective February 12, 2003.
* 31.1 Certification of Chief Executive Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
* 31.2 Certification of Chief Financial Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
* 32.1 Certification of Chief Executive Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
* 32.2 Certification of Chief Financial Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
* Filed with this Form 10-Q
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(b) Reports on Form 8-K
Date of
Date Filed Earliest Event Description of Event
-------------------------------------------------------------------------------------------------------------------
During the second quarter of 2003:
April 29, 2003 April 28, 2003 Items 9 and 12. Regulation FD Disclosure and Disclosure of
Results of Operations and Financial Condition for a press release
announcing 2003 first quarter results.
May 9, 2003 May 8, 2003 Item 9. Regulation FD furnishing Certifications to the SEC
pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section
906 of the Sarbanes-Oxley act of 2002, signed by David J. Lesar
and C. Christopher Gaut.
May 23, 2003 May 21, 2003 Item 9. Regulation FD Disclosure for a press release announcing a
2003 second quarter dividend.
May 23, 2003 May 21, 2003 Item 9. Regulation FD Disclosure for a press release announcing a
correction of the 2003 second quarter dividend announcement.
May 30, 2003 May 30, 2003 Item 9. Regulation FD Disclosure for a press release announcing
an agreement reached to settle class action lawsuits.
June 10, 2003 June 6, 2003 Item 9. Regulation FD Disclosure for a press release updating the
status of the proposed global settlement.
June 11, 2003 June 9, 2003 Item 9. Regulation FD Disclosure for a press release announcing a
conference call on July 31, 2003 to discuss 2003 second quarter
financial results.
June 20, 2003 June 20, 2003 Item 9. Regulation FD Disclosure for a press release announcing
updates on the Barracuda-Caratinga project, second quarter
earnings guidance, and findings of due diligence on the proposed
asbestos settlement.
June 25, 2003 June 23, 2003 Item 9. Regulation FD Disclosure for a press release announcing
the offering of convertible senior notes to qualified
institutional buyers pursuant to Rule 144A under the Securities
Act of 1933.
June 25, 2003 June 24, 2003 Item 9. Regulation FD Disclosure for a press release announcing
the pricing of convertible senior notes which were offered to
qualified institutional buyers pursuant to Rule 144A under the
Securities Act of 1933.
65
Date of
Date Filed Earliest Event Description of Event
-------------------------------------------------------------------------------------------------------------------
During the third quarter of 2003:
July 18, 2003 July 17, 2003 Item 9. Regulation FD Disclosure for a press release announcing a
2003 third quarter dividend.
July 21, 2003 July 21, 2003 Item 9. Regulation FD Disclosure for a press release announcing
asbestos plaintiffs agree to extend the current stay on asbestos
claims until September 30, 2003.
July 23, 2003 July 22, 2003 Item 9. Regulation FD Disclosure for a press release announcing
the Harbison-Walker bankruptcy court approved an agreement to
extend the current stay on asbestos claims through September 30,
2003.
August 4, 2003 July 31, 2003 Item 12.Disclosure of Results of Operations and Financial
Condition for a press release announcing 2003 second quarter
results.
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SIGNATURES
As required by the Securities Exchange Act of 1934, the registrant has
authorized this report to be signed on behalf of the registrant by the
undersigned authorized individuals.
HALLIBURTON COMPANY
Date: August 11, 2003 By: /s/ C. Christopher Gaut
------------------------ ----------------------------------
C. Christopher Gaut
Executive Vice President and
Chief Financial Officer
/s/ R. Charles Muchmore, Jr.
----------------------------------
R. Charles Muchmore, Jr.
Vice President and Controller and
Principal Accounting Officer
67