June 30, 2006 Form 10-Q Final
UNITED
STATES SECURITIES AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-Q
[X]
Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities
Exchange Act of 1934
For
the quarterly period ended June 30, 2006
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
at least the past 90 days.
Yes X No
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of “accelerated
filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check
one):
Large
accelerated filer
X
|
Accelerated
filer
|
Non-accelerated
filer
|
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).
Yes
No X
As
of
July 24, 2006, 1,031,152,062 shares of Halliburton Company common stock, $2.50
par value per share, were outstanding.
HALLIBURTON
COMPANY
Index
|
|
Page
No.
|
PART
I.
|
FINANCIAL
INFORMATION
|
|
|
|
|
Item
1.
|
Financial
Statements
|
3-27 |
|
|
|
|
- Condensed
Consolidated Statements of Operations
|
3 |
|
- Condensed
Consolidated Balance Sheets
|
4 |
|
- Condensed
Consolidated Statements of Cash Flows
|
5 |
|
- Notes
to Condensed Consolidated Financial Statements
|
6-27 |
|
|
|
Item
2.
|
Management’s
Discussion and Analysis of Financial Condition and
|
|
|
Results
of Operations
|
28-65 |
|
|
|
Item
3.
|
Quantitative
and Qualitative Disclosures About Market Risk
|
66 |
|
|
|
Item
4.
|
Controls
and Procedures
|
66 |
|
|
|
PART
II.
|
OTHER
INFORMATION
|
|
|
|
|
Item
1.
|
Legal
Proceedings
|
67 |
|
|
|
Item
1(a).
|
Risk
Factors
|
67 |
|
|
|
Item
2.
|
Unregistered
Sales of Equity Securities and Use of Proceeds
|
67 |
|
|
|
Item
3.
|
Defaults
Upon Senior Securities
|
67 |
|
|
|
Item
4.
|
Submission
of Matters to a Vote of Security Holders
|
67-69 |
|
|
|
Item
5.
|
Other
Information
|
69 |
|
|
|
Item
6.
|
Exhibits
|
69 |
|
|
|
Signatures
|
|
70 |
PART
I. FINANCIAL INFORMATION
Item
1. Financial Statements
HALLIBURTON
COMPANY
Condensed
Consolidated Statements of Operations
(Unaudited)
|
|
Three
Months Ended
|
|
Six
Months Ended
|
|
|
|
June
30
|
|
June
30
|
|
(Millions
of dollars and shares except per share data)
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
Revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Services
|
|
$
|
4,720
|
|
$
|
4,318
|
|
$
|
9,170
|
|
$
|
8,520
|
|
Product
sales
|
|
|
804
|
|
|
656
|
|
|
1,547
|
|
|
1,213
|
|
Equity
in earnings (losses) of unconsolidated affiliates, net
|
|
|
21
|
|
|
(1
|
)
|
|
12
|
|
|
23
|
|
Total
revenue
|
|
|
5,545
|
|
|
4,973
|
|
|
10,729
|
|
|
9,756
|
|
Operating
costs and expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost
of services
|
|
|
4,080
|
|
|
3,744
|
|
|
7,806
|
|
|
7,486
|
|
Cost
of sales
|
|
|
654
|
|
|
540
|
|
|
1,267
|
|
|
1,014
|
|
General
and administrative
|
|
|
100
|
|
|
96
|
|
|
200
|
|
|
197
|
|
Gain
on sale of business assets, net
|
|
|
(7
|
)
|
|
(3
|
)
|
|
(17
|
)
|
|
(112
|
)
|
Total
operating costs and expenses
|
|
|
4,827
|
|
|
4,377
|
|
|
9,256
|
|
|
8,585
|
|
Operating
income
|
|
|
718
|
|
|
596
|
|
|
1,473
|
|
|
1,171
|
|
Interest
expense
|
|
|
(43
|
)
|
|
(51
|
)
|
|
(90
|
)
|
|
(103
|
)
|
Interest
income
|
|
|
38
|
|
|
9
|
|
|
66
|
|
|
21
|
|
Foreign
currency losses, net
|
|
|
(10
|
)
|
|
(7
|
)
|
|
(2
|
)
|
|
(7
|
)
|
Other,
net
|
|
|
(4
|
)
|
|
(3
|
)
|
|
(1
|
)
|
|
(5
|
)
|
Income
from continuing operations before income taxes
|
|
|
|
|
|
|
|
|
|
|
|
|
|
and
minority interest
|
|
|
699
|
|
|
544
|
|
|
1,446
|
|
|
1,077
|
|
Provision
for income taxes
|
|
|
(226
|
)
|
|
(150
|
)
|
|
(481
|
)
|
|
(316
|
)
|
Minority
interest in net (income) loss of subsidiaries
|
|
|
36
|
|
|
(10
|
)
|
|
25
|
|
|
(18
|
)
|
Income
from continuing operations
|
|
|
509
|
|
|
384
|
|
|
990
|
|
|
743
|
|
Income
from discontinued operations, net of tax
|
|
|
|
|
|
|
|
|
|
|
|
|
|
provision
of $46, $5, $49, and $7
|
|
|
82
|
|
|
8
|
|
|
89
|
|
|
14
|
|
Net
income
|
|
$
|
591
|
|
$
|
392
|
|
$
|
1,079
|
|
$
|
757
|
|
Basic
income per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
from continuing operations
|
|
$
|
0.50
|
|
$
|
0.38
|
|
$
|
0.97
|
|
$
|
0.74
|
|
Income
from discontinued operations, net
|
|
|
0.08
|
|
|
0.01
|
|
|
0.08
|
|
|
0.01
|
|
Net
income
|
|
$
|
0.58
|
|
$
|
0.39
|
|
$
|
1.05
|
|
$
|
0.75
|
|
Diluted
income per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
from continuing operations
|
|
$
|
0.48
|
|
$
|
0.37
|
|
$
|
0.93
|
|
$
|
0.73
|
|
Income
from discontinued operations, net
|
|
|
0.07
|
|
|
0.01
|
|
|
0.08
|
|
|
0.01
|
|
Net
income
|
|
$
|
0.55
|
|
$
|
0.38
|
|
$
|
1.01
|
|
$
|
0.74
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
dividends per share
|
|
$
|
0.075
|
|
$
|
0.0625
|
|
$
|
0.15
|
|
$
|
0.125
|
|
Basic
weighted average common shares outstanding
|
|
|
1,026
|
|
|
1,006
|
|
|
1,025
|
|
|
1,004
|
|
Diluted
weighted average common shares outstanding
|
|
|
1,070
|
|
|
1,026
|
|
|
1,069
|
|
|
1,024
|
|
See
notes
to condensed consolidated financial statements.
HALLIBURTON
COMPANY
Condensed
Consolidated Balance Sheets
(Unaudited)
|
|
June
30,
|
|
December
31,
|
|
(Millions
of dollars and shares except per share data)
|
|
2006
|
|
2005
|
|
Assets
|
Current
assets:
|
|
|
|
|
|
|
|
Cash
and equivalents
|
|
$
|
3,673
|
|
$
|
2,391
|
|
Receivables:
|
|
|
|
|
|
|
|
Notes
and accounts receivable (less allowance for bad debts of $81 and
$90)
|
|
|
3,225
|
|
|
3,345
|
|
Unbilled
work on uncompleted contracts
|
|
|
1,581
|
|
|
1,456
|
|
Total
receivables
|
|
|
4,806
|
|
|
4,801
|
|
Inventories
|
|
|
1,128
|
|
|
953
|
|
Current
deferred income taxes
|
|
|
582
|
|
|
645
|
|
Other
current assets
|
|
|
462
|
|
|
522
|
|
Total
current assets
|
|
|
10,651
|
|
|
9,312
|
|
Property,
plant, and equipment, net of accumulated depreciation of $3,993 and
$3,838
|
|
|
2,774
|
|
|
2,648
|
|
Goodwill
|
|
|
774
|
|
|
765
|
|
Noncurrent
deferred income taxes
|
|
|
476
|
|
|
784
|
|
Equity
in and advances to related companies
|
|
|
383
|
|
|
382
|
|
Other
assets
|
|
|
1,116
|
|
|
1,119
|
|
Total
assets
|
|
$
|
16,174
|
|
$
|
15,010
|
|
Liabilities
and Shareholders’ Equity
|
Current
liabilities:
|
|
|
|
|
|
|
|
Accounts
payable
|
|
$
|
1,817
|
|
$
|
1,967
|
|
Advanced
billings on uncompleted contracts
|
|
|
1,123
|
|
|
661
|
|
Accrued
employee compensation and benefits
|
|
|
523
|
|
|
648
|
|
Current
maturities of long-term debt
|
|
|
360
|
|
|
361
|
|
Short-term
notes payable
|
|
|
6
|
|
|
22
|
|
Other
current liabilities
|
|
|
934
|
|
|
768
|
|
Total
current liabilities
|
|
|
4,763
|
|
|
4,427
|
|
Long-term
debt
|
|
|
2,772
|
|
|
2,813
|
|
Employee
compensation and benefits
|
|
|
694
|
|
|
718
|
|
Other
liabilities
|
|
|
524
|
|
|
535
|
|
Total
liabilities
|
|
|
8,753
|
|
|
8,493
|
|
Minority
interest in consolidated subsidiaries
|
|
|
93
|
|
|
145
|
|
Shareholders’
equity:
|
|
|
|
|
|
|
|
Common
shares, par value $2.50 per share - authorized 2,000 shares, issued
1,059
and 1,054
|
|
|
|
|
|
|
|
shares
|
|
|
2,647
|
|
|
2,634
|
|
Paid-in
capital in excess of par value
|
|
|
1,526
|
|
|
1,501
|
|
Deferred
compensation
|
|
|
-
|
|
|
(98
|
)
|
Accumulated
other comprehensive income
|
|
|
(224
|
)
|
|
(266
|
)
|
Retained
earnings
|
|
|
3,899
|
|
|
2,975
|
|
|
|
|
7,848
|
|
|
6,746
|
|
Less
30 and 26 shares of treasury stock, at cost
|
|
|
520
|
|
|
374
|
|
Total
shareholders’ equity
|
|
|
7,328
|
|
|
6,372
|
|
Total
liabilities and shareholders’ equity
|
|
$
|
16,174
|
|
$
|
15,010
|
|
See
notes
to condensed consolidated financial statements.
HALLIBURTON
COMPANY
Condensed
Consolidated Statements of Cash Flows
(Unaudited)
|
|
Six
Months Ended
|
|
|
|
June
30
|
|
(Millions
of dollars)
|
|
2006
|
|
2005
|
|
Cash
flows from operating activities:
|
|
|
|
|
|
|
|
Net
income
|
|
$
|
1,079
|
|
$
|
757
|
|
Adjustments
to reconcile net income to net cash from operations:
|
|
|
|
|
|
|
|
Depreciation,
depletion, and amortization
|
|
|
257
|
|
|
252
|
|
Provision
for deferred income taxes
|
|
|
367
|
|
|
126
|
|
Distribution
from (advances to) related companies, net of equity in (earnings)
losses
|
|
|
(16
|
)
|
|
20
|
|
Gain
on sale of assets
|
|
|
(113
|
)
|
|
(112
|
)
|
Asbestos
and silica liability payment related to Chapter 11 filing
|
|
|
-
|
|
|
(2,345
|
)
|
Collection
of asbestos- and silica-related receivables
|
|
|
91
|
|
|
1,028
|
|
Other
changes:
|
|
|
|
|
|
|
|
Receivables
and unbilled work on uncompleted contracts
|
|
|
(72
|
)
|
|
250
|
|
Accounts
receivable facilities transactions
|
|
|
-
|
|
|
(6
|
)
|
Inventories
|
|
|
(164
|
)
|
|
(141
|
)
|
Accounts
payable
|
|
|
(163
|
)
|
|
(411
|
)
|
Contributions
to pension plans
|
|
|
(142
|
)
|
|
(38
|
)
|
Advanced
billings
|
|
|
464
|
|
|
(68
|
)
|
Other
|
|
|
(1
|
)
|
|
25
|
|
Total
cash flows from operating activities
|
|
|
1,587
|
|
|
(663
|
)
|
Cash
flows from investing activities:
|
|
|
|
|
|
|
|
Capital
expenditures
|
|
|
(381
|
)
|
|
(289
|
)
|
Sales
of property, plant, and equipment
|
|
|
69
|
|
|
59
|
|
Dispositions
(acquisitions) of business assets, net of cash disposed
|
|
|
283
|
|
|
201
|
|
Proceeds
from sales of securities
|
|
|
10
|
|
|
-
|
|
Sales
(purchases) of short-term investments in marketable securities,
net
|
|
|
-
|
|
|
891
|
|
Other
investing activities
|
|
|
(17
|
)
|
|
(19
|
)
|
Total
cash flows from investing activities
|
|
|
(36
|
)
|
|
843
|
|
Cash
flows from financing activities:
|
|
|
|
|
|
|
|
Proceeds
from long-term debt, net of offering costs
|
|
|
30
|
|
|
12
|
|
Proceeds
from exercises of stock options
|
|
|
117
|
|
|
126
|
|
Payments
to reacquire common stock
|
|
|
(190
|
)
|
|
(9
|
)
|
Borrowings
(repayments) of short-term debt, net
|
|
|
(10
|
)
|
|
29
|
|
Payments
of long-term debt
|
|
|
(66
|
)
|
|
(541
|
)
|
Payments
of dividends to shareholders
|
|
|
(155
|
)
|
|
(126
|
)
|
Other
financing activities
|
|
|
(5
|
)
|
|
(5
|
)
|
Total
cash flows from financing activities
|
|
|
(279
|
)
|
|
(514
|
)
|
Effect
of exchange rate changes on cash
|
|
|
10
|
|
|
(8
|
)
|
Increase
(decrease) in cash and equivalents
|
|
|
1,282
|
|
|
(342
|
)
|
Cash
and equivalents at beginning of period
|
|
|
2,391
|
|
|
1,917
|
|
Cash
and equivalents at end of period
|
|
$
|
3,673
|
|
$
|
1,575
|
|
Supplemental
disclosure of cash flow information:
|
|
|
|
|
|
|
|
Cash
payments during the period for:
|
|
|
|
|
|
|
|
Interest
|
|
$
|
91
|
|
$
|
112
|
|
Income
taxes
|
|
$
|
156
|
|
$
|
150
|
|
See
notes
to condensed consolidated financial statements.
HALLIBURTON
COMPANY
Notes
to Condensed Consolidated Financial Statements
(Unaudited)
Note
1. Basis of Presentation and Description of Company
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 annual financial statements and
should be read together with our 2005 Annual Report on Form 10-K.
Certain
prior period amounts have been reclassified to be consistent with the current
presentation. See Note 4 for further information.
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 these accounting principles 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 revenue and expenses during the reporting
period.
|
Ultimate
results could differ from our estimates.
In
our
opinion, the condensed consolidated financial statements included herein contain
all adjustments necessary to present fairly our financial position as of June
30, 2006, the results of our operations for the three and six months ended
June
30, 2006 and 2005, and our cash flows for the six months ended June 30, 2006
and
2005. Such adjustments are of a normal recurring nature. The results of
operations for the three and six months ended June 30, 2006 may not be
indicative of results for the full year.
Common
share and earnings per share amounts have been restated for all periods
presented to reflect the increased number of common shares outstanding resulting
from the two-for-one common stock split, in the form of a stock dividend, paid
on July 14, 2006 to stockholders of record as of June 23, 2006.
We
intend
to completely separate KBR, Inc. from Halliburton as expeditiously as possible
through a tax-free dividend distribution of KBR, Inc. stock to Halliburton
stockholders. The distribution will be preceded by the filing of a Form 10
registration statement with the United States Securities and Exchange Commission
(SEC) to register the shares of KBR, Inc. stock under the Securities Exchange
Act of 1934. After the distribution, KBR, Inc. will be a separately traded
public company.
The
distribution of KBR, Inc. stock may be preceded by an initial public offering
(IPO) of less than 20% of KBR, depending on market conditions for initial public
offerings, valuations for publicly-traded engineering and construction
companies, and KBR-specific business conditions and results of operations.
In
April 2006, KBR, Inc. filed a Registration Statement on Form S-1 with the SEC
for an IPO of less than 20% of KBR, Inc. Since the initial filing, however,
the
market for initial public offerings has become less favorable, which has
resulted in many offerings being postponed or withdrawn. In addition, recently
announced operating results on KBR’s Escravos project and the outcome of ongoing
discussions with our customer on the Escravos project about mitigating future
risk could impact the desirability or timing of a KBR, Inc. IPO. We do not
intend to delay the complete separation of KBR to wait on favorable conditions
for an IPO of KBR, Inc.
Before
making the distribution of KBR, Inc. stock, we intend to seek a ruling from
the
Internal Revenue Service that, among other things, no gain or loss will be
recognized by Halliburton or its stockholders as a result of a distribution
of
KBR, Inc. stock, a process that could be completed within approximately nine
months. Prior to the IPO or separation occurring, we will enter into various
agreements to govern the separation of KBR from us, including, among others,
a
master separation agreement, transition services agreements, and a tax sharing
agreement. The master separation agreement will provide for, among other things,
KBR’s responsibility for liabilities relating to its business and Halliburton’s
responsibility for liabilities unrelated to KBR’s business. Halliburton expects
to provide indemnification in favor of KBR under the master separation agreement
for certain contingent liabilities. The Halliburton performance guarantees
and
letter of credit guarantees that are currently in place in favor of KBR’s
customers or lenders will continue after the separation of KBR until these
guarantees expire by their terms, although KBR will compensate Halliburton
for
these guarantees and indemnify Halliburton if Halliburton is required to perform
under any of these guarantees. The tax sharing agreement will provide for
allocations of United States income tax liabilities and other agreements between
us and KBR with respect to tax matters. Under the transition services
agreements, we expect to continue providing various interim corporate support
services to KBR, and KBR will continue to provide various interim corporate
support services to us.
Any
sale
of KBR, Inc. stock under a Form S-1 would be registered under the Securities
Act
of 1933, and such shares of common stock would only be offered and sold by
means
of a prospectus. This quarterly report does not constitute an offer to sell
or
the solicitation of any offer to buy any securities of KBR, and there will
not
be any sale of any such securities in any state in which such offer,
solicitation, or sale would be unlawful prior to registration or qualification
under the securities laws of such state.
Note
2. Percentage-of-Completion Contracts
Unapproved
claims
The
amounts of unapproved claims included in determining the profit or loss on
contracts and the amounts booked to “Unbilled work on uncompleted contracts” or
“Other assets” as of June 30, 2006 and December 31, 2005 are as
follows:
|
|
June
30,
|
|
December
31,
|
|
Millions
of dollars
|
|
2006
|
|
2005
|
|
Probable
unapproved claims
|
|
$
|
186
|
|
$
|
175
|
|
Probable
unapproved claims accrued revenue
|
|
|
183
|
|
|
172
|
|
Probable
unapproved claims from unconsolidated
|
|
|
|
|
|
|
|
related
companies
|
|
|
93
|
|
|
92
|
|
As
of
June 30, 2006, the probable unapproved claims, including those from
unconsolidated related companies, relate to seven contracts, most of which
are
complete or substantially complete. See Note 11 for a discussion of United
States government contract claims, which are not included in the table
above.
A
significant portion of the probable unapproved claims as of June 30, 2006 ($150
million related to our consolidated entities and $45 million related to our
unconsolidated related companies) arose from three completed projects with
Petroleos Mexicanos (PEMEX) that are currently subject to arbitration
proceedings. In addition, we have “Other assets” of $64 million for previously
approved services that are unpaid by PEMEX and have been included in these
arbitration proceedings. Actual amounts we are seeking from PEMEX in the
arbitration proceedings are in excess of these amounts. The arbitration
proceedings are expected to extend through 2007. PEMEX has asserted unspecified
counterclaims in each of the three arbitrations; however, it is premature based
upon our current understanding of those counterclaims to make any assessment
of
their merits. As of June 30, 2006, we had not accrued any amounts related to
the
counterclaims in the arbitrations.
At
June
30, 2006, $174 million of the amount classified as probable unapproved claims
accrued revenue included in the table above is reflected as “Other assets” on
the condensed consolidated balance sheets since the contracts will likely not
be
settled within one year. The remaining $9 million is included in “Unbilled work
on uncompleted contracts” since the contracts are expected to be settled within
one year. Our unconsolidated related companies include probable unapproved
claims as revenue to determine the amount of profit or loss for their contracts.
Probable unapproved claims from our related companies are included in “Equity in
and advances to related companies.”
Unapproved
change orders
We
have
contracts for which we are negotiating change orders to the contract scope
and
have agreed upon the scope of work but not the price. These change orders amount
to $251 million at June 30, 2006. Unapproved change orders at December 31,
2005
were $61 million. Our share of change orders from unconsolidated related
companies totaled $3 million at June 30, 2006 and $5 million at December 31,
2005.
Included
in the $251 million of change orders is $200 million for our consolidated 50%
owned gas-to-liquids project in Escravos, Nigeria. In the second quarter
of 2006, we recorded a $148 million charge, before income taxes and
minority interest, related to this project. This charge was primarily
attributable to increases in the overall estimated cost to complete the project.
The project is approximately 30% complete as of June 30, 2006. The project
has
experienced delays relating to civil unrest and security on the Escravos River,
near the project site. Further delays have resulted from scope changes and
engineering and construction modifications. We are currently discussing with
the
majority owner of our customer several contract changes to mitigate our
construction risk associated with this contract. We have reached a preliminary
agreement with our customer and are working on a final agreement to fund the
$200 million in change orders. We are continuing discussions regarding
additional contract changes related to scheduled completion, site access and
security, and other factors to mitigate our future risks on this
project.
Barracuda-Caratinga
project
Following
is the status, as of June 30, 2006, of our Barracuda-Caratinga project, a
multiyear construction project to develop the Barracuda and Caratinga crude
oilfields located off the coast of Brazil:
|
-
|
the
Barracuda and Caratinga vessels are both fully operational. In April
2006,
we executed an agreement with Petrobras that enabled us to achieve
conclusion of the Lenders’ Reliability Test and final acceptance of the
FPSOs. These acceptances eliminate any further risk of liquidated
damages
being assessed but do not address the bolt arbitration discussed
below;
|
|
-
|
in
the first quarter of 2006, we recorded a loss of $15 million related
to
additional costs to finalize the project and warranty matters. We
have
recorded inception-to-date losses on this project of approximately
$785
million; and
|
|
-
|
our
remaining obligation under the April 2006 agreement is primarily
for
warranty on the two vessels.
|
In
addition, at Petrobras’ direction, we have replaced certain bolts located on the
subsea flowlines that have failed through mid-November 2005, and we understand
that additional bolts have failed thereafter, which have been replaced by
Petrobras. These failed bolts were identified by Petrobras when it conducted
inspections of the bolts. The original design specification for the bolts was
issued by Petrobras, and as such, we believe the cost resulting from any
replacement is not our responsibility. Petrobras has indicated, however, that
they do not agree with our conclusion. We have notified Petrobras that this
matter is in dispute. We believe several possible solutions may exist, including
replacement of the bolts. Estimates indicate that costs of these various
solutions range up to $140 million. Should Petrobras instruct us to replace
the
subsea bolts, the prime contract terms and conditions regarding change orders
require that Petrobras make progress payments of our reasonable costs incurred.
Petrobras could, however, perform any replacement of the bolts and seek
reimbursement from KBR. In March 2006, Petrobras notified KBR that they have
submitted this matter to arbitration claiming $220 million plus interest for
the
cost of monitoring and replacing the defective stud bolts and, in addition,
all
of the costs and expenses of the arbitration including the cost of attorneys
fees. We disagree with the Petrobras claim since the bolts met Petrobras’ design
specification, and we do not believe there is any basis for the amount claimed
by Petrobras. We intend to vigorously defend ourselves and pursue recovery
of
the costs we have incurred to date through the arbitration process. As of June
30, 2006, we have not accrued any amounts related to this
arbitration.
Note
3. Dispositions
Production
Services
In
the
second quarter of 2006, we completed the sale of KBR’s Production Services
group, which was part of our Energy and Chemicals segment. In connection with
the sale, we received net proceeds of $265 million. The sale of Production
Services resulted in a pretax gain of $123 million in the second quarter of
2006, which is reflected in discontinued operations. As a result of the sale
agreement in March 2006, Production Services operations and assets and
liabilities were classified as discontinued operations, and all prior periods
presented were reclassified as well. At December 31, 2005, Production Services
assets were $207 million, of which $140 million were classified as current,
and
liabilities were $64 million, of which $54 million were classified as
current.
Subsea
7, Inc.
In
January 2005, we completed the sale of our 50% interest in Subsea 7, Inc. to
our
joint venture partner, Siem Offshore (formerly DSND Subsea ASA), for
approximately $200 million in cash. As a result of the transaction, we recorded
a gain of approximately $110 million during the first quarter of 2005. We
accounted for our 50% ownership of Subsea 7, Inc. using the equity method in
our
Production Optimization segment.
Note
4. Business Segment Information
We have
six business segments: Production Optimization, Fluid Systems, Drilling and
Formation Evaluation, Digital and Consulting Solutions, Government and
Infrastructure, and Energy and Chemicals.
We
refer
to the combination of the Production Optimization, Fluid Systems, Drilling
and
Formation Evaluation, and Digital and Consulting Solutions segments as the
Energy Services Group and the combination of our Government and Infrastructure
and our Energy and Chemicals segments as KBR.
During
the second quarter of 2006, we moved slickline services, tubing conveyed
perforating, and underbalanced applications from the Production Optimization
segment to the Drilling and Formation Evaluation segment, as these services
are
more closely aligned with the Drilling and Formation Evaluation segment. Prior
period balances have been reclassified to reflect this change. In addition,
for
internal management purposes we have combined our Drilling and Formation
Evaluation and Digital and Consulting Solutions divisions, forming three Energy
Services Group internal divisions. However, we will continue to disclose four
segments for the Energy Services Group.
KBR’s
Production Services operations were moved into discontinued operations for
reporting purposes in the first quarter of 2006. All prior period amounts have
been reclassified to discontinued operations.
The
table
below presents information on our segments.
|
|
Three
Months Ended
|
|
Six
Months Ended
|
|
|
|
June
30
|
|
June
30
|
|
Millions
of dollars
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
Revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Production
Optimization
|
|
$
|
1,292
|
|
$
|
971
|
|
$
|
2,488
|
|
$
|
1,805
|
|
Fluid
Systems
|
|
|
870
|
|
|
699
|
|
|
1,706
|
|
|
1,330
|
|
Drilling
and Formation Evaluation
|
|
|
774
|
|
|
641
|
|
|
1,499
|
|
|
1,196
|
|
Digital
and Consulting Solutions
|
|
|
180
|
|
|
160
|
|
|
361
|
|
|
324
|
|
Total
Energy Services Group
|
|
|
3,116
|
|
|
2,471
|
|
|
6,054
|
|
|
4,655
|
|
Government
and Infrastructure
|
|
|
1,881
|
|
|
2,035
|
|
|
3,589
|
|
|
4,123
|
|
Energy
and Chemicals
|
|
|
548
|
|
|
467
|
|
|
1,086
|
|
|
978
|
|
Total
KBR
|
|
|
2,429
|
|
|
2,502
|
|
|
4,675
|
|
|
5,101
|
|
Total
revenue
|
|
$
|
5,545
|
|
$
|
4,973
|
|
$
|
10,729
|
|
$
|
9,756
|
|
Operating
income (loss):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Production
Optimization
|
|
$
|
357
|
|
$
|
231
|
|
$
|
681
|
|
$
|
511
|
|
Fluid
Systems
|
|
|
193
|
|
|
135
|
|
|
375
|
|
|
248
|
|
Drilling
and Formation Evaluation
|
|
|
189
|
|
|
140
|
|
|
361
|
|
|
231
|
|
Digital
and Consulting Solutions
|
|
|
52
|
|
|
16
|
|
|
101
|
|
|
45
|
|
Total
Energy Services Group
|
|
|
791
|
|
|
522
|
|
|
1,518
|
|
|
1,035
|
|
Government
and Infrastructure
|
|
|
68
|
|
|
72
|
|
|
88
|
|
|
125
|
|
Energy
and Chemicals
|
|
|
(109
|
)
|
|
39
|
|
|
(67
|
)
|
|
80
|
|
Total
KBR
|
|
|
(41
|
)
|
|
111
|
|
|
21
|
|
|
205
|
|
General
corporate
|
|
|
(32
|
)
|
|
(37
|
)
|
|
(66
|
)
|
|
(69
|
)
|
Total
operating income
|
|
$
|
718
|
|
$
|
596
|
|
$
|
1,473
|
|
$
|
1,171
|
|
Intersegment
revenue was immaterial. Our equity in pretax earnings and losses of
unconsolidated affiliates that are accounted for on the equity method is
included in revenue and operating income of the applicable segment.
Total
revenue for the three and six months ended June 30, 2006 included $1.6 billion
and $2.9 billion or 28% and 27% of consolidated revenue from the United States
Government, which was derived almost entirely by the Government and
Infrastructure segment. Revenue from the United States Government during the
three and six months ended June 30, 2005 represented 33% and 34% of consolidated
revenue. No other customer represented more than 10% of consolidated revenue
in
any period presented.
Note
5. Accounts Receivable Facilities
Under
our
Energy Services Group accounts receivable securitization facility, we had the
ability to sell up to $300 million in undivided ownership interest in a pool
of
receivables. During the fourth quarter of 2005, $256 million in undivided
ownership interest that had been sold to unaffiliated companies was collected
and the balance retired. No further receivables were sold, and the facility
was
terminated in the first quarter of 2006.
In
May
2004, we entered into an agreement to sell, assign, and transfer the entire
title and interest in specified United States government accounts receivable
of
KBR to a third party. The face value of the receivables sold to the third party
was reflected as a reduction of accounts receivable in our condensed
consolidated balance sheets. The total amount of receivables outstanding under
this agreement was approximately $257 million as of June 30, 2005. As of
December 31, 2005, these receivables were collected, the balance was retired,
and the facility was terminated.
Note
6. Inventories
Inventories
are stated at the lower of cost or market. We manufacture in the United States
certain finished products and have parts inventories for drill bits, completion
products, bulk materials, and other tools that are recorded using the last-in,
first-out method totaling $59 million at June 30, 2006 and $42 million at
December 31, 2005. If the average cost method had been used, total inventories
would have been $24 million higher than reported at June 30, 2006 and $21
million higher than reported at December 31, 2005. Inventories consisted of
the
following:
Millions
of dollars
|
|
June
30,
2006
|
|
December
31, 2005
|
|
Finished
products and parts
|
|
$
|
801
|
|
$
|
715
|
|
Raw
materials and supplies
|
|
|
236
|
|
|
181
|
|
Work
in process
|
|
|
91
|
|
|
57
|
|
Total
|
|
$
|
1,128
|
|
$
|
953
|
|
Finished
products and parts are reported net of obsolescence accruals of $98 million
at
both June 30, 2006 and December 31, 2005.
Note
7. Restricted and Committed Cash
At
June
30, 2006, we had restricted cash of $129 million, which primarily consisted
of:
|
-
|
$102
million as collateral for potential future insurance claim reimbursements
included in “Other assets”; and
|
|
-
|
$23
million related to cash collateral agreements for outstanding letters
of
credit for various construction projects included in “Other
assets.”
|
At
December 31, 2005, we had restricted cash of $123 million in “Other assets,”
which primarily consisted of similar items as above.
Cash
and
equivalents include cash from advanced payments related to contracts in progress
held by ourselves or our joint ventures that we consolidate for accounting
purposes. The use of these cash balances is limited to the specific projects
or
joint venture activities and is not available for other projects, general cash
needs, or distribution to us without approval of the board of directors of
the
respective joint venture or subsidiary. At June 30, 2006 and December 31, 2005,
cash and equivalents include approximately $585 million and $223 million,
respectively, in cash from advanced payments held by ourselves or our joint
ventures that we consolidate for accounting purposes.
Note
8. Debt
The
stock conversion rate for the $1.2 billion of 3.125% convertible senior
notes issued in June 2003 has changed as a result of the recent stock split
and
an increase to our quarterly dividend. As of June 30, 2006, the
stock conversion rate is 53.15 shares of common stock per $1,000
principal amount of notes with a conversion price of approximately
$18.825.
Note
9. Comprehensive Income
The
components of other comprehensive income included the following:
|
|
Three
Months Ended
|
|
Six
Months Ended
|
|
|
|
June
30
|
|
June
30
|
|
Millions
of dollars
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
Net
income
|
|
$
|
591
|
|
$
|
392
|
|
$
|
1,079
|
|
$
|
757
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cumulative
translation adjustments
|
|
|
43
|
|
|
(19
|
)
|
|
37
|
|
|
(29
|
)
|
Realization
of (gains) losses included in net income
|
|
|
(19
|
)
|
|
-
|
|
|
(16
|
)
|
|
3
|
|
Net
cumulative translation adjustments
|
|
|
24
|
|
|
(19
|
)
|
|
21
|
|
|
(26
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized
net gains (losses) on investments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
and
derivatives
|
|
|
15
|
|
|
2
|
|
|
21
|
|
|
(1
|
)
|
Realization
of gains on investments and derivatives
|
|
|
|
|
|
|
|
|
|
|
|
|
|
included
in net income
|
|
|
(2
|
)
|
|
(3
|
)
|
|
-
|
|
|
(13
|
)
|
Net
unrealized gains (losses) on investments
|
|
|
|
|
|
|
|
|
|
|
|
|
|
and
derivatives
|
|
|
13
|
|
|
(1
|
)
|
|
21
|
|
|
(14
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
comprehensive income
|
|
$
|
628
|
|
$
|
372
|
|
$
|
1,121
|
|
$
|
717
|
|
Accumulated
other comprehensive income consisted of the following:
|
|
June
30,
|
|
December
31,
|
|
Millions
of dollars
|
|
2006
|
|
2005
|
|
Cumulative
translation adjustments
|
|
$
|
(51
|
)
|
$
|
(72
|
)
|
Pension
liability adjustments
|
|
|
(184
|
)
|
|
(184
|
)
|
Unrealized
gains (losses) on investments and derivatives
|
|
|
11
|
|
|
(10
|
)
|
Total
accumulated other comprehensive income
|
|
$
|
(224
|
)
|
$
|
(266
|
)
|
Note
10. Asbestos Insurance Recoveries
Several
of our subsidiaries, particularly DII Industries and Kellogg Brown & Root,
had been named as defendants in a large number of asbestos- and silica-related
lawsuits. Effective December 31, 2004, we resolved all open and future claims
in
the prepackaged Chapter 11 proceedings of DII Industries, Kellogg Brown &
Root, and our other affected subsidiaries (which were filed on December 16,
2003) when the plan of reorganization became final and
nonappealable.
During
2004, we settled insurance disputes with substantially all the insurance
companies for asbestos- and silica-related claims and all other claims under
the
applicable insurance policies and terminated all the applicable insurance
policies. Under the terms of our insurance settlements, we would receive cash
proceeds with a nominal amount of approximately $1.5 billion and with a then
present value of approximately $1.4 billion for our asbestos- and silica-related
insurance receivables. The present value was determined by discounting the
expected future cash payments with a discount rate implicit in the settlements,
which ranged from 4.0% to 5.5%. This discount is being accreted as interest
income (classified as discontinued operations) over the life of the expected
future cash payments. Cash payments of approximately $91 million related to
these receivables were received in the first six months of 2006. Under the
terms
of the settlement agreements, we will receive cash payments of the remaining
amounts, totaling $337 million at June 30, 2006, in several installments through
2010.
The
following table presents a rollforward of our asbestos- and silica-related
insurance receivables.
Millions
of dollars
|
|
|
|
Insurance
for asbestos- and silica-related liabilities:
|
|
|
|
|
December
31, 2005 balance (of which $193 was current)
|
|
$
|
396
|
|
Payments
received
|
|
|
(91
|
)
|
Accretion
|
|
|
9
|
|
Insurance
for asbestos- and silica-related liabilities - June 30,
2006
|
|
|
|
|
balance
(of which $120 is current)
|
|
$
|
314
|
|
A
significant portion of the insurance coverage applicable to Worthington Pump,
a
former division of DII Industries, was alleged by Federal-Mogul (and others
who
formerly were associated with Worthington Pump prior to its acquisition by
DII
Industries) to be shared with them. During 2004, we reached an agreement with
Federal-Mogul, our insurance companies, and another party sharing in the
insurance coverage to obtain their consent and support of a partitioning of
the
insurance policies. Under the terms of the agreement, DII Industries was
allocated 50% of the limits of any applicable insurance policy, and the
remaining 50% of limits of the insurance policies were allocated to the
remaining policyholders. As part of the settlement, DII Industries agreed to
pay
$46 million in three installment payments. In 2004, we accrued $44 million,
which represents the present value of the $46 million to be paid. The discount
is accreted as interest expense (classified as discontinued operations) over
the
life of the expected future cash payments beginning in the fourth quarter of
2004. The first payment of $16 million was paid in January 2005, and the second
payment of $15 million was paid in January 2006. The third and final payment
of
$15 million will be made in January 2007.
DII
Industries and Federal-Mogul agreed to share equally in recoveries from
insolvent London-based insurance companies. To the extent that Federal-Mogul’s
recoveries from certain insolvent London-based insurance companies received
on
or before January 1, 2006 did not equal at least $4.5 million, DII Industries
agreed to also pay to Federal-Mogul the difference between their recoveries
from
the insolvent London-based insurance companies and $4.5 million. Accordingly,
DII Industries paid Federal-Mogul $1.6 million in January 2006. This amount
is
expected to be received back from Federal-Mogul following recoveries received
by
Federal-Mogul from the insolvent London-based insurance companies.
Under
the
insurance settlements entered into as part of the resolution of our Chapter
11
proceedings, we have agreed to indemnify our insurers under certain historic
general liability insurance policies in certain situations. We have concluded
that the likelihood of any claims triggering the indemnity obligations is
remote, and we believe any potential liability for these indemnifications will
be immaterial. At June 30, 2006, we had not recorded any liability associated
with these indemnifications.
Note
11. United States Government Contract Work
We
provide substantial work under our government contracts to the United States
Department of Defense (DoD) and other governmental agencies. These contracts
include our worldwide United States Army logistics contracts, known as LogCAP,
and contracts to rebuild Iraq’s petroleum industry, such as PCO Oil South. Our
government services revenue related to Iraq totaled approximately $1.3 billion
and $2.4 billion for the three and six months ended June 30, 2006 compared
to
$1.4 billion and $2.9 billion for the three and six months ended June 30,
2005.
Given
the
demands of working in Iraq and elsewhere for the United States government,
we
expect that from time to time we will have disagreements or experience
performance issues with the various government customers for which we work.
If
performance issues arise under any of our government contracts, the government
retains the right to pursue remedies which could include threatened termination
or termination, under any affected contract. If any contract were so terminated,
we may not receive award fees under the affected contract, and our ability
to
secure future contracts could be adversely affected, although we would receive
payment for amounts owed for our allowable costs under cost-reimbursable
contracts. Other remedies that could be sought by our government customers
for
any improper activities or performance issues include sanctions such as
forfeiture of profits, suspension of payments, fines, and suspensions or
debarment from doing business with the government. Further, the negative
publicity that could arise from disagreements with our customers or sanctions
as
a result thereof could have an adverse effect on our reputation in the industry,
reduce our ability to compete for new contracts, and may also have a material
adverse effect on our business, financial condition, results of operations,
and
cash flow.
DCAA
audit issues
Our
operations under United States government contracts are regularly reviewed
and
audited by the Defense Contract Audit Agency (DCAA) and other governmental
agencies. The DCAA serves in an advisory role to our customer. When issues
are
found during the governmental agency audit process, these issues are typically
discussed and reviewed with us. The DCAA then issues an audit report with its
recommendations to our customer’s contracting officer. In the case of management
systems and other contract administrative issues, the contracting officer is
generally with the Defense Contract Management Agency (DCMA). We then work
with
our customer to resolve the issues noted in the audit report. If our customer
or
a government auditor finds that we improperly charged any costs to a contract,
these costs are not reimbursable, or, if already reimbursed, the costs must
be
refunded to the customer. Our revenue recorded for government contract work
is
reduced for our estimate of costs that may be categorized as disputed or
unallowable as a result of cost overruns or the audit process.
Laundry.
Prior to
the fourth quarter of 2005, we received notice from the DCAA that it recommended
withholding $18 million of subcontract costs related to the laundry service
for
one task order in southern Iraq for which it believed we and our subcontractors
have not provided adequate levels of documentation supporting the quantity
of
the services provided. In the fourth quarter of 2005, the DCAA issued a notice
to disallow costs totaling approximately $12 million, releasing $6 million
of
amounts previously withheld. In the second quarter of 2006, we successfully
resolved this matter with the DCAA and received payment of the remaining $12
million.
Containers. In
June
2005, the DCAA recommended withholding certain costs associated with providing
containerized housing for soldiers and supporting civilian personnel in Iraq.
The DCAA recommended that the costs be withheld pending receipt of additional
explanation or documentation to support the subcontract costs. As of June 30,
2006, the DCAA had issued notices to disallow $56 million of the withheld
amounts, of which $17 million has been withheld from our subcontractors. We
will
continue working with the government and our subcontractors to resolve this
issue.
Dining
facilities.
In
September 2005, Eurest Support Services (Cyprus) International Limited, or
ESS,
filed suit against us alleging various claims associated with its performance
as
a subcontractor in conjunction with our LogCAP contract in Iraq. The case was
settled during the first quarter of 2006 without material impact to
us.
Other
issues.
The DCAA
is continuously performing audits of costs incurred for the foregoing and other
services provided by us under our government contracts. During these audits,
there are likely to be questions raised by the DCAA about the reasonableness
or
allowability of certain costs or the quality or quantity of supporting
documentation. The DCAA might recommend withholding some portion of the
questioned costs while the issues are being resolved with our customer. Because
of the intense scrutiny involving our government contracts operations,
issues raised by the DCAA may be more difficult to resolve. We do not believe
any potential withholding will have a significant or sustained impact on our
liquidity.
Investigations
In
the
first quarter of 2005, the United States Department of Justice (DOJ) issued
two
indictments associated with overbilling issues we previously reported to the
Department of Defense Inspector General’s office as well as to our customer, the
Army Materiel Command, against a former KBR procurement manager and a manager
of
La Nouvelle Trading & Contracting Company, W.L.L.
In
October 2004, we reported to the Department of Defense Inspector General’s
office that two former employees in Kuwait may have had inappropriate contacts
with individuals employed by or affiliated with two third-party subcontractors
prior to the award of the subcontracts. The Inspector General’s office may
investigate whether these two employees may have solicited and/or accepted
payments from these third-party subcontractors while they were employed by
us.
In
October 2004, a civilian contracting official in the Army Corps of Engineers
(COE) asked for a review of the process used by the COE for awarding some of
the
contracts to us. We understand that the Department of Defense Inspector
General’s office may review the issues involved.
We
understand that the DOJ, an Assistant United States Attorney based in Illinois,
and others are investigating these and other individually immaterial matters
we
have reported related to our government contract work in Iraq. If criminal
wrongdoing were found, criminal penalties could range up to the greater of
$500,000 in fines per count for a corporation or twice the gross pecuniary
gain
or loss. We also understand that current and former employees of KBR have
received subpoenas and have given or may give grand jury testimony related
to
some of these matters.
Claims
In
addition, we had probable unapproved claims totaling $42 million at June 30,
2006 for the LogCAP contract. These unapproved claims related to this contract
are where our costs have exceeded the customer’s funded value of the task
order.
DCMA
system reviews
Report
on estimating system.
In
December 2004, the DCMA granted continued approval of our estimating system,
stating that our estimating system is “acceptable with corrective action.” We
are in the process of completing these corrective actions. Specifically, based
on the unprecedented level of support that our employees are providing the
military in Iraq, Kuwait, and Afghanistan, we needed to update our estimating
policies and procedures to make them better suited to such contingency
situations. Additionally, we have completed our development of a detailed
training program and have made it available to all estimating personnel to
ensure that employees are adequately prepared to deal with the challenges and
unique circumstances associated with a contingency operation.
Report
on purchasing system.
As a
result of a Contractor Purchasing System Review by the DCMA during the fourth
quarter of 2005, the DCMA granted the continued approval of our government
contract purchasing system. The DCMA’s October 2005 approval letter stated that
our purchasing system’s policies and practices are “effective and efficient, and
provide adequate protection of the Government’s interest.”
Report
on accounting system.
We
received two draft reports on our accounting system, which raised various issues
and questions. We have responded to the points raised by the DCAA, but this
review remains open. Once the DCAA finalizes the report, it will be submitted
to
the DCMA, who will make a determination of the adequacy of our accounting
systems for government contracting.
The
Balkans
We
have
had inquiries in the past by the DCAA and the civil fraud division of the DOJ
into possible overcharges for work performed during 1996 through 2000 under
a
contract in the Balkans, for which inquiry has not yet been completed by the
DOJ. Based on an internal investigation, we credited our customer approximately
$2 million during 2000 and 2001 related to our work in the Balkans as a result
of billings for which support was not readily available. We believe that the
preliminary DOJ inquiry relates to potential overcharges in connection with
a
part of the Balkans contract under which approximately $100 million in work
was
done. We believe that any allegations of overcharges would be without merit.
Amounts accrued related to this matter as of June 30, 2006 are not
material.
Note
12. Other Commitments and Contingencies
Foreign
Corrupt Practices Act investigations
The
SEC
is conducting a formal investigation into whether improper payments were made
to
government officials in Nigeria through the use of agents or subcontractors
in
connection with the construction and subsequent expansion by TSKJ of a
multibillion dollar natural gas liquefaction complex and related facilities
at
Bonny Island in Rivers State, Nigeria. The DOJ is also conducting a related
criminal investigation. The SEC has also issued subpoenas seeking information,
which we are furnishing, regarding current and former agents used in connection
with multiple projects over the past 20 years located both in and outside of
Nigeria in which The M .W. Kellogg Company, M. W. Kellogg, Ltd., Kellogg Brown
& Root or their joint ventures, as well as the Halliburton energy services
business, were participants.
TSKJ
is a
private limited liability company registered in Madeira, Portugal whose members
are Technip SA of France, Snamprogetti Netherlands B.V. (a subsidiary of Saipem
SpA of Italy), JGC Corporation of Japan, and Kellogg Brown & Root (a
subsidiary of ours and successor to The M.W. Kellogg Company), each of which
has
a 25% interest in the venture. TSKJ and other similarly owned entities entered
into various contracts to build and expand the liquefied natural gas project
for
Nigeria LNG Limited, which is owned by the Nigerian National Petroleum
Corporation, Shell Gas B.V., Cleag Limited (an affiliate of Total), and Agip
International B.V. (an affiliate of ENI SpA of Italy). M.W. Kellogg Limited
is a
joint venture in which we have a 55% interest; and M.W. Kellogg Limited and
The
M.W. Kellogg Company were subsidiaries of Dresser Industries before our 1998
acquisition of Dresser Industries. The M.W. Kellogg Company was later merged
with a subsidiary of ours to form Kellogg Brown & Root, one of our
subsidiaries.
The
SEC
and the DOJ have been reviewing these matters in light of the requirements
of
the United States Foreign Corrupt Practices Act (FCPA). In addition to
performing our own investigation, we have been cooperating with the SEC and
the
DOJ investigations and with other investigations into the Bonny Island project
in France, Nigeria and Switzerland. Our Board of Directors has appointed a
committee of independent directors to oversee and direct the FCPA
investigations.
The
matters under investigation related to the Bonny Island project cover an
extended period of time (in some cases significantly before our 1998 acquisition
of Dresser Industries). We have produced documents to the SEC and the DOJ both
voluntarily and pursuant to company subpoenas from the files of numerous
officers of Halliburton and KBR, including current and former executives of
Halliburton and KBR, and we are making our employees available to the SEC and
the DOJ for interviews. In addition, we understand that the SEC has issued
a
subpoena to A. Jack Stanley, who formerly served as a consultant and chairman
of
KBR, and to others, including certain of our current and former KBR employees,
former executive officers of KBR, and at least one subcontractor of KBR. We
further understand that the DOJ has invoked its authority under a sitting grand
jury to issue subpoenas for the purpose of obtaining information abroad, and
we
understand that other partners in TSKJ have provided information to the DOJ
and
the SEC with respect to the investigations, either voluntarily or under
subpoenas.
The
SEC
and DOJ investigations include an examination of whether TSKJ’s engagements of
Tri-Star Investments as an agent and a Japanese trading company as a
subcontractor to provide services to TSKJ were utilized to make improper
payments to Nigerian government officials. In connection with the Bonny Island
project, TSKJ entered into a series of agency agreements, including with
Tri-Star Investments, of which Jeffrey Tesler is a principal, commencing in
1995
and a series of subcontracts with a Japanese trading company commencing in
1996.
We understand that a French magistrate has officially placed Mr. Tesler under
investigation for corruption of a foreign public official. In Nigeria, a
legislative committee of the National Assembly and the Economic and Financial
Crimes Commission, which is organized as part of the executive branch of the
government, are also investigating these matters. Our representatives have
met
with the French magistrate and Nigerian officials. In October 2004,
representatives of TSKJ voluntarily testified before the Nigerian legislative
committee.
As
a
result of these investigations, information has been uncovered suggesting that,
commencing at least 10 years ago, members of TSKJ planned payments to Nigerian
officials. We have reason to believe, based on the ongoing investigations,
that
payments may have been made to Nigerian officials.
We
notified the other owners of TSKJ of information provided by the investigations
and asked each of them to conduct their own investigation. TSKJ has suspended
the receipt of services from and payments to Tri-Star Investments and the
Japanese trading company and has considered instituting legal proceedings to
declare all agency agreements with Tri-Star Investments terminated and to
recover all amounts previously paid under those agreements. In February 2005,
TSKJ notified the Attorney General of Nigeria that TSKJ would not oppose the
Attorney General’s efforts to have sums of money held on deposit in banks in
Switzerland transferred to Nigeria and to have the legal ownership of such
sums
determined in the Nigerian courts.
In
June
2004, all relationships with Mr. Stanley and another consultant and former
employee of M. W. Kellogg, Ltd. were terminated. The terminations occurred
because of violations of our Code of Business Conduct that allegedly involved
the receipt of improper personal benefits from Mr. Tesler in connection with
TSKJ’s construction of the Bonny Island project.
We
have
also suspended the services of another agent who has worked for KBR outside
of
Nigeria on several current projects and on numerous older projects going back
to
the early 1980’s until such time, if ever, as we can satisfy ourselves regarding
the agent’s compliance with applicable law and our Code of Business Conduct. In
addition, we are actively reviewing the compliance of an additional agent on
a
separate current Nigerian project with respect to which we have recently
received from a joint venture partner on that project allegations of wrongful
payments made by such agent.
If
violations of the FCPA were found, a person or entity found in violation could
be subject to fines, civil penalties of up to $500,000 per violation, equitable
remedies, including disgorgement, and injunctive relief. Criminal penalties
could range up to the greater of $2 million per violation or twice the gross
pecuniary gain or loss. Both the SEC and the DOJ could argue that continuing
conduct may constitute multiple violations for purposes of assessing the penalty
amounts per violation. Agreed dispositions for these types of matters sometimes
result in a monitor being appointed by the SEC and/or the DOJ to review future
business and practices with the goal of ensuring compliance with the FCPA.
Fines
and civil and criminal penalties could be mitigated, in the government’s
discretion, depending on the level of the cooperation in the
investigations.
Potential
consequences of a criminal indictment arising out of any of these investigations
could include suspension by the DoD or another federal, state, or local
government agency of KBR and its affiliates from their ability to contract
with
United States, state or local governments, or government agencies. If a criminal
or civil violation were found, KBR and its affiliates could be debarred from
future contracts or new orders under current contracts to provide services
to
any such parties. During 2005, KBR and its affiliates had revenue of
approximately $6.6 billion from its government contracts work with agencies
of
the United States or state or local governments. If necessary, we would seek
to
obtain administrative agreements or waivers from the DoD and other agencies
to
avoid suspension or debarment. Suspension or debarment from the government
contracts business would have a material adverse effect on the business, results
of operations, and cash flows of KBR and Halliburton.
These
investigations could also result in third-party claims against us, which may
include claims for special, indirect, derivative or consequential damages,
damage to our business or reputation, loss of, or adverse effect on, cash flow,
assets, goodwill, results of operations, business, prospects, profits or
business value, adverse consequences on our ability to obtain or continue
financing for current or future projects or claims by directors, officers,
employees, affiliates, advisors, attorneys, agents, debt holders or other
interest holders or constituents of us or our subsidiaries. In addition, we
could incur costs and expenses for any monitor required by or agreed to with
governmental authority to review our continued compliance with FCPA
law.
As
of
June 30, 2006, we have not accrued any amounts related to these investigations
other than our current legal expenses.
Bidding
practices investigation
In
connection with the investigation into payments related to the Bonny Island
project in Nigeria, information has been uncovered suggesting that Mr. Stanley
and other former employees may have engaged in coordinated bidding with one
or
more competitors on certain foreign construction projects, and that such
coordination possibly began as early as the mid-1980s.
On
the
basis of this information, we and the DOJ have broadened our investigations
to
determine the nature and extent of any improper bidding practices, whether
such
conduct violated United States antitrust laws, and whether former employees
may
have received payments in connection with bidding practices on some foreign
projects.
If
violations of applicable United States antitrust laws occurred, the range of
possible penalties includes criminal fines, which could range up to the greater
of $10 million in fines per count for a corporation, or twice the gross
pecuniary gain or loss, and treble civil damages in favor of any persons
financially injured by such violations. Criminal prosecutions under applicable
laws of relevant foreign jurisdictions and civil claims by, or relationship
issues with customers, are also possible.
As
of
June 30, 2006, we had not accrued any amounts related to this investigation
other than our current legal expenses.
Securities
and related litigation
In
June
2002, a class action lawsuit was filed against us in federal court on behalf
of
purchasers of our common stock during the period of approximately May 1998
until
approximately May 2002 alleging violations of the federal securities laws in
connection with the accounting change and disclosures involved in the SEC
investigation related to a change in accounting for revenue on long-term
construction projects and related disclosures, which we settled with the SEC
in
the second quarter of 2004. In addition, the plaintiffs allege that we
overstated our revenue from unapproved claims by recognizing amounts not
reasonably estimable or probable of collection. In the weeks that followed,
approximately twenty similar class actions were filed against us. Several of
those lawsuits also named as defendants Arthur Andersen LLP, our independent
accountants for the period covered by the lawsuits, and several of our present
or former officers and directors. The class action cases were later
consolidated, and the amended consolidated class action complaint, styled
Richard
Moore, et al. v. Halliburton Company, et al.,
was
filed and served upon us in April 2003 (the “Moore
class
action”).
In
early
May 2003, we announced that we had entered into a written memorandum of
understanding setting forth the terms upon which the Moore
class
action would be settled. In June 2003, the lead plaintiffs in the Moore
class
action filed a motion for leave to file a second amended consolidated complaint,
which was granted by the court. In addition to restating the original accounting
and disclosure claims, the second amended consolidated complaint includes claims
arising out of the 1998 acquisition of Dresser Industries, Inc. by Halliburton,
including that we failed to timely disclose the resulting asbestos liability
exposure (the “Dresser claims”). The Dresser claims were included in the
settlement discussions leading up to the signing of the memorandum of
understanding and were among the claims the parties intended to have resolved
by
the terms of the proposed settlement of the consolidated Moore
class
action and the derivative action. The memorandum of understanding called for
Halliburton to pay $6 million, which would be funded by insurance
proceeds.
In
June
2004, the court entered an order preliminarily approving the settlement.
Following the transfer of the case to another district judge and a final hearing
on the fairness of the settlement the court entered an order in September 2004
holding that evidence of the settlement’s fairness was inadequate, denying the
motion for final approval of the settlement in the Moore
class
action, and ordering the parties, among other things, to mediate. After the
court’s denial of the motion to approve the settlement, we withdrew from the
settlement as we believe we are entitled to do by its terms. The mediation
was
held in January 2005, but was declared by the mediator to be at an impasse
with
no settlement having been reached.
In
April
2005, the court appointed new co-lead counsel and a new lead plaintiff, directed
that they file a third consolidated amended complaint, and that we file our
motion to dismiss. The court held oral arguments on that motion in August 2005,
at which time the court took the motion under advisement. On March 14, 2006,
the
court entered an order in which it granted the motion to dismiss with respect
to
claims arising prior to June 1999 and granted the motion with respect to certain
other claims while permitting the plaintiffs to replead those claims to correct
deficiencies in their earlier complaint. On April 4, 2006, the plaintiffs filed
their fourth amended consolidated complaint. We have filed a motion to dismiss
those portions of the complaint that have been replead. The court has scheduled
the hearing on that motion for the end of July 2006.
As
of
June 30, 2006, we had not accrued any amounts related to this
matter.
Newmont
Gold
In
July
1998, Newmont Gold, a gold mining and extraction company, filed a lawsuit over
the failure of a blower manufactured and supplied to Newmont by Roots, a former
division of Dresser Equipment Group. The plaintiff alleges that during the
manufacturing process, Roots had reversed the blades of a component of the
blower known as the inlet guide vane assembly, resulting in the blower’s failure
and the shutdown of the gold extraction mill for a period of approximately
one
month during 1996. In January 2002, a Nevada trial court granted summary
judgment to Roots on all counts, and Newmont appealed. In February 2004, the
Nevada Supreme Court reversed the summary judgment and remanded the case to
the
trial court, holding that fact issues existed requiring a trial. Based on
pretrial reports, the damages claimed by the plaintiff are in the range of
$33
million to $39 million. We believe that we have valid defenses to Newmont Gold’s
claims and intend to vigorously defend the matter. After certain procedural
filings, the case will proceed to trial.
As
of
June 30, 2006, we had not accrued any amounts related to this
matter.
Improper
payments reported to the SEC
During
the second quarter of 2002, we reported to the SEC 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 our audit of the foreign subsidiary. We conducted an
investigation assisted by outside legal counsel, and, based on the findings
of
the investigation, we terminated several employees. None of our senior officers
were involved. We are cooperating with the SEC in its review of the matter.
We
took further action to ensure that our foreign subsidiary paid all taxes owed
in
Nigeria. A preliminary assessment of approximately $4 million was issued by
the
Nigerian tax authorities in the second quarter of 2003. We are cooperating
with
the Nigerian tax authorities to determine the total amount due as quickly as
possible.
Operations
in Iran
We
received and responded to an inquiry in mid-2001 from the Office of Foreign
Assets Control (OFAC) of the United States Treasury Department with respect
to
operations in Iran by a Halliburton subsidiary incorporated in the Cayman
Islands. The OFAC inquiry requested information with respect to compliance
with
the Iranian Transaction Regulations. These regulations prohibit United States
citizens, including United States corporations and other United States business
organizations, from engaging in commercial, financial, or trade transactions
with Iran, unless authorized by OFAC or exempted by statute. Our 2001 written
response to OFAC stated that we believed that we were in compliance with
applicable sanction regulations. In the first quarter of 2004, we responded
to a
follow-up letter from OFAC requesting additional information. We understand
this
matter has now been referred by OFAC to the DOJ. In July 2004, we received
a
grand jury subpoena from an Assistant United States District Attorney requesting
the production of documents. We are cooperating with the government’s
investigation and have responded to the subpoena by producing documents in
September 2004.
As
of
June 30, 2006, we had not accrued any amounts related to this
investigation.
Separate
from the OFAC inquiry, we completed a study in 2003 of our activities in Iran
during 2002 and 2003 and concluded that these activities were in compliance
with
applicable sanction regulations. These sanction regulations require isolation
of
entities that conduct activities in Iran from contact with United States
citizens or managers of United States companies. Notwithstanding our conclusions
that our activities in Iran were not in violation of United States laws and
regulations, we announced that, after fulfilling our current contractual
obligations within Iran, we intend to cease operations within that country
and
to withdraw from further activities there.
David
Hudak and International Hydrocut Technologies Corp.
In
October 2004, David Hudak and International Hydrocut Technologies Corp.
(collectively, Hudak) filed suit against us in the United States District Court
alleging civil Racketeer Influenced and Corporate Organizations Act violations,
fraud, breach of contract, unfair trade practices, and other torts. The action,
which seeks unspecified damages, arises out of Hudak’s alleged purchase in early
1994 of certain explosive charges that were later alleged by the DOJ to be
military ordnance, the possession of which by persons not possessing the
requisite licenses and registrations is unlawful. As a result of that allegation
by the government, Hudak was charged with, but later acquitted of, certain
criminal offenses in connection with his possession of the explosive charges.
As
mentioned above, the alleged transaction(s) took place more than 10 years ago.
The fact that most of the individuals that may have been involved, as well
as
the entities themselves, are no longer affiliated with us will complicate our
investigation. For those reasons and because the litigation is in its most
preliminary stages, it is premature to assess the likelihood of an adverse
result. We filed a motion to dismiss and, alternatively, a motion to transfer
venue. Those motions were denied during the first quarter of 2006. It is our
intention to vigorously defend this action.
Amounts
accrued related to this matter as of June 30, 2006 are not
material.
Convoy
ambush litigation
Several
of the families of truck drivers, employed by KBR and killed when a fuel convoy
was ambushed in Iraq in April 2004, have filed suit against us. These suits
allege that we are responsible for the deaths of these drivers for a variety
of
reasons and assert legal claims for fraud, wrongful death, civil rights
violations, and violations of the Racketeer Influenced and Corrupt Organizations
Act. We deny the allegations of wrongdoing and fully intend to vigorously defend
the actions. We believe that our conduct was entirely lawful and that our
liability is limited by federal law. In July 2005, the federal court in Houston,
Texas denied our motion to dismiss based upon a narrow exception to the Defense
Base Act.
As
of
June 30, 2006, we had not accrued any amounts related to these
matters.
Iraq
overtime litigation
During
the fourth quarter of 2005, a group of present and former employees working
on
the LogCAP contract in Iraq and elsewhere filed a class action lawsuit alleging
that KBR wrongfully failed to pay time and a half for hours worked in excess
of
40 per work week and that “uplift” pay, consisting of a foreign service bonus,
an area differential, and danger pay, was only applied to the first 40 hours
worked in any work week. The class alleged by plaintiffs consists of all current
and former employees on the LogCAP contract from December 2001 to present.
The
basis of plaintiffs’ claims is their assertion that they are intended
third-party beneficiaries of the LogCAP contract, and that the LogCAP contract
obligated KBR to pay time and a half for all overtime hours. We have moved
to
dismiss the case on a number of bases, and that motion remains pending at this
time. In the event the motion to dismiss is denied, we intend to vigorously
defend this case. It is premature to assess the probability of an adverse result
in this action. However, because the LogCAP contract is cost-reimbursable,
we
could charge any overtime and “uplift” pay to the customer in the event of an
adverse judgment.
As
of
June 30, 2006, we had not accrued any amounts related to this
matter.
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, among others:
|
-
|
the
Comprehensive Environmental Response, Compensation, and Liability
Act;
|
|
-
|
the
Resources Conservation and Recovery
Act;
|
|
-
|
the
Federal Water Pollution Control Act;
and
|
|
-
|
the
Toxic Substances Control Act.
|
In
addition to the federal laws and regulations, states and other countries where
we do business often have numerous environmental, legal, and regulatory
requirements by which we must abide. We evaluate and address the environmental
impact of our operations by assessing and remediating contaminated properties
in
order to avoid future liabilities and comply with environmental, legal, and
regulatory requirements. On occasion, we are involved in specific environmental
litigation and claims, including the remediation of properties we own or have
operated, as well as efforts to meet or correct compliance-related matters.
Our
Health, Safety and Environment group has several programs in place to maintain
environmental leadership and to prevent the occurrence of environmental
contamination.
We
do not
expect costs related to these remediation requirements to have a material
adverse effect on our consolidated financial position or our results of
operations. Our accrued liabilities for environmental matters were $41 million
as of June 30, 2006 and $50 million as of December 31, 2005. The liability
covers numerous properties, and no individual property accounts for more than
$5
million of the liability balance. We have subsidiaries that have been named
as
potentially responsible parties along with other third parties for 14 federal
and state superfund sites for which we have established a liability. As of
June
30, 2006, those 14 sites accounted for approximately $13 million of our total
$41 million liability. 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.
Letters
of credit
In
the
normal course of business, we have agreements with banks under which
approximately $1.1 billion of letters of credit or bank guarantees were
outstanding as of June 30, 2006, including $564 million that relate to our
joint
ventures’ operations. Also included in letters of credit outstanding as of June
30, 2006 were $8 million of performance letters of credit and $56 million of
retainage letters of credit related to the Barracuda-Caratinga project. Some
of
the outstanding letters of credit have triggering events which would entitle
a
bank to require cash collateralization.
Other
commitments
As
of
June 30, 2006, we had commitments to fund approximately $124 million to related
companies. These commitments arose primarily during the start-up of these
entities or due to losses incurred by them. We expect approximately $7 million
of the commitments to be paid during the next year.
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. However, 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 for liquidated damages
of $62 million at June 30, 2006 and $70 million at December 31, 2005 (including
amounts related to unconsolidated subsidiaries) that we could incur based upon
completing the projects as forecasted.
Note
13. Accounting for Stock-Based Compensation
Our
1993
Stock and Incentive Plan, as amended (1993 Plan), provides for the grant of
any
or all of the following types of stock-based awards:
|
-
|
stock
options, including incentive stock options and nonqualified stock
options;
|
|
-
|
restricted
stock awards;
|
|
-
|
restricted
stock unit awards;
|
|
-
|
stock
appreciation rights; and
|
|
-
|
stock
value equivalent awards.
|
There
are
currently no stock appreciation rights or stock value equivalent awards
outstanding.
Under
the
terms of the 1993 Plan, 98 million shares of common stock have been reserved
for
issuance to key employees. The plan specifies that no more than 32 million
shares can be awarded as restricted stock. At June 30, 2006, approximately
21
million shares were available for future grants under the 1993 Plan, of which
approximately 12 million shares remained available for restricted stock awards.
The stock to be offered pursuant to the grant of an award under the 1993 Plan
may be authorized but unissued common shares or treasury shares.
In
addition to the provisions of the 1993 Plan, we also have stock-based
compensation provisions under our Restricted Stock Plan for Non-Employee
Directors and our 2002 Employee Stock Purchase Plan (ESPP).
Effective
January 1, 2006, we adopted the fair value recognition provisions of Financial
Accounting Standards Board (FASB) Statement of Financial Accounting Standards
No. 123 (revised 2004), “Share-Based Payment” (SFAS No. 123(R)), using the
modified prospective application. Accordingly, we are recognizing compensation
expense for all newly granted awards and awards modified, repurchased, or
cancelled after January 1, 2006. Compensation cost for the unvested portion
of
awards that are outstanding as of January 1, 2006 is recognized ratably over
the
remaining vesting period based on the fair value at date of grant. Also,
beginning with the January 1, 2006 purchase period, compensation expense for
our
ESPP is being recognized. The cumulative effect of this change in accounting
principle related to stock-based awards was immaterial. Prior to January 1,
2006, we accounted for these plans under the recognition and measurement
provisions of Accounting Principles Board (APB) Opinion No. 25, “Accounting for
Stock Issued to Employees,” and related interpretations. Under APB No. 25, no
compensation expense was recognized for stock options or the ESPP. Compensation
expense was recognized for restricted stock awards.
Total
stock-based compensation expense, net of related tax effects, was $13 million
in
the second quarter of 2006 and $28 million in the first six months of 2006.
Total income tax benefit recognized in net income for stock-based compensation
arrangements was $6 million in the second quarter of 2006 and $15 million in
the
first six months of 2006, compared to $2 million in the second quarter of 2005
and $10 million in the first six months of 2005. Total incremental compensation
cost resulting from modifications of previously granted stock-based awards
was
$2 million and $8 million for the three and six months ended June 30, 2006,
compared to $1 million and $13 million for the three and six months ended June
30, 2005. These modifications allowed certain employees to retain their awards
after leaving the company.
The
following table summarizes the pro forma effect on net income and income per
share for the three and six months ended June 30, 2005 as if we had applied
the
fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based
Compensation,” to stock-based employee compensation.
|
|
Three
Months Ended
|
|
Six
Months Ended
|
|
Millions
of dollars except per share data
|
|
June
30, 2005
|
|
June
30, 2005
|
|
Net
income, as reported
|
|
$
|
392
|
|
$
|
757
|
|
Add:
Total stock-based compensation expense included
|
|
|
|
|
|
|
|
in
net income, net of related tax effects
|
|
|
5
|
|
|
19
|
|
Less:
Total stock-based compensation expense
|
|
|
|
|
|
|
|
determined
under fair-value-based method for all
|
|
|
|
|
|
|
|
awards,
net of related tax effects
|
|
|
(13
|
)
|
|
(33
|
)
|
Net
income, pro forma
|
|
$
|
384
|
|
$
|
743
|
|
|
|
|
|
|
|
|
|
Basic
income per share:
|
|
|
|
|
|
|
|
As
reported
|
|
$
|
0.39
|
|
$
|
0.75
|
|
Pro
forma
|
|
$
|
0.38
|
|
$
|
0.74
|
|
Diluted
income per share:
|
|
|
|
|
|
|
|
As
reported
|
|
$
|
0.38
|
|
$
|
0.74
|
|
Pro
forma
|
|
$
|
0.38
|
|
$
|
0.73
|
|
Each
of
the active stock-based compensation arrangements is discussed
below.
Stock
options
All
stock
options under the 1993 Plan are granted at the fair market value of the common
stock at the grant date. Employee stock options vest ratably over a three-
or
four-year period and generally expire 10 years from the grant date. Stock
options granted to non-employee directors vest after six months. No further
stock option grants are being made under the stock plans of acquired
companies.
The
fair
value of options at the date of grant was estimated using the Black-Scholes
option pricing model. The expected volatility is a blended rate based upon
implied volatility calculated on actively traded options on our common stock
and
upon the historical volatility of our stock. The expected term is based upon
observation of actual time elapsed between date of grant and exercise of options
for all employees. The assumptions and resulting fair values of options granted
are as follows:
|
|
Six
months ended June 30
|
|
|
|
2006
|
|
2005
|
|
Expected
term (in years)
|
|
|
5.24
|
|
|
5.00
|
|
Expected
volatility
|
|
|
42.20
|
%
|
|
51.71
- 52.79
|
%
|
Expected
dividend yield
|
|
|
0.76
- 0.91
|
%
|
|
1.05
- 1.16
|
%
|
Risk-free
interest rate
|
|
|
4.30
- 5.03
|
%
|
|
3.77
- 4.27
|
%
|
Weighted
average grant-date fair value per share
|
|
$
|
14.43
|
|
$
|
10.08
|
|
The
following table represents our stock options granted, exercised, and forfeited
during the first six months of 2006, and includes exercised and forfeited shares
from our acquired companies’ stock plans.
|
|
|
|
Weighted
|
|
Weighted
|
|
|
|
|
|
|
|
Average
|
|
Average
|
|
Aggregate
|
|
|
|
Number
|
|
Exercise
|
|
Remaining
|
|
Intrinsic
|
|
|
|
of
Shares
|
|
Price
|
|
Contractual
|
|
Value
|
|
Stock
Options
|
|
(in
millions)
|
|
per
Share
|
|
Term
(years)
|
|
(in
millions)
|
|
Outstanding
at January 1, 2006
|
|
|
22.4
|
|
$
|
16.81
|
|
|
|
|
|
|
|
Granted
|
|
|
1.4
|
|
|
34.73
|
|
|
|
|
|
|
|
Exercised
|
|
|
(5.2
|
)
|
|
17.70
|
|
|
|
|
|
|
|
Forfeited/expired
|
|
|
(0.2
|
)
|
|
16.47
|
|
|
|
|
|
|
|
Outstanding
at June 30, 2006
|
|
|
18.4
|
|
$
|
17.99
|
|
|
6.05
|
|
$
|
353
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable
at June 30, 2006
|
|
|
13.3
|
|
$
|
15.43
|
|
|
4.99
|
|
$
|
289
|
|
The
total
intrinsic value of options exercised was $40 million in the second quarter
of
2006 and $104 million in the first six months of 2006, compared to $24 million
in the second quarter of 2005 and $50 million in the first six months of 2005.
As of June 30, 2006, there was $43 million of unrecognized compensation cost,
net of estimated forfeitures, related to nonvested stock options, which is
expected to be recognized over a weighted average period of approximately 2.1
years.
Cash
received from option exercises was $28 million and $117 million during the
three
and six months ended June 30, 2006, compared to $37 million and $126 million
during the three and six months ended June 30, 2005. As a result of our net
operating loss position at June 30, 2006, our $36 million tax benefit from
exercise of stock options will not be realized until such time as the net
operating loss carryforwards are fully utilized.
Restricted
stock
Restricted
shares issued under the 1993 Plan are restricted as to sale or disposition.
These restrictions lapse periodically over an extended period of time not
exceeding 10 years. Restrictions may also lapse for early retirement and other
conditions in accordance with our established policies. Upon termination of
employment, shares on which restrictions have not lapsed must be returned to
us,
resulting in restricted stock forfeitures. The fair market value of the stock
on
the date of grant is amortized and ratably charged to income over the period
during which the restrictions lapse.
Our
Restricted Stock Plan for Non-Employee Directors (Directors Plan) allows for
each non-employee director to receive an annual award of 800 restricted shares
of common stock as a part of compensation. These awards have a minimum
restriction period of six months and the restrictions lapse upon termination
of
Board service. The fair market value of the stock on the date of grant is
amortized and ratably charged to income over the period during which the
restriction lapses. We reserved 200,000 shares of common stock for issuance
to
non-employee directors, which may be authorized but unissued shares or treasury
shares. At June 30, 2006, 98,400 shares had been issued to non-employee
directors under this plan. There were no awards of restricted stock under the
Directors Plan in the first half of 2006 or the first half of
2005.
The
following table represents our 1993 Plan and Directors Plan restricted stock
awards granted, vested, and forfeited during the first six months of
2006.
|
|
|
|
Weighted
|
|
|
|
Number
of Shares
|
|
Average
Grant-Date
Fair
|
|
Restricted
Stock
|
|
(in
millions)
|
|
Value
per Share
|
|
Nonvested
shares at January 1, 2006
|
|
|
7.5
|
|
$
|
17.07
|
|
Granted
|
|
|
2.0
|
|
|
35.04
|
|
Vested
|
|
|
(1.3
|
)
|
|
15.76
|
|
Forfeited
|
|
|
(0.2
|
)
|
|
19.93
|
|
Nonvested
shares at June 30, 2006
|
|
|
8.0
|
|
$
|
21.56
|
|
The
weighted average grant-date fair value of shares granted during the first six
months of 2005 was $22.14. The total fair value of shares vested during the
three and six months ended June 30, 2006 was $34 million and $48 million,
compared to $13 million and $30 million during the three and six months ended
June 30, 2005. As of June 30, 2006, there was $148 million of unrecognized
compensation cost, net of estimated forfeitures, related to nonvested restricted
stock, which is expected to be recognized over a period of 4.4
years.
2002
Employee Stock Purchase Plan
Under
the
ESPP, eligible employees may have up to 10% of their earnings withheld, subject
to some limitations, to be used to purchase shares of our common stock. Unless
the Board of Directors shall determine otherwise, each six-month offering period
commences on January 1 and July 1 of each year. The price at which common stock
may be purchased under the ESPP is equal to 85% of the lower of the fair market
value of the common stock on the commencement date or last trading day of each
offering period. Under this plan, 24 million shares of common stock have been
reserved for issuance. They may be authorized but unissued shares or treasury
shares. As of June 30, 2006, 10.6 million shares have been sold through the
ESPP.
The
fair
value of ESPP shares was estimated using the Black-Scholes option pricing model.
The expected volatility is a one-year historical volatility of our stock. The
assumptions and resulting fair values of options granted are as
follows:
|
|
Six
months ended June 30
|
|
|
|
2006
|
|
2005
|
|
Expected
term (in years)
|
|
|
0.5
|
|
|
0.5
|
|
Expected
volatility
|
|
|
35.65
|
%
|
|
26.93
|
%
|
Expected
dividend yield
|
|
|
0.75
|
%
|
|
1.16
|
%
|
Risk-free
interest rate
|
|
|
4.38
|
%
|
|
3.15
|
%
|
Weighted
average grant-date fair value per share
|
|
$
|
7.91
|
|
$
|
4.15
|
|
Note
14. Income per Share
Basic
income per share is based on the weighted average number of common shares
outstanding during the period. Diluted income per share includes additional
common shares that would have been outstanding if potential common shares with
a
dilutive effect had been issued. A reconciliation of the number of shares used
for the basic and diluted income per share calculation is as
follows:
|
|
Three
Months Ended
|
|
Six
Months Ended
|
|
|
|
June
30
|
|
June
30
|
|
Millions
of shares
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
Basic
weighted average common shares outstanding
|
|
|
1,026
|
|
|
1,006
|
|
|
1,025
|
|
|
1,004
|
|
Dilutive
effect of:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock
options
|
|
|
9
|
|
|
10
|
|
|
10
|
|
|
10
|
|
Convertible
senior notes premium
|
|
|
32
|
|
|
8
|
|
|
31
|
|
|
8
|
|
Restricted
stock
|
|
|
3
|
|
|
2
|
|
|
3
|
|
|
2
|
|
Diluted
weighted average common shares outstanding
|
|
|
1,070
|
|
|
1,026
|
|
|
1,069
|
|
|
1,024
|
|
All
the
share numbers included in the tables above have been adjusted to reflect the
two-for-one common stock split. See Note 16 for further
information.
Excluded
from the computation of diluted income per share are options to purchase one
million shares of common stock that were outstanding during the three and six
months ended June 30, 2006 and five million shares during the three months
ended
June 30, 2005 and four million shares during the six months ended June 30,
2005.
These options were outstanding during these quarters but were excluded because
the option exercise price was greater than the average market price of the
common shares.
Note
15. Retirement Plans
The
components of net periodic benefit cost related to pension benefits for the
three and six months ended June 30, 2006 and June 30, 2005 are as
follows:
|
|
Three
Months Ended June 30
|
|
|
|
2006
|
|
2005
|
|
Millions
of dollars
|
|
United
States
|
|
International
|
|
United
States
|
|
International
|
|
Components
of net periodic
|
|
|
|
|
|
|
|
|
|
|
|
|
|
benefit
cost:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Service
cost
|
|
$
|
-
|
|
$
|
18
|
|
$
|
-
|
|
$
|
16
|
|
Interest
cost
|
|
|
3
|
|
|
44
|
|
|
3
|
|
|
43
|
|
Expected
return on plan assets
|
|
|
(3
|
)
|
|
(49
|
)
|
|
(3
|
)
|
|
(46
|
)
|
Settlements/curtailments
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
Recognized
actuarial loss
|
|
|
1
|
|
|
7
|
|
|
1
|
|
|
4
|
|
Net
periodic benefit cost
|
|
$
|
1
|
|
$
|
20
|
|
$
|
1
|
|
$
|
17
|
|
|
|
Six
Months Ended June 30
|
|
|
|
2006
|
|
2005
|
|
Millions
of dollars
|
|
United
States
|
|
International
|
|
United
States
|
|
International
|
|
Components
of net periodic
|
|
|
|
|
|
|
|
|
|
|
|
|
|
benefit
cost:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Service
cost
|
|
$
|
-
|
|
$
|
35
|
|
$
|
-
|
|
$
|
39
|
|
Interest
cost
|
|
|
5
|
|
|
87
|
|
|
5
|
|
|
86
|
|
Expected
return on plan assets
|
|
|
(5
|
)
|
|
(97
|
)
|
|
(5
|
)
|
|
(92
|
)
|
Settlements/curtailments
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
5
|
|
Recognized
actuarial loss
|
|
|
3
|
|
|
13
|
|
|
2
|
|
|
9
|
|
Net
periodic benefit cost
|
|
$
|
3
|
|
$
|
38
|
|
$
|
2
|
|
$
|
47
|
|
In
the
first quarter of 2005, we amended the terms and conditions of one of our foreign
defined benefit plans and ceased future service and benefit accruals for all
plan participants. This action is defined as a curtailment under SFAS No. 88
and, therefore, during the first quarter of 2005, we recognized a curtailment
loss of approximately $5 million.
We
currently expect to contribute approximately $158 million to our international
pension plans and no more than $4 million to our domestic plans in 2006. As
of
June 30, 2006, we contributed $142 million of the $158 million to our
international pension plans. As part of the $142 million, ESG contributed $43
million, and KBR contributed $94 million to the United Kingdom pension plans
in
the first six months of 2006. We do not have a required minimum contribution
for
our domestic plans; however, we may make additional discretionary
contributions.
The
components of net periodic benefit cost related to other postretirement benefits
for the three and six months ended June 30, 2006 and June 30, 2005 are as
follows:
|
|
Three
Months Ended
|
|
Six
Months Ended
|
|
|
|
June
30
|
|
June
30
|
|
Millions
of dollars
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
Components
of net periodic
|
|
|
|
|
|
|
|
|
|
|
|
|
|
benefit
cost:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Service
cost
|
|
$
|
1
|
|
$
|
-
|
|
$
|
1
|
|
$
|
-
|
|
Interest
cost
|
|
|
2
|
|
|
2
|
|
|
4
|
|
|
5
|
|
Net
periodic benefit cost
|
|
$
|
3
|
|
$
|
2
|
|
$
|
5
|
|
$
|
5
|
|
Note
16. Common Stock
In
February 2006, our Board of Directors approved a share repurchase program of
up
to $1.0 billion. During the first half of 2006, we repurchased approximately
five million shares of our common stock for approximately $178 million, or
an
average price per share of $35.55.
In
May
2006, the stockholders increased the number of authorized shares of common
stock
to two billion. Also in May 2006, our Board of Directors finalized the terms
of
a two-for-one common stock split, effected in the form of a stock dividend.
As a
result, the split was paid in the form of a stock dividend on July 14, 2006
to
stockholders of record on June 23, 2006. The effect on the balance sheet was
to
reduce “Paid-in capital in excess of par value” by $1.3 billion and to increase
“Common shares” by $1.3 billion. All prior period common stock and applicable
share and per share amounts were retroactively adjusted to reflect the
split.
Note
17. Related Companies
During
the first quarter of 2006, included in Government and Infrastructure operating
income was a $30 million impairment charge and loss recorded on an equity
investment in an Australian railroad operation. Of the $30 million, $26 million
relates to the impairment charge. We will receive no tax benefit from this
charge as this is a capital loss in Australia for which we have no capital
gains
to offset. We own a 36.7% interest in the joint venture that is the holder
of a
50-year concession contract with the Australian government to operate and
maintain the railway. We account for this investment on the equity method of
accounting. Construction on the railway was completed in late 2003, and
operations commenced in early 2004. This joint venture has sustained losses
since the railway commenced operations in early 2004 and is now likely to
violate certain of the joint venture’s loan covenants in the future. These loans
are non-recourse to us. We received revised financial forecasts from the joint
venture during the first quarter of 2006. These forecasts took into account
decreases, as compared to prior forecasts, in anticipated freight volume related
to delays in mining of minerals, as well as a slowdown in the planned expansion
of the Port of Darwin. Because of this new information, we recorded an
impairment charge during the first quarter of 2006 in our equity investment.
As
of June 30, 2006, our investment in this joint venture and the related company
that performed the construction of the railroad was $60 million. In addition,
we
have a remaining commitment to purchase an additional $3 million subordinated
operating note.
In
2006,
we invested in a development company that has an indirect interest in an
ammonia plant project (the EBIC project) located in Egypt. We are
performing the engineering, procurement, and construction (EPC) work for the
project. We consolidate the development company for financial reporting purposes
within our Energy and Chemicals segment. The development company owns a 25%
ownership interest in Egypt Basic Industries Corporation (EBIC), which in
turn owns the ammonia plant. EBIC is considered a variable interest
entity. The development company accounts for its investment in EBIC using
the equity method of accounting. EBIC is funded through debt and equity. We
are not the primary beneficiary of EBIC. As of June 30, 2006, EBIC had
total assets of $285 million and total liabilities of $130 million. Our maximum
exposure to loss is limited to our equity investments totaling $17 million
and
our commitment to fund an additional $3 million of stand-by-equity as of June
30, 2006. In June 2006, the lenders of the project construction debt issued
a
“draw stop” which effectively prevents the project from making additional
borrowings until such time as certain security interest in the ammonia plant
assets can be perfected. Subsequently, the lenders granted EBIC additional
time
to perfect the security and approved funding through July. EBIC now has until
August 16, 2006 to perfect the lender’s security or find an alternative
solution, which would likely increase the cost estimates. Any solution resulting
in additional costs could require EBIC to raise additional financing, some
of
which could be from the current stakeholders. We are continuing work on the
project pursuant to the EPC contract. In the event the draw stop is reinstated
and not ultimately removed, the project may not have access to sufficient
financing to continue which could in turn result in an impairment of our
investment.
In
April
2006, we invested in a private financing initiative project (the
Allenby and Connaught project) to upgrade certain infrastructure accommodations
and provide related support services in the United Kingdom over 35 years. We
indirectly own a 45% interest in Aspire Defence, the project company that
is the holder of the 35-year concession contract with the Ministry of Defence
in
the United Kingdom. We also own a 50% interest in each of two joint ventures
that provide the construction and the related support services to Aspire
Defence. The project is funded through equity and subordinated debt provided
by
the project sponsors and the issuance of publicly held senior bonds. The
entities we hold an interest in are considered variable interest entities.
We
are not the primary beneficiary of these entities. We account for our interests
in each of the entities using the equity method of accounting. As of June 30,
2006, the aggregate total assets and total liabilities of the variable interest
entities were $2.9 billion each. Our maximum exposure to project company losses
as of June 30, 2006 is limited to our equity investments totaling $4 million
and
our commitment to fund debt totaling approximately $100 million. Our maximum
exposure to construction and operating joint venture losses is limited to the
funding of any future losses incurred by those entities.
Note
18. New Accounting Standards
In
June
2006, the FASB issued FASB Interpretation No. 48 (FIN 48), “Accounting for
Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109.” This
interpretation clarifies the accounting for uncertainty in income taxes
recognized in an enterprise’s financial statements in accordance with FASB
Statement No. 109, “Accounting for Income Taxes.” The interpretation prescribes
a recognition threshold and measurement attribute for a tax position taken
or
expected to be taken in a tax return and also provides guidance on
derecognition, classification, interest and penalties, accounting in interim
periods, disclosure, and transition. The provisions of FIN 48 are effective
for
fiscal years beginning after December 31, 2006. We are currently evaluating
what
impact, if any, this statement will have on our financial
statements.
Item
2. Management’s Discussion and Analysis of Financial Condition and Results of
Operations
EXECUTIVE
OVERVIEW
During
the first half of 2006, the Energy Services Group (ESG) produced revenue of
$6.1
billion and operating income of $1.5 billion, reflecting an operating margin
of
25.1%. Revenue increased $1.4 billion or 30% over the prior year period,
primarily driven by higher activity in North America, the Middle East, the
North
Sea, and Russia. In the second quarter of 2006, ESG generated record revenue
and
operating income. In the first half of 2006, operating income increased $483
million or 47% compared to the first half of 2005. Internationally, ESG
experienced 23% revenue growth and 45% operating income growth during the first
half of 2006 as compared to the first half of 2005. Increased customer drilling
and production activity, higher utilization of assets, and continued price
increases have allowed us to consistently produce improved revenue and operating
income.
For
the
first six months of 2006, KBR revenue was down $426 million to $4.7 billion
with
operating income decreasing $184 million to $21 million. The revenue decline
was
primarily due to decreased military support activities in Iraq.
In
July
2006, the United States Army announced it would rebid the LogCAP III contract
for logistical support that KBR provided in Iraq. KBR is eligible to bid on
the
future work, as the Army has determined it wants multiple service providers
to
perform the work currently provided entirely by us. In the first six months
of
2006, Iraq-related work contributed approximately $2.4 billion to consolidated
revenue and $74 million to consolidated operating income, resulting in a 3.1%
margin before corporate costs and taxes. KBR was awarded $68 million in LogCAP
award fees during the first quarter of 2006 as a result of our performance
rating. During the almost five-year period we have worked under this contract,
we have been awarded 42 “excellent” ratings out of 54 total
ratings.
In
the
second quarter of 2006, we recorded a $148 million charge, before income taxes
and minority interest, related to our consolidated 50% owned gas-to-liquids
project in Escravos, Nigeria. This charge was primarily attributable to
increases in the overall estimated cost to complete the project. The project
is
approximately 30% complete as of June 30, 2006. The project has experienced
delays relating to civil unrest and security on the Escravos River, near the
project site. Further delays have resulted from scope changes and engineering
and construction modifications. We are currently discussing with the majority
owner of our customer several contract changes to mitigate our construction
risk
associated with this contract. We have reached a preliminary agreement with
our
customer and are working on a final agreement to fund the $200 million in
change orders. We are continuing discussions regarding additional contract
changes related to scheduled completion, site access and security, and other
factors to mitigate our future risks on this project.
In
May
2006, we completed the sale of KBR’s Production Services group, which was part
of our Energy and Chemicals segment. In connection with the sale, we received
net proceeds of $265 million. The sale of Production Services resulted in a
pretax gain of $123 million in the second quarter of 2006. As a result of the
sale agreement in March 2006, Production Services operations and assets and
liabilities were classified as discontinued operations, and all prior periods
presented were reclassified as well.
We
intend
to completely separate KBR, Inc. from Halliburton as expeditiously as possible
through a tax-free dividend distribution of KBR, Inc. stock to Halliburton
stockholders. The distribution will be preceded by the filing of a Form 10
registration statement with the United States Securities and Exchange Commission
(SEC) to register the shares of KBR, Inc. stock under the Securities Exchange
Act of 1934. After the distribution, KBR, Inc. will be a separately traded
public company.
The
distribution of KBR, Inc. stock may be preceded by an initial public offering
(IPO) of less than 20% of KBR, depending on market conditions for initial public
offerings, valuations for publicly-traded engineering and construction
companies, and KBR-specific business conditions and results of operations.
In
April 2006, KBR, Inc. filed a Registration Statement on Form S-1 with the SEC
for an IPO of less than 20% of KBR, Inc. Since the initial filing,
however, the market for initial public offerings has become less favorable,
which has resulted in many offerings being postponed or withdrawn. In addition,
recently announced operating results on KBR’s Escravos project and the outcome
of ongoing discussions with our customer on the Escravos project about
mitigating future risk could impact the desirability or timing of a KBR, Inc.
IPO. We do not intend to delay the complete separation of KBR to wait on
favorable conditions for an IPO of KBR, Inc.
Before
making the distribution of KBR, Inc. stock, we intend to seek a ruling from
the
Internal Revenue Service that, among other things, no gain or loss will be
recognized by Halliburton or its stockholders as a result of a distribution
of
KBR stock, a process that could be completed within approximately nine months.
Prior to the IPO or separation occurring, we will enter into various agreements
to govern the separation of KBR from us, including, among others, a master
separation agreement, transition services agreements, and a tax sharing
agreement. The master separation agreement will provide for, among other things,
KBR’s responsibility for liabilities relating to its business and Halliburton’s
responsibility for liabilities unrelated to KBR’s business. Halliburton expects
to provide indemnification in favor of KBR under the master separation agreement
for certain contingent liabilities. The Halliburton performance guarantees
and
letter of credit guarantees that are currently in place in favor of KBR’s
customers or lenders will continue after the separation of KBR until these
guarantees expire by their terms, although KBR will compensate Halliburton
for
these guarantees and indemnify Halliburton if Halliburton is required to perform
under any of these guarantees. The tax sharing agreement will provide for
allocations of United States income tax liabilities and other agreements between
us and KBR with respect to tax matters. Under the transition services
agreements, we expect to continue providing various interim corporate support
services to KBR, and KBR will continue to provide various interim corporate
support services to us.
Any
sale
of KBR, Inc. stock under a Form S-1 would be registered under the Securities
Act
of 1933, and such shares of common stock would only be offered and sold by
means
of a prospectus. This quarterly report does not constitute an offer to sell
or
the solicitation of any offer to buy any securities of KBR, and there will
not
be any sale of any such securities in any state in which such offer,
solicitation, or sale would be unlawful prior to registration or qualification
under the securities laws of such state.
In
the
first quarter of 2006, KBR recorded a $26 million impairment charge and $4
million in losses related to our investment in a railway joint venture in
Australia. This joint venture has sustained losses since the railway commenced
operations in early 2004 and is now likely to violate certain of the joint
venture’s financial loan covenants in the future. We received revised financial
forecasts from the joint venture during the first quarter. As compared to prior
forecasts, these forecasts took into account decreases in anticipated freight
volume related to delays in mining of minerals, as well as a slowdown in the
planned expansion of the Port of Darwin. Because of this new information, we
recorded an impairment charge during the first quarter.
In
April
2006, KBR, Petrobras, and the project lenders agreed to technical and
operational acceptance of the completed Barracuda and Caratinga production
vessels. This agreement will not affect the bolt arbitration.
In
March
2006, Petrobras submitted to arbitration a $220 million claim related to the
Barracuda-Caratinga project. The submission claimed that certain subsea flowline
bolts failed and that the replacement of these bolts was our responsibility.
We
disagree with the Petrobras claim since the bolts met Petrobras’ design
specification, and we do not believe there is any basis for the amount claimed
by Petrobras. We have examined possible solutions to the problem and determined
the cost would not exceed $140 million. We are defending ourselves in the
arbitration process and will pursue recovery of our costs associated with this
defense.
In
May
2006, our Board of Directors approved a dividend for the second quarter of
2006
to shareholders of record at the close of business on June 1, 2006 of $0.075
per
share, payable on June 22, 2006. The Board of Directors also finalized the
terms
of a two-for-one common stock split, following the shareholder approval at
the
2006 annual shareholders meeting of a proposal to increase the number of
authorized shares of common stock from one billion shares to two billion shares.
On July 14, 2006, each shareholder of record as of June 23, 2006, received
one
additional share for each outstanding share held. All periods presented have
been adjusted to reflect the stock common split.
In
February 2006, our Board of Directors approved a share repurchase program of
up
to $1.0 billion. For the three and six months ended June 30, 2006, we
repurchased approximately 3.8 million and 5 million shares of our common stock
at an average price of $35.94 and $35.55, respectively. The total cost of
repurchasing the 5 million shares was approximately $178 million.
In
January 2006, we adopted Statement of Financial Accounting Standards No. 123
(revised 2004), “Share-Based Payment” (SFAS No. 123(R)) and began expensing the
cost of our employee stock option awards and our employee stock purchase plan.
These costs totaled approximately $20 million in the first six months of 2006
and are in addition to $15 million in costs we have historically expensed
related to other equity compensation and $8 million of incremental compensation
cost related to modifications of previously granted stock-based awards retained
when certain employees left the company. All expense related to stock
compensation awards was charged to the segments to which each affected employee
is assigned.
The
outlook for our business remains favorable. Stronger than historical commodity
prices, a lack of oil in storage compared to other periods when prices have
been
historically high, and continuing strong cash flow are driving increased
spending plans for our exploration and production customers. We believe oil
and
gas prices will fluctuate in the future. United States natural gas prices have
declined during the first six months of 2006 driven by record storage levels
and
are predicted to continue to be volatile during the second half of 2006. If
this
trend continues, it could have a negative impact on North American operations.
We expect the energy services sector in regions outside North America to grow.
Therefore, we are investing resources in Russia, Libya, Angola, the North Sea,
and Saudi Arabia. These investments are consistent with our initiative to
increase our Eastern Hemisphere growth.
For
the
remainder of 2006, we will continue to focus on:
|
-
|
improving
the utilization of our equipment and deploying additional resources
to
address the growing demand for our services and products, in particular,
our pressure pumping services and directional drilling and formation
evaluation tools;
|
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-
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increasing
pricing and reducing discounts, as the market allows, for ESG’s services
and products due to expected labor and material cost increases and
high
demand from customers;
|
|
-
|
leveraging
our technologies to provide our customers with the ability to more
efficiently drill and complete their wells and to increase their
productivity;
|
|
-
|
capitalizing
on the liquefied natural gas (LNG) and gas-to-liquids (GTL) markets.
Forecasted LNG market growth remains strong and is expected to grow
further. Significant numbers of new LNG liquefaction plant and LNG
receiving terminal projects are proposed worldwide and are in various
stages of development. We are currently in the bidding process for
several
LNG and GTL projects, and expect to receive decisions on those in
the next
few quarters;
|
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diversifying
the services of our Government and Infrastructure segment. With the
expected rebid of the LogCAP contract, we are focused on diversifying
the
Government and Infrastructure project portfolio. We continue to expand
our
work for the United States Navy under the CONCAP construction contingency
contract and are positioned for future contingency work for the United
States Air Force under the AFCAP contract. In addition, we have
strengthened our position with the United Kingdom Ministry of Defence,
as
we were awarded in April 2006, along with our joint venture partner,
the
$13.9 billion 35-year Allenby and Connaught project,
and
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maintaining
our ESG growth initiative both domestically and internationally through
capital expenditures of approximately $850 million during 2006 and
between
$1.0 and $1.2 billion in 2007.
|
Detailed
discussions of the Foreign Corrupt Practices Act investigations and our
liquidity and capital resources follow. Our operating performance is described
in “Business Environment and Results of Operations” below.
Foreign
Corrupt Practices Act investigations
The
United States Securities and Exchange Commission (SEC) is conducting a formal
investigation into whether improper payments were made to government officials
in Nigeria through the use of agents or subcontractors in connection with the
construction and subsequent expansion by TSKJ of a multibillion dollar natural
gas liquefaction complex and related facilities at Bonny Island in Rivers State,
Nigeria. The United States Department of Justice (DOJ), is also conducting
a
related criminal investigation. The SEC has also issued subpoenas seeking
information, which we are furnishing, regarding current and former agents used
in connection with multiple projects over the past 20 years located both in
and
outside of Nigeria in which The M .W. Kellogg Company, M. W. Kellogg, Ltd.,
Kellogg Brown & Root or their joint ventures, as well as the Halliburton
energy services business, were participants.
TSKJ
is a
private limited liability company registered in Madeira, Portugal whose members
are Technip SA of France, Snamprogetti Netherlands B.V. (a subsidiary of Saipem
SpA of Italy), JGC Corporation of Japan, and Kellogg Brown & Root (a
subsidiary of ours and successor to The M.W. Kellogg Company), each of which
has
a 25% interest in the venture. TSKJ and other similarly owned entities entered
into various contracts to build and expand the liquefied natural gas project
for
Nigeria LNG Limited, which is owned by the Nigerian National Petroleum
Corporation, Shell Gas B.V., Cleag Limited (an affiliate of Total), and Agip
International B.V. (an affiliate of ENI SpA of Italy). M.W. Kellogg Limited
is a
joint venture in which we have a 55% interest; and M.W. Kellogg Limited and
The
M.W. Kellogg Company were subsidiaries of Dresser Industries before our 1998
acquisition of Dresser Industries. The M.W. Kellogg Company was later merged
with a subsidiary of ours to form Kellogg Brown & Root, one of our
subsidiaries.
The
SEC
and the DOJ have been reviewing these matters in light of the requirements
of
the United States Foreign Corrupt Practices Act (FCPA). In addition to
performing our own investigation, we have been cooperating with the SEC and
the
DOJ investigations and with other investigations into the Bonny Island project
in France, Nigeria and Switzerland. Our Board of Directors has appointed a
committee of independent directors to oversee and direct the FCPA
investigations.
The
matters under investigation related to the Bonny Island project cover an
extended period of time (in some cases significantly before our 1998 acquisition
of Dresser Industries). We have produced documents to the SEC and the DOJ both
voluntarily and pursuant to company subpoenas from the files of numerous
officers of Halliburton and KBR, including current and former executives of
Halliburton and KBR, and we are making our employees available to the SEC and
the DOJ for interviews. In addition, we understand that the SEC has issued
a
subpoena to A. Jack Stanley, who formerly served as a consultant and chairman
of
KBR, and to others, including certain of our current and former KBR employees,
former executive officers of KBR, and at least one subcontractor of KBR. We
further understand that the DOJ has invoked its authority under a sitting grand
jury to issue subpoenas for the purpose of obtaining information abroad, and
we
understand that other partners in TSKJ have provided information to the DOJ
and
the SEC with respect to the investigations, either voluntarily or under
subpoenas.
The
SEC
and DOJ investigations include an examination of whether TSKJ’s engagements of
Tri-Star Investments as an agent and a Japanese trading company as a
subcontractor to provide services to TSKJ were utilized to make improper
payments to Nigerian government officials. In connection with the Bonny Island
project, TSKJ entered into a series of agency agreements, including with
Tri-Star Investments, of which Jeffrey Tesler is a principal, commencing in
1995
and a series of subcontracts with a Japanese trading company commencing in
1996.
We understand that a French magistrate has officially placed Mr. Tesler under
investigation for corruption of a foreign public official. In Nigeria, a
legislative committee of the National Assembly and the Economic and Financial
Crimes Commission, which is organized as part of the executive branch of the
government, are also investigating these matters. Our representatives have
met
with the French magistrate and Nigerian officials. In October 2004,
representatives of TSKJ voluntarily testified before the Nigerian legislative
committee.
As
a
result of these investigations, information has been uncovered suggesting that,
commencing at least 10 years ago, members of TSKJ planned payments to Nigerian
officials. We have reason to believe, based on the ongoing investigations,
that
payments may have been made to Nigerian officials.
We
notified the other owners of TSKJ of information provided by the investigations
and asked each of them to conduct their own investigation. TSKJ has suspended
the receipt of services from and payments to Tri-Star Investments and the
Japanese trading company and has considered instituting legal proceedings to
declare all agency agreements with Tri-Star Investments terminated and to
recover all amounts previously paid under those agreements. In February 2005,
TSKJ notified the Attorney General of Nigeria that TSKJ would not oppose the
Attorney General’s efforts to have sums of money held on deposit in banks in
Switzerland transferred to Nigeria and to have the legal ownership of such
sums
determined in the Nigerian courts.
In
June
2004, all relationships with Mr. Stanley and another consultant and former
employee of M. W. Kellogg, Ltd. were terminated. The terminations occurred
because of violations of our Code of Business Conduct that allegedly involved
the receipt of improper personal benefits from Mr. Tesler in connection with
TSKJ’s construction of the Bonny Island project.
We
have
also suspended the services of another agent who has worked for KBR outside
of
Nigeria on several current projects and on numerous older projects going back
to
the early 1980’s until such time, if ever, as we can satisfy ourselves regarding
the agent’s compliance with applicable law and our Code of Business Conduct. In
addition, we are actively reviewing the compliance of an additional agent on
a
separate current Nigerian project with respect to which we have recently
received from a joint venture partner on that project allegations of wrongful
payments made by such agent.
If
violations of the FCPA were found, a person or entity found in violation could
be subject to fines, civil penalties of up to $500,000 per violation, equitable
remedies, including disgorgement, and injunctive relief. Criminal penalties
could range up to the greater of $2 million per violation or twice the gross
pecuniary gain or loss. Both the SEC and the DOJ could argue that continuing
conduct may constitute multiple violations for purposes of assessing the penalty
amounts per violation. Agreed dispositions for these types of matters sometimes
result in a monitor being appointed by the SEC and/or the DOJ to review future
business and practices with the goal of ensuring compliance with the FCPA.
Fines
and civil and criminal penalties could be mitigated, in the government’s
discretion, depending on the level of the cooperation in the
investigations.
Potential
consequences of a criminal indictment arising out of any of these investigations
could include suspension by the United States Department of Defense (DoD) or
another federal, state, or local government agency of KBR and its affiliates
from their ability to contract with United States, state or local governments,
or government agencies. If a criminal or civil violation were found, KBR and
its
affiliates could be debarred from future contracts or new orders under current
contracts to provide services to any such parties. During 2005, KBR and its
affiliates had revenue of approximately $6.6 billion from its government
contracts work with agencies of the United States or state or local governments.
If necessary, we would seek to obtain administrative agreements or waivers
from
the DoD and other agencies to avoid suspension or debarment. Suspension or
debarment from the government contracts business would have a material adverse
effect on the business, results of operations, and cash flows of KBR and
Halliburton.
These
investigations could also result in third-party claims against us, which may
include claims for special, indirect, derivative or consequential damages,
damage to our business or reputation, loss of, or adverse effect on, cash flow,
assets, goodwill, results of operations, business, prospects, profits or
business value, adverse consequences on our ability to obtain or continue
financing for current or future projects or claims by directors, officers,
employees, affiliates, advisors, attorneys, agents, debt holders or other
interest holders or constituents of us or our subsidiaries. In addition, we
could incur costs and expenses for any monitor required by or agreed to with
governmental authority to review our continued compliance with FCPA
law.
As
of
June 30, 2006, we have not accrued any amounts related to these investigations
other than our current legal expenses.
Bidding
practices investigation
In
connection with the investigation into payments related to the Bonny Island
project in Nigeria, information has been uncovered suggesting that Mr. Stanley
and other former employees may have engaged in coordinated bidding with one
or
more competitors on certain foreign construction projects, and that such
coordination possibly began as early as the mid-1980s.
On
the
basis of this information, we and the DOJ have broadened our investigations
to
determine the nature and extent of any improper bidding practices, whether
such
conduct violated United States antitrust laws, and whether former employees
may
have received payments in connection with bidding practices on some foreign
projects.
If
violations of applicable United States antitrust laws occurred, the range of
possible penalties includes criminal fines, which could range up to the greater
of $10 million in fines per count for a corporation, or twice the gross
pecuniary gain or loss, and treble civil damages in favor of any persons
financially injured by such violations. Criminal prosecutions under applicable
laws of relevant foreign jurisdictions and civil claims by, or relationship
issues with customers, are also possible.
As
of
June 30, 2006, we had not accrued any amounts related to this investigation
other than our current legal expenses.
LIQUIDITY
AND CAPITAL RESOURCES
We
ended
the second quarter of 2006 with cash and equivalents of $3.7 billion compared
to
$2.4 billion at December 31, 2005.
Significant
sources of cash
Cash
flows from operations contributed $1.6 billion to cash in the first six months
of 2006. In the second quarter of 2006, we completed the sale of KBR’s
Production Services group, which was part of our Energy and Chemicals segment.
In connection with the sale, we received net proceeds of $265 million. Our
working capital requirements for our Iraq-related work, excluding cash and
equivalents, decreased from $495 million at December 31, 2005 to $404 million
at
June 30, 2006.
We
received approximately $91 million in asbestos- and silica-related insurance
proceeds in the first six months of 2006 and expect to receive additional
amounts as follows:
Millions
of dollars
|
|
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|
July
1 through December 31, 2006
|
|
$
|
76
|
|
2007
|
|
|
68
|
|
2008
|
|
|
46
|
|
2009
|
|
|
131
|
|
2010
|
|
|
16
|
|
Total
|
|
$
|
337
|
|
During
the first quarter of 2005, we sold $891 million in investments in marketable
securities and received approximately $200 million from the sale of our 50%
interest in Subsea 7, Inc.
Further
available sources of cash. In
the
first quarter of 2005, we entered into an unsecured $1.2 billion five-year
revolving credit facility for general working capital purposes. The credit
facility has a letter of credit issued under it with a balance of $49 million
as
of June 30, 2006. There were no cash drawings under the unsecured $1.2 billion
revolving credit facility as of June 30, 2006.
KBR
entered into an unsecured $850 million five-year revolving credit facility
in
the fourth quarter of 2005. Letters of credit that totaled $33 million were
subsequently issued under the KBR revolving credit facility, thus reducing
the
availability under the credit facility to approximately $817 million at June
30,
2006. There were no cash drawings under the unsecured $850 million revolving
credit facility as of June 30, 2006.
Significant
uses of cash
Capital
expenditures of $381 million in the first six months of 2006 were 32% higher
than in the first six months of 2005. Capital spending in the first six months
of 2006 was primarily directed to the Energy Services Group for the Production
Optimization, Drilling and Formation Evaluation, and Fluid Systems
segments.
In
February 2006, our Board of Directors approved a share repurchase program of
up
to $1.0 billion. During the first six months of 2006, we repurchased
approximately five million shares of our common stock at a cost of approximately
$178 million, or an average price per share of $35.55. The Board of Directors
also approved a dividend for the second quarter of 2006 to shareholders of
record at the close of business on June 1, 2006 of $0.075 per share, payable
on
June 22, 2006. We paid $155 million in dividends to our shareholders in the
first six months of 2006. We repurchased $41 million of debt at a total cost
of
$49 million in the first six months of 2006.
In
the
first six months of 2006, we contributed a total of $142 million to our
international pension plans, which included ESG contributing $43 million, and
KBR contributing $94 million to the United Kingdom pension plans. We expect
the
total amount contributed in 2006 for all pension plans to be approximately
$162
million.
We
also
continued to fund operating cash shortfalls on the Barracuda-Caratinga project,
a multiyear construction project to develop the Barracuda and Caratinga crude
oilfields off the coast of Brazil. During the first six months of 2006, we
funded approximately $34 million, net of revenue received.
Future
uses of cash.
Capital
spending for 2006 is expected to be approximately $850 million and approximately
$1.0 to $1.2 billion for 2007. The capital expenditures budget for 2006 includes
a steady level of activities related to our DML shipyard and increased spending
in the Energy Services Group to accommodate higher activity
levels.
In
future
periods, we expect to make $1.0 billion to $2.0 billion annually in acquisitions
in order to add to our oilfield products and technologies.
As
of
June 30, 2006, we had commitments to fund approximately $124 million to related
companies. These commitments arose primarily during the start-up of these
entities or due to losses incurred by them. We expect approximately $7 million
of the commitments to be paid during the remainder of 2006.
In
the
third quarter of 2006, our $275 million medium-term notes will mature. At June
30, 2006, these notes were included in “Current maturities of long-term debt” in
the condensed consolidated balance sheet.
Other
factors affecting liquidity
Accounts
receivable securitization facilities.
In April
2002, we entered into an agreement to sell eligible United States Energy
Services Group accounts receivable to a bankruptcy-remote limited-purpose
funding subsidiary. As of December 31, 2004, we had sold $256 million of
undivided ownership interest to unaffiliated companies. During the fourth
quarter of 2005, these receivables were collected and the balance retired.
No
further receivables were sold, and the facility was terminated in the first
quarter of 2006.
In
May
2004, we entered into an agreement to sell, assign, and transfer the entire
title and interest in specified United States government accounts receivable
of
KBR to a third party. The face value of the receivables sold to the third party
was reflected as a reduction of accounts receivable in our condensed
consolidated balance sheets. The total amount of receivables outstanding under
this agreement was approximately $257 million as of June 30, 2005. As of
December 31, 2005, these receivables were collected, the balance was retired,
and the facility was terminated.
Letters
of credit.
In the
normal course of business, we have agreements with banks under which
approximately $1.1 billion of letters of credit or bank guarantees were
outstanding as of June 30, 2006, including $564 million that relate to our
joint
ventures’ operations. Also included in the letters of credit outstanding as of
June 30, 2006 were $8 million of performance letters of credit and $56 million
of retainage letters of credit related to the Barracuda-Caratinga project.
Some
of the outstanding letters of credit have triggering events that would entitle
a
bank to require cash collateralization.
Credit
ratings. Our
current ratings are BBB+ on Standard & Poor’s and Baa1 on Moody’s Investors
Service. In the second quarter of 2006, Standard & Poor’s revised its
long-term senior unsecured debt rating from BBB to BBB+ with a “stable” outlook
due to the significant improvement in ESG operating performance and the
considerable reduction in debt over the past year. In the fourth quarter of
2005, Moody’s revised its long-term senior unsecured debt rating from Baa2 to
Baa1 with a “stable” outlook. In the first quarter of 2005, Standard &
Poor’s revised its credit watch listing for us from “developing” to “stable” and
its short-term credit and commercial paper rating from A-3 to A-2. Our Moody’s
Investors Service short-term credit and commercial paper rating is
P-2.
Debt
covenants.
Letters
of credit related to our Barracuda-Caratinga project and our $1.2 billion
revolving credit facility contain restrictive covenants, including covenants
that require us to maintain financial ratios as defined by the agreements.
For
the letters of credit related to our Barracuda-Caratinga project, we are
required to maintain interest coverage and leverage ratios. We are also required
to maintain a minimum debt-to-capitalization ratio under our $1.2 billion
revolving credit facility. At June 30, 2006, we were in compliance with these
requirements.
In
addition, the unsecured $850 million five-year revolving credit facility entered
into by KBR contains covenants including a limitation on the amount KBR can
invest in unconsolidated subsidiaries. KBR must also maintain financial ratios
including a debt-to-capitalization ratio, a leverage ratio, and a fixed charge
coverage ratio. At June 30, 2006, KBR was in compliance with these
requirements.
BUSINESS
ENVIRONMENT AND RESULTS OF OPERATIONS
We
currently operate in about 100 countries throughout the world. We provide a
comprehensive range of discrete and integrated services and products to the
energy industry and to other industrial and governmental customers. The majority
of our consolidated revenue is derived from the sale of services and products
to
major, national, and independent oil and gas companies and governments around
the world. The services and products provided to major, national, and
independent oil and gas companies are used throughout the energy industry from
the earliest phases of exploration, development, and production of oil and
gas
through refining, processing, and marketing. We have six business segments:
Production Optimization, Fluid Systems, Drilling and Formation Evaluation,
Digital and Consulting Solutions, Government and Infrastructure, and Energy
and
Chemicals. We refer to the combination of Production Optimization, Fluid
Systems, Drilling and Formation Evaluation, and Digital and Consulting Solutions
segments as ESG, and the combination of Government and Infrastructure and Energy
and Chemicals as KBR.
The
industries we serve are highly competitive with many substantial competitors
for
each segment. In the first six months of 2006, based upon the location of the
services provided and products sold, 33% of our consolidated revenue was from
the United States, and 19% of our consolidated revenue was from Iraq, primarily
related to work for the United States Government. In the first six months of
2005, 29% of our consolidated revenue was from Iraq, and 26% of our consolidated
revenue was from the United States. No other country accounted for more than
10%
of our revenue during these periods.
Operations
in some countries may be adversely affected by unsettled political conditions,
acts of terrorism, civil unrest, force majeure, war or other armed conflict,
expropriation or other governmental actions, inflation, exchange controls,
or
currency devaluation. Except for our government services work in Iraq discussed
above, we believe the geographic diversification of our business activities
reduces the risk that loss of operations in any one country would be material
to
our consolidated results of operations.
Halliburton
Company
Activity
levels within our business segments are significantly impacted by the
following:
|
-
|
spending
on upstream exploration, development, and production programs by
major,
national, and independent oil and gas
companies;
|
|
-
|
capital
expenditures for downstream refining, processing, petrochemical,
gas
monetization, and marketing facilities by major, national, and independent
oil and gas companies; and
|
|
-
|
government
spending levels.
|
Also
impacting our activity is the status of the global economy, which impacts oil
and gas consumption, demand for petrochemical products, and investment in
infrastructure projects.
Energy
Services Group
Some
of
the more significant indicators of current and future spending levels of oil
and
gas companies are oil and gas prices, exploration and production spending by
international and national oil companies, the world economy, and global
stability, which together drive worldwide drilling activity. Our ESG financial
performance is significantly affected by oil and gas prices and worldwide rig
activity, which are summarized in the following tables.
This
table shows the average oil and gas prices for West Texas Intermediate (WTI)
crude oil, United Kingdom Brent, and Henry Hub natural gas:
|
|
Three
Months Ended
|
|
Year
Ended
|
|
|
|
June
30
|
|
December
31
|
|
Average
Oil Prices (dollars
per barrel)
|
|
2006
|
|
2005
|
|
2005
|
|
West
Texas Intermediate
|
|
$
|
70.52
|
|
$
|
52.86
|
|
$
|
56.30
|
|
United
Kingdom Brent
|
|
|
69.58
|
|
|
51.58
|
|
|
54.45
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
United States Gas Prices (dollars
per million British
|
|
|
|
|
|
|
|
|
|
|
thermal
units, or mmBtu)
|
|
|
|
|
|
|
|
|
|
|
Henry
Hub
|
|
$
|
6.59
|
|
$
|
6.95
|
|
$
|
8.79
|
|
The
quarterly and yearly average rig counts based on the Baker Hughes Incorporated
rig count information were as follows:
|
|
Three
Months Ended
|
|
Six
Months Ended
|
|
|
|
June
30
|
|
June
30
|
|
Land
vs. Offshore
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
United
States:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Land
|
|
|
1,536
|
|
|
1,243
|
|
|
1,487
|
|
|
1,211
|
|
Offshore
|
|
|
97
|
|
|
93
|
|
|
89
|
|
|
97
|
|
Total
|
|
|
1,633
|
|
|
1,336
|
|
|
1,576
|
|
|
1,308
|
|
Canada:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Land
|
|
|
279
|
|
|
238
|
|
|
471
|
|
|
378
|
|
Offshore
|
|
|
3
|
|
|
3
|
|
|
3
|
|
|
3
|
|
Total
|
|
|
282
|
|
|
241
|
|
|
474
|
|
|
381
|
|
International
(excluding Canada):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Land
|
|
|
643
|
|
|
590
|
|
|
636
|
|
|
584
|
|
Offshore
|
|
|
270
|
|
|
269
|
|
|
269
|
|
|
253
|
|
Total
|
|
|
913
|
|
|
859
|
|
|
905
|
|
|
837
|
|
Worldwide
total
|
|
|
2,828
|
|
|
2,436
|
|
|
2,955
|
|
|
2,526
|
|
Land
total
|
|
|
2,458
|
|
|
2,071
|
|
|
2,594
|
|
|
2,173
|
|
Offshore
total
|
|
|
370
|
|
|
365
|
|
|
361
|
|
|
353
|
|
|
|
Three
Months Ended
|
|
Six
Months Ended
|
|
|
|
June
30
|
|
June
30
|
|
Oil
vs. Gas
|
|
2006
|
|
2005
|
|
2006
|
|
2005
|
|
United
States:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Oil
|
|
|
268
|
|
|
156
|
|
|
250
|
|
|
171
|
|
Gas
|
|
|
1,365
|
|
|
1,180
|
|
|
1,326
|
|
|
1,137
|
|
Total
|
|
|
1,633
|
|
|
1,336
|
|
|
1,576
|
|
|
1,308
|
|
Canada:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Oil
|
|
|
65
|
|
|
61
|
|
|
95
|
|
|
77
|
|
Gas
|
|
|
217
|
|
|
180
|
|
|
379
|
|
|
304
|
|
Total
|
|
|
282
|
|
|
241
|
|
|
474
|
|
|
381
|
|
International
(excluding Canada):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Oil
|
|
|
698
|
|
|
658
|
|
|
694
|
|
|
635
|
|
Gas
|
|
|
215
|
|
|
201
|
|
|
211
|
|
|
202
|
|
Total
|
|
|
913
|
|
|
859
|
|
|
905
|
|
|
837
|
|
Worldwide
total
|
|
|
2,828
|
|
|
2,436
|
|
|
2,955
|
|
|
2,526
|
|
Our
customers’ cash flows, in many instances, depend upon the revenue they generate
from the sale of oil and gas. Higher oil and gas prices usually translate into
higher exploration and production budgets. Higher prices also improve the
economic attractiveness of marginal exploration areas. This drives additional
investment by our customers in the sector, which benefits us. The opposite
is
true for lower oil and gas prices.
Oil
prices for both Brent and WTI crude continued to trend upward in the second
quarter of 2006, averaging approximately $70 per barrel. In July 2006, oil
prices continued to rise to record levels. Oil prices continue to remain
high due to a combination of the following factors:
|
-
|
growth
in worldwide petroleum demand remains robust, despite high oil
prices;
|
|
-
|
projected
growth in non-Organization of Petroleum Exporting Countries supplies
is
not expected to accommodate worldwide demand
growth;
|
|
-
|
worldwide
spare crude oil production capacity continues to remain
low;
|
|
-
|
downstream
sectors, such as refining and shipping, are expected to keep the
level of
uncertainty in world oil markets high as there is limited refining
capacity available, particularly in the United States;
and
|
|
-
|
fear
of possible supply disruptions from Organization of Petroleum Exporting
Countries Iran, Iraq, Nigeria, and Venezuela due to political or
social
circumstances.
|
It
is
common practice in the United States oilfield services industry to sell services
and products based on a price book and then apply discounts to the price book
based upon a variety of factors. The discounts applied typically increase to
partially or substantially offset price book increases in the weeks immediately
following a price increase. The discount applied normally decreases over time
if
the activity levels remain strong. During periods of reduced activity, discounts
normally increase, reducing the revenue for our services and, conversely, during
periods of higher activity, discounts normally decline resulting in revenue
increasing for our services.
During
the first half of 2006, the price increases we implemented during the fourth
quarter of 2005 increased revenue and operating income across all segments.
Additionally, an average price book increase of 5% for software products in
our
Digital and Consulting Solutions segment was implemented in January 2006. We
are
now focused on continuing to implement the recent price book increases when
our
customers’ contracts renew and on working down customer discounts. From April
2006 to July 2006, we implemented several United States price book increases
ranging from 5% to 12%, led by our pressure pumping services. We will continue
to evaluate future United States price book increases.
Overall
outlook.
The
outlook for world oil demand continues to remain strong, with China and North
America accounting for approximately 38% of the expected demand growth in 2006.
The Chinese rate of demand growth rebounded in the second quarter of 2006,
and
oil demand growth is continuing in other populous countries, including India.
Excess oil production capacity is expected to remain constrained and that,
along
with strong demand, is expected to keep supplies tight. Thus, any unexpected
supply disruption or change in demand could lead to fluctuating prices. The
International Energy Agency continues to forecast world petroleum demand growth
in 2006 to increase 2% over 2005. Our customers have indicated they intend
to
continue their increased spending patterns throughout 2006. The increasing
duration of contracts being signed for drilling rigs indicates that the strong
market in the oil service sector is likely to continue.
On
a
geographic basis, our business is well-positioned in North America, where our
revenue grew over $28 million since the first quarter of 2006. One of our
fastest growing operations in this region is production enhancement, where
we
help our customers optimize their wells’ production rates by providing
stimulation services. Among the other opportunities we expect is the growth
of
deepwater drilling. Although overall rigs in the Gulf of Mexico are expected
to
decrease in 2006, demand to drill in the deepwater of the Gulf of Mexico is
increasing. Despite having downsized our Gulf of Mexico operations due to its
downturn in 2002-2003, we continue to have a significant presence in the area
and are positioned to meet increasing customer demand. As a result, our revenue
from the Gulf of Mexico was up 19% year-over-year, which contributed to a 67%
increase in operating income in the Gulf of Mexico. Despite the significant
reduction in rig activity during the spring break-up season, our revenue from
Canada compared to the first half of 2005 was up 38%, driven primarily by the
Production Optimization segment.
During
the first half of 2006, we increased our international revenue by 23% or $622
million compared to the first half of 2005.
In
the
Middle East/Asia region, Saudi Arabia experienced 57% revenue growth compared
to
the first half of 2005, due to increased activity, led by the Drilling and
Formation Evaluation segment. A tool repair center was opened in Jebel Ali
in
the United Arab Emirates to help increase tool utilization by decreasing repair
times in the Middle East and returning damaged tools back into service. In
July
2006, we signed an agreement to provide the oilfield services component for
the
Saudi Aramco Al Khurais mega project. In the Asia Pacific area, China and
Australia led revenue growth compared to the first half of last year, with
Brunei and Sakhalin demonstrating large percentage revenue
growth.
In
our
Europe/Africa/CIS region, North Sea activity has continued to grow with Norway,
the United Kingdom, and the Netherlands accounting for almost $62 million of
revenue growth compared to the first half of 2005 led by the Production
Optimization segment. In the second quarter of 2006, we signed a $193 million
contract for cementing services, pumping, and drilling and completion fluids
in
Norway. Also in the second quarter, we signed an estimated $100 million contract
to provide completion products and services for oil and gas operations in the
United Kingdom, the Netherlands, Norway, and Ireland. In July 2006, we signed
a
$150 million contract to provide integrated drilling and well services in
Norway. Russia experienced strong revenue and operating income growth compared
to a slow first quarter due to extreme winter weather conditions. Activity
in
Africa has been volatile, but has experienced overall revenue growth of $92
million, representing a 21% increase compared to the first half of 2005. Fluid
Systems growth in both Nigeria and Angola, coupled with Production Optimization
growth across the region, accounted for the largest part of the revenue growth.
We are continuing to deploy additional logging and cementing equipment and
personnel into Libya where we expect to see growth later this year.
In
Latin
America, we experienced 9% revenue growth during the first six months of 2006
compared to the first six months of 2005, despite a decrease in revenue from
Mexico. This came from growth in excess of 40% from both Colombia and Ecuador,
both aided by the Fluid Systems contract start-ups that began in 2005, as well
as double digit growth in Brazil, Argentina, and Venezuela. The revenue decline
in Mexico resulted from lower activity on the turnkey drilling project, which
began in 2004 and was completed in July of 2006.
As
drilling activity remains strong, demand for Sperry Drilling Services is high
in
most regions of the world. As these services have high margins associated with
them, we have made the decision to increase our capital spending in this area,
especially for international markets.
Finally,
technology is an important aspect of our business, and we continue to focus
on
the development, introduction, and application of new technologies. We expect
our 2006 investment in new technology to increase compared to our 2005
investment of $220 million in research and development costs.
KBR
KBR
provides a wide range of services to energy, chemical, and industrial customers
and government entities worldwide. KBR’s customer base includes leading national
and international oil and gas companies, independent refiners, petrochemical
producers, fertilizer producers, and domestic and foreign government entities.
KBR projects are generally longer-term in nature than our ESG work and are
impacted by more diverse drivers than short-term fluctuations in oil and gas
prices and drilling activities, such as local economic cycles, introduction
of
new governmental regulation, and governmental outsourcing of services. Demand
for KBR’s services depends primarily on its customers’ capital expenditures for
construction and defense services. KBR is currently benefiting from increased
capital expenditures by our petroleum and petrochemical customers driven by
high
crude oil and natural gas prices and general global economic expansion.
Additionally, the heightened focus on global security and major military force
realignments, as well as, a global expansion in government outsourcing have
all
contributed to increased demand for KBR’s services.
Our
Government and Infrastructure segment provides support services to military
and
civilian branches of governments throughout the world. The Government and
Infrastructure segment's most significant contract is the worldwide United
States Army logistics contract, known as LogCAP. We were awarded the
competitively bid LogCAP III contract in December 2001 from the Army Materiel
Command (AMC) to provide worldwide United States Army logistics services. The
contract is a one-year contract with nine one-year renewal options. We are
currently in year five of the contract.
During
the second quarter of 2005, a large task order was assigned for the next phase
of work under the LogCAP III contract in Iraq and replaces several task
orders that are nearing completion. Our government services revenue related
to
Iraq under our LogCAP III and other contracts totaled approximately $2.4 billion
in the six months ended June 30, 2006, $5.4 billion in 2005, and $7.1 billion
in
2004. We expect the volume of work under our LogCAP III contract to continue
to
decline in 2006 as our customer scales back the amount of services we provide
under this contract. The DoD has also announced that it will solicit competitive
bids for a new multiple provider LogCAP IV contract to replace the current
LogCAP III contract, under which we are the sole provider. A decrease in the
magnitude of governmental spending and outsourcing for military and logistical
support of the type that we provide could have a material adverse affect on
our
business, results of operations, and cash flow. Work related to the United
States Navy under the CONCAP construction contingency contract was also lower
during the quarter as hurricane reconstruction neared completion. In order
to
diversify our government services portfolio, we continue to expand our work
for
the United States Air Force under the AFCAP contract and for the United Kingdom
Ministry of Defence. In addition, KBR was recently awarded the competitively
bid
Indefinite Delivery/Indefinite Quantity contract to support the Department
of
Homeland Security’s United States Immigration and Customs Enforcement facilities
in the event of an emergency. This contract has a five-year term, consisting
of
a one-year base period and four one-year options.
In
the
first quarter of 2006, a $13.9 billion private finance initiative contract
was signed with the United Kingdom Ministry of Defence for the Allenby and
Connaught project. This project will be operated by a joint venture in
which we have a 45% ownership interest. The project is for 35 years and consists
of a nine-year construction project to upgrade the British Army’s garrisons at
Aldershot and the Salisbury Plain in the United Kingdom. The contract also
includes provisions for additional services to be performed over the 35-year
period, including catering, transportation, office services and
maintenance services.
In
the
civil infrastructure sector, we believe there has been a general trend of
historic under-investment. In particular, infrastructure related to the quality
of water, wastewater, roads and transportation, airports, and educational
facilities has declined while demand for expanded and improved infrastructure
continues to outpace funding. As a result, we expect increased opportunities
for
our engineering and construction services and for our privately financed project
activities as our knowledge of financing structures make us an attractive
partner for state and local governments undertaking important infrastructure
projects.
Our
Energy and Chemicals segment develops energy and chemical projects throughout
the world, including LNG and GTL gas monetization facilities, refineries,
petrochemical plants, offshore oil and gas production platforms, and synthesis
gas facilities. The major focus is on our gas monetization work. For the global
market, forecasted LNG growth remains strong and is expected to grow rapidly.
Significant numbers of new LNG liquefaction plants and LNG receiving terminal
projects are proposed worldwide and are in various stages of development.
Committed LNG liquefaction engineering, procurement, and construction (EPC)
projects will yield substantial growth in worldwide LNG liquefaction capacity.
This trend is expected to continue through 2007 and beyond.
At
June
30, 2006, we had $3.5 billion in backlog related to major gas monetization
projects.
In
the
first quarter of 2006, we signed a $400 million contract for the construction
of
the EBIC ammonia project in Egypt. This contract is a turnkey engineering,
procurement, construction, commissioning, and testing contract to design and
construct an ammonia plant. In July 2006, we signed a lump-sum services contract
for engineering, procurement, and construction management of a 1.35 million
ton-per-year ethylene plant to be built in Saudi Arabia.
In
March
2006, we signed an agreement to sell KBR’s Production Services group, which was
part of our Energy and Chemicals segment. In the second quarter of 2006, we
completed the sale of KBR’s Production Services group. Under the terms of the
agreement, we received net proceeds of $265 million resulting in a pretax gain
of approximately $123 million. As a result of the sale agreement, Production
Services operations and assets and liabilities have been classified as
discontinued operations for all periods presented.
In
order
to meet growing energy demands, oil and gas companies are increasing their
exploration, production, and transportation spending to increase production
capacity and supply. KBR is currently targeting reimbursable EPC and
engineering, procurement, and construction management opportunities in northern
and western Africa, the Caspian area, Asia Pacific, Latin America, and the
North
Sea.
Outsourcing
of operations and maintenance work by industrial and energy companies has been
increasing worldwide. Opportunities in this area are anticipated as the aging
infrastructure in United States refineries and chemical plants requires more
maintenance and repairs to minimize production downtime. More stringent industry
safety standards and environmental regulations also lead to higher maintenance
standards and costs.
Contract
structure.
Engineering and construction contracts can be broadly categorized as either
cost-reimbursable or fixed-price, sometimes referred to as lump sum. 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
predetermine both the quantities of work to be performed and the costs
associated with executing the work. While fixed-price contracts involve greater
risk, they also are potentially more profitable for the contractor, since the
owner/customer pays a premium to transfer many risks to the
contractor.
Cost-reimbursable
contracts include contracts where the price is variable based upon our actual
costs incurred for time and materials, or for variable quantities of work priced
at defined unit rates. Profit 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/customer retains many of the
risks.
We
are
continuing with our strategy to move away from offshore fixed-price engineering,
procurement, installation, and commissioning (EPIC) contracts within our Energy
and Chemicals segment. We have only two remaining major fixed-price EPIC
offshore projects. As of June 30, 2006, they were substantially
complete.
RESULTS
OF OPERATIONS IN 2006 COMPARED TO 2005
Three
Months Ended June 30, 2006 Compared with Three Months Ended June 30,
2005
|
|
Three
Months Ended
|
|
|
|
|
|
REVENUE:
|
|
June
30
|
|
Increase
|
|
Percentage
|
|
Millions
of dollars
|
|
2006
|
|
2005
|
|
(Decrease)
|
|
Change
|
|
Production
Optimization
|
|
$
|
1,292
|
|
$
|
971
|
|
$
|
321
|
|
|
33
|
%
|
Fluid
Systems
|
|
|
870
|
|
|
699
|
|
|
171
|
|
|
24
|
|
Drilling
and Formation Evaluation
|
|
|
774
|
|
|
641
|
|
|
133
|
|
|
21
|
|
Digital
and Consulting Solutions
|
|
|
180
|
|
|
160
|
|
|
20
|
|
|
13
|
|
Total
Energy Services Group
|
|
|
3,116
|
|
|
2,471
|
|
|
645
|
|
|
26
|
|
Government
and Infrastructure
|
|
|
1,881
|
|
|
2,035
|
|
|
(154
|
)
|
|
(8
|
)
|
Energy
and Chemicals
|
|
|
548
|
|
|
467
|
|
|
81
|
|
|
17
|
|
Total
KBR
|
|
|
2,429
|
|
|
2,502
|
|
|
(73
|
)
|
|
(3
|
)
|
Total
revenue
|
|
$
|
5,545
|
|
$
|
4,973
|
|
$
|
572
|
|
|
12
|
%
|
Geographic
- Energy Services Group segments only:
|
|
Production
Optimization:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North
America
|
|
$
|
771
|
|
$
|
545
|
|
$
|
226
|
|
|
41
|
%
|
Latin
America
|
|
|
95
|
|
|
85
|
|
|
10
|
|
|
12
|
|
Europe/Africa/CIS
|
|
|
250
|
|
|
199
|
|
|
51
|
|
|
26
|
|
Middle
East/Asia
|
|
|
176
|
|
|
142
|
|
|
34
|
|
|
24
|
|
Subtotal
|
|
|
1,292
|
|
|
971
|
|
|
321
|
|
|
33
|
|
Fluid
Systems:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North
America
|
|
|
450
|
|
|
346
|
|
|
104
|
|
|
30
|
|
Latin
America
|
|
|
100
|
|
|
97
|
|
|
3
|
|
|
3
|
|
Europe/Africa/CIS
|
|
|
201
|
|
|
162
|
|
|
39
|
|
|
24
|
|
Middle
East/Asia
|
|
|
119
|
|
|
94
|
|
|
25
|
|
|
27
|
|
Subtotal
|
|
|
870
|
|
|
699
|
|
|
171
|
|
|
24
|
|
Drilling
and Formation Evaluation:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North
America
|
|
|
260
|
|
|
203
|
|
|
57
|
|
|
28
|
|
Latin
America
|
|
|
114
|
|
|
102
|
|
|
12
|
|
|
12
|
|
Europe/Africa/CIS
|
|
|
179
|
|
|
167
|
|
|
12
|
|
|
7
|
|
Middle
East/Asia
|
|
|
221
|
|
|
169
|
|
|
52
|
|
|
31
|
|
Subtotal
|
|
|
774
|
|
|
641
|
|
|
133
|
|
|
21
|
|
Digital
and Consulting Solutions:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North
America
|
|
|
60
|
|
|
43
|
|
|
17
|
|
|
40
|
|
Latin
America
|
|
|
46
|
|
|
49
|
|
|
(3
|
)
|
|
(6
|
)
|
Europe/Africa/CIS
|
|
|
44
|
|
|
37
|
|
|
7
|
|
|
19
|
|
Middle
East/Asia
|
|
|
30
|
|
|
31
|
|
|
(1
|
)
|
|
(3
|
)
|
Subtotal
|
|
|
180
|
|
|
160
|
|
|
20
|
|
|
13
|
|
Total
Energy Services Group revenue
|
|
|
|
|
|
|
|
|
|
|
|
|
|
by
region:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North
America
|
|
|
1,541
|
|
|
1,137
|
|
|
404
|
|
|
36
|
|
Latin
America
|
|
|
355
|
|
|
333
|
|
|
22
|
|
|
7
|
|
Europe/Africa/CIS
|
|
|
674
|
|
|
565
|
|
|
109
|
|
|
19
|
|
Middle
East/Asia
|
|
|
546
|
|
|
436
|
|
|
110
|
|
|
25
|
|
Total
Energy Services Group revenue
|
|
$
|
3,116
|
|
$
|
2,471
|
|
$
|
645
|
|
|
26
|
%
|
|
|
Three
Months Ended
|
|
|
|
|
|
OPERATING
INCOME (LOSS):
|
|
June
30
|
|
Increase
|
|
Percentage
|
|
Millions
of dollars
|
|
2006
|
|
2005
|
|
(Decrease)
|
|
Change
|
|
Production
Optimization
|
|
$
|
357
|
|
$
|
231
|
|
$
|
126
|
|
|
55
|
%
|
Fluid
Systems
|
|
|
193
|
|
|
135
|
|
|
58
|
|
|
43
|
|
Drilling
and Formation Evaluation
|
|
|
189
|
|
|
140
|
|
|
49
|
|
|
35
|
|
Digital
and Consulting Solutions
|
|
|
52
|
|
|
16
|
|
|
36
|
|
|
225
|
|
Total
Energy Services Group
|
|
|
791
|
|
|
522
|
|
|
269
|
|
|
52
|
|
Government
and Infrastructure
|
|
|
68
|
|
|
72
|
|
|
(4
|
)
|
|
(6
|
)
|
Energy
and Chemicals
|
|
|
(109
|
)
|
|
39
|
|
|
(148
|
)
|
|
NM
|
|
Total
KBR
|
|
|
(41
|
)
|
|
111
|
|
|
(152
|
)
|
|
NM
|
|
General
corporate
|
|
|
(32
|
)
|
|
(37
|
)
|
|
5
|
|
|
14
|
|
Total
operating income
|
|
$
|
718
|
|
$
|
596
|
|
$
|
122
|
|
|
20
|
%
|
Geographic
- Energy Services Group segments only:
|
|
Production
Optimization:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North
America
|
|
$
|
252
|
|
$
|
155
|
|
$
|
97
|
|
|
63
|
%
|
Latin
America
|
|
|
19
|
|
|
14
|
|
|
5
|
|
|
36
|
|
Europe/Africa/CIS
|
|
|
41
|
|
|
31
|
|
|
10
|
|
|
32
|
|
Middle
East/Asia
|
|
|
45
|
|
|
31
|
|
|
14
|
|
|
45
|
|
Subtotal
|
|
|
357
|
|
|
231
|
|
|
126
|
|
|
55
|
|
Fluid
Systems:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North
America
|
|
|
120
|
|
|
82
|
|
|
38
|
|
|
46
|
|
Latin
America
|
|
|
18
|
|
|
15
|
|
|
3
|
|
|
20
|
|
Europe/Africa/CIS
|
|
|
33
|
|
|
25
|
|
|
8
|
|
|
32
|
|
Middle
East/Asia
|
|
|
22
|
|
|
13
|
|
|
9
|
|
|
69
|
|
Subtotal
|
|
|
193
|
|
|
135
|
|
|
58
|
|
|
43
|
|
Drilling
and Formation Evaluation:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North
America
|
|
|
70
|
|
|
45
|
|
|
25
|
|
|
56
|
|
Latin
America
|
|
|
20
|
|
|
14
|
|
|
6
|
|
|
43
|
|
Europe/Africa/CIS
|
|
|
40
|
|
|
41
|
|
|
(1
|
)
|
|
(2
|
)
|
Middle
East/Asia
|
|
|
59
|
|
|
40
|
|
|
19
|
|
|
48
|
|
Subtotal
|
|
|
189
|
|
|
140
|
|
|
49
|
|
|
35
|
|
Digital
and Consulting Solutions:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North
America
|
|
|
28
|
|
|
7
|
|
|
21
|
|
|
300
|
|
Latin
America
|
|
|
8
|
|
|
(4
|
)
|
|
12
|
|
|
NM
|
|
Europe/Africa/CIS
|
|
|
11
|
|
|
8
|
|
|
3
|
|
|
38
|
|
Middle
East/Asia
|
|
|
5
|
|
|
5
|
|
|
-
|
|
|
-
|
|
Subtotal
|
|
|
52
|
|
|
16
|
|
|
36
|
|
|
225
|
|
Total
Energy Services Group
|
|
|
|
|
|
|
|
|
|
|
|
|
|
operating
income by region:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North
America
|
|
|
470
|
|
|
289
|
|
|
181
|
|
|
63
|
|
Latin
America
|
|
|
65
|
|
|
39
|
|
|
26
|
|
|
67
|
|
Europe/Africa/CIS
|
|
|
125
|
|
|
105
|
|
|
20
|
|
|
19
|
|
Middle
East/Asia
|
|
|
131
|
|
|
89
|
|
|
42
|
|
|
47
|
|
Total
Energy Services Group
|
|
|
|
|
|
|
|
|
|
|
|
|
|
operating
income
|
|
$
|
791
|
|
$
|
522
|
|
$
|
269
|
|
|
52
|
%
|
NM
-
Not
Meaningful
Note
1 -
All
periods presented reflect the reclassification of KBR’s Production Services
operations to discontinued operations, as well as the
reorganization of tubing conveyed perforating, slickline, and underbalanced
applications operations from Production Optimization
into the Drilling and Formation Evaluation segment.
The
increase in consolidated revenue in the second quarter of 2006 compared to
the
second quarter of 2005 was attributable to increased revenue from our Energy
Services Group, predominantly resulting from increased activity, higher
utilization of our equipment, and our ability to raise prices due to higher
exploration and production spending by our customers. This was partially offset
by reduced activity in our government services projects, primarily in the Middle
East. International revenue was 68% of consolidated revenue in the second
quarter of 2006 and 73% of consolidated revenue in the second quarter of 2005,
with the decrease primarily due to the decline of our government services
projects abroad. Revenue from the United States Government for all geographic
areas was approximately $1.6 billion or 28% of consolidated revenue in the
second quarter of 2006 compared to $1.6 billion or 33% of consolidated revenue
in the second quarter of 2005.
The
increase in consolidated operating income was due to stronger performance in
our
Energy Services Group resulting from improved demand due to increased rig
activity and improved pricing and asset utilization. KBR’s operating income
declined primarily due to a $148 million loss recorded on the Escravos, Nigeria
GTL project.
In
the
second quarter of 2006, Iraq-related work contributed approximately $1.3 billion
to consolidated revenue and $47 million to consolidated operating income, a
3.7%
margin before corporate costs and taxes.
Following
is a discussion of our results of operations by reportable segment.
Production
Optimization increase
in revenue compared to the second quarter of 2005 was driven by production
enhancement services revenue, which increased 38%. The improvement spanned
all
geographic regions and resulted primarily from higher demand for onshore and
offshore stimulation services and increased equipment utilization in North
America, new contracts in Russia, and pipeline projects and additional sales
and
services in the North Sea. Revenue from completion tools increased 17% due
to
higher demand for completions and service tool products in the United States
and
contract start-ups and increased sales of drill stem test and sand control
tool
projects in Africa and Asia Pacific. International revenue was 43% of total
segment revenue in the second quarter of 2006 compared to 47% in the second
quarter of 2005.
The
increase in operating income for the segment compared to the second quarter
of
2005 was led by production enhancement services operating income, which grew
65%. The improvement spanned all regions, particularly driven by strong demand
for stimulation services offshore, increased utilization of crews and assets
on
higher activity, and improved pricing in the United States. Completion tools
operating income increased 23% due to higher sales in the United States, Asia
Pacific, and Africa.
Fluid
Systems
revenue
improvement in the second quarter of 2006 compared to the second quarter of
2005
resulted from a 26% increase in revenue from sales of cementing services,
primarily due to improved activity and pricing in the United States and new
contracts, higher equipment sales, and improved pricing in Asia Pacific.
Cementing also benefited from increased activity in Russia and the North Sea.
Completion of contracts since the second quarter of 2005 and recent project
delays in Mexico adversely impacted the cementing services revenue comparison.
Baroid Fluid Services contributed 23% growth in revenue, spanning all regions,
largely due to improved activity and pricing in North America and west Africa
and increased sales in Russia, partially offset by decreased activity in
Indonesia and Mexico. International revenue was 51% of total segment revenue
in
the second quarter of 2006 compared to 54% in the second quarter of
2005.
The
segment operating income improvement compared to the second quarter of 2005
was
led by a 43% increase from cementing services, due to higher drilling activity
and improved pricing in the United States and improved sales and service
activity in Russia, the North Sea, and Asia Pacific. These results were
partially offset by lower offshore activity in Mexico. Baroid Fluid Services
operating income grew 44% on strong drilling activity and pricing improvements
in the United States and higher activity in Latin America and Russia. Partially
offsetting these results was lower activity in the North Sea.
Drilling
and Formation Evaluation
revenue
growth for the second quarter of 2006 compared to the second quarter of 2005
came from all regions, with all product service lines benefiting from increased
drilling activity in the United States. Drilling services contributed a 19%
increase, with 59% growth in the Gulf of Mexico and 51% growth in Asia Pacific
driven by new contracts, higher rig activity, and sales of tools. Logging
services revenue increased 21%, additionally benefiting from deployment of
tools
to high demand areas of the Middle East and increased activity in the United
States and Asia Pacific, partially offset by activity decline in the North
Sea.
Drill bits revenue increased 30%, largely derived from the United States, the
Middle East, Canada, and Australia due to heightened drilling activity.
International revenue was 70% of total segment revenue in the second quarter
of
2006 compared to 72% in the second quarter of 2005.
The
increase in segment operating income was led by a 28% improvement in drilling
services results, which benefited from increased directional drilling activity
in the United States, Australia, and the North Sea. These results were partially
offset by completion of contracts in Africa and lower margin work in the Middle
East. Logging services operating income increased 42% due to improved pricing
and increased activity in the United States, Latin America, Saudi Arabia, and
Asia Pacific. Drill bit sales operating income grew 39% over the prior year
second quarter, reflecting increased drilling activity in Canada and higher
sales of coring services in Australia and the Middle East.
Digital
and Consulting Solutions
revenue
improvement for the second quarter of 2006 compared to the second quarter of
2005 was led by a 21% increase in Landmark, primarily reflecting higher software
sales and consulting and customer support services in all four regions. Segment
revenue growth was partially offset by two fixed-price integrated solutions
projects in southern Mexico nearing completion. International revenue was 69%
of
total segment revenue in the second quarter of 2006 compared to 75% in the
second quarter of 2005.
The
segment operating income improvement primarily reflects a 55% increase in
Landmark results due to improved sales of software and consulting and customer
support services, primarily in the United States, Latin America, and northern
Africa. Second quarter of 2005 results included a $15 million loss on the
integrated solutions projects in southern Mexico.
Government
and Infrastructure
revenue
for the second quarter of 2006 totaled $1.9 billion, a $154 million decrease
compared to the second quarter of 2005. Revenue from Iraq-related work decreased
$155 million primarily due to lower activities on the LogCAP contract. Also
contributing to the decrease was lower revenue earned by the DML shipyard and
other government support services projects, partially offset by remaining
activities related to the hurricane relief effort in the United States. In
addition, we received revenue from our newly awarded Allenby and Connaught
project in the United Kingdom.
Segment
operating income for the second quarter of 2006 decreased $4 million compared
to
the second quarter of 2005. Results in the second quarter of 2006 were
positively impacted by a $6 million gain on sale of part of our interest in
a
United Kingdom government project. In addition, operating income was positively
impacted by better performance from our DML operations and various other
projects. These increases were offset by a $17 million loss on an equity
investment joint venture road project in the United Kingdom and lower operating
margins on various other projects.
Energy
and Chemicals
revenue
for the second quarter of 2006 totaled $548 million, an $81 million increase
compared to the second quarter of 2005. Increased revenue from a GTL project
in
Nigeria and recently awarded projects including a GTL project in Qatar, an
LNG
project in Yemen, joint venture activities in Mexico, and a new ammonia plant
construction project in Egypt contributed $165 million. In addition, an oil
and
gas project in Africa and a refining fabrication project in Canada contributed
a
combined $26 million to the second quarter revenue comparison. These increases
were partially offset by lower revenue on a crude oil facility in Canada and
on
an offshore engineering and project management contract in Angola, totaling
$85
million. In addition, revenue from a substantially complete LNG project and
an
offshore engineering and design project in Nigeria decreased by an aggregate
$24
million.
Segment
operating income declined $148 million in the second quarter of 2006 compared
to
the second quarter of 2005, primarily reflecting a $148 million charge on the
Escravos, Nigeria GTL project. The charge related to schedule delays and cost
increases arising from site issues and scope changes encountered on the
project.
General
corporate
expenses
were $32 million in the second quarter of 2006 compared to $37 million in the
second quarter of 2005. The decrease largely reflects a $7 million legal
settlement in the second quarter of 2005.
NONOPERATING
ITEMS
Interest
expense
decreased $8 million in the second quarter of 2006 compared to the second
quarter of 2005, primarily due to the redemption in April 2005 of $500 million
of our floating rate senior notes and the repayment in October 2005 of $300
million of our floating rate senior notes.
Interest
income
increased $29 million in the second quarter of 2006 compared to the second
quarter of 2005 due to higher interest rate driven earnings on higher cash
balances.
Foreign
currency losses, net
increased $3 million from $7 million in net losses in the second quarter of
2005. The increase was primarily due to the impact of United States dollar
proceeds from the sale of Production Services that were received by our United
Kingdom-based subsidiary, which uses British sterling as its functional
currency.
Provision
for income taxes
from
continuing operations in the second quarter of 2006 of $226 million resulted
in
an effective tax rate of 32% compared to an effective tax rate of 28% in the
second quarter of 2005. The lower rate for 2005 was primarily attributable
to
the release of a portion of the valuation allowance from our United States
net operating loss carryforward.
Minority
interest in net (income) loss of subsidiaries
increased $46 million compared to the second quarter of 2005 primarily due
to
the loss from the consolidated 50%-owned gas-to-liquids project in Escravos,
Nigeria.
Income
from discontinued operations, net of tax provision
in the
second quarter of 2006 primarily consisted of a $123 million pretax gain on
the
sale of KBR’s Production Services group and $5 million of pretax income related
to Production Services operations. Income from discontinued operations in the
second quarter of 2005 primarily consisted of $10 million of pretax income
related to Production Services operations.
RESULTS
OF OPERATIONS IN 2006 COMPARED TO 2005
Six
Months Ended June 30, 2006 Compared with Six Months Ended June 30,
2005
|
|
Six
Months Ended
|
|
|
|
|
|
REVENUE:
|
|
June
30
|
|
Increase
|
|
Percentage
|
|
Millions
of dollars
|
|
2006
|
|
2005
|
|
(Decrease)
|
|
Change
|
|
Production
Optimization
|
|
$
|
2,488
|
|
$
|
1,805
|
|
$
|
683
|
|
|
38
|
%
|
Fluid
Systems
|
|
|
1,706
|
|
|
1,330
|
|
|
376
|
|
|
28
|
|
Drilling
and Formation Evaluation
|
|
|
1,499
|
|
|
1,196
|
|
|
303
|
|
|
25
|
|
Digital
and Consulting Solutions
|
|
|
361
|
|
|
324
|
|
|
37
|
|
|
11
|
|
Total
Energy Services Group
|
|
|
6,054
|
|
|
4,655
|
|
|
1,399
|
|
|
30
|
|
Government
and Infrastructure
|
|
|
3,589
|
|
|
4,123
|
|
|
(534
|
)
|
|
(13
|
)
|
Energy
and Chemicals
|
|
|
1,086
|
|
|
978
|
|
|
108
|
|
|
11
|
|
Total
KBR
|
|
|
4,675
|
|
|
5,101
|
|
|
(426
|
)
|
|
(8
|
)
|
Total
revenue
|
|
$
|
10,729
|
|
$
|
9,756
|
|
$
|
973
|
|
|
10
|
%
|
Geographic
- Energy Services Group segments only:
|
|
Production
Optimization:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North
America
|
|
$
|
1,505
|
|
$
|
1,032
|
|
$
|
473
|
|
|
46
|
%
|
Latin
America
|
|
|
189
|
|
|
172
|
|
|
17
|
|
|
10
|
|
Europe/Africa/CIS
|
|
|
465
|
|
|
354
|
|
|
111
|
|
|
31
|
|
Middle
East/Asia
|
|
|
329
|
|
|
247
|
|
|
82
|
|
|
33
|
|
Subtotal
|
|
|
2,488
|
|
|
1,805
|
|
|
683
|
|
|
38
|
|
Fluid
Systems:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North
America
|
|
|
897
|
|
|
666
|
|
|
231
|
|
|
35
|
|
Latin
America
|
|
|
194
|
|
|
185
|
|
|
9
|
|
|
5
|
|
Europe/Africa/CIS
|
|
|
384
|
|
|
300
|
|
|
84
|
|
|
28
|
|
Middle
East/Asia
|
|
|
231
|
|
|
179
|
|
|
52
|
|
|
29
|
|
Subtotal
|
|
|
1,706
|
|
|
1,330
|
|
|
376
|
|
|
28
|
|
Drilling
and Formation Evaluation:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North
America
|
|
|
533
|
|
|
405
|
|
|
128
|
|
|
32
|
|
Latin
America
|
|
|
222
|
|
|
192
|
|
|
30
|
|
|
16
|
|
Europe/Africa/CIS
|
|
|
336
|
|
|
296
|
|
|
40
|
|
|
14
|
|
Middle
East/Asia
|
|
|
408
|
|
|
303
|
|
|
105
|
|
|
35
|
|
Subtotal
|
|
|
1,499
|
|
|
1,196
|
|
|
303
|
|
|
25
|
|
Digital
and Consulting Solutions:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North
America
|
|
|
119
|
|
|
93
|
|
|
26
|
|
|
28
|
|
Latin
America
|
|
|
101
|
|
|
98
|
|
|
3
|
|
|
3
|
|
Europe/Africa/CIS
|
|
|
84
|
|
|
78
|
|
|
6
|
|
|
8
|
|
Middle
East/Asia
|
|
|
57
|
|
|
55
|
|
|
2
|
|
|
4
|
|
Subtotal
|
|
|
361
|
|
|
324
|
|
|
37
|
|
|
11
|
|
Total
Energy Services Group revenue
|
|
|
|
|
|
|
|
|
|
|
|
|
|
by
region:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North
America
|
|
|
3,054
|
|
|
2,196
|
|
|
858
|
|
|
39
|
|
Latin
America
|
|
|
706
|
|
|
647
|
|
|
59
|
|
|
9
|
|
Europe/Africa/CIS
|
|
|
1,269
|
|
|
1,028
|
|
|
241
|
|
|
23
|
|
Middle
East/Asia
|
|
|
1,025
|
|
|
784
|
|
|
241
|
|
|
31
|
|
Total
Energy Services Group revenue
|
|
$
|
6,054
|
|
$
|
4,655
|
|
$
|
1,399
|
|
|
30
|
%
|
|
|
Six
Months Ended
|
|
|
|
|
|
OPERATING
INCOME (LOSS):
|
|
June
30
|
|
Increase
|
|
Percentage
|
|
Millions
of dollars
|
|
2006
|
|
2005
|
|
(Decrease)
|
|
Change
|
|
Production
Optimization
|
|
$
|
681
|
|
$
|
511
|
|
$
|
170
|
|
|
33
|
%
|
Fluid
Systems
|
|
|
375
|
|
|
248
|
|
|
127
|
|
|
51
|
|
Drilling
and Formation Evaluation
|
|
|
361
|
|
|
231
|
|
|
130
|
|
|
56
|
|
Digital
and Consulting Solutions
|
|
|
101
|
|
|
45
|
|
|
56
|
|
|
124
|
|
Total
Energy Services Group
|
|
|
1,518
|
|
|
1,035
|
|
|
483
|
|
|
47
|
|
Government
and Infrastructure
|
|
|
88
|
|
|
125
|
|
|
(37
|
)
|
|
(30
|
)
|
Energy
and Chemicals
|
|
|
(67
|
)
|
|
80
|
|
|
(147
|
)
|
|
NM
|
|
Total
KBR
|
|
|
21
|
|
|
205
|
|
|
(184
|
)
|
|
(90
|
)
|
General
corporate
|
|
|
(66
|
)
|
|
(69
|
)
|
|
3
|
|
|
4
|
|
Total
operating income
|
|
$
|
1,473
|
|
$
|
1,171
|
|
$
|
302
|
|
|
26
|
%
|
Geographic
- Energy Services Group segments only:
|
|
Production
Optimization:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North
America
|
|
$
|
496
|
|
$
|
385
|
|
$
|
111
|
|
|
29
|
%
|
Latin
America
|
|
|
34
|
|
|
34
|
|
|
-
|
|
|
-
|
|
Europe/Africa/CIS
|
|
|
74
|
|
|
44
|
|
|
30
|
|
|
68
|
|
Middle
East/Asia
|
|
|
77
|
|
|
48
|
|
|
29
|
|
|
60
|
|
Subtotal
|
|
|
681
|
|
|
511
|
|
|
170
|
|
|
33
|
|
Fluid
Systems:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North
America
|
|
|
240
|
|
|
151
|
|
|
89
|
|
|
59
|
|
Latin
America
|
|
|
32
|
|
|
31
|
|
|
1
|
|
|
3
|
|
Europe/Africa/CIS
|
|
|
60
|
|
|
43
|
|
|
17
|
|
|
40
|
|
Middle
East/Asia
|
|
|
43
|
|
|
23
|
|
|
20
|
|
|
87
|
|
Subtotal
|
|
|
375
|
|
|
248
|
|
|
127
|
|
|
51
|
|
Drilling
and Formation Evaluation:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North
America
|
|
|
151
|
|
|
92
|
|
|
59
|
|
|
64
|
|
Latin
America
|
|
|
38
|
|
|
26
|
|
|
12
|
|
|
46
|
|
Europe/Africa/CIS
|
|
|
67
|
|
|
51
|
|
|
16
|
|
|
31
|
|
Middle
East/Asia
|
|
|
105
|
|
|
62
|
|
|
43
|
|
|
69
|
|
Subtotal
|
|
|
361
|
|
|
231
|
|
|
130
|
|
|
56
|
|
Digital
and Consulting Solutions:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North
America
|
|
|
63
|
|
|
14
|
|
|
49
|
|
|
350
|
|
Latin
America
|
|
|
14
|
|
|
(6
|
)
|
|
20
|
|
|
NM
|
|
Europe/Africa/CIS
|
|
|
17
|
|
|
29
|
|
|
(12
|
)
|
|
(41
|
)
|
Middle
East/Asia
|
|
|
7
|
|
|
8
|
|
|
(1
|
)
|
|
(13
|
)
|
Subtotal
|
|
|
101
|
|
|
45
|
|
|
56
|
|
|
124
|
|
Total
Energy Services Group
|
|
|
|
|
|
|
|
|
|
|
|
|
|
operating
income by region:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North
America
|
|
|
950
|
|
|
642
|
|
|
308
|
|
|
48
|
|
Latin
America
|
|
|
118
|
|
|
85
|
|
|
33
|
|
|
39
|
|
Europe/Africa/CIS
|
|
|
218
|
|
|
167
|
|
|
51
|
|
|
31
|
|
Middle
East/Asia
|
|
|
232
|
|
|
141
|
|
|
91
|
|
|
65
|
|
Total
Energy Services Group
|
|
|
|
|
|
|
|
|
|
|
|
|
|
operating
income
|
|
$
|
1,518
|
|
$
|
1,035
|
|
$
|
483
|
|
|
47
|
%
|
NM
-
Not
Meaningful
Note
1 -
All
periods presented reflect the reclassification of KBR’s Production Services
operations to discontinued operations, as well as
the reorganization
of tubing conveyed perforating, slickline, and underbalanced applications
operations from Production
Optimization into
the
Drilling and Formation Evaluation segment.
The
increase in consolidated revenue in the first six months of 2006 compared to
the
first six months of 2005 was attributable to increased revenue from our Energy
Services Group, predominantly arising from increased drilling activity, higher
utilization of our equipment, and our ability to raise prices due to higher
exploration and production spending by our customers. This was partially offset
by reduced revenue from KBR primarily on government services projects in the
Middle East. International revenue was 67% of consolidated revenue in the first
six months of 2006 and 74% of consolidated revenue in the first six months
of
2005, with the decrease primarily due to the decline of our government services
projects abroad. Revenue from the United States Government for all geographic
areas was approximately $2.9 billion or 27% of consolidated revenue in the
first
six months of 2006 compared to $3.3 billion or 34% of consolidated revenue
in
the first six months of 2005.
The
increase in consolidated operating income was primarily due to stronger
performance in our Energy Services Group resulting from improved demand due
to
increased customer drilling and production activity and improved pricing and
asset utilization. KBR’s operating income declined chiefly due to a $148 million
loss recorded on the Escravos, Nigeria GTL project and reduced activity on
government services projects, particularly in the Middle East.
In
the
first six months of 2006, Iraq-related work contributed approximately $2.4
billion to consolidated revenue and $74 million to consolidated operating
income, resulting in a 3.1% margin before corporate costs and
taxes.
Following
is a discussion of our results of operations by reportable segment.
Production
Optimization
revenue
increase compared to the first six months of 2005 was driven by a 44% increase
in revenue from production enhancement services and an 18% increase from
completion tools sales and services. Both product service lines had increases
in
all geographic areas, with 63% of the segment revenue increase from the United
States due to higher drilling activity, improved pricing, and equipment
utilization. Production enhancement services had additional revenue uplift
from
expanded operations in Russia and higher activity in the Middle East. Sales
of
completion tools and services further benefited from increased completions,
drill stem test, and reservoir performance monitoring activities, primarily
in
Africa and the Middle East. International revenue was 44% of total segment
revenue in the first six months of 2006 compared to 47% in the first six months
of 2005.
The
increase in segment operating income in the first six months of 2006 compared
to
the first six months of 2005 was led by production enhancement services
operating income, which increased 84% and spanned all regions. The increase
in
production enhancement services operating income was largely driven by higher
activity, stronger utilization, and improved pricing in the United States.
Additionally, production enhancement services results doubled internationally
compared to the first half of 2005, in part due to expanded worldwide
operations. Completion tools operating income increased 20% compared to the
first six months of 2005, primarily on higher activity in the Middle East/Asia
region and the United States, partially offset by an unfavorable change in
product mix in Latin America. Operating income in the first six months of 2005
included a $110 million gain on the sale of our Subsea 7, Inc. equity
interest.
Fluid
Systems
revenue
increase compared to the first six months of 2005 was derived from all regions
but primarily from the United States due to increased activity and pricing
improvements. A 29% increase in revenue from cementing services also benefited
from increased service activity and improved sales in Indonesia, Russia, and
the
United Kingdom. Completion of contracts in Mexico since the first six months
of
2005 adversely impacted the cementing services revenue comparison. Baroid Fluid
Services revenue grew 28% largely on increased sales in Russia and Sakhalin,
higher rig activity in Angola, and increased operations in Venezuela, which
was
partially offset by contracts expiring in Mexico and Indonesia. International
revenue was 52% of total segment revenue in the first six months of 2006
compared to 54% in the first six months of 2005.
Fluid
Systems segment operating income increase compared to the first six months
of
2005 was led by a 53% increase from cementing services due to higher drilling
activity and pricing improvements in the United States and improved product
mix
in Angola, Norway, and Saudi Arabia. These results were partially offset by
lower offshore activity in Mexico. Baroid Fluid Services operating income
increased 46% compared to the first half of 2005 due primarily to continued
strong activity, pricing improvements, and hurricane insurance proceeds in
North
America, increased operations in Venezuela, and improved results from a joint
venture in the Netherlands. Partially offsetting these results was the
completion of a contract in Mexico.
Drilling
and Formation Evaluation
revenue
increase in the first six months of 2006 compared to the first six months of
2005 was derived from a 31% increase in drill bits revenue, a 26% increase
in
drilling services revenue, which spanned all four regions, and a 23% increase
in
logging service revenue, which also spanned all four regions. Sales of drill
bits largely benefited from increased fixed cutter sales in the United States
and increased drilling activity in Canada, the Middle East, and the North Sea.
The drilling services revenue increase is primarily due to heightened drilling
activity, improved pricing, and introduction of new technology in North America
and increased activity and sales of tools in Asia Pacific. Negatively impacting
drilling services revenue in the first six months of 2006 compared to the first
six months of 2005 was a decline in activity in Indonesia. Logging services
revenue grew largely due to improved pricing and increased cased-hole activity
in the United States, new contracts in the Middle East, and continued success
with our reservoir description tool. A lost contract in Malaysia decreased
results. International revenue was 70% of total segment revenue in the first
six
months of 2006 compared to 72% in the first six months of 2005.
The
segment operating income increase compared to the first six months of 2005
spanned all geographic regions, with North America as the predominant
contributor due to improved pricing, increased rig activity, and higher
equipment utilization. Drill bits operating income increased 72%, with
international operating income more than doubling. Contributing to drill bits
international operating income increase were improvements in Canada, Saudi
Arabia, and Australia. Drilling services operating income increased 62% on
increased activity, partially offset by increased costs in Russia, Kazakhstan,
and the Middle East. Logging services operating income increased 44% largely
due
to increased activity, improved product mix, and reservoir description tool
deployment in the Middle East/Asia region, where operating income increased
72%.
Digital
and Consulting Solutions
revenue
increase in the first six months of 2006 was led by Landmark, with a 16% revenue
increase compared to the first six months of 2005 and increases in all four
regions due to increased sales of software and maintenance and support services.
Project management revenue in the first six months of 2006 decreased 5% compared
to the first six months of 2005 due to two fixed-price integrated solutions
projects in southern Mexico nearing completion. International revenue was 69%
of
total segment revenue in the first six months of 2006 compared to 73% in the
first six months of 2005.
The
segment operating income improvement stemmed in part from a 90% increase in
Landmark operating income. Project management recorded $23 million in losses
in
the first half of 2005 on two fixed-price integrated solutions projects in
Mexico. These losses reflected increased costs to complete the projects and
longer drilling times than originally anticipated, chiefly due to unfavorable
geological conditions. The first six months of 2006 included a gain of $10
million from the sale of an investment accounted for under the cost method.
Included in the 2005 results was a $17 million favorable insurance settlement
related to a pipe fabrication and laying project in the North Sea.
Government
and Infrastructure
revenue
for the first six months of 2006 was $3.6 billion, a $534 million decrease
compared to the first six months of 2005. The majority of the decrease resulted
from lower activities on government projects, primarily on the LogCAP contract
in the Middle East and the DML shipyard. Partially offsetting the decreases
were
activities on the hurricane relief work project in the United States on the
CONCAP contract for $92 million. In addition, revenue was negatively impacted
by
a $26 million impairment charge recorded on an equity investment in an
Australian railroad operation and a $17 million impairment charge recorded
on an
equity investment in a joint venture road project in the United
Kingdom.
Segment
operating income for the first six months of 2006 was $88 million compared
to
$125 million in the first six months of 2005, a decrease of $37 million.
Operating income from Iraq-related work decreased $12 million primarily due
to
lower activities on the LogCAP contract. Iraq-related results in the first
six
months of 2005 were positively impacted by DFAC settlement and award fees on
definitized task orders. In addition, the first six months of 2006 operating
income was negatively impacted by a $26 million impairment charge recorded
on an
equity investment in an Australian railroad operation and a $17 million
impairment charge recorded on an equity investment in a joint venture road
project in the United Kingdom, partially offset by a $6 million gain on sale
of
part of our interest in a United Kingdom government project. Operating income
in
the first six months of 2005 included a one-time $11 million cash distribution
from a joint venture investment in a United States toll road that had been
fully
reserved.
Energy
and Chemicals
revenue
for the first six months of 2006 was $1.1 billion compared to $978 million
for
the first six months of 2005. The increase in revenue was primarily due to
activities on GTL projects located in Nigeria and Qatar, a recently awarded
ammonia plant construction project in Egypt, and LNG projects in Algeria and
Yemen, totaling $325 million. Partially offsetting the segment revenue
improvement were decreases from a substantially completed LNG project in
Nigeria, crude oil facility projects in Canada, and an olefins project in the
United States, totaling $215 million.
Energy
and Chemicals posted a $67 million loss for the first six months of 2006
compared to $80 million operating income in the first six months of 2005. The
$147 million decrease was primarily due to a $148 million charge on the
Escravos, Nigeria GTL project. In addition, segment results in the first six
months of 2006 were impacted by a $15 million loss provision on the
Barracuda-Caratinga project in Brazil and an aggregate $31 million decrease
in
operating income due to lower recovery of costs on a crude oil facility in
Canada and lower progress on an offshore engineering and project management
project in the Caspian. Substantially offsetting these declines were $45 million
of income from a newly awarded EBIC ammonia plant construction project in
Egypt, in which KBR holds an equity position, and an early works award on an
engineering, procurement, and construction project in Algeria.
General
corporate
expenses
were $66 million in the first six months of 2006 compared to $69 million in
the
first six months of 2005. The first half of 2005 included costs of a $7 million
legal settlement. In addition, general corporate expenses in the first six
months of 2006 were impacted by increases in executive compensation and legal
costs.
NONOPERATING
ITEMS
Interest
expense
decreased $13 million in the first six months of 2006 compared to the first
six
months of 2005, primarily due to the redemption in April 2005 of $500 million
of
our floating rate senior notes and the repayment in October 2005 of $300 million
of our floating rate senior notes.
Interest
income
increased $45 million in the first six months of 2006 compared to the first
six
months of 2005 due to higher interest rate driven earnings on higher cash
balances.
Foreign
currency losses, net
decreased $5 million from $7 million in net losses in the first six months
of
2005, primarily due to gains on the British pound sterling and Norwegian kroner.
These gains were offset by the impact of United States dollar proceeds from
the
sale of Production Services that were received by our United Kingdom-based
subsidiary, which uses British sterling as its functional currency.
Provision
for income taxes
from
continuing operations in the first six months of 2006 of $481 million resulted
in an effective tax rate of 33% compared to an effective tax rate of 29% in
the
first six months of 2005. The lower rate for 2005 was primarily attributable
to
the release of a portion of the valuation allowance from our United States
net operating loss carryforward.
Minority
interest in net (income)loss of subsidiaries
increased $43 million compared to the first six months of 2005 primarily due
to
the loss from the consolidated 50%-owned gas-to-liquids project in Escravos,
Nigeria.
Income
from discontinued operations, net of tax
in the
first six months of 2006 primarily consisted of a $123 million pretax gain
on
the sale of KBR’s Production Services group and $14 million of pretax income
related to Production Services operations. Income from discontinued operations
in the first six months of 2005 primarily consisted of $22 million of pretax
income related to Production Services operations.
OFF
BALANCE SHEET RISK
Under
our
Energy Services Group accounts receivable securitization facility we had the
ability to sell up to $300 million in undivided ownership interest in a pool
of
receivables. During the fourth quarter of 2005, $256 million in undivided
ownership interest that had been sold to unaffiliated companies was collected
and the balance retired. No further receivables were sold, and the facility
was
terminated in the first quarter of 2006.
In
May
2004, we entered into an agreement to sell, assign, and transfer the entire
title and interest in specified United States government accounts receivable
of
KBR to a third party. The face value of the receivables sold to the third party
was reflected as a reduction of accounts receivable in our condensed
consolidated balance sheets. The total amount of receivables outstanding under
this agreement was approximately $257 million as of June 30, 2005. As of
December 31, 2005, these receivables were collected, the balance was retired,
and the facility was terminated.
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, among others:
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the
Comprehensive Environmental Response, Compensation, and Liability
Act;
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the
Resources Conservation and Recovery
Act;
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the
Federal Water Pollution Control Act;
and
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the
Toxic Substances Control Act.
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In
addition to the federal laws and regulations, states and other countries where
we do business often have numerous environmental, legal, and regulatory
requirements by which we must abide. We evaluate and address the environmental
impact of our operations by assessing and remediating contaminated properties
in
order to avoid future liabilities and comply with environmental, legal, and
regulatory requirements. On occasion, we are involved in specific environmental
litigation and claims, including the remediation of properties we own or have
operated, as well as efforts to meet or correct compliance-related matters.
Our
Health, Safety and Environment group has several programs in place to maintain
environmental leadership and to prevent the occurrence of environmental
contamination.
We
do not
expect costs related to these remediation requirements to have a material
adverse effect on our consolidated financial position or our results of
operations. Our accrued liabilities for environmental matters were $41 million
as of June 30, 2006 and $50 million as of December 31, 2005. The liability
covers numerous properties, and no individual property accounts for more than
$5
million of the liability balance. We have subsidiaries that have been named
as
potentially responsible parties along with other third parties for 14 federal
and state superfund sites for which we have established a liability. As of
June
30, 2006, those 14 sites accounted for approximately $13 million of our total
$41 million liability. 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.
NEW
ACCOUNTING STANDARDS
In
December 2004, the Financial Accounting Standards Board (FASB) issued SFAS
No.
123 (revised 2004), “Share-Based Payment,” (SFAS No. 123(R)). SFAS No. 123(R) is
a revision of SFAS No. 123, “Accounting for Stock-Based Compensation,” and
supersedes Accounting Principles Board Opinion No. 25, “Accounting for Stock
Issued to Employees,” and related interpretations. In April 2005, the SEC
adopted a rule that defers the required effective date of SFAS No. 123(R).
The
SEC rule provides that SFAS No. 123(R) is now effective for registrants as
of
the beginning of the first fiscal year beginning after June 15, 2005. Effective
January 1, 2006, we adopted the provisions of SFAS No. 123(R) using the modified
prospective application. Accordingly, we recorded compensation expense for
all
newly granted awards and awards modified, repurchased, or cancelled after
January 1, 2006. Compensation cost for the unvested portion of awards that
are
outstanding as of January 1, 2006 is recognized ratably over the remaining
vesting period based on the fair value at date of grant as calculated for our
pro forma disclosure under SFAS No. 123. We also recognized compensation expense
for our employee stock purchase plan beginning with the January 1, 2006 purchase
period. See Note 13 to the condensed consolidated financial statements for
further information.
In
June
2006, the FASB issued FASB Interpretation No. 48 (FIN 48), “Accounting for
Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109.” This
interpretation clarifies the accounting for uncertainty in income taxes
recognized in an enterprise’s financial statements in accordance with FASB
Statement No. 109, “Accounting for Income Taxes.” The interpretation prescribes
a recognition threshold and measurement attribute for a tax position taken
or
expected to be taken in a tax return and also provides guidance on
derecognition, classification, interest and penalties, accounting in interim
periods, disclosure, and transition. The provisions of FIN 48 are effective
for
fiscal years beginning after December 31, 2006. We are currently evaluating
what
impact, if any, this statement will have on our financial
statements.
FORWARD-LOOKING
INFORMATION AND RISK FACTORS
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,” “anticipates,” “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 risk 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.
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 or furnished to the SEC. We also suggest that you listen to our quarterly
earnings release conference calls with financial analysts.
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 materially and adversely affect our financial
condition and results of operations, including the risks related
to:
United
States Government Contract Work
We
provide substantial work under our government contracts to the United States
Department of Defense and other governmental agencies. These contracts include
our worldwide United States Army logistics contracts, known as LogCAP, and
contracts to rebuild Iraq’s petroleum industry, such as PCO Oil South. Our
government services revenue related to Iraq totaled approximately $1.3 billion
and $2.4 billion for the three and six months ended June 30, 2006 compared
to
$1.4 billion and $2.9 billion for the three and six months ended June 30,
2005.
Given
the
demands of working in Iraq and elsewhere for the United States government,
we
expect that from time to time we will have disagreements or experience
performance issues with the various government customers for which we work.
If
performance issues arise under any of our government contracts, the government
retains the right to pursue remedies which could include threatened termination
or termination, under any affected contract. If any contract were so terminated,
we may not receive award fees under the affected contract, and our ability
to
secure future contracts could be adversely affected, although we would receive
payment for amounts owed for our allowable costs under cost-reimbursable
contracts. Other remedies that could be sought by our government customers
for
any improper activities or performance issues include sanctions such as
forfeiture of profits, suspension of payments, fines, and suspensions or
debarment from doing business with the government. Further, the negative
publicity that could arise from disagreements with our customers or sanctions
as
a result thereof could have an adverse effect on our reputation in the industry,
reduce our ability to compete for new contracts, and may also have a material
adverse effect on our business, financial condition, results of operations,
and
cash flow.
DCAA
audit issues
Our
operations under United States government contracts are regularly reviewed
and
audited by the Defense Contract Audit Agency (DCAA) and other governmental
agencies. The DCAA serves in an advisory role to our customer. When issues
are
found during the governmental agency audit process, these issues are typically
discussed and reviewed with us. The DCAA then issues an audit report with its
recommendations to our customer’s contracting officer. In the case of management
systems and other contract administrative issues, the contracting officer is
generally with the Defense Contract Management Agency (DCMA). We then work
with
our customer to resolve the issues noted in the audit report. If our customer
or
a government auditor finds that we improperly charged any costs to a contract,
these costs are not reimbursable, or, if already reimbursed, the costs must
be
refunded to the customer.
Containers. In
June
2005, the DCAA recommended withholding certain costs associated with providing
containerized housing for soldiers and supporting civilian personnel in Iraq.
The DCAA recommended that the costs be withheld pending receipt of additional
explanation or documentation to support the subcontract costs. As of June 30,
2006, the DCAA had issued notices to disallow $56 million of the withheld
amounts, of which $17 million has been withheld from our subcontractors. We
will
continue working with the government and our subcontractors to resolve this
issue.
Other
issues.
The DCAA
is continuously performing audits of costs incurred for the foregoing and other
services provided by us under our government contracts. During these audits,
there are likely to be questions raised by the DCAA about the reasonableness
or
allowability of certain costs or the quality or quantity of supporting
documentation. The DCAA might recommend withholding some portion of the
questioned costs while the issues are being resolved with our customer. Because
of the intense scrutiny involving our government contracts operations, issues
raised by the DCAA may be more difficult to resolve. We do not believe any
potential withholding will have a significant or sustained impact on our
liquidity.
Investigations
In
the
first quarter of 2005, the United States Department of Justice (DOJ) issued
two
indictments associated with overbilling issues we previously reported to the
Department of Defense Inspector General’s office as well as to our customer, the
Army Materiel Command, against a former KBR procurement manager and a manager
of
La Nouvelle Trading & Contracting Company, W.L.L.
In
October 2004, we reported to the Department of Defense Inspector General’s
office that two former employees in Kuwait may have had inappropriate contacts
with individuals employed by or affiliated with two third-party subcontractors
prior to the award of the subcontracts. The Inspector General’s office may
investigate whether these two employees may have solicited and/or accepted
payments from these third-party subcontractors while they were employed by
us.
In
October 2004, a civilian contracting official in the Army Corps of Engineers
(COE) asked for a review of the process used by the COE for awarding some of
the
contracts to us. We understand that the Department of Defense Inspector
General’s office may review the issues involved.
We
understand that the DOJ, an Assistant United States Attorney based in Illinois,
and others are investigating these and other individually immaterial matters
we
have reported related to our government contract work in Iraq. If criminal
wrongdoing were found, criminal penalties could range up to the greater of
$500,000 in fines per count for a corporation or twice the gross pecuniary
gain
or loss. We also understand that current and former employees of KBR have
received subpoenas and have given or may give grand jury testimony related
to
some of these matters.
Claims
In
addition, we had probable unapproved claims totaling $42 million at June 30,
2006 for the LogCAP contract. These unapproved claims related to this contract
are where our costs have exceeded the customer’s funded value of the task
order.
DCMA
system reviews
Report
on estimating system.
In
December 2004, the DCMA granted continued approval of our estimating system,
stating that our estimating system is “acceptable with corrective action.” We
are in the process of completing these corrective actions. Specifically, based
on the unprecedented level of support that our employees are providing the
military in Iraq, Kuwait, and Afghanistan, we needed to update our estimating
policies and procedures to make them better suited to such contingency
situations. Additionally, we have completed our development of a detailed
training program and have made it available to all estimating personnel to
ensure that employees are adequately prepared to deal with the challenges and
unique circumstances associated with a contingency operation.
Report
on purchasing system.
As a
result of a Contractor Purchasing System Review by the DCMA during the fourth
quarter of 2005, the DCMA granted the continued approval of our government
contract purchasing system. The DCMA’s October 2005 approval letter stated that
our purchasing system’s policies and practices are “effective and efficient, and
provide adequate protection of the Government’s interest.”
Report
on accounting system.
We
received two draft reports on our accounting system, which raised various issues
and questions. We have responded to the points raised by the DCAA, but this
review remains open. Once the DCAA finalizes the report, it will be submitted
to
the DCMA, who will make a determination of the adequacy of our accounting
systems for government contracting.
The
Balkans
We
have
had inquiries in the past by the DCAA and the civil fraud division of the DOJ
into possible overcharges for work performed during 1996 through 2000 under
a
contract in the Balkans, for which inquiry has not yet been completed by the
DOJ. Based on an internal investigation, we credited our customer approximately
$2 million during 2000 and 2001 related to our work in the Balkans as a result
of billings for which support was not readily available. We believe that the
preliminary DOJ inquiry relates to potential overcharges in connection with
a
part of the Balkans contract under which approximately $100 million in work
was
done. We believe that any allegations of overcharges would be without merit.
Amounts accrued related to this matter as of June 30, 2006 are not
material.
Development
Fund for Iraq
We
have
some task orders issued and executed under the PCO Oil contract that are funded
under the Development Fund for Iraq (DFI). We received notification in the
third
quarter of 2005 that United States government personnel have decided to cease
all administration of DFI funded contracts after December 31, 2005. In December
2005, we received notification that this deadline was deferred until December
31, 2006. If not deferred again at year end 2006, that could mean that we may
be
required to obtain payment for all services provided under the affected task
orders after that date and for all invoices submitted and not paid prior to
that
date from the sovereign Republic of Iraq. As our PCO Oil contract is with the
United States government, it is unclear what the ramifications of such a change
in funding, if implemented, would have or what the financial implications would
be. We currently have approximately $9 million in receivables recorded from
the
United States government related to this issue.
Foreign
Corrupt Practices Act investigations
The
SEC
is conducting a formal investigation into whether improper payments were made
to
government officials in Nigeria through the use of agents or subcontractors
in
connection with the construction and subsequent expansion by TSKJ of a
multibillion dollar natural gas liquefaction complex and related facilities
at
Bonny Island in Rivers State, Nigeria. The DOJ is also conducting a related
criminal investigation. The SEC has also issued subpoenas seeking information,
which we are furnishing, regarding current and former agents used in connection
with multiple projects over the past 20 years located both in and outside of
Nigeria in which The M .W. Kellogg Company, M. W. Kellogg, Ltd., Kellogg Brown
& Root or their joint ventures, as well as the Halliburton energy services
business, were participants.
TSKJ
is a
private limited liability company registered in Madeira, Portugal whose members
are Technip SA of France, Snamprogetti Netherlands B.V. (a subsidiary of Saipem
SpA of Italy), JGC Corporation of Japan, and Kellogg Brown & Root (a
subsidiary of ours and successor to The M.W. Kellogg Company), each of which
has
a 25% interest in the venture. TSKJ and other similarly owned entities entered
into various contracts to build and expand the liquefied natural gas project
for
Nigeria LNG Limited, which is owned by the Nigerian National Petroleum
Corporation, Shell Gas B.V., Cleag Limited (an affiliate of Total), and Agip
International B.V. (an affiliate of ENI SpA of Italy). M.W. Kellogg Limited
is a
joint venture in which we have a 55% interest; and M.W. Kellogg Limited and
The
M.W. Kellogg Company were subsidiaries of Dresser Industries before our 1998
acquisition of Dresser Industries. The M.W. Kellogg Company was later merged
with a subsidiary of ours to form Kellogg Brown & Root, one of our
subsidiaries.
The
SEC
and the DOJ have been reviewing these matters in light of the requirements
of
the United States Foreign Corrupt Practices Act (FCPA). In addition to
performing our own investigation, we have been cooperating with the SEC and
the
DOJ investigations and with other investigations into the Bonny Island project
in France, Nigeria and Switzerland. Our Board of Directors has appointed a
committee of independent directors to oversee and direct the FCPA
investigations.
The
matters under investigation related to the Bonny Island project cover an
extended period of time (in some cases significantly before our 1998 acquisition
of Dresser Industries). We have produced documents to the SEC and the DOJ both
voluntarily and pursuant to company subpoenas from the files of numerous
officers of Halliburton and KBR, including current and former executives of
Halliburton and KBR, and we are making our employees available to the SEC and
the DOJ for interviews. In addition, we understand that the SEC has issued
a
subpoena to A. Jack Stanley, who formerly served as a consultant and chairman
of
KBR, and to others, including certain of our current and former KBR employees,
former executive officers of KBR, and at least one subcontractor of KBR. We
further understand that the DOJ has invoked its authority under a sitting grand
jury to issue subpoenas for the purpose of obtaining information abroad, and
we
understand that other partners in TSKJ have provided information to the DOJ
and
the SEC with respect to the investigations, either voluntarily or under
subpoenas.
The
SEC
and DOJ investigations include an examination of whether TSKJ’s engagements of
Tri-Star Investments as an agent and a Japanese trading company as a
subcontractor to provide services to TSKJ were utilized to make improper
payments to Nigerian government officials. In connection with the Bonny Island
project, TSKJ entered into a series of agency agreements, including with
Tri-Star Investments, of which Jeffrey Tesler is a principal, commencing in
1995
and a series of subcontracts with a Japanese trading company commencing in
1996.
We understand that a French magistrate has officially placed Mr. Tesler under
investigation for corruption of a foreign public official. In Nigeria, a
legislative committee of the National Assembly and the Economic and Financial
Crimes Commission, which is organized as part of the executive branch of the
government, are also investigating these matters. Our representatives have
met
with the French magistrate and Nigerian officials. In October 2004,
representatives of TSKJ voluntarily testified before the Nigerian legislative
committee.
As
a
result of these investigations, information has been uncovered suggesting that,
commencing at least 10 years ago, members of TSKJ planned payments to Nigerian
officials. We have reason to believe, based on the ongoing investigations,
that
payments may have been made to Nigerian officials.
We
notified the other owners of TSKJ of information provided by the investigations
and asked each of them to conduct their own investigation. TSKJ has suspended
the receipt of services from and payments to Tri-Star Investments and the
Japanese trading company and has considered instituting legal proceedings to
declare all agency agreements with Tri-Star Investments terminated and to
recover all amounts previously paid under those agreements. In February 2005,
TSKJ notified the Attorney General of Nigeria that TSKJ would not oppose the
Attorney General’s efforts to have sums of money held on deposit in banks in
Switzerland transferred to Nigeria and to have the legal ownership of such
sums
determined in the Nigerian courts.
In
June
2004, all relationships with Mr. Stanley and another consultant and former
employee of M. W. Kellogg, Ltd. were terminated. The terminations occurred
because of violations of our Code of Business Conduct that allegedly involved
the receipt of improper personal benefits from Mr. Tesler in connection with
TSKJ’s construction of the Bonny Island project.
We
have
also suspended the services of another agent who has worked for KBR outside
of
Nigeria on several current projects and on numerous older projects going back
to
the early 1980’s until such time, if ever, as we can satisfy ourselves regarding
the agent’s compliance with applicable law and our Code of Business Conduct. In
addition, we are actively reviewing the compliance of an additional agent on
a
separate current Nigerian project with respect to which we have recently
received from a joint venture partner on that project allegations of wrongful
payments made by such agent.
If
violations of the FCPA were found, a person or entity found in violation could
be subject to fines, civil penalties of up to $500,000 per violation, equitable
remedies, including disgorgement, and injunctive relief. Criminal penalties
could range up to the greater of $2 million per violation or twice the gross
pecuniary gain or loss. Both the SEC and the DOJ could argue that continuing
conduct may constitute multiple violations for purposes of assessing the penalty
amounts per violation. Agreed dispositions for these types of matters sometimes
result in a monitor being appointed by the SEC and/or the DOJ to review future
business and practices with the goal of ensuring compliance with the FCPA.
Fines
and civil and criminal penalties could be mitigated, in the government’s
discretion, depending on the level of the cooperation in the
investigations.
Potential
consequences of a criminal indictment arising out of any of these investigations
could include suspension by the DoD or another federal, state, or local
government agency of KBR and its affiliates from their ability to contract
with
United States, state or local governments, or government agencies. If a criminal
or civil violation were found, KBR and its affiliates could be debarred from
future contracts or new orders under current contracts to provide services
to
any such parties. During 2005, KBR and its affiliates had revenue of
approximately $6.6 billion from its government contracts work with agencies
of
the United States or state or local governments. If necessary, we would seek
to
obtain administrative agreements or waivers from the DoD and other agencies
to
avoid suspension or debarment. Suspension or debarment from the government
contracts business would have a material adverse effect on the business, results
of operations, and cash flows of KBR and Halliburton.
These
investigations could also result in third-party claims against us, which may
include claims for special, indirect, derivative or consequential damages,
damage to our business or reputation, loss of, or adverse effect on, cash flow,
assets, goodwill, results of operations, business, prospects, profits or
business value, adverse consequences on our ability to obtain or continue
financing for current or future projects or claims by directors, officers,
employees, affiliates, advisors, attorneys, agents, debt holders or other
interest holders or constituents of us or our subsidiaries. In addition, we
could incur costs and expenses for any monitor required by or agreed to with
governmental authority to review our continued compliance with FCPA
law.
As
of
June 30, 2006, we have not accrued any amounts related to these investigations
other than our current legal expenses.
Bidding
practices investigation
In
connection with the investigation into payments related to the Bonny Island
project in Nigeria, information has been uncovered suggesting that Mr. Stanley
and other former employees may have engaged in coordinated bidding with one
or
more competitors on certain foreign construction projects, and that such
coordination possibly began as early as the mid-1980s.
On
the
basis of this information, we and the DOJ have broadened our investigations
to
determine the nature and extent of any improper bidding practices, whether
such
conduct violated United States antitrust laws, and whether former employees
may
have received payments in connection with bidding practices on some foreign
projects.
If
violations of applicable United States antitrust laws occurred, the range of
possible penalties includes criminal fines, which could range up to the greater
of $10 million in fines per count for a corporation, or twice the gross
pecuniary gain or loss, and treble civil damages in favor of any persons
financially injured by such violations. Criminal prosecutions under applicable
laws of relevant foreign jurisdictions and civil claims by, or relationship
issues with customers, are also possible.
As
of
June 30, 2006, we had not accrued any amounts related to this investigation
other than our current legal expenses.
Operations
in Iran
We
received and responded to an inquiry in mid-2001 from the Office of Foreign
Assets Control (OFAC) of the United States Treasury Department with respect
to
operations in Iran by a Halliburton subsidiary incorporated in the Cayman
Islands. The OFAC inquiry requested information with respect to compliance
with
the Iranian Transaction Regulations. These regulations prohibit United States
citizens, including United States corporations and other United States business
organizations, from engaging in commercial, financial, or trade transactions
with Iran, unless authorized by OFAC or exempted by statute. Our 2001 written
response to OFAC stated that we believed that we were in compliance with
applicable sanction regulations. In the first quarter of 2004, we responded
to a
follow-up letter from OFAC requesting additional information. We understand
this
matter has now been referred by OFAC to the DOJ. In July 2004, we received
a
grand jury subpoena from an Assistant United States District Attorney requesting
the production of documents. We are cooperating with the government’s
investigation and have responded to the subpoena by producing documents in
September 2004.
Separate
from the OFAC inquiry, we completed a study in 2003 of our activities in Iran
during 2002 and 2003 and concluded that these activities were in compliance
with
applicable sanction regulations. These sanction regulations require isolation
of
entities that conduct activities in Iran from contact with United States
citizens or managers of United States companies. Notwithstanding our conclusions
that our activities in Iran were not in violation of United States laws and
regulations, we announced that, after fulfilling our current contractual
obligations within Iran, we intend to cease operations within that country
and
to withdraw from further activities there.
Geopolitical
and International Environment
International
and political events
A
significant portion of our revenue is derived from our non-United States
operations, which exposes us to risks inherent in doing business in each of
the
countries in which we transact business. The occurrence of any of the risks
described below could have a material adverse effect on our consolidated results
of operations and consolidated financial condition.
Our
operations in countries other than the United States accounted for approximately
67% of our consolidated revenue during the first six months of 2006 and 74%
of
our consolidated revenue during the first six months of 2005. Based upon the
location of services provided and products sold, 19% of our consolidated revenue
in the first six months of 2006 and 29% during the first six months of 2005
was from Iraq, primarily related to our work for the United States Government.
Operations in countries other than the United States are subject to various
risks unique to each country. With respect to any particular country, these
risks may include:
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expropriation
and nationalization of our assets in that
country;
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political
and economic instability;
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civil
unrest, acts of terrorism, force majeure, war, or other armed
conflict;
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natural
disasters, including those related to earthquakes and
flooding;
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currency
fluctuations, devaluations, and conversion
restrictions;
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confiscatory
taxation or other adverse tax
policies;
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governmental
activities that limit or disrupt markets, restrict payments, or limit
the
movement of funds;
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governmental
activities that may result in the deprivation of contract rights;
and
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governmental
activities that may result in the inability to obtain or retain licenses
required for operation.
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Due
to
the unsettled political conditions in many oil-producing countries and countries
in which we provide governmental logistical support, our revenue and profits
are
subject to the adverse consequences of war, the effects of terrorism, civil
unrest, strikes, currency controls, and governmental actions. Countries where
we
operate that have significant amounts of political risk include: Afghanistan,
Algeria, Indonesia, Iran, Iraq, Nigeria, Russia, Venezuela, and Yemen. In
addition, military action or continued unrest in the Middle East could impact
the supply and pricing for oil and gas, disrupt our operations in the region
and
elsewhere, and increase our costs for security worldwide.
In
addition, investigations by governmental authorities (see “Foreign Corrupt
Practices Act investigations” above), as well as legal, social, economic, and
political issues in Nigeria, could materially and adversely affect our Nigerian
business and operations.
Our
facilities and our employees are under threat of attack in some countries where
we operate, including Iraq and Saudi Arabia. In addition, the risks related
to
loss of life of our personnel and our subcontractors in these areas
continue.
We
are
also subject to the risks that our employees, joint venture partners, and agents
outside of the United States may fail to comply with applicable
laws.
Military
action, other armed conflicts, or terrorist attacks
Military
action in Iraq, military tension involving North Korea and Iran, as well as
the
terrorist attacks of September 11, 2001 and subsequent terrorist attacks,
threats of attacks, and unrest, have caused instability or uncertainty in the
world’s financial and commercial markets and have significantly increased
political and economic instability in some of the geographic areas in which
we
operate. Acts of terrorism and threats of armed conflicts in or around various
areas in which we operate, such as the Middle East and Indonesia, could limit
or
disrupt markets and our operations, including disruptions resulting from the
evacuation of personnel, cancellation of contracts, or the loss of personnel
or
assets.
Such
events may cause further disruption to financial and commercial markets and
may
generate greater political and economic instability in some of the geographic
areas in which we operate. In addition, any possible reprisals as a consequence
of the war and ongoing military action in Iraq, such as acts of terrorism in
the
United States or elsewhere, could materially and adversely affect us in ways
we
cannot predict at this time.
Income
taxes
We
have
operations in about 100 countries other than the United States. Consequently,
we
are subject to the jurisdiction of a significant number of taxing authorities.
The income earned in these various jurisdictions is taxed on differing bases,
including net income actually earned, net income deemed earned, and
revenue-based tax withholding. The final determination of our tax liabilities
involves the interpretation of local tax laws, tax treaties, and related
authorities in each jurisdiction, as well as the significant use of estimates
and assumptions regarding the scope of future operations and results achieved
and the timing and nature of income earned and expenditures incurred. Changes
in
the operating environment, including changes in tax law and
currency/repatriation controls, could impact the determination of our tax
liabilities for a tax year.
Foreign
exchange and currency risks
A
sizable
portion of our consolidated revenue and consolidated operating expenses are
in
foreign currencies. As a result, we are subject to significant risks,
including:
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foreign
exchange risks resulting from changes in foreign exchange rates and
the
implementation of exchange controls;
and
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limitations
on our ability to reinvest earnings from operations in one country
to fund
the capital needs of our operations in other
countries.
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We
conduct business in countries that have nontraded or “soft” currencies which,
because of their restricted or limited trading markets, may be more difficult
to
exchange for “hard” currency. We may accumulate cash in soft currencies, and we
may be limited in our ability to convert our profits into United States dollars
or to repatriate the profits from those countries.
We
selectively use hedging transactions to limit our exposure to risks from doing
business in foreign currencies. For those currencies that are not readily
convertible, our ability to hedge our exposure is limited because financial
hedge instruments for those currencies are nonexistent or limited. Our ability
to hedge is also limited because pricing of hedging instruments, where they
exist, is often volatile and not necessarily efficient.
In
addition, the value of the derivative instruments could be impacted
by:
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adverse
movements in foreign exchange
rates;
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the
value and time period of the derivative being different than the
exposures
or cash flows being hedged.
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Customers
and Business
Exploration
and production activity
Demand
for our services and products depends on oil and natural gas industry activity
and expenditure levels that are directly affected by trends in oil and natural
gas prices.
Demand
for our services and products is particularly sensitive to the level of
exploration, development, and production activity of, and the corresponding
capital spending by, oil and natural gas companies, including national oil
companies. Prices for oil and natural gas are subject to large fluctuations
in
response to relatively minor changes in the supply of and demand for oil and
natural gas, market uncertainty, and a variety of other factors that are beyond
our control. Any prolonged reduction in oil and natural gas prices will depress
the immediate levels of exploration, development, and production activity,
often
reflected as changes in rig counts. Perceptions of longer-term lower oil and
natural gas prices by oil and gas companies can similarly reduce or defer major
expenditures given the long-term nature of many large-scale development
projects. Lower levels of activity result in a corresponding decline in the
demand for our oil and natural gas well services and products, which could
have
a material adverse effect on our revenue and profitability. Factors affecting
the prices of oil and natural gas include:
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governmental
regulations, including the policies of governments regarding the
exploration for and production and development of their oil and natural
gas reserves;
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global
weather conditions and natural
disasters;
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worldwide
political, military, and economic
conditions;
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the
level of oil production by non-OPEC countries and the available excess
production capacity within OPEC;
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economic
growth in China and India;
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oil
refining capacity and shifts in end-customer preferences toward fuel
efficiency and the use of natural
gas;
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the
cost of producing and delivering oil and
gas;
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potential
acceleration of development of alternative fuels;
and
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the
level of demand for oil and natural gas, especially demand for natural
gas
in the United States.
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Historically,
the markets for oil and gas have been volatile and are likely to continue to
be
volatile. Spending on exploration and production activities and capital
expenditures for refining and distribution facilities by large oil and gas
companies have a significant impact on the activity levels of our businesses.
In
the current environment where oil and gas demand exceeds supply, the ability
to
rebalance supply with demand may be constrained by the global availability
of
rigs. Full utilization of rigs could lead to limited growth in revenue. In
addition, the extent of the growth in oilfield services may be limited by the
availability of equipment and manpower.
Governmental
and capital spending
Our
business is directly affected by changes in governmental spending and capital
expenditures by our customers. Some of the changes that may materially and
adversely affect us include:
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a
decrease in the magnitude of governmental spending and outsourcing
for
military and logistical support of the type that we provide. For
example,
the current level of government services being provided in the Middle
East
will not likely continue for an extended period of time and the current
rate of spending has decreased substantially compared to 2005 and
2004.
Our government services revenue related to Iraq under our LogCAP
III and
other contracts totaled approximately $2.4 billion in the six months
ended
June 30, 2006, $5.4 billion in 2005, and $7.1 billion in 2004. We
expect
the volume of work under our LogCAP III contract to continue to decline
in
2006 as our customer scales back the amount of services we provide
under
this contract. The DoD has also announced that it will solicit competitive
bids for a new multiple provider LogCAP IV contract to replace the
current
LogCAP III contract, under which we are the sole provider. A decrease
in
the magnitude of governmental spending and outsourcing for military
and
logistical support of the type that we provide could have a material
adverse effect on our business, results of operations, and cash
flow.
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an
increase in the magnitude of governmental spending and outsourcing
for
military and logistical support, which can materially and adversely
affect
our liquidity needs as a result of additional or continued working
capital
requirements to support this work;
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a
decrease in capital spending by governments for infrastructure projects
of
the type that we undertake;
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the
consolidation of our customers, which
could:
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cause
customers to reduce their capital spending, which would in turn reduce
the
demand for our services and products;
and
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result
in customer personnel changes, which in turn affects the timing of
contract negotiations and settlements of claims and claim negotiations
with engineering and construction customers on cost variances and
change
orders on major projects;
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adverse
developments in the business and operations of our customers in the
oil
and gas industry, including write-downs of reserves and reductions
in
capital spending for exploration, development, production, processing,
refining, and pipeline delivery networks;
and
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ability
of our customers to timely pay the amounts due
us.
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Customers
Both
our
Energy Services Group and KBR depend on a limited number of significant
customers. While, except for the United States Government, none of these
customers represented more than 10% of consolidated revenue in any period
presented, the loss of one or more significant customers could have a material
adverse effect on our business and our consolidated results of
operations.
Acquisitions,
dispositions, investments, and joint ventures
We
continually seek opportunities to maximize efficiency and value through various
transactions, including purchases or sales of assets, businesses, investments,
or joint ventures. These transactions are intended to result in the realization
of savings, the creation of efficiencies, the generation of cash or income,
or
the reduction of risk. Acquisition transactions may be financed by additional
borrowings or by the issuance of our common stock. These transactions may also
affect our consolidated results of operations.
These
transactions also involve risks and we cannot ensure that:
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any
acquisitions would result in an increase in
income;
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any
acquisitions would be successfully integrated into our operations
and
internal controls;
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any
disposition would not result in decreased earnings, revenue, or cash
flow;
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any
dispositions, investments, acquisitions, or integrations would not
divert
management resources; or
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any
dispositions, investments, acquisitions, or integrations would not
have a
material adverse effect on our results of operations or financial
condition.
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We
conduct some operations through joint ventures, where control may be shared
with
unaffiliated third parties. As with any joint venture arrangement, differences
in views among the joint venture participants may result in delayed decisions
or
in failures to agree on major issues. We also cannot control the actions of
our
joint venture partners, including any nonperformance, default, or bankruptcy
of
our joint venture partners. These factors could potentially materially and
adversely affect the business and operations of the joint venture and, in turn,
our business and operations.
We
own a
36.7% interest in a joint venture that is the holder of a 50-year concession
contract with the Australian government to operate and maintain a railway in
Australia. We account for this investment on the equity method of accounting.
Construction on the railway was completed in late 2003, and operations commenced
in early 2004. This joint venture has sustained losses since the railway
commenced operations in early 2004 and is now likely to violate certain of
the
joint venture’s loan covenants in the future. These loans are non-recourse to
KBR and us. We received revised financial forecasts from the joint venture
during the first quarter of 2006. These forecasts took into account decreases,
as compared to prior forecasts, in anticipated freight volume related to delays
in mining of minerals, as well as a slowdown in the planned expansion of the
Port of Darwin. Because of this new information, we recorded a $26 million
impairment charge during the first quarter of 2006 in our equity investment.
We
will receive no tax benefit from this charge as this is a capital loss in
Australia for which we have no capital gains to offset. We also recorded a
$4
million equity loss related to our investment in this joint venture during
the
first quarter of 2006. As of June 30, 2006, our investment in this joint venture
and the related company that performed the construction of the railroad was
$60
million. In addition, we have a remaining commitment to purchase an additional
$3 million subordinated operating note.
Risks
related to contracts
Our
long-term contracts to provide services are either on a cost-reimbursable basis
or on a fixed-price basis. Our failure to estimate accurately the resources
and
time required for a fixed-price project or our failure to complete our
contractual obligations within the time frame and costs committed could have
a
material adverse effect on our business, results of operations, and financial
condition. In connection with projects covered by fixed-price contracts, we
bear
the risk of cost over-runs, operating cost inflation, labor availability and
productivity, and supplier and subcontractor pricing and performance. In both
our fixed-price contracts and our cost-reimbursable contracts, we generally
rely
on third parties for many support services, and we are subject to liability
for
engineering or systems failures. Occasionally we contract to perform work for,
as well as take a minority ownership interest in, a developmental entity. We
may
incur contractually reimbursable costs, make an equity investment prior to
this
entity achieving operational status or completing its full project financing.
Should a developmental project fail to achieve full financial close, we could
incur losses including our contractual receivables and our equity
investment.
Risks
under our fixed-price contracts.
Our
significant EPC projects may encounter difficulties that may result in
additional costs to us, reductions in revenue, claims, or disputes. These
projects generally involve complex design and engineering, significant
procurement of equipment and supplies, and extensive construction management.
Many of these projects involve design and engineering production and
construction phases that may occur over extended time periods, often in excess
of two years. We could encounter difficulties that may be beyond our control
in
design, engineering, equipment and supply delivery, schedule changes, and other
factors. These factors could impact our ability to complete the project in
accordance with the original delivery schedule and cost estimates. For example,
the equipment we purchase for a project or that is provided to us by the
customer could not perform as expected, and these performance failures may
result in delays in completion of the project or additional costs to us or
the
customer to complete the project and, in some cases, may require us to obtain
alternate equipment at additional cost.
In
addition, some of our contracts may require that our customers provide us with
design or engineering information or with equipment or materials to be used
on
the project. In some cases, the customer may provide us with deficient design
or
engineering information or equipment or may provide the information or equipment
to us later than required by the project schedule. The customer may also
determine, after commencement of the project, to change various elements of
the
project. Our project contracts generally require the customer to compensate
us
for additional work or expenses incurred due to customer-requested change orders
or failure of the customer to provide us with specified design or engineering
information or equipment. Under these circumstances, we generally negotiate
with
the customer with respect to the amount of additional time required and the
compensation to be paid to us. We are subject to the risk that we are unable
to
obtain, through negotiation, arbitration, litigation, or otherwise, adequate
amounts to compensate us for the additional work or expenses incurred by us
due
to customer-requested change orders or failure by the customer to timely provide
required items. A failure to obtain adequate compensation for these matters
could require us to record an adjustment to amounts of revenue and gross profit
that were recognized in prior periods. Any such adjustments, if substantial,
could have a material adverse effect on our results of operations and financial
condition.
We
may be
required to pay liquidated damages upon our failure to meet schedule or
performance requirements of our contracts. In certain circumstances, we
guarantee facility completion by a scheduled acceptance date or achievement
of
certain acceptance and performance testing levels. Failure to meet any such
schedule or performance requirements could result in additional costs, and
the
amount of such additional costs could exceed projected profit margins for the
project. These additional costs include liquidated damages paid under
contractual penalty provisions, which can be substantial and can accrue on
a
daily basis. In addition, our actual costs could exceed our projections.
Performance problems for existing and future contracts could cause actual
results of operations to differ materially from those anticipated by us and
could cause us to suffer damage to our reputation within our industry and our
client base.
Risks
under our fixed-price or cost-reimbursable contracts.
We
generally rely on third-party subcontractors as well as third-party equipment
manufacturers to assist us with the completion of our contracts. To the extent
that we cannot engage subcontractors or acquire equipment or materials, our
ability to complete a project in a timely fashion or at a profit may be
impaired. If the amount we are required to pay for these goods and services
exceeds the amount we have estimated in bidding for fixed-price work, we could
experience losses in the performance of these contracts. Any delay by
subcontractors to complete their portion of the project, or any failure by
a
subcontractor to satisfactorily complete its portion of the project, and other
factors beyond our control may result in delays in the overall progress of
the
project or may cause us to incur additional costs, or both. These delays and
additional costs may be substantial, and we may be required to compensate the
project customer for these delays. While we may recover these additional costs
from the responsible vendor, subcontractor, or other third party, we may not
be
able to recover all of these costs in all circumstances. In addition, if a
subcontractor or a manufacturer is unable to deliver its services, equipment,
or
materials according to the negotiated terms for any reason, including the
deterioration of its financial condition, we may be required to purchase the
services, equipment, or materials from another source at a higher price. This
may reduce the profit or award fee to be realized or result in a loss on a
project for which the services, equipment, or materials were
needed.
Our
projects expose us to potential professional liability, general and third-party
liability, warranty, and other claims. We engineer, construct, and perform
services in large industrial facilities in which accidents or system failures
can be disastrous. Any catastrophic occurrences in excess of insurance limits
at
locations engineered or constructed by us or where our services are performed
could result in significant professional liability, general and third-party
liability, warranty, and other claims against us. The failure of any systems
or
facilities that we engineer or construct could result in warranty claims against
us for significant replacement or reworking costs. In addition, once our
construction is complete, we may face claims with respect to the performance
of
these facilities.
Our
contracts generally contain provisions where our customers agree to limitations
of our liability resulting from certain events such as damage to underground
reservoirs and wells, costs for loss of control of a well, loss of production,
damage to existing facilities, and consequential damages. It is also common
to
have arrangements with the customer and its other contractors that protect
us
against large exposures for damage to or loss of drilling units and injury
to
other contractors’ personnel. These contract provisions are standard in our
industries, and any erosion of these contractual protections in future contracts
could result in significant additional liability and associated
cost.
Barracuda-Caratinga
project.
The
Barracuda and Caratinga vessels are both fully operational. In April 2006,
we
executed an agreement with Petrobras that enabled us to achieve conclusion
of
the Lenders’ Reliability Test and final acceptance of the FPSOs. These
acceptances eliminate any further risk of liquidated damages being assessed
but
do not address the bolt arbitration discussed below.
In
addition, at Petrobras’ direction, we have replaced certain bolts located on the
subsea flowlines that have failed through mid-November 2005, and we understand
that additional bolts have failed thereafter, which have been replaced by
Petrobras. These failed bolts were identified by Petrobras when it conducted
inspections of the bolts. The original design specification for the bolts was
issued by Petrobras, and as such, we believe the cost resulting from any
replacement is not our responsibility. Petrobras has indicated, however, that
they do not agree with our conclusion. We have notified Petrobras that this
matter is in dispute. We believe several possible solutions may exist, including
replacement of the bolts. Estimates indicate that costs of these various
solutions range up to $140 million. Should Petrobras instruct us to replace
the
subsea bolts, the prime contract terms and conditions regarding change orders
require that Petrobras make progress payments of our reasonable costs incurred.
Petrobras could, however, perform any replacement of the bolts and seek
reimbursement from KBR. In March 2006, Petrobras notified KBR that they have
submitted this matter to arbitration claiming $220 million plus interest for
the
cost of monitoring and replacing the defective stud bolts and, in addition,
all
of the costs and expenses of the arbitration including the cost of attorneys
fees. We disagree with the Petrobras claim since the bolts met Petrobras’ design
specification, and we do not believe there is any basis for the amount claimed
by Petrobras. We intend to vigorously defend ourselves and pursue recovery
of
the costs we have incurred to date through the arbitration process. See Note
2
to the condensed consolidated financial statements for more
information.
Environmental
requirements
Our
businesses are subject to a variety of environmental laws, rules, and
regulations in the United States and other countries, including those covering
hazardous materials and requiring emission performance standards for facilities.
For example, our well service operations routinely involve the handling of
significant amounts of waste materials, some of which are classified as
hazardous substances. We also store, transport, and use radioactive and
explosive materials in certain of our operations. Environmental requirements
include, for example, those concerning:
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the
containment and disposal of hazardous substances, oilfield waste,
and
other waste materials;
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the
importation and use of radioactive
materials;
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the
use of underground storage tanks;
and
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the
use of underground injection wells.
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Environmental
and other similar requirements generally are becoming increasingly strict.
Sanctions for failure to comply with these requirements, many of which may
be
applied retroactively, may include:
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administrative,
civil, and criminal penalties;
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revocation
of permits to conduct business; and
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corrective
action orders, including orders to investigate and/or clean-up
contamination.
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Failure
on our part to comply with applicable environmental requirements could have
a
material adverse effect on our consolidated financial condition. We are also
exposed to costs arising from environmental compliance, including compliance
with changes in or expansion of environmental requirements, which could have
a
material adverse effect on our business, financial condition, operating results,
or cash flow.
We
are
exposed to claims under environmental requirements, and, from time to time,
such
claims have been made against us. In the United States, environmental
requirements and regulations typically impose strict liability. Strict liability
means that in some situations we could be exposed to liability for clean-up
costs, natural resource damages, and other damages as a result of our conduct
that was lawful at the time it occurred or the conduct of prior operators or
other third parties. Liability for damages arising as a result of environmental
laws could be substantial and could have a material adverse effect on our
consolidated results of operations.
Changes
in environmental requirements may negatively impact demand for our services.
For
example, oil and natural gas exploration and production may decline as a result
of environmental requirements (including land use policies responsive to
environmental concerns). A decline in exploration and production, in turn,
could
materially and adversely affect us.
Law
and regulatory requirements
In
the
countries in which we conduct business, we are subject to multiple and at times
inconsistent regulatory regimes, including those that govern our use of
radioactive materials, explosives, and chemicals in the course of our
operations. Various national and international regulatory regimes govern the
shipment of these items. Many countries, but not all, impose special controls
upon the export and import of radioactive materials, explosives, and chemicals.
Our ability to do business is subject to maintaining required licenses and
complying with these multiple regulatory requirements applicable to these
special products. In addition, the various laws governing import and export
of
both products and technology apply to a wide range of services and products
we
offer. In turn, this can affect our employment practices of hiring people of
different nationalities because these laws may prohibit or limit access to
some
products or technology by employees of various nationalities. Changes in,
compliance with, or our failure to comply with these laws may negatively impact
our ability to provide services in, make sales of equipment to, and transfer
personnel or equipment among some of the countries in which we operate and
could
have a material adverse affect on the results of operations.
Raw
materials
Raw
materials essential to our business are normally readily available. Current
market conditions have triggered constraints in the supply chain of certain
raw
materials, such as, sand, cement, and specialty metals. The majority of our
risk
associated with the current supply chain constraints occurs in those situations
where we have a relationship with a single supplier for a particular
resource.
Intellectual
property rights
We
rely
on a variety of intellectual property rights that we use in our services and
products. We may not be able to successfully preserve these intellectual
property rights in the future, and these rights could be invalidated,
circumvented, or challenged. In addition, the laws of some foreign countries
in
which our services and products may be sold do not protect intellectual property
rights to the same extent as the laws of the United States. Our failure to
protect our proprietary information and any successful intellectual property
challenges or infringement proceedings against us could materially and adversely
affect our competitive position.
Technology
The
market for our services and products is characterized by continual technological
developments to provide better and more reliable performance and services.
If we
are not able to design, develop, and produce commercially competitive products
and to implement commercially competitive services in a timely manner in
response to changes in technology, our business and revenue could be materially
and adversely affected, and the value of our intellectual property may be
reduced. Likewise, if our proprietary technologies, equipment and facilities,
or
work processes become obsolete, we may no longer be competitive, and our
business and revenue could be materially and adversely affected.
Systems
Our
business could be materially and adversely affected by problems encountered
in
the installation of a new SAP financial system to replace some of the current
systems for KBR.
Reliance
on management
We
depend
greatly on the efforts of our executive officers and other key employees to
manage our operations. The loss or unavailability of any of our executive
officers or other key employees could have a material adverse effect on our
business.
Technical
personnel
Many
of
the services that we provide and the products that we sell are complex and
highly engineered and often must perform or be performed in harsh conditions.
We
believe that our success depends upon our ability to employ and retain technical
personnel with the ability to design, utilize, and enhance these services and
products. In addition, our ability to expand our operations depends in part
on
our ability to increase our skilled labor force. The demand for skilled workers
is high, and the supply is limited. A significant increase in the wages paid
by
competing employers could result in a reduction of our skilled labor force,
increases in the wage rates that we must pay, or both. If either of these events
were to occur, our cost structure could increase, our margins could decrease,
and our growth potential could be impaired.
Weather
Our
businesses could be materially and adversely affected by severe weather,
particularly in the Gulf of Mexico where we have operations. Repercussions
of
severe weather conditions may include:
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evacuation
of personnel and curtailment of
services;
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weather-related
damage to offshore drilling rigs resulting in suspension of
operations;
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weather-related
damage to our facilities and project work
sites;
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inability
to deliver materials to jobsites in accordance with contract schedules;
and
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Because
demand for natural gas in the United States drives a significant amount of
our
Energy Services Group’s United States business, warmer than normal winters in
the United States are detrimental to the demand for our services to gas
producers.
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;
|
|
-
|
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 the Securities Exchange Act of 1934 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, 2006 to provide reasonable assurance
that information required to be disclosed in our reports filed or submitted
under the Exchange Act is recorded, processed, summarized, and reported within
the time periods specified in the Securities and Exchange Commission’s rules and
forms. Our disclosure controls and procedures include controls and procedures
designed to ensure that information required to be disclosed in reports filed
or
submitted under the Exchange Act is accumulated and communicated to our
management, including our Chief Executive Officer and Chief Financial Officer,
as appropriate, to allow timely decisions regarding required
disclosure.
There
has
been no change in our internal control over financial reporting that occurred
during the three months ended June 30, 2006 that has materially affected, or
is
reasonably likely to materially affect, our internal control over financial
reporting.
PART
II. OTHER INFORMATION
Item
1. Legal Proceedings
Information
related to various commitments and contingencies is described in “Management’s
Discussion and Analysis of Financial Condition and Results of Operations,” in
“Forward-Looking Information and Risk Factors,” and in Notes 2, 10, 11, and 12
to the condensed consolidated financial statements.
Item
1(a). Risk Factors
Information
related to risk factors is described in “Management’s Discussion and Analysis of
Financial Condition and Results of Operations” under “Forward-Looking
Information and Risk Factors.”
Item
2. Unregistered Sales of Equity Securities and Use of
Proceeds
Following
is a summary of our repurchases of our common stock during the three-month
period ended June 30, 2006.
|
|
|
|
|
|
Total
Number of
|
|
|
|
|
|
|
|
Shares
Purchased
|
|
|
|
|
|
|
|
as
Part of
|
|
|
|
|
|
|
|
Publicly
|
|
|
|
Total
Number of
|
|
Average
Price
|
|
Announced
|
|
|
|
Shares
|
|
Paid
per
|
|
Plans
|
|
Period
|
|
Purchased
(a)
|
|
Share
|
|
or
Programs (b)
|
|
April
1-30
|
|
|
42,476
|
|
$
|
35.95
|
|
|
-
|
|
May
1-31
|
|
|
1,028,760
|
|
$
|
36.65
|
|
|
950,138
|
|
June
1-30
|
|
|
2,916,074
|
|
$
|
35.74
|
|
|
2,857,200
|
|
Total
|
|
|
3,987,310
|
|
$
|
35.98
|
|
|
3,807,338
|
|
(a) |
Of
the 3,987,310 shares purchased during the three-month period ended
June
30, 2006, 179,972 shares were acquired from employees in connection
with
the settlement of income tax and related benefit withholding obligations
arising from vesting in restricted stock grants. These share purchases
were not part of a publicly announced program to purchase common
shares.
|
(b) |
In
February 2006, our Board of Directors approved a share repurchase
program
of up to $1.0 billion. During the second quarter of 2006, we repurchased
3,807,338 shares of our common stock at a cost of approximately $137
million, or an average price per share of $35.94. There is $822 million
remaining under this program for future
repurchases.
|
Item
3. Defaults Upon Senior Securities
None.
Item
4. Submission of Matters to a Vote of Security Holders
At
our
Annual Meeting of Stockholders held on May 17, 2006, stockholders were asked
to
consider and act upon:
|
(1)
|
the
election of Directors for the ensuing
year;
|
|
(2)
|
a
proposal to ratify the appointment of KPMG LLP as independent accountants
to examine the financial statements and books and records of Halliburton
for the year 2006;
|
|
(3)
|
a
proposal to amend the Certificate of
Incorporation;
|
|
(4)
|
a
proposal on severance agreements;
|
|
(5)
|
a
stockholder proposal on human rights
review;
|
|
(6)
|
a
stockholder proposal on Director election vote threshold;
and
|
|
(7)
|
a
stockholder proposal on a poison
pill.
|
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
|
|
|
|
Alan
M. Bennett
|
435,212,839
|
3,716,975
|
James
R. Boyd
|
435,214,516
|
3,715,298
|
Robert
L. Crandall
|
418,733,506
|
20,196,308
|
Kenneth
T. Derr
|
434,570,231
|
4,359,583
|
S.
Malcolm Gillis
|
430,633,870
|
8,295,944
|
W.
R. Howell
|
428,927,684
|
10,002,130
|
Ray
L. Hunt
|
429,503,307
|
9,426,507
|
David
J. Lesar
|
431,483,808
|
7,446,006
|
J.
Landis Martin
|
434,641,023
|
4,288,791
|
Jay
A. Precourt
|
435,144,181
|
3,785,633
|
Debra
L. Reed
|
435,155,440
|
3,744,374
|
(2) Proposal
for ratification of the selection of auditors:
Number
of Votes For
|
432,611,595
|
Number
of Votes Against
|
3,626,898
|
Number
of Votes Abstain
|
2,691,321
|
Number
of Broker Non-Votes
|
0
|
(3) Proposal
to amend the Certificate of Incorporation:
Number
of Votes For
|
427,779,792
|
Number
of Votes Against
|
8,267,621
|
Number
of Votes Abstain
|
2,882,401
|
Number
of Broker Non-Votes
|
0
|
(4) Proposal
on severance agreements:
Number
of Votes For
|
430,548,704
|
Number
of Votes Against
|
4,719,022
|
Number
of Votes Abstain
|
3,662,088
|
Number
of Broker Non-Votes
|
0
|
(5) Stockholder
proposal on human rights review:
Number
of Votes For
|
77,145,398
|
Number
of Votes Against
|
253,394,054
|
Number
of Votes Abstain
|
41,659,479
|
Number
of Broker Non-Votes
|
66,730,883
|
(6) Stockholder
proposal on Director election vote threshold:
Number
of Votes For
|
217,987,136
|
Number
of Votes Against
|
150,679,100
|
Number
of Votes Abstain
|
3,532,695
|
Number
of Broker Non-Votes
|
66,730,883
|
(7) Stockholder
proposal on a poison pill:
Number
of Votes For
|
22,476,008
|
Number
of Votes Against
|
346,251,374
|
Number
of Votes Abstain
|
3,471,549
|
Number
of Broker Non-Votes
|
66,730,883
|
Item
5. Other Information
None.
Item
6. Exhibits
3.1
|
Restated
Certificate of Incorporation of Halliburton Company filed
with
|
|
the
Secretary of State of Delaware on May 30, 2006
(incorporated
|
|
by
reference to Exhibit 3.1 to Halliburton’s Form 8-K
filed
|
|
June
5, 2006, File No. 1-3492).
|
|
|
3.2
|
By-laws
of Halliburton revised effective May 17, 2006 (incorporated
by
|
|
reference
to Exhibit 3.1 to Halliburton’s Form 8-K filed
|
|
May
22, 2006, File No. 1-3492).
|
|
|
*
12
|
Statement
of Computation of Ratio of Earnings to Fixed Charges.
|
|
|
*
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
|
**
|
Furnished
with this Form 10-Q
|
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
/s/
C. Christopher Gaut
|
/s/
Mark A. McCollum
|
C.
Christopher Gaut
|
Mark
A. McCollum
|
Executive
Vice President and
|
Senior
Vice President and
|
Chief
Financial Officer
|
Chief
Accounting Officer
|
Date: July
28, 2006