UNITED
STATES SECURITIES AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-Q
T Quarterly
Report Pursuant to Section 13 or 15(d) of the
Securities
Exchange Act of 1934
For
the quarterly period ended September 30, 2008
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 1-33146
KBR,
Inc.
(a
Delaware Corporation)
20-4536774
601
Jefferson Street
Suite
3400
Houston,
Texas 77002
(Address
of Principal Executive Offices)
Telephone
Number – Area Code (713) 753-3011
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 T No£
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
definition of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large
accelerated
filer T
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Accelerated
filer £
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Non-accelerated
filer £
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(Do
not check if a smaller reporting company)
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Smaller
reporting company £
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Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).
Yes £ No T
As of
October 27, 2008, 161,544,162 shares of KBR, Inc. common stock, $0.001 par
value per share, were outstanding.
Index
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Page No.
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PART
I.
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FINANCIAL
INFORMATION
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Item
1.
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4
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4
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5
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6
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7
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Item
2.
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33
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Item
3.
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51
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Item
4.
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51
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PART
II.
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OTHER
INFORMATION
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Item
1.
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52
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Item
1A.
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52
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Item
2.
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52
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Item
3.
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52
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Item
4.
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52
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Item
5.
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52
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Item
6.
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53
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54
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Forward-Looking
and Cautionary Statements
This
report contains certain statements that are, or may be deemed to be,
“forward-looking statements” within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended. The Private Securities Litigation Reform Act of 1995 provides safe
harbor provisions for forward-looking information. The words “believe,” “may,”
“estimate,” “continue,” “anticipate,” “intend,” “plan,” “expect” and similar
expressions are intended to identify forward-looking statements. All statements
other than statements of historical fact are, or may be deemed to be,
forward-looking statements. Forward-looking statements include information
concerning our possible or assumed future financial performance and results of
operations and backlog information.
We
have based these statements on our assumptions and analyses in light of our
experience and perception of historical trends, current conditions, expected
future developments and other factors we believe are appropriate in the
circumstances. Although we believe that the forward-looking statements contained
in this report are based upon reasonable assumptions, forward-looking statements
by their nature involve substantial risks and uncertainties that could
significantly affect expected results, and actual future results could differ
materially from those described in such statements. While it is not possible to
identify all factors, factors that could cause actual future results to differ
materially include the risks and uncertainties disclosed in our 2007 Annual
Report on Form 10-K contained in Part I under “Risk Factors.”
Many
of these factors are beyond our ability to control or predict. Any of these
factors, or a combination of these factors, could materially and adversely
affect our future financial condition or results of operations and the ultimate
accuracy of the forward-looking statements. These forward-looking statements are
not guarantees of our future performance, and our actual results and future
developments may differ materially and adversely from those projected in the
forward-looking statements. We caution against putting undue reliance on
forward-looking statements or projecting any future results based on such
statements or present or prior earnings levels. In addition, each
forward-looking statement speaks only as of the date of the particular
statement, and we undertake no obligation to publicly update or revise any
forward-looking statement.
PART
I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed
Consolidated Statements of Income
(In
millions, except for per share data)
(Unaudited)
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Three Months Ended
September
30,
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Nine Months
Ended
September
30,
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2008
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2007
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2008
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2007
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Revenue:
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Services
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$ |
3,005 |
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$ |
2,142 |
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$ |
8,161 |
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$ |
6,285 |
|
Equity in earnings of unconsolidated affiliates,
net
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13 |
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35 |
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34 |
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71 |
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Total revenue
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3,018 |
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|
2,177 |
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8,195 |
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6,356 |
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Operating
costs and expenses:
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Cost
of services
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2,819 |
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2,010 |
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7,646 |
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5,967 |
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General
and administrative
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55 |
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65 |
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163 |
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177 |
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Gain on sale of assets
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— |
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— |
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(2
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) |
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— |
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Total operating costs and
expenses
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2,874 |
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2,075 |
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7,807 |
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6,144 |
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Operating
income
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144 |
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|
102 |
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|
388 |
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212 |
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Interest
income, net
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7 |
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17 |
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32 |
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44 |
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Foreign
currency losses, net
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— |
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(11
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) |
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(2
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) |
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(16
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) |
Other non-operating gains,
net
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— |
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— |
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— |
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1 |
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Income
from continuing operations before income taxes and minority
interest
|
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151 |
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108 |
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418 |
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241 |
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Provision
for income taxes
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(55
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) |
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(35
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) |
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(151
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) |
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(93
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) |
Minority interest in net earnings of
subsidiaries
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(22
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) |
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(13
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) |
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(47
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) |
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(14
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) |
Income
from continuing operations
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74 |
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60 |
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220 |
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134 |
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Income from discontinued operations, net of tax
benefit (provision)
of $11,$3, $11 and
$(130)
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11 |
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3 |
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11 |
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97 |
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Net income
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$ |
85 |
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$ |
63 |
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$ |
231 |
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$ |
231 |
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Basic
income per share (1):
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Continuing
operations
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$ |
0.45 |
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$ |
0.36 |
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$ |
1.31 |
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$ |
0.80 |
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Discontinued operations,
net
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0.07 |
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|
0.02 |
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0.07 |
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0.58 |
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Net income per share
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$ |
0.51 |
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$ |
0.38 |
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$ |
1.38 |
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$ |
1.38 |
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Diluted
income per share (1):
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Continuing
operations
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$ |
0.44 |
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$ |
0.35 |
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$ |
1.30 |
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$ |
0.79 |
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Discontinued operations,
net
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0.07 |
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0.02 |
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0.07 |
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0.57 |
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Net income per share
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$ |
0.51 |
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$ |
0.37 |
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$ |
1.37 |
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$ |
1.37 |
|
Basic weighted average common shares
outstanding
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|
166 |
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|
168 |
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|
168 |
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|
168 |
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Diluted weighted average common shares
outstanding
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|
167 |
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|
170 |
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|
169 |
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|
169 |
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Cash dividends declared per
share
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$ |
0.05 |
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$ |
— |
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$ |
0.15 |
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$ |
— |
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(1)
|
Due
to the effect of rounding, the sum of the individual per share amounts may
not equal the total shown.
|
See
accompanying notes to condensed consolidated financial
statements.
|
Condensed
Consolidated Balance Sheets
(In
millions except share data)
(Unaudited)
|
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September
30,
|
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December
31,
|
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2008
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2007
|
|
Assets
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Current
assets:
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Cash
and equivalents
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$ |
1,110 |
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$ |
1,861 |
|
Receivables:
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Notes
and accounts receivable, net of allowance for bad debts of $20 and
$23
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1,333 |
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|
927 |
|
Unbilled receivables on uncompleted
contracts
|
|
|
760 |
|
|
|
820 |
|
Total
receivables
|
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|
2,093 |
|
|
|
1,747 |
|
Deferred
income taxes
|
|
|
167 |
|
|
|
165 |
|
Other
current assets
|
|
|
289 |
|
|
|
282 |
|
Current assets related to discontinued
operations
|
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|
— |
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|
1 |
|
Total
current assets
|
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|
3,659 |
|
|
|
4,056 |
|
Property,
plant, and equipment, net of accumulated depreciation of $240 and
$227
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|
262 |
|
|
|
220 |
|
Goodwill
|
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|
679 |
|
|
|
251 |
|
Intangible
assets, net
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|
74 |
|
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|
15 |
|
Equity
in and advances to unconsolidated affiliates
|
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|
177 |
|
|
|
294 |
|
Noncurrent
deferred income taxes
|
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|
92 |
|
|
|
139 |
|
Unbilled
receivables on uncompleted contracts
|
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|
133 |
|
|
|
196 |
|
Other assets
|
|
|
247 |
|
|
|
32 |
|
Total assets
|
|
$ |
5,323 |
|
|
$ |
5,203 |
|
Liabilities,
Minority Interest and Shareholders’ Equity
|
|
|
|
|
|
|
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|
Current
liabilities:
|
|
|
|
|
|
|
|
|
Accounts
payable
|
|
$ |
1,140 |
|
|
$ |
1,117 |
|
Due
to Halliburton, net
|
|
|
17 |
|
|
|
16 |
|
Advanced
billings on uncompleted contracts
|
|
|
686 |
|
|
|
794 |
|
Reserve
for estimated losses on uncompleted contracts
|
|
|
92 |
|
|
|
117 |
|
Employee
compensation and benefits
|
|
|
362 |
|
|
|
316 |
|
Other
current liabilities
|
|
|
327 |
|
|
|
262 |
|
Current liabilities related to discontinued
operations
|
|
|
6 |
|
|
|
1 |
|
Total
current liabilities
|
|
|
2,630 |
|
|
|
2,623 |
|
Noncurrent
employee compensation and benefits
|
|
|
109 |
|
|
|
79 |
|
Other
noncurrent liabilities
|
|
|
184 |
|
|
|
151 |
|
Noncurrent
income tax payable
|
|
|
80 |
|
|
|
78 |
|
Noncurrent deferred tax
liability
|
|
|
43 |
|
|
|
37 |
|
Total liabilities
|
|
|
3,046 |
|
|
|
2,968 |
|
Minority interest in consolidated
subsidiaries
|
|
|
— |
|
|
|
(32
|
) |
Shareholders’
equity and accumulated other comprehensive loss:
|
|
|
|
|
|
|
|
|
Preferred
stock, $0.001 par value, 50,000,000 shares authorized, no shares issued
and outstanding
|
|
|
— |
|
|
|
— |
|
Common
shares, $0.001 par value, 300,000,000 shares authorized;169,944,948 and
169,709,601 shares issued; 161,544,948 and 169,709,601 shares
outstanding
|
|
|
— |
|
|
|
— |
|
Paid-in
capital in excess of par value
|
|
|
2,086 |
|
|
|
2,070 |
|
Accumulated
other comprehensive loss
|
|
|
(136 |
) |
|
|
(122
|
) |
Retained earnings
|
|
|
523 |
|
|
|
319 |
|
|
|
|
2,473 |
|
|
|
2,267 |
|
Less: 8,400,000 and zero shares
of treasury stock, at cost
|
|
|
(196 |
) |
|
|
— |
|
Total shareholders’ equity and accumulated other
comprehensive loss
|
|
|
2,277 |
|
|
|
2,267 |
|
Total liabilities, minority interest ,
shareholders’ equity and accumulated other comprehensive
loss
|
|
$ |
5,323 |
|
|
$ |
5,203 |
|
See
accompanying notes to condensed consolidated financial
statements.
Condensed
Consolidated Statements of Cash Flows
(In
millions)
(Unaudited)
|
|
Nine
Months Ended
|
|
|
|
September 30,
|
|
|
|
2008
|
|
|
2007
|
|
Cash
flows from operating activities:
|
|
|
|
|
|
|
Net
income
|
|
$ |
231 |
|
|
$ |
231 |
|
Adjustments
to reconcile net income to net cash provided by
operations:
|
|
|
|
|
|
|
|
|
Depreciation
and amortization
|
|
|
33 |
|
|
|
30 |
|
Equity
in earnings of unconsolidated affiliates
|
|
|
(34
|
) |
|
|
(71
|
) |
Deferred
income taxes
|
|
|
52 |
|
|
|
8 |
|
Gain
on sale of assets, net
|
|
|
— |
|
|
|
(216
|
) |
Other
|
|
|
10 |
|
|
|
52 |
|
Changes
in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
Receivables
|
|
|
(119
|
) |
|
|
(247
|
) |
Unbilled
receivables on uncompleted contracts
|
|
|
73 |
|
|
|
271 |
|
Accounts
payable
|
|
|
(102
|
) |
|
|
(91
|
) |
Advanced
billings on uncompleted contracts
|
|
|
(212
|
) |
|
|
87 |
|
Accrued
employee compensation and benefits
|
|
|
(2
|
) |
|
|
35 |
|
Reserve
for loss on uncompleted contracts
|
|
|
(25
|
) |
|
|
(43
|
) |
Collection
(repayment) of advances from (to) unconsolidated affiliates,
net
|
|
|
69 |
|
|
|
(39
|
) |
Distribution
of earnings from unconsolidated affiliates
|
|
|
88 |
|
|
|
93 |
|
Other
assets
|
|
|
(89
|
) |
|
|
(38
|
) |
Other liabilities
|
|
|
28 |
|
|
|
110 |
|
Total cash flows provided by operating
activities
|
|
|
1 |
|
|
|
172 |
|
Cash
flows from investing activities:
|
|
|
|
|
|
|
|
|
Capital
expenditures
|
|
|
(27
|
) |
|
|
(32
|
) |
Sales
of property, plant and equipment
|
|
|
6 |
|
|
|
1 |
|
Acquisition
of businesses, net of cash acquired
|
|
|
(498
|
) |
|
|
— |
|
Disposition of businesses/investments, net of cash
disposed
|
|
|
— |
|
|
|
334 |
|
Total cash flows provided by (used in) investing
activities
|
|
|
(519
|
) |
|
|
303 |
|
Cash
flows from financing activities:
|
|
|
|
|
|
|
|
|
Payments
to Halliburton, net
|
|
|
— |
|
|
|
(120
|
) |
Payments
on long-term borrowings
|
|
|
— |
|
|
|
(7
|
) |
Payments
to reacquire common stock
|
|
|
(196
|
) |
|
|
— |
|
Net
proceeds from issuance of common stock
|
|
|
3 |
|
|
|
4 |
|
Excess
tax benefits from stock-based compensation
|
|
|
2 |
|
|
|
3 |
|
Payments
of dividends to shareholders
|
|
|
(17
|
) |
|
|
— |
|
Payments of dividends to minority
shareholders
|
|
|
(23
|
) |
|
|
(28
|
) |
Total cash flows used in financing
activities
|
|
|
(231
|
) |
|
|
(148
|
) |
Effect of exchange rate changes on
cash
|
|
|
(2
|
) |
|
|
7 |
|
Increase
(decrease) in cash and equivalents
|
|
|
(751
|
) |
|
|
334 |
|
Cash and equivalents at beginning of
period
|
|
|
1,861 |
|
|
|
1,461 |
|
Cash and equivalents at end of
period
|
|
$ |
1,110 |
|
|
$ |
1,795 |
|
Noncash financing
activities
|
|
|
|
|
|
|
|
|
Dividends
declared but not paid
|
|
$ |
9 |
|
|
$ |
— |
|
See
accompanying notes to condensed consolidated financial
statements.
Notes
to Condensed Consolidated Financial Statements
(Unaudited)
Note
1. Description of Business and Basis of Presentation
KBR, Inc.
and its subsidiaries (collectively, KBR) is a global engineering, construction
and services company supporting the energy, petrochemicals, government services
and civil infrastructure sectors. We offer a wide range of services through six
business units; Government and Infrastructure (“G&I”), Upstream, Services,
Downstream, Technology and Ventures. See Note 6 for financial information
about our reportable business segments.
KBR,
Inc., a Delaware corporation, was formed on March 21, 2006 as an indirect,
wholly owned subsidiary of Halliburton. KBR, Inc. was formed to own and operate
KBR Holdings, LLC (“KBR Holdings”). In November 2006, we completed an initial
public offering of 32,016,000 shares of our common stock (the “Offering”) at
$17.00 per share.
On
February 26, 2007, Halliburton’s board of directors approved a plan under which
Halliburton would dispose of its remaining interest in KBR through a tax-free
exchange with Halliburton’s stockholders pursuant to an exchange offer. On April
5, 2007, Halliburton completed the separation of KBR by exchanging the
135,627,000 shares of KBR owned by Halliburton for publicly held shares of
Halliburton common stock pursuant to the terms of the exchange offer (the
“Exchange Offer”) commenced by Halliburton on March 2, 2007.
The
accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with the rules of the United States Securities and
Exchange Commission (“SEC”) for interim financial statements and do not include
all annual disclosures required by accounting principles generally accepted in
the United States ("GAAP"). These condensed consolidated financial statements
should be read in conjunction with the audited consolidated financial statements
and notes thereto included in our Annual Report on Form 10-K for the fiscal year
ended December 31, 2007 filed with the SEC. We believe that the presentation and
disclosures herein are adequate to make the information not misleading, and the
condensed consolidated financial statements reflect all normal adjustments that
management considers necessary for a fair presentation of our consolidated
results of operations, financial position and cash flows. Operating results for
interim periods are not necessarily indicative of results to be expected for the
full fiscal year 2008 or any other future periods.
The
preparation of our condensed consolidated financial statements in conformity
with GAAP requires us to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosures of contingent assets and
liabilities at the balance sheet dates and the reported amounts of revenue and
costs during the reporting periods. Actual results could differ materially from
those estimates. On an ongoing basis, we review our estimates based on
information currently available, and changes in facts and circumstances may
cause us to revise these estimates.
Our
condensed consolidated financial statements include the accounts of
majority-owned, controlled subsidiaries and variable interest entities where we
are the primary beneficiary. The equity method is used to account for
investments in affiliates in which we have the ability to exert significant
influence over the affiliates’ operating and financial policies. The cost method
is used when we do not have the ability to exert significant influence. All
material intercompany accounts and transactions are eliminated.
Minority
interest in consolidated subsidiaries in our condensed consolidated balance
sheets principally represents minority shareholders’ proportionate share of the
equity in our consolidated subsidiaries. Minority interest in consolidated
subsidiaries is adjusted each period to reflect the minority shareholders’
allocation of income or the absorption of losses by the
minority shareholders on certain majority-owned, controlled investments
where the minority shareholders are obligated to fund the balance of their share
of these losses.
Revisions. Our prior period
consolidated statements of income have been revised to reclassify certain
indirect expenses as components of general and administrative expenses rather
than as components of cost of services to allow transparency of business unit
margins and general and administrative expense consistent with the nature of the
underlying costs and the manner in which the costs are managed. See Note 6 for
financial information about our reportable business segments and how indirect
costs are managed. There was no impact on net income as previously reported in
the consolidated statements of income, or on the consolidated balance sheets or
the consolidated statements of cash flows, as a result of these revisions. A
summary of the financial statement line items affected by the revisions is
presented below.
|
|
For the three months ended
September 30, 2007
|
|
|
For the nine months ended
September 30, 2007
|
|
Millions of dollars
|
|
As Previously
Reported
|
|
|
As Revised
|
|
|
As Previously Reported
|
|
|
As Revised
|
|
Cost
of services
|
|
$ |
2,043 |
|
|
$ |
2,010 |
|
|
$ |
6,053 |
|
|
$ |
5,967 |
|
General and administrative
|
|
$ |
32 |
|
|
$ |
65 |
|
|
$ |
91 |
|
|
$ |
177 |
|
Note
2. Income per Share
Basic income per share is based upon
the weighted average
number of common shares outstanding during the period. Dilutive 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 calculations is as follows:
|
Three
Months Ended
|
Nine
Months Ended
|
|
September
30,
|
September
30,
|
Millions of shares
|
2008
|
2007
|
2008
|
2007
|
Basic
weighted average common shares outstanding
|
|
|
166 |
|
|
|
168 |
|
|
|
168 |
|
|
|
168 |
|
Stock options and restricted
shares
|
|
|
1 |
|
|
|
2 |
|
|
|
1 |
|
|
|
1 |
|
Diluted weighted average common shares
outstanding
|
|
|
167 |
|
|
|
170 |
|
|
|
169 |
|
|
|
169 |
|
No
adjustments to net income were required in calculating diluted earnings per
share for the three and nine months ended September 30, 2008 and
2007.
Note
3. Acquisitions
BE&K,
Inc. On
July 1, 2008, we acquired 100% of the outstanding common shares of BE&K,
Inc., (“BE&K”) a privately held, Birmingham, Alabama-based engineering,
construction and maintenance services company. The acquisition of BE&K will
enhance our ability to provide contractor and maintenance services in North
America. The agreed-upon purchase price was $550 million in cash subject to
certain indemnifications and stockholders equity adjustments as defined in the
stock purchase agreement. BE&K and its acquired divisions have
been integrated into our Services, Downstream and Government &
Infrastructure business units based upon the nature of the underlying projects
acquired. As a result of the acquisition, the condensed consolidated statements
of income for the three and nine months ended September 30, 2008, include the
results of operations of BE&K since the date of acquisition.
In
accordance with Statement of Financial Accounting Standards No. 141, “Business
Combinations”, (“FAS 141”), the acquisition was accounted for using the purchase
method. For accounting purposes, the purchase consideration paid was
approximately $552 million, including direct transaction costs of approximately
$2 million. We conducted an external valuation of certain acquired assets for
inclusion in our balance sheet at the date of acquisition. Long-lived assets
such as property, plant and equipment largely reflect a value of replacing the
assets, which takes into account changes in technology, usage, and relative
obsolescence and depreciation of the assets. In addition, assets that would not
normally be recorded in ordinary operations (i.e., customer relationships and
other intangibles) were recorded at their estimated fair values. The excess of
preliminary purchase price over the estimated fair values of the net assets
acquired was recorded as goodwill. The following is a condensed balance sheet
reflecting our preliminary allocation of the purchase price to the fair value of
the major assets acquired and liabilities assumed at the date of
acquisition:
Allocation
of purchase price:
|
|
|
|
(In millions)
|
|
|
|
Net
tangible assets acquired:
|
|
|
|
Cash
and equivalents
|
|
$ |
66 |
|
Notes
and accounts receivable
|
|
|
308 |
|
Other
current assets
|
|
|
52 |
|
Property,
plant, and equipment, net
|
|
|
55 |
|
Other
assets
|
|
|
7 |
|
Accounts
payable and advanced billings
|
|
|
(244
|
) |
Other
current liabilities
|
|
|
(105
|
) |
Other
noncurrent liabilities
|
|
|
(67
|
) |
Minority interest in unconsolidated subsidiaries
|
|
|
(3
|
) |
Total
net tangible assets
|
|
|
69 |
|
Identifiable
intangible assets:
|
|
|
|
|
Customer relationships
and backlog
|
|
|
49 |
|
Tradenames
|
|
|
12 |
|
Other
|
|
|
1 |
|
Total
amount allocated to identifiable intangible assets
|
|
|
62 |
|
Goodwill
|
|
|
421 |
|
Total purchase price
|
|
$ |
552 |
|
Goodwill
has been allocated among our business segments with $356 million in Services,
$60 million in Other and $5 million in our Government & Infrastructure
segments. The acquired intangible assets consist primarily of customer
relationships which are amortized over the estimated remaining life of these
relationships. The customer relationships and the backlog acquired, with a value
of approximately $49 million, has a weighted average useful life of
approximately 6 years. Tradenames and other intangible assets subject to
amortization have a weighted average useful life of 3 years.
We have
not yet completed our allocation of the purchase price to the fair values of the
acquired assets and liabilities. In addition, we have not yet finalized the
purchase price to be paid pursuant to the terms of the stock purchase agreement.
We do not believe the resolution of these matters will result in a material
change to our preliminary purchase accounting or purchase price
consideration.
The
following pro forma information presents the Company’s revenues, net income and
earnings per share as if the BE&K acquisition had occurred on the first day
of the year presented below.
|
|
Nine
Months Ended
|
|
|
|
September 30,
|
|
Millions of dollars
|
|
2008
|
|
|
2007
|
|
Total
revenue
|
|
$ |
9,544 |
|
|
$ |
7,896 |
|
Income
from continuing operations (1)
|
|
$ |
224 |
|
|
$ |
146 |
|
Discontinued
operations (2)
|
|
|
20 |
|
|
|
91 |
|
Net
income
|
|
$ |
244 |
|
|
$ |
237 |
|
|
|
|
|
|
|
|
|
|
Basic
income per share
|
|
$ |
1.45 |
|
|
$ |
1.41 |
|
Diluted income per share
|
|
$ |
1.45 |
|
|
$ |
1.41 |
|
(1)
|
The
pro forma income from continuing operations for the nine months ended
September 30, 2008 and 2007 include approximately $6 and $9 million,
respectively, of incremental depreciation and amortization, net of the
related tax effects. The pro forma income from continuing operations for
the nine months ended September 30, 2008 include approximately $17 million
in incremental non-recurring stock-based and other compensation expenses
and approximately $9 million of seller-incurred transaction fees and
expenses, both net of the applicable tax, and were incurred in
contemplation of sale to KBR.
|
|
|
(2)
|
Pro
forma discontinued operations for the nine months ended September 30, 2008
includes the sale of certain business units by BE&K prior to our
acquisition of
BE&K.
|
The pro
forma supplemental information is not necessarily indicative of actual results
had the acquisition occurred on the first day of the respective period, nor is
it necessarily indicative of future results. The pro forma supplemental
information does not reflect potential synergies, integration costs, or other
such costs or savings.
Turnaround Group
of Texas, Inc. In April 2008, we
acquired 100% of the outstanding common stock of Turnaround Group of Texas, Inc.
(“TGI”). TGI is a Houston-based turnaround management and consulting company
that specializes in the planning and execution of turnarounds and outages in the
petrochemical, power, and pulp & paper industries. The total purchase
consideration for this stock purchase transaction was approximately $6 million.
As a result of the acquisition, we recognized goodwill of $4 million and other
intangible assets of $2 million. Beginning in April 2008, TGI’s results of
operations are included in our Services business unit. We have not yet completed
our allocation of the purchase price to the fair values of the acquired assets
and liabilities.
Catalyst
Interactive. In April 2008, we acquired 100% of the
outstanding common stock of Catalyst Interactive, an Australian e-learning and
training solution provider that specializes in the defense, government and
industry training sectors. The total purchase consideration for this stock
purchase transaction was approximately $5 million. As a result of the
acquisition, we recognized goodwill of approximately $3 million and other
intangible assets of approximately $2 million. Beginning in April 2008,
Catalyst Interactive’s results of operations are included in our Government
& Infrastructure business unit. We have not yet completed our
allocation of the purchase price to the fair values of the acquired assets and
liabilities.
Wabi Development
Corporation. In October 2008, we
acquired 100% of the outstanding common stock of Wabi Development Corporation
(“Wabi”) for approximately $20 million in cash. Wabi is a privately held
Canada-based general contractor, which provides services for the energy,
forestry and mining industries. Wabi currently employs over 350 people,
providing maintenance, fabrication, construction and construction management
services to a variety of clients in Canada and Mexico. Wabi will be integrated
into our Services business unit. The integration of Wabi into our Services
business will provide additional growth opportunities for our heavy hydrocarbon,
forestry, oil sand, general industrial and maintenance services business. We
have not yet completed our allocation of the purchase price to the fair values
of the acquired assets and liabilities.
Note
4. Percentage-of-Completion Contracts
Unapproved
claims
The
amounts of unapproved claims included in determining the profit or loss on
contracts that use the percentage of completion method of revenue recognition
and the amounts included in “Unbilled receivables on uncompleted contracts” as
of September 30, 2008 and December 31, 2007 are as follows:
|
|
September
30,
|
|
|
December
31,
|
|
Millions of dollars
|
|
2008
|
|
|
2007
|
|
Probable
unapproved claims
|
|
$ |
131 |
|
|
$ |
178 |
|
Probable
unapproved change orders
|
|
|
2 |
|
|
|
4 |
|
Probable
unapproved claims related to unconsolidated subsidiaries
|
|
|
38 |
|
|
|
36 |
|
Probable unapproved change orders related to
unconsolidated subsidiaries
|
|
|
1 |
|
|
|
15 |
|
As of
September 30, 2008, the probable unapproved claims, including those from
unconsolidated subsidiaries, related to five completed contracts. See Note 9 for
a discussion of certain United States government contract claims, which are not
included in the table above because such contracts are not accounted for using
the percentage of completion method.
Included
in the table above are contracts with probable unapproved claims that will
likely not be settled within one year totaling $131 million at September 30,
2008 and $178 million at December 31, 2007, which are reflected as a non-current
asset in “Unbilled receivables on uncompleted contracts” on the condensed
consolidated balance sheets. Other probable unapproved claims that we believe
will be settled within one year have been recorded as a current asset in
“Unbilled receivables on uncompleted contracts” on the condensed consolidated
balance sheets.
Skopje
Embassy Project
In 2005,
we were awarded a fixed-price contract to design and build a U.S. embassy in
Skopje, Macedonia. As a result of a project estimate update and progress
achieved on design drawings, we recorded a $12 million loss in connection with
this project during the fourth quarter of 2006. Subsequently in 2007, we
recorded additional losses on this project of approximately $27 million, and
approximately $15 million during the first half of 2008 with no
additional losses recorded in the third quarter of 2008, bringing our total
estimated losses to approximately $54 million. These additional costs are a
result of identifying increased costs of materials and the related costs of
freight, installation and other costs. We could incur additional costs and
losses on this project if our cost estimation processes identify new costs not
previously included in our total estimated costs or if our plans to make up lost
schedule are not achieved. As of September 30, 2008, the project was
approximately 82% complete.
Escravos
Project
In
connection with our review of a consolidated 50%-owned GTL project in
Escravos, Nigeria, during the second quarter of 2006, we identified increases in
the overall cost to complete this four-plus year project, which resulted in our
recording a $148 million charge before minority interest and taxes during the
second quarter of 2006. These cost increases were caused primarily by schedule
delays related to civil unrest and security on the Escravos River, changes
in the scope of the overall project, engineering and construction changes due to
necessary front-end engineering design changes and increases in procurement cost
due to project delays. The increased costs were identified as a result of our
first check estimate process.
During
the first half of 2007, we and our joint venture partner negotiated
modifications to the contract terms and conditions resulting in an executed
contract amendment in July 2007. The contract was amended to convert from a
fixed price to a reimbursable contract whereby we will be paid our actual cost
incurred less a credit that approximates the charge we identified in the second
quarter of 2006. The unamortized balance of the charge is included as a
component of the “Reserve for estimated losses on uncompleted contracts” in the
accompanying condensed consolidated balance sheets. Also included in the amended
contract are client determined incentives that may be earned over the remaining
life of the contract. Under the terms of the amended contact, the first $21
million of incentives earned over the remaining life of the contract are not
payable to us. During the nine months ended September 30, 2008, we did
not recognize approximately $11 million of incentives earned but not
payable under the provisions of the amended contract. Since the contract
was amended, we have earned approximately $17 million of incentives. Our
Advanced billings on uncompleted contracts included in our condensed
consolidated balance sheets related to this project, was $60 million at
September 30, 2008 and $236 million at December 31, 2007.
Note
5. PEMEX
In 1997
and 1998 we entered into three contracts with PEMEX, the project owner, to build
offshore platforms, pipelines and related structures in the Bay of Campeche
offshore Mexico. The three contracts are known as EPC 1, EPC 22 and EPC 28,
respectively. All three projects encountered significant schedule delays and
increased costs due to problems with design work that was the contractual
responsibility of PEMEX, late delivery and defects in equipment provided by
PEMEX, increases in scope and other changes made by PEMEX. We completed work on
EPC 28 and EPC 22 in August 2002 and March 2004, respectively. PEMEX took
possession of the offshore facilities of EPC 1 in March 2004 after having
achieved oil production and prior to our completion of our scope of work
pursuant to the contract.
In
accordance with the terms of each of the contracts, we filed for arbitration
with the International Chamber of Commerce (ICC) in 2004 and 2005 claiming
recovery of damages of $323 million, $215 million and $142 million for EPC 1, 22
and 28, respectively. PEMEX subsequently filed counterclaims totaling $157
million, $42 million and $2 million for EPC 1, 22 and 28, respectively. The
arbitration hearings were held in 2006 for EPC 22 and EPC 28 and in November
2007 for EPC 1. In January 2008, we received payment from PEMEX related to the
EPC 22 arbitration award of the ICC panel which was sufficient for recovery of
our investment in the note receivable for this contract, as well as $4 million
in interest income in the fourth quarter of 2007. We received notice in February
2008, that the ICC approved the arbitration panel’s decision to award in favor
of KBR on the EPC 28 arbitration. The net award in our favor was approximately
$76 million plus accrued interest since 2002 which we estimate ranges between
$36 million and $49 million depending on whether interest is calculated on a
simple or compound method. The amount of the award exceeded the book value of
our claim receivable and accounts receivable of $61 million related to this
project. As a result, we recorded in the first quarter of 2008 an increase to
revenue and a gain of $51 million. Although the arbitration award is legally
binding and enforceable, we have filed a proceeding in the U.S. to recognize the
award. PEMEX filed a legal proceeding in Mexico to challenge the award. The
Mexican court rejected PEMEX’s contention that the arbitration award should be
nullified. PEMEX has filed an appeal challenging the ruling. As a result, we
believe collection of the award may not occur in the next 12 months and
therefore, we have classified the total $111 million due from PEMEX for EPC 28
as a long term receivable included in “Other assets” on the condensed
consolidated balance sheet at September 30, 2008. We estimate that a decision
from the ICC will be reached regarding the EPC 1 arbitration in the fourth
quarter of 2008.
As a
result of the arbitration awards for EPC 22 and EPC 28, the costs incurred
related to these two projects are no longer classified as probable claims. The
costs incurred related to EPC 1 continues to be classified as a probable claim
receivable. There have been no significant adjustments to the EPC 1 claim amount
since 2004. Based on facts known by us as of September 30, 2008, we believe that
the remaining EPC 1 counterclaims referred to above filed by PEMEX are without
merit and have concluded there is no reasonable possibility that a loss has been
incurred. No amounts have been accrued for these counterclaims at September 30,
2008.
Note
6. Business Segment Information
We
provide a wide range of services, but the management of our business is heavily
focused on major projects within each of our reportable segments. At any given
time, a relatively few number of projects and joint ventures represent a
substantial part of our operations. Intersegment revenues are immaterial. Our
equity in earnings and losses of unconsolidated affiliates that are accounted
for using the equity method of accounting is included in revenue of the
applicable segment.
The table
below presents information on our business segments.
|
|
Three
Months Ended
|
|
|
Nine Months
Ended
|
|
|
|
September 30,
|
|
|
September 30,
|
|
Millions of dollars
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
Revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
Government
and Infrastructure
|
|
$ |
1,759 |
|
|
$ |
1,566 |
|
|
$ |
5,150 |
|
|
$ |
4,505 |
|
Upstream
|
|
|
550 |
|
|
|
407 |
|
|
|
1,860 |
|
|
|
1,284 |
|
Services
|
|
|
539 |
|
|
|
77 |
|
|
|
776 |
|
|
|
226 |
|
Other
|
|
|
170 |
|
|
|
127 |
|
|
|
409 |
|
|
|
341 |
|
Total revenue
|
|
$ |
3,018 |
|
|
$ |
2,177 |
|
|
$ |
8,195 |
|
|
$ |
6,356 |
|
Operating
segment income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Government
and Infrastructure
|
|
$ |
104 |
|
|
$ |
98 |
|
|
$ |
247 |
|
|
$ |
226 |
|
Upstream
|
|
|
53 |
|
|
|
57 |
|
|
|
197 |
|
|
|
124 |
|
Services
|
|
|
27 |
|
|
|
6 |
|
|
|
57 |
|
|
|
33 |
|
Other
|
|
|
20 |
|
|
|
6 |
|
|
|
50 |
|
|
|
16 |
|
Operating
segment income (a)
|
|
$ |
204 |
|
|
$ |
167 |
|
|
$ |
551 |
|
|
$ |
399 |
|
Unallocated
amounts:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Labor
cost absorption (b)
|
|
|
(5
|
) |
|
|
— |
|
|
|
— |
|
|
|
(10
|
) |
Corporate general and
administrative
|
|
|
(55
|
) |
|
|
(65
|
) |
|
|
(163
|
) |
|
|
(177
|
) |
Total operating income
|
|
$ |
144 |
|
|
$ |
102 |
|
|
$ |
388 |
|
|
$ |
212 |
|
|
(a)
|
Operating
segment performance is evaluated by our chief operating decision maker
using operating segment income which is defined as operating segment
revenue less the cost of services and segment overhead directly
attributable to the operating segment. Operating segment income excludes
certain cost of services directly attributable to the operating segment
that is managed and reported at the corporate level, and corporate general
and administrative expenses. We believe this is the most accurate measure
of the ongoing profitability of our operating
segments.
|
|
(b)
|
Labor
cost absorption represents costs incurred by our central service labor and
resource groups (above)/ under the amounts charged to the operating
segments.
|
Note
7. Committed Cash
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 September 30, 2008 and December 31,
2007, cash and equivalents include approximately $302 million and $483 million,
respectively, in cash from advanced payments held by ourselves or our joint
ventures that we consolidate for accounting purposes.
Note
8. Comprehensive Income
The
components of comprehensive income included the following:
|
Three
Months Ended
|
|
Nine Months
Ended
|
|
|
September 30,
|
|
September
30,
|
|
Millions of dollars
|
2008
|
|
2007
|
|
2008
|
|
2007
|
|
Net
income
|
|
$ |
85 |
|
|
$ |
63 |
|
|
$ |
231 |
|
|
$ |
231 |
|
Net
cumulative translation adjustments
|
|
|
(20
|
) |
|
|
4 |
|
|
|
(22
|
) |
|
|
(14
|
) |
Pension
liability adjustment
|
|
|
2 |
|
|
|
3 |
|
|
|
6 |
|
|
|
103 |
|
Net unrealized losses on investments and
derivatives
|
|
|
(1
|
) |
|
|
— |
|
|
|
— |
|
|
|
(1
|
) |
Total comprehensive income
|
|
$ |
66 |
|
|
$ |
70 |
|
|
$ |
215 |
|
|
$ |
319 |
|
Comprehensive
income for the nine months ended September 30, 2007 includes the elimination of
net cumulative translation and pension liability adjustments of $(22) million
and $90 million, respectively, related to the disposition of our 51%
interest in DML in the second quarter of 2007.
Accumulated
other comprehensive loss consisted of the following:
|
|
September
30,
|
|
|
December
31,
|
|
Millions of dollars
|
|
2008
|
|
|
2007
|
|
Cumulative
translation adjustments
|
|
$ |
16 |
|
|
$ |
38 |
|
Pension
liability adjustments
|
|
|
(151
|
) |
|
|
(159
|
) |
Unrealized losses on investments and
derivatives
|
|
|
(1
|
) |
|
|
(1
|
) |
Total accumulated other comprehensive
loss
|
|
$ |
(136 |
) |
|
$ |
(122 |
) |
Accumulated
other comprehensive loss was charged $2 million, net of tax as of January 1,
2008, as a result of the measurement date requirements of SFAS No. 158,
“Employers’ Accounting for Defined Benefit Pension and Other Postretirement
Plans, an amendment of FASB Statements No. 87, 88, 106, and
132(R).” See Note 14 for further information.
Note 9.
United States Government Contract Work
We
provide substantial work under our government contracts with the United States
Department of Defense and other governmental agencies. These contracts include
our worldwide United States Army logistics contracts, known as LogCAP and U.S.
Army Europe (“USAREUR”).
Given the
demands of working in Iraq and elsewhere for the United States government, we
have from time to time, had disagreements or performance issues with the various
government customers for which we work. In such instances, 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 incurred under
cost-reimbursable contracts. To date, none of our U.S. or any other government
contracts have been terminated. 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.
We have
experienced and expect to be a party to various claims against us by employees,
third parties, soldiers and others that have arisen out of our work in war zones
such as claims for wrongful termination, assaults against employees, personal
injury claims by third parties and army personnel, and contractor claims. While
we believe we conduct our operations safely, the environments in which we
operate often lead to these types of claims. We believe the vast majority of
these types of claims are governed by the Defense Base Act or precluded by other
defenses. We have a dispute resolution program under which most of these
employee claims are subject to binding arbitration. However, an unfavorable
resolution or disposition of these matters could have a material adverse effect
on our business, results of operations, financial condition and cash flow.
We accrue
estimated award fees based on historical performance scores and award rates. Our
last award fee letter was issued in the second quarter of 2008 for the period
from November 2007 through February 2008. At September 30, 2008,
approximately $48 million is recorded in unbilled receivables in the
accompanying balance sheet as our estimate of award fees earned since our last
award fee letter. If our next award fee letter has performance scores
and award rates higher or lower than our historical rates, our accrual will be
adjusted accordingly.
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
identified 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. We
self-disallow costs that are expressly not allocable to government contracts per
the relevant regulations. However, if our customer or a government auditor forms
an opinion that we improperly charged any costs to a contract, these costs,
depending on facts and circumstances and the issue resolution process, could
become non-reimbursable and in such instances if already reimbursed, the costs
must be refunded to the customer. Our revenue recorded for government contract
work is reduced for our estimate of potentially refundable costs related to
dispute issues that may be categorized as disputed or unallowable as a result of
cost overruns or the audit process.
Security.
In February 2007, we received a letter from the Department of the Army informing
us of their intent to adjust payments under the LogCAP III contract associated
with the cost incurred by the subcontractors to provide security to their
employees. Based on this letter, the Army withheld it’s initial assessment of
$20 million. The Army based its assessment on one subcontract wherein, based on
communications with the subcontractor, the Army estimated 6% of the total
subcontract cost related to the private security costs. The Army indicated that
not all task orders and subcontracts have been reviewed and that they may make
additional adjustments. The Army indicated that, within 60 days, they would
begin making further adjustments equal to 6% of prior and current subcontractor
costs unless we provided timely information sufficient to show that such action
was not necessary to protect the government’s interest.
The Army
indicated that they believe our LogCAP III contract prohibits us from billing
costs of privately acquired security. We believe that, while the LogCAP III
contract anticipates that the Army will provide force protection to KBR
employees, it does not prohibit any of our subcontractors from using private
security services to provide force protection to subcontractor personnel. In
addition, a significant portion of our subcontracts are competitively bid lump
sum or fixed price subcontracts. As a result, we do not receive details of the
subcontractors’ cost estimate nor are we legally entitled to it. Accordingly, we
believe that we are entitled to reimbursement by the Army for the cost of
services provided by our subcontractors, even if they incurred costs for private
force protection services. Therefore, we believe that the Army’s position that
such costs are unallowable and that they are entitled to withhold amounts
incurred for such costs is wrong as a matter of law.
If we are
unable to demonstrate that such action by the Army is not necessary, a 6%
suspension of all subcontractor costs incurred to date could result in suspended
costs of approximately $400 million. The Army has asked us to provide
information that addresses the use of armed security either directly or
indirectly charged to LogCAP III. The actual costs associated with these
activities cannot be accurately estimated, but we believe that they should be
less than 6% of the total subcontractor costs. We will continue to work with the
Army to resolve this issue. In October 2007, we filed a claim to recover the
amounts withheld which was deemed denied as a result of no response from the
DCMA. In March 2008, we filed an appeal to the Armed Services Board of Contracts
Appeals to recover the amounts withheld. At this time, the likelihood that a
loss related to this matter has been incurred is remote. As of September 30,
2008, we had not adjusted our revenues or accrued any amounts related to this
matter.
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. During
2006, we resolved approximately $26 million of the withheld amounts with our
contracting officer and payment was received in the first quarter of 2007. In
May of 2008, we received notice from the DCMA of their intention to rescind
their 2006 determination to allow the $26 million of costs pending additional
supporting information. As of September 30, 2008, approximately $55 million of
costs have been suspended related to this matter of which $31 million has been
withheld by us from our subcontractors. In April 2008, we filed a counterclaim
in arbitration against one of our LogCAP III subcontractors, First Kuwaiti
Trading Company, to recover approximately $51 million paid to the subcontractor
for containerized housing as further described under the caption First Kuwaiti
Arbitration below. We will continue working with the government and our
subcontractors to resolve the remaining amounts. At this time, the likelihood
that a loss in excess of the amount accrued for this matter is
remote.
Dining
facilities. In
the third quarter of 2006, the DCAA raised questions regarding $95 million of
costs related to dining facilities in Iraq. We responded to the DCAA that our
costs are reasonable. In the fourth quarter of 2007, the DCMA suspended payment
for $11 million of costs related to these dining facilities until such time we
provide documentation to support the price reasonableness of the rates
negotiated with our subcontractor and demonstrate that the amounts billed were
in accordance with the contract terms. In the first quarter of 2008, the DCMA
suspended payment for an additional $53 million of costs until such time we
provide documentation to support the price reasonableness of the rates
negotiated with the subcontractor. We believe the prices obtained for these
services were reasonable and intend to vigorously defend ourselves on this
matter. In 2008, we filed two claims to recover approximately $52 million of
amounts previously withheld from us by the DCMA. With respect to questions
raised regarding billing in accordance with contract terms, as of September 30,
2008, we believe it is reasonably possible that we could incur losses in excess
of the amount accrued for possible subcontractor costs billed to the customer
that were possibly not in accordance with contract terms. However, we are unable
to estimate an amount of possible loss or range of possible loss in excess of
the amount accrued related to any costs billed to the customer that were not in
accordance with the contract terms.
Kosovo
fuel. In April
2007, the DOJ issued a letter alleging the theft in 2004 and subsequent
sale of diesel fuel by KBR employees assigned to Camp Bondsteel
in Kosovo. In addition, the letter alleges that KBR employees falsified records
to conceal the thefts from the Army. The total value of the fuel in question is
estimated by the DOJ at approximately $2 million based on an audit report
issued by the DCAA. We believe the volume of the alleged misappropriated fuel is
significantly less than the amount estimated by the DCAA. We responded to the
DOJ that we had maintained adequate programs to control, protect, and preserve
the fuel in question. We further believe that our contract with the Army
expressly limits KBR’s responsibility for such losses. Our discussions with the
DOJ are ongoing and have included items ranging from settlement of this matter
for de minimus amounts to the DOJ reserving their rights to litigate. Should
litigation occur, we believe we have meritorious defenses and intend to
vigorously defend ourselves. Neither our client nor the DCAA has indicated
any intent to withhold payments from us relating to this matter. We believe the
likelihood that a loss has been incurred related to this matter is remote and
accordingly, no amounts have been accrued.
Transportation
costs. The DCAA, in performing its audit activities under the
LogCAP III contract, raised a question about our compliance with the
provisions of the Fly America Act. Subject to certain exceptions, the Fly
America Act requires Federal employees and others performing U.S. Government
financed foreign air travel to travel by U.S. flag air carriers. There are
times when we transported personnel in connection with our services for the U.S.
military where we may not have been in compliance with the Fly America Act and
its interpretations through the Federal Acquisition Regulations and the
Comptroller General. As of September 30, 2008, we have accrued an estimate of
the cost incurred for these potentially non-compliant flights with a
corresponding reduction to revenue. The DCAA may consider additional flights to
be noncompliant resulting in potential larger amounts of disallowed costs than
the amount we have accrued. At this time, we cannot estimate a range of
reasonably possible losses that may have been incurred, if any, in excess of the
amount accrued. We will continue to work with our customer to resolve this
matter.
Dining Facility
Support Services. In April 2007, DCAA recommended withholding $13 million
of payments from KBR alleging that Eurest Support Services (Cypress)
International Limited (“ESS”), a subcontractor to KBR providing dining facility
services in conjunction with our LogCAP III contract in Iraq, over-billed for
the cost related to the use of power generators. Payments of $13 million were
withheld from us. In the first quarter of 2008, we favorably resolved this
matter with the DCAA resulting in the DCAA rescinding its previously issued
withholding.
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 have been 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.
Investigations
relating to Iraq, Kuwait, Afghanistan and Other
In the
first quarter of 2005, the 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. We provided information to the DoD Inspector
General’s office in February 2004 about other contacts between former employees
and our subcontractors. In March 2006, one of these former employees pled guilty
to taking money in exchange for awarding work to a Saudi Arabian subcontractor.
The Inspector General’s investigation of these matters may
continue.
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 or trial testimony
related to some of these and other matters.
Various
Congressional committees have conducted hearings on the U.S. military’s reliance
on civilian contractors, including with respect to military operations in Iraq.
We have provided testimony and information for these hearings. We continue to
provide information and testimony with respect to operations in Iraq in these
Congressional committees, including the House Armed Services Committee. During
the first quarter of 2008, we received Congressional inquiries regarding our
offshore payroll structure and whether FICA taxes should have been withheld. We
have responded to those inquiries and we believe we have substantially complied
with the applicable laws and regulations that pertain to our payroll
withholdings. In June 2008, the Heroes Earnings Assistance and Relief Tax
(HEART) Act was signed into law and is effective beginning August 1,
2008. We believe our employees that are U.S. citizens or residents
performing services on U.S. government contracts are subject to the HEART Act.
Accordingly, at the effective date we began withholding FICA taxes, pay the
employer matching of such taxes and charge such costs to our reimbursable
contract. We do not believe that the change in law will have a material impact
to our financial position, results of operations, or cash flows.
We have
identified and reported to the U.S. Departments of State and Commerce numerous
exports of materials, including personal protection equipment such as helmets,
goggles, body armor and chemical protective suits, that possibly were not in
accordance with the terms of our export license or applicable regulations.
However, we believe that the facts and circumstances leading to our conclusion
of possible non-compliance relating to our Iraq and Afghanistan activities are
unique and potentially mitigate any possible fines and penalties because the
bulk of the exported items are the property of the U.S. government and are used
or consumed in connection with services rendered to the U.S. government. In
addition, we have responded to a March 19, 2007, subpoena from the DoD Inspector
General concerning licensing for armor for convoy trucks and antiboycott issues.
We continue to comply with the requests to provide information under the
subpoena. Whereas it is reasonably possible that we may be subject to fines and
penalties for possible acts that are not in compliance with our export licenses
or regulations, at this time it is not possible to estimate an amount of loss or
range of losses that may have been incurred. A failure to comply with applicable
laws and regulations could result in civil and/or criminal sanctions, including
the imposition of fines upon us as well as the denial of export privileges and
debarment from participation in U.S. government contracts. We are in ongoing
communications with the appropriate authorities with respect to these matters.
There can be no assurances that we will not be subject to any sanctions nor
that, if any such sanctions are imposed, they will not have a material adverse
impact on us.
Claims
We had
unapproved claims for costs incurred under various government contracts totaling
$74 million at September 30, 2008 and $82 million at December 31, 2007. The
unapproved claims outstanding at September 30, 2008 and December 31, 2007 are
considered to be probable of collection and have been recognized as revenue.
These unapproved claims relate to contracts where our costs have exceeded the
customer’s funded value of the task order and therefore could not be billed. We
understand that our customer is actively seeking funds that have been or will be
appropriated to the Department of Defense that can be obligated on our
contract.
In
addition, as of September 30, 2008 and December 31, 2007, we had incurred
approximately $35 million and $156 million, respectively, of costs under the
LogCAP III contract that could not be billed to the government due to lack of
appropriate funding on various task orders. These amounts were associated with
task orders that had sufficient funding in total, but the funding was not
appropriately allocated among the task orders. We have submitted requests for
reallocations of funding to the U.S. Army and continue to work with them to
resolve this matter. We anticipate the negotiations will result in an
appropriate distribution of funding by the client and collection of the full
amounts due.
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 have addressed the issues raised by the DCMA.
Specifically, based on the unprecedented level of support that our employees are
providing the military in Iraq, Kuwait, and Afghanistan, we updated 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. We continue to
address new issues as they are raised by the DCAA.
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.” During the second quarter of 2008, the DCMA granted, again, continued
approval of our government contract purchasing system.
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. In the fourth quarter
of 2006, the DCAA finalized its report and submitted it to the DCMA, who will
make a determination of the adequacy of our accounting systems for government
contracting. We have prepared an action plan considering the DCAA
recommendations and continue to meet with these agencies to discuss the ultimate
resolution. KBR’s accounting system is currently deemed acceptable for
accumulating costs incurred under US Government contracts.
SIGIR
Report
The
Special Inspector General for Iraq Reconstruction, or SIGIR, was created by
Congress to provide oversight of the Iraq Relief and Reconstruction Fund (IRRF)
and all obligations, expenditures, and revenues associated with reconstruction
and rehabilitation activities in Iraq. SIGIR reports, from time to time, make
reference to KBR regarding various matters. We believe we have addressed all
issues raised by prior SIGIR reports and we will continue to do so as new issues
are raised.
McBride
Qui Tam suit
In
September 2006, we became aware of a qui tam action filed against us by a former
employee alleging various wrongdoings in the form of overbillings of our
customer on the LogCAP III contract. This case was originally filed pending the
government’s decision whether or not to participate in the suit. In June 2006,
the government formally declined to participate. The principal allegations are
that our compensation for the provision of Morale, Welfare and Recreation
(“MWR”) facilities under LogCAP III is based on the volume of usage of those
facilities and that we deliberately overstated that usage. In accordance with
the contract, we charged our customer based on actual cost, not based on the
number of users. It was also alleged that, during the period from November 2004
into mid-December 2004, we continued to bill the customer for lunches, although
the dining facility was closed and not serving lunches. There are also
allegations regarding housing containers and our provision of services to our
employees and contractors. On July 5, 2007, the court granted our motion to
dismiss the qui tam claims and to compel arbitration of employment claims
including a claim that the plaintiff was unlawfully discharged. The majority of
the plaintiff’s claims were dismissed but the plaintiff was allowed to pursue
limited claims pending discovery and future motions. All employment claims were
sent to arbitration under the Company’s dispute resolution program. The
appellate court affirmed the lower court’s dismissal. We believe the relator’s
claim is without merit and that the likelihood that a loss has been incurred is
remote. As of September 30, 2008, no amounts have been accrued.
Wilson
and Warren Qui Tam suit
During
November 2006, we became aware of a qui tam action filed against us alleging
that we overcharged the military $30 million by failing to adequately maintain
trucks used to move supplies in convoys and by sending empty trucks in convoys.
It was alleged that the purpose of these acts was to cause the trucks to break
down more frequently than they would if properly maintained and to unnecessarily
expose them to the risk of insurgent attacks, both for the purpose of
necessitating their replacement thus increasing our revenue. The suit also
alleges that in order to silence the plaintiffs, who allegedly were attempting
to report those allegations and other alleged wrongdoing, we unlawfully
terminated them. On February 6, 2007, the court granted our motion to dismiss
the plaintiffs’ qui tam claims as legally insufficient and ordered the
plaintiffs to arbitrate their claims that they were unlawfully discharged. The
final judgment in our favor was entered on April 30, 2007 and subsequently
appealed by the plaintiffs on May 3, 2007. The appellate court affirmed the
lower courts dismissal. As of September 30, 2008, we consider the matter to be
concluded.
Godfrey Qui Tam
suit
In
December 2005, we became aware of a qui tam action filed against us and several
of our subcontractors by a former employee alleging that we violated the False
Claims Act by submitting overcharges to the government for dining facility
services provided in Iraq under the LogCAP III contract. As required by the
False Claims Act, the lawsuit was filed under seal to permit the government to
investigate the allegations. In early April 2007, the court denied the
government’s motion for the case to remain under seal, and on April 23, 2007,
the government filed a notice stating that it was not participating in the suit.
In August 2007, the relator filed an amended complaint which added an additional
contract to the allegations and added retaliation claims. We filed motions to
dismiss and to compel arbitration which were granted on March 13, 2008 for all
counts except as to the employment issues which were sent to arbitration. The
relator has filed an appeal. We are unable to determine the likely outcome at
this time. No amounts have been accrued because we cannot determine any
reasonable estimate of loss that may have been incurred, if any.
ASCO
Litigation
On July
23, 2008, a jury in Texas returned a verdict against KBR awarding
Associated Construction Company WLL (ASCO) damages of $39 million with the
court to determine attorneys fees and interest. In 2003, ASCO was a
subcontractor to KBR in Iraq related to work performed on our LogCAP III
contract. On August 25, 2008 the court entered a judgment which
included damages of approximately $18 million, interest of approximately $3
million and attorney’s fees of $6 million bringing the total judgment to
$27 million. We continue to believe that the damages awarded are
subject to challenge on appeal. We intend to appeal, but we will seek
our customer’s advice regarding other actions to take which may include an
appeal. At this time, we cannot predict the likelihood of succeeding in our
appeal. As a result of the final judgment, we reduced our previous
accrual from $40 million to $27 million during the third quarter of 2008
and we believe the entire amount is billable to the customer. However, we will
not recognize such amount as revenue until such time as we are reasonably
assured of collection.
First
Kuwaiti Arbitration
In April
2008 First Kuwaiti Trading Company, one of our LogCAP III subcontractors, filed
for arbitration of a subcontract under which KBR had leased vehicles related to
work performed on our LogCAP III contract. First Kuwaiti alleged that we
did not return or pay rent for many of the vehicles and sought damages in the
amount of $39 million. We filed a counterclaim to recover amounts which may
ultimately be determined due to the Government for the $51 million in suspended
costs as discussed in the preceding section of this footnote titled
“Containers.” First Kuwaiti subsequently responded by adding additional
subcontract claims, increasing its total claim to approximately $96 million.
This matter is in the early stages of the arbitration process and no amounts
have been accrued as we are unable to determine a reasonable estimate of loss,
if any, at this time.
Electrocution
Litigation
During
2008, two separate lawsuits were filed against KBR alleging that the Company was
responsible in two separate electrical incidents which resulted in the deaths of
two soldiers. One incident occurred at Radwaniyah Palace Complex and the other
occurred at Al Taqaddum. It is alleged in each suit that the electrocution
incident was caused by improper electrical maintenance or other electrical work.
KBR denies that its conduct was the cause of either event and denies legal
responsibility. Both cases have been removed to Federal Court where motions to
dismiss have been filed and are currently pending. Discovery has not yet begun
in one case, and is in early stages in the other case. We are unable to
determine the likely outcome of these cases at this time. As of September 30,
2008, no amounts have been accrued.
Note
10. Other Commitments and Contingencies
Foreign
Corrupt Practices Act investigations
Halliburton
provided indemnification in favor of KBR under the Master Separation Agreement
for certain contingent liabilities, including Halliburton’s indemnification of
KBR and any of its greater than 50%-owned subsidiaries as of November 20, 2006,
the date of the master separation agreement, for fines or other monetary
penalties or direct monetary damages, including disgorgement, as a result of a
claim made or assessed by a governmental authority in the United States, the
United Kingdom, France, Nigeria, Switzerland and/or Algeria, or a settlement
thereof, related to alleged or actual violations occurring prior to November 20,
2006 of the FCPA or particular, analogous applicable foreign statutes, laws,
rules, and regulations in connection with investigations pending as of that date
including with respect to the construction and subsequent expansion by TSKJ of a
natural gas liquefaction complex and related facilities at Bonny Island in
Rivers State, Nigeria. The following provides a detailed discussion of the FCPA
investigation.
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 has been furnished regarding current and former agents
used in connection with multiple projects, including current and prior projects,
over the past 20 years located both in and outside of Nigeria in which we,
Halliburton, The M.W. Kellogg Company, M.W. Kellogg Limited or their or our
joint ventures are or were participants. In September 2006, the SEC
requested that Halliburton, for itself and all of its subsidiaries, enter into a
tolling agreement on behalf of Halliburton and KBR with respect to its
investigation. In 2008, Halliburton entered into tolling agreements with the SEC
and the DOJ. KBR has also entered into tolling agreements with the DOJ and
SEC.
In 2007,
we and Halliburton each received a grand jury subpoena from the DOJ and
subpoenas from the SEC related to the Bonny Island project asking for
additional information on the immigration service providers used by TSKJ. We
have provided the requested documents to the DOJ and SEC and will continue to
provide Halliburton with the requested information in accordance with the master
separation agreement.
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 LLC
(a subsidiary of ours and successor to The M.W. Kellogg Company), each of which
had an approximately 25% interest in the venture at December 31, 2007. 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 had a 55% interest
at December 31, 2007, and M.W. Kellogg Limited and The M.W. Kellogg Company
were subsidiaries of Dresser Industries before Halliburton’s 1998 acquisition of
Dresser Industries. The M.W. Kellogg Company was later merged with a
Halliburton subsidiary 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 FCPA. Halliburton and KBR have been cooperating with the SEC and DOJ
investigations and with other investigations into the Bonny Island project
in France, Nigeria and Switzerland. The Serious Frauds Office in the United
Kingdom is conducting an investigation relating to the Bonny Island project
and recently made contact with KBR to request limited information. Under the
master separation agreement, Halliburton will continue to oversee and direct the
investigations and, pursuant to the terms of the Master Separation Agreement,
will at all times have and maintain control over the investigation, defense
and/or settlement of the matters under investigation.
The
matters under investigation relating to the Bonny Island project cover an
extended period of time (in some cases significantly before Halliburton’s 1998
acquisition of Dresser Industries and continuing through the current time
period). We have produced documents to the SEC and the DOJ both voluntarily and
pursuant to company subpoenas from the files of numerous officers and employees
of Halliburton and KBR, including many 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 subpoenas to others, including
certain of our current and former employees, former executive officers and at
least one of our subcontractors. We further understand that the DOJ issued
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 engagement 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.
Halliburton
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 accounts of
Tri-Star Investments in banks in Switzerland transferred to Nigeria and to have
the legal ownership of such sums determined in the Nigerian courts.
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 by agents of TSKJ to Nigerian officials. The
government has recently confirmed that it has evidence of such payments. The
government has also recently advised Halliburton and KBR that it has evidence of
payments to Nigerian officials by another agent in connection with a separate
KBR-managed offshore project in Nigeria, and possibly evidence of payments in
connection with other projects in Nigeria. In addition, information uncovered in
the summer of 2006 suggests that, prior to 1998, plans may have been made by
employees of The M.W. Kellogg Company to make payments to government officials
in connection with the pursuit of a number of other projects in countries
outside of Nigeria. Halliburton is reviewing a number of documents related to
KBR activities in countries outside of Nigeria with respect to agents for
projects after 1998. Certain of the activities involve current or former
employees or persons who were or are consultants to us, and the investigation is
continuing.
In June
2004, all relationships with A. Jack Stanley, who formerly served as a
consultant and chairman of Kellogg Brown & Root, and another consultant
and former employee of M.W. Kellogg Limited were terminated. The terminations
occurred because of violations of Halliburton’s 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.
In
September 2008, Mr. Stanley pleaded guilty to conspiring to violate
the Foreign Corrupt Practices Act (FCPA). By the plea, Mr. Stanley admitted that
he participated in a scheme to bribe Nigerian government officials and that
payments were made by agents of TSKJ to Nigerian officials in connection with
the construction and expansion by TSKJ of the complex at Bonny Island. He also
pleaded guilty to conspiracy to commit mail and wire fraud in causing a
Kellogg Brown & Root consultant to pay kickbacks to Mr. Stanley in
connection with the Bonny Island and other liquefied natural gas projects
of Kellogg Brown & Root. In a related action, the SEC charged
Mr. Stanley with violating the anti-bribery provisions of the FCPA and
knowingly falsifying books and records to falsely reflect payments to these
agents of TSKJ as legitimate business expenses and knowingly circumventing
internal accounting controls. Without admitting or denying the allegations
in the complaint, Mr. Stanley has consented to the entry of a final
judgment that permanently enjoins him from violating the anti-bribery,
record-keeping and internal control provisions of the Securities Exchange Act of
1934. Mr. Stanley also has agreed to cooperate with the SEC's and the DOJ's
ongoing investigations.
In 2006,
Halliburton and KBR suspended the services of another agent who, until such
suspension, had worked for us outside of Nigeria on several current projects,
including a separate KBR managed offshore project in Nigeria, and on numerous
older projects going back to the early 1980s. In addition, Halliburton suspended
the services of an additional agent on a separate current Nigerian project with
respect to which Halliburton has received from a joint venture partner on that
project allegations of wrongful payments made by such agent. Until such time as
the agents’ suspensions are favorably resolved, KBR will continue the suspension
of its use of both of the referenced agents.
A person
or entity found in violation of the FCPA could be subject to fines, civil
penalties of up to $500,000 per violation, equitable remedies, including
disgorgement (if applicable) generally of profits, including prejudgment
interest on such profits, causally connected to the violation, and injunctive
relief. Criminal penalties could range up to the greater of $2 million per
violation or twice the gross pecuniary gain or loss from the violation, which
could be substantially greater than $2 million per violation. It is possible
that both the SEC and the DOJ could assert that there have been multiple
violations, which could lead to multiple fines. The amount of any fines or
monetary penalties which could be assessed would depend on, among other factors,
the findings regarding the amount, timing, nature and scope of any improper
payments, whether any such payments were authorized by or made with knowledge of
us or our affiliates, the amount of gross pecuniary gain or loss involved, and
the level of cooperation provided the government authorities during the
investigations. Agreed dispositions of these types of violations also frequently
result in an acknowledgement of wrongdoing by the entity and the appointment of
a monitor on terms negotiated with the SEC and the DOJ to review and monitor
current and future business practices, including the retention of agents, with
the goal of assuring compliance with the FCPA. Other potential consequences
could be significant and include suspension or debarment of our ability to
contract with governmental agencies of the United States and of foreign
countries. In the three and nine months ended September 30, 2008, we had revenue
of approximately $1.6 billion and $4.6 billion, respectively, from our
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. In
addition, we may be excluded from bidding on MoD contracts in the United Kingdom
if we are convicted for a corruption offense or if the MoD determines that our
actions constituted grave misconduct. During the three and nine months ended
September 30, 2008, we had revenue of approximately $51 million and $179
million, respectively, from our government contracts work with the MoD.
Suspension or debarment from the government contracts business would have a
material adverse effect on our business, results of operations, and cash
flow.
These
investigations, and any related settlements, could also result in
(1) third-party claims against us, which may include claims for special,
indirect, derivative or consequential damages, (2) damage to our business
or reputation, (3) loss of, or adverse effect on, cash flow, assets,
goodwill, results of operations, business, prospects, profits or business value,
(4) adverse consequences on our ability to obtain or continue financing for
current or future projects and/or (5) claims by directors, officers,
employees, affiliates, advisors, attorneys, agents, debt holders or other
interest holders or constituents of us or our subsidiaries. In this connection,
we understand that the government of Nigeria gave notice in 2004 to the French
magistrate of a civil claim as an injured party in that proceeding. We are not
aware of any further developments with respect to this claim. In addition, our
compliance procedures or having a monitor required or agreed to be appointed at
our cost as part of the disposition of the investigations have resulted in a
more limited use of agents on large-scale international projects than in the
past and put us at a competitive disadvantage in pursuing such projects.
Continuing negative publicity arising out of these investigations could also
result in our inability to bid successfully for governmental contracts and
adversely affect our prospects in the commercial marketplace. In addition, we
could incur costs and expenses for any monitor required by or agreed to with a
governmental authority to review our continued compliance with FCPA
law.
The
investigations by the SEC and DOJ and foreign governmental authorities are
continuing. The various governmental authorities could conclude that violations
of the FCPA or applicable analogous foreign laws have occurred with respect to
the Bonny Island project and other projects in or outside of Nigeria. In such
circumstances, the resolution or disposition of these matters, even after taking
into account the indemnity from Halliburton with respect to any liabilities for
fines or other monetary penalties or direct monetary damages, including
disgorgement, that may be assessed by the U.S. and certain foreign governments
or governmental agencies against us or our greater than 50%-owned subsidiaries
could have a material adverse effect on our business, prospects, results or
operations, financial condition and cash flow.
Under the
terms of the master separation agreement entered into in connection with our
initial public offering, Halliburton has agreed to indemnify us, and any of our
greater than 50%-owned subsidiaries, for our share of fines or other monetary
penalties or direct monetary damages, including disgorgement, as a result of
claims made or assessed by a governmental authority of the United States, the
United Kingdom, France, Nigeria, Switzerland or Algeria or a settlement
thereof relating to FCPA Matters (as defined), which could involve Halliburton
and us through The M. W. Kellogg Company, M. W. Kellogg Limited or, their or our
joint ventures in projects both in and outside of Nigeria, including the Bonny
Island, Nigeria project. Halliburton’s indemnity will not apply to any other
losses, claims, liabilities or damages assessed against us as a result of or
relating to FCPA Matters or to any fines or other monetary penalties or direct
monetary damages, including disgorgement, assessed by governmental authorities
in jurisdictions other than the United States, the United Kingdom, France,
Nigeria, Switzerland or Algeria, or a settlement thereof, or assessed against
entities such as TSKJ, in which we do not have an interest greater than
50%.
Halliburton
is currently engaged in discussions with the SEC and/or the DOJ regarding a
settlement of these matters. We are observing certain meetings in
which these discussions are held. Pursuant to the Master Separation Agreement,
Halliburton controls these discussions and the terms of any settlement. At the
time any settlement may be reached between Halliburton and the SEC and/or DOJ,
Halliburton must submit the settlement terms to KBR.
Although
the Master Separation Agreement provides that Halliburton will indemnify KBR for
penalties (defined as a fine or other monetary penalty or direct monetary
damage, including disgorgement, as a result of a Government FCPA claim), any
settlement may also include terms that are not indemnified by Halliburton. These
terms may include disbarment from working on US government contracts,
acknowledgment of wrongdoing and/or appointment of a monitor on terms negotiated
by Halliburton with the DOJ and SEC. Any such terms could result in damages to
us as described above with respect to the investigations. If the terms of any
settlement reached by Halliburton are not acceptable to KBR, we are not
obligated by such terms; however, if KBR does not accept the terms of the
settlement reached by Halliburton, Halliburton may terminate its indemnity of
KBR. There can be no assurance that a settlement will be reached or, if a
settlement is reached, that the terms of any such settlement will not have a
material adverse impact on us.
We are
aware from public disclosure that Halliburton has recorded $342 million in
accruals related to various indemnities of and guarantees of KBR. However, we do
not have information about how those amounts were determined or how much of that
amount is related exclusively to KBR’s FCPA matters. Because of the terms of the
Master Separation Agreement and the uncertainties related to the acceptability
of the terms and conditions of the settlement that might be offered to us in the
future, as of September 30, 2008, we are unable to estimate an amount of
probable loss or a range of possible loss related to these various matters, as
it relates to us.
Halliburton
incurred $1 million for expenses relating to the FCPA and bidding practices
investigations for the quarter ended March 31, 2007. We do not know the amount
of costs incurred by Halliburton following our separation from Halliburton on
April 5, 2007. Halliburton did not charge any of these costs to us. These
expenses were incurred for the benefit of both Halliburton and us, and we and
Halliburton have no reasonable basis for allocating these costs between us.
Subsequent to our separation from Halliburton and in accordance with the Master
Separation Agreement, Halliburton will continue to bear the direct costs
associated with overseeing and directing the FCPA and bidding practices
investigations. We will bear costs associated with monitoring the continuing
investigations as directed by Halliburton which include our own separate legal
counsel and advisors. For the year ended December 31, 2007, we incurred
approximately $1 million in expenses related to monitoring these
investigations.
Bidding
practices investigation
In
connection with the investigation into payments relating 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, Halliburton and the DOJ have broadened their
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. We understand that Mr. Stanley,
in the context of his plea agreement, may have provided information to the DOJ
relating to the bidding allegations. In a recent SEC filing,
Halliburton expressed its opinion that its indemnification obligations to KBR in
the MSA do not extend to any liabilities for governmental fines or third
party claims that may arise from the bidding allegations. Pursuant
to the MSA, Halliburton has led and controlled the investigation of these
allegations and the FCPA matters and controlled all related settlement
discussions. If there is a settlement, we believe that this coordinated bidding
allegation will be resolved as part of any settlement of the FCPA issues. We are
still obtaining information regarding these matters, and are investigating the
possible liability of other parties for any loss KBR may experience if the
coordinated bidding allegations are not resolved in the settlement of the FCPA
issues.
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.
The
results of these investigations may have a material adverse effect on our
business and results of operations. As of September 30, 2008, we are unable to
estimate a range of possible loss related to these matters.
Barracuda-Caratinga
project arbitration
In June
2000, we entered into a contract with Barracuda & Caratinga Leasing
Company B.V., the project owner, to develop the Barracuda and Caratinga crude
oilfields, which are located off the coast of Brazil. We recorded losses on the
project of $19 million and $8 million for the years ended December 31, 2006 and
2005, respectively. No losses have been recorded on the project since 2006. We
have been in negotiations with the project owner since 2003 to settle the
various issues that have arisen and have entered into several agreements to
resolve those issues.
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 eliminated any further risk of liquidated damages being
assessed. In November 2007, we executed a settlement agreement with the project
owner to settle all outstanding project issues except for the bolts arbitration
discussed below. The agreement resulted in the project owner assuming
substantially all remaining work on the project and the release of us from any
further warranty obligations. The settlement agreement did not have a material
impact to our results of operations or financial position.
At
Petrobras’ direction, we 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. In March 2006, Petrobras notified us 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
do not believe that it is probable that we have incurred a liability in
connection with the claim in the bolt arbitration with Petrobras and therefore,
no amounts have been accrued. We disagree with Petrobras’ claim since the bolts
met the design specification provided by Petrobras. Although we believe
Petrobras is responsible for any maintenance and replacement of the bolts, it is
possible that the arbitration panel could find against us on this issue. In
addition, Petrobras has not provided any evidentiary support or analysis for the
amounts claimed as damages. A preliminary hearing on legal and factual issues
relating to liability with the arbitration panel was held in April 2008. The
final arbitration hearings have not yet been scheduled. Therefore, at this time,
we cannot conclude that the likelihood that a loss has been incurred is remote.
Due to the indemnity from Halliburton, we believe any outcome of this matter
will not have a material adverse impact to our operating results or financial
position. KBR incurred legal fees and related expenses of $4 million in 2007,
related to this matter. For the nine months ended September 30, 2008, KBR has
incurred approximately $1 million in legal fees and related expenses related to
this matter.
Under the
master separation agreement, Halliburton has agreed to indemnify us and any of
our greater than 50%-owned subsidiaries as of November 2006, for all
out-of-pocket cash costs and expenses (except for ongoing legal costs), or cash
settlements or cash arbitration awards in lieu thereof, we may incur after the
effective date of the master separation agreement as a result of the replacement
of the subsea flowline bolts installed in connection with the
Barracuda-Caratinga project.
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. During 2003, we filed all outstanding tax returns and paid the
associated taxes.
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. On September 26, 2006, the
court granted the motion to dismiss insofar as claims for overtime pay and
“uplift” pay are concerned, leaving only a contractual claim for miscalculation
of employees’ pay. In the fourth quarter of 2007, the class action lawsuit was
withdrawn by the plaintiffs.
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;
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•
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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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|
•
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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 by complying with environmental, legal and
regulatory requirements. On occasion, we are involved in specific environmental
litigation and claims, including the remediation of properties we own or have
operated as well as efforts to meet or correct compliance-related matters. We
make estimates of the amount of costs associated with known environmental
contamination that we will be required to remediate and record accruals to
recognize those estimated liabilities. Our estimates are based on the best
available information and are updated whenever new information becomes known.
For certain locations, including our property at Clinton Drive, we have not
completed our analysis of the site conditions and until further information is
available, we are only able to estimate a possible range of remediation costs.
This range of costs could change depending on our ongoing site analysis and the
timing and techniques used to implement remediation activities. We do not expect
costs related to environmental matters will have a material adverse effect on
our consolidated financial position or our results of operations. At September
30, 2008 our accrual for the estimated assessment and remediation costs
associated with all environmental matters was approximately $6 million,
which represents the low end of the range of possible costs that could be as
much as $15 million.
Letters
of credit
In
connection with certain projects, we are required to provide letters of credit,
surety bonds or other financial and performance guarantees to our customers. As
of September 30, 2008, we had approximately $1.1 billion in letters of credit
and financial guarantees outstanding, of which $550 million were issued under
our Revolving Credit Facility. Approximately $447 million of these letters of
credit were issued under various Halliburton facilities and are irrevocably and
unconditionally guaranteed by Halliburton.
In
addition, we and Halliburton have agreed that until December 31, 2009,
Halliburton will issue additional guarantees, indemnification and reimbursement
commitments for our benefit in connection with (a) letters of credit necessary
to comply with our EBIC contract, our Allenby & Connaught project and all
other contracts that were in place as of December 15, 2005; (b) surety bonds
issued to support new task orders pursuant to the Allenby & Connaught
project, two job order contracts for our G&I business unit and all other
contracts that were in place as of December 25, 2005; and (c) performance
guarantees in support of these contracts. Each credit support instrument
outstanding at November 20, 2006, the time of our initial public offering, and
any additional guarantees, indemnification and reimbursement commitments will
remain in effect until the earlier of: (1) the termination of the underlying
project contract or our obligations thereunder or (2) the expiration of the
relevant credit support instrument in accordance with its terms or release of
such instrument by our customer. In addition, we have agreed to use our
reasonable best efforts to attempt to release or replace Halliburton’s liability
under the outstanding credit support instruments and any additional credit
support instruments relating to our business for which Halliburton may become
obligated for which such release or replacement is reasonably available. For so
long as Halliburton or its affiliates remain liable with respect to any credit
support instrument, we have agreed to pay the underlying obligation as and when
it becomes due. Furthermore, we agreed to pay to Halliburton a quarterly carry
charge for its guarantees of our outstanding letters of credit and surety bonds
and agreed to indemnify Halliburton for all losses in connection with the
outstanding credit support instruments and any new credit support instruments
relating to our business for which Halliburton may become obligated following
the separation. We currently pay an annual fee to Halliburton calculated at
0.40% of the outstanding performance-related letters of credit and 0.80% of the
outstanding financial-related letters of credit guaranteed by Halliburton.
Effective January 1, 2010, the annual fee increases to 0.90% and 1.65% of the
outstanding performance-related and financial-related outstanding issued letters
of credit, respectively.
During
the second quarter of 2007, a £20 million letter of credit was issued on our
behalf by a bank in connection with our Allenby & Connaught project. The
letter of credit supports a building contract guarantee executed between KBR and
certain project joint venture company to provide additional credit support as a
result of our separation from Halliburton. The letter of credit issued by the
bank is guaranteed by Halliburton.
Other
commitments
We had
commitments to provide funds to our privately financed projects of $85 million
as of September 30, 2008, and $113 million as of December 31, 2007. Our
commitments to fund our privately financed projects are supported by letters of
credit as described above. These commitments arose primarily during the start-up
of these entities or due to losses incurred by them. At September 30, 2008,
approximately $20 million of the $85 million commitments are
current.
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 $26 million and $28 million at September 30, 2008 and December 31, 2007,
respectively (including amounts related to our share of unconsolidated
subsidiaries), that we could incur based upon completing the projects as
forecasted.
Leases
We are
obligated under operating leases, principally for the use of land, offices,
equipment, field facilities, and warehouses. We recognize minimum rental
expenses over the term of the lease. When a lease contains a fixed escalation of
the minimum rent or rent holidays, we recognize the related rent expense on a
straight-line basis over the lease term and record the difference between the
recognized rental expense and the amounts payable under the lease as deferred
lease credits. We have certain leases for office space where we receive
allowances for leasehold improvements. We capitalize these leasehold
improvements as property, plant, and equipment and deferred lease credits.
Leasehold improvements are amortized over the shorter of their economic useful
lives or the lease term.
Note
11. Income Taxes
Our
effective tax rate was 36% for the three and nine months ended September
30, 2008. Our effective tax rate for the three and nine months ended September
30, 2007 was approximately 32% and 39%, respectively. Our effective tax rate for
the three and nine months ended September 30, 2008 exceeded our
statutory rate of 35% primarily due to not receiving a tax benefit for operating
losses incurred on our railroad investment in Australia, and state and other
taxes. Our effective tax rate for the nine months ended September 30, 2007
exceeded our statutory rate of 35% primarily due to non-deductible operating
losses from our railroad investment in Australia, and state and other taxes. Our
effective tax rate for continuing operations for 2008 is forecasted to be
approximately 38%.
In the
second quarter of 2008, we recorded a $12 million charge related to a U.K. tax
court ruling in excess of the amounts previously provided. We intend to appeal
the court ruling. We reviewed the availability of US foreign tax credits based
on tax minimization strategies available under existing US and UK tax law and
determined that approximately $15 million of the total UK tax assessment will be
realizable through future tax deductions. As such, we recognized a tax benefit
during the third quarter of 2008 in accordance with FIN 48. Additionally,
we recognized tax expense related certain foreign and domestic return to accrual
tax adjustments for tax returns filed during the third quarter of 2008 and other
adjustments resulting in tax expense of approximately $13 million during the
third quarter of 2008.
KBR is
the parent of a group of our domestic companies which were in the U.S.
consolidated federal income tax return of Halliburton through April 5, 2007, the
date of our separation from Halliburton. We also file income tax returns in
various states and foreign jurisdictions. Prior to the separation from
Halliburton, income tax expense for KBR, Inc. was calculated on a pro rata
basis. Under this method, income tax expense was determined based on KBR, Inc.
operations and their contributions to income tax expense of the Halliburton
consolidated group. For the period post separation from Halliburton, income tax
expense is calculated on a stand alone basis.
Note
12. Fair Value Measurements
In
September 2006, the FASB issued Statement of Financial Accounting Standards
(“SFAS”) No. 157, “Fair Value Measurements” (“SFAS 157”). This statement defines
fair value, establishes a framework for using fair value to measure assets and
liabilities, and expands disclosures about fair value measurements. The
statement applies whenever other statements require or permit assets or
liabilities to be measured at fair value. SFAS 157 is effective for interim
periods and fiscal years beginning after November 15, 2007. In February 2008,
the FASB issued FASB Staff Position No. 157-2 that provides for a one-year
deferral for the implementation of SFAS 157 for non-financial assets and
liabilities. SFAS 157 does not require any new fair value measurements, but
rather, it provides enhanced guidance to other pronouncements that require or
permit assets or liabilities to be measured at fair value.
With its
disclosure requirements, SFAS 157 establishes a three-tier value hierarchy,
categorizing the inputs used to measure fair value. The hierarchy can be
described as follows: (Level 1) observable inputs such as quoted prices in
active markets; (Level 2) inputs other than the quoted prices in active markets
that are observable either directly or indirectly; and (Level 3) unobservable
inputs in which there is little or no market data, which require the reporting
entity to develop its own assumptions.
The
financial assets and liabilities measured at fair value on a recurring basis are
included below:
|
|
Fair Value Measurements at Reporting Date
Using
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Millions of dollars
|
|
September 30,
2008
|
|
|
Quoted Prices in Active Markets for Identical
Assets
(Level 1)
|
|
|
Significant
Other
Observable
Inputs
(Level 2)
|
|
|
Significant Unobservable
Inputs
(Level 3)
|
|
Marketable
securities
|
|
$ |
22 |
|
|
$ |
22 |
|
|
$ |
— |
|
|
$ |
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivative
assets
|
|
$ |
6 |
|
|
$ |
— |
|
|
$ |
6 |
|
|
$ |
— |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivative liabilities
|
|
$ |
3 |
|
|
$ |
— |
|
|
$ |
3 |
|
|
$ |
— |
|
We manage
our currency exposures through the use of foreign currency derivative
instruments denominated in our major currencies, which are generally the
currencies of the countries for which we do the majority of our international
business. We utilize derivative instruments to manage the foreign currency
exposures related to specific assets and liabilities that are denominated in
foreign currencies, and to manage forecasted cash flows denominated in foreign
currencies generally related to long-term engineering and construction projects.
The purpose of our foreign currency risk management activities is to protect us
from the risk that the eventual dollar cash flow resulting from the sale and
purchase of products and services in foreign currencies will be adversely
affected by changes in exchange rates. The currency derivative instruments are
carried on the condensed consolidated balance sheet at fair value and are based
upon market observable inputs.
Note
13. Equity Method Investments and Variable Interest Entities
We
conduct some of our operations through joint ventures which are in partnership,
corporate, undivided interest and other business forms and are principally
accounted for using the equity method of accounting. The following represents
significant activity during the periods presented related to our equity method
investments and variable interest entities.
Brown & Root
Condor Spa (“BRC”). BRC was a joint venture in which we sold
our 49% interest and other rights in BRC in the third quarter of 2007, to
Sonatrach for approximately $24 million, resulting in a pre-tax gain of
approximately $18 million. In the first quarter of 2007, we recorded an $18
million impairment charge of which $16 million was classified as “Equity in
earnings (losses) of unconsolidated affiliates” and $2 million as a component of
“Cost of services” in our condensed consolidated statements of income. As of
September 30, 2008, we have not collected the remaining $20 million due for the
sale of our interest in BRC, which is included in “Notes and accounts
receivable.” We will continue to work with Sonatrach, or take other actions as
deemed necessary, to collect the remaining amounts.
Roads
project. During the first quarter of 2008, we acquired an additional 8%
interest in a joint venture related to one of our privately financed projects to
design, build, operate, and maintain roadways for certain government agencies in
the United Kingdom. The additional interest was purchased from an existing
shareholder for approximately $8 million in cash. The joint venture is
considered a variable interest entity; however, we are not the primary
beneficiary. We continue to account for this investment using the equity method
of accounting. In April 2008, we completed the sale of the additional 8%
interest in the joint venture to an unrelated party for approximately $9
million. As of September 30, 2008, we owned a 25% interest in the joint
venture.
Note
14. Retirement Plans
The
components of net periodic benefit cost related to pension benefits for the
three and nine months ended September 30, 2008 and 2007 were as
follows:
|
|
Three Months Ended September
30,
|
|
|
|
2008
|
|
|
2007
|
|
Millions of dollars
|
|
United States
|
|
|
International
|
|
|
United States
|
|
|
International
|
|
Components
of net periodic
|
|
|
|
|
|
|
|
|
|
|
|
|
Benefit
cost:
|
|
|
|
|
|
|
|
|
|
|
|
|
Service
cost
|
|
$ |
— |
|
|
$ |
3 |
|
|
$ |
— |
|
|
$ |
2 |
|
Interest
cost
|
|
|
— |
|
|
|
24 |
|
|
|
1 |
|
|
|
21 |
|
Expected
return on plan assets
|
|
|
(1
|
) |
|
|
(27
|
) |
|
|
(1 |
) |
|
|
(24
|
) |
Amortization
of prior service cost
|
|
|
— |
|
|
|
(1
|
) |
|
|
— |
|
|
|
— |
|
Actuarial (gain)/ loss
amortization
|
|
|
— |
|
|
|
3 |
|
|
|
— |
|
|
|
5 |
|
Net periodic benefit cost
|
|
$ |
(1 |
) |
|
$ |
2 |
|
|
$ |
— |
|
|
$ |
4 |
|
|
|
Nine Months Ended September
30,
|
|
|
|
2008
|
|
|
2007
|
|
Millions of dollars
|
|
United States
|
|
|
International
|
|
|
United States
|
|
|
International
|
|
Components
of net periodic
|
|
|
|
|
|
|
|
|
|
|
|
|
Benefit
cost:
|
|
|
|
|
|
|
|
|
|
|
|
|
Service
cost
|
|
$ |
— |
|
|
$ |
7 |
|
|
$ |
— |
|
|
$ |
7 |
|
Interest
cost
|
|
|
2 |
|
|
|
74 |
|
|
|
2 |
|
|
|
62 |
|
Expected
return on plan assets
|
|
|
(3
|
) |
|
|
(83
|
) |
|
|
(2 |
) |
|
|
(71
|
) |
Amortization
of prior service cost
|
|
|
— |
|
|
|
(1
|
) |
|
|
— |
|
|
|
— |
|
Actuarial (gain)/ loss
amortization
|
|
|
— |
|
|
|
9 |
|
|
|
— |
|
|
|
15 |
|
Net periodic benefit cost
|
|
$ |
(1 |
) |
|
$ |
6 |
|
|
$ |
— |
|
|
$ |
13 |
|
As of
September 30, 2008, we contributed $64 million of the $70 million we currently
expect to contribute in 2008 to our international plans. This contribution
amount includes a payment of approximately $54 million, made in the first
quarter of 2008 to the Kellogg, Brown, & Root (UK) Limited Pension Plan,
related to a February 2008 agreement-in-principle regarding partial deficit
funding for this Plan. We do not have a required minimum contribution for our
domestic plans. As of September 30, 2008, we contributed $3 million of the $3
million, we currently expect to contribute to our domestic plan in
2008.
The
components of net periodic benefit cost related to other postretirement benefits
were immaterial for the three and nine months ended September 30, 2008 and
2007.
Note
15. Reorganization of Business Operations
In the
fourth quarter of 2007, we initiated a restructuring whereby we committed to
a minor headcount reduction and ceased using certain leased office
space. In connection with this restructuring we recorded charges totaling
approximately $5 million of which the majority related to a vacated lease,
previously utilized by our G&I division in Arlington. This amount was
included in “Cost of services” in our statements of income for the year ended
December 31, 2007. Less than $1 million consists of standard termination
benefits payable to a limited number of corporate and division employees. These
termination costs were included in “General and Administrative” in our
statements of income for the year ended December 31, 2007. The amounts recorded
represent the total amounts expected to be incurred in connection with these
activities. For the nine months ended September 30, 2008, we paid approximately
$4 million of the lease and the termination benefits, which included a lease
cancellation penalty. The remaining balance in connection with this
restructuring reserve was approximately $1 million at September 30,
2008.
Note
16. Related Party
Halliburton
In
connection with our initial public offering in November 2006 and the separation
of our business from Halliburton, we entered into various agreements with
Halliburton including, among others, a master separation agreement, tax
sharing agreement, transition services agreements and an employee matters
agreement.
Pursuant
to our master separation agreement, we agreed to indemnify Halliburton for,
among other matters, all past, present and future liabilities related to our
business and operations, subject to specified exceptions. We agreed to indemnify
Halliburton for liabilities under various outstanding and certain additional
credit support instruments relating to our businesses and for liabilities under
litigation matters related to our business. Halliburton agreed to indemnify us
for, among other things, liabilities unrelated to our business, for certain
other agreed matters relating to the Foreign Corrupt Practices Act (“FCPA”)
investigations and the Barracuda-Caratinga project and for other litigation
matters related to Halliburton’s business. See Note 10 for a further
discussion of the FCPA investigations and the Barracuda-Caratinga
project.
The tax
sharing agreement, as amended, provides for certain allocations of U.S. income
tax liabilities and other agreements between us and Halliburton with respect to
tax matters. As a result of our initial public offering, Halliburton will be
responsible for filing all U.S. income tax returns required to be filed through
April 5, 2007, the date KBR ceased to be a member of the Halliburton
consolidated tax group. Halliburton will also be responsible for paying the
taxes related to the returns it is responsible for filing. We will pay
Halliburton our allocable share of such taxes. We are obligated to pay
Halliburton for the utilization of net operating losses, if any, generated by
Halliburton prior to the deconsolidation which we may use to offset our
future consolidated federal income tax liabilities.
Under the
transition services agreements, Halliburton is expected to continue providing
various interim corporate support services to us and we will continue to provide
various interim corporate support services to Halliburton. These support
services relate to, among other things, information technology, legal, human
resources, risk management and internal audit. The services provided under the
transition services agreement between Halliburton and KBR are substantially the
same as the services historically provided. Similarly, the related costs of such
services will be substantially the same as the costs incurred and recorded in
our historical financial statements. As of December 31, 2007, most of the
corporate service activities have been discontinued and primarily related to
human resources and risk management. During the nine months ended September 30, 2008, the only significant
corporate service activities relate to fees for ongoing guarantees provided by Halliburton
on existing credit support instruments which have not yet
expired.
In
connection with certain projects, we are required to provide letters of credit,
surety bonds or other financial and performance guarantees to our customers. As
of September 30, 2008, we had approximately $1.1 billion
in letters of credit and financial guarantees outstanding of which $430 million
related to our joint venture operations, including $183 million issued in
connection with the Allenby & Connaught project. Of the total $1.1 billion,
approximately $447 million in letters of credit were irrevocably and
unconditionally guaranteed by Halliburton. In addition, Halliburton has
guaranteed surety bonds and provided direct guarantees primarily related to our
performance. Under certain reimbursement agreements, if we were unable to
reimburse a bank under a paid letter of credit and the amount due is paid by
Halliburton, we would be required to reimburse Halliburton for any amounts drawn
on those letters of credit or guarantees in the future. The Halliburton
performance guarantees and letter of credit guarantees that are currently in
place in favor of KBR’s customers or lenders will continue until the earlier of
(a) the termination of the underlying project contract or KBR’s obligations
thereunder or (b) the expiration of the relevant credit support instrument in
accordance with its terms or release of such instrument by the customer.
Furthermore, we agreed to pay to Halliburton a quarterly carry charge for its
guarantees of our outstanding letters of credit and surety bonds and agreed to
indemnify Halliburton for all losses in connection with the outstanding credit
support instruments and any new credit support instruments relating to our
business for which Halliburton may become obligated following the separation. We
currently pay an annual fee to Halliburton calculated at 0.40% of the
outstanding performance-related letters of credit and 0.80% of the outstanding
financial-related letters of credit guaranteed by Halliburton. Effective January
1, 2010, the annual fee increases to 0.90% and 1.65% of the outstanding
performance-related and financial-related outstanding issued letters of credit,
respectively.
At
September 30, 2008 and December 31, 2007, we had a $17 million and $16 million,
respectively, balance payable to Halliburton which consists of amounts we owe
Halliburton for estimated outstanding income taxes, and credit support fees
pursuant to our transition services agreement and other amounts. The balances
for these related party transactions are reflected in the consolidated balance
sheets as “Due to Halliburton, net.”
Other
Related Party Transactions
We
perform many of our projects through incorporated and unincorporated joint
ventures. In addition to participating as a joint venture partner, we often
provide engineering, procurement, construction, operations or maintenance
services to the joint venture as a subcontractor. Where we provide services to a
joint venture that we control and therefore consolidate for financial reporting
purposes, we eliminate intercompany revenues and expenses on such transactions.
In situations where we account for our interest in the joint venture under the
equity method of accounting, we do not eliminate any portion of our revenues or
expenses. We recognize the profit on our services provided to joint ventures
that we consolidate and joint ventures that we record under the equity method of
accounting primarily using the percentage-of-completion method. Total revenue
from services provided to our unconsolidated joint ventures recorded in our
consolidated statements of income were $48 million and $163 million for the
three and nine months ended September 30, 2008, respectively. Total revenues
from services provided to our unconsolidated joint ventures recorded in our
consolidated statements of income were $73 million and $276 million for the
three and nine months ended September 30, 2007, respectively. Profit on
transactions with our joint ventures recognized in our consolidated statements
of income was $4 million and $22 million for the three and nine months ended
September 30, 2008, respectively and $14 million and $27 million for the three
and nine months September 30, 2007, respectively.
Note
17. New Accounting Standards
In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statement-amendments of ARB No. 51,” (“SFAS 160”). SFAS
160 states that accounting and reporting for minority interests will be
recharacterized as noncontrolling interests and classified as a component of
equity. The Statement also establishes reporting requirements that provide
sufficient disclosures that clearly identify and distinguish between the
interests of the parent and the interests of the noncontrolling owners. SFAS 160
is effective for fiscal years beginning after December 15, 2008, early adoption
is prohibited. We are currently evaluating the impact the adoption of SFAS 160
will have on our financial position, results of operations and cash flows.
In April
2008, the FASB issued FASB Staff Position (FSP) FAS 142-3, “Determination of the
Useful Life of Intangible Assets.” This FSP amends the factors that should be
considered in developing renewal or extension assumptions used to determine the
useful life of a recognized intangible asset under FASB Statement No. 142,
“Goodwill and Other Intangible Assets.” The intent of this FSP is to improve the
consistency between the useful life of a recognized intangible asset under
Statement 142 and the period of expected cash flows used to measure the fair
value of the asset under FASB Statement No. 141 (Revised 2007), “Business
Combinations,” and other U.S. generally accepted accounting principles (GAAP).
This FSP is effective for financial statements issued for fiscal years beginning
after December 15, 2008, and interim periods within those fiscal years. Early
adoption is prohibited. We are currently evaluating the impact the adoption of
this FSP will have on our financial position, results of operations or cash
flows.
In June
2008, the FASB issued FSP EITF 03-6-1, “Determining Whether Instruments Granted
in Share-Based Payment Transactions Are Participating
Securities.” This FSP provides that unvested share-based payment
awards that contain non-forfeitable rights to dividends or dividend equivalents
(whether paid or unpaid) are participating securities and shall be included in
the computation of earnings per share pursuant to the two-class method. The FSP
is effective for financial statements issued for fiscal years beginning after
December 15, 2008, and interim periods within those years. All prior period
earnings per share data presented shall be adjusted retrospectively. Early
application of this FSP is prohibited. We are currently evaluating the potential
impact of adopting FSP EITF 03-6-1.
Note
18. Discontinued Operations
In May
2006, we completed the sale of our Production Services group, which was part of
our Services business unit. The Production Services group delivers a range of
support services, including asset management and optimization; brownfield
projects; engineering; hook-up, commissioning and start-up; maintenance
management and execution; and long-term production operations, to oil and gas
exploration and production customers. In connection with the sale, we received
net proceeds of $265 million. The sale of Production Services resulted in a
pre-tax gain of approximately $120 million in the year ended December 31,
2006. We settled certain claims and provided an allowance against certain
receivables from the Production Services group resulting in a charge of
approximately $15 million during the nine months ended September 30,
2007.
On June
28, 2007, we completed the disposition of our 51% interest in DML to Babcock
International Group plc. DML owns and operates Devonport Royal Dockyard, one of
Western Europe’s largest naval dockyard complexes. Our DML operations, which was
part of our G&I business unit, primarily involved refueling nuclear
submarines and performing maintenance on surface vessels for the U.K. Ministry
of Defence as well as limited commercial projects. In connection with the sale,
we received $345 million in cash proceeds, net of direct transaction costs for
our 51% interest in DML. The sale of DML resulted in a gain of approximately
$101 million, net of tax of $115 million in the year ended December 31, 2007.
During the preparation of our 2007 tax return in the third quarter of
2008, we identified additional foreign tax credits upon completion of a tax pool
study resulting from the sale of our interest in DML in the U.K.
Approximately $11 million of the foreign tax credits were recorded as a tax
benefit in discontinued operations for the quarter ended September 30,
2008.
In
accordance with the provisions of SFAS No. 144, “Accounting for Impairment
or Disposal of Long-Lived Assets,” the results of operations of the Production
Services group and DML for the prior periods have been reported as discontinued
operations. At September 30, 2008, the condensed consolidated balance sheet
consisted of $6 million in other current liabilities related to
discontinued operations.
The
consolidated operating results of our Production Services group and DML, which
are classified as discontinued operations in our consolidated statements of
income, are summarized in the following table for the nine months ended
September 30, 2007.
|
|
Three
Months Ended
|
|
|
Nine
Months Ended
|
|
Millions of dollars
|
|
September 30, 2007
|
|
|
September 30, 2007
|
|
Revenue
|
|
$ |
— |
|
|
$ |
449 |
|
|
|
|
|
|
|
|
|
|
Operating
profit
|
|
$ |
— |
|
|
$ |
22 |
|
|
|
|
|
|
|
|
|
|
Pretax income
|
|
$ |
— |
|
|
$ |
11 |
|
The
purpose of management’s discussion and analysis (“MD&A”) is to increase the
understanding of the reasons for material changes in our financial condition
since the most recent fiscal year-end and results of operations during the
current fiscal period as compared to the corresponding period of the preceding
fiscal year. The MD&A should be read in conjunction with the condensed
consolidated financial statements and accompanying notes and our 2007 Annual
Report on Form 10-K.
BE&K
Acquisition
On July
1, 2008, we acquired 100% of the outstanding common shares of BE&K, Inc.,
(“BE&K”) a privately held, Birmingham, Alabama-based engineering,
construction and maintenance services company. The acquisition of BE&K will
enhance our ability to provide contractor and maintenance services in North
America. The agreed-upon purchase price was $550 million in cash subject to
certain indemnifications and stockholders equity adjustments as defined in the
purchase agreement. BE&K and its acquired divisions have been
integrated into our Services, Downstream and Government & Infrastructure
business units based upon the nature of the underlying projects acquired. As a
result of the acquisition, the condensed consolidated statements of income for
the three and nine months ended September 30, 2008, include the results of
operations of BE&K since the date of acquisition.
Separation from
Halliburton
On
February 26, 2007, Halliburton’s board of directors approved a plan under which
Halliburton would dispose of its remaining interest in KBR through a tax-free
exchange with Halliburton’s stockholders pursuant to an exchange offer. On April
5, 2007, Halliburton completed the separation of KBR by exchanging the
135,627,000 shares of KBR owned by Halliburton for publicly held shares of
Halliburton common stock pursuant to the terms of the exchange offer (the
“Exchange Offer”) commenced by Halliburton on March 2, 2007.
In
connection with our initial public offering in November 2006 and the separation
of our business from Halliburton, we entered into various agreements with
Halliburton including, among others, a master separation agreement, tax
sharing agreement, transition services agreements and an employee matters
agreement.
Pursuant
to our master separation agreement, we agreed to indemnify Halliburton for,
among other matters, all past, present and future liabilities related to our
business and operations, subject to specified exceptions. We agreed to indemnify
Halliburton for liabilities under various outstanding and certain additional
credit support instruments relating to our businesses and for liabilities under
litigation matters related to our business. Halliburton agreed to indemnify us
for, among other things, liabilities unrelated to our business, for certain
other agreed matters relating to the Foreign Corrupt Practices Act (“FCPA”)
investigations and the Barracuda-Caratinga project and for other litigation
matters related to Halliburton’s business. See Note 10 to our condensed
consolidated financial statements for a further discussion of the FCPA
investigations and the Barracuda-Caratinga project.
The tax
sharing agreement, as amended, provides for certain allocations of U.S. income
tax liabilities and other agreements between us and Halliburton with respect to
tax matters. As a result of our initial public offering, Halliburton will be
responsible for filing all U.S. income tax returns required to be filed through
April 5, 2007, the date KBR ceased to be a member of the Halliburton
consolidated tax group. Halliburton will also be responsible for paying the
taxes related to the returns it is responsible for filing. We will pay
Halliburton our allocable share of such taxes. We are obligated to pay
Halliburton for the utilization of net operating losses, if any, generated by
Halliburton prior to the deconsolidation which we may use to offset our future
consolidated federal income tax liabilities.
Under the
transition services agreements, Halliburton is expected to continue providing
various interim corporate support services to us and we will continue to provide
various interim corporate support services to Halliburton. These support
services relate to, among other things, information technology, legal,
human resources, risk management and internal audit. The services provided under
the transition services agreement between Halliburton and KBR are substantially
the same as the services historically provided. Similarly, the related costs of
such services will be substantially the same as the costs incurred and recorded
in our historical financial statements. As of December 31, 2007, most of
the corporate service activities have been discontinued and primarily related to
human resources and risk management. In 2008, the only
significant corporate service activities relate to fees for ongoing guarantees
provided by Halliburton on existing credit support instruments which have not
yet expired.
See Note
16 to our condensed consolidated financial statements for further discussion of
the above agreements and other related party transactions with
Halliburton.
Revisions
We
reclassified certain overhead expenses in our prior period statements of income
previously recorded as cost of services to general and administrative expense in
our statements of income. These expenses relate to certain overhead expenses and
indirect costs that were previously managed and reported within our business
units but are now managed and reported at a corporate level. These expenses were
reclassified to allow transparency of business unit margins and general and
administrative expense consistent with the nature of the underlying costs and
the manner in which the costs are managed. See Note 1 to the condensed
consolidated financial statements for further discussion of this
reclassification.
Business
Environment and Results of Operations
Business
Environment
We are a
leading global engineering, construction and services company supporting the
energy, petrochemicals, government services and civil infrastructure sectors. We
are a leader in many of the growing end-markets that we serve, particularly gas
monetization, having designed and constructed, alone or with joint venture
partners, more than half of the world’s operating LNG liquefaction capacity over
the past 30 years. In addition, we are one of the largest government defense
contractors worldwide and we believe we are the world’s largest government
defense services provider.
We offer
our wide range of services through six business units; G&I, Upstream,
Services, Downstream, Technology and Ventures. Although we provide a wide range
of services, our business is heavily focused on major projects. At any given
time, a relatively few number of projects and joint ventures represent a
substantial part of our operations. Our projects are generally long term in
nature and are impacted by factors including local economic cycles, introduction
of new governmental regulation, and governmental outsourcing of services.
Demand for our services depends primarily on our customers’ capital expenditures
and budgets for construction and defense services. We have benefited 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, particularly in the Middle East, as well as a
global expansion in government outsourcing, have all contributed to increased
demand for the type of services that we provide.
Our
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 fluctuations.
Contract
Structure
Our
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 us, since the owner/customer pays a premium to transfer many
risks to us. 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 to
us, since the owner/customer retains many of the risks.
G&I
Business Unit Activity
Our
G&I business unit provides program and project management, contingency
logistics, operations and maintenance, construction management, engineering and
other services to military and civilian branches of governments and private
clients worldwide. We deliver on-demand support services across the full
military mission cycle from contingency logistics and field support to
operations and maintenance on military bases. A significant portion of our
G&I business unit’s current operations relate to the support of the United
States government operations in the Middle East, which we refer to as our Middle
East operations, one of the largest U.S. military deployments since World War
II. In the civil infrastructure market, we operate in diverse sectors, including
transportation, waste and water treatment and facilities maintenance. We design,
construct, maintain and operate and manage civil infrastructure projects ranging
from airport, rail, highway, water and wastewater facilities, and mining and
mineral processing to regional development programs and major events. We provide
many of these services to foreign governments such as the United Kingdom and
Australia.
In the
civil infrastructure sector, there has been a general trend of historic
under-investment. In particular, infrastructure related to the quality of water,
wastewater, roads and transit, 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.
We
provide substantial work under our government contracts to the DoD and other
governmental agencies. Most of the services provided to the U.S. government are
under cost-reimbursable contracts where we have the opportunity to earn an award
fee based on our customer’s evaluation of the quality of our performance. These
award fees are evaluated and granted by our customer periodically. For contracts
entered into prior to June 30, 2003, all award fees are recognized during the
term of the contract based on our estimate of amounts to be
awarded.
LogCAP Project. In
August 2006, the DoD issued a request for proposals on a new competitively bid,
multiple service provider LogCAP IV contract to replace the current
LogCAP III contract. We are currently the sole service provider under our
LogCAP III contract, which has been extended by the DoD through the fourth
quarter of 2008. In June 2007, we were selected as one of the executing
contractors under the LogCAP IV contract to provide logistics support to
U.S. Forces deployed in the Middle East. The LogCAP IV award was
reevaluated by the GAO as a result of actions brought by various unsuccessful
bidders. In April 2008, the DoD again selected KBR as one of the executing
contractors. Despite the award of a portion of the LogCAP IV
contract, we expect our overall volume of work to decline as our customer scales
back its requirement for the types and the amounts of services we
provide. However, although we continue to experience increased activity as
a result of the surge of additional troops in 2007 and extended tours of duty in
Iraq, we expect our overall volume of work to decline in 2008 as our customer
scales back its requirements for the types and amounts of services we
provide. However, as a result of the surge of additional troops in 2007 and
extended tours of duty in Iraq, we expect the decline may occur more slowly than
we previously expected.
Backlog
related to the LogCAP III contract at September 30, 2008 was $1.6 billion.
During the almost six-year period we have worked under the LogCAP III
contract, we have been awarded 82 “excellent” ratings out of 104 total ratings.
Our award fees on the LogCAP III contract are recognized based on our
estimate of the amounts to be awarded. Once award fees are granted and task
orders underlying the work are definitized, we adjust our estimate of award fees
to the actual amounts earned. No award fee board ratings have been issued to us
since our last ratings received during the second quarter of 2008. We expect to
complete all open task orders under our LogCAP III contract during the
third quarter of 2009.
Allenby & Connaught
project. In April 2006, Aspire Defence, a joint venture between us,
Carillion Plc. and a financial investor, was awarded a privately financed
project contract, the Allenby & Connaught project, by the MoD to upgrade and
provide a range of services to the British Army’s garrisons at Aldershot and
around Salisbury Plain in the United Kingdom. In addition to a package of
ongoing services to be delivered over 35 years, the project includes a nine year
construction program to improve soldiers’ single living, technical and
administrative accommodations, along with leisure and recreational facilities.
Aspire Defence will manage the existing properties and will be responsible for
design, refurbishment, construction and integration of new and modernized
facilities. Our Venture’s business unit manages KBR’s equity interest in Aspire
Defence, the project company that is the holder of the 35-year concession
contract. At September 30, 2008, we indirectly owned a 45% interest in Aspire
Defence. In addition, at September 30, 2008, we owned a 50% interest in each of
two joint ventures that provide the construction and the related support
services to Aspire Defence. As of September 30, 2008, our performance through
the construction phase is supported by $183 million in letters of credit and
surety bonds totaling $204 million, both of which have been guaranteed by
Halliburton. Furthermore, our financial and performance guarantees are joint and
several, subject to certain limitations, with our joint venture partners. The
project is funded through equity and subordinated debt provided by the project
sponsors, including us, and the issuance of publicly held senior
bonds.
Skopje Embassy Project. In 2005, we were awarded a
fixed-price contract to design and build a U.S. embassy in Skopje, Macedonia. As
a result of a project estimate update and progress achieved on design drawings,
we recorded a $12 million loss in connection with this project during the fourth
quarter of 2006. Subsequently in 2007, we recorded additional losses on this
project of approximately $27 million, and approximately $15 million during
the first half of 2008 with no additional losses recorded in the third quarter
of 2008, bringing our total estimated losses to approximately
$54 million. These additional costs are a result of identifying
increased costs of materials and the related costs of freight, installation and
other costs. We could incur additional costs and losses on this project if our
cost estimation processes identify new costs not previously included in our
total estimated costs or if our plans to make up lost schedule are not
achieved. As of September 30, 2008, the project was approximately 82%
complete.
Upstream
Business Unit Activity
Our
Upstream business unit provides a full range of services for large, complex
upstream projects, including liquefied natural gas (“LNG”), gas-to-liquids
(“GTL”), onshore oil and gas production facilities, offshore oil and gas
production facilities, including platforms, floating production and subsea
facilities, and onshore and offshore pipelines. In gas-to-liquids, we are
leading the construction of two of the world’s three gas-to-liquids projects
under construction or start-up, the size of which exceeds that of almost any
other in the industry. Our Upstream business unit has designed and constructed
some of the world’s most complex onshore facility and pipeline projects and, in
the last 30 years, more than half of the world’s operating LNG liquefaction
capacity. In oil & gas, we provide integrated engineering and program
management solutions for offshore production facilities and subsea developments,
including the design of the largest floating production facility in the world to
date.
Skikda project. During the third quarter of
2007, we were awarded the engineering, procurement and construction (“EPC”)
contract for the Sonatrach Skikda LNG project, to be constructed at Skikda,
Algeria. In addition to performing the EPC work for the 4.5 million metric tons
per annum LNG train, we will execute the pre-commissioning and commissioning
portion of the contract. The contract has an approximate value of $2.8 billion.
As of September 30, 2008 the Skikda project was approximately 30%
complete.
Escravos project. In
connection with our review of a consolidated 50%-owned GTL project in
Escravos, Nigeria, during the second quarter of 2006, we identified increases in
the overall cost to complete this four-plus year project, which resulted in our
recording a $148 million charge before minority interest and taxes during the
second quarter of 2006. These cost increases were caused primarily by schedule
delays related to civil unrest and security on the Escravos River, changes
in the scope of the overall project, engineering and construction changes due to
necessary front-end engineering design changes and increases in procurement cost
due to project delays. The increased costs were identified as a result of our
first check estimate process.
During
the first half of 2007, we and our joint venture partner negotiated
modifications to the contract terms and conditions resulting in an executed
contract amendment in July 2007. The contract has been amended to convert from a
fixed price to a reimbursable contract whereby we will be paid our actual cost
incurred less a credit that approximates the charge we identified in the second
quarter of 2006. The unamortized balance of the charge is included as a
component of the “Reserve for estimated losses on uncompleted contracts” in the
accompanying condensed consolidated balance sheets. Also included in the amended
contract are client determined incentives that may be earned over the remaining
life of the contract. Under the terms of the amended contact, the first $21
million of incentives earned over the remaining life of the contract are not
payable to us. During the nine months ended September 30, 2008, we did not
recognize approximately $11 million of incentives earned but not
payable under the provisions of the amended contract. Since the
contract was amended, we have earned approximately $17 million of incentives.
Our Advanced billings on uncompleted contracts included in our condensed
consolidated balance sheets related to this project, was $60 million and
$236 million at September 30, 2008 and December 31, 2007,
respectively.
Brown & Root Condor Spa
(“BRC”). BRC was a joint venture in which we sold our 49%
interest and other rights in BRC in the third quarter of 2007, to Sonatrach for
approximately $24 million, resulting in a pre-tax gain of approximately $18
million. In the first quarter of 2007, we recorded an $18 million impairment
charge of which $16 million was classified as “Equity in earnings (losses) of
unconsolidated affiliates” and $2 million as a component of “Cost of services”
in our condensed consolidated statements of income. As of September 30, 2008, we
have not collected the remaining $20 million due for the sale of our interest in
BRC, which is included in “Notes and accounts receivable.” We will continue to
work with Sonatrach, or take other actions as deemed necessary, to collect the
remaining amounts.
Results
of Operations
|
|
Three
Months Ended September 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
Increase
(Decrease)
|
|
|
Percentage
Change
|
|
|
|
(In millions of dollars)
|
|
Revenue:
(1)
|
|
|
|
|
|
|
|
|
|
|
|
|
G&I:
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S.
Government —Middle East Operations
|
|
$ |
1,364 |
|
|
$ |
1,217 |
|
|
$ |
147 |
|
|
|
12
|
% |
U.S.
Government —Americas Operations
|
|
|
183 |
|
|
|
192 |
|
|
|
(9
|
) |
|
|
(5
|
)% |
International
Operations
|
|
|
212 |
|
|
|
157 |
|
|
|
55 |
|
|
|
35
|
% |
Total
G&I
|
|
|
1,759 |
|
|
|
1,566 |
|
|
|
193 |
|
|
|
12
|
% |
Upstream:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gas
Monetization
|
|
|
434 |
|
|
|
265 |
|
|
|
169 |
|
|
|
64
|
% |
Offshore
|
|
|
97 |
|
|
|
92 |
|
|
|
5 |
|
|
|
5
|
% |
Other
|
|
|
19 |
|
|
|
50 |
|
|
|
(31
|
) |
|
|
(62
|
)% |
Total
Upstream
|
|
|
550 |
|
|
|
407 |
|
|
|
143 |
|
|
|
35
|
% |
Services
|
|
|
539 |
|
|
|
77 |
|
|
|
462 |
|
|
|
600
|
% |
Downstream
|
|
|
138 |
|
|
|
103 |
|
|
|
35 |
|
|
|
34
|
% |
Technology
|
|
|
19 |
|
|
|
26 |
|
|
|
(7
|
) |
|
|
(27
|
)% |
Ventures
|
|
|
1 |
|
|
|
(2
|
) |
|
|
3 |
|
|
|
150
|
% |
Other
|
|
|
12 |
|
|
|
— |
|
|
|
12 |
|
|
|
—
|
% |
Total
revenue
|
|
$ |
3,018 |
|
|
$ |
2,177 |
|
|
$ |
841 |
|
|
|
39
|
% |
(1)
|
Our
revenue includes both equity in the earnings of unconsolidated affiliates
as well as revenue from the sales of services into the joint ventures. We
often participate on larger projects as a joint venture partner and also
provide services to the venture as a subcontractor. The amount included in
our revenue represents our share of total project revenue, including
equity in the earnings (loss) from joint ventures and revenue from
services provided to joint
ventures.
|
|
|
Three
Months Ended September 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
Increase
(Decrease)
|
|
|
Percentage
Change
|
|
|
|
(In
millions of dollars)
|
|
Business
Unit Income (loss):
|
|
|
|
|
|
|
|
|
|
|
|
|
G&I:
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S.
Government —Middle East Operations
|
|
$ |
78 |
|
|
$ |
61 |
|
|
$ |
17 |
|
|
|
28
|
% |
U.S.
Government —Americas Operations
|
|
|
13 |
|
|
|
31 |
|
|
|
(18
|
) |
|
|
(58
|
)% |
International
Operations
|
|
|
42 |
|
|
|
36 |
|
|
|
6 |
|
|
|
17
|
% |
Total
job income
|
|
|
133 |
|
|
|
128 |
|
|
|
5 |
|
|
|
4
|
% |
Divisional
overhead
|
|
|
(29
|
) |
|
|
(30
|
) |
|
|
1 |
|
|
|
3
|
% |
Total
G&I business unit income
|
|
|
104 |
|
|
|
98 |
|
|
|
6 |
|
|
|
6
|
% |
Upstream:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gas
Monetization
|
|
|
37 |
|
|
|
31 |
|
|
|
6 |
|
|
|
19
|
% |
Offshore
|
|
|
20 |
|
|
|
15 |
|
|
|
5 |
|
|
|
33
|
% |
Other
|
|
|
6 |
|
|
|
26 |
|
|
|
(20
|
) |
|
|
(77
|
)% |
Total
job income
|
|
|
63 |
|
|
|
72 |
|
|
|
(9
|
) |
|
|
(13
|
)% |
Divisional
overhead
|
|
|
(10
|
) |
|
|
(15
|
) |
|
|
5 |
|
|
|
33
|
% |
Total
Upstream business unit income
|
|
|
53 |
|
|
|
57 |
|
|
|
(4
|
) |
|
|
(7
|
)% |
Services:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Job
income
|
|
|
41 |
|
|
|
9 |
|
|
|
32 |
|
|
|
356
|
% |
Divisional
overhead
|
|
|
(14
|
) |
|
|
(3
|
) |
|
|
(11
|
) |
|
|
(367
|
)% |
Total
Services business unit income
|
|
|
27 |
|
|
|
6 |
|
|
|
21 |
|
|
|
350
|
% |
Downstream:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Job
income
|
|
|
20 |
|
|
|
7 |
|
|
|
13 |
|
|
|
186
|
% |
Divisional
overhead
|
|
|
(5
|
) |
|
|
(3
|
) |
|
|
(2
|
) |
|
|
(67
|
)% |
Total
Downstream business unit income
|
|
|
15 |
|
|
|
4 |
|
|
|
11 |
|
|
|
275
|
% |
Technology:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Job
income
|
|
|
10 |
|
|
|
10 |
|
|
|
— |
|
|
|
—
|
% |
Divisional
overhead
|
|
|
(6
|
) |
|
|
(5
|
) |
|
|
(1
|
) |
|
|
(20
|
)% |
Total
Technology business unit income
|
|
|
4 |
|
|
|
5 |
|
|
|
(1
|
) |
|
|
(20
|
)% |
Ventures:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Job
income (loss)
|
|
|
1 |
|
|
|
(2
|
) |
|
|
3 |
|
|
|
150
|
% |
Divisional
overhead
|
|
|
(1
|
) |
|
|
(1
|
) |
|
|
— |
|
|
|
—
|
% |
Total
Ventures business unit loss
|
|
|
— |
|
|
|
(3
|
) |
|
|
3 |
|
|
|
100
|
% |
Other:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Job
income
|
|
|
4 |
|
|
|
— |
|
|
|
4 |
|
|
|
—
|
% |
Divisional
overhead
|
|
|
(3
|
) |
|
|
— |
|
|
|
(3
|
) |
|
|
—
|
% |
Total
Other business unit income
|
|
|
1 |
|
|
|
— |
|
|
|
1 |
|
|
|
—
|
% |
Total
business unit income
|
|
$ |
204 |
|
|
$ |
167 |
|
|
$ |
37 |
|
|
|
22
|
% |
Unallocated
amounts:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Labor
costs absorption (1)
|
|
|
(5
|
) |
|
|
— |
|
|
|
(5
|
) |
|
|
—
|
% |
Corporate
general and administrative
|
|
|
(55
|
) |
|
|
(65
|
) |
|
|
10 |
|
|
|
15
|
% |
Total
operating income
|
|
$ |
144 |
|
|
$ |
102 |
|
|
$ |
42 |
|
|
|
41
|
% |
|
(1)
|
Labor
cost absorption represents costs incurred by our central labor and
resource groups (above)/ under the amounts charged to the operating
business units.
|
Three
months ended September 30, 2008 compared to three months ended September 30,
2007
Government and
Infrastructure. Revenue from our G&I business unit was $1.8 billion
and $1.6 billion for the three months ended September 30, 2008 and 2007,
respectively. The increase in revenue from our Middle East Operations is largely
a result of higher volume on U.S. military support activities in Iraq under our
LogCAP III contract due to a U.S. military troop surge in the second half of
2007 that continues to positively impact our 2008 revenue. We expect to provide
services under our LogCAP III contract through the third quarter of 2009. In
April 2008, we were selected as one of the executing contractors of the LogCAP
IV contract. Despite the award of the LogCAP IV contract, we expect our overall
volume of work to decline as our customer scales back its requirements for the
types and amounts of services we provide under these programs. Revenue from our
Americas Operations decreased primarily as a result of reduced activity on
several existing domestic cost-reimbursable U.S. Government projects, including
the CENTCOM and CONCAP projects. The increase in revenue from our International
Operations is largely due to a project to design, procure and construct
facilities for the U.K. MoD in Basra, southern Iraq and several engineering
projects in Australia.
Business
unit income was $104 million and $98 million for the three months ended
September 30, 2008 and 2007, respectively. During the third quarter of 2008, job
income from our Middle East Operations increased as a result of the reversal of
approximately $13 million of the $40 million charge recognized in the second
quarter of 2008 related to the judgment from litigation with one of our
subcontractors for work performed on our LogCAP III contract in 2003. We believe
the judgment is billable to our customer. However, we will not recognize such
amounts as revenue until such time as we are reasonably assured of collection.
Job income from our Americas Operations decreased as a result of lower activity
and award fees on several domestic cost-reimbursable U.S. Government projects.
In our International Operations, job income increased primarily due to increased
performance on the construction and service portions of the Allenby &
Connaught project as well as the project for the U.K. MoD in Iraq which is now
fully mobilized.
Upstream. Revenue from our
Upstream business unit was $550 million and $407 million for the three months
ended September 30, 2008 and 2007, respectively. The increase in revenue is
primarily due to increased activity from several Gas Monetization projects
including the Escravos GTL, Gorgon LNG and Skikda LNG projects. Revenue from
these three projects increased an aggregate $199 million during the third
quarter of 2008. Partially offsetting these increases were decreases in revenue
of approximately $43 million in the aggregate for the Pearl GTL, Yemen LNG,
Nigeria LNG and Tanguuh LNG projects primarily due to lower activity as compared
to the same period of the prior year.
Business
unit income was $53 million and $57 million for the three months ended September
30, 2008 and 2007, respectively. In our Gas Monetization operations, the
increase in job income was driven by higher relative progress on our Gorgon LNG
and Skikda LNG projects over the same period of the prior year. In
the third quarter of 2007, we sold a 49% interest and other rights in an
Algerian joint venture which resulted in an $18 million gain in our Other
operations.
Services. Revenue from our
Services business unit was $539 million and $77 million for the three months
ended September 30, 2008 and 2007, respectively. The increase in revenue is
primarily due to business we obtained through the acquisition of BE&K on
July 1, 2008, which contributed approximately $399 million of revenue during the
third quarter of 2008. Also contributing to the increase in revenue
during the quarter are increases in activity from direct construction and
modular fabrication services in our Canadian and North American Construction
operations. Revenue from the Shell Scotford Upgrader project in Canada increased
approximately $62 million during the third quarter of 2008.
Business
unit income was $27 million and $6 million for the three months ended September
30, 2008 and 2007, respectively. The increase in business unit income
is primarily due to business we obtained through the acquisition of BE&K,
which contributed approximately $13 million to business unit income, including
$24 million in job income less business unit overhead expense of $11 million
during the third quarter of 2008. The remainder of the increase was
due to increased job income associated with our Canadian operations, North
American Construction operations and our jointly operated offshore venture in
Mexico.
Downstream. Revenue from our
Downstream business unit was $138 million and $103 million for the three months
ended September 30, 2008 and 2007, respectively. During the third quarter 2008,
revenue increased by approximately $33 million primarily related to business we
obtained through the acquisition of BE&K. Also contributing to
the increase in revenue was increased activity related to the Saudi Kayan olefin
and Ras Tanura integrated chemical projects in Saudi Arabia. Increase in revenue
related to these and other projects were partially offset by a $32 million
decrease in revenue during the quarter on the EBIC ammonia plant project in
Egypt as it nears completion.
Business
unit income was $15 million and $4 million for the three months ended September
30, 2008 and 2007, respectively. This increase is primarily due to an aggregate
$7 million increase in job income from the Saudi Kayan project and program
management services for the Ras Tanura project in Saudi
Arabia. Business unit income for the third quarter of 2008 also
included $5 million in job income from the Kevlar project obtained through the
acquisition of BE&K.
Technology. Revenue from our
Technology business unit was $19 million and $26 million for the three months
ended September 30, 2008 and 2007, respectively. Business unit income was $4
million and $5 million for the three months ended September 30, 2008 and 2007,
respectively. The decrease in revenue and business unit income is primarily
attributable to several projects with lower activity in the third quarter of
2008 compared to the activity for the same period in 2007.
Ventures. Revenue from our
Ventures business unit was $1 million and $(2) million for the three months
ended September 30, 2008 and 2007, respectively. Revenue during third quarter of
2008 is primarily attributable to the Aspire Defence projects in the U.K.
Business unit income was $0 million and a loss of $3 million for the three
months ended September 30, 2008 and 2007, respectively. Revenue and business
unit income for the third quarter of 2007 included continued operating losses
generated on our investment in APT/FreightLink, the Alice Springs-Darwin
railroad project in Australia. Our investment in the APT/Freightlink project was
reduced to below zero to the extent of our future funding obligations and no
further operating losses have been recognized.
Labor cost
absorption. Labor cost absorption was $5 million and $0
million for the three months ended September 30, 2008 and 2007, respectively.
Labor cost absorption represents costs incurred by our central labor and
resource groups (above) or under the amounts charged to the operating business
units. The increase in labor cost absorption for the three months ended
September 30, 2008 compared to the three months ended September 30, 2007 was
primarily due to a $7 million charge resulting from the impact of Hurricane Ike
in Houston, Texas.
General and Administrative
expense. General and
administrative expense was $55 million and $65 million for the three months
ended September 30, 2008 and 2007, respectively. The decrease in general and
administrative expense results from lower incentive compensation, insurance
costs and other costs partially offset by higher general and administrative
expenses as a result of our acquisition of BE&K and $3 million in
property damage at several of our Houston-area facilities resulting from the
impact of Hurricane Ike.
Non-operating
items.
Net
interest income was $7 million for the three months ended September 30, 2008
compared to net interest income of $17 million for the three months ended
September 30, 2007. The decrease in net interest income primarily relates to the
decline in our cash and equivalents during the first nine months of 2008. As of
September 30, 2008, we had total cash and equivalents of approximately $1.1
billion (including committed cash of $302 million) compared to $1.8 billion as
of September 30, 2007. The decrease in cash is largely attributable to the
acquisition of BE&K on July 1, 2008 with a purchase price of approximately
$552 million and stock repurchases totaling $196 million during the third
quarter of 2008.
Provision
for income taxes from continuing operations in the third quarter of 2008 was $55
million compared to $35 million in the third quarter of 2007. The effective tax
rate for the third quarter of 2008 was approximately 36% as compared to a rate
of 32% in the third quarter of 2007. Our effective tax rate for the three months
ended September 30, 2008 exceeded our statutory rate of 35% primarily due to not
receiving a benefit for operating losses on our railroad investment in
Australia, and state and other taxes. In the second quarter of 2008, we
recorded a $12 million charge related to a U.K. tax court ruling in excess of
the amounts previously provided. We intend to appeal the court ruling. We
reviewed the availability of US foreign tax credits based on tax minimization
strategies available under existing US and UK tax law and determined that
approximately $15 million of the total UK tax assessment will be realizable
through future tax deductions. As such, we recognized a tax benefit
during the third quarter of 2008 in accordance with FIN 48. Additionally,
we recorded tax expense related to certain foreign and domestic return to
accrual adjustments for tax returns filed during the third quarter of 2008 and
other adjustments resulting in tax expense of approximately $13 million during
the third quarter of 2008. Our effective tax rate for the third quarter of
2007 was below our statutory rate of 35% primarily due to the receipt of tax
refunds for prior year taxes paid and a decrease in the U.K. statutory rate from
30% to 28% as a result of changes in enacted tax law.
Income
from discontinued operations, net of tax was $11 million and $3 million for the
three months ended September 30, 2008 and 2007, respectively. In the third
quarter of 2008, we recognized a tax benefit related to foreign tax credits upon
completion of a tax pool study related to DML. We sold our 51% interest in
DML in June 2007.
|
|
Nine
months Ended September 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
Increase
(Decrease)
|
|
|
Percentage
Change
|
|
|
|
(In millions of dollars)
|
|
Revenue:
(1)
|
|
|
|
|
|
|
|
|
|
|
|
|
G&I:
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S.
Government —Middle East Operations
|
|
$ |
4,072 |
|
|
$ |
3,529 |
|
|
$ |
543 |
|
|
|
15
|
% |
U.S.
Government —Americas Operations
|
|
|
460 |
|
|
|
565 |
|
|
|
(105
|
) |
|
|
(19
|
)% |
International
Operations
|
|
|
618 |
|
|
|
411 |
|
|
|
207 |
|
|
|
50
|
% |
Total
G&I
|
|
|
5,150 |
|
|
|
4,505 |
|
|
|
645 |
|
|
|
14
|
% |
Upstream:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gas
Monetization
|
|
|
1,454 |
|
|
|
907 |
|
|
|
547 |
|
|
|
60
|
% |
Offshore
|
|
|
332 |
|
|
|
260 |
|
|
|
72 |
|
|
|
28
|
% |
Other
|
|
|
74 |
|
|
|
117 |
|
|
|
(43
|
) |
|
|
(37
|
)% |
Total
Upstream
|
|
|
1,860 |
|
|
|
1,284 |
|
|
|
576 |
|
|
|
45
|
% |
Services
|
|
|
776 |
|
|
|
226 |
|
|
|
550 |
|
|
|
243
|
% |
Downstream
|
|
|
339 |
|
|
|
276 |
|
|
|
63 |
|
|
|
23
|
% |
Technology
|
|
|
61 |
|
|
|
72 |
|
|
|
(11
|
) |
|
|
(15
|
)% |
Ventures
|
|
|
(3
|
) |
|
|
(7
|
) |
|
|
4 |
|
|
|
57
|
% |
Other
|
|
|
12 |
|
|
|
— |
|
|
|
12 |
|
|
|
—
|
% |
Total
revenue
|
|
$ |
8,195 |
|
|
$ |
6,356 |
|
|
$ |
1,839 |
|
|
|
29
|
% |
|
(1)
|
Our
revenue includes both equity in the earnings of unconsolidated affiliates
as well as revenue from the sales of services into the joint ventures. We
often participate on larger projects as a joint venture partner and also
provide services to the venture as a subcontractor. The amount included in
our revenue represents our share of total project revenue, including
equity in the earnings (loss) from joint ventures and revenue from
services provided to joint
ventures.
|
|
|
Nine
months Ended September 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
Increase
(Decrease)
|
|
|
Percentage
Change
|
|
|
|
(In
millions of dollars)
|
|
Business
Unit Income (loss):
|
|
|
|
|
|
|
|
|
|
|
|
|
G&I:
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S.
Government —Middle East Operations
|
|
$ |
183 |
|
|
$ |
193 |
|
|
$ |
(10 |
) |
|
|
(5
|
)% |
U.S.
Government —Americas Operations
|
|
|
27 |
|
|
|
49 |
|
|
|
(22
|
) |
|
|
(45
|
)% |
International
Operations
|
|
|
126 |
|
|
|
82 |
|
|
|
44 |
|
|
|
54
|
% |
Total
job income
|
|
|
336 |
|
|
|
324 |
|
|
|
12 |
|
|
|
4
|
% |
Divisional
overhead
|
|
|
(89
|
) |
|
|
(98
|
) |
|
|
9 |
|
|
|
9
|
% |
Total
G&I business unit income
|
|
|
247 |
|
|
|
226 |
|
|
|
21 |
|
|
|
9
|
% |
Upstream:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gas
Monetization
|
|
|
110 |
|
|
|
112 |
|
|
|
(2
|
) |
|
|
(2
|
)% |
Offshore
|
|
|
104 |
|
|
|
38 |
|
|
|
66 |
|
|
|
174
|
% |
Other
|
|
|
18 |
|
|
|
13 |
|
|
|
5 |
|
|
|
38
|
% |
Total
job income
|
|
|
232 |
|
|
|
163 |
|
|
|
69 |
|
|
|
42
|
% |
Divisional
overhead
|
|
|
(35
|
) |
|
|
(39
|
) |
|
|
4 |
|
|
|
10
|
% |
Total
Upstream business unit income
|
|
|
197 |
|
|
|
124 |
|
|
|
73 |
|
|
|
59
|
% |
Services:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Job
income
|
|
|
76 |
|
|
|
41 |
|
|
|
35 |
|
|
|
85
|
% |
Gain
on sale of assets
|
|
|
1 |
|
|
|
— |
|
|
|
1 |
|
|
|
—
|
% |
Divisional
overhead
|
|
|
(20
|
) |
|
|
(8
|
) |
|
|
(12
|
) |
|
|
(150
|
)% |
Total
Services business unit income
|
|
|
57 |
|
|
|
33 |
|
|
|
24 |
|
|
|
73
|
% |
Downstream:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Job
income
|
|
|
52 |
|
|
|
18 |
|
|
|
34 |
|
|
|
189
|
% |
Divisional
overhead
|
|
|
(15
|
) |
|
|
(11
|
) |
|
|
(4
|
) |
|
|
(36
|
)% |
Total
Downstream business unit income
|
|
|
37 |
|
|
|
7 |
|
|
|
30 |
|
|
|
429
|
% |
Technology:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Job
income
|
|
|
32 |
|
|
|
33 |
|
|
|
(1
|
) |
|
|
(3
|
)% |
Divisional
overhead
|
|
|
(16
|
) |
|
|
(15
|
) |
|
|
(1
|
) |
|
|
(7
|
)% |
Total
Technology business unit income
|
|
|
16 |
|
|
|
18 |
|
|
|
(2
|
) |
|
|
(11
|
)% |
Ventures:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Job
loss
|
|
|
(3
|
) |
|
|
(7
|
) |
|
|
4 |
|
|
|
57
|
% |
Gain
on sale of assets
|
|
|
1 |
|
|
|
— |
|
|
|
1 |
|
|
|
—
|
% |
Divisional
overhead
|
|
|
(2
|
) |
|
|
(2
|
) |
|
|
— |
|
|
|
—
|
% |
Total
Ventures business unit loss
|
|
|
(4 |
) |
|
|
(9
|
) |
|
|
5 |
|
|
|
56
|
% |
Other:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Job
income
|
|
|
4 |
|
|
|
— |
|
|
|
4 |
|
|
|
—
|
% |
Divisional
overhead
|
|
|
(3
|
) |
|
|
— |
|
|
|
(3
|
) |
|
|
—
|
% |
Total
Other business unit income
|
|
|
1 |
|
|
|
— |
|
|
|
1 |
|
|
|
—
|
% |
Total
business unit income
|
|
$ |
551 |
|
|
$ |
399 |
|
|
$ |
152 |
|
|
|
38
|
% |
Unallocated
amounts:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Labor
costs absorption (1)
|
|
|
— |
|
|
|
(10
|
) |
|
|
10 |
|
|
|
100
|
% |
Corporate
general and administrative
|
|
|
(163
|
) |
|
|
(177
|
) |
|
|
14 |
|
|
|
8
|
% |
Total
operating income
|
|
$ |
388 |
|
|
$ |
212 |
|
|
$ |
176 |
|
|
|
83
|
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
|
Labor
cost absorption represents costs incurred by our central labor and
resource groups (above)/ under the amounts charged to the operating
business units.
|
Nine
months ended September 30, 2008 compared to nine months ended September 30,
2007
Government and
Infrastructure. Revenue from our G&I business unit was $5.2 billion
and $4.5 billion for the nine months ended September 30, 2008 and 2007,
respectively. The increase in revenue from our Middle East Operations is largely
a result of higher volume on U.S. military support activities in Iraq under our
LogCAP III contract due to a U.S. military troop surge in the second half of
2007 that continues to positively impact our 2008 revenue. We expect to provide
services under our LogCAP III contract through the third quarter of 2009. In
April 2008, we were selected as one of the executing contractors of the LogCAP
IV contract. Despite the award of the LogCAP IV contract, we expect our overall
volume of work to decline as our customer scales back its requirements for the
types and amounts of services we provide under these programs. Revenue from our
Americas Operations decreased primarily as a result of reduced activity on
several domestic cost-reimbursable U.S. Government projects including the
CENTCOM, CONCAP and Los Alamos projects. The increase in revenue from our
International Operations is largely due to a project to design, procure and
construct facilities for the U.K. MoD in Basra, southern Iraq. Also
contributing to the increase in International Operations are several engineering
projects in Australia.
Business
unit income was $247 million and $226 million for the nine months ended
September 30, 2008 and 2007, respectively. The increase in job income from our
Middle East Operations decreased as a result of a $27 million charge recognized
in the during the nine months ended September 30, 2008 related to an unfavorable
judgment from litigation with one of our subcontractors for work performed on
our LogCAP III contract in 2003. We believe the judgment is billable to our
customer. However, we will not recognize such amount as revenue until such time
as we are reasonably assured of collection. Job income from our
Americas Operations decreased as a result of lower activity and award fees on
the CENTCOM, CONCAP and Los Alamos projects. Job income from
our International Operations increased due to several projects including
increased earnings from the Allenby & Connaught project and the recently
awarded project to design, procure and construct facilities for the U.K. MoD in
southern Iraq.
Upstream. Revenue from our
Upstream business unit was $1.9 billion and $1.3 billion for the nine months
ended September 30, 2008 and 2007, respectively. The increase in revenue is
primarily due to increased activity from several Gas Monetization projects
including the Escravos GTL, Pearl GTL, Gorgon LNG and Skikda LNG projects.
Revenue from these four projects increased an aggregate $637 million during the
nine months ended September 30, 2008. We continue to experience a strong market
for gas monetization projects with an increasing number of LNG projects in the
development stage. In addition, in the first quarter of 2008 we recognized
revenue in the amount of $51 million related to the favorable arbitration award
related to one of our three projects performed for PEMEX, EPC 28, in our
Offshore operations. Partially offsetting these increases were decreases in
revenue of approximately $96 million in the aggregate for the Yemen LNG, Nigeria
LNG and Tanguuh LNG projects primarily due to lower activity as compared to the
same period of the prior year.
Business
unit income was $197 million and $124 million for the nine months ended
September 30, 2008 and 2007, respectively. The increase in business unit income
was largely driven by a $51 million favorable arbitration award on one of our
three PEMEX projects EPC 28 in the first quarter of 2008 in our Offshore
operations. In our Gas Monetization operations, job income increased
approximately $27 million on our LNG project in Algeria due to a full nine
months of activity in 2008 as compared to only 3 months of activity in
2007. Job income increased by approximately $31 million combined
primarily due to increased activity on the Gorgon LNG project and higher
incentive fees recognized on the Pearl GTL project during the nine months ended
September 30, 2008 as compared to the same period in 2007. These
increases were partially offset by a reduction in estimated profits on one of
our LNG projects caused by increases in estimated costs of our joint venture,
which decreased KBR’s recognized profits by $24 million during the second
quarter of 2008. During the second quarter, the joint venture and the project
owner reached a settlement that is expected to cover the increases in estimated
costs. Based on the timing and approvals required for the settlement, a formal
change order has not yet been completed between the joint venture and the
project owner; however, we believe that it is likely that a change order will be
executed covering the increases in estimated costs.
Services. Revenue from our
Services business unit was $776 million and $226 million for the nine months
ended September 30, 2008 and 2007, respectively. The increase in revenue is
primarily due to business we obtained through the acquisition of BE&K on
July 1, 2008, which contributed approximately $399 million of revenue during the
first nine months of 2008. Additionally, revenue increased a combined $141
million as a result of newly awarded and reoccurring construction and modular
fabrication services in our Canadian and our North American construction
operations. Revenue from the Shell Scotford Upgrader project in Canada increased
approximately $113 million during the nine months ended September 30,
2008.
Business
unit income was $57 million and $33 million for the nine months ended September
30, 2008 and 2007, respectively. The increase in business unit income is
primarily due to of the business we obtained through the acquisition of BE&K
which contributed approximately $13 million to business unit income, including
$24 million in job income less business unit overhead expense of $11 million
during the first nine months of 2008. The remainder of the increase business
unit income was driven primarily by the Shell Scotford Upgrader project in our
Canadian operations.
Downstream. Revenue from our
Downstream business unit was $339 million and $276 million for the nine months
ended September 30, 2008 and 2007, respectively. During the first nine months of
2008, revenue increased by approximately $25 million on the Saudi Kayan olefin
and $43 million on the Ras Tanura projects in Saudi Arabia due to increased
activity. Revenue for the nine months ended September 30, 2008 increased an
additional $33 million as a result of the business we obtained
through the acquisition of BE&K. Increase in revenue related to
these and other projects were partially offset by a $73 million decrease in
revenue during the first nine months of 2008 on the EBIC ammonia plant project
in Egypt as it nears completion.
Business
unit income was $37 million and $7 million for the nine months ended September
30, 2008 and 2007, respectively. This increase is primarily due to an aggregate
$21 million increase in job income from the Saudi Kayan project and program
management services for the Ras Tanura project in Saudi
Arabia. During the second quarter of 2008, we reversed $8 million of
the previously recognized losses on the Saudi Kayan resulting from the effects
of change orders executed during the second quarter of 2008. Also contributing
to the increases is $5 million in job income from the Yanbu export refinery
project which was in the early stages of execution during the first quarter of
2007.
Technology. Revenue from our
Technology business unit was $61 million and $72 million for the nine months
ended September 30, 2008 and 2007, respectively. Business unit income was $16
million and $18 million for the nine months ended September 30, 2008 and 2007,
respectively. The decrease in revenue and business unit income is primarily
attributable to a several projects in China and South America with lower
activity as they are completed or nearly completed in 2008. The decreases in
revenue and income from these projects are partially offset by increases from
technology licensed to an ammonia plant in Venezuela and an aniline plant in
China awarded in early 2008.
Ventures. Revenue from our
Ventures business unit was $(3) million and $(7) million for the nine months
ended September 30, 2008 and 2007, respectively. Business unit loss was $4
million and $9 million for the nine months ended September 30, 2008 and 2007,
respectively. Revenue and business unit loss for the first nine months of 2008
and 2007 are primarily driven by continued operating losses generated on our
investment in APT/FreightLink, the Alice Springs-Darwin railroad project in
Australia. These losses were partially offset by income generated by
the Aspire Defence project.
Labor cost absorption. Labor
cost absorption was $0 million and $(10) million for the nine months ended
September 30, 2008 and 2007, respectively. The increase in labor cost absorption
for the nine months ended September 30, 2008 compared to the nine months ended
September 30, 2007 was primarily due to increased volume at our resource
centers. Partially offsetting these decreases was a $7 million charge
recorded in the third quarter of 2008 related to the impact of Hurricane Ike in
Houston, Texas.
General and Administrative expense.
General and administrative expense was $163 million and $177 million for
the first nine months ended 2008 and 2007, respectively. General and
administrative costs for first nine months of 2009 decreased because of lower
activity related to our deployment of our HR/Payroll instance of SAP and
associated charges from Halliburton for access to their HR/Payroll system,
decreases in incentive compensation as compared to the same period of the prior
year, and lower costs from acquisition related activities. These
decreases were partially offset by increases in general and administrative
expenses from our acquisition of BE&K and $3 million in property damage at
several of our Houston-area facilities resulting from the impact of Hurricane
Ike.
Non-operating
items.
Net
interest income was $32 million for the first nine months of 2008 compared to
net interest income of $44 million for the first nine months of 2007. In July
2007 our Escravos Project was converted from a fixed price contract to a
reimbursable contract. In conjunction with this conversion of the contract, we
were no longer entitled to interest income earned on advanced funds from the
project owner. The decrease in net interest income earned in 2008 related to our
Escravos project, was partially offset by interest income related to the payment
from PEMEX for the EPC 22 arbitration award. As of September 30, 2008, we had
total cash and equivalents of approximately $1.1 billion (including committed
cash of $302 million) compared to $1.8 billion as of September 30, 2007. The
decrease in cash is largely attributable to the acquisition of BE&K on July
1, 2008 with a purchase price of approximately $552 million and stock
repurchases totaling $196 million during the third quarter of 2008.
Provision
for income taxes from continuing operations in the first nine months of 2008 was
$151 million compared to $93 million in the first nine months of 2007. The
effective tax rate for the first nine months of 2008 was approximately 36% as
compared to a rate of 39% in the first nine months of 2007. Our effective tax
rate for the nine months ended September 30, 2008 exceeded our statutory rate of
35% primarily due to not receiving a benefit for operating losses on our
railroad investment in Australia, and state and other taxes. In the second
quarter of 2008, we recorded a $12 million charge related to a U.K. tax court
ruling in excess of the amounts previously provided. We intend to appeal the
court ruling. We reviewed the availability of US foreign tax credits based on
tax minimization strategies available under existing US and UK tax law and
determined that approximately $15 million of the total UK tax assessment will be
realizable through future tax deductions. As such, we recognized a net tax
benefit during the first nine months of 2008 related to this
matter. Our effective tax rate for the nine months ended September
30, 2007 exceeded our statutory rate of 35% primarily due to operating losses
from our railroad investment in Australia, and state and other
taxes.
Income
from discontinued operations, net of tax was $11 million and $97 million for the
nine months ended September 30, 2008 and 2007, respectively. Discontinued
operations represents revenues and gain on the sale of our Productions Services
group in May 2006 and the disposition of our 51% interest in DML in June 2007.
Revenues from our discontinued operations were $449 million for the nine months
ended September 30, 2007. In the third quarter of 2008, we recognized a tax
benefit related to foreign tax credits upon completion of a tax pool study
related to DML. We sold our 51% interest in DML in June 2007.
Backlog
Backlog
represents the dollar amount of revenue we expect to realize in the future as a
result of performing work under multi-period contracts that have been awarded to
us. Backlog is not a measure defined by generally accepted accounting
principles, and our methodology for determining backlog may not be comparable to
the methodology used by other companies in determining their backlog. Backlog
may not be indicative of future operating results. Not all of our revenue is
recorded in backlog for a variety of reasons, including the fact that some
projects begin and end within a short-term period. Many contracts do not provide
for a fixed amount of work to be performed and are subject to modification or
termination by the customer. The termination or modification of any one or more
sizeable contracts or the addition of other contracts may have a substantial and
immediate effect on backlog.
We
generally include total expected revenue in backlog when a contract is awarded
and/or the scope is definitized. For our projects related to unconsolidated
joint ventures, we have included in the table below our percentage ownership of
the joint venture’s backlog. However, because these projects are accounted for
under the equity method, only our share of future earnings from these projects
will be recorded in our revenue. Our backlog for projects related to
unconsolidated joint ventures in our continuing operations totaled $2.8 billion
at September 30, 2008 and $3.1 billion and December 31, 2007. We also
consolidate joint ventures which are majority-owned and controlled or are
variable interest entities in which we are the primary beneficiary. Our backlog
included in the table below for projects related to consolidated joint ventures
with minority interest includes 100% of the backlog associated with those joint
ventures and totaled $3.5 billion at September 30, 2008 and $3.2 billion at
December 31, 2007.
For
long-term contracts, the amount included in backlog is limited to five years. In
many instances, arrangements included in backlog are complex, nonrepetitive in
nature, and may fluctuate depending on expected revenue and timing. Where
contract duration is indefinite, projects included in backlog are limited to the
estimated amount of expected revenue within the following twelve months. Certain
contracts provide maximum dollar limits, with actual authorization to perform
work under the contract being agreed upon on a periodic basis with the customer.
In these arrangements, only the amounts authorized are included in backlog. For
projects where we act solely in a project management capacity, we only include
our management fee revenue of each project in backlog.
Backlog(1)
(in
millions)
|
|
September 30,
2008
|
|
|
December 31,
2007
|
|
G&I:
|
|
|
|
|
|
|
U.S.
Government - Middle East Operations
|
|
$ |
1,570 |
|
|
$ |
1,361 |
|
U.S.
Government - Americas Operations
|
|
|
705 |
|
|
|
548 |
|
International
Operations
|
|
|
1,928 |
|
|
|
2,339 |
|
Total
G&I
|
|
$ |
4,203 |
|
|
$ |
4,248 |
|
Upstream:
|
|
|
|
|
|
|
|
|
Gas
Monetization
|
|
|
6,597 |
|
|
|
6,606 |
|
Offshore
Projects
|
|
|
239 |
|
|
|
173 |
|
Other
|
|
|
106 |
|
|
|
118 |
|
Total
Upstream
|
|
$ |
6,942 |
|
|
$ |
6,897 |
|
Services
|
|
|
2,884 |
|
|
|
765 |
|
Downstream
|
|
|
360 |
|
|
|
313 |
|
Technology
|
|
|
95 |
|
|
|
128 |
|
Ventures
|
|
|
766 |
|
|
|
700 |
|
Total
backlog for continuing operations
|
|
$ |
15,250 |
|
|
$ |
13,051 |
|
(1)
|
Our
G&I business unit’s total backlog from continuing operations
attributable to firm orders was $4.0 billion as of both September 30, 2008
and December 31, 2007. Our G&I business unit’s total backlog from
continuing operations attributable to unfunded orders was $0.2 billion as
of both September 30, 2008 and December 31,
2007.
|
We
estimate that as of September 30, 2008, 57% of our backlog will be complete
within one year. As of September 30, 2008, 20% of our backlog for continuing
operations was attributable to fixed-price contracts and 80% was attributable to
cost-reimbursable contracts. For contracts that contain both fixed-price and
cost-reimbursable components, we classify the components as either fixed-price
or cost-reimbursable according to the composition of the contract except for
smaller contracts where we characterize the entire contract based on the
predominant component.
In August
2006, we were awarded a task order for approximately $3.5 billion for our
continued services in Iraq through the third quarter of 2009 under the LogCAP
III contract in our G&I-Middle East operations. As of September 30, 2008,
our backlog under the LogCAP III contract was $1.6 billion. In July 2007, we
were awarded the EPC contract for the Skikda LNG project for approximately $2.8
billion. As of September 30, 2008, the Skikda backlog was $2.7 billion and was
included in our Upstream-Gas Monetization operations. As a result of
the acquisition of BE&K July 1, 2008, our backlog increased approximately
$2.0 billion most of which is included in our Services business
unit.
Liquidity
and Capital Resources
Cash and
equivalents totaled $1.1 billion at September 30, 2008 and $1.9 billion December
31, 2007, which included $302 million and $483 million, respectively, of cash
and equivalents from advanced payments related to contracts in progress held by
our joint ventures and other subsidiaries that we consolidate for accounting
purposes. The use of these cash balances in consolidated joint ventures 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 ventures or
subsidiaries. In addition, cash and equivalents includes $236 million and $213
million as of September 30, 2008 and December 31, 2007, respectively, from
advanced payments related to a contract in progress that was approximately 30%
complete at September 30, 2008. We expect to use the cash and equivalents
advanced on this project to pay project costs.
Our
Revolving Credit Facility has a $930 million capacity and is available for cash
working capital needs and letters of credit to support our operations. During
2008, we expanded the capacity of our Revolving Credit Facility in the amount of
$80 million. This expansion increased the capacity under the Revolving Credit
Facility from $850 million to $930 million. Letters of credit issued in support
of our operations reduce the Revolving credit Facility capacity on a
dollar-for-dollar basis. As of September 30, 2008 we had approximately $550
million of letters of credit outstanding under our Revolving Credit Facility,
which reduced the availability to $380 million. In addition, we have
approximately $447 million in letters of credit issued under various Halliburton
facilities. The letters of credit are irrevocably and unconditionally guaranteed
by Halliburton. Under the terms of the master separation agreement, we provide
an indemnification to Halliburton in the event of a drawing under these letters
of credits. Also, we have agreed to use our reasonable best efforts to attempt
to release or replace Halliburton’s liability under these outstanding credit
support instruments. We currently pay an annual fee to Halliburton calculated at
0.40% of the outstanding performance-related letters of credit and 0.80% of the
outstanding financial-related letters of credit guaranteed by Halliburton.
Effective January 1, 2010, the annual fee increases to 0.90% and 1.65% of the
outstanding performance-related and financial-related outstanding issued letters
of credit, respectively.
We are
also pursuing several large projects that, if awarded to us will likely require
us to issue letters of credit that could be large in amount. The current
capacity of our Revolving Credit Facility is not adequate for us to issue
letters of credit necessary to replace all outstanding letters of credit issued
under the various Halliburton facilities and issue letters of credit for
projects that we are currently pursuing should they be awarded to us. In
addition, we would not be able to make working capital borrowings against the
Revolving Credit Facility if the availability is fully reduced by issued letters
of credit. We are currently pursuing further expansion of our credit
capacity.
Our
business strategy includes our evaluation of strategic acquisitions of other
businesses. We are currently evaluating several opportunities that, if
successfully acquired, will require the use of a portion of our existing cash
balances.
Operating
activities. Cash provided by operating activities was $1
million for the nine months of 2008. Collections of accounts receivable balances
and a payment from PEMEX related to the EPC 22 arbitration award of $79 million
were more than offset by the use of cash on our Escravos project of
approximately $180 million during the nine months ended September 30, 2008. Cash
used in operating activities also includes approximately $67 million of
contributions made to our international and domestic pension plans during the
nine months ended September 30, 2008. Our working capital requirements for our
Iraq-related work decreased from $239 million at December 31, 2007 to $117
million at September 30, 2008, generating cash of $122 million.
Cash
provided by operating activities was $172 million for the first nine months of
2007. This includes a $113 million advance payment received related to our
Skikda LNG project. Collections of accounts receivable balances, including a
significant milestone payment from one of our joint ventures were partially
offset by the timing of mid-month billing for our LogCAP III project. Cash
flow provided by operations for the nine months ended September 30, 2007, also
includes cash outflows for a tax payment related to the gain on the sale of our
51% interest in DML.
Investing activities. Cash
used in investing activities was $519 million for the first nine months of 2008,
were primarily for business acquisitions. In July 2008, we acquired BE&K for
$487 million, net of cash received. In April 2008, we acquired TGI and Catalyst
Interactive for a combined purchase price of approximately $11 million, net of
cash received.
Cash flow
provided by investing activities was $303 million for the first nine months of
2007, which was primarily related to the sale in the second quarter of 2007
of our 51% interest in DML for cash proceeds of approximately $345 million, net
of direct transaction costs.
Capital
expenditures were $27 million for the nine months of 2008 and $23 million for
the nine months of 2007.
Financing activities. Cash
used in financing activities was $231 million for the first nine months of 2008,
which was almost entirely related to $196 million of payments to reacquire our
common stock and $40 million related to dividend payment to shareholders and
minority shareholders. On August 6, 2008, our Board of Directors authorized a
program to repurchase up to five percent of our outstanding common
shares. We entered into an agreement with an agent to conduct a designated
portion of the repurchase program in accordance with Rules 10b-18 and 10b5-1
under the Securities Exchange Act of 1934. In the third quarter of 2008, we
repurchased 8.4 million shares at a cost of $196 million, which was funded
through our current cash position. We have completed our repurchases under this
plan. See our share repurchases table under “Item 2. Unregistered Sales of
Equity Securities and Use of Proceeds.”
Cash used
in financing activities was $148 for the first nine months of 2007, primarily
for payments made to Halliburton and the payment of dividends to minority
shareholders. The payments to Halliburton during the nine months ended September
30, 2007, related to various support services provided by Halliburton under our
transition services agreement and other amounts.
Future sources of
cash. Future sources of cash include cash flows from
operations, including cash advance payments from our customers, and borrowings
under our Revolving Credit Facility. The Revolving Credit Facility is available
for cash advances required for working capital and letters of credit to support
our operations. However, to meet our short- and long-term liquidity
requirements, we will primarily look to cash generated from operating
activities. As such, we will be required to consider the working capital
requirements of future projects.
Future uses of cash. Future
uses of cash will primarily relate to working capital requirements for our
operations. In addition, we will use cash for capital expenditures, pension
obligations, operating leases, cash dividend payments and various other
obligations, as they arise.
As of
September 30, 2008, we had commitments to fund approximately $85 million to
related companies. Our commitments to fund our privately financed projects are
supported by letters of credit as described above. These commitments arose
primarily during the start-up of these entities due to the losses incurred by
them. At September 30, 2008, approximately $20 million of the $85 million
commitments are current.
We
currently expect to contribute approximately $70 million and $3 million to our
international and domestic pension plans, respectively, in 2008. As of September
30, 2008, we had contributed approximately $64 million and $3 million to our
international and domestic pension plans, respectively.
We expect
that capital spending for 2008 will be approximately $51 million, which
primarily relates to information technology and real estate.
On August
6, 2008, our Board of Directors declared a quarterly cash dividend of $0.05 per
share of common stock payable on October 15, 2008 to shareholders of record on
September 15, 2008. The dividend payment was approximately $9 million and is
included in other current liabilities as of September 30, 2008. Any future
dividend declarations will be at the discretion of our Board of
Directors.
Letters of credit, bonds and
financial and performance guarantees. We and Halliburton have agreed that
the existing surety bonds, letters of credit, performance guarantees, financial
guarantees and other credit support instruments guaranteed by Halliburton will
remain in full force and effect following the separation of our companies. In
addition, we and Halliburton have agreed that until December 31, 2009,
Halliburton will issue additional guarantees, indemnification and reimbursement
commitments for our benefit in connection with (a) letters of credit
necessary to comply with our EBIC contract, our Allenby & Connaught project
and all other contracts that were in place as of December 15, 2005; (b) surety
bonds issued to support new task orders pursuant to the Allenby & Connaught
project, two job order contracts for our G&I business unit and all other
contracts that were in place as of December 15, 2005; and (c) performance
guarantees in support of these contracts. Each credit support instrument
outstanding at the time of our initial public offering and any additional
guarantees, indemnification and reimbursement commitments will remain in effect
until the earlier of: (1) the termination of the underlying project contract or
our obligations thereunder or (2) the expiration of the relevant credit support
instrument in accordance with its terms or release of such instrument by the
customer. In addition, we have agreed to use our reasonable best efforts to
attempt to release or replace Halliburton’s liability under the outstanding
credit support instruments and any additional credit support instruments
relating to our business for which Halliburton may become obligated for which
such release or replacement is reasonably available. For so long as Halliburton
or its affiliates remain liable with respect to any credit support instrument,
we have agreed to pay the underlying obligation as and when it becomes due.
Furthermore, we agreed to pay to Halliburton a quarterly carry charge for its
guarantees of our outstanding letters of credit and surety bonds and agreed to
indemnify Halliburton for all losses in connection with the outstanding credit
support instruments and any new credit support instruments relating to our
business for which Halliburton may become obligated following the
separation.
During
the second quarter of 2007, a £20 million letter of credit was issued on our
behalf by a bank in connection with our Allenby & Connaught project. The
letter of credit supports a building contract guarantee executed between KBR and
certain project joint venture company to provide additional credit support as a
result of our separation from Halliburton. The letter of credit issued by the
bank is guaranteed by Halliburton.
Debt covenants. The Revolving
Credit Facility contains a number of covenants restricting, among other things,
our ability to incur additional indebtedness and liens, sales of our assets and
payment of dividends, as well as limiting the amount of investments we can make.
We are limited in the amount of additional letters of credit and other debt we
can incur outside of the Revolving Credit Facility. Also, under the current
provisions of the Revolving Credit Facility, it is an event of default if any
person or two or more persons acting in concert, other than Halliburton or us,
directly or indirectly acquire 25% or more of the combined voting power of all
outstanding equity interests ordinarily entitled to vote in the election of
directors of KBR Holdings, LLC, the borrower under the facility and a wholly
owned subsidiary of KBR. Prior to our amendment to the Revolving Credit Facility
on January 17, 2008 (referred to below), we were generally prohibited from
purchasing, redeeming, retiring, or otherwise acquiring any of our common stock
unless it is in connection with a compensation plan, program, or practice
provided that the aggregate price paid for such transactions does not exceed $25
million in any fiscal year.
On
January 17, 2008, we entered into an Agreement and Amendment to the Revolving
Credit Facility effective as of January 11, 2008, (the “Amendment”). The
Amendment (i) permits us to elect whether any increase in the aggregate
commitments under the Revolving Credit Facility used solely for the issuance of
letters of credit are to be funded from existing banks or from one or more
eligible assignees; and (ii) permits us to declare and pay shareholder dividends
and/or engage in equity repurchases not to exceed $400 million.
The
Revolving Credit Facility also requires us to maintain certain financial ratios,
as defined by the Revolving Credit Facility agreement, including a
debt-to-capitalization ratio that does not exceed 50%; a leverage ratio that
does not exceed 3.5; and a fixed charge coverage ratio of at least
3.0. At September 30, 2008 and December 31, 2007, we were in compliance
with these ratios and other covenants.
Effective
May 2008, our 55%-owned consolidated subsidiary, M.W. Kellogg Limited, entered
into a credit facility with Barclays Bank totaling £15 million. This facility
replaces a previous facility with Barclays Bank. This facility, which is
non-recourse to us, is primarily used for bonding, guarantee, and other
purposes.
Off
balance sheet arrangements
We
participate, generally through an equity investment in a joint venture,
partnership or other entity, in privately financed projects that enable our
government customers to finance large-scale projects, such as railroads, and
major military equipment purchases. We evaluate the entities that are created to
execute these projects following the guidelines of Financial Accounting
Standards Board (“FASB”) Interpretation No. 46R. These projects typically
include the facilitation of non-recourse financing, the design and construction
of facilities, and the provision of operations and maintenance services for an
agreed period after the facilities have been completed. The carrying value of
our investments in privately financed project entities totaled $65 million and
$40 million at September 30, 2008 and December 31, 2007, respectively. Our
equity in earnings from privately financed project entities totaled $9 million
and $23 million for the three and nine months ended September 30, 2008,
respectively. Our equity in earnings from privately financed project entities
totaled $10 million and $14 million for the three and nine months ended
September 30, 2007, respectively.
Other
factors affecting liquidity
We had
unapproved claims for costs incurred under various government contracts totaling
$74 million at September 30, 2008 and $82 million at December 31, 2007. The
unapproved claims outstanding at September 30, 2008 and December 31, 2007 are
considered to be probable of collection and have been recognized as revenue.
These unapproved claims related to contracts where our costs have exceeded the
customer’s funded value of the task order and therefore could not be billed. We
understand that our customer is actively seeking funds that have been or will be
appropriated to the Department of Defense that can be obligated on our
contract.
As of
September 30, 2008 and December 31, 2007, we had incurred approximately $35
million and $156 million, respectively, of costs under the LogCAP III contract
that could not be billed to the government due to lack of appropriate funding on
various task orders. These amounts were associated with task orders that had
sufficient funding in total, but the funding was not appropriately allocated
among the task orders. We are in the process of preparing a request for a
reallocation of funding to be submitted to the U.S. Army for negotiation. We
believe the negotiations will result in an appropriate distribution of funding
by the U.S. Army and collection of the full amounts due.
As a
result of the current worldwide economic downturn, the actual return on our
pension plan assets could be significantly less than expected. A
significant change in the expected return on plan assets could lead to, among
other things, changes in the funded status, future plan contributions, net
periodic pension expense, and deferred actuarial losses included in accumulated
other comprehensive income. Our next pension plan valuation will occur
during the fourth quarter of 2008 at which time any difference between actual
and expected return on plan assets and changes in other pension assumptions will
be measured and recorded in our financial statements.
Additionally,
we are currently monitoring the nature of our and our unconsolidated
subsidiaries’ financial investments including cash, cash equivalents, marketable
securities and foreign exchange contracts in light of recent market volatility,
change in credit ratings and overall instability of the financial systems.
Certain financial institutions and counterparties may encounter credit rating
downgrades which could result in greater volatility of our financial
investments.
Legal
Proceedings
Information
related to various commitments and contingencies is described in Notes 9 and 10
to the condensed consolidated financial statements.
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: the Comprehensive Environmental Response, Compensation,
and Liability Act; the Resources Conservation and Recovery Act; the Clean Air
Act; the Federal Water Pollution Control Act; and the Toxic Substances Control
Act.
In
addition to the federal laws and regulations, states and other countries where
we do business 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 by complying with environmental, legal and
regulatory requirements. On occasion, we are involved in specific environmental
litigation and claims, including the remediation of properties we own or have
operated as well as efforts to meet or correct compliance-related matters. We
make estimates of the amount of costs associated with known environmental
contamination that we will be required to remediate and record accruals to
recognize those estimated liabilities. Our estimates are based on the best
available information and are updated whenever new information becomes known.
For certain locations including our property at Clinton Drive, we have not
completed our analysis of the site conditions and until further information is
available, we are only able to estimate a possible range of remediation costs.
This range of costs could change depending on our ongoing site analysis and the
timing and techniques used to implement remediation activities. We do not expect
costs related to environmental matters will have a material adverse effect on
our consolidated financial position or our results of operations. At September
30, 2008 our accrual for the estimated assessment and remediation costs
associated with all environmental matters was approximately $6 million, which
represents the low end of the range of possible costs that could be as much as
$15 million.
New
Accounting Standards
In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statement-amendments of ARB No. 51,” (“SFAS
160”). SFAS 160 states that accounting and reporting for minority
interests will be recharacterized as noncontrolling interests and classified as
a component of equity. The Statement also establishes reporting
requirements that provide sufficient disclosures that clearly identify and
distinguish between the interests of the parent and the interests of the
noncontrolling owners. SFAS 160 is effective for fiscal years
beginning after December 15, 2008, early adoption is prohibited. We
are currently evaluating the impact the adoption of SFAS 160 will have on our
financial position, results of operations and cash flows.
In April
2008, the FASB issued FASB Staff Position (FSP) FAS 142-3, “Determination of the
Useful Life of Intangible Assets.” This FSP amends the factors that should be
considered in developing renewal or extension assumptions used to determine the
useful life of a recognized intangible asset under FASB Statement No. 142,
“Goodwill and Other Intangible Assets.” The intent of this FSP is to improve the
consistency between the useful life of a recognized intangible asset under
Statement 142 and the period of expected cash flows used to measure the fair
value of the asset under FASB Statement No. 141 (Revised 2007), “Business
Combinations,” and other U.S. generally accepted accounting principles (GAAP).
This FSP is effective for financial statements issued for fiscal years beginning
after December 15, 2008, and interim periods within those fiscal years. Early
adoption is prohibited. We are currently evaluating the impact the adoption of
this FSP will have on our financial position, results of operations or cash
flows.
In June
2008, the FASB issued FSP EITF 03-6-1, “Determining Whether Instruments Granted
in Share-Based Payment Transactions Are Participating
Securities.” This FSP provides that unvested share-based payment
awards that contain non-forfeitable rights to dividends or dividend equivalents
(whether paid or unpaid) are participating securities and shall be included in
the computation of earnings per share pursuant to the two-class
method. The FSP is effective for financial statements issued for
fiscal years beginning after December 15, 2008, and interim periods within those
years. All prior period earnings per share data presented shall be
adjusted retrospectively. Early application of this FSP is
prohibited. We are currently evaluating the potential impact of
adopting FSP EITF 03-6-1.
Item 3. Quantitative and Qualitative Disclosures About Market
Risk
We are
exposed to financial instrument market risk from changes in foreign currency
exchange rates and interest rates. 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 September 30, 2008 to provide reasonable
assurance that information required to be disclosed in our reports filed or
submitted under the Exchange Act is recorded, processed, summarized, and
reported within the time periods specified in the Securities and Exchange
Commission’s rules and forms. Our disclosure controls and procedures include
controls and procedures designed to ensure that information required to be
disclosed in reports filed or submitted under the Exchange Act is accumulated
and communicated to our management, including our Chief Executive Officer and
Chief Financial Officer, as appropriate, to allow timely decisions regarding
required disclosure.
During
the most recent fiscal quarter, there have been no changes in our internal
control over financial reporting that have materially affected, or are
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 Notes 9 and 10
to the condensed consolidated financial statements and in Managements’
Discussion and Analysis of Financial Condition and Results of Operations – Legal
Proceedings.
There are
no material changes from the risk factors previously disclosed in Part I,
Item 1A in our Annual Report on Form 10-K, which is incorporated herein by
reference, for the year ended December 31, 2007.
Item 2. Unregistered Sales of Equity Securities and Use of
Proceeds
|
(c)
|
On
August 6, 2008, our Board of Directors authorized a program to repurchase
up to five percent of our outstanding common shares. As of the
announcement date, we had approximately 170 million shares outstanding. In
the third quarter of 2008, we repurchased 8.4 million shares at a cost of
$196 million. We entered into an agreement with an agent to conduct a
designated portion of the repurchase program in accordance with Rules
10b-18 and 10b5-1 under the Securities Exchange Act of 1934. The share
repurchases were funded through our current cash
position.
|
Purchase Period
|
|
Total Number of Shares
Purchased
|
|
|
Average Price Paid per
Share
|
|
|
Total Number of Shares Purchased as Part of
Publicly Announced Plans or Programs
|
|
|
Maximum Number of Shares that May Yet Be Purchased
Under the Plans or Programs
|
|
August
12, 2008 –
August
29, 2008
|
|
|
6,266,498 |
|
|
$ |
23.12 |
|
|
|
6,266,498 |
|
|
|
2,133,502 |
|
September 2, 2008 –
September 8, 2008
|
|
|
2,133,502 |
|
|
$ |
24.02 |
|
|
|
2,133,502 |
|
|
|
— |
|
Total
|
|
|
8,400,000 |
|
|
$ |
23.35 |
|
|
|
8,400,000 |
|
|
|
— |
|
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security
Holders
None.
Item 5. Other Information
None.
*
|
10.1
|
|
Form
of Severance and Change in Control Agreement (incorporated by reference to
Exhibit 10.1 of the Company’s Form 8-K filed on August 28,
2008)
|
|
|
|
|
*
|
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
|
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.
KBR,
INC.
/s/ T.
Kevin DeNicola
|
|
/s/ John
W. Gann, Jr.
|
T.
Kevin DeNicola
|
|
John
W. Gann, Jr.
|
Chief
Financial Officer
|
|
Vice
President and Chief Accounting
Officer
|
Date:
October 31, 2008
Exhibit
Index
*
|
10.1
|
|
Form
of Severance and Change in Control Agreement (incorporated by reference to
Exhibit 10.1 of the Company’s Form 8-K filed on August 28,
2008)
|
|
|
|
|
*
|
|
|
Certification of
Chief Executive Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
|
|
|
|
|
*
|
|
|
Certification
of Chief Financial Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
|
|
|
|
|
**
|
|
|
Certification
of Chief Executive Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
|
|
|
|
|
**
|
|
|
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
|