UNITED
STATES SECURITIES AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-Q
[X]
Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities
Exchange Act of 1934
For
the quarterly period ended March 31, 2005
OR
[ ]
Transition Report Pursuant to Section 13 or 15(d)
of the
Securities Exchange Act of 1934
For the
transition period from _____ to _____
Commission
File Number 1-3492
HALLIBURTON
COMPANY
(a
Delaware Corporation)
75-2677995
5
Houston Center
1401
McKinney, Suite 2400
Houston,
Texas 77010
(Address
of Principal Executive Offices)
Telephone
Number - Area Code (713) 759-2600
Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.
Yes X No
Indicate
by check mark whether the registrant is an accelerated filer (as defined in Rule
12b-2 of the Exchange Act).
Yes X
No
As of
April 22, 2005, 505,744,263 shares of Halliburton Company common stock, $2.50
par value per share, were outstanding.
HALLIBURTON
COMPANY
Index
|
|
Page
No. |
PART
I. |
FINANCIAL
INFORMATION |
|
|
|
|
Item
1. |
Financial
Statements |
3-25 |
|
|
|
|
- Condensed
Consolidated Statements of Operations |
3 |
|
- Condensed
Consolidated Balance Sheets |
4 |
|
- Condensed
Consolidated Statements of Cash Flows |
5 |
|
- Notes
to Condensed Consolidated Financial Statements |
6-25 |
|
|
|
Item
2. |
Management’s
Discussion and Analysis of Financial Condition and |
|
|
Results
of Operations |
26-55 |
|
|
|
Item
3. |
Quantitative
and Qualitative Disclosures about Market Risk |
56 |
|
|
|
Item
4. |
Controls
and Procedures |
56 |
|
|
|
PART
II. |
OTHER
INFORMATION |
|
|
|
|
Item
1. |
Legal
Proceedings |
57 |
|
|
|
Item
2. |
Unregistered
Sales of Equity Securities and Use of Proceeds |
57 |
|
|
|
Item
3. |
Defaults
Upon Senior Securities |
57 |
|
|
|
Item
4. |
Submission
of Matters to a Vote of Security Holders |
57 |
|
|
|
Item
5. |
Other
Information |
57 |
|
|
|
Item
6. |
Exhibits |
57-58 |
|
|
|
Signatures |
|
59 |
PART
I. FINANCIAL INFORMATION
Item
1. Financial Statements
HALLIBURTON
COMPANY
Condensed
Consolidated Statements of Operations
(Unaudited)
(Millions
of dollars and shares except per share data)
|
|
Three
Months Ended |
|
|
|
March
31 |
|
|
|
2005 |
|
2004 |
|
Revenue: |
|
|
|
|
|
|
|
Services |
|
$ |
4,357 |
|
$ |
5,036 |
|
Product
sales |
|
|
557 |
|
|
491 |
|
Equity
in earnings (losses) of unconsolidated affiliates, net |
|
|
24 |
|
|
(8 |
) |
Total
revenue |
|
|
4,938 |
|
|
5,519 |
|
Operating
costs and expenses: |
|
|
|
|
|
|
|
Cost
of services |
|
|
3,886 |
|
|
4,795 |
|
Cost
of sales |
|
|
474 |
|
|
453 |
|
General
and administrative |
|
|
101 |
|
|
96 |
|
Gain
on sale of business assets, net |
|
|
(109 |
) |
|
- |
|
Total
operating costs and expenses |
|
|
4,352 |
|
|
5,344 |
|
Operating
income |
|
|
586 |
|
|
175 |
|
Interest
expense |
|
|
(52 |
) |
|
(56 |
) |
Interest
income |
|
|
12 |
|
|
10 |
|
Foreign
currency gains (losses), net |
|
|
- |
|
|
(3 |
) |
Other,
net |
|
|
(2 |
) |
|
5 |
|
Income
from continuing operations before income taxes and
minority |
|
|
|
|
|
|
|
interest |
|
|
544 |
|
|
131 |
|
Provision
for income taxes |
|
|
(169 |
) |
|
(49 |
) |
Minority
interest in net income of subsidiaries |
|
|
(8 |
) |
|
(6 |
) |
Income
from continuing operations |
|
|
367 |
|
|
76 |
|
Loss
from discontinued operations, net of tax benefit of $1 and
$59 |
|
|
(2 |
) |
|
(141 |
) |
Net
income (loss) |
|
$ |
365 |
|
$ |
(65 |
) |
Basic
income (loss) per share: |
|
|
|
|
|
|
|
Income
from continuing operations |
|
$ |
0.73 |
|
$ |
0.17 |
|
Loss
from discontinued operations, net |
|
|
- |
|
|
(0.32 |
) |
Net
income (loss) |
|
$ |
0.73 |
|
$ |
(0.15 |
) |
Diluted
income (loss) per share: |
|
|
|
|
|
|
|
Income
from continuing operations |
|
$ |
0.72 |
|
$ |
0.17 |
|
Loss
from discontinued operations, net |
|
|
- |
|
|
(0.32 |
) |
Net
income (loss) |
|
$ |
0.72 |
|
$ |
(0.15 |
) |
|
|
|
|
|
|
|
|
Cash
dividends per share |
|
$ |
0.125 |
|
$ |
0.125 |
|
Basic
weighted average common shares outstanding |
|
|
501 |
|
|
436 |
|
Diluted
weighted average common shares outstanding |
|
|
510 |
|
|
440 |
|
See notes to condensed
consolidated financial statements.
HALLIBURTON
COMPANY
Condensed
Consolidated Balance Sheets
(Unaudited)
(Millions
of dollars and shares except per share data)
|
|
March
31, |
|
December
31, |
|
|
|
2005 |
|
2004 |
|
Assets |
|
Current
assets: |
|
|
|
|
|
|
|
Cash
and equivalents |
|
$ |
1,812 |
|
$ |
1,917 |
|
Investments
in marketable securities |
|
|
- |
|
|
891 |
|
Receivables: |
|
|
|
|
|
|
|
Notes
and accounts receivable (less allowance for bad debts of $113 and
$127) |
|
|
2,935 |
|
|
2,873 |
|
Unbilled
work on uncompleted contracts |
|
|
1,843 |
|
|
1,812 |
|
Insurance
for asbestos- and silica-related liabilities |
|
|
96 |
|
|
1,066 |
|
Total
receivables |
|
|
4,874 |
|
|
5,751 |
|
Inventories |
|
|
880 |
|
|
791 |
|
Other
current assets |
|
|
642 |
|
|
680 |
|
Total
current assets |
|
|
8,208 |
|
|
10,030 |
|
Property,
plant, and equipment, net of accumulated depreciation of $3,672 and
$3,674 |
|
|
2,556 |
|
|
2,553 |
|
Goodwill |
|
|
794 |
|
|
795 |
|
Noncurrent
deferred income taxes |
|
|
727 |
|
|
780 |
|
Equity
in and advances to related companies |
|
|
427 |
|
|
541 |
|
Insurance
for asbestos- and silica-related liabilities |
|
|
297 |
|
|
350 |
|
Other
assets |
|
|
797 |
|
|
815 |
|
Total
assets |
|
$ |
13,806 |
|
$ |
15,864 |
|
Liabilities
and Shareholders’ Equity |
Current
liabilities: |
|
|
|
|
|
|
|
Accounts
payable |
|
$ |
2,357 |
|
$ |
2,339 |
|
Current
maturities of long-term debt |
|
|
862 |
|
|
347 |
|
Accrued
employee compensation and benefits |
|
|
538 |
|
|
473 |
|
Advanced
billings on uncompleted contracts |
|
|
499 |
|
|
553 |
|
Asbestos-
and silica-related liabilities |
|
|
- |
|
|
2,408 |
|
Other
current liabilities |
|
|
923 |
|
|
1,012 |
|
Total
current liabilities |
|
|
5,179 |
|
|
7,132 |
|
Long-term
debt |
|
|
3,109 |
|
|
3,593 |
|
Employee
compensation and benefits |
|
|
631 |
|
|
635 |
|
Other
liabilities |
|
|
435 |
|
|
464 |
|
Total
liabilities |
|
|
9,354 |
|
|
11,824 |
|
Minority
interest in consolidated subsidiaries |
|
|
114 |
|
|
108 |
|
Shareholders’
equity: |
|
|
|
|
|
|
|
Common
shares, par value $2.50 per share - authorized 1,000 shares, issued 520
and 458 shares |
|
|
1,300 |
|
|
1,146 |
|
Paid-in
capital in excess of par value |
|
|
2,544 |
|
|
277 |
|
Common
shares to be contributed to asbestos trust - 59.5 shares |
|
|
- |
|
|
2,335 |
|
Deferred
compensation |
|
|
(75 |
) |
|
(74 |
) |
Accumulated
other comprehensive income |
|
|
(166 |
) |
|
(146 |
) |
Retained
earnings |
|
|
1,173 |
|
|
871 |
|
|
|
|
4,776 |
|
|
4,409 |
|
Less
15 and 16 shares of treasury stock, at cost |
|
|
438 |
|
|
477 |
|
Total
shareholders’ equity |
|
|
4,338 |
|
|
3,932 |
|
Total
liabilities and shareholders’ equity |
|
$ |
13,806 |
|
$ |
15,864 |
|
See notes to condensed consolidated financial statements.
HALLIBURTON
COMPANY
Condensed
Consolidated Statements of Cash Flows
(Unaudited)
|
Three
Months Ended |
|
March
31 |
(Millions
of dollars) |
2005 |
2004 |
Cash
flows from operating activities: |
|
|
Net
income (loss) |
$365 |
$(65) |
Adjustments
to reconcile net income (loss) to net cash from
operations: |
|
|
Loss
from discontinued operations |
2 |
141 |
Depreciation,
depletion, and amortization |
125 |
132 |
Provision
(benefit) for deferred income taxes, including $0 and $(52) related
to |
|
|
discontinued
operations |
79 |
(78) |
Distribution
from (advances to) related companies, net of equity in (earnings)
losses |
7 |
(15) |
Gain
on sale of assets |
(109) |
(6) |
Asbestos
and silica liability payments related to Chapter 11 filing |
(2,345) |
- |
Collection
of asbestos receivables |
1,023 |
- |
Other
changes: |
|
|
Receivables
and unbilled work on uncompleted contracts |
(85) |
(470) |
Accounts
receivable facilities transactions |
(21) |
- |
Inventories |
(89) |
(39) |
Accounts
payable |
33 |
289 |
Restricted
cash related to Chapter 11 proceedings |
4 |
(103) |
Other |
(30) |
38 |
Total
cash flows from operating activities |
(1,041) |
(176) |
Cash
flows from investing activities: |
|
|
Capital
expenditures |
(142) |
(130) |
Sales
of property, plant, and equipment |
20 |
32 |
Dispositions
(acquisitions) of business assets, net of cash disposed |
203 |
(22) |
Proceeds
from sale of long-term securities |
- |
20 |
Proceeds
from (purchases of) short-term investments in marketable securities,
net |
891 |
(381) |
Investments
- restricted cash |
- |
(43) |
Other
investing activities |
(8) |
(5) |
Total
cash flows from investing activities |
964 |
(529) |
Cash
flows from financing activities: |
|
|
Proceeds
from long-term debt, net of offering costs |
- |
496 |
Proceeds
from exercises of stock options |
89 |
20 |
Payments
to reacquire common stock |
(6) |
(4) |
Borrowings
(repayments) of short-term debt, net |
(4) |
(9) |
Payments
of long-term debt |
(36) |
(6) |
Payments
of dividends to shareholders |
(63) |
(55) |
Other
financing activities |
(3) |
- |
Total
cash flows from financing activities |
(23) |
442 |
Effect
of exchange rate changes on cash |
(5) |
- |
Decrease
in cash and equivalents |
(105) |
(263) |
Cash
and equivalents at beginning of period |
1,917 |
1,104 |
Cash
and equivalents at end of period |
$1,812 |
$841 |
Supplemental
disclosure of cash flow information: |
|
|
Cash
payments during the period for: |
|
|
Interest |
$73 |
$74 |
Income
taxes |
$83 |
$43 |
See notes
to condensed consolidated financial statements.
HALLIBURTON
COMPANY
Notes
to Condensed Consolidated Financial Statements
(Unaudited)
Note
1. Basis of Presentation
The
accompanying unaudited condensed consolidated financial statements were prepared
using generally accepted accounting principles for interim financial information
and the instructions to Form 10-Q and Regulation S-X. Accordingly, these
financial statements do not include all information or footnotes required by
generally accepted accounting principles for annual financial statements and
should be read together with our 2004 Annual Report on Form 10-K.
Certain
prior period amounts have been reclassified to be consistent with the current
presentation.
Our
accounting policies are in accordance with generally accepted accounting
principles in the United States of America. The preparation of financial
statements in conformity with these accounting principles requires us to make
estimates and assumptions that affect:
|
- |
the
reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements;
and |
|
- |
the
reported amounts of revenue and expenses during the reporting
period. |
Ultimate
results could differ from our estimates.
In our
opinion, the condensed consolidated financial statements included herein contain
all adjustments necessary to present fairly our financial position as of March
31, 2005, the results of our operations for the three months ended March 31,
2005 and 2004, and our cash flows for the three months ended March 31, 2005 and
2004. Such adjustments are of a normal recurring nature. The results of
operations for the three months ended March 31, 2005 and 2004 may not be
indicative of results for the full year.
Note
2. Percentage-of-Completion Contracts
Unapproved
claims
The
amounts of unapproved claims included in determining the profit or loss on
contracts and the amounts booked to “Unbilled work on uncompleted contracts” as
of March 31, 2005 and December 31, 2004 are as follows:
|
|
March
31, |
|
December
31, |
|
Millions
of dollars |
|
2005 |
|
2004 |
|
Probable
unapproved claims |
|
$ |
181 |
|
$ |
182 |
|
Probable
unapproved claims accrued revenue |
|
|
176 |
|
|
182 |
|
Probable
unapproved claims from unconsolidated |
|
|
|
|
|
|
|
related
companies |
|
|
78 |
|
|
51 |
|
The
probable unapproved claims as of March 31, 2005 relate to four contracts, most
of which are complete or substantially complete.
A
significant portion of the probable unapproved claims ($153 million related to
our consolidated entities and $45 million related to our unconsolidated related
companies, arose from three completed projects with Petroleos Mexicanos (PEMEX)
that are currently subject to arbitration proceedings. In addition, we have
“Other assets” of $64 million for previously approved services that are unpaid
by PEMEX and have been included in these arbitration proceedings. Actual amounts
we are seeking from PEMEX in the arbitration proceedings are in excess of these
amounts. The arbitration proceedings are expected to extend through 2007. PEMEX
has asserted unspecified counterclaims in each of the three arbitrations;
however, it is premature based upon our current understanding of those
counterclaims to make any assessment of their merits.
We have
contracts with probable unapproved claims that will likely not be settled within
one year totaling $181 million at March 31, 2005 and $153 million at December
31, 2004 included in the table above, which are reflected as “Other assets” on
the condensed consolidated balance sheets. Other probable unapproved claims that
we believe will be settled within one year, included in the table above, have
been recorded to “Unbilled work on uncompleted contracts,” included in the
“Total receivables” amount on the condensed consolidated balance sheets. Our
unconsolidated related companies include probable unapproved claims as revenue
to determine the amount of profit or loss for their contracts. Probable
unapproved claims from our related companies are included in “Equity in and
advances to related companies.”
See Note
12 for discussion of government contract claims, which are not included in the
table above.
Unapproved
change orders
We have
other contracts for which we are negotiating change orders to the contract scope
and have agreed upon the scope of work but not the price. These change orders
amount to $50 million at March 31, 2005. Unapproved change orders at December
31, 2004 were $43 million. Our share of change orders from unconsolidated
related companies totaled $5 million at March 31, 2005 and $37 million at
December 31, 2004.
Barracuda-Caratinga
project
Following
is the status, as of March 31, 2005, of our Barracuda-Caratinga project, a
multiyear construction project to develop the Barracuda and Caratinga crude
oilfields located off the coast of Brazil:
|
- |
the
project was approximately 97% complete; |
|
- |
we
have recorded an inception-to-date loss of $762 million related to the
project, of which $407 million was recorded in 2004 ($97 million during
the first quarter of 2004), $238 million was recorded in 2003, and $117
million was recorded in 2002; |
|
- |
the
losses recorded include $22 million in liquidated damages paid based on
the final agreement with Petrobras; |
|
- |
the
$300 million of advance payments have been completely repaid;
and |
|
- |
we
have received $101 million relating to approved change
orders. |
We
continue to fund operating cash shortfalls on this project, and estimate that we
will pay approximately $65 million in the remainder of 2005, which represents
remaining project costs, net of revenue to be received.
Note
3. Acquisitions and Dispositions
Subsea
7, Inc.
In
January 2005, we completed the sale of our 50% interest in Subsea 7, Inc. to our
joint venture partner, Siem Offshore (currently Subsea 7, Inc.), for $203
million in cash. As a result of the transaction, we recorded a gain of
approximately $110 million during the first quarter of 2005. We accounted for
our 50% ownership of Subsea 7, Inc. using the equity method in our Production
Optimization segment.
Note
4. Business Segment Information
Our six
business segments are organized around how we manage the business: Production
Optimization, Fluid Systems, Drilling and Formation Evaluation, Digital and
Consulting Solutions, Government and Infrastructure, and Energy and Chemicals
segments.
We refer
to the combination of Production Optimization, Fluid Systems, Drilling and
Formation Evaluation, and Digital and Consulting Solutions segments as the
Energy Services Group and the combination of our Government and Infrastructure
and Energy and Chemicals segment as KBR.
The table
below presents information on our segments.
|
|
Three
Months Ended |
|
|
|
March
31 |
|
Millions
of dollars |
|
2005 |
|
2004 |
|
Revenue: |
|
|
|
|
|
|
|
Production
Optimization |
|
$ |
900 |
|
$ |
708 |
|
Fluid
Systems |
|
|
631 |
|
|
535 |
|
Drilling
and Formation Evaluation |
|
|
489 |
|
|
444 |
|
Digital
and Consulting Solutions |
|
|
164 |
|
|
129 |
|
Total
Energy Services Group |
|
|
2,184 |
|
|
1,816 |
|
Government
and Infrastructure |
|
|
2,091 |
|
|
2,868 |
|
Energy
and Chemicals |
|
|
663 |
|
|
835 |
|
Total
KBR |
|
|
2,754 |
|
|
3,703 |
|
Total |
|
$ |
4,938 |
|
$ |
5,519 |
|
Operating
income (loss): |
|
|
|
|
|
|
|
Production
Optimization |
|
$ |
291 |
|
$ |
82 |
|
Fluid
Systems |
|
|
113 |
|
|
60 |
|
Drilling
and Formation Evaluation |
|
|
80 |
|
|
43 |
|
Digital
and Consulting Solutions |
|
|
29 |
|
|
29 |
|
Total
Energy Services Group |
|
|
513 |
|
|
214 |
|
Government
and Infrastructure |
|
|
53 |
|
|
62 |
|
Energy
and Chemicals |
|
|
52 |
|
|
(77 |
) |
Total
KBR |
|
|
105 |
|
|
(15 |
) |
General
corporate |
|
|
(32 |
) |
|
(24 |
) |
Total |
|
$ |
586 |
|
$ |
175 |
|
Intersegment
revenue is immaterial. Our equity in pretax earnings and losses of
unconsolidated affiliates that are accounted for on the equity method is
included in revenue and operating income of the applicable segment.
Total
revenue for the three months ended March 31, 2005 included $1.7 billion or 34%
of consolidated revenue from the United States Government, which was derived
almost entirely from the Government and Infrastructure segment. Revenue from the
United States Government during the three months ended March 31, 2004
represented 47% of consolidated revenue. No other customer represented more than
10% of consolidated revenue in any period presented.
Note
5. Receivables (Other than “Insurance for asbestos- and silica- related
liabilities”)
In April
2005, the term of our Energy Services Group accounts receivable securitization
facility was extended to April 2006. We have the ability to sell up to $300
million in undivided ownership interest in the pool of receivables under this
facility. As of both March 31, 2005 and December 31, 2004, $256 million of
undivided ownership interest had been sold to unaffiliated
companies.
In May
2004, we entered into an agreement to sell, assign, and transfer the entire
title and interest in specified United States government accounts receivable of
KBR to a third party. The face value of the receivables sold to the third party
is reflected as a reduction of accounts receivable in our condensed consolidated
balance sheets. The amount of receivables that can be sold under the agreement
varies based on the amount of eligible receivables at any given time and other
factors, and the maximum amount that may be sold and outstanding under this
agreement at any given time is $650 million. The total amount of receivables
outstanding under this agreement was approximately $242 million as of March 31,
2005 and approximately $263 million as of December 31, 2004. Subsequent to March
31, 2005, the receivables were collected, and we have not sold any additional
receivables.
Note
6. Inventories
Inventories
are stated at the lower of cost or market. We manufacture in the United States
finished products and parts inventories for drill bits, completion products,
bulk materials, and other tools that are recorded using the last-in, first-out
method totaling $42 million at March 31, 2005 and $37 million at December 31,
2004. If the average cost method had been used, total inventories would have
been $18 million higher than reported at March 31, 2005 and $17 million higher
than reported at December 31, 2004. Inventories consisted of the
following:
|
|
March
31, |
|
December
31, |
|
Millions
of dollars |
|
2005 |
|
2004 |
|
Finished
products and parts |
|
$ |
645 |
|
$ |
602 |
|
Raw
materials and supplies |
|
|
179 |
|
|
156 |
|
Work
in process |
|
|
56 |
|
|
33 |
|
Total |
|
$ |
880 |
|
$ |
791 |
|
Finished
products and parts are reported net of obsolescence accruals of $118 million at
March 31, 2005 and $119 million at December 31, 2004.
Note
7. Other Investments
Investments
in marketable securities
Our
investments in marketable securities are reported at fair value. At December 31,
2004, our investments in marketable securities consisted of $891 million of
auction rate securities classified as available-for-sale. As of March 31, 2005,
we had no investments in auction rate securities. Although the auction rate
securities generally have original maturities of 20 to 30 years, the underlying
interest rates on these securities reset at intervals usually ranging from 7 to
35 days. Therefore, these auction rate securities are priced and subsequently
traded as short-term investments because of remarketing and the interest rate
reset feature. The 2004 balance of the auction rate securities was previously
classified as cash and equivalents due to our intent and ability to quickly
liquidate these securities to fund current operations and the pricing reset
feature. The auction rate securities were reclassified as investments in
marketable securities. There was no impact on net income or cash flow from
operating activities as a result of the reclassification.
Restricted
cash
At March
31, 2005, we had restricted cash of $134 million, which consisted
of:
|
- |
$98
million as collateral for potential future insurance claim reimbursements
included in “Other assets”; and |
|
- |
$36
million ($23 million in “Other assets” and $13 million in “Other current
assets”) primarily related to cash collateral agreements for outstanding
letters of credit for various construction
projects. |
At
December 31, 2004, we had restricted cash of $121 million in “Other assets” and
$17 million in “Other current assets,” which consisted of similar items as
above.
Note
8. Property, Plant, and Equipment
In the
second quarter of 2004, we implemented a change in accounting estimate to more
accurately reflect the useful life of some of the tools of our Drilling and
Formation Evaluation segment. This resulted in a $9 million reduction in
depreciation expense in the first quarter of 2005, as well as a combined $35
million reduction in depreciation expense in the last three quarters of 2004. We
extended the useful lives of these tools based on our review of their service
lives, technological improvements in the tools, and recent changes to our repair
and maintenance practices that helped to extend the lives.
Note
9. Comprehensive Income
The
components of other comprehensive income (loss) included the
following:
|
|
Three
Months Ended |
|
|
|
March
31 |
|
Millions
of dollars |
|
2005 |
|
2004 |
|
Net
income (loss) |
|
$ |
365 |
|
$ |
(65 |
) |
|
|
|
|
|
|
|
|
Cumulative
translation adjustments |
|
|
(10 |
) |
|
20 |
|
Realization
of losses included in net income (loss) |
|
|
3 |
|
|
- |
|
Net
cumulative translation adjustments |
|
|
(7 |
) |
|
20 |
|
|
|
|
|
|
|
|
|
Unrealized
net losses on investments and derivatives |
|
|
(3 |
) |
|
(5 |
) |
Realization
of gains included in net income (loss) |
|
|
(10 |
) |
|
- |
|
Net
unrealized losses on investments and derivatives |
|
|
(13 |
) |
|
(5 |
) |
|
|
|
|
|
|
|
|
Total
comprehensive income (loss) |
|
$ |
345 |
|
$ |
(50 |
) |
Accumulated
other comprehensive income consisted of the following:
|
|
March
31, |
|
December
31, |
|
Millions
of dollars |
|
2005 |
|
2004 |
|
Cumulative
translation adjustments |
|
$ |
(38 |
) |
$ |
(31 |
) |
Pension
liability adjustments |
|
|
(130 |
) |
|
(130 |
) |
Unrealized
gains on investments and derivatives |
|
|
2 |
|
|
15 |
|
Total
accumulated other comprehensive income |
|
$ |
(166 |
) |
$ |
(146 |
) |
Note
10. Debt
Senior
notes due 2007
On
January 26, 2004, we issued $500 million aggregate principal amount of senior
notes due 2007 bearing interest at a floating rate equal to three-month LIBOR
plus 0.75%, payable quarterly. On April 26, 2005, we redeemed, at par plus
accrued interest, all $500 million of these senior notes
outstanding.
Revolving
credit facilities
In March
2005, we entered into a $1.2 billion five-year unsecured revolving credit
agreement, which replaced our secured $700 million three-year revolving credit
facility and our secured $500 million 364-day revolving credit facility. The
letter of credit outstanding under the previous $700 million revolving credit
facility is now outstanding under our $1.2 billion revolving credit agreement
and has a balance of $166 million as of March 31, 2005. As of March 31, 2005,
approximately $1.0 billion was available for borrowing under the $1.2 billion
revolving credit agreement, but no borrowings had been made.
We are
subject to a maximum debt-to-capitalization ratio of not greater than 60% under
this revolver and are in full compliance at March 31, 2005.
Interest
rates applicable to this facility are variable.
Note
11. Asbestos and Silica Obligations and Insurance
Recoveries
Several
of our subsidiaries, particularly DII Industries and Kellogg Brown & Root,
had been named as defendants in a large number of asbestos- and silica-related
lawsuits. The plaintiffs alleged injury primarily as a result of exposure
to:
|
- |
asbestos
used in products manufactured or sold by former divisions of DII
Industries (primarily refractory materials, gaskets, and packing materials
used in pumps and other industrial
products); |
|
- |
asbestos
in materials used in the construction and maintenance projects of Kellogg
Brown & Root or its subsidiaries; and |
|
- |
silica
related to sandblasting and drilling fluids
operations. |
Effective
December 31, 2004, we resolved all open and future claims in the prepackaged
Chapter 11 proceedings of DII Industries, Kellogg Brown & Root, and our
other affected subsidiaries (which were filed on December 16, 2003) upon the
plan of reorganization becoming final and nonappealable. The following table
presents a rollforward of our asbestos- and silica-related liabilities and
insurance receivables.
Millions
of dollars |
|
|
|
Asbestos-
and silica-related liabilities: |
|
|
|
|
December
31, 2004 balance (of which $2,408 was current) |
|
$ |
(2,445 |
) |
Payment
to trusts in accordance with the plan of reorganization |
|
|
2,345 |
|
First
installment payment of partitioning agreement with
Federal-Mogul |
|
|
16 |
|
Cash
settlement payment to the silica trust |
|
|
15 |
|
First
installment payment on one-year asbestos note |
|
|
8 |
|
Reclassification
of remaining note balances to other current |
|
|
|
|
liabilities
and long-term debt |
|
|
61 |
|
Asbestos-
and silica-related liabilities - March 31, 2005 balance |
|
$ |
- |
|
Insurance
for asbestos- and silica-related liabilities: |
|
|
|
|
December
31, 2004 balance (of which $1,066 was current) |
|
$ |
1,416 |
|
Payments
received |
|
|
(1,023 |
) |
Write-off
of insurance recoveries/net present value true-up |
|
|
(3 |
) |
Accretion |
|
|
3 |
|
Insurance
for asbestos- and silica-related liabilities - March 31,
2005 |
|
|
|
|
balance
(of which $96 was current) |
|
$ |
393 |
|
In
accordance with the plan of reorganization, in January 2005 we contributed the
following to trusts for the benefit of current and future asbestos and silica
personal injury claimants:
|
- |
approximately
$2.345 billion in cash, which represents the remaining portion of the
$2.775 billion total cash settlement after payments of $311 million in
December 2003 and $119 million in June
2004; |
|
- |
59.5
million shares of Halliburton common stock; |
|
- |
a
one-year non-interest-bearing note of $31 million for the benefit of
asbestos claimants. We prepaid the initial installment on the note of
approximately $8 million in January 2005. The remaining note will be paid
in three equal quarterly installments starting in the second quarter of
2005; and |
|
- |
a
silica note plus an initial payment into a silica trust of $15 million.
The note provides that we will contribute an amount to the silica trust at
the end of each year for the next 30 years of up to $15 million. The note
also provides for an extension of the note for 20 additional years under
certain circumstances. We have estimated the value of this note plus the
initial cash payment to be approximately $24 million at December 31, 2004.
We will periodically reassess our valuation of this note based upon our
projections of the amounts we believe we will be required to fund into the
silica trust. |
Our plan
of reorganization called for a portion of our total asbestos liability to be
settled by contributing 59.5 million shares of Halliburton common stock to the
trust. At March 31, 2004, we revalued our shares to approximately $1.7 billion
($29.37 per share) from $1.6 billion ($26.27 per share) at December 31, 2003,
resulting in a $190 million charge to discontinued operations. Effective
December 31, 2004, concurrent with receiving final and nonappealable
confirmation of our plan of reorganization, we reclassified from a long-term
liability to shareholders’ equity the final value of the 59.5 million shares of
Halliburton common stock to be contributed to the asbestos trust. In January
2005, when the 59.5 million shares were actually contributed to the trust, the
$2.335 billion value of the common shares was reclassified to common stock and
paid-in capital in excess of par value on the condensed consolidated balance
sheets.
Insurance
settlements. During
2004, we settled insurance disputes with substantially all the insurance
companies for asbestos- and silica-related claims and all other claims under the
applicable insurance policies and terminated all the applicable insurance
policies. Under the terms of our insurance settlements, we will receive cash
proceeds with a nominal amount of approximately $1.5 billion and with a present
value of approximately $1.4 billion for our asbestos- and silica-related
insurance receivables. The present value was determined by discounting the
expected future cash payments with a discount rate implicit in the settlements,
which ranged from 4.0% to 5.5%. This discount is being accreted as interest
income (classified as discontinued operations) over the life of the expected
future cash payments. Cash payments of approximately $1.023 billion related to
these receivables were received in the first quarter of 2005. Under the terms of
the settlement agreements, we will receive cash payments of the remaining
amounts in several installments beginning in July 2005 through
2009.
A
significant portion of the insurance coverage applicable to Worthington Pump, a
former division of DII Industries, was alleged by Federal-Mogul (and others who
formerly were associated with Worthington Pump prior to its acquisition by DII
Industries) to be shared with them. During 2004, we reached an agreement with
Federal-Mogul, our insurance companies, and another party sharing in the
insurance coverage to obtain their consent and support of a partitioning of the
insurance policies. Under the terms of the agreement, DII Industries was
allocated 50% of the limits of any applicable insurance policy, and the
remaining 50% of limits of the insurance policies were allocated to the
remaining policyholders. As part of the settlement, DII Industries agreed to pay
$46 million in three installment payments. The first payment of $16 million was
paid in January 2005. The second and third payments of $15 million each will
occur on the first and second anniversaries from the date of the first payment.
In 2004, we accrued $44 million, which represents the present value of the $46
million to be paid. The discount is accreted as interest expense (classified as
discontinued operations) over the life of the expected future cash payments
beginning in the fourth quarter of 2004.
DII
Industries and Federal-Mogul agreed to share equally in recoveries from
insolvent London-based insurance companies. To the extent that Federal-Mogul’s
recoveries from certain insolvent London-based insurance companies received on
or before January 1, 2006 do not equal at least $4.5 million, DII Industries
agreed to also pay to Federal-Mogul the difference between their recoveries from
the insolvent London-based insurance companies and $4.5 million. Any recoveries
received by Federal-Mogul from the insolvent London-based insurance companies
after January 1, 2006 will be reimbursed to DII Industries until such time as
DII Industries is fully reimbursed for the amount of the payment.
Under the
insurance settlements entered into as part of the resolution of our Chapter 11
proceedings, we have agreed to indemnify our insurers under certain historic
general liability insurance policies in certain situations. We have concluded
that the likelihood of any claims triggering the indemnity obligations is
remote, and we believe any potential liability for these indemnifications will
be immaterial. At March 31, 2005, we had not recorded any liability associated
with these indemnifications.
Note
12. United States Government Contract Work
We
provide substantial work under our government contracts business to the United
States Department of Defense and other governmental agencies, including
worldwide United States Army logistics contracts, known as LogCAP, and contracts
to rebuild Iraq’s petroleum industry, known as RIO and PCO Oil South. Our
government services revenue related to Iraq totaled approximately $1.5 billion
in the first quarter of 2005 compared to $2.4 billion in the first quarter of
2004.
Given the
demands of working in Iraq and elsewhere for the United States government, we
expect that from time to time we will have disagreements or experience
performance issues with the various government customers for which we work. If
performance issues arise under any of our government contracts, the government
retains the right to pursue remedies under any affected contract, which remedies
could include threatened termination or termination. If any contract were so
terminated, we may not receive award fees under the affected contract, and our
ability to secure future contracts could be adversely affected, although we
would receive payment for amounts owed for our allowable costs under
cost-reimbursable contracts.
DCAA
audit issues
Our
operations under United States government contracts are regularly reviewed and
audited by the Defense Contract Audit Agency (DCAA) and other governmental
agencies. The DCAA serves in an advisory role to our customer. When issues are
found during the governmental agency audit process, these issues are typically
discussed and reviewed with us. The DCAA then issues an audit report with its
recommendations to our customer’s contracting officer. In the case of management
systems and other contract administrative issues, the contracting officer is
generally with the Defense Contract Management Agency (DCMA). We then work with
our customer to resolve the issues noted in the audit report.
Dining
facilities (DFAC). During
2003, the DCAA raised issues relating to our invoicing to the Army Materiel
Command (AMC) for food services for soldiers and supporting civilian personnel
in Iraq and Kuwait. During 2004, we received notice from the DCAA that it was
recommending withholding 19.35% of our DFAC billings relating to subcontracts
entered into prior to February 2004 until it completed its audits. Approximately
$213 million had been withheld as of March 31, 2005. Subsequent to February
2004, we renegotiated our DFAC subcontracts to address the specific issues
raised by the DCAA and advised the AMC and the DCAA of the new terms of the
arrangements. We have had no objection by the government to the terms and
conditions associated with these new DFAC subcontract agreements. On March 31,
2005, we reached an agreement with the AMC regarding the cost associated with
the DFAC subcontractors, which totaled approximately $1.2 billion. Under the
terms of the agreement, the AMC agreed to the DFAC subcontractor costs except
for $55 million, which it will retain from the $213 million previously withheld
amount. We will attempt to pass this $55 million price reduction to the
subcontractors. We are currently withholding funds from the subcontractors in
excess of this amount. These excess amounts will be paid to the subcontractors
upon release of the withholds from the government. As a result of this
agreement, we recorded $10 million in additional operating income during the
first quarter of 2005.
Fuel. In
December 2003, the DCAA issued a preliminary audit report that alleged that we
may have overcharged the Department of Defense by $61 million in importing fuel
into Iraq. The DCAA questioned costs associated with fuel purchases made in
Kuwait that were more expensive than buying and transporting fuel from Turkey.
We responded that we had maintained close coordination of the fuel mission with
the Army Corps of Engineers (COE), which was our customer and oversaw the
project, throughout the life of the task order, and that the COE had directed us
to use the Kuwait sources. After a review, the COE concluded that we obtained a
fair price for the fuel. However, Department of Defense officials thereafter
referred the matter to the agency’s inspector general, which we understand has
commenced an investigation.
The DCAA
has issued various audit reports related to task orders under the RIO contract
that currently report $276 million in questioned and unsupported costs (down
from $304 million originally reported because some issues have been resolved).
To date, the DCAA has not recommended that any portion of the questioned and
unsupported costs be withheld from payments to us. The majority of these costs
are associated with the humanitarian fuel mission. In these reports, the DCAA
has compared fuel costs we incurred during the duration of the RIO contract in
2003 and early 2004 to fuel prices obtained by the Defense Energy Supply Center
(DESC) in April 2004 when the fuel mission was transferred to that agency. We
are working with our customer to resolve this issue.
Laundry. During
the third quarter of 2004, we received notice from the DCAA that it recommended
withholding $16 million of subcontract costs related to the laundry service for
one task order in southern Iraq for which it believes we and our subcontractors
have not provided adequate levels of documentation supporting the quantity of
the services provided. In the first quarter of 2005, the DCAA issued a second
notice to withhold approximately $2 million. The DCAA recommended that the costs
be withheld pending receipt of additional explanation or documentation to
support the subcontract costs. The $18 million has been withheld from the
subcontractor. We are working with the AMC and the subcontractor to resolve this
issue.
Other
issues. The DCAA
is continuously performing audits of costs incurred for other services provided
by us under our government contracts. During these audits, there are likely to
be questions raised by the DCAA about the reasonableness or allowability of
certain costs or the quality or quantity of supporting documentation. No
assurance can be given that the DCAA might not recommend withholding some
portion of the questioned costs while the issues are being resolved with our
customer. We do not believe any potential withholding will have a significant or
sustained impact on our liquidity.
Investigations
On
January 22, 2004, we announced the identification by our internal audit function
of a potential overbilling of approximately $6 million by La Nouvelle Trading
& Contracting Company, W.L.L. (La Nouvelle), one of our subcontractors,
under the LogCAP contract in Iraq, for services performed during 2003. In
accordance with our policy and government regulation, the potential overcharge
was reported to the Department of Defense Inspector General’s office as well as
to our customer, the AMC. On January 23, 2004, we issued a check in the amount
of $6 million to the AMC to cover that potential overbilling while we conducted
our own investigation into the matter. Later in the first quarter of 2004, we
determined that the amount of overbilling was $4 million, and the subcontractor
billing should have been $2 million for the services provided. As a result, we
paid La Nouvelle $2 million and billed our customer that amount. We subsequently
terminated La Nouvelle’s services under the LogCAP contract. In October 2004, La
Nouvelle filed suit against us alleging $224 million in damages as a result of
its termination. We are continuing to investigate whether La Nouvelle paid, or
attempted to pay, one or two of our former employees in connection with the
billing. See Note 13 to our consolidated financial statements for further
discussion.
In
October 2004, we reported to the Department of Defense Inspector General’s
office that two former employees in Kuwait may have had inappropriate contacts
with individuals employed by or affiliated with two third-party subcontractors
prior to the award of the subcontracts. The Inspector General’s office may
investigate whether these two employees may have solicited and/or accepted
payments from these third-party subcontractors while they were employed by
us.
In
October 2004, a civilian contracting official in the COE asked for a review of
the process used by the COE for awarding some of the contracts to us. We
understand that the Department of Defense Inspector General’s office may review
the issues involved.
We
understand that the United States Department of Justice, an Assistant United
States Attorney based in Illinois, and others are investigating these and other
individually immaterial matters we have reported relating to our government
contract work in Iraq. If criminal wrongdoing were found, criminal penalties
could range up to the greater of $500,000 in fines per count for a corporation,
or twice the gross pecuniary gain or loss. We also understand that current and
former employees of KBR have received subpoenas and have given or may give grand
jury testimony relating to some of these matters.
In the
first quarter of 2005, the Department of Justice issued two indictments
associated with these issues against a former KBR procurement manager and a
manager at our subcontractor, La Nouvelle.
Withholding
of payments
During
2004, the AMC issued a determination that a particular contract clause could
cause it to withhold 15% from our invoices until our task orders under the
LogCAP contract are definitized. The AMC delayed implementation of this
withholding pending further review. During the third quarter of 2004, we and the
AMC identified three senior management teams to facilitate negotiation under the
LogCAP task orders, and these teams concluded their effort by successfully
negotiating the final outstanding task order definitization on March 31, 2005.
This makes us current with regard to definitization of historical LogCAP task
orders and eliminates the potential 15% withholding issue under the LogCAP
contract. In addition, we recorded $12 million in additional income in the first
quarter of 2005 resulting from the recognition of incremental award fees related
to the definitized task orders.
As of
March 31, 2005, the COE had withheld $95 million of our invoices related to a
portion of our RIO contract pending completion of the definitization process.
All 10 definitization proposals required under this contract have been submitted
by us, and three have been finalized through a task order modification. After
review by the DCAA, we have resubmitted five of the unfinalized seven proposals
and are in the process of developing revised proposals for the remaining two.
These withholdings represent the amount invoiced in excess of 85% of the funding
in the task order. The COE also could withhold similar amounts from future
invoices under our RIO contract until agreement is reached with the customer and
task order modifications are issued. Approximately $2 million was withheld from
our PCO Oil South project as of March 31, 2005. The PCO Oil South project has
definitized substantially all of the task orders, and withholdings are not
continuing on those task orders. We do not believe the withholding will have a
significant or sustained impact on our liquidity because the withholding is
temporary and ends once the definitization process is complete.
We are
working diligently with our customers to proceed with significant new work only
after we have a fully definitized task order, which should limit withholdings on
future task orders for all government contracts.
In
addition, we had unapproved claims totaling $102 million at March 31, 2005 for
the LogCAP, RIO, and PCO Oil South contracts. These unapproved claims related to
contracts where our costs have exceeded the funded value of the task order or
were related to lost, damaged, and destroyed equipment.
Cost
reporting
We
received notice that a contracting officer for our PCO Oil South project
considers our monthly categorization and detail of costs and our ability to
schedule and forecast costs to be inadequate, and he requested corrections be
made. We provided our cost report and believe that we made the requested
corrections. If we are unable to satisfy our customer, our customer may pursue
remedies under the applicable federal acquisition regulations, including
terminating the affected contract. Although there can be no assurances, we do
not expect that our work on the PCO Oil South project will be terminated for
default. We are continuing to work with our customer to develop a mutually
acceptable management cost reporting system and are supplementing the existing
PCO Oil South cost reporting team with additional manpower. The PCO Oil South
contract has been challenging in part due to violent attacks by insurgents on
infrastructure in the southern part of Iraq. Currently, the volume of work
performed on PCO Oil South is lower than we had projected initially, and we
believe the risk/reward profile is unattractive.
DCMA
system reviews
Report
on estimating system. On
December 27, 2004, the DCMA granted continued approval of our estimating system,
stating that our estimating system is “acceptable with corrective action.” We
are in process of completing these corrective actions. Specifically, based on
the unprecedented level of support our employees are providing the military in
Iraq, Kuwait, and Afghanistan, we needed to update our estimating policies and
procedures to make them better suited to such contingency situations.
Additionally, we have completed our development of a detailed training program
and have made it available to all estimating personnel to ensure that employees
are adequately prepared to deal with the challenges and unique circumstances
associated with a contingency operation.
Report
on purchasing system. As a
result of a Contractor Purchasing System Review by the DCMA during the second
quarter of 2004, the DCMA granted the continued approval of our government
contract purchasing system. The DCMA’s approval letter, dated September 7, 2004,
stated that our purchasing system’s policies and practices are “effective and
efficient, and provide adequate protection of the Government’s
interest.”
Report
on accounting system. We have
received an initial draft report on our accounting system and have responded to
the points raised by the DCAA. Once the DCAA finalizes the report it will be
submitted to the DCMA, who will make a determination of the adequacy of our
accounting systems for government contracting.
The
Balkans
We have
had inquiries in the past by the DCAA and the civil fraud division of the United
States Department of Justice into possible overcharges for work performed during
1996 through 2000 under a contract in the Balkans, which inquiry has not yet
been completed by the Department of Justice. Based on an internal investigation,
we credited our customer approximately $2 million during 2000 and 2001 related
to our work in the Balkans as a result of billings for which support was not
readily available. We believe that the preliminary Department of Justice inquiry
relates to potential overcharges in connection with a part of the Balkans
contract under which approximately $100 million in work was done. We believe
that any allegations of overcharges would be without merit.
Note
13. Other Commitments and Contingencies
Nigerian
joint venture and investigations
Foreign
Corrupt Practices Act investigation. The
Securities and Exchange Commission (SEC) is conducting a formal investigation
into payments made in connection with the construction and subsequent expansion
by TSKJ of a multibillion dollar natural gas liquefaction complex and related
facilities at Bonny Island in Rivers State, Nigeria. The United States
Department of Justice is also conducting an investigation. TSKJ is a private
limited liability company registered in Madeira, Portugal whose members are
Technip SA of France, Snamprogetti Netherlands B.V., which is an affiliate of
ENI SpA of Italy, JGC Corporation of Japan, and Kellogg Brown & Root, each
of which owns 25% of the venture.
The SEC
and the Department of Justice have been reviewing these matters in light of the
requirements of the United States Foreign Corrupt Practices Act (FCPA). We have
produced documents to the SEC both voluntarily and pursuant to subpoenas, and we
are making our employees available to the SEC for testimony. In addition, we
understand that the SEC has issued a subpoena to A. Jack Stanley, who most
recently served as a consultant and chairman of Kellogg Brown & Root, and to
other current and former Kellogg Brown & Root employees. We further
understand that the Department of Justice has invoked its authority under a
sitting grand jury to obtain letters rogatory for the purpose of obtaining
information abroad.
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., which is an affiliate of
ENI SpA of Italy. Commencing in 1995, TSKJ entered into a series of agency
agreements in connection with the Nigerian project. We understand that a French
magistrate has officially placed Jeffrey Tesler, a principal of Tri-Star
Investments, an agent of TSKJ, 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
and expressed our willingness to cooperate with those investigations. In October
2004, representatives of TSKJ voluntarily testified before the Nigerian
legislative committee.
As a
result of our continuing investigation into these matters, information has been
uncovered suggesting that, commencing at least 10 years ago, the members of TSKJ
considered payments to Nigerian officials. We provided this information to the
United States Department of Justice, the SEC, the French magistrate, and the
Nigerian Economics and Financial Crimes Commission. We also notified the other
owners of TSKJ of the recently uncovered information and asked each of them to
conduct their own investigation.
We
understand from the ongoing governmental and other investigations that payments
may have been made to Nigerian officials. In addition, TSKJ has suspended the
receipt of services from and payments to Tri-Star Investments and is considering
instituting legal proceedings to declare all agency agreements with Tri-Star
Investments terminated and to recover all amounts previously paid under those
agreements.
We also
understand that the matters under investigation by the Department of Justice
involve parties other than Kellogg Brown & Root and M. W. Kellogg, Ltd. (a
joint venture in which Kellogg Brown & Root has a 55% interest), cover an
extended period of time (in some cases significantly before our 1998 acquisition
of Dresser Industries (which included M. W. Kellogg, Ltd.)), and possibly
include the construction of a fertilizer plant in Nigeria in the early 1990s and
the activities of agents and service providers.
In June
2004, we terminated all relationships with Mr. Stanley and another consultant
and former employee of M. W. Kellogg, Ltd. The termination occurred because of
violations of our Code of Business Conduct that allegedly involve the receipt of
improper personal benefits in connection with TSKJ’s construction of the natural
gas liquefaction facility in Nigeria.
In
February 2005, TSKJ notified the Attorney General of Nigeria that TSKJ would not
oppose the Attorney General’s efforts to have sums of money held on deposit in
banks in Switzerland transferred to Nigeria and to have the legal ownership of
such sums determined in the Nigerian courts.
If
violations of the FCPA were found, we could be subject to civil penalties of
$500,000 per violation, and criminal penalties could range up to the greater of
$2 million per violation or twice the gross pecuniary gain or loss.
There can
be no assurance that any governmental investigation or our investigation of
these matters will not conclude that violations of applicable laws have occurred
or that the results of these investigations will not have a material adverse
effect on our business and results of operations.
As of
March 31, 2005, we have not accrued any amounts related to this
investigation.
Bidding
practices investigation. In
connection with the investigation into payments made in connection with the
Nigerian project, 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, which was significantly before our
1998 acquisition of Dresser Industries.
On the
basis of this information, we and the Department of Justice have broadened our
investigations to determine the nature and extent of any improper bidding
practices, whether such conduct violated United States antitrust laws, and
whether former employees may have received payments in connection with bidding
practices on some foreign projects.
If
violations of applicable United States antitrust laws occurred, the range of
possible penalties includes criminal fines, which could range up to the greater
of $10 million in fines per count for a corporation, or twice the gross
pecuniary gain or loss, and treble civil damages in favor of any persons
financially injured by such violations. If such violations occurred, the United
States government also would have the discretion to deny future government
contracts business to KBR or affiliates or subsidiaries of KBR. Criminal
prosecutions under applicable laws of relevant foreign jurisdictions and civil
claims by or relationship issues with customers are also possible.
There can
be no assurance that the results of these investigations will not have a
material adverse effect on our business and results of operations.
As of
March 31, 2005, we had not accrued any amounts related to this
investigation.
SEC
investigation of change in accounting for revenue on long-term construction
projects and related disclosures
In August
2004, we reached a settlement in the investigation by the SEC involving our 1998
and 1999 disclosure of and accounting for the recognition of revenue from
unapproved claims on long-term construction projects. Our settlement with the
SEC covers a failure to disclose a 1998 change in accounting practice. We
disclosed the change in accounting practice in our 1999 Form 10-K and continued
to do so in subsequent periods. The SEC did not determine that we departed from
generally accepted accounting principles, nor did it find errors in accounting
or fraud. We neither admitted nor denied the SEC’s findings, but paid a $7.5
million civil penalty and recorded a charge of that amount in the second quarter
of 2004. As part of the settlement, the company agreed to cease and desist from
committing or causing future securities law violations.
Securities
and related litigation
On June
3, 2002, a class action lawsuit was filed against us in federal court on behalf
of purchasers of our common stock during the period of approximately May 1998
until approximately May 2002 alleging violations of the federal securities laws
in connection with the accounting change and disclosures involved in the SEC
investigation discussed above. In addition, the plaintiffs allege that we
overstated our revenue from unapproved claims by recognizing amounts not
reasonably estimable or probable of collection. After that date, approximately
twenty similar class actions were filed against us. Several of those lawsuits
also named as defendants Arthur Andersen LLP, our independent accountants for
the period covered by the lawsuits, and several of our present or former
officers and directors. The class action cases were later consolidated and the
amended consolidated class action complaint, styled Richard
Moore, et al. v. Halliburton Company, et al., was
filed and served upon us on or about April 11, 2003 (the “Moore class
action”). Subsequently, in October 2002 and March 2003, two derivative actions
arising out of essentially the same facts and circumstances were filed, one of
which was subsequently dismissed, while the other was transferred to the same
judge before whom the Moore class
action was pending.
In early
May 2003, we announced that we had entered into a written memorandum of
understanding setting forth the terms upon which both the Moore class
action and the remaining derivative action would be settled. In June 2003, the
lead plaintiffs in the Moore
class
action filed a motion for leave to file a second amended consolidated complaint,
which was granted by the court. In addition to restating the original accounting
and disclosure claims, the second amended consolidated complaint includes claims
arising out of the 1998 acquisition of Dresser Industries, Inc. by Halliburton,
including that we failed to timely disclose the resulting asbestos liability
exposure (the “Dresser claims”). The Dresser claims were included in the
settlement discussions leading up to the signing of the memorandum of
understanding and are among the claims the parties intended to be resolved by
the terms of the proposed settlement of the consolidated Moore class
action and the derivative action.
The
memorandum of understanding called for Halliburton to pay $6 million, which
would be funded by insurance proceeds. After the May 2003 announcement regarding
the memorandum of understanding, one of the lead plaintiffs in the consolidated
class action announced that it was dissatisfied with the lead plaintiffs’
counsel’s handling of settlement negotiations and what the dissident plaintiff
regarded as inadequate communications by the lead plaintiffs’ counsel. The
dissident lead plaintiff further asserted that it believed that, for various
reasons, the $6 million settlement amount is inadequate.
The
attorneys representing the dissident plaintiff filed another class action
complaint in August 2003, raising allegations similar to those raised in the
second amended consolidated complaint regarding the accounting/disclosure claims
and the Dresser claims. In addition, the complaint enhances the Dresser claims
to include allegations related to our accounting with respect to the
acquisition, integration, and reserves of Dresser. We moved to dismiss that
complaint, styled Kimble
v. Halliburton Company, et al. (the
“Kimble
action”); however, the court never ruled on our motion and ordered the case
consolidated with the Moore class
action. On August 3, 2004, the attorneys representing the dissident plaintiff
filed a motion for leave to file yet another class action complaint styled
Murphey
v. Halliburton Company, et al., which
was recently granted by the court. The Murphey complaint raises and augments
allegations similar to those in the Moore class
action and the Kimble action,
including additional allegations regarding disclosure of asbestos liability
exposure.
On June
7, 2004, the court entered an order preliminarily approving the settlement.
Following the transfer of the case(s) to another district judge and a final
hearing on the fairness of the settlement, on September 9, 2004, the court
entered an order holding that evidence of the settlement’s fairness was
inadequate and denying the motion for final approval of the settlement in the
Moore class
action and ordering the parties, among other things, to mediate. After the
court’s denial of the motion to approve the settlement, we withdrew from the
settlement as we believe we are entitled to do by its terms, although the
settling plaintiffs assert otherwise. In the days preceding the mediation, two
union-sponsored pension funds filed motions seeking leave to intervene in the
consolidated class action litigation and to file their own class action
complaint. The court has granted those motions. The mediation was held on
January 27, 2005 and, at the conclusion of that day, was declared by the
mediator to be at an impasse with no settlement having been
reached.
After the
mediation, the lead plaintiff and lead counsel filed motions to withdraw as lead
plaintiff and lead counsel. The court has set a hearing on these motions, which
were unopposed, for April 29, 2005. We anticipate that at that time the court
will appoint a new lead counsel and issue an order directing which complaint we
are required to respond to and the date by which any answer or responsive motion
should be filed. We intend to file a motion to dismiss and to vigorously defend
the action.
On
September 9, 2004, the court ordered that if no objections to the settlement of
the derivative action described above were made by October 20, 2004, the court
would finally approve the derivative action settlement. On February 18, 2005,
the court entered an order dismissing the derivative action with
prejudice.
Newmont
Gold
In July
1998, Newmont Gold, a gold mining and extraction company, filed a lawsuit over
the failure of a blower manufactured and supplied to Newmont by Roots, a former
division of Dresser Equipment Group. The plaintiff alleges that during the
manufacturing process, Roots had reversed the blades on a component of the
blower known as the inlet guide vane assembly, resulting in the blower’s failure
and the shutdown of the gold extraction mill for a period of approximately one
month during 1996. In January 2002, a Nevada trial court granted summary
judgment to Roots on all counts, and Newmont appealed. In February 2004, the
Nevada Supreme Court reversed the summary judgment and remanded the case to the
trial court, holding that fact issues existed requiring a trial. Based on
pretrial reports, the damages claimed by the plaintiff are in the range of $33
million to $39 million. We believe that we have valid defenses to Newmont Gold’s
claims and intend to vigorously defend the matter. The case is scheduled for
trial beginning the last full week of May 2005. As of March 31, 2005, we had not
accrued any amounts related to this matter.
Smith
International award
In June
2004, a Texas district court jury returned a verdict in our favor in connection
with a patent infringement lawsuit we filed against Smith International (Smith).
We were awarded $24 million in damages by the jury. We filed the lawsuit in
September 2002, seeking damages for Smith’s infringement of our patented Energy
Balanced™ roller cone drill bit technology. The jury found that Smith’s
competing bits willfully infringed on three of our patents. Under applicable
law, the judge has the discretion to enhance the damages to a total amount of up
to three times the amount awarded by the jury and to award attorneys’ fees and
costs. Subsequent to the verdict, upon our motion, the court enhanced the jury
verdict by $12 million and added another $5 million in attorneys’ fees and costs
for a total judgment of $41 million. Post-trial motions for a new trial and for
judgment as a matter of law were denied, and Smith appealed the judgment. Smith
has filed its principal brief, and our brief will be filed in the coming
weeks.
Related
litigation dealing with claims of infringement of the same technology was tried
in January and February 2005 in England, and a decision is expected shortly.
Similar litigation is pending in courts in Italy and is expected to go to trial
during 2005.
In
anticipation of Smith filing an infringement action against us, in March 2005 we
filed a declaratory judgment action against Smith in the court in which the $41
million judgment currently on appeal was entered related to certain patents held
by Smith dealing with essentially the same technology that underlies that
judgment. Smith then filed an infringement action against us in a Houston court.
We intend to seek to have the Houston infringement action transferred to the
original court and consolidated with the declaratory judgment
action.
As of
March 31, 2005, we had not recorded any amounts related to this
matter.
Improper
payments reported to the SEC
During
the second quarter of 2002, we reported to the SEC that one of our foreign
subsidiaries operating in Nigeria made improper payments of approximately $2.4
million to entities owned by a Nigerian national who held himself out as a tax
consultant, when in fact he was an employee of a local tax authority. The
payments were made to obtain favorable tax treatment and clearly violated our
Code of Business Conduct and our internal control procedures. The payments were
discovered during our audit of the foreign subsidiary. We conducted an
investigation assisted by outside legal counsel and, based on the findings of
the investigation, we terminated several employees. None of our senior officers
were involved. We are cooperating with the SEC in its review of the matter. We
took further action to ensure that our foreign subsidiary paid all taxes owed in
Nigeria. A preliminary assessment of approximately $4 million was issued by the
Nigerian tax authorities in the second quarter of 2003. We are cooperating with
the Nigerian tax authorities to determine the total amount due as quickly as
possible.
Operations
in Iran
We
received and responded to an inquiry in mid-2001 from the Office of Foreign
Assets Control (OFAC) of the United States Treasury Department with respect to
operations in Iran by a Halliburton subsidiary incorporated in the Cayman
Islands. The OFAC inquiry requested information with respect to compliance with
the Iranian Transaction Regulations. These regulations prohibit United States
citizens, including United States corporations and other United States business
organizations, from engaging in commercial, financial, or trade transactions
with Iran, unless authorized by OFAC or exempted by statute. Our 2001 written
response to OFAC stated that we believed that we were in compliance with
applicable sanction regulations. In January 2004, we received a follow-up letter
from OFAC requesting additional information. We responded to this request on
March 19, 2004. We understand this matter has now been referred by OFAC to the
Department of Justice. In July 2004, we received a grand jury subpoena from an
Assistant United States District Attorney requesting the production of
documents. We are cooperating with the government’s investigation and have
responded to the subpoena by producing documents on September 16, 2004. As of
March 31, 2005, we had not accrued any amounts related to this
investigation.
Separate
from the OFAC inquiry, we completed a study in 2003 of our activities in Iran
during 2002 and 2003 and concluded that these activities were in compliance with
applicable sanction regulations. These sanction regulations require isolation of
entities that conduct activities in Iran from contact with United States
citizens or managers of United States companies. Notwithstanding our conclusions
that our activities in Iran were not in violation of United States laws and
regulations, we have recently announced that, after fulfilling our current
contractual obligations within Iran, we intend to cease operations within that
country and to withdraw from further activities there.
Litigation
brought by La Nouvelle
In
October 2004, La Nouvelle, a subcontractor to us in connection with our
government services work in Kuwait and Iraq, filed suit alleging breach of
contract and interference with contractual and business relations. The relief
sought includes $224 million in damages for breach of contract, which includes
$34 million for tortuous interference, and an unspecified sum for consequential
and punitive damages. The dispute arises from our termination of a master
agreement pursuant to which La Nouvelle operated a number of DFACs in Kuwait and
Iraq and the replacement of La Nouvelle with ESS, which prior to La Nouvelle’s
termination had served as La Nouvelle’s subcontractor. In addition, La Nouvelle
alleges that we wrongfully withheld from La Nouvelle certain sums due La
Nouvelle under its various subcontracts.
We
believe that we were contractually entitled to withhold the sums from La
Nouvelle and that we had the right to terminate the master agreement with La
Nouvelle for cause. The case has only recently been filed and our investigation
is in its preliminary stages. Accordingly, it is premature to assess the
likelihood of an unfavorable result.
During
the first quarter of 2005, La Nouvelle requested and we agreed to stay all
proceedings for a period of 60 days, during which we engaged in mediation. While
the mediation was unsuccessful, constructive discussions were held between the
parties. We cannot presently assess the likelihood that those discussions will
ultimately result in a settlement. Should they not, however, it is our intention
to vigorously defend the action. As of March 31, 2005, except for amounts
previously invoiced to us by La Nouvelle for work performed, we had not accrued
any amounts related to this litigation.
David
Hudak and International Hydrocut Technologies Corp.
On
October 12, 2004, David Hudak and International Hydrocut Technologies Corp.
(collectively, Hudak), filed suit against us in the United States District Court
alleging civil Racketeer Influenced and Corrupt Organizations Act violations,
fraud, breach of contract, unfair trade practices, and other torts. The action,
which seeks unspecified damages, arises out of Hudak’s alleged purchase in early
1994 of certain explosive charges that were later alleged by the United States
Department of Justice to be military ordnance, the possession of which by
persons not possessing the requisite licenses and registrations is unlawful. As
a result of that allegation by the government, Hudak was charged with, but later
acquitted of, certain criminal offenses in connection with his possession of the
explosive charges. As mentioned above, the alleged transaction(s) took place
more than 10 years ago. The fact that most of the individuals that may have been
involved, as well as the entities themselves, are no longer affiliated with us
will complicate our investigation. For those reasons and because the litigation
is in its most preliminary stages, it is premature to assess the likelihood of
an adverse result. It is, however, our intention to vigorously defend this
action. As of March 31, 2005, we had not accrued any amounts related to this
matter.
Convoy
ambush litigation
We have
recently become aware that several of the families of truck drivers employed by
KBR and killed when a fuel convoy was ambushed in Iraq on April 9, 2004 have
filed suit against us. These suits allege that we are responsible for the deaths
of these drivers for a variety of reasons and assert legal claims for fraud,
wrongful death, civil rights violations, and violations of the Racketeer
Influenced and Corrupt Organization Act. We deny the allegations of wrongdoing
and fully intend to vigorously defend the actions. We believe that our conduct
was entirely lawful and that our liability is limited by federal law. As of
March 31, 2005, we had not accrued any amounts related to these
matters.
Environmental
We are
subject to numerous environmental, legal, and regulatory requirements related to
our operations worldwide. In the United States, these laws and regulations
include, among others:
|
- |
the
Comprehensive Environmental Response, Compensation, and Liability
Act; |
|
- |
the
Resources Conservation and Recovery Act; |
|
- |
the
Federal Water Pollution Control Act; and |
|
- |
the
Toxic Substances Control Act. |
In
addition to the federal laws and regulations, states and other countries where
we do business may have numerous environmental, legal, and regulatory
requirements by which we must abide. We evaluate and address the environmental
impact of our operations by assessing and remediating contaminated properties in
order to avoid future liabilities and comply with environmental, legal, and
regulatory requirements. On occasion, we are involved in specific environmental
litigation and claims, including the remediation of properties we own or have
operated, as well as efforts to meet or correct compliance-related matters. Our
Health, Safety and Environment group has several programs in place to maintain
environmental leadership and to prevent the occurrence of environmental
contamination.
We do not
expect costs related to these remediation requirements to have a material
adverse effect on our consolidated financial position or our results of
operations. Our accrued liabilities for environmental matters were $44 million
as of March 31, 2005 and $41 million as of December 31, 2004. The liability
covers numerous properties, and no individual property accounts for more than $5
million of the liability balance. We have been named as potentially responsible
parties along with other third parties for 14 federal and state superfund sites
for which we have established a liability. As of March 31, 2005, those 14 sites
accounted for approximately $14 million of our total $44 million liability. In
some instances, we have been named a potentially responsible party by a
regulatory agency, but in each of those cases, we do not believe we have any
material liability.
Letters
of credit
In the
normal course of business, we have agreements with banks under which
approximately $1.2 billion of letters of credit or bank guarantees were
outstanding as of March 31, 2005, including $294 million which relate to our
joint ventures’ operations. Also included in letters of credit outstanding as of
March 31, 2005 were $276 million of performance letters of credit and $170
million of retainage letters of credit related to the Barracuda-Caratinga
project. Certain of the outstanding letters of credit have triggering events
which would entitle a bank to require cash collateralization.
Other
commitments
As of
March 31, 2005, we had commitments to fund approximately $50 million to certain
of our related companies. These commitments arose primarily during the start-up
of these entities or due to losses incurred by them. We expect approximately $38
million of the commitments to be paid during the next year.
Liquidated
damages
Many of
our engineering and construction contracts have milestone due dates that must be
met or we may be subject to penalties for liquidated damages if claims are
asserted and we were responsible for the delays. These generally relate to
specified activities within a project by a set contractual date or achievement
of a specified level of output or throughput of a plant we construct. Each
contract defines the conditions under which a customer may make a claim for
liquidated damages. However, in most instances, liquidated damages are not
asserted by the customer but the potential to do so is used in negotiating
claims and closing out the contract. We had not accrued liabilities for $48
million at March 31, 2005 and $44 million at December 31, 2004 of liquidated
damages we could incur based upon completing the projects as
forecasted.
Note
14. Accounting for Stock-Based Compensation
We have
six stock-based employee compensation plans. We account for those plans under
the recognition and measurement principles of Accounting Principles Board
Opinion No. 25, “Accounting for Stock Issued to Employees,” and related
interpretations. No cost for stock options granted is reflected in net income,
as all options granted under our plans have an exercise price equal to the
market value of the underlying common stock on the date of grant. In addition,
no cost for the 2002 Employee Stock Purchase Plan (ESPP) is reflected in net
income because it is not considered a compensatory plan.
The fair
value of options at the date of grant and the ESPP shares were estimated using
the Black-Scholes option pricing model. The following table illustrates the
effect on net income (loss) and income (loss) per share if we had applied the
fair value recognition provisions of Financial Accounting Standards Board (FASB)
Statement of Financial Accounting Standards (SFAS) No. 123, “Accounting for
Stock-Based Compensation,” to stock-based employee compensation.
|
|
Three
Months Ended |
|
|
|
March
31 |
|
Millions
of dollars except per share data |
|
2005 |
|
2004 |
|
Net
income (loss), as reported |
|
$ |
365 |
|
$ |
(65 |
) |
Total
stock-based employee compensation expense determined |
|
|
|
|
|
|
|
under
fair value based method for all awards (except restricted |
|
|
|
|
|
|
|
stock),
net of related tax effects |
|
|
(6 |
) |
|
(6 |
) |
Net
income (loss), pro forma |
|
$ |
359 |
|
$ |
(71 |
) |
|
|
|
|
|
|
|
|
Basic
income (loss) per share: |
|
|
|
|
|
|
|
As
reported |
|
$ |
0.73 |
|
$ |
(0.15 |
) |
Pro
forma |
|
$ |
0.72 |
|
$ |
(0.16 |
) |
Diluted
income (loss) per share: |
|
|
|
|
|
|
|
As
reported |
|
$ |
0.72 |
|
$ |
(0.15 |
) |
Pro
forma |
|
$ |
0.70 |
|
$ |
(0.16 |
) |
We also
maintain a restricted stock program wherein the fair market value of the stock
on the date of issuance is being amortized and ratably charged to income over
the average period during which the restrictions lapse. The related expense, net
of tax, reflected in net income as reported was $7 million for the three-month
period ended March 31, 2005 and $2 million for the three-month period ended
March 31, 2004.
In
December 2004, the FASB issued SFAS No. 123R, “Shared-Based Payment.” We will
adopt the provisions of SFAS No. 123R on January 1, 2006 using the modified
prospective application. Accordingly, we will recognize compensation expense for
all newly granted awards and awards modified, repurchased, or cancelled after
January 1, 2006. Compensation cost for the unvested portion of awards that are
outstanding as of January 1, 2006 will be recognized ratably over the remaining
vesting period. The compensation cost for the unvested portion of awards will be
based on the fair value at date of grant as calculated for our pro forma
disclosure under SFAS No. 123. We will recognize compensation expense for our
ESPP beginning with the January 1, 2006 purchase period.
We
estimate that the effect on net income and earnings per share in the periods
following adoption of SFAS No. 123R will be consistent with our pro forma
disclosure under SFAS No. 123, except that estimated forfeitures will be
considered in the calculation of compensation expense under SFAS No. 123R.
Additionally, the actual effect on net income and earnings per share will vary
depending upon the number of options granted in subsequent periods compared to
prior years and the number of shares purchased under the ESPP.
Note
15. Income (Loss) per Share
Basic
income (loss) per share is based on the weighted average number of common shares
outstanding during the period and, effective January 1, 2005, included the 59.5
million shares that were contributed to the trusts established for the benefit
of asbestos claimants. Diluted income (loss) 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 (loss) per share calculation is as
follows:
|
|
Three
Months Ended |
|
|
|
March
31 |
|
Millions
of shares |
|
2005 |
|
2004 |
|
Basic
weighted average common shares outstanding |
|
|
501 |
|
|
436 |
|
Dilutive
effect of: |
|
|
|
|
|
|
|
Stock
options |
|
|
5 |
|
|
2 |
|
Convertible
senior notes premium |
|
|
3 |
|
|
- |
|
Restricted
stock |
|
|
1 |
|
|
1 |
|
Other |
|
|
- |
|
|
1 |
|
Diluted
weighted average common shares outstanding |
|
|
510 |
|
|
440 |
|
In
December 2004, we entered into a supplemental indenture that requires us to
satisfy our conversion obligation for our $1.2 billion 3.125% convertible senior
notes in cash, rather than in common stock, for at least the aggregate principal
amount of the notes. This reduced the resulting potential earnings dilution to
only include the conversion premium, which is the difference between the
conversion price per share of common stock and the average share price. See the
table above for the dilutive effect for the three months ended March 31, 2005.
The conversion price of $37.65 per share of common stock was greater than our
average share price in the first three months ended March 31, 2004 and,
consequently, did not result in dilution.
Excluded
from the computation of diluted income (loss) per share are options to purchase
two million shares of common stock which were outstanding during the three
months ended March 31, 2005 and nine million shares during the three months
ended March 31, 2004. These options were outstanding during these quarters but
were excluded because the option exercise price was greater than the average
market price of the common shares.
Note
16. Income Taxes
Provision
for income taxes from continuing operations of $169 million resulted in an
effective tax rate of 31% in the first quarter of 2005, compared to an effective
tax rate of 37% in the first quarter of 2004. Our annualized tax rate as applied
to the first quarter of 2005 was positively impacted by a reduction in our
valuation allowance against future tax attributes related to our asbestos
liabilities. This reduction occurred due to an increase in our projection of
full-year 2005 United States taxable income, which reduces the number of years
we project foreign tax credits to be displaced.
Note
17. Retirement Plans
The
components of net periodic benefit cost related to pension benefits for the
three months ended March 31, 2005 and March 31, 2004 are as
follows:
|
|
Three
Months Ended |
|
|
|
March
31 |
|
|
|
2005 |
|
2004 |
|
Millions
of dollars |
|
United
States |
|
International |
|
United
States |
|
International |
|
Components
of net periodic |
|
|
|
|
|
|
|
|
|
|
|
|
|
benefit
cost: |
|
|
|
|
|
|
|
|
|
|
|
|
|
Service
cost |
|
$ |
- |
|
$ |
23 |
|
$ |
- |
|
$ |
22 |
|
Interest
cost |
|
|
2 |
|
|
43 |
|
|
2 |
|
|
36 |
|
Expected
return on plan assets |
|
|
(2 |
) |
|
(46 |
) |
|
(3 |
) |
|
(41 |
) |
Settlements/curtailments |
|
|
- |
|
|
5 |
|
|
1 |
|
|
- |
|
Recognized
actuarial loss |
|
|
1 |
|
|
5 |
|
|
1 |
|
|
4 |
|
Net
periodic benefit cost |
|
$ |
1 |
|
$ |
30 |
|
$ |
1 |
|
$ |
21 |
|
We
amended the terms and conditions of one of our foreign defined benefit plans and
ceased future service and benefit accruals for all plan participants. This
action is defined as a curtailment under SFAS No. 88 and during the first
quarter of 2005, we recognized a curtailment loss of approximately $5
million.
We
currently expect to contribute approximately $72 million to our international
pension plans and between $1 million to $5 million to our domestic pension plans
in 2005. As of March 31, 2005, we had contributed $21 million of this
amount.
The
components of net periodic benefit cost related to other postretirement benefits
for the three months ended March 31, 2005 and March 31, 2004 are as
follows:
|
|
Three
Months Ended |
|
|
|
March
31 |
|
Millions
of dollars |
|
2005 |
|
2004 |
|
Components
of net periodic |
|
|
|
|
|
|
|
benefit
cost: |
|
|
|
|
|
|
|
Interest
cost |
|
$ |
3 |
|
$ |
1 |
|
Amortization
of prior service cost |
|
|
- |
|
|
(2 |
) |
Net
periodic benefit cost |
|
$ |
3 |
|
$ |
(1 |
) |
Note
18. New Accounting Pronouncements
In March
2005, the FASB issued FASB Interpretation No. 47, “Accounting for Conditional
Asset Retirement Obligations, an interpretation of FASB Statement No. 143” (FIN
47). This statement clarifies that an entity is required to recognize a
liability for the fair value of a conditional asset retirement obligation when
incurred, if the liability’s fair value can be reasonably estimated. The
provisions of FIN 47 are effective no later than December 31, 2005. We are
currently evaluating what impact, if any, this statement will have on our
financial statements.
Item 2. Management’s Discussion and Analysis of
Financial Condition and Results of Operations
EXECUTIVE
OVERVIEW
During
the first quarter of 2005, we had the following developments:
|
- |
upon
finalization of our asbestos and silica settlements and our subsidiaries’
related emergence from Chapter 11 proceedings, we funded the asbestos and
silica trusts in January 2005 with $2.3 billion in cash, promissory notes,
and 59.5 million shares of our common stock. We received approximately
$1.023 billion in cash during the first quarter of 2005 under the terms of
our insurance settlement agreements; |
|
- |
our
Energy Services Group (ESG) had continued strong performance. ESG had
record levels of revenue, operating income, and operating margins,
benefiting from strong oilfield activity around the world, the price
increases we implemented during 2004, the return of activity in the
deepwater Gulf of Mexico, and increased activity for pressure pumping
through our production enhancement and cementing
services; |
|
- |
KBR
delivered operating income of $105 million, which reflected savings from
our restructuring plan, settlement of our dining facility (DFAC) issues,
and the definitization of a number of outstanding task orders related to
the LogCAP contract; and |
|
- |
our
Barracuda-Caratinga project is still on track and is approximately 97%
complete at March 31, 2005. |
In the
first quarter of 2005, we continued to provide substantial work under our
government contracts business to the United States Department of Defense and
other governmental agencies. Total revenue from the United States Government
during the first quarter of 2005 includes $1.7 billion or 34% of consolidated
revenue, and revenue related to Iraq (which includes Kuwait) totaled
approximately $1.5 billion or 30% of consolidated revenue.
Looking
ahead, the outlook for our business is positive. Current market conditions for
our energy services business are good with strong commodity prices, and our
customers are increasing their exploration and production budgets. We believe
oil prices will continue to fluctuate, but the fundamentals that support demand
for our products or services will not change in the next several quarters. In
addition to the benefits expected from our recent restructuring initiative at
KBR, we will continue to pursue our natural gas monetization
strategy.
Detailed
discussions of our United States government contract work, the Nigerian joint
venture and investigations, and our liquidity and capital resources follow. Our
operating performance is described in “Business Environment and Results of
Operations” below.
United
States Government Contract Work
We
provide substantial work under our government contracts business to the United
States Department of Defense and other governmental agencies, including
worldwide United States Army logistics contracts, known as LogCAP, and contracts
to rebuild Iraq’s petroleum industry, known as RIO and PCO Oil South. Our
government services revenue related to Iraq totaled approximately $1.5 billion
in the first quarter of 2005 compared to $2.4 billion in the first quarter of
2004.
Given the
demands of working in Iraq and elsewhere for the United States government, we
expect that from time to time we will have disagreements or experience
performance issues with the various government customers for which we work. If
performance issues arise under any of our government contracts, the government
retains the right to pursue remedies under any affected contract, which remedies
could include threatened termination or termination. If any contract were so
terminated, we may not receive award fees under the affected contract, and our
ability to secure future contracts could be adversely affected, although we
would receive payment for amounts owed for our allowable costs under
cost-reimbursable contracts.
DCAA
audit issues
Our
operations under United States government contracts are regularly reviewed and
audited by the Defense Contract Audit Agency (DCAA) and other governmental
agencies. The DCAA serves in an advisory role to our customer. When issues are
found during the governmental agency audit process, these issues are typically
discussed and reviewed with us. The DCAA then issues an audit report with its
recommendations to our customer’s contracting officer. In the case of management
systems and other contract administrative issues, the contracting officer is
generally with the Defense Contract Management Agency (DCMA). We then work with
our customer to resolve the issues noted in the audit report.
Dining
facilities (DFAC). During
2003, the DCAA raised issues relating to our invoicing to the Army Materiel
Command (AMC) for food services for soldiers and supporting civilian personnel
in Iraq and Kuwait. During 2004, we received notice from the DCAA that it was
recommending withholding 19.35% of our DFAC billings relating to subcontracts
entered into prior to February 2004 until it completed its audits. Approximately
$213 million had been withheld as of March 31, 2005. Subsequent to February
2004, we renegotiated our DFAC subcontracts to address the specific issues
raised by the DCAA and advised the AMC and the DCAA of the new terms of the
arrangements. We have had no objection by the government to the terms and
conditions associated with these new DFAC subcontract agreements. On March 31,
2005, we reached an agreement with the AMC regarding the cost associated with
the DFAC subcontractors, which totaled approximately $1.2 billion. Under the
terms of the agreement, the AMC agreed to the DFAC subcontractor costs except
for $55 million, which it will retain from the $213 million previously withheld
amount. We will attempt to pass this $55 million price reduction to the
subcontractors. We are currently withholding funds from the subcontractors in
excess of this amount. These excess amounts will be paid to the subcontractors
upon release of the withholds from the government. As a result of this
agreement, we recorded $10 million in additional operating income during the
first quarter of 2005.
Fuel. In
December 2003, the DCAA issued a preliminary audit report that alleged that we
may have overcharged the Department of Defense by $61 million in importing fuel
into Iraq. The DCAA questioned costs associated with fuel purchases made in
Kuwait that were more expensive than buying and transporting fuel from Turkey.
We responded that we had maintained close coordination of the fuel mission with
the Army Corps of Engineers (COE), which was our customer and oversaw the
project, throughout the life of the task order, and that the COE had directed us
to use the Kuwait sources. After a review, the COE concluded that we obtained a
fair price for the fuel. However, Department of Defense officials thereafter
referred the matter to the agency’s inspector general, which we understand has
commenced an investigation.
The DCAA
has issued various audit reports related to task orders under the RIO contract
that currently report $276 million in questioned and unsupported costs (down
from $304 million originally reported because some issues have been resolved).
To date, the DCAA has not recommended that any portion of the questioned and
unsupported costs be withheld from payments to us. The majority of these costs
are associated with the humanitarian fuel mission. In these reports, the DCAA
has compared fuel costs we incurred during the duration of the RIO contract in
2003 and early 2004 to fuel prices obtained by the Defense Energy Supply Center
(DESC) in April 2004 when the fuel mission was transferred to that agency. We
are working with our customer to resolve this issue.
Laundry. During
the third quarter of 2004, we received notice from the DCAA that it recommended
withholding $16 million of subcontract costs related to the laundry service for
one task order in southern Iraq for which it believes we and our subcontractors
have not provided adequate levels of documentation supporting the quantity of
the services provided. In the first quarter of 2005, the DCAA issued a second
notice to withhold approximately $2 million. The DCAA recommended that the costs
be withheld pending receipt of additional explanation or documentation to
support the subcontract costs. The $18 million has been withheld from the
subcontractor. We are working with the AMC and the subcontractor to resolve this
issue.
Other
issues. The DCAA
is continuously performing audits of costs incurred for other services provided
by us under our government contracts. During these audits, there are likely to
be questions raised by the DCAA about the reasonableness or allowability of
certain costs or the quality or quantity of supporting documentation. No
assurance can be given that the DCAA might not recommend withholding some
portion of the questioned costs while the issues are being resolved with our
customer. We do not believe any potential withholding will have a significant or
sustained impact on our liquidity.
Investigations
On
January 22, 2004, we announced the identification by our internal audit function
of a potential overbilling of approximately $6 million by La Nouvelle Trading
& Contracting Company, W.L.L. (La Nouvelle), one of our subcontractors,
under the LogCAP contract in Iraq, for services performed during 2003. In
accordance with our policy and government regulation, the potential overcharge
was reported to the Department of Defense Inspector General’s office as well as
to our customer, the AMC. On January 23, 2004, we issued a check in the amount
of $6 million to the AMC to cover that potential overbilling while we conducted
our own investigation into the matter. Later in the first quarter of 2004, we
determined that the amount of overbilling was $4 million, and the subcontractor
billing should have been $2 million for the services provided. As a result, we
paid La Nouvelle $2 million and billed our customer that amount. We subsequently
terminated La Nouvelle’s services under the LogCAP contract. In October 2004, La
Nouvelle filed suit against us alleging $224 million in damages as a result of
its termination. We are continuing to investigate whether La Nouvelle paid, or
attempted to pay, one or two of our former employees in connection with the
billing. See Note 13 to our consolidated financial statements for further
discussion.
In
October 2004, we reported to the Department of Defense Inspector General’s
office that two former employees in Kuwait may have had inappropriate contacts
with individuals employed by or affiliated with two third-party subcontractors
prior to the award of the subcontracts. The Inspector General’s office may
investigate whether these two employees may have solicited and/or accepted
payments from these third-party subcontractors while they were employed by
us.
In
October 2004, a civilian contracting official in the COE asked for a review of
the process used by the COE for awarding some of the contracts to us. We
understand that the Department of Defense Inspector General’s office may review
the issues involved.
We
understand that the United States Department of Justice, an Assistant United
States Attorney based in Illinois, and others are investigating these and other
individually immaterial matters we have reported relating to our government
contract work in Iraq. If criminal wrongdoing were found, criminal penalties
could range up to the greater of $500,000 in fines per count for a corporation,
or twice the gross pecuniary gain or loss. We also understand that current and
former employees of KBR have received subpoenas and have given or may give grand
jury testimony relating to some of these matters.
In the
first quarter of 2005, the Department of Justice issued two indictments
associated with these issues against a former KBR procurement manager and a
manager at our subcontractor, La Nouvelle.
Withholding
of payments
During
2004, the AMC issued a determination that a particular contract clause could
cause it to withhold 15% from our invoices until our task orders under the
LogCAP contract are definitized. The AMC delayed implementation of this
withholding pending further review. During the third quarter of 2004, we and the
AMC identified three senior management teams to facilitate negotiation under the
LogCAP task orders, and these teams concluded their effort by successfully
negotiating the final outstanding task order definitization on March 31, 2005.
This makes us current with regard to definitization of historical LogCAP task
orders and eliminates the potential 15% withholding issue under the LogCAP
contract. In addition, we recorded $12 million in additional income in the first
quarter of 2005 resulting from the recognition of incremental award fees related
to the definitized task orders.
As of
March 31, 2005, the COE had withheld $95 million of our invoices related to a
portion of our RIO contract pending completion of the definitization process.
All 10 definitization proposals required under this contract have been submitted
by us, and three have been finalized through a task order modification. After
review by the DCAA, we have resubmitted five of the unfinalized seven proposals
and are in the process of developing revised proposals for the remaining two.
These withholdings represent the amount invoiced in excess of 85% of the funding
in the task order. The COE also could withhold similar amounts from future
invoices under our RIO contract until agreement is reached with the customer and
task order modifications are issued. Approximately $2 million was withheld from
our PCO Oil South project as of March 31, 2005. The PCO Oil South project has
definitized substantially all of the task orders, and withholdings are not
continuing on those task orders. We do not believe the withholding will have a
significant or sustained impact on our liquidity because the withholding is
temporary and ends once the definitization process is complete.
We are
working diligently with our customers to proceed with significant new work only
after we have a fully definitized task order, which should limit withholdings on
future task orders for all government contracts.
In
addition, we had unapproved claims totaling $102 million at March 31, 2005 for
the LogCAP, RIO, and PCO Oil South contracts. These unapproved claims related to
contracts where our costs have exceeded the funded value of the task order or
were related to lost, damaged, and destroyed equipment.
Cost
reporting
We
received notice that a contracting officer for our PCO Oil South project
considers our monthly categorization and detail of costs and our ability to
schedule and forecast costs to be inadequate, and he requested corrections be
made. We provided our cost report and believe that we made the requested
corrections. If we are unable to satisfy our customer, our customer may pursue
remedies under the applicable federal acquisition regulations, including
terminating the affected contract. Although there can be no assurances, we do
not expect that our work on the PCO Oil South project will be terminated for
default. We are continuing to work with our customer to develop a mutually
acceptable management cost reporting system and are supplementing the existing
PCO Oil South cost reporting team with additional manpower. The PCO Oil South
contract has been challenging in part due to violent attacks by insurgents on
infrastructure in the southern part of Iraq. Currently, the volume of work
performed on PCO Oil South is lower than we had projected initially, and we
believe the risk/reward profile is unattractive.
DCMA
system reviews
Report
on estimating system. On
December 27, 2004, the DCMA granted continued approval of our estimating system,
stating that our estimating system is “acceptable with corrective action.” We
are in process of completing these corrective actions. Specifically, based on
the unprecedented level of support our employees are providing the military in
Iraq, Kuwait, and Afghanistan, we needed to update our estimating policies and
procedures to make them better suited to such contingency situations.
Additionally, we have completed our development of a detailed training program
and have made it available to all estimating personnel to ensure that employees
are adequately prepared to deal with the challenges and unique circumstances
associated with a contingency operation.
Report
on purchasing system. As a
result of a Contractor Purchasing System Review by the DCMA during the second
quarter of 2004, the DCMA granted the continued approval of our government
contract purchasing system. The DCMA’s approval letter, dated September 7, 2004,
stated that our purchasing system’s policies and practices are “effective and
efficient, and provide adequate protection of the Government’s
interest.”
Report
on accounting system. We have
received an initial draft report on our accounting system and have responded to
the points raised by the DCAA. Once the DCAA finalizes the report it will be
submitted to the DCMA, who will make a determination of the adequacy of our
accounting systems for government contracting.
The
Balkans
We have
had inquiries in the past by the DCAA and the civil fraud division of the United
States Department of Justice into possible overcharges for work performed during
1996 through 2000 under a contract in the Balkans, which inquiry has not yet
been completed by the Department of Justice. Based on an internal investigation,
we credited our customer approximately $2 million during 2000 and 2001 related
to our work in the Balkans as a result of billings for which support was not
readily available. We believe that the preliminary Department of Justice inquiry
relates to potential overcharges in connection with a part of the Balkans
contract under which approximately $100 million in work was done. We believe
that any allegations of overcharges would be without merit.
Nigerian
Joint Venture and Investigations
Foreign
Corrupt Practices Act investigation. The
Securities and Exchange Commission (SEC) is conducting a formal investigation
into payments made in connection with the construction and subsequent expansion
by TSKJ of a multibillion dollar natural gas liquefaction complex and related
facilities at Bonny Island in Rivers State, Nigeria. The United States
Department of Justice is also conducting an investigation. TSKJ is a private
limited liability company registered in Madeira, Portugal whose members are
Technip SA of France, Snamprogetti Netherlands B.V., which is an affiliate of
ENI SpA of Italy, JGC Corporation of Japan, and Kellogg Brown & Root, each
of which owns 25% of the venture.
The SEC
and the Department of Justice have been reviewing these matters in light of the
requirements of the United States Foreign Corrupt Practices Act (FCPA). We have
produced documents to the SEC both voluntarily and pursuant to subpoenas, and we
are making our employees available to the SEC for testimony. In addition, we
understand that the SEC has issued a subpoena to A. Jack Stanley, who most
recently served as a consultant and chairman of Kellogg Brown & Root, and to
other current and former Kellogg Brown & Root employees. We further
understand that the Department of Justice has invoked its authority under a
sitting grand jury to obtain letters rogatory for the purpose of obtaining
information abroad.
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., which is an affiliate of
ENI SpA of Italy. Commencing in 1995, TSKJ entered into a series of agency
agreements in connection with the Nigerian project. We understand that a French
magistrate has officially placed Jeffrey Tesler, a principal of Tri-Star
Investments, an agent of TSKJ, 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
and expressed our willingness to cooperate with those investigations. In October
2004, representatives of TSKJ voluntarily testified before the Nigerian
legislative committee.
As a
result of our continuing investigation into these matters, information has been
uncovered suggesting that, commencing at least 10 years ago, the members of TSKJ
considered payments to Nigerian officials. We provided this information to the
United States Department of Justice, the SEC, the French magistrate, and the
Nigerian Economics and Financial Crimes Commission. We also notified the other
owners of TSKJ of the recently uncovered information and asked each of them to
conduct their own investigation.
We
understand from the ongoing governmental and other investigations that payments
may have been made to Nigerian officials. In addition, TSKJ has suspended the
receipt of services from and payments to Tri-Star Investments and is considering
instituting legal proceedings to declare all agency agreements with Tri-Star
Investments terminated and to recover all amounts previously paid under those
agreements.
We also
understand that the matters under investigation by the Department of Justice
involve parties other than Kellogg Brown & Root and M. W. Kellogg, Ltd. (a
joint venture in which Kellogg Brown & Root has a 55% interest), cover an
extended period of time (in some cases significantly before our 1998 acquisition
of Dresser Industries (which included M. W. Kellogg, Ltd.)), and possibly
include the construction of a fertilizer plant in Nigeria in the early 1990s and
the activities of agents and service providers.
In June
2004, we terminated all relationships with Mr. Stanley and another consultant
and former employee of M. W. Kellogg, Ltd. The termination occurred because of
violations of our Code of Business Conduct that allegedly involve the receipt of
improper personal benefits in connection with TSKJ’s construction of the natural
gas liquefaction facility in Nigeria.
In
February 2005, TSKJ notified the Attorney General of Nigeria that TSKJ would not
oppose the Attorney General’s efforts to have sums of money held on deposit in
banks in Switzerland transferred to Nigeria and to have the legal ownership of
such sums determined in the Nigerian courts.
If
violations of the FCPA were found, we could be subject to civil penalties of
$500,000 per violation, and criminal penalties could range up to the greater of
$2 million per violation or twice the gross pecuniary gain or loss.
There can
be no assurance that any governmental investigation or our investigation of
these matters will not conclude that violations of applicable laws have occurred
or that the results of these investigations will not have a material adverse
effect on our business and results of operations.
As of
March 31, 2005, we have not accrued any amounts related to this
investigation.
Bidding
practices investigation. In
connection with the investigation into payments made in connection with the
Nigerian project, 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, which was significantly before our
1998 acquisition of Dresser Industries.
On the
basis of this information, we and the Department of Justice have broadened our
investigations to determine the nature and extent of any improper bidding
practices, whether such conduct violated United States antitrust laws, and
whether former employees may have received payments in connection with bidding
practices on some foreign projects.
If
violations of applicable United States antitrust laws occurred, the range of
possible penalties includes criminal fines, which could range up to the greater
of $10 million in fines per count for a corporation, or twice the gross
pecuniary gain or loss, and treble civil damages in favor of any persons
financially injured by such violations. If such violations occurred, the United
States government also would have the discretion to deny future government
contracts business to KBR or affiliates or subsidiaries of KBR. Criminal
prosecutions under applicable laws of relevant foreign jurisdictions and civil
claims by or relationship issues with customers are also possible.
There can
be no assurance that the results of these investigations will not have a
material adverse effect on our business and results of operations.
As of
March 31, 2005, we had not accrued any amounts related to this
investigation.
LIQUIDITY
AND CAPITAL RESOURCES
We ended
the first quarter of 2005 with cash and equivalents of $1.8 billion compared to
$1.9 billion at December 31, 2004.
Significant
sources of cash
During
2004, we settled insurance disputes with substantially all the insurance
companies for asbestos- and silica-related claims and all other claims under the
applicable insurance policies and terminated all the applicable insurance
policies. We received approximately $1.023 billion in insurance proceeds in the
first quarter of 2005 and expect to receive additional amounts as
follows:
Millions
of dollars |
|
|
|
April
1 through December 31, 2005 |
|
$ |
15 |
|
2006 |
|
|
184 |
|
2007 |
|
|
41 |
|
2008 |
|
|
46 |
|
2009 |
|
|
132 |
|
Thereafter |
|
|
16 |
|
Total |
|
$ |
434 |
|
During
the first quarter of 2005, we sold $891 million in investments in marketable
securities.
Our cash
flow was supplemented by cash totaling $203 million from the sale of our 50%
interest in Subsea 7, Inc. in January 2005.
Further
sources of cash. In the
first quarter of 2005, we entered into an unsecured $1.2 billion five-year
revolving credit facility for general working capital purposes. The new credit
facility replaced our secured $700 million three-year revolving credit facility
and our secured $500 million 364-day revolving credit facility. The letter of
credit issued under the previous secured $700 million three-year revolving
credit facility is now under our unsecured $1.2 billion revolving facility and
has a balance of $166 million as of March 31, 2005. The letter of credit reduces
the availability under the revolving credit facility to approximately $1.0
billion. There were no cash drawings under the unsecured $1.2 billion revolving
credit facility as of March 31, 2005.
Significant
uses of cash
We used
approximately $2.4 billion in the first quarter of 2005 to fund the asbestos and
silica liability trusts in January 2005.
In
January 2005, we made the following payments for our asbestos and silica
liability settlement:
Millions
of dollars |
|
|
|
Payment
to the asbestos and silica trust in accordance |
|
|
|
|
with
the plan of reorganization |
|
$ |
2,345 |
|
Payment
related to insurance partitioning |
|
|
|
|
agreement
reached with Federal-Mogul in |
|
|
|
|
October
2004 - first of three installments |
|
|
16 |
|
Cash
settlement payment to the silica trust |
|
|
15 |
|
Payments
related to RHI Refractories agreement |
|
|
11 |
|
First
of four installments for the one-year non-interest- |
|
|
|
|
bearing
note of $31 million for the benefit of |
|
|
|
|
asbestos
claimants |
|
|
8 |
|
Total |
|
$ |
2,395 |
|
Our
working capital requirements for our Iraq-related work, excluding cash and
equivalents, were down from $700 million at December 31, 2004 to approximately
$600 million at March 31, 2005.
On April
26, 2005, we redeemed, at par plus accrued interest, all $500 million of these
senior notes outstanding.
Capital
expenditures of $142 million in the first quarter of 2005 were 9% higher than in
the first quarter of 2004. Capital spending in 2005 continued to be primarily
directed to the Energy Services Group for the Production Optimization, Drilling
and Formation Evaluation, and Fluid Systems segments. We paid $63 million in
dividends to our shareholders in the first quarter of 2005 and $55 million in
the first quarter of 2004. Dividends increased as a result of the issuance of
the 59.5 million shares of our common stock contributed to the asbestos trust in
January 2005.
Future
uses of cash. Capital
spending for 2005 is expected to be approximately $650 million. The capital
expenditures budget for 2005 includes increased software spending as KBR moves
forward with the implementation of SAP and higher spending in the Energy
Services Group to accommodate increased business.
As of
March 31, 2005, we had commitments to fund approximately $50 million to certain
of our related companies. These commitments arose primarily during the start-up
of these entities or due to losses incurred by them. We expect approximately $38
million of the commitments to be paid during the remainder of 2005.
We
continue to fund operating cash shortfalls on the Barracuda-Caratinga project, a
multiyear construction project to develop the Barracuda and Caratinga crude
oilfields off the coast of Brazil, and are obligated to fund total shortages
over the remaining project life. Estimated cash flows relating to the losses are
as follows:
Millions
of dollars |
|
|
|
Amount
funded through March 31, 2005 (including |
|
|
|
|
repayment
of $300 million of advance payments) |
|
$ |
734 |
|
Amounts
to be paid (received) in the remainder of 2005: |
|
|
|
|
Change
orders |
|
|
(37 |
) |
Remaining
project costs, net of revenue to be received |
|
|
65 |
|
Total
cash shortfalls |
|
$ |
762 |
|
Of the
$734 million funded through March 2005, as reflected in the table above, $148
million was funded in the first quarter of 2005.
Other
factors affecting liquidity
Accounts
receivable securitization facilities. In May
2004, we entered into an agreement to sell, assign, and transfer the entire
title and interest in specified United States government accounts receivable of
KBR to a third party. The total amount outstanding under this agreement as of
March 31, 2005 was approximately $242 million. Subsequent to March 31, 2005, the
receivables were collected, and we have not sold any additional receivables. See
“Off Balance Sheet Risk” below for further discussion regarding this
facility.
Letters
of credit. In the
normal course of business, we have agreements with banks under which
approximately $1.2 billion of letters of credit or bank guarantees were
outstanding as of March 31, 2005, including $294 million that relate to our
joint ventures’ operations. Also included in the letters of credit outstanding
as of March 31, 2005 and related to the Barracuda-Caratinga project were $276
million of performance letters of credit and $170 million of retainage letters
of credit. Certain of the outstanding letters of credit have triggering events
which would entitle a bank to require cash collateralization.
Credit
ratings. Investment
grade ratings are BBB- or higher for Standard & Poor’s and Baa3 or higher
for Moody’s Investors Service. Our current ratings are one level above BBB- on
Standard & Poor’s and one level above Baa3 on Moody’s Investors Service. In
the first quarter of 2005, Standard & Poor’s revised its credit watch
listing for us from “developing” to “stable” and its short-term paper and
commercial rating from A-3 to A-2, and Moody’s Investors Service revised its
outlook from “stable” to “positive.” Both companies revised their ratings in
response to our announcement that, effective December 31, 2004, we have resolved
all open and future asbestos and silica claims.
Debt
covenants. Letters
of credit related to our Barracuda-Caratinga project and our $1.2 billion
revolving credit facility contain restrictive covenants, including covenants
that require us to maintain certain financial ratios as defined by the
agreements. For the letters of credit related to our Barracuda-Caratinga
project, we are required to maintain an interest coverage ratio of at least 3.5
and a leverage ratio of not greater than 55%. We are also required to maintain a
debt-to-capitalization ratio of not greater than 60% for the $1.2 billion
revolving credit facility. At March 31, 2005, our interest coverage ratio was
9.3, our leverage ratio was 40%, and our debt-to-capitalization ratio was 48%.
Due to the redemption of the $500 million senior notes in April 2005, we
estimate that our debt-to-capitalization ratio will decline to
45%.
BUSINESS
ENVIRONMENT AND RESULTS OF OPERATIONS
We
currently operate in over 100 countries throughout the world, providing a
comprehensive range of discrete and integrated products and services to the
energy industry and to other industrial and governmental customers. The majority
of our consolidated revenue is derived from the sale of services and products,
including engineering and construction activities. We sell services and products
primarily to major, national, and independent oil and gas companies and the
United States government. The products and services provided to major, national,
and independent oil and gas companies are used throughout the energy industry
from the earliest phases of exploration, development, and production of oil and
gas resources through refining, processing, and marketing. Our six business
segments are organized around how we manage the business: Production
Optimization, Fluid Systems, Drilling and Formation Evaluation, Digital and
Consulting Solutions, Government and Infrastructure, and Energy and Chemicals.
We refer to the combination of Production Optimization, Fluid Systems, Drilling
and Formation Evaluation, and Digital and Consulting Solutions segments as the
Energy Services Group, and the combination of Government and Infrastructure and
Energy and Chemicals as KBR.
The
industries we serve are highly competitive with many substantial competitors for
each segment. In the first quarter of 2005, based upon the location of the
services provided and products sold, 30% of our consolidated revenue was from
Iraq, primarily related to our work for the United States Government, and 25% of
our consolidated revenue was from the United States. In the first quarter of
2004, 39% of our consolidated revenue was from Iraq, and 17% of our consolidated
revenue was from the United States. No other country accounted for more than 10%
of our revenue during these periods.
Operations
in some countries may be adversely affected by unsettled political conditions,
acts of terrorism, civil unrest, force majeure, war or other armed conflict,
expropriation or other governmental actions, inflation, exchange controls, or
currency devaluation. Except for our government services work in Iraq discussed
above, we believe the geographic diversification of our business activities
reduces the risk that loss of operations in any one country would be material to
our consolidated results of operations.
Halliburton
Company
Activity
levels within our business segments are significantly impacted by the
following:
|
- |
spending
on upstream exploration, development, and production programs by major,
national, and independent oil and gas
companies; |
|
- |
capital
expenditures for downstream refining, processing, petrochemical, and
marketing facilities by major, national, and independent oil and gas
companies; and |
|
- |
government
spending levels. |
Also
impacting our activity is the status of the global economy, which indirectly
impacts oil and gas consumption, demand for petrochemical products, and
investment in infrastructure projects.
Energy
Services Group
Some of
the more significant barometers of current and future spending levels of oil and
gas companies are oil and gas prices, exploration and production activities by
international and national oil companies, the world economy, and global
stability, which together drive worldwide drilling activity. Also, our margins
associated with services and products for offshore rigs are generally higher
than those associated with land rigs. Our Energy Services Group financial
performance is significantly affected by oil and gas prices and worldwide rig
activity which are summarized in the following tables.
This
table shows the average oil and gas prices for West Texas Intermediate crude oil
and Henry Hub natural gas prices:
|
|
Three
Months Ended |
|
Year
Ended |
|
|
|
March
31 |
|
December
31 |
|
Average
Oil and Gas Prices |
|
2005 |
|
2004 |
|
2004 |
|
West
Texas Intermediate (WTI) |
|
|
|
|
|
|
|
|
|
|
oil
prices (dollars per barrel) |
|
$ |
49.58 |
|
$ |
35.22 |
|
$ |
41.31 |
|
Henry
Hub gas prices (dollars per |
|
|
|
|
|
|
|
|
|
|
million
cubic feet) |
|
$ |
6.40 |
|
$ |
5.61 |
|
$ |
5.85 |
|
The
quarterly and yearly average rig counts based on the Baker Hughes Incorporated
rig count information are as follows:
|
|
Three
Months Ended |
|
Year
Ended |
|
|
|
March
31 |
|
December
31 |
|
Average
Rig Counts |
|
2005 |
|
2004 |
|
2004 |
|
Land
vs. Offshore |
|
|
|
|
|
|
|
United
States: |
|
|
|
|
|
|
|
|
|
|
Land |
|
|
1,178 |
|
|
1,021 |
|
|
1,093 |
|
Offshore |
|
|
101 |
|
|
98 |
|
|
97 |
|
Total |
|
|
1,279 |
|
|
1,119 |
|
|
1,190 |
|
Canada: |
|
|
|
|
|
|
|
|
|
|
Land |
|
|
518 |
|
|
524 |
|
|
365 |
|
Offshore |
|
|
3 |
|
|
4 |
|
|
4 |
|
Total |
|
|
521 |
|
|
528 |
|
|
369 |
|
International
(excluding Canada): |
|
|
|
|
|
|
|
|
|
|
Land |
|
|
629 |
|
|
562 |
|
|
594 |
|
Offshore |
|
|
247 |
|
|
235 |
|
|
242 |
|
Total |
|
|
876 |
|
|
797 |
|
|
836 |
|
Worldwide
total |
|
|
2,676 |
|
|
2,444 |
|
|
2,395 |
|
Land
total |
|
|
2,325 |
|
|
2,107 |
|
|
2,052 |
|
Offshore
total |
|
|
351 |
|
|
337 |
|
|
343 |
|
|
|
Three
Months Ended |
|
Year
Ended |
|
|
|
March
31 |
|
December
31 |
|
Average
Rig Counts |
|
2005 |
|
2004 |
|
2004 |
|
Oil
vs. Gas |
|
|
|
|
|
|
|
|
|
|
United
States: |
|
|
|
|
|
|
|
|
|
|
Oil |
|
|
185 |
|
|
153 |
|
|
165 |
|
Gas |
|
|
1,094 |
|
|
966 |
|
|
1,025 |
|
Total |
|
|
1,279 |
|
|
1,119 |
|
|
1,190 |
|
Canada:
* |
|
|
521 |
|
|
528 |
|
|
369 |
|
International
(excluding Canada): |
|
|
|
|
|
|
|
|
|
|
Oil |
|
|
668 |
|
|
598 |
|
|
648 |
|
Gas |
|
|
208 |
|
|
199 |
|
|
188 |
|
Total |
|
|
876 |
|
|
797 |
|
|
836 |
|
Worldwide
total |
|
|
2,676 |
|
|
2,444 |
|
|
2,395 |
|
*
Canadian rig counts by oil and gas were not available.
Our
customers’ cash flows, in many instances, depend upon the revenue they generate
from the sale of oil and gas. With higher prices, they may have more cash flow,
which usually translates into higher exploration and production budgets. Higher
prices may also mean that oil and gas exploration in marginal areas can become
attractive, so our customers may consider investing in such properties when
prices are high. When this occurs, it means more potential work for us. The
opposite is true for lower oil and gas prices.
Oil
prices continued to trend upward in the first quarter of 2005 and the Energy
Information Administration expects prices to remain above $50 per barrel for the
rest of 2005 and 2006. Increases in crude oil prices are due to a combination of
the following factors:
|
- |
growth
in worldwide petroleum demand remains robust, despite high oil
prices; |
|
- |
projected
growth in the non-Organization of Petroleum Exporting Countries (non-OPEC)
supplies is not expected to accommodate worldwide demand
growth; |
|
- |
worldwide
spare crude oil production capacity has recently diminished and is
projected to remain low; and |
|
- |
geopolitical
risks are continuing, such as the insurgency in Iraq and political unrest
in Nigeria and Venezuela. |
In March
2005, OPEC announced it would increase its production quota by 500,000 barrels
per day and was prepared to approve an additional 500,000 barrels per day quota
increase should oil prices remain at current levels.
Natural
gas prices for the first quarter of 2005 continued to move higher compared to
last quarter and a year ago. The upward trend in natural gas prices is expected
to continue, in spite of adequate natural gas storage, due to a continued strong
economy and the expectation that Pacific northwest hydroelectric resources will
be below normal through mid-summer.
Heightened
demand coupled with high petroleum and natural gas prices in the first quarter
of 2005 contributed to a 10% increase in average worldwide rig count compared to
the first quarter of 2004. This increase was primarily driven by the United
States rig count, which grew 14% year-over-year. Land gas drilling in the United
States rose sharply, as gas prices remained high due to economic demand growth
and higher fuel oil prices that discouraged switching to a lower-priced fuel
source to minimize cost. Average Canadian rig counts remained relatively flat
year-over-year. Outside of North America, average rig counts increased in Latin
America, Asia Pacific, and the Middle East, with nearly the entire increase
related to oil production. In Europe, where average rig counts declined compared
to the first quarter of 2004, oil company dissatisfaction with high operating
costs and inconsistent government policies impeded exploration and production
recovery. Spears and Associates predicted that operators as a group will
increase their activity in terms of rigs, wells, and footage in the range of 4%
to 6% in most regions in 2005. Spears and Associates forecasted a 4% increase in
United States rigs, with a 5% rise offshore. Thus, the three-year downturn in
the United States offshore rig count is expected to end in 2005. Spears and
Associates is projecting a 5% increase in international rig count in
2005.
It is
common practice in the United States oilfield services industry to sell services
and products based on a price book and then apply discounts to the price book
based upon a variety of factors. The discounts applied typically increase to
partially or substantially offset price book increases in the weeks immediately
following a price increase. The discount applied normally decreases over time if
the activity levels remain strong. During periods of reduced activity, discounts
normally increase, reducing the net revenue for our services and conversely,
during periods of higher activity, discounts normally decline resulting in net
revenue increasing for our services.
In the
second and third quarters of 2004, we implemented several United States price
book increases, primarily in pressure pumping services. We worked diligently to
minimize the impact of inflationary pressures in our cost base in 2004 and are
maintaining a steady focus on capital discipline. During the first quarter of
2005, we realized some of the benefits of these price book increases and expect
to realize the remaining benefits during the remainder of 2005. Effective April
15, 2005, we implemented additional price increases ranging from 11% to 15%.
Some of the increase will be used to offset higher labor and supply costs we are
currently experiencing.
Overall
outlook. The
outlook for world oil demand continues to remain strong, with increasing demand
from China and India being significant factors. Excess oil production capacity
will remain low and that, along with strong demand, will keep supplies tight.
Thus, any unexpected supply disruption or change in demand could lead to
fluctuating prices. The Energy Information Administration forecasts world
petroleum demand growth for 2005-2006 to remain strong, but down from the rate
of demand growth seen in 2004.
We are
well-positioned in the strong United States pressure pumping market, where we
have a leading share of the United States onshore gas market. We are also
well-positioned in the offshore segments that could experience a rebound over
the next several quarters, particularly the deepwater Gulf of
Mexico.
Finally,
technology is an important aspect of our business, and we continue to focus on
improving the development and introduction of new technologies. In 2005, we
expect to continue to invest in technology at a similar level as
2004.
KBR
KBR
provides a wide range of services to energy and industrial customers and
government entities worldwide. KBR projects are generally longer-term in nature
than our Energy Services Group work and are impacted by more diverse drivers
than short-term fluctuations in oil and gas prices and drilling
activities.
Effective
October 1, 2004, we restructured KBR into two segments, Government and
Infrastructure and Energy and Chemicals. As a result of the reorganization and
in a continued effort to better position KBR for the future, we made several
strategic organizational changes. We eliminated certain internal expenditures;
we refocused our research and development expenditures with emphasis on the more
profitable liquefied natural gas (LNG) market; and we took appropriate steps to
streamline the entire organization. KBR’s first quarter 2005 results reflect
significant progress related to the restructuring, and we continue to believe
the restructuring of KBR will yield approximately $100 million in annual
savings.
In our
Government and Infrastructure segment, our government services work is
forecasted to grow in all regions, with United States government spending
outpacing other markets. Our work in Iraq continues to be our largest revenue
contributor within this segment. In April 2005, KBR successfully resolved two
issues under our LogCAP contract. See Note 12 to the condensed consolidated
financial statements for further discussion. Going forward, we expect activity
in Iraq to decline, but not as much as we had previously
anticipated.
Within
our Energy and Chemicals segment, the major focus is on our gas monetization
work. Forecasted LNG market growth remains strong in a range of 7% to 10% annual
growth through 2010, with demand indicated to double in the period through 2015.
Significant numbers of new LNG liquefaction plant and LNG receiving terminal
projects are proposed worldwide and are in various stages of development.
Committed LNG liquefaction engineering, procurement, and construction (EPC)
projects are now yielding substantial growth in worldwide LNG liquefaction
capacity. This trend is expected to continue through 2007 and beyond. During the
first quarter of 2005, KBR and its joint venture partners were awarded a gas
monetization contract valued at $1.8 billion for the engineering, procurement,
construction, and commissioning (EPCC) of the grassroots Tangguh LNG facility.
In April 2005, KBR and a joint venture partner were also awarded an EPC contract
valued at $1.7 billion for a gas-to-liquids (GTL) facility in Escravos, Nigeria.
This grassroots facility is the first of its kind in West Africa and will
provide significant environmental benefits by converting currently flared
natural gas to produce clean GTL fuels.
Outsourcing
of operations and maintenance work by industrial and energy companies has been
increasing worldwide. Even greater opportunities in this area are anticipated as
the aging infrastructure in United States refineries and chemical plants require
more maintenance and repairs to minimize production downtime. More stringent
industry safety standards and environmental regulations also tend to lead to
higher maintenance standards and costs.
Contract
structure.
Engineering and construction contracts can be broadly categorized as either
cost-reimbursable or fixed-price, sometimes referred to as lump sum. Some
contracts can involve both fixed-price and cost-reimbursable elements.
Fixed-price contracts are for a fixed sum to cover all costs and any profit
element for a defined scope of work. Fixed-price contracts entail more risk to
us as we must predetermine both the quantities of work to be performed and the
costs associated with executing the work.
Cost-reimbursable
contracts include contracts where the price is variable based upon actual costs
incurred for time and materials, or for variable quantities of work priced at
defined unit rates. Profit elements on cost-reimbursable contracts may be based
upon a percentage of costs incurred and/or a fixed amount. Cost-reimbursable
contracts are generally less risky, since the owner retains many of the risks.
While fixed-price contracts involve greater risk, they also are potentially more
profitable for the contractor, since the owners pay a premium to transfer many
risks to the contractor.
We are
continuing with our strategy to move away from fixed-price engineering,
procurement, installation, and commissioning (EPIC), offshore contracts within
our Energy and Chemical segments. We have two remaining major fixed-price EPIC
offshore projects. As of March 31, 2005, they are substantially
complete.
RESULTS
OF OPERATIONS IN 2005 COMPARED TO 2004
|
|
Three
Months Ended |
|
|
|
|
|
Revenue: |
|
March
31 |
|
Increase |
|
Percentage |
|
Millions
of dollars |
|
2005 |
|
2004 |
|
(Decrease) |
|
Change |
|
Production
Optimization |
|
$ |
900 |
|
$ |
708 |
|
$ |
192 |
|
|
27 |
% |
Fluid
Systems |
|
|
631 |
|
|
535 |
|
|
96 |
|
|
18 |
|
Drilling
and Formation Evaluation |
|
|
489 |
|
|
444 |
|
|
45 |
|
|
10 |
|
Digital
and Consulting Solutions |
|
|
164 |
|
|
129 |
|
|
35 |
|
|
27 |
|
Total
Energy Services Group |
|
|
2,184 |
|
|
1,816 |
|
|
368 |
|
|
20 |
|
Government
and Infrastructure |
|
|
2,091 |
|
|
2,868 |
|
|
(777 |
) |
|
(27 |
) |
Energy
and Chemicals |
|
|
663 |
|
|
835 |
|
|
(172 |
) |
|
(21 |
) |
Total
KBR |
|
|
2,754 |
|
|
3,703 |
|
|
(949 |
) |
|
(26 |
) |
Total
revenue |
|
$ |
4,938 |
|
$ |
5,519 |
|
$ |
(581 |
) |
|
(11 |
)% |
Geographic - Energy Services Group segments
only: |
|
|
|
|
|
|
|
|
|
|
|
|
|
Production
Optimization: |
|
|
|
|
|
|
|
|
|
|
|
|
|
North
America |
|
$ |
503 |
|
$ |
354 |
|
$ |
149 |
|
|
42 |
% |
Latin
America |
|
|
95 |
|
|
73 |
|
|
22 |
|
|
30 |
|
Europe/Africa |
|
|
163 |
|
|
146 |
|
|
17 |
|
|
12 |
|
Middle
East/Asia |
|
|
139 |
|
|
135 |
|
|
4 |
|
|
3 |
|
Subtotal |
|
|
900 |
|
|
708 |
|
|
192 |
|
|
27 |
|
Fluid
Systems: |
|
|
|
|
|
|
|
|
|
|
|
|
|
North
America |
|
|
320 |
|
|
259 |
|
|
61 |
|
|
24 |
|
Latin
America |
|
|
88 |
|
|
74 |
|
|
14 |
|
|
19 |
|
Europe/Africa |
|
|
123 |
|
|
118 |
|
|
5 |
|
|
4 |
|
Middle
East/Asia |
|
|
100 |
|
|
84 |
|
|
16 |
|
|
19 |
|
Subtotal |
|
|
631 |
|
|
535 |
|
|
96 |
|
|
18 |
|
Drilling
and Formation Evaluation: |
|
|
|
|
|
|
|
|
|
|
|
|
|
North
America |
|
|
186 |
|
|
153 |
|
|
33 |
|
|
22 |
|
Latin
America |
|
|
82 |
|
|
65 |
|
|
17 |
|
|
26 |
|
Europe/Africa |
|
|
86 |
|
|
81 |
|
|
5 |
|
|
6 |
|
Middle
East/Asia |
|
|
135 |
|
|
145 |
|
|
(10 |
) |
|
(7 |
) |
Subtotal |
|
|
489 |
|
|
444 |
|
|
45 |
|
|
10 |
|
Digital
and Consulting Solutions: |
|
|
|
|
|
|
|
|
|
|
|
|
|
North
America |
|
|
50 |
|
|
48 |
|
|
2 |
|
|
4 |
|
Latin
America |
|
|
49 |
|
|
17 |
|
|
32 |
|
|
188 |
|
Europe/Africa |
|
|
38 |
|
|
27 |
|
|
11 |
|
|
41 |
|
Middle
East/Asia |
|
|
27 |
|
|
37 |
|
|
(10 |
) |
|
(27 |
) |
Subtotal |
|
|
164 |
|
|
129 |
|
|
35 |
|
|
27 |
|
Total
Energy Services Group revenue |
|
|
|
|
|
|
|
|
|
|
|
|
|
by
region: |
|
|
|
|
|
|
|
|
|
|
|
|
|
North
America |
|
|
1,059 |
|
|
814 |
|
|
245 |
|
|
30 |
|
Latin
America |
|
|
314 |
|
|
229 |
|
|
85 |
|
|
37 |
|
Europe/Africa |
|
|
410 |
|
|
372 |
|
|
38 |
|
|
10 |
|
Middle
East/Asia |
|
|
401 |
|
|
401 |
|
|
- |
|
|
- |
|
Total
Energy Services Group revenue |
|
$ |
2,184 |
|
$ |
1,816 |
|
$ |
368 |
|
|
20 |
% |
|
|
Three
Months Ended |
|
|
|
|
|
Operating
income (loss): |
|
March
31 |
|
Increase |
|
Percentage |
|
Millions
of dollars |
|
2005 |
|
2004 |
|
(Decrease) |
|
Change |
|
Production
Optimization |
|
$ |
291 |
|
$ |
82 |
|
$ |
209 |
|
|
255 |
% |
Fluid
Systems |
|
|
113 |
|
|
60 |
|
|
53 |
|
|
88 |
|
Drilling
and Formation Evaluation |
|
|
80 |
|
|
43 |
|
|
37 |
|
|
86 |
|
Digital
and Consulting Solutions |
|
|
29 |
|
|
29 |
|
|
- |
|
|
- |
|
Total
Energy Services Group |
|
|
513 |
|
|
214 |
|
|
299 |
|
|
140 |
|
Government
and Infrastructure |
|
|
53 |
|
|
62 |
|
|
(9 |
) |
|
(15 |
) |
Energy
and Chemicals |
|
|
52 |
|
|
(77 |
) |
|
129 |
|
|
168 |
|
Total
KBR |
|
|
105 |
|
|
(15 |
) |
|
120 |
|
|
NM |
|
General
corporate |
|
|
(32 |
) |
|
(24 |
) |
|
(8 |
) |
|
(33 |
) |
Operating
income |
|
$ |
586 |
|
$ |
175 |
|
$ |
411 |
|
|
235 |
% |
Geographic
- Energy Services Group segments only: |
|
|
|
|
|
|
|
|
|
|
|
|
|
Production
Optimization: |
|
|
|
|
|
|
|
|
|
|
|
|
|
North
America |
|
$ |
232 |
|
$ |
47 |
|
$ |
185 |
|
|
394 |
% |
Latin
America |
|
|
20 |
|
|
10 |
|
|
10 |
|
|
100 |
|
Europe/Africa |
|
|
20 |
|
|
4 |
|
|
16 |
|
|
400 |
|
Middle
East/Asia |
|
|
19 |
|
|
21 |
|
|
(2 |
) |
|
(10 |
) |
Subtotal |
|
|
291 |
|
|
82 |
|
|
209 |
|
|
255 |
|
Fluid
Systems: |
|
|
|
|
|
|
|
|
|
|
|
|
|
North
America |
|
|
69 |
|
|
31 |
|
|
38 |
|
|
123 |
|
Latin
America |
|
|
16 |
|
|
11 |
|
|
5 |
|
|
45 |
|
Europe/Africa |
|
|
18 |
|
|
11 |
|
|
7 |
|
|
64 |
|
Middle
East/Asia |
|
|
10 |
|
|
7 |
|
|
3 |
|
|
43 |
|
Subtotal |
|
|
113 |
|
|
60 |
|
|
53 |
|
|
88 |
|
Drilling
and Formation Evaluation: |
|
|
|
|
|
|
|
|
|
|
|
|
|
North
America |
|
|
45 |
|
|
17 |
|
|
28 |
|
|
165 |
|
Latin
America |
|
|
12 |
|
|
5 |
|
|
7 |
|
|
140 |
|
Europe/Africa |
|
|
7 |
|
|
4 |
|
|
3 |
|
|
75 |
|
Middle
East/Asia |
|
|
16 |
|
|
17 |
|
|
(1 |
) |
|
(6 |
) |
Subtotal |
|
|
80 |
|
|
43 |
|
|
37 |
|
|
86 |
|
Digital
and Consulting Solutions: |
|
|
|
|
|
|
|
|
|
|
|
|
|
North
America |
|
|
7 |
|
|
23 |
|
|
(16 |
) |
|
(70 |
) |
Latin
America |
|
|
(2 |
) |
|
4 |
|
|
(6 |
) |
|
(150 |
) |
Europe/Africa |
|
|
22 |
|
|
- |
|
|
22 |
|
|
NM |
|
Middle
East/Asia |
|
|
2 |
|
|
2 |
|
|
- |
|
|
- |
|
Subtotal |
|
|
29 |
|
|
29 |
|
|
- |
|
|
- |
|
Total
Energy Services Group |
|
|
|
|
|
|
|
|
|
|
|
|
|
operating
income by region: |
|
|
|
|
|
|
|
|
|
|
|
|
|
North
America |
|
|
353 |
|
|
118 |
|
|
235 |
|
|
199 |
|
Latin
America |
|
|
46 |
|
|
30 |
|
|
16 |
|
|
53 |
|
Europe/Africa |
|
|
67 |
|
|
19 |
|
|
48 |
|
|
253 |
|
Middle
East/Asia |
|
|
47 |
|
|
47 |
|
|
- |
|
|
- |
|
Total
Energy Services Group |
|
|
|
|
|
|
|
|
|
|
|
|
|
operating
income |
|
$ |
513 |
|
$ |
214 |
|
$ |
299 |
|
|
140 |
% |
NM - Not
Meaningful
The
decrease in consolidated revenue in the first quarter of 2005 compared to the
first quarter of 2004 was largely attributable to reduced activity in our
government services projects, primarily in the Middle East, and the winding down
of offshore fixed-price EPIC operations. This was partially offset by increased
revenue from sales of our Energy Services Group products and services,
predominantly resulting from significantly higher oil and gas prices favorably
impacting worldwide rig counts and United States price book increases beginning
in the second quarter of 2004. International revenue was 75% of consolidated
revenue in the first quarter of 2005 and 83% of consolidated revenue in the
first quarter of 2004, with the decrease primarily due to the decline of our
government services projects abroad. Revenue from the United States Government
for all geographic areas was approximately $1.7 billion or 34% of consolidated
revenue in the first quarter of 2005 compared to $2.6 billion or 47% of
consolidated revenue in the first quarter of 2004.
The
increase in consolidated operating income was primarily due to stronger
performance in our Energy Services Group resulting from strong demand due to
increased oilfield activity and KBR’s settlement of DFAC issues, definitization
of task orders under LogCAP, and savings from our restructuring plan. Also
contributing to consolidated operating income in the first quarter of 2005 was
the $110 million gain on sale of our equity investment in the Subsea 7, Inc.
joint venture.
In the
first quarter of 2005, Iraq-related work contributed approximately $1.5 billion
to consolidated revenue and $38 million to consolidated operating income, a 2.6%
margin before corporate costs and taxes.
Following
is a discussion of our results of operations by reportable segment.
Production
Optimization increase
in revenue compared to the first quarter of 2004 was driven by a 29% improvement
in revenue from production enhancement services, largely attributable to
increased onshore activity and pricing improvements in the United States. Sales
of completion tools increased 10%, which includes a $13 million revenue decline
in surface well testing due to the sale of that operation in the third quarter
of 2004. Completion tools saw improvement across all four regions, led by Latin
America, largely resulting from increased reservoir performance services in
Mexico, and North America, due to increased activity both onshore and in the
Gulf of Mexico. Additionally, WellDynamics contributed revenue of $15 million in
the first quarter of 2005 compared to revenue of $2 million in the first quarter
of 2004. Also impacting the segment revenue comparison was a $17 million
operating loss in the first quarter of 2004 on our equity investment in the
Subsea 7, Inc. joint venture, which was sold in January 2005. International
revenue was 50% of total segment revenue in the first quarter of 2005 compared
to 56% in the first quarter of 2004.
The
increase in operating income for the segment compared to the first quarter of
2004 included a $110 million gain on the sale of our equity interest in the
Subsea 7, Inc. joint venture. Production enhancement services was the major
contributor to segment operating income, increasing 76% over the first quarter
of 2004, primarily resulting from increased land rig activity, higher equipment
utilization, and improved pricing in the United States. Improved results from
production enhancement services in Asia, southern Africa, and the North Sea were
partially offset by lower activity in the Caspian and the Middle East.
Completions tools operating income increased 93% and spanned all four geographic
regions, largely due to increased well completion, sand control, and reservoir
performance activities. Additionally, the first quarter of 2004 results included
a $17 million operating loss on our Subsea 7, Inc. equity investment, which was
sold in January 2005.
Fluid
Systems revenue
improvement in the first quarter of 2005 compared to the first quarter of 2004
resulted from a 20% increase in revenue from cementing activities and a 17%
increase from sales of Baroid Fluid Services. All geographic regions yielded
increased revenue from both product service lines, with North America providing
the largest portion due to improved pricing and higher rig activity, both
onshore and in the Gulf of Mexico. Baroid Fluid Services revenue also benefited
from increased activity in Asia. International revenue was 55% of total segment
revenue in the first quarter of 2005 compared to 58% in the first quarter of
2004.
The
segment operating income increase compared to the first quarter of 2004 resulted
from increases of 60% from cementing services and 230% from Baroid Fluid
Services. Both product service lines saw improved results from all geographic
regions, with the majority derived from North America on pricing improvements
and higher rig activity across the region. Cementing services results further
benefited from improved crew and equipment utilization in the United States,
while Baroid Fluid Services benefited from increased deepwater activity and
lower costs in the Gulf of Mexico and improved results in Nigeria and
Mexico.
Drilling
and Formation Evaluation increase
in revenue compared to the first quarter of 2004 was driven by a 16% increase in
drilling services revenue, primarily derived from new contract start-ups in
Latin America and increased land rig activity and pricing improvements in North
America. Additionally, both of these geographies benefited from strong sales of
GeoPilot® services in the first quarter of 2005. Drill bits sales increased 19%
over the prior year quarter, predominantly in the United States due to strong
drilling activity and our new fixed cutter bit technology. Revenue from logging
services decreased 3%, while substantially increased demand for services in the
United States was offset by direct sales to China included in the first quarter
of 2004. International revenue was 71% of total segment revenue in the first
quarter of 2005 compared to 75% in the first quarter of 2004.
The
increase in segment operating income for the first quarter of 2005 resulted
chiefly from improved pricing and increased onshore activity in the United
States across all product service lines. Operating income from drilling services
was the primary contributor to segment operating income, increasing 71%.
Drilling services benefited from improved pricing and volume and higher
equipment utilization in Latin America, as well as lower depreciation expense of
$9 million in the first quarter of 2005 due to extending depreciable asset lives
of certain drilling tools beginning in the second quarter of 2004. Logging
services operating income increased 65% due to improved activity and pricing in
North America. Drill bits results yielded a 300% improvement due to strong fixed
cutter bit sales in North America and cost reduction efforts primarily in North
America and Latin America.
Digital
and Consulting Solutions revenue
improvement in the first quarter of 2005 compared to the first quarter of 2004
was largely driven by project management services, with a 54% increase in
revenue due to increased activity in Mexico, partially offset by reductions in
Indonesia and Eurasia. Landmark revenue improved 10%, achieving a first quarter
revenue record despite the usual seasonal decline, due to increased sales of
real-time drilling applications as well as increased services from data bank
projects. International revenue was 71% of total segment revenue in the first
quarter of 2005 compared to 66% in the first quarter of 2004.
Segment
operating income was flat compared to the first quarter of 2004. Included in the
first quarter of 2005 results was a $17 million insurance claim settlement
related to a pipe fabrication and laying project in the North Sea. This was
partially offset by an $8 million loss on two fixed-price integrated solutions
projects in Mexico due to some additional downhole well problems. The first
quarter of 2004 operating income included a $13 million release of legal
liability accruals related to the Anglo-Dutch settlement.
Government
and Infrastructure revenue
declined $777 million compared to the first quarter of 2004, primarily due to
declining government services in the Middle East resulting from completion of
the RIO contract in late 2004. Partially offsetting the decreases was $47
million higher revenue earned by our DML shipyard activities.
Government
and Infrastructure operating income decreased $9 million compared to the first
quarter of 2004. Contributing to the earnings decline were completion of the RIO
contract in 2004 and an $11 million loss on a joint venture road project in the
United Kingdom. Partially offsetting these decreases are a one-time $11 million
cash distribution from a cost basis investment in the United States that had
been fully reserved. In addition, the first quarter of 2005 results were
positively impacted by $22 million of operating income resulting from award fees
related to definitized task orders in excess of our historical award fee accrual
rate and the settlement of the DFAC services under our LogCAP
contract.
Energy
and Chemicals revenue
decreased $172 million compared to the first quarter of 2004. Revenue from
several LNG and oil and gas projects in Africa declined by $108 million, as they
were completed or substantially completed in the last 12 months. Additionally,
revenue from offshore fixed-price EPIC projects decreased $76 million compared
to the first quarter of 2004, as they are substantially completed. Partially
offsetting the segment decrease was $35 million in increased revenue from higher
progress and activities on an offshore project management contract in Kazakhstan
and a crude oil facility project in Canada.
Segment
operating income totaled $52 million in the first quarter of 2005 compared to a
$77 million loss in the first quarter of 2004. Included in the first quarter of
2004 results was a $97 million loss on the Barracuda-Caratinga project in
Brazil. Contributing to the earnings increase in the first quarter of 2005 were
stronger results on many projects, including offshore engineering and management
projects in the Caspian and Angola and offshore production services projects in
the United Kingdom. In addition, the first quarter of 2005 results benefited
from $9 million in equity income, from a joint venture, related to a gain on
sale of marketable equity securities.
General
corporate expenses
were $32 million in the first quarter of 2005 compared to $24 million in the
first quarter of 2004. The increase was primarily due to legal expenses related
to the Nigeria LNG investigation, higher professional expenses on specific
projects, and an adjustment to our self-insurance reserve, all during the first
quarter of 2005.
Nonoperating
Items
Interest
expense
decreased $4 million in the first quarter of 2005 compared to the first quarter
of 2004, primarily due to the write-off of issue costs related to a master
letter of credit facility upon its expiration in the fourth quarter of
2004.
Foreign
currency gains (losses), net improved
to even in the first quarter of 2005 from a $3 million net loss in the first
quarter of 2004. Various currencies contributed to the improvement, most notably
the Canadian dollar.
Other,
net in the
first quarter of 2005 includes $2 million in costs related to our ESG accounts
receivable securitization facility and sales of our United States government
accounts receivable. “Other, net” in the first quarter of 2004 primarily
reflects a $6 million pretax gain on the sale of our remaining shares of
National Oilwell, Inc. common stock received in the January 2003 disposition of
Mono Pumps.
Provision
for income taxes from continuing operations in the
first quarter of 2005 resulted in an effective tax rate of 31% compared to an
effective tax rate of 37% for the first quarter of 2004. Our annualized tax rate
as applied to the first quarter of 2005 was positively impacted by a reduction
in our valuation allowance against future tax attributes related to our asbestos
liabilities. This reduction occurred due to an increase in our projection of
full-year 2005 United States taxable income, which reduces the number of years
we project foreign tax credits to be displaced.
Loss
from discontinued operations, net of tax in the
first quarter of 2004 included a $190 million pretax charge for the March 31,
2004 revaluation of the 59.5 million shares of Halliburton common stock that
were contributed to the trusts established for the benefit of asbestos and
silica claimants.
OFF
BALANCE SHEET RISK
In April
2005, the term of our Energy Services Group accounts receivable securitization
facility was extended to April 2006. We have the ability to sell up to $300
million in undivided ownership interest in the pool of receivables under this
facility. As of both March 31, 2005 and December 31, 2004, $256 million of
undivided ownership interest had been sold to unaffiliated
companies.
In May
2004, we entered into an agreement to sell, assign, and transfer the entire
title and interest in specified United States government accounts receivable of
KBR to a third party. The face value of the receivables sold to the third party
is reflected as a reduction of accounts receivable in our condensed consolidated
balance sheets. The amount of receivables that can be sold under the agreement
varies based on the amount of eligible receivables at any given time and other
factors, and the maximum amount that may be sold and outstanding under this
agreement at any given time is $650 million. The total amount of receivables
outstanding under this agreement was approximately $242 million as of March 31,
2005 and approximately $263 million as of December 31, 2004. Subsequent to March
31, 2005, the receivables were collected, and we have not sold any additional
receivables.
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
Federal Water Pollution Control Act; and |
|
- |
the
Toxic Substances Control Act. |
In
addition to the federal laws and regulations, states and other countries where
we do business may have numerous environmental, legal, and regulatory
requirements by which we must abide. We evaluate and address the environmental
impact of our operations by assessing and remediating contaminated properties in
order to avoid future liabilities and comply with environmental, legal, and
regulatory requirements. On occasion, we are involved in specific environmental
litigation and claims, including the remediation of properties we own or have
operated, as well as efforts to meet or correct compliance-related matters. Our
Health, Safety and Environment group has several programs in place to maintain
environmental leadership and to prevent the occurrence of environmental
contamination.
We do not
expect costs related to these remediation requirements to have a material
adverse effect on our consolidated financial position or our results of
operations. Our accrued liabilities for environmental matters were $44 million
as of March 31, 2005 and $41 million as of December 31, 2004. The liability
covers numerous properties, and no individual property accounts for more than $5
million of the liability balance. We have been named as potentially responsible
parties along with other third parties for 14 federal and state superfund sites
for which we have established a liability. As of March 31, 2005, those 14 sites
accounted for approximately $14 million of our total $44 million liability. In
some instances, we have been named a potentially responsible party by a
regulatory agency, but in each of those cases, we do not believe we have any
material liability.
NEW
ACCOUNTING PRONOUNCEMENTS
In March
2005, the FASB issued FASB Interpretation No. 47, “Accounting for Conditional
Asset Retirement Obligations, an interpretation of FASB Statement No. 143” (FIN
47). This statement clarifies that an entity is required to recognize a
liability for the fair value of a conditional asset retirement obligation when
incurred, if the liability’s fair value can be reasonably estimated. The
provisions of FIN 47 are effective no later than December 31, 2005. We are
currently evaluating what impact, if any, this statement will have on our
financial statements.
In
December 2004, the FASB issued SFAS No. 123R, “Shared-Based Payment.” We will
adopt the provisions of SFAS No. 123R on January 1, 2006 using the modified
prospective application. Accordingly, we will recognize compensation expense for
all newly granted awards and awards modified, repurchased, or cancelled after
January 1, 2006. Compensation cost for the unvested portion of awards that are
outstanding as of January 1, 2006 will be recognized ratably over the remaining
vesting period. The compensation cost for the unvested portion of awards will be
based on the fair value at date of grant as calculated for our pro forma
disclosure under SFAS No. 123. We will recognize compensation expense for our
ESPP beginning with the January 1, 2006 purchase period.
We
estimate that the effect on net income and earnings per share in the periods
following adoption of SFAS No. 123R will be consistent with our pro forma
disclosure under SFAS No. 123, except that estimated forfeitures will be
considered in the calculation of compensation expense under SFAS No. 123R.
Additionally, the actual effect on net income and earnings per share will vary
depending upon the number of options granted in subsequent periods compared to
prior years and the number of shares purchased under the ESPP.
FORWARD-LOOKING
INFORMATION AND RISK FACTORS
The
Private Securities Litigation Reform Act of 1995 provides safe harbor provisions
for forward-looking information. Forward-looking information is based on
projections and estimates, not historical information. Some statements in this
Form 10-Q are forward-looking and use words like “may,” “may not,” “believes,”
“do not believe,” “expects,” “do not expect,” “anticipates,” “do not
anticipate,” and other expressions. We may also provide oral or written
forward-looking information in other materials we release to the public.
Forward-looking information involves risk and uncertainties and reflects our
best judgment based on current information. Our results of operations can be
affected by inaccurate assumptions we make or by known or unknown risks and
uncertainties. In addition, other factors may affect the accuracy of our
forward-looking information. As a result, no forward-looking information can be
guaranteed. Actual events and the results of operations may vary
materially.
We do not
assume any responsibility to publicly update any of our forward-looking
statements regardless of whether factors change as a result of new information,
future events, or for any other reason. You should review any additional
disclosures we make in our press releases and Forms 10-K, 10-Q, and 8-K filed
with or furnished to the Securities and Exchange Commission (SEC). We also
suggest that you listen to our quarterly earnings release conference calls with
financial analysts.
While it
is not possible to identify all factors, we continue to face many risks and
uncertainties that could cause actual results to differ from our forward-looking
statements and potentially materially and adversely affect our financial
condition and results of operations, including the risks relating
to:
Legal
Matters
United
States Government Contract Work
We
provide substantial work under our government contracts business to the United
States Department of Defense and other governmental agencies, including
worldwide United States Army logistics contracts, known as LogCAP, and contracts
to rebuild Iraq’s petroleum industry, known as RIO and PCO Oil South. Our
government services revenue related to Iraq totaled approximately $1.5 billion
in the first quarter of 2005 compared to $2.4 billion in the first quarter of
2004.
Given the
demands of working in Iraq and elsewhere for the United States government, we
expect that from time to time we will have disagreements or experience
performance issues with the various government customers for which we work. If
performance issues arise under any of our government contracts, the government
retains the right to pursue remedies under any affected contract, which remedies
could include threatened termination or termination. If any contract were so
terminated, we may not receive award fees under the affected contract, and our
ability to secure future contracts could be adversely affected, although we
would receive payment for amounts owed for our allowable costs under
cost-reimbursable contracts.
DCAA
audit issues
Our
operations under United States government contracts are regularly reviewed and
audited by the Defense Contract Audit Agency (DCAA) and other governmental
agencies. The DCAA serves in an advisory role to our customer. When issues are
found during the governmental agency audit process, these issues are typically
discussed and reviewed with us. The DCAA then issues an audit report with its
recommendations to our customer’s contracting officer. In the case of management
systems and other contract administrative issues, the contracting officer is
generally with the Defense Contract Management Agency (DCMA). We then work with
our customer to resolve the issues noted in the audit report.
Dining
facilities (DFAC). During
2003, the DCAA raised issues relating to our invoicing to the Army Materiel
Command (AMC) for food services for soldiers and supporting civilian personnel
in Iraq and Kuwait. During 2004, we received notice from the DCAA that it was
recommending withholding 19.35% of our DFAC billings relating to subcontracts
entered into prior to February 2004 until it completed its audits. Approximately
$213 million had been withheld as of March 31, 2005. Subsequent to February
2004, we renegotiated our DFAC subcontracts to address the specific issues
raised by the DCAA and advised the AMC and the DCAA of the new terms of the
arrangements. We have had no objection by the government to the terms and
conditions associated with these new DFAC subcontract agreements. On March 31,
2005, we reached an agreement with the AMC regarding the cost associated with
the DFAC subcontractors, which totaled approximately $1.2 billion. Under the
terms of the agreement, the AMC agreed to the DFAC subcontractor costs except
for $55 million, which it will retain from the $213 million previously withheld
amount. We will attempt to pass this $55 million price reduction to the
subcontractors. We are currently withholding funds from the subcontractors in
excess of this amount. These excess amounts will be paid to the subcontractors
upon release of the withholds from the government. As a result of this
agreement, we recorded $10 million in additional operating income during the
first quarter of 2005.
Fuel. In
December 2003, the DCAA issued a preliminary audit report that alleged that we
may have overcharged the Department of Defense by $61 million in importing fuel
into Iraq. The DCAA questioned costs associated with fuel purchases made in
Kuwait that were more expensive than buying and transporting fuel from Turkey.
We responded that we had maintained close coordination of the fuel mission with
the Army Corps of Engineers (COE), which was our customer and oversaw the
project, throughout the life of the task order, and that the COE had directed us
to use the Kuwait sources. After a review, the COE concluded that we obtained a
fair price for the fuel. However, Department of Defense officials thereafter
referred the matter to the agency’s inspector general, which we understand has
commenced an investigation.
The DCAA
has issued various audit reports related to task orders under the RIO contract
that currently report $276 million in questioned and unsupported costs (down
from $304 million originally reported because some issues have been resolved).
To date, the DCAA has not recommended that any portion of the questioned and
unsupported costs be withheld from payments to us. The majority of these costs
are associated with the humanitarian fuel mission. In these reports, the DCAA
has compared fuel costs we incurred during the duration of the RIO contract in
2003 and early 2004 to fuel prices obtained by the Defense Energy Supply Center
(DESC) in April 2004 when the fuel mission was transferred to that agency. We
are working with our customer to resolve this issue.
Laundry. During
the third quarter of 2004, we received notice from the DCAA that it recommended
withholding $16 million of subcontract costs related to the laundry service for
one task order in southern Iraq for which it believes we and our subcontractors
have not provided adequate levels of documentation supporting the quantity of
the services provided. In the first quarter of 2005, the DCAA issued a second
notice to withhold approximately $2 million. The DCAA recommended that the costs
be withheld pending receipt of additional explanation or documentation to
support the subcontract costs. The $18 million has been withheld from the
subcontractor. We are working with the AMC and the subcontractor to resolve this
issue.
Other
issues. The DCAA
is continuously performing audits of costs incurred for other services provided
by us under our government contracts. During these audits, there are likely to
be questions raised by the DCAA about the reasonableness or allowability of
certain costs or the quality or quantity of supporting documentation. No
assurance can be given that the DCAA might not recommend withholding some
portion of the questioned costs while the issues are being resolved with our
customer. We do not believe any potential withholding will have a significant or
sustained impact on our liquidity.
Investigations
On
January 22, 2004, we announced the identification by our internal audit function
of a potential overbilling of approximately $6 million by La Nouvelle Trading
& Contracting Company, W.L.L. (La Nouvelle), one of our subcontractors,
under the LogCAP contract in Iraq, for services performed during 2003. In
accordance with our policy and government regulation, the potential overcharge
was reported to the Department of Defense Inspector General’s office as well as
to our customer, the AMC. On January 23, 2004, we issued a check in the amount
of $6 million to the AMC to cover that potential overbilling while we conducted
our own investigation into the matter. Later in the first quarter of 2004, we
determined that the amount of overbilling was $4 million, and the subcontractor
billing should have been $2 million for the services provided. As a result, we
paid La Nouvelle $2 million and billed our customer that amount. We subsequently
terminated La Nouvelle’s services under the LogCAP contract. In October 2004, La
Nouvelle filed suit against us alleging $224 million in damages as a result of
its termination. We are continuing to investigate whether La Nouvelle paid, or
attempted to pay, one or two of our former employees in connection with the
billing. See Note 13 to our consolidated financial statements for further
discussion.
In
October 2004, we reported to the Department of Defense Inspector General’s
office that two former employees in Kuwait may have had inappropriate contacts
with individuals employed by or affiliated with two third-party subcontractors
prior to the award of the subcontracts. The Inspector General’s office may
investigate whether these two employees may have solicited and/or accepted
payments from these third-party subcontractors while they were employed by
us.
In
October 2004, a civilian contracting official in the COE asked for a review of
the process used by the COE for awarding some of the contracts to us. We
understand that the Department of Defense Inspector General’s office may review
the issues involved.
We
understand that the United States Department of Justice, an Assistant United
States Attorney based in Illinois, and others are investigating these and other
individually immaterial matters we have reported relating to our government
contract work in Iraq. If criminal wrongdoing were found, criminal penalties
could range up to the greater of $500,000 in fines per count for a corporation,
or twice the gross pecuniary gain or loss. We also understand that current and
former employees of KBR have received subpoenas and have given or may give grand
jury testimony relating to some of these matters.
In the
first quarter of 2005, the Department of Justice issued two indictments
associated with these issues against a former KBR procurement manager and a
manager at our subcontractor, La Nouvelle.
Withholding
of payments
During
2004, the AMC issued a determination that a particular contract clause could
cause it to withhold 15% from our invoices until our task orders under the
LogCAP contract are definitized. The AMC delayed implementation of this
withholding pending further review. During the third quarter of 2004, we and the
AMC identified three senior management teams to facilitate negotiation under the
LogCAP task orders, and these teams concluded their effort by successfully
negotiating the final outstanding task order definitization on March 31, 2005.
This makes us current with regard to definitization of historical LogCAP task
orders and eliminates the potential 15% withholding issue under the LogCAP
contract. In addition, we recorded $12 million in additional income in the first
quarter of 2005 resulting from the recognition of incremental award fees related
to the definitized task orders.
As of
March 31, 2005, the COE had withheld $95 million of our invoices related to a
portion of our RIO contract pending completion of the definitization process.
All 10 definitization proposals required under this contract have been submitted
by us, and three have been finalized through a task order modification. After
review by the DCAA, we have resubmitted five of the unfinalized seven proposals
and are in the process of developing revised proposals for the remaining two.
These withholdings represent the amount invoiced in excess of 85% of the funding
in the task order. The COE also could withhold similar amounts from future
invoices under our RIO contract until agreement is reached with the customer and
task order modifications are issued. Approximately $2 million was withheld from
our PCO Oil South project as of March 31, 2005. The PCO Oil South project has
definitized substantially all of the task orders, and withholdings are not
continuing on those task orders. We do not believe the withholding will have a
significant or sustained impact on our liquidity because the withholding is
temporary and ends once the definitization process is complete.
We are
working diligently with our customers to proceed with significant new work only
after we have a fully definitized task order, which should limit withholdings on
future task orders for all government contracts.
In
addition, we had unapproved claims totaling $102 million at March 31, 2005 for
the LogCAP, RIO, and PCO Oil South contracts. These unapproved claims related to
contracts where our costs have exceeded the funded value of the task order or
were related to lost, damaged, and destroyed equipment.
Cost
reporting
We
received notice that a contracting officer for our PCO Oil South project
considers our monthly categorization and detail of costs and our ability to
schedule and forecast costs to be inadequate, and he requested corrections be
made. We provided our cost report and believe that we made the requested
corrections. If we are unable to satisfy our customer, our customer may pursue
remedies under the applicable federal acquisition regulations, including
terminating the affected contract. Although there can be no assurances, we do
not expect that our work on the PCO Oil South project will be terminated for
default. We are continuing to work with our customer to develop a mutually
acceptable management cost reporting system and are supplementing the existing
PCO Oil South cost reporting team with additional manpower. The PCO Oil South
contract has been challenging in part due to violent attacks by insurgents on
infrastructure in the southern part of Iraq. Currently, the volume of work
performed on PCO Oil South is lower than we had projected initially, and we
believe the risk/reward profile is unattractive.
DCMA
system reviews
Report
on estimating system. On
December 27, 2004, the DCMA granted continued approval of our estimating system,
stating that our estimating system is “acceptable with corrective action.” We
are in process of completing these corrective actions. Specifically, based on
the unprecedented level of support our employees are providing the military in
Iraq, Kuwait, and Afghanistan, we needed to update our estimating policies and
procedures to make them better suited to such contingency situations.
Additionally, we have completed our development of a detailed training program
and have made it available to all estimating personnel to ensure that employees
are adequately prepared to deal with the challenges and unique circumstances
associated with a contingency operation.
Report
on purchasing system. As a
result of a Contractor Purchasing System Review by the DCMA during the second
quarter of 2004, the DCMA granted the continued approval of our government
contract purchasing system. The DCMA’s approval letter, dated September 7, 2004,
stated that our purchasing system’s policies and practices are “effective and
efficient, and provide adequate protection of the Government’s
interest.”
Report
on accounting system. We have
received an initial draft report on our accounting system and have responded to
the points raised by the DCAA. Once the DCAA finalizes the report it will be
submitted to the DCMA who will make a determination of the adequacy of our
accounting systems for government contracting.
The
Balkans
We have
had inquiries in the past by the DCAA and the civil fraud division of the United
States Department of Justice into possible overcharges for work performed during
1996 through 2000 under a contract in the Balkans, which inquiry has not yet
been completed by the Department of Justice. Based on an internal investigation,
we credited our customer approximately $2 million during 2000 and 2001 related
to our work in the Balkans as a result of billings for which support was not
readily available. We believe that the preliminary Department of Justice inquiry
relates to potential overcharges in connection with a part of the Balkans
contract under which approximately $100 million in work was done. We believe
that any allegations of overcharges would be without merit.
Nigerian
joint venture and investigations
Foreign
Corrupt Practices Act investigation. The SEC
is conducting a formal investigation into payments made in connection with the
construction and subsequent expansion by TSKJ of a multibillion dollar natural
gas liquefaction complex and related facilities at Bonny Island in Rivers State,
Nigeria. The United States Department of Justice is also conducting an
investigation. TSKJ is a private limited liability company registered in
Madeira, Portugal whose members are Technip SA of France, Snamprogetti
Netherlands B.V., which is an affiliate of ENI SpA of Italy, JGC Corporation of
Japan, and Kellogg Brown & Root, each of which owns 25% of the
venture.
The SEC
and the Department of Justice have been reviewing these matters in light of the
requirements of the United States Foreign Corrupt Practices Act. We have
produced documents to the SEC both voluntarily and pursuant to subpoenas, and we
are making our employees available to the SEC for testimony. In addition, we
understand that the SEC has issued a subpoena to A. Jack Stanley, who most
recently served as a consultant and chairman of Kellogg Brown & Root, and to
other current and former Kellogg Brown & Root employees. We further
understand that the Department of Justice has invoked its authority under a
sitting grand jury to obtain letters rogatory for the purpose of obtaining
information abroad.
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., which is an affiliate of
ENI SpA of Italy. Commencing in 1995, TSKJ entered into a series of agency
agreements in connection with the Nigerian project. We understand that a French
magistrate has officially placed Jeffrey Tesler, a principal of Tri-Star
Investments, an agent of TSKJ, 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
and expressed our willingness to cooperate with those investigations. In October
2004, representatives of TSKJ voluntarily testified before the Nigerian
legislative committee.
As a
result of our continuing investigation into these matters, information has been
uncovered suggesting that commencing at least 10 years ago, the members of TSKJ
considered payments to Nigerian officials. We provided this information to the
United States Department of Justice, the SEC, the French magistrate, and the
Nigerian Economics and Financial Crimes Commission. We also notified the other
owners of TSKJ of the recently uncovered information and asked each of them to
conduct their own investigation.
We
understand from the ongoing governmental and other investigations that payments
may have been made to Nigerian officials. In addition, TSKJ has suspended the
receipt of services from and payments to Tri-Star Investments and is considering
instituting legal proceedings to declare all agency agreements with Tri-Star
Investments terminated and to recover all amounts previously paid under those
agreements.
We also
understand that the matters under investigation by the Department of Justice
involve parties other than Kellogg Brown & Root and M.W. Kellogg, Ltd. (a
joint venture in which Kellogg Brown & Root has a 55% interest), cover an
extended period of time (in some cases significantly before our 1998 acquisition
of Dresser Industries (which included M.W. Kellogg, Ltd.)), and possibly include
the construction of a fertilizer plant in Nigeria in the early 1990s and the
activities of agents and service providers.
In June
2004, we terminated all relationships with Mr. Stanley and another consultant
and former employee of M.W. Kellogg, Ltd. The terminations occurred because of
violations of our Code of Business Conduct that allegedly involve the receipt of
improper personal benefits in connection with TSKJ’s construction of the natural
gas liquefaction facility in Nigeria.
In
February 2005, TSKJ notified the Attorney General of Nigeria that TSKJ would not
oppose the Attorney General’s efforts to have sums of money held on deposit in
banks in Switzerland transferred to Nigeria and to have the legal ownership of
such sums determined in the Nigerian courts.
If
violations of the FCPA were found, we could be subject to civil penalties of
$500,000 per violation, and criminal penalties could range up to the greater of
$2 million per violation or twice the gross pecuniary gain or loss.
There can
be no assurance that governmental investigation or our investigation of these
matters will not conclude that violations of applicable laws have occurred or
that the results of these investigations will not have a material adverse effect
on our business and results of operations.
Bidding
practices investigation. In
connection with the investigation into payments made in connection with the
Nigerian project, 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, which was significantly before our
1998 acquisition of Dresser Industries.
On the
basis of this information, we and the Department of Justice have broadened our
investigations to determine the nature and extent of any improper bidding
practices, whether such conduct violated United States antitrust laws, and
whether former employees may have received payments in connection with bidding
practices on some foreign projects.
If
violations of applicable United States antitrust laws occurred, the range of
possible penalties includes criminal fines, which could range up to the greater
of $10 million in fines per count for a corporation, or twice the gross
pecuniary gain or loss, and the treble civil damages in favor of any persons
financially injured by such violations. If such violations occurred, the United
States government also would have the discretion to deny future government
contracts business to KBR or affiliates or subsidiaries of KBR. Criminal
prosecutions under applicable laws of relevant foreign jurisdictions and civil
claims by or relationship issues with customers are also possible.
There can
be no assurance that the results of these investigations will not have a
material adverse effect on our business and results of operations.
Operations
in Iran
We
received and responded to an inquiry in mid-2001 from the Office of Foreign
Assets Control (OFAC) of the United States Treasury Department with respect to
operations in Iran by a Halliburton subsidiary incorporated in the Cayman
Islands. The OFAC inquiry requested information with respect to compliance with
the Iranian Transaction Regulations. These regulations prohibit United States
citizens, including United States corporations and other United States business
organizations, from engaging in commercial, financial, or trade transactions
with Iran, unless authorized by OFAC or exempted by statute. Our 2001 written
response to OFAC stated that we believed that we were in compliance with
applicable sanction regulations. In January 2004, we received a follow-up letter
from OFAC requesting additional information. We responded to this request on
March 19, 2004. We understand this matter has now been referred by OFAC to the
Department of Justice. In July 2004, we received a grand jury subpoena from an
Assistant United States District Attorney requesting the production of
documents. We are cooperating with the government’s investigation and have
responded to the subpoena by producing documents on September 16,
2004.
Separate
from the OFAC inquiry, we completed a study in 2003 of our activities in Iran
during 2002 and 2003 and concluded that these activities were in compliance with
applicable sanction regulations. These sanction regulations require isolation of
entities that conduct activities in Iran from contact with United States
citizens or managers of United States companies. Notwithstanding our conclusions
that our activities in Iran were not in violation of United States laws and
regulations, we have recently announced that, after fulfilling our current
contractual obligations within Iran, we intend to cease operations within that
country and to withdraw from further activities there.
Geopolitical
and International Environment
International
and political events
A
significant portion of our revenue is derived from our non-United States
operations, which exposes us to risks inherent in doing business in each of the
more than 100 other countries in which we transact business. The occurrence of
any of the risks described below could have a material adverse effect on our
consolidated results of operations and consolidated financial
condition.
Our
operations in more than 100 countries other than the United States accounted for
approximately 75% of our consolidated revenue during the first quarter of 2005
and 78% of our consolidated revenue during 2004. Based on the location of
services provided and products sold, 30% of our consolidated revenue in the
first quarter of 2005 and 26% during 2004 were from Iraq, primarily related to
our work for the United States Government. Operations in countries other than
the United States are subject to various risks peculiar to each country. With
respect to any particular country, these risks may include:
|
- |
expropriation
and nationalization of our assets in that
country; |
|
- |
political
and economic instability; |
|
- |
civil
unrest, acts of terrorism, force majeure, war, or other armed
conflict; |
|
- |
natural
disasters, including those related to earthquakes and
flooding; |
|
- |
currency
fluctuations, devaluations, and conversion
restrictions; |
|
- |
confiscatory
taxation or other adverse tax policies; |
|
- |
governmental
activities that limit or disrupt markets, restrict payments, or limit the
movement of funds; |
|
- |
governmental
activities that may result in the deprivation of contract rights;
and |
|
- |
governmental
activities that may result in the inability to obtain or retain licenses
required for operation. |
Due to
the unsettled political conditions in many oil-producing countries and countries
in which we provide governmental logistical support, our revenue and profits are
subject to the adverse consequences of war, the effects of terrorism, civil
unrest, strikes, currency controls, and governmental actions. Countries where we
operate that have significant amounts of political risk include: Afghanistan,
Algeria, Indonesia, Iran, Iraq, Nigeria, Russia, and Venezuela. In addition,
military action or continued unrest in the Middle East could impact the supply
and pricing for oil and gas, disrupt our operations in the region and elsewhere,
and increase our costs for security worldwide.
In
addition, investigations by governmental authorities (see “Legal Matters -
Nigerian joint venture and investigations” above), as well as the social,
economic, and political climate in Nigeria, could materially and adversely
affect our Nigerian business and operations. In September 2004, the Federal
Republic of Nigeria issued a directive banning Halliburton Energy Services
Nigeria Limited, one of our subsidiaries, from receiving contracts from the
Nigerian government or from companies controlled by the Nigerian government. We
believe this directive to have been originally issued as a result of an adverse
reaction in Nigeria to the theft of radioactive material that we used in
wireline logging operations, which was subsequently recovered and returned to
Nigeria. We believe this continues to be unresolved because of the matters under
investigation. We are currently working with the Nigerian government to obtain a
lifting of the ban. If the ban is not lifted, it will have an adverse effect on
our ability to conduct portions of our ESG business in Nigeria.
Our
facilities and our employees are under threat of attack in some countries where
we operate, including Iraq and Saudi Arabia. In addition, the risk of loss of
life of our personnel and of our subcontractors in these areas
continues.
Military
action, other armed conflicts, or terrorist attacks
Military
action in Iraq, increasing military tension involving North Korea, as well as
the terrorist attacks of September 11, 2001 and subsequent terrorist attacks,
threats of attacks, and unrest, have caused instability in the world’s financial
and commercial markets and have significantly increased political and economic
instability in some of the geographic areas in which we operate. Acts of
terrorism and threats of armed conflicts in or around various areas in which we
operate, such as the Middle East and Indonesia, could limit or disrupt markets
and our operations, including disruptions resulting from the evacuation of
personnel, cancellation of contracts, or the loss of personnel or
assets.
Such
events may cause further disruption to financial and commercial markets and may
generate greater political and economic instability in some of the geographic
areas in which we operate. In addition, any possible reprisals as a consequence
of the war and ongoing military action in Iraq, such as acts of terrorism in the
United States or elsewhere, could materially and adversely affect us in ways we
cannot predict at this time.
Income
taxes
We have
operations in more than 100 countries other than the United States.
Consequently, we are subject to the jurisdiction of a significant number of
taxing authorities. The income earned in these various jurisdictions is taxed on
differing bases, including net income actually earned, net income deemed earned,
and revenue based tax withholding. The final determination of our tax
liabilities involves the interpretation of local tax laws, tax treaties, and
related authorities in each jurisdiction, as well as the significant use of
estimates and assumptions regarding the scope of future operations and results
achieved and the timing and nature of income earned and expenditures incurred.
Changes in the operating environment including changes in tax law and
currency/repatriation controls could impact the determination of our tax
liabilities for a tax year.
Foreign
exchange and currency risks
A sizable
portion of our consolidated revenue and consolidated operating expenses are in
foreign currencies. As a result, we are subject to significant risks,
including:
|
- |
foreign
exchange risks resulting from changes in foreign exchange rates and the
implementation of exchange controls; and |
|
- |
limitations
on our ability to reinvest earnings from operations in one country to fund
the capital needs of our operations in other
countries. |
We
conduct business in countries that have nontraded or “soft” currencies which,
because of their restricted or limited trading markets, may be more difficult to
exchange for “hard” currency. We may accumulate cash in soft currencies, and we
may be limited in our ability to convert our profits into United States dollars
or to repatriate the profits from those countries.
We
selectively use hedging transactions to limit our exposure to risks from doing
business in foreign currencies. For those currencies that are not readily
convertible, our ability to hedge our exposure is limited because financial
hedge instruments for those currencies are nonexistent or limited. Our ability
to hedge is also limited because pricing of hedging instruments, where they
exist, is often volatile and not necessarily efficient.
In
addition, the value of the derivative instruments could be impacted
by:
|
- |
adverse
movements in foreign exchange rates; |
|
- |
the
value and time period of the derivative being different than the exposures
or cash flows being hedged. |
Customers
and Business
Exploration
and production activity
Demand
for our services and products depends on oil and natural gas industry activity
and expenditure levels that are directly affected by trends in oil and natural
gas prices.
Demand
for our products and services is particularly sensitive to the level of
exploration, development, and production activity of, and the corresponding
capital spending by, oil and natural gas companies, including national oil
companies. Prices for oil and natural gas are subject to large fluctuations in
response to relatively minor changes in the supply of and demand for oil and
natural gas, market uncertainty, and a variety of other factors that are beyond
our control. Any prolonged reduction in oil and natural gas prices will depress
the immediate levels of exploration, development, and production activity, often
reflected as changes in rig counts. Perceptions of longer-term lower oil and
natural gas prices by oil and gas companies can similarly reduce or defer major
expenditures given the long-term nature of many large-scale development
projects. Lower levels of activity result in a corresponding decline in the
demand for our oil and natural gas well services and products that could have a
material adverse effect on our revenue and profitability. Factors affecting the
prices of oil and natural gas include:
|
- |
governmental
regulations, including the policies of governments regarding the
exploration for and production and development of their oil and natural
gas reserves; |
|
- |
global
weather conditions and natural disasters; |
|
- |
worldwide
political, military, and economic
conditions; |
|
- |
the
level of oil production by non-OPEC countries and the available excess
production capacity within OPEC; |
|
- |
economic
growth in China and India; |
|
- |
oil
refining capacity and shifts in end-customer preferences toward fuel
efficiency and the use of natural gas; |
|
- |
the
cost of producing and delivering oil and
gas; |
|
- |
potential
acceleration of development of alternative fuels;
and |
|
- |
the
level of demand for oil and natural gas, especially demand for natural gas
in the United States. |
Historically,
the markets for oil and gas have been volatile and are likely to continue to be
volatile in the future. Spending on exploration and production activities and
capital expenditures for refining and distribution facilities by large oil and
gas companies have a significant impact on the activity levels of our
businesses.
Governmental
and capital spending
Our
business is directly affected by changes in governmental spending and capital
expenditures by our customers. Some of the changes that may materially and
adversely affect us include:
|
- |
a
decrease in the magnitude of governmental spending and outsourcing for
military and logistical support of the type that we provide. For example,
the current level of government services being provided in the Middle East
may not continue for an extended period of
time; |
|
- |
an
increase in the magnitude of governmental spending and outsourcing for
military and logistical support, which can materially and adversely affect
our liquidity needs as a result of additional or continued working capital
requirements to support this work; |
|
- |
a
decrease in capital spending by governments for infrastructure projects of
the type that we undertake; |
|
- |
the
consolidation of our customers, which has: |
|
|
- |
caused
customers to reduce their capital spending, which has in turn reduced the
demand for our services and products; and |
|
|
- |
resulted
in customer personnel changes, which in turn affects the timing of
contract negotiations and settlements of claims and claim negotiations
with engineering and construction customers on cost variances and change
orders on major projects; |
|
- |
adverse
developments in the business and operations of our customers in the oil
and gas industry, including write-downs of reserves and reductions in
capital spending for exploration, development, production, processing,
refining, and pipeline delivery networks;
and |
|
- |
ability
of our customers to timely pay the amounts due
us. |
Customers
Both our
Energy Services Group and KBR depend on a limited number of significant
customers. While, except for the United States Government, none of these
customers represented more than 10% of consolidated revenue in any period
presented, the loss of one or more significant customers could have a material
adverse effect on our business and our consolidated results of
operations.
Acquisitions,
dispositions, investments, and joint ventures
We may
actively seek opportunities to maximize efficiency and value through various
transactions, including purchases or sales of assets, businesses, investments or
contractual arrangements or joint ventures. These transactions would be intended
to result in the realization of savings, the creation of efficiencies, the
generation of cash or income, or the reduction of risk. Acquisition transactions
may be financed by additional borrowings or by the issuance of our common stock.
These transactions may also affect our consolidated results of
operations.
These
transactions also involve risks and we cannot ensure that:
|
- |
any
acquisitions would result in an increase in
income; |
|
- |
any
acquisitions would be successfully integrated into our
operations; |
|
- |
any
disposition would not result in decreased earnings, revenue, or cash
flow; |
|
- |
any
dispositions, investments, acquisitions, or integrations would not divert
management resources; or |
|
- |
any
dispositions, investments, acquisitions, or integrations would not have a
material adverse effect on our results of operations or financial
condition. |
Now that
we have resolved our asbestos and silica liability and our affected subsidiaries
have exited Chapter 11 reorganization proceedings, we intend to separate KBR
from Halliburton, which could include a transaction involving a spin-off,
split-off, public offering, or sale of KBR or its operations. In order to
maximize KBR’s value for our shareholders, and to determine the most appropriate
form of the transaction and its components, it may be necessary for KBR to
establish a track record of positive earnings for a number of quarters and to
seek resolution of governmental issues, investigations, and other
disputes.
We
conduct some operations through joint ventures, where control may be shared with
unaffiliated third parties. As with any joint venture arrangement, differences
in views among the joint venture participants may result in delayed decisions or
in failures to agree on major issues. We also cannot control the actions of our
joint venture partners, including any nonperformance, default, or bankruptcy of
our joint venture partners. These factors could potentially materially and
adversely affect the business and operations of the joint venture and, in turn,
our business and operations.
Fixed-price
contracts
We
contract to provide services either on a cost-reimbursable basis or on a
fixed-price basis. We bear the risk of cost overruns, operating cost inflation,
labor availability and productivity, and supplier and subcontractor pricing and
performance in connection with projects covered by fixed-price contracts. Our
failure to estimate accurately the resources and time required for a fixed-price
project or our failure to complete our contractual obligations within the time
frame and costs committed could have a material adverse effect on our business,
results of operations, and financial condition.
Environmental
requirements
Our
businesses are subject to a variety of environmental laws, rules, and
regulations in the United States and other countries, including those covering
hazardous materials and requiring emission performance standards for facilities.
For example, our well service operations routinely involve the handling of
significant amounts of waste materials, some of which are classified as
hazardous substances. We also store, transport, and use radioactive and
explosive materials in certain of our operations. Environmental requirements
include, for example, those concerning:
|
- |
the
containment and disposal of hazardous substances, oilfield waste, and
other waste materials; |
|
- |
the
importation and use of radioactive
materials; |
|
- |
the
use of underground storage tanks; and |
|
- |
the
use of underground injection wells. |
Environmental
and other similar requirements generally are becoming increasingly strict.
Sanctions for failure to comply with these requirements, many of which may be
applied retroactively, may include:
|
- |
administrative,
civil, and criminal penalties; |
|
- |
revocation
of permits to conduct business; and |
|
- |
corrective
action orders, including orders to investigate and/or clean-up
contamination. |
Failure
on our part to comply with applicable environmental requirements could have a
material adverse effect on our consolidated financial condition. We are also
exposed to costs arising from environmental compliance, including compliance
with changes in or expansion of environmental requirements, such as the
potential regulation in the United States of our Energy Services Group’s
hydraulic fracturing services and products as underground injection, which could
have a material adverse effect on our business, financial condition, operating
results, or cash flows.
We are
exposed to claims under environmental requirements, and, from time to time, such
claims have been made against us. In the United States, environmental
requirements and regulations typically impose strict liability. Strict liability
means that in some situations we could be exposed to liability for clean-up
costs, natural resource damages, and other damages as a result of our conduct
that was lawful at the time it occurred or the conduct of prior operators or
other third parties. Liability for damages arising as a result of environmental
laws could be substantial and could have a material adverse effect on our
consolidated results of operations.
Changes
in environmental requirements may negatively impact demand for our services. For
example, oil and natural gas exploration and production may decline as a result
of environmental requirements (including land use policies responsive to
environmental concerns). A decline in exploration and production, in turn, could
materially and adversely affect us.
Regulatory
requirements
We are
subject to a number of global and industry wide regulatory and licensing
requirements related to the radioactive sources, explosives and chemicals used
in our business. In addition, there are numerous regulatory and licensing
requirements related to ownership, employee qualifications, transportation,
storage, and handling of those materials. Changes in the regulatory and
licensing requirements or our failure to comply with regulatory or licensing
requirements related to those materials may negatively impact our ability to
provide services in some jurisdictions and could materially and adversely affect
us.
Intellectual
property rights
We rely
on a variety of intellectual property rights that we use in our products and
services. We may not be able to successfully preserve these intellectual
property rights in the future, and these rights could be invalidated,
circumvented, or challenged. In addition, the laws of some foreign countries in
which our products and services may be sold do not protect intellectual property
rights to the same extent as the laws of the United States. Our failure to
protect our proprietary information and any successful intellectual property
challenges or infringement proceedings against us could materially and adversely
affect our competitive position.
Technology
The
market for our products and services is characterized by continual technological
developments to provide better and more reliable performance and services. If we
are not able to design, develop, and produce commercially competitive products
and to implement commercially competitive services in a timely manner in
response to changes in technology, our business and revenue could be materially
and adversely affected, and the value of our intellectual property may be
reduced. Likewise, if our proprietary technologies, equipment and facilities, or
work processes become obsolete, we may no longer be competitive, and our
business and revenue could be materially and adversely affected.
Systems
Our
business could be materially and adversely affected by problems encountered in
the installation of a new SAP financial system to replace the current systems
for KBR.
Technical
personnel
Many of
the services that we provide and the products that we sell are complex and
highly engineered and often must perform or be performed in harsh conditions. We
believe that our success depends upon our ability to employ and retain technical
personnel with the ability to design, utilize, and enhance these products and
services. In addition, our ability to expand our operations depends in part on
our ability to increase our skilled labor force. The demand for skilled workers
is high, and the supply is limited. A significant increase in the wages paid by
competing employers could result in a reduction of our skilled labor force,
increases in the wage rates that we must pay, or both. If either of these events
were to occur, our cost structure could increase, our margins could decrease,
and our growth potential could be impaired.
Weather
Our
businesses could be materially and adversely affected by severe weather,
particularly in the Gulf of Mexico where we have significant operations.
Repercussions of severe weather conditions may include:
|
- |
evacuation
of personnel and curtailment of services; |
|
- |
weather-related
damage to offshore drilling rigs resulting in suspension of
operations; |
|
- |
weather-related
damage to our facilities; |
|
- |
inability
to deliver materials to jobsites in accordance with contract schedules;
and |
Because
demand for natural gas in the United States drives a disproportionate amount of
our Energy Services Group’s United States business, warmer than normal winters
in the United States are detrimental to the demand for our services to gas
producers.
Item
3. Quantitative and Qualitative Disclosures about Market
Risk
We are
exposed to financial instrument market risk from changes in foreign currency
exchange rates, interest rates, and, to a limited extent, commodity prices. We
selectively manage these exposures through the use of derivative instruments to
mitigate our market risk from these exposures. The objective of our risk
management is to protect our cash flows related to sales or purchases of goods
or services from market fluctuations in currency rates. Our use of derivative
instruments includes the following types of market risk:
|
- |
volatility
of the currency rates; |
|
- |
time
horizon of the derivative instruments; |
|
- |
the
type of derivative instruments used. |
We do not
use derivative instruments for trading purposes. We do not consider any of these
risk management activities to be material.
Item
4. Controls and Procedures
In
accordance with the Securities Exchange Act of 1934 Rules 13a-15 and 15d-15, we
carried out an evaluation under the supervision and with the participation of
management, including our Chief Executive Office 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 March 31, 2005 to provide reasonable assurance
that information required to be disclosed in our reports filed or submitted
under the Exchange Act is recorded, processed, summarized, and reported within
the time periods specified in the Securities and Exchange Commission’s rules and
forms. Our disclosure controls and procedures include controls and procedures
designed to ensure that information required to be disclosed in reports filed or
submitted under the Exchange Act is accumulated and communicated to our
management, including our Chief Executive Officer and Chief Financial Officer,
as appropriate, to allow timely decisions regarding required
disclosure.
There has
been no change in our internal control over financial reporting that occurred
during the three months ended March 31, 2005 that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.
PART
II. OTHER INFORMATION
Item
1. Legal Proceedings
Information
relating to various commitments and contingencies is described in “Management’s
Discussion and Analysis of Financial Condition and Results of Operations,” in
“Forward-Looking Information and Risk Factors,” and in Notes 11, 12, and 13 to
the condensed consolidated financial statements.
Item
2. Unregistered Sales of Equity Securities and Use of
Proceeds
Following
is a summary of our repurchases of our common stock during the three-month
period ended March 31, 2005.
|
|
|
|
|
|
Total
Number of |
|
|
|
|
|
|
|
Shares
Purchased as |
|
|
|
Total |
|
|
|
Part
of Publicly |
|
|
|
Numberof
Shares |
|
Average
Price Paid |
|
Announced
Plans or |
|
Period |
|
Purchased
(a) |
|
per
Share |
|
Programs |
|
January
1-31 |
|
|
86,578 |
|
$ |
40.24 |
|
|
- |
|
February
1-28 |
|
|
21,503 |
|
$ |
40.13 |
|
|
- |
|
March
1-31 |
|
|
45,017 |
|
$ |
44.54 |
|
|
- |
|
Total |
|
|
153,098 |
|
$ |
41.49 |
|
|
- |
|
(a) All of
the shares repurchased during the three-month period ended March 31, 2005 were
acquired from employees in connection with the settlement of income tax and
related benefit withholding obligations arising from vesting in restricted stock
grants. These share purchases were not part of a publicly announced program to
purchase common shares.
On April
25, 2000, our Board of Directors approved plans to implement a share repurchase
program for up to 44 million shares of our common stock, of which 22,385,700
shares may yet be purchased.
Item
3. Defaults Upon Senior Securities
None.
Item
4. Submission of Matters to a Vote of Security Holders
None.
Item
5. Other Information
None.
Item
6. Exhibits
10.1 |
Five
Year Revolving Credit Agreement among Halliburton, as Borrower, the Banks
and the Issuing Banks party thereto, Citicorp North America, Inc.
(“CNAI”), as Paying Agent, and CNAI and JPMorgan Chase Bank, N.A., as
Co-Administrative Agents (incorporated by reference to Exhibit 10.1 to
Halliburton’s Form 8-K filed March 10, 2005, File No.
1-3492). |
|
|
10.2 |
Amendment
to Stockholder Agreement dated March 17, 2005 between Halliburton Company
and DII Industries, LLC Asbestos PI Trust (incorporated by reference to
Exhibit 10.1 to Halliburton’s Form 8-K filed March 18, 2005, File No.
1-3492). |
|
|
10.3 |
Underwriting
Agreement dated March 17, 2005 among Halliburton Company, DII Industries,
LLC Asbestos PI Trust, J.P. Morgan Securities Inc., Goldman, Sachs &
Co., and Citigroup Global Markets Inc. (incorporated by reference to
Exhibit 10.2 to Halliburton’s Form 8-K filed March 18, 2005, File No.
1-3492). |
|
|
* 12 |
Statement
of Computation of Ratio of Earnings to Fixed Charges. |
|
|
* 31.1 |
Certification
of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002. |
|
|
* 31.2 |
Certification
of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002. |
|
|
** 32.1 |
Certification
of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002. |
|
|
** 32.2 |
Certification
of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002. |
|
|
* |
Filed
with this Form 10-Q |
** |
Furnished
with this Form 10-Q |
SIGNATURES
As
required by the Securities Exchange Act of 1934, the registrant has authorized
this report to be signed on behalf of the registrant by the undersigned
authorized individuals.
HALLIBURTON
COMPANY
|
|
|
|
/s/ C.
Christopher Gaut |
|
|
/s/ Mark A.
McCollum |
|
|
|
|
C. Christopher
Gaut Executive Vice President and Chif Financial Officer |
|
|
Mark A. McCollum
Senior Vice President
and Chief Accounting
Officer |
Date: April
29, 2005