form10k.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

(Mark One)
T
Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the fiscal year ended December 31, 2008

OR

£
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the transition period from              to

Commission File Number 1-33146

KBR, Inc.
(Exact name of registrant as specified in its charter)

 
Delaware
20-4536774
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)

601 Jefferson Street
Suite 3400
Houston, Texas 77002
(Address of principal executive offices)
Telephone Number - Area code (713) 753-3011

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

Title of each class
 
Name of each Exchange on which registered
Common Stock par value $0.001 per share
 
New York Stock Exchange

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

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes  T    No  £

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes  £    No  T

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    T     No    £

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer T
Accelerated filer £
Non-accelerated filer £
Smaller reporting company £
(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  £    No  T

The aggregate market value of the voting stock held by non-affiliates on June 30, 2008, was approximately $5,423,000,000, determined using the closing price of shares of common stock on the New York Stock Exchange on that date of $34.91.

As of February 20, 2009, there were 161,811,707 shares of KBR, Inc. Common Stock, $0.001 par value per share, outstanding.

DOCUMENTS INCORPORATED BY REFERENCE
Portions of the KBR, Inc. Company Proxy Statement for our 2009 Annual Meeting of Stockholders are incorporated by reference into Part III of this report.
 


 
 

 

TABLE OF CONTENTS

 
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Forward-Looking and Cautionary Statements

This report contains certain statements that are, or may be deemed to be, “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The Private Securities Litigation Reform Act of 1995 provides safe harbor provisions for forward looking information. Some of the statements contained in this annual report are forward-looking statements. All statements other than statements of historical fact are, or may be deemed to be, forward-looking statements. The words “believe,” “may,” “estimate,” “continue,” “anticipate,” “intend,” “plan,” “expect” and similar expressions are intended to identify forward-looking statements. Forward-looking statements include information concerning our possible or assumed future financial performance and results of operations.

We have based these statements on our assumptions and analyses in light of our experience and perception of historical trends, current conditions, expected future developments and other factors we believe are appropriate in the circumstances. Forward-looking statements by their nature involve substantial risks and uncertainties that could significantly affect expected results, and actual future results could differ materially from those described in such statements. While it is not possible to identify all factors, factors that could cause actual future results to differ materially include the risks and uncertainties described under “Risk Factors” contained in Part I of this Annual Report on Form 10-K.

Many of these factors are beyond our ability to control or predict. Any of these factors, or a combination of these factors, could materially and adversely affect our future financial condition or results of operations and the ultimate accuracy of the forward-looking statements. These forward-looking statements are not guarantees of our future performance, and our actual results and future developments may differ materially and adversely from those projected in the forward-looking statements. We caution against putting undue reliance on forward-looking statements or projecting any future results based on such statements or present or prior earnings levels. In addition, each forward-looking statement speaks only as of the date of the particular statement, and we undertake no obligation to publicly update or revise any forward-looking statement.


PART I

Item 1. Business

General

KBR, Inc. (“KBR”) is a leading global engineering, construction and services company supporting the energy, petrochemicals, government services, industrial and civil infrastructure sectors. We provide our wide range of services through six business units; Government and Infrastructure (“G&I”), Upstream, Services, Downstream, Technology and Ventures.  See Note 7 to our consolidated financial statements for financial information about our reportable business segments.

KBR, Inc. was incorporated in Delaware on March 21, 2006 as an indirect wholly-owned subsidiary of Halliburton Company (“Halliburton”). KBR was formed to own and operate KBR Holdings, LLC (“KBR Holdings”), which was contributed to KBR by Halliburton in November 2006. KBR had no operations from the date of its formation to the date of the contribution of KBR Holdings. In November 2006, KBR, Inc. completed an initial public offering of 32,016,000 shares, or approximately 19%, of its common stock (the “Offering”) at $17.00 per share. Halliburton retained all of the KBR shares owned prior to the Offering and, as a result of the Offering, its 135,627,000 shares of common stock represented 81% of the outstanding common stock of KBR, Inc. after the Offering. On February 26, 2007, Halliburton’s board of directors approved a plan under which Halliburton would dispose of its remaining interest in KBR through a tax-free exchange with Halliburton’s stockholders pursuant to an exchange offer. On April 5, 2007, Halliburton completed the separation of KBR by exchanging the 135,627,000 shares of KBR owned by Halliburton for publicly held shares of Halliburton common stock pursuant to the terms of the exchange offer (the “Exchange Offer”) commenced by Halliburton on March 2, 2007.

In May 2006, we completed the sale of our Production Services group, which was part of our Services business unit. The Production Services group delivers a range of support services, including asset management and optimization; brownfield projects; engineering; hook-up, commissioning and start-up; maintenance management and execution; and long-term production operations, to oil and gas exploration and production customers. In connection with the sale, we received net proceeds of $265 million. The sale of Production Services resulted in a pre-tax gain of approximately $120 million in the year ended December 31, 2006.

In June 2007, we completed the disposition of our 51% interest in Devonport Management Limited (“DML”) to Babcock International Group plc. DML owns and operates Devonport Royal Dockyard, one of Western Europe’s largest naval dockyard complexes. Our DML operations, which was part of our G&I business unit, primarily involved refueling nuclear submarines and performing maintenance on surface vessels for the U.K. Ministry of Defence as well as limited commercial projects. In connection with the sale of our 51% interest in DML, we received $345 million in cash proceeds, net of direct transaction costs, resulting in a gain of approximately $101 million, net of tax of $115 million.

In April 2008, we acquired 100% of the outstanding common stock of Turnaround Group of Texas, Inc. (“TGI”) and Catalyst Interactive for approximately $12 million. TGI is a Houston-based turnaround management and consulting company that specializes in the planning and execution of turnarounds and outages in the petrochemical, power, and pulp & paper industries. Catalyst Interactive is an Australian e-learning and training solution provider that specializes in the defense, government and industry training sectors. TGI’s results of operations are included in our Services business unit. Catalyst Interactive’s results of operations are included in our Government & Infrastructure business unit.

In July 2008, we acquired 100% of the outstanding common shares of BE&K, Inc., (“BE&K”) a privately held, Birmingham, Alabama-based engineering, construction and maintenance services company. The acquisition of BE&K enhances our ability to provide contractor and maintenance services in North America. The agreed-upon purchase price was $550 million in cash subject to certain indemnifications and stockholders equity adjustments as defined in the stock purchase agreement. BE&K and its acquired divisions have been integrated into our Services, Downstream and Government & Infrastructure business units based upon the nature of the underlying projects acquired.

In October 2008, we acquired 100% of the outstanding common stock of Wabi Development Corporation (“Wabi”) for approximately $20 million in cash. Wabi is a privately held Canada-based general contractor, which provides services for the energy, forestry and mining industries. Wabi currently employs over 120 people, providing maintenance, fabrication, construction and construction management services to a variety of clients in Canada and Mexico. Wabi has been integrated into our Services business unit and it provides additional growth opportunities for our heavy hydrocarbon, forestry, oil sand, general industrial and maintenance services business.

See Note 4 to our consolidated financial statements for further discussion of our recent acquisitions.


Our Business Units

Downstream.  Our Downstream business unit serves clients in the petrochemical, refining, coal gasification and syngas markets, executing projects throughout the world. We leverage our differentiated process technologies, some of which are the most efficient ones available in the market today, and also execute projects using non-KBR technologies, either alone or with joint venture or alliance partners to a wide variety of customers. Downstream’s work with KBR’s Ventures business unit has resulted in creative equity participation structures such as our Egypt Basic Industries Corporation Ammonia plant which offers our customers unique solutions to meet their project development needs. We are a leading contractor in the markets that we serve delivering projects through a variety of service offerings including front-end engineering design (“FEED”), detailed engineering, engineering, procurement and construction (“EPC”), engineering, procurement and construction management  (“EPCM”) and program management. We are dedicated to providing life cycle value to our customers.

Government and Infrastructure.  Our G&I business unit provides program and project management, contingency logistics, operations and maintenance, construction management, engineering and other services to military and civilian branches of governments and private clients worldwide. We deliver on-demand support services across the full military mission cycle from contingency logistics and field support to operations and maintenance on military bases. A significant portion of our G&I business unit’s current operations relate to the support of the United States government operations in the Middle East, which we refer to as our Middle East operations, and is one of the largest U.S. military deployments since World War II. In the civil infrastructure market, we operate in diverse sectors, including transportation, waste and water treatment and facilities maintenance. We design, construct, maintain and operate and manage civil infrastructure projects ranging from airport, rail, highway, water and wastewater facilities, and mining and mineral processing to regional development programs and major events. We provide many of these services to foreign governments such as the United Kingdom and Australia.

Services. Our Services business unit delivers full scope construction, construction management, fabrication, maintenance, and turnaround expertise to customers worldwide.  Our experience is broad and based on 90 years of successful project realization beginning with the founding of legacy company Brown & Root in 1919.  With the acquisition of BE&K, our reach has expanded and now includes engineering as well as construction and maintenance services to address power, alternate energy, pulp and paper, industrial and manufacturing, and pharmaceutical industries in addition to our base markets in the oil, gas, petrochemicals and hydrocarbon processing industries.  We provide construction related services to education, food and beverage, healthcare, hospitality and entertainment, life science and technology, and mixed use building clients through our Building Group. KBR Services and its joint venture partner offer maintenance and construction related services for offshore oil and gas producing facilities in the Bay of Campeche through the use of semisubmersible vessels.

Technology.  Our Technology business unit offers differentiated process technologies, some of which are the most efficient ones available in the market today, including value-added technologies in the coal monetization, petrochemical, refining and syngas markets. We offer technology licenses, and, in conjunction with our Downstream business unit, offer project management and engineering, procurement and construction for integrated solutions worldwide. We are one of a few engineering and construction companies to possess a technology center, with 80 years of experience in technology research and development.

Upstream.  Our Upstream business unit provides a full range of services for large, complex upstream projects, including liquefied natural gas (“LNG”), gas-to-liquids (“GTL”), onshore oil and gas production facilities, offshore oil and gas production facilities, including platforms, floating production and subsea facilities, and onshore and offshore pipelines. In gas-to-liquids, we are leading the construction of two of the world’s three gas-to-liquids projects under construction or start-up, the size of which exceeds that of almost any other in the industry. Our Upstream business unit has designed and constructed some of the world’s most complex onshore facility and pipeline projects and, in the last 30 years, more than half of the world's operating LNG liquefaction capacity. In oil & gas, we provide integrated engineering and program management solutions for offshore production facilities and subsea developments, including the design of the largest floating production facility in the world to date.

Ventures.   Our Ventures business unit assists clients to realize projects through innovative commercial structures that lead to financed projects. The business unit invests and manages KBR equity in certain projects where the Company’s other business units provide engineering, procurement, construction, and/or operations and maintenance services. Project equity investments under current management include defense equipment and housing, toll roads and petrochemicals.


Our Significant Projects

The following table summarizes several significant contracts under which business units are currently providing or have recently provided services.

G&I-Middle East

Project Name
 
Customer Name
 
Location
 
Contract Type
 
Description
 LogCAP III
 
U.S. Army
 
Worldwide
 
Cost-reimbursable
 
Contingency support services.

G&I-Americas

Project Name
 
Customer Name
 
Location
 
Contract Type
 
Description
CENTCOM
 
U.S. Army
 
Middle East
 
Fixed-price and cost-reimbursable
 
Construction of military infrastructure and support facilities.
                 
U.S. Embassy Macedonia
 
U.S. Department of State
 
Macedonia
 
Fixed-price
 
Design and construction of embassy.
                 
DOCCC-Office of Space Launch
 
NRO Office of Space Launch
 
USA
 
Fixed-price plus award fee
 
Provide on call project management, construction management and related support for mission critical facilities at Cape Canaveral and other locations.
                 
Qatar Bahrain Causeway Phase I and II
 
Qatar Bahrain Causeway Foundation
 
Qatar/Bahrain
 
Cost-reimbursable
 
Program management contracting.
                 
USAREUR
 
U.S. Army
 
Europe (Balkans)
 
Fixed- price and cost-reimbursable
 
Contingency support within the USAREUR AOR; Balkans Support.

G&I-International

Project Name
 
Customer Name
 
Location
 
Contract Type
 
Description
Aspire Defence-Allenby & Connaught Accommodation Project
 
Aspire Defence U.K. Ministry of Defence
 
U.K.
 
Fixed-price and cost-reimbursable
 
Design, build and finance the upgrade and service of army facilities.
                 
Temporary Deployable Accommodations (“TDA”)
 
U.K. Ministry of Defence
 
Worldwide
 
Fixed-price
 
Battlefield infrastructure support.
                 
CONLOG
 
U.K. Ministry of Defence
 
Worldwide
 
Fixed- price and cost-reimbursable
 
Provide contingency support services to MOD.
                 
Hope Downs Iron Ore Project
 
Rio Tinto IO
 
Western Australia
 
Cost-reimbursable
 
Engineering, Procurement & Construction Management.
                 
Afghanistan ISP UK
 
Ministry of Defense (Defense Estates)
 
Afghanistan
 
Firm-fixed price
 
Construction of military infrastructure and support facilities.
                 
Tier 3 Basra
 
UK Ministry of Defense Basra
 
Iraq
 
Fixed-price and cost-reimbursable
 
Construction of Hardened Accommodation (Field Hospital, DFAC)


Upstream- Gas Monetization

Project Name
 
Customer Name
 
Location
 
Contract Type
 
Description
Tangguh LNG
 
BP Berau Ltd.
 
Indonesia
 
Fixed-price
 
EPC-CS services for two LNG liquefaction trains; joint venture with JGC and PT Pertafenikki Engineering of Indonesia.
                 
Yemen LNG
 
Yemen LNG Company Ltd.
 
Yemen
 
Fixed-price
 
EPC-CS services for two LNG liquefaction trains; joint venture with JGC and Technip.
                 
NLNG Train 6
 
Nigeria LNG Ltd.
 
Nigeria
 
Fixed-price
 
EPC-CS services for one LNG liquefaction train; working through TSKJ joint venture.
                 
Skikda LNG
 
Sonatrach
 
Algeria
 
Fixed-price and cost-reimbursable
 
EPC-CS services for one LNG liquefaction train.
                 
Escravos GTL
 
Chevron Nigeria Ltd & Nigeria National Petroleum Corp.
 
Nigeria
 
Cost-reimbursable
 
EPC-CS services for a GTL plant producing diesel, naphtha and liquefied petroleum gas; joint venture with JGC and Snamprogetti.
                 
Pearl GTL
 
Qatar Shell GTL Ltd.
 
Qatar
 
Cost-reimbursable
 
Front-end engineering design (“FEED”) work and project management for the overall complex and EPCM for the GTL synthesis and utilities portions of the complex; joint venture with JGC.
   
 
           
Gorgon LNG
 
Chevron Australia Pty Ltd
 
Australia
 
Cost-reimbursable
 
Front-end engineering design (“FEED”) work and project management for a Liquefied Natural Gas (LNG) facility on Barrow Island; joint venture with KJVG.

Upstream-Offshore

Project Name
 
Customer Name
 
Location
 
Contract Type
 
Description
Azeri-Chirag- Gunashli
 
AIOC
 
Azerbaijan
 
Cost-reimbursable
 
Engineering and procurement services for six offshore platforms, subsea facilities, 600 kilometers of offshore pipeline and onshore terminal upgrades.
                 
Kashagan
 
AGIP
 
Kazakhstan
 
Cost-reimbursable
 
Project management services for the development of multiple facilities in the Caspian Sea.
                 
EOS JV North Rankin 2 (NR2)
 
Woodside Energy Limited
 
Australia
 
Fixed-price
 
Detailed engineering and procurement management services to maintain gas supply to its onshore LNG facility, principally by providing compression facilities for the low pressure Perseus reservoir.

Upstream-Other

Project Name
 
Customer Name
 
Location
 
Contract Type
 
Description
KEP2010
 
Statoil Hydro
 
Norway
 
Cost-reimbursable
 
Engineering and support services for the overall construction of an upgrade to a gas plant.


Services

Project Name
 
Customer Name
 
Location
 
Contract Type
 
Description
Georgia Power
 
Georgia Power
 
Georgia
 
Cost-reimbursable
 
Provision of project management, procurement, and construction services for coal-fired power generation plant and environmental remediation.
                 
Shell Scotford
 
Shell Canada
 
Canada
 
Cost-reimbursable and fixed-price
 
Provision of direct hire construction services and fixed-unit rate module/pipe fabrication for oil sands upgrader project.
                 
LCRA
 
Lower Colorado River Authority
 
Texas
 
Cost- reimbursable
 
Provision of project management, procurement, and construction services of power generation plant.
                 
Hunt Refining
 
Hunt Refining
 
Alabama
 
Cost-reimbursable
 
Provision of process construction services and project management for refinery expansion.
                 
Borger
 
ConocoPhillips
 
Texas
 
Cost- reimbursable
 
Provision of direct hire construction services for a Benzene unit

Downstream

Project Name
 
Customer Name
 
Location
 
Contract Type
 
Description
Ethylene/Olefins Facility
 
Saudi Kayan Petrochemical Company
 
Saudi Arabia
 
Fixed-price
 
Basic process design and EPCM services for a new ethylene facility using SCORE technology
                 
Ras Tanura Integrated Project
 
Dow and Saudi Aramco
 
Saudi Arabia
 
Cost-reimbursable
 
FEED and PM/CM of an integrated refinery and Petrochemical complex.
                 
Yanbu Export Refinery Project
 
Aramco Services Co. and ConocoPhillips Yanbu Ltd.
 
Saudi Arabia
 
Cost-reimbursable
 
Program management services including FEED for a new 400,000 barrels per day green field export refinery.
                 
Ammonia Plant
 
Egypt Basic Industries Corporation
 
Egypt
 
Fixed-price
 
EPC-CS services for an ammonia plant based on KBR Advanced Ammonia Process technology.

Technology

Project Name
 
Customer Name
 
Location
 
Contract Type
 
Description
Moron Ammonia Plant
 
Ferrostaal/Pequiven
 
Venezuela
 
Fixed-price
 
Technology license and engineering services.
                 
Jose Ammonia Facility LBEP
 
Pequiven
 
Venezuela
 
Fixed-price
 
Technology license and basic engineering services.
                 
Puerto Nutrias Ammonia Facility LBEP
 
Pequiven
 
Venezuela
 
Fixed-price
 
Technology license and basic engineering services.
                 
Hazira Ammonia Plant Revamp
 
KRIBHCO
 
India
 
Fixed-price
 
Technology license and basic engineering services.


Ventures

Project Name
 
Customer Name
 
Location
 
Contract Type
 
Description
Egypt Basic Industries (EBIC)-Ammonia Project
 
Various
 
Egypt
 
Market rates
 
Design, build, own, finance and operate an ammonia plant.
                 
Aspire Defence-Allenby & Connaught Defence Accommodation Project
 
U.K. Ministry of Defence
 
U.K.
 
Fixed-price and cost-reimbursable
 
Design, build and finance the upgrade and service of army facilities.

See Note 7 to the consolidated financial statements for financial information about our reportable business segments.

Our Business Strategy

Our business strategy is to create sustainable shareholder value by providing our customers differentiated capital project and services offerings across the entire engineering, construction and services project lifecycle.  We will execute our business strategy on a global scale through best in class risk awareness, delivering consistent, predictable financial results in all markets where we operate. Our core skills are conceptual design, FEED (front-end engineering design), engineering, project management, procurement, construction, construction management, operations and maintenance.  Our primary activities are scalable, which will enable us to grow the company organically. We will complement organic growth by pursuing targeted merger and acquisition opportunities with a focus on expanding our product and services offerings and market coverage to accelerate implementation of individual Business Unit strategies. Key features of our business unit strategies include:

 
·
The Government and Infrastructure business unit will broaden our logistical design, infrastructure and other service offerings to existing customers and cross-sell to adjacent markets.

 
·
The Upstream business unit will build on our world-class strength and experience in gas monetization and seek to expand our footprint in offshore oil and gas services.

 
·
The Services business unit will expand existing operations while pursuing new offerings that capitalize on our brand reputation and legacy core competencies.

 
·
The Downstream business unit will grow by leveraging our leading technologies and execution excellence to provide life-cycle value to customers.

 
·
The Technology business unit will expand our range of differentiated process technologies and increase our proprietary equipment and catalyst offerings.

 
·
The Ventures business unit will differentiate the offerings of our business units by investing capital and arranging project finance.

Competition and Scope of Global Operations

We operate in highly competitive markets throughout the world. The principal methods of competition with respect to sales of our capital project and service offerings include:

 
customer relationships;

 
technical excellence or differentiation;

 
price;

 
service delivery, including the ability to deliver personnel, processes, systems and technology on an “as needed, where needed, when needed” basis with the required local content and presence;

 
service quality;

 
health, safety, and environmental standards and practices;


 
financial strength;

 
breadth of technology and technical sophistication;

 
risk management awareness and processes; and

 
warranty.

We conduct business in over 45 countries. Based on the location of services provided, our operations in countries other than the United States accounted for 85% of our consolidated revenue during 2008, 89% of our consolidated revenue during 2007 and 85% of our consolidated revenue during 2006. Revenue from our operations in Iraq, primarily related to our work for the U.S. government, was 43% of our consolidated revenue in 2008, 50% of our consolidated revenue in 2007 and 49% of our consolidated revenue in 2006. See Note 7 to our consolidated financial statements for selected geographic information.

We market substantially all of our capital project and service offerings through our servicing and sales organizations. We serve highly competitive industries and we have many substantial competitors in the markets that we serve. Some of our competitors have greater financial and other resources and better access to capital than we do, which may enable them to compete more effectively for large-scale project awards. The companies competing in the markets that we serve include but are not limited to AMEC, Bechtel Corporation, CH2M Hill Companies Ltd., Chicago Bridge and Iron Co., N.V., Chiyoda, DynCorp, Fluor Corporation, Foster Wheeler Ltd., Jacobs Engineering Group, Inc., Shaw Group, Inc., Technip, URS Corporation, and Worley Parsons Ltd. Additionally, in April 2008, we were selected as one of the executing contractors under the multiple service provider LogCAP IV contract along with Fluor Corporation and DynCorp International. Since the markets for our services are vast and cross numerous geographic lines, we cannot make a meaningful estimate of the total number of our competitors.

Our operations in some countries may be adversely affected by unsettled political conditions, acts of terrorism, civil unrest, force majeure, war or other armed conflict, expropriation or other governmental actions, inflation, exchange controls and currency fluctuations. Please read “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Financial Instruments Market Risk” and Note 15 to our consolidated financial statements for information regarding our exposures to foreign currency fluctuations, risk concentration, and financial instruments used to manage our risks.

Joint Ventures and Alliances

We enter into joint ventures and alliances with other industry participants in order to reduce and diversify risk, increase the number of opportunities that can be pursued, capitalize on the strengths of each party, expand or create the relationships of each party with different potential customers, and allow for greater flexibility in choosing the preferred location for our services based on the greatest cost and geographical efficiency. Several of our significant joint ventures and alliances are described below. All joint venture ownership percentages presented are as of December 31, 2008.

In 2002, we entered into a cooperative agreement with ExxonMobil Research and Engineering Company for licensing fluid catalytic cracking technology that was an extension of a previous agreement with Mobil Oil Corporation. Under this alliance, we offer to the industry certain fluid catalytic cracking technology that is available from both parties. We lead the marketing effort under this collaboration, and we co-develop certain new fluid catalytic cracking technology.

 M.W. Kellogg Limited (“MWKL”) is a London-based joint venture that provides full EPC-CS contractor services for LNG, GTL and onshore oil and gas projects. MWKL is owned 55% by us and 45% by JGC. MWKL supports both of its parent companies, on a stand-alone basis or through our gas alliance with JGC, and also provides services to other third party customers. We consolidate MWKL for financial accounting purposes.

TKJ Group is a consortium consisting of several private limited liability companies registered in Dubai, UAE. The TKJ Group was created for the purpose of trading equipment and the performance of services required for the realization, construction, and modification of maintenance of oil, gas, chemical, or other installations in the Middle East. KBR holds a 33.3% interest in the TKJ Group companies. We account for this investment using the equity method of accounting.

TSKJ Group is a joint venture consisting of several limited liability companies formed to design and construct large-scale projects in Nigeria. TSKJ’s members are Technip, SA of France, Snamprogetti Netherlands B.V., which is a subsidiary of Saipem SpA of Italy, JGC and us, each of which has a 25% interest. TSKJ has completed six LNG production facilities on Bonny Island, Nigeria and has performed the engineering and design work on a seventh such facility. We account for this investment using the equity method of accounting.

Aspire Defence—Allenby & Connaught is a joint venture between us, Carillion Plc. and a financial investor formed to contract with the U.K. Ministry of Defence to upgrade and provide a range of services to the British Army’s garrisons at Aldershot and around the Salisbury Plain in the United Kingdom. We own a 45% interest in Aspire Defence. In addition, we own a 50% interest in each of the two joint ventures that provide the construction and related support services to Aspire Defence. We account for our investments in these entities using the equity method of accounting.


MMM is a joint venture formed under a Partners Agreement with Grupo R affiliated entities. The principal Grupo R entity is Corporative Grupo R, S.A. de C.V. and Discoverer ASA, Ltd a Cayman Islands company. The partners agreement covers five joint venture entities related to the Mexico contract with PEMEX. The MMM joint venture was set up under Mexican maritime law in order to hold navigation permits to operate in Mexican waters. The scope of the business is to render services of maintenance, repair and restoration of offshore oil and gas platforms and provisions of quartering in the territorial waters of Mexico. We own a 50% interest in MMM and in each of the four other joint ventures. We account for our investment in these entities using the equity method of accounting.

Backlog

Backlog represents the dollar amount of revenue we expect to realize in the future as a result of performing work under multi-period contracts that have been awarded to us. Backlog is not a measure defined by generally accepted accounting principles, and our methodology for determining backlog may not be comparable to the methodology used by other companies in determining their backlog. Backlog may not be indicative of future operating results. Not all of our revenue is recorded in backlog for a variety of reasons, including the fact that some projects begin and end within a short-term period. Many contracts do not provide for a fixed amount of work to be performed and are subject to modification or termination by the customer. The termination or modification of any one or more sizeable contracts or the addition of other contracts may have a substantial and immediate effect on backlog.

We generally include total expected revenue in backlog when a contract is awarded and/or the scope is definitized. For our projects related to unconsolidated joint ventures, we have included in the table below our percentage ownership of the joint venture’s revenue in backlog. However, because these projects are accounted for under the equity method, only our share of future earnings from these projects will be recorded in our revenue. Our backlog for projects related to unconsolidated joint ventures totaled $2.4 billion at December 31, 2008 and $3.1 billion at December 31, 2007. We also consolidate joint ventures which are majority-owned and controlled or are variable interest entities in which we are the primary beneficiary. Our backlog included in the table below for projects related to consolidated joint ventures with minority interest includes 100% of the backlog associated with those joint ventures and totaled $3.1 billion at December 31, 2008 and $3.2 billion at December 31, 2007.

For long-term contracts, the amount included in backlog is limited to five years. In many instances, arrangements included in backlog are complex, nonrepetitive in nature, and may fluctuate depending on expected revenue and timing. Where contract duration is indefinite, projects included in backlog are limited to the estimated amount of expected revenue within the following twelve months. Certain contracts provide maximum dollar limits, with actual authorization to perform work under the contract being agreed upon on a periodic basis with the customer. In these arrangements, only the amounts authorized are included in backlog. For projects where we act solely in a project management capacity, we only include our management fee revenue of each project in backlog.


Backlog(1)

(in millions)
 
December 31,
 
   
2008
   
2007
 
G&I:
           
U.S. Government - Middle East Operations
  $ 1,428     $ 1,361  
U.S. Government - Americas Operations
    600       548  
International Operations
    1,446       2,339  
Total G&I
  $ 3,474     $ 4,248  
Upstream:
               
Gas Monetization
    6,196       6,606  
Offshore Projects
    148       173  
Other
    112       118  
Total Upstream
  $ 6,456     $ 6,897  
Services
    2,810       765  
Downstream
    578       313  
Technology
    130       128  
Ventures
    649       700  
Total backlog
  $ 14,097     $ 13,051  
_________________________
(1)
Our G&I business unit’s total backlog attributable to firm orders was $3.3 billion and $4.0 billion as of December 31, 2008 and 2007. Our G&I business unit’s total backlog attributable to unfunded orders was $0.2 billion and $0.2 billion as of December 31, 2008 and 2007, respectively.

We estimate that as of December 31, 2008, 62% of our backlog will be complete within one year. As of December 31, 2008, 20% of our backlog was attributable to fixed-price contracts and 80% was attributable to cost-reimbursable contracts. For contracts that contain both fixed-price and cost-reimbursable components, we classify the components as either fixed-price or cost-reimbursable according to the composition of the contract except for smaller contracts where we characterize the entire contract based on the predominant component.

As of December 31, 2008, backlog in our G&I business unit includes approximately $1.4 billion for our continued services under the LogCAP III contract in our Middle East operations and $1.0 billion related to the Allenby & Connaught for the U.K. Ministry of Defence.

Backlog in our Upstream business unit decreased primarily as a result of work-off on several Gas Monetization projects including the Pearl GTL, Tangguh LNG and Yemen LNG projects.  As of December 31, 2008, our Gas Monetization backlog included $2.4 billion on the Escravos LNG project and $2.8 billion on the Skikda LNG project.

Total KBR backlog increased by approximately $2.0 billion as a result of the acquisition of BE&K on July 1, 2008 of which $1.9 billion was added to our Services business unit.

Contracts

Our contracts can be broadly categorized as either cost-reimbursable or fixed-price, the latter sometimes being 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 because they require us to predetermine both the quantities of work to be performed and the costs associated with executing the work. Although fixed-price contracts involve greater risk than cost-reimbursable contracts, they also are potentially more profitable since the owner/customer pays a premium to transfer more project risk to us.

Cost-reimbursable contracts include contracts where the price is variable based upon our actual costs incurred for time and materials, or for variable quantities of work priced at defined unit rates, including reimbursable labor hour contracts. Profit on cost-reimbursable contracts may be based upon a percentage of costs incurred and/or a fixed amount. Cost reimbursable contracts are generally less risky than fixed-price contracts because the owner/customer retains many of the project risks.


Our G&I business unit provides substantial work under government contracts with the Department of Defense (“DoD”),  the Ministry of Defense (“MoD”) and other governmental agencies. These contracts include our LogCAP contract and contracts to rebuild Iraq’s petroleum industry such as the PCO Oil South contract. If our customer or a government auditor finds that we improperly charged any costs to a contract, these costs are not reimbursable or, if already reimbursed, the costs must be refunded to the customer. If performance issues arise under any of our government contracts, the government retains the right to pursue remedies, which could include threatened termination or termination under any affected contract. Furthermore, the government has the contractual right to terminate or reduce the amount of work under our contracts at any time.

Customers

We provide services to a diverse customer base, including international and national oil and gas companies, independent refiners, petrochemical producers, fertilizer producers and domestic and foreign governments. Revenue from the U.S. government, resulting primarily from work performed in the Middle East by our G&I business unit, represented 53% of our 2008 consolidated revenue, 62% of our 2007 consolidated revenue and 66% of our 2006 consolidated revenue. No other customer represented more than 10% of consolidated revenue in any of these periods.  See “Risk Factors – Risk related to our customers and contracts – Our government contracts work is regularly reviewed and audited by our customer, government auditors and others, and these reviews can lead to withholding or delay of payments to us, non-receipt of award fees, legal actions, fines, penalties and liabilities and other remedies against us.”

Raw Materials

Equipment and materials essential to our business are available from worldwide sources. The principal equipment and materials we use in our business are subject to availability and pricing fluctuations due to customer demand, producer capacity, market conditions and material shortage.  We monitor the availability and pricing of equipment and materials on a regular basis.  Our procurement department actively leverages our size and buying power to ensure that we have access to key equipment and materials at the best possible prices and delivery schedule.  Globally, current market conditions indicate supply chain opportunities exist due to increases in fabrication capacity and decreases in pricing for a wide array of equipment and materials as a result of delays or cancellation of some major projects.  While we do not currently foresee the lack of availability of equipment and materials in the near term, the availability of these items may vary significantly from year to year and any prolonged unavailability or significant price increases for equipment and materials necessary to our projects and services could have a material adverse effect on our business. Please read, “Risk Factors—Risks Related to Our Customers and Contracts—Difficulties in engaging third party subcontractors, equipment manufacturers or materials suppliers or failures by third party subcontractors, equipment manufacturers or materials suppliers to perform could result in project delays and cause us to incur additional costs.”

Intellectual Property

We have developed or otherwise have the right to license leading technologies, including technologies held under license from third parties, used for the production of a variety of petrochemicals and chemicals and in the areas of olefins, refining, fertilizers and semi-submersible technology. Our petrochemical technologies include SCORE and SUPERFLEX. SCORE is a process for the production of ethylene which includes technology developed with ExxonMobil. SUPERFLEX is a flexible proprietary technology for the production of high yields of propylene using low value chemicals. We also license a variety of technologies for the transformation of raw materials into commodity chemicals such as phenol and aniline used in the production of consumer end-products. Our Residuum Oil Supercritical Extraction (ROSE) heavy oil technology is designed to maximize the refinery production yield from each barrel of crude oil. The by-products from this technology, known as asphaltenes, can be used as a low-cost alternative fuel. We are also a licensor of ammonia process technologies used in the conversion of Syngas to ammonia. KAAPplus, our ammonia process which combines the best features of the KBR Advanced Ammonia Process, the KBR Reforming Exchanger System and the KBR Purifier technology, offers ammonia producers reduced capital cost, lower energy consumption and higher reliability. We believe our technology portfolio and experience in the commercial application of these technologies and related know-how differentiates us from other contractors, enhances our margins and encourages customers to utilize our broad range of engineering, procurement, construction and construction services (“EPC-CS”) services.

Our rights to make use of technologies licensed to us are governed by written agreements of varying durations, including some with fixed terms that are subject to renewal based on mutual agreement. For example, our SCORE license runs until 2028 while our rights to SUPERFLEX currently expire in 2013, which can be extended by mutual concurrence indefinitely for 5-year periods. Each agreement may be further extended and we have historically been able to renew existing agreements before they expire. We expect these and other similar agreements to be extended so long as it is mutually advantageous to both parties at the time of renewal. For technologies we own, we protect our rights through patents and confidentiality agreements to protect our know-how and trade secrets. KBR’s ammonia process technology is continually protected through trade secrets and the patent process; currently, KBR’s ammonia process consists of twenty-five US patents, eighteen US patent applications, and corresponding foreign filings in at least twenty-five different jurisdictions.


Technology Development

We own and operate a technology center in Houston, Texas, where we collaborate with our customers to develop new technologies and improve existing ones. We license these technologies to our customers for the design, engineering and construction of oil and gas and petrochemical facilities. We are also working to identify new technologically driven opportunities in emerging markets, including coal gasification technologies to promote more environmentally friendly uses of abundant coal resources and CO2 sequestration to reduce CO2 emissions by capturing and injecting them underground. Our expenditures for research and development activities were immaterial in each of the past three fiscal years.

Seasonality

On an overall basis, our operations are not generally affected by seasonality. Weather and natural phenomena can temporarily affect the performance of our services, but the widespread geographic scope of our operations mitigates those effects.

Employees

As of December 31, 2008, we had over 57,000 employees in our continuing operations, of which approximately 4.9% were subject to collective bargaining agreements. Based upon the geographic diversification of our employees, we believe any risk of loss from employee strikes or other collective actions would not be material to the conduct of our operations taken as a whole. We believe that our employee relations are good.

Health and Safety

We are subject to numerous health and safety laws and regulations. In the United States, these laws and regulations include: the Federal Occupation Safety and Health Act and comparable state legislation, the Mine Safety and Health Administration laws, and safety requirements of the Departments of State, Defense, Energy and Transportation. We are also subject to similar requirements in other countries in which we have extensive operations, including the United Kingdom where we are subject to the various regulations enacted by the Health and Safety Act of 1974.

These regulations are frequently changing, and it is impossible to predict the effect of such laws and regulations on us in the future. We actively seek to maintain a safe, healthy and environmentally friendly work place for all of our employees and those who work with us. However, we provide some of our services in high-risk locations and, as a result, we may incur substantial costs to maintain the safety of our personnel.

Environmental Regulation

We are subject to numerous environmental, legal, and regulatory requirements related to our operations worldwide. In the United States, these laws and regulations include, among others:

 
the Comprehensive Environmental Response, Compensation and Liability Act;

 
the Resources Conservation and Recovery Act;

 
the Clean Air Act;

 
the Federal Water Pollution Control Act; and

 
the Toxic Substances Control Act.

In addition to federal and state laws and regulations, other countries where we do business often have numerous environmental regulatory requirements by which we must abide in the normal course of our operations. The portions of our business to which these requirements apply primarily relates to our Upstream, Downstream and Services business units where we perform construction and industrial maintenance services or operate and maintain facilities. For certain locations, including our property at Clinton Drive, we have not completed our analysis of the site conditions and until further information is available, we are only able to estimate a possible range of remediation costs. These locations were primarily utilized for manufacturing or fabrication work and are no longer in operation. The use of these facilities created various environmental issues including deposits of metals, volatile and semi-volatile compounds, and hydrocarbons impacting surface and subsurface soils and groundwater. The range of remediation costs could change depending on our ongoing site analysis and the timing and techniques used to implement remediation activities. We do not expect costs related to environmental matters will have a material adverse effect on our consolidated financial position or our results of operations. Based on the information presently available to us, we have accrued approximately $8 million for the assessment and remediation costs associated with all environmental matters, which represents the low end of the range of possible costs that could be as much as $15 million. See Note 11 to our consolidated financial statements for more information on environmental matters.


Website Access

Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act of 1934 are made available free of charge on our internet website at www.kbr.com as soon as reasonably practicable after we have electronically filed the material with, or furnished it to, the SEC. The public may read and copy any materials we have filed with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. The SEC maintains an internet site that contains our reports, proxy and information statements, and our other SEC filings. The address of that site is www.sec.gov. We have posted on our website our Code of Business Conduct, which applies to all of our employees and Directors and serves as a code of ethics for our principal executive officer, principal financial officer, principal accounting officer, and other persons performing similar functions. Any amendments to our Code of Business Conduct or any waivers from provisions of our Code of Business Conduct granted to the specified officers above are disclosed on our website within four business days after the date of any amendment or waiver pertaining to these officers.

Item 1A. Risk Factors

Risks Related to Our Customers and Contracts

Our G&I and Services business units are directly affected by spending and capital expenditures by our customers and our ability to contract with our customers.

A decrease in the magnitude of work we perform for the U.S. government in Iraq and for the MoD or other decreases in governmental spending and outsourcing for military and logistical support of the type that we provide could have a material adverse effect on our business, results of operations and cash flow. For example, the current level of government services being provided in the Middle East will not likely continue for an extended period of time. We are currently the sole service provider under our LogCAP III contract to provide logistics support to U.S. Forces deployed in the Middle East and elsewhere, under which certain task orders have been extended by the DoD through the third quarter of 2009.  In April 2008, we were selected as one of the executing contractors under the LogCap IV contract, a new competitively bid, multiple service provider contract to replace the current LogCAP III contract. Despite the backlog under the current LogCAP III contract and the award of a portion of the LOGCAP IV contract, we expect our overall volume of work to decline as our customer scales back its requirement for the types and the amounts of services we provide.

The loss of the U.S. government as a customer would, and the loss of the MoD as a customer could, have a material adverse effect on our business, results of operations and cash flow. The loss of the U.S. government as a customer, or a significant reduction in our work for it, would have a material adverse effect on our business, results of operations and cash flow. Revenue from U.S. government agencies represented 53% of our revenues in 2008, 62% of our revenues in 2007 and 66% of our revenues in 2006. The MoD is also a substantial customer, the loss of which could have a material adverse effect on our business, results of operations and cash flow.

In our G&I and Services business units, a decrease in capital spending for infrastructure and other projects of the type that we undertake could have a material adverse effect on our business, results of operations and cash flow.

Our Upstream, Services, Downstream, and Technology business units depend on demand and capital spending by customers in their target markets, many of which are directly affected by trends in oil, gas and commodities  prices as well as other factors.

Demand for many of our services depends on capital spending by oil and natural gas companies, including national and international oil companies, and industrial and power companies, which is directly affected by trends in oil, natural gas and commodities prices. Capital expenditures for refining and distribution facilities by large oil and gas companies have a significant impact on the activity levels of our businesses. Demand for LNG facilities for which we provide construction services would decrease in the event of a sustained reduction in crude oil or natural gas prices. Perceptions of longer-term lower oil and natural gas prices by oil and gas companies or longer-term higher material and contractor prices impacting facility costs can similarly reduce or defer major expenditures given the long-term nature of many large-scale projects. Prices for oil, natural gas and commodities are subject to large fluctuations in response to relatively minor changes in supply and demand, market uncertainty, and a variety of other factors that are beyond our control. Factors affecting the prices of oil, natural gas and other commodities include:


 
worldwide political, military, and economic conditions;

 
the cost of producing and delivering oil and natural gas;

 
the level of demand for oil, natural gas, industrial services and power generation;

 
governmental regulations or policies, including the policies of governments regarding the use of energy and the exploration for and production and development of their oil and natural gas reserves;

 
a reduction in energy demand as a result of energy taxation or a change in consumer spending patterns;

 
global economic growth or decline;

 
the level of oil production by non-OPEC countries and the available excess production capacity within OPEC;

 
global weather conditions and natural disasters;

 
oil refining capacity;

 
shifts in end-customer preferences toward fuel efficiency and the use of natural gas;

 
potential acceleration of the development and expanded use of alternative fuels;

 
environmental regulation, including limitations on fossil fuel consumption based on concerns about its relationship to climate change; and

 
reduction in demand for pulp and paper.

Historically, the markets for oil and natural gas have been volatile and are likely to continue to be volatile in the future.

Demand for our services may also be materially and adversely affected by the consolidation of our customers, which:

 
could cause customers to reduce their capital spending, which in turn reduces the demand for our services; and

 
could result in customer personnel changes, which in turn affects the timing of contract negotiations and settlements of claims and claim negotiations with engineering and construction customers on cost variances and change orders on major projects.

Our results of operations depend on the award of new contracts and the timing of the performance of these contracts.

Because a substantial portion of our revenue is generated from large-scale projects and the timing of new project awards is unpredictable, our results of operations and cash flow may be subject to significant periodic fluctuations. A substantial portion of our revenue is directly or indirectly derived from large-scale international and domestic projects. Delays in the timing of the awards or potential cancellations of such prospects as a result of economic conditions, material and equipment pricing and availability, or other factors could impact our long term projected results. It is generally very difficult to predict whether or when we will receive such awards as these contracts frequently involve a lengthy and complex bidding and selection process which is affected by a number of factors, such as market conditions, financing arrangements, governmental approvals and environmental matters. Because a significant portion of our revenue is generated from large projects, our results of operations and cash flow can fluctuate significantly from quarter to quarter depending on the timing of our contract awards and the commencement or progress of work under awarded contracts. In addition, many of these contracts are subject to financing contingencies and, as a result, we are subject to the risk that the customer will not be able to secure the necessary financing for the project.

If we are unable to provide our customers with bonds, letters of credit or other credit enhancements, we may be unable to obtain new project awards. In addition, we cannot rely on Halliburton to provide payment and performance guarantees of our bonds, letters of credit and contracts entered into after our initial public offering as it has done in the past, except to the extent Halliburton has agreed to do so under the terms of the master separation agreement. Customers may require us to provide credit enhancements, including bonds, letters of credit or performance or financial guarantees. Consistent with industry practice, we are often required to provide performance and surety bonds to customers. These bonds indemnify the customer should we fail to perform our obligations under the contract. Since the separation from Halliburton we have been engaged in discussions with surety companies and have arranged lines with multiple firms for our own stand-alone capacity. Since the arrangement of this stand alone capacity, we have been sourcing our surety bonds from our own capacity without Halliburton credit support. Due to events that affect the insurance and bonding markets generally, bonding may be difficult to obtain or may only be available at significant cost. In addition, future projects may require us to obtain letters of credit that extend beyond the term of our current credit facility. Further, our credit facility limits the amount of new letters of credit and other debt we can incur outside of the credit facility to $250 million, which could adversely affect our ability to bid or bid competitively on future projects if the credit facility is not amended or replaced. Prior to our initial public offering, Halliburton provided guarantees of most of our surety bonds and letters of credit as well as most other payment and performance guarantees under our contracts. The credit support arrangements in existence at the completion of our initial public offering will remain in effect, but Halliburton is not expected to enter into any new credit support arrangements on our behalf, except to the limited extent Halliburton is obligated to do so under the master separation agreement. We have agreed to indemnify Halliburton for all losses under our outstanding credit support instruments and any additional credit support instruments for which Halliburton may become obligated following our initial public offering, and under the master separation agreement, we have agreed to use our reasonable best efforts to attempt to release or replace Halliburton’s liability thereunder for which such release or replacement is reasonably available. Any inability to obtain adequate bonding and/or provide letters of credit or other customary credit enhancements and, as a result, to bid on new work could have a material adverse effect on our business prospects and future revenue.


The DoD awards its contracts through a rigorous competitive process and our efforts to obtain future contract awards from the DoD, including the LogCAP IV contract, may be unsuccessful, and the DoD has recently favored multiple award task order contracts. The DoD conducts a rigorous competitive process for awarding most contracts. In the services arena, the DoD uses multiple contracting approaches. It uses omnibus contract vehicles, such as LogCAP, for work that is done on a contingency, or as-needed basis. In more predictable “sustainment” environments, contracts may include both fixed-price and cost-reimbursable elements. The DoD has also recently favored multiple award task order contracts, in which several contractors are selected as eligible bidders for future work. Such processes require successful contractors to continually anticipate customer requirements and develop rapid-response bid and proposal teams as well as have supplier relationships and delivery systems in place to react to emerging needs. We will face rigorous competition for any additional contract awards from the DoD, and we may be required to qualify or continue to qualify under the various multiple award task order contract criteria. The DoD has awarded us a portion of the new LogCAP IV contract, which will replace the current LogCAP III contract under which we are the sole provider, which is a multiple award task order contract. Despite being awarded a portion of the LogCAP IV contract, we may not be awarded any task orders under the LogCAP IV contract, which may have a material adverse effect on future results of operations. It may be more difficult for us to win future awards from the DoD and we may have other contractors sharing in any DoD awards that we win. In addition, negative publicity regarding findings out of DCAA and Congressional investigations may adversely affect our ability to obtain future awards.  See “Management’s Discussion and Analysis of Financial Condition and Results of Analysis – U.S. Government Matters.”

The uncertainty of the timing of future contract awards may inhibit our ability to recover our labor costs. The uncertainty of our contract award timing can also present difficulties in matching workforce size with contract needs. In some cases, we maintain and bear the cost of a ready workforce that is larger than called for under existing contracts in anticipation of future workforce needs for expected contract awards. If an expected contract award is delayed or not received, we may not be able to recover our labor costs, which could have a material adverse effect on us.

A portion of our projects are on a fixed-price basis, subjecting us to the risks associated with cost over-runs, operating cost inflation and potential claims for liquidated damages.

Our long-term contracts to provide services are either on a cost-reimbursable basis or on a fixed-price basis. At December 31, 2008, 20% of our backlog for continuing operations was attributable to fixed-price contracts and 80% was attributable to cost-reimbursable contracts. Our failure to accurately estimate the resources and time required for a fixed-price project or our failure to complete our contractual obligations within the time frame and costs committed could have a material adverse effect on our business, results of operations and financial condition. In connection with projects covered by fixed-price contracts, we generally bear the risk of cost over-runs, operating cost inflation, labor availability and productivity, and supplier and subcontractor pricing and performance. Under both our fixed-price contracts and our cost-reimbursable contracts, we generally rely on third parties for many support services, and we could be subject to liability for engineering or systems failures. Risks under our contracts include:

 
Our engineering, procurement and construction projects may encounter difficulties in the design or engineering phases, related to the procurement of supplies, and due to schedule changes, equipment performance failures, and other factors that may result in additional costs to us, reductions in revenue, claims or disputes.

 
We may not be able to obtain compensation for additional work or expenses incurred as a result of customer change orders or our customers providing deficient design or engineering information or equipment or materials.

 
We may be required to pay liquidated damages upon our failure to meet schedule or performance requirements of our contracts.


 
Difficulties in engaging third party subcontractors, equipment manufacturers or materials suppliers or failures by third party subcontractors, equipment manufacturers or materials suppliers to perform could result in project delays and cause us to incur additional costs.

 
Our projects expose us to potential professional liability, product liability, warranty, performance and other claims that may exceed our available insurance coverage.

Our government contracts work is regularly reviewed and audited by our customer, government auditors and others, and these reviews can lead to withholding or delay of payments to us, non-receipt of award fees, legal actions, fines, penalties and liabilities and other remedies against us.

Given the demands of working in Iraq and elsewhere for the U.S. government, we expect that from time to time we will have disagreements or experience performance issues with the various government customers for which we work. If performance issues arise under any of our government contracts, the government retains the right to pursue remedies, which could include threatened termination or termination under any affected contract. If any contract were so terminated, we may not receive award fees under the affected contract, and our ability to secure future contracts could be adversely affected, although we would receive payment for amounts owed for our allowable costs under cost-reimbursable contracts. Other remedies that our government customers may seek for any improper activities or performance issues include sanctions such as forfeiture of profits, suspension of payments, fines and suspensions or debarment from doing business with the government. Further, the negative publicity that could arise from disagreements with our customers or sanctions as a result thereof could have an adverse effect on our reputation in the industry, reduce our ability to compete for new contracts, and may also have a material adverse effect on our business, financial condition, results of operations and cash flow.

To the extent that we export products, technical data and services outside the United States, we are subject to U.S. laws and regulations governing international trade and exports, including but not limited to the International Traffic in Arms Regulations, the Export Administration Regulations and trade sanctions against embargoed countries, which are administered by the Office of Foreign Assets Control within the Department of the Treasury. A failure to comply with these laws and regulations could result in civil and/or criminal sanctions, including the imposition of fines upon us as well as the denial of export privileges and debarment from participation in U.S. government contracts. From time to time, we identify certain inadvertent or potential export or related violations. These violations may include, for example, transfers without required governmental authorizations. We can give no assurance as to whether we will ultimately be subject to sanctions as a result of such practices or the disclosure thereof, or the extent or effect thereof, if any sanctions are imposed, or whether individually or in the aggregate such practices or the disclosure thereof will have a material adverse effect on our business, financial condition or results of operations.

We have identified issues for disclosure to the government, and it is possible that we will identify additional issues for disclosure. Specifically, we have reported to the U.S. Department of State and Department of Commerce that exports of materials, including personal protection equipment such as helmets, goggles, body armor and chemical protective suits, in connection with personnel deployed to Iraq and Afghanistan may not have been in accordance with current licenses or applicable regulations. Please read “Management’s Discussion and Analysis of Financial Condition and Results of Operations – U.S. Government Matters – Investigations Relating to Iraq, Kuwait and Afghanistan” for more information. We expect to incur legal and other costs, which could include penalties, in connection with these export control disclosures and investigations.

We are involved in a dispute with Petrobras with respect to responsibility for the failure of subsea flow-line bolts on the Barracuda-Caratinga project.

In June 2000, we entered into a contract with Barracuda & Caratinga Leasing Company B.V., the project owner, to develop the Barracuda and Caratinga crude oilfields, which are located off the coast of Brazil. The construction manager and project owner’s representative is Petrobras, the Brazilian national oil company. The project consists of two converted supertankers, Barracuda and Caratinga, which are being used as floating production, storage, and offloading units, commonly referred to as FPSOs. At Petrobras’ direction, we have replaced certain bolts located on the subsea flow-lines that have failed through mid-November 2005, and we understand that additional bolts have failed thereafter, which have been replaced by Petrobras. These failed bolts were identified by Petrobras when it conducted inspections of the bolts. The original design specification for the bolts that have failed was issued by Petrobras, and as such, we believe the cost resulting from any replacement is not our responsibility. Petrobras has indicated, however, that they do not agree with our conclusion. On March 9, 2006, Petrobras notified us that they have submitted this matter to arbitration claiming $220 million plus interest for the cost of monitoring and replacing the defective bolts and, in addition, all of the costs and expenses of the arbitration including the cost of attorneys fees. The arbitration is being conducted in New York under the guidelines of the United Nations Commission on International Trade Law (“UNCITRAL”). Although we believe Petrobras is responsible for any maintenance and replacement of the bolts, it is possible that the arbitration panel could find against us on this issue. Consequences of this matter could have a material adverse effect on our results of operations, financial condition and cash flow. Please read “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Business Environment and Results of Operations” for further discussion.


We are actively engaged in claims negotiations with some of our customers, and a failure to successfully resolve our unapproved claims may materially and adversely impact our results of operations.

We report revenue from contracts to provide construction, engineering, design or similar services under the percentage-of-completion method of accounting. The recording of profits and losses on long-term contracts requires an estimate of the total profit or loss over the life of each contract. Total estimated profit is calculated as the difference between total estimated contract value and total estimated costs. When calculating the amount of total profit or loss, we include unapproved claims as contract value when the collection is deemed probable based upon the four criteria for recognizing unapproved claims under the American Institute of Certified Public Accountants Statement of Position 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type Contracts.” Including probable unapproved claims in this calculation increases the operating income (or reduces the operating loss) that would otherwise be recorded without consideration of the probable unapproved claims. For example, we are involved in an arbitration matter with PEMEX as discussed in Note 11 to our consolidated financial statements.

Risk Factors relating to FCPA Matters and Investigations of Related Corruption Allegations

We pleaded guilty to violating provisions of the United States FCPA and agreed to the entry of a civil judgment and injunction with the SEC relating to such violations that could have a material adverse effect on our business, prospects, results of operations, financial condition and cash flow.

On February 11, 2009, Kellogg Brown and Root LLC, one of our subsidiaries, pleaded guilty to one count of conspiring to violate the FCPA and four counts of violating the FCPA, all arising from the intent to bribe various Nigerian officials through commissions paid to agents working on behalf of TSKJ, a joint venture in which one of our subsidiaries (a successor to The M.W. Kellogg Company) had an approximate 25% interest at December 31, 2008, of a multibillion dollar contract to construct a natural gas liquefaction complex and related facilities at Bonny Island in Rivers State, Nigeria. On the same date, the SEC filed a complaint, and we consented to the filing of a final judgment against us in the Court. The complaint and the judgment were filed as part of a settled civil enforcement action by the SEC, to resolve the civil portion of the government’s investigation of the Bonny Island project. Please read “Risks Related to Our Relationship With Halliburton—Halliburton’s indemnity for Foreign Corrupt Practices Act matters does not apply to all potential losses, Halliburton’s actions may not be in our stockholders’ best interests and we may take or fail to take actions that could result in our indemnification from Halliburton with respect to related corruption allegations no longer being available,” and “Management’s Discussion and Analysis of Financial condition and Results of Operations—Legal Proceedings—FCPA Investigations” for more information.

Potential consequences arising out of our guilty plea to violations of the FCPA could include suspension or debarment of our ability to contract with the United States, state or local governments, U.S. government agencies or the MoD, third party claims, loss of business, adverse financial impact, damage to reputation and adverse consequences on financing for current or future projects.

Potential consequences of the guilty plea arising out of the investigations into FCPA matters or related corruption allegations could include suspension of our ability to contract with the United States, state or local governments, U.S. government agencies or the MoD in the United Kingdom. We and our affiliates could be debarred from future contracts or new orders under current contracts to provide services to any such parties. During 2008, we had revenue of $6.2 billion from our government contracts work with agencies of the United States or state or local governments. In addition, we may be excluded from bidding on MoD contracts in the United Kingdom because the guilty plea involved corruption allegations or if the MoD determines that our actions constituted grave misconduct. During 2008, we had revenue of $234 million from our government contracts work with the MoD. Suspension or debarment from the government contracts business would have a material adverse effect on our business, results of operations and cash flow. Please read “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Legal Proceedings – FCPA Investigations” for more information.

Limitations on our use of agents as part of our efforts to comply with applicable laws, including the FCPA, could put us at a competitive disadvantage in pursuing large-scale international projects. Most of our large-scale international projects are pursued and executed using one or more agents to assist in understanding customer needs, local content requirements, and vendor selection criteria and processes and in communicating information from us regarding our services and pricing. As a result of our settlement of the FCPA matters described below under “—Risks Relating to Investigations” and “—Risks Related to Our Relationship With Halliburton” a monitor will be appointed to review future practices for compliance with the FCPA, including with respect to the retention of agents. Our compliance procedures and our requirement to have a monitor may result in a more limited use of agents on large-scale international projects than in the past. Accordingly, we could be at a competitive disadvantage in successfully being awarded such future projects, which could have a material adverse effect on our ability to win contracts and our future revenue and business prospects.


Other Risks Related to Our Business

Our revolving credit facility imposes restrictions that limit our operating flexibility and may result in additional expenses, and this credit facility will not be available if financial covenants are not met or if an event of default occurs.

 Our Revolving Credit Facility provides up to $930 million of borrowing and letters of credit capacity and expires in December 2010. This facility serves to assist us in providing working capital and letters of credit for our projects. The revolving credit facility contains a number of covenants restricting, among other things, incurrence of additional indebtedness and liens, sales of our assets, the amount of investments we can make, and the amount of dividends we can declare to pay or equity shares that can be repurchased. We are also subject to certain financial covenants, including maintenance of ratios with respect to consolidated debt to total consolidated capitalization, leverage and fixed charge coverage. If we fail to meet the covenants or an event of default occurs, we would not have available the liquidity that the facility provides.

It is an event of default if any person or two or more persons acting in concert, other than Halliburton or our Company, directly or indirectly acquires 25% or more of the combined voting power of all outstanding equity interests ordinarily entitled to vote in the election of directors of KBR Holdings, LLC, our wholly owned subsidiary, the borrower under the credit facility. In the event of a default, the banks under the facility could declare all amounts due and payable and cease to provide additional advances and require cash collateralization for all outstanding letters of credit. If we were unable to obtain a waiver from the banks or negotiate an amendment or a replacement credit facility prior to an event of default, it could have a material adverse effect on our liquidity, financial condition and cash flow.

We conduct a large portion of our engineering and construction operations through joint ventures. As a result, we may have limited control over decisions and controls of joint venture projects and have returns that are not proportional to the risks and resources we contribute.

We conduct a large portion of our engineering and construction 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, and we typically have joint and several liability with our joint venture partners under these joint venture arrangements. These factors could potentially materially and adversely affect the business and operations of a joint venture and, in turn, our business and operations.

Operating through joint ventures in which we are minority holders results in us having limited control over many decisions made with respect to projects and internal controls relating to projects. These joint ventures may not be subject to the same requirements regarding internal controls and internal control reporting that we follow. As a result, internal control issues may arise, which could have a material adverse effect on our financial condition and results of operation. When entering into joint ventures, in order to establish or preserve relationships with our joint venture partners, we may agree to risks and contributions of resources that are proportionately greater than the returns we could receive, which could reduce our income and returns on these investments compared to what we would have received if the risks and resources we contributed were always proportionate to our returns.

We make equity investments in privately financed projects on which we have sustained losses and could sustain additional losses.

We participate in privately financed projects that enable our government and other customers to finance large-scale projects, such as railroads, and major military equipment, capital project and service purchases. These projects typically include the facilitation of non-recourse financing, the design and construction of facilities, and the provision of operation and maintenance services for an agreed to period after the facilities have been completed.

We may incur contractually reimbursable costs and typically make an equity investment prior to an entity achieving operational status or completing its full project financing. If a project is unable to obtain financing, we could incur losses including our contractual receivables and our equity investment. After completion of these projects, our equity investments can be at risk, depending on the operation of the project and market factors, which may not be under our control. As a result, we could sustain a loss on our equity investment in these projects. Current equity investments in projects of this type include the Allenby & Connaught project in the U.K. and the Egypt Basic Industries Corporation ammonia plant in Egypt. Please read Note 16 to our consolidated financial statements for further discussion of these projects.


Intense competition in the engineering and construction industry could reduce our market share and profits.

We serve markets that are highly competitive and in which a large number of multinational companies compete. These highly competitive markets require substantial resources and capital investment in equipment, technology and skilled personnel whether the projects are awarded in a sole source or competitive bidding process. Our projects are frequently awarded through a competitive bidding process, which is standard in our industry. We are constantly competing for project awards based on pricing and the breadth and technological sophistication of our services. Any increase in competition or reduction in our competitive capabilities could have a significant adverse impact on the margins we generate from our projects or our ability to retain market share.

If we are unable to attract and retain a sufficient number of affordable trained engineers and other skilled workers, our ability to pursue projects may be adversely affected and our costs may increase.

Our rate of growth will be confined by resource limitations as competitors and customers compete for increasingly scarce resources. We believe that our success depends upon our ability to attract, develop and retain a sufficient number of affordable trained engineers and other skilled workers that can execute our services in remote locations under difficult working conditions. If we are unable to attract and retain a sufficient number of skilled personnel, our ability to pursue projects may be adversely affected and the costs of performing our existing and future projects may increase, which may adversely impact our margins.

We ship a significant amount of cargo using seagoing vessels which expose us to certain maritime risks.

We execute different projects around the world that include remote locations.  Depending on the type of contract, location and the nature of the work, we may charter vessels under time and bareboat charter parties that assume certain risks typical of those agreements.  Such risks may include damage to the ship and liability for cargo and liability which charterers and vessel operators have to third parties “at law”.  In addition, we ship a significant amount of cargo and are subject to hazards of the shipping and transportation industry.

If we are unable to enforce our intellectual property rights or if our intellectual property rights become obsolete, our competitive position could be adversely impacted.

We utilize a variety of intellectual property rights in our services. We view our portfolio of process and design technologies as one of our competitive strengths and we use it as part of our efforts to differentiate our service offerings. We may not be able to successfully preserve these intellectual property rights in the future and these rights could be invalidated, circumvented, or challenged. In addition, the laws of some foreign countries in which our services may be sold do not protect intellectual property rights to the same extent as the laws of the United States. Because we license technologies from third parties, there is a risk that our relationships with licensors may terminate or expire or may be interrupted or harmed. In some, but not all cases, we may be able to obtain the necessary intellectual property rights from alternative sources. If we are unable to protect and maintain our intellectual property rights, or if there are any successful intellectual property challenges or infringement proceedings against us, our ability to differentiate our service offerings could be reduced. In addition, if our intellectual property rights or work processes become obsolete, we may not be able to differentiate our service offerings, and some of our competitors may be able to offer more attractive services to our customers. As a result, our business and revenue could be materially and adversely affected.

Our current business strategy relies on acquisitions. Acquisitions of other companies present certain risks and uncertainties.

We see business merger and acquisition activities as an integral means of broadening our offerings and capturing additional market opportunities by our business units. As a result, we may incur certain additional risks accompanying these activities. These risks include the following:

 
·
We may not identify or complete future acquisitions conducive to our current business strategy;

 
·
Any future acquisition activities may not be completed successfully as a result of potential strategy changes, competitor activities, and other unforeseen elements associated with merger and acquisition activities;

 
·
Valuation methodologies may not accurately capture the value proposition;


 
·
Future completed acquisitions may not be integrated within our operations with the efficiency and effectiveness initially expected resulting in a potentially significant detriment to the associated product service line financial results, and pose additional risks to our operations as a whole;

 
·
We may have difficulty managing the growth from merger and acquisition activities;

 
·
Key personnel within an acquired organization may resign from their related positions resulting in a significant loss to our strategic and operational efficiency associated with the acquired company;

 
·
The effectiveness of our daily operations may be reduced by the redirection of employees and other resources to acquisition activities;

 
·
We may assume liabilities of an acquired business (e.g. litigation, tax liabilities, contingent liabilities, environmental issues), including liabilities that were unknown at the time the acquisition, that pose future risks to our working capital needs, cash flows and the profitability of related operations;

 
·
Business acquisitions often may include unforeseen substantial transactional costs to complete the acquisition that exceed the estimated financial and operational benefits;

 
·
We may experience significant difficulties in integrating our current system of internal controls into the acquired operations; and

 
·
Future acquisitions may require us to obtain additional equity or debt financing, which may not be available on attractive terms. Moreover, to the extent an acquisition transaction results in additional goodwill, it will reduce our tangible net worth, which might have an adverse effect on our credit capacity.

If we need to sell or issue additional common shares to finance future acquisitions, our existing shareholder ownership could be diluted.

Part of our business strategy is to expand into new markets and enhance our position in existing markets both domestically and internationally through the merging and acquiring of complementary businesses. To successfully fund and complete such identified, potential acquisitions, we may issue additional equity securities that have the potential to dilute our earnings per share and our existing shareholder ownership.

Risks Related to Geopolitical and International Operations and Events

International and political events may adversely affect our operations.

A significant portion of our revenue is derived from our non-United States operations, which exposes us to risks inherent in doing business in each of the countries in which we transact business. The occurrence of any of the risks described below could have a material adverse effect on our results of operations and financial condition.

Our operations in countries other than the United States accounted for approximately 85% of our consolidated revenue during 2008, 89% of our consolidated revenue during 2007 and 85% of our consolidated revenue during 2006. Based on the location of services provided, 43% of our consolidated revenue in 2008, 50% of our consolidated revenue in 2007 and 49% in 2006 was from our operations in 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;

 
inflation;

 
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, Iraq, Nigeria, Russia, and Yemen. In addition, military action or continued unrest in the Middle East could impact the supply and pricing for oil and gas, disrupt our operations in the region and elsewhere, and increase our costs for security worldwide.

We work in international locations where there are high security risks, which could result in harm to our employees and contractors or substantial costs.

Some of our services are performed in high-risk locations, such as Iraq, Afghanistan, Nigeria and Algeria where the country or location is suffering from political, social or economic issues, or war or civil unrest. In those locations where we have employees or operations, we may incur substantial costs to maintain the safety of our personnel. Despite these precautions, the safety of our personnel in these locations may continue to be at risk, and we have in the past and may in the future suffer the loss of employees and contractors.

We are subject to significant foreign exchange and currency risks that could adversely affect our operations and our ability to reinvest earnings from operations, and our ability to limit our foreign exchange risk through hedging transactions may be limited.

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.

In particular, we conduct business in countries that have non-traded or “soft” currencies which, because of their restricted or limited trading markets, may be difficult to exchange for “hard” currencies. The national governments in some of these countries are often able to establish the exchange rates for the local currency. As a result, it may not be possible for us to engage in hedging transactions to mitigate the risks associated with fluctuations of the particular currency. We are often required to pay all or a portion of our costs associated with a project in the local soft currency. As a result, we generally attempt to negotiate contract terms with our customer, who is often affiliated with the local government, to provide that we are paid in the local currency in amounts that match our local expenses. If we are unable to match our costs with matching revenue in the local currency, we would be exposed to the risk of an adverse change in currency exchange rates.

Where possible, we selectively use hedging transactions to limit our exposure to risks from doing business in foreign currencies. Our ability to hedge is 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;

 
interest rates;

 
commodity prices; or

 
the value and time period of the derivative being different than the exposures or cash flow being hedged.

Risks Related to Our Relationship With Halliburton

Halliburton’s indemnity for FCPA matters and related corruption allegations does not apply to all potential losses, Halliburton’s actions may not be in our stockholders’ best interests and we may take or fail to take actions that could result in our indemnification from Halliburton with respect to corruption allegations no longer being available.

Under the terms of the master separation agreement entered into in connection with our initial public offering, Halliburton has agreed to indemnify us for, and any of our greater than 50%-owned subsidiaries for our share of, fines or other monetary penalties or direct monetary damages, including disgorgement, as a result of claims made or assessed by a governmental authority of the United States, the United Kingdom, France, Nigeria, Switzerland or Algeria, or a settlement thereof, relating to FCPA Matters (as defined below), which could involve Halliburton and us through The M. W. Kellogg Company, M. W. Kellogg Limited or their or our joint ventures in projects both in and outside of Nigeria, including the Bonny Island, Nigeria project. Halliburton’s indemnity does not apply to any other losses, claims, liabilities or damages assessed against us as a result of or relating to FCPA Matters or to any fines or other monetary penalties or direct monetary damages, including disgorgement, assessed by governmental authorities in jurisdictions other than the United States, the United Kingdom, France, Nigeria, Switzerland or Algeria, or a settlement thereof, or assessed against entities such as TSKJ, in which we do not have an interest greater than 50%. For purposes of the indemnity, “FCPA Matters” include claims relating to alleged or actual violations occurring prior to the date of the master separation agreement of the FCPA or particular, analogous applicable statutes, laws, regulations and rules of U.S. and foreign governments and governmental bodies identified in the master separation agreement in connection with the Bonny Island project in Nigeria and in connection with any other project, whether located inside or outside of Nigeria, including without limitation the use of agents in connection with such projects, identified by a governmental authority of the United States, the United Kingdom, France, Nigeria, Switzerland or Algeria in connection with the current investigations in those jurisdictions. Please read “—Risks Relating to Investigations—We pleaded guilty to violating provisions of the FCPA and agreed to the entry of a civil judgment and injunction with the SEC relating to such violations that could have a material adverse affect on our business, prospects, results of operations, financial conditions and cash flows.” and “Risks Related to Our Relationship with Halliburton—Our indemnification from Halliburton for FCPA Matters may not be enforceable as a result of being against governmental policy.”


Either before or after a settlement or disposition of any remaining corruption allegations, we could incur losses as a result of or relating to such corruption allegations for which Halliburton’s indemnity will not apply, and we may not have the liquidity or funds to address those losses, in which case such losses could have a material adverse effect on our business, prospects, results of operations, financial condition and cash flow.

As part of the master separation agreement, Halliburton has agreed to indemnify us for certain FCPA Matters, but we had to agree that Halliburton will, in its sole discretion, have and maintain control over the investigation, defense and/ or settlement of FCPA Matters until such time, if any, that we exercise our right to assume control of the investigation, defense and/or settlement of FCPA Matters. We have also agreed, at Halliburton’s expense, to assist with Halliburton’s full cooperation with any governmental authority in Halliburton’s investigation of FCPA Matters and its investigation, defense and/or settlement of any claim made by a governmental authority or court relating to FCPA Matters, in each case even if we assume control of FCPA Matters.

Subject to the exercise of our right to assume control of the investigation, defense and/or settlement of FCPA Matters, Halliburton will have broad discretion to investigate and defend FCPA Matters. We expect that Halliburton will take actions that are in the best interests of its stockholders, which may not be in our or our stockholders’ best interests, particularly in light of the potential differing interests that Halliburton and we may have with respect to the matters currently under investigation and their defense and/or settlement. In addition, the manner in which Halliburton controls the investigation, defense and/or settlement of FCPA Matters and our ongoing obligation to cooperate with Halliburton in its investigation, defense and/or settlement thereof could adversely affect us and our ability to defend or settle FCPA or other claims against us, or result in other adverse consequences to us or our business that would not be subject to Halliburton’s indemnification. We may take control over the investigation, defense and/or settlement of FCPA Matters or we may refuse to agree to a settlement of FCPA Matters negotiated by Halliburton. Notwithstanding our decision, if any, to assume control or refuse to agree to a settlement of FCPA Matters, we will have a continuing obligation to assist in Halliburton’s full cooperation with any government or governmental agency, which may reduce any benefit of our taking control over the investigation of FCPA Matters or refusing to agree to a settlement. If we take control over the investigation, defense and/or settlement of FCPA Matters, refuse a settlement of FCPA Matters negotiated by Halliburton, enter into a settlement of FCPA Matters without Halliburton’s consent, materially breach our obligation to cooperate with respect to Halliburton’s investigation, defense and/or settlement of FCPA Matters or materially breach our obligation to consistently implement and maintain, for five years following our separation from Halliburton, currently adopted business practices and standards relating to the use of foreign agents, Halliburton may terminate the indemnity, which could have a material adverse effect on our financial condition, results of operations and cash flow.

Our indemnification from Halliburton for FCPA matters or related corruption allegations may not be enforceable as a result of being against governmental policy.

Our indemnification from Halliburton relating to FCPA matters and related corruption allegations (as defined under “—Risks Related to Our Relationship With Halliburton”) may not be enforceable as a result of being against governmental policy. Under the indemnity with Halliburton, our share of any liabilities for fines or other monetary penalties or direct monetary damages, including disgorgement, as a result of U.S. or certain foreign governmental claims or assessments relating to corruption allegations would be funded by Halliburton and would not be borne by us and our public stockholders.  If we are assessed by or agree with U.S. or certain foreign governments or governmental agencies to pay any such fines, monetary penalties or direct monetary damages, including disgorgement, and Halliburton’s indemnity cannot be enforced or is unavailable because of governmental requirements of a settlement, we may not have the liquidity or funds to pay those penalties or damages, which would have a material adverse effect on our business, prospects, results of operations, financial condition and cash flow. Please read “Management’s Discussion and Analysis of Financial Condition and Results of OperationsTransactions with former Parent.”


Halliburton’s indemnity for matters relating to the Barracuda-Caratinga project only applies to the replacement of certain subsea bolts, and Halliburton’s actions may not be in our stockholders’ best interests.

Under the terms of the master separation agreement, Halliburton agreed to indemnify us and any of our greater than 50%-owned subsidiaries as of November 20, 2006, the date of the master separation agreement, for out-of-pocket cash costs and expenses, or cash settlements or cash arbitration awards in lieu thereof, we incur as a result of the replacement of certain subsea flow-line bolts installed in connection with the Barracuda-Caratinga project, which we refer to as “B-C Matters.” Please read “Risks Related to Our Customers and Contracts—We are involved in a dispute with Petrobras with respect to responsibility for the failure of subsea flow-line bolts on the Barracuda-Caratinga Project.”

At our cost, we will control the defense, counterclaim and/or settlement with respect to B-C Matters, but Halliburton will have discretion to determine whether to agree to any settlement or other resolution of B-C Matters. We expect Halliburton will take actions that are in the best interests of its stockholders, which may or may not be in our or our stockholders’ best interests. Halliburton has the right to assume control over the defense, counterclaim and/or settlement of B-C Matters at any time. If Halliburton assumes control over the defense, counterclaim and/or settlement of B-C Matters, or refuses a settlement proposed by us, it could result in material and adverse consequences to us or our business that would not be subject to Halliburton’s indemnification. In addition, if Halliburton assumes control over the defense, counterclaim and/or settlement of B-C Matters, and we refuse a settlement proposed by Halliburton, Halliburton may terminate the indemnity. Also, if we materially breach our obligation to cooperate with Halliburton or we enter into a settlement of B-C Matters without Halliburton’s consent, Halliburton may terminate the indemnity.

If the exchange fails to qualify as a tax-free transaction because of actions we take or because of a change of control of us, we will be required to indemnify Halliburton for any resulting taxes, and this potential obligation to indemnify Halliburton may prevent or delay a change of control of us.

In connection with the exchange offer, we and Halliburton will be required to comply with representations that have been made to Halliburton’s tax counsel in connection with the tax opinion that was issued to Halliburton regarding the tax-free nature of the exchange offer and with representations that have been made to the Internal Revenue Service in connection with the private letter ruling that Halliburton has received. If we breach any representations with respect to the opinion or any ruling request or takes any action that causes such representations to be untrue and which causes the exchange offer to be taxable, we will be required to indemnify Halliburton for any and all taxes incurred by Halliburton or any of its affiliates resulting from the failure of the exchange offer to qualify as tax-free transactions as provided in the tax sharing agreement between us and Halliburton. Further, we have agreed not to enter into transactions for two years after the completion of the exchange offer and any that would result in a more than immaterial possibility of a change of control of us pursuant to a plan unless a ruling is obtained from the Internal Revenue Service or an opinion is obtained from a nationally recognized law firm that the transaction will not affect the tax-free nature of the exchange offer. For these purposes, certain transactions are deemed to create a more than immaterial possibility of a change of control of us pursuant to a plan, and thus require such a ruling or opinion, including, without limitation, the merger of us with or into any other corporation, stock issuances (regardless of size) other than in connection with our employee incentive plans, or the redemption or repurchase of any of our capital stock (other than in connection with future employee benefit plans or pursuant to a future market purchase program involving 5% or less of KBR’s publicly traded stock). If we take any action which results in the exchange offer becoming a taxable transaction, we will be required to indemnify Halliburton for any and all taxes incurred by Halliburton or any of its affiliates, on an after-tax basis, resulting from such actions. The amounts of any indemnification payments would be substantial and would have a material adverse effect on our financial condition.

Depending on the facts and circumstances, the exchange offer may be taxable to Halliburton if KBR undergoes a 50% or greater change in stock ownership within two years after the exchange offer and any subsequent spin-off distribution. Under the tax sharing agreement, as amended, between KBR and Halliburton, Halliburton is entitled to reimbursement of any tax costs incurred by Halliburton as a result of a change in control of KBR after the exchange offer. Halliburton would be entitled to such reimbursement even in the absence of any specific action by KBR, and even if actions of Halliburton (or any of its officers, directors or authorized representatives) contributed to a change in control of KBR. These costs may be so great that they delay or prevent a strategic acquisition, a change in control of KBR or an attractive business opportunity. Actions by a third party after the exchange offer causing a 50% or greater change in KBR’s stock ownership could also cause the exchange offer and any subsequent spin-off distribution by Halliburton to be taxable and require reimbursement by KBR.


Provisions in our charter documents and Delaware law may inhibit a takeover or impact operational control, since our separation from Halliburton, which could adversely affect the value of our common stock.

Our certificate of incorporation and bylaws, as well as Delaware corporate law, contain provisions that could delay or prevent a change of control or changes in our management that a stockholder might consider favorable. These provisions include, among others, a staggered board of directors, prohibiting stockholder action by written consent, advance notice for raising business or making nominations at meetings of stockholders and the issuance of preferred stock with rights that may be senior to those of our common stock without stockholder approval. Many of these provisions became effective following the exchange offer. These provisions would apply even if a takeover offer may be considered beneficial by some of our stockholders. If a change of control or change in management is delayed or prevented, the market price of our common stock could decline.

Item 1B. Unresolved Staff Comments

None.

Item 2. Properties

We own or lease properties in domestic and foreign locations. The following locations represent our major facilities.

Location
 
Owned/Leased
 
Description
 
Business Unit
Houston, Texas
 
Leased(1)
 
High-rise office facility
 
All and Corporate
             
Arlington, Virginia
 
Leased
 
High-rise office facility
 
G&I
             
Houston, Texas
 
Owned
 
Campus facility
 
All and Corporate
             
Birmingham, Alabama
 
Owned
 
Campus facility
 
Services
             
Leatherhead, United Kingdom
 
Owned
 
Campus facility
 
All
             
Greenford, Middlesex
United Kingdom
 
Owned(2)
 
High-rise office facility
 
Upstream, Downstream and Technology
_________________________
(1)
At December 31, 2008, we had a 50% interest in a joint venture which owns this office facility.
(2)
At December 31, 2008, we had a 55% interest in a joint venture which owns this office facility.

We also own or lease numerous small facilities that include our technology center, sales offices and project offices throughout the world. We own or lease marine fabrication facilities, which are currently for sale, covering approximately 300 acres in Scotland. All of our owned properties are unencumbered and we believe all properties that we currently occupy are suitable for their intended use.

Item 3. Legal Proceedings

Information relating to various commitments and contingencies is described in “Risk Factors” contained in Part I of this Annual Report on Form 10-K and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in Notes 10 and 11 to our consolidated financial statements and the information discussed therein is incorporated by reference into this Item 3.

Item 4. Submission of Matters to a Vote of Security Holders

There were no matters submitted to a vote of security holders during the fourth quarter of 2008.


PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Our common stock is traded on the New York Stock Exchange under the symbol “KBR.”  The following table sets forth, on a per share basis for the periods indicated, the high and low sale prices per share for our common stock as reported by the New York Stock Exchange and dividends declared:

   
Common Stock Price Range
   
Dividends Declared
 
   
High
   
Low
   
Per Share (a)
 
Fiscal Year 2008
                 
First quarter ended March 31, 2008
  $ 41.95     $ 24.00     $ 0.05  
Second quarter ended June 30, 2008
    38.41       27.79       0.05  
Third quarter ended September 30, 2008
    35.30       13.50       0.05  
Fourth quarter ended December 31, 2008
    18.59       9.78       0.05  
Fiscal Year 2007
                       
First quarter ended March 31, 2007
  $ 26.10     $ 19.66     $  
Second quarter ended June 30, 2007
    29.32       20.13        
Third quarter ended September 30, 2007
    40.38       26.31        
Fourth quarter ended December 31, 2007
    45.24       33.76        
                         
(a) Dividends declared per share represents dividends declared and payable to shareholders of record in our fiscal year ended December 31, 2008. Excluded from the table are dividends declared of $0.05 per share, which were declared in December 2008 for shareholders of record as of March 13, 2009.

At February 20, 2009, there were 158 shareholders of record. In calculating the number of shareholders, we consider clearing agencies and security position listings as one shareholder for each agency or listing.

On August 6, 2008, our Board of Directors authorized a program to repurchase up to five percent of our outstanding common shares. In the third quarter of 2008, we repurchased 8.4 million shares at a cost of $196 million. The share repurchases were funded through our current cash position. In December 2008, our Board of Directors authorized a new share repurchase program pursuant to which we will repurchase shares in the open market to reduce and maintain, over time, our outstanding shares at approximately 160 million shares. No shares were repurchased in 2008 under the new program.

Our $930 million revolving credit facility (“Revolving Credit Facility”) restricts, among other things, the total dollar amount of we may pay for dividends and equity repurchases of our common stock. During 2008, we expanded the capacity of our Revolving Credit Facility by $80 million. This expansion increased the capacity under the Revolving Credit Facility from $850 million to $930 million. On January 17, 2008, we entered into an Agreement and Amendment to the Revolving Credit Facility effective as of January 11, 2008, (the “Amendment”). The Amendment, among other things, permits us to declare and pay shareholder dividends and/or engage in equity repurchases not to exceed $400 million in the aggregate. We have the capacity to pay additional dividends or repurchase shares in the amount of $163 million after the declaration of dividends and shares repurchased in 2008.  See Note 9 to our consolidated financial statements. The declaration and payment of any future dividends will be at the discretion of our Board of Directors and will depend upon, among other things, future earnings, general financial condition and liquidity, success in business activities, capital requirements, and general business conditions.

The information required by this item regarding securities authorized for issuance under equity compensation plans is incorporated by reference to the information set forth in Item 12 of this Form 10-K and the information discussed therein is incorporated by reference into this Item 5.


Performance Graph

The chart below compares the cumulative total shareholder return on our common shares from November 16, 2006 (the date of our initial public offering) to the end of the year with the cumulative total return on the Dow Jones Heavy Construction Industry Index and the Russell 1000 Index for the same period. The comparison assumes the investment of $100 on November 16, 2006, and reinvestment of all dividends. The shareholder return is not necessarily indicative of future performance.

Graph 1
 
   
11/16/2006
   
12/29/2006
   
6/29/2007
   
12/31/2007
   
6/30/2008
   
12/31/2008
 
KBR
  $ 100.00     $ 126.07     $ 126.41     $ 187.01     $ 168.77     $ 73.93  
Dow Jones Heavy Construction
    100.00       103.62       153.21       196.48       204.10       87.91  
Russell 1000
    100.00       101.31       107.64       105.22       92.51       64.17  


Item 6. Selected Financial Data

The following table presents selected financial data for the last five years. You should read the following information in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and the related notes to the consolidated financial statements.

   
Years Ended December 31, (a)
 
   
2008
   
2007
   
2006
   
2005
   
2004
 
   
(In millions, except for per share amounts)
 
Statements of Operations Data:
                             
Total revenue
  $ 11,581     $ 8,745     $ 8,805     $ 9,291     $ 11,173  
Operating costs and expenses:
                                       
Cost of services
    10,820       8,225       8,433       8,858       11,427  
General and administrative
    223       226       226       158       161  
Gain on sale of assets, net
    (3 )           (6 )     (110 )      
Operating income (loss)
    541       294       152       385       (415 )
Interest income (expense), net
    35       62       27       (1 )     5  
Interest expense—related party
                (36 )     (24 )     (15 )
Foreign currency gains (losses), net
    (8 )     (15 )     (16 )     2       6  
Foreign currency gains, net—related party
                1       3       (18 )
Other, net
          1             (1 )     (2 )
Income (loss) from continuing operations before income taxes and minority interest
    568       342       128       364       (439 )
Benefit (provision) for income taxes
    (212 )     (138 )     (94 )     (160 )     113  
Minority interest in net (income) loss of consolidated subsidiaries
    (48 )     (22 )     20       (19 )     (7 )
Income (loss) from continuing operations
    308       182       54       185       (333 )
Income from discontinued operations, net of tax provisions
    11       120       114       55       30  
Net income (loss)
  $ 319     $ 302     $ 168     $ 240     $ (303 )
Basic income (loss) per share:
                                       
—Continuing operations
  $ 1.86     $ 1.08     $ 0.39     $ 1.36     $ (2.45 )
—Discontinued operations
    0.07       0.71       0.81       0.40       0.22  
Basic income (loss) per share
  $ 1.92     $ 1.80     $ 1.20     $ 1.76     $ (2.23 )
Diluted income (loss) per share:
                                       
—Continuing operations
  $ 1.84     $ 1.08     $ 0.39     $ 1.36     $ (2.45 )
—Discontinued operations
    0.07       0.71       0.81       0.40       0.22  
Diluted income (loss) per share
  $ 1.91     $ 1.79     $ 1.20     $ 1.76     $ (2.23 )
Basic weighted average shares outstanding
    166       168       140       136       136  
Diluted weighted average shares outstanding
    167       169       140       136       136  
Cash dividends declared per share (b)
  $ 0.20     $     $     $     $  
                                         
Other Financial Data:
                                       
Capital expenditures (c)
  $ 37     $ 36     $ 47     $ 51     $ 56  
Depreciation and amortization expense (d)
    49       31       29       29       28  

 
   
At December 31,
 
   
2008
   
2007
   
2006
   
2005
   
2004
 
   
(In millions)
 
Balance Sheet Data:
                             
Cash and equivalents
  $ 1,145     $ 1,861     $ 1,410     $ 362     $ 220  
Net working capital
    1,099       1,433       915       944       765  
Property, plant and equipment, net
    245       220       211       185       178  
Total assets
    5,884       5,203       5,414       5,182       5,487  
Total debt (including due to and notes payable to former parent)
                      774       1,189  
Shareholders’ equity
    2,052       2,267       1,794       1,256       812  

(a)
In May 2006 we completed the sale of our Production Services group and in June 2007 we completed the disposition of our 51% interest in DML. The results of operations of Production Services group and DML for all periods presented have been reported as discontinued operations. See Note 22 to the consolidated financial statements for information about discontinued operations.

(b)
Dividends declared per share represents dividends declared and payable to shareholders of record in our fiscal year ended December 31, 2008. Excluded from the table are dividends declared of $0.05 per share, which were declared in December 2008 for shareholders of record as of March 13, 2009.

(c)
Capital expenditures do not include capital expenditures for DML, which was sold in the second quarter of 2007 and is accounted for as discontinued operations. Capital expenditures for DML were $7 million, $10 million, $25 million   and $18 million for the years ended December 31, 2007, 2006, 2005 and 2004, respectively.

(d)
Depreciation and amortization expense does not include depreciation and amortization expense for DML, which was sold in the second quarter of 2007 and is accounted for as discontinued operations. Depreciation and amortization expense for DML was $10 million, $18 million, $27 million and $24 million for the years ended December 31, 2007, 2006, 2005 and 2004, respectively.

 
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Introduction

The purpose of management’s discussion and analysis (“MD&A”) is to increase the understanding of the reasons for material changes in our financial condition, results of operations, liquidity and certain other factors that may affect our future results. The MD&A should be read in conjunction with the consolidated financial statements and related notes included in Item 8 of this Annual Report on Form 10-K.

Executive Overview

Summary of Consolidated Results

Consolidated revenues in 2008 were $11.6 billion as compared to $8.7 billion in 2007. Revenue was significantly impacted by our Middle East operations in our G&I business unit where we provide support services to the U.S. military primarily in Iraq. Revenues from our Middle East Operations were up approximately $736 million in 2008 largely as a result of higher volume on U.S. military support activities in Iraq under our LogCAP III contract due to a U.S. military troop surge in the second half of 2007 that continues to positively impact our 2008 revenue.  In 2008, the total number of employees working in the Middle East increased by approximately 11% to just over 72,000 including direct hires, subcontractors and local hires.  Although total DoD spending increased throughout 2008, we continue to believe overall spending in the long term is likely to decline. Revenues from our Gas Monetization operations in our Upstream business unit increased approximately $755 million in 2008 due to increased progress on a number of GTL and LNG projects.  Although we continue to experience increased activity on existing LNG and GTL projects, we are seeing indication that our customers are delaying investment decisions pending stabilization in the marketplace.  Revenues from our Services business unit increased significantly during 2008 by approximately $1.1 billion.  The majority of this increase relates to the business we obtained through the acquisition of BE&K which contributed approximately $825 million of revenue during 2008.  Also contributing to the increase in 2008 in our Services business unit were increases in activity from direct construction and modular fabrication services in our Canadian and North American construction operations.

Consolidated operating income in 2008 was $541 million as compared to $294 million in 2007. All of our business units had improvements in business unit income primarily due to increased revenue from work performed.  Income from our Services business unit increased significantly both as a result of continued growth in our legacy operations and as a result of the business we obtained through the acquisition of BE&K. In addition, our Offshore operations in the Upstream business unit recognized increased income as a result of a $51 million favorable arbitration award on the EPC 28 PEMEX project in the first quarter of 2008. Our Downstream income increased primarily due to increased activity on several large petrochemical projects in Saudi Arabia and newly awarded refining projects as well as a result of the work we obtained in the BE&K acquisition. We also reduced our labor cost absorption and our corporate general and administrative expenses during 2008.

Consolidated revenues in 2007 were $8.7 billion as compared to $8.8 billion in 2006. Revenue decreased in 2007 by approximately $480 million in our Middle East operations largely due to the lower volume of activities on our LogCAP III and PCO Oil contracts as our customer continued to scale back the construction and procurement related to military sites in Iraq.  The decrease in revenue from our Middle East operations was partially offset by continued revenue growth on several of our Gas Monetization projects, including our Escravos LNG and Pearl GTL projects.

Consolidated operating income in 2007 was $294 million as compared to $152 million in 2006. Operating income in 2007 includes positive contributions from a number of Gas Monetization projects including our Pearl GTL, Yemen LNG, Nigeria LNG and the Skikda LNG projects and various offshore projects, including Kashagan, in our Upstream business unit.  Operating income also included positive contributions from our LOGCAP III contract in our G&I business unit. Our operating income in 2006 was negatively impacted by $157 million in charges related to our Escravos GTL project in Nigeria.

Acquisition of BE&K, Inc.

On July 1, 2008, we acquired 100% of the outstanding common shares of BE&K, Inc., (“BE&K”) a privately held, Birmingham, Alabama-based engineering, construction and maintenance services company. BE&K serves both domestic and international customers, and employs roughly 9,000 people. BE&K’s international operations are located in Poland and Russia.  The acquisition of BE&K enhances our ability to provide contractor and maintenance services in North America. The agreed-upon purchase price was $550 million in cash subject to certain indemnifications and stockholders equity adjustments as defined in the stock purchase agreement. BE&K and its acquired divisions have been integrated into our Services, Downstream and Government & Infrastructure business units based upon the nature of the underlying projects acquired. As a result of the acquisition, the condensed consolidated statements of income for December 31, 2008, include the results of operations of BE&K since the date of acquisition. See Note 4 to our consolidated financial statements for further discussion of the BE&K acquisition.


Acquisition of Wabi Development Corporation.

In October 2008, we acquired 100% of the outstanding common stock of Wabi Development Corporation (“Wabi”) for approximately $20 million in cash. Wabi is a privately held Canada-based general contractor, which provides services for the energy, forestry and mining industries. Wabi currently employs over 120 people, providing maintenance, fabrication, construction and construction management services to a variety of clients in Canada and Mexico. Wabi has been integrated into our Services business unit. The integration of Wabi into our Services business will provide additional growth opportunities for our heavy hydrocarbon, forestry, oil sand, general industrial and maintenance services business.  See Note 4 to our consolidated financial statements for further discussion of the Wabi acquisition.

Acquisition of TGI and Catalyst Interactive

In April 2008, we acquired 100% of the outstanding common stock of Turnaround Group of Texas, Inc. (“TGI”) and Catalyst Interactive for approximately $12 million. TGI is a Houston-based turnaround management and consulting company that specializes in the planning and execution of turnarounds and outages in the petrochemical, power, and pulp & paper industries. Catalyst Interactive is an Australian e-learning and training solution provider that specializes in the defense, government and industry training sectors. TGI’s results of operations are included in our Services business unit. Catalyst Interactive’s results of operations are included in our Government & Infrastructure business unit.

Business Environment and Results of Operations

Business Environment

Government business.  A significant portion of our G&I business unit’s current operations relate to the support of the United States government operations in the Middle East, which we refer to as our Middle East operations, one of the largest U.S. military deployments since World War II. These services are provided under our LogCAP III contract with the DoD. Revenues under the LogCAP III project were approximately $5.5 billion, $4.7 billion, and $5.0 billion for the years ended December 31, 2008, 2007 and 2006, respectively.  Revenue from our Middle East Operations has historically been impacted by the level of DoD spending which has increased significantly in recent years primarily as a result of the current military operations in Iraq, Afghanistan and elsewhere in the region.  However, we expect the overall DoD spending to decline because of troop reductions in the Middle East region and the current economic conditions in the United States.

In the civil infrastructure sector, we operate in diverse sectors, including transportation, waste and water treatment and facilities maintenance.  In addition to the U.S government, we provide many of these services to foreign governments such as the United Kingdom and Australia. There has been a general trend of historic under-investment in the sector. In particular, infrastructure related to the quality of water, wastewater, roads and transit, airports, and educational facilities has declined while demand for expanded and improved infrastructure continues to outpace funding. As a result, we expect increased opportunities for our engineering and construction services and for privately financed project activities where our ability to assist with arranging financing and our desire to participate in project ownership make us an attractive partner for state and local governments undertaking important infrastructure projects. However, it is difficult to predict the availability of funding and timing for such projects and programs both domestically and internationally as a result of the current financial market crisis and overall worldwide economic conditions.

Engineering and Construction business.  We provide a full range of engineering and construction services for large and complex upstream and downstream projects, including LNG and GTL facilities, onshore and offshore oil and gas production facilities, industrial, power generation and other projects.  We serve customers in the gas monetization, oil and gas, petrochemical, refining, and chemical markets throughout the world.   At any given time, a relatively few number of projects and joint ventures represent a substantial part of our operations.  Our projects are generally long term in nature and are impacted by factors including market conditions, financing arrangements, governmental approvals and environmental matters. Demand for our services depends primarily on our customers’ capital expenditures and budgets for construction services. We have benefited in recent years from increased capital expenditures from our petroleum and petrochemical customers driven by historically high crude oil and natural gas prices and general global economic expansion.  However, the recent worldwide economic conditions, volatility in oil and gas prices and current financial market crisis has resulted in the delay of several major projects currently under development.  Many of our customers have decreased their capital expenditure budgets in the short term until the economic conditions become more favorable.  Additionally, some customers are deferring projects to take advantage of what they believe will be decreasing equipment, material and labor costs.  Although it is presently not possible to determine the impact these conditions may have on us in the future, to date we have not experienced any significant impact to our business.


Results of Operations

LogCap Project. Backlog related to the LogCAP III contract at December 31, 2008 was $1.4 billion. During the almost seven-year period we have worked under the LogCAP III contract, we have been awarded 82 “excellent” ratings out of 104 total ratings. Our award fees on the LogCAP III contract are recognized based on our estimate of the amounts to be awarded.  Once the task orders underlying the work are definitized and award fees are granted, we adjust our estimate of award fees to the actual amounts earned.  In 2007, we reduced our award fee accrual rate on the LogCAP III contract from 84% to 80% as a result of award fee scores received in that year resulting in a charge of approximately $2 million in 2007.    In 2008, based upon the self evaluations of our performance, we reduced the award fee accrual rate on this project from 80% to 72% for the performance period beginning in April 2008, resulting in a charge of approximately $5 million in the fourth quarter of 2008. As of December 31, 2008, we have recognized approximately $65 million in unbilled receivables as our estimate of award fees earned since the April 2008 performance period.  If our next award fee letter has performance scores and award rates higher or lower than our historical rates, our accrual will be adjusted accordingly

In August 2006, the DoD issued a request for proposals on a new competitively bid, multiple service provider LogCAP IV contract to replace the current LogCAP III contract. We are currently the sole service provider under our LogCAP III contract, which has been extended by the DoD through the third quarter of 2009. In June 2007, we were selected as one of the executing contractors under the LogCap IV contract to provide logistics support to U.S. Forces deployed in the Middle East. The LogCAP IV contract award was reevaluated by the GAO as a result of actions brought by various unsuccessful bidders. In April 2008, the DoD again selected KBR as one of the executing contractors. Despite the award of a portion of the LogCAP IV contract, we expect our overall volume of work to decline in the long term as our customer scales back its requirement for the types and the amounts of services we provide. However, although we continue to experience increased activity as a result of the surge of additional troops in late 2007 and extended tours of duty in Iraq, we expect the decline may occur more slowly than we previously expected.

Skopje Embassy Project.  In 2005, we were awarded a fixed-price contract to design and build a U.S. embassy in Skopje, Macedonia.  In the fourth quarter of 2006, as a result of a project estimate update and progress achieved on design drawings, we recorded a $12 million loss in connection with this project. Subsequently, we recorded additional losses on this project of approximately $27 million in 2007 and approximately $21 million in 2008, bringing our total estimated losses to approximately $60 million. These additional costs are a result of identifying increased costs of materials and the related costs of freight, installation and other costs. We could incur additional costs and losses on this project if our cost estimation processes identify new costs not previously included in our total estimated costs or if our plans to make up lost schedule are not achieved.

Escravos project.  In connection with our review of a consolidated 50%-owned GTL project in Escravos, Nigeria, during the second quarter of 2006, we identified increases in the overall cost to complete this four-plus year project, which resulted in our recording a $148 million charge before minority interest and taxes during the second quarter of 2006. These cost increases were caused primarily by schedule delays related to civil unrest and security on the Escravos River, changes in the scope of the overall project, engineering and construction changes due to necessary front-end engineering design changes and increases in procurement cost due to project delays. The increased costs were identified as a result of our first check estimate process.

During the first half of 2007, we and our joint venture partner negotiated modifications to the contract terms and conditions resulting in an executed contract amendment in July 2007. The contract was amended to convert from a fixed price to a reimbursable contract whereby we will be paid our actual cost incurred less a credit that approximates the charge we identified in the second quarter of 2006. The unamortized balance of the charge is included as a component of the “Reserve for estimated losses on uncompleted contracts” in the accompanying condensed consolidated balance sheets. Also included in the amended contract are client determined incentives that may be earned over the remaining life of the contract. Under the terms of the amended contract, the first $21 million of incentives earned over the remaining life of the contract are not payable to us. Since the contract was amended in July 2007, we have earned in the aggregate $21 million in client determined incentives. Any future incentives will be recognized if and when they are earned. Our Advanced billings on uncompleted contracts included in our condensed consolidated balance sheets related to this project, was $1 million at December 31, 2008 and $236 million at December 31, 2007.


For purposes of presenting our results of operations, we supplementally provide financial results for each of our six business units and certain product service lines. The business units presented are consistent with our reportable operating segments discussed in Note 7 (Business Segment Information) to our consolidated financial statements. We also present the results of operations for product service lines (“PSL”). While certain of the business units and product service lines presented below do not meet the criteria for reportable segments in accordance with SFAS No. 131, we believe this supplemental information is relevant and meaningful to our investors for various reasons including monitoring our progress and growth in certain markets and product lines.

For purposes of reviewing the results of operations, “business unit income” is calculated as revenue less cost of services managed and reported by the business unit and are directly attributable to the business unit. Business unit income excludes corporate general and administrative expenses and other non-operating income and expense items.

In millions
 
Years Ended December 31,
 
Revenue (1)
 
2008
   
2007
   
Increase (Decrease)
   
Percentage Change
   
2006
   
Increase (Decrease)
   
Percentage Change
 
G&I:
                                         
U.S. Government – Middle East Operations
  $ 5,518     $ 4,782     $ 736       15 %   $ 5,262     $ (480 )     (9 %)
U.S. Government – Americas Operations
    618       721       (103 )     (14 %)     837       (116 )     (14 %)
International Operations
    802       590       212       36 %     407       183       45 %
Total G&I
    6,938       6,093       845       14 %     6,506       (413 )     (6 %)
Upstream:
                                                       
Gas Monetization
    2,157       1,402       755       54 %     1,012       390       39 %
Offshore
    413       338       75       22 %     388       (50 )     (13 %)
Other
    112       147       (35 )     (24 %)     300       (153 )     (51 %)
Total Upstream
    2,682       1,887       795       42 %     1,700       187       11 %
Services
    1,373       322       1,051       326 %     314       8       3 %
Downstream
    484       361       123       34 %     315       46       15 %
Technology
    84       90       (6 )     (7 %)     62       28       45 %
Ventures
    (2 )     (8 )     6       75 %     (92 )     84       91 %
Other
    22             22                          
Total revenue
  $ 11,581     $ 8,745     $ 2,836       32 %   $ 8,805     $ (60 )     (1 %)
_________________________
(1)
Our revenue includes both equity in the earnings of unconsolidated affiliates and revenue from the sales of services into the joint ventures. We often participate on larger projects as a joint venture partner and also provide services to the venture as a subcontractor. The amount included in our revenue represents our share of total project revenue, including equity in the earnings (loss) from joint ventures and revenue from services provided to joint ventures.

 
In millions
 
Years Ending December 31,
 
   
2008
   
2007
   
Increase (Decrease)
   
Percentage Change
   
2006
   
Increase (Decrease)
   
Percentage Change
 
Business unit income (loss):
                                         
G&I:
                                         
U.S. Government – Middle East Operations
  $ 242     $ 231     $ 11       5 %   $ 350     $ (119 )     (34 %)
U.S. Government – Americas Operations
    36       68       (32 )     (47 %)     83       (15 )     (18 %)
International Operations
    170       116       54       47 %     73       43       59 %
Total job income
    448       415       33       8 %     506       (91 )     (18 %)
Divisional overhead
    (116 )     (136 )     20       15 %     (179 )     43       24 %
Total G&I business unit income
    332       279       53       19 %     327       (48 )     (15 %)
Upstream:
                                                       
Gas Monetization
    165       161       4       2 %     (4 )     165       4,125 %
Offshore
    116       59       57       97 %     60       (1 )     (2 %)
Other
    25       22       3       14 %     28       (6 )     (21 %)
Total job income
    306       242       64       26 %     84       158       188 %
Divisional overhead
    (44 )     (54 )     10       19 %     (44 )     (10 )     (23 %)
Total Upstream business unit income
    262       188       74       39 %     40       148       370 %
Services:
                                                       
Job income
    151       67       84       125 %     50       17       34 %
Gain on sale of assets
    1             1                          
Divisional overhead
    (42 )     (11 )     (31 )     (282 %)     (5 )     (6 )     (120 %)
Total Services business unit income
    110       56       54       96 %     45       11       24 %
Downstream:
                                                       
Job income
    72       26       46       177 %     54       (28 )     (52 %)
Divisional overhead
    (21 )     (16 )     (5 )     (31 %)     (13 )     (3 )     (23 %)
Total Downstream business unit income
    51       10       41       410 %     41       (31 )     (76 %)
Technology:
                                                       
Job income
    41       39       2       5 %     28       11       39 %
Divisional overhead
    (22 )     (20 )     (2 )     (10 %)     (18 )     (2 )     (11 %)
Total Technology business unit income
    19       19                   10       9       90 %
Ventures:
                                                       
Job loss
    (4 )     (9 )     5       56 %     (91 )     82       90 %
Gain on sale of assets
    1             1             6       (6 )     (100 %)
Divisional overhead
    (2 )     (3 )     1       33 %     (1 )     (2 )     (200 %)
Total Ventures business unit income (loss)
    (5 )     (12 )     7       58 %     (86 )     74       86 %
Other: