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Article by DailyStocks_admin    (09-23-08 05:22 AM)

The Daily Magic Formula Stock for 09/22/2008 is KBR Inc. According to the Magic Formula Investing Web Site, the ebit yield is 14% and the EBIT ROIC is 75-100 %.

Dailystocks.com only deals with facts, not biased journalism. What is a better way than to go to the SEC Filings? It's not exciting reading, but it makes you money. We cut and paste the important information from SEC filings for you to get started on your research on a specific company.


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BUSINESS OVERVIEW

General
KBR, Inc. (“KBR”) is a leading global engineering, construction and services company supporting the energy, petrochemicals, government services and civil infrastructure sectors. We offer a wide range of services. Our business however, is heavily focused on major projects. At any given time, a relatively few number of projects and joint ventures represent a substantial part of our operations. We provide our wide range of services through six business units; Government and Infrastructure (“G&I”), Upstream, Services, Downstream, Technology and Ventures. During the third quarter of 2007, we announced the reorganization of our operations into six business units as a result of a change in operational and market strategies in order to maximize KBR’s resources for future opportunities. During the fourth quarter of 2007, we revised our internal reporting structure which resulted in changes in the monthly financial and operating information provided to our chief operating decision maker. Prior to the reorganization, the business activities included in the Upstream, Services, Downstream and Technology business units had previously been reported as part of the Energy and Chemicals segment. Prior period information has been reclassified to conform with the new segment reporting structure. See Note 10 to the 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. At inception, KBR, Inc. issued 1,000 shares of common stock for $1 to Halliburton. On October 27, 2006, KBR effected a 135,627-for-one split of its common stock. In connection with the stock split, the certificate of incorporation was amended and restated to increase the number of authorized shares of common stock from 1,000 to 300,000,000 and to authorize 50,000,000 shares of preferred stock with a par value of $0.001 per share. All share data of the company has been adjusted to reflect the stock split.
In November 2006, KBR, Inc. completed an initial public offering of 32,016,000 shares of its common stock (the “Offering”) at $17.00 per share. The Company received net proceeds of $511 million from the offering after underwriting discounts and commissions. 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 connection with the Offering in November 2006 and the separation of our business from Halliburton, we entered into various agreements with Halliburton including, among others, a master separation agreement, tax sharing agreement, transition services agreements and an employee matters agreement. Refer to “Separation from Halliburton ” in “Management’s Discussion and Analysis of Financial Condition and Results of Operation” and Notes 2 and 20 to the consolidated financial statements for further discussion of the above agreements and other related party transactions with Halliburton.
On June 28, 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 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 accordance with the provisions of Statement of Financial Accounting Standards No. 144 “Accounting for Impairment or Disposal of Long-Lived Assets,” the results of operations of the Production Services group and DML for the current and prior periods have been reported as discontinued operations in our consolidated statements of income. See Note 25 to the consolidated financial statements for information about discontinued operations.
Our Business Units
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, 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.
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.
Services. Our Services business unit provides construction and industrial services built on the legacy established by the founders Brown & Root almost 100 years ago. Our construction services include major project construction, construction management and module and pipe fabrication services. Our industrial services include routine maintenance, small capital and turnaround services as well as the full range of high value services including startup commissioning, procurement support, facility services, supply chain solutions, and electrical and instrumentation solutions. We also provide offshore maintenance and construction services to oil and gas facilities using semisubmersible vessels in the Bay of Campeche through a jointly held venture. Our services are delivered to customers in variety of industries including the petrochemical, refining, pulp and paper, and energy industries.
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, EPC, EPCM and Program Management. We are dedicated to providing life cycle value to our customers.
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.
Ventures . Our Ventures business unit develops, provides assistance in arranging financing for, makes equity and/or debt investments in and participates in managing entities owning assets generally from projects in which one of our other business units has a direct role in engineering, construction, and/or operations and maintenance. The creation of the Ventures business unit provides management focus on our investments in the entities that own the assets. Projects developed and under current management include government services, such as defense procurement and operations and maintenance services for equipment, military infrastructure construction and program management, toll roads and railroads, and energy and chemical plants.
Our Significant Projects

Our Business Strategy
Our business strategy is to increase shareholder value by delivering consistent, predictable financial results in growth markets. We will also pursue targeted merger and acquisition activity to complement organic growth and accelerate implementation of individual Business Unit strategies. Key features of our business unit strategies include:
• The Government and Infrastructure business unit will broaden its service offerings to existing customers and cross-sell to adjacent markets.

• The Upstream business unit will build on its world-class strength in gas monetization and regain its leading position in offshore oil and gas services.

• T he Services business unit will grow organically by expanding existing operations while pursuing new offerings that capitalize on our brand reputation and legacy core competencies.

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

• The Technology business unit will expand its range of differentiated process technologies and increase its 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
Our services are sold in highly competitive markets throughout the world. The principal methods of competition with respect to sales of our services include:
• price;

• technical excellence or differentiation;

• 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;

• health, safety, and environmental standards and practices;

• financial strength;

• service quality;

• warranty;

• breadth of technology and technical sophistication; and

• customer relationships.
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 89% of our consolidated revenue during 2007, 85% of our consolidated revenue during 2006 and 86% of our consolidated revenue during 2005. Revenue from our operations in Iraq, primarily related to our work for the U.S. government was 50% of our consolidated revenue in 2007, 49% of our consolidated revenue in 2006 and 55% in 2005.
We market substantially all of our services through our servicing and sales organizations. We serve highly competitive industries and we have many substantial competitors. Some of our competitors have greater financial and other resources and access to capital than we do, which may enable them to compete more effectively for large-scale project awards. 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 18 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, 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, 2007.
We began working with JGC Corporation (“JGC”) in 1978 to pursue an LNG project in Malaysia. This relationship was formalized into a gas alliance agreement in 1999, which was renewed in 2005. KBR and JGC have been awarded 24 FEED and/or EPC-CS contracts for LNG and GTL facilities, and have completed over 35 million metric tons per annum of LNG capacity between 2000 and 2007. We operate this alliance through global hubs in Houston, Yokohama and London.
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.
TSKJ Group is a joint venture 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 five LNG production facilities on Bonny Island, Nigeria and is nearing completion on a sixth such facility. We account for this investment using the equity method of accounting.
KSL is a joint venture with Shaw Group and Los Alamos Technical, formed to provide support services to the Los Alamos National Security, LLC in New Mexico. We are a 55% owner and the managing partner of KSL. The joint venture serves as subcontractor to Los Alamos National Security (“LANS”) , which in December 2005 won a rebid for laboratory operatorship. As part of the rebid, LANS is required to continue using KSL for support services. This contract has five one-year extension options beginning in 2008. We consolidate KSL for financial accounting purposes.
APT/ FreightLink—The Alice Springs-Darwin railroad is a privately financed project initiated in 2001 to build, own and operate the transcontinental railroad from Alice Springs to Darwin, Australia and has been granted a 50-year concession period by the Australian government. We provided EPC services and are the largest equity holder in the project with a 36.7% interest, with the remaining equity held by eleven other participants. 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.

MANAGEMENT DISCUSSION FROM LATEST 10K

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 2007 were $8.7 billion as compared to $8.8 billion in 2006. 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 down approximately $480 million in 2007 largely due to the lower volume of activities on our LogCAP III and PCO Oil contracts as our customer continues to scale back the construction and procurement related to military sites in Iraq. We expect overall spending by the U.S. military in Iraq to continue to decline in 2008 and beyond. The decrease in Middle East Operations was partially offset by continued revenue growth on several of our Gas Monetization projects in our Upstream business unit, 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 recently awarded Skikda LNG projects and various offshore projects, including Kashagan, in our Upstream business unit operating income also includes positive contributions from our LOGCAP III contract in our G&I business unit. Our 2006 operating income was negatively impacted by $157 million in charges related to our Escravos GTL project in Nigeria.
Consolidated revenues in 2006 were $8.8 billion as compared to $9.3 billion in 2005. The decrease was largely due to a $618 million decrease in our military support activities in Iraq in our Middle East operations, a $184 million decrease in other U.S. government work in our G&I business unit, and other decreases in our Offshore operations in the Upstream business unit primarily related to the completion of the Barracuda-Caratinga and Belanak projects. These decreases were partially offset by increases of approximately $594 million related to several of our gas monetization projects that were either awarded in late 2005 or early 2006.
Consolidated operating income in 2006 was $152 million as compared to $385 million in 2005. Operating income for 2006 included $157 million in charges related to our Escravos GTL project in Nigeria as well as $58 million of impairment charges recorded on an equity investment in an Australian railroad project in our Ventures business unit. In 2005, we recognized a gain on sale of a one-time distribution from our interest in the Dulles Greenway Toll Road joint venture in the amount of $96 million.
Reorganization of Business Units
During the third quarter of 2007, we announced the reorganization of our business into six business units each with its own business unit leader who reports to our chief executive officer (“CEO”) and chief operating decision maker. The reorganized business units are Government & Infrastructure, Upstream, Services, Downstream, Technology and Ventures. During the fourth quarter of 2007, we completed the reorganization of our monthly financial and operating information provided to our CEO and chief operating decision maker and accordingly, we have redefined our reportable segments consistent with the financial information that our chief operating decision maker reviews to evaluate operating performance and make resource allocation decisions. Our reportable segments are Government and Infrastructure, Upstream and Services. See Note 10 to our consolidated financial statements for further discussion of our reportable segments.
In the fourth quarter of 2007, we initiated a restructuring whereby we committed to a minor headcount reduction and ceased using certain leased office space. In connection with this restructuring we recorded charges totaling approximately $5 million of which the majority related to a vacated lease, previously utilized by our G&I division in Arlington. This amount is included in “Cost of services” in our statements of income for the year ended December 31, 2007. Less than $1 million of the charge consists of standard termination benefits payable to a limited number of corporate and division employees. These termination costs are included in “General and Administrative” in our statements of income for the year ended December 31, 2007. The amounts recorded represent the total amounts expected to be incurred in connection with these activities.
Reclassification
We reclassified certain overhead expenses in our prior period statements of income previously recorded as cost of services to general and administrative expense in our statements of income. These expenses relate to certain overhead expenses and indirect costs that were previously managed and reported within our business units but are now managed and reported at a corporate level. These expenses were reclassified to allow transparency of business unit margins and general and administrative expense consistent with the nature of the underlying costs and the manner in which the costs are managed. See Note 1 to the consolidated financial statements for further discussion of this reclassification.
Separation from Halliburton
On February 26, 2007, Halliburton’s board of directors approved a plan under which Halliburton would dispose of its remaining interest in KBR through a tax-free exchange with Halliburton’s stockholders pursuant to an exchange offer. On April 5, 2007, Halliburton completed the separation of KBR by exchanging the 135,627,000 shares of KBR owned by Halliburton for publicly held shares of Halliburton common stock pursuant to the terms of the exchange offer (the “Exchange Offer”) commenced by Halliburton on March 2, 2007.
In connection with the Offering in November 2006 and the separation of our business from Halliburton, we entered into various agreements with Halliburton including, among others, a master separation agreement, tax sharing agreement, transition services agreements and an employee matters agreement.
Pursuant to our master separation agreement, we agreed to indemnify Halliburton for, among other matters, all past, present and future liabilities related to our business and operations, subject to specified exceptions. We agreed to indemnify Halliburton for liabilities under various outstanding and certain additional credit support instruments relating to our businesses and for liabilities under litigation matters related to our business. Halliburton agreed to indemnify us for, among other things, liabilities unrelated to our business, for certain other agreed matters relating to the Foreign Corrupt Practices Act (“FCPA”) investigations, the Barracuda-Caratinga matters regarding subsea bolts and for other litigation matters related to Halliburton’s business. See Note 8 to our consolidated financial statements for further discussion of the FCPA investigations and the Barracuda-Caratinga project.
The tax sharing agreement, as amended, provides for certain allocations of U.S. income tax liabilities and other agreements between us and Halliburton with respect to tax matters. As a result of the Offering, Halliburton is responsible for filing all U.S. income tax returns required to be filed through April 5, 2007, the date KBR ceased to be a member of the Halliburton consolidated tax group. Halliburton is responsible for paying the taxes related to the returns it is responsible for filing. We will pay Halliburton our allocable share of such taxes. We are obligated to pay Halliburton for the utilization of net operating losses, if any, generated by Halliburton prior to the deconsolidation which we may use to offset our future consolidated federal income tax liabilities.
Under the transition services agreements, Halliburton is expected to continue providing various interim corporate support services to us and we will continue to provide various interim corporate support services to Halliburton. These support services relate to, among other things, information technology, legal, human resources and risk management. The services provided under the transition services agreement between Halliburton and KBR are substantially the same as the services historically provided. Similarly, the related costs of such services will be substantially the same as the costs incurred and recorded in our historical financial statements. As of December 31, 2007, most of the corporate service activities have been discontinued and primarily related to human resources and risk management. In 2008, the only significant corporate service activities expected to be incurred relate to fees for ongoing guarantees provided by Halliburton on existing credit support instruments which have not yet expired.
The employee matters agreement provides for the allocation of liabilities and responsibilities to our current and former employees and their participation in certain benefit plans maintained by Halliburton. Among other items, the employee matters agreement and the KBR, Inc. Transitional Stock Adjustment Plan provide for the conversion, upon the complete separation of KBR from Halliburton, of stock options and restricted stock awards (with restrictions that have not yet lapsed as of the final separation date) granted to KBR employees under Halliburton’s 1993 Stock and Incentive Plan (“1993 Plan”) to stock options and restricted stock awards covering KBR common stock. On April 5, 2007, immediately after our separation from Halliburton, the conversion of such stock options and restricted stock awards occurred. A total of 1,217,095 Halliburton stock options and 612,857 Halliburton restricted stock awards were converted into 1,966,061 KBR stock options with a weighted average exercise price per share of $9.35 and 990,080 million restricted stock awards with a weighted average grant-date fair value per share of $11.01. The conversion of such stock options and restricted stock was accounted for as a modification in accordance with SFAS No. 123(R) and resulted in an incremental charge to expense of less than $1 million, recognized in 2007, representing the change in fair value of the converted awards from Halliburton stock options and restricted stock awards to KBR stock options and restricted stock awards. See Notes 3 and 17 to our consolidated financial statements for information regarding stock-based compensation and stock incentive plans.
See Notes 2 and 20 to our consolidated financial statements for further discussion of the above agreements and other related party transactions with Halliburton.
Other Corporate Matters
Share-Based Payment. Effective January 1, 2006, we adopted the fair value recognition provisions of Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standard No. 123 (revised 2004), “Share Based Payment (“SFAS No. 123(R)”), using the modified prospective application. Accordingly, compensation expense is recognized for all newly granted awards and awards modified, repurchased, or cancelled after January 1, 2006 based on their fair values. Compensation cost for the unvested portion of awards that were outstanding as of January 1, 2006 is recognized ratably over the remaining vesting period based on the fair value at date of grant. Also, beginning with the January 1, 2006 purchase period, compensation expense for Halliburton’s ESPP was being recognized. The cumulative effect of this change in accounting principle related to stock-based awards was immaterial. Prior to January 1, 2006, we accounted for these plans under the recognition and measurement provisions of APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. Under APB Opinion No. 25, no compensation expense was recognized for stock options or the ESPP. Compensation expense was recognized for restricted stock awards.
Total stock-based compensation expense, net of related tax effects, was $7 million in 2007, $11 million in 2006 and $8 million in 2005. Total income tax benefit recognized in net income for stock-based compensation arrangements was $4 million in 2007, $6 million in 2006, and $5 million in 2005. Incremental compensation cost resulting from modifications of previously granted stock-based awards which allowed certain employees to retain their awards after leaving the company, was less than a million in 2007, $6 million in 2006 and $8 million in 2005. In 2007, we also recognized less than $1 million in incremental compensation cost from modifications of previously granted stock-awards due to the conversion of Halliburton stock options and restricted stock awards granted to KBR employees to KBR awards of stock options and restricted stock, after our separation from Halliburton on April 5, 2007. Effective upon our complete separation from Halliburton, the Halliburton ESPP plan was terminated to KBR employees. No shares were purchased by KBR employees in 2007 under the Halliburton ESPP plan and therefore no stock-based compensation expense was recorded in 2007. Halliburton shares previously purchased under the ESPP plan remained Halliburton common stock and did not convert to KBR common stock at the date of separation. Refer to “Separation from Halliburton.”
Business Environment and Results of Operations
Business Environment
We are a leading global engineering, construction and services company supporting the energy, petrochemicals, government services and civil infrastructure sectors. We are a leader in many of the growing end-markets that we serve, particularly gas monetization, having designed and constructed, alone or with joint venture partners, more than half of the world’s operating LNG liquefaction capacity over the past 30 years. In addition, we are one of the largest government defense contractors worldwide and we believe we are the world’s largest government defense services provider.
We offer our wide range of services through six business units; G&I, Upstream, Services, Downstream, Technology and Ventures. Although we provide a wide range of services, our business is heavily focused on major projects. At any given time, a relatively few number of projects and joint ventures represent a substantial part of our operations. Our projects are generally long term in nature and are impacted by factors including local economic cycles, introduction of new governmental regulation, and governmental outsourcing of services. Demand for our services depends primarily on our customers’ capital expenditures and budgets for construction and defense services. We have benefited from increased capital expenditures by our petroleum and petrochemical customers driven by high crude oil and natural gas prices and general global economic expansion. Additionally, the heightened focus on global security and major military force realignments, particularly in the Middle East, as well as a global expansion in government outsourcing, have all contributed to increased demand for the type of services that we provide.

Our operations in some countries may be adversely affected by unsettled political conditions, acts of terrorism, civil unrest, force majeure, war or other armed conflict, expropriation or other governmental actions, inflation, exchange controls, or currency fluctuations.
Contract Structure
Our contracts can be broadly categorized as either cost-reimbursable or fixed-price (sometimes referred to as lump sum). Some contracts can involve both fixed-price and cost-reimbursable elements. Fixed-price contracts are for a fixed sum to cover all costs and any profit element for a defined scope of work. Fixed-price contracts entail more risk to us as we must predetermine both the quantities of work to be performed and the costs associated with executing the work. While fixed-price contracts involve greater risk, they also are potentially more profitable for us, since the owner/customer pays a premium to transfer many risks to us. Cost-reimbursable contracts include contracts where the price is variable based upon our actual costs incurred for time and materials, or for variable quantities of work priced at defined unit rates. Profit on cost-reimbursable contracts may be based upon a percentage of costs incurred and/or a fixed amount. Cost-reimbursable contracts are generally less risky to us, since the owner/customer retains many of the risks.
G&I Business Unit Activity
Our G&I business unit provides program and project management, contingency logistics, operations and maintenance, construction management, engineering and other services to military and civilian branches of governments and private clients worldwide. We deliver on-demand support services across the full military mission cycle from contingency logistics and field support to operations and maintenance on military bases. A significant portion of our G&I business unit’s current operations relate to the support of the United States government operations in the Middle East, which we refer to as our Middle East operations, one of the largest U.S. military deployments since World War II. In the civil infrastructure market, we operate in diverse sectors, including transportation, waste and water treatment and facilities maintenance. We design, construct, maintain and operate and manage civil infrastructure projects ranging from airport, rail, highway, water and wastewater facilities, and mining and mineral processing to regional development programs and major events. We provide many of these services to foreign governments such as the United Kingdom and Australia.
In the civil infrastructure sector, there has been a general trend of historic under-investment. In particular, infrastructure related to the quality of water, wastewater, roads and transit, airports, and educational facilities has declined while demand for expanded and improved infrastructure continues to outpace funding. As a result, we expect increased opportunities for our engineering and construction services and for our privately financed project activities as our financing structures make us an attractive partner for state and local governments undertaking important infrastructure projects.
We provide substantial work under our government contracts to the DoD and other governmental agencies. Most of the services provided to the U.S. government are under cost-reimbursable contracts where we have the opportunity to earn an award fee based on our customer’s evaluation of the quality of our performance. These award fees are evaluated and granted by our customer periodically. For contracts entered into prior to June 30, 2003, all award fees are recognized during the term of the contract based on our estimate of amounts to be awarded.
LogCap Project . In August 2006, we were awarded a $3.5 billion task order under our LogCAP III contract for additional work through 2007. Backlog related to the LogCAP III contract at December 31, 2007 was $1.4 billion. During the almost six-year period we have worked under the LogCAP III contract, we have been awarded 72 “excellent” ratings out of 89 total ratings. In addition, based on recent award fee scores, which determined the fees awarded during 2007, we decreased our award fee accrual rate on the LogCAP III contract from 84% to 80%, which resulted in a decrease of $2 million of award fees being recorded in 2007.
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 2008. In June 2007, we were selected as one of the executing contractors under the LogCap IV contract to provide logistics support to U.S. Forces deployed in the Middle East. Since the award of the LogCAP IV contract, unsuccessful bidders have brought actions at the GAO protesting the contract award. The GAO rendered a decision upholding portions of the bid protests. Currently, the DoD has implemented a process to reevaluate the previous contract awards in accordance with the GAO’s decision. We expect the DoD’s reevaluation will be completed in the first quarter of 2008. Despite the award of a portion of the LogCAP IV contract and extension of our LogCAP III contract, we expect our overall volume of work to decline as our customer scales back its requirement for the types and the amounts of services we provide. However, as a result of the recently announced surge of additional troops and extended tours of duty in Iraq, we expect the decline may occur more slowly than we previously expected.
Allenby & Connaught project . In April 2006, Aspire Defence, a joint venture between us, Carillion Plc. and a financial investor, was awarded a privately financed project contract, the Allenby & Connaught project, by the MoD to upgrade and provide a range of services to the British Army’s garrisons at Aldershot and around Salisbury Plain in the United Kingdom. In addition to a package of ongoing services to be delivered over 35 years, the project includes a nine year construction program to improve soldiers’ single living, technical and administrative accommodations, along with leisure and recreational facilities. Aspire Defence will manage the existing properties and will be responsible for design, refurbishment, construction and integration of new and modernized facilities. Our Venture’s business unit manages KBR’s equity interest in Aspire Defence, the project company that is the holder of the 35-year concession contract. At December 31, 2007, we indirectly owned a 45% interest in Aspire Defence. In addition, at December 31, 2007, we owned a 50% interest in each of two joint ventures that provide the construction and the related support services to Aspire Defence. As of December 31, 2007, our performance through the construction phase is supported by $214 million in letters of credit and surety bonds totaling $226 million, both of which have been guaranteed by Halliburton. Furthermore, our financial and performance guarantees are joint and several, subject to certain limitations, with our joint venture partners. The project is funded through equity and subordinated debt provided by the project sponsors, including us, and the issuance of publicly held senior bonds.
Skopje Embassy Project. In 2005, we were awarded a fixed-price contract to design and build a U.S. embassy in Skopje, Macedonia. As a result of a project estimate update and progress achieved on design drawings, we recorded a $12 million loss in connection with this project during the fourth quarter of 2006. We identified additional increases in cost on this project due to escalating material, labor and other costs including schedule delays. As a result of these cost increases identified in 2007, we recorded an additional loss on this project of approximately $27 million during 2007 which we believe are not recoverable under the contract. We could incur additional costs and losses on this project if our plan to make up lost schedule is not achieved or if material, labor or other costs incurred exceed the amounts we have estimated. As of December 31, 2007, the project was approximately 45% complete.
Upstream Business Unit Activity
Skikda project. During the third quarter of 2007, we were awarded the engineering, procurement and construction (“EPC”) contract for the Sonatrach Skikda LNG project, to be constructed at Skikda, Algeria. In addition to performing the EPC work for the 4.5 million metric tons per annum LNG train, we will execute the pre-commissioning and commissioning portion of the contract. The contract has an approximate value of $2.8 billion. As of December 31, 2007 the Skikda project was approximately 10% complete.
Escravos project . In connection with our review of a consolidated 50%-owned GTL project in Escravos, Nigeria, during the second quarter of 2006, we identified increases in the overall cost to complete this four-plus year project, which resulted in our recording a $148 million charge before minority interest and taxes during the second quarter of 2006. These cost increases were caused primarily by schedule delays related to civil unrest and security on the Escravos River, changes in the scope of the overall project, engineering and construction changes due to necessary front-end engineering design changes and increases in procurement cost due to project delays. The increased costs were identified as a result of our first check estimate process.
In the fourth quarter of 2006, we reached agreement with the project owner to settle $264 million of change orders. We also recorded an additional $9 million loss in the fourth quarter of 2006 related to non-billable engineering services we provided to the Escravos joint venture. These services were in excess of the contractual limit to total engineering costs each partner can bill to the joint venture.
During the first half of 2007, we and our joint venture partner negotiated modifications to the contract terms and conditions resulting in an executed contract amendment in July 2007. The contract has been amended to convert from a fixed price to a reimbursable contract whereby we will be paid our actual cost incurred less a credit that approximates the charge we identified in the second quarter of 2006. Also included in the amended contract are client determined incentives that may be earned over the remaining life of the contract. The effect of the modifications resulted in a $3 million increase to operating income in the second quarter of 2007. In addition, minority interest shareholders’ absorption of losses increased by $15 million resulting in an increase to net income of $12 million in the second quarter of 2007. Because our amended agreement with the client provides that we will be reimbursed for our actual costs incurred, as defined, all amounts of probable unapproved change order revenue that were previously included in the project estimated revenues are now considered approved. As of December 31, 2007, our Advanced billings on uncompleted contracts related to this project was $236 million.
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. We have recorded losses on the project of $19 million and $8 million for the years ended December 31, 2006 and 2005, respectively. No losses were recorded on the project in 2007. We have been in negotiations with the project owner since 2003 to settle the various issues that have arisen and have entered into several agreements to resolve those issues. We funded approximately $3 million in cash shortfalls during 2007.
In April 2006, we executed an agreement with Petrobras that enabled us to achieve conclusion of the Lenders’ Reliability Test and final acceptance of the FPSOs. These acceptances eliminated any further risk of liquidated damages being assessed but did not address the bolt arbitration discussed below. In November 2007, we executed a settlement agreement with the project owner to settle all outstanding project issues except for the bolts arbitration discussed below. The agreement resulted in the project owner assuming substantially all remaining work on the project and the release of us from any further warranty obligations. The settlement agreement did not have a material impact to our results of operations or financial position.
At Petrobras’ direction, we replaced certain bolts located on the subsea flowlines that have failed through mid-November 2005, and we understand that additional bolts have failed thereafter, which have been replaced by Petrobras. These failed bolts were identified by Petrobras when it conducted inspections of the bolts. The original design specification for the bolts was issued by Petrobras, and as such, we believe the cost resulting from any replacement is not our responsibility. In March 2006, Petrobras notified us that they have submitted this matter to arbitration claiming $220 million plus interest for the cost of monitoring and replacing the defective stud bolts and, in addition, all of the costs and expenses of the arbitration including the cost of attorneys fees. We do not believe that it is probable that we have incurred a liability in connection with the claim in the bolt arbitration with Petrobras and therefore, no amounts have been accrued. We disagree with Petrobras’ claim since the bolts met the design specification provided by Petrobras. Although we believe Petrobras is responsible for any maintenance and replacement of the bolts, it is possible that the arbitration panel could find against us on this issue. In addition, Petrobras has not provided any evidentiary support or analysis for the amounts claimed as damages. We expect to have a preliminary hearing on legal and factual issues relating to liability with the arbitration panel in April 2008. The actual arbitration hearings have not yet been scheduled. Therefore, at this time, we cannot conclude that the likelihood that a loss has been incurred is remote. Due to the indemnity from Halliburton, we believe any outcome of this matter will not have a material adverse impact to our operating results or financial position. KBR has incurred legal fees and related expenses of $4 million, $1 million and $0 million for the years ended December 31, 2007, 2006 and 2005, respectively, related to this matter.
Under the master separation agreement, Halliburton has agreed to indemnify us and any of our greater than 50%-owned subsidiaries as of November 2006, for all out-of-pocket cash costs and expenses (except for ongoing legal costs), or cash settlements or cash arbitration awards in lieu thereof, we may incur after the effective date of the master separation agreement as a result of the replacement of the subsea flowline bolts installed in connection with the Barracuda-Caratinga project.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

Results of Operations

Three months ended June 30, 2008 compared to three months ended June 30, 2007

Government and Infrastructure. Revenue from our G&I business unit was $1.7 billion and $1.5 billion for the three months ended June 30, 2008 and 2007, respectively. The increase in revenue from our Middle East Operations is largely a result of higher volume on U.S. military support activities in Iraq under our LogCAP III contract due to a U.S. military troop surge in the second half of 2007. We expect to provide services under our LogCAP III contract through the first quarter of 2009. In April 2008, we were selected as one of the executing contractors of the LogCAP IV contract. Despite the award of the LogCAP IV contract, we expect our overall volume of work to decline as our customer scales back its requirements for the types and amounts of services we provide under these programs. Revenue from our Americas Operations decreased primarily as a result of lower activity on several domestic cost-reimbursable U.S. Government projects, including the CENTCOM, CONCAP and Los Alamos projects. The increase in revenue from our International Operations is largely due to a project to design, procure and construct facilities for the U.K. MoD in Basra, southern Iraq and several engineering projects in Australia.

Business unit income was $63 million and $58 million for the three months ended June 30, 2008 and 2007, respectively. Job income from our Middle East Operations decreased as a result of a $40 million charge recognized in the second quarter of 2008 related to an unfavorable jury verdict from litigation with one of our subcontractors for work performed on our LogCAP III contract in 2003. We believe the jury award is billable to our customer, but we have not yet determined if the jury award can be fully recovered at this time. Job income from our Americas Operations increased primarily due to the prior job loss of $24 million recognized on the U.S. embassy project in Skopje, Macedonia in the second quarter of 2007 compared to a $3 million loss recognized in the second quarter of 2008. This increase was partially offset by decreases in job income on several domestic cost-reimbursable U.S. Government projects resulting from lower activity. In our International Operations, job income increased primarily due to increased performance on the construction portion of the Allenby & Connaught project as well as the project for the U.K. MoD in Iraq.

Upstream. Revenue from our Upstream business unit was $699 million and $485 million for the three months ended June 30, 2008 and 2007, respectively. The increase in revenue is primarily due to increased activity from several Gas Monetization projects including the Escravos GTL, Pearl GTL, Gorgon LNG and Skikda LNG projects. Revenue from these four projects increased an aggregate $257 million during the second quarter of 2008. We continue to experience a strong market for gas monetization projects with an increasing number of LNG projects in the development stage.

Business unit income was $39 million and $47 million for the three months ended June 30, 2008 and 2007, respectively. In our Gas Monetization operations, the decrease was largely driven by a reduction in estimated profits on one of our LNG projects caused by increases in estimated costs of our joint venture which decreased KBR’s recognized profits by $24 million during the quarter. During the quarter, the joint venture and the project owner reached a settlement that is expected to cover the increases in estimated costs. Based on the timing and approvals required for the settlement, a formal change order was not completed between the joint venture and the project owner during the second quarter of 2008; however, we believe that it is likely that a change order will be executed covering the increases in estimated costs. This decrease in business unit income was partially offset by increases in job income on other Gas Monetization projects as a result of increased activity.

Services. Revenue from our Services business unit was $129 million and $78 million for the three months ended June 30, 2008 and 2007, respectively. The increase in revenue is primarily due to increases in newly awarded and reoccurring direct construction and modular fabrication services in our Canadian and North American Construction operations. Revenue from the Shell Scotford Upgrader project in Canada increased approximately $66 million during the second quarter of 2008.

Business unit income was $17 million for both the three months ended June 30, 2008 and 2007. Job income increased by approximately $2 million in our Canadian operations primarily attributable to the Shell Scotford Upgrader project and several projects in our North American Construction operations. The increases were offset by lower results from our MMM joint venture which provides marine vessel support services in the Gulf of Mexico.

Downstream. Revenue from our Downstream business unit was $101 million and $88 million for the three months ended June 30, 2008 and 2007, respectively. During the second quarter 2008, revenue increased by approximately $27 million from the Saudi Kayan olefin and Ras Tanura integrated chemical projects in Saudi Arabia due to increased activity. Increase in revenue related to these and other projects were partially offset by an $18 million decrease in revenue during the quarter on the EBIC ammonia plant project in Egypt as it nears completion.

Business unit income was $14 million and $1 million for the three months ended June 30, 2008 and 2007, respectively. This increase is primarily due to an increase in job income from the Saudi Kayan project and additional positive contributions from the Yanbu Export Refining project and program management services for the Ras Tanura project in Saudi Arabia as well as the reversal of $8 million of the previously recognized losses on the Saudi Kayan project resulting from the effects of change orders executed during the second quarter of 2008.

Technology. Revenue from our Technology business unit was $23 million and $18 million for the three months ended June 30, 2008 and 2007, respectively. Business unit income was $7 million and $2 million for the three months ended June 30, 2008 and 2007, respectively. The increase in revenue and business unit income is primarily attributable to several projects with higher activity in the second quarter of 2008.

Ventures. Revenue from our Ventures business unit was $(1) million and $1 million for the three months ended June 30, 2008 and 2007, respectively. Business unit loss was $0 million and $1 million for the three months ended June 30, 2008 and 2007, respectively. Revenue and business unit income for the second quarter of 2008 included continued operating losses generated on our investment in APT/FreightLink, the Alice Springs-Darwin railroad project in Australia. These losses were offset by income from various other investments including the Aspire Defence and various road projects in the U.K.

Labor cost absorption. Labor cost absorption was $2 million and $(4) million for the three months ended June 30, 2008 and 2007, respectively. Labor cost absorption represents costs incurred by our central labor and resource groups (above) or under the amounts charged to the operating business units. The increase in labor cost absorption for the three months ended June 30, 2008 compared to the three months ended June 30, 2007 was primarily due to increased volume at MWKL.

General and Administrative expense. General and administrative expense was $52 million and $55 million for the three months ended June 30, 2008 and 2007, respectively. The decrease was primarily due to settlement of certain sales and use tax issues that were under audit and lower information technology costs incurred due mainly to headcount reductions. These decreases were slightly offset by an increase in performance award unit and stock based compensation expense.

Non-operating items.

Net interest income was $9 million for the three months ended June 30, 2008 compared to net interest income of $14 million for the three months ended June 30, 2007. The decrease in net interest income primarily relates to the decrease in interest income earned related to our Escravos Project. In July 2007 our Escravos Project was converted from a fixed price contract to a reimbursable contract. In conjunction with this conversion of the contract, we were no longer entitled to interest income earned on advanced funds from the project owner. As of June 30, 2008, we had total cash and equivalents of approximately $1.6 billion (including committed cash of $211 million) compared to $2.0 billion as of June 30, 2007.

Provision for income taxes from continuing operations in the second quarter of 2008 was $36 million compared to $32 million in the second quarter of 2007. The effective tax rate for the second quarter of 2008 was approximately 36% as compared to a rate of 41% in the second quarter of 2007. Our effective tax rate for the three months ended June 30, 2008 exceeded our statutory rate of 35% primarily due to not receiving a benefit for operating losses on our railroad investment in Australia, and state and other taxes. We received an unfavorable tax ruling in the U.K. on the deduction of certain capital losses that were deducted in prior years related to the separations of the Highlands Insurance Company from Halliburton in 1996. In addition, we recognized a benefit to our tax provision in the second quarter of 2008 related to amended tax returns filed in Australia for losses previously surrendered to Halliburton for which Halliburton has surrendered back to KBR and we believe can be carried forward to recover taxes paid by KBR in a subsequent period, deductions in the U.K. related to research and development and in the U.S. related to extraterritorial income exclusion for certain activities supporting foreign projects. The net impact of recording the U.K. court ruling and the amended tax returns in the second quarter of 2008 was a benefit of approximately $4 million. Our effective tax rate for the second quarter of 2007 exceeded our statutory rate of 35% primarily due to not receiving a tax benefit for a portion of our impairment charge related to our investment in BRC, operating losses from our railroad investment in Australia, and state and other taxes. Income from discontinued operations was $0 million and $90 million for the three months ended June 30, 2008 and 2007, respectively. Discontinued operations represents revenues and gain on the sale of our Productions Services group in May 2006 and the disposition of our 51% interest in DML in June 2007. Revenues from our discontinued operations were $225 million for the three months ended June 30, 2007.

CONF CALL

Rob Kukla, Jr. - Director, Investor Relations

Thank you, Stephanie. Good morning and welcome to KBR second quarter 2008 earnings conference call. Today's call is also being webcast, and a replay will be available on KBR's website for seven days. The press release announcing the second quarter results is available on KBR's website. We have tentatively scheduled our 2008 third quarter earnings conference call for Friday, October 31,t 2008.

Joining me today are Bill Utt, our Chairman, President and Chief Executive Officer; and Kevin DeNicola, Senior Vice President and Chief Financial Officer. In today's call, Bill will provide opening remarks and business outlook. Kevin will address KBR's operating performance, financial position, backlog and other financial matters. We will welcome questions after we complete our prepared remarks.

Before turning the call over to Bill, I would like to remind our audience that today's comments may include forward-looking statements, reflecting KBR's views about future events and their potential impact on performance. These matters involve risks and uncertainties that could impact operations and financial results and cause our actual results to differ from our forward-looking statements. These risks are discussed in KBR's Form 10-K for the year-ended December 31, 2007, KBR's quarterly reports on Forms 10-Q and KBR's current reports on Form 8-K.

Now, I'll turn the call over to Bill Utt. Bill?

William P. "Bill" Utt - President and Chief Executive Officer

Thanks Rob, and good morning everyone. Let me begin this morning by welcoming Kevin to our KBR earnings call. As CFO at Lyondell Chemicals for six years, Kevin brings to KBR both a demonstrated financial and operating experience. Also while at Lyondell, Kevin served as both Vice President of Corporate Development and Investor Relations, which complements nicely with the talent of KBR's management team. I am extremely pleased that Kevin is on Board. With the addition of Kevin to KBR's management team, I am pleased with the mix of experience and capabilities embedded in our management team, and believe this mix will continue to successfully drive KBR over the coming years.

The composition of the management team comes from both inside and outside the engineering and construction industry. With experiences in not only in engineering and construction, but also in energy generation and trading, commodity chemicals as well as project finance just to name a few. This mix of people and experiences has greatly contributed to KBR's success in implementing a best-in-class risk awareness and management culture, which will remain a core driver of KBR's current and future successes.

Now I will like to make some comments on the specific items outlined in this morning's earnings release. On July 23, 2008, KBR received an adverse an unexpected jury award related to 2003 LogCAP III subcontract. We estimate the jury award... the jury award the plain of approximately $40 million which gave rise to our charge of $0.15 per share. While we are appreciative of the efforts of judges and juries, we all recognize that errors are made and we believe, the award is not correct for the following reasons.

First, the jury ignored an executed change order, which reduce the work to be performed by the player, which included a release from future claims. Second the contract with the plaintive contained a cause disallowing claims for lost profits. And third the plaintive offered no evidence of its cost or profits in performing the work. The judge is yet to certify the award and we are also planning to appeal the award. Further, we are reviewing our options related to recovering all or part of the award from our customer. However, given the recent nature of the award, we have not had time to thoughtfully examine our path forward in this regard.

The second item outlined in our earnings release, relates to a failure on the part of one of KBR's L&G projects to receive final customer approval for a settlement in connection with KBR's second quarter close. As a result, KBR recorded a charge in the amount of $0.09 per share during the quarter. During the second quarter, our customer agreed to compensate the contract for additional cost and time require to construct the L&G facility. A settlement was negotiated and agreed between the customer and contractor, however the customer was unable to present the settlement to its board which is comprised of representatives of several international companies for a final approval prior to KBR having to close its books for the second quarter of 2008.

KBR believes it is likely that the settlement will ultimately be approved by the customers' board covering the increase in estimated costs and time to complete the project. Of the $15 million mentioned in the press release relating to two other one-time events, one was an $8 million pick-up related to change orders, which reduced the expected losses at completion for the Saudi Kayan project, and the other was a $7 million benefit related to a reassessment of our approval rate for incentives fees on the Pearl GTL project.

Now I would like to come in on the quarter and business outlook. Income from continuing operations for the second quarter of 2008 was $48 million or $0.28 per diluted share, compared to $50 million or $0.30 per diluted share for the prior-year second quarter. Consolidated the KBR revenue for the second quarter of 2008, totaled $2.7 billion, up almost 24% from the $2.2 billion for the second quarter of 2007.

Year-over-year improved quarterly revenue was lead by a 65% increase for services, followed by a 44% increase in for upstream, a 28% increase for technology, a 15% increase for downstream, and 50% increase of G&I. Total backlog at June 30, 2008 was $12.6 billion compared to $13.4 billion at March 31, 2008 and $13.1 billion at December 31, 2007.

During the quarter, KBR announced that it was awarded 275 million Canadian dollar contract for construction and fabrication of our LC refinery unit in Alberta Canada. KBR has not included this project in our backlog as of June 30, 2008. The project will be added to our backlog, when the notice to proceed on the contract is received from Northwest Upgrading, which is expected to occur upon the closing of project financing for the project.

Kevin will have additional comments regarding KBR's backlog during his segment of our presentation. Looking forward, I remain pleased with KBR's positioning for several large projects in the gas monetization, offshore and downstream market segments.

Let me also take a few moments, to update you on the BE&K acquisition, which was closed, on July 1, 2008. The integration of BE&K into KBR is going were well, and we have met our day one cost synergy targets. KBR also expects to exceed our year-end cost savings targets, as well. As we initially looked at BE&K, the main drivers for the acquisition were to accelerate KBR's reentry in the U.S domestic construction market and to broaden our presence in industrial services.

As our current mix of work at KBR is approximately 85% international, with a significant focus on large projects. We also believe the increased exposure to the U.S. market and to the small and midsized projects pursued by BE&K would be a good addition to our portfolio mix of business. In addition to the items described above, we are also excited about BE&K's other businesses, including the engineering business, which expands our industrial or non-several capabilities by 30%; the construction, fabrication industrial service operations in Poland and Russia; the successful track record for construction in the domestic power business, as well as the opportunities for KBR to move into the commercial buildings arena, where we expect that the combination of KBR's brand and financial capabilities will add to our business that already have a strong regional reputation based on execution skills and client satisfaction.

BE&K's work for the US Navy also complements nicely, KBR's U.S. Army work. The feedback form BE&K's customers to the KBR acquisition has been encouraging and many of our current KBR customers in traditional KBR markets such as chemicals and refining as well as historical customers important pulp, paper in power, are happy to have us back supporting their businesses again.

For the year ended March 30, 2008, BE&K had revenues up $1.937 billion. Gross profit on contracts or job income was $180 million and net income after-tax from continuing operations was $34.5 million. Backlog at June 30, 2008 was $2.01 billion broken down as follows: construction $908 million; building group, $840 million; industrial services, $113 million; government, $102 million; and downstream $49 million.

As mentioned earlier we have also been working on capturing synergies. On the cost side, we look at the economies available to the combined organization and took out positions and costs from overhead that have a projected run rate of over $13 million per year. These savings began on closing day and will be fully implemented by January 1, 2009 by which time the majority of the transition work will be complete.

KBR is also expecting to achieve revenues synergies in the following areas. Expanding the population at BE&K's engineering offices to execute KBR's future international engineering work. Leveraging BE&K's dominantly domestic customer base and product service offering through KBR's global project delivery infrastructure. And increasing the size and the volume of BE&K projects by leveraging KBR's larger balance sheet and available capital resources. We are currently mapping the BE&K business in the KBR, and will report in the combined BE&K-KBR business, beginning in the third quarter.

Now let me turn to some operational highlights for our KBR business units and updates the KBR's end markets. With respect to our upstream business unit, I would like to comment on the status of our portfolio of large lumsum, during key project. Despite the issues arising during the quarter, related to the timing of approval for a settlement agreement, each of KBR LNG projects and our other large lumsum turnkey projects remain profitable. At the end of June 2008, the Tangguh project was 93% complete and we expect the first train to complete in early 2009. The Yemen LNG project remains on track for the completion of the first train in the first half of 2009, and at the end of the second quarter the project was 85% complete.

The Skikda LNG project continues to proceed very well, and at the end of the second quarter was 23% complete. With regard to the NLNG Train 7 project in Bonny Island Nigeria, the projects anticipated final investment decision has been delayed from our previous assessments due to what we believe our events, outside the EPC contract. KBR continues to maintain a dialog with the client and stands ready to resume active discussion, when so advised by the client.

KBR's involvement on the Gorgan LNG project is continuing to ramp up, as we work on a reefed and the project was a contributor to second quarter results. We're also helping our customer in reevaluating the scope and scale of the facility as they work towards a final investment decision.

KBR continues to be successful on project awards related to offshore work. We remain very optimistic about the opportunities that are available to KBR to continue to grow this business, given the very favorable market conditions. KBR was recently awarded a fourth quarter-year contract, including an option for extension by BP to provide engineering and project management services for BP's future offshore work. KBR and KBR's subsidiaries Granherne and GVA Consultants will provide conceptual studies, front-end engineering and design, detail design and project management services for BP's global offshore projects.

This award builds on our 40-year working relationship with BP and demonstrates our abilities and track record to deliver quality and experience in the offshore arena. For government and infrastructure, we have participated in several conferences and meetings with our customer to get greater details on the scope and timings of the transition from LogCAP III to LogCAP IV. We expect the first request for proposal under the LogCAP IV contract to be issued in the coming months. However, we believe the initial task orders under LogCAP IV may be smaller in comparison to previous task orders, under LogCAP III. We expect worked under LogCAP III, to essentially continue at present levels for the remainder of 2008, and that all currently open task orders under LogCAP III, will be complete during the first quarter of 2009.

As I discussed in last quarter's call, we have concluded our detail review of material requirements to complete the scope, Skopje Embassy project. Upon this review, and as a result, of construction delays related to visa issues, KBR took an additional $3 million charge on this project during the second quarter of 2008. However, I believe barring any further unforeseen events that KBR is in position to close out construction activities for this project in a reasonable manner. At the end of June, 2008, the project was approximately 73% complete and we currently believe, this project will substantially complete by the end of this year.

KBR services business units continue to make outstanding progress. I'm very pleased with the heavy oil sands work in Canada, and the opportunities we see in the that market. Revenue grew 65% from the second quarter of 2007 with a corresponding backlog growth of 62% year-over-year.

During the second quarter of 2008, services was awarded a $275 million Canadian dollar contract for the construction of fabrication of LC refinery unit by Northwest Upgrading in Alberta Canada. The LC refinery unit scope will include prefabrication of 40 mile to be later assembled as a part of the Northwest Upgrading project and is expected to last approximately 30 months. However, as I mentioned earlier, this project will be booked in the backlog when the customers issues a notice to proceed on the project. Currently the customer is seeking a financing partner. We are confident that the project will commence later this year at which time that will booked in the KBR's backlog.

We have also experienced successes in KBR's return to the domestic construction market. As a direct result of a successful ongoing environmental construction project in the Gulf Coast region, we were subsequently award an EPC project for emissions reduction project by the client at another refinery in Texas.

For our downstream business unit, the second quarter results continue to be led by Ras Tanura and Yanbu Export Refinery projects in Saudi Arabia, as well as the EBIC Ammonia Plant in Asia. For the second quarter, we also recorded change orders for the Saudi Kayan olefins project, which converted the nature of the project from fix price to reimbursable.

The EBIC project continues to progress very well and is approximately 99% complete. Construction and commissioning is target to be completed in the first quarter of 2009. KBR's global resource pools also contributed to our success during the second quarter. Labor cost adsorption driven by volume and cost efficiency was $6 million better during the second quarter of 2008, compared to the same period in 2007.

Now I will turn the call over to Kevin. Kevin?

T. Kevin DeNicola - Senior Vice President and Chief Financial Officer

Okay, thanks Bill. I'll begin by reviewing KBR's consolidated second quarter of 2008 results, which primarily focuses on year-over-year comparisons.

Our consolidated KBR revenue for the second quarter of 2008 totaled $2.7 billion as compared to $2.2 billion in the second quarter of 2007. Consolidated operating income was $90 million in the second quarter of 2008 compared to income of $65 million in the second quarter of 2007. As I discussed earlier, operating income in the second quarter of 2008 included a charge related to an unfavorable jury verdict of approximately $40 million for litigation, with one of our subcontractors for work performed on the LogCAP III contract getting back to 2003, and also a $24 million charge related to timing issues related to client approval of the settlement on one L&G project. Operating income in the second quarter of 2007 included $24 million charge, related to Skopje Embassy project in Macedonia.

Upstream revenue was $699 million in the second quarter of 2008, up $214 million or 44% in the second quarter of 2007. Business unit income was $39 million of second quarter of 2008 compared to $47 million reported in the second quarter of 2007. Business unit income in the second quarter of 2008 included a $24 million reduction in estimated profits one LNG project which Bill addressed in detail earlier. Partially offsetting the year-over-year decline were increases the Skikda LNG project, the Pearl GTL project, increased work scope on the Gorgon L&G and North Ranking 2 offshore project in Australia.

Our government infrastructure revenue in the second quarter of 2008 was $1.7 billion compared to $1.5 billion for the prior year second quarter. Business unit income with $63 million in the second quarter of 2008 which included the $40 million charge related to 2003 LogCAP III subcontract and $3 million charge related to the Skopje Embassy project. This compares to $58 million in the second quarter 2007, which include a $24 million charge related Skopje Embassy project in Macedonia.

The decrease in business unit income was partially offset by higher levels of construction activity on the Allenby/Connaught project, a UK facilities project in Iraq for the Ministry of Defense, multiple water projects in Australia and Scotland.

Services revenue was $128 million in the second quarter of 2008 up from $78 million for the second quarter of 2007. Business unit income was $17 million flat compared to the prior quarter, due primarily to a positive tax credit in second quarter of 2007 associated with our service and maintenance vessels in the Gulf of Mexico. Second quarter of 2008 results benefited from work on the Scotford upgraded project in Canada and several industrial services projects.

Downstream revenue was a $101 million in the second quarter 2008 compared to $88 million for the second quarter of 2007. Business unit income was $14 million in the second quarter of 2008 compared to $1 million in the second quarter of 2007. The increase in business unit income was primarily due to a reduction in accrued project losses resulting from the Saudi Kayan olefins project change order, as well as progress on the Ras Tanura and Yanbu export refinery projects in Saudi Arabia.

Technology revenue for the second quarter of 2008 was $23 million compared to $18 million in the second quarter of 2007. Business unit income in the second quarter of 2008 was compared to $2 million in the prior year second quarter, the increase primarily relates to an ammonia process project in Venezuela and the start of an aniline project in China.

Now with respect to the ventures unit, business unit income for the second quarter of 2008 was zero compared to a loss of $1 million in the second quarter of 2007. The improvement was primarily related to the purchase and sale of pre-emption rights on two UK road projects, increased profitability on the Allenby & Connaught investment in the UK and improvements on several other road project investments. During the second quarter of 2008, losses recorded on the Alice Springs-Darwin railroad project represented the final amounts of operational losses that we recorded to achieve full impairment of KBR's push of the investment and a book value of zero. So we don't expect to record any feature operating losses on this project.

Let's review some other financial items. General and administrative expenses for the second quarter of 2008 were $52 million, down $4 million for the first quarter of 2008. For 2008, we expect recurring corporate costs to approach $200 million, excluding any impact from BE&K acquisition and we expect the additional impact to G&A expenses for BE&K to be approximately $10 million for the second half 2008. Our effective tax rate in the second quarter of 2008 was 36% flat compared to the first quarter of 2008. For the full year, we still expect our effective tax rate to be in the 38% to 39% range.

Moving on to backlog; total backlog for June 30, 2008 was $12.6 billion compared to $13.4 billion at March 31. The sequential back log decrease was primarily your to work loss from our Middle East operations. While KBR has not announced many new or large projects awards during the year, we continue to see strong scope growth in our existing projects across the company with particular emphasis in gas monetization, offshore, downstream in LogCAP III. KBR still openly expects to be successful in a number of our current large project pursuits. Overall the backlog portfolio mix at the end of the second quarter was 76% cost reimbursable, 24% fixed price, same mix as compared to the sequential quarter.

Next I'll discuss our liquidity and balance sheet. At the end of June 2008, our balance sheet remained strong with no debt in cash and cash equivalents of $1.6 billion in which $211 million is cash associated with our consolidated joint ventures. Now in addition cash and cash equivalents included $216 million from advance payments related to a contract in progress.

Total cash balances decrease by $371 million during the second quarter of 2008, primarily driven by a reduction in cash associated with our consolidated joint ventures and the amount of a $147 million and timing our LogCAP billings received there after June 30, 2008 in the amount of $156 million. So after paying $550 million for the acquisition of BE&K on July 1st, that leaves our cash balance of approximately $600 million, before other working capital needs for LogCAP and other projects.

So working capital at the end of the second quarter of 2008 was $1.6 billion, that's up slightly compared to the prior sequential quarter. Working capital in Iraq was $211 million at the end of the second quarter 2008, up approximately $49 million from the sequential quarter, again due to timing of collections.

Capital expenditures totaled $8 million and depreciation was $9 million during the second quarter of 2008. Capital expenditures were flat compare to the sequential quarter, and we've revised our expectations for capital expenditures for 2008 to be well less than $60 million from the previously discussed expectations of less then $70 million and that's excluding BE&K.

And now, I will turn the call back over to Bill, for his final remarks. Bill?

William P. "Bill" Utt - President and Chief Executive Officer

Thanks, Kevin. As you can see, the second quarter of 2008 contained a lot of moving pieces. We recognize the confusion this present when discussing the financial performance of KBR. Management is confident the underlying businesses will continue to perform as strongly as we have seen over the first half of 2008.

I wanted to briefly discuss recent press coverage related to KBR and it's work in Iraq. We have previously provided the government information related to the electrical safety issue. At Senator KC's invitation, I went to Capitol Hill last week to visit with members of Congress. I believe the meetings were fruitful and established a dialog that we hope will continue. We pledge continued cooperation with the government on this and other issues as they arise.

We look forward to expanding the thoughtful and fact-based dialog we had on Capitol Hill. KBR's steadfast commitment to the safety and security of all employees and those the company serves remains. We are proud of our work and honor to serve our trips. We remain committed to providing the highest quality service to our customer, the U.S. Military. I thank all of our employees who at risk to themselves perform this service.

When one considers where KBR has come over the past several quarters, much of this achievement is do the powerful and significant efforts by our teams across the globe. We also welcome the BE&K teams in the KBR and look forward to their contributions to KBR's continued strong performance over the years to come.

Now we'll take your questions. We ask that you please limit your comments to one question and one follow-up.

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