June 2006 10Q


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

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended June 30, 2006

OR

o 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 1-16619


KERR-McGEE CORPORATION
(Exact Name of Registrant as Specified in its Charter)



Delaware
73-1612389
(State or Other Jurisdiction of
(I.R.S. Employer
Incorporation or Organization)
Identification No.)


123 Robert S. Kerr Avenue, Oklahoma City, Oklahoma 73102
(Address of Principal Executive Offices and Zip Code)

Registrant's telephone number, including area code (405) 270-1313

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x    No o 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.

Large Accelerated Filer x         Accelerated Filer o          Non-Accelerated Filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o   No x 

Number of shares of common stock, $1.00 par value, outstanding as of July 31, 2006: 227,404,381.


 
 
KERR-McGEE CORPORATION
 
     
 
INDEX
 
   
PAGE
PART I - FINANCIAL INFORMATION
 
     
Item 1.  Financial Statements (Unaudited)
 
 
   
 
Condensed Consolidated Statement of Income for the Three and Six Months Ended June 30, 2006 and 2005
1
 
   
 
Condensed Consolidated Balance Sheet at June 30, 2006 and December 31, 2005
2
 
   
 
Condensed Consolidated Statement of Cash Flows for the Six Months Ended June 30, 2006 and 2005
3
 
   
 
Condensed Consolidated Statement of Comprehensive Income (Loss) and Stockholders’ Equity for the Six Months Ended June 30, 2006 and 2005
4
     
 
Notes to Condensed Consolidated Financial Statements
5
     
Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations
33
 
 
 
Item 3.  Quantitative and Qualitative Disclosures about Market Risk
45
 
 
 
Item 4.  Controls and Procedures
47
     
Forward-Looking Information
47
   
   
PART II - OTHER INFORMATION
 
 
 
 
Item 1.  Legal Proceedings
47
   
Item 1A. Risk Factors
48
   
Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds
49
   
Item 4.  Submission of Matters to a Vote of Security Holders
49
   
Item 6.  Exhibits
50
 
 
 
SIGNATURE
51
 
 
 
   
 


PART I - FINANCIAL INFORMATION

Item 1. Financial Statements.

KERR-McGEE CORPORATION AND SUBSIDIARY COMPANIES
CONDENSED CONSOLIDATED STATEMENT OF INCOME
(UNAUDITED)


   
Three Months Ended
 
Six Months Ended
 
   
June 30,
 
June 30,
 
(Millions of dollars, except per-share amounts)
 
2006
 
2005
 
2006
 
2005
 
                   
Revenues
                         
Oil and gas sales
 
$
1,227
 
$
1,108
 
$
2,406
 
$
2,114
 
Loss on commodity derivatives
   
(130
)
 
(82
)
 
(244
)
 
(168
)
Gas marketing revenues
   
147
   
138
   
360
   
270
 
Other revenues
   
23
   
19
   
45
   
38
 
Total Revenues
   
1,267
   
1,183
   
2,567
   
2,254
 
                       
Operating Expenses
                     
Lease operating costs
   
128
   
115
   
259
   
223
 
Production and ad valorem taxes
   
43
   
34
   
74
   
64
 
Transportation expense
   
25
   
24
   
48
   
47
 
General and administrative expense
   
60
   
62
   
134
   
115
 
Merger-related costs
   
8
   
-
   
8
   
-
 
Exploration expense
   
106
   
116
   
158
   
171
 
Gas gathering, processing and other expenses
   
27
   
26
   
61
   
54
 
Gas marketing costs
   
145
   
139
   
359
   
269
 
Depreciation, depletion and amortization
   
194
   
220
   
383
   
443
 
Accretion expense
   
4
   
5
   
7
   
11
 
Provision for environmental remediation costs
   
3
   
2
   
3
   
2
 
Asset impairments
   
-
   
-
   
-
   
4
 
Gain on sales of oil and gas properties
   
(1
)
 
(25
)
 
(5
)
 
(47
)
Total Operating Expenses
   
742
   
718
   
1,489
   
1,356
 
                           
Operating Income
   
525
   
465
   
1,078
   
898
 
                           
Interest expense
   
(49
)
 
(58
)
 
(90
)
 
(118
)
Loss on early repayment and modification of debt
   
-
   
-
   
(81
)
 
-
 
Other income (expense)
   
(3
)
 
(4
)
 
(6
)
 
(6
)
                           
Income from Continuing Operations before Income Taxes
   
473
   
403
   
901
   
774
 
Provision for income taxes
   
(167
)
 
(147
)
 
(319
)
 
(275
)
                           
Income from Continuing Operations
   
306
   
256
   
582
   
499
 
Income (loss) from discontinued operations, net of taxes
   
(1
)
 
114
   
(24
)
 
226
 
Cumulative effect of change in accounting principle, net of taxes
   
-
   
-
   
2
   
-
 
                           
Net Income
 
$
305
 
$
370
 
$
560
 
$
725
 
                           
Income (Loss) per Common Share
                         
Basic -
                         
Continuing operations
 
$
1.36
 
$
.91
 
$
2.57
 
$
1.69
 
Discontinued operations
   
(.01
)
 
.40
   
(.11
)
 
.76
 
Cumulative effect of change in accounting principle
   
-
   
-
   
.01
   
-
 
Net income
 
$
1.35
 
$
1.31
 
$
2.47
 
$
2.45
 
                           
Diluted -
                         
Continuing operations
 
$
1.33
 
$
.90
 
$
2.53
 
$
1.65
 
Discontinued operations
   
-
   
.40
   
(.11
)
 
.74
 
Cumulative effect of change in accounting principle
   
-
   
-
   
.01
   
-
 
Net income
 
$
1.33
 
$
1.30
 
$
2.43
 
$
2.39
 
                           
Dividends Declared per Common Share
 
$
.03125
 
$
.025
 
$
.05625
 
$
.25
 
                         
The accompanying notes are an integral part of these consolidated financial statements.

- 1 -


KERR-McGEE CORPORATION AND SUBSIDIARY COMPANIES
CONDENSED CONSOLIDATED BALANCE SHEET
(UNAUDITED)

   
June 30,
 
 December 31,
 
(Millions of dollars)
 
2006
 
 2005
 
   
 
 
 
 
ASSETS  
 
Current Assets
   
       
Cash and cash equivalents
 
$
156
 
$
1,053
 
Accounts receivable
   
751
   
753
 
Derivatives and other current assets
   
204
   
205
 
Deferred income taxes
   
380
   
547
 
Assets held for sale and Tronox assets
   
24
   
691
 
Total Current Assets
   
1,515
   
3,249
 
               
Property, Plant and Equipment
   
12,091
   
13,629
 
Less reserves for depreciation, depletion and amortization
   
(3,874
)
 
(5,194
)
     
8,217
   
8,435
 
               
Investments, Derivatives and Other Assets
   
321
   
427
 
Goodwill and Other Intangible Assets
   
1,175
   
1,179
 
Assets Held for Sale and Tronox Assets
   
710
   
986
 
               
Total Assets
 
$
11,938
 
$
14,276
 
 
 
LIABILITIES AND STOCKHOLDERS' EQUITY
 
Current Liabilities
             
Accounts payable
 
$
398
 
$
425
 
Long-term debt due within one year
   
309
   
306
 
Income taxes payable
   
53
   
429
 
Commodity derivative liabilities
   
877
   
1,506
 
Accrued liabilities
   
831
   
846
 
Liabilities associated with assets held for sale and Tronox
   
25
   
419
 
Total Current Liabilities
   
2,493
   
3,931
 
               
Long-Term Debt
   
2,097
   
2,277
 
               
Noncurrent Liabilities
             
Deferred income taxes
   
1,620
   
1,445
 
Asset retirement obligations
   
212
   
310
 
Commodity derivative liabilities
   
323
   
658
 
Other
   
451
   
471
 
Liabilities associated with assets held for sale and Tronox
   
126
   
1,069
 
Total Noncurrent Liabilities
   
2,732
   
3,953
 
               
Contingencies and Commitments (Notes 13 and 14)
             
               
Stockholders' Equity
             
Common stock, par value $1 - 500,000,000 shares authorized,
             
234,412,964 and 232,231,760 shares issued at June 30, 2006
             
and December 31, 2005, respectively
   
234
   
120
 
Capital in excess of par value
   
3,654
   
3,702
 
Preferred stock purchase rights
   
1
   
1
 
Retained earnings
   
2,006
   
1,704
 
Accumulated other comprehensive loss
   
(621
)
 
(1,079
)
Common stock in treasury, at cost - 7,105,344 and 3,456,918 shares
             
at June 30, 2006 and December 31, 2005, respectively
   
(635
)
 
(266
)
Deferred compensation cost
   
(23
)
 
(67
)
Total Stockholders' Equity
   
4,616
   
4,115
 
               
Total Liabilities and Stockholders’ Equity
 
$
11,938
 
$
14,276
 

The company followed the "successful efforts" method of accounting for oil and gas exploration and production activities in preparing these consolidated financial statements.



The accompanying notes are an integral part of these consolidated financial statements.

- 2 -


KERR-McGEE CORPORATION AND SUBSIDIARY COMPANIES
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)


   
Six Months Ended
 
   
June 30,
 
(Millions of dollars)
 
2006
 
2005
 
           
Cash Flows from Operating Activities
             
Net income
 
$
560
 
$
725
 
Adjustments to reconcile net income to net cash
             
provided by operating activities -
             
Depreciation, depletion and amortization
   
430
   
650
 
Deferred income taxes
   
107
   
265
 
Dry hole expense
   
73
   
91
 
Asset impairments
   
-
   
5
 
Gain on sale of assets
   
(5
)
 
(46
)
Accretion expense
   
7
   
17
 
Loss on early repayment and modification of debt
   
81
   
-
 
Provision for Tronox guarantee
   
56
   
-
 
Other noncash items affecting net income
   
(25
)
 
146
 
Changes in assets and liabilities
   
(574
)
 
(275
)
Net Cash Provided by Operating Activities
   
710
   
1,578
 
               
Cash Flows from Investing Activities
             
Capital expenditures
   
(925
)
 
(808
)
Dry hole costs
   
(40
)
 
(75
)
Proceeds from sales of assets
   
11
   
63
 
Other investing activities
   
15
   
(21
)
Net Cash Used in Investing Activities
   
(939
)
 
(841
)
               
Cash Flows from Financing Activities
             
Issuance of common stock upon exercise of stock options
   
43
   
159
 
Purchases of treasury stock
   
(369
)
 
(250
)
Shares repurchased under the tender offer
   
-
   
(3,975
)
Repayment of debt
   
(250
)
 
(392
)
Proceeds from borrowings
   
-
   
4,250
 
Dividends paid
   
(11
)
 
(142
)
Settlement of Westport derivatives
   
(30
)
 
(80
)
Tronox Distribution (1)
   
(57
)
 
-
 
Other financing activities
   
9
   
(58
)
Net Cash Used in Financing Activities
   
(665
)
 
(488
)
               
Effects of Exchange Rate Changes on Cash and Cash Equivalents
   
(3
)
 
(1
)
Net Increase (Decrease) in Cash and Cash Equivalents
   
(897
)
 
248
 
Cash and Cash Equivalents at Beginning of Year
   
1,053
   
76
 
Cash and Cash Equivalents at End of Period
 
$
156
 
$
324
 

(1)  
Represents Tronox’s cash balance deconsolidated upon the Distribution. See Note 2.
 
The accompanying notes are an integral part of these consolidated financial statements.
 
- 3 -

KERR-McGEE CORPORATION AND SUBSIDIARY COMPANIES
CONDENSED CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (LOSS)
AND STOCKHOLDERS’ EQUITY
(UNAUDITED)



(Millions of dollars)
 
Common
Stock
 
Capital in
Excess of
Par Value
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Treasury
Stock
 
Deferred
Compensation
and Other
 
Total
Stockholders'
Equity
 
Balance at December 31, 2004
 
$
152
 
$
4,205
 
$
1,102
 
$
(79
)
$
(8
)
$
(54
)
$
5,318
 
Comprehensive Income (Loss):
                                           
Net income
   
-
   
-
   
725
   
-
   
-
   
-
   
725
 
Other comprehensive loss
   
-
   
-
   
-
   
(562
)
 
-
   
-
   
(562
)
Comprehensive income
                                       
163
 
Stock issued upon conversion of debt
   
10
   
583
   
-
   
-
   
-
   
-
   
593
 
Purchases of treasury stock
   
-
   
-
   
-
   
-
   
(250
)
 
-
   
(250
)
Shares repurchased and retired
   
(47
)
 
(1,410
)
 
(2,517
)
 
-
   
-
   
(1
)
 
(3,975
)
Stock option exercises
   
3
   
156
   
-
   
-
   
-
   
-
   
159
 
Restricted stock activity
   
1
   
25
   
-
   
-
   
(3
)
 
(13
)
 
10
 
ESOP deferred compensation
   
-
   
-
   
-
   
-
   
-
   
3
   
3
 
Tax benefit from stock-based awards
   
-
   
21
   
-
   
-
   
-
   
-
   
21
 
Dividends declared ($.25 per share)
   
-
   
-
   
(80
)
 
-
   
-
   
-
   
(80
)
Balance at June 30, 2005
 
$
119
 
$
3,580
 
$
(770
)
$
(641
)
$
(261
)
$
(65
)
$
1,962
 
                                             
Balance at December 31, 2005
 
$
120
 
$
3,702
 
$
1,704
 
$
(1,079
)
$
(266
)
$
(66
)
$
4,115
 
Comprehensive Income:
                                           
Net income
   
-
   
-
   
560
   
-
   
-
   
-
   
560
 
Other comprehensive income
   
-
   
-
   
-
   
458
   
-
   
-
   
458
 
Comprehensive income
                                       
1,018
 
Adoption of FAS No. 123(R)
   
-
   
(42
)
 
-
   
-
   
-
   
42
   
-
 
Purchases of treasury stock
   
-
   
-
   
-
   
-
   
(369
)
 
-
   
(369
)
Stock option exercises
   
1
   
42
   
-
   
-
   
-
   
-
   
43
 
Amortization of options and restricted
                                           
   stock cost, net of forfeitures
   
-
   
43
   
-
   
-
   
-
   
-
   
43
 
ESOP deferred compensation and other
   
-
   
-
   
(1
)
 
-
   
-
   
2
   
1
 
Tax benefit from stock-based awards
   
-
   
22
   
-
   
-
   
-
   
-
   
22
 
Dividends declared ($.05625 per share)
   
-
   
-
   
(13
)
 
-
   
-
   
-
   
(13
)
Tronox Distribution (Note 2)
   
-
   
-
   
(244
)
 
-
   
-
   
-
   
(244
)
Two-for-one stock split
   
113
   
(113
)
 
-
   
-
   
-
   
-
   
-
 
Balance at June 30, 2006
 
$
234
 
$
3,654
 
$
2,006
 
$
(621
)
$
(635
)
$
(22
)
$
4,616
 
                                             


 
 
The accompanying notes are an integral part of these consolidated financial statements.


- 4 -


KERR-McGEE CORPORATION AND SUBSIDIARY COMPANIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2006

1.
The Company, Basis of Presentation and Accounting Policies

The Company

Kerr-McGee is an independent exploration and production company that explores for, develops, produces and markets crude oil and natural gas, with major areas of operation in the United States and China. Exploration efforts also extend to the North Slope of Alaska and offshore West Africa, Brazil and Trinidad and Tobago. Terms such as “Kerr-McGee,” “the company,” “we,” “our,” and similar terms are used interchangeably in these condensed consolidated financial statements to refer to the consolidated group or to one or more of the companies that are part of the consolidated group.


Pending Merger

On June 22, 2006, Kerr-McGee and Anadarko Petroleum Corporation (Anadarko) entered into a definitive agreement which provides for the company’s merger with a subsidiary of Anadarko. Under the terms of the agreement, each outstanding share of Kerr-McGee Corporation common stock will be converted into the right to receive $70.50 in cash, without interest, subject to increase at the rate of $.01255 per day for each day after August 10, 2006 that the merger has not been completed, but not exceeding $71.0271 per share. The transaction, which is subject to approval by Kerr-McGee’s stockholders and customary terms and conditions, is expected to close during the third quarter of 2006. A special meeting of stockholders to vote on the proposed merger is to be held on August 10, 2006. Following completion of the merger, the company will become a wholly-owned subsidiary of Anadarko. Note 9 describes the anticipated effect of the merger on stock-based awards issued under the company’s long-term incentive plans and outstanding at the merger date.


Other Recent Developments
 
·  
On May 9, 2006, the company’s Board of Directors (the Board) authorized a two-for-one split of Kerr-McGee’s outstanding common stock. The stock split was accomplished through a stock dividend issued on June 14, 2006 to stockholders of record at the close of business on June 2, 2006. Stock held in treasury was not split. Unless otherwise indicated, common shares outstanding and per-share amounts in the accompanying condensed consolidated financial statements and notes thereto have been retroactively adjusted to reflect the stock split. The par value of Kerr-McGee’s common stock remains $1 per share.
 
·  
The Board approved a 25% increase in the company's quarterly dividend effective with the dividend paid on July 3, 2006. On a post-split basis, the quarterly dividend increased from $.025 to $.03125 per share.
 
·  
In January 2006, the company entered into an agreement to sell its interests in certain Gulf of Mexico shelf oil and natural gas properties to W&T Offshore, Inc. (W&T) for approximately $1.34 billion in cash, subject to certain adjustments. The transaction, which has an effective date of October 1, 2005 and is subject to customary closing conditions and regulatory approvals, is expected to close in the third quarter.
 
·  
In January 2006, the Board approved a $1 billion stock repurchase program. During the first six months of 2006, approximately 3.4 million shares of stock (on a pre-split basis) were repurchased at an aggregate cost of $356 million.
 
·  
In November 2005, Tronox Incorporated (Tronox), a former wholly-owned subsidiary that held Kerr-McGee's chemical business, completed an initial public offering (IPO) of 17.5 million shares of Class A common stock, which reduced Kerr-McGee’s equity interest in Tronox to 57%. On March 30, 2006, Kerr-McGee completed a pro rata distribution to its stockholders in the form of a dividend of shares of Tronox Class B common stock it owned (the Distribution) and no longer has any ownership or voting interest in Tronox.
 


- 5 -


Basis of Presentation

The unaudited condensed consolidated financial statements included herein have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (SEC) and, in the opinion of management, include all adjustments necessary to a fair statement of the results for the interim periods presented. Except for adjustments to reflect the stock split, the Distribution and reclassifications discussed below, such adjustments are normal and recurring in nature. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations. Although the company believes that the disclosures are adequate to make the information presented not misleading, these financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in the company's latest annual report on Form 10-K.

With the separation of the chemical business, the income statement format has been changed to better reflect the operations of an exploration and production company. Certain 2005 amounts included in the accompanying condensed consolidated financial statements have been reclassified to conform to the 2006 presentation. The operating results of and other costs directly associated with Tronox and the company’s North Sea oil and gas business that was sold in November 2005 are reported as discontinued operations.

Accounting Policies

Employee Stock-Based Compensation - Under Kerr-McGee's long-term incentive plans, the company generally grants nonvested stock, stock options and performance unit awards to nonemployee directors and qualifying employees (the terms of the awards are described in Note 9). Prior to 2006, the company’s stock-based employee compensation was accounted for under the recognition and measurement provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (APB No. 25), and related Interpretations, as permitted by Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (FAS No. 123). Under the intrinsic-value-based accounting model specified in APB No. 25, the company generally did not recognize compensation cost for its stock option awards, as most options granted had an exercise price equal to the market value of the underlying common stock on the date of grant.

Effective January 1, 2006, the company adopted the fair value recognition provisions of FAS No. 123 (Revised 2004), “Share-Based Payment” (FAS No. 123(R)), using the modified prospective transition method. Under this method, stock-based compensation cost recognized in income from continuing operations for the three and six months ended June 30, 2006 includes:
 
·  
Compensation cost for all stock option and stock awards that were unvested as of January 1, 2006 based on the grant-date fair value estimated in accordance with the original provisions of FAS No. 123
 
·  
Compensation cost for all stock options and nonvested stock awards granted subsequent to January 1, 2006 based on the grant-date fair value estimated in accordance with the provisions of FAS No. 123(R)
 
·  
Compensation cost for performance units outstanding as of January 1, 2006 and granted subsequent to that date based on the change in their estimated fair value
 
Results for prior periods have not been retroactively adjusted for the adoption of FAS No. 123(R). The company recognized cumulative effect of adoption as an increase in net income of $2 million ($3 million on a pretax basis). This adjustment reflects a reduction in the performance units liability to its estimated fair value and the effect of the change in the company’s accounting policy for forfeitures. FAS No. 123(R) requires that compensation cost be recognized only for awards for which the requisite service is expected to be rendered, using an estimated forfeiture rate. Prior to January 1, 2006, the company accounted for forfeitures as they occurred.


- 6 -

The following table presents the increase (decrease) in reported earnings for the three- and six-month periods ended June 30, 2006 as a result of adopting FAS No. 123(R), as well as the change in classification of reported cash flows associated with excess tax benefits, as compared to results that would have been reported had the company continued to apply provisions of APB No. 25:

   
Three Months
Ended
 
Six Months
Ended
 
(Millions of dollars, except per share amounts)
 
June 30, 2006
 
June 30, 2006
 
           
Increase (decrease) in:
             
Income from continuing operations before income taxes
 
$
(4
)
$
(16
)
Income from continuing operations
   
(3
)
 
(11
)
Net income
   
(3
)
 
(9
)
Earnings per share:
             
   Basic
   
(.01
)
 
(.04
)
   Diluted
   
(.01
)
 
(.04
)
Net cash provided by operating activities
   
(4
)
 
(13
)
Net cash used in financing activities
   
4
   
13
 

The following table illustrates the effect on net income and earnings per share for the three and six months ended June 30, 2005 assuming stock-based compensation cost was determined using the fair-value-based method prescribed by FAS No. 123:

   
Three Months
Ended
 
Six Months
Ended
 
(Millions of dollars, except per share amounts)
 
June 30, 2005
 
June 30, 2005
 
           
Net income, as reported
 
$
370
 
$
725
 
Add: stock-based employee compensation expense
             
included in reported net income, net of taxes
   
4
   
13
 
Deduct: stock-based compensation expense
             
determined using a fair-value method, net of taxes
   
(6
)
 
(22
)
Pro forma net income
 
$
368
 
$
716
 
               
Net income per share -
             
Basic -
             
As reported
 
$
1.31
 
$
2.45
 
Pro forma
   
1.31
   
2.42
 
               
Diluted -
             
As reported
 
$
1.30
 
$
2.39
 
Pro forma
   
1.29
   
2.36
 

New Accounting Pronouncements - In July 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation (FIN) No. 48, Accounting for Uncertainty in Income Taxes - An Interpretation of FASB Statement No. 109 (FIN 48). FIN 48 prescribes how a company should recognize, measure, present and disclose in its financial statements uncertain tax positions the company has taken or expects to take on a tax return. The provisions of FIN 48 are effective in 2007 and will apply to all tax positions upon initial adoption. The company is currently evaluating the possible financial statement effects of adopting this new standard.

- 7 -

2.
Tronox Separation

In November 2005, Tronox, a former subsidiary that held Kerr-McGee's chemical business, completed an initial public offering (IPO) of 17.5 million shares of its Class A common stock. Following the IPO, Kerr-McGee continued to own 22.9 million shares of Tronox Class B common stock, representing approximately 57% of the equity interest and 89% of the total voting power of Tronox. On March 8, 2006, Kerr-McGee's Board of Directors approved a pro rata distribution to its stockholders of Tronox Class B common stock the company owned. The Distribution was completed on March 30, 2006 and resulted in holders of Kerr-McGee common stock as of March 20, 2006 receiving a dividend of .20164 of a share of Tronox Class B common stock for each share of Kerr-McGee common stock they owned (on a pre-split basis). Stockholders entitled to fractional shares of Tronox Class B common stock received cash in lieu of fractional shares. As a result of the Distribution, retained earnings and other comprehensive income were reduced by a total of $265 million, which represented the carrying amount of Kerr-McGee's investment in Tronox as of the Distribution date (including the effect of transferring additional assets from Kerr-McGee’s qualified retirement plan to the Tronox plan in May 2006 as discussed in Note 10).
 
Under the terms of the Master Separation Agreement entered into between Kerr-McGee and Tronox in connection with the IPO, Kerr-McGee agreed to reimburse Tronox for 50% of certain qualifying environmental remediation costs incurred and paid by Tronox and its subsidiaries before November 28, 2012, subject to certain limitations and conditions. The seven-year reimbursement obligation is limited to a maximum aggregate reimbursement of $100 million. In connection with the Distribution, Kerr-McGee recognized a fair-value-based liability of $56 million associated with this reimbursement obligation, with the associated charge reflected as a component of loss from discontinued operations.

Historically, certain Tronox employees and retirees participated in stock-based compensation, retirement, and health and life postretirement plans established by Kerr-McGee. As more fully discussed in Note 9, except for vested stock options and performance unit awards, Kerr-McGee’s stock-based awards held by Tronox employees were forfeited on the date of the Distribution and replaced with stock-based awards of comparable value issued by Tronox. Additionally, on the Distribution date, Tronox assumed obligations for retirement and health and life postretirement benefits for Tronox’s U.S. employees and retirees. In connection with the assumption of the benefit obligations, the company also transferred to Tronox trust assets associated with the transferred benefit obligations. Note 10 provides additional information regarding the effects of the separation on Kerr-McGee's obligations for pension and postretirement health and life benefits.

- 8 -

3. Discontinued Operations and Assets Held for Sale

Discontinued Operations - The following tables summarize the components of income (loss) from discontinued operations for the periods presented:

   
Three Months Ended June 30,
 
   
2006
 
2005
 
       
North Sea
         
       
Oil and Gas
         
(Millions of dollars) 
 
Tronox
 
Business
 
Tronox
 
Total
 
                   
Revenues
 
$
-
 
$
311
 
$
356
 
$
667
 
                           
Income (loss) from Discontinued Operations:
                         
Income from operations
 
$
(1
)
$
160
(1) 
$
16
(1) 
$
176
 
Income tax (expense) benefit
   
-
   
(55
)
 
(7
)
 
(62
)
Income (loss) from discontinued operations, net of tax
 
$
(1
)
$
105
 
$
9
 
$
114
 
                           

   
Six Months Ended June 30,
 
   
2006
 
2005
 
       
North Sea
         
       
Oil and Gas
         
(Millions of dollars) 
 
Tronox
 
Business
 
Tronox
 
Total
 
                   
Revenues
 
$
336
 
$
623
 
$
690
 
$
1,313
 
                           
Income (loss) from Discontinued Operations:
                         
Income from operations
 
$
34
 
$
343
(1) 
$
22
(1)
$
365
 
Provision for Tronox guarantee (2)
   
(56
)
 
-
   
-
   
-
 
Pretax income (loss) from discontinued operations
   
(22
)
 
343
   
22
   
365
 
Income tax (expense) benefit
   
7
   
(133
)
 
(6
)
 
(139
)
Net income from operations allocable to minority interests
   
(9
)
 
-
   
-
   
-
 
Income (loss) from discontinued operations, net of tax
 
$
(24
)
$
210
 
$
16
 
$
226
 
                           
(1)  
Under the company’s $5.25 billion secured credit agreement which was in effect from May 2005 through January 9, 2006, the company was required to use 100% of the net after-tax cash proceeds from disposition of certain assets to repay debt. Because the North Sea oil and gas and Tronox assets were subject to this requirement, interest expense on debt that was required to be repaid upon the sale of the North Sea business and the Tronox IPO ($19 million and $5 million, respectively) is classified as a component of income from discontinued operations for the three and six months ended June 30, 2005 (or $15 million on an after-tax basis).

- 9 -

(2)  
Additional information about the guarantee is provided in Note 2.

Assets and liabilities of Tronox are segregated as assets and liabilities of discontinued operations in the accompanying Condensed Consolidated Balance Sheet as of December 31, 2005.
 
Assets Held for Sale - Assets held for sale at June 30, 2006 and associated liabilities consist of assets and liabilities associated with the company’s interests in certain Gulf of Mexico shelf oil and gas properties to be sold to W&T. The company expects to complete the sale in the third quarter.


4.
Other Comprehensive Income (Loss)

Components of other comprehensive income (loss) for the three and six months ended June 30, 2006 and 2005 are presented in the following table and include amounts associated with discontinued operations. Components of accumulated other comprehensive income (loss) associated with Tronox were reclassified to retained earnings in connection with the Distribution.

   
Three Months Ended
 
Six Months Ended
 
   
June 30,
 
June 30,
 
(Millions of dollars)
 
2006
 
2005
 
2006
 
2005
 
                   
Foreign currency translation -
                         
Translation adjustments, net of minority interest of $2
 
$
5
 
$
(16
)
$
6
 
$
(14
)
Reclassification to retained earnings
   
-
   
-
   
(24
)
 
-
 
Total foreign currency translation adjustments
   
5
   
(16
)
 
(18
)
 
(14
)
Net gains (losses) on commodity derivatives -
                         
Unrealized gains (losses), net of taxes of nil, $81, $(111) and $353
   
-
   
(139
)
 
207
   
(623
)
Reclassification of realized losses to net income,
   net of taxes of $(52), $(28), $(150) and $(43)
   
98
   
50
   
276
   
75
 
Reclassification to retained earnings
   
-
   
-
   
1
   
-
 
Total gains (losses) on commodity derivatives, net
   
98
   
(89
)
 
484
   
(548
)
Minimum pension liability -
                         
Minimum pension liability adjustments, net of taxes of $5
   
-
   
-
   
(10
)
 
-
 
Reclassification to retained earnings, net of taxes of $(1)
   
-
   
-
   
2
   
-
 
Total minimum pension liability adjustments
   
-
   
-
   
(8
)
 
-
 
Other comprehensive income (loss)
 
$
103
 
$
(105
)
$
458
 
$
(562
)

Components of accumulated other comprehensive loss at June 30, 2006 and December 31, 2005, net of applicable tax effects, are as follows:
 
   
June 30,
 
December 31,
 
(Millions of dollars)
 
2006
 
2005
 
           
Foreign currency translation adjustments
 
$
17
 
$
35
 
Unrealized loss on commodity derivatives
   
(611
)
 
(1,095
)
Minimum pension liability adjustments
   
(27
)
 
(19
)
   
$
(621
)
$
(1,079
)


5.  Derivative Instruments

The company is exposed to risk from fluctuations in crude oil and natural gas prices, foreign currency exchange rates and interest rates. To reduce the impact of these risks on earnings and to increase the predictability of cash flows, the company enters into derivative contracts that are primarily comprised of swaps and collars for a portion of its future oil and gas production and interest rate swaps to hedge the fair value of its fixed-rate debt. Effects of interest rate swaps on the company's financial statements were not material for the periods presented.


- 10 -

The following tables summarize the balance sheet presentation of the company’s oil and gas commodity derivatives as of June 30, 2006 and December 31, 2005:
 
   
As of June 30, 2006
 
   
Derivative Fair Value
     
   
Current
 
Long-Term
 
Current
 
Long-Term
 
Deferred
 
(Millions of dollars)
 
Asset
 
Asset
 
Liability
 
Liability
 
Loss in AOCI(1)
 
                       
Oil and gas production-related derivatives
 
$
98
 
$
23
 
$
(872
)
$
(322
)
$
(611
)
Gas marketing-related derivatives
   
5
   
1
   
(5
)
 
(1
)
 
-
 
Total
 
$
103
 
$
24
 
$
(877
)
$
(323
)
$
(611
)

   
As of December 31, 2005
 
   
Derivative Fair Value
     
   
Current
 
Long-Term
 
Current
 
Long-Term
 
Deferred
 
(Millions of dollars)
 
Asset
 
Asset
 
Liability
 
Liability
 
Loss in AOCI(1)
 
                       
Oil and gas production-related derivatives
 
$
101
 
$
34
 
$
(1,492
)
$
(658
)
$
(1,095
)
Gas marketing-related derivatives
   
13
   
1
   
(14
)
 
-
   
-
 
Total
 
$
114
 
$
35
 
$
(1,506
)
$
(658
)
$
(1,095
)

(1)  
Amounts deferred in accumulated other comprehensive income (AOCI) are reflected net of taxes.
 
The following table summarizes components of gain (loss) on commodity derivative instruments associated with continuing operations for the three- and six-month periods ended June 30, 2006 and 2005:
 
   
Three Months Ended
 
Six Months Ended
 
   
June 30,
 
June 30,
 
(Millions of dollars)
 
2006
 
2005
 
2006
 
2005
 
                   
Loss on hedge derivatives
 
$
(150
)
$
(59
)
$
(424
)
$
(85
)
Mark-to-market nonhedge derivative gain (loss)
   
20
   
12
   
150
   
(39
)
Gain (loss) due to hedge ineffectiveness
   
-
   
(35
)
 
30
   
(44
)
     
(130
)
 
(82
)
 
(244
)
 
(168
)
Gas marketing-related derivatives
   
-
   
2
   
-
   
4
 
Total
 
$
(130
)
$
(80
)
$
(244
)
$
(164
)
                           
 
Discontinuation of Hedge Accounting - Beginning March 1, 2006, the company elected to discontinue hedge accounting for its commodity derivatives since a large portion of the company’s natural gas derivatives no longer qualified for hedge accounting and to increase clarity in its financial statements. Consequently, from that date forward, the company recognizes mark-to-market gains and losses on all of its oil and gas derivatives in earnings, rather than deferring such amounts in accumulated other comprehensive income. The net mark-to-market loss on outstanding derivatives at June 30, 2006 included in accumulated other comprehensive income will be reported in future earnings through 2007 as the original hedged oil and gas sales occur. The company expects to reclassify $463 million of the net after-tax derivative loss from accumulated other comprehensive income to earnings during the next 12 months.


6.
Exploratory Drilling Costs

At June 30, 2006, the company had capitalized exploratory drilling costs of approximately $234 million associated with ongoing exploration and/or appraisal activities primarily in the deepwater Gulf of Mexico, Alaska and Brazil (including $41 million associated with the Gulf of Mexico shelf properties to be sold to W&T). Such capitalized costs may be charged against earnings in a future period if management determines that commercial quantities of hydrocarbons have not been discovered or that future appraisal drilling or development activities are not likely to occur.
 
- 11 -


7.
Debt

The following table summarizes changes in total debt for the six months ended June 30, 2006:

       
Debt
 
Carrying
 
(Millions of dollars)
 
Principal
 
Discount
 
Amount
 
               
Balance at December 31, 2005 (1)
 
$
3,232
 
$
(99
)
$
3,133
 
Amortization of discount
   
-
   
3
   
3
 
Change in the fair value of hedged debt
   
-
   
1
   
1
 
Early redemption of 7% debentures due 2011
   
(250
)
 
69
   
(181
)
Tronox Distribution
   
(550
)
 
-
   
(550
)
Balance at June 30, 2006
 
$
2,432
 
$
(26
)
$
2,406
 

(1)  
Includes $550 million of Tronox debt presented in the Condensed Consolidated Balance Sheet as liabilities associated with Tronox.

In February 2006, the company redeemed its 7% deep-discount debentures with a face value of $250 million using cash on hand. In connection with the early redemption, a pretax loss of $69 million, representing a write-off of unamortized discount on the debentures, was recognized. Additionally, in January 2006, the company terminated its $1.25 billion secured revolving credit facility, which resulted in a write-off of unamortized debt issue costs of $12 million associated with the facility. The terminated facility was replaced with a $1.25 billion unsecured revolving credit agreement. At June 30, 2006, no borrowings were outstanding under the revolving facility, while outstanding letters of credit that reduce borrowing capacity totaled $57 million.


8.
Exit, Disposal and Restructuring Activities

The following table presents the changes in the reserve for exit, disposal and restructuring activities during the six months ended June 30, 2006. No significant changes in the status of exit activities occurred during this period.

   
Reserve Activity 
 
   
Dismantlement
 
Personnel
     
(Millions of dollars)
 
and Closure
 
Costs
 
Total
 
               
Balance at December 31, 2005
 
$
6
 
$
21
 
$
27
 
Provisions/Accruals (1)
   
-
   
7
   
7
 
Payments
   
(1
)
 
(12
)
 
(13
)
Tronox Distribution
   
(5
)
 
(6
)
 
(11
)
Balance at June 30, 2006
 
$
-
 
$
10
 
$
10
 

(1)  
Includes a $2 million charge related to Tronox, which is reflected in loss from discontinued operations in the Condensed Consolidated Statement of Income. 
 


9.  Employee Stock-Based Compensation

Overview - The company's 2005 Long Term Incentive Plan (the Plan) authorizes the issuance of shares of the company’s common stock to certain employees and non-employee directors at any time prior to May 10, 2015 in the form of fixed-price stock options, restricted stock or performance awards. At June 30, 2006, approximately 8.5 million shares of Kerr-McGee stock were available to be granted under the Plan. Prior to the approval of the Plan by the company’s stockholders, stock-based awards were granted under similar plans, all of which have been terminated. Although no more awards can be issued under those plans, their termination had no effect on awards that had been previously issued and are outstanding.


- 12 -


Stock-based awards granted by the company to its employees and non-employee directors in recent years generally have the following terms:

   
Vesting
 
Cash- or
 
 
Contractual
Period
Vesting
Stock-
Vesting and Other
 
Life (Years)
(Years)
Term (1)
Settled
Conditions
         
Stock options
10
3
Graded
Stock
Employee service
Restricted stock
not applicable
3
Cliff
Stock
Employee service
Performance units (2)
3
3
Cliff
Cash
Employee service and
         
achievement of specified
         
stockholder return targets
           
(1)  
An employee holding stock options vests in one third of the award annually. An employee vests in the entire restricted stock award at the end of the three-year vesting period. Employees terminating their employment due to retirement fully vest in their stock option and restricted stock awards upon retirement, and, subject to certain conditions, retain the right to receive a pro rata payout under the performance unit awards to the extent services have been provided.
 
(2)  
Performance unit awards provide an employee with a potential cash payment at the end of a three-year performance cycle based on Kerr-McGee's total stockholder return (stockholder return assuming dividend reinvestment) relative to selected peer companies. Payout levels vary depending upon Kerr-McGee's rank relative to its peers.
 
Impact of Pending Merger - Consistent with the provisions of the company’s long-term incentive plans, upon completion of the merger, all options to purchase Kerr-McGee common stock, shares of Kerr-McGee restricted stock and performance units outstanding as of the merger date will vest immediately. The merger agreement provides that all outstanding stock options will be cancelled upon completion of the merger and the option holders will receive cash consideration for each option equal to the excess of the per-share merger consideration over the exercise price (subject to applicable tax withholdings). Restrictions on all shares of restricted stock will lapse and the shares will be converted into rights to receive the per-share merger consideration. The company’s performance unit awards outstanding as of the merger completion date will settle in cash consistent with the provisions of the long term incentive plans under which they were issued.

Effect of Tronox Separation and the Stock Split - As provided in the Employee Benefits Agreement between Kerr-McGee and Tronox, except for vested stock options, vested performance unit awards, and awards held by retirement-eligible employees, Kerr-McGee stock-based awards held by Tronox employees at the date of the Distribution were forfeited and replaced with stock-based awards of comparable value issued by Tronox. Retirement-eligible Tronox employees fully vested in their Kerr-McGee stock options and restricted stock on the Distribution date. In connection with the Distribution, a reversal of pretax expense of $3 million was recognized as a component of loss from discontinued operations, reflecting the net effect of reversing previously recognized compensation cost for Kerr-McGee awards forfeited by Tronox employees and accelerated amortization of compensation cost for awards held by retirement-eligible employees of Tronox.

In connection with the Distribution, the holders of Kerr-McGee stock options were not entitled to receive the dividend of Tronox Class B common stock. Accordingly, following provisions of the relevant incentive plans, the company adjusted the terms of stock options outstanding as of March 30, 2006 to reduce the exercise price and increase the number of shares subject to the options. On a post-split basis, the number of shares subject to the options increased by 387,310 and the weighted average exercise price decreased by $1.12 per share. This antidilution adjustment preserved the intrinsic value of the options prior to the Tronox share dividend and maintained the ratio of the exercise price of each option to the market price of Kerr-McGee stock as of the Distribution date.

Following provisions of the long-term incentive plans, the terms of stock options outstanding as of June 14, 2006, the date of the two-for-one stock split, were modified, whereby the number of shares subject to each option has doubled and the exercise price decreased 50%. Additionally, holders of Kerr-McGee restricted stock received the stock dividend in connection with the stock split.

The company evaluated the impact of award modifications in connection with the Distribution and the stock split on compensation cost and determined that the modifications did not increase the fair value of the awards. Therefore, there was no effect on compensation cost recognized in the first six months of 2006 and no effect is expected on cost recognition in future periods.

- 13 -


Stock-Based Compensation Cost - The following summarizes stock-based compensation expense recognized in income from continuing operations for the three and six months ended June 30, 2006 and 2005. Refer to Note 1 for information regarding the change in the accounting policy for stock-based awards effective January 1, 2006.

   
Three Months Ended
 
Six Months Ended
 
   
June 30,
 
June 30,
 
(Millions of dollars)
 
2006
 
2005
 
2006
 
2005
 
                   
Stock options
 
$
5
 
$
-
 
$
25
 
$
1
 
Restricted stock
   
5
   
5
   
20
   
10
 
Performance units
   
11
   
-
   
17
   
7
 
Total stock-based compensation expense
   
21
   
5
   
62
   
18
 
Income tax benefit
   
(8
)
 
(1
)
 
(22
)
 
(6
)
Total stock-based compensation expense, net of taxes
 
$
13
 
$
4
 
$
40
 
$
12
 

The following table presents unamortized cost associated with awards outstanding at June 30, 2006 and the weighted average period over which it is expected to be recognized (before considering the associated income tax benefit). Compensation cost ultimately recognized and the remaining recognition period may differ from those presented below due to changes in the estimate of forfeitures, accelerated vesting upon a change in control, or changes in fair value of performance units, which are remeasured each reporting period.

   
Unrecognized
 
Remaining
 
   
Cost
 
Period
 
(Millions of dollars)
 
(Pretax)
 
(Years)
 
           
Stock options
 
$
28
   
2.1
 
Restricted stock
   
25
   
1.8
 
Performance units
   
29
   
2.0
 
   
$
82
   
2.0
 

Stock Options - The following table presents a summary of activity for Kerr-McGee options for the six months ended June 30, 2006. The share and per-share information has been retroactively adjusted to reflect the effects of the two-for-one stock split and an antidilution adjustment in connection with the Distribution, which are described below.
 
               
Intrinsic
 
   
Number of
     
Contractual
 
Value
 
Options
 
Shares
 
Price (2)
 
 Life (Years) (2)
 
   (Millions) (3)
 
                   
Outstanding at December 31, 2005
   
9,929,090
 
$
25.65
             
Granted
   
2,431,304
   
45.36
             
Exercised
   
(1,727,552
)
 
24.87
             
Forfeited (1)
   
(462,305
)
 
29.07
             
Expired
   
(8,558
)
 
23.82
             
Outstanding at June 30, 2006
   
10,161,979
 
$
30.34
   
7.2
 
$
396
 
Exercisable at June 30, 2006
   
5,403,830
 
$
25.66
   
5.8
 
$
236
 

(1)  
Includes options to purchase 335,165 shares of Kerr-McGee stock that were forfeited by Tronox employees at the date of the Distribution.
 
(2)  
Represents weighted average exercise price and weighted average remaining contractual life, as applicable.
 
(3)  
Reflects aggregate intrinsic value based on the difference between the market price of Kerr-McGee common stock and the options' exercise price.


- 14 -


The following table presents selected information with respect to options exercised during the first six months of 2006 and 2005:

(Millions of dollars)
 
  2006
 
  2005
 
       
Intrinsic value
 
$
47
 
$
58
 
Cash proceeds received
   
43
   
159
 
Tax benefit realized
   
16
   
20
 

Compensation Cost Measurement
 
Valuation and Cost Attribution Methods - Prior to January 1, 2006, the company utilized the Black-Scholes-Merton option-pricing model to estimate the fair value of its stock option awards. Starting with its 2006 grant, the company estimates the fair value of its option awards using a lattice model, which management believes results in a more accurate measurement of fair value as compared to the Black-Scholes-Merton formula. Fair value is determined on the date of grant and recognized in earnings (net of expected forfeitures) on a straight-line basis over the employee service period necessary to earn the awards, which is generally the vesting period. However, compensation cost associated with employees whose retention of the options is not contingent on providing future service is recognized immediately upon grant. 
 
The following table presents the weighted-average fair-value measurement assumptions for options granted during the first six months of 2006 and 2005, followed by additional information regarding the assumptions.
           
   
2006
 
2005
 
           
Expected volatility (annualized)
   
28.0
%
 
26.4
%
Expected dividend yield (annualized)
   
.2
%
 
3.5
%
Expected term (years)
   
5.6
   
6
 
Risk-free rate
   
4.49
%
 
3.9
%
Weighted average per-share fair value of options granted(1)
 
$
16.20
 
$
10.11
 

(1)  
Retroactively adjusted to reflect the effects of the two-for-one stock split and the Distribution.
 
Expected Volatility - In determining the volatility assumption, the company considers both the implied volatility of its traded options and historical volatility of its stock price over the same contractual term as the options.
 
Expected Dividend Yield - The dividend yield assumption is based on the company’s expectation, as of the grant date, about its dividend policy over the contractual option term. In March 2005, subsequent to the 2005 stock option grant, Kerr-McGee’s Board of Directors approved a change in the dividend policy that reduced quarterly dividends from $.225 to $.025 per share. The company’s 2006 expected dividend yield reflects that change in the dividend policy.
 
Expected Term - The expected term represents the period that the company’s options are expected to be outstanding. Under the lattice model, expected term is derived from assumptions of employee post-vesting termination and retirement rates, as well as voluntary exercise behavior correlated to various market price scenarios for the company’s stock. Assumptions made regarding employee exercise behavior are based on analyses of historical experience for similar awards over a period of ten years, giving consideration to the contractual terms of the options, demographic characteristics of option holders, vesting schedules and expectations of future employee behavior.
 
Risk-Free Interest Rate - The company bases the risk-free interest rate on the U.S. Treasury securities rates over the contractual term of the options.


- 15 -


Nonvested and Restricted Stock - The following table summarizes information about nonvested and restricted stock activity during the first six months of 2006:

   
Shares
 
Fair Value (1)
 
           
Balance at December 31, 2005
   
2,481,250
 
$
26.93
 
Granted
   
482,140
   
49.29
 
Vested
   
(819,770
)
 
21.61
 
Forfeited (2)
   
(193,318
)
 
32.20
 
Balance at June 30, 2006
   
1,950,302
 
$
34.16
 

(1)  
Represents the weighted-average grant-date fair value.
 
(2)  
Includes approximately 146,000 shares forfeited by Tronox employees as of the Distribution date.

Valuation and Cost Attribution Method - Grant-date fair value of nonvested shares is determined by reference to market quotes for the company’s common stock. Compensation cost is recognized in earnings (net of expected forfeitures) on a straight-line basis over the employee service period necessary to earn the awards, which is generally the vesting period. However, compensation cost associated with employees whose retention of stock awards is not contingent on providing future service is recognized immediately upon grant. 

Performance Units - The following summarizes activity associated with the company's performance unit awards, as well as the changes in the performance units liability for the six months ended June 30, 2006:
 
       
Carrying
 
   
Performance
 
Amount of
 
(Millions of dollars)
 
Units
 
Liability
 
           
Balance at December 31, 2005
   
33,545,679
 
$
21
 
Cumulative effect of adopting FAS 123(R)
   
(675,871
)
 
(2
)
Forfeitures by Tronox employees upon the Distribution
   
(2,794,330
)
 
(1
)
Units granted (1)
   
15,980,157
   
N/A
 
Award settlement
   
(9,292,084
)
 
(9
)
Compensation cost recognized
   
-
   
17
 
Balance at June 30, 2006 (2)
   
36,763,551
 
$
26
 

(1)  
Grant-date measurement of new performance unit awards is not required. Rather, fair value of the 2006 grant was estimated as of June 30, 2006 to determine the 2006 compensation cost associated with these awards.
 
(2)  
Performance units shown represent units outstanding and expected to vest.