哈里伯頓 (HAL) 2003 Q2 法說會逐字稿

Welcome to the Halliburton Company second quarter 2003 earnings results conference call. (CALLER INSTRUCTIONS). At this time for opening remarks and introductions, I would like to turn the call over to the Vice President of Investor Relations, Mr. Cedric Burgher. Please go ahead sir.

Thank you. Good morning and welcome to Halliburton's second quarter 2003 earnings release conference call. Today's call is being Webcast and a replay will be available on our website. Joining me today are Dave Lesar, our Chairman, President and Chief Executive Officer; Chris Gaut, Executive Vice President and Chief Financial Officer and John Gibson, Chief Executive Officer of Energy Services Group.

Following our prepared remarks, we will take questions from the investment community. We will limit each caller to one question in order to maximize participation in the call allowed.

Before turning the call over to Dave for opening comments, I would like to remind our audience that some of today's comments may include forward-looking statements reflecting the Company's view about future events and the potential impact on financial performance. These matters involve risks and uncertainties that could impact the Company's operations and financial results as discussed in our Form 10-K for the year ended December 31, 2002.

With that, I will turn the call over to Dave Lesar. Dave?

Thank you Cedric and good morning to everyone. On today's call, John Gibson, Chris and I will discuss our operating performance and give you an update on the Barracuda project and of course, where we are in asbestos.

Beginning with this quarter, we are increasing our transparency by presenting our business in 5 segments and also, expanding our geographic market disclosures. Today's press release, which came out earlier this morning, includes a lot of this detail and expanded information, in addition a condensed balance sheet. This is something that many of our investors have asked for and we want to be responsive to you.

As you know, Doug Foshee has also resigned as our Executive Vice President and Chief Operating Officer to become the President and CEO of El Paso Corporation. In his nearly two years at Halliburton, I think Doug has made a significant contribution to the Company and I want to wish him well.

However, today Halliburton has a deep bench of very talented managers that I believe will drive us to industry-leading performance in the years to come. I will be assuming the responsibilities of the Chief Operating Officer, as I do not plan to fill that position. John Gibson, who is President and CEO of Halliburton Energy Services Group and Randy Harl, who is President and CEO of KBR, will now report directly to me.

As for the quarter, our second quarter income from continuing operations was $42 million or 9 cents per diluted share. This includes $104 million after-tax loss or 24 cents on the Barracuda project, which we had announced earlier in the quarter. This continues to be a difficult project and exemplifies why I announced a year ago that we would not be taking on any more fixed-price offshore EPIC contracts where the risks exceed the potential rewards.

We are determined to limit any negative liquidity and impact of the Barracuda projects. With this in mind, we have signed a non-binding heads of agreement with the project owner and Chris will discuss this agreement in further detail later in the call.

As you saw in this morning's press release and you will hear in today's call, we have changed the way in which we are managing our energy services group business today. I would like to invite John onto the call now to explain the rationale for these moves. John?

Thanks Dave. In order to capture new markets and achieve better integration including joint research and development of new products and technologies and other synergies within ESG, we have grouped each of our ESG product service line components into 4 segments that we feel naturally align with our customers activities. These new segments are as follows -- Drilling and Formation Evaluation consisting of Sperry Sun, logging and security DBS; Fluids, consisting of Baroid, cementing and our investment in Inventure; Production Optimization consisting of completion products and services, tools and testing, production enhancement and our investment in Subsea 7; and finally, Landmark and other ESG consisting of Landmark, real-time operations, integrated solution projects, our investment in well dynamics as well as non-core activities.

This structure better positions us with the future of the energy industry, allows us to adapt to the changing needs of our customers and to become recognized in the industry as the go to Company.

I will turn the call now over to Chris, who will talk about the results of operations. Chris?

Things John and good morning. Hopefully everyone has a copy of the press release but if you don't, you can obtain one from our website, halliburton.com. Following up on what Dave mentioned about the change in our press release, we are now providing information for each of our 5 segments and geographic detail by quarter for 2001, 2002 and 2003 year to date.

The operating results shown in these tables are all inclusive, but we will also including footnote tables that provide a menu of these special transactions that we have had over time and that will make it easier for you to examine these special transactions and if you want to see the impact that they have on our results or do your own work adjusting for these results, one can do so. Our objective in providing this additional information was to improve the transparency of our results.

Now my comments today will include updates on our company and segment results, our liquidity and other financial information, guidance for the third quarter 2003, an update on the SEC investigation and on asbestos matters.

On the operating results, I will be comparing second quarter 2003 results from continuing operations sequentially to our first quarter.

Total company revenues for the quarter were up 18 percent sequentially due to improved activity in all segments. International revenues were 67 percent of the total in the second quarter 2003, essentially unchanged from the mix as compared to the first quarter. Operating income decreased 71 million or 50 percent sequentially primarily due to the larger charge on the Barracuda project in the second quarter compared to the first quarter. This was partially offset by improved results in our ESG segments. Income from continuing operations was 42 million or 9 cents per diluted share and that's after the 24 cent charge related to the Barracuda project and after the 3 cents per share gain on the sale of Halliburton Measurement Systems. We also had foreign currency gains of almost 3 cents per share which is included in our 9 cents for the quarter.

Now I will review our segment operating results and review revenues and then operating income. ESG revenue totaled 1.8 billion which was an 11 percent increase from the first quarter. Results for the new ESG segments are as follows -- Drilling and Formation Evaluation segment revenue increased by 9 percent with improvements in each of its product service lines. Sperry Sun revenue increased by 6 percent compared to the first quarter with improved activity in Norway, Russia, Mexico and Africa. Logging sequential revenues improved 20 percent due to higher land rig counts in the U.S., increased activity in Venezuela from Pedavasa and higher direct sales to the Far East.

For drill bits, Security DBS' revenues increased by 4 percent primarily due to increased rig activity in the United States. In the Fluids segment, revenue increased 8 percent compared to the first quarter with improved activity in both cementing and Baroid.

Cementing revenue was up 10 percent with increased activity in the U.S. due to the higher land rig counts and internationally in Mexico, Norway and Saudi Arabia. Baroid revenue increased 8 percent overall with the largest increases in Nigeria, Angola and the North Sea.

Production Optimization segment revenue increased by 10 percent sequentially with large improvements in production enhancement and our Subsea 7 operations, which benefited from significantly higher vessel utilization compared to the prior quarter. Completion products revenues were flat. Tools and testing revenues increased 5 percent and production enhancement revenue was up 9 percent, primarily in the U.S. and Mexico as rig counts increased. Landmark and other ESG revenues increased 26 percent. We saw an $11 million of increase -- which reflects increased integrated service activity in Iraq and Landmark revenue, Landmark itself was up 7 percent due primarily to revenue growth in Latin America.

Now turning from revenue to operating income and margins, ESG operating income totaled $235 million. That's an increase of 31 percent from the first quarter with an incremental margin of 33 percent. Excluding the effect of our Mono pump, which was first quarter and HMS divestiture in the second quarter, all 4 ESG segments contributed to the operating income improvement and each had a strong incremental margin.

Drilling information evaluation operating income decreased 26 percent and that is fully due to the 36 million Mono pumps gain recorded in the first quarter. The first quarter gain was offset by a $21 million improvement across all 3 product service lines in Q2, which created a 60 percent incremental margin this quarter. Sperry Sun operating income improved 15 percent due to new work in Algeria, additional PMEX work in Mexico and increased activity in Norway. Logging rebounded from a poor first quarter as margins improved to 13 percent. Increased activity in the U.S. and Mexico, equipment sales in Russia and additional work in Venezuela and Indonesia all contributed to the improved performance (technical difficulty).

Drillbits, Security DBS also recovered from a depressed first quarter as margined improved to 11 percent from 2 percent. In the Fluids segment, operating margins increased by almost 2 percentage points and operating income was up 24 percent and we had a 34 percent incremental margin comparing the second quarter to the first quarter.

Cementing operating income increased 37 percent due to increased activity in the U.S., Mexico and Norway and Baroid operating income increased 9 percent on higher activity but we're continuing to see stiff price competition in this sector. Production optimization segment operating income improved 61 percent due to the 24 million second quarter HMS gain along with a $19 million net improvement. These product service lines created a 30 percent incremental margin.

Production enhancement operating income improved $7 million or 14 percent due to increased activity in Mexico and Norway and higher direct sales and these more than offset a seasonal decline from Canadian work. In addition, we've begun to see some increases in pricing and hope to continue this trend into the second half of the year.

Completion products operating (ph) increased significantly in Q2 with an almost 7 percentage point drop in margins mainly due to inventory adjustments and customs duties in the second quarter as well as continued pricing pressure. Tools and testing results were down $2 million due to increased costs and inventory adjustments and mobilization charges. Subsea 7's $25 million increase in operating income from Q1 reflects a rebound from low utilization and high dry-docking costs in the first quarter.

Landmark and other ESG operating income was up $16 million due to the $15 million first quarter loss in the Wellstream sale but we had increased second quarter integrated solutions work in Iraq and higher second quarter activity in Landmark and that was offset by a $4 million second quarter charge on a real estate sale.

Now on a geographic basis for ESG, sequential revenues were up in all regions with double-digit percentage revenue increases in every one except North America and that's due to seasonal decline in Canada and a flat Gulf of Mexico.

The Europe Africa region was up 15 percent primarily due to a 23 million increase in Norway. Middle East Asia revenues increased 16 percent mainly on a recovery following the end of hostilities in the Middle East which affected the first quarter and we had new work in Iraq. Revenue was up 24 percent in Latin America as we are finally seeing some improvement in Venezuela due to an increase in Pedevesa activity, as well as significantly higher activity in Mexico across all PSL's. Mexico was kind of a star this quarter as their revenues increased 48 percent sequentially for us.

Geographically, North American margins were up almost one percentage point sequentially. Latin American margins improved by 6 percentage points with increases in Mexico and Venezuela. Increased activity in Norway impacted margins positively in Europe and Africa. In the Middle East Asia, operating income increased 21 percent on higher revenues.

Now I would like to move to our engineering and construction segment, KBR and again, I will review revenue followed by operating income and again, we're comparing second quarter 2003 or 2003 sequentially to the first quarter this year.

Revenues for KBR increased 26 percent sequentially to approximately $1.8 billion. The increase was primarily in our onshore operations and government services businesses due to increased activity on several major projects. Revenue for the quarter related to Iraq with the United States Army was $292 million, most of which was under the competitively bid LOGCAP contract which is for the support of our troops in Iraq. In addition, we have performed some work in our Ministry of Defense of the UK. We added 2.2 billion to KBR backlog in the second quarter, which represents over 120 percent of KBR's revenues for the quarter.

KBR's operating loss was $148 million which was 129 million greater than in Q1. That's due to a loss on the Barracuda project of 173 million in the second quarter compared to a 55 million loss in the first quarter. I will come back to Barracuda in a minute.

The only other offshore fixed-price EPIC project that is not substantially completed is the Bellenek project in Indonesia which is now 76 percent complete with 221 million in backlog. The project remains in a profitable position.

Onshore EMC operations had an operating loss for the quarter primarily related to a project that we serviced through a 55 percent owned consolidated joint venture in Europe. Operating loss for the quarter was negatively impacted on this project by $29 million. Whoever -- when one backs out the 45 percent of the project that we do not own, the impact on our pretax results was about $16 million.

On a more positive note, onshore LNG projects continue to realize excellent job performance and financial contributions exceeding our expectations. We anticipate our backlog to continue to climb in this area.

Our government services product line had a very good quarter with a 67 percent increase in operating income and a slight increase in margins. KBR's government services continued to see improved results due to our D&L operations at the Devonport Royal dockyard. KBR's Iraq related work for both the United States and the UK contributed 17 million in operating income for the second quarter.

On a consolidated basis, our Iraq related activity company wide in ESG and KBR represented about 9 percent of both our revenue and operating income before the Barracuda charge in the second quarter.

Now on Barracuda, as was already mentioned, we recorded in the second quarter a $173 million pre-tax charge amounting to 24 cents a share after-tax. The Barracuda project charge was due to higher cost estimates, schedule extensions, increased project contingencies and other factors identified during the quarterly project review. As is obvious by the amount of the charge, this continues to be our most challenging project in KBR. Since the inception of the project, we've recorded a pretax aggregate loss on Barracuda of $345 million. We have outstanding claims which we believe are probable collection totaling at least 182 million and we are potentially liable for liquidated damages of 266 million.

We currently estimate that the Barracuda project is now approximately 75 percent complete. The schedule extensions for Barracuda have no impact on the percentage completion as this amount is calculated on the physical percent complete.

KBR has signed a non-binding LOGCAP agreement as Dave mentioned with the project owner that would resolve a number of disputed issues and refer remaining issues to arbitration. This agreement is subject to lender approval and final agreement. We are actively engaged in negotiations with the lenders to obtain their approval.

This heads of agreement calls for the project owner to pay 59 million of KBR's disputed claims, that's 59 of that 182 million I mentioned earlier. We don't have final agreement, so the number remains at 182 and for KBR to take remaining claims arbitration in New York but our recovery would be capped at 375 million. In addition, the agreement would extend the schedule completion of the project to 2005, which could reduce the amount of liquidated damages. Under the heads of agreement, the project owner would also agree to delay the potential assessment of liquidated damages for delays beyond the original time schedule as well as the potential drawing of letters of credit.

On July 13, the floating production storage offloading vessel FPSO Barracuda, set sale from the shipyard in Singapore bound for Brazil and we expect the vessel to arrive in Brazil in late September.

Now turning from segment operating results to other financial matters, general corporate expenses were 16 million in the second quarter compared to 19 million in the first quarter and we expect general corporate expense to be approximately $18 to 20m quarter for the remainder of the year.

A note here, I would suggest when comparing our results and margins to our competitors, we would urge you to keep in mind that corporate expenses should be treated consistently, we think. At Halliburton, we allocate most of our G&A costs to our operations, which means that our reported segment operating margins are burdened with more G&A costs. Once one adjusts our competitors reported results for this difference in methodology, we think you'll see our results and margins compare favorably.

Interest expense was 25 million in the second quarter 2003 and that's compared to 27 million in the previous quarter. The decrease is due to second quarter payments of schedule maturities of debt and the remaining quarters in 2003 we expect interest expense to increase to approximately 35 million per quarter and that's due primarily to our recent issuance of convertible notes.

Now in the second quarter as I mentioned we had a foreign currency gain of 19 million as primarily related to a significant strengthening of the British Pound to the U.S. Dollar. Our effective tax rate for the quarter was 39 percent which is about the rate we expect for the rest of this year.

Capital expenditures totaled 128 million for the quarter. That's up 27 million sequentially. We have been more focused on capital discipline and expect our full year capital spending to be down year-over-year to approximately 600 million. This is a reduction of about 100 million in our spending guidance for 2003.

Depreciation, depletion and amortization expense was 125 million for the quarter and that's about equal to our CAPEX. And that 125m approximates our expected DD&A run rate for 2003.

Now let me update you on several key issues affecting our debt and liquidity. Total debt at June 30 was 2.6 billion which is up 1.1 billion from March 31 and that's because at the end of the second quarter, we issued 1.2 billion of convertible senior notes with a coupon of 3 1/8 percent and a 65 percent conversion premium. That's a conversion price of $37.65. Also, during the quarter, we repaid 139 million in senior notes which matured in April. Our debt to capital at end of the quarter increased to 42 percent due to the issuance of convertible debt but our net debt to cap ratio -- our net debt to capital ratio taking into account our 1.9 billion of cash is only 16 percent and of course, we maintain our investment-grade credit ratings.

Subsequent to quarter end, we paid off 150 million of medium-term notes as they matured in July and we reduced the amounts outstanding under our accounts receivable securitization facility from 180 million to zero. We ended the quarter with 1.9 billion in cash. That's up from 1.1 billion at the end of 2002. This increase is due to proceeds from our convertible debt issuance partially offset by increased working capital requirements.

Our headcount was around 96,000 at end of the quarter, which is up sequentially and that is primarily due to increases in our activities related to Iraq.

Now guidance for the third quarter. In the second quarter we began to see a modest recovery in activity levels in the energy industry. We expect to see these activity levels sustain throughout the balance of the year accordingly. We expect earnings per share from continuing operations for the third quarter to be at least 32 cents per share. That's excluding any impact of the proposed asbestos settlement.

Let me update you on the SEC investigation. We are cooperating with the staff. We're providing additional documents and the SEC continues to conduct interviews. To our knowledge, generally the scope of the investigation has not changed and relates to the accrual of revenue associated with cost overruns and unapproved claims for long-term engineering and construction projects.

With regard to asbestos, first let me give you the statistics. During the quarter, an estimated 37,000 new claims were filed. This number is high, but we believe it is driven by the plaintiff's attorneys attempting to get new claims on file ahead of any prepac filing and any potential legislation. In addition, we believe in most cases, single claimants are filing against multiple Halliburton entities and we believe the actual number of additional claimants is about half that number. Only 1000 cases were settled during the second quarter as this activity has for the most part has been on hold awaiting the outcome of our proposed settlement. This leaves us with a total number of claims of 425,000. But for the purpose of the proposed settlement, the number we focus on is the total number of claimants. We currently estimate that number to be about 345,000 individuals. The difference is due to a number of claimants who are filing multiple claims which would be resolved on a per claimant basis under the proposed settlement.

We are continuing our due diligence review of current asbestos claims to be included in the proposed settlement. We have now received in excess of 75 percent of the necessary files related to medical evidence and we've reviewed substantially all of that information provided. In regards to product ID due diligence, the project is moving at a steady pace but not as rapidly as the medical due diligence. While no assurance can be given if we will continue to receive documentation that's consistent with the recent quality and quantity received to date, we do expect this documentation will provide an acceptable basis on which to proceed with the proposed settlement.

In June 2003, we announced that as a result of an increase in the estimated number of claims asserted, the cash required to fund the proposed settlement may modestly exceed the previously announced 2.775 billion. If it does, we would expect either to adjust the settlement matrices to reduce the overall amounts per claim or increase the amount we would be willing to pay to resolve our asbestos and silica claims.

Finally on July 22nd, the Bankruptcy Court approved for our agreement -- I'm sorry, the Bankruptcy Court approved our agreement with the Official Committee of Asbestos Creditors to extend the temporary restraining order related to Harbison-Walker claims through to September 30, 2003. In addition, should this day expire at September 30, discovery on the state claims cannot begin until November 1 and trial dates cannot be set before January 1, 2004. While we continue to head down a path towards our proposed asbestos settlement, we are monitoring the progress of legislative developments.

Now with that, let me give the call back to John for a view on the ESG market outlook.

Thanks Chris. With U.S. rigs increasing about 14 percent in the second quarter and international rigs up about 3 percent, we assume a somewhat steady increase in overall activity this year. As Chris just detailed, absent the gains on the sales of HMS and Mono, all 4 of our ESG segments experienced sequential revenue and operating income increases in the second quarter. After taking into account corporate expenses, we believe that ESG's operating margins have improved significantly relative to our peers.

Looking ahead, I believe U.S. activity levels will increase modestly in the second half of the year. We expect continued strong drilling activity onshore in North America. Although some operators are releasing rigs we expect other independents to contract these rigs with minimal market disruption. Activity in the U.S. Gulf of Mexico has been disappointing in the first half of this year but we see only a modest improvement through year-end. A number of onshore rigs have moved to other areas and Mexico in particular, has shown a significant increase in drilling activity, which we expect to continue.

Outside North America, we expect rig counts will be flat to up slightly for the balance of the year. We focused on international 2003 where non North America second quarter revenue increased 17 percent sequentially compared to 8 percent in the U.S. with excellent growth in the Middle East and additional opportunities if sanctions are removed from countries as they have been in Iraq.

Overall our revenue growth internationally compares favorably to our peers. Pricing on new contracts for products and services began to improve in the second quarter. Pricing increases typically lag activity increases in our business and that has certainly been the case in this cycle. We are optimistic that the pricing environment will gradually improve for the balance of the year. We are implementing pricing increases and discount reductions in selected product service lines and geographies. We are actively managing our operating costs and working capital. We are working to improve our service quality for all of our customers and we're making sure that all is done safely. Ultimately we're focused on improving our relative margin performance and return on capital employed.

Now I would like to turn the call back over to Dave who will make some closing comments. Dave?

Things John and Chris. Just a few closing comments and then we will take some questions. As you have heard, I guess the Barracuda project -- I believe the rest of our operations performed very well during the second quarter as we continue to achieve both revenue growth and more importantly, improved profitability. I'm very pleased with the margin improvements that we had in the second quarter. Our margins are beginning to approach the levels we last experienced in 2001 although our pricing in 2001 was much more favorable than it is today and I think that's reflective of the cost-cutting that we have done over the past year so, which I think will give us increasing leverage as pricing comes up. I also believe we have improved our competitive position in many areas and as I said, have become much more efficient. I'm very excited about our upside earnings potential.

As we have discussed in recent quarterly calls, the continuing economic and political uncertainty adversely impacted many of our customer spending in the first half of 2003. However as worldwide and U.S. rig counts have improved, oil and gas prices also remain high and I think we are starting to see some of our customers start to have a desire to spend additional money. We anticipate a continuing recovery through the second half of the year, reflective of -- with our increased earnings guidance.

Once again as I always do, I want to recognize the contribution of the now 96,000 Halliburton employees who together and individually, make this Company work every day. I especially want to thank those that are working in the Middle East today and I look forward, I think, to a better second half of the year.

This concludes our remarks and at this point in time, let's kick it open for some questions and we will answer as many as we have time for.

(CALLER INSTRUCTIONS). Jim Wicklund of Bank of America Securities.

Good morning gentlemen. John, you talked about you're focused on international growth for the Company and your revenues demonstrated that. You did very well in Mexico. You did very well in Norway. Is that the result of focusing growth efforts specifically on those countries or is it more reactive, no offense, but more reactive than if those markets were strong and so you benefited?

Jim, obviously it is a result obviously of our focus.

(laughter)

We put a lot of effort into international growth and we've been talking about a design for growth since the beginning of this year focused on improving internationally. We're very strong in the U.S. and for us to be -- reach our potential, we had to focus on international growth. We've done extremely well in the Middle East. We've done extremely well in Asia Pacific during this quarter and I think you'll see us continue to work on focusing growth there as well as in the emerging Russian market. We will stay focused on international markets, Jim.

Rob Mackenzie of Friedman, Billings, Ramsey.

Good morning gentlemen. Got a question for you. I noticed among your results and some of your competitors, that logging and LWD results in general for most of you, have improved stronger than overall industry revenue growth if my calculations are correct. What do you anticipate is driving the improvement in this pipeline? Is it actually an increase in exploration work or is something else impacting these product lines?

Yes, this is Dave. Let me take a shot at it. I think what we are seeing is that our customers have come to recognize the value of the information and data they can get, either from traditional wireline but I think in our case, more and more the capabilities of the LWD and MWD tools that we are putting in the holes. So many of the measurements and pieces of data that they have wanted for years is now becoming available through those mechanisms and I think it's helping to make more efficient evaluation of the reservoir, more efficient drainage patterns and therefore, better overall results from a finding and development standpoint. So I think the promise of getting real-time or very quick information from a down hole standpoint is something that our customers are beginning to recognize and are willing to pay for at this point in time. And with the price of some of the cash prices of some of the wells we are seeing today, getting that information on a more timely basis, I think is something that they see a big advantage in doing that. So I think the new technologies that we have like GeoTap and some of the others, rotary steerables and some of those tools, are something that just have a real good uptake in the market today and I also think those are areas that we are making market penetration in. So I think that's really the reason. It's really a new technology message more than anything else.

Once again, I would like to remind everyone to please limit yourself to one question, one question please. Next question comes from Geof Kieburtz of Smith Barney.

Good morning. I would like to ask a little bit about asbestos and given the one question limitation, let me try to phrase it carefully. I appreciate the update on the due diligence. Could you kind of give us a little bit of a snapshot of the outlook here? I am thinking that the next meaningful event is the completion of the disclosure statement. I'm also assuming that the game plan is to try to get responses to that disclosure statement prior to filing the prepackaged bankruptcy, and I just wondered if you could give us any sense, given that is a process that will probably take between 30 and 45 days, what is your level of confidence at this point in actually being able to file the prepac by the end of September?

Jeff, let me ask -- although we didn't introduce him at the beginning, Bert Cornelison, who is our General Counsel, is sitting in the room here with us today and I am going to invite him up to the phone and let him cover at least what we believe is a reasonable way forward in terms of the question you asked.

Good morning. We are currently in the final stages of negotiating the trust distribution procedures, which are an integral part of the plan, which will have to be included in the disclosure statement. Our goal is to get the disclosure statement circulated by the middle of August with approximately a 35 or 40 day voting period, which would put us in a position to file at the end of September. The end of September is we believe, an achievable date and one which we are directing all of our efforts to be in a position to meet and our discussions with the plaintiff's attorneys have been going productively.

Ken Sill of Credit Suisse First Boston.

: Good morning gentlemen. I wanted to dig a little bit deeper into some of the comments in the press release on pricing pressures in North America. You mentioned higher mobilization costs. If you could get a little more detail on where you're seeing pricing pressures and on the mobilization costs, is that something that's ongoing or was that just reallocating assets and we should see some of that come off as we move forward?

I know there is a lot of conversation around pricing increases occurring in North America but in actuality, we are seeing a lot of our fears that are working on marketshare positions as opposed to just pricing increases and so we are obligated to respond in that area. We've been really disciplined. If you look at our revenue, we have gone after quality revenue, revenues with margins this quarter including in the US so that our growth and operating income is actually greater than our growth in our revenues. But there is strong pricing pressure. We have increased our pricing where it's been possible in each of our product service lines and our geographies but we have targeted that where we believe we can realize those increases. It's not simply an increase that has been lost again through discounting.

And Ken, the cost I mentioned in connection with two of the smaller PSLs, tools and testing and completion products were more of a onetime nature there in the second quarter.

Scott Gill of Simmons & Company.

Yes, good morning. John, I guess this question is directed towards you. In the new structure of the organization, can you talk a little bit as to why you have strategically divided your pressure pumping operation cementing in one area and stimulation work in the other? Talk to us a little bit about why you did that and is that an efficient use of those pressure pumping assets?

That's an excellent question and one we debated at length before making the decision to organize the Company as we have. Fundamentally, we have organized around our customer and we've naturally aligned the units around the buyer and what we are seeing is customer needs. In the area of cementing, the buyer's really drilling departments and the value proposition there is associated with cost improvement. On the production enhancement side, the buyer is reservoir engineering departments with our customers and the real value proposition for the customer there is an improvement of production or the optimization of recovery. And so looking at the two buying segments, we needed efficiency in our sales forces. We were looking at sales force effectiveness and efficiency and we felt like alignment to the natural markets and the evolution of the technology associated with those two different areas might branch as we go forward and that we wanted to have the right technology investments in both areas and focus on our buyers and the customers needs as opposed to focusing just on internal operational efficiency. We do have integration in the back office so that the motor pools for Mono pumps in each one of our camps where we still have the same people working on the trucks, we still have efficiencies in the maintenance of the equipment. But we are focused on the front end with regard to the evolution of technology and evolution of focus on customer's needs and buying trends.

Kurt Hallead of RBC Capital Markets.

(No response)

Your line is open, please go-ahead.

Great thank you. Actually my question has been answered. Thank you.

(CALLER INSTRUCTIONS). James Stone, UBS.

Good morning guys. I just want to dig a little bit more into the ECG numbers in the quarter. It seemed to me that given the strong increase that you had in revenues in the quarter, particularly what looked like very strong increase in government ops, which has historically been one of your more profitable segments there, I'm having trouble getting to why the margins were so low, why you didn't see better incremental profitability and is that a timing issue, something that will come forward as you move into the third or fourth quarter or is there something else working here?

This is Dave. Let me take that one. I think if you remember when you look at the structure of our contracts especially in the government services area, those are typically contracts that are cost plus a very small amount plus an award fee and as we ramp up on these projects, we typically have to assess what we believe the award fee pool is going to be and therefore, make a determination and a judgment as to how much of that potential award fee we should recognize on a quarter to quarter basis. And as this was really the first quarter that those revenues ramped up, I think that we have been a little bit slow in terms of recording the award fees related to that and I believe that what we did in the final analysis from a judgment standpoint was booked about half of what we thought potential award fee would be. As time goes on here and we get a little more experience with how the contract is going, we will decide whether that's the right judgment or whether we can increase our recognition of profits, so it really is more or less a judgment that was taken on the front end, as we start to ramp these projects up. We don't have a history yet on the Iraq theatre and these award fees.

Wes Matt of Fulcrum

Good morning. LNG is a pick (ph). We are seeing imports come up here, if my memory serves me right, gentlemen you have had a hand in about 60 percent of the LNG installations historically. What's the outlook? What do you see potentially coming down the chute in the next 6 to 12 months that could indicate the backlog and can you provide a flavor of geographically, where it might come from?

This is Dave again. LNG obviously is an area that gets a lot of interest in the energy sector today and it's an area that we obviously, have a very big play in. If you look at what we are involved in today from a geographic standpoint, obviously we've got a big play in the LNG program that is going on in Nigeria. We won and have announced in the last quarter or so that we've won the Tangguh project for BP. That project has not yet started. We are doing the Union Fenosa plant in Egypt at this point in time. We are on the very front end of the project for Marathon in Mexico, which is an LNG receiving terminal. It was announced within the last week or so that we have one pre-engineering for a big receiving terminal, in fact, the largest receiving terminal that will be built for a plant in the UK. So geographically -- and of course, we are working on plants in Australia and a number of other places around the world today.

If you look out and look at the LNG facilities that are being discussed at this point in time, of course, there are a number of plant that look like they are going to go forward and gutter in the Middle East. There is additional trains being talked about for Egypt and for Nigeria, there's a greenfield plant being talked about for Peru. On the receiving terminal side, there are a number of receiving terminals being looked at and discussed for the U.S. because ultimately, that's where our customers want the product to come, is to be brought into the U.S. to alleviate some of the gas pressure that we see here today. So we couldn't be more excited about this industry as we look forward. As you know, LNG either liquefaction or re-gasification projects take a long time to mature. They are also very large projects.

I think this is something we have to look at at more than a 6 to 12 month horizon, but at this point in time, I think we're very well positioned to be competitive, to look at almost every single plant or liquefaction facility that's being discussed around the world and we intend to aggressively defend our position that we have in this market.

Pierre Conner, Hibernia Southcoast.

Good morning everybody. Nice review Chris, thank you. The question may be for you or Dave but a lot of moving parts in E&C and I wondered if you can boil it down on a margin ex all those moving parts and then if you could even look a little forward at one point, Dave had spoke about targeting, I believe correct me if I'm wrong Dave, a 3 percent margin in that business once you move out of the fixed-price EPIC, can you move that direction and how long backlog up, is that important? Thank you.

Yes Pierre, thank you. KBR is building a revenue principally in those two areas, government services and onshore. What hurt us here in the second quarter were two things. Obviously KBR and then also the charge on the onshore plants in Europe. Away from that, KBR would have been on track and in line with kind of the 3 percent margin you're speaking to there.

With the growth that we see in government services and LNG potential that Dave was mentioning earlier, we see good potential for KBR in the future. And we think that that division, barring further unforeseen charges, is on track to improve their margin as we talked about previously.

We have time for one more question.

Robin Shoemaker of Bear Stearns.

Good morning. I wanted to ask if the 4 divisions, relating to the 4 divisions of ESG, now that you have set those up and are reporting those to us, whether you have done this with the idea of calculating your return on capital employed for each division and if that's a parameter that managers of those divisions are going to be measured by or if you are going to be giving us an indication in the future as to what kind of return on capital -- what are the best performing divisions in terms of that calculation? Basically, that's my question.

It is an excellent question. We are trying to get all of our compensation for each one of the divisions aligned to their performance and so, our internal management metrics do include capital metrics as well as revenue metrics and margin metrics. And so the capital focus is as important in each one of those divisions as is their growth as well as in their margins. So it makes up a part of their overall compensation package. I do believe that you'll see us very focused on tracking each one of the balance sheet items as well internally for the divisions and we are holding them accountable on Accounts Receivable, as well. So we are trying to take a good blocking and tackling approach to the business fundamentals and driving those down to each one of the divisions so that we can get improved performance across the whole of the group.

I think there is one other thing I would like to add on that; obviously when you have a company in our energy services group that has as many product lines in it, there is clearly a lot of shared capital in the business and I think before we start discussing publicly the return on capital on a segment by segment basis, we really need to get a better idea of perhaps identifying some of that shared capital with specific drivers within the business before I think it will be meaningful to you from a comparative standpoint. As John has indicated, I think we have taken the first big step which is to make sure internally, we are managing the capital that we do have efficiently, but I think you are going to have to give us some time to assess that big base of shared capital that we have in the organization before any numbers, with respect to return on capital, would be worthwhile and meaningful from an external reporting standpoint.

Thank you for joining us on today's call. A replay will be available on our website.

Thank you.

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