哈里伯頓 (HAL) 2004 Q2 法說會逐字稿

Good day and welcome to today's Halliburton Company's second quarter 2004 results conference call. Today's call is being recorded. At this time for opening remarks and introductions I'd like to turn the call over to the Vice President of Investor Relations, Mr. Paul Koeller. Please go ahead.

Thank you. Good morning and welcome to Halliburton's second quarter 2004 earnings release conference call.

My name is Paul Koeller and I recently assumed the role of Vice President of Investor Relations for Halliburton, taking over from Cedric Berger, who has taken the position of Corporate Treasurer. I look forward to working with and getting to know all of you in the months ahead.

Today's call is being Web cast and a replay will be available on our Web site. Joining me today are Dave Lesar, Chairman, President and Chief Executive Officer, Chris Gaut, Executive Vice President and Chief Financial Officer, John Gibson, Chief Executive Officer of Energy Services Group, Randy Harl, Chairman of KBR, Andy Lane, Chief Executive Officer of KBR, and Bert Cornelison, Executive Vice President and General Counsel.

On today's call, Dave will provide opening remarks. Chris will discuss our overall operating performance and financial position and update you on the progress of our asbestos settlement and a few other important matters for the company. Next, John and Randy will cover the business outlook and competitive position at the Energy Services Group and KBR respectively. Finally, Dave will provide a few concluding remarks before opening up the call for questions.

We will limit each caller to one question and one related follow-up in order to maximize participation in the time allowed.

I expect by now most of you have seen this morning's press release with our first quarter results. If you don't have a copy of our press release, you can obtain it from our Web site, www.Halliburton.com.

Before turning the call over the Dave, 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 their potential impact on our performance. These matters involve risks and uncertainties that could impact the company's operations and financial results and cause our actual results to differ from our forward-looking statements. These risks are discussed in Halliburton's Form 10-K-A for the year ended December 31, 2003, Form 10-Q for the quarter ended March 31, 2004, and Form 8-K dated July 19, 2004.

With that I'll now turn the call over to Dave Lesar. Dave?

Thank you, Paul, and good morning everyone.

As Paul has mentioned, he's just recently moved into the Investor Relations role. Paul was previously a Vice President in Business Development with our Energy Services Group, where he handled the global BP account for us.

I'm very sure that Paul will continue to give all of you great support and insight into Halliburton just as Cedric did. I want to thank Cedric for his contribution and I'm confident that he'll do a great job as our Treasurer.

I have three important pieces of information that I want to start the meeting with today and talk about: Asbestos, management changes, and the very good operating results of ESG.

Let me start with the important news on our asbestos settlement that we put out earlier this week. I think that this is positive news for Halliburton's employees, customers, and shareholders.

I'm also pleased that we're taking our final steps toward permanently resolving our asbestos liability. Now that the plan has been approved by the Bankruptcy Court, and we have a confirmation, the asbestos chapter in Halliburton's history will soon be closed.

We also announced this morning a change in KBR leadership. I'm pleased to announce that Andy Lane is moving to KBR as President and CEO to succeed Randy Har1 who will assume the role of Chairman of KBR. These moves are effective today.

Randy has led KBR through a period of tremendous growth and change during his more than three years as President and CEO and I thank him for his hard work.

Before his appointment Andy has spent more than 20 years in the industry. He was a Senior Vice President of our Energy Services Group, regional organization. Before that he was President and CEO of Landmark Graphics, and before that he held a number of Management, Director, and Vice President positions, all focused on Halliburton's industry-leading well completions and production enhancement businesses.

I have great confidence in Andy. He is one of the highest potential executives at Halliburton and I believe that he'll have a great impact at KBR.

Moving on to our operations, overall I'm very pleased with our ESG operating performance during the quarter. However, the operating loss on Barracuda-Caratinga was disappointing but we've enhanced our project management and increased our effort to complete this difficult project.

As John and Randy will tell you, the outlook for our business continues to improve. Particularly for the Energy Services and LNG businesses. Customer spending in the second quarter continues to increase, reflecting a stronger view that high commodity prices are sustainable over the long-term.

As our customers continue to feel more confident about the fundamentals that are underlying the high oil and gas prices that are out there today, we would expect further increases in spending in both the U.S. and internationally.

I just want to do and cover a couple of highlights for the quarter.

The previously announced price increases within the Energy Services Group are taking hold with our customers. With the increase in activity, as reflected in the current rig count, our utilization of equipment is high, and price improvements have delivered improved margins.

Sequentially for ESG revenue totaled $1.9 billion, up 5% sequentially from the first quarter, while our operating income totaled 271 million, an increase of 27% compared to the first quarter, and our operating margins increased 2.4 full percentage points. Chris and John will provide further details in their discussion.

We are also benefiting from our efforts to right-size our cost structure that we've discussed the past several quarters. Especially in those markets that are experiencing weakness, such as the Gulf of Mexico and the North Sea.

Chris and Randy will give you an update on our activity in Iraq, but one significant thing to note is that we have substantially completed the RIO 1 contract resulting in reduction in working capital.

With our cash position, the new KBR accounts receivable facility, and our new $500 million revolving credit facility, we have improved our liquidity position. Chris will go into that in detail.

We do, however, continue to be a political punching bag. This week is no different. But simply put, war is a chaotic environment.

As hostilities have escalated, we have been on the front lines losing 42 KBR and subcontractor personnel. However, we continue to deliver our mission with great pride. No other company in the world could have acted with such resolve and dedication and accomplish so much in a short order.

With the rapid growth of our assignments and the demands of war, we have placed continuous pressure on ourselves to do better. We have worked equally hard with oversight teams from the Army and other Department of Defense offices and have refined our systems, improved our processes and performance, and we continue to do so.

To reinforce my point on the chaotic nature of this project, the recent GAO report stated that one of KBR's task orders for work in Iraq was changed seven times in less than 12 months, and that a task order for work in Kuwait was changed 18 times in 15 months. We do a good job in a constantly changing environment and I'm very proud of our people.

As Chris will say later, we believe that the first award fee review boards could begin as early as the third quarter.

With that I'll turn the call over to Chris.

Thanks, Dave, and good morning. I'm going to cover four things this morning.

First I'm going to summarize our operating results for each of our five segments, I will review the Barracuda-Caratinga project and our previously announced second quarter charge, I will then talk about our liquidity and other financial matters and I'll close with an update on asbestos. Throughout the call I will be comparing second quarter 2004 results from continuing operations sequentially to the first quarter 2004.

Lets move to our operating results.

Total company revenues for quarter were $5 billion, that's down 563 million from last quarter, and that's due to the substantial completion of the RIO 1 contract during the second quarter as Dave mentioned. This is partially offset by continued strong onshore drilling activity in the United States.

International revenues were 71% of our total in the second quarter, that compares to 76% in the first quarter, and that's due to decrease in Iraq work as well as increase in U.S. revenue on the ESG side.

Operating income decreased $194 million sequentially primarily due to larger charge on the Barracuda-Caratinga project in the second quarter compared to the first quarter. The loss from continuing operations was 54 million or 12 cents per diluted share after the 46-cent per share after-tax charge related to the Barracuda project.

Now I will review our segment operating results and first let's start with ESG, the Energy Services Group.

ESG revenue totaled $1.9 billion for quarter, which is up approximately 5% from the first quarter. ESG operating income totaled 271 million, an increase of 57 million compared to the first quarter, due to increased U.S. and international rig counts, improved pricing in the U.S., reduced losses in our Subsea 7 joint venture, as well as cost reductions. These improvements more than offset the normal seasonal decline in Canadian drilling activity.

The ESG segment showed strong, sequential improvement with very attractive incremental margins due to both revenue increases and operating efficiencies. Results for the individual ESG segments are as follows: The Production Optimization segment revenue at PO increased $89 million with revenue growth in all geographic regions.

Revenue from our stimulation business was up 39 million with strong growth in land drilling activity and improved pricing in the United States, and increased activity in the North Sea and Russia. These increases were partially offset by lower revenues in Canada and the Middle East.

Revenue from completion and reservoir optimization services was up 25 million on improved activity in the Gulf of Mexico and Saudi Arabia, testing and exploration wells in Mexico and sales of completion tools in North Africa. These increases were somewhat offset by lower sand control work in the North Sea.

Our Subsea 7 joint venture recorded $2 million in equity losses in the second quarter, but that's a $15 million improvement over the seasonally slower first quarter. Second quarter results for Subsea 7 were hurt by higher project estimates and lower estimates for claims recovery.

Following the restructuring of our joint ventures with Shell, we began consolidating the operations of Well Dynamics during the first quarter of 2004. 13 million of Production Optimization's revenue increase was due to this change in accounting.

Production Optimization operating income increased 39 million attributed to increased revenue, improved pricing, and the lower equity losses in Subsea 7. Production Optimization had a very strong quarter with the only negative being the continued disappointing performance from the Subsea 7 joint venture.

In the Fluids segment, second quarter revenue was up 19 million compared to the first quarter with increases in all geographic regions. Baroid revenue increased 17 million on strong activity in the North Sea, Russia, Brazil, and the United States where revenue increased 10% in the Gulf of Mexico.

Cementing revenue was up 5 million with improvements in Latin America, Europe-Africa and the Middle East-Asia regions. The North America region improved revenue in the United States which was offset by this drilling slowdown in Canada.

Fluid segment operating income was up 17 million, primarily due to dramatically improved results at Baroid. At Baroid, operating income increased 13 million, due to increased activity and cost reduction efforts in the U.S. including Gulf of Mexico, where improved customer mix and the effect of previously announced cost reduction program improved operating results.

Internationally, increases in Latin America and in the North Sea were partially offset by higher expenses in Algeria and continental Europe.

Cementing operating income increased 4 million, primarily from increased equipment utilization and improved pricing onshore U.S. and lower operating expenses in Europe-Africa offset by, of course, the reduced activity in Canada.

The Drilling and Formation Evaluation segment revenue decreased 21 million, with declines in each business. Logging revenue decreased $9 million sequentially due primarily to lower product sales into China, partially offset by increased U.S. land activity.

Revenue from Directional Drilling and Logging Well Drilling services decreased 9 million, due to the seasonal decline in Canadian drilling activity, and reduced product sales in Russia. These declines were partially offset by increased activity in Norway, Kazakhstan, U.S. land, Venezuela, and Brazil.

Drilling and Formation Evaluation operating income increased $16 million, with improvement in each geographic region. Operating income from Directional Drilling and LWD services increased 8 million from the prior quarter, due primarily to a $13 million positive impact from the change in accounting estimate to extend the useful life of directional drilling and LWD tools for depreciation purposes, and to a lesser extent improved U.S. land drilling activity.

The change in depreciable life is supported by our experience and a technical analysis of the service life of our tools. It also puts Sperry-Sun on a more comparable basis with its competitors. These increases were partially offset by seasonal declines in Canada and fewer product sales in Russia.

Logging operating income increased 7 million sequentially, on improved U.S. land activity and pricing. Within DFB we received a favorable jury verdict in a drill bit patent infringement case against a competitor in the second quarter. However, we will not record any gain on that lawsuit until final adjudication.

Revenues in the Landmark and Other Energy Services segment remained essentially flat, and operating income decreased $15 million, due to the first quarter $13 million favorable adjustment resulting from settlement of the Anglo Dutch litigation during the first quarter. Landmark Graphics second quarter revenue, it's just Landmark Graphics as opposed to the Landmark and Other Energy Services division, Landmark Graphics second quarter revenues increased, were up by 4% and operating income increased 22%, on higher software-related sales in Latin America and hardware sales in Asia.

A geographic summary for ESG. Our strongest improvements were in the traditional markets of the U.S., both on and offshore, the North Sea, and Venezuela.

In North America, sequential operating income increased $34 million, on strong onshore drilling activity and pricing improvement in the United States, and an improved Gulf of Mexico. Partially offset by the seasonal decline in Canada, and the $13 million favorable Anglo Dutch settlement adjustment we had in the first quarter.

Latin America operating income was up $6 million due to improvement in Venezuela and Argentina, partially offset by activity declines in Mexico, as our new, integrated solutions projects in Mexico are getting underway just this third quarter.

Europe-Africa operating income increased $7 million, primarily due to improved activity in the North Sea, offset by higher cost in Algeria and reduced activity in Angola and Nigeria.

Middle East-Asia operating income was up 10 million on improvement in Kazakhstan, Saudi, and Australia, offset by lower equipment sales in China and Russia, and lower activity in Kuwait and Oman.

Now I'll move to our Engineering Construction segment KBR, and we're comparing the second quarter 2004 sequentially to the first quarter 2004.

KBR revenue totaled 3.1 billion, that's down 651 million from the previous quarter, primarily due to the substantial completion of the government services RIO 1 project in the Middle East. This was partially offset by higher revenue earned on activities at our shipyard in the United Kingdom and ammonia and gas projects in China, Algeria, and Australia.

We added a 3.4 billion to KBRs backlog in the second quarter, which represents more than 100% of the revenue for the quarter. Net of workoff, KBR backlog at the end of June was 8.8 billion, that's up 400 million from the March 31, 2004 date, primarily due to additional work under the LogCAP III contract. Of the total backlog, 4.7 billion is for the government services projects.

KBR's operating loss was 277 million in the second quarter which included the $310 million loss on the Barracuda-Caratinga project in the second quarter.

As you know, once construction contracts fall below breakeven, the accounting rules and our policy require the recognition of the total estimated loss into the future through project completion. Each quarter, therefore, we consider all of the information currently available to us related to costs and productivity trends in order to develop our best estimate of future costs to complete the project.

We then add a reasonable amount of contingency to the estimate based on the remaining work scope and our experience, but we must have support for the charge based on information available. The additional charge we recorded this quarter followed our detailed review of the project which indicated higher cost estimates and schedule delays, and we also increased contingencies for the balance of the project.

Specifically during the second quarter, with the integration phase now fully underway, the Barracuda vessel construction experienced a significant loss in productivity as well as rework required for the vessel conversion. Similar issues are being experienced in the Caratinga vessel. As of June 30, the project was 87% complete and we have $513 million yet to spend.

As we announced in April, KBR has entered into a non-binding agreement in principal with Petrobras and that agreement would provide resolution to our claims that would otherwise go to arbitration. The new agreement is subject to final agreement and approval by the project lenders and the Bankruptcy Court.

The agreement, if completed, would amend the existing agreements and release both parties from claims arising prior to the effective date of the agreement, reduce KBR's scope of work to be performed after the two vessels sail away, extend milestone deadlines, and reduce our exposure to late delivery penalties. In determining the amount of the second quarter charge, we assume that the April agreement in principal will be successfully finalized.

In KBR's other business lines, the operating income contribution was down in the second quarter as compared to Q1. KBR's work for the U.S. and U.K. governments in Iraq continued at high activity levels though revenue and operating income decreased from the first quarter, due to substantial completion of the RIO 1 contract.

Iraq-related work for Halliburton as a whole contributed approximately 23 million in operating income before corporate costs and taxes, for the second quarter on 1.7 billion of revenue. That's only a 1.4% margin, compared to 37 million in operating income for the first quarter on 2.4 billion of revenue, and a 1.6% margin before corporate costs and taxes.

The reduction in the margin is a mix of factors as the RIO 1 contract, that's winding down carried a higher margin. The absence of RIO 1 in the third quarter will tend to further reduce our margins from Iraq.

We have begun the planning and preparation process with the DCAA and our customers for the board reviews to determine KBR's performance bonus levels. We believe the first award fee board review could begin in the third quarter.

Now turning from segment operating results to other financial items.

General corporate expenses were 13 million in the second quarter and that compares to 24 million in the first quarter. The decrease was due mainly to lower legal and communication expense.

We expect general corporate expenses in the second half 2004 to be around $20 million per quarter due to Sarbanes-Oxley compliance costs, and if necessary, increased spending on media relations and professional fees to defend Halliburton's reputation at least through the November election.

Interest expense was 53 million in the second quarter, compared to 56 million in the prior quarter. Our effective tax rate on continuing operations for the quarter was 36%.

We were not able to fully benefit the full tax loss for the Barracuda-Caratinga charge. As a result, our effective tax rate for the first half of 2004 was 40%, which is the rate we now expect for the full year.

Capital expenditures totaled 154 million for the second quarter, that's up 24 million sequentially. Capital spending in the first half was about 185, and we expect it to remain at this level in the second half.

Depreciation expense was 124 million for the second quarter, compared to 132 million in the prior quarter. The decrease is primarily due to the second quarter change in estimated useful life of the directional drilling and LWD tools which will lower depreciation in future periods.

Now I'd like to take a minute to update you on our debt and liquidity.

Total debt at June 30 approximately 4 billion, consistent with the prior quarter. We ended the second quarter with $2.2 billion in cash and cash equivalents, and that's up from 1.9 billion at March 31.

In April, we renewed for another year, our ESG accounts receivable securitization facility. As of June 30, the balance outstanding under this facility was about $260 million.

In May, KBR entered into an agreement to sell specified United States government accounts receivable to a third party. At June 30, the amount that we sold was approximately $50 million, but we expect this amount to increase in order to reduce our investment in working capital.

In July, we entered into a new, secured $500 million 364-day revolving credit facility for general working capital purposes, with terms substantially similar to our existing $500 million revolving credit facility. We have no outstanding advances under either of these facilities.

Our working capital position on our government services work was approximately 1.1 billion at June 30, down from approximately 1.25 billion at March 31. We expect a continued, general decline in our working capital requirements during the second half of the year, primarily due to the substantial completion of the RIO 1 project, and the leveling off of LogCAP III project work after the initial ramp-up in 2003.

Our liquidity position is strong and we believe it will be more than adequate to fund our asbestos funding needs. In addition to the 2.2 billion of cash on hand at June 30, we had the 1.2 billion of unused credit lines, the ability to sell additional accounts receivable, as well as improving working capital position in Iraq.

Our outlook is for improvement in operating results for third quarter particularly strong performance at ESG. However the decline in activity under the RIO contract in Iraq will lead to lower profit contribution at KBR.

Regarding asbestos.

With regard to proposed asbestos settlement, as we previously announced, DI Industries, KBR and the other affected subsidiaries filed a Chapter 11 proceedings December 16th of last year. On May 10th, the Bankruptcy Court completed the hearings on the proposed reorganization. On July 16th, just last week, the Bankruptcy Court issued an order approving the debtors' disclosure statement and solicitation procedures and confirmed our plan of reorganization.

We expect that the District Court will affirm the order issued by the Bankruptcy Court and once appeals, if any, to the District Court affirmation are exhausted, we would fund the trust and we expect this to occur in November or December.

In June 2004, we announced that under the terms of the previously announced insurance settlements, we expect to receive cash proceeds with a present value of approximately $1.4 billion for the asbestos and silica-related insurance receivables. As a result in the second quarter, we reduced the amount recorded as insurance receivables and recorded a charge to discontinued operations of approximately $609 million or $1.39 per share after-tax.

Finally, as a reminder, we intend to hold an analyst and investor day on September 23rd, in Houston. And now I'd like to turn the call over to John Gibson for his remarks on the Energy Services Group, their environment, and their outlook. John?

Thanks, Chris. Good morning everyone.

As Chris and Dave have mentioned, we had a strong quarter in almost all of our product lines and geographies, underpinned by continued strength in the market. The impact of our earlier 8% price book increase and increased focus on cost control.

As many have noted, the oil price outlook continues to be bullish in both the short and the medium-term, driven by both increasing demand and concerns over the capacity to meet the supply needs. Despite such high prices, global economic growth seems to continue, and we're seeing signs even our most conservative customers are becoming more confident about the future.

The situation with regard to gas, particularly in North America, is similar and the medium-term is likely to see continued strong demand. Despite this, we're continuing to apply discipline to our allocation of capital, particularly where surplus capacity could undermine pricing.

Where opportunities for profitable growth can be clearly justified, we will act quickly and allocate both resources and capital. As I've announced before, we have re-allocated resources from the Gulf of Mexico, which is still disappointing overall to other areas very successfully and benefited from the same between Canada and U.S. in this last quarter.

Chris has gone through our divisional results in some detail, so I'll be selective here. I'll discuss 2Q results by segment and on a geographic basis, I'll then look at examples of recent contract and technology wins which I believe provide a particularly sound platform for our future.

In the Production Optimization segment, our production enhancement business was outstanding. As the need for reservoir stimulation grows, particularly in gas and mature assets, this is a growth area for us and a core area for us as well.

Completions in reservoir optimization which was formerly completion products, tools, testing and tubing conveyed perforating, had a really strong quarter, where we have now installed more than 40 expandable liner hangers, all successfully.

In our Fluid segment, where cementing has continued its strong growth in both revenues and margins, I am particularly pleased to see us turning the corner in Baroid, not only financially, but as what is so important to Halliburton in the area of safety, which we believe is a key indicator of a well run business.

Landmark Graphics had its highest ever second quarter revenue, and has secured additional wins in its consulting and project management business. In the Drilling and Formation Evaluation area, our logging business continues to improve and perform well as a result of the strategic focus we initiated last year.

For Security BBS, our bit business, an otherwise strong performance was somewhat offset by legal fees associated with our successful patent infringement litigation against Smith International. Last month, the U.S. District Court jury in Tyler, Texas awarded Halliburton $24 million in damages for Smith's infringement of Halliburton's patents on Energy-Balancing technology for Roller-Cone bits.

The jury also found that Smith's infringement was willful. Based on that finding, the judge will now have an opportunity to consider whether Halliburton is entitled to recover enhanced damages and attorneys' fees. At the same time, we are pursuing similar patent infringement litigation against Smith in the U.K. and Italy.

Finally, I'd like to discuss Sperry-Sun.

As outlined to you previously, Sperry saw significant declines in its historical core markets at the Gulf of Mexico and the North Sea during 2003. We've completed the cost rationalization of those markets and have aggressively addressed additional markets to enable us to successfully redeploy our assets.

This is culminated in some substantial contract wins which either have recently commenced, or will commence in quarter three. Examples of these wins for Sperry include, a $300 million three-year contract awarded by ConocoPhillips in Norway, a $120 million three-year agreement with Norsk Hydro, also in Norway, and substantial awards for Caspian and offshore Brazil drilling services.

In addition to these segment-specific wins, we announced two, two-year agreements totaling 230 million with Pemex to drill 33 turnkey wells in Southern Mexico which we will see a combined package of our product and services across our strengths. It's in an area which we have significant potential for growth.

As with our approach to capital discipline, we will be selective and focused in pursuit of these multi-service opportunities provided the reward is appropriate to the risk. If we add this win to our successes on the largest multi-contract bids, we have this year secured over $800 million of new awards, and these strategic tenders our win rate so far in 2004 is in excess of 80%.

Before I move on to discussing results on a geographic basis, let me say a few words about our joint ventures, which as a whole, are yet to perform to our expectations.

Our Well Dynamics and Subsea 7 joint ventures both have new CEOs from this month and we will be working hard to support improvements in both top line and bottom line growth. For Subsea 7, the negative second quarter results, although better than Q1, were affect by the termination of two FMA vessels, together with certain balance sheet adjustments and provisions against variation orders for projects completed, within the second quarter. These project are currently under discussion with clients.

On a sequential basis, all geographic regions recorded growth of both revenues and operating income, and I'd like to focus on three areas in particular. The 29% increase in operating income in North America was largely a result of very strong performance onshore in the U.S., particularly associated with the intensive gas-related drilling going on in the Rockies, which offset the seasonal decline in Canada.

U.S. land activity appears to be particularly robust, and is generally forecast to continue to be so through the end of the year. We believe the Gulf of Mexico has now stabilized, but it has not returned to previously expected levels of activity.

Russia is emerging as an attractive area of opportunity with significant growth for our stimulation business and other product lines related to operating cost side of our customer spend. This reflects the current emphasis on redevelopment activities in the major fields in Russia, where scope exists for continued introduction of cost-effective technologies that have proven to deliver breakthrough performance elsewhere.

We're scaling our business to the most attractive profitable growth opportunities in this large and complex market.

The Middle East continues to be one of our top performing areas as well. As with the industry at large, security is an increasing concern and is something that we are watching closely in our partnership with our longstanding customers in the area.

In the area of technology, we continue to see positive trends from the uptake of new products that I've reported to you previously. Six of our new technologies won Hart's Meritorious Engineering awards this year, more than any other service provider, and the most Halliburton has won in any year.

In addition, we were awarded the top ASME award for Depth Star, and have five other finalist technologies.

We intend to capitalize on our focused investment in research and technology by ensuring that we obtain pricing commensurate with the value of these technologies bring to our customers, while at the same time, ensuring that we protect the intellectual property that we have worked hard to create.

So in summary, I am very pleased with our strong results from the last quarter and feel we are well positioned to profitably capitalize on this improving market. We have sufficient capacity to be able to respond to attractive opportunities without compromising our ability to maintain and enhance pricing.

Now I will turn the call over to Randy for his discussion of KBR.

Thanks, John. I'd like to start by acknowledging the KBR has certainly had a higher profile in the media in recent months than ever before. And some have pointed to the danger that certain issues could taint our reputation.

I'd like to start by making it clear to you, as I have to our employees, suppliers, and partners, that integrity is number one. Our company has an established code of business conduct, which we expect employees to follow in order to promote the integrity of our company.

This doesn't mean that problems don't, and challenges don't arise, but when they do, we confront them, and we resolve them.

Certainly the most disappointing news for the quarter was the problems that surfaced on the Barracuda-Caratinga project in Brazil. These problems were identified during the recently begun integration phase when a detailed review revealed higher cost estimates and schedule delays.

There were two primary contributing factors, a significant reduction in productivity, and rework that was discovered when we began to integrate the equipment modules onto the vessels.

We have taken steps to mobilize more resources, including specialized management personnel in both Houston and South America, to oversee the final stages of the project. We've conducted additional cost and schedule reviews of the remaining project activities, and we have initiated several work process changes to move the project along more quickly.

Today, Barracuda-Caratinga is 87% complete, and KBR's project team continues to put a tremendous effort forth to move the project along to completion. We are eager to put it behind us.

In Indonesia, our other remaining major offshore engineering procurement installation and commissioning, or EPIC project, Belanak is nearing completion. The project for ConocoPhillips is a floating production, storage, and offloading vessel with a storage capacity of one million barrels of oil.

Commissioning work is ongoing on the Batam Island with the vessel scheduled for delivery offshore Indonesia in the fourth quarter of this year. At the end of the quarter, the project was 94% complete, with about 96 million of remaining backlog.

With the exception of Barracuda-Caratinga project, however, I'm pleased to report that the rest of KBR's core businesses are performing at or near the business plan for the year.

I'll start with an update on our government operations business which had a solid second quarter. I'll begin with work in the Middle East.

Despite the dangers and despite the fact that 42 of our employees and subcontractors have been killed in Iraq, we are continuing to stay the course and provide support to approximately 150,000 U.S. and coalition troops in Kuwait and Iraq.

Yesterday, a group of KBR employees testified before the House Committee on Government Reform. This is the first time a government-approved contractor has been invited to testify in a forum such as this.

We accepted this unprecedented invitation to appear before the Committee, because we are proud of our achievements in Iraq, proud to offer our global resources at this critical time in the Middle East, and we wanted to present the facts to the Committee. The fact is that KBR has successfully helped to restore needed services in Iraq that will help create some sense of normalcy for those who have suffered losses.

And we have done this while making every effort to comply with the many rules and regulations required to execute U.S. Government contracts. We are supporting the U.S. military in Iraq with the largest civilian force ever assembled, and our priority has been, and still is, to make certain that the troops have food, shelter, and tolerable living conditions they need while deployed in Iraq.

Questions have been raised by former employees. We take any allegations seriously, and have researched each and every one to first assure ourselves that our practices have been in accordance with government contracting rules, and then to assure the government of that fact.

As to our accusers, we certainly understand how some employees could believe something to be true when it is based on limited information and within the context of their own assignment. We believe we provided the committee with extremely detailed responses to refute all of these allegations raised by the former employees yesterday.

You can find more information about KBR's testimony to the committee yesterday and additional statements about our work in Iraq at our Web site at www.Halliburton.com.

We are operating in a war zone where decisions are made in minutes, not months, because of the ever-changing conditions. We continue to deliver the needed services to our troops while surmounting the enormous obstacles facing us and doing so at a fair and reasonable cost.

During the second quarter, we saw the work we were doing under the first Restore Iraqi Oil contract, or RIO 1, come to an end. Our work under LogCAP III is expected to remain stable throughout the year.

The RIO 2 contract has been officially renamed Repair and Continuity Operations of Iraq Oil Infrastructure South, or PCO Oil South, and is currently funded at about $450 million. The U.S. State Department's Project and Contracting Office in Baghdad is now overseeing the contract and working closely with the Iraq Ministry of Oil to identify and assign new oil infrastructure initiatives to KBR for Iraq's Central and Southern region.

I will now update you on the provisions of food services to the soldiers and discuss other operational performance highlights.

Progress is being made with the Defense Contract Audit Agency, or DCAA, by providing support for all costs that the agency has questioned. We continue to increase our internal compliance reviews and oversight to effectively and adequately respond to the questions and requests for information.

First, I'd like to address the widely-publicized issue of our subcontracting of dining facilities, or DIFACs. We remain confident that these subcontracts and our procurement practices in this area fully comply with government regulations, and that all costs associated with providing food to U.S. soldiers are allowable by the government.

In order to resolve this issue, we continue to work with our customer, the Army Materiel Command, and the DCAA, to prove this point. The DCAA has issued several Form 1's that total 207 million as the end of July 12th, 2004.

We, in turn, have outstanding payables to our subcontractors for a similar amount until this issue is resolved. We continue to assert that our approach is correct and will use the government-defined processes contained in every government contract to resolve disagreements of this nature.

From the operations perspective, I'm pleased to announce that KBR has achieved an aggregate award fee score of 97%, on part of our Balkan support contract, where we provide logistics and troop support to the U.S. Army in the Balkans, similar to what we do for the troops in Iraq. I believe this demonstrates the superior performance which KBR provides to the U.S. Government on a daily basis, and we congratulate our employees who achieved the highest results on behalf of KBR and our U.S. Government customers.

As we have reported on past calls, the markets for natural gas, liquefied natural gas, or LNG, and gas to liquids, or GTL, continue to be strong. Our current workload in LNG, the LNG arena, remains robust, as well as LNG work we are pursuing.

Due to the increased demand for natural gas, we are bidding more LNG work today than ever before. To give you a snapshot of what that looks like, today KBR is executing liquefaction projects in Nigeria, Egypt, Malaysia, Algeria, and Australia.

We will soon commence work on a liquefaction project in Indonesia, and we are bidding similar projects in Angola, Nigeria, Quatar, Egypt, Australia, and South America. We continue to work on the Seagas LNG project in Egypt, the first single-train, 5 million ton per year, LNG plant ever built. It's expected to be complete later this year.

We are also currently working on five LNG terminal projects in the U.S., Canada, and the U.K., and bidding on several more throughout North America and Europe.

Last quarter I mentioned that we would be signing a letter of intent for an additional LNG train at one of the sites where KBR is currently working. I am pleased to report that the work is progressing and we are working with the customer to finalize the contract details.

As for GTL, we have an ongoing front end engineering design project in Quatar, and are pursuing other GTL projects in Nigeria and Quatar, as countries look for ways to monetize their natural gas reserves.

In closing, we are continuing to focus on the completion of the Barracuda-Caratinga project. Our outlook remains that the world economic recovery should continue to have a beneficial impact on all our engineering and construction businesses.

Now I'll turn the call over to Andy Lane, President and CEO of KBR.

Thanks, Randy. Good morning everyone.

I'm very pleased to be the new President and CEO of KBR. As you know, we are under unparalleled scrutiny as a company right now. I want to briefly cover my top priorities for KBR, and what you should expect from us.

The top priorities on our agenda are, completing work on the Barracuda-Caratinga FBSOs and resolving all outstanding issues with Petrobras, improving KBR's profitability, resolving all disputing billing issues in our government service business in Iraq, continue adding profitable projects to our current $8.8 billion backlog, focusing on projects that utilize our core engineering and operational strengths, continue work on improving KBR's reputation with its customers and the general public. We will enforce our emphasis on integrity and accountability.

My main theme as CEO is going to be on business execution in every facet of KBR's business. We're going to focus on excellence in engineering, procurement, construction, government services, overall project management, and integrity in everything we do.

I have 23 years with Halliburton NG Service Group, and a track record of running financially successful businesses. We have a very experienced executive leadership team in engineering and construction, and over 64,000 great employees, so I'm very optimistic about KBR's future.

Now I will turn the call over to Dave who will make some closing comments.

Thank you, Andy, and welcome on board.

As you've heard, we've made great progress this quarter in the following: Resolving asbestos, improving our margins, making sure that our U.S. pricing is taking hold, looking at the increase in customer spending which creates enhanced opportunities moving forward, declining working capital, mainly from Iraq, and improving liquidity.

Our hearts continue to grieve for the ones we have lost and our empathy and sympathy goes out to their family. As Randy has told, you we continue to serve the military, the largest civilian work force ever assembled, and I'm proud of the tenacity, courage, and sacrifice of our employees all over the world.

We've got a lot of moving parts this quarter, so let's turn it over to questions now.

First question, please?

Thank you. Ladies and gentlemen, if you would like to ask a question at this time you may do so by pressing the star key followed by the digit one on your touch-tone telephone. Again, star one for questions or comments at this time. We'll go first to Michael Lamotte with J.P. Morgan.

Good morning, guys. Question for John. I guess the first one is on Baroid. From a top-line perspective, it still seems to be struggling to keep up with MI. Can you address specifically the strategy there and the impact of the solids-controlled venture that you've set up with National Oilwell, perhaps within that context?

Sure, that's great question. We have focused a lot on the improvement in Baroid. At the top line we did gain a little market share this past quarter, and we certainly improved margins through focus on cost control. So we have a much more solid profitable position with Baroid today than we had even a few quarters ago.

We think that to increased that business and to really get some increases in top line growth and secure a better position with customers, it's important for to us improve our solid control business, and we've undertaken two activities to do that, that you've probably noted in the last few quarters. One is the working with National Oilwell so that we're able to have access to the equipment that's required for solid controls.

And we also made an acquisition of ITS in order to enhance our ability to provide a solid control solution for customers as well. We see that as a great growth area for us and one of the areas we'll be able to grow both the top and the bottom line for Baroid.

Is that a critical component, solids control, for the bundled business that is increasingly dominant in international markets?

It is a very important part of the business. You have the standard fluids business but for many customers particularly in more remote areas, they want a total solution, and that total solution includes solid controls and so we have a good business there. It's rapidly growing, and we're just going to continue to focus on the growth of that component of our business.

Thank you and great job on the margins, John. That's good work.

Thanks.

We'll go next to James Wicklund with Banc of America Securities.

Good morning guys. And since everything else is working so well, I'll just pick on John, too. John, Landmark Graphics even adjusted for the gain in the first quarter margins were down, and this was as you reported on sales of software which usually has pretty good margins. Can you talk to us about Landmark a little bit? And then my follow-up question, which I'll go ahead and ask now and then get off, the integrated solutions business can be either based on, you know, equipment, I guess, or engineering. How much of your integrated solutions business that you see going forward is going to be based more off the geoscience end toward Landmark, rather than the equipment end like Production Optimization?

Well, Jim, first, I'd say go back and take a little closer look at Landmark. It was a record revenue quarter for Landmark, certainly record on profitability, so the LGC piece, that's the highest second quarter revenue we've ever had for Landmark in its history and it had strong earnings there as well.

You do have to take into account that last quarter we reported the about 13 million as a result of an Anglo Dutch reserve release. So, you know, I wouldn't factor that into the operating income from the Landmark and Other group.

But taking a look at integrated projects, I think one of the biggest parts for you to look at with us is that we're just not focused on the drilling side, we're going out partnering with world-class drilling contractors, and so we're not pursuing any of the markets where you have to have a complete integrated solution which includes drilling rigs. We think that's a very capital-intensive and that there are companies out in the marketplace that do an excellent job at that. But where we are focused is on the integrated projects where it brings value to us and it's not simply volume discounting.

So it has to be something where we do see an opportunity to lead with Landmark which brings in sort of the intellectual property, intellectual capital side of our business where we better understand the reservoir, we understand new production techniques, we're able to take the new technologies and apply those, and we're excited about some of the work that's going on in Asia, for instance.

We have some very strong contracts where we're looking at leading with the geoscience analysts component that comes out of Landmark and the consulting there, and believe that will follow on with integrated project work that brings all of the right technologies to bear to improve production for our customers. And so you'll see some large integrated projects around intellectual capital, not around volume discounting. That's not really what our intent is on the integrated project side.

We'll go next to Ken Sill with Credit Suisse First Boston.

I wanted to flip over to the KBR side for a second. You guys had a good results in the oil service side. I was kind of surprised by Chris's comments that he expected Kellogg Brown & Root to be down I guess sequentially in terms of contribution in the third quarter, and I was wondering if you could kind of, if you look at things, you're obviously moving at a lower margin part of the Iraq stuff, but all indications are that the LNG gas to liquids chemical businesses should be getting better with theoretically higher margin and you are getting into the period where you might be able to start booking some of the contract awards. What are your expectations for the non-Iraq portion of KBR in Q3 and Q4?

Yeah, Ken, I think it's important to make a distinction between the very near-term and the medium-term. The Iraq work currently being so big, but the mix effect being as we saw here and comparing the first quarter to second quarter as the RIO piece, which is higher margin, is reduced, the mix effect is lower margins from Iraq, and with about two thirds of KBR's revenue coming from Iraq, that's just a big factor in KBR's results right now. And with even less RIO work as that has come to an end in the third quarter, the contribution from Iraq will be down in the third quarter.

As we look beyond the third quarter, we will begin to expect these award fees to become more significant, and we have quite a few task orders that will be coming up for review late this year and into next year, and the potential there is significant, six different task orders we expect coming up there and review boards.

As then we look beyond that, into next year, is when we would expect to begin to see the impact, the revenue coming on from these numerous gas monetization projects that we are currently on the design stage of and are bidding, and we look for those beginning next year but that's more of a medium-term thing, wouldn't you say, Randy?

I would say that, you know, that's right, Chris. We're just in the bidding phase of an awful lot of work, and that will continue through this fall and into the beginning of next year with those projects being awarded sort of the mid next year and that will have an impact on later quarters in 2005.

Does that help, Ken?

Okay. Thank you.

We'll go next to Scott Gill with Simmons & Company.

Good morning gentlemen. If I could kind of continue the questioning here on KBR, I'm trying to understand the second quarter numbers and, Chris, if I heard what you said correctly, the Iraq contribution during the second quarter was 23 million of operating income. If we look at the, you know, back out the Barracuda-Caratinga charge here, it looks like KBR in total was 33 million less the 23 would give about 10 million for other non-Iraq awards. Can you just kind of walk us through these numbers, why that number looks low, if my math is right?

Why the government number looks low, why the Iraq number looks low?

No, no, no, why the non-government number looks low.

Yes. As I mentioned, the other businesses within KBR were down in the second quarter from the first quarter.

One of our business lines there on infrastructure, building road projects and hospital projects in Northern Africa, they had a negative contribution during the second quarter, which provided a negative comparison, for instance. So that was a factor.

Will that be repeated in the third quarter or is there some carry-over?

We hope not, no.

Okay. Alright. And if could I get one more question in, I would like to go to the Barracuda-Caratinga project. Looks like you've got kind of the cost nailed down to get this thing complete. Can you just kind of give us some idea of what could be, you know, another cause or a source of further cost overrun here?

You say you're asking where's the risk in the project? Well, it has been a problematic project. We do have a ways to go yet.

We have tried to anticipate, as I mentioned, all the trends that we see and put a contingency on that. But we do have over $500 million yet to spend on what's been a troublesome project to date. So we have given it our best estimate of what we expect to complete, but, you know, there can be no guarantees on this project as we've learned. Any addition there, Randy?

No, I think for what we have left at shore, we have a very detailed estimate of the cost and schedule going forward. It's down to the specific items that have to be completed.

Once we go offshore we have performed very well on the Subsea portion of this project. It's come in pretty much on cost and schedule and on a lot of the activities that are remaining are those Subsea ones, so we have a high degree of confidence on the cost and schedule side of the at-shore work, the Subsea work, and so it really comes down to the commissioning and start-up of the vessels which we think we're well prepared to do.

Right. As I mentioned, too, Scott, we are assuming that these agreements with Petrobras are finalized and those are being worked. Thank you.

Thank you.

We'll go now to James Stone of UBS.

I just wanted to follow up on the Barracuda-Caratinga as well. After you guys announced your schedule delays to the two vessels, Petrobras indicated and is still indicating they expect production from Barracuda and Caratinga to be earlier than the dates that you guys have given for the vessel delivery dates. And I'm just a little confused trying to square the opinion on first oil from your customers to your view on schedule deliveries for the vessels.

Yes. We are booking this project on what we believe is a reasonably conservative estimate. And we think that that's the best basis for estimating costs, which is a somewhat deferred schedule from what Petrobras has been talking about publicly.

Okay. Thanks.

We'll go next to Terry Darling of Goldman Sachs.

Thanks. I had a couple of follow-ups on the oil field side. First, John, I'm wondering if you could share with us the extent to which the 8% price increase on the pumping side, and I guess, 4 or 5% increase in other product lines, North America, is actually reflected in second quarter results, and to what extend are we going to see more of in that Q3? And then my second question is, Chris, can you review the change in useful lives at Sperry, what's the new life, what's the old life, and did I hear you correctly indicate that was a 2 cent benefit this quarter?

Yeah, Terry, I'll answer the first part first, then we'll put it on to John. On the Sperry equipment, as we looked at our overall downhole equipment, we felt that the legacy accounting policy that Sperry had from even before the Halliburton acquisition was both, you know, not reflective of our experience, nor with how we were treating our other, some of our other downhole tools. The policy had been to depreciate that equipment not more than four years, and it is now to depreciate it and have it written off in not more than six years. And, John, on the first half of the question?

Well, let me add a little bit more to the Sperry change. The big factor in that is the, as we look at our use of the tools, you have to include in that lost in hole. And as we've improved process and the equipment, we've actually reduced our lost in hole, and that's a fairly substantial factor in increasing the overall life of the inventory that we have in place there as well.

I would also say that this is going to provide I think more comparable results from Sperry versus the competition based on how we understand others are treating the depreciable policies.

But it actually reflects the actual life of the equipment as well. And we did fairly thorough analysis on that.

Now, the answer to the other question on price increases, we initiated the price increase on May the 1st. We've been out working with all of our customers. And though, as you'd expect, some are reluctant, we are actually getting the price increase through. I would say it reflects in Q2, no more than about 30% of what was possible to Q2 because we really just got the benefit in the month of June in the U.S.

And it also, you have to look at the mix between our long-term contracts and those immediate contracts where we're able to reflect that price increase. We do keep pricing indexes that would show though that we did get substantial improvement from it in June. And I think that our margins will reflect that as well as you go through and do your analysis.

Across the other product lines we're instituting the 5% increase and we also would have only gotten a small percentage of that in Q2, mainly in the month of June, and we are looking forward to pushing that price increase through here as we go into Q3, and evaluating the potential for future price increases as well.

Great. And Chris, did you indicate that the Sperry delta was 13 million, or 2 cents a share?

13 million. That's approximately 2 cents, yes.

Thank you very much.

And that will be an ongoing change, it's not a one-time event.

We'll go next to Jim Crandall with Lehman Brothers.

John, some of your recent contract awards particularly in Norway, are very impressive. How much better a technology company do you think Halliburton is perceived out there versus two years ago? And can you maybe touch on some of the reasons why that you're now winning some of these major contracts?

Well, I think we are the technology leader in many, many of the markets that we participate in and we're recognized as such and that's a big benefit to us. We have to continue focusing on service quality and I think our service quality is also perceived as leadership as well, so that plays a great deal in the award of the large contracts.

Confidence that you can deliver, confidence that your technology is going to provide optimum results with regard to production, and we're recognized for that. We have some real industry leading technologies. The Energy-Balanced Roller-Cone technology for security is a real industry leader that we believe we'll benefit from going forward.

Our Geo-Pilot tools as well are doing well for us and we're working with those tools. That was a new technology for the marketplace when it was introduced also.

Our production enhancement, I mean, just real strength there across the board, in both the technology we use as well as the process we use and we give great results with regard to well and production. So I think that's the principal reason we're winning.

Okay. John, and a follow-up question is, your major competitor said I guess last month, that 50% of their oil service revenues would be associated with integrated project management by the end of the decade. I guess, what's your view on how important this business will become for Halliburton, and what are you think are the relative strengths that would you bring to the table vis-a-vis them to capture a substantial part of that business?

Well, I understand that's part of their strategy but it's, I don't think you're going to see that become part of our strategy, for two reasons. First reason is that that really disenfranchises our major customer, our IOC customers with national oil companies and we're committed to our major customers and we're going to continue to work closely with them. And so we don't want to get in a situation where we're in conflict with our major customers. We really value their business.

Second one is that it really amounts to, in our opinion at this time, nothing more than volume discounting, and I'm not interested in a 5% margin business. And I would prefer to go in on a value basis bringing our products together and demonstrating our technology differentiation, our real strength in the change of the value proposition for the customer, than I would to pursue a 50% of our revenue at 5% as a result of volume discounting.

Okay. That's an interesting response. Thank you.

We'll go next to John Dowd with Sanford Bernstein.

I think we've got time for two more questions.

This one and one more.

Alright. I'll be quick in that case. You mentioned the wind down of the RIO 1 contract influencing margins going forward. Can you help us gauge the impact of that going forward by telling us what the revenues associated with the RIO 1 contract were in the second quarter?

John, we can't, but you can see the reduction in revenue there from the first to the second, and we don't expect a large change from the second to the third in revenue, although that's a little bit hard to judge, could be down a bit but not a lot, I think about as much of a feel as I can give you for that. Most of the change in the RIO contract volume was in the second to the first.

Okay. So that would suggest that most of the margin decline is actually behind us in that business segment?

Yes, and then the RIO 2 contract, we have a quite low margin that we're booking initially since most of our benefit there is going to be on the award fees.

Right.

And so that was very low in the second quarter. So to the extent that might pick up in the third quarter that would also be a downward pressure on margins from Iraq.

Okay. And can you, separately, can you discuss the wireline business in a little bit more detail? Why did profits there improve so substantially when revenues were basically in line with the average of the past year?

We have done a lot to modify the cost basis in every one of our businesses to become more efficient. We've consolidated equipment into better markets and taking it out of markets where we had high overhead associated with the revenue that we were bringing in and so they've done an excellent job in that division of focusing on better margin contracts and I think it's just really blocking and tackling that's improved logging. We're doing a fundamentally good job in running that business now, much better than we were doing two years ago.

Okay. So there was nothing sort of one-time in nature in the wireline results? If anything, we should expect that to improve going forward? From a profitability point of view?

Well, we always want to improve, but there's nothing about that that's one-time. We are affected occasionally from quarter-to-quarter with direct sales in that business, so you have to look at the direct sales component on a quarter-to-quarter basis and factor that out but the fundamental business is solid and doing well for us.

And our [inaudible] were down in the second quarter.

That's right.

Thanks, John.

We'll go next to Mark Earnest with Merrill Lynch.

Yes, good morning. I had a final question on Barracuda-Caratinga, maybe for Randy and Chris. If you're not able to finalize the April agreement what would that mean? Maybe you should discuss how far along you are on finalizing that agreement. But if you can't finalize it, what would be your exposure in terms of penalties?

That would be a judgment that we'd have to make at the time, Mark. On one hand we would have the matters that would be going to arbitration are very large claims that we would agree to settle in this proposed agreement coming back, but then we would have, on the other hand, exposure for additional LDs, potentially.

So, you know, both numbers could be big and it would be a judgment we'd have to make, but that's not our expectation or our plan at this point. We're working in a cooperative manner with Petrobras on our letter of intent and working with the financial institutions as well and Randy we're working towards an agreement there.

We want to thank you all for joining us. And we look forward to seeing you at our analyst and investor day on September 23rd here in Houston.

Thank you. Once again ladies and gentlemen, that concludes today's question-and-answer session and today's call. Thank you for your participation. You may disconnect at this time.