哈里伯頓 (HAL) 2005 Q3 法說會逐字稿

Good day and welcome to today's Halliburton Company third quarter 2005 results conference call. This call is being recorded. At this time, for opening remarks and introductions I would like to turn the call over to the Vice President of Investor Relations, Ms. Evelyn Angelle. Please go ahead.

Good morning and welcome to Halliburton's third quarter 2005 earnings release conference call. Today's call is being webcast and a replay will be available on our website for seven days. Joining me today are Dave Lesar, Chairman, President, and CEO; Chris Gaut, Executive Vice President and CFO; and Andy Lane, Executive Vice President and COO. The press release announcing our third quarter results is available on our website at www.Halliburton.com. It estimates the impact the Gulf of Mexico hurricanes had on different parts of our business. Overall the hurricanes negatively impacted our third quarter net income by 5 points per diluted share.

We have tentatively scheduled our 2005 fourth quarter evenings release conference call, Friday, January 27, 2006, at 9:00 a.m. central standard time. In today's call, Dave will provide opening remarks. Chris will discuss our overall operating performance and financial results followed by Andy, covering strategy and our business outlook. We will welcome questions after we complete our prepared remarks.

Before turning the call over to 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 for the year ended December 31, 2004, Form 10-Q for the period ended June 30, 2005 and recent current reports on Forms 8-K. Now I will turn the call over to our CEO, Dave Lesar. Dave.

Thank you Evelyn and good morning everyone. I'm pleased to report another quarter of solid financial performance at Halliburton. Despite the Gulf of Mexico's pretax impact from the hurricanes of approximately $33 million, we achieved record consolidated operating income of $690 million. While the situation in the Gulf has claimed everyone's attention, in reality the hurricanes are only a small part of the news we will share with you this morning. First of all, regardless of what you may read in the papers, we did not do any work for FEMA. In fact, as of today, KBR's hurricane-related work is less than $200 million and is being done under the competitively bid CONCAP contract.

In the ESG, I'm happy to report that not only did we achieve record revenues in operating income, but we also posted an operating income margin of 21.8%. Part of this is attributable to the price increases we have implemented in the past. I also announced in September additional price increases beginning this month. These will range from 6 to 18% depending on the product line and Andy will give you more details on those in a moment.

We also continue to benefit from our strong focus on return on capital. This is being demonstrated by our fixed or exit strategy, where we are focusing our attention on our lowest performing areas in order to continue driving up our margins and returns by getting better terms from our customers or by exiting the market and taking that equipment to areas where we see higher returns. This has a short-term impact on a region's revenue and cost as we demobilize and remobilize that equipment, but I believe that it is in ESG's best interest in the long run and Andy will give you more details on that in a moment. At KBR, revenue is strong, margins have improved and we have landed some exciting new contracts, including new awards for LNG, and gas-to-liquid projects that are strengthening our backlog and portfolio.

This quarter also, as expected, we had successful resolution of some of our fuel issues under the Rio contracts. We have settled six of the ten task orders under review with no decrease in the amount of costs we will be reimbursed by the government. We have also monetized an investment we had in a toll road we constructed a number of years ago. Our only disappointment this quarter at KBR were some losses incurred in our E&C operations in Algeria. You will hear more about those in a moment.

I would also like to mention that we have and continue to make, strategic investments in the U.S. to take advantage of this strong market, just as we said we would. This has strengthened our returns and is helping us build for growth in the rest of the world. It now seems even the skeptics have changed their view of the continued strength of the North American market. Now, let's turn to Chris for the financial highlights and then Andy will come in with some more operational details.

Thanks, Dave and good morning. I will comment on the overall company and individual segment results. I will summarize the change in revenue and then operating income for each of our six segments and then discuss our liquidity and other financial matters. In my remarks, I will be comparing third quarter of 2005 results sequentially to the second quarter of 2005.

Halliburton Company revenue was $5.1 billion in Q3, essentially flat from the prior quarter. Energy service group revenue was up $126 million, or 5% sequentially with three of the four ESG divisions setting new revenue records. KBR revenue went down 7% sequentially primarily due to reduced activity on the competitively bid LogCAP contract in Iraq. On a consolidated basis, international revenue was 72% of the total. Halliburton achieved record operating income of $690 million for the third quarter. Overall, ESG operating income increased by $44 million reflecting a 70 basis point operating margin increase. This was driven by higher natural gas drilling activity and continued pricing strength for our services, particularly in North America, where the market continues to be exceptionally strong. KBR operating income increased 23% in the third quarter to $150 million, operating margins rose by 150 basis points to 6%, with the sale of an interest in the U.S. toll road contributing $85 million to operating income, partially offset by losses and project joint ventures in Algeria.

Now, I will highlight the ESG segment results. Beginning with production optimization, where revenues increased $61 million or 6% compared to the second quarter of 2005. Production enhancement led the segment with a 14% increase due to high demand in U.S. land for stimulation services and a strong rebound in Canada. Completion tools revenue decreased 10% due to effects of the hurricanes in the Gulf of Mexico, the large second quarter sales into Asia, and the completion of a large project in Mortania last quarter.

Production optimization operating income increased sequentially 7% or $18 million with a 40 basis point improvement in margins. In production enhancement, operating income grew 22% and margins continued to benefit from improved pricing and increased equipment utilization in the U.S. and Canada and lower cost due to a change in mix in Algeria. However, completion tools operating income decreased 26%, largely reflecting the negative impact of the hurricanes and lower sales for the quarter.

In the fluid systems segment, revenue increased $32 million or 5% over the second quarter of 2005. Cementing revenue increased 4% primarily driven by better pricing in the U.S., land, and strengthened activity in Canada. Third quarter results were negatively impacted by the hurricanes in the Gulf Coast, and decreased activity in Mexico. Baroid revenue increase by 5% reflecting activity and pricing increases in Western Africa and in the U.S. In addition, the rebound from the Canadian spring breakup contributed to Baroid revenue improvement. The hurricanes damaged or temporarily halted operations at several of our cementing and Baroid facilities in Louisiana many of which have already come back online.

Fluid systems operating income was up $4 million or 3% sequentially with continued margin strength. Cementing services operating income increased 3% and Baroid operating income increased 2% due to the same factors that drove revenue. Our drilling information evaluation segment had a revenue increase of $22 million or 4% sequentially of which 59% came from international operations. Sperry Drilling Services grew revenue by 7% due to a robust Canadian market and strong activity in the U.S., the Middle East, and the North Sea. Security DBS increased revenue 13%, driven primarily by Canada, the U.S. and the North Sea. The logging services revenue declined sequentially due to higher direct sales in Asia in the prior quarter. Partially offsetting this decline was increased activity in the U.S., and Latin America in logging.

Drilling information evaluation operating income increased $3 million or 2% over the second quarter. Sperry Drilling Services operating income increased 6%, mainly due to increased activity in Canada, the U.S., and the Middle East. Security DBS drill bits operating income increased 46%, driven by the strength in rig count in Canada, as well as increased activity in the U.S. and Europe/Africa. Logging operating income decreased 16% due to the decline in direct sales in Asia. Drilling information evaluation margins remained essentially flat from the prior quarter, despite the impact of the hurricanes which halted or delayed activity in operations and manufacturing facilities along the Gulf Coast. Digital and consulting solutions segment revenue was up 7% compared to the second quarter of 2005, primarily due to sales in North Africa. Digital and consulting solutions operating income increased $19 million or 119% compared to the second quarter of 2005. The second quarter included a $15 million charge for the integrated solutions projects in Mexico.

Now let's turn to the two KBR segments. Government and infrastructure revenue for the third quarter of 2005 was $1.9 billion, compared to 2 billion in the second quarter. The decrease resulted from lower activities and the LogCAP contract and at the DML shipyard in the UK. Government infrastructures operating income for the third quarter was $149 million, up $76 million or 104% over the second quarter. The increase is primarily the result of $85 million in operating income on the sale of our interest in the toll road we built in the '90s outside Washington, D.C. As part of our plans to develop various projects, we occasionally take an ownership interest in the constructed asset, such as a toll road or a railroad. Our strategy is to monetize that ownership interest once the operation matures and the asset increases in value and this is what happened in the case of this toll road.

This quarter, KBR revenue related to Iraq activities was $1.9 billion, operating income was $45 million resulting in an operating margin of 3.7%. We recognized $24 million in income related to the favorable settlement of various Iraq-related audit issues, particularly fuel. The second quarter included $29 million in Iraq-related award fees granted on definitized past quarters. Nonetheless our cumulative operating margin on the Iraq-related activities over the past two and a half years is less than 2% of revenue.

In the energy and chemical segment, revenue for the third quarter of 2005 was $614 million, compared to $653 million for the second quarter. Operating income for the third quarter of 2005 was $1 million versus $49 million in the second quarter. Operating income declined primarily as a result of a total of $70 million in losses on various projects in Algeria. Approximately $47 million related to charges we took on an unconsolidated Algerian joint venture. About half of this amount related to project losses and the other half was a write-down of our carrying value of the venture. Separately, from this joint venture we recognized 23 million in additional losses on a gas project in Algeria. Outside of Algeria, E&C continued to have very strong results with the commencement of the new LNG and GTL projects, continued good performance on reimbursable oil gas production facilities and the completion of our work scope on the Belanak FPSO project in Indonesia.

Now let's review other financial items. General corporate expenses were 26 million in the third quarter, compared to 37 million in the second quarter of 2005. The decrease was mainly due to reduced outside professional fees. Our effective tax rate this quarter was 20% which is lower than the 28% estimate we provided you last quarter. The reason for the decline is similar to what we have seen during the first and second quarters of this year, the improving profitability of our domestic operations is causing our estimates of U.S. taxable income for 2005 to increase. This allows us to use more of our tax losses and foreign tax credits than we previously estimated. Utilization of these tax benefits has a direct positive impact on our cash flow.

We are now estimating a 26% effective tax rate for 2005, compared to our estimate of 29% last quarter. We had to adjust our third quarter tax rate down to get to a 26% tax rate for the nine month results. And we expect a 26% rate about -- about a 26% rate for the fourth quarter. However, this may change as we now are in our budgeting and planning process for future years. If as a result of this process, our estimate of U.S. taxable income for future years increases significantly, we may record a large one-time favorable adjustment to our valuation allowance during the fourth quarter of 2005 which could result in a large reversal of income tax expense and a large positive income contribution. Essentially this would be recognized in the tax deductions for the asbestos settlement that we were not able to benefit previously.

In 2006, and thereafter, we continue to believe our effective tax rate will be back at our normal range of 36 to 38%. I would also like to point out that our diluted weighted average shares outstanding increased to 525 million shares this quarter. This caused additional dilution to our EPS of approximately $0.02. The dilution was attributable to the significant increase of our stock price in the third quarter, the impact this had on our convertible notes, and employee stock options in the diluted EPS calculation. Generally at this level, a $5 increase in our quarterly average stock price results in 1.6 million additional diluted shares. As you know we plan to adopt a new accounting standard on expensing employee stock options effective January 1, of 2006. We expect this will result in $0.02 of additional ongoing quarterly expense starting next year.

Now, let's turn to liquidity. Cash and marketable securities were $2.1 billion at September 30, which is an increase of approximately $550 million from June 30, 2005. Our debt-to-total capitalization ratio was 39% as of September 30, and last week we paid off the $300 million variable rate senior notes that matures this month. Our September 30, 2005 debt-to-total capitalization ratio would have been 37%, including this debt reduction in October.

We also had further improvement to our return on capital employed during Q3, which is now running at an annual rate of 25.3%, and that's a 260 basis point improvement from last quarter, and that includes 70 basis points related to income from the toll road sale. We calculate return on capital employed differently from some other companies as we do not deduct our significant cash balance from capital employed. During Q3 our capital spending increased to meet the higher level of activity due to our customers' increase in E&P spending, up about 25% versus the run rate in the first half. We expect our CapEx to be in its higher range of 180 to $200 million per quarter into next year. We are confident that we have planned for the appropriate level investment in 2006.

Before turning it over to Andy, I will give you an update about the separation of KBR, as we announced in January, we believe it is necessary for KBR to deliver solid operating performance for a number of quarters to build KBR's backlog and to reduce uncertainty around the various disputes and investigations under way in order to maximize KBR's value for our shareholders. We have made progress in these areas but no time line has been set for a separation of KBR. In pursuing the potential separation of KBR we will consider an initial public offering of KBR, as well as private transactions. Andy?

Thanks, Chris. Good morning, everyone. ESG turned in another record-setting quarter. Reflecting continued robust activity in the market. The management team we have in place at the ESG is doing an excellent job in capitalizing on the current opportunities. Our employees are working very hard and we continue to add direct resources to meet the improved demand. If you look at the first nine months of 2005, compared to this same period in 2004, we've had top line growth of over $1.4 billion, or 24%, and we've improved the operating income by over $700 million. Our September ESG year-to-date margins were 22%. We are proud of our management and our dedicated hard-working employees who delivered these great results.

I will talk about each region in a moment but first I wanted to describe how the hurricanes in the Gulf of Mexico prevented us from having an even greater quarter. Halliburton was relatively fortunate, nevertheless, we sustained heavy damages to both our Baroid and cementing Louisiana facilities in Cameron, Bennett and Intercoastal City. We have shifted our activity to other facilities while those are being repaired and we are now ready to continue operations at the pre hurricane levels. As you know, some our customers' platforms and rigs were damaged or lost and it will take them a while to reestablish pre hurricane activity levels. We do expect customers to resume the activities that were curtailed by the storms throughout the end of the year, and into the first half of 2006. Our Gulf of Mexico activity is about 70% of pre hurricane levels. Meanwhile, we have deployed a number of our Gulf of Mexico personnel to higher utilization areas until activity levels resume. The third quarter ESG hurricane impact of $0.04 per share is based on a mix of lower operational activity and temporary declines in manufacturing productivities.

Looking forward to the fourth quarter of 2005, we expect a similar financial impact as seen in the third quarter. Primarily due to lower operational activities, and the number of offshore rigs that are out of service. I would like to thank all of our employees on the Gulf Coast for helping us secure our facilities, ensure the safety of our workers, and return our business to normal operations. I also appreciate our employees worldwide who very generously helped take care of people who were displaced by the storms, by contributing to a Halliburton matching assistance fund.

A positive contributor to this quarter's performance was improved pricing. Since May of 2004, we have had three U.S. price book increases ranging from 8 to 15%. We have announced an additional price increase effective October 15, in three divisions. The increases are as follows: Production optimization 15%, in fluid systems, 10 to 18%, and in drilling and formation evaluation, 6 to 15%. Our price increase in digital and consulting solutions will become effective January 1, 2006 and will be 5 to 9%.

Beyond the U.S., we continue to improve our prices. We are pushing for and have been successful with increases in new and existing contracts through direct negotiations and tendered opportunities. We believe additional pricing opportunities exist in every region. Over the last six quarters, on average, our revenues have grown 8% per quarter in North America, and 5% per quarter in the rest of the world. In North America, revenues increased 12% and operating income increased 20%. We continue to focus on pricing improvements, disciplined capital deployment, control of operating costs, and efficient use of our existing capital base while maintaining our leadership position in the U.S. land.

This substantial improvement in our productivity reflects improved pricing and better utilization of our equipment. For example, our revenue for U.S. crack crew has grown 65% in the last six quarters. These efforts mitigated the effects of the Gulf of Mexico. Canada experienced strong growth sequentially as activity levels improved from weather-related slowdowns in the second quarter. In Latin America, margins improved in Mexico, where we improved our operational performance on our integrated drilling projects for Pemex. We are encouraged that recent performance gains will be carried through the remainder of the project which we expect to conclude in April of 2006.

We continue to focus on improved results in certain areas of Latin America to meet our performance expectations. In our Middle East and Asia region, revenue was down 5% and operating income was down 12%. Partly as a result of lower direct sales to certain countries, and the deployment of resources to growing markets. In the third quarter, we mobilized additional service equipment and personnel to meet the overall rig and E&P investment we are experiencing in the Middle East. We are well positioned to capitalize on this opportunity. We expect to see improved results in this area in 2006, led by Saudi Arabia, Oman, and Malaysia.

In our Europe/Africa CIS region, revenues were up 4% and operating income was down 4%. We saw improved profitability in the rapidly growing Russia and Caspian markets. This demonstrates our commitment to growing in these markets while maximizing our return on investments. Activity picked up in Northern Africa where our revenues were up as we broaden our customer base. West Africa is another growth area in the deep water market and our well dynamics joint venture won several intelligent well contracts in Angola, expanding our strong position in completions in West Africa. We continue efforts to meet local content goals in Nigeria, which should help to improve our margins there. We are also focused on our fix it or exit strategy for improving financial performance in operations throughout Europe and Africa. In the North Sea, profitabilities declined because of product mix and rig scheduling. So overall for ESG in the third quarter I'm very pleased with our results, again. For the fourth quarter, notwithstanding the seasonal impact and the continued effects of the Gulf of Mexico, we remain positive.

Now, let's turn to KBR. Looking at the first nine months, revenue is down $1.5 billion, or 16%, primarily due to the completion of the Rio contract and the ramp down of LogCAP work in Iraq. As well as the completion of certain E&C products. The KBR operating income for the same nine-month period has increased by over $700 million, a significant improvement. But we still have work to do. We continue to focus on profitability, the quality of backlogs, and resolving outstanding issues regarding government contracts, and investigations. KBR's total backlog at the end of September was 14.3 billion. With our G&I -- within our G&I segment we expect the volume of work on the LogCAP 3 contract to continue to decline into 2006. As our customer scales back the amount of services that KBR provides.

We are pleased with our progress we have made in resolving over $1 billion in issues related to fuel services under the Rio contract. We have favorably settled the majority of the task orders affected by this issue and have forecast orders still under negotiation of which three are fuel related. Fuel was our second major dispute to resolve. As you will remember, we settled (indiscernible) facilities in the second quarter. The G&I backlog at the end of the quarter was $3.6 billion in firm orders, an additional $3.9 billion in government orders are firm, but are not yet funded or the letters of intent or contracts have been awarded but not yet signed.

In E&C, we've had significant gas monetization wins this quarter. A major contract award was from Yemen LNG Company Limited for the first LNG plant in Yemen. Another important new contract is for a payout of lump sum turnkey price for an LNG facility to be located in Peru. This grass roots facility will be Latin America's first LNG export plant. And finally we were awarded the project management work for Qatar Shell GTL Limited Pearl project in Qatar. It will be the largest gas to liquids plant in the world. This is our second major GTL project win in 2005 and positions us well in this emerging market.

Our E&C backlog at the end of the third quarter was 6.8 billion. Approximately half of this is from our industry leading gas monetization projects. We are actively pursuing 11 new LNG liquefaction plants for 2006 and 2007 awards. We are disappointed in Algerian losses in E&C. To address these issues we will be more selective about what kind of work we take on in Algeria in the future. For example some of the losses the unconsolidated venture has experienced are related to infrastructure projects such as hospitals and government buildings. So we don't plan to participate in those type of projects in Algeria in the future. The second major loss was with a gas plant that will be completed in May of 2006. This is a plant where we have filed a major site relocation claim and it's currently going through arbitration.

In conclusion, let me say a few words about our industry outlook and the roles I think ESG and KBR will play. This quarter the hurricanes in the Gulf of Mexico had a dramatic impact on activities, and among other things focused attention on America's shortage of refining capacity. During the quarter, we began discussing the first significant refinery expansion in the U.S. in the last 20 years. If and when refineries are built, KBR will be in good position to compete for this business. Similarly if more LNG regasification terminals are to be built in the U.S, KBR is the engineering industry leader in the designing these terminals, we'll be well positioned in that market as well. KBR is involved in nearly all aspects of the LNG value chain from onshore and offshore gas production facilities to liquefaction plants and regasification terminals. We are optimistic about KBR's continued growth and success in future gas developments, LNG and GTL projects.

For the ESG none of the events of this quarter have changed our positive view of the future. Oil and gas prices will fluctuate but all the evidence indicates higher E&P spending by our customers around the world through next year. Therefore the demand for our energy services will continue to be robust, particularly those services that reduce drilling time and increase production rates. We believe E&C spending will remain strong due to increased demand for energy. The positive industry outlook will not cause us to change our strategy of cost containment, capital discipline, and a focus on profits. Now, I will turn the call back over to Dave Lesar for a closing comment. Dave?

Thank you, Andy. You can see we remain very bullish and optimistic about where the industry is, and the future in terms of customer spending. Our company has obviously endured a lot of challenges in the past year, including resolving asbestos, getting the election behind us, and our learning experience on Barricuda. But that's behind us now. Today we're going about our daily business of focusing on higher profits and returns for our shareholders. And we are moving forward with quarter after quarter of financial improvements. I think that the management team feels good to get back to some semblance of life being normal. Now we'll take your questions. We ask you to limit to one question, and one follow-up per caller. Thank you.

Thank you. [OPERATOR INSTRUCTIONS] And we'll take our first question from Jim Crandell with Lehman Brothers.

Good morning. A question for Andy. Andy, in the international oil service operations, your revenues in the Middle East and Asia were down in quarter to quarter and they were up only nominally in Europe/Africa, and in both areas margins were below the levels of the last quarter. Can you comment in more detail on the reasons for this?

Sure, Jim, good morning. Before we get to that question, let me clarify one of the numbers that I spoke about earlier. On the government and infrastructure segment, revenues for the third quarter of 2005 G&I revenue for Q3 was $1.9 billion of which 1.2 billion was associated with Iraq. Now, Jim, on your question regarding ESG, in the Middle East and Asia, yes, revenues were down about $20 million Q2 to Q3. Some of the factors there, we had lower direct sales, principally for logging tools in China and India. We had a completion of a project in Bangladesh, and of another project in the Timor Sea, Bangladesh, DFE, and a lot of Timor Sea and production optimization. So that was the reason for a lot of the change there in operating income. I'm sorry, the change there in revenue.

In Europe, revenue was up -- operating income in Europe was affected by lower completions activity in the UK. And Norway, we had some lower activity with Sperry, and some increased maintenance costs just for the quarter. But Russia activity was up in Europe. So those are some of the reasons why we had the revenue change, in Middle East and Asia, although Europe/Africa revenue was up, while the operating income was not up proportionally. Andy?

Yes, Jim, just to add a little bit to what Chris covered, what you are seeing is a combination in the third quarter of some of the underperforming countries where -- where you are taking the choices that if we can't get pricing up and improvement, we are exiting. So there is short-term costs associated with that. But we believe that strongly is going to position us for the future and we're going to put our resources where we can get the right pricing in today's market. So there's an offset there. The North Sea was weak compared to activity level that we have expected from both the UK 8 sector and the Norway sector. But there is some good price spots in Northern Africa and Nigeria improved. Saudi was strong. And we are making investment also in places like Saudi and like Caspian and like Russia where we are mobilizing additional capital equipment, we moved several logging trucks into Saudi so there's an incremental increase in direct costs while we gear up these operations for the activity that's coming and you see some of that in the third quarter also.

Okay. And my follow-up is that, Andy, the price increases are pretty high in many areas. How long would you expect the timetable to be that you can realize the entirety of the price increases?

Jim, we looked at these real closely and we feel like at our cost increases that we are getting from our supply chain, and the activity -- the overall activity level and the cost of different divisions we have, that this is appropriate level for the market. We think this will work for the next six months and that's been our review and we'll review it at mid 2006 again. But we believe these are the right prices given our position in the market.

Excuse me?

Our next question comes from James Wicklund with Banc of America.

Jamie, do we have an open mic?

Mr. Wicklund?

Yes.

Your line is open. Please go ahead.

Okay. It was the other people I was listening to. A little bit more on this, if I could, following up on Jim. I understand the lower direct sales of logging tools in India and China and ending a project in the Timor Sea but are there any other big projects that are going to end in this quarter? I mean, with the size of the Company, aren't projects starting and ending on a regular basis? I mean when you talk about -- I understand mix, but broadening the customer base in North Africa, doesn't have a good sound to it? When do we quit gearing up and when do we start seeing flat out operations?

Well, of course, Jim, as you know, our operating activities in the third quarter here are substantially higher than they were in the Middle East and Asia through the first quarter of this year. So the activity is up substantially from the run rates that it had prior to the second quarter. What we're talking about is trying -- the question was -- Comparing third quarter to the second quarter. There's no question we are operating at a much higher level than we were previously. Now, some of the areas where we are seeing increases in revenue in Asia would certainly include Saudi Arabia, other parts of the Persian Gulf, such as UAE, Kuwait. So yes, many areas are increasing and -- but I think the -- when you cut through it, we are -- our activity levels, our revenues and our income levels are at a much better and higher level than they were, earlier through Q1 of this year.

So the trend line is at a steeper slope but the second quarter was a little above that trend line and the third quarter was a little below that trend line?

Well, Jim as I mentioned, we did -- I'm not sure what the question is. But the levels of activity in the Middle East and Asia is significantly higher than it was -- previously. The reasons for the change versus the second quarter we just mentioned when we'd go through those again.

Okay. My follow-up question, you, Andy talked about pricing improvements. On an international basis, can you talk about how long it will take some pricing improvements generally internationally for us to be seeing, with the idea of when will it start to show a boost to the operating margins?

Well, we handle every project and every bid individually, and it takes -- the contracts internationally are more the two to three years time frame. So it's going to take us awhile into 2006 to still push prices that were back from some of our previous contracts. So we continue to move those. We are -- if we can't get the prices up, we will move the equipment. So it's going to be into 2006 for some of the international locations. But I do want to add a comment about your North Africa question. The primary ramp up there is with Libya. We see Libya as the third tier of the North Africa. We see it as strong as Algeria and Egypt in the future. And we are going to invest in Libya over the next couple of quarters to ramp up activity like logging in there where we haven't had it -- the business.

Okay, gentlemen. Thank you.

Our next question comes from James Stone with UBS.

Yes, could you just talk a little bit about KBR and what -- as you look at the backlog on the energy and the chemical side, can you give us a sense of what is left in there that might surprise us like Algeria did this quarter? I mean, as you scrub your project backlog, is there anything that you are worried about going into the fourth quarter or going into 2006 that we ought to be on the lookout for?

Okay. If you look at the KBR backlog, most of last year, and we spent time cleaning up the offshore backlog from some of the legacy projects where we had fixed price in a lump sum offshore work. That's largely behind us with Barricuda-Caratinga 98% complete now and we are going through the final acceptance test there from the lenders. So that, along with the Belanak and several other offshore projects we really feel we put those behind us towards the end of last year. This is a legacy gas project we have from a bid back in '99, early 2000 and it has been a troubled project for us. And we are working our way through it. We have taken a cost in the third quarter of 23 million related to the gas plant that we believe is the cost that we need to finish the project through May.

And we have a -- so we're working through each of those and we feel very good about the backlog. It's much more heavily weighted towards reimbursable and LNG and GTL projects. We have a new ammonia plant project that's not in the backlog in Egypt that will close shortly. So we feel -- we feel very good about the backlog, and we are disappointed about the losses in the third quarter in Algeria, but it was very much isolated to Algeria. The rest of the projects we have that we have been talking about for a couple of quarters performed very well.

Jim, I would also note though, it's the nature of E&C business that you don't have always a direct matchup in terms of timing of when you recognize costs and when you recognize revenue. When we recognize that cost have increased, of course we accrue that, and if the project is not a profitable one, we look through to the end of the project and recognize all the potential losses on that. Sometimes we make claims against our customer for those increase in costs. But we can't recognize the revenue until we satisfy some very specific criteria in terms of the probability of collections and so forth. So for instance, on Algeria on the joint venture and these infrastructure projects, a number of those are actually reimbursable projects. And our local partner, managing partner, he believes, personally, that the joint venture will collect on those reimbursable contracts, the cost overruns there. Until, if and when, we become satisfied of the probability of collection, we can't recognize that additional revenue and therefore we book the cost but not the revenue.

Okay.

So there is that nature of E&C business.

Okay. And then just as a somewhat related follow-up, related to KBR, can you just update us on the status of the FCPA investigation and of the four remaining task orders to be negotiated, particularly the three fuel ones, are those three fuel ones related to the Kuwaiti fuel shipments, the stuff that was -- really preoccupied the press last year or are those the ones then among the ones that were settled?

The first question regarding the investigation on the FCPA matter that investigation is ongoing. We are cooperating with the investigation. And since it is a matter under investigation, what we would suggest on that is we'll point you to the disclosure we have had and we'll provide any updates in our SEC disclosure in our 10-Q.

And then on the fuel issue this goes back to the Rio contract, $2.1 billion, $2.2 billion, $1.4 billion was related to fuel and primarily that is the fuel issue that you spoke of, the shipments from Kuwait, we have resolved the majority of that over 1 billion of the 1.4 in fuel. So that's largely behind us and we are just negotiating the remaining few past quarters that were separate that had some other activities also with them.

Our next question comes from Terry Darling with Goldman Sachs.

Thanks, good morning, everyone. Can you hear me okay, Chris.

Yes.

I'm wondering if on the Gulf hurricane impact, Chris, you can share with us, even in approximate terms what the revenue impact was? Trying to dial back into how the sequential incremental margins in your North America geomarkets stacked up there? And to what extent? We're seeing the impact of earlier price increases versus, still waiting for that to come through.

Yes, on the revenue side for ESG, just under $50 million in revenue there against the 28 in operating income impact, on the KBR side, those were essentially costs that we incurred that we couldn't bill. So no revenue but we did incur the costs.

Okay. And so let's translate in there that your sequential incrementals might have been down a little bit but still at very high, very positive levels. Just in terms of thinking, about you know--.

Yes, I think the sequential incrementals would have been up. But, yes, go ahead.

It looks like 47.5 versus 55. But we can debate that offline. I guess where I'm really trying to go is to what extent are we really seeing the impact of the price realizations? Do we expect to see incremental margins moving higher as we progress into 2006, based on the new round of increases? Can you help us understand the fight that you are waging against raw material cost inflation, particularly in the fluids and the cementing business? Where we'd see that headed.

Yes, we are seeing cost increases, annual run rate on materials costs in the upper single digits, personnel side, I don't think we would argue too much with the 10% range overall on labor costs. Andy, maybe you can address discussion of customers.

Yes, so on the pricing side, Terry, we see we will -- this will carry us into 2006, to get them, through, We saw a 2 to 3% in pump and services this quarter, in pricing improvements, and it's a constant battle, like Chris said, managing the cost increases from our suppliers, keeping up with the personnel demands and increased costs there, and then getting the price increases through on our contracts.

Andy, did that 2 to 3% sequential improvement reflect the totality of the May 1, price increase or are we still going to see some people rolling onto that higher May price book as we go into Q4?

You will see some roll onto the May price increase as their other contracts come out and we'll certainly try to move them to the October 15, price increase as fast as possible. But that was the totality of all the previous price increases, the impact in the third quarter.

Our next question comes from Michael Lamotte with JP Morgan.

Thank you. Andy, I want to -- I don't mean to make too much of this export sale issue but I was going through the second quarter transcript, and the sales to China was described as 5 million and I calculate a 27 million in logging alone. Were there other countries that had big exports? I mean I know just about every quarter there is going to be something in there. But Q2 just was unusually large and it seemed like there were, I guess, a lot of different countries that piled in there.

Yes. The earnings impact, the operating income impact last quarter of the sales there was about $5 million. And we -- in addition to that had sales into India.

In India, Vietnam, and China, Michael, and so we saw a drop sequentially in the third quarter from the second quarter, of around 11 million revenue and around 4 million profit from the drop-off of the direct sales.

Okay.

But those three countries primarily.

Okay. And then can you -- can you perhaps, quantify some of the cost absorption issues in terms of, maybe what that hurt you in margin, in ECA as well as MEA? I mean, is that 100 basis points?

Well, it's a bigger impact in Europe and Africa, that's where we are concentrating more than the Middle East and Asia as part of the fix it or exit strategy. And so it's -- I don't want to quote a number across the whole region but it did have an impact in the quarter, and -- but primarily in Europe and Africa region.

Okay. And is it fair to assume that assets moving out of that region are moving into the Middle East?

Yes.

Okay. Great. That's it for me. Thanks.

Geoff Kieburtz with Citigroup has our next question.

A question for Andy. Can you give us a sense of sort of what percentage of the ESG business is being looked at with a fix or exit sort of analysis?

Yes, we review this every month in our performance reviews and it's really signaling the bottom 5, the bottom 10% of the performing countries by product lines that we are looking at either improving or getting out of, but it's -- that magnitude, the biggest geographic area is Central Africa, and we've made a lot of progress, though. I want to give credit for this, this is one of the big areas of improvement, when you look year-on-year over the nine months, we have either renegotiated contracts or exited countries where we're not getting fair returns and so it is very successful for us, and we're just going to continue down this path, and the issues are it takes a couple of quarters to see the full results of that, that we have short-term costs and improvement initiatives but then you are going to see the gain once the equipment is remobilized and deployed and on new contracts. So it's the right strategy, and we'll have a stronger operation and we'll take out the bottom 10% performing operations that don't improve.

Is this a continue continuous improvement type of process, where you are always going to be attacking the bottom 10%, or is there a point at which you say, we've now fixed or exited everything and we're now going forward with what we've got?

It's a continuous improvement and it is the way we want to run things and in a tight market with assets as valuable as they are and a shortage of personnel that we have, we are going to continue to look at our bottom 10% performing and underperforming areas, and improve them.

Scott Gill with Simmons & Co. has our next question.

I guess this is for you, Andy. Looking at the energy and chemical component of KBR, if we were to add back the $70 million of losses associated with Algeria, that would indicate kind of 11 to 12% operating margins at the energy and chemical section. I guess my first question is, am I looking at that correctly? And if you could give some color as to why those margins would look so high? And then my follow-up would be, help us to kind of reset our models here for the fourth quarter in '06 with respect to margins for that part of your KBR business as you get rid of these legacy contracts.

Yes, Scott, the -- the performance in the E&C away from Algeria as we mentioned in the prepared remarks was quite good in the third quarter, led by the LNG projects, as well as the oil and gas production facilities projects we do on a reimbursement basis now. And it -- our performance is always reflective of the mix of the projects that we have. And our guidance is that we look for the E&C business to perform at at least a 5% margin is our target there, 5% or better operating margin, away from Algeria, it was quite good. Once you include Algeria and look to the whole thing, obviously we underperformed significantly the target in the quarter.

Chris, were there any one-time benefits in the quarter, through some of these other contracts that made that number look so good absent Algeria?

The only one that was kind of a cleanup was the conclusion as we completed our work scope on the Belanak project which was in the $7 million range.

Dan Pickering, with Pickering Energy Partners has the next question.

Chris, you mentioned some ownership stakes and the toll road being won. Is this the same toll road that last year, as you did your cleanup I think you had written down 11 million on a toll road project last year, is it the same one? And then how many other ownership stakes do you have and where are you in terms of that monetization process?

It's Andy. It was not the project we took a loss on last year in the cleanup. That was the U.K highway project.

Okay.

There's two of them. We have some equity in Irish highways, UK highways and also the railroad in Australia.

So there are a number of these and -- you know, it's -- when they get to a certain point of maturity, as this one has, then we look to harvest them. So don't have any heat up for the near term, but as they reach the right level, and somebody hits our bid we'll take the gain. We'll take what, one more question, Evelyn.

Yes, one more.

And our final question will come from Ken Sill with Credit Suisse First Boston.

Yes, good morning. And I hope Dave is right that this is an ordinary business environment going forward. My last question is landmark -- I mean, not landmark, I guess digital and consulting solutions. You had the 15 million recovery in margins but this was a great quarter from a margin basis. Is there anything unusual in there and do you expect to be able to sustain these kind of 20% gross margins going forward or maybe even improve them given the price increase projected for January?

Yes, let me take that one. Landmarks, this was a record third quarter for the business. As you know, historically our best quarter and it will be this year again is the fourth quarter. So we expect a big quarter out of landmark coming up. It was a very strong quarter. We grew the service base in the U.S. We had good software sales outside the U.S. It was -- we have also our project management business, which performed much better. We did not have any losses in Mexico in this segment, in the DTS segment and also the small equity we have in oil and gas that falls in that segment also performed very well in the quarter. So all that together was good news in that division and we expect even better things from landmark next quarter.

And Schlumberger had mentioned they might see a little bit of -- not quite as good a fourth quarter because the E&C companies are preoccupied with the recovery in the Gulf of Mexico. Do you guys see any slowdown or slippage into Q1 maybe of revenues at landmark?

No, we see a very strong fourth quarter. We do not see it impacted by the Gulf of Mexico. Okay. Thank you very much.

Thank you, everyone, for calling. I realize we didn't have time to get to everyone who's been waiting to ask a question. Feel free to call me here in the office today and we'll take care of your questions. Thanks, again, everyone. This concludes our call this morning.

That does conclude today's conference call. We thank you for your participation and have a nice day.