KBR Inc (KBR) 2007 Q2 法說會逐字稿

Good day, and welcome to the KBR 2007 Second Quarter Earnings Conference Call.

(OPERATOR INSTRUCTIONS)

For opening remarks and introductions, I'd like to turn the call over to Mr. Rob Kukla, Director of Investor Relations.

Please go ahead, sir.

Thank you, Bill. Good morning, and welcome to KBR's second quarter 2007 earnings conference call.

Today's call is also being webcast and a replay will be available on KBR's website for seven days. The press release announcing the second quarter results is also available on KBR's website.

We have tentatively scheduled our 2007 third quarter earnings conference call for Thursday, November 1, 2007.

Joining me today are Bill Utt, Chairman, President, and CEO, and Cedric Burgher, our CFO.

In today's call, Bill will provide opening remarks and business outlook. Cedric will address KBR's operating performance, financial position, backlog, and other financial items. We will welcome questions after we complete our prepared remarks.

Before turning the call over to Bill, I would like to remind our audience that today's comments may include forward-looking statements reflecting KBR's views about future events and their potential impact on performance.

These matters involve risks and uncertainties that could impact operations and financial results and cause our actual results to differ from forward-looking statements.

These risks are discussed in KBR's Form 10-K for the year ended December 31, 2006, the final prospectus for the exchange offer dated March 27th, 2007, Form 10-Q for the quarter ended June 30, 2007, and recent KBR current reports on Form 8-K. Now I'll turn the call over to Bill Utt.

Bill?

Thanks, Rob, and good morning, everyone.

In previous discussions, KBR has outlined a number of strategic initiatives. Over the past several months, KBR has made progress in its achievement of these initiatives, and I would like to start today's call by discussing a few of these developments.

The first KBR key initiative is improving our customer relationships. Since the split off, we have visited many of our customers, in some cases several times, to better understand their needs in today's environment.

We believe our positive sales results achieved in the second quarter and into the third quarter reflect KBR's progress towards developing better and closer customer relationships.

The next key initiative focuses on the improvement of our risk-return profile and developing best-in-class project risk awareness and management. This is demonstrated with the award of the Skikda LNG project and the contract conversion of the Escravos gas-to-liquids project.

With respect to the Skikda LNG project and in response to customer concerns about contractor risk premiums in today's environment, KBR took an innovative approach to deliver a contract structure that encompasses concepts from both the lump-sum and reimbursable contract structures, sometimes referred to as a hybrid contract.

This resulted in a more favorable risk allocation within the project and an overall lower price to the customer.

In terms of the Escravos gas-to-liquids project, as you may have read in this morning's earnings release and in our 8-K filling earlier this week, KBR, our joint venture partner and the customer have agreed to amend the contract to a reimbursable structure.

Also included in the terms of the contract are customer-determined performance incentives. This conversion has changed the risk profile for our backlog, which at the end of the second quarter was 71% reimbursable.

This conversion allows the contractor and the owner to become more closely aligned to execute this project in today's challenging environment in a more efficient, economical, and expeditious fashion, while permitting the construction of the new project in a more coordinated fashion with the owner's current onsite operations.

Another initiative that has been the keen focus of KBR over the last several quarters has been the redeployment of some of our business development resources to pursue opportunities across the broader hydrocarbon value chain within our E&C division and to continue to capture opportunities related to the increase in government outsourcing within our G&I division.

Towards the end of 2006, KBR had high expectations for project awards and subsequent backlog growth.

This repositioning is now showing positive results, as seen by the recent announcement of diversified projects, which include Skikda LNG, the Ras Tanura chemicals and plastics production complex, the Statoil gas treatment facility in Norway and LOGCAP IV.

These recent awards are what we had expected to realize late 2006 and in early 2007 and will contribute significantly to rebuilding KBR's backlog during the third quarter.

I am proud of the accomplishments by both our business development and operations teams and I'm optimistic that their ongoing efforts will continue to drive KBR performance in each of these key strategic areas.

With the recent awards, I would also like to take a moment and discuss KBR's human resource capacity, an issue that I know is on your mind. While we have increased our contracted backlog recently at KBR, we do not feel we are capacity constrained in our ability to take on new work.

The diversity of our recent awards, particularly with the Skikda and Ras Tanura projects, and when compared to the status of KBR's other large projects, require different skill sets due to the different project scope and scheduling of when resources are required at each stage of these projects.

As we are all aware, there is considerable pressure on skilled labor in the industry on the entire energy spectrum.

With KBR's current projects and prospects, we are confident that KBR has and will continue to have the people we need to further grow the business through careful resource allocation planning, ongoing hiring and retention programs and growth in responsibility of our high-value engineering centers.

We recently closed the sale of a non-core joint venture, DML, thus eliminating the significant time and attention requirements of this complicated joint venture that had on the KBR management team.

The sale of this entity is a logical transaction that coincides with KBR's overall corporate strategic and initiatives, which is to focus on and continue to grow our core service and technology-based businesses.

With this divestiture and our continued progress to reduce or eliminate our involvement in other very management-intensive joint ventures, KBR's management team will be afforded more time to concentrate on our hydrocarbon and government and infrastructure businesses, the main driver's of KBR's future growth.

Let me now discuss the charge we took on our embassy project in Macedonia. During the quarter, we identified additional increases in cost on this project, due to escalating material, labor, soft contractor and other costs, including schedule deals.

These cost increases are, in essence, largely attributable to the use of factored estimates, or estimates based on scaled-up estimates from other projects, as opposed to detailed estimates of the project at hand.

This practice had been utilized previously on some of KBR's smaller lump-sum projects. As a result of the embassy overruns, as well as a smaller overrun on another project, the practice of factoring estimates for any lump-sum project has been stopped.

Let me now turn to some highlights in our other segments. I would like to discuss some additional awards and achievements in the Energy & Chemicals division that were received during the second quarter.

We were awarded contracts to provide field construction and modular fabrication services by Shell Canada for the Scotford Upgrader expansion, which we are excited about, as it demonstrates our presence and capabilities within the North American fabrication and construction market.

In addition, we were awarded the program management contract for the FEED Phase of the Integrated Gas Development Project near Abu Dhabi. This win positions us for a potential role as project manager for the EPC tendering and execution phase.

Separately, with the amount of work we have executed in Nigeria, currently and over the years, we were pleased to announce that we have established an engineering presence in Lagos.

This will enable us to more fully support and focus on our Nigerian customers and further their commitment to meeting the country's goals for increased local content. These recent awards underscore the strong growth we are seeing in the oil and gas end markets.

Despite the high level of LNG construction and progress today, we feel the LNG market potential will remain healthy for several years.

Currently, the industry continues to experience some delay in project awards due to cost escalations and the risks inherent in doing lump-sum projects in today's environment.

With respect to risk allocation, we have been taking an innovative approach, as previously discussed, on structuring our contracts to better allocate project risks and required risk premiums through hybrid contracts.

We believe our customers are increasingly more receptive to this form of risk allocation and pricing to find the optimum way to move forward with their projects, as shown by the recent Skikda LNG award.

With this in mind, we continue to believe the prospects in the pipeline still make good sense for our customers.

With respect to refining and petrochemicals, we feel that these markets are very robust now and for the foreseeable future. Announced refining capacity additions will approach 22 million barrels per day by 2015.

Additionally, research has shown that over the next five years, there will need to be approximately 22 million tons of added ethylene capacity and 18 million tons of added propylene capacity to meet the additional demand.

With our strong global presence, good customer relationships, and a proven downstream technology portfolio, we feel KBR is well positioned to competitively bid these projects.

With regard to technology, we continue to invest in research development, as it is a key part of KBR's growth. We see a great opportunity in technology as a way to further grow the downstream business, particularly with income from licensing and potential pull-through of EPC work.

In 2007, we expect an approximate 50% increase in income from technology licensing relative to 2006. In the second quarter of 2007, we had 22 technology booked awards, which were evenly spread over our downstream technology portfolio.

We like the technology business, as the intellectual property assets in our technology portfolio are very leverageable and offer many synergies with KBR's human resource assets.

I will now discus the government and infrastructure segments, starting with an update on our LOGCAP work.

As we previously announced, KBR was chosen as one of the three contract providers for LOGCAP IV. Since the award of the LOGCAP IV contract, two actions have been brought at the GAO by unsuccessful bidders, protesting the contract awards.

Until the .protests have been resolved, the customer is unable to proceed with the transaction of the LOGCAP III contract to the LOGCAP IV contract.

However, we did receive a six-month extension of the LOGCAP III umbrella contract concerning performance anywhere in the world until December 2007.

Specifically for the Middle East, we have been notified by the government of the intent to extend Task Order 139, the Iraqi umbrella contract, from the original completion date of August 2007 to the end of February 2008.

I would like now to provide a highlight on our Allenby & Connaught project, which reached a significant milestone by completing the first phase of construction activity and handing over the first installment of new living and working accommodations for occupation by the United Kingdom's 2nd Royal Tank Regiment.

The accommodations include 452 single in-suite bed spaces, two mess facilities, two diners, workshops and storage. This handover marks a major in-service date for this project and was achieved on schedule and on budget.

With regard to the government services market, one area of Department of Defense spending that is expected to increase significantly is the military's construction budget, which is expected to nearly double in fiscal year 2008 to $21 billion, and is also forecasted to remain higher than past levels over the next five years.

This increase is largely driven by base closures and realignment, the increase in size of the military in the next five years and upgrades to existing military housing.

We are excited about this growth, as it provides KBR a great opportunity to diversify our government infrastructure business away from Iraq-related work, which is expected to decline in the coming years.

As we discussed in detail last quarter, for our Ventures segment, we will continue to monitor the equity landscape for potential investment opportunities that would involve the services of one of our other two divisions.

Now I would like to turn the call over to Cedric. Cedric?

Thanks, Bill. I will begin with reviewing KBR's consolidated second quarter results, which will primarily focus on year-over-year comparisons.

Consolidated KBR revenue for the second quarter of 2007 totaled $2.2 billion, which is relatively flat compared to the second quarter of 2006.

Consolidated operating income for the second quarter of 2007 was $65 million, compared to a loss of $47 million in the second quarter of 2006, which included a $148 million charge on the Escravos gas-to-liquids project.

In the second quarter of 2007, the operating income was largely driven by Iraq-related work, the ammonia plant project in Egypt, and Yanbu export refinery in Saudi Arabia.

The results of the second quarter of 2007 were partially offset by a $24 million charge related to the U.S. embassy project in Macedonia.

Also, the earnings contribution for DML has now moved to discontinued opportunities due to the completion of the sale in the second quarter.

Energy & Chemicals revenue for the second quarter of 2007 was $669 million, compared to $560 million for the second quarter of 2006.

Operating income in the second quarter of 2007 was $41 million, compared to a loss of $97 million in the prior quarter last year, which was impacted by the charges taken on the Escravos project.

Contributing nicely to the second quarter of 2007 were the Pearl gas liquids project, the Tangu and Yemen LNG projects, the EBIC ammonia project in Egypt, and the Yanbu refinery project in Saudi Arabia.

Now let's talk about the Government & Infrastructure division. Second quarter of 2007 revenue was $1.5 billion, which compares to $1.7 billion in revenue for the quarter ended June of 2006.

Operating income was $25 million in the second quarter of 2007, a $33 million decrease from the comparable period last year, primarily due to the $24 million charge on the Macedonia embassy project and the decrease in activity in Iraq-related work.

The Allenby & Connaught project made a positive impact to the second quarter 2007 operating income. With respect to the Ventures division, operating loss for the second quarter of 2007 was $1 million, compared to a loss of $8 million for the second quarter of 2006.

The second quarter of 2007 loss was partially offset by better-than-expected performance on our military housing and services venture with the MOD in the UK.

Now I'll discuss backlog. Total backlog at June 30 was $9.6 billion, which excludes the $3 billion from the Skikda LNG and Ras Tanura projects that were awarded in early July.

Overall, the backlog portfolio mix at the end of the second quarter has moved to 71% cost reimbursable, and 29% fixed price, as compared to 64% and 36% respectively in the prior quarter.

The conversion of the Escravos gas-to-liquids project to reimbursable and work off on the fixed-price contracts account for the large shift in backlog mix towards the lower-risk, reimbursable work.

The Energy & Chemical division's backlog as of June 30, 2007, was $4.8 billion, which was relatively flat compared to the previous quarter.

A decrease in backlog due to the work off in gas monetization was offset by the reclassification of the Escravos project and the award of an upgrader expansion project in Canada.

However, if we were to pro forma the backlog to include the Skikda and the Ras Tanura projects, the E&C backlog would have been $7.8 billion, up almost 40% compared to the December 31 E&C backlog figure.

The Government & Infrastructure division's backlog as of the second quarter of 2007 was $4.2 billion, a $1.1 billion decrease from the last quarter, primarily driven by significant work off on our LOGCAP III contract.

Ventures division's backlog as of June 30, 2007, was down slightly from the first quarter of 2007.

Now I'd like to discuss our liquidity and balance sheet.

At the end of June 2007, our balance sheet remains strong, with no debt and cash and cash equivalents of $2 billion, of which $771 million is cash associated principally with our consolidated joint ventures, which leaves approximately $1.3 billion available for general corporate use.

Total has balances increased by approximately $700 million during the quarter, which was primarily driven by the proceeds of the sale of DML, a reduction in our receivables and a milestone payment from one of our consolidated joint venture projects.

As we discussed on last quarter's call, we continue to review the alternatives for the potential strategic use of cash, which includes opportunistic acquisitions, increased technology development or investments, project equity investments and returning capital to our shareholders.

We are currently evaluating some potential acquisitions, which you all know require considerable amount of time and effort.

In tandem with these efforts, we also continue to analyze optimal ways to increase shareholder value through the deployment of our excess cash resources.

Now let's review other financial items.

General and administrative expenses included in operating income remained relatively flat, at approximately $30 million in the second quarter of 2007. We continued to expect our quarterly G&A costs to run at about this level for the back half of this year.

Our effective tax rate in the second quarter 2007 was 41%, as compared to a rate of 47% in the first quarter of 2007.

Our effective tax rate for 2007, the entire year, is expected to be 43%, which exceeds our U.S. statutory rate of 35%, primarily due to nondeductible losses on the Australian railroad and on the BRC impairment charge recorded in the first quarter of 2007.

As Bill mentioned earlier, we completed the sale of DML at the end of June. As outlined in the 10-Q we filed this morning, the proceeds, net of transaction costs, were $345 million.

After netting out the book value of the investment, this resulted in a gain on sale before income tax of $216 million, or $97 million, after tax.

The DML business has historically been accretive to our earnings and would have delivered approximately $22 million in operating income, or $0.04 per share after tax and minority interest in the second quarter.

Therefore, we are working hard to redeploy capital and increase profitability to overcome the dilution resulting from the sale.

As you know, we have provided historical DML revenue and operating income in our past public filings, including the 8-K that we filed on July 13th upon completion of the sale.

From a cash flow from operating activities perspective, DML contributed approximately $13 million for the six months ended June 30, 2007, and $59 million for the year ended December 31, 2006.

Also, capital expenditures related to DML were approximately $7 million and $9 million for the same periods, respectively.

While we have not historically and do not intend to give quarterly earnings guidance, we would like to provide you with a preliminary understanding of our outlook for 2008.

After removing the impact of the DML contribution to earnings and considering the positive impact of recent contract awards and amendments, we anticipate 2008 earnings to be in the range of $1.20 to $1.60 per share.

This is admittedly a broad range, which in part reflects some degree of uncertainty with respect to our government work in the Middle East. We will provide you an updated view at the end of the year, following the completion of our annual planning process.

Our working capital at the end of the second quarter was $1.3 billion, an increase of approximately $200 million over the prior quarter.

This sequential increase in working capital is mainly due to the proceeds from the sale of DML and the larger cash balance.

Our working capital continues to trend down for Iraq-related activities and was $217 million at the end of the second quarter, the lowest it has ever been.

This is primarily due to the successful implementation of our billing systems, which now allow us to turn our receivables on average in about 14 days.

Capital expenditures totaled $11 million and depreciation was $11 million during the second quarter of 2007.

For the six months ended June 30, 2007, and 2006, capital expenditures totaled $23 million and $42 million, respectively.

For the full year of 2007, we now expect capital expenditures to be approximately $69 million and depreciation to be approximately $38 million.

Our 2007 forecast for capital expenditures is reduced from our prior guidance due to the recent disposition of DML and the removal of its capital budget.

And now I'll turn it back over to Bill for his final remarks. Bill?

Thank you, Cedric. I am pleased with the progress that KBR has made towards our strategic initiatives that are driving KBR's culture, decisionmaking and work ethic.

Our customer relationships are growing stronger and the efforts of our business development group are being rewarded, as shown by the high-quality projects that are being added to backlog.

We have made significant inroads to becoming the best-in-class project risk awareness and management company, as evidenced by our backlog mix and contract structuring.

The outlook for the markets in which we participate is very healthy, and I believe it will continue to remain positive for several years.

As a Company, we have made decent headway since we started this journey in 2006. We still have a long way to go and a lot of hard work ahead of us.

But I am confident in the ability of our people to build upon the progress we have already made. And now we'll take your questions. Thank you.

Thank you, Mr. Utt. (OPERATOR INSTRUCTIONS)

And we'll take our first question from Jamie Cook, Credit Suisse.

Hi, good morning, and congratulations. I guess just my first question, can you guys talk a little -- you mentioned in your press release and your prepared remarks, the embassy project.

Can you just give us a little more color on that on how far along are we on that project and the potential for charges going forward?

Yes, Jamie. The embassy project is early in the field. We are completing the engineering services on that and expect to complete largely the procurement by the end of September. In terms of the charges that we've looked at, the project to date is 23% complete.

We have done a very thorough estimate again on that project, and, as you might recall, we did take a provision in the fourth quarter of 2006 on this project that we thought we had been able to look at the impact of the cost to complete the project, and obviously we had underestimated that.

And so when we went back and looked at it again this quarter, we made, certainly to my view, a much more detailed, a much more sober assessment of where we are and certainly had the full management team of the Company involved in looking at these estimates.

Right now, we still have a long way to go, but having factored into our estimates the productivities that we've seen in Macedonia and also the additional costs that we expect to incur because of the delay, we believe today that we have prudently put together a cost estimate to address perhaps a greater uncertainty than we envisioned in the fourth quarter, but believe we have gotten the full impact of that nonetheless.

And then my follow-up question, since the first quarter, you guys have made great progress on winning some nice new awards, the LNG project in Algeria.

We actually put a press release out on Ras Tanura. So, one, can you help us out with what Ras Tanura can mean for KBR, given that you won the project management?

And then secondly, I guess, as you look at some of the other projects that were delayed, one of them is gone, can you just sort of give us an update on that and potential timing of other projects that are in the pipeline?

Well, I think in Cedric's comments, he made a reference to the impact of (technical difficulty) and Ras Tanura of about $3 billion for us. We're not at liberty to comment specifically on Ras Tanura.

The project awards that we see, they continue to be delayed. We obviously have seen over the past years run-ups in raw material costs that we believe are -- we believe we're seeing some signs that the dramatic increases are leveling off.

We've also looked at the major equipment fabricators and have tried to look at where -- comparing their bid validities and pricing to us, and we feel that the backlogs for these fabricators is probably pretty strong through '07, but as you get into '08, we start seeing some capacity there.

Yes, and we're optimistic that the continued strong gas price market that we see, and I'm talking more about the calendar strips for '08 and '09, not necessarily the [prop] month, that it's still a good market and that a lot of these projects that have been delayed will start moving forward, as we saw with the Skikda project.

And so we're optimistic that we've seen some of the other projects that we've been involved in, additional trains being contemplated and feed work underway on these projects.

And while maybe they did not happen in 2007, as we might have originally anticipated, that we expect to see more progress in late '07 and early '08 with respect to their award, and we think we're positioned very well with some of these projects, having done the first series of trains, to be able to be very competitive on these next series of incremental additions.

But on Ras Tanura, I mean, did hear the prepared remarks that would imply a couple hundred millions, given you gave us the amount on the LNG project.

But I'm just trying to get a feel for -- can you talk about the other types of stuff, the other types of services you could provide on that project, without talking dollar amounts, I guess, if you feel uncomfortable there? I'm just trying to figure out where this project could go for KBR.

Well, I think if you go back and you look at the type of services that we're providing on our Pearl project, where we're the program manager for that project in Qatar, there are obviously a series of lump-sum projects that are being performed by third parties underneath our arrangement at Pearl, but there are also scopes for utilities, site work and things that kind of tie the various different components together.

With respect to Ras Tanura, it is too early to tell, quite honestly, as we're still in the process of getting mobilized and beginning to begin the planning work on this very large project, but clearly there will be technology packages, there will be service packages.

And whether we compete or are able to compete, because of our role as the PMC contractor, remains to be seen, but it could have an additional involvement for KBR, but I would certainly defer comment on that until we get a little further into the project, because right now we're really at the planning stages and it is a very complex project.

But, over time, I think we're very pleased with our role and certainly you become known in part by the Company you keep, and we're very pleased to be with Aramco and Dow on the Ras Tanura project.

All right, thanks. I'll get back in queue. And congratulations on Escravos.

Thank you.

And we'll take our next question from Barry Bannister, Stifel Nicolaus.

Hi, gentlemen, nice quarter.

Thank you.

When I think about the fact that you did the FEED on this nice Yanbu refinery project and you got some work on the FEED on Bonny train seven, any idea of when those might proceed to FID, particularly the Yanbu?

I don't know that there's any particular change in the schedule that had been talked about on Yanbu. Clearly, that project, we're performing a lot of engineering services surrounding the FEED and to my knowledge now, it remains on schedule.

With respect to Bonny Island, that's one we expect to see sliding into the early parts of 2008, just tighten the schedule that we're on and where the customer is in terms of his development and procurement process.

And in terms of the timing of the ramp of the earnings effect of Algeria LNG, is it linear through 2011, when you flip the switch, or is it front-end loaded or back end? How can you quantify that effect for us?

I think in terms of Skikda, it will have some element of an S-curve to it. Obviously we've got right now 40 people working o the project. It will certainly ramp up to several hundred over the 2008 and 2009 period. We're going to have a lot of construction management work when we get into the field.

And then, as you get into commissioning and startup, those people will ramp down and smaller commissioning teams will take over.

But it does portend to have a fairly normal S-curve for us in terms of the ramping up of our service components. Lighter in the early stages, kind of lighter in the back end and heavier during detailed engineering and construction.

And just housekeeping, what's your SG&A and COGS in the quarter, so we can do our models? And was there a balance sheet effect from the reclassification of Escravos?

No, there was no balance sheet effect on Escravos. There was a backlog effect of a few hundred million dollars.

On the SG&A, I think we gave you the $30 million for the quarter, and that's what we expect to occur quarterly for the rest of this year.

COGS?

Cost of goods sold? I'd have to -- we put the Q out --

We can follow-up, no problem.

It was $2.1 billion for the three months ended June 30.

Thanks.

Yes.

Our next question, from Dan Pickering, Pickering Energy.

Good morning. Could you help us with your bids outstanding in Energy & Chemicals? You've won several awards. There's always a big number of potential projects swirling out there.

What would kind of on a percentage increase or decrease or dollar increase or decrease, where would your bid stand to relative to a quarter ago, six months ago?

Dan, I would say in the near term we clearly have brought in Escravos -- excuse me, brought in Skikda, but that's a lump-sum project that we have 100% of, so that's clearly a larger project.

We still have several material projects that we're chasing. I'm not sure that we can really point to any specific numbers, but the prospect list continues to be very attractive.

We have a couple really competitive bids outstanding in the market that we could hear about in the next six weeks. And, beyond that, we still have a number of the larger projects that continue to float out there, principally on the LNG side.

Okay, that's helpful. And then, Bill, as we look at the fixed or lump-sum backlog, if you will, which I think is around $2.8 billion or so, still, how much of that would have been bid using this factoring process that you talked about on the embassy project?

If you're talking about the big lump-sum projects, Dan, none of it.

These are projects -- when you get factoring, these are projects that are generally less than $100 million-type efforts, where people look at what we have bid on previous projects, make at the time are educated guesses for how it might differ from a different scope, and we found that the mathematical imprecision from that base has become too large for us in today's environment.

And so we have dramatically scaled back the magnitude of any factoring that goes on in any estimate.

For instance, anchor bolts will typically factor, but when you aggregate the components of that, that's much smaller.

And so we're really bringing down by a large measure any degree of non [stiff] built estimating that would be part of any bid that we would be having.

But none of this was any part of the big projects and certainly, having seen this, we have instituted a new policy that makes it very clear that the factoring that gave us the very unfortunate results on the embassy and the other project are not going to occur in the future.

Yes, and I guess I understand the look-forward, you're not going to do it this way.

I guess I'm just trying to assess if there is any risk that there are some more embassy-type projects still in the backlog that have not yet been scrubbed and might result in future adjustments.

We don't see any, and certainly the projects, because they're smaller, they tend to go through sooner, more quickly, through the books.

And since we inputted our business development oversight capability in September of last year, I think we've done a good job of really scrubbing back the basis of estimates and the underlying risks there.

So we haven't seen any yet and we are on the lookout, because, as we all know, when you find one you want to make sure there aren't others lurking along with it, but we have not seen any to date in our estimates.

Okay, thank you.

And our next question comes from Brad Handler, Wachovia.

Thanks. Good morning, guys. Could you please speak a little bit to the gas monetization operating income in the quarter?

I guess I'm trying to reconcile a few moving pieces -- Escravos, you mentioned some positive contributions from Pearl and Tangu. And yet the total was $1 million.

So if you could just speak to some of the pieces there and their contribution, that would be helpful.

And some of it is -- in the Q, we tried to give you some disclosure related to the table that we produced.

What's kind of awkward is that table is not a segment, one thing that one thing we've discovered in this process is that our method of allocating overheads hit that segment harder, because it's revenue only and Escravos has a lot of revenue.

It's consolidated 50%-50%, a lot of revenue, but no margin. So it got a lot of disproportionate amount of G&A allocation, potentially.

But in the Q, we mentioned for example that that group earned $35 million of job income, the gas monetization, which includes Pearl.

It includes the big LNG projects that are going very well, Yemen and Tangu. And so it's been something we're looking at, but that's a little more granularity for you there.

Okay, that is helpful. Is it also a function to some degree of bidding costs, which has been appropriately allocated?

No, not really. Those are pretty even from our sales efforts, evenly allocated.

Okay, okay, fair enough. Let me switch gears please then and talk about LOGCAP.

I got your comments from your prepared remarks, but I was wondering, has their been any additional definition related to LOGCAP IV for the way that things might be divvied up in terms of task orders going out to bid?

No, we received nothing direct that's any different from what our understanding was before.

Certainly, the two parties who have protested the award have fundamentally stopped the progress of LOGCAP IV in its tracks, so LOGCAP III continues on its present course until such time as those protests have resolved.

At that point, we would expect that there would be packages that would be developed that would begin being bid within the LOGCAP IV contract.

And certainly the one thing that when we talk to the folks in the Pentagon about this transition, they're very mindful that they don't want to create gaps in the services by taking away something out of LOGCAP III that isn't directly covered in LOGCAP IV, because it is a very integrated, very complex integration between KBR and the Army at present.

Fair enough. Just a follow-up then on LOGCAP III, please. I don't know if this is the best way to ask it, but maybe this helps.

In terms of maybe when award reviews are coming down the pike, I'm just trying to get a handle on margins, thinking about the fact that you've approached 4% some quarters, 2.5% the last couple of quarters, how might we think about what's possible in terms of the earning bonuses in the second half of '07?

Well, I would say there we have several award fee boards that will be taking place in August on LOGCAP III in Iraq.

We have continued to accrue award fees based on our historical performance and don't expect to see material differences, plus or minus, around our accrual rate.

And we would expect to be able to maintain those accruals and that level of performance as long as LOGCAP III continues.

Just to add a little bit to that, Brad, some of the volatility you've seen historically in the margin there is more driven by some of the items that we have reserved, some of the disputed items, the container settlement, particularly, in the fourth quarter last year comes to mind. But that often will drive more volatility than the award fee boards.

Now, under LOGCAP IV, you should expect that the volatility could increase, because we won't be accruing for award fees. We'll only be booking them when they're actually awarded.

So we've had the successful resolution of a number of these disputed items, and that has the impact of increasing the margins, but also increasing margin volatility.

Okay, so just to make sure I've got it, and then I'll hop off, the 2.5% that we've seen reflects accruals, it reflects no reserves of any new concerns and perhaps that's a pretty good metric for us going forward again?

I think it's pretty close to a steady rate. We are very open about the 2% base fee and 0.8% award fee that we accrue, so it's around 2.8%, 2.9%. So 2.5% is a little bit low. It does reflect a little bit of additional accruals this quarter.

Okay, very good. Thank you very much.

We'll take our next question from Andy Kaplowitz at Lehman Brothers.

Good morning, guys. Bill, you talked about the strategic initiatives that you put in place in 2006?

Where do you think you are on the impact of these initiatives on the Company, maybe in terms of innings or in terms of progression? Are you still in the early going, or are you sort of in the middle? Where do you think you are?

I think we've made very good progress within the business development oversight within the Company. That clearly was one of the key areas of focus we looked at very early on.

And I would say that we're probably pretty mature today in our processes. I'd say, if you want to do a baseball analogy, we may be in the fifth or sixth inning on that.

I think there's a little bit of opportunity for us to refine our processes, but I think we've got 80% of what we wanted to achieve already taken care of in BDO.

And I'm very pleased with not only how that group has functioned and come together, but also how well our sales teams have responded to the higher standards that we've wanted to put in terms of our due diligence on new product evaluations.

The other areas that we've made good headway in, and I would say we might be in the third or fourth inning there, is certainly our EPCS business, where we have taken a single view of all of our labor pools in a way that allows us to rigorously monitor our overheads and chargeabilities and to do a great job of planning what reduction resource availabilities are for a number of different scenarios of new work that will come in.

And it is that capability that gives us the very good confidence to make the statements that we did related to our ability to execute the work we've sold, but also new work that we see on the horizon.

And then also the project management oversight and control group is doing a good job of continuing to find some of these issues earlier and let us start addressing some projects that my get off the tracks a little bit before they become bigger financial impacts that we have seen in our past.

So I think from a corporate standpoint, in terms of our oversight and governance, I'm very pleased with the maturity of that.

We're looking at today the various operations within the Company and today we have two divisions and we are undertaking some reviews of where are the markets for KBR in the future?

What do we need to effectively pursue those markets, maintain the customer relationships to sell the work, to execute the work.

And so we're going to look really hard at the spans of control that we're asking our people to undertake and that will be, I think, the early stages, were we can continue to drive a further organizational improvement within KBR.

Great. Shifting gears for a second, you talked about cash deployment and how you think about it. I guess what I'm wondering is timeframe.

The market's very strong, as you know, in oil and gas and petrochemicals, and so you have quite a bit of cash on your balance sheet. I know that you have to change your revolver, and that might take some time.

But when could investors see things like share repurchases? Any color there?

Well, we're thoroughly looking through a number of acquisition opportunities, which I alluded to earlier, which take some time. We think those would be attractive to our shareholders and so we're using that a little bit as the baseline.

But I'd say generally by the end of the year we should be through the process of making our assessments of how best to deploy the cash.

Okay, great, just a couple little nits. The Escravos contract, now that it's cost reimbursable, is it still essentially going to be zero margin flowing through?

Are we going to get some margin on that contract? Can you elaborate on incentives that you might be able to achieve on that contract?

Well, we believe there will be chance for us to recognize margin on that project. It's clearly going to be client determined, and so you have the issue of what will the incentives be measured against and then the subjective evaluation by the client.

I think it is the intent of the client that we would recognize incentives, because we are committing a lot of very talented people within both KBR, as well as [Stanford Getty's] organization to execute this contract.

But I think it's very difficult for us to really make any forward-looking comments as to what those incentives might be like. We did conclude that at the end of the second quarter and we're now beginning that transition and starting to develop and discuss and establish what those incentives might be.

But, over time, we will get incentives. How much I'd like to defer to maybe a later point to comment when we have some track record established.

Okay, great. One more quick thing on minority interest expense. It was a positive in the quarter, small positive. What is making up that line now that DML is out? How should (technical difficulty).

With DML out, that was obviously a big component, historically. Escravos moving to reimbursable is going to reduce the impact of that, and that was a big driver for the second quarter, as some of this puts and takes happen in reversal of losses and so on. So those are the two big ones.

And it's our expectation, especially -- the Skikda project we're doing 100%. So, as those kind of things occur, the impact of minority interest ought to decline.

So it should be relatively minimal going forward, you think?

Well, we still have a number of majority-consolidated positions that are out there, but they're much smaller in magnitude than those two.

I guess what I'm trying to figure utility is how much noise from the conversion of Escravos was in the quarter that resulted in a positive number there. Is there any way to --

I think we have it in the Q, don't we?

Well, we broke out, I'm trying to think -- it's about $15 million.

After tax, after minority.

The minority impact from Escravos was $15 million, pre-tax.

$15 million pre-tax and less than that after tax positive on minority interest income.

Correct, that is correct.

Okay, and that won't be repeated going forward.

No, because it's reimbursable now. Should be zero.

Thank you.

And we'll take our next question from Albert Kabili at Goldman Sachs.

Great, good morning, guys. A question on the G&I other margins. You got some pretty good sequential improvement there. Is that due to the Allenby & Connaught milestone completion? And could you give us a sense of, if it is, what the impact was there?

It wasn't directly for that event. It's overall portfolio across the portfolio, which certainly included a good quarter from Allenby & Connaught, but it wasn't just tied to that specific event, although that was helpful.

Okay, so were there any one-time accruals or anything in the G&I segment that hit in 2Q that we should be thinking about?

No, pretty clean.

Okay, great. And then I wanted to clarify, I think you gave an initial outlook of $1.20 to $1.60 in 2008 for EPS.

Right, that's right. And, obviously, we're no longer including DML. I'm not sure if the models have been updated, but we just wanted to be sure that point was made. But that excludes DML in '08, obviously.

Right -- does that -- how much in that number are you factoring in terms of additional award activity that hasn't been announced yet?

Can you give us a sense for that and then also a sense in kind of what drives the lower range and the upper end of that?

There's some level in there. I'd say it's fairly modest. It's larger on the G&I side because they have a quicker churn rate historically, just particularly in the Middle East work. They tend to be awarded with much shorter turn on the backlog.

Okay, and can you give us a sense in terms of what some of the drivers might be in terms of the low need of that range versus the high end and how much you'd be assuming in, for example, Iraq?

Yes, the biggest driver by far is the LOGCAP assumption. And obviously that's been declining, but it could decline much quicker. So there's a lot of we don't there. And it hasn't been awarded.

Additionally, moving to LOGCAP IV introduces the potential that we don't win as much work, or any work, potentially.

I also want to emphasize that we are early in our planning process for '08. We wanted to give some indication of what we were thinking, particularly what the absence of DML might do for '08, but we will update you at the end of the year once we've concluded our planning process and have a better visibility on our end.

Okay, and just to clarify, could you give us a sense for the LOGCAP assumptions that you might be using for the low end of that range and the high end?

I don't want to be too precise, but it's a pretty sharp decline, quarterly decline for an annual rate that's down quite a bit from '07.

Okay, and then final question is on the sequential margin improvement in E&C, if you'd back out the RC charge. How do we think about it?

Is this a sustainable trend going forward in terms of continued margin improvement and in the E&C segment? Is there contracts running off, one-time items we should be thinking about?

No, I think it was a very solid quarter within our E&C division and probably is -- for us, we're getting our chargeabilities managed appropriately and we see a very strong market in front of us, and particularly a lot of the smaller work that comes in and out of the shops that typically we do very well on from a margin perspective on that work.

So I don't think there's anything unusual that we can point to in the E&C performance that would cause it to be considered aberrational.

I would also add, the other E&C contributions were very broad, across a very broad number of projects, contributing. It wasn't one or two items, and so the portfolio looks pretty good.

Okay, terrific. Congrats and thanks, guys.

Thank you.

Time for one more call?

This will probably be our last question.

And that comes from Steven Fisher at UBS.

Good morning, and thanks for taking the call. It sounds like Yemen and Tangu are going pretty well. I wonder if you could just give a little more color there. What level of cost inflation are you seeing, how are you managing that?

What stage of completion are you on those projects, and then maybe any chance that you would be interested in changing those contracts to cost-plus, or could you even do so?

Well, both of those projects are fairly along in their cycle, and we're in the field executing and building these things. On Tangu, we're hanging pipes. So the opportunity to convert to reimbursable, it would be fairly difficult.

Specifically, Yemen's right now 56% complete and Tangu's 81% complete. So these are fairly late stage, but we're also very pleased with how they're performing. We bought all the equipment, we bought all the construction commodities. We're through engineering.

We are really at a point now where we'll be able to assess the design allowances on the Yemen project to see how do we compare in terms of our as realized from what we expected, and we had been, I think, somewhat conservative, as we always are, in these estimates.

But we very much like where we stand, and barring an unforeseen incident that could result in a material delay in the startup of these projects, we're very happy that they're in the portfolio as a lump-sum project.

And working very hard to get them up and running for our customers in the time that they can get their product to market sooner.

Okay. And then on the Macedonian Embassy, one of the reasons you cited there for the challenges is scheduled delays. What's causing the scheduled delays? Is it equipment availability?

There's a couple of pieces. This is Cedric. I was there a couple of weeks ago. It's been, I guess, a confluence of event that have worked against us. We changed subcontract -- we are subbing a lot of the work.

One of the major subcontractors we changed out in the fall of last year when we took the fourth quarter charge. And we were optimistic about the new subcontractor and the productivity and labor rates and so on, and unfortunately it has not gone well there either, hence this change.

Also, the design firm and some of the engineering work was having to be redone. And we think we're near completion there, but it's actually still not fully complete on that piece of it, either.

So that's caused a lot of changes in the schedule, as well as equipment and other material ordering, and so we've been behind in the procurement side as well.

So it's not really one thing, but we are optimistic that we are focused and back on tack and that we can improve our productivity and get the final materials bought out and finalize our designs and get this project due to completion.

It's schedule to be complete in April or so of next year, and we're going to work very hard to hit that.

Okay, and then, lastly, can you just remind me on the security cost disagreement you have with the Army. You have got a $400 million number in your filings for the last couple of quarters for possible suspension of cost.

Is that a cash -- is there any potential that could be a cash payment and you need to keep some of your cash balance reserved for that?

No, I think we commented previously. We have looked at it in terms of what our rights are under the contract to retain third-party security in certain situations. We've also had outside counsel look at that as well.

We believe that the Army is presently misinterpreting the contract, and therefore we feel that it will be unlikely that we would have any charges that require us to pay cash for the security issues on the LOGCAP III project.

I'd just say we've done a good bit more work going back to other subcontracts, and we found that the basis for getting to the $400 million number is an outlier, that if you look at the other work we've found, that you would come up with a number much, much smaller than that, even if you were to apply the withholds, which we think are incorrect in the first place.

But, if you were to apply them, using that incorrect thinking, you would still come up with a fraction of the $400 million number.

Is that -- I know that's a worst-case scenario, but is this cash that you've already paid to the subcontractors, or would you have to make some future payment?

Well, I think, again, in our view we've had the withhold of $19 million from us, which was their first look at it, and we think that's been incorrectly retained from us.

Obviously, if we are proven wrong and the opinions of our outside counsel are also proven to be wrong, that if there are additional withholds, it would require us to then either offset against future payments to these subcontractors or to go back to them for a recovery of these amounts that would be assessed against KBR.

Okay, I got it. Thanks a lot.

Thank you very much for joining us today. We look forward in November for our third quarter call. Thank you very much.

Thank you. That does conclude today's conference call. We do thank you for your participation. You may disconnect at this time.