KBR Inc (KBR) 2007 Q3 法說會逐字稿

Good day and welcome to the 2007 third quarter earnings conference call hosted by KBR. This call is being recorded. As a reminder, your lines will be in a listen-only mode for the duration of the call. There will be a question and answer session immediately following prepared remarks. You will receive instructions at that time. For opening remarks and introductions I would like to turn the call over to Mr. Rob Kukla, Director of Investor Relations. Please go ahead sir.

Thank you Sherry. Good morning and welcome to the KBR third quarter 2007 earnings conference call. Today's call is being webcast and a replay will be available on KBR's website for seven days. The press release announcing the third quarter results is available on KBR's website. We have tentatively scheduled our 2007 fourth quarter earnings conference call for Tuesday, February 26, 2008.

Joining me today are Bill Utt, Chairman, President and Chief Executive Officer and Cedric Burgher, Senior Vice President and Chief Financial Officer. 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 our forward-looking statements. These risks are discussed in KBR's Form 10K for the year ended December 31, 2006, the final prospectus for the exchange offer dated March 27, 2007, KBR's quarterly reports on Forms 10Q and 10Q-A, and KBR's current reports on Form 8K. Now I'll turn the call over to Bill Utt. Bill?

Thanks Rob and good morning everyone. Shortly after I became CEO in early 2006, KBR made changes at the corporate level with the creation of the business development oversight group, the project management oversight and controls group and the EPC services organization.

Over the past year we took a long look at the market opportunities available to KBR, our customer relationships and our efficiency of project execution at the divisional levels, and decided to restructure the business into six business units; downstream, government and infrastructure, services, technology, upstream and ventures.

Our new KBR organization now based on six discrete reporting units creates better transparency of our operations, and increases the focus by our management teams on their markets, customer relationships and on their projects. This improved transparency and focus will provide our customers with an improved KBR experience in the form of better performance by KBR on our project and services offerings. This new structure will also provide increased transparency into KBR's businesses both financially and operationally to external stakeholders, investors and analysts.

We intend to begin reporting based on these new segments in the near future. So with this new organization in place I believe KBR will be far better positioned for a very strong level of future growth and improved financial performance by delivering a more focused management approach to our employees, customers and market segments.

In the third quarter of 2007, we completed the sale of our Algerian based joint venture, Brown & Root-Condor. As demonstrated by KBR's recent success in acquiring the Skikda LNG project, we determined it was no longer critical to maintain a joint venture ownership position in this Algerian based engineering firm.

The disposition of this non-core asset is a continuation of KBR's strategy to focus on and grow our core service and technology based businesses. And we are pleased to have sold this venture to our other shareholder of BRC. In our call last quarter I talked extensively about the redeployment of some of our business development resources and the positive impact this had on our pursuit and capture of opportunities.

During the third quarter of 2007 our business development efforts continued to successfully deliver new awards with the Skikda LNG and Ras Tanura projects. Both of which I spoke in great depth about last call. However, there was several other key and strategic wins for KBR.

Let me start with the Orlando Gasification Project in Orlando Florida. On September 10, along with Southern Company, The Orlando Utilities Commission and the U.S. Department of Energy, KBR broke ground to begin construction of an advanced 285 megawatt integrated coal gasification combined cycle facility. This facility incorporates KBR and Southern Company's jointly developed transport reactor integrated gasification or TRIG technology, and is part of the U.S. Clean Coal Power Initiative.

Through the TRIG technology the facility will turn coal into synthetic gas for generation electricity in a standard combined cycle power plant, while producing 20% to 25% less carbon dioxide emissions than current pulverized coal plants and significantly reducing emissions of sulfur dioxide, nitrogen oxides and mercury.

We are pleased to be able to permit such a facility in an environmentally sensitive area of Florida. We are extremely proud to be a partner in this project, with the commercial operation of the facility expected for June 2010. KBR believes the successful construction and operation of this project is critical to the commercialization of our coal gasification technology. While we remain extremely optimistic regarding the long-term prospects for KBR as a co-owner of this technology, as required under the U.S. Clean Coal Power Initiative, our feed and EPC work to date has been performed at cost.

KBR will also perform any future work related to this project similarly on an at-cost basis. KBR believes that short-term investments in our goal gasification technology is crucial to move this technology from the pilot plant to full commercialization scale up. Also from a strategic perspective we are also excited about the feed support work on the West Mediterranean Concession Deepwater Development project in Egypt, and the Ozona feasibility contract with Marathon, because they exhibit KBR's capabilities in the offshore markets.

As KBR looks to expand its offshore opportunity set, this type of work enables KBR to leverage its legacy engineering capabilities and expertise to provide customers with solutions with respect to field development, sub sea and semi-submersible applications. Now let me turn to some operational highlights for our service segments and updates to KBR's end markets.

With respect to our upstream business unit, the market direction and outlook for capital projects continues to remain healthy for the next several years. Although projects continue to experience some award delays. Our LNG projects continue to make good progress on all fronts and the Pearl GTL project was a significant contributor to this quarter's results.

I am pleased to say that work on the Skikda LNG project is ramping up according to plan and had a modest positive impact on the quarter. As this project continues to ramp up, we expect it to make more meaningful contributions to our future quarterly results. From a potential projects perspective we still believe a possible announcement on the NLNG Train 7 project in Bonny Island, Nigeria will be forthcoming in the early part of 2008.

Also, the Gorgon LNG project in Australia overcame some environmental hurdles this quarter to receive its final permits and the clients are in the midst of final economic and feasibility studies of this project prior to committing to a final investment decision.

For our downstream business unit, market indicators continue to show long-term strength in the refining and petrochemicals markets. Because of tight capacity and high utilization rates, continued investments will need to be made in refining with expected expansions of existing refineries primarily in the U.S. and Asia-Pacific, and expected new build work mainly occurring in the Middle East, China and India.

The addition of the Ras Tanura project to this quarter's backlog reinforces KBR's capabilities in this end market. KBR's EBIC ammonia project in Egypt and the Yanbu' export refinery project in Saudi Arabia also continue to make good progress, and were strong contributors to the third quarter results.

The new services business unit is a group that has an excellent legacy reputation in this markets. I am very optimistic about leveraging the KBR brand and our legacy expertise as KBR seeks to grow these businesses back to historical levels. KBR services has also been tasked with studying KBR's possible re-entry into offshore fabrication, supporting our current efforts in the upstream business unit.

With thoughtful review and careful analysis, we will investigate how KBR can take advantage of our legacy fabrication roots to create synergies with some of our existing engineering and construction activities. Currently KBR provides maintenance operations on about 30 refining, petrochemical, pulp and paper and other industrial facilities.

Over the past several months KBR has been successful in renewing these existing contract, particularly in the Gulf Coast region, as well as expanding our service offerings we are providing under these contracts.

In construction, KBR continues to see opportunities in our Canadian operations, in particular in the oil sands market. Leveraging our fabrication operations in Canada allows us to capture these broader construction and fabrication opportunities. In the U.S. the strong domestic construction market affords opportunities that can have significant impact to KBR. This quarter KBR won a contract from [Bisell] to install a new extruder, piping and other equipment.

KBR currently provides the maintenance services at this facility and this contract again demonstrates KBR ability to expand the scope of services it provides to its customers from the foundation of the O&M business. Currently there are several larger construction projects being actively pursued by KBR and we hope to be able to announce several awards in the upcoming months.

For government and infrastructure business unit the protests surrounding the LOGCAP IV award are still ongoing. At this time we don't know when the transition from LOGCAP III to LOGCAP IV will occur. In the meantime we will continue to provide on an exclusive basis, great quality services under the extensions of the LOGCAP III and Task Order 139 contracts.

Also related to our work under LOGCAP III, we were disappointed with the most recent award fee scores from July 2007 which fell from an excellent rating to a very good rating. Currently there are new teams in place for our customer and we are working hard to resolve any customer concerns and bring the award fee scores back up to historical levels. During the almost five year period, we have worked under the LOGCAP III contract. We have been awarded 72 excellent ratings out of 89 total ratings.

During the third quarter of 2007 the G&I division was awarded approximately $100 million in new work outside of LOGCAP III and Iraq related activities. This additional work primarily consists of several task orders to provide engineering, design, construction management and technical support to the U.S. Air Force under an existing contract.

Other projects contributing to the backlog were repair and maintenance work on existing military bases in the U.S., a program management contract for improvements to an airport in Arizona and a mining construction project in Australia. A periodic review and adjustment to the forecast five year revenue stream for our Allenby & Connaught project also contributed an additional $100 million to backlog during the third quarter.

For technology, KBR continues to make great progress in the commercial implementation of our superflex technology. This first of a kind technology takes lower grade refined products and upgrades them into ethylene and propylene. This month our superflex unit for [Sassal] in South Africa achieved startup and within three days of fee stock entering the system, the ethylene and propylene products were on spec and the unit is operating as planned.

Earned income from technology for the third quarter on a variety of projects, including refining, petrochemicals, and fertilizers was 30% greater than the second quarter of this year. Also during the quarter KBR was awarded a licensing fee for an ammonia plan in Latin America. Now I will turn the call over to Cedric. Cedric?

Thanks Bill. I'll begin with reviewing KBR's consolidated third quarter results, which primarily focus on year over year comparisons. Consolidated KBR revenue for the third quarter of 2007 totaled $2.2 billion, which is relatively flat compared to the third quarter of 2006.

Consolidated operating income was $102 million in the third quarter of 2007, compared to income of $66 million in the third quarter of 2006. Operating income in the third quarter of 2007 included positive contributions from certain gas modernization projects and from our rock related work. In addition, we recognized an $18 million pre-tax gain on the sale of our interest in the Brown & Root-Condor BRC joint venture in Algeria.

Operating income during the third quarter of 2006 included a $32 million impairment charge related to our equity investment in the Alice Springs to Darwin railroad project in Australia. Energy and chemicals revenue for the third quarter of 2007 was $613 million, compared to 602 million for the third quarter of 2006.

Operating income in the third quarter of '07 was $46 million, flat compared to the prior year third quarter. Contributing positively to our third quarter of 2007 results were the EBIC ammonia project in Egypt, the Pearl Gas Liquids project in Qatar, the Yanbu' export refinery in Saudi Arabia and our large LNG projects.

In the supplemental information given in today's press release, the ENC gas modernization operating loss for the third quarter of 2007 was $13 million. The job income for this segment was $22 million, which was offset by a $35 million divisional and general and administrative expense allocation. Since the allocation is based on revenue, the overhead allocation was heavily weighted towards gas modernization.

Remember that the Escravos gas to liquids project in Nigeria is a significant revenue contributor as it is a consolidated 50%-50% joint venture, and it has very little operating income impact. Now let's talk about the government infrastructure division. Third quarter of 2007 revenue was $1.6 billion, which compares to $1.7 billion in revenue for the quarter ended September 2006.

Operating income was $59 million in the third quarter of '07, a $4 million increase from the comparable period last year. During the third quarter of 2007 operating income was positively impacted by the Allenby & Connaught project, Iraq related activities, and work on the CENTCOM project.

Because of the award fee scorers that Bill previously mentioned, the award fee accrual dropped from 84% to 80% during the third quarter of 2007. This accrual adjustment had a $3 million adverse impact on operating income. With respect to the ventures division, operating loss for the third quarter of 2007 was $3 million, compared to a loss of $35 million for the third quarter of 2006.

The third quarter of 2006 was impacted by a $32 million impairment charge related to our equity investment in the ASD railroad project in Australia. Now I will discuss backlog. Total backlog at September 30, 2007 was $12 billion, compared to $9.6 billion at June 30, 2007. Overall the backlog portfolio mix at the end of the third quarter was 71% cost reimbursable and 29% fixed price, the same mix as the prior quarter.

The backlog mix was primarily influenced by work off from large cost reimbursable projects and the addition of the Skikda LNG project, which has components of both fixed price and cost reimbursable terms. The energy and chemicals division's backlog as of September 30, 2007 was $7.4 billion, up $2.7 billion or 56% compared to the previous quarter. The increase in backlog was due to the addition of $3 billion for the Skikda LNG and the Ross Tanura projects which was partially offset by work off in gas modernization.

The government and infrastructure division's backlog as of the end of the third quarter 2007 was $3.9 billion, a $300 million decrease from last quarter, primarily driven by work off from Iraq related activities. The venture division's backlog as of September 30, 2007 was up slightly from the second quarter of 2007.

Now let's review other financial items. General and administrative expenses for the third quarter of 2007 were up slightly at approximately $32 million, which included $4 million for acquisition related activities, as compared to $2 million in the second quarter of 2007.

During the third quarter of 2007 we recorded an $11 million net currency loss, compared to a second quarter loss of $2 million. This quarter's pre-tax loss, which totals $8 million net of minority interests, is primarily related to the weakening dollar and unusual volatility encountered during the quarter.

The third quarter of 2007 cost of services included a $4 million accrual for assessment and remediation costs associated with an industrial site at our Clinton Drive facility in Houston. Due to the nature of operations previously conducted at this site, we are aware that some contamination may have occurred. However, more analysis at the site, including timing and techniques used to implement remediation are required which could result in an additional $7 million for all identified environmental matters on eight of our properties.

Our effective tax rate in the third quarter of 2007 was 32%, as compared to a rate of 41% in the second quarter of 2007. The decrease in the third quarter of 2007 related primarily to agreements reached on foreign tax credits in the U.K. for an Algerian project and benefits associated from an IRS refund from completed audits on long-term construction projects from 2000 to 2002.

Our effective tax rate for 2007 is now expected to be 39%, which exceeds our statutory rate of 35% primarily due to not receiving a benefit for non-deductible operating losses from our railroad investment in Australia and adjustments for prior year taxes in various tax jurisdictions.

Now I'd like to discuss our liquidity and balance sheet. At the end of September 2007 our balance sheet remains strong with no debt and cash and cash equivalents of $1.8 billion, of which $651 million is cash associated with our consolidated joint ventures, which leaves approximately $1.1 billion available for general corporate use.

Total cash balances decreased by approximately $200 million during the quarter, which was driven primarily by a tax payment related to the second quarter gain on the sale of DML and a $147 million increase in Iraq working capital. Also during the third quarter of 2007 a $113 million prepayment related to the Skikda LNG project was received, partially offsetting the decrease.

Our working capital at the end of the third quarter was $1.4 billion, an increase of approximately $100 million over the prior quarter. This sequential increase in working capital is mainly due to the Iraq related increase in working capital, which increased to $364 million. This increase is due to the timing of cash receipts.

Capital expenditures totaled $9 million and depreciation was $6 million during the third quarter of 2007. For the nine months ended September 30, 2007 and 2006, capital expenditures totaled $32 million and $50 million respectively.

KBR did file a Form 10Q amendment for the second quarter of 2007 today to correct a classification error on the statement of cash flows. Certain amounts, primarily related to the sale of (technical difficulty) were incorrectly classified as foreign exchange movements, rather than an effect on cash flow provided from operating activities. This error had no impact to the income statement, balance sheet or total cash and cash equivalence at the end of the period.

We determined that this issue constituted a material weakness in the monitoring of the preparation of our statement of cash flow for the six month ended June 30, 2007. However, controls were revised and operated effectively during the preparation of our third quarter financial statements such that we and our auditors believe this material weakness has now been remediated. And now I'll turn it back over to Bill for his final remarks.

Thanks Cedric. There are a number of positives that occurred during the quarter that exemplifies the continued progress KBR has made as a company this year. Our backlog continues to strengthen with solid quality projects being added. Overall, backlog was up 25% over last quarter, with ANC backlog up 56%.

We had some strategic awards in the quarter which allow us to build upon our capabilities in the upstream markets with onshore and offshore development scales and our sub sea expertise. From an emerging markets perspective the coal gasification project in Florida is a prime example of how KBR technology will enable us to capture expanded future services opportunities.

While we continue to make tangible progress at KBR in a number of fronts, over the near term KBR will continue to work through several legacy issues that remain a drag on our operating performance. As the conversion of the Escravos project at the end of the second quarter removed a significant risk in our portfolio. We continue to execute this project at cost.

Looking forward, KBR anticipates it may begin earning some nominal project incentives beginning in the third quarter of 2008. Also, KBR continues to execute the Skopje Embassy project in Macedonia within the provisions established in the second quarter.

Over time, these non contributing projects as well as our strategic investment in our coal gasification technology will be replaced by more profitable projects and this will have a positive impact on KBR's operating margins. Although there is much work to be done within the organization, I'm pleased with how the restructuring of our operational divisions is progressing to allow us greater focus on our customers and the projects we execute on their behalf.

I believe this new organization as well as the continuing improvements in KBR project execution over time will position us for growth and benefit our employees and shareholders. Now we'll take your questions. We ask that you please limit your comments to one question and one follow up. Thank you.

Thank you. (OPERATOR INSTRUCTIONS). We'll take our first question from John Rogers.

Morning.

Good morning.

Bill, you mentioned Bonny Island and the Australian LNG projects as possibilities out in 2008, and I was wondering if you could talk a little bit about other bidding opportunities particularly that you see coming up over the next couple of quarters or a year?

Well we are also looking at other projects beyond Bonny Island and the Gorgon Project. Currently there's a couple of projects where we are presently providing services in [Tangu] and [Darmonyeto] are also examining what are the opportunities for expansion.

And certainly as the incumbent of these very successful projects we feel we're well positioned for future work. There are also some other projects that have been - earlier discussions in the Southeast Asia market, Australia markets, that we're interested in. We're trying to position ourselves in the, you know, some studies and some pre feed work for those, but we're optimistic that over time those projects could move forward and we believe our position will be competitive across those projects as well.

Okay. And in terms of Gorgon and Bonny Island, I mean, are they comparable to the Algerian in scope, in total size?

No. They're not. The Algerian project while it's four and a half million tons per year is clearly, it also has a big fractionation plant there. And so you've got a lot of liquids coming off that plant. You know, the Bonny Island is project is, you know, if you look at train seven and the possibility that they would go to a train eight.

You know, these are very large trains. Certainly much larger than what we're looking at on Skikda. I think they're seven and a half million tons each. The - obviously the Gorgon project could be as many as three trains, and the final sizing is being determined. So, you know, these look to be more standard LNG plants with maybe a little bit less liquids than you see at the Skikda plant.

Okay. Thank you.

We'll take our next question from Barry Bannister.

Just a clean up on what the prior analyst had asked. What you were talking about much larger trains at Bonny seven and on Gorgon in cumulative amounts. So even though there's less liquids these are much larger in million ton per anum, are they not?

Well, that's correct. In aggregate they are.

Okay. What are you seeing in terms of the pricing environment for work? Is it increasing the same or in terms of competition, particularly with competition out of Asia for some of the gas modernization that's coming down the pike right now?

Well if we -- I'm interpreting your question to go towards competition as opposed to a supply chain cost volatility, so I'll try to focus on the first a little bit more.

The projects that, particularly train seven, if you just looked at the size of those projects and the possibility of doing two trains and even some of the earlier announcements, the capital costs of these projects over the last two or three years have grown at a much faster rate than the balance sheets within the industry.

And so as we have on trains one through trains six on Bonny Island, we are pursuing this with our consortium of three other parties that allows us to share risks more efficiently and better manage the balance sheet commitments. And so by putting the consortium together, we have created an environment where we have a much more stable project execution.

We also on the project on Australia are in a partnership there with JGC, and again it's driven by risk sharing. We also look at the business and I think there is some segmentation going on regarding technologies that are being offered by certain of our competitors. And on some plants that exclusive technology play may preclude them from participating.

Also others are more focused on EPCM projects as opposed to EPC. And so you're seeing it at a second level of segmentation of the competition, and clearly KBR continues to remain interested in doing EPC work. And with the controls that we put on our business with our business development oversight process, that we think we're going to do a much better job in terms of continuing to do a best in class risk awareness and identification of risk and pricing of risks.

So yes, I think the market is becoming a little more competitive but again as we look out at the market there sure are a lot of projects being talked about, and it doesn't appear to be that we will be suffering from lack of work with respect to LNG over time. Now clearly we have to get some of these awards going forward for us to be able to get the phenomenon of several projects moving forward.

But certainly the fundamentals of the market appear to drive a continuing increase in gas demand on a global basis. Very quickly on the supply chain side, we see continued price increases. They do not appear to be as volatile as they had been over the last two or three years. Certainly as we look at these prices and the volatility surrounding these prices it is impacting our commercial offerings to our clients.

And certainly as we saw with the Skikda project, where we thought it was where our client determined that it was less costly for them to take that risk than for KBR to underwrite that risk. We're seeing that move through the industry a little bit more thoughtful fashion because of all of our collective experiences on volatilities.

Okay. And then the run rate on gas modernization revenues, Cedric, do you have any idea when we could perhaps get back above 300 in terms of Skikda ramping up? How much Escravos was in the quarter as well?

Clearly the Skikda is continuing to build. Some of the things going on in gas mod for the quarter, of course you look at that supplemental table we give you in our MDA as well as the earnings release. There's some movements there both in revenue and op inc. I'll try to explain for you.

Certainly we allocate overhead based on revenue and as I mentioned Escravos as a 50%-50% project gets twice the revenue versus our share at basically no margins. So that's a big driver for revenue as well as lower job income or lower margins, if you will.

We also had train six in Nigeria nearing completion, which produced lower revenue and lower operating income this quarter versus last quarter. That would be probably the biggest driver. There were a lot of other little movements. You know, some completed work on very small studies and jobs in the gas mod area that we hope will lead to more work in the future. But at this point was less of a benefit this quarter versus last quarter.

I think as we look forward we still see increasing staff that we're putting onto the Pearl project. That will have a positive impact on revenue. Skikda is going to ramp up. Tangu we're pretty much into the field right now on that, so the revenues we have will continue through '08 as we finish the construction of that project.

Yemen is in its transition into the field. We still have some engineering that we're wrapping up or the late stages of the engineering, but that's moving to the field. EBIC ammonia is pretty much in the field right now. So the big drivers I think on our revenue base are clearly going to be Skikda, because we'll be running through a lot of the costs through our PNL. But also the - it will have an added benefit on Pearl.

Thank you.

Once again, it is star one if you would like to ask a question. We'll take our next question from Andy Kaplowitz.

Good morning guys. Could you talk a little bit more about refinery in petrochemical work that you could get ahead. I mean, there are some big projects out there possible. So maybe anymore color you could give us in that area would be helpful.

Yes. I would say, Andy, that we continue to have a lot of people invested in the feed work for the Yanbu' refinery project. And I'm confident that that will continue in the next year, and as that project gets sanctioned we think in the late first half of next year we could see that project ramp up for us in terms of additional revenues.

The Ras Tanura project is ramping up for us. We're going be still in the early innings of the feed phase there, but that project is going to have eventually a lot of work coming out of it. And we hope - we are optimistic that we could continue as the project management contractor and also get some awards related to the integration of the services, much like we're doing on the very large Pearl project.

We do see a lot of activity in the Middle East that we are positioning ourselves for that will come to tender in the '08 timeframe. And we like what we're seeing there in terms of opportunity sets and the volume of opportunities. We're even looking at some projects that we have been involved with for several years in Africa that appear to be moving forward to, you know, from a feed phase and into an EPC phase.

And we're optimistic that, you know, what we see just in the Middle East and Africa is very strong. We've continued to deliver some other work within the U.S. and see that market expanding a little bit more as they deal with some expansions as well as a little bit of technological obsolescence of the plants.

Even with the recent disclosures by the Alberta government in Canada related to the tax regime there, we think a lot of -- and our discussions with our customers, they have already factored a lot of that into their plans. And we still see it today's prices with this new oil regime, a continuing opportunity for us to build that type of business in Canada.

And we just see it a very strong business overall. And we think we'll be able to continue to make announcements and receive material awards that will have a very positive effect on our income statements in 2008 and beyond.

Great. That's helpful. Cedric, the minority interest expense line bounces around a bit. It was a little bit more negative than I thought in the quarter. I'm just trying to figure out what it is? Is it Escravos? Is it something else?

Which expense line, the G&A or --

Minority interest.

Yes. I'm sorry. Yes. I think a piece of that was the FX loss that was on the 50%-50% Escravos project that was coming back. So that's a piece. That was about $3 million.

If you take that out, that negative $10 million, is that a good run rate to use going forward? Or is there, you know, I thought that is a little less than that in each quarter.

Well, you know, one of the big pieces there would be as we look forward is MWKL, our 55% venture with JGC which has been experiencing an increase in work activity quarter over quarter for some time now. And we would hope that would continue. So you could see that minority interest - all things being equal, that would drive an increase in future minority interests.

Okay. Understand. Thank you.

We'll move now to Al Kabili.

Hi. Good morning guys.

Good morning.

Just wanted to clarify on the gas modernization business and the operating income. So we've got some profitable projects in Yemen and you've got zero margin Escravos, are you saying then that with the profitable projects and the zero margin Escravos that once you apply overhead to all that you're -- that brings you down to negative?

Yes. And we give you, in the queue, a footnote that gives you exactly what the job income was. It's $22 million for the quarter. So you can see the overhead amount, and it does that.

But the phenomenon on Escravos is because it is a high revenue project as it's consolidated, it attracts a lot of corporate overhead. So if you were to pull Escravos out of that segment line, you'd see a much better result because Escravos comes in negative. It's 40%, 45% of our Q3 revenue.

A couple of other pieces. Just if you look a little more granularly quarter to quarter, second quarter to this quarter. Last quarter you recall we had $3 million benefit through the conversion of Escravos that we didn't experience this quarter. That was a one time conversion experience, $3 million.

We also had a few other pieces. I mentioned the Nigeria train six is nearly completion, and so it was a much bigger contributor last quarter versus this quarter. We had slightly lower work on Pearl this quarter. We don't think - as Bill mentioned, we are putting more people on that job. So that should turn.

And then there were some other pieces. There was one other project closeout which was a negative $2 million comparison to last quarter. So it was a number of puts and takes, but you can see exactly what the overhead line is if you look at the footnote in the queue. This quarter as well as last quarter.

Yes. And I guess, can Skikda ramp up fast enough near term to reverse this loss in gas modernization? Or is this something that it's a slow ramp up so we could see a drag here for a couple of quarters?

Well, I think you - we've got to try to step back and separate out the method by which we allocate the overhead, which is revenue based. Cedric pointed out it was plus $22 million before the overhead allocation. And that's after minus $13 million. So we had a $35 million allocation of overhead there.

But it's something that at Skikda ramps up that too will attract overhead charges, so it will be very important for us to keep a eye on the footnotes so you can see the, you know, what we hope will be a ramp up in the margins before the overhead. So that the revenues aren't attracting a continuing increasing proportion of the overall SG&A in the company.

Okay. And then if we could just switch over to LOGCAP III a little bit. Given the changes in award incentives, when does that potentially reset to a more normalized level? Or how long does this kind of drag on at these lower margins?

Well, as long as LOGCAP III is essentially a call option for up to 10 years in total length by the government on our services. So LOGCAP III in and of itself we're locked in as long as we continue to perform under LOGCAP III to the margins that we see.

As we get into LOGCAP IV, whenever that transition will occur we will have the opportunity to bid pieces of work and there are limits on what we can bid. But they're certainly far in excess above what we're realizing now. And the Army will rely on the competitive market to determine the economic value or profits from that work through competitive bidding. So any kind of material change that we see in margins will only come with LOGCAP IV.

Now the other thing we look at here is 100% of the LOGCAP work at our present margins, how will that compare to what will be less than 100% which we expect to get under LOGCAP IV but at a higher margin. So there's two degrees of freedom. One is volume. The other one is unit margin.

And I would just add, you know, we mentioned the $3 million impact of the award fee accrual being reduced from 84% to 80%. Also if you look in the footnote to that table, because the revenue actually increased modestly but it did increase sequentially, it attracted a higher overhead allocation as well based on the revenue allocation we used.

Right. And is there any chance for that award fee to come back up? When's your next chance? You're award score fell, when's you're next chance to get that boosted up and get these award fees?

Well, it's on every task order. They are typically every six months award fee board.

Okay. And then a final follow up, any talks of extensions beyond on LOGCAP III but beyond what you've already indicated given this protracted dispute on the LOGCAP IV award?

It will continue to provide those services so long as we there is a need for those services. And there is not a LOGCAP IV award. It's anybody's guess at this point.

Okay. Thank you.

Our next question comes from Michael Dudas.

Good morning gentlemen.

Morning.

Talking about the IGCC project, are you using sweat equity from the foregone margin as your investment into this project? Could you explain a little bit more how this is going to play out over the years of the feed and into the construction and potential O&M business?

Yes. I'm happy to discuss that. When we talk about sweat equity you really have to go back and look at the rules under which the clean coal programs exist. And because this project is this integrated gas combined cycle project has benefited by a contribution from the Department of Energy to help demonstrate this technology.

Certainly all providers of services cannot recognize any profits on that project. And because this is a government audited contract, we have elected for the sake of our sanity in many respects, to have this contract executed under our government and infrastructure division, which is compliant with government contracting.

And so the very, very low overhead that we recover under the work with the government, is the only recovery above our salaries that we have on this project. And that applies to the feed work and the early stage EPC work that are performing on that project. And as we continue to perform services, any services for that we provide for procurement or construction management or further engineering will also attract a very low overhead rate.

So really our sweat equity is the opportunity costs we have of doing a $300 million, $400 million EPC project at cost compared to what we could get on the open market with respect to doing other work for other customers.

So that's our investment. It is foregone opportunity. And as we described in our prepared comments, this does have an adverse impact on our unit margins. But it is something that when we've looked at the technology and we have looked at the opportunity and discussed it with our board, we're very excited about the prospect of being able to be a first demonstrator of a successful gasification technology.

And some of the drivers that really make this exciting for us are that it is air blown. It does not require an oxygen plant like many of the other competing technologies. And on a pilot plant demonstration has proven to successfully convert low grade coal, such as lignite or subbituminous coal, into gas and giving it a much wider fuel spectrum to gasify coal than also some of the competing technologies.

So we're making a near term investment in terms of foregone opportunity on our people, but we believe that long-term will be very beneficial to us as we can then take that project not only to other power applications, but also into our legacy hydrocarbon and thin gas operations.

I appreciate the detail. Just an idea on internally, is it three, four years before you think you can take this success and market it? Or will you hit some milestones sooner that would allow you to take advantage of the market, which admittedly is pretty competitive versus the PC and IGCC world, et cetera, given with regulators willing to pay and allow them to pass through.

I think we're looking at a 2010 commercial operation. As we move forward and we look at this, I think in terms of doing other dropping a gasifier in front of a 250,000 megawatts of combined cycle plants that were built in the U.S. in the last seven years. You know, that's probably going to be out there in 2010.

But as we look at the technology, you know, we continue to have a very active program at our pilot plant down in Wilsonville, Alabama. I would like to see us move forward and do some ventures with our more traditional customers certainly on a much smaller scale, but use that - use those opportunities to try to demonstrate this back in our, perhaps, downstream businesses where we can replace some natural gas with gas derived from coal as a feed stock.

I appreciate that thought. One follow up. As we get to year end '07, can you help us with where do you think you'll be relative to professional and field staff at KBR? How successful do you think you've been in '07 attracting and retaining talent? And what kind of turnover were you seeing? And do you feel that you have the resources to meet, you know, if you get some fortunate wins in the next 12 months to work off those businesses?

We have been, you know, at the first level we've been successful in growing our headcount to be able to execute the work. And I'm speaking more of the engineering talent. But below that we've probably had more people leave in terms of the churn in the industry, particularly some of the back end departments that are more commodity driven in terms of their offering. And while we've lost some, we've gained back equally.

I believe we've done a good job in preserving the project management and process engineering capabilities of the company, and are looking to continue to grow and enhance those. Certainly we have work coming off. You know, we've moved out of engineering on EBIC and in the near term we'll be out of engineering on Tangu and Yemen. And so we are creating additional engineering capacity to undertake this work.

Which we really want to put those people to work on projects that will be accretive to our PNL. In terms of field services and construction, we are certainly able to attract folks, particularly in the Gulf Coast region, as we begin reramping up our construction activities. You know, there are a lot of people out there who had a great affinity towards the legacy organization and we've brought back a lot of our veterans and alumni to feed this work.

We also have the added prospect of being able to look at our personnel over in Iraq and on the LOGCAP project. And eventually as that business shrinks and certainly even at a steady state we have new people coming in and existing people coming out who have done their rotation in theatre. That we have a very large labor staff that we have access to with which to put to work on construction projects.

And many of these people have been with KBR for a couple of years. Some have been with us for a long time. But they're clearly, as they come out of theatre, are interested in remaining part of our organization. And we think that's a hidden resource that we hope to exploit on our construction and operating services business to be able to meet our human resource requirements.

Very well. Thank you very much.

We'll move now to Jamie Cook.

Hi. Good morning. Just to build on the last question. I guess, Bill, you gave a good overview of what you're seeing internally in your company in terms of capacity and where you could add more people. I guess, can you just talk about on a broader basis what you're seeing the market? Are you seeing your competition have to turn down or walk away from projects? And do you think that you are better positioned competitively in terms of resources?

I think you, Jamie, would have to look at where we are on the life cycle of projects. And I cannot tell you with any degree of precision where our competitors are with respect to their life cycle of projects. But as I made my comments earlier, we do have projects coming off that create opportunities for us to redeploy the people.

I would also tell you that while we've had probably an okay sales year this year, I wouldn't describe it in any terms close to being an exceptional sales year. So I see our sales team having made some transitions with the organization both in terms of our business development oversight processes as well as our new line management organization.

So I'm very optimistic that with this additional capacity and with some of the issues that we are putting behind us organizationally at KBR that we will be able to do better in terms of our sales for next year than we have done this year. It's certainly my expectation.

All right. And then just as a follow up, can you just talk about on the cash flow side, we've been waiting for a decision on what you're going to do with your free cash flow. Anything you want to update us on that front? And then can you just talk more broadly on, you know, we keep hearing about you guys getting more deeper into the offshore infrastructure business. How do you want to - how do you do that? Is it acquisition? Is it organically? If you could just elaborate on that.

Yes, Jamie, this is Cedric. We are really no big changes from last quarter in terms of what we're looking at, which is to say primarily focused on acquisitions.

You did see in my earlier comments, an increase in some of the monies we've spent this quarter on acquisition efforts. That includes due diligence and so on. So we're looking at a lot of things. We are, in our view, being very disciplined about what would be a successful acquisition here. So we're looking at a lot and being very selective. We are going to continue that focus.

We do have some limitations in terms of our bank agreements, intact sharing agreement with Halliburton that restrain us from a significant share buy back. But that's something over time we would consider as well. And of course we've talked about in making investments in technology and ventures related areas if we find those opportunities. And we are looking at some of those as well.

On the offshore side, Jamie, we clearly got a -- clearly have a historical and legacy expertise in that market. Our Leatherhead operation is one of the strongest in the industry. It's our hope we can do a lot of that organically.

But it will take some time for us to get back into this. We're going to be very systematic and diligent. That goes towards any efforts we're going to look at regarding the fabrication side, as well as any acquisitions we may make. It's for us, we see a great opportunity set out there, and what we want to do is create for our company the broadest possible resource space where we can take the projects that have the highest value to KBR and apply our human and financial resources against those projects we choose.

So we clearly see a lot of money being spent offshore. We think that it's an attractive place to be, but we're going to look at that as a compliment to how do we build value at KBR. And we're optimistic that there will be more opportunity sets that open up for us because of that expansion. And we're not going to do so in any way that is not going to create shareholder value.

All right. And then just last, Cedric, unless I missed it in your prepared comments did you reaffirm your '08 guidance?

No. We did not. We had said last quarter that we would give an update at the end of the year when we conclude our planning process for '08 and we are still in the middle of that.

All right. Great. Thanks. I'll get back in queue.

Our next question comes from Brad Handler.

Thanks. Good morning.

Morning.

Could we please just spend a little time on the other ENC, I guess, the margins second quarter running in the 13, mid-13% range? I guess it sounds like it's benefiting a little bit from G&A allocation, I suppose. But help us think a little bit about whether that's, you know, we see a couple quarters in a row we start to think about a trend. That sort of thing. How sustainable is it? And maybe how sensitive is it to technology license fees I know you're going to change how you report this soon. But just for the time being if you could speak to that.

Yes. A couple of things. One, you certainly have to take account for the BRC gain of $18 million that shows up in this quarter. That's obviously not expected to reoccur. There is movement. I think we highlighted some of the big projects there. Certainly Ras Tanura, Yambu', EBIC all show up in there and those are good performing projects that we expect to continue to improve.

We also report our triple m venture there. That is not a consolidated so it has a much higher margin because of the equity method accounting, but it's also a very high performing asset, the two vessels that we use with Pemex. And those are continuing to perform well. And we think the trend will continue there. So and then we highlighted I think some other opportunities we're looking at in a robust market both in the Middle East and Africa for downstream and refining opportunities.

Very helpful Cedric. Thanks. And then just as a follow up I threw a line at you there. In terms of the licensing aspect itself, is it a meaningful portion of what we're looking at and how regular, if you will, is that?

Well when we look at our licenses we should be able to do dozens a year in terms of licensing. Last year we had a very successful year licensing our rose technology. And if we look at our project life cycles, you know, we have a very mature ammonia business. You know, rose is getting up in the curve. Superflex is now starting up.

From my side, and part of why we wanted to go to technology is it is an important part of our business. It is a business that we think we'll be able to grow and you'll be able to judge for yourself when we disclose those results, how meaningful or how material it will be.

But certainly from our interests we're looking to grow that technology portfolio, and by putting it out there we're really putting pressure on ourselves to grow that business. And it is -- it's a high margin business, as Cedric said. And certainly was very positive this year because it was a 30% year over -- improved performance relative to the second quarter.

Fair enough. Okay guys. Thanks.

Okay. Sherry, this will be our last question. So we'll take one more. Thank you.

We'll go now to Dan Pickering.

In under the bell.

Congratulations.

Yes. Thanks. Bill, you made mention of several -- we've obviously got several projects that are coming through at relatively low margins. Could you or Cedric kind of help quantify in the energy and chemicals and G&I, kind of how much of the revenue that we saw booked was carrying low or no margins just to help us understand the margins at the remainder of the business?

Yes. I think we covered some of the causes. I don't know, Cedric, do you have?

Yes. I'm just kind of scanning down the page. We don't have it summed up neatly. But let me do it and obviously I want to do it on the call as opposed to not having an option of doing it any other time. It's going to be, I'm going to guess, couple hundred million dollars round numbers for the -- it would be under that. But call it $150 million or so.

And that's in both segments combined or just energy and chemical?

That's all of energy and chemicals. I -- of course LOGCAP we talked about being a low margin.

[Escova] is in G&I.

Escova is in G&I.

As well as the Orlando project.

The Orlando project --

Yes, that would be reported in G&I.

Orlando is a pretty low number at this point.

Okay.

But that will ramp up. That's $300 million, $400 million and as that ramps up to full engineering it will become a material component of revenues that will not attract problems. I think that's going to have a normal S curve, Dan. Really at the early stages of detailed engineering, and so if you think about it the feed's complete. We're at that early stage and it should be ramping up significantly certainly in '08.

Escova is, while it has had a large financial impact even with the adjusted cost budget it's still less than $100 million. So -- and we're in the field there. So that's going to have a continuing impact for us for the next four, five quarters. Escravos, that - the moving part there is, you know, the costs have continued to escalate. The good news is, the cost, that escalation no longer has an impact on us.

Right.

But we are completing on that site the soil borings and getting ready to begin a heavier activity construction wise, the engineering's just about done. And most of the procurement is complete. So, yes, I probably still would be ramping up on Escravos in the fourth quarter. And we'll have some big numbers running through our books through '08. And, again, that was one time through cost was originally about 1.7 and it's really run up since then with the escalations that we've seen.

I've now had a little more time to do my math. Thank you Bill. About $150 million including the Skopje, excluding LOGCAP. But if you look at kind of the low margin projects we've talked about virtually all of them. But it's about $150 million in the second, third quarter of '07.

Okay. It sounds like that number is going to be stable in G&I and ramping up a little bit in energy and chemical.

Well it should be ramping up in G&I as the clean coal project is going to go with it.

Okay. Thank you. And then, Bill, I think I've asked you this in the past but I couldn't find it in my notes the answer. So I'm going to come back to it. Can you give us just a ballpark in the energy and chemicals, sort of where you're dollar amount of active sort of bids outstanding would be today? And where was it six months ago?

I would say that, Dan, that our bids six months ago which would put us back into April are probably about where they were. Now when we were back in April we, in my recollection, were still in pursuit of Olocola, which we did not get. But as I intuitively and subjectively look at our pipeline today, we do have a lot of bids outstanding.

And we expect -- yes, and I like our position on some of those. Because there are a few of them are sole source negotiation. But we got to get them in the boat. And some of the projects are with customers that we kind of got our arms around, but we don't quite have them in the boat yet.

But I think we will be successful there. So from a bids outstanding standpoint I think it's about the same. But we got to remember that you're looking at probably a $10 billion Olocola bid out there in April that is no longer -- that we're no longer counting in the current bids outstanding.

Okay. So we lost one big project and filled in with a number of others.

Yes.

Okay. And last question, Rob, I'm sorry I've got to ask one more. Which is, back to the gas modernization business, I understand we're making money at the gross profit level and then the allocations are getting it.

Again, lots of moving pieces which you described very well. But if we boiled that down over the next couple of quarters, are we going to get back to the point where we're actually booking operating profit there, or is it going to take a little while longer than the next quarter or two?

Net of the G&A?

Correct. As kind of a reported operating income number?

Well we -- that's going to vary on a lot of things, Dan. I think the obviously how we continue on LOGCAP is going to have a big impact because that draws a lot of overhead. Some of the other projects that we have - will we see similar increase in revenues?

I would anticipate, Dan, at some point. I really believe that we'll see some good results this quarter and into '08 in our construction activities. That will generate a lot of revenue growth for the company. And that will pull away from the gas modernization some of that overhead.

Right.

But we're also hopeful that as we conclude some of the projects and close them out, we'll be able to close them out favorably. So within gas modernizations we hope we can build the profitability. And as we build the rest of the business it will attract away from the gas modernization side some of the overhead allocation.

Just to add a little. In terms of big projects to watch, obviously Escravos at low margin is the big revenue, low margin. But you have Pearl, as we mentioned, potentially increasing. While we're coming off of train six in Nigeria we're hoping and looking forward to train seven, as well as the Gorgon. And so those would be the big projects to watch for us in the gas modernization area specifically that could lead to increased profitability.

Yes, great. Thank you guys.

And thank you.

Thanks for the call and we look forward to next call.

Thank you. This does conclude today's presentation. You may disconnect at this time.