KBR Inc (KBR) 2008 Q2 法說會逐字稿

Good day, everyone, and welcome to this 2008 second 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.

And now for opening remarks and introductions I'll turn the call to Mr. Rob Kukla, Director of Investor Relations. Please go ahead sir.

Thank you, Stephanie. Good morning and welcome to the KBR second quarter 2008 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 2008 third quarter earnings conference call for Friday, October 31, 2008.

Joining me today are Bill Utt, Chairman, President, and Chief Executive Officer; and Kevin DeNicola, Senior Vice President and Chief Financial Officer. In today's call, Bill will provide opening remarks and business outlook. Kevin will address KBR's operating performance, financial position, backlog, and other financial matters. 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 10-K for the year ended December 31, 2007, KBR's quarterly reports on Form 10Q, and KBR's current reports on Form 8-K. Now I'll turn the call over to Bill Utt.

Thanks, Rob, and good morning, everyone. Let me begin this morning by welcoming Kevin to our KBR earnings call. As CFO at Lyondell Chemical for six years, Kevin brings to KBR both a demonstrated financial and operating experience. Also while at Lyondell, Kevin served as both Vice President of Corporate Development and Investor Relations which compliments nicely with the talent of KBR's management team. I am extremely pleased that Kevin is on board.

With the addition of Kevin to KBR's management team, I am pleased with the mix of experience and capabilities embedded in our management team and believe this mix will continue to successfully drive KBR over the coming years. The composition of the management team comes from both inside and outside the engineering and construction industry with experiences in not only in engineering and construction, but also in energy generation and trading, commodity chemicals, as well as project finance just to name a few. This mix of people and experiences has greatly contributed to KBR's success in implementing a best in class risk awareness and management culture, which will remain a core driver of KBR's current and future successes. Now I would like to make some comments on the specific items outlined in this morning's earnings release.

On July 23, 2008, KBR received an adverse and unexpected jury award related to a 2003 [LOGCAP] III subcontract. We estimate the jury award -- the jury awarded the plaintiff approximately $40 million which gave rise to a charge of $0.15 per share. While we are appreciative of the efforts of judges and juries, we all recognize that errors are made, and we believe the award is not correct for the following reasons. First, the jury ignored an executed change order which reduced the work to be performed by the plaintiff which included a release from future claims. Second, the contract with the plaintiff contained a clause disallowing claims for lost profits. And third, the plaintiff offered no evidence of its cost or profits in performing the work. The judge has yet to certify the award, and we are also planning to appeal the award. Further, we are reviewing our options related to recovering all or part of the award from our customer. However, given the recent nature of the award, we have not had time to thoughtfully examine our path forward in this regard.

The second item outlined in our earnings release relates to a failure on the part of one of KBR's LNG projects to receive final customer approval for a settlement in connection with KBR's second quarter close. As a result, KBR recorded a charge in the amount of $0.09 per share during the quarter. During the second quarter, our customer agreed to compensate the contractor for additional costs and time required to construct the LNG facility.

A settlement was negotiated, and agreed between the customer and contractor. However, the customer was unable to present the settlement to its board, which is comprised of representatives of several international companies for final approval prior to KBR having to close its books for the second quarter of 2008. KBR believes it is likely that the settlement will ultimately be approved by the customer's board, covering the increases and estimated costs and time to complete the project.

Of the $15 million mentioned in the press release relating to two other one-time events, one was an $8 million pick up related to change orders which reduced the expected losses at completion for the Saudi Kayan project and the other was a $7 million benefit related to a reassessment of our prior accrual rate for incentive fees on the Pearl GTL project.

Now I would like to comment on the quarter and business outlook. Income from continuing operations for the second quarter of 2008 was $48 million or $0.28 per diluted share compared to $50 million or $0.30 per diluted share for the prior year second quarter. Consolidated KBR revenue for the second quarter of 2008 totaled $2.7 billion, up almost 24% from the $2.2 billion for the second quarter of 2007. Year-over-year improved quarterly revenue was led by a 65% increase for services followed by a 44% increase for upstream, a 28% increase for technology, a 15% increase for downstream, and a 15% increase of G&I. Total backlog at June 30, 2008 was $12.6 billion compared to $13.4 billion at March 31, 2008 and $13.1 billion at December 31, 2007.

During the quarter, KBR announced it was awarded a $275 million Canadian dollar contract for construction and fabrication of an LC-Finer unit in Alberta, Canada. KBR has not included this project in our backlog as of June 30, 2008. The project will be added to our backlog when a notice to proceed on the contract is received from Northwest Upgrading which is expected to occur upon the closing of project financing for the project. Kevin will have additional comments regarding KBR's backlog during his segment of our presentation. Looking forward, I remain pleased with KBR's positioning for several large projects in the gas monetization, offshore, and downstream market segments.

Let me also take a few moments to update you on the BE&K acquisition which was closed on July 1, 2008. The integration of BE&K into KBR is going very well, and we have met our day one cost synergy targets. KBR also expects to exceed our year end cost saving targets as well.

As we initially looked at BE&K, the main drivers for the acquisition were to accelerate KBR's reentry into the US domestic construction market and to broaden our presence in industrial services. As our current mix of work at KBR is approximately 85% international with a significant focus on large projects, we also believe the increased exposure to the US market and to the small and mid-size projects pursued by BE&K would be a good addition to our portfolio mix of business.

In addition to the items described above, we were also excited about BE&K's other businesses, including the engineering business, which expands our industrial or noncivil capabilities by 30%; the construction fabrication industrial service operations in Poland and Russia; the successful track record for construction in the domestic power business, as well as the opportunity for KBR to move into the commercial building arena where we expect that the combination of KBR's brand and financial capabilities will add to a business that already has a strong regional reputation based on execution skills and client satisfaction. BE&K's work for the US Navy also compliments nicely KBR's US army work. The feedback from BE&K's customers to the KBR acquisition has been encouraging and many of our current KBR customers in traditional KBR markets, such as chemicals and refining, as well as historical customers in pulp and paper and power are happy to have us back supporting their businesses again.

For the year ended March 30, 2008, BE&K had revenues of $1.937 billion. Gross profit on contracts or job income was $180 million, and net income after tax from continuing operations was $34.5 million. Backlog at June 30, 2008, was $2.01 billion broken down as follows: construction, $908 million; building group, $840 million; industrial services, $113 million; government, $102 million; and downstream, $49 million.

As mentioned earlier, we have also been working on capturing synergies. On the cost side, we looked at the economies available to the combined organization and took out positions and costs from overhead that have a projected run rate of over $13 million per year. These savings began closing date and will implemented by January 1, 2009 by which time the majority of the transition work will be complete.

KBR is also expecting to achieve revenue synergies in the following areas: Expanding the population at BE&K engineering offices to execute KBR's future international engineering work, leveraging BE&K's predominantly domestic customer base and product service offering through KBR's global project delivery infrastructure, and increasing the size and volume of BE&K projects by leveraging KBR's larger balance sheet and available capital resources. We are currently mapping the BE&K businesses into KBR, and we'll report on the combined BE&K/KBR business beginning in the third quarter.

Now let me turn to some operational highlights for our KBR business units and update the KBR end-markets. With respect to our upstream business units, I would like to comment on the status of our portfolio of large lump sum turnkey projects. Despite the issues arising during the quarter, related to the timing of approval for a settlement agreement, each of KBR's LNG projects and our other large lump sum turnkey projects remain profitable. At the end of June 2008, the Tangguh project was 93% complete, and we expect the first train to complete in early 2009.

The Yemen LNG project remains on track for the completion of the first train in the first half of 2009 and at the end of the second quarter, the project was 85% complete. The [Skikda] project continues to proceed very well and at the end of the second quarter was 23% complete. With regard to the NLNG Train 7 project in Bonny Island, Nigeria, the project's anticipated final investment decision has been delayed from our previous assessments due to what we believe are events outside the EPC contract. KBR continues to maintain a dialogue with the client and stands ready to resume active discussions when so advised by the client.

KBR's involvement on the Gorgon LNG project is continuing to ramp up as we work on a [refeed], and the project was a contributor to second quarter results. We are also helping our customer reevaluating the scope and scale of the facility as they work towards a final investment decision. KBR continues to be successful in project awards related to offshore work. We remain very optimistic about the opportunities that are available to KBR to continue to grow this business, given the very favorable market conditions.

KBR was recently awarded a four-year contract including an option for extension by BP to provide engineering and project management services for BP's future offshore work. KBR's and KBR's subsidiaries [Granherne] and GVA Consultants will provide conceptual studies, front end engineering and design, detail design, and project management services for BP's global offshore projects. This award builds on our 40 year working relationship with BP and demonstrates our abilities and track record to deliver quality and experience in the offshore arena. For government and infrastructure, we have participated in several conferences and meetings with our customer to get greater details on scope and timing of the transition from LOGCAP III to LOGCAP IV. We expect the first request for proposal under the LOGCAP IV contract to be issued in the coming months.

However, we believe the initial task orders under LOGCAP IV may be smaller in comparison to previous task orders under LOGCAP III. We expect work under LOGCAP III to essentially continue at present levels for the remainder of 2008 and that all currently open task [orders] under LOGCAP III will be complete during the first quarter of 2009. As I discussed in last quarters call, we have concluded our detailed review of material requirements to complete the Skopje Embassy Project.

Upon this review, and as a result of construction delays related to visa issues, KBR took an additional $3 million charge on this project during the second quarter of 2008. However, I believe barring any further unforeseen events that KBR is in position to close out construction activities for this project in a reasonable manner. At the end of June 2008, the project was approximately 73% complete, and we currently believe this project will be substantially complete by the end of this year.

KBR services business unit continues to make outstanding progress. I am very pleased with the heavy oil sands work in Canada and the opportunities we see in that market. Revenue grew 65% from the second quarter of 2007 with a corresponding backlog growth of 62% year-over-year. During the second quarter of 2008, services was awarded a $275 million Canadian contract for the construction of fabrication of an LC-Finer unit by Northwest Upgrading in Alberta, Canada.

The LC-Finer unit scope will include free fabrication of 40 modules to be later assembled as part of the Northwest Upgrading project and is expected to last approximately 30 months. However, as I mentioned earlier, this project will be booked into backlog when the customer issues a notice to proceed on the project. Currently, the customer is seeking a financing partner. We are confident that the project will commence later this year at which time it will be booked into KBR's backlog.

We have also experienced successes in KBR's return to the domestic construction market. As a direct result of a successful ongoing environmental construction project in the Gulf Coast region we were subsequently awarded an EPC project for emissions reduction project by the client at another refinery in Texas. For our downstream business unit, the second quarter results continue to be led by Ras Tanura and [Yanbu] export refinery projects in Saudi Arabia as well as the EBIC ammonia plant in Egypt. For the second quarter we also recorded change orders for the Saudi Kayan's [olifin] project which converted the nature of the project from fixed price to reimbursable.

The EBIC project continues to progress very well and is approximately 99% complete. Construction and commissioning is targeted to be completed in the first quarter of 2009. KBR's global resource pulls also contributed to our success during the second quarter. Labor cost absorption, driven by volume and cost efficiency, was $6 million better during the second quarter of 2008 compared to the same period in 2007. Now I will turn the call over to Kevin. Kevin?

Okay. Thanks Bill. I'll begin by reviewing KBR's consolidated second quarter 2008 results, which primarily focus on year-over-year comparisons. Consolidated KBR revenue for the second quarter of 2008 totaled $2.7 billion; that compared to $2.2 billion in the second quarter of 2007. Consolidated operating income was $90 million in the second quarter of 2008 compared to income of $65 million in the second quarter of 2007. Now as discussed earlier operating income in the second quarter of 2008 included a charge related to an unfavorable jury verdict of $40 million for litigation with one of our subcontractors for work performed on the LOGCAP III contract dating back to 2003 and also a $24 million charge related to timing issues related to client approval of a settlement on one LNG project.

Operating income in the second quarter of 2007 included a $24 million charge related to the Skopje Embassy Project in Macedonia. Upstream revenue was $699 million in the second quarter of 2008 up $214 million or 44% in the second quarter of 2007. Business unit income was $39 million in the second quarter of 2008 compared to $47 million reported in the second quarter of 2007. Business unit income in the second quarter of 2008 included a $24 million reduction and estimated profits of one LNG project which Bill addressed in detail earlier. Partially offsetting the year-over-year decline were increases in the Skikda NG project, the Pearl GTL project, increased work scope on the Gorgon LNG and North Rankin II offshore project in Australia.

Government infrastructure revenue in the second quarter of 2008 was $1.7 billion compared to $1.5 billion for the prior year second quarter. Business unit income was $63 million in the second quarter of 2008 which included the $40 million charge related to 2003 LOGCAP III subcontract and a $3 million charge related to the Skopje Embassy Project. This compares to $58 million in the second quarter of 2007 which included a $24 million charge related to the Skopje Embassy Project in Macedonia. The decrease in business unit income was partially offset by higher levels of construction activity on the Allenby & Connaught project, the UK facilities project in Iraq for the Ministry of Defense, multiple water projects in Australia and Scotland.

Services revenue was $128 million in the second quarter of 2008 up from $78 million for the second quarter of 2007. Business unit income was $17 million flat compared to the prior quarter due primarily to a positive tax credit in the second quarter of 2007 associated with our service and maintenance vessels in the Gulf of Mexico.

Second quarter 2008 results benefited from work on the Scotford Upgrader project in Canada and several industrial services projects. Downstream revenue was $101 million in the second quarter of 2008 compared to $88 million from the second quarter of 2007. Business unit income was $14 million in the second quarter of 2008 compared to $1 million in the second quarter of 2007. The increase in business unit income was primarily due to a reduction of crude project losses resulted from the Saudi Kayan olifin's project change order as well as progress Ras Tanura and Yanbu export refinery projects in Saudi Arabia.

Technology revenue for the second quarter of 2008 was $23 million compared to $18 million in the second quarter of 2007. Business unit income in the second quarter of 2008 was $7 million compared to $2 million in the prior year second quarter. The increase primarily relates to an ammonia process project in Venezuela and the start of the an [annaline] project in China. [Now] respect to the venture's unit, business income for the second quarter of 2008 was zero compared to a loss of $1 million in the second quarter of 2007. That improvement was primarily related to the purchase and sale of [pre-emption] rights on two UK road projects increased, profitability on the Allenby & Connaught investment in the UK, and improvement on several other road project investments.

During the second quarter of 2008 losses reported on Alice Springs Darwin railroad project represented the final amounts of operational losses to be recorded to achieve full impairment of KBR's portion of the investment and a book value of 0. So we don't expect to record any future operating losses on this project.

Let's review some other financial items. General and administrative expenses for the second quarter of 2008 were $52 million down $4 million for the first quarter of 2008. For 2008 we expect recurring corporate cost to approach $200 million excluding any impact from the BE&K acquisition. We expect the additional impact to G&A expenses for BE&K to be approximately $10 million for the second half of 2008.

Our effective tax rate in the second quarter of 2008 was 36% flat compared to the first quarter of 2008. For the full year, we still expect our effective tax rate to be in the 38 to 39% range.

Moving on to backlog, total backlog for June 30, 2008 was $12.6 billion compared to $13.4 billion at March 31. This sequential backlog decrease was primarily due to work off from our Middle East operations. While KBR has not announced many large projects awards during the year, we continue to see strong scope growth in our existing projects across the company with particular emphasis on gas monetization, offshore, downstream, and LOGCAP III. KBR still ultimately expects to be successful in a number of our current large project pursuits. Overall the backlog portfolio mix at the end of the second quarter was 76% cost reimbursable 24% fixed price, same mix as compared to the sequential quarter.

Next I'll discuss our liquidity and balance sheet. At the end of June 2008 our balance sheet remained strong with no debt and cash and cash equivalents of $1.6 billion in which $211 million is cash associated with our consolidated joint ventures. Now in addition cash and cash equivalence included $216 million from advance payments related to a contract in progress. Total cash balances decreased by $371 million during the second quarter of 2008 primarily driven by a reduction in cash associated with our consolidated joint ventures in the amount of $147 million and timing on LOGCAP billings received after June 30, 2008 in the amount of $156 million. So after paying $550 million for the acquisition of BE&K on July 1 that leaves a cash balance of approximately $600 million before other working capital needs for LOGCAP and other projects. So our working capital at the end of the second quarter of 2008 was $1.6 billion; that's up slightly compared to the prior sequential quarter.

Working capital in Iraq was $211 million at the end of the second quarter of 2008 up approximately $49 million from the sequential quarter again due to timing of collections. Capital expenditures totaled $8 million and depreciation was $9 million during the second quarter of 2008. Capital expenditures were flat compared to the sequential quarter; we revised our expectations for capital expenditures for 2008 to be less than $60 million from the previously discussed expectations of less $70 million; that's excluding BE&K. And now I'll turn the call back over to Bill for his final remarks. Bill?

Thanks Kevin. As you can see, the second quarter of 2008 contained a lot of moving pieces. We recognized the confusion this presents when discussing the financial performance of KBR. Management is confident the underlying businesses will continue to perform as strongly as we have seen over the first half of 2008.

I want to briefly discuss recent press coverage related to KBR and its work in Iraq. We have previously provided the government information related to the electrical safety issue. At Senator Casey's invitation, I went to Capital Hill last week to visit with the members of Congress. I believe the meetings were fruitful and established a dialogue that we hope will continue. We pledge continued cooperation with the government on this and other issues as they arise. We look forward to expanding the thoughtful and fact-based dialogue we had on Capitol Hill.

KBR's steadfast commitment to the safety and security of all employees and those the company serves remains. We are proud of our work and honored to serve our troops. We remain committed to providing the highest quality service to our customer, the US military. I thank all of our employees who at great risk to themselves perform this service. When one considers where KBR has come over the past several quarters, much of this achievement is due to the thoughtful and significant efforts by our teams across the globe. We also welcome the BE&K teams into KBR and look forward to their contributions to KBR's continued strong performance over the years to come. Now we'll take your questions. We ask that you please limit your comments to one question and one follow up.

(OPERATOR INSTRUCTIONS) We'll take a question from Barry Bannister with Stifel Nicolaus.

Hi guys. Question, I notice that your -- you had a working capital build in the quarter and in particular there were a couple of items that rose more than others. Could you talk about the working capital build and the cause of it on a sequential basis?

Yes. This is Kevin. I think we just tried to address some of that in the remarks. Again, there was a little shift in the LOGCAP III billing that was came across the quarter. That's about half of the number, really a $150 million of it there. Some is just timing on some other things there but overall it is not really a significant change.

I thought there was a bigger change in advanced billings and uncompleted contracts.

There was a change in that. That's what he said, there was a taking down some of that as cash, right? For the specific project. I think those are the two things that really answer the question of what changed in the working capital there.

And you didn't mention very much about Yanbu or [Aramco DOW] in the project's discussion. What sort of move forward are they having in relation to the kind of movement you are seeing at Gorgon?

Well we are still seeing a number of those projects offer us work releases under the contracts we have signed, and they have contributed to the continuing performance of the downstream business as well as the increase in backlog of the downstream business unit. While we don't talk about them in the context of an announcement, we do roll those work releases into the backlog as we receive them.

But there's been no FID on Yanbu and on DOW Aramco, you're still just doing the project management, and you haven't received any sort of larger awards, have you?

No. I think both projects are looking at a 2009 FID, and I certainly would refer those questions to the sponsors because we are dealing with what we read in the press and largely on terms of their FIDs.

Thanks Bill.

Your next question is from Jamie Cook with Credit Suisse.

Hi. Good morning. My first question -- thanks for the additional info on BE&K. Just a question. You said that net income was $34.5 million. I just want to make sure that that's a clean number so that when I think about modeling purposes going forward just to try to model for myself for 2009. And then can you give an operating profit number?

Well, Jamie, the $34.5 number I quoted was the net income from continuing operations which did eliminate the one timers that plus and minus that they saw during their fiscal year. So it is a clean number in our world. We did also give the equivalent of our job income of $180 million, which is I think addresses what you are looking at because we tried to make it consistent with KBR.

Okay. That's helpful. One other quick follow-up question. If you back out the litigation in the G&I segment, your margins, I think, would have been about 6% which is higher I guess than I thought they would be trending. Was there anything unusual in there? How should we look at the margins in that segment going forward?

Speaking specifically to G&I?

Yes, just in the quarter if you backed out the litigation it looks like the margins would have been about 6%.

When we look at the G&I backlog at the end of the quarter compared to the end of the prior quarter, while the revenue backlog went down, we are seeing the mix of work change, and we are seeing particularly on our international work in Australia, the Middle East and the UK, higher margin work being added in the portfolio which is -- we saw a resulting increase in our backlog job income percentage quarter-over-quarter.

All right. And just last question. Kevin, do you care to give any initial observation since you've been at KBR six weeks or so?

It's a steep learning curve. To just come into any new company like that and in a business; well, I've had some experience with the different things using these ENC companies as a client, I haven't had the experience of being on the other side. So I can tell you it's been very interesting and it's been very active.

Thanks. I'll get back in queue.

[ OPERATOR INSTRUCTIONS ]. We'll go next to Steven Fisher with UBS.

Hi. Good morning. On the $24 million in LNG charge, could you talk about what type of cost caused the increase there? Was it materials, wages or productivity?

We were looking at client -- subcontractor incentives to put more people on to drive the project harder than what we were seeing in the field and that also-- the performance we saw had given rise to longer time. We weren't seeing necessarily the productivity for a number of reasons in the field that we had looked at. And so in discussing the issues and the causes of that with our customers, they agreed that it would be reasonable for us to be compensated for the increased cost and the increased time that would be required to complete the project. So it was subcontractor construction cost as well as a component related to time extension.

I know you do projects in various parts of the world, is there any sense that could be a similar issue on your other LNG legacy projects right now?

No. I think it's an isolated case. We do monitor these things very closely. We are much -- obviously it's on (inaudible) that we've taken some steps on recent projects to develop perhaps a slightly different risk allocation between KBR and the clients on those matters given where we are in the market, but we don't see this having any knock on impact to our other lump sum turnkey projects in our portfolio.

And when do you expect to finalize the change order?

Well, we are -- fundamentally we ran out of time. We have a settlement that's been initialed between ourselves and the customer, and it's taken us more time to present the change order to the board of the customer, which as I mentioned was comprised of several international companies and getting them all the background not only for our change but also for what we understand are other matters outside the EPC contract.

So we had thought, we had hoped, and we had planned on hopefully getting this done this quarter. We were unsuccessful, but we do view this as being likely. I've also done our checks with our partners, and we are of the same view that this will get taken care of the in the normal course of business.

Okay. Great. And then lastly, I know you mentioned in terms of awards the Canadian project not in backlog do you have the Papua New Guinea LNG feeds in your Q2 backlog?

No. We have not announced any awards there related to that project.

Okay. Thanks.

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

Good morning guys.

Hi Andy.

You had talked about last quarter that you felt pretty good about several projects going into Q2 and beyond. I'm just wondering sort of what's going on with those projects. You talked obviously about Nigeria, Bonny Train 7, but besides that are there still several sort of medium to large size projects that are out there that you could win before Ras Tanura comes and before Yanbu comes? Where are they?

We talked about those two projects specifically for '09. I think we've also commented previously that Gorgon is also going to be an '09 FID, but we are still seeing good work flow through on those. There are also some other LNG projects, some we've talk about and some we're following very closely that have moved forward. Some are dealing with obviously the very volatile nature of the cost side of the industry that we see and digesting that. Others are working on citing issues. Those are all very good prospects for us, and we're still feeling very positive about where we stand. Perhaps there's a little bit of a lull going on there right now as people recalibrate based on the commodity prices both on their-- both on what they're selling in terms of crude oil and natural gas and the escalations that we are seeing, but we are still not changed in our outlook and optimism regarding the ability to get a couple of these projects signed up in the next year. We'd like to get them signed up sooner obviously, but we think they are out there and we think our positioning is very strong.

That's fair. And Bill, when you are talking about -- obviously this situation with the jury came up pretty unexpectedly. Is there anything else out there that we need to sort of keep our eye on that -- in a given quarter we can have another charge like this from some unfavorable jury verdict or the government says, you know you did this wrong. Is there anything else out there that we need to focus on?

Andy, I would say first of all, I was trying to be very explicit for why we believe the jury award is just wrong. And I think we've given some good reasons why we don't think ultimately that that award will stand. Now, if we can remove for the time being in my comment the specter of a completely wrong jury award, I will tell you that there are other items that are out there that we've certainly have disclosed in our filings that we have taken provisions that we have looked at both with internal counsel, outside counsel and our auditors, and we believe we are properly provisioned in those amounts. So we don't see anything in the normal course of business with respect to normal evolutions of juries and matters like that that we should be concerned about.

Clearly this one coming up as it did on July 23, it didn't give us a lot of time to really develop our thinking and theories of how we would talk to the judge about how--certifying the award, the appeal process, the possible recovery of this through our customer. So I think we're okay in terms of these other matters particularly related to G&I. But timing and the outcome of a jury is stuff we'll have to deal with.

Great. Just one more quickie. You have a signed -- it seems like you have a signed agreement of some sort with your customers on that $24 million change order. I know that you are waiting for the board of that customer, but I'm not exactly sure how the accounting works. Why do you need to take a charge if you know there's a very high likelihood that you would get the money?

Andy, there are very specific provisions within US GAAP giving rise to the recognition of a change order, and these, very honestly, are different standards than exist under IFRS, the International Financial Reporting Standards. We are -- we follow the US GAAP. We are very systematic in our review and discipline in looking at the change orders, and we came to the conclusion that technically while it is likely and while we do ultimately expect to get that change order executed, that we could not take credit for that this quarter based on our strict interpretation of US GAAP. That's why we've made such a very specific and precise disclosure in both our release and our call regarding that nuance.

Thank you.

[ OPERATOR INSTRUCTIONS ]. We'll take our next question from Dan Pickering with Tudor Pickering & Company.

Good morning, Bill and Kevin. Back to BE&K for a second, guys. Could you talk a little bit about where you see the organic growth prospect for the next year or so? You outlined kind of the numbers for the year ended March of '08, but is this a growth business and is the mix changing such that the margins would look much different over the next year than they have been over the past year?

Dan, we think the business is a good business and that certainly over the near term we want BE&K to continue doing what it is doing in the manner that they've done it. They've performed in their business. I think we commented in May when we announced kind of what the expected financial impact of BE&K would be for us over the next two and a half years, and we haven't done enough work or seen results to make any kind of change in what we previously disclosed.

We do see as we look at the business a real good opportunity to even double the size of their engineering offices, and as you know with major operations in Houston and London these are very competitive engineering markets, and for us to be able to add very competent capable experienced people in Birmingham, Alabama; Raleigh, North Carolina; and Wilmington, Delaware, just to pick out three, that we think the talent pool can allow for an expansion and possible doubling of these offices over time, and that the markets are not nearly as competitive as what we see in Houston and London. And that's somewhat of an aspirational statement. We still have to go out and get the work and grow the offices, but we feel there is a great opportunity for us to significantly increase our engineering capabilities particularly on the hydrocarbon side with the acquisition of BE&K and the platform it provides us for future growth.

Okay. And I guess from a reporting perspective, is BE&K going to show up in a number of different divisions and how are you going to help us track the progress going forward? Is it just going to be rolled in with all of the other segments?

We are working on that right now. Our initial desire is to look at our services business unit where most of the BE&K will reside, and attempt to present that consistent with some of our other large business units in a manner that does give you some granularity there.

That would be helpful. So I apologize for sort of beating a dead horse here, but if I were to make the assumption that BE&K was from a mix perspective at least neutral as we step forward over the next year, I would then think about the cost savings that you outlined at the-- I think you said $13 million range on an annualized basis. That sort of helps me drive down toward what I think the bottom line impact should be. Is that the way to do the math Bill?

Dan, when we put it in context, we made the disclosures in May, we had done so based on our expectations of the future businesses of BE&K at the time, the expected level of cost savings that we were expecting to achieve and I think I commented that we've done better than that. And then we also were looking at the expected intangible amortization associated with the acquisition, and we're wrestling all those things through but largely the cost savings are embedded, or to some degree the cost savings are embedded in what our comments were back in May.

Okay. Last question then would be back to the LNG charge. Have you -- has the Company ever been in a situation where you've reached an agreement like you have reached at this point? I understand not agreed to by the board yet of the other side, but have you ever been in a situation where it's been agreed to this level and then not actually been approved?

We are looking around the room and we are all shaking our heads no. We can't recall any instance where we've had -- the change order reversed as you've described.

Okay. Great. Looks like third quarter will catch that back up. Thank you.

Thank you, Dan.

We'll go next to John Rogers with D. A. Davidson.

Hi. Good morning.

Good morning, John.

Bill, just to follow up on a couple of questions ago, you talked about some of the optimism for the projects going forward. Could you run through again just the end markets in particular? I mean you talked about LNG, but the other areas that you are looking at as well?

Well, since I've already commented on LNG, we'll move to offshore, which is the other half of our upstream business, and we are -- in looking at our prospect list and our growth plans in terms of staffing for our offshore business, we think we can get a series of awards over the next year that will be -- will really increase our penetration -- our performance in the offshore business. So we see a lot of opportunities there. We have a number of opportunities in the downstream side of our business that we are looking at, and we are actually trying to take some of those projects that are on the prospect list and really focus on a lesser number to drive the quality of the projects and then their expected impacts to KBR in a much more positive fashion.

So we are seeing both of those two areas look very promising. We're certainly seeing a continued deal flow or project flow coming out of the BE&K organization. One of the things I had some worries with the transition from announcement to closing was would their sales guys continue to sell and certainly by our early measures there are projects in the pipeline that we think could result in them continuing to give us opportunities to grow our business. So those are the three biggest drivers we have that I can comment on. Offshore, downstream, and services.

Okay. And the $2 billion in backlog of BE&K?

Yes. I think it was 2.01.

Is the mix there between cost plus and fixed price contracts similar to your split?

Yes, I think we commented in May that it was about identical to ours. So they are about 75/25 reimbursable to fixed price.

And with the projects that you are looking at going forward, any reason to think that mix is going to change either for the legacy KBR or BE&K business?

We don't -- I haven't seen enough data to understand if it's going to change, and we haven't given any instructions to change it. I would imagine if it has arrived at that type of a mix that it will continue to stay generally in that balance.

You are not seeing any changes in the market that would suggest that change?

No. We are still looking at their customers and their markets that should give us a similar composition of project type.

Right. Thank you.

(OPERATOR INSTRUCTIONS) We'll go next to [Joe Richey] with Goldman Sachs.

Good morning, everyone.

Good morning.

A quick question on Bonny Island Train 7. You mentioned that the project is delayed beyond your expectations and that based on events outside of EPC. Can you talk more about that specifically? And when is the timing now for that project to get awarded and is there a possibility that the project never gets awarded?

We obviously are all aware of what is going in Nigeria. It's still a very difficult place to do business, so there are elements we believe both within the broader Train 7 project and perhaps even outside the Train 7 project for our customers that have delayed this, we think fundamentally that the Train 7 project is a stand-alone project that will be executed on its merits. When this will happen, we can't comment specifically given all the external factors that are involved. But from what we've seen and what we believe, it is a very good project that will ultimately get built when our customers determine when it's appropriate to build it.

Okay. Great. Thanks for that color. And on BE&K, when I take a look at the break down that you gave earlier of your backlog primarily most of that business is domestic construction, and given that your nonresidential construction in the US is starting to show some signs of slowing down, I was just wondering what your thoughts were in terms of the growth trajectory of some of those segments.

The buildings group's largest element is healthcare, and we haven't seen and we are talking to the management this week about their markets and the conditions. They believe that the healthcare and the educational market will remain very strong. And so we are very optimistic about the continued performance of the building group with those two markets.

In terms of the other construction business, we've seen volumes that certainly in the proposals that are being submitted that we haven't seen a slowdown. They do some projects in the chemical and petrochemical side that are traditional KBR markets. We're seeing good activity in the power segment that BE&K has developed a very good track record on it. We are hoping that we'll be able to continue to be an active participant in the construction of power projects. So we feel pretty good at this stage. Certainly we're mindful of what's happening in the US domestic market, but the positioning of the BE&K businesses and the resulting activity that we see today looks pretty good.

Great. Thanks for taking my question.

Okay, Stephanie, we have time for one more question please.

We'll take a follow-up from Barry Bannister from Stifel Nicolaus.

Guys, last quarter you said that Skopje was going to be audited for what you had already purchased because you [bidded](sic) on a template, and it looked like it had to be customized. It only moved forward 5% in the quarter. Can you give us an update on the procurement risk and also the local labor risk of why such a small movement?

Of the $3 million charge, we took about half of that was related to the visa issues we encountered in getting our construction forces on site and that contributed to our lower expected progress that we achieved during the quarter. The other half was largely represented by expediting and freight as well as additional project management costs. With respect to the inventories, it was less than $0.5 million type of adjustment within the $3 million.

Okay. And then on BE&K, gross margin is about 9.5 which is about average for an engineer, but it's 1.8 on the net margin, which is very low. Would you talk about the G&A level in the company as well as the tax rate that they were employing?

Well, I guess I'm not prepared to talk about their tax rate because I don't really have that. We can certainly get back to you with analysis, but certainly the cost that we took out at closing and that we expect to achieve sitting four weeks after we closed the transaction of $13 million a year are evidence to the G&A that as part of the broader KBR platform we are going to achieve. And then we don't need that level of G&A. We are hopeful as time goes on we'll be able to identify further synergies or opportunities to reduce cost and increase efficiency, but certainly with respect to what we were targeting in terms of getting the transaction approved, signed up, and announced, we've exceeded our expectations at $13 million a year.

Okay. And then just a housekeeping. If you do receive back the $0.09 a share from Tangguh when the board meets, could you press release that?

We have not disclosed the project where the $0.09 occurred, and I'm not -- I don't know that we will or not because we'll have to look at the materiality of it.

Okay. And then am I correct in saying that your earnings before the charges was really $0.47 I believe most investors thought it was $0.46 but the first paragraph of the release left out, I believe -- left out the Skopje Embassy which was a penny.

That's correct. We certainly -- when we look at the quarter, we thought we had a very good quarter at KBR. The underlying businesses are continuing to show improvement. They are continuing to perform. You can look at what we've said on revenues and job incomes, the progress we've made on reducing overheads, the labor absorption. So the efficiency of the business is very strong, and as we peel back and think about the quarter. Yes, we are somewhat disappointed by these one off items, many or which -- one of which was July 23 which was unfortunate, but as we look at this, we feel very comfortable that we did have a strong performance and in terms of how we talk about the quarter at KBR, we consider it a $0.46 $0.47 quarter.

So do we. Thanks a lot.

Thank you.

That's it, Stephanie.

Thank you. That concludes our teleconference. Thank you for your participation and have a great day.