KBR Inc (KBR) 2013 Q2 法說會逐字稿

Good day, everyone, and welcome to the KBR second-quarter 2013 earnings conference call. 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 conference over to Mr. Zac Nagle, Vice President of Investor Relations and Communications. Please go ahead, sir.

Good morning, and welcome to KBR's second-quarter 2013 earnings conference call. Today's call is also being webcast, and a replay will be available on KBR's website for seven days at KBR.com. The press release announcing second-quarter results is also available on KBR's website.

Joining me today are Bill Utt, Chairman, President and Chief Executive Officer; and Sue Carter, Executive Vice President and Chief Financial Officer. During today's call, Bill will provide an overview of KBR's second-quarter operating results, highlighting a number of key areas from each of our business units. Sue will then provide an overview of the key financial takeaways for today's call. Lastly, before turning the call over to Q&A, Bill will provide brief closing comments.

After our prepared remarks, we will open the floor for questions. Before I turn 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 second-quarter press release issued last night, KBR's Form 10-Q for the period ended June 30, 2013, and KBR's current reports on Form 8-K. You can find all these documents at KBR.com.

Now I will turn the call over to Bill. Bill?

Thank you, Zac, and good morning, everyone. KBR delivered a solid second quarter with earnings per share of $0.61. Overall, we had strong project execution across our businesses, which drove job income up 8% year-over-year, with job income margins up 153 basis points. The second quarter results were negatively impacted by nonrecurring charges in the amount of $11 million. These costs include office closure and severance costs in the amount of $7 million, as well as $4 million related to a true-up of lease expenses in Australia.

Second-quarter results were also favorably impacted by a 12% effective tax rate for the quarter. The second quarter was also a strong bookings quarter for KBR. Ignoring foreign-exchange impacts across our backlog in the amount of $611 million, KBR's second-quarter book to bill ratio was 1.1. Across the five problem projects we discussed on our fourth-quarter call, our execution remained consistent with the project provisions we took in the fourth quarter, and we did not take any further charges in this portfolio of projects in excess of these provisions.

At our US construction business unit, one project experienced an increase in costs, which was offset by lower estimates complete on the other two projects. We continue to estimate that all of the projects will be completed by the end of 2013. For the KPC projects, KBR has completed its work on the available construction fronts.

On the KPC-2 project, all construction activities have been completed. However, due to operational requirements, the customer has elected not to provide KBR the opportunity to shut down a portion of the plant, so as to allow KBR to complete punchlist activities and conduct final performance testing. As a result, KBR has commenced demobilization on the KPC 2 project.

On the KPC-1 project, KBR has completed all construction activities with the exception of a conveyor across an area where the customer has placed wastefill from its coal mining operations. As a result of this waste disposal activity, the soils upon which KBR was expected to construct the conveyor have not adequately settled to permit construction of the remaining works. This ongoing soil movement has been documented by third-party geotechnical firms.

We have notified the customer of this issue, and have issued a change order for both the time and cost to allow for the soils to settle, and KBR to properly construct the remaining conveyor system. This request has been rejected by the customer. As a result, KBR has completed the construction on the available fronts, and is also in the process of demobilizing its staff on the KPC-1 project.

During the fourth quarter of 2012, KBR took provisions to complete the projects and accrue any potential liquidated damages. We believe these provisions remain appropriate under the present circumstances, and KBR did not take any further provisions for the KPC projects during the second quarter, and do not anticipate taking any further provisions going forward.

As we look out to the balance of 2013, we are revising our EPS guidance range to $2.55 to $2.90 from $2.45 to $2.90, reflecting our outlook after two quarters of solid performance. We see our LCA expense higher than we expected when we gave our initial guidance in January, which will continue to be a drag on earnings in 2013. The improvement in LCA, with the timing of awards for new projects, has been slower than we anticipated, and we will continue to maintain our resource center staffing to execute key projects as they are awarded to KBR.

We do anticipate improvement in the second half over our first half LCA results. Generally offsetting these higher LCA costs is a lower tax rate. As we look at 2013 our execution, the expected pace of new awards, and our outlook for resolving a few outstanding issues on some legacy projects, we feel good about our position and our prospects to continue to deliver strong returns to our shareholders over time.

Turning to some of the business unit highlights from Q2, and the trends we see heading into the balance of the year, bookings remain generally consistent with our expectations for singles and doubles, while several large projects continue to move to the right. We had some key wins in the second quarter, such as two North American ammonia EPC awards, including Dyno Nobel, worth approximately $600 million, and an ethylene furnace.

Additionally, we recently announced an important win at NAGL, valued at $134 million, to support Europe's first land-based ballistic missile defense system at Romania's Deveselu Air Base. We also were awarded a FEED contract for Petrobras's Canadian Pacific Northwest LNG project.

Moving on to some key business unit highlights, at Gas Monetization, Q2 job income increased 7% year-over-year, due to strong project execution and increased volumes at our two primary LNG projects, Gorgon and Ichthys. Looking forward, we continue to expect strong margins in this business through the continued strong project execution; a mix shift away from lower margin projects, which are at or nearing completion; project milestone achievements; and potential for favorable resolution on project closeout items we have previously discussed.

Additionally, we continue to have a very healthy pipeline of future prospects. For the Kitimat LNG project, the additional FEED analysis is substantially complete, and we are preparing for the EPC competition for the project. For the Gorgon LNG fourth training project, extended pre-FEED activities continue, and we now anticipate a transition into FEED in the first quarter of 2014.

For the Tanzania LNG project, KBR continues to execute pre-FEED activities. For the Tangu 3 expansion train, we are in the bid preparation phase for the FEED, which we anticipate will move forward in the first quarter of 2014.

In the US, we are in talks with a customer regarding a GTL project, and believe that project could reach FEED in 2013. We also continue to track opportunities for additional LNG and GTL developments, maintaining an active dialogue with sponsors regarding opportunities in both areas, and remain enthusiastic that a number of projects will move forward. Regarding our other projects in Gas Monetization, both the Escravos and Skikda projects are now in the commissioning phase.

At downstream, we had a tremendous level of US bookings in the quarter, with a book to bill of 5.8 across a number of key strategic areas. This includes our previously announced Dyno Nobel project, as well as another ammonia EPC project worth approximately $250 million. New awards also include the EPC contract for two new ethylene furnaces utilizing KBR's SCORE technology valued at approximately $100 million. We continue to be bullish on growing prospects in the US for additional ammonia, urea and chemicals projects. We have several bids outstanding, and anticipate an acting -- active bidding environment for the second half of 2013.

From an execution standpoint, the Uzbekistan ethylene project is progressing well, as are our Middle East portfolio of PMC and CM projects. We also have a couple of bids in for FEED and PMC work in the Middle East for refinery and petrochemical projects. And we are seeing increasing engineering work volumes associated with our KBR-AMCDE joint venture.

Technology delivered another strong quarter, with 47% job income growth year-over-year, driven by execution on the business units' backlog build over the past several quarters. In the quarter, we also booked a number of new ammonia and ethylene awards in conjunction with our downstream EPC project awards. We continue to see a robust series of global opportunities for growth across our world-class portfolio of leading technologies, with particular strength in the ammonia and fertilizer spaces, driven by continued strong project economics.

At oil and gas, we continue to perform post-FEED and pre-FID activities for the Shah Deniz 2 project. KBR is also involved in and pursuing two floating LNG developments, one with Hope, and the other with GDF Suez on the Bonaparte project.

At services, we had a strong second quarter, with revenue up 46% and job income up 31% year-over-year. Our Canadian business has doubled in size year-over-year during the first half of 2013. We continue to anticipate a robust flow of new work from the oil sands, as well as substantial opportunities from natural gas, mining, potash and SAGD. During the second quarter, we also saw solid income growth from industrial services and at the building group, driven by new manufacturing-related projects in aerospace and technology.

At Power, our two large EPC projects, SWA and Ghent, are progressing as scheduled. We are also seeing an improved bidding environment for both pollution control and combined cycle projects.

At NAGL, sequestration, government budget uncertainty, and a slower award environment remain challenging. However, we continue to believe this business has generally stabilized at current levels. Our recently announced award for a $134 million contract to support Europe's first land-based ballistic missile defense system at Romania's Deveselu Air Base is a good example of how we're building in backlog. We continue to see other solid opportunities in the marketplace for NAGL over the coming months.

At IGDSS, execution on our Allenby & Connaught and our Afghanistan-related project continues to be strong. While we anticipate the construction component of the Allenby & Connaught project to be completed next year, the services component of the contract will continue to ramp slowly in anticipation of the completion of construction. We are continuing our efforts to diversify this business in anticipation of the Afghanistan activity wind-down and completion of the Allenby & Connaught construction project.

As part of these efforts, during the second quarter, we were awarded a contract by the London Mayor's Office for Policing and Crime to provide facilities, management integrator services to the Metropolitan police service. Building off this award, we see additional opportunities to expand services to other Metro London and UK policing departments. We also continue to pursue new opportunities at the Ministry of Defense through public/private partnerships in the UK and Australia, camp support in the nongovernment market, and potential emerging opportunities in Libya.

Adventures, an ongoing issue at the EBIC ammonia plant in Egypt, is natural gas supply, which has impacted ammonia production. The owners are working on stabilizing natural gas supply, but overall, we still anticipate lower ammonia volumes in 2013 relative to 2012.

Now I would like to turn the call over to Sue to discuss KBR's financial performance and outlook in more detail.

Thanks, Bill, and good morning, everyone. Let me summarize our financial performance and then go deeper on some of the key areas. KBR had a solid quarter of execution with job income up 8% and job income margins improving 153 basis points versus the second quarter of 2012. Hydrocarbons business group job income margins were up 390 basis points, driven by strength in Gas Monetization, downstream and technology. The NAGL, IGDSS, Canada, and industrial services business units also delivered job income margin improvement year-over-year.

Operating leverage was reduced in the quarter by higher business unit overhead, driven primarily by higher proposal costs; higher SG&A expenses, including $11 million associated with implementation costs for our new ERP system; and higher labor costs absorption, or LCA expenses, driven by our resource centers' labor underabsorption of $12 million and $5 million related to an office closure. Over time, we expect to see these three areas return to historical norms, which will help drive bottom-line growth.

Second-quarter revenue was down compared to the prior-year's second-quarter, consistent with our expectations, primarily driven by lower revenues from the Escravos GTL and Skikda LNG projects, which are largely complete. We did, however, see solid revenue growth in two key areas for KBR -- downstream and services, driven by strong bookings over the past several quarters. Downstream revenue was up 33% year-over-year, and services was up 46%, led by outstanding growth in Canada operations of 153%, and robust growth in building group and industrial services up 44% and 27%, respectively.

I'd like to highlight the $11 million of nonrecurring expense that we incurred in the quarter. The first piece of this is the closure of an office, which cumulatively cost approximately $7 million. These costs were split between LCA, which was approximately $5 million, and overhead, which was approximately $2 million.

The second is related to a review of our lease expenses in Australia, which resulted in an unfavorable true-up of approximately $4 million. These costs were split between corporate G&A of approximately $2 million and business unit overhead in IGP of approximately $2 million.

Corporate G&A was $63 million in the quarter, including $11 million in expected ERP costs as that project continues to move forward into implementation. As we look towards the balance of the year, we now expect corporate G&A to be between $230 million and $240 million for 2013, down $10 million from the top end of our previous guidance range of $230 million to $250 million. We also expect ERP costs to be at the high end of the previously communicated range of $30 million to $40 million, based on the pace of the project's implementation. We expect to drive cost savings across other areas to achieve the lower G&A guidance range.

KBR underabsorbed its labor costs in our centralized engineering pool by $17 million. After taking into account approximately $5 million related to shutdown costs associated with the office closure, approximately $12 million remains in LCA expense for the quarter, representing a $3 million improvement compared to the first quarter.

KBR's effective tax rate in the second quarter was 12%, lower than our guidance range of 26% to 28%, primarily due to favorable tax rate differentials on foreign earnings, as well as tax reserve releases related to final negotiations of transfer pricing agreements. For the second half of 2013, we are guiding to an effective tax rate of between 24% and 26%.

KBR's backlog at the end of the second quarter was $13.8 billion, down $411 million from our March 2013 backlog, primarily related to normal project work-off, and adjustments in backlog, based on the Ichthys project equity accounting. The backlog reduction also included a negative FX impact of approximately $611 million relating to the 12% devaluation of the Aussie dollar against the US dollar in the quarter, and the fact that our backlog for both Ichthys and Gorgon are predominantly Aussie dollar-based.

As of June 2013, 48% of our backlog was fixed price and 52% was reimbursable, compared to the 43% and 57% mix we reported for March 2013. The mix shift is primarily attributable to the backlog booked for downstream, which had a large fixed-price EPC component. As we have discussed on prior calls, the types of risk in KBR's backlog include a high percentage of back-to-back contracts, funded contingencies, and KBR home office services. So, in our view, the risks are not as high as the percentages of fixed versus reimbursable might suggest on the surface.

Turning to KBR's balance sheet, we ended the second quarter in a strong cash position with cash and equivalents of $800 million, down $104 million from the previous quarter. Operating cash flow for the second quarter was negative $4 million, which included approximately $108 million of bond draws related to the Pemex EPC-1 dispute. Operating cash flow without the bond draw was a positive $104 million. Also, we had a negative $32 million impact to cash balances related to foreign exchange. Cash deployment in the quarter was $37 million for dividends, pension contributions, and CapEx.

Working capital, defined as current accounts receivable minus current accounts payable, improved $65 million. Unbilled receivables improved $74 million, with improvements across nearly all the business units. The NAGL unbilled receivables balance declined $6 million in the quarter. We continue to work very diligently with our government customer to obtain funding and resolve open items. Improving our working capital position remains a key area of focus for the Company going forward.

Moving on to our guidance for 2013. As Bill discussed, we raised our EPS range to $2.55 to $2.90 from $2.45 to $2.90. There are a number of initiatives and factors we are working through which could impact our earnings.

One of the key areas that will clearly drive our results is the level of improvement in our operating performance in the second half. We have had solid execution through the first half, and we expect to see significant further improvement in operating income and margins in the second half, as we continue to execute on our current projects, and our new projects continue or begin to ramp.

We also anticipate additional singles and doubles in the second half that could add to earnings this year. A second key area is a closeout of certain issues on projects in our Gas Monetization business. We have talked about potential upsides in Gas Monetization on prior calls, and we have a number of issues where successful resolution can provide upside in the second half.

A third area is the potential resolution of a number of litigation matters such as EPC-1, that could also contribute to our results. One final item that I would like to address is the Pemex performance bond draw. I will refer you to our 8-K and 10-Q for all of the details surrounding the ongoing dispute with Pemex on the EPC-1 arbitration award. KBR was successful in an international Chamber of Commerce arbitration award in 2009. The underlying work, for which the performance bonds were posted, was complete.

Through actions and appeals in the Mexican courts, the bonds were drawn for their base value of $80 million plus interest for a total of $108 million, which appears in noncurrent unbilled receivables on uncompleted contracts on the balance sheet. We believe the arbitration award will be upheld, and that KBR will be able to collect on the award as well as recover our cash from the bond draw.

And now I'll turn the call back to Bill for his final remarks.

Thank you, Sue. At this stage of the year, our business is progressing satisfactorily, with large awards slower than expected. We have had solid execution so far in 2013, and our win rate on new awards is improving. While our 2013 labor cost absorption expenses are higher than expected, these have been offset in part by lower tax expenses.

We continue to see a robust series of new opportunities across our 14 market-facing business units. The potential opportunity set for KBR continues to expand, given our solid positioning and capabilities. And I am confident in our ability to successfully win and execute this work, both in the second half of 2013 and beyond.

We will now open the call for questions. We ask that you please limit your comments to one question and one follow-up.

(Operator Instructions). Vishal Shah, Deutsche Bank.

Thanks for taking my question. Bill, I just wanted to better understand the -- how we should be thinking about LCA going forward. Do you need some of the big projects to drive your LCA improvement in the second half and also in 2014?

And can you also talk about the cost increase that you saw in one of the US project? Should we expect any more increases going forward? Thank you.

On the labor cost absorption, we are seeing that being a regional issue for us. We look at weakness in our Australian markets, which we are trying to take steps to correct. And that involves mostly the civil infrastructure business in Australia, which is not megaproject-related. We are seeing weakness in our Singapore and Jakarta offices, which is more oil and gas-centric in terms of their outlook. And we have worked to move some other work into those offices to minimize that impact.

But those are really going to come back based on either the additional work we saw in oil and gas or possibly looking at some of the larger LNG projects going forward. We're also seeing some underabsorption in our London offices. That is -- part of it will get solved with the FID on Shah Deniz when that takes place. And we expect that to take place later this year. But there is also additional FEED work that will help mitigate that. And as we move into Gorgon Train 4 FEED later this year or the first part of next year, that will improve the situation.

We did see some mitigation of the LCA with the PETRONAS FEED, which is being executed in London. But to get the London situation fully recovered, yes, it's going to take some of the larger projects to move forward. Now offsetting that is, we are doing very well in the US. We see very positive labor cost absorption numbers, and we're looking at ways to try to balance off the portfolio effect of LCA. But we're clearly focused on what we need to do in those regional markets, and are maintaining capacity for work that we do believe will come forward.

Now with respect to the US construction projects, the cost we saw really got back to productivity and wage rates. One project -- there is some opportunity to recover some other expenses related to that project, but we do have the fundamental base productivity and the wage rates for the work under contract that we signed up for. But overall, we do feel that the portfolio is appropriately provisioned, and that we do see, across the three US construction projects, prospectively upside opportunities that could balance any future downside effects for further wage increases or productivity impacts.

That's helpful, thank you.

Jerry Revich, Goldman Sachs.

Bill, can you give us an update on the number of US nitrogen projects that you are bidding on currently? And would love your perspective on the delays we have seen for the urea and UAN projects recently. And where do you think the return structures stack up on the various derivative projects?

Well, we have a number of projects we are pursuing. Off the top -- yes, I think there are four of them that we are looking at, at various stages of development that we are pursuing from an EPC perspective. We do think there are other ones out there that haven't gotten to the point where I would say we are actively pursuing them, but we have four of them that we're looking at right now.

The -- I think, in terms of what we expect to see on the margins, we are not seeing any change from our previous comments. These look like -- more like power plants and less like LNG facilities from a margin standpoint, because they are more of a product than a design for the specific fuel type or the specific site. These are all burning pipeline gas. And so they look more like a combined cycle standpoint from our perspective, as far as the economic opportunity for us.

Okay. And in Canada, with the various LNG projects at various stages moving forward, can you just talk about how you see that base and evolving? And what are the implications for construction costs? Depending on when projects move forward, it feels like a pretty concentrated area where the projects are being developed.

Well, I think you're going -- I think, obviously, Canada -- a resource-rich country with a small population, it's just like Australia in many regards. The projects going forward are going to be heavily modularized, and you're going to have to really focus on how you are able to get the residual on-site construction talent either by partnering with folks or having subcontractors who are very strong in construction in those areas. We have got a pretty good construction business in Alberta, but we're also talking to -- have other partners for some of the pursuits that are very strong contractors across Canada.

We're also looking at the opportunity to bring in third country nationals, just to maintain capability to do all that work. I do think you're going to see these projects kind of spread out in time. There was originally talk of four of them moving forward. I think that you are starting to see a separation with that. You will have, ultimately, some challenges in Canada when you look at multiple projects being at various forms of construction concurrently. And we're going to have to manage that by tapping into as much either offshore construction through modular fabrication, coupled with as much resourcing either within Canada, the Western US, or even third country nationals, to come in and help those projects move forward.

Thank you.

Jamie Cook, Credit Suisse.

Two follow-up questions. One going back to the higher LCA, relative to what you originally expected. Is there any way that you can quantify that? I'm just trying to figure out when -- the raise in EPS and trying to figure out how much was tax versus the LCA headwind.

And then I guess just my second question relates to the guidance. Obviously, job income ramped significantly second half versus first half. How much of that is Ichthys? And I guess if you could rank-order sort of where the growth is coming from, and then how much is dependent on new project wins? Thanks.

Under LCA, Jamie, I think our comments, really, it's going to continue to improve. It's probably a slower progression than we had articulated in our original guidance. So it's a little bit slower going, but an improving situation for us. We have elected not to make a formal guide on LCA.

With respect to our guidance for the year, Ichthys will continue to ramp up like a traditional S-curve. We do expect to see contributions from the new works that we are selling. We had a good -- we sold $2.2 billion to $2.3 billion in the quarter, and we are very pleased with what we sold there.

And we are going to get some additional volumes there. We're going to get some additional, we believe, recoveries as we work out the closing issues on -- you know, the LNG and GTL projects are getting towards completion. And so I do think there are a number of areas that we have opportunity to deliver the guidance. And in part, these various areas have caused us not to narrow our guidance maybe as much as we would have in past years. But we do think there is some new work that we want to sell, particularly in our IGP business, to help improve their job incomes for the second half. But we think the opportunity set out there is pretty good for us to be within the guidance range we offered.

I guess, Bill, one last question on EPC-1 or Pemex. I guess the news flow over the quarter was a little bit disappointing from my perspective. Can you just provide how you are viewing the potential for you guys to get cash from Pemex and sort of the timing of when we will have final resolution?

Well, yes, the news was -- it was, for us, mixed at the quarter. We did have some progress in Luxembourg regarding the enforcement of the ICC arbitration. And we believe the -- Pemex continues to lose their protest in the Luxembourg system, and we are working towards a seizure of assets to the extent we can find them in the Luxembourg banking system. And so we continue to have progress there, but that path takes time.

We had a fairly -- in our view, a fairly good session in front of Judge Hellerstein in New York some time ago, at which he said he would rule fairly promptly. We are still waiting for his ruling. But part of his initial ruling was that we were in good shape with respect to our claims on that award. The Appeals Court asked him to go back and consider -- have available remedies, were they available, to KBR in Mexico. And we went back to Hellerstein's request, and have, we believe, proven to our satisfaction what we believe will be the judge's satisfaction that we did not have adequate relief in Mexico for this. And expect that that fact, plus the drawing of our bonds by Pemex -- which the judge really encouraged Pemex not to do -- should help our situation in the New York Court.

So really, we are pursuing very actively two opportunities to recover. And we're also in the early stages of a NAFTA filing to get that money. Net-net what that means with respect to when cash will flow, we don't know. It could -- you could get a ruling from Hellerstein today that could have cash flowing based on his ruling -- assuming the Appeals Court acts fairly quickly on his logic, because we believe Pemex would appeal -- we do believe you could see cash possibly as early as this year. But, again, that would depend on Hellerstein ruling and the outcome from an Appeals Court. But, yes, more likely, it's probably going to drag into '14.

Okay, thank you. I'll get back in queue.

Steve Fisher, UBS.

Bill, where you're seeing costs running up in North America, to what extent are you seeing customers ending up granting better terms and conditions, as opposed to just deferring projects, or compared to just they're still trying to find some contactor to take lump sum terms?

Well, I think their first step is always to try to find a contractor to take lump sum terms. But I think there is a reality setting in where customers aren't generally going to be able to get lump sum construction, certainly in the US Gulf Coast. We have seen, in our contracts, a pretty good risk-sharing that has been developed between the contractor and the owner, where things that we can manage, such as productivity, get allocated more towards us. And where you have labor per diem and other financial matters, we are sharing those risks, you know, to have some skin in the game related to the cost.

So, we do see the market changing. I can't comment on what will happen going forward, particularly as it relates to some of our peers, but from the KBR perspective, we do see an environment where there is a pretty good degree of risk-sharing going on between the customer and the contractor related to those matters that, particularly the wage rates and per diems, that will drive impacts on productivities.

Okay, that's helpful. And then, Bill, are the singles and doubles you mentioned going to be enough to keep your backlog flat over the next few quarters? And does that include an assumption of Shah Deniz?

Well, I think we are operating under the presumption that Shah Deniz will achieve its FID in December, and we would call that a good, solid double for KBR. From a backlog standpoint, I think we did a pretty good job this quarter of -- ignoring -- we had a lot of FX change in the month of June, where I think the Australian dollar went from about [AUD1.02 to AUD0.94], and that took our backlogs down [$600-plus-million].

I think we can get close on the singles and doubles. We have to have all of our business units contribute to get there. I don't think you're going to see it being a downstream-only event. You're going to have to see some pickup in the services group. They were about 0.7 last quarter. And we got -- we continue to be optimistic at Canada. We do see some pretty good opportunities in the rest of the businesses, industrial services and building group.

And we've got to continue to drive sales within the IGP business. I have talked about some of recoveries in infrastructure. I think mining is going to be challenged. Power has got to step up. NAGL has got to step up. And hopefully, we'll see some progress on the diversification efforts at IGDSS. So if we execute, then I think we'll -- you'll be able to maintain backlog generally at its -- about where it is now.

Okay, great, thank you.

Andy Kaplowitz, Barclays.

Bill, can you give us a little more color on the risk of KPC-1 and KPC-2? It seems like you do have some significant disagreements with the customer. How confident should we be that the reserves you have already taken to these projects so far should hold, as you negotiate with the customer going forward?

Well, we've -- we'd looked very closely at where we were on those reserves throughout the month of June. And a lot of these activities took place in May. And then, certainly, when we set the provisions up, we had expected that this work would go on throughout 2013, and we had accrued the potential LD exposure we had for being late and meeting the obligations under our performance -- under our contracts.

As we look at KPC-2, the customer was not going to give us any kind of window of opportunity to go in and do our punch list, and do our performance tests. And with respect to performance tests, we had taken provisions that looked at things in the worst-case. And there's a possibility we could have done better, but we have already provisioned the worst-case.

Now their operational constraints on KPC-2 really are their business. And we just can't afford to keep a full construction team mobilized, including the vendor support reps, to on-site on standby for some chance they might, in the next month or two or three, allow us to go on and complete the punch list.

The plant's in operation; it's running and the customer doesn't want to turn it off. So, we made the decision that our work is essentially complete, and they have not allowed us, by their affirmative actions, to complete our work under the contract. And so we have deemed it complete. The customer would prefer that we stay around on-site to some point that's indefinitely defined in the future, to do these activities. And we've elected to say no, that's not consistent with the contract, and we're going to demobilize.

So there is some disagreement there. You know, KPC-1, we had bid that project to go across a pit, a pit that was very constructible, and we could build foundations and not have movement. However, during the course of construction, the customer elected to put its waste disposals from its coal mining operation in this pit and attempt to fill it up. And right now I've got -- we've got moving soils that are moving significantly in a way that do not allow us to safely or productively build conveyors. I'm not sure how you would build a conveyor that could move several centimeters a month on, in terms of up or down or left or right or forward and backwards.

And so we have filed a change order with the customer, both for time and money, that would allow us to complete those panels across that area. And the customer said, no, that's -- you should fix that and continue your construction, and we're not going to give you any relief. And we feel that we are very clearly entitled to the relief if we're going to continue that. The customer has disagreed with us.

We have had a third-party geotechnical firm look at the movements of the soils in that area. Their results have confirmed our internal reviews of the geotechnical situation. And we feel that we are entitled to relief if we are to complete it. Again, we can't build that safely or productively or cost-efficiently, and therefore, have told the customer that, unless they give us this relief -- including the time to allow this area to appropriately settle, so that we can do our foundation work for these panels -- that we have no choice but to demobilize and declare our activities complete.

So that's the situation we are in on KPC-1. But I think it is an appropriate action on the part of KBR, given the actions caused by our customer that prevent us from performing the work according to how we had planned to execute this work when we signed the contract, and that until we get the appropriate relief in both time and cost to facilitate construction over this new environment created by the customer, that we're going to demobilize and just wait. And so how that plays out remains to be seen. But from our standpoint, it did not make sense for KBR to continue to go forward with this work in a manner that we didn't think would be safe, either to our employees or the safe operation of those facilities for the customer.

Somewhat lengthy explanation, but that's the context.

Okay, that's helpful, Bill. Just shifting gears, I think we can understand the infrastructure, relative weakness in Australia. What I'm having a little bit of a hard time with is on the oil and gas side, I mean, we all know about Shah Deniz and its ramp-up. But oil and gas itself, there's quite a few opportunities out there; yet slowly but surely, your backlog has been coming down in that business. And you talked about some incremental weakness. So where is it coming from? Are customers now taking more time to make decisions? Has it been that you bid on those Middle East projects and you didn't win those, that we heard about last quarter? What is it in oil and gas that's happening?

Well, I think, Andy, what we are seeing is twofold. One, we have been without a leader in that business for a while, and I think that's affected the business. We announced a new leader for our oil and gas business yesterday, and we expect that that will be helpful in getting us more volume. But I think the broader issue is the types of projects that we have performed, which have -- and we performed very successfully, which is design of topsides for oil and gas facilities, we haven't seen a lot of that work.

And so we have seen KBR look for other opportunities, which led us to move more into project delivery with respect to the Middle East projects we bid last year. And we are continuing to look for a bigger play and delivery with respect to FLNG and the two projects I talked about in my comments.

We would still look for those opportunities to do our traditional engineering and lump sum engineering on topsides, and we just haven't seen the volume of work to allow us to get our share on those in the last 18 to 24 months. One observation I will make is, when we had the Macondo issue in the Gulf of Mexico, we said that we would start feeling the impacts 18 to 30 months after it because of the prohibition on drilling at that time. We are suffering through a very low level of activity in the Gulf of Mexico at present. We do see prospects on the horizon, because the drilling that has taken place post the moratorium -- that is 18 to 24 months ahead of where we get active -- has resumed.

So, we do believe our business certainly in the Gulf of Mexico will pick up because of the resumption of drilling in the facilities related to development of oil and gas facilities in the Gulf of Mexico. And so, help is on the way in that regard. But we have a number of things that have impacted us, oil and gas, ranging from the lack of leadership, the Macondo issues, just absence of what has traditionally been our business on topsides design, and the timetable to move into more project delivery opportunities.

Got you. So it sounds to me like maybe sort of a bottoming process now in that business. And then as you ramp up on Shah Deniz, and you get the new leader in place, maybe next year could be better?

Yes, the new leader was with us 18 years before leaving us a couple of years ago, so I expect his learning curve to be pretty fast. And we're looking forward to his impact being felt more quickly than normal because of his legacy knowledge of KBR.

Okay, thank you, Bill.

John Rogers, D.A. Davidson.

Bill, when you have talked about the delays in some of these larger projects, especially getting to the FEED and final decisions on it, is there a point in here -- and I'm assuming you don't want to talk too much about 2014, but -- where you have to really start shifting the targets that you're going after, to fill in for work, if these bigger projects continue to get pushed out?

That's an easy question to ask and a harder question to answer.

Yes, that's (multiple speakers).

We do look at more projects and pursue more projects than we can execute, John. If we were to be able to get all of the projects that I alluded to in our call, we would oversell the physical capabilities for KBR to do that work. So there is an element of attrition that we are planning in our bidding.

And so the first one or two that may get delayed, they might not have any impact on us. But however, if you see several getting delayed, it could have delays across the entire E&C space.

You know, as we look at Shah Deniz, which would be a very, very significant project for oil and gas, that's obviously caught up in a broader project discovery -- you know, related to the pipelines that will get the products to market. And so we are seeing the big projects being looked at from the entirety of the infrastructure. Shah Deniz was -- could have gone forward to FID several months ago, but, again when you're -- as an owner, you're looking at not just our project, but the full value chain to get your product to market, which has delayed us from achieving FID. And candidly, I agree with the owner, that that's the right thing that they need to be doing.

And some of the LNG projects, we have got some of our customers who are waiting to achieve a certain level of heads of agreement on LNG sales, before kicking projects off -- and, again, we had -- Kitimat could have gone to FID several months ago, but the owners are electing to fill out other areas of their value chain before dealing with what is the mainstream activity for an E&C firm.

So I agree with what everybody is doing. They are doing the right things from a business perspective. But across their value chains, it's not just the leadtime for doing a FEED before you get FID, but how does everything else evolve in their businesses to permit them to confidently take an FID on our segment, so that their business model is preserved and meeting their overall risk requirements.

But I guess -- and as you look at this, I mean, are there other -- not completely different markets, but other areas of emphasis or target that you can shift towards?

Well, I think we're looking (multiple speakers) -- we're looking at everything we can. We've -- obviously, putting a lot of emphasis on the US market, driven by our downstream business. And we continue to believe that we can sell more work in that market, and we believe work may come faster in that market compared to our Gas Monetization business, for example.

We've got some really big opportunities in the floating LNG space as well as Shah Deniz that we are looking at in oil and gas. We do see some opportunities in Power that will be out there and bids that we have in place today that we want to drive very strongly towards. There is a lot of opportunity that IGDSS is looking at, but it's high risk in new markets. And, for example, their efforts in Libya, lots of needs have been identified, but do they have the infrastructure to have budgets and cut projects for it? That's something to be seen.

So I think we're taking the appropriate steps to sign up whatever we can that meets our risk-adjusted job income thresholds. And we have opportunities to fulfill the capacity that we are currently carrying. And we're making an investment in the future at KBR by carrying this LCA. And we also believe that we have an opportunity to grow our resource centers by -- growing them 25% would get us back to where we were three years ago.

So, we are not just sitting around waiting for the next LNG project to come in. We're very active in trying to get the business in the house to generate not only the job income, but reversing the LCA charges and getting that turned around to being a positive, as it was a couple of years ago.

Okay, thank you. I appreciate the color.

Tahira Afzal, KeyBanc.

I guess first question is, Bill, at a recent conference, you highlighted around 15 FEEDs and preliminary FEEDs that you were tracking. And I just wanted to see if you have an update on them as a whole, as we go into the second half of 2013 and into 2014?

I don't have anything substantive to say specifically to that. I will say that we are continuing to win some FEEDs, and some FEEDs are being completed. So we still see a pretty good FEED window that we hope will evidence future work when those FEEDs are complete.

Got it.

So, really, we are not seeing any material change to those earlier comments.

Okay. And I guess the second question I have is for Sue, and that's really on free cash flow. If you can provide us any update in how the reason Pemex bond really plays into your cash allocation objectives going forward? And a few quarters back, you talked about DSO improvements and some focus there. Any update on that would be helpful as well. Thank you.

Sure. So as we look at the cash situation, I mean, obviously, as I said, we are very focused on what is happening with working capital and all of the different elements. So we work very hard, and have been working very hard over the last year, to make some improvements. And we have some headwinds with our government customer that's hard to move. And as I said in my prepared remarks, that didn't move very much during the quarter.

The bond draw, obviously, was operating cash, and took the operating cash down to a lower level. But I will also say that one of the things I didn't highlight is that, as we move through the end of the quarter, we did see that we had some timing once again with heavy receipts; in fact, the receipts were $63 million in the first week of July. So, I think the cash flow in the second quarter was better than what it appeared on paper, and is encouraging from an outlook standpoint, in terms of what we're trying to do with improving working capital and doing all of that.

In terms of the cash deployment and the activities, obviously, it is not necessarily the cash balance. It's where the cash balances are located that impacts whether we continue to do our dividend -- which, of course, we do, and have increased that, and plan to continue with evaluating the dividend. We continue to invest in capital to grow the business, as we have said, in our pension obligations. But we didn't make any share repurchases in the second quarter. And, again, that's a function of where we're at US cash and a whole bunch of considerations.

So I think our main focus in terms of cash and the deployment of cash is, one, to right the working capital situation. And that's what the focus is all about. And as that continues, and some of our work continues to shift to more of a US base -- so, for instance, the ammonia project start to be more of a US look, and hopefully, some of the other projects will go forward. Then we will continue to look at adding back the share repurchase to the deployment actions.

Great, thank you very much.

Robert Norfleet, BB&T Capital Markets.

This is John Ellison on for Rob. In regards to your revenues for the second half of 2013, I wanted to know, can we expect to see any meaningful growth here? I know that a lot of the work being booked in the backlog, especially relating to LNG and petrochemicals, is FEED-related. And I want to know if we should expect to see a more muted level of top line growth in the near to intermediate term, before moving towards larger EPC-related work that we expect in 2014 and out-years?

So, John, as we think about where the revenue goes as we look at the second half, I think what we saw in the second quarter is fairly indicative of what happens in the remainder of 2013. Again, we do have some FEED activity coming onboard. We do have other projects ramping up, but we also have the Escravos project and Skikda really not a piece of the overall revenue profile, as they are in the commissioning stage.

So I think where we are at is pretty indicative until we get more of the projects to ramp up. And again, it never hurts to remind that the Ichthys project is an equity-based project -- meaning that it doesn't have the same revenue profile as what, say, the Gorgon project, that's a consolidated project, would. And that also has an impact. But again, I think it looks about like where we are at in the second quarter.

Okay, got you. And with hydrocarbons margins around [14.8%], I wanted to know if we should assume -- like, for the remainder of 2013 -- if this margin trajectory should continue, especially as you mentioned with Skikda and Escravos winding down, and Ichthys ramping up? (multiple speakers) And also to add on to that, also as we look into 2014 with these FEEDs moving to EPC work, while dollar profit will likely increase, should we expect a lower effective margin here?

Yes, I mean, I think your points are valid as we look at this. So what happens to margins over the last part of '13, and as we go into the later pieces where we are booking the EPC contracts, particularly in Gas Monetization -- you know, your -- you've got the Ichthys project, which, again is going to continue to ramp over its five-year period with sort of that bell-shaped curve we're in; about 1.5 years out of the five years. So that continues to grow and does have a good impact on margins. The roll-off of Skikda and Escravos, which were lower margin projects -- albeit great projects -- will continue to show a better margin profile for us going forward, again, because those are rolling off.

Right.

And then to your point on the FEED versus the EPC contracts, as you get into EPC, those margins may be different than the FEED. But again, the business is performing well. We're operating well. You will get a bit of lumpiness, if -- as we talked about in the prepared remarks, that we do get some closeout activities on the projects. But overall, we think they're performing very well and will continue to in Gas Monetization.

Okay, thank you so much.

Brian Konigsberg, Vertical Research.

Thanks for taking my question. Good morning. Bill, maybe just starting with US LNG, so it sounds like you are pursuing a couple of FEEDs here. You know, it sounds like the fundamentals of the market may be getting a tad better. I was just curious, is your interest raising in the prospects for participating in the market? I know you wanted to do some select projects, but maybe just give us an updated thoughts on how aggressive you might be.

Well, I think our criteria for pursuing LNG projects hasn't changed. It remains a global outlook for KBR -- that we'll weigh an opportunity at Tangu, for example, the same way we would on the US Gulf Coast, and try to pursue projects that way. We do look to work -- have a preference for working more with sponsors as opposed to developers of projects. We are interested in finding projects that can provide the right risk and return balance for us.

There is an awful lot of risk allocation that goes in a project financing, that does factor into our internal analyses when we looked at risk-adjusted rates of return. That being said, we are interested in pursuing that market, but want to pursue it in a way that represents a fair risk-adjusted job income for KBR, as well as represents the best and highest use of our people for the project, given all things considered in terms of the risks, the timings, et cetera.

So, yes, we are still interested. We still want to be a player. We think that there is a lot of projects that will ultimately move forward in the US. And we would like to find a way to be a player consistent with how we would like to execute projects from a risk-adjusted job income perspective.

Maybe can you quantify how many you, at this point, intend on trying to participate in?

No. We don't comment on stuff we are interested in. I could say we look at everything, and then we make our calls on what we pursue. And then we have something tangible to talk about, such as a FEED award, we will let you know as quickly as we can.

Okay. And then just moving on to power markets. So it sounds like you are still looking for a combined cycle on some environmental work. Has the discussion changed at all with some of the policy discussions we've had over the last couple of months related to government? I mean, do you find that some of utilities are maybe pulling back on their plans to potentially implement environmental retrofits, and maybe more intend to kind of close down plants instead?

We haven't seen anything directly from those recent discussions on that. Now, where that will manifest itself will be in what projects go out to bid and not. And that may have some impact on that; we can't tell yet.

We did have a flurry of mostly industrial activity after the elections, when it became clear that the proposed boiler Mac rules would get adopted. And we had a number of folks want to move forward on studies and some projects, and we have been executing those. But right now it's a little early for us to see any impacts, and I am sure a lot of utilities that are planning some of the pollution control projects are still trying to digest what these proposed changes or actual changes in regulations mean to them.

Actually, if I could just slip in one more. Just a point of clarification, you mention the FX impact on backlog book to bill. It sounds like the FX, that $600 million is an impact to the balance of your backlog. But I just don't know where are you coming up with the 1.1 times book to bill? Did it actually impact orders during the quarter? Or was it purely a backlog impact?

It was a backlog impact. If you were to -- if you think about it from a mathematical standpoint, we started out the quarter with $14.2 billion in backlog based on the exchange rates at the beginning of the quarter. If you would have taken that beginning backlog and applied the exchange rates at the end of the quarter, that $14.2 billion would have been $13.6 billion.

So when we look at $13.6 billion on the adjusted beginning backlog, relative to the $13.8 billion that we had at the end based on those same exchange rates, there is a $200 million difference. And so when we look at the $2 billion of revenues, and we increase backlog adjusted for exchange rates by $200 million, that's where we get the 1.1 in our mathematics.

Okay, thank you very much.

Will Gabrielski, Lazard.

Last quarter, you guys called out two larger power EPC opportunities, I believe in the US. Have those gone through the bidding phase? And have you been notified yet on those?

We are still working on one.

Okay.

And one we are no longer working on.

Okay. Can you talk about the downstream business margins going forward? Obviously, the margins have been very good, but it's has been a very fee-dominated end market for you or segment for you. And I'm wondering what that will look like going forward, as you move through the EPC phases on your recent large wins?

I think the way we look at it, and it's going to stay really high level, is that we will see dollars of income go up, and go up pretty nicely, and we will see margins come down to reflect the reality of the margins on EPC being less than what we see on FEEDs.

Okay. Can you sustain double-digit margins in that business?

I'd rather not give that forward-looking statement.

Okay. The cost you're holding, the LCA costs, are those being held for open book tenders? Or are those competitive bids, where you are specifically holding capacity for anticipated awards?

We don't break it down that way. We just look out at our business where we think it will be, and we make an assessment, an intuitive assessment, are we better off letting all those folks go? And then when this business hits, so having to rehire and deal with all the training of people -- and we have made the decision every quarter, that the amount of work that we see on the horizon is better for us, as KBR, to carry these costs and these people, because it will be a better solution for us than trying to hire these folks that we may see this -- we expect to see this situation continue to improve. And therefore, the issue, we believe, will ultimately go away.

Okay. Then lastly, just a follow-up on the US Pacific LNG question that was asked earlier. Maybe a different way of asking that is, are you at any level on any project engaged in a contracted feasibility, prefeasibility, early engineering, any type of actual work order you have on any of these larger export jobs in the US?

My comment is still when we have something tangible to share with you, we will.

Okay, great. Thank you very much, Bill.

Robert Connors, Stifel Nicolaus.

Outside Kitimat, it looks like the majority of the gas mon projects are transitioning to the FEED phase. Just wondering if these are the typical 18 to 24 month lead lag before you start to see EPC awards? And related to that, it was a few years ago before the Australian LNG, when we were all talking about that, that I believe KBR indicated the LNG capacity was about five projects at one time that you were capable of executing. Is that still accurate? Or has that changed over the years?

Well, I'll just make a comment relative to what we previously said. And whatever that was, I don't recall at this moment. But the capacity we have to execute major projects -- be they LNG, GTL, downstream, chemical projects, what have you -- remains the same level we commented on previously.

Okay. And then for these -- the majority of those gas mon awards, it looks like outside of Kitimat, they're just transitioning to FEED. Is there anything different where these projects will be sort of that typical 18 to 24 month lead lag before EPC?

I think you've got to draw -- I mean, I think we have been pretty clear on what we've disclosed our role is on these projects. And we don't see anything that's out of the ordinary in terms of what the progression is. Now, we have some of these things like we talked about on Kitimat, where the customer wants to get a certain amount of gas under heads of agreement, which could delay it. But, yes, the market hadn't changed in terms of really where the timing is once you start a FEED and how long you go until you have an FID.

Okay. And if I could squeeze in one more, just sort of strategically. When KBR bought BE&K, if I recall correctly, BE&K was largely a southeastern US contractor. So just wondering if their skill set is easily transferable to the US Gulf Coast, where much of the construction labor supply is non-unionized? And do they need to develop the direct hire capabilities -- or excuse me -- direct hire relations in that region? Or is it easily transferable?

Well, BE&K was a non-union contractor throughout the Southeast. One of their projects was a combined cycle project for the lower Colorado River Authority in Waco, Texas. They fit in nicely to what residual capabilities we had at the Brown & Root construction business. And that's positioned us to be able to be a very -- to date, a very successful EPC contractor for projects that have been driven by the shale advances.

So there's nothing that we're -- we needed to do at BE&K to prepare for this market. They were already there, in terms of capabilities, networks and then the integration with our Brown & Root construction.

We'll move to your final question. That will come from Michael Dudas from Sterne, Agee.

That's it. Everything's been asked and answered, Bill and Sue. Thanks a lot.

Well, thanks for bearing with us, Mike. It's great chatting with you (multiple speakers) --

Yes, that was good.

(multiple speakers) -- and now we can conclude our call.

Really enjoyed it, Bill. Yes, thank you. la

We will give you a Mulligan question next time. But thank you.

Not at all. Have a great weekend.

Okay, well, thanks, everybody, for joining us. I know we've gone a little bit over our time, and we appreciate your continued interest in KBR.

And that does conclude today's teleconference. We thank you all for your participation.