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KBR (NYSE:KBR)

Q1 2010 Earnings Call

April 29, 2010 11:00 am ET

Executives

William Utt - Chairman, Chief Executive Officer and President

Susan Carter - Chief Financial Officer and Senior Vice President

Rob Kukla - Director of Investor Relations

Analysts

Vance Edelson - Morgan Stanley

Michael Dudas - Jefferies & Company, Inc.

Barry Bannister - Stifel, Nicolaus & Co., Inc.

Peter Chang - Crédit Suisse First Boston, Inc.

Andy Kaplowitz - Barclays Capital

Will Gabrielski - Broadpoint AmTech, Inc.

Steven Fisher - UBS Investment Bank

Operator

Good day, and welcome to the KBR First Quarter 2010 Earnings Call hosted by KBR. [Operator Instructions] For opening remarks and introductions, I would like to turn the call over to Mr. Rob Kukla, Director of Investor Relations. Please go ahead.

Rob Kukla

Thanks, Brandon. Good morning, and welcome to KBR's First Quarter 2010 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 first quarter results is available on KBR's website.

Joining me today are Bill Utt, Chairman, President and Chief Executive Officer; and Sue Carter, Senior Vice President and Chief Financial Officer.

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

Before turning the call over to Bill, I would like to remind our audience that today's comments may include forward-looking statements reflecting KBR's views about future events and their potential impact on performance. These matters involve risks and uncertainties that could impact operations and financial results, and cause our actual results to differ from our forward-looking statements. These risks are discussed in KBR's Form 10-K for the year ended December 31, 2009, KBR's quarterly reports on Forms 10-Q and KBR's current reports on Form 8-K.

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

William Utt

Thanks, Rob, and good morning, everyone. From an earnings perspective, I was disappointed in KBR's first quarter results. However, I feel the earnings shortcomings was more the result of timing issues as opposed to unexpected costs or slowing of KBR's business. From an investor perspective, KBR's international lump-sum turnkey EPC projects frequently do not cooperate with smooth and efficient financial reporting. Let me elaborate.

For the Yemen LNG project, Train 2 successfully achieved ready for start up on March 12 and care, custody and control of the Yemen LNG project has been turned over to the client. During the quarter, KBR booked additional provisions for subcontractor claims resulting in a $6 million loss. Also during the quarter, we achieved agreements with the client on change orders to recover prior provisions related to scheduled liquidated damages, as well as subcontractor claims. However, we were not successful in concluding these change orders during the quarter.

We believe these change orders will be concluded and recognized next quarter. At the Tangguh project, the client is operating the LNG plant and both LNG trains are producing LNG for shipment. However, as a result of our client's sales commitments for LNG, KBR was requested to delay performance testing of the LNG plant, which would require a shutdown of the LNG trains. As with the Yemen LNG plant, KBR has fully provisioned the expected level of scheduled LDs and subcontractor claims. KBR is also discussing with the client change orders to close out the project that would provide recoveries of prior scheduled LDs, as well as subcontractor claims.

We believe these change orders will be concluded during 2010. The Tangguh project did not impact KBR's earnings during the first quarter. Also during the first quarter, KBR saw LogCAP revenues fall $553 million from the prior-year first quarter. This decline was not unexpected and is consistent with the announced decline in troop count in Iraq. Also, KBR continued to transition its operations in Afghanistan, and expects LogCAP activities in Afghanistan to cease by the summer.

During the quarter, KBR did not recognize any award fees from the LogCAP contract. This represents an estimated $0.05 per share impact during the quarter. During the first quarter, Award Fee Boards were convened for the period May 2008 through August 2009. We expect to receive the results of this Award Fee Board determination during the second quarter of 2010.

During the 2010 first quarter, KBR did have several business units that reported improved results over the 2009 first quarter. The Hydrocarbons business group revenue was up 4%, with job income up 5% over this period. Within the Infrastructure Government and Power business group, the International Government and Defense and Power and Industrial units reported job income growth of 29%, and 56% respectively over the 2009 first quarter.

Services job income was up $1 million for the first quarter, despite a $60 million decrease in revenue from the 2009 first quarter.

Corporately, we continue to work hard to manage our corporate overhead expenses, which were flat compared to the same quarter of last year. I would now like to make some comments on several of KBR's discrete business units.

For our Gas Monetization business unit, the Gorgon LNG, Pearl GTL and Skikda LNG projects were positive contributors to this quarter's results. The Inpex Ichthys FEED and the Pluto 2 and 3 FEED, as well as the Browse LNG basis of design projects are proceeding as planned and also contributed nominally to the quarter's results. Also during the first quarter, KBR was awarded additional scope on the Pluto 2 and 3 project for procurement services of long-lead items for the Pluto 2 segment of that project.

For our Oil & Gas business unit, work continued on a number of FEED projects and we expect to convert these FEEDs into detailed design during 2010. Additionally, KBR recently announced the acquisition of Houston-based Energo Engineering. Energo expands KBR's offshore capabilities in the areas of Integrity Management and Advanced Structural Engineering. Energo's advanced structural engineering capabilities includes specialty hurricane, earthquake, ultimate strength and blast analysis and design.

For our Downstream business unit, EPC packages have been received on the Yanbu project. Regarding the withdrawal of ConocoPhillips from the Yanbu project, it is KBR's current understanding that this withdrawal may delay commencement of construction activities by one month. Separately, FEED activities continue on the Ras Tanura Integrated Project. The two refinery projects in Africa continue to move forward. We expect the first phases of the EPCM for the Lobito refinery project in Angola will move forward during the first half of 2010. We also expect FEED activities to commence on the PetroSA refinery project later this year as well.

I continue to be pleased with the Technology business unit's performance with revenues up 50% and job income up 33% compared to the 2009 first quarter. During the first quarter, Technology signed a collaboration agreement with BP to promote market and execute licensing and engineering services for the slurry bed residue and coal upgrading Veba Combi Cracker or VCC Technology.

As a result of the increased levels of professional services in KBR's backlog related to our recent awards, during the first quarter, KBR expanded its primarily hydrocarbon-based technical staff by 586 people or approximately 10%.

For our North American Government and Defense business unit, I previously commented on the impacts of the continued reduction of troops in Iraq and the transition of KBR's LogCAP III activities in Afghanistan. In early March, KBR was awarded its first task order under the LogCAP IV contract to execute Corps Logistics Support Services, Theater Transportation Mission and Postal Services in Iraq. KBR booked approximately $100 million to backlog on this initial LogCAP IV logistics task order. We expect full transition from LogCAP III to LogCAP IV to occur over the next 120 to 210 days.

Also, bids for Iraq-based Life Support Services are due to the customer by the end of April. Finally, the third-party protest on the Turkey-Spain Base Operations contract awarded to KBR was rejected, and transition activities are expected to get underway shortly.

KBR also realized several favorable evolutions on legacy LogCAP III contract issues during the quarter through a series of favorable judicial determinations around our protections under the Defense Base Act and political question doctrine. Support from the U.K. Ministry of Defense and former officials in the U.S. Department of Defense in response to active and threatened litigations supporting KBR assertions regarding our responsibilities as a contractor on the battlefield, as well as the seating of senior Department of Defense panels designed to break the logjam and facilitate settlement of legacy LogCAP issues.

KBR's charges for the quarter related to these legacy LogCAP III issues totaled $10 million. We believe that charges such as these to resolve legacy LogCAP III issues may continue for the balance of 2010.

The International Government and Defense business unit performed well compared to last year's first quarter as we continue to support the U.K. Ministry of Defense on several projects in Afghanistan, and on the Allenby and Connaught project.

Our Infrastructure and Minerals business units saw results fall from the prior quarter, as well as last year's first quarter, as global infrastructure spending continued to contract.

The Power and Industrial business unit generated 55% growth and job income over last year's first quarter, and benefited from increased work on an activated carbon project in Louisiana and a waste-to-energy project in Palm Beach, Florida.

KBR's Services business unit performed acceptably during the quarter, led by an active quarter for awards at our Building Group.

During the quarter, Building Group was awarded a $47 million contract by the U.S. General Services Administration, a contract by the Medical College of Georgia for a new $112 million School of Dentistry, and a $52 million contract by the state of North Carolina Department of Health and Human Services.

Services was also awarded a contract to provide instrument and electrical support services for capital projects, turnarounds and continuing maintenance needs to Shell's chemical plant in Deer Park, Texas and its refining joint venture facilities with PMI Norteamérica.

In Canada, Services was awarded a contract by International Alliance Group on behalf of Consumers Cooperative Refineries to provide fabricated pipe spools for an industrial facility in Regina, Saskatchewan.

Also in the first quarter, Services mobilized on 16 new sites for DuPont for an award that was announced last quarter.

After Sue's comments, I will comment in more detail on the market outlook for our business before turning the call over to questions. Sue?

Susan Carter

Thanks, Bill. I will review KBR's consolidated first quarter 2010 results, which primarily focuses on year-over-year comparisons. Consolidated KBR revenue totaled $2.6 billion in the first quarter of 2010, a $569 million or 18% decrease from the prior-year first quarter. Over this time period, the North American Government and Defense revenue declined $553 million or 35%, primarily related to a 27% reduction in troop levels on our Iraq-related services.

Revenue in our Technology business unit increased 50%, International Government and Defense increased 34%, Downstream increased 18%, and Gas Monetization increased 3%.

Consolidated operating income was $99 million in the first quarter of 2010 compared to operating income of $144 million in the first quarter of 2009. Net income attributable to KBR for the first quarter of 2010 was $46 million or $0.29 per diluted share, compared to $77 million or $0.48 per diluted share for the prior-year first quarter.

The first quarter of 2010 net income was impacted by lower year-over-year volume on LogCAP III work, the absence of award fee income accrued on LogCAP III, which impacted earnings per diluted share by $0.05, and decreases in Gas Monetization job income.

Gas Monetization revenue was $675 million in the first quarter of 2010, up $19 million from the first quarter of 2009. Job income was $53 million in the first quarter of 2010 compared to $65 million reported in the first quarter of 2009. Job income for the first quarter 2009 was positively impacted by the reversal of accruals totaling $16 million on completed EPC projects, which did not repeat in the first quarter of 2010.

Lower activity on the Pearl GTL project, slower activity on the Skikda LNG project and the absence of incentive FEEDs on the Escravos GTL project.

Partially offsetting the job income decline was increased Gordon LNG project on focus shifted from FEED to EPCM services in several LNG FEED projects.

Oil & Gas revenue was $84 million in the first quarter of 2010 compared to $95 million in the first quarter of 2009. Job income was $16 million in the first quarter of 2010 compared to $18 million in the first quarter of 2009, which included a net $7 million charge to an unfavorable arbitration decision related to the In Amenas project and several small one-time gains. The decrease in job income primarily relates to several technical services projects that were either complete or near completion at the end of the first quarter of 2010.

Also, the first quarter of 2010 included $3 million in additional costs related to GVA restructuring and legal costs related to the upcoming hearing on the Barracuda-Caratinga bolts arbitration.

Downstream revenue was $133 million in the first quarter of 2010, up $20 million or 18% compared to the first quarter of 2009. Job income was $22 million in the first quarter of 2010 compared to $6 million in the first quarter of 2009. The increase in job income primarily relates to increased work on the Lobito refinery in Angola and several petrochemical projects. Also, the first quarter of 2009 was impacted by additional costs related to the commissioning and start up of the EBIC ammonia project.

Technology revenue was $30 million in the first quarter of 2010, up $10 million or 50% compared to the first quarter of 2009. Job income was $12 million in the first quarter of 2010 compared to $9 million in the first quarter of 2009. The increase in job income primarily relates to several refining technology packages for a facility in Angola and a new ammonia project in Turkmenistan.

North American Government and Defense revenue in the first quarter of 2010 was $1 billion compared to $1.6 billion for the prior-year first quarter. Job income was $36 million in the first quarter of 2010 compared to $74 million in the first quarter of 2009. The decrease in job income was related to no award fees in 2010 compared to approximately $21 million in the prior-year first quarter, and lower overall volume on the LogCAP III project, which impacted job income by $14 million.

International Government and Defense revenue in the first quarter of 2010 was $94 million compared to $70 million for the first quarter of 2009. Job income was $18 million in the first quarter of 2010 compared to $14 million in the first quarter of 2009, an increase of 29%. The increase in job income was primarily related to increased contingency, logistics, operations and maintenance services for the U.K. Ministry of Defense.

Infrastructure and Minerals revenue in the first quarter of 2010 was $73 million compared to $86 million for the prior-year first quarter. Job income was $18 million in the first quarter of 2010 compared to $24 million in the first quarter of 2009. The decrease in job income was related to the completion or near completion of several water projects in Australia and the U.K.

Power and Industrial revenue in the first quarter of 2010 was $97 million compared to $104 million for the prior-year first quarter. Job income was $14 million in the first quarter of 2010 compared to $9 million in the first quarter of 2009, a 56% increase. The increase in job income primarily relates to increased activity at an activated carbon project in Louisiana.

Services revenue was $415 million in the first quarter of 2010 compared to $475 million in the first quarter of 2009. Job income was $37 million compared to $36 million for the prior-year first quarter. The increase in job income was driven by increased activity on the Scotford Upgrader project in Canada, which was partially offset by reduced work volume at some industrial services sites.

Ventures job income in the first quarter of 2010 was $9 million compared to $8 million for the first quarter of 2009, which benefited from $8 million in income on two road projects related to favorable U.K. tax rulings. The increase is primarily related to improved financial performance at the EBIC ammonia project.

Now let's review other financial items. General and administrative expenses for the first quarter of 2010 were $49 million, flat from the first quarter of 2009. Sequentially, the corporate G&A was down $11 million, primarily related to lower tax consulting and legal costs and a $4 million write-off of the Westside campus in the fourth quarter of 2009 that did not repeat in the first quarter of 2010.

For the full year 2010, our current estimates for corporate G&A expenses remain in the $230 million range, driven by general wage adjustments and expenses related to enhancing our IT systems.

Our effective tax rate in the first quarter of 2010 was 36%, which is slightly higher than our statutory rate of 35%. We continue to expect the full year 2010 effective tax rate to be approximately the U.S. statutory rate of 35%.

The backlog as of March 31, 2010 was $13.3 billion, up 5% from a year ago, March 31, and down 5% compared to the sequential quarter. Contributing to the sequential backlog decline was Gas Monetization, which declined $485 million from normal project work-off and modest declines across the IGD business units.

Services backlog was up during the first quarter of 2010, bringing a 49% growth in backlog for Services over the past two quarters. Overall, the backlog portfolio mix at the end of the fourth quarter was 81% reimbursable and 19% fixed-price. Approximately the same mix we reported from the sequential quarter.

Next, I will discuss our liquidity and balance sheet. Cash flow from operations for the first quarter of 2010 used $5 million, which includes an approximately $95 million increase in working capital primarily due to the timing of payments associated with Iraq-related activities. This is a timing difference, which has reversed in the second quarter of 2010.

In addition, our Skikda working capital decreased by $24 million in the first quarter of 2010. Already in the second quarter of 2010, we have received payments from the customer, which begins our anticipated 25% reduction of working capital on this project, which we anticipate will occur over the remainder of 2010.

At the end of March 2010, our balance sheet remained strong with cash and cash equivalents of $908 million, which net of $264 million of cash associated with our consolidated joint ventures was approximately $644 million.

During the first quarter of 2010, we had capital expenditures of $14 million. We invested $20 million in the BP VCC Technology, which Bill mentioned earlier. We bought back approximately $1 million in shares and we paid $8 million in a quarterly dividend. In addition, in the second quarter of 2010, we closed the $16 million acquisition of Energo Engineering.

Also on the balance sheet, you will notice two new entries for current and noncurrent nonrecourse project finance debt totaling $105 million related to our fast-track project. A variable interest joint venture entity that operates and maintains a portion of the British Army's heavy equipment transport fleet.

Effective January 1, 2010, upon the adoption of FASB ASC 810, we determined that we are the primary beneficiary of this project entity and therefore, we now consolidate this joint venture for accounting purposes.

Before turning the call over to Bill, I would like to recap a few of the financial items in the quarter. The first quarter of 2010 results include an estimated impact of $0.05 per share related to the absence of award fee accruals for the LogCAP III project, an approximate $10 million impact on accrued costs on existing legal issues and unallowable costs on the LogCAP III project and $3 million in cost in the Oil & Gas business unit for restructuring at GVA and legal costs related to the upcoming hearings on the Barracuda-Caratinga bolts arbitration.

When comparing the first quarters of 2010 and 2009, there was a net $12 million negative impact related to foreign exchange and interest income net of expense primarily related to lower cash deposit rates, higher credit facility fees and the result of generally strengthening U.S. dollar. We also expect capital expenditures to total $55 million for the full year 2010.

We remain comfortable with the full year 2010 guidance range of $1.50 to $1.80 per share, which we updated on last quarter's conference call due to the changes in the LogCAP III award fee accruals.

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

William Utt

Thanks, Sue. I'd like to provide KBR's outlook for our businesses. In our Gas Monetization business unit, we continue to see our most attractive markets in Australia. We believe we are competitively positioned to win additional new work on the Inpex, Pluto 2 and 3 and Browse LNG projects over the next two years. We are less bullish on Africa and other markets as we see a slower development of these opportunities, which are generally expected to lag behind developments in the Australia market.

In our Oil & Gas business unit, we continue to see a strong level of global activity. As mentioned earlier, we are looking to turn several FEED studies into detailed design during 2010 and are positioning our offshore business to move deeper into project delivery from our recent focus on engineering services. We also see several excellent opportunities in the Caspian and West Africa regions that we hope will add to our backlog over the next 18 months.

Additionally, giving KBR's unique expertise in both hydrocarbons, as well as working in Iraq, we feel we are competitively positioned to win additional hydrocarbon work associated with the rebuilding of the Iraqi oil sector.

Our Downstream business unit expects to see continued recovery of spending in the Middle East, evidenced by the expected near-term commencement of construction activities on the Yanbu project and the continuation of the Ras Tanura FEED project. KBR also expects to move into the next stages of development on our African refinery projects during 2010.

We are also seeing an uptick in activity in many of the markets served by our Technology business unit, which typically is a leading indicator of future volumes of engineering and construction work in the downstream sector.

Overall, we continue to see margin pressures throughout our Hydrocarbons business, as our customers continue their efforts to drive down margins and cost at every part of the value chain. Additionally, we are seeing very aggressive bidding behaviors as companies seek to rebuild their backlogs to more comfortable levels.

For our Government and Defense business units, troop drawdowns will take place as scheduled in Iraq. We expect to complete our LogCAP activities in Afghanistan by the end of the summer, but we'll still see activity in Afghanistan primarily through our International Government and Defense business unit supporting the U.K. Ministry of Defense and NATO forces.

We are also seeing several interesting non-Defense opportunities arising at both our North American and International Government and Defense business units with other non-Defense customers, as well as new Defense customers throughout the world.

Fuel switching and environmental concerns in the U.S. power markets are driving a higher level of proposal activity for our Power and Industrial business unit. We are looking for an increased level of awards on gas for our powered plants and environmental control projects during the second half of 2010.

While our Services business unit has seen a good series of awards in our Building Group, the U.S. and Canadian construction and maintenance business remains mixed. On the positive side, we are seeing a continued strong level of activity in our Maintenance and Small Capital Projects businesses. We are seeing signs of increased activity in the Alberta oil sands region. We are seeing some renewed activity in the U.S. construction market, generally on small to midsize projects. We are not yet seeing a return of larger domestic construction projects.

Overall, I would expect Services backlog to remain flat to slightly growing during 2010. So as I conclude my comments on KBR's 2010 first quarter, I feel that the quarter was impacted by timing issues on several projects and I believe these issues will be sorted out and successfully resolved during 2010 so as to permit KBR to meet its 2010 expectations.

Now we'll take your questions. We ask that you please limit your comments to one question and one follow-up. Thank you.

Question-and-Answer Session

Operator

[Operator Instructions] We will now take our first question from Steven Fisher with UBS.

Steven Fisher - UBS Investment Bank

I just wanted to follow up and understand the interest expense dynamics a little bit better. I know, Sue, you mentioned the debt coming on the balance sheet, but how does that drive the interest expense that you reported -- I think it was a net of $4 million in the quarter, should that be kind of quarterly run rate going forward? And how does that translate to an interest rate?

Susan Carter

It's actually -- let me start out some of the comments, Steve. It is primarily fees related to the new revolver. So we're amortizing the fees that were associated with that, and that is actually the biggest piece of that. So the actual interest expense is actually a very small piece of that on the revolver. So the majority of it is actually funding fees and origination fee amortization on the new credit facility.

Steven Fisher - UBS Investment Bank

So is this the run rate that we should expect on a quarterly basis for the rest of the year?

Susan Carter

Yes, I think that's correct.

Steven Fisher - UBS Investment Bank

Bill, the first quarter run rate below the annual guidance, you mentioned a number of things that you expect later in the year. I mean what are the most important things that have to happen in order to ramp up to that guidance? Where are you more confident. and kind of where do you see the bigger risk at this point?

William Utt

Well, I think the two change orders, Steve, I alluded to are really at front and center for the Gas Monetization business. These are change orders that we expect to be $0.15 a share or better, each. I think that Yemen change orders probably a little bit ahead of the discussions on Tangguh, but the discussions have been cordial with the customer and I think it's a matter of time before we get the final documentation in place. We also are expecting to see the award fees come in. We have a big chunk that's out there in the second quarter based on the Award Fee Boards that were convened in March. As you recall, we took -- because of the actions on the period from January '08 to April '08, our ability to reasonably estimate those fees changed, and so we had to take the provisions in the last year. We're looking to see some of that award fee come back and we believe in the second quarter, but during the course of the year, you could see some fairly large lumpy award fees, perhaps one around midyear and maybe one towards the end of the year hitting the KBR P&L. And I think we'll have probably -- continue to see some continued resolution of some legacy LogCAP issues that might offset those two. But those are the four things that I think that we're looking at here as being areas that we want to focus on and make sure we manage appropriately to achieve our expectations.

Steven Fisher - UBS Investment Bank

And if you got a favorable decision on the award fees this quarter, would that change the way you're currently accruing the LogCAP III for the rest of the work that you have there?

William Utt

No, I don't think it would change the accruals. We're getting ready to transfer the LogCAP IV scope and that contract is not grandfathered from the accounting pronouncements that came out recently. In contrast, the LogCAP III that was -- as LogCAP III tails down and we move on to LogCAP IV, we wouldn't even have any opportunity to do that. But I think we're prudent given the environment we're in to recognize those as awarded.

Operator

We will now take our next question from Jamie Cook with Credit Suisse.

Peter Chang - Crédit Suisse First Boston, Inc.

It's actually Peter Chang calling in for Jamie. You guys made some comments about some opportunities in the Oil and Gas business in Iraq. And I just wondered if you could provide a little bit more color and perhaps some thoughts on timing.

William Utt

You're aware that they've been out due to -- I think around 10 different companies with concessions to rebuild the Iraqi oil infrastructure. We have been contacted by a lot of people and we have submitted bids to a few of the firms to support them and their infrastructure development that they believe is necessary to bring the volumes of Iraqi oil supply to the levels that they've committed to in their agreements with the Iraqi Government. Right now, we're seeing the early phases are there. We're seeing the oilfield service companies, Schlumberger, Halliburton, Baker Hughes so they're performing work and as that cycle of work matures, then slightly downstream firms like KBR will see opportunities to build the infrastructure that once the oil is able to come out of the ground, then it can be taken to market. So we're optimistic that, we've got a compelling value proposition given our seven years of experience in Iraq and also the Hydrocarbons business that as the Shells and Exxons and BPs and some of the national oil companies move forward on their work, that I think KBR is very well positioned to get that work.

Peter Chang - Crédit Suisse First Boston, Inc.

And will this work be bid out lump-sum turnkey, and do you expect sort of the competitive dynamics that we're seeing in maybe like Saudi Arabia also take place in Iraq?

William Utt

I think there will be a lesser tendency to bid lump-sum turnkey in Iraq, and I'm making a relative judgment because the environment's fairly uncertain there. You still have some activities that are considered hostile or quasi-hostile. I think most of it's going to be -- I think the work will tend to be less lump-sum turnkey compared to what we see in Saudi Arabia, for example. But as the market matures, I think that the project execution across the region will converge, but initially I think we'll see more reimbursable work out of that market until things are fairly more routine in people's minds.

Operator

Our next question will come from Barry Bannister with Stifel Nicolaus.

Barry Bannister - Stifel, Nicolaus & Co., Inc.

Did you say, Bill, that there was a $10 million increase in legal fees associated with past LogCAP III legacy issues?

William Utt

No, I did not. The $10 million, Barry, part of its legal fees, part of it are provisions we've taken on some of these issues from 2003 and 2004. The aggregate of which is the $10 million. Ballpark, very rough order, it was about 50/50.

Barry Bannister - Stifel, Nicolaus & Co., Inc.

So are we talking about continuation of that on a quarterly basis per the conversation earlier so that we're totaling approximately $40 million for the year, or would it be less?

William Utt

We're hoping it would be less. We do believe that as we move forward on some of these legacy issues, we'll start clearing our debts and there may be some charges there. But I really can't tell. It's really issue-dependent on the outcome, particularly the panels and how they look at things. It's certainly our hope we'll be able to manage it perspectively at a lower level than what we saw in the first quarter.

Barry Bannister - Stifel, Nicolaus & Co., Inc.

And then long-lead time Pluto 2 procurement seems to be beyond the scope of a typical FEED. So are these client releases that are a quasi-award proportions of a pending project? Or is it all pretty normal for a FEED to do that sort of thing?

William Utt

I can't recall this effort being part of a FEED on the prior FEEDs we've done on the LNG side. I would think that there is obviously within the LNG project, some long-lead time efforts and procurement services that somebody needs to do, and our award is, I think reflective of the strength we've had in performing the FEED work, and we were very pleased to have received that work mandate from Woodside.

Operator

We'll now hear from Andrew Kaplowitz with Barclays Capital.

Andy Kaplowitz - Barclays Capital

Bill, if you exclude -- I think you said there was a $6 million charge on the Yemen Project. If you exclude that, you're talking about almost 9% gross margins in Gas Monetization. My question is, is there anything to stop that margin from going double-digit once we get Tangguh and the Yemen behind us, do you expect that to happen?

William Utt

Yes, I do. I think simply as we run down Skikda and Escravos that our margins should continue to increase. I think the one area that we're trying to get a better handle on here, and I would ask you and others to think about this, is while our backlog went down in the Hydrocarbons from last quarter, we believe we're seeing a roll off of a lot of third-party costs of subcontracts, materials and equipment coming out of our backlog as we work off Skikda, as we work off Escravos. And we seem to be replacing that with more professional services work. And that's how we're looking at the increase in headcount of 10% in the Hydrocarbons business in light of a shrinking backlog. So we're seeing a change in complexion within our backlog to get more towards professional services. I think as we see that, Andy, I think your thesis that the margin should go up, should go to double-digit, I think holds, and that's what I ascribe to.

Andy Kaplowitz - Barclays Capital

And they could do that this year? We're not talking about 2011 or '12, right? They could do that this year?

William Utt

Well, I think the -- obviously, we took some hits on Yemen this quarter. If we factor in the impact of those change orders that I talked about earlier, I think you could see some upside on the margins beyond what we saw this quarter.

Andy Kaplowitz - Barclays Capital

And then if I focus on -- one thing that I was interested in is your Infrastructure and Minerals business now that you broke it out. It seems like -- I mean you talked about that business picking up over time but when you break it out, it looks like it's just kind of flattish. So are you seeing a pick up there and do you expect to see better new awards as you go forward?

William Utt

Yes. What we're seeing in the Infrastructure business is it's really pretty flat here in the U.S. In fact, it's shrinking. We just haven't seen any impact on the stimulus at all and that's a smaller impact to us. We are seeing in the Australia market where we've got our biggest concentration of infrastructure, some pick-up in activity and awards in the transport sector that we think will bode very well for us over the next two or three quarters through 2010. On the Minerals business, we are seeing an increase in activity led largely by the increased consumption of iron ore and coal in China, where we believe our backlog related to minerals projects in Australia will pick up in the second half of the year. We're seeing a lot of proposal activity right now as well.

Andy Kaplowitz - Barclays Capital

If I can just summarize these two questions, I mean one thing that's just hard to understand a little, but I think I do, is it seems like you're absorbing $0.04 a quarter of these extra sort of legacy LogCAP stuff in your guidance. Is there anything that you want to highlight that's actually better than our expectations that's helping you do that as you go throughout the year?

William Utt

Well I think, one, there's our view that there's a little bit of an overhang on KBR, you'd call it a dark cloud regarding LogCAP. And we specifically wanted to talk about some of the good things that had happened this quarter that we think bodes well for us in getting towards a resolution of the numerous items that we've described in our 10-K. So we have, in my mind, some real positive momentum on getting some resolutions. Secondly, as we look at the transition in the LogCAP IV, we are hitting the margin expectations that we have been discussing since the IPO back in November of '06. We expect the logistics work that we got the initial task order on and expect to transition this year. That's mid-single-digits-based fee. And that's a big pick-up for us, compared to the 1% based 2% award fee we historically have had, and even a bigger pick-up compared to the 1% base that we recognized in Q1 with the absence of the award fees.

Operator

Our next question comes from Vance Edelson with Morgan Stanley.

Vance Edelson - Morgan Stanley

Bill, when you think about the troop drawdown in Iraq, which you mentioned will take place as scheduled, any changes in your mind to how long-tailed it might be in the coming years relative to your thinking six months ago or 12 months ago?

William Utt

No change in thinking from six to 12 months ago regarding the tail. And we really don't have any inside information other than you can look at where we are. We still got people in Europe from World War II and while that's a very dramatic example of the U.S. bases in Germany, I think they'll be a force there for a while. But it certainly -- for two or three years, I feel that we're going to have a presence there. And I'm not suggesting we'll be there for 50 years, but we do have a continuing interest strategically and militarily in that region to make sure it's settled. And so I think that level should continue for a while. At least for what we look at as our foreseeable future.

Vance Edelson - Morgan Stanley

And with the change orders not completed on the LNG projects, could you point to anything in particular that happened that caused the delay? Or would you say the initial thinking was just a bit too optimistic in retrospect?

William Utt

Well, things always seem to take longer in the LNG world internationally than we'd like. And when we put together our budgets last October, we looked out and thought that from October, we saw a path to get this concluded in first quarter. And we were incorrect. But we do have new information that we referenced in the specific comments of what the client has accepted and we're in the process of doing the documentation, and regrettably for our quarterly reporting, we find that when you go through government agencies, the IOCs, and as well as E&P companies, things take a little bit longer to get buttoned up than perhaps dealing with a single customer in the U.S. market environment setting.

Vance Edelson - Morgan Stanley

And maybe on that exact topic about the delays, you mentioned the stimulus doesn't seem to be having any impact yet. Are there any signs of life there? Or are there any of the delays that you've seen that you think might be forces that are lifted in the coming months?

William Utt

Well my comments regarding the stimulus spending relate to our Transportation and Infrastructure business in Texas and a little bit in Alabama. And we're watching, waiting and looking. And for the services that we provide, we haven't seen -- we do a lot of construction management, and we haven't seen projects in those areas come forward, and our businesses have declined in their size because of the apparent shrinkage of the construction work. And we're not seeing the volume of design services that we had hoped to. And again, we're dealing with a small microcosm of the U.S. infrastructure market. But certainly, in the areas where we are present, we are not seeing the positive impacts to our business from stimulus spending.

Vance Edelson - Morgan Stanley

And just one more question back on Iraq, and maybe this is more for Sue. With the increase in working capital there, should we expect that to kind of reverse in the second quarter? Would that be a somewhat fair assumption?

Susan Carter

Absolutely. It was a payment that was outstanding across the end of the quarter. And we actually received the funds in the first week of the second quarter. So that is timing and it has righted itself.

Operator

We will now take our next question from Michael Dudas with Jefferies.

Michael Dudas - Jefferies & Company, Inc.

Bill, could you maybe give a little bit more color or characterize your comments in your prepared remarks regarding the competition in the energy space? Can you characterize it relative to front-end work, the detailed design, EPC lump sum, and are there certain regions or product mixes that are a little bit more or less competitive than others? And are you surprised at some of the newer entrants you've been seeing going after your business?

William Utt

I would say that -- I was looking at some of the wire service reports today and I know Technic was out and literally have the same comments I had generally about the margins. The business ran up really well in terms of margins and the pricing of our delivered products and capital projects became much higher in late '08, early '09 compared to where we were several years before. And we saw a lot of opportunity pricing as opposed to cost-base pricing take place. And that's led to an effort by our customer base to continue to challenge margins at all steps of the way. And we're seeing that on the engineering and services side. The margins have become more modest for us. We have seen a very high degree of competition, particularly on downstream projects in the Middle East, where you're seeing a lot of initial awards won by Korean contractors at very, very competitive prices. And the owners of the facilities at Jubail, at Yanbu, even the owners of Gorgon as we've gone out to do procurement globally, have seen their cost budgets very positively underrun because of what we believe are efforts on the part of fabricators and equipment manufacturers to build back their backlogs that we think had gotten down to very, very challenging levels. In fact the -- anecdotally, the award efforts and the very aggressive bidding by a number of contractors from Korea and the Middle East on these downstream projects could be likened in some respects to a Korean stimulus package to bring new work and new manufacturing into that country. We believe that the competition will remain high. I think that as companies begin building their backlogs, they'll turn their attentions to how can they begin lifting margins throughout the chain and things will continue. I think there's been a general rush for people to buy some market share in the Saudi Arabian market. But how much that aggressive behavior continues, I can't tell. But I believe it will start backing off a little bit in the second half of the year as we return to a more normal bidding environment.

Operator

[Operator Instructions] We will now take our next question from Will Gabrielski with Broadpoint Gleacher.

Will Gabrielski - Broadpoint AmTech, Inc.

You have a really good vantage point obviously in Australia with your involvement with Pluto, Browse and obviously Gorgon, Inpex. Can you talk about steel prices, maybe? I know you talked about some of the procurement costs and fabrication, but are bid validity periods shortening up? Is there any impact there, and also what you're seeing in the labor front, because presumably there could be another wave of projects here. I'm wondering how that could impact contracting terms?

William Utt

I think steel in our world is a globally sourced commodity. And we do keep an eye on that. I think we have seen a recovery, but I don't sense we're at a point where the market's started getting really hot again. And I think pricing has firmed, but has not started the increase we saw between '06 and '08. On the labor side, I think the market is adjusting. As an example, in Gorgon, that's primarily going to be a fabrication yard construction with assembly at the side on modules. At Gorgon, we're doing about 250,000 tons of modules on that project and the number of beds we have on Barrow Island is very relatively limited I believe it's about 5,000 beds on Barrow Island and you contrast that to the SEGAS project, it was a single 5 million-ton-per-year train, compared to Gorgon which is three. And on SEGAS, we had 10,000 people on site. So you're seeing the market adjust to become more aware of some of the labor issues and the labor shortages that could arise in Australia and are trying to minimize the construction labor impact on these projects by doing more of the construction in fab yards where you can better control the labor cost and productivity.

Will Gabrielski - Broadpoint AmTech, Inc.

We all sit here and we're worried about fixed-price work and what some of the other contractors maybe have taken on projects, some of the SEGAS and LNG projects. If you look out six to 12 months when some of these other LNG projects will move into the EPC phase, whether it's Pluto 2, 3, Browse, Inpex, et cetera, do you see a scenario where they'll be enough projects moving forward at once that maybe the contractors have a little bit more negotiating leverage at the table, and you're not too worried about that developing?

William Utt

Well, I could never admit we have more negotiating leverage with any of our clients. But we do see projects moving forward. I think as we talk to our customers around the world, they are similar in their belief that the volatilities, the very aggressive volatilities that we saw in the last five years, are largely muted compared to what we've seen. And we would expect that the customers will be pushing back for increased degrees of lump-sum work. Now when I say "lump sum," moving from an all-reimbursable construction project to where you do lump-sum home office services and maybe do the construction management on a reimbursable basis, that's a movement towards more lump sum. And we are expecting that with our clients, because those are certainly costs and resources that we better control, than certainly the fieldwork in Australia, for example. As you see the national oil companies move forward, I think their bias has always been to do more on a lump-sum basis. And I think you'll see some movement in that respect. And it wouldn't surprise me to see the breakdown between lump sum and reimbursable work move upward a little bit at KBR as we address this reality. I think we're very comfortable bidding lump sum but we're also very cognizant of what the risks are, and how we price the risks, and commercially what risks we're willing to take as a company. And that's had an effect in the recent environment of driving us more on a reimbursable basis. But with the present environment and a lower volatility, I think you could see that 19% fixed-price work and you move up some in the coming years.

Will Gabrielski - Broadpoint AmTech, Inc.

The refinery in Angola which you talked about EPCM opportunity in the first half of 2010, is that expected to be competitively bid or not?

William Utt

Right now, we're working with the customer to take that FEED activities and move them into the next step. So I don't believe so.

Operator

We will now take our final question from Barry Bannister with Stifel Nicolaus.

Barry Bannister - Stifel, Nicolaus & Co., Inc.

When I look at the news that came out regarding the Ras Tanura petrochemical facility moving itself to Jubail and doing away with the integrated refinery, also in so doing, they go from naptha to an ethane feedstock, which reduces the slate of petrochemicals produced. So can you give us some color on just how large a decrease this would be in the size of the award? And since you're sharing with Foster Wheeler, what is your role in the potential FID here, and what would it change given this change in the size of the job?

William Utt

Well, Barry, I think we've seen numbers that have been bandied about and I'm only referring to what's in the press now. The project has shrunk from maybe a $25 billion project to $17 billion, which is a very big savings in today's market. I think the owners are kind of rethinking how they want to move forward on undertaking the FEED, and at this stage, I think there's question in the owner's mind of do you want to have that work across three companies on two different continents, and what are the costs to undertake such an effort? And as they descoped the project, clearly, it becomes more bite-size for any number of players including KBR. And we still believe that we're providing great value to them as the PMC contractor, they have some of the license work we're doing and we continue to have an active dialogue of how we can best serve the owner group going forward under the new configuration with a location at Jubail.

Barry Bannister - Stifel, Nicolaus & Co., Inc.

And then on LogCAP III, being the current life-support role in Iraq. I'm not sure why the Army would transition to LogCAP IV if they have an open call option on you for a 1% base rate and a 2% award fee to continue in your current capacity. So is there some foot-dragging? Is that an option that they can pursue or are they going to award a LogCAP IV for the life-support function?

William Utt

Well, we do know that the bid is due tomorrow, which is the end of April. And that they have asked for a bid validity period of, I believe, about double what we had on the logistics. It may be as much as six months, 120 days to six months. I agree with you. I think there is -- the call option aspect, which you have to weigh against the political benefits of just saying LogCAP III is gone, now we're on LogCAP IV. But I think the bigger issue is as the Army is moving troops out of Iraq and they're shutting down bases and moving people to other bases and consolidating efforts and taking equipment, materials and putting them over to Afghanistan and taking some of it back to staging areas all over the world, I'm sure the guys in theater with all of the issues that they're facing in this massive troop movement, probably do question why do we want to make a change right now possibly to somebody we don't know or haven't dealt with. And I guess in our minds, it is conceivable that the Department of Defense could come to the conclusion as why not just keep this on LogCAP III or, let's give it to KBR on LogCAP IV simply because the coordination issues between the Army and the contractor are very different because of the degree of troop movements and equipment movements and that's going to be going on in the next six months there.

Barry Bannister - Stifel, Nicolaus & Co., Inc.

And lastly, any progress on the PEMEX arbitration payment? I know it's not as small as EPC-22 and 28, but those took three to six months.

William Utt

Certainly, as we quoted in the Q, there've been some rejection of PEMEX's efforts in Mexico on procedural matters. We filed to validate the award in New York as quickly as we could. We think we're very well positioned in New York to affirm the award. I think honestly for an award this size and the duty PEMEX has to its shareholders, i.e. the Government and the Constitution of Mexico, they need to exhaust all possible avenues to seek to overturn this before they would be able to make the payment to KBR. But we feel we're in a very strong position, and we also have an interest clock ticking on the award that I think PEMEX and certainly we're aware of, we've not included any of the interest on that award in our financials. But we're waiting. We think we're in good shape. And we think eventually, that amount will get paid.

Operator

I would now like to turn the conference back over to our presenters for any additional or closing remarks.

William Utt

Thank you for joining us today. As always, if you have any follow-up questions don't hesitate to give me a call today. I'll be in the office all day. Thank you.

Operator

This does conclude the KBR First Quarter 2010 Earnings Call hosted by KBR. We thank you for your participation.

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