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Foster Wheeler Ltd. (FWLT)

Q2 2007 Earnings Call

August 8, 2007 9:30 am ET

Executives

Scott Lamb – VP, IR

Ray Milchovich - Chairman and CEO

Umberto Della Sala - President and COO

John La Duc – EVP, CFO

Peter Ganz - EVP, General Counsel and Secretary

Lisa Wood – VP, Controller

Franco Baseotto - EVP

Dave Parham – EVP, Global Sales and Marketing, Global Power Group

Carolyn Greenhalgh – Corporate Communications

Analysts

Andy Kaplowitz - Lehman Brothers

Barry Bannister - Stifel Nicolaus

Nick Capuano - Imperial Capital

Chris Hussey - Goldman Sachs

Lawrence Nesbitt - Nesbitt & Associates

George Meelas - Lord Abbott

Kent Mortensen – Thrivent Asset Management

Simon Wilson - Sarasin

Presentation

Operator

I would like to welcome everyone to the Foster Wheeler second quarter 2007 earnings conference call. (Operator Instructions) It is now my pleasure to turn the floor over to Scott Lamb, VP of Investor Relations. Sir, you may begin your conference.

Scott Lamb

Good day, everyone, and thank you for joining us. Our news release announcing second quarter 2000 results was issued this morning and has been posted on our website at FWC.com. The presentation that we will take you through today has also been posted on our website and you can find it under the Investor Relations section and also under the tab labeled presentations.

Before turning to the discussion of our financial results, I need to remind you that any comments made today about future operating results or other future events are forward-looking statements under the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Actual results may differ substantially from such forward-looking statements. A discussion of factors that could cause actual results to vary is contained in our annual and quarterly reports filed with the SEC. The company's Form 10-Q for the second quarter of 2007 was filed with the SEC just this morning.

Joining me on the call today are Ray Milchovich, Chairman and CEO of the company; Umberto Della Sala, President and Chief Operating Officer; John La Duc, Executive Vice President and CFO; Peter Ganz, Executive Vice President and General Counsel and Secretary; and Lisa Wood, Vice President and Controller. We also have Franco Baseotto, Executive Vice President and CFO effective August 13th; and Dave Parham, Executive Vice President of Global Sales and Marketing in our Global Power Group. After our prepared remarks and the accompanying presentation slides, we will have time to take your questions as the operator mentioned.

Now I'll turn the call over to Ray.

Ray Milchovich

Thank you, Scott and good morning, everyone. Thank you for joining us. Before I start walking us through the Q2 results, the first thing I'd like to do is recognize my colleague and good friend, John La Duc, who is retiring at the end of this week. Franco Baseotto, as Scott mentioned, will take over as CFO of the company and I would just like to recognize the many contributions made by John La Duc and wish him well in his retirement.

With that, let me go to our presentation and let me ask you to turn to Page 3. Before I walk you through the 2007 highlights, I would like you to first refer to the footnotes at the bottom of the page because I think if we focus on the footnotes, the prepared statements above will be much clearer.

Footnote 1, Q2 '07 includes the impact of an increase in the reserve for a legacy power project in an after-tax amount of $30 million or $0.42 a share.

Footnote 2, Q2 '06 adjusted to exclude asbestos-related gain and loss on debt reduction initiatives and for further details, please see the appendices 2, 3, and 5.

With that and focusing on the quarter, consolidated net income was $71.9 million, up 75% versus adjusted Q2 '06. Diluted EPS of $0.99 was up 71% versus adjusted Q2 '06. Consolidated EBITDA in the quarter of $118.6 million was up 39% versus adjusted Q2 of '06. We had continued strong EBITDA margins on scope revenues; global E&C, which obviously has been very, very strong was up 4.7% versus Q2 of '06. Global Power was up 25% on an adjusted basis versus Q2 of '06. Consolidated scope revenues of $817.6 million were up 31% versus Q2 of '06.

During the quarter, we continued to increase capacity and volume in both business groups. The Global E&C Group has added 13.7% of capacity year to date, and is up 34.6% versus Q2 '06. We expect increased bookings in the second half of '07 to support these capacity increases.

Turning to the Global Power Group, we had our second consecutive strong bookings quarter in Q2, which sets a solid base for the second half of '07 and for 2008. At this point, we expect the full year of '07 revenues to be approximately 10% above 2006 levels.

Turning to page 4, Q2 '07 consolidated scope revenues were up 31% versus Q2 '06, as you can see on the graph below. Turning to page 5, Q2 '07 consolidated net income of $71.9 million was up 75% versus adjusted Q2 of '06. However, I will refer you to the footnote below the graph, which obviously shows that Q2 of '07 was up 148% versus adjusted Q2 of '06, excluding the impact of an increased reserve on a legacy power project in an after-tax amount of $30 million.

Page 6, Q2 of '07 diluted EPS of $0.99 was up 71% versus adjusted Q2 '06 as is shown by the graph below. However, also looking at the footnote below the graph, Q2 of '07 was up 143% versus adjusted Q2 of '06 if we exclude the impact of an increased reserve on the legacy power project of an after-tax amount of $0.42 a share.

Turning to page 7, Q2 '07 consolidated EBITDA of $118.6 million was up 39% versus adjusted Q2 of '06 as shown below. But once again, if we look at the footnote, Q2 of 07 was up 74% versus adjusted Q2 of '06 if we exclude the impact of an increased reserve on a legacy power project in an after-tax amount, as we've mentioned, of $30 million.

Page 8, now turning to bookings and backlog. What you see below is consolidated scope bookings during the quarter and in the previous periods. Quite frankly, if we look at the first two quarters of this year, we're very happy with the bookings that we have experienced in the Global Power Group. However, the bookings and backlog in the E&C Group has been somewhat of a disappointment.

With that, in terms of E&C, as we look at our E&C position, there are two items of particular note. The less than expected bookings in the first half did not impact in any way the first half operating performance of E&C. If we look at the various projects that we are anticipating dealing with in the second half, we are expecting strong second-half bookings in our Global E&C Group to support the growth that that group continues to add and to support our expectations for 2008.

Turning to page 9, what you see on Page 9 is our consolidated scope backlog. Basically, what you see at the bottom of the page in the lower right-hand corner is that basically we are flat Q1 to Q2 with our Global Power Group up somewhat and our Global E&C Group down somewhat in the first half, consistent with the comments that I made previously.

Turning to page 10, Q2 '07 Global E&C Group EBITDA was up 43% versus Q2 of '06 as shown below. Turning to Page 11, Global Power Group EBITDA shown in the graph obviously was significantly impacted by the reserve increase that we took, but as you can see and as is shown by the footnote, Q2 of '07 was up 55% in Global Power versus Q2 of '06 if we exclude the impact of the increased reserve on the legacy project of after-tax amount of $30 million.

Turning to page 12, Q2 '07 cash balances are at an all-time record level for the company. They are up 119% from Q2 of '06 and obviously closing in the quarter at $782.9 million. Page 13 to summarize the quarter for us, (1) the markets that we serve in both business groups continue to be very, very robust. (2) We have very strong operating performance in both business groups, which is a carryover of Q1 and prior periods.

If we turn to the Global E&C Group, we have added capacity of 13.7% year-to-date and 34.6% versus Q2 of '06. We expect strong bookings in the second half of '07. In terms of the Global Power Group, we had strong first-half bookings setting the foundation for the second half of '07 as well as 2008 and we expect 2007 revenue to be approximately 10% above our 2006 levels.

Scott Lamb

Operator, that concludes the formal presentation for us and we would be happy to go to Q&A right now.

Question-and-Answer Section

Operator

(Operator Instructions) Your first question comes from Andy Kaplowitz - Lehman Brothers.

Andy Kaplowitz - Lehman Brothers

A quick question on the power business. Margins sequentially went down a little bit and Ray, I know we had talked about publicly margins and backlog could go up over time, so I'm just wondering, excluding the $30 million charge, what's happening in the power business and can we look for better margins going forward?

John La Duc

Sequentially, Andy, 11.3 to 10.3. Is that what you were looking at?

Andy Kaplowitz - Lehman Brothers

Yes.

Ray Milchovich

Quite frankly, that kind of movement quarter to quarter is really a quarter-to-quarter variation that we really wouldn't spend much time analyzing, Andy. Let's put margins and GPG in perspective. We were very openly critical of margins and performance a year ago. I'm very happy with the progress that group made in the first quarter. I'm also very happy with the progress they made in the second quarter. My expectation at this point for the year is that '07 will be the building block that we were working on all of last year for that group and it will establish the kind of momentum that we want going into '08.

As I've stated before, we're working through some backlog that we booked in '05, but I'm happy with the margin improvement as we disaggregate it and look at its component parts. The operating performance in Q2 was solid again, repeating what we did in Q1, and I think what we're going to see there is a steady and systemic increase in margins going forward second half and '08.

So the short of it is, the quarter to quarter, frankly, movement that we saw, we're going to see that kind of movement quarter to quarter and that's not troubling to me. But the trend that we wanted and the trend that we forecasted is still the trend that is, as far as we are concerned, we're getting and we're going to get.

Andy Kaplowitz - Lehman Brothers

That's fine, Ray. I think we all understand that margins are lumpy. I guess we just wanted to make sure that the trend is still there for the long term.

Ray Milchovich

The performance that we are seeing in that group and we are looking at that very, very closely, is exactly what we wanted when we did the work that we did a year ago. The trajectory is, frankly, what we would like to see. The bookings that they've delivered in the first two quarters, they are quality bookings. We know what the margins are and we think those margins in those bookings support the assertion I just made about second half and '08.

Andy Kaplowitz - Lehman Brothers

And if we could talk about the $30 million charge for a second, you've talked about this contract before; it's a legacy contract. I think it was even signed before you came to the company. Is that true?

Ray Milchovich

The contract was approved in the first half of '01. It was booked in '02. But yes, the contract was approved at the senior level before I arrived. It's a problematic job. The increase in the reserve in Q2 was a function of outages being taken on both plants and an inspection that was able to be made in a fair amount of detail in the back end of both plants that, frankly, we were not able to do before the outages. What we found was corrosion beyond that which was anticipated.

Being over here in Reading this week, I had the opportunity to tour both plants this past Saturday with our team at this site; both plants were down. I toured the entire functions of both plants. I think we have got a very, very good handle on the work to be done. So obviously, we think given the reserve that we took, we've got it now very well quantified.

The big issue at this point is, and I think we've shared this before, is there's going to be some discussion with the client as we go forward in terms of who pays for what. That's going to be a factor. Now we think we've been very mindful of that as we have reserved the project, but that will be an issue going forward and we will see where that takes us. But the good news is I think we've got a good fix on where the plant is. I think we've got a good fix on what needs to take place on both plants to make the repairs that are required. I think technically we know where we are headed. So it's just a matter of resolving who pays for what.

Andy Kaplowitz - Lehman Brothers

Great. One more quick question if I could. On new awards, you mentioned stronger new awards expected. You are in the running for several large awards. Is there anything more that you could tell us? A couple big LNG prospects out there it seems for you guys, anymore color you could give on the new award potential for the next six to 12 months?

Ray Milchovich

Let me just say this about E&C, and I said this last quarter and let me candidly speak to that and then let me just put it in perspective. We are disappointed with the first-half bookings at E&C because we expected more. However, in terms of supporting the profitability of the business, it's had zero impact on the first half and we expect it will have zero impact on our profit expectation for that business in the second half. As we have stated before, our objective is not to hit a booking target. Our objective is to have backlog to support the profit targets that we have for the business and the margin optimized to do that.

Now, as we stated before, we're very rigorous only to book when we've got a signed contract that's completed for the scope that's released. Why do we believe we're going to have a second half? Because we are deep into several very significant projects that we think are very likely to book and we think it's very likely that we will book those prospects. So therefore, we're prepared to say our expectation is we're going to have a very strong second half.

In addition to that, as a leading indicator, I will turn to Umberto to talk about the mix of our bookings which have changed dramatically from '06 to '07 which we think is reflective of (a) the strength of the market, and (b) if you will, the strategic position of Foster Wheeler to be in position to book very attractive business beyond this. Specifically, what I'm talking about is the mix of feed that we booked in the first half of '07, but Umberto's folks are closer to this than I am and I'm going to ask him to speak to that.

Umberto Della Sala

If we compare the amount in terms of man hours, the amount of feed work that we have booked in the first half of '07 versus first half of '06, we are up almost four times. So this is a good indication number one, that the market is very strong. This feed work is indication of projects and new investments coming up on the market. Number two is there is a great potential for us to leverage the feed work to move into EPC. So I confirm what Ray said, we are very optimistic about the second half of the year and in general, about the market strength.

Ray Milchovich

The short of it is, Andy, we are not concerned about booking E&C at all. E&C is off to a very, very good start for '07. We're positioning the business for '08. We think we're going to have the business booked that we need to support '08 and it is just that simple. So we think we are in very good shape.

Operator

Your next question comes from Barry Bannister - Stifel Nicolaus.

Barry Bannister - Stifel Nicolaus

Could you talk about the competitive pricing environment? Are you holding out for a higher profit or are you being left behind as some of your competitors just booked less profitable growth?

Ray Milchovich

That's a great question. I will turn to Umberto.

Umberto Della Sala

That's a good question. Now, let me talk about the E&C first. The assessment we're making is that given the current market strength, we can maintain the margins that we have been enjoying so far. With this market there is no reason to believe why the margins should go down.

For the power business, I think we are seeing clearly improvement of the margins of the projects that we book. This is again an indication of the further of the market has been getting stronger and we can enjoy better margins.

The last comment I'd like to make, Barry, however, is that we measure the margins not when we book the project, but when we complete the project, because contingencies are part of the margins when we book a project and if we've properly execute the project we can convert the contingency into profit. So the real improvement of the margins is only measured again to each project. The performance of it is demonstrating that we are improving the margins because we actually convert all the contingency to profit at the end of the project.

Ray Milchovich

Let me just add one comment to what Umberto has said. Because the question you asked is, are we being left behind? My observation is this. Even recognizing what I think is very dramatic organic growth that we have affected into this business over a relatively short period of time, we don't have enough capacity to serve this market. Now given that, if we are winning everything we're approaching, I'm not convinced we're margin optimized. So our objective is not to win everything we go after because I don't think if we do that, we can be convinced that we're optimizing our margins. Frankly, given the strength of this market I think we have an obligation to do that.

So we are not getting everything we're going after, but in my view, that's not a bad thing. That's a good thing for our business because in the strength of this market, I think it's incumbent upon us and I think it's part of our obligation to make sure that we are optimizing this business. I think we're running the commercial function the way it ought to be run given the strength of the market. If the market were weaker, we may approach the market differently. As a matter of fact, I think we would. But I think in this market, I think we're approaching this market the way we should as stewards of the business.

Barry Bannister - Stifel Nicolaus

So is the less rational competitive element still not aware that just booking a lot of big jobs at low margins is a foolish strategy? Do you have any capacity constraints as the industry moves from feed to FID?

Ray Milchovich

Well, let me say this, Barry, and we've said this before. I can't speak to the margins and the commercial approach of our competitors. I just don't know enough about how they report the segments in which they report to speak to that. That would be unfair. I think I know how we run the commercial function and I'm very, very satisfied with the way we run it and we have spoken about that before.

Now, in terms of capacity to leverage these feeds that Umberto mentioned, we've been very aggressive laying in organic growth. You saw what we did last year. You've seen what we've done in the first half of this year. We don't intend to stop. We intend to continue to add organic growth as fast as we can assimilate the people. the second half of '07 and into '08 because obviously if we position ourselves for these feeds as we have, it would be very disappointing to us if we didn't have the capacity in here to leverage these into EPCs that we're targeting. So our intent is to have the EPC capacity when we have the option to get it, because we will continue to grow these businesses organically.

We are, as you know, we are over here in our Reading subsidiary all this week and we are very close to what's going on here and these guys are adding capacity at a very, very rapid rate, as is being done throughout the business. So our intent will be to have the EPC capacity when it's needed.

Barry Bannister - Stifel Nicolaus

The last question is, and Andy alluded to this, but we know LNG globally looks great, but is the Middle East and Asian refining and pet chem market played out for you or do you see any opportunities there?

Umberto Della Sala

No, no, no, we see a lot of opportunities in the Middle East and in Asia for the downstream type of plant. Not at all.

Ray Milchovich

I think it's safe to say, Barry, we don't see any evidence of that; do we, Umberto?

Umberto Della Sala

No, not at all.

Operator

Your next question comes from Nick Capuano - Imperial Capital.

Nick Capuano - Imperial Capital

Just a question on your expense trends and SG&A trends, what do you see going forward relative to the bidding activity? Is that going to have an impact on it? If you could address that.

Also, relative to the second half bookings increase you see, to what extent are you changing your strategy at all or is it just a function of that's just the timing of a lot of the projects you are lining up relative to the stronger activity you see in the second half?

Ray Milchovich

Let me deal with the spending in the SG&A first. Obviously we analyze every quarter when we close it. There is no nothing in Q2 versus Q1 or prior periods that's anything other than normal quarter to quarter variation. We're just going to have quarter-to-quarter spending differences with sales support costs and various expenses in the business that obviously aren't going to be completely linear quarter to quarter. There is nothing in there that's anything other than what we would consider quarter-to-quarter variation. That's number one.

Number two, the second half, when we say we're expecting a strong second half in E&C, there is absolutely no difference in our commercial approach to the business. This is strictly the timing of awards that are dictated by clients. So this has got nothing to do in terms of our approach to the marketplace. This is strictly client driven timing, if you will.

Operator

Your next question comes from Chris Hussey - Goldman Sachs.

Chris Hussey - Goldman Sachs

A question on the customer base and just trying to get around the E&C order expectations a little bit further. Two parts. One, how much of the shortfall that, as you've described it, was a disappointment in the E&C order base in the first half came from you guys missing contracts because you've taken an aggressive approach to price so you bid it, you bid just as much as you thought you were going to bid but it didn't come through versus projects that you thought were going to go from feed to EPC the customer didn't go there yet. Timing is just off.

The second part of that question is, have you seen any behavioral changes in the part of your customers in less willingness to go to the EPC because of cost escalation?

Ray Milchovich

I'll defer to Umberto on both parts of your question.

Umberto Della Sala

First question, we have not lost any major project. Maybe the only one I can mention is [inaudible], which we lost, but however it was not in our let's say top list of forecasted awards. For the rest, we have not lost any major project and it's only a question of timing. So this is why we are very confident about the second-half awards.

Ray Milchovich

Nick, we have an 80/20 forecast when we approach the year and it's those projects that we think we have an 80% probability of booking and it just so happened that wasn't included in our 80/20.

Umberto Della Sala

Yes.

Ray Milchovich

So it would have been upside had we won it.

Umberto Della Sala

So timing. To answer your second question, about the change in the markets, I think we have been discussing this change in the last calls. Certainly the market seems to move our way from feed and it is becoming for the majority [inaudible]. The reason why it is no more let's say fashionable is mainly because there is an increasing cost of material cost of construction, and it is becoming a very risky type of business. Clients are not willing to pay any more heavy contingency to contractors to take on board this risk. So the change in the market is moving towards reimbursable.

As I said in the previous call, what we try to do is also to try to negotiate incentive schemes according to which we can improve our margins if we properly perform. Properly perform means delivering the project on schedule, possibly ahead of schedule and within the budget. So that's the major change that we're seeing in the market.

Ray Milchovich

Once again, that's not driven by us. That is a client driven change right, Umberto? That's completely client preference.

Umberto Della Sala

We just follow the market.

Chris Hussey - Goldman Sachs

Some might argue that cost-plus is a less risky business for you than a fixed price as well. But just getting to the heart of the question though, have you seen any over the last two, three months, any measurable change in your customers' behavior where they are making you have to negotiate those cost-plus contracts even harder than you have been, maybe pulling back on scope more than what you expected?

Umberto Della Sala

No, Chris, the only change is that typically it takes a little bit more time for the clients to approve the investment. In a difficult project, we start with conceptual design and with the feed and then we deliver an estimate. And typically after we deliver the estimate, it is taking a little bit more time to refine the estimate and go through value engineering to scope optimization to make sure that the investment is within the expectation of the client. But in terms of let's say pressure on the cost and the price of our services, we have not seen any major change.

Chris Hussey - Goldman Sachs

I know you spoke about it before, but maybe just to help everybody on the call, the power plant projects that you have had problems with today, maybe just remind us all what is the scale of those projects, the cost, the charge you're taking today relative to the scale of those projects and is there any possibility that you would have to actually rip the boiler out and have to put a whole new boiler in?

Ray Milchovich

First of all, let's be specific. The increase in the reserve we took today is on one project. It's on one project and two plants. As you will see in our Q, which was filed first thing this morning, there is a put-right in the contract if the client attempts to enforce rejection. Now, in our view, that is very, very, very highly unlikely that would occur and that the clients would have a basis to take that action. But technically, the contract provides that opportunity for the client. Am I sitting here today worried about that? The answer is no.

Chris Hussey - Goldman Sachs

Technically the problem with the project is the boilers are corroding?

Ray Milchovich

The problem with this project is, it was, as we stated before, it was approved in 2001. This is an old project. The fuel is clearly out of specification. There's no dispute on that. But the dispute is over the language in the contract, which obligates us to do certain things and the client to do certain things. That contract is not as clear as we would like it to be, but it is what it is and we're going to end up having to deal with that with the client. Now hopefully we will be able to negotiate a reasonable distribution of effects between the client and us. If we don't, then we will have to find some other way to resolve those differences. Given the increase in reserve, we think we have very prudently reserved for that.

But let's be clear; it's one project, two plants, and it's the only legacy project we've got left.

Chris Hussey - Goldman Sachs

Those two boilers, how much do they cost to build today?

Ray Milchovich

I wouldn't even venture a guess because it would be significantly more than the contract value given this contract was priced back in 2001. But I really wouldn't venture a guess, Chris. But a material amount of money more than the contract price was back then, obviously, given the escalation of labor and materials.

Let's be clear, though. The plants have a corrosion problem that is technically fixable and when the plants are operating, the plants operate very, very, very well. So it's inconceivable to me that the client would have any motivation to want to put those plants back to us, because the plants are needed to supply the power on the grid, and when the plants operate, they operate very well. The issues that we're suffering corrosion on are material usages in the plants that would have been differently specced had we realized the specification of the fuels that we would be burning. The materials in the plants were specced according to a fuel spec. The chemical reactions taking place inside both plants are different because the fuel specification is different which requires different types of materials, which is what we're in the process of doing at the plants as we speak and we're getting planned to do in the future as we get different materials in.

So we are not at all concerned that remedies can't be implemented. It's just a matter of who pays for them. And as I said, had we realized the fuel we're going to burn, we would have specced the plants differently from the start.

Chris Hussey - Goldman Sachs

If you had to guess, what's the timing on the final resolution of this dispute?

Ray Milchovich

It depends whether or not we can negotiate it or we have to litigate it. I wouldn't even want to speculate. What we've agreed with the client, which I think is constructive, is let's set aside that debate. Let's work collaboratively to get the plants repaired and get the plants highly functional, because we're a leader in this marketplace. We want to continue to be a leader and we want to make these plants right. Frankly, I think we've created a very constructive environment with the client to do this. Now we're going to have a dispute over who pays for what and we know that. We just decided to defer that right now because it's in both parties' best interests to do that.

Whether we can agree on that, whether we have to litigate that, I wouldn't venture a guess and obviously the answer to your question is different whether we negotiate or we litigate. At this point I just have no basis for making that estimate.

Operator

Your next question comes from Lawrence Nesbitt - Nesbitt & Associates.

Lawrence Nesbitt - Nesbitt & Associates

I believe you said that your backlog from Q1 to Q2 was linear. How does your backlog at the end of Q2 compare to '06 Q2 backlog?

Ray Milchovich

Let me go back and perhaps be a little clearer on what I said, and it's on page 9 our prepared materials. The backlog measured in scope revenues in the aggregate, the aggregate being the two groups , the Global Power Group as well as the Global E&C Group, was virtually flat Q1 of '07 to Q2 of '07. If we compare that to Q2 of '06, it's down slightly from the aggregate backlog in Q2 of '06. It was 2.843 in Q2 of '06 and it's 2.729 Q2 of '07, so down slightly from the same period a year ago quarter.

Lawrence Nesbitt - Nesbitt & Associates

You anticipate probably improving that in the third quarter?

Ray Milchovich

If we have a strong second half that we expect in E&C and if that begins in Q3, which I think is likely, and we continue to book in power as we have, I think it's likely that that backlog increases in Q3.

Operator

Your next question comes from Barry Bannister - Stifel Nicolaus.

Barry Bannister - Stifel Nicolaus

Just to clarify, you didn't lose any of your priority one projects, it was just more a case of clients taking their time to aggregate and rescope and make some changes to the bid that they wanted to finally submit?

Ray Milchovich

That is correct, Barry.

Barry Bannister - Stifel Nicolaus

Okay, good, so it's not a market share issue.

Ray Milchovich

We have an 80/20 forecast. Those projects we think we have an 80% probability of booking. So obviously when we put them on the list, we expect to book them. Not one of those was not booked in the first half. Not one of those was lost, rather. It may have been delayed into the second half and we may have gone into the year anticipating it would be booked in the first half, right?

Umberto Della Sala

And by the way, not even canceled.

Ray Milchovich

Not cancelled or lost.

Barry Bannister - Stifel Nicolaus

I understand. Just to clarify, you did about 5% contract capital in the quarter, is that a run rate we would expect, given the increased migration of the mix towards more cost-plus and less LSDK with its front end payment.

John La Duc

Barry, this is a number with which I'm not familiar, so I guess I need to go back and see if I can replicate your numbers here.

Barry Bannister - Stifel Nicolaus

I was just using AR, BIE, CIE and payables as a percentage of revenues.

John La Duc

That's what you're doing, if you followed it for the last several quarters, particularly this year, you saw we made an investment in working capital in the first quarter which we explained was in large part due to the trend toward reimbursables. But the other thing you have there is as you trend toward reimbursables, you don't get as many advanced payments and we also have the working off of former advanced payments. So there a lot of swings here and there.

If we have a constant contract mix and we continue to grow our business, we would likely continue to have an investment in working capital. Having said that, we spend a lot of time on contract terms for payment and managing the receivables. I think we are focused on cash.

Ray Milchovich

What I'd like to do, Barry, is make sure that we don't give you an aggregate answer to what ought to be a mix adjusted answer. So what I would like to do is look at that, spend some time scrutinizing it and perhaps mix adjust it and come back and provide an answer.

Barry Bannister - Stifel Nicolaus

One large Middle East oil producer is adding a great deal of productive capacity for crude oil and has a couple of major projects, for example, to do that. You have received pieces on both of those projects, but is your role spent on those project or are there more awards to flow if they are to realize their goal of increasing oil production by the amount that they have said?

Umberto Della Sala

Barry, I don't believe that our role is over on those projects.

Barry Bannister - Stifel Nicolaus

In terms of incremental new awards, would it be material or how far along do you think it is right now or what can you say?

Umberto Della Sala

Well, Barry, I would not speculate about the timing, but certainly there would be additional opportunities for us on those projects.

Barry Bannister - Stifel Nicolaus

Lastly, McDermott in their boiler business did an 11.25% operating margin in the quarter. When can we get to a double-digit margin in Global Power?

Ray Milchovich

Barry, one minute. I think Carolyn Greenhalgh, she wants to add to Umberto's comment on Middle East and then I will deal with the margins.

Carolyn Greenhalgh

I just wanted to add that beyond these projects, we also see significant opportunity in the upstream oil and gas business. We see that there are likely to be more projects beyond the projects that have been announced. So taking a slightly longer point of view, we also see further significant opportunity.

Ray Milchovich

So in addition to what's been announced, our view is there will be additional opportunities announced which we think we're very well-positioned to compete for.

Barry Bannister - Stifel Nicolaus

Regional opportunities?

Ray Milchovich

Regional opportunities, yes.

Barry Bannister - Stifel Nicolaus

Not specific to any one country?

Ray Milchovich

No, not at all. Not at all. Barry, GPG margin. What we're doing is we've got a portfolio. We've got the portfolio of projects that were booked '05, '06 and in '07 in large part, maybe some booked prior to that. We have to work through that backlog on a weighted average basis before we get the full effect of the increased margins that we were booking in the second half of '06 and the first half of '07. It's just going to take some time to do that.

But as I answered to Andy earlier, I think that's going to be steady; there's going to be some quarter-to-quarter movement. But as we analyze that and we do on a portfolio basis and I've done that with the folks in that business, we think we just need to work off some of the backlog that we've got, enrich that mix with the projects that we are booking now and over time. Second half in '08, we will see those margins continue to rise.

Barry Bannister - Stifel Nicolaus

Last question, did the charge that you took in that for Ireland, finish the project or was it just a band-aid to get us through until the next one?

Ray Milchovich

No. That increase in reserve we took on that project is our best estimate of cost to complete. And, it assumes recovery in the distribution of cost between us and the client. So the accounting treatment is our best estimate highly scrutinized on cost to complete and the distribution of who pays for what and those assumptions are all audited by our outside auditor. We spend hours on that. So that's our best estimate of what it takes to be done. As I said, we are inside both plants from start to finish as we speak. I was on Saturday.

Operator

Your next question comes from George Meelas - Lord Abbott.

George Meelas - Lord Abbott

I have a clarification. Umberto said that man hours booked were up four times 1H07 to 1H06. I didn't quite understand that. Maybe you could clarify that.

Excuse me, that's not what he said, so I'm going to ask him to clarify what he said.

Umberto Della Sala

No, I said that the feed work expressed in terms of man hours is 4 times in the first half of '07 versus the first half of '06. So I was referring in particular to the man hours related to conceptual design and feed work only.

George Meelas - Lord Abbott

Okay. And the opportunities that that turns into EPC work?

Umberto Della Sala

Of course there is always the opportunity there.

George Meelas - Lord Abbott

Okay very good.

Umberto Della Sala

But I wanted to stress that also to give you an understanding of the strength of the market because conceptual work, feed work means new investment coming on the market.

George Meelas - Lord Abbott

If you have a ratio of feed work turns into how much of EPC work? I'm sure it varies a lot.

Umberto Della Sala

No, I don't think that I can speak really because it depends on each particular project, so I wouldn't venture in giving you any kind of indication.

Ray Milchovich

And let me tell you why we don't measure that. There are times we do the feed and we have no desire to leverage it in the EPC. So we would only measure it if we had a constant assumption set going into it and had an objective that we wanted to convert a given percentage. But since we take each project on a project-by-project basis and we only want to leverage it into EPC if we think it fits what we do best, then it wouldn't be appropriate for us in our judgment to measure that on a consistent percentage basis.

George Meelas - Lord Abbott

Right. I understand. I was thinking more generically, not necessarily for you, but for the industry.

Ray Milchovich

All right.

George Meelas - Lord Abbott

On the charge that you took, it seems like the terms of conditions on the contract were a little bit sort of vague. Do you think that right now when you book new business, your terms of conditions would be tough enough that you would not be on the hook for something like that because of the client using fuel that's out of spec?

Ray Milchovich

Let me be painfully clear. It's no news flash to anybody that this company was a turnaround when we started in late '01. We spent some hard times getting this company fixed in '02, '03, '04. This contract was approved in the first half of '01 prior to my arrival. Needless to say, in many, many ways, the contracts we sign today are materially different in terms of clarity, terms, conditions, price, et cetera than this contract. So, I am highly confident that in a whole variety of ways there is no contract we sign today that is like this contract.

George Meelas - Lord Abbott

Very good. The work that you are booking now in CPG, does it have the type of margin that McDermott is showing at this point?

Ray Milchovich

What margin is McDermott showing at this point?

George Meelas - Lord Abbott

I think they were talking about 11% EBIT margins.

Ray Milchovich

EBIT margin?

George Meelas - Lord Abbott

Probably EBITDA I'm sorry.

Ray Milchovich

So a percentage point beyond where we were in the quarter?

George Meelas - Lord Abbott

I guess you're very close.

Scott Lamb

EBITDA was about 10.3% setting aside the charge.

Ray Milchovich

We were 10.3 EBITDA margin in the quarter and you're saying can we get that to 11?

George Meelas - Lord Abbott

I'm sure you can.

Ray Milchovich

I'm going to be terribly disappointed if we don't go beyond 11.

Operator

Your next question comes from Kent Mortensen – Thrivent Asset Management.

Kent Mortensen – Thrivent Asset Management

I've been reading a little bit about concerns with regard to potential CO2 caps in the United States and wondering if you are seeing that slowdown any sort of bid activity or projects here in the United States at this point. Is that kind of freezing the market or not?

Ray Milchovich

I would ask David Parham. Dave is on the line back in the U.S. Dave runs Global Sales, Marketing and Strategic Planning for GPG, who I think is closer to that market than I to respond to the question. David?

Dave Parham

Yes, we have seen the greenhouse gas issue impacting the market in the U.S. with a few prospect cancellations. But these cancellations represent only a small percentage of the over 200 gigawatts of coal-fired power plants announced to be in various stages of development globally. So globally we do not see a large decline in new coal as the global power needs cannot be supported without coal playing a major role in the balance portfolio going forward.

In the U.S., there's prospects that are in various stages of mature development that would still be in the 8 to 10 gigawatts per year for the next few years as far as the development. Just to put this in perspective, we are very selective in the pursuit of the projects we go after globally, and we do have our balance of projects that we have booked have been on a global basis. We've booked year-to-date projects in the U.S., China, Europe, Thailand, Latin America, Korea. So we do pick the projects where we add value and get value out of the projects.

In addition to that, in regard to the greenhouse gas issue, Foster Wheeler is very active in the advance clean coal technologies for carbon capture and storage. We are working on the integrated gasification combined cycle projects out of Italy, and we are also in development of some demonstration projects on oxy combustion technology, which will also facilitate CO2 capture and storage for future legislation that could be in place.

Kent Mortensen – Thrivent Asset Management

I'm assuming that if you are seeing some push-outs of projects, it's mainly temporary just given they don't know what their costs are going to be yet, right?

Dave Parham

Yes, we have seen some of that, but a lot of the coal projects that are in the mature stage of development are still proceeding and we're still pursuing several of those.

Ray Milchovich

Dave, is it not also safe to say that some of the delay could be permitting issues?

Dave Parham

Yes.

Ray Milchovich

I mean on the client side.

Dave Parham

Yes, and the permitting issue delays has always been a part of it. Now there's some uncertainty on some of the projects in regard to potential for greenhouse gas legislation coming up which has delayed some of the projects, but the pipeline is still very full with very good prospects that have their air permits and are moving forward.

Ray Milchovich

Let me also add to what Dave said and perhaps put the issue in a broader perspective. Even given those issues, which we think are real issues and our view is strategically that it is inconceivable to us that in the future, coal is not part of the fuel mix. However, as a leader in that industry, our view is we also need to be a leader in technology to reduce fugitive emissions. And as Dave vindicated, we are very active in that area. So our view is coal will be part of the fuel mix, but we are going to need to advance technology rapidly to ensure that.

However, putting them in perspective, we are booking very favorably in that business, first half '07. Our view is revenues in that business right now look to be about 10% higher than '06 and we are actually building backlog such that our expectation is '08 will take another revenue jump from '07. So the business as we know it today, given today's technology, and given the opportunities in the marketplace, is booking very heavily and our volume is increasing '07 over '06 and our anticipation is it is likely that it increases '08 over '07.

Operator

Your next question comes from Andy Kaplowitz - Lehman Brothers.

Andy Kaplowitz - Lehman Brothers

Ray, just on what you were saying on coal-fired opportunities, the CFB opportunity in particular, you booked quite a few CFB boilers in the last quarter. How is the CFB market in general? It seems like it's getting stronger as we speak every quarter, worldwide. Is that true? Do you have significant opportunities still in the U.S. with your CFB technology?

Ray Milchovich

I will answer the question generally and then I will turn it to Dave, who's closer to the details. Let me just say this. In the six years I've been interfacing with our folks here, this is the strongest demand we've seen for the CFB product worldwide. That is out of all of our major units, which is North America, Europe, and Asia. So yes, we have had a very strong first half, very strong second quarter, specifically very strong in CFB, and it looks to us like the near to medium-term is going to stay that way given the prospect set that we have in front of us. Dave, I will turn to you for increased specificity there if you have got something to offer.

Dave Parham

Yes, a couple of things on these CFB technology. Foster Wheeler has really developed this into utility size, which is accepted now in the utility size in the 300 plus megawatt size, which makes the market more available for the utilities to buy in the larger size units. Including we have the supercritical CFB unit currently in construction in Poland which is a 460 MW supercritical CFB. So that opens up some market opportunities for us in that size range.

The other very big benefit that a CFB does is it has tremendous fuel flexibility while meeting the environmental requirements for emissions from the plant and that improves the economics where customers, the utility customers, can buy fuel on the spot market, lower-cost fuels, more difficult to burn fuels, what we call opportunity fuels. And these include bio mass, which is also fits in with the future greenhouse gas legislation that could be implemented, where to burn bio mass, which is a net neutral then on the CO2 emissions.

You have the capability to burn a variety of fuels in the CFB, which is one major advantage, and the second is they are proven high reliability, high availability, and the utility size range 300 to 600 MW sizes now are available and customers are pursuing those options.

Andy Kaplowitz - Lehman Brothers

Dave, do you think we're still ramping up the CFB opportunity worldwide from last quarter which was already relatively robust?

Dave Parham

We see a lot of announced prospects that are in our pipeline that do use the larger utility-size CFB units. We see that number of prospects in that size range increasing year on year and with the demonstration of the supercritical CFB, which will be available up to 600 MW, we see that even potentially advancing further.

Andy Kaplowitz - Lehman Brothers

Ray, just one quick other question. On the balance sheet, obviously it continues to improve, so maybe if you could just go over the opportunity set of things that you would have us focus on. You've talked about acquisitions in the past. Anything out there that seems more interesting? Valuations too high? Maybe just give us the lay of the land.

Ray Milchovich

Well I mean nothing really material to report other than our first objective with excess cash is to be used as currency for M&A. Our focus in M&A is E&C and specifically, our focus in E&C is upstream oil and gas to cause that business to be more robust, given our anticipation of capital spending by clients in that area and in several geographies around the world. We are very active right now, but we have nothing to report that's far enough along for us to do so. That's our first objective.

The second objective that we have is we are in hot pursuit of an investment-grade credit rating and so therefore, we're looking at any legacy form of notional debt such as underfunded pension or lease liability on our balance sheet. We'll be looking at that in the second half of the year, and we will seriously consider pre-funding liabilities if we think the pre funding will speed up our getting the investment-grade rating because that does a whole series of things for us, not the least of which is reducing global bonding costs.

Those are our first two priorities, and I think we've stated those before. Nothing there has changed, Andy, and nothing has developed that is really material that we are prepared to announce yet.

Operator

Your final question comes from Simon Wilson - Sarasin.

Simon Wilson - Sarasin

Sorry to go back to the E&C bookings chart on Page 8, but there is a clear pattern of sequential improvement in Q1, Q2, and Q3 dropping off in Q4 and seeing it in '06 as well. But then in '07, it's plain to see Q2 is down. I'm still unclear why that is the case even listening to what you've said. Is it a case that your clients are saying they're looking at sort of the capital markets around the world and saying let's hold back because of funding costs? Is that an issue?

Ray Milchovich

Let me just say this. I do not dispute that there are two data points shown on Page 8, which is that we increase bookings one, two, and three is a big quarter and we drop off in four for two years. I would also, however, say to you is that those are two data points and the trend there is, in our judgment, completely irrelevant.

So I understand that you could draw that conclusion from looking at this dataset, but our judgment is that's two years and it's completely irrelevant. I mean we've said booking business is a nonlinear exercise. It occurs when the clients choose to book.

Simon Wilson - Sarasin

So why are the clients choosing to book later? Is it to do with cost of debt increasing?

Ray Milchovich

They're not choosing to book later. They have simply chosen to book a couple of big projects in calendar year '07 later than we had anticipated. Maybe our anticipation was optimistic. So it's no more than that. I don't want this to be misunderstood. This is simply what's happened versus what we expected to have happened. It's not a function that the market is cooling in any way. The market is hotter than we've ever seen. It's not a function of clients delaying or clients reconsidering. It's simply a function of getting the approval processes completed inside the client's organization and the 80/20 plan we put together from what we wanted to book and what we didn't anticipate we would book. It's nothing more than that.

Simon Wilson - Sarasin

But within the clients' organization, what are they doing differently to book a month later for instance?

Ray Milchovich

Differently than when?

Simon Wilson - Sarasin

From your expectation.

Ray Milchovich

In the first half, they're booking later than we expected them to book. We expected a couple of big awards to book in the first half and it appears as though they are going to book a couple of months later than we thought. I wouldn't read anything more into that than just that. I'm not so sure there wasn't a forecast problem on our fault as opposed to something that occurred in the client's shop. It's really no more than that.

Simon Wilson - Sarasin

You're saying it's completely irrelevant to look at the debt market being overpriced or anything like that in relation to the bookings?

Ray Milchovich

That's exactly what I'm saying. What I'm saying to you is I am not the least bit concerned about booking this E&C business, and there's only one thing more important than that, and that's that Umberto is not worried at all about bookings. He's one step closer to it than I am. We're not the least bit concerned about that, not at all. It will not impact this business's performance at all.

Simon Wilson - Sarasin

Okay, thanks.

Operator

Ladies and gentlemen, it appears that there are no further questions at this time. I will turn the floor back over to Scott Lamb.

Scott Lamb

Thank you, operator, and I will turn it to Ray for a few wrap-up comments.

Ray Milchovich

I thank everyone for joining us and I'll just reinforce several points. Once again, the market to support both these business groups, the E&C Group as well as The Global Power Group remains very, very robust. We just came off of another very solid quarter of operating performance. I'm very happy with the way these two businesses are positioned and we are very optimistic about the future. We look forward to talking with you at the end of next quarter. Thank you very much for joining us.

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Source: Foster Wheeler Q2 2007 Earnings Call Transcript
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