KBR Q3 2007 Earnings Call Transcript

KBR, Inc.(KBR)

Q3 2007 Earnings Call

November 1, 2007 11:00 am ET

Executives

Bill Utt - Chairman, President, and CEO

Cedric Burgher - SVP and CFO

Rob Kukla - Director, IR

Analysts

John Rogers - D.A. Davidson & Co.

Barry Bannister - Stifel Nicolaus

Andy Kaplowitz. - Lehman Brothers

Al Kabili - Goldman Sachs

Michael Dudas - Bear, Stearns & Company

Jamie Cook - Credit Suisse

Brad Handler - Wachovia Capital

Dan Pickering - Tudor Pickering & Company

Presentation

Operator

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

Rob Kukla

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

Joining me today are Bill Utt, Chairman, President and Chief Executive Officer, and Cedric Burgher, our Senior Vice President and Chief Financial Officer.

In today's call, Bill will provide opening remarks and business outlook. Cedric will address KBR’s operating performance, financial position, backlog and other financial items. We will open 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, 2006, the final prospectus for the exchange offer dated March 27^th, 2007, KBR’s quarterly reports on Forms 10-Q and 10-QA and KBR’s current reports on Form 8-K.

Now I'll turn the call over to Bill Utt. Bill?

Bill Utt

Thanks, Rob, and good morning, everyone. Shortly after I became CEO in early 2006 KBR made changes at the corporate level with the creation of the Business Development Oversight Group, the Project Management Oversight and Controls Group, and the EPC Services Organization. Over the past year, we took a long look at the market opportunities available to KBR. Our customer relationships and our efficiency of project execution at the divisional levels, and decided to restructure the business into six business units: Downstream government infrastructure, services, technology, upstream and ventures.

Our new KBR organization, now based on six discrete reporting units, creates better transparency of our operations and increases the focus by our management teams on their markets, customer relationships and on their projects.

This improved transparency and focus will provide our customers with an improved KBR experience in the form of better performance by KBR on our project and services offerings.

This new structure will also provide increased transparency in the KBR's businesses, both financially and operationally to external stakeholders, investors and analysts. We intend to begin reporting based on these new segments in the near future.

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

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

The disposition of this non-core asset is a continuation of KBR's strategy to focus on, and grow, our core service and technology base businesses. And we are pleased to have sold this venture to our other shareholder of BRC.

In our call last quarter, I talked extensively about the redeployment of some of our business development resources, and the positive impact this had on our pursuit of the capture of opportunities.

During the third quarter of 2007, our business development efforts continued to successfully deliver new awards with the Skikda LNG and Ras Tanura projects. Both of which I spoke in great debt about, last call.

However, there was several other key and strategic wins for KBR. Let me start with the Orlando gasification project in Orlando, Florida. On September 10th along with Southern Company, the Orlando Utilities Commission and the U.S. Department of Energy, KBR broke ground to begin construction of an advanced 285 megawatt integrated coal gasification combined cycle facility.

This facility incorporates KBR, and Southern Company's jointly developed transport reactor integrated gasification or TRIG technology, and is part of the U.S. Clean Coal Power Initiative.

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

We are pleased to be able to permit such a facility in an environmentally sensitive area of Florida. We are extremely proud to be a partner in this project, with the commercial operation of the facility expected for June 2010. KBR believes the successful construction and operation of this project is critical to the commercialization of our coal gasification technology.

While we remain extremely optimistic, regarding the long-term prospects for KBR as a co-owner of this technology. As required under the U.S. Clean Coal Power initiative, our FEED and EPC work to-date has being performed at cost. KBR will also perform any future work related to this project similarly on an at-cost basis. KBR believes the short-term investment in our coal gasification technology is crucial to move this technology from the power plant to full commercialization scale-up.

Also, from a strategic perspective we are also excited about the FEED support work on the West Mediterranean concession deep water development project in Egypt, and the Ozona feasibility contract with Marathon, because they exhibit KBR’s capabilities in the offshore markets.

As KBR looks to expand it’s offshore opportunities, this type of work enables KBR to leverage its legacy engineering capabilities and expertise to provide customers with solutions with respect to field development, sub-sea and semi-submersible applications.

Now, let me turn to some operational highlights for our service segments and updates to KBR’s end markets. With respect to our upstream business unit, the market direction and outlook for capital projects continues to remain healthy for the next several years, although projects continue to experience some award delays. Our LNG projects continue to make good progress on all fronts and the Pearl GTL project was a significant contributor to this quarter’s results.

I am pleased to say that work on the Skikda LNG project is ramping up according to plan, and had a modest positive impact on the quarter. As this project continues to ramp up, we expect it to make more meaningful contributions to our future quarterly results.

From a potential projects perspective, we still believe a possible announcement on the LNG train seven project in Bonny Island, Nigeria will be forthcoming in the early part of 2008. Also, the Gorgon LNG project in Australia overcame some environmental hurdles this quarter to receive its final permit, and the clients are in the midst of final economic and feasibility studies of this project, prior to committing to a final investment decision.

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

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

The new services business is a group that has an excellent legacy reputation in these markets.

I am very optimistic about leveraging the KBR brand and our legacy expertise as KBR seeks to grow these businesses back to historical levels. KBR services has also been test for studying in KBR’s hospital re-entry into offshore fabrication, supporting our current efforts in the upstream business unit.

With thoughtful review, and careful analysis, we will investigate how KBR can take advantage of our legacy fabrication routes, to create synergies with some of our existing engineering and construction activities.

Currently, KBR provides maintenance operations on about 30 refining, petrochemical, pulp and paper and other industrial facilities. Over the past several months, KBR has been successful in renewing these existing contracts, particularly in the Gulf-coast region as well as expanding our service offering we are providing under these contracts.

In construction, KBR continues to see opportunities in our Canadian operations, in particular, in the oil sands market. Leveraging our fabrication operations in Canada, allows us to capture these broader construction and fabrication opportunities.

In the U.S, the strong domestic construction market affords opportunities that can have significant impact to KBR. This quarter KBR won a contract from Brazil to install a new extruder piping and other equipment.

KBR currently provides the maintenance services at this facility and this contract again demonstrates KBRs' ability to expand the scope of services it provides to its customers from the foundation of the O&M business.

Currently, there are several larger construction projects being actively pursued by KBR and we hope to be able to announce several awards in the upcoming months. For our government and infrastructure business unit, a protest surrounding the LogCAP IV award are still ongoing. At this time we don't know when the transition from LogCAP III to LogCAP IV will occur. In the meantime, we will continue to provide on an exclusive basis great quality services under the extensions of the LogCAP III a Task Order 139 contracts.

Also related to our work under LogCAP III, we were disappointed with the most recent award fee scores from July 2007, which fell from an excellent rating to a very good rating. Currently there are new teams in place for our customer and we are working hard to resolve any customer concerns and bring the award fee scores back up to historic levels.

During the almost 5-year period we have worked under the LogCAP III contract, we have been awarded 72 excellent ratings out of 89 total ratings. During the third quarter of 2007, the G&I division was awarded approximately $100 million in new work outside of LogCAP III in Iraq related activities. This additional work primarily consists of several Task Orders to provide to engineering, design, construction management, technical support to the U.S. Air Force under and existing contract.

Other projects contributing to the backlog were repair and maintenance work on existing military bases in the U.S, a program management contract for improvements to an airport in Arizona and a mining construction project in Australia.

We periodically view an adjustment to the forecasted five year revenue stream for our Allenby & Connaught project also contributed an additional $100 million to backlog, during the third quarter.

For technology KBR continues to make great progress in the commercial implementation of our Superflex technology. This first of a kind technology takes low grade refined products and upgrades then went to ethylene and propylene.

This month our Superflex unit for SASOL in South Africa achieved startup and within three days of these stock entering the system the ethylene and propylene products were on spec and the unit is operating as planned.

Earned income from technology for the third quarter on a variety of projects, including refining, petrochemicals and fertilizers was 30% greater than the second quarter of this year. Also during the quarter, KBR was awarded a licensing fee for an ammonia plant in Latin America.

Now I’ll turn the call over to Cedric. Cedric?

Cedric Burgher

Thanks, Bill. I will begin with reviewing KBR's consolidated third quarter results, which primarily focus on year-over-year comparisons.

Consolidated KBR revenue for the third quarter of 2007 totaled $2.2 billion, which is relatively flat compared to the third quarter of 2006. Consolidated operating income was $102 million in the third quarter of 2007 compared to an income of $66 million in the third quarter of 2006.

Operating income in the third quarter of 2007 included positive contributions from certain gas monetization projects and from our rock related work. In addition, we recognized an $18 million pre-tax gain on the sale of our interest in the Brown & Root-Condor (BRC) joint venture in Algeria. Operating income during the third quarter of 2006 included a $32 million impairment charge related to our equity investments in the Alice Springs to Darwin railroad project in Australia.

Energy and Chemicals revenue for the third quarter of 2007 was $613 million compared to $602 million for the third quarter of 2006. Operating income in the third quarter of ’07 was $46 million, flat compared to the prior year of third quarter. Contributing positively to our third quarter of 2007 results were the EBIC ammonia project in Egypt, the Pearl Gas to Liquids projects in Qatar, the Yanbu export refinery in Saudi Arabia, and our large LNG projects.

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

Remember that Escravos gas-to-liquids project in Nigeria is a significant revenue contributor as it is a consolidated 50:50 joint venture, and it has a very little operating income impact.

Now, let’s talk about the Government Infrastructure Division. Third quarter of 2007 revenue was $1.6 billion, which compares to $1.7 billion in revenue for the quarter ended September 2006. Operating income was $59 million in the third quarter of ’07, a $4 million increase from the comparable period last year.

During the third quarter of 2007, operating income was positively impacted by the Allenby & Connaught project, Iraq related activities and work on the [Simton] project.

Because of the award fee scores that Bill previously mentioned, the award fee accrual dropped from 84% to 80% during the third quarter of 2007. This accrual adjustment had a $3 million adverse impact on operating income.

With respect to the Ventures division, operating loss for the third quarter of 2007 was $3 million compared to a loss of $35 million for the third quarter of 2006. The third quarter of 2006 was impacted by a $32 million impairment charge related to our equity investments in the ASD railroad project in Australia. Now, I’ll discuss backlog.

Total backlog at September 30, 2007 was $12 billion compared to $9.6 billion at June 30, 2007. Overall, the backlog portfolio makes at the end of the third quarter was 71% cost reimbursable and 29% fixed price, the same mix as the prior quarter. The backlog mix was primarily influenced by work off from large cost reimbursable projects, and the addition of the Skikda LNG project which has components of both fixed price and cost reimbursable terms.

The energy and chemical division’s backlog as of September 30, 2007 was $7.4 billion, up $2.7 billion or 56% compared to the previous quarter. The increase in backlog was due to the addition of $3 billion for the Skikda LNG and the Ras Tanura projects, which was partially offset by work off in gas monetization.

The government and infrastructure division's backlog as of the end of the third quarter 2007, was $.39 billion. A $300 million decrease, from the last quarter, primarily driven by workoff from Iraq related activities. The Venture division's backlog as of September 30, 2007 was up slightly, from the second quarter of 2007.

Now, let's review other financial items. General and administrative expenses for the third quarter of 2007 were up slightly at approximately $32 million, which included $4 million for acquisition related activities, as compared to $2 million in the second quarter of 2007. During the third quarter of 2007, we've recorded an $11 million net currency loss, compared to a second quarter loss of $2 million.

This quarter's pretax loss, which totals $8 million net of minority interest is primarily related to the weakening dollar and unusual volatility encountered during the quarter. The third quarter of 2007 cost of services included a $4 million accrual, for assessments and remediation cost, associated with an industrial site at our Clinton Drive facility in Houston.

Due to the nature of operations previously conducted at this site, we are aware that some contamination may have occurred. However, more analysis at this site, including timing and techniques used to implement remediation are required, which could result in an additional $7 million for all identified environmental matters on eight of our properties.

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

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

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

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

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

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

KBR did file a Form 10-Q amendment for the second quarter of 2007 today, to correct a classification error on the statement of cash flows. Certain amounts primarily related to the sale of DML, were incorrectly classified as foreign exchange movements rather than an effect on cash flow provided from operating activities.

This error had no impact to the income statement, balance sheet or total cash and cash equivalents at the end of the period. We determined that this issue constituted a material weakness in the monitoring of the preparation of our statement of cash flow for the six month ended June 30, 2007.

However, controls will revise and operated effectively during the preparation of our third quarter financial statements, such that we and our auditors believe this material weakness is now been remediated

And now I’ll turn it back over to Bill for his final remarks.

Bill Utt

Thanks, Cedric. There are a number of positives that occurred during the quarter that exemplifies the continued progress, KBR has made as a company this year.

Our backlog continues to strengthen with solid quality projects being added. Overall backlog was up 25% over the last quarter, with AMC backlog up 56%. We have some strategic awards in the quarter, which allows to build upon our capabilities in the upstream markets with onshore and offshore developments skills and our sub-sea expertise.

From an emerging markets perspective the coal, gasification project in Florida is a prime example of how KBR technology will enable us to capture expanded future services opportunities.

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

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

Overtime these non-contributing projects, as well as our strategic investment in our coal gasification technology will be replaced by more profitable projects and this will have a positive impact on KBR's operating margins.

Although there is much work to be done within the organization, I'm pleased we have the restructuring of our operational divisions is progressing to allow us greater focus on our customers and the projects we execute on their behalf. I believe this new organization as well as the continuing improvements in KBR project execution overtime will position us for growth and benefit our employees and shareholders.

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

Question-and-Answer Session

Operator

Thank you. The question-and-answer session will be conducted electronically today. (Operator Instructions) We will take our first question from John Rogers.

John Rogers - D.A. Davidson & Co.

Good morning,

Bill Utt

Good morning

John Rogers - D.A. Davidson & Co.

Bill you mentioned that Bonny Island in the Australian LNG project's possibilities out in to 2008. I was wondering if you could talk a little bit about other bidding opportunities, particularly that you see coming up over the next couple of quarters over here.

Bill Utt

Well, we're also looking at other projects beyond Bonny Island and the Gorgon project. Currently a couple of projects where we are presently providing services is Tangguh and [Damy] that we are also - we are examining what are the opportunities for expansion. And certainly as the incumbent of these very successful projects we feel we're well positioned for future work.

There are also some other projects that have been that are -- in my earlier discussions in the South-East Asia market, the Australia market that we're interested in, we're trying to position ourselves in the some studies and some pre FEED work for those, but we're optimistic and that over time this projects could move forward and then we believe our position will be competitive across those projects as well.

John Rogers - D.A. Davidson & Co.

In terms of Gorgon and Bonny Island, are they comparable to the Algerian in scope and total size.

Bill Utt

Well they are not. The Algerian project while its $4.5 million tones per year is clearly -- we also has a big fractionation plant there and so you get a lot of liquids coming off that plant. And the Bonny island project is, if you look at Train 7 and the possibility that they would go to a Train 8, these are very large Trains certainly much larger than what we're looking at on [Skeet] I think there are 7.5 million ton trains each.

Obviously, the Gorgon project could be as many three trains and the sub final sizing is being determined. So, these looked to be in a more standard LNG plants with may be a little bit less liquids than you see we are going see at the Skikda plant.

John Rogers - D.A. Davidson & Co.

Okay, thank you.

Operator

We will take our next question from Barry Bannister.

Barry Bannister - Stifel Nicolaus

To clean up on what the prior analyst had asked. What you were talking about much larger trains at Bonny 7 and on Gorgon in cumulative amounts. So, even though there is less liquid, these are much larger in million ton per annum are they are not?

Bill Utt

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

Barry Bannister - Stifel Nicolaus

Okay. What are you seeing in terms of the pricing environment for work? Is it increasing, the same or in terms of competition, particularly with competition out of Asia for some of the gas monetization is coming down a bit right now?

Bill Utt

Well, I am interpreting your question to go towards competition, as opposed to supply chain cost volatility. So I will try to focus on the first a little bit more. The project there, particularly Train 7, if you just look at the size of those projects and the possibility of doing two trains and even some of the earlier announcements, the capital cost of these projects over the last two or three years have grown at a much faster rate than the balance sheets within the industry. And so, as on train, as we have on Trains 1 through Train 6 at Bonny, we are pursuing this with our consortia of three other parties that allows us to share risks more efficiently and better manage the balance sheet commitments. And so by putting the consortia together we've created an environment where we have a much more stable project execution.

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

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

So, yeah, I think that the market is becoming a little more competitive, but as against we look out at the market there is sure a lot of projects being talked about and it doesn't appear to be that we will be suffering from lack of work with respect to LNG overtime. Now, clearly we have to get some of these awards going forward for us to be able to get the phenomenon of several projects moving forward, but certainly the fundamentals of the market appear to drive a continuing increase in gas demand on a global basis. Very quickly on the supply chain side, we see continued price increases that do not appear to be as volatile as they had been over the last two or three years. Certainly, as we look at these prices and the volatility surrounding these prices, it is impacting our commercial offerings to our clients, and certainly as we saw with the Skikda project where we thought it was our client determined that it was less costly for them to take that risk and for KBR to underwrite that risk. We are seeing that move through the industry in a little more thoughtful fashion because of all of our collective experiences on volatilities.

Barry Bannister - Stifel Nicolaus

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

Cedric Burgher

Clearly the Skikda is continuing to build some of the things going on a gas monetization for the quarter, of course, you look at that table with -- it’s a supplemental table we give you on our [M&A] and as well as the earnings release. There is some movement here both in revenue and I think I will try to explain for you.

Certainly, we allocate overhead based on revenue, and as I mentioned, Escravos has a 50:50 project, gets twice the revenue versus our share at basically no margin. So that's a big driver for revenue, as well as, lower job income or lower margins, if you will. We also had train six in Nigeria nearing completion which produced lower revenue and lower operating income this quarter versus last quarter. That would be probably the biggest driver. There were a lot of other little movements, some completed work on very small studies and jobs in the gas monetization area that we hope will lead to more work in future, but at this point was less of a benefit this quarter versus last quarter.

Bill Utt

I think as we look forward, we still see increasing staff that we are putting under the Pearl project that will have a positive impact on revenue, Skikda's going to ramp up. Tangguhwe are pretty much into the field right now on that. So the revenues we have will continue through. So right as we finish the construction of that project, Yemen is in its transition into the field. We saw some engineering that we were wrapping up with the late stages of the engineering but that’s another thing to the field.

EBIC ammonia is pretty much in the field right now. So, the big drivers I think on a revenue basis is clearly going to be Skikda because we’ll be running through a lot of the cost through our P&L but also, we have an added benefit on Pearl.

Barry Bannister - Stifel Nicolaus

Thank you.

Operator

(Operator Instructions).

We’ll take our next question from Andy Kaplowitz.

Andy Kaplowitz. - Lehman Brothers

Good morning guys. Could you talk a little bit more about refinery and petrochemical work that you could get ahead? I know there are some big projects out there possible. So maybe any more color you could give us on that area will be helpful.

Bill Utt

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

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

We do see a lot of activity in the Middle East that we're positioning ourselves for that will come to tender in the '08 timeframe and we like what we're seeing there in terms of opportunity sets and the volume of opportunities.

We're even looking at some projects that we’ve been involved with for several years in Africa that appeared to be moving forward to from a FEED phase and into an EPC phase and we're optimistic that what we see just in the Middle East and Africa is very strong. We've continued to deliver some other work within the U.S. and see that market expanding a little bit more as they deal with some expansions as well as the little bit of technological obsolesce of the plants.

Even with the recent disclosures by the Alberta government in Canada related to the tax regime there, we think a lot of in our discussions with our customers, they have already factored a lot of that into their plans and we still see at today's prices with this new oil regime, a continuing opportunity for us to build that type of business in Canada and we just say we've seen a very strong business overall and we think we be able to continue to make announcements and receive material awards, that will have a very positive effect on our income statements in 2008 and beyond.

Andy Kaplowitz. - Lehman Brothers

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

Cedric Burgher

Yeah, which expense line, the G&A or --

Andy Kaplowitz. - Lehman Brothers

The minority interest.

Cedric Burgher

The minority interest, yeah, I am sorry. I think a piece of that was the FX loss that was on the 50:50 Escravos project; it was coming back. So, that's a piece. That was about $3 million.

Andy Kaplowitz. - Lehman Brothers

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

Cedric Burgher

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

Andy Kaplowitz. - Lehman Brothers

Okay. I understand. Thank you.

Operator

We will move now to Al Kabili.

Al Kabili - Goldman Sachs

Hi. Good morning, guys.

Bill Utt

Good morning.

Al Kabili - Goldman Sachs

I just wanted to clarify on the gas monetization business and the operating income. So, we have got some profitable projects in Yemen, and you have got zero margin Escravos. So, I mean, are you saying then that with the profitable projects and the zero-margin Escravos that once you apply overhead to all, that brings you down to negative?

Bill Utt

Yes, and we give you in the Q a footnote that gives you exactly what the job income was. It’s $22 million for the quarter, so you can see the overhead amount and it does that. But the phenomenon on Escravos is because it is a high revenue project, as it’s consolidated, it attracts a lot of corporate overheads. So, if you were to pull Escravos out of that segment line, you’d see a much better result because Escravos comes in negative. It’s 40% to 45% of our Q3 revenue.

Cedric Burgher

Couple of other pieces just, if you look a little more granularly quarter-to-quarter, second quarter to this quarter, last quarter you’ll recall we had a $3 million benefit through the conversion of the Escravos that we didn’t experience this quarter. And that was a one-time conversion experience, $3 million. We also had a few other pieces, I mentioned, the Nigeria Train 6 is nearing completion, and so it was a much bigger contributor last quarter versus this quarter. We had slightly lower work on Pro this quarter. We don’t think that, as Bill mentioned, we are putting more people on that job, so that should turn.

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

Al Kabili - Goldman Sachs

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

Bill Utt

Well, I think we’ve got to try to step back and separate out the method by which we allocate the overhead, which is revenue based. As Cedric pointed out, it was plus 22 before the overhead allocation in that we've to minus 13, so we had a $35 million allocation of overhead there. But its something that as Skikda ramp up that too will attract overhead charges. So it will be very important for us to keep an eye on the footnotes. So you can see the -- what we hope would be a ramp up in the margins before the overhead.

So that the revenues aren’t attracting a continuing increasing proportion of the overall SG&A in the Company.

Al Kabili - Goldman Sachs

Okay. And then we can just switch over to LOGCAP III a little bit. It, given the changes in award incentives, when that potentially reset to a more normalized level or how long this can drag on at these lower margins?

Bill Utt

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

As we get into the LogCAP IV whenever that transition will occur, we all have the opportunities to bid pieces of work. And there are limits on what we can bid but they are certainly fair in excess above what we're realizing now. And the army will rely on the competitive markets, determine the economic value or profits from that work through competitive biding. So any kind of material change that we see in margins, it will only come with LogCAP IV.

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

Cedric Burgher

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

Al Kabili - Goldman Sachs

Right. And is there any chance for that award fee to come back up? When is your next change here? What score fell? When is your next change to get that boosted up and get these award fees?

Bill Utt

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

Al Kabili - Goldman Sachs

Okay. And then a final follow-up is, any talks of extensions beyond on LogCAP III, beyond what you have already indicated, given this protracted dispute on the LogCAP IV award?

Bill Utt

We’ll continue to provide those services so long there is a need for those services and there is not a LogCAP IV award. It's anybody guess at this point.

Al Kabili - Goldman Sachs

Okay. Thank you.

Operator

Our next question comes from Michael Dudas

Michael Dudas - Bear, Stearns & Company

Good morning, gentlemen.

Bill Utt

Good morning.

Michael Dudas - Bear Stearns and Company

Talking about the IGCC project, are you using sweat equity from the Gorgon margin as your investment into this project, can you explain little bit more, how this is going to play out over the years of the FEED and into the construction and financial O&M businesses?

Bill Utt

Yes, I am happy to discuss that. When we talk about sweat equity you really have to go back and look at the rules under which the clean coal programs exist, and because this project is integrated gas supply combined project it’s benefited by contribution from the Department of Energy to help demonstrate this technology. Certainly, all providers of services cannot recognize any profits on that project. And because this is a government audited contract we have elected, for the sake of our sanity, in many respects, to have this contract executed under our government and infrastructure division, which is complying with government contracting.

And so, the very, very low overhead that we cover under the work with the government is the only recovery above our salaries that we have on this project and that applies to the FEED work and the early stage EPC work that we’re performing on that project, and as we continue to perform services, any services for that we provide for procurement or construction management, their further engineering will also attract a very low overhead rate. So, really our sweat equity is the opportunity cost we have of doing a $300 million to $400 million EPC project at cost compared to what we could get on the open market in a -- with respect to doing other work for other customers.

So that’s our investment; it is forgone opportunity, and as we described in our prepared comments, this does have an adverse impact on our unit margins. But, it is something that when we have looked at the technology, and we have looked at the opportunity and discussed it with our board we were very excited about the prospect of being able to be a first demonstrator of a successful gasification technology, and some of the drivers, that really make this exciting for us, so that it is air blown, it does not require an oxygen plant like many of the other competing technologies.

And on a pilot plants demonstration has proven to successfully convert low-grade coal such as lignite or sub-bituminous coal into gas giving at a much wider fuel spectrum to gasify coals, and also some other competing technology. So, we are making a near-term investment in terms of foregone opportunity on our people, but we believe that long-term will be very beneficial to us, as we can then take that project not only to other power applications, but also into our legacy hydrocarbon and syn gas operations.

Michael Dudas - Bear, Stearns & Company

I appreciate the detail. Just an idea on, internally is it three, four years before you think you can take this success and market it, or -- I have hit some milestones sooner that will allow you to take advantage of the market, which many of these pretty competitive versus the PC and IGCC World etcetera given with regulators who want to pay it and allowed to pass through?

Bill Utt

I think we are looking at 2010 commercial operation. As, we move forward, and we look at this, I think, in terms of doing other dropping a gasifier in the front of the 250,000 megawatts of combined cycle plants that were built in the US in the last seven years, that's probably going to be out there, you know, ten, but as we look at the technology, we continue to have a very active program at our pilot plant down in Wilsonville, Alabama. I would like to see us move forward and do some ventures with our more traditional customers, certainly on a much smaller scale, but use those opportunities to try to demonstrate this back in our, perhaps downstream businesses where we can replace some natural gas with gas derived from coal as a feedstock.

Michael Dudas - Bear, Stearns & Company

Appreciate that, but one follow-up. As we get to year end '07, can you help us with where do you think you'll be relative to professional and field staff at KBR? How successful you think you’ve been in '07 attracting and retaining talent? What kind of turnover you'll see? And you feel that you have the resources to meet if you get some fortunate wins in the next 12 months to work off those businesses?

Bill Utt

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

I believe we had done a good job in preserving the project management process engineering capabilities in the company and are looking to continue to grow and enhance those. And certainly we have work coming off. You know we've moved out of engineering on EBIC and in the near term we will out of engineering on Tanghhu and Yemen and so we are creating additional engineering capacity to undertake this work which we really want to put those people to work on projects that you know will be accretive to our P&L.

In terms of field services and construction, we are certainly able to attract folks particularly in the Gulf Coast region as we begin re-ramping up our construction activities. There are lots of people out there who have had a great affinity towards the legacy organization and then we brought back a lot of our veterans to an alumni to feed this work.

We also have the added prospect of being able to look at our personnel over in Iraq and LogCAP project and eventually as that business shrinks and certainly even at a steady state we have new people going in and existing people coming out who've done their rotation in theatre. That we have a very large labor staff that we have access to with which to put the work on construction projects and many of these people have been with KBR for a couple of years. Some of them are with us for a long time, but they are clearly as they come out theatre are interested in remaining part of our organization and we think that's a hidden resource that we hope to exploit on our construction and operating services business to be able to meet our human resource requirements.

Michael Dudas - Bear, Stearns & Company

Very well, thank you very much.

Operator

We move now to Jamie Cook.

Jamie Cook - Credit Suisse

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

Bill Utt

I don't think, Jamie, we have to look at where we are in the life cycle of projects and I cannot tell you with any degree of precision where our competitors are with respect to their life-cycle projects. But as my comment, as I made my comments earlier, we do have projects coming off that create new opportunities for us to redeploy the people. I would also tell you that why we’ve had a probably an okay sale through this year, I wouldn’t describe it in any terms closed to being an exceptional sales year.

So, and I see our sales teams having made some transitions with the organization both in terms of our business development oversight processes, as well as, our new line management organization. So, I am very optimistic that with this additional capacity and with some of the issues that we’re putting behind us organizationally at KBR that we will be able to do better in terms of our sales for next year than we have done this year, and that is certainly my expectation.

Jamie Cook - Credit Suisse

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

Cedric Burgher

Yes. Jamie, this is Cedric. We are -- really no big changes from last quarter in terms of what we are looking at, which is to say, primarily focused on acquisitions. You did see in my earlier comments, an increase in some of the monies that we’ve spent this quarter on acquisition efforts that includes due diligence and so on. So, we’re looking at lot of things. We are, in our view, being very disciplined about what would be a successful acquisition here. So, we’re looking it at lot and being very selective. We are going to continue that focus. We do have some limitations in terms of our bank agreements and tax sharing agreement with Halliburton that restrains us from a significant share buyback, but that’s something over time we would consider as well. And of course we've talked about in making investments in technology and winters related areas, if we find those opportunities, and we are looking at some of those as well.

On the offshore side, Jamie, we clearly have a historical and legacy expertise in that market. Our Leatherhead operation is one of the strongest in the industry. It’s our hope, we can do a lot of that organically, but it will take some time for us to get back into this. We're going to be very systematic and diligent. That goes towards any efforts we're going to look at regarding the fabrication side, as well as, any acquisitions we may make. It's, you know, for us we see a great opportunity set out there and what we want to do is create for our company the broadest possible resource base where we can take the project to have the highest value to KBR and apply our human and financial resources against those projects we choose. So, we clearly see a lot of money being spent offshore, we think that it's an attractive place to be, but we are going to look at that as a compliment to how do we build value at KBR, and we are optimistic that there will be more opportunities set, would open up for us because of that expansion, and we are not going to do so in any way that is not going to create shareholder value.

Jamie Cook - Credit Suisse

All right and then just last Cedric, I must say I missed it in your prepared comments, did you re-affirm your’08 guidance?

Cedric Burgher

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

Jamie Cook - Credit Suisse

All right, great. Thanks. I'll get back, thank you.

Bill Utt

Okay.

Operator

Our next question comes from Brad Handler.

Brad Handler - Wachovia Capital

Thanks, good morning.

Bill Utt

Good morning.

Brad Handler - Wachovia Capital

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

Cedric Burgher

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

We also report our MMM venture there. That is not a consolidated, so it has a much higher margin because of the equity method accounting but it's also a very high performing asset, the two vessels that we used with [PMAX] and those are continuing to perform well and we think the trend will continue there.

So, and then we highlighted I think some other opportunities we're looking at in a robust market, both in the Middle East and Africa for downstream and refining opportunities.

Brad Handler - Wachovia Capital

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

Bill Utt

Well, we look at our licenses, we should be able to do dozens a year. In terms of licensing, last year we had a very successful year licensing our ROSE technology. If we look at our project lifecycles, we had material ammonia business. ROSE is getting up the curve; SUPERFLEX is now starting up. From my side and part of why we want to go to technologies is, it's an important part of our business. It is a business that we think we'll be able to grow and you'll be able to judge for yourself when we disclose those results. How meaningful or how material it will be. But certainly from our interest we are looking to grow that technology portfolio and by putting out there its -- we really putting pressure on ourselves to grow that business. And it’s a high margin business as Cedric said and certainly was very positive this year because there was a 30% improved performance relative to the second quarter.

Brad Handler - Wachovia Capital

Fair enough. Okay guys thanks.

Rob Kukla

And Sherry, this will be our last question. So we will take one more, thank you.

Operator

We will go now to Dan Pickering

Dan Pickering - Tudor Pickering & Company

In under the bell.

Bill Utt

Congratulations.

Dan Pickering - Tudor Pickering & Company

Yeah thanks. Bill, you may have mentioned several -- obviously we've got several projects that are coming through relatively low margins. Could you and Cedric kind of help quantify in both energy and chemicals, and G&I? Kind of how much is the revenue that we saw books was carrying, lower or no margins just to help us understand the margins of the remainder of the business?

Bill Utt

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

Cedric Burgher

Just kind of scanning that in the page, we don’t have the sum definitely, but let me do it and obviously I wanted to it on the call, as opposed to not having an option doing it any other time. It’s going to be, I am in a guess, couple of $100 million, a quarter of round numbers for the year. It will be under that but, call it 150 or so.

Dan Pickering - Tudor Pickering & Company

And that’s in both segments combined or just energy and chemicals?

Bill Utt

That’s all of energy and chemicals. I did, of course, LOGCAP we talked about being a low margin. That is just completely…..

Rob Kukla

…copious as in G&I.

Bill Utt

As copious in G&I.

Dan Pickering - Tudor Pickering & Company

As well as the, I guess, as well as the Orlando project?

Bill Utt

The Orlando project? Yeah. That would be reported in G&I.

Cedric Burgher

Yeah. Orlando is pretty low number at this point.

Dan Pickering - Tudor Pickering & Company

Okay.

Bill Utt

But that will ramp up -- that’s $300 million to $400 million and as that ramps up to pull engineering will become a material component of revenues that we will not attract. I think that’s going to have a normal S-curve there? Really the early stages of detailed engineering and so when we think about FEED as complete, we are at that early stage, and there should be ramping up significantly, certainly in “08. [Scopia], while it has a large financial impact, even with the adjusted cost budget, it’s still a plus $100 million. So and we’re in the field there -- So, that’s going to have a continuing impact for us for the next four, five quarters. Escravos, the moving part there is cost to continue to escalate, the good news is the cost, you know, that escalation no longer has an impact on us.

Dan Pickering - Tudor Pickering & Company

Right.

Bill Utt

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

Cedric Burgher

I now have a little more time to do my math. Thank you, Bill, about a $150 million including this [Scopi] excluding LOGCAP, but if you look at kind of a low-margin projects, we've talked about virtually all of them, but it's about a $150 million in the third quarter of ’07.

Dan Pickering - Tudor Pickering & Company:

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

Bill Utt

Should be ramping up in G&I, is that clean coal project.

Dan Pickering - Tudor Pickering & Company

All right.

Bill Utt

Is going to go with it.

Dan Pickering - Tudor Pickering & Company

Yes, okay. Thank you. And then, though I think I have asked you this in the past, but I couldn’t find them in my notes the answer, so I am going to come back to it. Can you give us just a ball mark in the energy and chemicals, sort of, where your dollar amount of active sort of bids outstanding will be today and where was it six months ago?

Bill Utt

I would say that our bids six months ago, which would put us back into April are probably about where they were now. When we were in April in my recollection, we are still in pursuit of all the coal, which did not. But as I intuitively and subjectively look at the pipeline today, we do have a lot of bids outstanding. And we expect -- I don’t like our position on some of those because they are few of them are our sole source negotiations, but we got to get them in the boat and some of the projects are with customers that were we kind of got our arms around, but we don't quite have in the boat yet. But I think we'll be successful there so from our bids outstanding standpoint I think it's about the same. But we got to remember that you look at buying $10 billion or coal bid out there in April that is no longer a little longer -- that we are no longer accounting in the current bids outstanding

Dan Pickering - Tudor Pickering & Company

Okay, So if you lost one project and still then with a number of others.

Cedric Burgher

Yeah.

Dan Pickering - Tudor Pickering & Company

Okay, and last question, rather. I am sorry I got to ask one more, which is back to the gas Monetization business. I understand you've been money at the gross profit level and then the allocations are getting it, again lots of moving pieces, which you described very well but if we boil that down over the next couple of quarters, are we going to get back to the point where we're actually booking operating profit there or is it going to take a little while longer than the next quarter or two?

Cedric Burgher

Is that in the G&A?

Dan Pickering - Tudor Pickering & Company

Correct, I mean as a kind of reported operating income number.

Bill Utt

Well, I mean that’s is going to vary a lot of things Dan. I think that obviously how we continue on LogCAP's is going to have a big impact because that draws a lot of overhead in some of the other projects that we have. Will we see a similar increase in revenues? I would anticipate, Dan, that at some point, I really believe that will see some good results this quarter and into '08 and our construction activities that will generate a lot of revenue growth for the company and that will pull away from the gas monetization. Some of that overhead.

Dan Pickering - Tudor Pickering & Company

Fine.

Bill Utt

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

Cedric Burgher

Just to add a little bit. In terms of big projects to watch obviously Escravos is a low margin is the big revenue low margin. But you have Pearl as we mentioned potentially increasing. While we are coming off a Train 6 in Nigeria, we are hoping and looking forward to Train 7 as well as the Gorgon. And so those will be the big projects to watch for us, in the gas monetization area specifically that could lead to increased profitability.

Dan Pickering - Tudor Pickering & Company

Great thank you, guys.

Cedric Burgher

And thank you

Bill Utt

All right.

Rob Kukla

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

Operator

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

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