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Chicago Bridge & Iron Company (NYSE:CBI)

Credit Suisse Engineering & Construction Conference

June 7, 2012, 9:50 a.m. ET

Executives

Philip Asherman - President and CEO

Ronald Ballschmiede - EVP and CFO

Christi Thoms - IR

Analysts

Jamie Cook - Credit Suisse

Jamie Cook - Credit Suisse

Sorry, we're running a little behind. Next up, we have Chicago Bridge & Iron with us. We have Phil Asherman to my right, he’s the president and chief executive officer as well as Ron Ballschmiede, executive vice president and chief financial officer, and Christi Thoms, manager of investor relations. So I think in light of time, Phil is going to give a few prepared remarks and then we’re just going to open it to Q&A. So thank you for coming.

Philip Asherman

Well, thanks for having us, Jamie. There’s a lot of familiar faces here, so I will try to set a good base, but I have committed to the team that for once I would try this base to the script to not vary too much before we open for questions. But thank you for your interest today. And there we go.

All right. Safe harbor statement. Anybody got that ingrained. Okay. All right. Few comments about the company, Ron will go into the specifics of the financials and then we’ll open the mic for your questions. But as most of you know, CB&I is certainly one of the world’s leading engineering procurement fabrication and construction companies, and also a major process technology licensor. We certainly provide a comprehensive range of solutions to customers in the energy and natural resource industries.

We have 21,000 employees worldwide. We offer a full scope of services from conceptual design and technology licensing through engineering, procurement fabrication and construction to final commissioning and beyond.

Chicago Bridge & Iron has been in existence for nearly 125 years. I know probably the previous presenter liked to talk about his 100 year anniversary, I am sure you heard that. But we’re nearly 125 years young, and as importantly, we have been a multi-national company for most of that time, and it’s been a real competitive advantage for us and our customers to be able to demonstrate actual experience in virtually every region in most countries throughout the world, and primarily through our legacy businesses or in the resumes we’ve acquired with Lummus Engineering and Lummus Technology.

This is a picture of what we call our dream harbor. We think it exists somewhere in probably Texas and Louisiana but it certainly is just an illustration of the type of work in an energy infrastructure we do. Certainly that includes upstream where we serve the oil and gas industries and certainly in the 20th century, when we began building storage tanks for then a somewhat young oil business. Today, we offer a comprehensive range of technology and EPC services for the upstream oil and gas sector with primarily focused on offshore oil and gas production systems, platform topsides and floating production, storage and offloading facility FPSOs, onshore oil and gas field production, onshore pipelines natural gas processing, LNG liquefaction plants and regasification terminals as well as bulk liquid storage structures.

Also downstream, some of the best known names of the industry have worked with CB&I to design and build downstream oil and gas processing facilities, and for Lummus technologies to provide cost effective license technologies and catalysts. Of course, we focus on refinery process units, petrochemical facilities, gasification plants, hydrogen generation plants, sulfur processing plants and bulk storage facilities. And then certainly on LNG where we have a very strong position, we serve the liquefied natural gas industry for more than 50 years, and we’ve designed and built nearly every type of LNG project operating on a global basis. We offer a comprehensive range of technology and engineering, procurement fabrication and construction services for the LNG industry around the world.

And to a lesser degree but certainly quite important to us is our experience in the power industry where we have a history of – in the original construction wave of power plants. Many years ago, we participated in 78 of the 104 original reactors built in the United States and our actual today, in a number of areas, including plant Vogtle and plant Summer where we are constructing the containment vessels for those projects.

This is a new graph we’ve added to our deck to give you an illustration of our backlog and where it’s concentrated in our primary end markets. This certainly changes as new awards are awarded during the year but it generally breaks down the distribution pretty well and given the relativity of project size in each segment, that overall distribution percentage shouldn’t change much as we’re growing organically. And the bubble chart to the right illustrates how we see our position relative to global competitors.

Again as the market grows in activity, I think some of these charts will show a much more fragmented competitive landscape particularly in the petrochemical and gas processing industries. But today with the exception of offshore and power where there is clearly a lot of headroom for our company, we enjoy a pretty strong position in the markets that we serve.

This is our analysis of what we’ve identified as addressable opportunities in our key end markets. The circles indicate the business sector which has a predominant business opportunity for us. For example, LNG while it’s presenting significant tank storage opportunities, the majority of our backlog and share of the anticipated CapEx will be captured in our engineering construction sector. But it also illustrates the absence of new awards for project, there are still legitimate opportunities for the other two business sectors. So we have a lot of ways to access individual markets.

Okay, let’s talk briefly about the three sectors. We think this is the heart of the business model and certainly encourage you to look closely at these three verticals. Prior to our acquisition of Lummus in 2007, we were almost exclusively reporting on a purely regional basis. After the acquisition of Lummus, it allowed us to move to an industry alignment in the energy and report our business through what we call three business sectors. Each with very distinct characteristics both in what they do from Lummus technology to engineering and construction and steel plate structures, very different operating characteristics and margin opportunities. And let’s talk about each one a little bit.

Certainly at Lummus technology, we continue to be a leading player in licensing proprietary processing technologies to the hydrocarbon industry. Lummus is renowned for the scope of its technology assets and its ability to provide single source solutions that licences over 70 processes, that are supported by more than 2800 current and pending patents with our key strengths in olefins, petrochemical intermediates and polymers, refining including hydro processing, residuum upgrading, fluid catalytic cracking and lubes and natural gas processing.

We also have a heat transfer group which is a world leader in the design and supply of specialized heat transfer equipment to process industries around the world. That’s been in business since around 1930s and it’s supplied fired heaters of every size and type, including ethylene cracker heaters which are used to produce about 40% of the world’s annual ethylene capacity.

Our engineering construction business which is comps – probably closer to the other businesses or other firms that you’ve heard about this morning, typical engineering, construction fabrication type services, very global throughout North America, Europe and Asia, providing engineering procurement services for offshore systems, onshore and off-gas production, a number of downstream projects, certainly in our acquisition of Lummus which is the important part to give us the kind of critical mass that we needed to enter many of these end markets and certainly as far as our mix of projects added to our technical strengths around the world.

And then our legacy business, our steel plate structure, this consolidates all of our flat bottom tank, our pressure sphere, nuclear containment, and low temp cryogenic storage business. This is a part of the business that goes back to the first storage vessel in 1893, Ron remembers that job. I think it’s a good job. Extensive global experience on virtually any tank construction in the industry. We’ve built in excess of 45,000 storage tanks in more than 100 countries on all seven continents.

So with that, Ron, I will let you talk a little bit about the financial overview.

Ronald Ballschmiede

Thanks Phil. Good morning. Over the last dozen or so years, we’ve transformed CB&I from a legacy above ground storage business into a significant global player for each of our sectors. This growth resulted from strong organic growth over that period of time. That also included several key strategic acquisitions. These acquisitions included the 2000 acquisition of Howe-Baker where we introduced to the hydrocarbon processing plants, John Brown in 2003 which provided our first major engineering offshore and provided specialties in offshore design, pipeline design and LNG engineering services.

And then in 2007, we completed our largest acquisition, we acquired Lummus Global from ABB. This acquisition included our Lummus Technology business and several significant engineering office around the globe. Over that period of time, we reported compound annual growth rate of approximately 20%. That revenue growth rate is expected to continue, and in 2012, our revenue guidance reflects that with the guidance of $5.2 billion to $5.6 billion.

As you can see, our backlog peaked in 2007 previously with several awards, both LNG import and export opportunities and the acquisition of Lummus Global backlog and then you’re about $1 billion. We saw the first effects of that what we term this financial pause in late ’08 and the first half of ’09 and our backlog performed nicely over that period of time. New awards were pretty quiet until the last half of 2009, where we booked in excess of $5 billion works in and around all of our sectors, LNG, large steel plate structure awards and perhaps – well, certainly the largest refinery opportunity we’ve had in our history, the Cartagena refinery somewhere north of $1.5 billion.

In 2011, our new awards totaled $6.8 billion, that was a certainly high point of our history and included significant awards for LNG work in and around Australia, and additional works on the Kearl oil sands. These new awards brought our backlog to $209 billion at the end of 2011. New awards in the first quarter of 2012 totaled $1.7 billion, resulting in backlog of $9.6 billion, and key awards including that additional $750 million award for the additional expansion of the Kearl oil sands projects and $300 million of the U.S. petrochemical expansion for Williams, a project that hopefully will lead to other opportunities like that in the United States, and while not a large amount of award, certainly strategically important award, the FEED for the Freeport liquefaction export terminal in the United States. Our strong first quarter new awards supports our confidence in our previously commuted 2012 guidance of $5.5 billion to $7 billion of new awards.

Our SG&A expense remains well controlled, decreasing to 4.5% of revenues in 2011 from 5.1% in the prior year. The most significant component of our year-over-year absolute dollar increase in SG&A was the December 2010 transaction where we bought a majority ownership and full ownership of our Chevron, CDTECH joint venture and that was a previously unconsolidated joint venture. Without that, we saw inflationary increases somewhere around 2% to 3%, and we expect that kind of rate in 2012.

On that basis, we would expect 2012 SG&A to be about 4% of revenue, a 50 basis point reduction in 2011, and certainly this improvement reflects the operating leverage that we are getting through double digit revenue growth I discussed earlier.

An important metric in our business is SG&A as a percentage backlog, when you think about it, that’s more reflective of the size we’re expecting to be and as you can see on the blue line, that is continuing to decrease over time and we would expect that to continue.

Slide is a bit busy but it’s frankly one of my favorites. So let me take you through it in pieces. The yellow shaded band is the operating margin range of our selected U.S. peer companies, generally a 3% to 6% operating income model. The green shaded band is CB&I’s operating bandwidth of 6% to 8%, certainly bump up above that periodically over the 13 quarters with our peer. And certainly CBI’s higher operating margin reflects our unique business model, a combination of our engineering procurement and construction business, that 3% to 6% operating income consistent with the yellow bandwidth. But then our legacy steel plate structure sector delivering consistent operating margin of 7% to 10%, and reflecting margins a little bit more consistent with the engineering project, product type category of business.

And then finally, our Lummus technology sector, we call it our operating income basis because of the joint ventures and the way we share some of our technologies around the world, but continue to expect that to be plus or minus $100 million operating income business and we expect it to continue to grow.

The second item of note is the stability of our white line, if will, CBI’s operating margins over the trailing 13 quarters, that will return in, frankly, a naturally lumpy business, and reflects our strong project execution, the mix of our backlog and the predictability provided by some of our sector performance recurring revenues coming out of particularly Lummus technology.

And finally, the blue bar reflects earnings per share for each in the past three years, each representing a record in their respective years, and take me forward to 2012, our EPS guidance for ’12 is $2.75 to $3.05.

Quickly, we got a great start to 2012. Revenue for the first quarter is $1.2 billion, up 26% from 2011. The revenue increase reflects the increasing activity of some of our large job particularly in our project engineering and construction business. And we would expect increasing project activity continuing throughout 2012 and expect sequentially increases in quarterly revenue.

Our 2012 first quarter operating income totaled $86 million, and reflects that higher revenue particularly out of almost 40% growth in the project business, construction business. The higher operating income flowed down to net income to $59 million, or $0.60 for the first quarter, and up 20% over the prior year. The strongest first quarter in our company’s history.

The $1.7 billion first award which I have discussed earlier, to put our backlog at the end of the quarter at a new high watermark at $9.6 billion. And importantly our cash balance at the end of the quarter was $640 million, up $2 million over the year ago period and during that same thread like four quarters look back, we returned over $220 million to our shareholders through stock repurchases and dividends.

Just some of the financial highlights, certainly global opportunities continue to be strong, driving our backlog to these new high levels, with good diversity around the projects geographically and contracting type to manage risk. Our growth in operating margins of our sectors remained consistent with ranges we talked earlier. While they had different growth rates, we would continue to expect that 3% to 6% for PC, 7% to 10% for steel plate structures and operating income of approximately $100 million for Lummus technology.

So good start to the year, certainly met our expectations on all of the key areas, and continue to deliver return on equity in excess of 20% for 2011 but also expect for 2012 and a balance sheet liquidity which allows us a fair amount of flexibility and opportunities to attack the global marketplace and continue to provide the growth. And certainly confidence in the guidance that I went through on there as well. Phil?

Philip Asherman

Good. On summary, we described many of these attributes which you see on the slide, which we feel are certainly differentiators for CB&I. But we think as important is the uniqueness of our business model which provides us with the opportunity to address our markets in many different ways with a variety of commercial approaches and gives our investors a more diverse balance of margin opportunity and risk profiles. So with that, I will open it for your questions. Jamie?

Question-and-Answer Session

Jamie Cook - Credit Suisse

Thank you. 80% of your revenues are outside the U.S.

Philip Asherman

That’s correct.

Jamie Cook - Credit Suisse

How does FX affect you, then, I mean stronger dollar.

Ronald Ballschmiede

Yeah, generally we’ll contract in the currencies where we are doing the work, so for instance, in Australia, certainly onshore work we've quoted and collected in a natural hedge in Australian currency. So it doesn’t move the needle much with one exception, certainly backlog because that backlog is a snapshot at the end of the quarter foreign currency movements can move that backlog up and down by, in some case $0.5 billion, but it has really minimal effect on our operating income as we roll that backlog out, anything we perhaps give up or increase on the operating income line, we tend to make up with procurement opportunities, global procurement process.

Jamie Cook - Credit Suisse

I guess, I will go. So it’s always interesting -- what was in favor last year is not in favour this year, so last year everyone was very excited about Australian LNG opportunities and more recently the market is obviously more tampered with some of the things you are hearing about in terms of delays, in terms of cost issues et cetera. So one, can you just talk to me about how you are feeling about one of the projects that you are in, and the prospects, and then your ability to mitigate cost issues going forward, and does it make sense for you to sort of – I don’t know – are growth opportunities I guess still heavily weighted towards LNG?

Philip Asherman

Well, we certainly have a large concentration in LNG. I think one of the charts I showed was up to around 45% and that should grow. That should grow but certainly balanced by other opportunities that we are seeing in North America in petrochemicals and elsewhere in the world. But in Australia, nothing that we’ve been involved in has slowed down with the exception of just some inherent risk on some of these jobs in Papua New Guinea on Gorgon where logistics and environmental issues certainly have an impact on the schedule. But that’s a matter of progress, not investment.

So we are involved – where we are not involved in the EPC, we are certainly involved in a lot of the tank works for many of these jobs, and that is continuing as well. We think Gorgon is going to continue to grow, at a very perhaps sluggish or more sluggish rate than we anticipated, and certainly there will be additional, we think, scope on that job this year. Arrow was the other project that we are actively working on the FEED for Shell. And they have, I think, publicly stated that they intend to be last on the queue as far as the permitting in Australia but again, we have seen nothing that concerns us as far as overall slowing down of the job. And you look at our forecast, it’s probably got more upside, if one of these jobs were to come in earlier than we expected, we intend to factor these jobs pretty low and I think as most companies probably told you they’d have a position in LNG, this is certainly the year of the FEED. And we see that with our FEED work we’re competed against on Browse with our joint venture partners Chiyoda and Saipem against one of your next speakers’ of KBR on the other side. Certainly Mold (ph) is the job we’ve been working on in Russia, we think that’s got some traction, and so we hopefully will see something by the end of the year as far as at least a tender for the EPC.

So again, these jobs have got some momentum. As far as the North America export, and I think there has been a lot of skepticism if you will, healthy scepticism about the progress of these jobs but again, the job that we are currently active on with Freeport is moving ahead with FEED. There has been some delay announced relative to FERC permitting but again, nothing has changed in terms of the overall schedule for that job. And again, most of these jobs have offtake agreements pretty well in place. The next exciting place, I think that we see developing over the next few years in terms of LNG is in Africa where we are currently looking at some very preliminary work in Mozambique.

So again, we are optimistic, it’s going to take some patience. I don’t think we’re really going to see any real movement till at least 2015 from some of the earliest of the new works. But again, there is nothing that we see that has concerned this is about the overall development of these LNG projects around the world. Jamie?

Jamie Cook - Credit Suisse

The other question is, because there are many, sorry, just on the ability to manage cost –

Philip Asherman

I read some of that. Yeah, I think we’ve said this, and others have come out with some statements around our costs, 65%, 70% of this in equipment and materials, we’ve had – we’ve enjoyed a fairly stable supply market for a long time. There is a mitigating factor, I think, in the fabrication of these large modules for most of these big developments, which we haven’t seen any, again real volatility in those cost yet. But they are complicated. These are several trains, multi-billions of dollars investment, and I think they are planning to spend as much as they can upfront before they could sign on their final execution model.

So we anticipate that Browse, for example, should be awarded to a EPC contractor, if not by the end of this year, early in next year, and where it goes from there as far as FID is still up for question but I think certainly we anticipate it next, or the first half of 2013 would not be bad estimate at this point. Yes sir.

Unidentified Analyst

You mentioned Freeport North American export, could you go in a little more detail on what else you are seeing away from that?

Philip Asherman

Well, there is lot of speculation obviously, there is a number on the list, and certainly North America, there is a couple of smaller trains certainly in Canada that they are looking at, the four major developments in the U.S. could include the Freeport, Janeiro (ph), perhaps BG, Lake Charles, Dominion seemed to be at the top of some of those estimates. Freeport -- we’ve signed an agreement with Freeport already to begin the FEED work. We have a joint venture with Zachry Construction which is a private company out of Dallas which have built the original regasification terminal. So we are moving ahead on that. It’s a matter of determining the feasibility work whether it’s going to be one-train, two-trains, or multiple trains and again, the permitting process is well underway. I think it’s already gone through DOE, there is some additional FERC approvals but we anticipate that’s going to continue with FEED certainly through this year and hopefully we’ll get into FID by early next year.

Jamie Cook - Credit Suisse

Okay. Two questions, one for you, Ron, some of the companies that have presented this morning have talked about how they are thinking about the use of cash, one, in terms of given how the stock have traded recently and your belief in the market, how are you thinking about sort of capital allocation and returning cash to shareholders? And then one on to your repo but then on the other side, on the acquisition front, can you just talk about opportunities on the acquisition front, and for historically, I think you talked a lot about building more of the upstream type business. With some of the stuff you are seeing in LNG, or resurgence of the petrochem, is that big of a focus now as it was probably two to three years ago with some of the other markets?

Ronald Ballschmiede

Let me start and then I will hand it over to Phil for the (indiscernible). I think we always look at our balance sheet as a precious jewel, we want to make sure that we have the ability to, not only delivery the projects but the financial ability to take advantage of acquisitions if they arise in right nature to grow our business. That’s always the first crack at our liquidity and why we keep that powder there.

And secondly, buybacks, cash dividends are always on the table, we certainly look at that and periodically are in the market as we have been this year. And we will continue to kind of weigh that every quarter as we look forward in the opportunities around that. Phil, I will let you talk about this acquisition strategy.

Philip Asherman

If you just look at our end markets, there is no reason to believe that most of our end markets we can grow the kind of capacity we’re going to need for these markets organically. Certainly the two obvious markets where we have a tremendous amount of headroom is offshore and in power. We participate in both of those markets with -- the offshore business is a great business for us in terms of topside design FPSO work. It fills our engineering offices around the world and we’ve got a lot of expertise there. And so when you start going on to the water, that we start getting a little nervous as far as our background.

So that would take a major change to really enter that market, and I am not sure that’s likely any time soon. But certainly not completely impossible. But that would have to be through some kind of acquisition or financial transaction or collaboration. But certainly we’ve gotten a lot of potential through some of the other types of collaborations. We have joint ventures, for example that we have with Chiyoda and Saipem which is sort of the financial transaction that I think we get a lot of leverage out – a lot of leverage on and participate in some of these multi-billion dollar projects around the world. So I think it’s going to be a combination, we’re always in the market – I shouldn’t say always but we’re typically in the market for acquisitions on technology where we think that’s some of the best return for your capital that we can find. But again, they tend to be smaller, very discreet, somewhat difficult in terms of the deal. But certainly we would look for that as an opportunity if it presents itself.

Jamie Cook - Credit Suisse

Just with regards to acquisition in technology, one of the presenters this morning talked about with insurance sub-segments within energy that proprietary technologies have become more commoditized, or that there is more competitors, so – and that’s one of the reasons why they got out of the market. Can you talk about certain markets within energy where you see that there is still a technology that gives you that much advantage or commands a higher – is it LNG, is it –

Philip Asherman

Well, our technologies, we approach a little different than some of the other companies in our space. When we acquired Lummus and Lummus Technology, we made the decision not to embed that in our EPC offering for the very reason that you mentioned, Jamie, is we didn’t want it to be commoditized. We think it’s very much a value add, and a wonderful source of recurring and predictable income for our company. So the comparatives out there would be companies like UOP, Shell Global Solutions and BHF (ph) and those types of companies. So quite different than the EPC space.

But again, it’s been a great contributor to the overall business model and that’s why we plan. So that’s a little bit different. I think when you look at many companies in our peer group, the tendency to be embedded in your EPC model and use it as a full factor for EPC opportunities, we do that. We certainly leverage our technology expertise, particularly in petrochemicals. When you look at the previous cycle of petrochemical plants there was more of a commercial tendency, if you will, among owners to take the technology provider through basic engineering and preliminary design. And if you had a delivery solution in construction, you have pretty good chance to negotiate a lot of that work with, or at least to tender a lot of the work in petrochemicals. And we would hope that this next wave of petrochemical development could be similar to that.

In other cases, like gas processing, we’ve just been able to bundle a number of services, starting off with technology and then taking that opportunity to introduce our EPC capabilities as well as our (indiscernible) storage. So it’s a great opportunity for us to get the early view of the job and the early view of the market around the world, and certainly deal with the level of management that you may not get a chance to deal with as just an EPC contractor or tank supplier. So it’s been very useful in that respect as well. So I don’t know if that’s commoditized, certainly there is a lot of mature technologies such as ethylene, which we have a very strong position in. I think certainly there is other opportunities there. I think the recent acquisition we saw with Stone & Webster, I think you probably would see Technip showcase that as a technology they want to leverage and take advantage of going forward as well.

Jamie Cook - Credit Suisse

We probably have time for one more question if there is one.

Philip Asherman

Who has got the best question in the room today?

Jamie Cook - Credit Suisse

Quiet bunch.

Philip Asherman

If that’s what your question is, what time is lunch?

Jamie Cook - Credit Suisse

No, I said quiet bunch -- I said quiet bunch. No, we have you again for lunch in about 45 minutes. Aren’t you lucky? All right. So actually we are back on schedule. So thank you very much. I appreciate your time.

Philip Asherman

Well, thank you. Appreciate your time.

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