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KBR, Inc. (NYSE:KBR)

Q1 FY08 Earnings Call

May 02, 2008, 11:00 AM ET

Executives

Rob Kukla, Jr. - Director, IR

William P. Utt - President and CEO

Charles E. Schneider - Interim VP and CFO

Analysts

Jeff Tillery - Tudor Pickering & Co.

Andy Kaplowitz - Lehman Brothers

Barry Bannister - Stifel Nicolaus

Jamie Cook - Credit Suisse

Steve Fisher - UBS Investment Research

John Rogers - D.A. Davidson & Co.

Operator

Good day, everyone, and welcome to the 2008 First Quarter Earnings Conference 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 opening remarks and introductions, I'd like to turn the call over to Mr. Rob Kukla, Director of Investor Relations. Please go ahead, sir.

Rob Kukla, Jr. - Director, Investor Relations

Thanks, Audra, and good morning and welcome to KBR first quarter 2008 earnings conference call. Today's call is also being webcast, and a replay will be available on KBR's website for seven days. The press release announcing the first quarter's results is available on KBR's website. We have tentatively scheduled our 2008 second quarter earnings conference call for Friday, August 1st, 2008.

Joining me today are Bill Utt, our Chairman, President and Chief Executive Officer; and Chip Schneider, Vice President, Treasurer and Interim Chief Financial Officer. In today's call, Bill will provide opening remarks and business outlook. Chip will address KBR's operating performance, financial position, backlog and other financial items. We will welcome questions after we complete our prepared remarks.

Before turning the call over to Bill, I would like to remind our audience that today's comments may include forward-looking statements reflecting KBR’s views about future events and their potential impact on performance. These matters involve risks and uncertainties that could impact operations and financial results and cause our actual results to differ from our forward-looking statements. These risks are discussed in KBR's Form 10-K for the year-ended December 31st, 2007, KBR's quarterly reports on Forms 10-Q and KBR's current reports on Form 8-K.

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

William P. Utt - President and Chief Executive Officer

Thank you, Rob, and good morning everyone. I am very pleased with KBR's first quarter results. Net income for the first quarter of 2008 was $98 million or $0.58 per diluted share compared with $28 million or $0.17 per diluted share for the prior-year first quarter. Consolidated KBR revenue for the first quarter of 2008 totaled $2.5 billion, up 24% from the $2 billion for the first quarter of 2007. All business units reported, with the exception of Technology, year-over-year improved quarterly revenue led by a 56% increase for Upstream, a 52% increase for Services, and 18% increase for Downstream and a 16% increase at G&I. Technology revenue was adversely affected by several project completions prior to the first quarter of 2008, combined with delays in other expected projects.

Now, let me turn to some operational highlights for our business units and updates to KBR's end-markets. With respect to our Upstream business unit, during the first quarter KBR's bid was submitted as planned for the NLNG Train Seven Project in Bonny Island, Nigeria. KBR continues to maintain an active dialogue with the client and we believe the project continues to move forward towards the conclusion of negotiations with the successful contractor.

During last quarter's call, I talked about the status of KBR's other large lump-sum turnkey projects. During the quarter, the Tangguh and Yemen LNG projects continued to perform to our expectations with the first trains on both projects expected to be completed by the early 2009 time frame. At the end of the first quarter, the Tangguh project was 91% complete and the Yemen project was 74% complete. Through our Eos joint adventure, KBR was awarded contract options for the detailed engineering and procurement management services for Woodside's North Rankin 2 Project. The North Rankin B platform will be installed alongside the existing North Rankin A platform. Eos has already completed the feet for the North Rankin B platform. The combined revenue for the feet and contract options for the Eos joint venture is approximately $320 million.

Over the past several quarters, KBR had a successful series of project awards related to offshore work. We remain very optimistic about the opportunities that are available to KBR to continue to grow this business, given the very favorable market conditions. Recently, our consulting group, Granherne, was selected as the contractor for the Trans Caspian Oil and Gas Study funded by United States Trade and Development Agency. Granherne's feasibility study will provide for conceptual pipeline routing and design, financial analysis, economic modeling, CapEx and OpEx estimates, as well as environmental reviews.

For government and infrastructure, the U.S. Army announced two weeks ago that KBR was once again selected as one of the executing contractors of the U.S. Army's LOGCAP IV contract. Although this brings the re-award base and protest to a close, the terms and timing of the transition from LOGCAP III to LOGCAP IV are still forthcoming. Until this transition occurs, we will continue to work under LOGCAP III, providing quality services to the U.S. Military.

Also related to our work under LOGCAP III, we received award fee letters on our Iraq, Afghanistan and Kuwait work as a result of recent award fee Board reviews. I am pleased to announce that for Iraq and Kuwait, KBR received excellent award fee scores. In regards to our Afghanistan work, the results ranged from very good to excellent. Since our work under LOGCAP III began, we have been awarded 75 excellent ratings out of 95 total ratings. However, we will continue to accrue award fees at the current level of 80%.

I am however disappointed with the $12 million charge taken on the Skopje Embassy project in the first quarter. As a result of a project estimate update, we identified increases in cost on this project for additional materials and related freight and installation cost. We are in the process of further refining the material requirements, which we expect to be completed by the end of June of this year. At the end of March 2008, the project was approximately 62% complete and we believe this project will be completed by the end of the year.

On April 8th of this year, KBR announced that it had been a... it had acquired Catalyst Interactive, an Australian e-learning and training solutions provided that specializes in defense, government and industry training. This acquisition enables KBR to build on its leadership position in providing aviation training solutions in Australia and will allow KBR to extend and broaden its training and technology offerings across all of KBR globally.

Overall, KBR's G&I business unit had a very strong performance during the first quarter, despite our continuing issues on the Skopje Embassy project. I am particularly pleased by the continued strong performance of KBR's military and infrastructure businesses in United Kingdom and Australia, which contributed strongly to the overall G&I results.

KBR's Services business unit continues to make outstanding progress, driven by its heavy oil sands work in Canada and the domestic U.S. construction projects. Revenue grew by 52% from the first quarter of 2007, with a corresponding backlog growth of 208% year-over-year. Services has been successful in its focus on domestic construction projects. I mentioned several awards during last quarter's call including a flare gas control project and a new sulfur unit on an emissions controls project. These projects and several others in the construction arena were initiated near the end of the fourth quarter of last year. These projects continue to progress well and have positive impacts to Services results in terms of revenue and business unit income.

On April 2007 to 2008, KBR announced that they had acquired Turnaround Group of Texas Inc., a Houston-based turnaround management and consulting company that specializes in the planning and execution of plant turnarounds and outages in the petrochemical, pulp and paper, and power industries. This acquisition fits nicely into our industrial services product line and demonstrates KBR's commitment to grow in the construction and maintenance markets with an ability to diversify and broaden our portfolio of offerings. This acquisition also enhances the organization's capabilities for schedulers and planners, bringing 230 years of combined previous KBR experience and over 1000 years of industry experience into our company.

KBR sees a continued strong market for our legacy North American construction and maintenance businesses and expects the recent strong growth of the businesses to continue during 2008. Further, the continued growth and capabilities of KBR's Services business unit will enable KBR to be a much stronger and more capable provider of services on international lump-sum turnkey projects.

For our Downstream business unit, the first quarter's results continued to be led by the Ras Tanura and Yanbu export refinery projects in Saudi Arabia, along with the EBIC ammonia project in Egypt. Overall, the EBIC project is going very well and is approximately 96% complete. Construction and commissioning is targeted to be complete by the end of the year. The downstream market outlook remains strong for refining and petrochemical projects in the Middle East. With regard to the Yanbu export refinery project, KBR has concluded the feed work, but continues to work on the design of long lead equipment, obtaining vendor data, evaluation of EPC packages, site preparation and detailed engineering of interconnecting systems, which will become part of the project’s final investment decision.

The Technology business was awarded a contract by Ningbo Wanhua Polyurethanes Company to provide technology and basic engineering for a 360,000 MTPA aniline plant, which will be the largest in China and the largest single-train facility in the world.

At the beginning of April, KBR successfully completed an MTBE to Iso-octene Conversion Project for Valero in Corpus Christi, Texas. This conversion project was based on Neste Oil Corporation's NExOCTANE process, which is licensed exclusively through KBR in the Americas.

KBR's global resource pools also contributed to our success during the first quarter. Labor cost absorption driven by volume and cost efficiency was $9 million better during the first quarter of 2008 compared to the same period in 2007.

Lastly, in the Form 10-Q that was filed this morning, we expanded and emphasized disclosures in the liquidity and capital resources section in order to be more transparent about the way we look at our cash balance and credit facilities. I want to spend a few minutes discussing our cash balance and walking you through the details of our potential uses of cash.

At the end of March 2008, our cash and cash equivalents was $1.9 billion, of which $358 million is associated with our consolidated joint ventures and $231 million constitutes advance payments associated with a contract being executed by a wholly owned subsidiary of KBR. As we have previously outlined in prior earnings calls, KBR also has capital requirements to accommodate large intra-month working capital swings related to our LOGCAP III project, which we have said is in the range of $200 million to $300 million. We have also stated that KBR needs approximately $100 million on the balance sheet for other businesses in operating working capital needs. This leads KBR with a truly discretionary cash balance of between $900 million and $1 billion.

In terms of uses of this discretionary cash, our business strategy continues to include evaluation of strategic and niche acquisitions of other businesses, which if successful in acquiring we would expect to fund all or a portion of the acquisition with cash. We are currently evaluating several such opportunities that if successful will require the use of a portion of our existing discretionary cash balance.

KBR is very cognizant of the need to productively to use this cash to increase earnings and optimize our return on capital. If over time, we cannot productively put that cash to use, we would examine other uses for this cash including returning this cash to KBR's shareholders in the form of stock dividends and/or share repurchases. While we do not have a definitive timetable established to complete any acquisitions or return cash to shareholders, this is a topic that KBR Board reviews and discusses at every Board meeting.

Now, I will turn the call over to Chip.

Charles E. Schneider - Interim Vice President and Chief Financial Officer

Thanks, Bill, and good morning. I will begin with a review of KBR's consolidated first quarter 2008 results, which primarily focus on year-over-year comparisons. Consolidated KBR revenue for the first quarter of 2008 totaled $2.5 billion compared to $2 billion in the first quarter of 2007. Consolidated operating income was $154 million in the first quarter of 2008 compared to income to $45 million in the first quarter of 2007.

Operating income in the first quarter of 2008 included a $51 million gain on a favorable PEMEX arbitration award. This was partially offset by a $12 million charge related to our Skopje Embassy Project in Macedonia. Recall that operating income in the first quarter of 2007 included a $20 million charge related to the Brown & Root-Condor Spa joint venture in Algeria.

With regard to the business units, Upstream revenue was $611 million in the first quarter of 2008, up $219 million or 56% from the first quarter of 2007. Business unit income was $105 million in the first quarter of 2008 compared to $20 million reported in the first quarter of 2007. Business unit income in the first quarters of 2008 and 2007 included a $51 million gain on a favorable arbitration award and a $20 million charge related to our Brown & Root-Condor Spa JV in Algeria respectively. From an operational perspective, the year-over-year business unit income increase was primarily driven by the Skikda LNG project, the Pearl GTL project and multiple offshore projects including the North Rankin 2 project in Australia.

Government and infrastructure revenue in the first quarter of 2008 was $1.7 billion compared to $1.5 billion for the prior year first quarter. Business unit income was $80 million in the first quarter of 2008, which included a $12 million charge related to the Skopje Embassy Project in Macedonia compared to favorably to $70 million in the first quarter of 2007. The increase primarily related to higher levels of activity on the Allenby & Connaught project, Iraq-related activities and multiple water projects in Australia and Scotland.

Services revenue was $108 million in the first quarter of 2008, up from $71 million from the first quarter of 2007. Business unit income was $13 million, a $3 million increase from the first quarter of 2007, due primarily to the start of work on the Scotford Upgrader project in Canada, several North American construction projects, and increased work for service and maintenance vessels in the Gulf of Mexico. Partially offsetting the Services year-over-year increase was the completion of several projects in Canada.

Downstream revenue was $100 million in the first quarter of 2008 compared to $85 million from the first quarter of 2007. Business unit income was $8 million in the first quarter of 2008 compared to $2 million in the first quarter of 2007. Contributing to the business unit income increase was the Yanbu export refinery project, a pre-feasibility study for a refinery in South Africa and the Ras Tanura project in Saudi Arabia. This increase was partially offset by job income losses of approximately $3 million on the Saudi Kayan olefin project.

Technology revenue for the first quarter of 2008 was $19 million compared to $28 million in the first quarter of 2007. Business unit income in the first quarter of 2008 was $5 million compared to $11 million for the prior year first quarter. The decrease primarily relates to several project completions as of the first quarter of 2008. Additionally, we have experienced delays and some cancellations of anticipated project awards. Partially offsetting the decrease was work performed on a new award for ammonia process project in Venezuela.

With respect to the Ventures unit, business unit loss for the first quarter of 2008 was $4 million compared to a loss of $5 million for the first quarter of 2007. The improvement was primarily related to increased profitability on the Allenby & Connaught investment in the UK and reduced losses on the Australian railroad project as general freight in bulk mineral transportation improves.

Now, let's review some other financial items. General and administrative expenses for the first quarter of 2008 were $56 million, up $7 million from the fourth quarter of 2007. Included in the first quarter of 2008 corporate G&A expense are net costs totaling $7 million, which are not expected to recur. These include costs associated with the deployment of an HR/Payroll system within SAP together with a charge for access to Halliburton's HR/Payroll system while we transition the position over to our own systems. Also included were costs accrued for sales in U.S. taxes for periods currently under audit. Partially offsetting these costs were discretionary adjustments determined and recorded in the first quarter of 2008 related to our 2007 short-term incentive program and other adjustments. For fiscal year of 2008, we expect recurring corporate cost to run in the $200 million range.

Our effective tax rate in the first quarter of 2008 was 36% as compared to a rate of 44% in the fourth quarter of 2007. The decrease in the first quarter of 2008 primarily relates to a tax planning strategy, which enhances KBR's utilization of foreign tax credits. Also, the fourth quarter of 2007 rate was unusually high due to related discrete adjustments, including additional U.S. taxes on some of our foreign subsidiaries. For the full year of 2008, we still expect our effective tax rate to be in the high-30s.

Turning to backlog, total backlog at March 31, 2008 was $13.4 billion compared to $13.1 billion at December 31, 2007. This sequential backlog increase was primarily due to added work for our Middle Eastern operations with modest additions to Upstream, including the addition of a pass for FPSO award and growth on existing projects in the Services business unit. Overall, the backlog portfolio mix at the end of the first quarter was 76% cost-reimbursable and 24% fixed price as compared to 72% cost-reimbursable and 28% fixed price for the sequential quarter, primarily driven by the added work for our Middle East operations.

Next, I will discuss our liquidity and balance sheet. As Bill mentioned earlier, at the end of March 2008, our balance sheet remains strong with no debt and cash and cash equivalents of $1.9 billion, of which $358 million was cash associated with our consolidated joint ventures. Total cash balances increased by approximately $66 million during the first quarter of 2008.

Our working capital at the end of the first quarter was $1.5 billion, up slightly compared to the year-end 2007. Working capital in Iraq was $161 million at the end of the first quarter, down approximately $81 million from the year-end 2007 due to timing of collections on receivables.

CapEx totaled $8 million and depreciation was $8 million during the first quarter of 2008. CapEx decreased approximately $3 million compared to the sequential quarter, primarily due to lower IT and real estate expenses. We continue to expect CapEx for 2008 to be less than $70 million with our spending focused on the potential expansion of fabrication capabilities in our Canadian operations, a number of IT projects, and various relocations, upgrades and maintenance on G&I offices.

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

William P. Utt - President and Chief Executive Officer

Thank you, Chip. In closing, we continue to be optimistic about the outlook in 2008 across all of KBR's end-markets. Our strong global sales force continues to constantly pursue profitable prospects with the reinforcement of project screening, technical and commercial execution, our reputation in the industry and our outstanding customer relationships. Our portfolio of major lump-sum turnkey EPC projects are strong, continues to remain profitable and is progressing according to our expectations. KBR continues to carefully and thoughtfully evaluate taking on additional lump-sum risk into our portfolio.

We continue to work on innovative risk-sharing project structures with our customers as evidenced on our Skikda project in Algeria. While our backlog from continuing operations reflects a 76% cost reimbursable composition, I'm confident KBR's people, processes, systems and culture will allow KBR to profitably execute additional lump-sum turnkey projects, particularly as our existing backlog of lump-sum turnkey projects are successfully completed.

Organizationally, our restructured business units are demonstrating new levels of efficiency, both operationally and financially. The increased focused on the delivery of results, accountability and performance is yielding positive sales and operating results benefiting our customers, shareholders and employees. From a corporate perspective, we continue to evaluate our overhead structure to drive efficiency and reduce cost.

Lastly, KBR is working hard to put its excess cash to work productively to increase shareholder value and improve both KBR's earnings and return on capital. We made two small acquisitions during the past month and we continue to evaluate other opportunities that may have a bigger impact on KBR to broaden, strengthen and deepen our service offerings. We're also looking to continue to expand our credit capacity, which will enable KBR to grow the business by capturing the work we see in the future.

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

Question and Answer

Operator

Thank you. [Operator Instructions]. We'll go first to Jeff Tillery at Tudor Pickering & Co.

Jeff Tillery - Tudor Pickering & Co.

Hi, good morning.

William P. Utt - President and Chief Executive Officer

Good morning.

Jeff Tillery - Tudor Pickering & Co.

I just wanted to ask a question on the Downstream business. The outlook continues to be pretty strong with... you got Ras Tanura and Yanbu, a lot of that work potentially sitting in front of you. The orders have been pretty measured in the recent past. How do you think about that business going forward? Is it going to be big project driven or is it more of a mix of smaller kind of individual projects?

William P. Utt - President and Chief Executive Officer

Jeff, one of the things that we've hope to achieve by breaking down the old Energy and Chemicals business into the various business units that exist today, Upstream, Downstream, Services and Technology, was to provide a greater view into discrete market segments, where in the past we might have been over-focused on LNG projects. While we are still focused very heavily on LNG projects, the creation of the Downstream business from our perspective gives us an opportunity to have a wider array of projects with which we can execute in these hydrocarbon markets. It's really expanded our opportunity set for our people. And so I think we'll be able to make better, more profitable decisions from a broader choice of projects going forward.

Within the Downstream business, we oftentimes talk about the continued big projects that we're following, Yanbu and Ras Tanura, but I can also tell you that there are dozens of smaller projects, smaller studies that go in and out, below the surface. And last year, I think we had executed well over 700 projects during 2007 and a lot of those were the hydrocarbon projects in Downstream. Nonetheless, when we look at Yanbu or Ras Tanura, you're talking about projects that could consume project teams in the order of 400. But we are looking broadly and we are looking at how do we maintain a presence across this hydrocarbon value chain that's the best value for our shareholders. And we think that's going to be driven by a mix of big projects and small projects, feed work that positions us later for more leveraging bigger projects. And overall, the portfolio is turning up for us a much larger number of opportunities for which to deploy our human resource capacity.

Jeff Tillery - Tudor Pickering & Co.

Okay, thank you. And my last question is just, as we see… commodity prices fluctuating pretty significantly over the past couple of months. We saw this in 2006 and that ended up pushing out some of the larger projects as it was harder to get kind of cost detriments and what not in place. Do you think the customers are better prepared to deal with the volatility and right now or do you think this will again lead to some projects being pushed up?

William P. Utt - President and Chief Executive Officer

Jeff, I think the customers are… our clients are better able to deal with the volatility because they’ve had more time to get used to it. I think we have seen with respect to our customers that the price tick they are using to evaluate their capital projects continues to move up and is being viewed as more sustainable pricing of the commodity at higher levels than they did a year ago. We are also seeing generally an easing of the appreciation on the commodities side, which... it's still going up, but not going up perhaps at the dramatic rates we saw in '04, '05 and into '06 and '07. We are also seeing in terms of the equipment community... our manufactured equipment that the bid validities are returning a little bit more to longer periods of time and we are also seeing the delivery cycles come back to more towards historical levels of deliveries, which implies a little bit of easing of the volatility we've seen on the equipment side. We are still very focused on the construction markets, particularly in the Middle East, because of the number of projects that are ongoing today and the difficulty a lot of people are having in executing projects in the Middle East on a lump-sum basis in terms of getting labor, the productivity of the labor, the quality of the labor and also the first-line construction management, the superintendents. And so, we'd been benefited by not having large lump-sum positions in the Middle East during this time, and as we look at additional projects we certainly keep this in mind. But the situation is getting a little more balanced but there is still volatility in the system, but the system is in part self-correcting in terms of people's acceptance of this volatility and how they priced it into there their purchase decisions.

Jeff Tillery - Tudor Pickering & Co.

Okay. Thank you very much.

Operator

Next, we'll move to Andrew Kaplowitz at Lehman Brothers.

Andy Kaplowitz - Lehman Brothers

Good morning, guys. Nice quarter.

William P. Utt - President and Chief Executive Officer

Thank you.

Andy Kaplowitz - Lehman Brothers

Bill, in the past you talked about… or you've given guidance, EPS guidance. Is there any changes to the guidance that you have given out in the past?

William P. Utt - President and Chief Executive Officer

No. Our policy, Andy, is to offer guidance in December for the subsequent year-end and we're not going to deviate from that in terms of trying to steer a change from what we've gave out before. I think our policy will be to talk about the market on a real-time basis in these calls. But you look for us to offer the guidance only in December of the year for the next year.

Andy Kaplowitz - Lehman Brothers

That's fair. I guess, just one follow-up on that. You had mentioned when you gave out that guidance that one of the big fluctuations was obviously Iraq. I guess it looks to me like you're going to have more revenue rather than less in Iraq compared to when we were sitting there in December. Is that a fair statement?

Charles E. Schneider - Interim Vice President and Chief Financial Officer

I think when we sat there in December we were unaware of when LogCap IV would happen. And clearly, now that we've gotten to the point of LogCap IV being announced, there is a transition period that we see, that will take… that will require timing before the consultant to the Army develops the packages that will be put out to bid and transitions get taken. So with respect to 2008, we're probably a little more confident about our volumes because we now have a greater certainty. And when we commented in December, we weren't sure when the LogCap IV would come. And so we kind of hedged our bets in case we had an award of LogCap IV.

Andy Kaplowitz - Lehman Brothers

Okay. And Bill, you had in the past also given us a time frame around Nigeria, Bonny Train 7, and I noticed you didn't do that this time. And so I guess the question is, is it still on schedule for the first half of this year you think? And then just along those lines, obviously in the quarter the Government backlog itself was very good, but wasn't that much in the sea [ph] space. So I'm wondering, versus your expectations are projects getting pushed out that you might have thought would have happened in 1Q and maybe they're going to happen in 2Q or 3Q?

William P. Utt - President and Chief Executive Officer

Well, you kind of threw in a couple of questions there. My congratulations to your innovation. With respect to Train 7, we have an active dialog going on with the customer. It's a very active dialog. It’s one that would lead us to believe that we're still progressing positively. But we don't control with respect to our clients when they take final investment decisions and when that would happen, but we are as I mentioned in an active dialog with them.

With respect to backlog, I think it’s more a rhythm of our business, and the businesses have different rhythms. And as you saw last year, we saw a lot of things happen for us in the July time frame with Skikda and Ras Tanura. And so for us things tend to come in bunches and we didn't have any bunches in the first quarter. But I like very much where our position is on several projects and I'm optimistic that we'll have a… perhaps a different story to tell in the second quarter. But we still have to win the work and our customers have to give us the authorization to proceed, but our rhythm deals with a certain degree of lumpiness that things will tend... may tend to bunch up and that's been our history in the last couple of years.

Andy Kaplowitz - Lehman Brothers

Thank you very much, Bill.

Operator

Next we'll move to Barry Bannister of Stifel Nicolaus.

Barry Bannister - Stifel Nicolaus

Hi, Bill. A few quarters ago, you characterized your market opportunities as having a lot of fish that you just needed to reel into the boat and then we were hit with economic lows, which seemed to be lifting with positive economic news and even crude oil is up today despite dollar strength on economic optimism. So do you still feel you have all these opportunities that are just waiting to be reeled into the boat or has the feed gone stale and you might have to rework them?

William P. Utt - President and Chief Executive Officer

No, Barry. I think as we look across the company, our backlog if you... and this is an informal study of… kind of our proposal backlog is still strong. The economic woes that we have seen, you have been primarily… I believe you're referring to the US housing market and the financial sector. And we haven't seen that impact move over to the Asian or the Middle East markets or the African markets. And what the observations that I’ve made is perhaps ten years ago this may have caused a global slowdown, but right now as we see it things are fairly limited to the US and the business opportunities for us remain fairly robust as we look out over time, particularly as I mentioned in the Middle East and Asia.

Barry Bannister - Stifel Nicolaus

You didn’t mention in Australia and LNG where you've done some impressive feed work and there are some large projects coming. Is there a chance that despite project pushbacks that those are still waiting to be reeled into the boat?

William P. Utt - President and Chief Executive Officer

Well, we have commented last quarter on Gorgon and I think nothing has changed there. We're certainly seeing some discussion from Chevron. This may ultimately get larger than we had initially envisioned and we're continuing to do our re-feed work on that. We see a lot of activity on the North West Shelf. We have got some irons in the fire in that region that we have to be able to comment on coming quarters. But it is a point of great interest for us because of the significant demand that the Asian market has towards gas is pulling a lot of the extractive industries in Australia and nearby and dropping that market.

Barry Bannister - Stifel Nicolaus

And then to wrap up, your CFO search for a permanent replacement and your success, I've heard it's been good, in attracting resumes to fill key senior post of the engineering variety, have you got an update for us on either of those?

William P. Utt - President and Chief Executive Officer

I will… with respect to the CFO search, I would first offer you publicly my compliments to the efforts of Chip Schneider in stepping into the breach that he has done so very well in handling. And so we haven't missed a beat in terms of our efforts to continue to run the business smartly and aggressively along the lines that we wish to transform our business.

I'm still optimistic that we will be able to identify good candidates and possibly conclude the search by the middle of the year… by the end of the second quarter. So we are moving ahead very quickly on that and we hope to be able to, as I said, conclude that by the second quarter.

With respect to the other positions in the organization, we have had some really good success in attracting some additional talent into our organization. Breaking up the business units as we have to six business units gives us a much cleaner story to tell that people when they look at KBR can understand where they are going to fit into organization within our Technology business. We’ve brought in some great commercial management there. We’ve brought in a great manager to help look at our... lead our gas monetization activities in Upstream. We are continuing to broaden our management talent across all of our Downstream, our Offshore businesses, and Services businesses. And so we're really pleased with the reception that KBR has received by that senior management community based on where the business is going, how we are performing. And certainly the increased transparency that we provide gives them a greater certainty that this is a business that's moving forward very positively.

Barry Bannister - Stifel Nicolaus

Thank you. Good quarter.

William P. Utt - President and Chief Executive Officer

Thank you.

Charles E. Schneider - Interim Vice President and Chief Financial Officer

Thank you.

Operator

We'll go next to Jamie Cook at Credit Suisse.

Jamie Cook - Credit Suisse

Hi. Good morning, and congratulations.

William P. Utt - President and Chief Executive Officer

Thank you. Jamie.

Jamie Cook - Credit Suisse

I guess my first question, someone earlier asked a question about commodity prices and how your customers are dealing with that. At the same time, we've seen some other players in the industry have issues with commodity prices. And I guess, Bill, as you look at some of your legacy projects today, I mean do you see any risk in offsetting commodity prices with some of the legacy projects, given just the continued increase in prices I guess?

William P. Utt - President and Chief Executive Officer

Well, Jamie, I think in terms of Tangguh, Yemen and [inaudible], those are all bought out, those are all late-stage. We're in the field assembling, we're welding, in some cases we're doing pneumatic testing of the plant. So we are beyond that stage in terms of the existing projects. And if you look at Skikda, which is really the new one that we added, that's got a component where the reimbursable expenses are being... that risk was being taken by the customer on that project because he made the decision that he was better able to manage our short-commodity position against his long-commodity position than to pay us to take that risk and underwrite that risk. So we're... we don't see that risk of any prevalence on our Skikda project. So we feel pretty good about our existing turnkey portfolio as it relates to materials and equipments. Where we focus on is right now construction productivity and making sure that we can get these plants up in running to enable our customers to sell gas from these facilities.

Jamie Cook - Credit Suisse

Okay, well, that's good news. I guess just my second question, Bill, you talked a lot about acquisitions in your prepared comments. You've made a couple of small ones that are nice niche ones, but they don't really move the needle. I mean, when I think about some of your comments, it sounds like you could be looking at something more material and I… am I reading that the wrong way or can you give us a sense of if there is any thing eminent or anything larger?

William P. Utt - President and Chief Executive Officer

Well, Jamie, I would say that the two acquisitions are relatively niche roll-ups for us but... and they do help broaden some very focused skill sets we’re looking to build in. Yes, it does… it has taken us a while to build the pipeline. We've had the teams in place for really since last... late last spring to begin the process of evaluating and screening the projects. We do have a series of projects that are for us all over the map. And some of them could be material, some of them could be smaller, some could be sooner rather than later. And really for us it's just trying to make sure that we are looking at how we create transactions that create shareholder value and they do include larger transactions that would move the needle from the KBR perspective.

Jamie Cook - Credit Suisse

And would they be... just back to your prepared comments, would you be using just cash or would you consider issuing equity, given the size?

William P. Utt - President and Chief Executive Officer

Well, I would think that we need to... obviously, that goes to size of the transactions, which I really can't comment on.

Jamie Cook - Credit Suisse

I had to try.

William P. Utt - President and Chief Executive Officer

Yes, I know, but… it was good, but our desire would be to certainly look at our resources and we are clearly along cash today and that would be our first resource we deploy and then beyond that we'd look at other debt equity, but it all depends on the transaction.

Jamie Cook - Credit Suisse

All right, congratulations.

William P. Utt - President and Chief Executive Officer

Thank you.

Charles E. Schneider - Interim Vice President and Chief Financial Officer

Thank you.

Operator

We will move next to Steven Fisher at UBS.

Steve Fisher - UBS Investment Research

Good morning. Just first on some of the legacy projects. On Macedonia, it sounds like you're going to finalize the materials cost by the end of the second quarter. I am just wondering, how much of the charge in the first quarter was materials and how much was execution? I guess what I'm trying to get at is one is you’re pricing the materials do the potential charges become more quantifiable and possibly smaller?

William P. Utt - President and Chief Executive Officer

Well, what we're doing in the second quarter are two things. One, we are going back and we are… to the construction drawing and to the site personal. We are going to create a very detailed and specific takeoff of the items we need to complete the project. And we are fundamentally out of the ground, the structure is fundamentally built. It's those internal items that you have that are certainly much smaller in cost and certainly much higher in volumes, so that... we're not [ph] going to do the takeoff on that.

The other thing we are in the process of doing is we have a warehouse and I am a little disappointed that our inventory system for that warehouse is not necessarily where it needs to be. And so, we are in the process of taking a full inventory of what we've already ordered for these materials and as we get to... between the two we look at what do we were have on hand and what do we need we may or may not have further charges. But we're trying to clean up what candidly is a bad inventory situation that we shouldn't have allowed ourselves to get into.

Steve Fisher - UBS Investment Research

So, as you get beyond that inventory assessment, does it become more... does the project become more quantifiable?

William P. Utt - President and Chief Executive Officer

Well, I think that will be the final quantification and we will be down to details of light fixtures, doors, door knobs that kind of inventory.

Steve Fisher - UBS Investment Research

Okay. And then you mentioned in a couple of different way that Yemen and Tangguh are going well. I'm just wondering how confident are you that the projects will actually complete without any material charges? And are we going to have watch these through the early part of 2009 or might you have any sense of that before then?

William P. Utt - President and Chief Executive Officer

Well, we are knocking on wood as we speak, and we watch these projects very carefully. We have some what I think are best-in-class systems and processes to track our progress on these projects. We're very pleased with where we sit today in terms of our ability to meet our commitments to our customers, which would entail being within the provisions we've established on the projects, not anticipating any further financial erosion in terms of schedule damages, etcetera. We do however are going to go to a startup, and every time you go through a startup, you plan it as well as you can, you get all the equipment there, you get people there early, you test it. And we went through an excellent startup on Train 6 in Nigeria. We got that turned over to the client in very short order and they were producing LNG in record time we understand, and we are hopeful that the same planning, the same tools, the same processes we use to plan the startups in commissioning for Tangguh and Yemen will yield the same results for us that we saw on Train 6. Now, every project is different and we will continue to work hard and stay awake at night making sure we get the projects up and running.

Steve Fisher - UBS Investment Research

Okay, great. And then lastly, I think you mentioned some delays and cancellations in the downstream area. Can you just discuss what types of projects those are and why they are being cancelled?

William P. Utt - President and Chief Executive Officer

Well, there were some technology cancellations. These were more licensing agreements that had been issued and they’ve decided to… with the current market going in a different direction with respect to their need for the license… these were not downstream projects, they were not major engineering, it was more the license income and maybe some base engineering packages around that.

Steve Fisher - UBS Investment Research

Okay. So it wasn't economics of a project not making sense?

William P. Utt - President and Chief Executive Officer

Yes. We don't know ultimately what the reason was, but there were some cancellations and it could have been just a delay or change in plans or change in strategy by the customer. But we think that as we look out for the remainder of 2008 that we will be able to meet the targets that were part of our guidance in the December of last year in terms of licensing and the work in technology. So it's… perhaps you move to the right a little bit for us in terms of the performance of that business.

Steve Fisher - UBS Investment Research

Okay, great. Thanks a lot.

Operator

And we'll take our next question from John Rogers at D. A. Davidson.

John Rogers - D.A. Davidson & Co.

Hi, good morning.

William P. Utt - President and Chief Executive Officer

Good morning, John.

John Rogers - D.A. Davidson & Co.

I was just wondering if you could talk a little bit more about some of the Iraq work? I noticed the uptick in backlog there and I assume those are primarily projects there are going to be completed over the next six, nine months?

William P. Utt - President and Chief Executive Officer

Well, they are... we get our work in LOGCAP generally just in time.

John Rogers - D.A. Davidson & Co.

Yes.

William P. Utt - President and Chief Executive Officer

And they basically... we'll go through and we'll burn off several hundred million dollars in a month and then they'll give us the next quarter during that month. And in this case, they gave us a longer lead because of the status of LOGCAP IV and knowing that they can’t transition so they're trying… they are giving us some signals of what… of additional volume we can expect on the LOGCAP III and that perhaps accounts for a little bit of the pickup in the backlog of G&I for the LOGCAP work.

John Rogers - D.A. Davidson & Co.

Okay. And then secondly, in terms of the award fees associated with a lot of this work, you mentioned that you're accruing at the 80% level. As you go through this transition and everything under LOGCAP III is completed, will you start... is there a pool of fees that are yet to be recognized and...?

William P. Utt - President and Chief Executive Officer

The fees that we have presently under LOGCAP III we're accruing. And I will point a distinction that on LOGCAP IV with the new accounting literature, we will only be able to recognize award fee income during the period in which the award fees are determined. So we'll see a change in our reporting because of the new accounting regulations.

With respect to the award fees that we presently have under LOGCAP III, they are really for a period of time and as work progresses over a couple of month period, we'll have an award fee board and to look back over that period and assess our performance for the award fees. I'm gathering your question may go to are other any awards fee pools out there based on the completion of the project or anything unusual, and really there is not. It is simply any award fees will be related to the work we performed over the period for which the award fees are judged, not anything that would be to look-back over five years or anything.

John Rogers - D.A. Davidson & Co.

Okay. So there is no significant potential for catch-up or investments here as you transition out of LOGCAP III?

William P. Utt - President and Chief Executive Officer

No, I think you'll see some volume. And obviously when you transition things and things move over, there are... there will be work that will be required to transition or if the true volumes change but nothing that's… that won’t follow the work that will be asked to perform.

John Rogers - D.A. Davidson & Co.

Okay. Thank you.

Operator

And that does conclude our question-and-answer session. I'll turn the conference back over to Mr. Kukla for any closing remarks.

Rob Kukla, Jr. - Director, Investor Relations

Well, I just want to thank you for joining us today. We do appreciate your time with us this morning. Look forward to getting with you on the second quarter call at the beginning of August. Thank you very much.

Operator

And that does conclude today's conference. Again, thank you for your participation.

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Source: KBR, Inc. Q1 2008 Earnings Call Transcript
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