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McDermott International Inc. (NYSE:MDR)

Q4 2008 Earnings Call

March 3, 2009 10:00 am ET

Executives

Jay Roueche – Vice President of Investor Relations and Corporate Communications

John A. Fees – President and Chief Executive Officer

Michael S. Taff – Senior Vice President and Chief Financial Officer

Analysts

Andy Kaplowitz – Barclays Capital

Marty Malloy – Johnson Rice & Company

Stephen Gengaro – Jefferies & Co.

Jamie Cook – Credit Suisse

John Rogers – D.A. Davidson & Co.

Joe Gibney – CapitalOne Southcoast

Tahira Afzal – KeyBanc Capital Markets

Brian Chin – Citigroup

Steven Fisher – UBS

[Jeff Spittel]

Rick Johnson – Thai Capital

Operator

Thank you for standing by and welcome to the McDermott International fourth quarter 2008 earnings conference call. (Operator Instructions). Now I'd like to turn the conference over to our host, Mr. Jay Roueche, McDermott's Vice President of Investor Relations.

Jay Roueche

Thank you, [LaManuel] and thank you all to all the participants joining us this morning to discuss our 2008 fourth quarter financial results, which we reported yesterday afternoon. Joining me on the call today I have John Fees, McDermott's Chief Executive Officer, and Mike Taff, Senior Vice President and Chief Financial Officer.

Before we discuss the quarter let me remind you that this event is being recorded and a replay will be available for a limited time on our website. In addition, some of our comments today will include forward-looking statements and estimates. These comments are subject to various risks and uncertainties. Please refer to our filings with the Securities and Exchange Commission which are available on our website including our recently filed Form 10-K for the year ended December 31, 2008, for a complete discussion of the factors that may cause actual results to differ from management's projections, forecasts, estimates, and expectations.

With that I'll now turn the call over to John.

John A. Fees

Thanks, Jay and good morning everyone. We have a fair amount to discuss this morning, however, since McDermott's results yesterday were largely at the high end of our earnings preview that we gave in early February, I'll ask Mike to run through the numbers fairly quickly. This will allow us more time to focus on the business environment, our progress with some related issues, as well as to provide sufficient time for your questions.

So let me turn it over to Mike right now.

Michael S. Taff

Thanks, John and good morning. McDermott reported net income of $43 million or $0.19 per diluted share in the fourth quarter of 2008 compared to last year's quarter of $160 million or $0.70 per share. As John indicated this performance was at the upper end of our earnings preview range. Obviously, the $57 million of after-tax net expenses disclosed in the preview was a major variance between the two periods.

The company's consolidated backlog remains strong at $9.8 billion. This is right at our all time year end record level set last year and was up sequentially on a quarterly basis. Our liquidity end of the year was just under $1.1 billion in cash and investments which is net of the purchase of Nuclear Fuel Services which we completed on December 31st. This cash payment of a little over $150 million was a primary reason our cash and investment portfolio declined sequentially.

While we continue to monitor the credit market McDermott has solid flexibility from a liquidity standpoint. In addition to our cash and investment position we have a couple of years left on most of our existing credit facilities with over $750 million available capacity. Currently these facilities are only used for letters of credit.

Looking quickly at our results for each segment finds that offshore oil and gas construction reported segment income of almost $15 million in the final quarter of 2008, this included about $70 million of increased cost adjustments that we indicated in the preview, primarily in the Middle East region, including the pipeline contracts which should be break even at the gross margin level going forward.

These increased costs were partially offset by a $36 million benefit from the resolution and receipt of a prior claim netting to about a $35 million negative impact in this segment. Government operations had another good quarter with segment income of $35.2 million. Our site management activities which are largely reflected as equity income had a very strong quarter as we trued up to the actual fees earned at the various sites.

Finally our manufacturing of nuclear components for commercial and governmental continued their historical strong performance. Power generation systems completed a record year of segment income finishing with a fourth quarter segment income of $48.7 million. Although the GAAP number was generally in line with our previous expectations for this segment, we also had nearly $15 million of identified charges in the period, including the previously disclosed inventory write-down as a result of market adjustments.

Returning to the consolidated numbers total revenues were almost $1.7 billion about 9% above a year ago. This increase came predominantly from the offshore oil and gas construction segment but was also aided by a 13% increase from government operations. McDermott's consolidated operating income was almost $90 million in the 2008 fourth quarter compared to just under $187 million a year ago. The improvements in government operations and reductions in unallocated corporate expenses were more than offset by the segment income decline in power generation systems and offshore oil and gas segments, including the previously identified net expenses.

Primarily due to low interest rates earned on our cash and investments, interest income declined about $12 million in the 2008 fourth quarter compared to a year ago, but since we utilized very little credit, the income reduction far exceeded the benefit we recognized from lower interest expense. And with about $10 million of foreign currency translation losses in the 2008 fourth quarter our other expense net line item increased over $5 million compared to the 2007 quarter.

Adding it all up our pre-tax income declined by over $111 million compared to the 2007 fourth quarter. Yet due to the mix of taxing jurisdictions where our income and losses were derived, our provision for income tax actually increased by over $5 million, increasing from an effective tax rate of 17.6% in the quarter a year ago to almost 48% in the 2008 fourth quarter.

As most of you know, our tax rate varies quarter to quarter and year to year depending on which tax jurisdictions we are working in and the respective profit and losses incurred in those regions. The final balance sheet issue to discuss this morning is the impact that the financial crisis has had on our pension plans in 2008. By year end, our pension plan assets had declined about 20% for 2008, a decent performance considering the markets. However, this represented a $372 million reduction in the market value of our pension assets and increased our pension liability on the balance sheet to a net $721 million.

While the impact of the market decline was not unique to our plans, we do believe McDermott has developed a strong investment strategy for our pensions and we have taken steps over the past few years to mitigate this obligation in the future. For instance, we have curtailed the offshore construction pension plan and duration massed its assets with liabilities. We have eliminated new employees and those employees with less than five years of service from accruing benefits throughout the company, so the number of participants in our plans is regularly declining. We have also funded well beyond what was required in recent years.

Finally it's worth noting that about 43% of our underfunded amount relates to the government operations plan. This is important since the contributions made to this plan are essentially reimbursed by the customer albeit with timing differences. So generally there is very little risk associated with this portion of the plan. In total we will recognize an increase in our GAAP pension expense in 2009, although most of the expense this year will be non cash.

In 2009 we now expect our GAAP pension expense will increase about $90 million from 2008 about double what we had previously budgeted. However, on a cash basis we expect our funding to decrease from $160 million in 2008 to only $46 million this year.

I'll now turn the call back to John for his comments on our operations and business environment.

John A. Fees

Thanks Mike. As I indicated earlier since yesterday's release was mainly just a confirmation of the earnings preview, I'll make a few comments on the quarter and the offshore oil and gas construction segment charges, but I'll focus more on bidding, booking of new work and the overall environment.

Clearly there were a lot of puts and takes during the fourth quarter but we saw a number of positives. As Mike mentioned our liquidity remained strong and I was also very pleased that the year end backlog remained robust, growing to $9.8 billion with over $1 billion of bookings recognized in our government operations segment, which is historically our most profitable work. Consolidated backlogs stayed near our all time year end high level.

The purchase of Nuclear Fuel Services was completed, which adds to our positioning in the government and commercial nuclear markets. And we settled a long-standing claim to provide income to offset some of the charges that we took in the quarter.

Let me provide some more specifics. As we disclosed, about $70 million of charges were taken during the fourth quarter in our offshore oil and gas construction segment, partially offset by the claim settlement that I mentioned earlier. The preponderance of the charges related to the three pipeline projects that we discussed last quarter.

Obviously, we were not pleased that additional costs were required on these projects. Like you, we don’t want these issues to persist. However, the weather we experienced in the fourth quarter was worse than our forecast, which we established in October, which limited our working days, so we also wanted to be more conservative with our ongoing forward-looking assumptions for the future.

So let me explain some of the logic. In the fourth quarter, we only worked about 40% of the days available, which was worse than our revised forecast. The good news is that when we were working the rates we achieved laying pipe were better than we had forecast. So it’s really just a matter of getting workable days within the weather windows at this point.

Only about a third of the pipeline charges we took in the period actually related to the 90 day period. The majority of the fourth quarter charges on these projects, about two-thirds resulted from adding anticipated 2009 fiscal year downtime days to the estimated cost to complete.

Doing this almost doubled the downtime days for 2009 compared to our prior forecast, which we believe will be sufficient to complete these projects. We employed what we believe to be a conservative methodology; however, recognize we’re forecasting weather for essentially a year. So we may prove to be too conservative, but we’re tracking pretty well on these revised estimates year-to-date.

Recognized weather patterns in the Mid-East are the most favorable, typically from April through October, so we really hope to hit our stride during these working months.

Let me provide you some update on the first two months of 2009. So far this year, we completed one of the two major facilities associated with the Ross Gas job which is the only project of the three problem projects that was on our schedule during these months. As we indicated in the earnings preview, January was ahead of schedule and now we only need a few working days to complete the second major pipeline of the Ross Gas job, roughly about four days.

We are now essentially in line with the revised forecast at this point; the end is very much in sight for these Ross Gas truck lines and should be completed in March. There’s additional scope, on this contract to perform, but the truck lines were the problematic portion and are now nearly complete.

We’ll next move on to the Cutter Gas pipelines, which should resume work early in the second quarter. We’re currently forecasting a mid-summer completion, in what is traditionally a better weather period. The last of the three projects, the Shell Gas, the liquids pipeline, should also begin in the second quarter and is scheduled for a late fourth quarter completion.

Regarding the potential for liquidated damages, no new charges were incurred in the quarter. We have had meaningful and productive discussions with our customers and we have formally exchanged proposals, so we continue to believe that we will achieve a successful resolution that is satisfactory for all parties concerned.

This is obviously a lot of discussion on primarily just three of our four projects, of our total projects – three of all of our projects, but I wanted to assure you that we’re on top of it and that we’ll complete the remaining work and we anticipate having these projects behind us at the year end.

At the same time, please recognize these construction projects are at sea so actual results are not always predictable. However, I believe we will get there.

Generally, the rest of the portfolio has performed more in line with history, with puts and takes, but within our expectations.

Both government and power had a solid fourth quarter. Our equity income line in government was at the highest level ever and as we graded out well in our performance at the various sites which we manage, power had some charges related to items like non-cash inventory write-downs, but all in all in line with our expectations with those included.

Looking at the business environment and starting with consolidated bookings, we added about $2 billion to our backlog during the quarter, more than offsetting the revenue burn which increased year-end backlog to essentially tie last year’s level.

Our government segment delivered the vast majority of these new awards, which is a pretty good development considering that it tends to be the most profitable and has historically good, consistent performance.

Power and oil and gas were both soft in bookings and certainly having 25% of the quarter shot due to the holiday season every year makes the quarter traditionally a much more variable one for new large project awards. However, the overall bidding environment that we’re in remains sizeable. We have over $7 billion in bids outstanding at the year-end 2008 across these two segments.

I believe the offshore construction business will remain solid, in terms of new work in industries, so we don’t view our fourth quarter bookings level as indicative of the future ahead. In fact, during the quarter we signed a Letter of Intent for a project that’s over $1 billion in size and if we get a signed contract, by the end of March which we expect backlog in this segment should back up sequentially.

I believe we are fortunate in this segment. Our customers are large, but not levered. Projects are extended duration, not easily started or stopped. Our customers need to keep spending just to offset their decline curves.

Offshore is seen as a core area now by our customers and commodity prices expected two years out and over the life of the field matter much more than the current spot prices.

While globally there may be a modest decline in CapEx spent by the industry, it is still at a historically high range and we believe spend by our customer base, is likely to be flat to up modestly. And frankly, with so much of our projects' costs being procured items, our customers can get more for a dollar spent today than they could a year ago. And we’re working closely with them to help them realize value from these lower procured costs, and we really believe that our EPCI model will prove itself out in this environment that we face.

Our power generation segment is a more mixed story. Clearly one of our strengths compared to many of our peers is the high amount of recurring parts, service, and environmental work that we have on the install base of power plants. While customers may procrastinate a little on this type of work, it should remain a solid foundation for us.

However, the other part of our business, these large North American capital projects, is being impacted by capital markets, the in-and-out nature of the CARE Act and CO2 regulations. As the uncertainty surrounding these issues lessens, which we believe the Obama Administration will make an attempt to expedite, there should be significant pent-up demand for new projects. And we see opportunities on the international front that are much less sensitive to these issues.

We believe beginning in 2009 you’ll begin to notice a shift in our backlog to more international projects as a result of this focus. I continue to feel confident that the power projects and our backlog will continue to proceed. Delays on new projects coming to market, and what I mean by that is getting through the bid phase to our backlog, is very normal in the best of times and we’ve certainly seen that persist in this environment.

In the short-term, bids on power capital projects will be more sensitive to the current business cycle than our other segments, and longer term I remain very bullish on power.

In my view, McDermott is a strong company as a result of its diversity, particularly in this environment. Whether it's the geographies, the customer base, the industries served, our position in the cycle or the types of projects, we have an extremely good balance.

Our 2008 revenues were about half North America and half international, and our customers are the who's who of the peer group; the U.S. government, super majors and large national oil companies, as well as very large utilities and power producers. Government projects are long wait orders, power is somewhat in the middle, and oil and gas is very late cycle.

We have a substantial, recurring, repeatable base mixed with an after-market parts and service business to supplement our large project business. This balance enables our shareholders to have confidence and conviction in our business over the long-term, and it provides fundamental strength in what I would classify as somewhat nervous times.

That wraps up my prepared remarks for our operations. In summary, McDermott’s backlog remains at record levels, we have a solid balance sheet, and we will work through the current challenges. I also feel positive about many elements of our performance in 2008, while obviously disappointed in one. We feel confident that our chips are strategically placed and that opportunities are ahead of us.

Next week we are planning to be in Boston for UBS's one-by-one conference and we plan to be in New York a few times in May and June. Hope to see many of you all at these venues and with that, operator we’ll now open the conference call for questions.

Presentation

Operator

(Operator Instructions) The first question will come from the line of Andrew Kaplowitz – Barclays Capital.

Andy Kaplowitz – Barclays Capital

So just talking about power in a little more detail, if you look at the parts and service business, you mention customers may take a little bit of time but John, how do you feel about the next couple of years in power, parts and service? Can it hold up, given the state of the U.S. economy?

John A. Fees

Andy, typically what we have seen in a recessionary period is that business being essentially flat to maybe 5% down from prior year levels. And that’s the indications that we’re getting right now. We really don’t have any other insight forward-looking other than that. We know that capital budgets are certainly constrained, but I think it has a tendency to hit off against the initiation and the start of the large projects, much more than running the day-to-day at the existing power plants that are out there in the install base.

So fundamentally we usually walk into a period like this with a decent level of confidence that we’re going to remain somewhere in and around the prior year levels to maybe a 5% trim based upon capital constraints impacting the budgets. Basically the customers and the clients out there are relying on us to keep their plants operating on a day-to-day basis, and with the install base we have being some of the lowest priced megawatts out there on the market and particularly in a market like this, it’s very important that those plants keep operating at peak efficiency level.

So that’s why we kind of walk into a period like this with a decent level of confidence.

Michael S. Taff

This is Mike. I think the other thing to note on that, as you’re aware I believe, but just our – the share we have at 38 to 40% of that capacity certainly bodes well for us in this environment.

Andy Kaplowitz – Barclays Capital

I understand that. And John, obviously if parts and service ramps up at part of the business versus the other businesses, the margins should get a positive tailwind. But, of course, if the other businesses are going down, maybe you have more absorption issues so how do you feel about the 7 to 10%, I don’t know if it’s guidance but objective in power margins going forward over the next couple years?

John A. Fees

I see no reason for us to think outside of that box at this particular point. One of the things that we have done in the parts side I think that was very good is that business ramped up over the last several years in environmental and new OEM orders, new boiler orders domestically here in the United States. We had a tendency to continue to build on our internal capability, but we also made sure that we leveraged and shared risks through subcontracts and other things along those lines.

And so in the environment we’re facing, we’re really not burdened with a tremendous amount of overhead that we have to worry about with the amount that that side of the business is changing. And so we feel pretty confident in where we are from an overhead support standpoint. We basically need the people that we have in the business to execute our work and our backlog, and so we would see a little bit of upward pressure, we feel, from the parts and service becoming maybe a more substantial piece of what we’re doing on a go forward basis, but we really are not fearful that we have a overhead reduction program that we have to execute to be able to maintain profitability at those levels.

Andy Kaplowitz – Barclays Capital

And if you look at your nuclear component business in the government segment, on a go-forward basis obviously you’ve had a ton of bookings here. How do you feel about margins going forward? Because obviously they’re very lumpy from quarter to quarter if I exclude the DOE, equity income it looks like margins came down a little bit in the quarter versus last quarter. So how should we think about margins in that segment? Can they hold up compared to how they’ve been the last year? Is the government going to try and squeeze you a little bit because it’s giving you more work? How should we think about this going forward?

John A. Fees

Well I think they’re a couple of things to think about here. We have done some fairly large deals with the government to pull together a family of work that is really to the government’s advantage and to our advantage. I mean we are all about trying to be good vendors to the U.S. Government to keep costs in line and make these very effective programs. In the environment that we’re in Washington, we think that that’s a central part of survival of federal government programs, and so we are very much engaged in any activity of providing them a good value.

Now what that typically means to us is that we have to work very strong in our plants and in our operations to be able to maintain our margins and to be able to get certain incentives that exist under these contracts. And we’ve historically done very well on that. I would expect that trend to continue.

The other thing that I think works in our favor is that in all the operations and all the physical plant locations in which we perform this work, we’re adding volume in every location. And so there will be an absorption benefit that we think we’ll get over the next couple of years because of the increased volume.

Net-net all in, I really believe that we will see typical margins in this business going forward.

Jay Roueche

And Andy, it’s also probably worth pointing out that in the government segment this quarter that there were some charges that were in SG&A that impacted that segment operated income line that were probably to the tune of a few million dollars for IT related initiatives, as well as some compensation, bonus compensation for the government employees for producing what was an all time record year for them.

Andy Kaplowitz – Barclays Capital

That’s very helpful Jay. Just one more quick thing. Last month when you put out your preview you talked about being comfortable with consensus at the time it was $1.35 to $2.14. How do you feel about that in light of the additional pension expense that you told us about last night?

John A. Fees

Let me comment on that just overall and briefly here and answer your question as part of that, Andy. Let me give you the logic about why we said what we said. I guess I was concerned that the combination of the issues that we had in the offshore campaigns that we were running and JayRay combined with the economic conditions out there may have left a lot of uncertainty in the investors' minds about where we were heading going forward with this company. And so we wanted to give some insight into how we felt going forward.

And so what we did is we made a comment relative to the range that was out there from the analysts and we represented them as reasonable book-ins that we thought as we proceeded in the year. It’s not our intent to regularly comment on independent analyst estimates or in this business as we’ve indicated in the past, it’s been our practice and at least at this point in time will continue to be our practice not to give guidance due to the nature of this business and the lumpy nature of what can occur. So with all that being said, we felt that it was a reasonable thing to do.

Now when we did that, we did not have the insight on the pension, the non-cash GAAP pension expense that we have at this point in time. We’ve been through our work with our actuarials. We’ve looked at our liabilities and our assets and came up with revised estimates that are really not factored. And so there’s about $65 million worth of non-cash GAAP pension expense that would have to be tax effective to relate to the numbers that we talked about earlier.

Operator

And our next question will come from the line of Martin Malloy – Johnson & Rice.

Marty Malloy – Johnson Rice & Company

Did you a give bids outstanding for the JayRay unit? I may have missed it.

John A. Fees

We did not, Marty. We said $7 billion combined for power and oil and gas. If you want that broken down it’s roughly $4.5 for oil and gas and roughly $2.6 I think for power.

Marty Malloy – Johnson Rice & Company

And the cash balances before you all talked about maybe a discretionary cash balance of somewhere around $500 million, if you back out the working capital in these and the advanced payments, is that still a roughly good number?

John A. Fees

It's probably roughly so. Although we did spend $150 million for the purchase of NFS that would have come somewhat out of that number but we also added cash through operating earnings in the fourth quarter as well to help mitigate that expense.

Operator

And our next question will come from the line of Stephen Gengaro – Jefferies & Co. Please proceed.

Stephen Gengaro – Jefferies & Co.

Thank you. Good morning gentlemen. Two questions, the first on the JayRay side – it's kind of I guess a two-part question but one is are the bids outstanding at similar contractual terms and pricing to what you've been seeing over the last year? And then how do we – whether it's yes or no, how should we read that into the kind of the margin trajectory as we look out for 2009 given the three contracts, which remain?

John A. Fees

I would say at this point in time that the bids that we have outstanding are within our historical practice relative to margins and how we analyze that going forward, and how we would expect to execute on that. The one thing that I would comment on is that obviously our tolerance for risk has changed to a certain degree.

So to the degree that we're analyzing risk and being willing to accept risk at this point, is probably the barometer on that I think has moved a little conservative within the range which we can move it and still participate in the market and properly execute work. But we're certainly working very hard to make sure that we've captured all the lessons learned from the three problem projects and not to repeat those problems again. That's our objective.

Stephen Gengaro – Jefferies & Co.

So I read that your tolerance of risk is getting less, and how do customers react to that in an environment where there's arguably that they probably have a few more choices?

John A. Fees

I think there's a couple of places where it gets to the point where we have to make fundamental decisions about doing or not doing the work based upon the risk tolerance of the client. In that case, we certainly are looking very hard to make sure we have those risks properly priced and set up in our contingencies.

And in other cases, we continue to work with the clients on risks that we're willing to take, not just related to weather but just generally in the business that I think our risk tolerance has tightened up a bit from where we were.

Stephen Gengaro – Jefferies & Co.

Thank you. And then as a follow up my sense is that this is not a major issue but I wanted to ask you to comment on the letter from the SEC on these three jobs, and if you could give us any details on the percentage of completion, accounting methods applied properly, etc. It would be helpful to be maybe calm some fears we've been hearing from some investors.

Michael S. Taff

Stephen, Mike Taff. Yes we did receive an inquiry from the letter, from SEC, it was dated the last week of February. They've asked us to respond in the next two to four weeks or so. And we certainly intend to fully cooperate with the SEC.

As we mentioned in the 10-K, it was an informal inquiry that was specifically related to the accounting and related to these three pipeline projects, and obviously we feel the accounting is correct. Our auditors have scrutinized this and looked at it immensely as well.

So that's really probably the most that we're, at this point, willing to say about this matter. But again, I think the way I would summarize it, it's an informal inquiry, it's specifically related to the accounting related to these three projects and that we will certainly comply with their wishes and plan to go meet with them very shortly.

Stephen Gengaro – Jefferies & Co.

That's helpful. Thanks, and then I'll pass it on.

Operator

The next question will come from the line of Jamie Cook – Credit Suisse.

Jamie Cook – Credit Suisse

My first question, could you guys just talk about any actions you're taking within the different divisions to prepare for what seems to be a prolonged economic recession and whether there's any cost savings in your sort of, not that you give formal guidance but what ever is in – that you basically affirmed without the pension the annual assessments. So I'm just wondering if there's anything in that number?

And then my second question, unless I misinterpreted this, I thought you said you thought there were some [Power-Gen] opportunities on the overseas front. If you could just sort of get into a little more detail on that.

John A. Fees

Okay, let me start with your question related to cost and cost structure. As we indicated, we're at a backlog level, which was about the same as what it was last year, about $9.8 billion record level of backlog. And we really don't see much of an opportunity at the operating cost level to be able to go after significant structural changes because we have a lot of work to do.

We've got a really strong backlog. It looks like that backlog could be enhanced in the current quarter, which some of the things that we mentioned in our prepared remarks. So we have a lot of work to do and need to execute it at that level.

One thing that we have done is we have taken a pretty hard look with the operating units at above that, above the operating cost level, and really looked for opportunities on SG&A and other areas like that. And we continue to work on those issues.

There are some opportunities that we hope to realize in 2009, and we're working those issues going forward. And so I would say in general we pretty much need most of the resources that we have because we so much work to execute.

And cost sensitivity is something that we've always paid a lot of attention to in the company. And if we see an opportunity to reduce our operating costs, improve our margins, do things like that, we'd certainly take that on and do it.

Jamie Cook – Credit Suisse

What about on the headcount front? Where are you now versus last quarter, and where do you expect to be towards the end of the year?

John A. Fees

I don't have those numbers. Mike, do you?

Michael S. Taff

Well, yes. I think, Jamie just in general from a headcount kind of point, we're down a little bit at the end of the year compared to where we were at our count of the last year, middle of the year all-time high.

As John said, with the backlog that we have, really the areas we're looking at from a cost standpoint and which is really consistent with every Fortune 500 Company in North America probably today, we're looking at SG&A and we've got plans in place to have some reductions.

It's not what I'd call massive from that standpoint of large, that you'll see things in the press and all. But we're certainly looking at what we call support cost and SG&A. The other thing that I think you're aware of but others my not be is just our ability to flex, and we continue to work that.

And so as one region of the world is going down, we flex that cost down and reduce that down to the bare minimum, and then we're able to flex up as another region of the world has an increase in backlog. So right now for example, in Asia Pacific we had record number of man-hours there in '07, less in '08, and '09 we're expecting to go up.

So we're actually flexing up in Asia Pacific as we speak today, hiring people on a weekly basis. And we're flexing down in Baku over in the Caspian Sea. So that's kind of the nature of our business there. But cost is something we're certainly paying attention to.

John A. Fees

And so I would generally characterize it as that if you take a look in the aggregate, the net headcount and operating support that we need to execute our backlog, it's going to be similar in 2009 to what it was in 2008 because we have roughly about the same level of run rate on the majority of our businesses in that regard.

And there are some puts and takes and regions moving, and things along those lines. But we'll continue to stay focused on cost, and continue to try to do a good job there keeping our costs to the minimum level, and look for opportunities and synergies that we can take advantage of to improve our margins.

On to your other question about International Power, back about a year ago we continued to see the conditions in North America and really set it out as an objective of trying to take better advantage of our international foot-print with our facilities in China, our waste-to-energy and [BioMass] business in Europe and things along those lines, and see how we can best take advantage of that footprint moving forward.

And so we've gone out and continued to cast a pretty wide net evaluating and looking at opportunities. There are very good opportunities that are emerging for us in place like India, South Africa, some broader opportunities in Europe for us to be able to use and implement our technology.

And so we're moving forward on that. Even to the point where we can look at supporting desalinization plants in the Middle East with oil burner technology using conventional boiler. And we feel that we are very competitive there. So we continue to evaluate to look at those projects work with worldwide partners and move forward in that area.

And as we indicated in the remarks we would expect to see in 2009 a shift of our backlog a little more internationally throughout the year as we realize some of those opportunities.

Operator

And our next question would come from Tahira Afzal – KeyBanc.

Tahira Afzal – KeyBanc Capital Markets

Just wanted to start off by thinking about your tax rate what should we be modeling out for ’09 in your assumptions and if you look into 2010, assuming that you do see more of a shift to international do we expect that to proceed down in terms of 2010?

John A. Fees

I think that you’re right on 2010. I think from a tax rate standpoint for ’09 we’re forecasting somewhere in the 30% range or so. And then as we have more international revenues that tax rate will decline and get back down into the mid 20% range.

Tahira Afzal – KeyBanc Capital Markets

All right. Okay and then I know that you haven’t signed officially on the [Karun] deal but let’s assume for the sake of argument you do get it. When would a project like that be expected to start as of what you know right now?

John A. Fees

Related to that, assuming that does come to pass we have signed a letter of intent on a large project in the Middle East region and we had expect a majority of those – that revenue to hit '010 and '011. We would have some probably in the latter half of ’09.

But the substantial portion of that would be 10 and 11. But the earlier phases are typically heavier engineering and preparatory procurement things along those lines and most of the revenues hit when we actually start in the construction phase which would be beyond this year.

Tahira Afzal – KeyBanc Capital Markets

Right. Okay and I mean if I look in terms of the profile of that project is it similar to what you have right now or would we be starting off with a fabrication portion followed by more of an installation portion?

Michael S. Taff

I think so, Tahira. It’s any project of that size would have a combination of both significant procurement with fabrication hours as well as an off shore marine campaign.

Tahira Afzal – KeyBanc Capital Markets

All right okay so maybe 2010 would end up being more for fabrication for you and 2011 would progress more to installation?

Michael S. Taff

I would say that would be typical – a typical profile of a project of the size and the magnitude of excess of a billion dollars. Again we’re really trying to focus right now on brining to our clients that whole EPCI frame work.

Where we’re doing the engineering, construction procurement and the installation so most of the large projects we have are really trying to take advantage of that whole spectrum.

Tahira Afzal – KeyBanc Capital Markets

All right okay. And last I checked which was just in fact over the weekend it seems like [Brarzone] one of the opportunities you’re looking at Ross Gas is saying it's proceeding well. If you were to see [Brarzone] and you see it in your prospect list right now when do you think the contract would likely be signed based on what you know right now?

Michael S. Taff

Well I think that’s a project where we’re doing some front end engineering on Tahira. And the bulk of that is still remaining to be bid so – and how it’s bid. There’s been different suggestions related to that whether it’s going to be broken up into two or three different pieces. In totality it’s thought to be in excess of a billion dollars I think.

But which portions we choose to bid on and obviously which one s we win would really be dependent on that whole process and so obviously it would definitely be '010 2010 to 2012 type of work should we win that work.

Tahira Afzal – KeyBanc Capital Markets

And then if I look at your utilization rates on your fabrication facilities and I’ll follow up with Jay after the call. I don’t want to inundate you with the details here but if you look at utilization in ’09 which is what you think you’re looking at in 2010 even assuming you get [Caran] and maybe incremental a couple of smaller projects would it be similar would it be down?

John A. Fees

It would probably be somewhat of a shift. Middle East we’ll probably see a little less man hours; Asia Pacific we’ll probably see ramp in man hours compared to 2008; Caspian and the Americas much more modest.

Tahira Afzal – KeyBanc Capital Markets

And just based on what we’re hearing from Obama and his energy policies it seems it’s going to be perhaps a negative for U.S. offshore drilling as of right now. If that’s the case would you be looking at if you think you get a sense that the U.S. portion of the Gulf of Mexico might be dead in terms of incremental activity for let’s say five six years.

Would you look at alternate strategies for your Louisiana fabrication facility?

John A. Fees

No I wouldn’t assume that the U.S. Gulf of Mexico is going to be dead. I mean there are very attractive projects out there that continue to build up in the Q and could continue to go forward. I think the piece that would be questionable, for example, are we going to go off the shelf off of the east coast around Virginia into Chesapeake Bay.

I think those are the things that are going to be more questionable in terms of moving forward but we would not anticipate I mean there is not a lot of activity, major project activity in the gulf right now but I would not make the assumption that because of what’s going on in Washington that the Gulf of Mexico is going to be dead going into the near future. I think we could see some project opportunities continue to develop early next decade that could be very meaningful for us as a company.

Michael S. Taff

There’s been literally our customers have spent millions and millions of dollars on the exploratory phases a number have fields out there I mean the best example is the [Jack Field] which was announced 24 plus months ago, and the infrastructure phase is yet to begin on that. So we know those fields are out there, there is just a lot of engineering going on to determine what is the best way to develop these fields? Once that determination is made then really the fun begins so to speak.

Tahira Afzal – KeyBanc Capital Markets

Just last question it seems then in terms of utilization on these facilities that essentially you end up being maybe flat with a mix shift in 2010 then potentially it ramps up?

Michael S. Taff

I think when Jay answered your question earlier he was answering your question related to utilization in '09, '010 still looks very good with our back log and with the additions we expect to book this year as well.

So I mean from looking outward '09 and '010 we got pretty good prospect there and I’d say right now initially utilization for '09 and '010 would be pretty similar just based on the data we have today, but obviously that can change immensely depending on what jobs we’re awarded in '09 that we would begin work in '010 on.

Operator

And our next question will come from the line Steven Fisher – UBS.

Steven Fisher – UBS

Just to get a sense of how the overall mix could shift. Could you just give us a sense over what period of time you’re expecting to generate revenues or profits from the big government booking this quarter? I mean is it going to – are the revenues and profits going to ramp up in line with backlog?

Michael S. Taff

I think on the government side yes you can expect that to a certain extent. We should see I would guess a 10 to 20% increase in revenues in that segment for 2009.

Jay Roueche

But the recognize on that particular business there is a capacity constraint at the factories that you can ramp up to a certain extent but your typically limited by capital equipment and clear personnel that are trained and able to do this work.

So we’ve got some flexibility ramping up and we expect to that with the level of backlog, as I indicated earlier I think we’re going to see man hours go up in all the plants associated with this work. But there it s a constraint it’s not like some of our fabrication yards where we can run up and all of the sudden put 10 million man hours where the year before we did five, so it's a little different.

John A. Fees

If you just looked at our back log roll off Steven, we’re estimating $870 million going through the government operations segment in 2009 versus a full year $850 or so for 2008. So backlog roll-off alone should see growth and then we’re going to have additional book and burn work that goes on top of that so you should see some pretty reasonable growth.

Steven Fisher – UBS

So 10 to 20% overall it sounds like. Now related to the power bookings, can you just characterized the types of projects that make up the bulk of what you book by major categories in the quarter, maintenance or new build or scrubber?

Jay Roueche

I think the bulk of them would end up being the parts and service work that are relatively small ticket items.

Steven Fisher – UBS

Okay. Is this considered a steady state level do you think?

John A. Fees

I think where we are and what we saw. Again, our expectation would be is that year-over-year levels should be about the same to maybe a 5% reduction based upon prior experience going into recessionary periods.

Now whether or not that environment holds up in the type of recession that we’re in I think still remains to be seen. I think we’re rather early, I mean this financial crisis feels like it’s been going on forever, but it’s really the bulk of the crisis has really occurred over the last five to six months and so I would consider that to be still somewhat a little early and the nature of the cycle and the emergence from it, as we all know, is yet to be determined. But based upon historical precedence, I’d say that we would expect about flat to 5% reduction over prior year levels. That’s been pretty typical.

Steven Fisher – UBS

In the Indonesia boiler refurbishment that you announced in January, was that a Q4 or a Q1 booking?

John A. Fees

Q4.

Steven Fisher – UBS

Okay and then just lastly, at JayRay, if the bids outstanding from a margin perspective are kind of in a historical range, I know it’s still early, but as you look out to 2010, would 10 to 12% be your kind of theoretical margin objective?

Michael S. Taff

Yes I think so. I think what we mentioned is that we feel comfortable and the average run rate is in that range looking outward into 2010 and beyond.

And keep in mind the 10 to 12% range that we’ve talked about in the past is at the operating income level and it’s really for a portfolio of projects and that there are projects that make up our portfolio that are below that range and those that are above it.

Operator

Our next question comes from the line of John Rogers – D.A. Davidson & Co.

John Rogers – D.A. Davidson & Co.

Could you talk a little bit, you touched on this, but in terms of the cash flow this year you absorbed or in 2008, you convert a lot of those advanced billings over, as more of your work comes out of the government side of the business, should that cash flow match up closer with earnings this year and then what happens as you go into the end of the year especially with the larger oil and gas projects that are potentially out there in the international power projects? Are there a lot of advance payments associated with that work?

John A. Fees

It’s really contract-by-contract driven.

Michael S. Taff

Yes John, what I would say related to that, you look at it from just a pure free cash flow standpoint, '09 looks positive when you take our EBITDA less CapEx, cash taxes and cash interests. From that standpoint and really obviously the big swing variable then is gets to be what happens with working capital? But as we book new work, we expect to, those to be positive throughout the life of those contracts, so I’d expect some positive cash flow during the year.

John Rogers – D.A. Davidson & Co.

But the oil and gas business in general, what you do is characterized by more upfront payments because of the procurement involved?

Michael S. Taff

In general, that’s generally true.

John Rogers – D.A. Davidson & Co.

And as you shipped over to a more international power work, is that also applicable?

John A. Fees

Yes, I would say that typically what we see in domestic as well as international power projects is a similar type of behavior where there’s usually upfront payment associated with moving forward on procurements and trying to keep the project cash neutral or cash positive throughout its lifetime, so I would say that’s a pretty typical profile.

John Rogers – D.A. Davidson & Co.

And just to confirm, the government, the federal government these big programs, those you collect are what, 30 days after billing or?

John A. Fees

Usually a little less than that.

Michael S. Taff

We don’t discuss the specific terms, but we have a very good collection process with our customer from that standpoint.

Operator

And our next question will come from the line of Joe Gibney – CapitalOne Southcoast

Joe Gibney – CapitalOne Southcoast

Just want to follow up a little bit on the JayRay side, curious on the vessel acquisition market right now, there's certainly some pretty attractive deep water pipeline units that are out there, you guys considering possibly pulsing up a little bit and adding to the deep water orientation on JayRay, or are bid out spreads getting attractive, just curious your thoughts on incremental vessel acquisitions out of JayRay?

John A. Fees

I think we’re seeing a little of the front end of that right now on the type of vessels that we would have an interest in. I think we’re starting to see a little bit of distress in that market and some distressed assets out there.

This is not a big community. This is a fairly small community of shipyards, of users, of investors associated with this particular market. So generally everybody kind of knows what’s being built, where it’s being built and what the status of it is.

So we’re very tightly in tune with that set of circumstances and one of the reasons that we relish the cash position that we have and the financial position that we have is that it may really lead us in the environment if we continue to go forward and to having some great opportunities relative to capital assets for our vessel fleet.

So we’re paying close attention to that, we’re tightly in tune with it and I would say that we’re on the front end of the emergence of those things coming up as opportunities. We’ve seen a few pop up, nothing actionable at this point in time, but we’re certainly paying quite a bit of attention to it.

Joe Gibney – CapitalOne Southcoast

Any color on the status of LTA? Were there any incremental bookings here in the fourth quarter and any outlook there for the first half of the year?

Michael S. Taff

We had a small booking isn't that right, Jay? About $100 million or so that led into that and that’s really, the way LTA, it looks like its proceeding is more in the kind of bite size incremental bookings versus the large over $500 million, but it’s still, from a contract standpoint it’s still proceeding very well.

We’ve got a lot of work on that and we’re having very good conversations with the customer on the next round of work that would be led on that.

Operator

Our next question will come from the line of [Jeff Spittel].

[Jeff Spittel]

Just one quick follow up on JayRay as you look at the backlog roll off schedule, you indicated in the queue for Q3 at $1.3 billion related to the problem projects in the Middle East down to $1.1 billion at year end, can we assume that run rate of roll-offs starts to accelerate based on your comments about seasonality in the Middle East in the second and third quarters this year?

Michael S. Taff

I think that’s a fair statement, I think we’ve mentioned that we’ve got about $1.1 billion left on that as you just indicated and as John indicated in his call, we’ll have basically all of those projects completed by the end of the year and really kind of, as John mentioned, hitting our stride on the next two projects starting in second quarter, third quarter.

John A. Fees

The first quarter and second quarter have probably the highest dollar levels and then it trends down.

[Jeff Spittel]

Just a follow up, sorry if I missed this, but in the past you’ve talked about the focus projects in the JayRay piece of the business beyond bids outstanding, can you give us a flavor for where you are there right now?

John A. Fees

Don’t have the number exactly in front of me, but it was certainly north of $11 billion type range.

Operator

Our next question will come from the line of Brian Chin – Citigroup

Brian Chin – Citigroup

Asked and answered. Thank you.

Operator

(Operator Instructions) Our next question will come from the line of Rick Johnson – Thai Capital

Rick Johnson – Thai Capital

You had comments on the liquidated damages and you’re negotiating with customers, does that mean that you would expect some amount of liquidated damages or that you could not incur any?

Michael S. Taff

I think where we stood at year end is based on our conversation with our customers and analyzing this from a FAS 5 standpoint of being probable and estimable, we do not feel it is probable that we would incur additional liquidated damages on these contracts as of this date.

Rick Johnson – Thai Capital

The $65 million of additional pension expense over and above what you expected, that’s after-tax, correct?

Michael S. Taff

No, that’s pre-tax. And essentially all of that would be U.S. domiciled plans so you’d be using the higher U.S. type tax rate.

Rick Johnson – Thai Capital

And that tax rate’s about what?

Michael S. Taff

Thirty-five percent federal, 34% state.

Rick Johnson – Thai Capital

So about 39.

Operator

At this time I see no more questions in the queue. I would like to turn the call back over to management for closing remarks.

John A. Fees

Thank you all again for joining us today, just a quick reminder that the call did include some forward-looking statements and estimates; for more information on these, I encourage you to see our SEC filings. Please call [Robbie Belamy] or myself if you have any follow-up questions or need any clarification. We look forward to seeing many of you in Boston next week at the UBS events and elsewhere in the coming months.

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Source: McDermott International Inc. Q4 2008 Earnings Call Transcript

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