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McDermott International Inc. (NYSE:MDR)

Q2 2009 Earnings Call

August 11, 2009 10:00 am ET

Executives

Jay Roueche – Vice President Investor Relations

John Fees – Chief Executive Officer

Michael Taff – Senior Vice President, Chief Financial Officer

Analysts

Martin Malloy – Johnson Rice

Graham Mattison – Lazard Capital Markets

Andrew Kaplowitz – Barclays Capital

John Rogers – D. A. Davidson

Tahira Afzal –KeyBanc Capital Markets

Steven Fisher – UBS

Joe Gibney – Capital One

Will Gabrielski – Broadpoint AmTech

[Jeff Spiddle – Natixis]

Operator

Welcome to McDermott International's second quarter 2009 earnings conference call. (Operator Instructions) I would now like to turn the conference over to our host, Mr. Jay Roueche, McDermott's Vice President of Investor Relations.

Jay Roueche

Good morning everyone. We appreciate you joining us to discuss McDermott's second quarter 2009 financial results which we reported yesterday afternoon and is still available on our website. Joining me on the call this morning are John Fees, McDermott's Chief Executive Officer and Mike Taff, Senior Vice President and Chief Financial Officer.

Before I turn the call over, let me remind you that today's event is being recorded and a replay will be available for a limited time on our website. In addition, some of today's comments 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 also available on our website for a discussion of the factors that may cause actual results to differ from management's projections, forecasts, estimates and expectations.

I'll now turn the call over to John.

John Fees

Good morning everyone. The second quarter of 2009 was an active one at McDermott. First and foremost, we were particularly pleased with our consolidated results this quarter. There are a lot of moving parts, but the puts and takes pretty well balance out.

We recorded over $1.1 billion in new bookings which we feel good about. In addition, we rolled out our new Empower initiative for a modular nuclear reactor design, participated in four investor conferences and hosted our annual shareholder meeting.

The company completed construction and started pilot skill testing of carbon dioxide control technology at our regenerative solvent absorption technology facility and have continued with our efforts on combustion as well.

Our offshore Oil and Gas Construction segment in particular, has been very active in the bidding front and has made good progress on Middle East pipeline contracts, completing the Ross Gas and [Cutter] Gas pipelines this summer. The Government Operations business had its best quarter ever income wise and won a new high enriched uranium company contract from the Department of Energy.

At corporate we resolved a decade long litigation so the legal section of our financials continues to shorten. In short, there's a lot to talk about today, but before I go into greater details, let me turn the call over to Mike to take you through the financials since that's the catalyst for this morning's conference.

Michael Taff

Good morning. As I normally do, I'll walk you through our financials and discuss the variances to the second quarter a year ago. It's worth reminding everyone that last year is a quarterly high water mark on a number of metrics including revenues, operating income and net income. So while a lot of the commentary will indicate this year is down in comparison, it's worth highlighting that the 2009 second quarter is the highest level of quarterly income since the record results a year ago. As such, we feel positive about our numbers we reported this quarter.

Starting with the income statement; total revenues were almost $1.6 billion, down a little over $200 million from a year ago primarily as a result of a reduced top line in the Power Generation Systems segment, which overshadowed the year over year increase in Government Operations.

McDermott's consolidated operating income of almost $148 million in the 2009 second quarter compares to about $231 million a year ago. About 25% of this decline was due to the $22 million increase in pension expense which is predominantly a non cash item.

The power generations systems business had the most substantial reduction in segment income, as a result of lower revenues in 2009, and fewer project improvements than we had a year ago. Offshore Oil and Gas Construction was also down year over year largely due to the over $330 million of revenues from the Middle East projects which had no associated margin benefit.

The low operating income, our results of the quarter were impacted by $15 million swing in the other income and expense line item compared to a year ago. Net interest income declined by $3.2 million. Lower interest rates earned on our cash and investments coupled with a lower balance more than offset the benefit of lower expense and capitalized interest.

In addition, the other, other expense worsened by about $12 million. This decline is a little frustrating since it's just due to foreign currency translation adjustments. These adjustments are non cash, non operational and frequently just inter company related. Historically, these adjustments have not been a significant factor from an EPS standpoint. However, in the recent volatility in currencies, this line can now equate for a few cents per share in the quarter. So it has become something we're going to see if we can mitigate.

All in all, pre tax income declined about $100 million compared to the 2008 quarter. Due to the mix in tax jurisdictions where our income and losses were derived, our effective tax rate grew about 500 basis points versus a year ago. As we often remind you, McDermott's tax rate varies quarter to quarter and year to year depending on which taxing jurisdiction we are working in and the respective profit and losses incurred in those regions.

A new line item to our income statement this quarter is attributable to non controlling interests. In many locations, we have some local partners on projects to help us meet the local content requirements for certain contracts. The $5.3 million taken in the second quarter is a cumulative amount so I don't expect it to remain this high on a quarterly basis.

Taking it all to the bottom line, McDermott reported net income is $92.6 million or $0.40 per diluted share in the 2009 second quarter compared to $177 million or $0.77 per share last year.

Reviewing each of the business segments in a little more detail; offshore and gas construction reported segment income of almost $68 million in the second quarter of 2009. As has been the case of late, the Asia Pacific and Middle East markets were the strongest with the America's and Caspian together in a more break even state.

The Middle East projects which have been problematic of late, we completed the pipelines associated with Qatar gas contract, the second of these projects. So now the major project left on these in the Shell GTL pipeline.

In the second quarter we incurred about $11 million in additional charges when we incorporated a higher cost vessel to perform support work. The good news is this charge is largely offset by contract improvements elsewhere and we expect to fully complete the Shell pipeline by early 2010 and be substantially complete by year end 2009.

Government Operations had another record quarter with segment income of nearly $57.5 million. Despite D&A doubling year over year due to the NFS purchase and an $8 million increase in pension expense.

Just like our other businesses, Government Operations can be lumpy quarter to quarter and contract improvements provided a nice pick up in the recently ended period. As such we view the 2009 second quarter as a near term peak and unlikely to remain at this level on an ongoing basis. It does seem reasonable to look for the periods to be more in line with this segment's historical margins.

Power Generation Systems, after last year's blow out results returned to a more normalized level in the 2009 second quarter. Despite the pull back, the 9.3% margin reported this quarter is still at the upper end of the 7% to 10% target range that we've expressed in the past for this segment. John will talk in greater detail about the marketplace, but we feel positive about the performance of this segment again this quarter considering the current economic, regulatory and industry environment.

Looking at some of the other financial categories, we are pleased that the company's consolidated back log remains strong at over $9.5 billion, down only about 2.5% versus a year ago and still very much near record levels.

Turning to the balance sheet, our liquidity remained at the $1 billion plus level of cash and investments, coupled with less than $10 million of funded debt. Cash and shareholders equity increased over $140 million during the quarter and our working capital position improved by over $80 million in the quarter.

McDermott's financial position remains an overall strength of the company. We continue to monitor the financial markets and expect to begin the process of removing our credit facilities in the near future.

That pretty well covers the financials. John, I'll turn the call back to you for comments on the operational and business environment.

John Fees

Thanks for the summary Mike. As you indicated our results were solid for the quarter and also for the first half of the year. However, good quarters and bad, I'll always remind investors not to get overly excited about any 90 day span. It's only a snapshot from a portfolio that generally consists of multi-year projects. Our ongoing goal is to perform every day throughout these project's tenure, so we're not going to rest and become complacent or satisfied.

The global macro economic environment in the industries we serve continue to simultaneously display mixed messages with both signs of optimism and indications of caution. As such, our crystal ball remains somewhat hazy.

The bidding environment, probably our most relative data point is good, particularly for oil and gas projects. The global economic climate remains somewhat uncertain and fragile, but credit markets appear to be opening up and some large projects are proceeding and commodity and equity valuations seem more stable.

Global electricity demand is likely to be down for the first time since World War II, coal is piling up outside the mines waiting for an order and natural gas remains the commodity of choice for the time being. From a regulatory viewpoint, there's more potential legislation being discussed in Washington that should it become law, could have a significant impact on McDermott, more than any other time I can remember.

In aggregate, we believe McDermott is as well positioned for these realities and as such we are moving ahead with confidence while at the same time, preparing the company for contingencies in case any potential hazards we identify become certainties.

In addition, our strong liquidity position as Mike mentioned, I also like our significant backlog which together provides a solid foundation in this environment. Let me jump to some specifics.

The Oil and Gas Construction segment generated its best quarterly income since quarter two a year ago. Considering about 40% of this revenue this quarter provided no margin benefit, our results here are even more impressive. These Middle East pipeline projects which proved to be a temporary setback for us are now very much in control.

We have now completed two of the three jobs by successfully laying about 29,000 joints out of a total 36,000 pipe joints required. We continue to believe that we are on target with our estimated cost to complete and we expect to conclude what's left at or better than the plan.

During the quarter, we did take about $11 million of additional net charges as Mike mentioned. This is related primarily to the use of a different support vessel than the vessel that was previously planned.

Regarding liquidated damages, no new charges were incurred during the quarter. We continue to believe the potential for LD's are not probable to be incurred. The discussions with our customers are ongoing and we believe a successful resolution will be reached that is satisfactory for all the parties. The key as I see it is getting the projects completed.

The regions we serve are at opposite ends of the spectrum. Virtually all of our backlog, bids, revenues and income are derived from the Middle East and Asia Pacific markets today. Although the Caspian and American regions are currently soft, the good news is that they is likely to be significant work in these markets coming to the industry in the foreseeable future. If we win our share and the other regions remain strong, the growth potential is sizeable.

Looking through the second quarter backlog declined as a result. Neither of these facts is disturbing because we stayed active in bid review meetings and the vast of majority of these prospects have yet to be awarded.

Although customers have been slow to confer new contracts and timing is still difficult to predict, there's just a lot of attractive work out there that we're pursuing. Typically, once a customer finds a proven quantity of hydrocarbons offshore, the odds of a project proceeding is not a question of if but when.

Bookings however are normally the most volatile metric in any 90 day period so instead of focusing on reported backlog, I concern myself with the level of activity and let the wins fall into which every quarter they may. One reason we can be patient is that we already have about $2.4 billion of backlog expected to be revenues in 2010 and with a few more hits, we could be right where we need to be.

As Mike mentioned, the Power Generation Systems segment had the most significant year over year decline in income, representing about 60% of the pre tax income variance. As we've been indicating for well over a year now, this area is probably the most exposed to the overall economic environment of our three segments.

Electricity demand in our country is down over 3.4% for the year through May. We are likely to see the first annual decrease at global electricity demand in six decades. Our customers have been taking generating capacity offline, cutting CapEx and are focused on critical spending only. For the time being, it seems natural gas is actively competing with coal for base load generation.

As I said earlier however, none of this is really new. Longer term, we do expect that electricity demand will grow in line with the population, GDP and as emerging countries become more industrialized.

The shorter term catalyst for our business remains in Washington, requiring legislators to finalize the rules of the game.

Despite the soft overall market, we had the best bookings in this segment since the second quarter of 2008. We won the Scrubber project for Pacific Corp's plant and a contract to supply four modularized blowers at a Canadian oil sands known as [Croel] project.

While not backlogged due to equity accounting, our Chinese joint venture also announced a good size order award for a Vietnamese power plant. As this project is performed by our JV, our share of the income will show up in the equity investee line.

From an operational standpoint, the power group has made good progress on a number of fronts. The power plant we operate and maintain in Northern County Resource Recovery facility in Palm Beach County, Florida, won the 2009 large waste energy facility award for outstanding performance in North America.

Our Mount Vernon location which is the only plant in the United States with in-plant accreditation to manufacture heavy pressure vessels for the nuclear industry shipped the first of two closure heads for the Diablo Canyon nuclear power plant.

We also just recently shipped the second of two replacement steam generators for Progress Energy's crystal rover unit three. As I mentioned in my opening remarks, we completed construction and began pilot scale testing at our new regenerative solvent absorption technology facility or RSAP for short.

Between RSAP and combustion, we believe McDermott is well positioned for a carbon constrained world which will make us sought out by customers and industry partners alike.

During the quarter, we formally announced our Empire Nuclear Initiative, a potentially game changing alternative in the commercial nuclear power marketplace which takes full advantage of our expertise, our assets and our capabilities. While it will be several years before revenue generation, we initiated the Empire roll out at this time as it was directed towards potential customers, regulators and other government officials.

This option needed to be known early in the marketplace because utilities plan their new build requirements years in advance, and to the extent we want them to consider something new, they need to know that it's coming. Quite simply, the Empire reactor design is meant to be a scalable modular advance white water reactor. Each factory built reactor would come in a standard 120 megawatt size and is expected to have a five year operating cycle before refuel.

Virtually all the power generating companies we've met with are very supportive of this concept since it should help bring cost certainty to new nuclear plants and thus financeability. We made the public announcement by TBA and Exelon two of the largest nuclear operators.

While the large players are clearly interested, one of the key advantages to Empire will be the opportunity to expand the customer base. The new plant requires less fuel construction can increase capacity over time and has better location options, and we're excited about this initiative.

We've talked about it for some time, even including the concept in our annual report, but now we can put a name with the idea. We've got a lot of work to do including submittal of the COO plant for 2012, but you'll be hearing more about this program in the quarters in the years to come as we make progress through our staged gate process.

The Government Operations segment built on its strong first quarter with an even better second quarter earnings. Year to date revenues were up almost 25% and the segment income grew to exceed the threshold despite the substantial increase in D&A and pension expenses.

During the quarter we were awarded a contract for 12 metric tons of high enriched uranium, a further benefit of our NFS acquisition and our NRC category one licenses. This award enabled us to spread the cost associated with setting up the lines for our prior down blending awards over another contract which improved all the projects in the backlog.

The integration of the NFS acquisition continues to go reasonably well in this new ATU contract provided an added benefit to the purchase. As the government looks to further reduce its stockpile of weapon graded material, we should be well positioned to garner additional work such as this.

In the site management front, we expect bidding to increase over the next year. There are quite a few new and existing contracts expected to be awarded during the remainder of 2009 and even more next year.

Our Y-12 facilities are the largest of these projects and we work hard to win these rebids which should be awarded in the second half of 2010. As a reminder, we don't bid all the sites out there, only the ones we believe are well suited to our skills and our expertise where we can add significant value.

Returning to an overall McDermott view, we're keeping our eyes on Washington. The administration and Congress have an active legislative agenda, so our efforts in DC are as important as ever. In addition to the environmental CO2 lawmaking process, we are also paying attention to the potential for tax jurisdiction, government procurement and other legislative efforts.

Rest assured, we endeavor to stay full abreast of the applicable pending issues and realign our activities and legislative resources in an effort to influence any result of the bills.

Let me finish up with my view of the overall marketplace. Generally, our expectations on the near term award outlook, that is the next quarter or two, remain modest. While our bids outstanding are still at a high level, there are a lot of projects expected to come to bid stage in the foreseeable future.

The number of projects that we view as on the lip of the cup is smaller. Some of the larger projects that the financial community is tracking may occur by the year end but could certainly slip into the first quarter of 2010.

But again, quarterly booking levels typically aren't what cause me to lose any sleep, and delays in awards don't necessarily equate to delays in project execution or revenue recognition. All in all, projects are still there for our business. The primary question is really timing.

That wraps up my prepared remarks for operations. In summary, McDermott's backlog remains at near record levels. We have a solid balance sheet and we continue to make progress on our work. The second quarter keeps us on pace for a good year, but our ongoing mission will be to remain focused on our project execution.

We are headed to Chicago later today for the Jefferies and UBS conferences this week. We also have some trips planned later in August to meet with investors in their offices. In September we travel to New York for the Barclay's Energy and Product Conference and to San Francisco for Davidson's ENC Conference.

And so many opportunities in the coming months. We hope to see you all at these venues. If you have any questions regarding the quarter or the company after today's call, I encourage you to call Jay Roueche in our investor relations department.

With that, we'll now open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Martin Malloy – Johnson Rice.

Martin Malloy – Johnson Rice

Congratulations on the quarter. Could you talk a little bit more about the timing of the bidding opportunities, and particular in the Caspian region with respect to J. Ray and also in the Gulf of Mexico? There's been a couple of deep water projects that have been mentioned recently and I think you have done the top sides on a couple of those, the original top sides for those projects, and they're looking at follow on platforms.

John Fees

I would say that right now we have a number of bids outstanding for the Caspian. I mentioned it last quarter. That was a little bit sooner than we expected, so we do have some work that has been inquired, bid and we're waiting on clients to decide on award decisions. I would anticipate that some of those award decisions could come as early as late this year.

I think the Gulf of Mexico is behind that, probably into 2010. But that's just my perspective sitting here today trying to judge client activity as well as the timing of awards.

Martin Malloy – Johnson Rice

On the power side, it sounded like on the last call the pollution control equipment market might have been turning up a little bit. Can you comment on what you're seeing out there now?

John Fees

We do have in large project work, we have about $3.4 billion in bids outstanding in the power group. That covers nuclear, environmental equipment and everything else that we're doing in that sector in the large project side.

And that covers a variety of different technologies and projects. One of the things that you'll see is that you've seen it in the award framework, but the modular boilers in Canada, the work that we've done for E-Solar, and things along those lines. So a different mix of products coming in there, and in the $3.4 billion there are dry and wet FGD's that have been inquired and we have bids outstanding on.

The only thing that really remains in question at this time in my mind is going to be the timing of awards. We're sort of accumulating, I would call it accumulating bids outstanding in the power sector and I believe it's going to need to see some break in the market for power demand before we see a whole lot of momentum there. So we're just sort of waiting for that piece to start moving.

But in the interim, I would expect that some of these other opportunities that we have for waste energy, CFB, some things like that to continue to unfold.

Michael Taff

The other positive sign we're seeing there too is just a little bit of the opening up of the credit markets, as I'm sure you've seen as well, and that will help that business as well going forward.

Operator

Your next question comes from Graham Mattison – Lazard Capital Markets.

Graham Mattison – Lazard Capital Markets

I wonder if you could just give a little more color on your comment about bidding activity being good. Was that specifically in the Middle East and Asia or was that more just around the world. If you just speak to more color on where you're really seeing the activity.

John Fees

I'd say right now Asia is probably number one followed by the Middle East followed by the Caspian in that order. So we're seeing it across those three spectrums. A little bit the Gulf of Mexico, Brazil, but predominantly in those three regions with Asia pack leading the pace right now.

Michael Taff

What we're seeing is not only bids outstanding, but as John mentioned in his prepared comments, what we're really focused on as well is those focus projects and we mentioned that in the past. Those focused projects, especially on the oil and gas side still are north of $10 billion range, so it's still a healthy amount of projects that we're following we know will come to market, say in the next 24 plus months that are basically in our sweet spot of jobs we execute.

Graham Mattison – Lazard Capital Markets

Turning to the government segment, you had made a comment about margins are turning more towards historical levels. What drove the margins in this quarter versus the first quarter and the more historical quarters?

John Fees

It was a combination of things as it always is. We had excellent project execution on our projects inside of our plants. We had a very good pull through inside of the factories. But in addition to that, we did have the award of this 12 metric ton down lending contract which created, the way I would describe it would be an over absorption situation relative to the absorption of the cost associated with the assets that were installed to be able to do that work. They had a favorable influence on the backlog. That probably was one of the larger margin contributions that we had in the quarter.

Graham Mattison – Lazard Capital Markets

But then going forward, it would come back to sort of the level we saw in the first quarter or more along the lines of the third and fourth quarter?

John Fees

If you think about longer term historical margins, that's probably the way to be thinking.

Operator

Your next question comes from Andrew Kaplowitz – Barclays Capital.

Andrew Kaplowitz – Barclays Capital

At J. Ray, if you exclude the cutter projects, you jump from high single digits last quarter to the mid teens this quarter. I know the business is lumpy. I kind of know what you're going to tell me, but my question is, is there any sort of improvement that you really focused on in the J. Ray business that can sustain these margins at higher levels X problems that occasionally come up?

John Fees

It's a combination of things. We're not moving off of our thinking of the historical 10% to 12% feeling about the business in terms of our margins. But when you ask what are we focusing on, we're certainly focusing on the project execution. We're focusing on our problem children that we've been talking about for the last couple of quarters. I look at those projects daily with the management team over at J. Ray.

But behind all that, we're keeping our discipline relative to project bidding. Our competitive posture that we keep and the J. Ray team in combination with us at corporate, have looked very, very hard at our overhead and G&A expenses and we're really keeping the line on that in this particular environment that we're in.

And there are opportunities that we see to continue to maintain that going forward in the business environment that we see ourselves in. So it's a lot of fundamentals in there, but the backbone of that is the bidding and project execution. But right now, I would still give you my feeling on the 10% to 12% run rate on margins in that sector excluding things like the projects we have in the Middle East. That would be our expectation for return.

Andrew Kaplowitz – Barclays Capital

You have a ton of non cash items that are affecting you in the first half of this year, the biggest pension, and currency translation. Mike mentioned that you might try to mitigate currency translation somehow. I would be interested in what you could do for that.

And then also, I know its early too, but let's say the market ended where it is today, is there any way to think about the approximately $0.25 which is the run rate of pension expense headwind this year versus last year that you're running at as we go into 2010?

Michael Taff

A couple of things; on the pension side, it's probably a little bit early to really think about 2010. As you know, the biggest driver of that is going to be how the markets treat us from an asset return in the second half of the year. We had decent performance through the first half of the year, so we'll let the actuaries do their things, but I would think heading into 2010 our expense for 10 would be similar to '09 unless we see some dramatic improvement in asset performance over the next five months.

On the foreign currency translation, that's something we'll look at. It's hard to combat that, but we can look at where we're holding cash around the world and then having to translate that back in, what functional currencies we're holding cash in and things like that, primarily due to the volatility with the U.S. dollar compared to the Peso and the Canadian dollar.

Andrew Kaplowitz – Barclays Capital

It seems like you're competitors on the on-shore side have, and they've been talking about this for a couple of years now, trying to get more into off-shore type work. How do you view that going forward? Obviously you've seen some of the deals that have been made recently. Will you see more, obviously you'll see more competition, but do you think it will affect your business? Is there anything that you're doing to sort of stay ahead of the game versus these guys?

John Fees

Our approach on this is consistent, and we think it's being tested, has been tested in the prior environment, will continue to be going forward. We're focusing as an EPCI contractor, and we can fully integrate our engineering, our procurement, our fabrication facilities, in construction, in our installation fleet and a seamless organization that serves our clients.

We've had many consortium come up against that and I don't expect that to go away, but we think that the key that we provide is that seamless integration of all that capability to our clients with owned and operated facilities that we totally control and manage, and our ability to be able to do that seamlessly on an integrated basis is really the key.

I would expect more of this to continue to occur, to ebb and flow, and I consider it somewhat of a compliment to our company in terms of our strong performance in the market, and I think others look to it as an attractive place to be. But we've done a great job of really learning how to execute lump sum, very competitively in this environment, and I think we're going to continue to be successful.

Operator

Your next question comes from John Rogers – D. A. Davidson.

John Rogers – D. A. Davidson

Just following up on the question relative to margin in the oil and gas business, no margin business that you have left in backlog, remind me what's the schedule on when that's to be completed?

John Fees

For all practical purposes, it's going to be done by year end. There's a little bit that's going to trail into 2010, but the vast majority is done by the end of 2009.

Michael Taff

Also just a little more clarity on that, we had about $330 million of revenues this quarter related to those projects and you can think in the same terms the next two quarters, $300 million or so in each of the next two quarters would be rolling off associated with those contracts, and hopefully that will pretty much wrap them up.

John Rogers – D. A. Davidson

On the power side of the business, at this point how much of that work would you classify as more maintenance type projects or small as opposed to new generation?

John Fees

The better way to answer that is kind of give you a breakdown of our backlog and when we think of our backlog which also is kind of a good footprint for our existing revenues we're booking, it's about 40% parts and service, and then OEM is about 20%, environment work would be about 25% and then the remainder is nuclear, bio-waste, things like that.

Michael Taff

The one thing that's worth adding to that, as you know beyond backlog we also have a pretty robust book and burn work in the parts and service business probably to the tune of about $100 million a quarter. That's in addition to the backlog roll off.

John Rogers – D. A. Davidson

A year ago, how much was the OEM portion of that?

John Fees

It's been pretty consistent around that 20% range or so.

Operator

Your next question comes from Tahira Afzal –KeyBanc Capital Markets.

Tahira Afzal –KeyBanc Capital Markets

If I heard correctly, your focus lift is now $10 billion, is that correct?

John Fees

I think the number is closer to $14 billion to $15 billion.

Tahira Afzal –KeyBanc Capital Markets

So it's kind of in line with the last quarter then.

John Fees

Exactly. I think when Mike used the $10 billion dollar number, he was taking out what we were already bidding on.

Michael Taff

I think I said north of $10 billion, but I think John's right. It's in that $14 billion plus range.

Tahira Afzal –KeyBanc Capital Markets

So $4 billion to $5 billion is what you've got to keep bidding on. Would that imply $4 billion to $5 billion perhaps on projects that are likely to go ahead in the next let's say six to nine months?

John Fees

I would classify it more like 18 months. I don't think all that will land this year.

Tahira Afzal –KeyBanc Capital Markets

In terms of the start of Karan, is there any update there?

John Fees

It's still early. Things are progressing well. Obviously we're knee deep into engineering work. We've preformed a lot of the procurement activities to date and you'll see us getting kicked off heavily into the fabrication side of that project in 2010.

Tahira Afzal –KeyBanc Capital Markets

So utilization rate in terms of J. Ray, do you still expect those to be sort of in line if not better perhaps in 2010?

John Fees

I think it really depends on the timing of orders coming into backlog. Right now Asia is very busy. I think Asia continues to be busy into the future. The Middle East probably about where it is. If we have some good fortune in the Caspian, we could see an uptick in the Caspian next year, but I think it all depends on the timing of orders.

Tahira Afzal –KeyBanc Capital Markets

So the Caspian and Gulf of Mexico might be the swing factors in 2010.

John Fees

Yes. When I say Gulf of Mexico I also include Mexico which we're bidding a reasonable amount of work as well. So I'm not speaking domestic Gulf of Mexico there, I'm sort of talking regionally there.

Tahira Afzal –KeyBanc Capital Markets

In terms of Empire, I would like to get a sense of the, you talked about feedback has been positive to date. To the extent you can elaborate on that, I'd love to get a sense of what your ability, you're thinking and what they like in terms of the economic incentive perhaps, or the practical incentive of that versus some of the more traditional or larger alternative options that are out there today?

John Fees

I could talk quite awhile on that; maybe consume the rest of the call. Let me just briefly describe where I see this being different and why it's important. We really believe there's an opportunity that exists because of the large field of erection labor content as well as the limited supply chain associated with big nuclear systems, 1200 to 1700 megawatts that creates an opportunity for us to come in with something on a modular basis which widens the supply chain tremendously, very heavily factory built and very light field construction.

So when you add up all those pieces, we think that it's much more financeable, shorter schedules and a lot more cost certainty. So that's the innovation that we're bringing to utilities in a way that we want to propose this going forward.

Recognize that there's a pretty decent amount of distance between now and when we start making megawatts. But since the nuclear renaissance has generally moved to the right, we really don't feel that we've missed the market here at all. So what we're working to do is put an innovative game changing opportunity in front of the utility clients and move that forward for their future nuclear deployments directly in competition with the large nuclear systems.

We really don't want to go forward building one 125 megawatt module. We want to build power plants with modular clusters that are going to be cost effective, factory built, financeable, schedule certain and have all those opportunities.

Tahira Afzal –KeyBanc Capital Markets

Is it too early to put a price on megawatts on the cost?

John Fees

I would say yes. The only thing that I would classify it at at this point in time is we think we can be competitive, very competitive with what's out there in the marketplace, and the rest of that will be tied up in our selling schemes, margins and so forth.

Tahira Afzal –KeyBanc Capital Markets

In the prepared commentary, you touched on what you said in regards to clean, move towards clean environment and clean fuels and renewable etc, and that McDermott has never been better positioned and the momentum you're seeing here in terms of leverage from McDermott is probably one of the best you've seen. Would love to hear you elaborate on some of the opportunities outside of the nuclear space that you think would be positive as we migrate to more of a carbon free environment.

John Fees

What we're seeing from our clients even in these economic conditions, is a lot more interest in thermal solar and we've got a bit of a foot in the water there with what we've done with the solar work we've done. We have some waste energy plants that we have in the bids outstanding stage that we're moving forward. Bio-mass co-firing, all those things are very active right now with the clients.

Beyond that, probably one of the bigger revenue opportunities that we have is where we can go with constrained carbon coming out of coal fired plants, and we mentioned before that we have the fire technology that we've matured to the point of doing demonstration. We have an active project that we have in front of the Department of Energy with a utility partner, Black Hills in the U.S.

We're hopeful that that project will go forward under some of the initiatives that the government has taken for CO2 carbon reduction and trying to move clean coal forward. We think that that's a very important, it's a very viable project and it's actively being discussed between ourselves, the utility, state government and those in Washington as a model project.

In addition to that, we completed a construction. We have started up the demonstration testing that we intend to do for our RSAT, regenerative solvent absorption technology, post combustion scrubbing system. We've very pleased with the results that we've seen so far and in my eyes, I've been around the utility industry and the coal industry a lot. It's from where I sit the largest scale demonstration that's been done like this to move the technology on a CO2 post combustion scrubbing absorbent technology forward.

Our steps from this would be the same steps forward that we took on oxi to make it available for scale demonstration in the field after we get here. It's not really difficult in my mind to capture CO2 using a solvent. The solution that we're really focusing on is making it such that the parasitic load on the water is at the optimal point so we don't waste a lot of energy by capturing the CO2.

The solvent regenerates at very high efficiencies and we make all this available for later. So we've got a very comprehensive program here. We're very proud of it. We think it's unique in the industry and some of the largest scale work that's being done.

So when I say we're positioning ourselves well and we're moving forward into this carbon constrained environment, I would package all those things that I described into that framework.

Operator

Your next question comes from Steven Fisher – UBS.

Steven Fisher – UBS

How would you characterize the traction you're making on the international tower front? At the beginning of the year, maybe within the last year, you had suggested that we could see your mix in the international side pick up and you mentioned Viet Nam. I'm just wondering how its going and do you have any meaningful booking opportunities is the second half?

John Fees

I would say that the global economic crisis has put a sort of a kink in the demand curve, is the way that I would describe it. I don't think that the main curve has fundamentally changed from a long term perspective, but I would say that right now there's a kink in the demand curve that has really slowed down new build opportunities in many places.

As an example, there are coal plants that are being erected in China that aren't being started because the industrial demand at this particular point in time is very low. And so we've seen that occur, but we've kept up our effort to pursue our opportunities in India as well as our ongoing work in China.

I really believe that the mix swing that we talked about on the OEM side, we will continue to move in that direction. But I would say that this kink in the demand curve has probably moved that out about 12 months on us, and we like many industries are waiting to see that economic recovery that all the forecasters have been projecting for later this year, early next year to bring that swing back.

Steven Fisher – UBS

In the 10-Q you cited lower productivity on a minimally fabrication job. Can you just talk a little bit more about that and what kind of job it is? Is the situation resolved and could it have any carry forward impact?

John Fees

That was a fabrication job. It's well underway and we don't see any long term affect of that. Actually, I think that job was, fabrication on that has been completed and the deck was set. So it's well on its way to being completed.

Steven Fisher – UBS

So no real schedule impact there.

John Fees

No.

Steven Fisher – UBS

I wonder if you could give a little more color on the non controlling interest. I think you mentioned that it was going to be trending lower. Can you just go over why, what drives that and how much lower it could be?

John Fees

I think the best way to look at that is that we've had that always in the past but there's new FAS that came out that we adopted this year that requires you to break that out. Historically, that was just lumped into the other income line item.

We've got that in a number of places in our international operations where we'll have a 2% to 5% minority interest owner on some of these jobs. So I think you'll always see that as part of the J. Ray business model, but for GAAP purposes, it will be broken out. But I don't think it will be running in the $5 million range on a quarterly basis going forward. It will be something less than that.

Operator

Your next question comes from Joe Gibney – Capital One.

Joe Gibney – Capital One

A couple of questions on the J. Ray side, you've obviously been dealing with some third party vessel delays and some headaches there. Do you feel you're appropriately positioned from a vessel standpoint going forward for some of the work that you're bidding? Obviously centered in the Middle East and Asia pack right now, is there anything attractive third party vessel sales that might be out there you're looking at or are prices still a little bit too proud.

And I wanted to follow up on your comments on the J. Ray burn through, at least from a revenue standpoint as we work our way through the Shell GTO, I know April through October can usually be your better weather months. I thought we might see a little bit more revenue flow through in the third quarter versus fourth quarter, but just want to confirm that you deem a little bit more as a run rate the back half of the year.

John Fees

Let me talk about the vessel front first. We believe that the fleet that we have very well supports the bidding activity we have in the markets that we're pursuing. So we feel we're pretty well in balance there. We continue to focus on the long term investment in our fleet. We have a lot of active projects going there which include a new build vessel for shallow water pipe lay that should be complete early next year that we're building a single for.

We are looking at other assets that are in the marketplace that are distressed, semi completed and so forth. Right now we haven't found anything that we have taken full action on at this point. It's been a combination of ongoing discussion and dialogue and maybe people just being a little bit too proud of as you indicated, some of those assets, and really not seeing the right balance of the stress versus what we need to do to get ship shape for our operations versus going off an otherwise contracting and building a new vessel that would be directly in compliance with our requirements.

So we continue to evaluate that market, continue to look at it going forward. But right now we haven't seen anything there that we've taken action.

Michael Taff

Just to give you a little bit more clarity, looking at the burn on that $600 million plus of backlog, it looks right now we've scheduled about 50% in Q3, about 40% in Q4 and then the remaining 10% in Q1 next year.

Joe Gibney – Capital One

One point of clarity on the oil sands, I just want to confirm. Did the entirety of that modular booking fall into 2Q and just some expectations there. Is there any other work out there in your near term sights as you're rolling off some of your work at Fort Hills? Is there anything else out there?

John Fees

Yes to both. It was all in that quarter and we are seeing more activity out there that we would anticipate could lead to bidding opportunities for us in that area.

Operator

Your next question comes from Will Gabrielski – Broadpoint AmTech.

Will Gabrielski – Broadpoint AmTech

If you go back over the last few quarters from when this Qatar problem became a problem and then you compare how you've handled that from a standpoint since then versus what you consider your peer group who may have had similar problems over the past few years, any changes that have happened under the new CEO? Are you seeing opportunities to kind of shake up the team a little bit and pull cost out of other projects that you may not have gone after? Just some color on what you're doing there.

John Fees

I would say that I'm not proud of the problem that we had. But I'm certainly proud of how we responded to that problem, and that response was not a radical shake up of the team, because the team had developed a tremendous amount of great foundational programs, and it was a matter of going back and figure out what happened in the foundation that we needed to strengthen going forward.

So that's really been more of our approach. I think Bob and his team have done an excellent job. We've really moved forward strong to put corrective actions in place to assure ourselves that we're not going to create the problem that we created on these particular projects.

In addition to that, you may remember that I did bring on board a COO with Steve Johnson, with broad ENC experience. Steve has been directly involved in helping us continue to evaluate that foundation that we've put in place and strengthen it where we feel appropriate.

So it's not so much a radical shift, but these things you've got to roll up your sleeves and you've got to dig through the details and you've got to work every one of the issues, as well as paying strict attention to what you're doing on a project execution business while putting your backlog moving forward.

So it rolls into our bidding environment. It rolls into our execution environment, and we're paying quite a lot of attention to that as we go forward. And I'm very proud of the team. I'm proud of what they accomplished. I'm not proud of the problem, but I am proud of the response to the problem that the team has done.

Will Gabrielski – Broadpoint AmTech

You walked into a little bit of a fire storm so I think it's gone exceptionally well, so congratulations on that front. From a math standpoint, if I go back to Q1, you exited the quarter with $850 million or so left in the Middle East and you burned $330 million this quarter, so that would leave you around $520 million, yet you're implying there's about $300 million left per quarter the rest of the year. Were there some scope changes in those projects or is there any potential profit recovery or cost recovery on some of the charges you've taken?

Michael Taff

I'd be surprised if the math works just because obviously when you have these multi hundred million dollar projects, things ebb and flow in the project and there's always some scope and growth and all. So I think we've quantified it. I think we feel good.

I think the important thing to focus on is our estimated cost to complete. We've been pretty much on track the last couple of quarters. We feel good about the productivities that we're getting and certainly we're working with our clients to try to recover some of that cost as John said in the prepared comments as well as come to a satisfactory results on the LD front which we think will come to a successful conclusion on all those fronts over the next two quarters of so.

Will Gabrielski – Broadpoint AmTech

You gave bids outstanding for power and I heard the total focus list of projects. Did you give the bids outstanding for J. Ray?

John Fees

If you look at the total bids outstanding, $7 billion or so, that's about equally split between power and oil and gas.

Will Gabrielski – Broadpoint AmTech

On [Tenesca], which is a clean coal project in Texas, I was curious if you have any exposure there on the boiler side or if you're engaged with that particular firm?

John Fees

No. I think that's an IGCC project right?

Will Gabrielski – Broadpoint AmTech

They have two projects. One is in Illinois and that's IGCC and I think the one is Texas is a carbon capturing sequence.

John Fees

It is, and I don't think the boiler decision has been made on that project yet. But if you ask us what's our involvement and are we involved at this point, do we have revenue in hands on work with that project right now, the answer is no.

Will Gabrielski – Broadpoint AmTech

Two projects, one Barzon gas, obviously that was delayed and it may have accelerated again, so any color on that, and any potential releases under the [Eramco] long term agreement and some of their new exploratory work obviously for gas. As you seeing anything there?

John Fees

We've got both the LTA and Barzon in backlog right now and we're working through the scope that's been released to date. Both of those projects have additional scope that's going to come to market that we feel fit pretty well with our skill set and we'll be looking forward to that as it comes to market and ultimately gets awarded.

Operator

Your next question comes from [Jeff Spiddle – Natixis]

[Jeff Spiddle – Natixis]

If we could touch on J. Ray, you talked about it being a pretty competitive bidding environment. Where do you think you are in terms of pulling costs out of your supply chain, whether it's in procurement or other areas? Where are the sources of push back you're getting the most on the pricing side from customers in terms of getting costs down on projects that you're bidding?

John Fees

Our environment because of the fact that we're primarily a lump sum, we don't get a lot of push back from clients. We either get awarded or don't get awarded work, and so that's predominantly the gauge and the measure in that particular area.

I would say right now that we've had really good success this year in seeing lower commodity and lower unit rates for activities that support the business. So I can't gauge what people have done inside of other projects quite as directly, but we've have fairly substantial reductions if you compare it against a year ago relative to purchased items and things along those lines.

I'm not really anticipating that that's going to stay forever.

In fact, we're spending a lot of time trying to make sure we don't get trapped on the other side of that, and really thinking about our forward escalation on projects that run two or three years. And so we're probably spending as much time thinking about that as what we can do upfront in the bidding environment that we're in today.

[Jeff Spiddle – Natixis]

You talked about Asia pretty hot bidding environment relevant to some of the other geographies. Anything associated with those LNG projects down there that you're either bidding on or looks like it's getting closer to going into bids outstanding at this point?

John Fees

We've had some bids outstanding associated with some of that work at the end of the quarter and we don't really have anything that's been announced by the client to discuss in that area. So we continue to focus on that.

The thing I think that's more important than any particular project though in the mix itself, is that we are thinking more about the overall mix and what we're going to be bidding. We're really not trying to sacrifice or take any unique stands on any one particular project. We want to win work that we can win at the margins that we think we deserve and best utilize our facilities including our fab yards and our vessels.

So we're really marching through that large $14 billion to $15 billion worth of opportunities trying to maximize that utilization. So for example, we may bid something in a particular area that we may put a little more pressure on the price that we would expect the client to pay, fully understanding that we have levels of backup and levels of contingency with other opportunities that may be more strategic relative to utilization and asset deployment.

So we're really not trying to look at it on a project by project basis, but look across the family across all these opportunities to make sure that we get our best utilization and our best profit opportunity out of this mix.

Operator

That does conclude today's question and answer session. I would now like to turn the call back over to Mr. Jay for closing comments.

Jay Roueche

Thank you all again for joining us today. Just a quick reminder that the call did include some forward-looking statements. For more information on these I encourage you to see our SEC filings, call Robbie or me if you have any follow up questions or need any clarification, and we look forward to seeing many of you in one of many locations we're going to be in in the next few months.

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Source: McDermott International Inc. Q2 2009 Earnings Call Transcript
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