McDermott International Q3 2009 Earnings Call Transcript

Nov.10.09 | About: McDermott International, (MDR)

McDermott International, Inc. (NYSE:MDR)

Q3 2009 Earnings Call

November 10, 2009 10:00 am ET

Executives

Jay Roueche – Vice President of Investor Relations

John A. Fees – Chief Executive Officer & Director

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

Analysts

Andy Kaplowitz – Barclays Capital

Roger Reed – Natexis Bleichroeder

Jamie Cook – Credit Suisse

Steven Fisher – UBS

John Rogers – D. A. Davidson & Co.

Tahira Afzal – KeyBanc Capital Markets

Graham Mattison – Lazard Capital Markets

[Will Gabriosi] – Broadpoint Capital

Welcome to McDermott International’s third quarter 2009 earnings conference call. At this time all participants are in listen only mode. Following the company’s prepared remarks we will conduct a question and answer session and instructions will be given at that time. I would now like to turn the conference over to our host Mr. Jay Roueche, McDermott’s Vice President of Investor Relations.

Jay Roueche

We appreciate you joining us to discuss McDermott’s third quarter 2009 financial results which we reported yesterday afternoon and the press release is 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 turning the call over, 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 this morning will include forward-looking statements and estimates. These comments are subject to various risks and uncertainties. Please refer to our filings with the US Securities & Exchange Commission which are 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 will now turn the call over to Mike to discuss our results for the third quarter.

Michael S. Taff

Starting with the income statement, total revenues were almost $1.7 billion up modestly from a year ago on a consolidated basis but offshore oil and cash construction had record quarterly revenues and government operations also increased by double digit percentage but the top line growth of these segments was essentially offset by the decline experienced in the power generation systems revenues.

Consolidated operating income of almost $145 million in the 2009 third quarter was a 57% increase compared to about $92 million a year ago, even with a $45 million headwind from pension and depreciation and amortization expenses in the 2009 quarter. The offshore oil and gas construction segment did a 180 degree turn from the segment loss in the third quarter of 2008 to its second best income quarter ever in the 2009 period. The power generation systems business has the most substantial reduction in segment income as a result of lower revenues in the 2009 quarter, fewer project improvements than a year ago and generally a softer overall power environment.

Government operations had its lowest earnings quarter in four years. We recognized about $13 million in project losses on down blending activities due to production delays and other factors that John will discuss and with our NFS purchase price accounting now finalized, it resulted in about $3 million of additional depreciation and amortization expense for the 2009 third quarter.

Below operating income our results for the quarter were impacted by a $9 million swing in the other income and expense line compared to a year ago. Net interest income declined about $3 million. Lower interest rates earned no our cash investment coupled with the lower balance more than offset the benefit of lower expense and capitalized interest. In addition, the other other expense worsened by about $6 million primarily due to non-cash foreign currency translation losses. All-in-all pre-tax income improved about $44 million compared to the 2008 quarter.

With a strong international performance in the offshore oil and gas segment, our effective tax rate was about 16.5%. Last year the consolidated tax rate was lower due to a onetime $45 million tax benefit from the release of state valuation allowances and as a result of audit activity. Taking it all to the bottom line, McDermott reported net income of $118.1 million or $0.50 per diluted share in the 2009 third quarter compared to about $85.6 million or $0.37 per share last year. In addition to the 35% EPS growth over the comparable 2008 period, this quarter also represented a 25% sequential EPS improvement.

We feel good about the quality of our earnings this quarter particularly since the growth was all operating income driven but between the segments our results were mixed so let me review each in a little more detail. The offshore oil and gas construction segment reported its second highest quarterly segment income ever coming in at $106.5 million trailing only the first quarter of 2007. This is a huge improvement over the $20 million loss reported a year ago when we increased expected cost to complete on a number of projects incurring about $90 million of contract losses. Further, the 10% operating margins were outstanding considering about 30% of the segment revenues were from lost contracts this quarter.

As has been the case of late the Asia Pacific and Middle East markets were the strongest with the Americas and Caspian still profitable but closer to breakeven. On the Middle East projects that have been problematic, we incurred about $23 million in additional charges but the good news is this incremental expense was more than offset from the benefit of high asset utilization as well as contract improvements elsewhere. John will discuss these projects and our outlook in more detail but we don’t expect this level to be the run rate in the near term however.

Offshore oil and gas construction truly delivered in Q3. After achieving two record income quarter in a row during the first half of 2009, government operations took a step backwards in the third quarter. Granted, the almost $25 million in increased pension, depreciation and amortization expenses more than explained the year-over-year variance in the segment however, since we were incurring these costs during the first half of 2009 clearly some other issues occurred.

While we readily acknowledge that the government segment results earlier this year were peak levels and that as quarterly results are lumpy we were not anticipating taking additional charges of about $13 million for down blending work and the additional depreciation and amortization expenses of about $3 million this quarter. As such, we view this segment’s 2009 third quarter is not indicative of what we would expect on an ongoing basis.

The power generation system segment maintain operating margins at 8.8% in the 2009 third quarter which remains in the upper half of our suggested 7% to 10% range. But, while the margins are fine, unfortunately the segment reported its lowest level of quarterly revenues since the power group was reconsolidated in 2006. John will provide greater detail in his update of the marketplace. But, we have said for some time that the power industry was stuck somewhat in a holding pattern until the uncertainties of the industry get resolved and the softening revenues this quarter seem to be confirmation of that prior commentary.

Turning to the balance sheet, our liquidity improved sequentially during the 2009 third quarter and remained at about the $1.1 billion level for cash and investments compared to a minimal $11 million dollars of funded debt. Cash flow was positive for the quarter and the full year which is impressive considering about 20% of the third quarter’s revenues were from lost projects and our bookings and therefore cash advances were light. Both shareholders’ equity and our working capital position increased about $160 million during the quarter so McDermott’s financial position remains an overall strength of the company.

We are feeling more confident in the financial markets and have begun the process of redoing our bank lines which is timely considering government operation’s credit facility matures in just a few months. That pretty well covers our financials in the third quarter 2009. I’ll now turn the call over to John for his remarks on the operational and business environment.

John A. Fees

Overall I am quite pleased with the consolidated results the company delivered this quarter. Q3 has kept us on pace for a solid earnings year. As most of you know, in good quarters and in bad I always remind investors not to get overly excited about any 90 day span since it’s only a snap shot from a portfolio that consists of mostly multiyear projects. Not only can our overall results be lumpy but each of our segments can be that way as well.

The 2009 third quarter evidenced this fact as McDermott saw our offshore oil and gas construction segment exceeded our expectation, government operations fell short and the power segment continued to do pretty well considering it is serving in a weak market. Together though we delivered the highest level of quarterly earnings over the last year, we strengthened the balance sheet and continued to progress on a number of our growth initiatives.

As we expected and indicated on the last call new awards during the third quarter were light across our segments with about $700 million in new bookings this quarter combined with one of our highest revenue quarters ever backlog fell considerably. While it’s not aesthetically pleasing but the decline is not a situation that particularly worries me at this time either. Just looking at the offshore oil and gas segment which has experienced the largest backlog drop year-to-date through Q3 there are still a lot of projects either in the mid stage or anticipated to come to market in the near future.

Granted, we still need to win our share but the market appears to be there. These opportunities seem to be better spread across our geographic regions than the current workload. Additionally, the quality of the existing backlog has improved versus the start of the year. For instance, on January 1st, about 25% of the oil and gas backlog was from projects with no margin or in a loss position. At the end of the quarter that percentage was under 8% of backlog. As such, the dollar value of gross profit in our backlog has actually improved rather substantially during the year even though backlog in the segment has declined.

Looking at the government business, we tend to get the vast majority of our awards all in one quarter following the government’s budgeting processes. We typically see a sizeable backlog jump occur in the fourth quarter and then backlog typically falls in that segment for the next three periods.

The power business is somewhat different than the other two as it is being hit by the economic slowdown coupled with the current regulatory uncertainty. While the award activity in this segment reflects those issues, we feel pretty good about booking almost $1 billion worth of work in the power segments through three quarters of this year and we do not expect the current economic and regulatory state to continue indefinitely. Since I’ve already started down this path I’ll go ahead and jump to the business specifics in each of our segments.

Starting with the oil and gas construction segment as Mike and I have indicated, it had an extraordinary third quarter. We realized the highest level of quarterly revenues ever generating the second best quarterly earnings. Considering about 30% of the segment’s revenues this quarter provided no margin benefit, we’re pleased with this combination. Further, the Middle East pipeline projects which proved to be a temporary setback for us over the last year or so are now complete.

I want to congratulate Bo Deason and his team for getting all 260 miles of these pipelines laid and for staying on top of the projects and finishing them reasonably in line with our estimates. To be clear, we have about $333 million in zero margin revenue still recognized about 70% of which should burn in Q4 but it was the pipeline portion of these jobs which was particularly challenging and that scope is now finished.

We continue to believe the vast majority of potential liquidated damages on these projects are unlikely to be incurred and I think once these projects are 100% done we’ll see this potential exposure get resolved to all parties’ satisfaction. The segment’s current results were still mainly derived from the Middle East and Asia Pacific markets however, the markets in the Caspian and America regions are showing good indications of significant work coming to the industry in the foreseeable future and if we win our share and the other regions remain strong, the growth potential for this segment’s work load is sizeable.

Another large market that is relatively new for us is Brazil and it too looks promising. Our joint venture company Flotec received a letter of intent from Petrobras during the third quarter for a $1 billion project know as Papa-Terra. We are currently working with the client to finalize the contract and the success of this will be the first tension laid platform production facility in Brazil and we’re excited to be a part of it. This likely win also validates our approach with Flotec. As you may recall, the partnership with [inaudible] is focused exclusively on floating structures for the offshore market offering a number of proprietary technologies so we can provide unbiased solutions to our customers.

In addition to recognize half of Flotec’s net results in our financials part of the goal in forming the joint venture was also to allocate work back to the parent companies. In the case of Papa-Terra about 20% of the project’s value is expected to show up in our backlog and ultimately flow through our income statement.

We continue to proceed with a number of growth initiatives in the offshore oil and gas construction segment. Despite a current cautious market environment we remain confident in the growth potential of the industry. As such, we are methodically investing in the business. Our new shallow lay barge that we authorized is scheduled to be delivered in the first half of 2010 and is expected to be working in the second quarter. We finalized a non-recourse financing for the proposed Chinese FPSO joint venture so that effort is advancing forward.

Likewise in Kazakhstan we are about to begin land reclamation at our new Bautino Bay fabrication facility and we continue to strategically assess new vessels and we may be getting close on such an opportunity. Even after the year long pause we’ve experienced, we believe this is a good time to be evaluating initiatives and selectively positioning ourselves for the anticipated growth we see in this market.

As Mike discussed, we think that our quarter was a near term peak in the business in terms of revenues and earnings. This quarter’s strong result came from high utilization particularly our construction vessels and exceptional productivity. In addition, we benefitted from realized and expected cost savings in a number of other project improvements. In the next quarter or two we are not expecting this same utilization level that we achieved this quarter and in addition to still running through a large amount of zero margin work we expect to have an increase in available marine [days].

As such I’d encourage you to expect margins for the fourth quarter to be more in line with the 6% to 8% range that we’ve talked about for the full year 2009. All in, the third quarter was an outstanding one for the segment and for the full year we should be at the upper end or somewhat exceed the margin range we set a year ago.

Now, turning to the power generation systems segment, it maintained good margins in the 2009 third quarter and we booked about $230 million of new work to keep backlog at about $2.1 billion. But revenues for the quarter dropped to under $400 million for the first time in several years. Essentially we’re working to make the most of a tough market. We have spoken a bit to the business environment in the past but let me give you some additional background. As most of you know at this time our power generation system business is predominately North America and most of our revenues are derived from existing or new coal fire power plants.

According to the EIA, total electricity generation in our country is down over 5% through July compared to last year mainly due to the recession and the associated decline in industrial demand. As unprecedented as this is, a greater concern for McDermott is coal fire generation is down over 13%. The primary reason for coals’ decline is the current low cost of natural gas and the excess capacity to burn this fuel. When you combine these factors with the uncertainty surrounding the regulated emissions it makes for a soft market effecting most of our coal fire product and services.

While we believe industrial demand will return and Washington will eventually provide some certainty as to what the rules of the game are McDermott isn’t standing idly by. We are actively looking to expand more internationally on the coal side and we are looking to increase our business here with additional waste energy, bio mass solar and nuclear offerings. Year-to-date we’ve invested about $34 million in R&D primarily in our empire modular nuclear program and our carbon capture technologies and see that spending increasing as we go forward.

We’ve also made some bolt on acquisitions and continue to evaluate opportunities. While we are diversifying we remain strong believers in coal. Even down by double digits this year, coal still represents nearly half of America’s electricity generation and we have abundant supplies of it domestically. With our technologies, we expect strong retrofit opportunities in the time ahead and yes, new plants as well. The next year or so will probably remain challenging as compared to the last couple of years, however we also expect some important developments to come.

The most important catalyst we expect is a climate change bill and new care roles in 2010 both of which should be key drivers for our customers’ future capital projects. We also expect as industrial demand returns we will see the associated pickup in the aftermarket spending. We continued to advance technology in this quarter including that our first thermal solar collector was installed in California and at first light it exceeded its performance criteria. We have continued testing using advanced solvents for carbon capture and have routinely demonstrated capture rates at the 90% plus level.

Ultimately, we intend to conduct durability tests at the new Department of Energy National Carbon Capture Center late next year. We continue to make design progress on our empire reactor and are pleased at how government and industries is embracing our approach. The NRC has announced staffing changes directly to support licensing of modular reactors and the DOE have announced their intention to launch a new public private cost sharing initiative to develop small reactors. We continue to be pleased with the evolution of the technology.

Overall, to summarize the segment, it is doing well in a challenging environment. We’re addressing costs, we’re working with our customers and regulators alike in positioning the business for the return of growth in the marketplace. As a 140 year old business that’s built strong relationships it has evolved with the industry and enjoys a solid mix of recurring and project oriented work. The future fundamentals of the power business look promising with agent plants, [inaudible] gas prices, the growing population, the green focus and a better worldwide economy and we are very bullish on this segment over the long term.

Wrapping up with government operations segment, the third quarter of 2009 is not representative of what we expect on an ongoing basis. After indicating our second quarter results were a near term peak I think it’s safe to say that Q3 is the valley. A better expectation is probably averaging those two periods. There were really two items that combined to make this quarter unusually low by hitting us with about $16 million of non-recurring expenses. Both the issues relate to the nuclear fuel services business we acquired late last year.

Mike discussed the additional depreciation and amortization expenses for this quarter and next. The more significant issue relates to our down blending contracts and ironically the same projects that gave us the pickup in the second quarter. In the third quarter however we experienced delays due to completing the processing line and obtaining NRC license approval and the increased associated costs, some low processing grades and the supply material not meeting specifications. However, for the two contracts in question, we have less than $19 million of work remaining to execute. Needless to say we feel like we left some additional upside to an already strong quarter on the table with this unexpected development.

As many of you who have followed us for some time already know, our government operations segment has consistently been a stable operator, a solid performer and the most consistent of our three segments. We do not believe that the issues experienced in this quarter change any of those characteristics. We believe we have our arms around the issue and expect to recover some of the cost through customer claims. The rest of our government operations continued to perform about as expected.

On 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 in the next year or so. Our Y12 and Pantex facilities are the largest of these projects and we are working hard to position ourselves for these contracts which are expected to be awarded in the second half of 2010 if no extensions are granted. During our nine plus year tenure at both of these sites, we are very proud of our accomplishments and the success we’ve delivered.

Returning to a consolidated McDermott view, we remain very focused on Washington and our legislative agenda there. The drafts of legislation and various rules proposed or in effect are potentially far reaching so our efforts in DC remain as important as ever. We’re paying close attention to replacement environment legislation, potential foreign tax jurisdiction issues, government contracting regulations, Co2, global warming, climate change bills, just to rattle off a few. Our Washington office does a great job utilizing internal and external resources as they are required and since the government is McDermott’s largest single customer the issues in DC get our attention at the highest level.

Let me finish up with another view of the overall marketplace. We continue to have only modest expectation for near term award outlook probably the next quarter or two. In both the power business and the oil and gas area it appears some competitors are willing to get aggressive with their bids and to be clear, we don’t intend to follow them. Part of the rational of our management team not being backlog focused is that it helps us from the feeling of a need to chase work.

We believe being earnings focused which is a much better strategy. We will endeavor to keep our costs in line and fully analyze the projects we bid but in a predominately fixed price word it’ just doesn’t make sense bidding too low just to win work and then hoping that it all works out in the end. We have followed this disciplined approach in the past going back to the run up that happened in 2004 and 2005 when others didn’t and it paid off well.

While our bids outstanding are still at a high level and there are a lot of projects expecting to come to bid stage in the foreseeable future, other than Papa-Terra and the annual government awards, we don’t see many other large ones likely booking before year end. But, we believe 2010 could be an improved year for contract awards.

That wraps up my prepared remarks for our operations. In summary, it was a good quarter for McDermott primarily on the back of the offshore oil and gas construction segment, our backlog remains solid, the balance sheet is strong and we continue to make progress on our projects and initiatives. The third quarter keeps us on pace for a good year but our mission remains focused on execution.

We are headed back to New York for the KeyBanc Conference next week and based upon the schedule that I saw I look forward to seeing many of you there. We’ve had an active investor relations schedule this year and I have found it beneficial in meeting with our owners and potential shareholders. If you have any questions regarding the quarter or the company after today’s call I encourage you to call Jay or Robbie in our investor relations department. With that operator, we’ll now open the call for questions.

Question-and-Answer Session

Operator

Your first question comes from Andy Kaplowitz – Barclays Capital.

Andy Kaplowitz – Barclays Capital

John, can you talk about maybe an additional look at fleet utilization in 2010? I mean you talked about how it would be down a little bit in 4Q but how much more bookings do we need to have over the next couple of quarters to get a good level of utilization next year?

John A. Fees

Andy, it’s a combination of factors there. We have certain things in our backlog that is going to drive fleet utilization and the real question is what we call the drive by work and the opportunistic things that happen during the year. For example, if you took a look back at this year, the DV50 in the Gulf of Mexico and the amount of bookings we had walking in to the year, you would not have expected that vessel to be very heavily utilized and that vessel just remains busy in the Gulf.

So, I think that’s really the variable here. Based upon the spending trends and things that we see, I think there’s a little bit of a question in my mind as we look in to the year next year but don’t have a major concern at this point keeping utilization at a reasonable level.

Andy Kaplowitz – Barclays Capital

If I could shift gears and talk about power, obviously we understand your commentary and I think the expectations around power have been relatively low but do you think the business has sort of – is it in the process of troughing here in 3Q. Do you see signs that parts and service can better versus seasonality as we go over the next two quarters?

Michael S. Taff

You know Andy I would say if we would be in a situation where we call this troughing I wouldn’t expect a spike. I’m expecting a little bit more of a gradual return then a massive run up over the next couple of quarters so I expect it to sort of climb out of this level beyond the next two quarters but not really a big run up.

I think one of the things that’s kind of interesting, if you take a look at the bids outstanding that we have in that area I think you see a different mix there than you would have seen maybe a year or two ago. I mean, we have a reasonable amount of biomass work that we have bid, we have got some waste energy in our bids outstanding, you know we have a reasonable amount of nuclear probably one of the highest level of nuclear bids for nuclear service and replacement components as we’ve tried to emphasize that particular segment.

So I’d say as we go in to the future you may also see a little bit of a different mix coming out of there. I think one of the big drivers though as look in to the future is when are we going to get changes to the care rules and when does that environmental equipment market start to pick back up. We anticipate that’s going to happen next year and we’re looking forward to that event.

Andy Kaplowitz – Barclays Capital

So one more power related question if I could, I noticed that your Chinese JV showed a little bit more equity income in the quarter, it’s been kind of light over the last two quarters and had a little bit of a tick up in this quarter. So, how is that business going and can we see some nice equity come out of that business as we go forward over the next year or two?

John A. Fees

We’re just comparing some notes here Andy and related to the Chinese JV what we’re seeing from overseas and right now we see that facility continues to stay booked up. We had a little bit of a hit on our backlog back several quarters ago associated with material price escalation that we saw inside of China, that situation has reversed and we’re seeing that pick back up. I think I looks very strong for the future. I think the plan is to continue to stay ambitious there and we’re still running 20 gigawatts or so in the backlog and continues to stay strong so I would expect to have continued good earnings out of our Chinese joint venture.

Operator

Your next question comes from the line of Roger Reed – Natexis Bleichroeder.

Roger Reed – Natexis Bleichroeder

A question I have, if I look at the backlog run off both in the remainder of ’09 and 2010 in the offshore oil and gas construction segment, I’m just wondering if any of the strength that we saw in the third quarter was an acceleration of backlog that was expected in 2010 or if there was something else that led to the decline? Just on the June 30th 10Q you had $2.4 billion expected in 2010, now it’s $2.145 billion, maybe just help us understand some of the changes there.

Michael S. Taff

Roger, the strong utilization and high level of productivity that the offshore oil and gas enjoyed this quarter we were able to pull forward some revenues which brought them in to Q3 and expectations for Q4 which dropped the backlog roll off for 2010 by a little bit.

John A. Fees

The other commentary I would give to that though is that doesn’t really create any general concern for me because if there’s any part of our business that’s great at flexing up and down, it’s our offshore oil and gas construction business. We’ve got a lot of flexibility in that so moving some between the quarters really doesn’t create a concern on our part and if we have an opportunistic set of circumstances we’ll take advantage.

Michael S. Taff

I think this $2.1, $2.2 billion of backlog that we currently have in the queue today certainly gives us good visibility going in to next year related to that segment.

Roger Reed – Natexis Bleichroeder

I just wanted to make sure that we didn’t have like a cancellation issue or anything like that.

Michael S. Taff

No.

John A. Fees

No, not at all.

Roger Reed – Natexis Bleichroeder

Then, in terms of your vessel acquisition plans, obviously you’re building one, certainly if you expect to see a little less utilization of your fleet going forward that’s got to be an issue for the industry. At this point does it make more sense to buy or to build?

John A. Fees

Right now we started what we call DB 32, our shallow water lay barge back some time and that vessel hit the water just the other day. It was launched just the other day. We think that’s going to be a great vessel for us it’s going to really – it incorporates all of the latest technology that we have for pipe lay barge and construction barge that would work in the realm of this one so we’re excited about that vessel. We think it’s going to be a good vessel.

I would say though that in light of the environment, we are trying to take advantage of opportunities that have been arising with what I would classify as stressed or semi distressed assets in the system and we’re trying to work towards those ends to make the kind of acquisitions and capture or management of vessels that would not have existed a couple of years ago. So, there are good opportunities in the market place.

I think the real key here is finding the right vessel that does the kind of right work for us. We have a very comprehensive strategy that goes out very long, 20 or 30 years. These are long life capital assets and we’re really trying to match that strategy against where we think that market is going to be and then feather in the proper assets that we think that we could best utilize. So even though there may be a lot of assets out there for acquisition. We’re really looking for the nice ones but this is a nice opportunity and I think it’s part of sort of embracing just part of the cycle would be my characterization of our approach.

Roger Reed – Natexis Bleichroeder

If you can help us out just a little bit, your commentary on kind of the bidding prospects and inquiries that are out there to the extent that our competitors are being let’s say a little more aggressive on pricing, is it kind of a situation here the amount of projects that you see let them take the first wave that comes through there appears to be enough behind that that you’ll be able to maintain a better price discipline or is it just sort of a hope that these guys don’t do anything too stupid and drag the market down? Just kind of a little more clarity there would be good.

John A. Fees

It’s far from a hope. We think there’s going to be enough work in the market that we would rather use our ability to flex our capability, focus on our earnings and focus on high quality projects and backlog that represents our expectations for the business. I mean, in the oil and gas business we have an expectation that we’re going to make 10% to 12% margins in that business and we’re trying maintain our discipline in the short term knowing that we can do that or maybe exceed that in the future if we just hold on to our principles so that’s our approach.

Michael S. Taff

Roger, I think just look at the quantum of the projects is still very, very strong. We’ve got $2.7 million of bids outstanding at J. Ray and then our focus projects we’re following continues to climb, I think last quarter we reported in the $14 billion range, that’s up to $15 or $16 billion this quarter. So there is a large volume of work out there but as John said we’ll keep our bidding discipline, we’ll win our fair share and we should be fine.

Operator

Your next question comes from Jamie Cook – Credit Suisse.

Jamie Cook – Credit Suisse

My first question is just a follow up on I think on what Roger was asking, within J. Ray we know about $2.1 billion of revenues that will potentially have in 2010 and it didn’t sound like you were very cautious because it’s lower than where we sit last year at this time. So I guess John as you look with the bidding activity, is it unreasonable for us to assume that your revenues next year in 2010 for J. Ray next year should be flat to at least up just given what you’re seeing out there? Is that an unreasonable assumption?

John A. Fees

I would say that’s not a bad assumption at all. I would say flat to up. I think some of it depends on timing but I would probably give it a flat to up view point.

Michael S. Taff

Clearly, the most important factor is that this year we’re having about a third of our that are running through at zero margin and we’re not expecting to have that next year.

Jamie Cook – Credit Suisse

So theoretically we can assume what you want on the other businesses, maybe they’re flattish but your EPS should be up dramatically, I don’t want to put a number in your mouth but just ex those problem projects?

Michael S. Taff

As you know we don’t guidance but we would tell you that our expectation in that particular area of the business is that we would maintain our historical levels of markets in that area.

Jamie Cook – Credit Suisse

Then John, just a longer term question on the margins within in J. Ray, right now the areas that continue to be strong are Asia Pac and the Middle East but you talked about a couple of other regions picking up whether it was Brazil that we didn’t have before, whether it’s the Caspian Sea or even the Gulf of Mexico longer term. Over the next couple of years you could see an opportunity where you have all businesses running at pretty healthy levels versus before you’d have two or three markets running at a good level and the rest sort of depressed so how do we think about margins in that context and why wouldn’t they exceed the 10% to 12% just on better utilization?

John A. Fees

Well, I think that opportunity may exist, that’s somewhat rarified [air]. In my 30 years in the company we haven’t experienced much, if ever where we’ve really had the Middle East, Asia, Caspian and the Gulf all hitting together. So, I think there may be some opportunities there, I think it’s a little bit early to predict that they will materialize in to better than the 10% to 12% margin. Certainly when we get in to that rarified [air] we’re going to certainly try and take advantage of that.

We are hoping to get close on some work up in the Caspian and again we talked a little bit about Brazil. There are few other opportunities that would maybe influence the Gulf a little bit more in the shorter term. One of the things that I would caution a little bit on is that on major projects, large projects, from the time we book to the time we start actually seeing revenue, there is a lag. It takes us anywhere from six months to maybe a year to get through your engineering and procurement and get in a position where we can start delivering man hours.

Obviously the vessels and the fleet is different. We get opportunities that next month we’ll get utilization of vessels but on major projects there is somewhat of a delay there and I think you’ve got to kind of caution the optimism that you might have a little bit with the fact that there is a little bit of a delay built in.

Jamie Cook – Credit Suisse

I guess what I’m struggling with is if revenues next year are flat to up in 2010, why would our utilization be lower? Back to sort of what Andy was questioning because that would imply to me that our margins should probably be at levels where we are ex the problem projects.

Michael S. Taff

Related to that I think that all gets down to basically where we’re getting our revenues from versus vessels days versus fabrication days. We had a very strong marine campaign in 2009 related to a lot of these pipeline projects and all that and even though some of those contracts are at zero margin from the utilization basically absorbing a lot of fixed costs, the vessels absorb a lot of fixed costs, we don’t see as large of a vessel campaign in our system it’s more of kind of a year of fabrication work and all. That certainly affects the margins.

Kind of just think of J. Ray’s business overall, vessel marine work is generally higher margin work than traditional fabrication work. So, you really have to kind of slice and dice the revenues in to where we’re getting it from versus just looking at the pure quantum of revenues. As John said, when we talk about the volume of work out there, I think most of the new bookings that we’ll see occur during 2010 won’t really hit the books so to speak from a revenue standpoint until ’11 and so when we start talking about the opportunities of getting three and four of these regions all hitting on six or eight cylinders we see that as really a 2011, ’12, ’13 type horizon and all.

John A. Fees

Just for clarity we do not have all of our vessels 100% booked for next year and the utilization of that – and that was consistent with this prior year as well. And, utilization of that is going to be heavily dependent upon region by region work and our ability to garner work for vessels in this upcoming year and we really as Mike indicated, we don’t have this massive campaign in the Middle East. So, we’re working on it, we’re hopeful there are a lot of opportunities and we’re focused on doing a good job in that area but it’s not a done deal yet.

Operator

Your next question comes from Steven Fisher – UBS.

Steven Fisher – UBS

It sounds like there are a number of opportunities on the DOE side, if you needed to replace Y12 and Pantex are there sufficient opportunities do you think to fully replace all of your earnings that you’re getting from that today?

Michael S. Taff

I would characterize it as not all. We could probably replace one but probably not both. But, right now we feel fairly confident of our ability to be able to be competitive based upon our performance. Our performance has been very strong in both of those locations. I would characterize it more as a maybe one but not both.

Steven Fisher – UBS

Shifting over to the power side, last quarter you thought the timing of international full fired bookings could be pushed out a bit from what you were thinking a little bit earlier. Can you comment how you’re thinking about that timing today?

John A. Fees

Probably feeling a little bit better than I felt at this time last year. I think we were really uncertain about how the global situation was going to shake out. I think we’ve seen a little more resilience in the international markets and I think a little bit more of a steadiness up there and so I would say that I’m probably more optimistic than I was a year ago.

Steven Fisher – UBS

Then I guess the follow up to Andy’s question on power and I guess it kind of follows in to this one, I think that the revenues should come down there in power to match the booking trend but it sounds like you think you could actually start to climb. Is that international opportunity or how should we think about that?

Michael S. Taff

I think international opportunities would be a factor but probably not as large a factor as the return of the [inaudible] which we expect to happen next year. That’s probably going to have more of a short term influence on our ability to generate revenue.

John A. Fees

Just with the timing of that again, similar to J. Ray’s business once those rules are reenacted and we start the bidding process a majority of the benefit that we’ll get from that will be latter part of ’10 and ’11 and ’12. I think our expectation from a revenue standpoint related to the power group is to be kind of flat where we are today at best.

Operator

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

John Rogers – D. A. Davidson & Co.

Two things, first of all in terms of the marine capacity and more about the entire market here, is there any significant capacity that may have been on order that’s coming on line next year?

John A. Fees

You’re talking about vessels and ships?

John Rogers – D. A. Davidson & Co.

Yes, primarily.

John A. Fees

Yes, there are. There are things in process in ship yards that was coming on line. I’d say that the brake Scott put on in some of the build campaigns last year, I think some of those things that were in process have run in to trouble with finance. I mean, some of them were partially financed when they went in to construction. Sometimes you build a bare boat and then you’ve got to outfit it with the proper kind of equipment cranes, pipe laying equipment, welding equipment, things like that so there’s a series of things that got hampered as the economy turned down and those are some of the opportunities that we’re looking at.

John Rogers – D. A. Davidson & Co.

But you don’t see that as enough to significantly disrupt the market?

John A. Fees

It’s really not a lot more John than what was probably needing to come out of service because of age and technologies advance. So some of the technology inherent on some of the older vessels really can’t do some of the work that clients are looking for today and so the market is kind of moving a little bit in to higher technology vessels. And so, I think it’s probably consistent with that trend. I would not characterize it at this point that there was a glut of equipment that was coming on board and therefore everybody was going to have a lot of unutilized assets. I don’t think it was trending it that direction at all.

John Rogers – D. A. Davidson & Co.

Then just on the power side, and here I’m looking at over the next couple of years, when you talk about initiatives and you’ve talked about them in the past on the nuclear carbon capture and then solar side. Could you kind of characterize each of those as to where you’ve gotten the best response so far from customers and where you think the biggest opportunities for B&W are?

John A. Fees

I would say John the strongest response that we’ve has was probably on end power. I think the reason being is that solves a lot of the problems that exist with large nuclear plant deployment. You know, factory built, cost contained, modular, scalable probably more financeable so I would say the embracing of that by the government regulators and industry has been very, very strong. I would say that solar has probably some of the nearest term potential relative to projects and revenue depending upon electricity demand and regulation.

I would say CO2 is sort of one of these things where everybody thinks they need it but they’re really not sure it’s going to be required yet and so I’d say we’ve had a lot of good discussions, we’ve had a lot of clients in witness work with us on our testing programs but it’s one of those things where I think there’s a little bit more uncertainty and a little bit more betting on the requirements that are going to come out of Washington so I think there’s a little bit more wait and see there. I hope that’s helpful.

Operator

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

Tahira Afzal – KeyBanc Capital Markets

The first question is in regards to some of the contingencies you might have booked in regards to the problem projects in J. Ray. Could you give us a little more color on how that stands and as you see it right now potentially which way they could unwind?

Michael S. Taff

Overall Tahira I’d say that we feel pretty good about where we stand there. As John indicated on the call, we’ve got a little over $300 million in revenues left on those projects. About two thirds of those will roll off in the fourth quarter, the other third of that will roll off kind of throughout 2010 as we’re kind of in the wrap up and commission phase of those projects. We’re currently in the process of kind of closing those one-by-one, having discussions with our customers and as John said in the comments we expect the LD issues to be resolved.

In addition, as we’ve spoken in the past, we’ve issued some significant claims to our customers as well and we’re in the process of negotiating those. So, as we book those claims and get those resolved, resolve our LD it will also resolve any remaining contingency that we have on those jobs as well.

Tahira Afzal – KeyBanc Capital Markets

Then if you look at the [Pemex] there seems to be some activity in terms of the new hydrocarbon committee that they formed there. It seems like this could potentially be still in its infancy of getting exploration up on the deep water side in Mexico but I would appreciate any comments that you would care to provide in terms of McDermott.

John A. Fees

Tahira, they’ve been a good customer and it’s a customer we want to develop a relationship with. I think there are still some things to emerge relative to that market and we’re focused on it and working in it. But, I would say that there are still some things to develop in the market with [Pemex] to get to the point where it becomes a significant needle mover for us relative to our work.

Tahira Afzal – KeyBanc Capital Markets

One last question was really regarding your modular nuclear capabilities and the technical aspect. Given the recent headline news around Westinghouse and some of the technical issue over there, could you talk about how you would compare the empower capabilities and practical issues versus what you might be seeing on the Westinghouse side and really seeing if there are any implications that might be there for empower?

John A. Fees

There are a lot of things that empower can do that some of the larger reactor systems have run in to. I won’t try to contrast our technology against any other reactor technology, I would just say that from a standpoint of seismic, from a standpoint of the fact of air cool versus water cool, from the standpoint of the constructability and all that, there’s just a lot of advantages but we’re a little bit early. Westinghouse has a much more mature design that they have gone further down the road on.

You may look at that as a disadvantage to us but I consider it to be somewhat of an advantage because we’re really designing in to the issues that the industry has faced and so I would not expect us to run in to a lot of hurdles with our design as long as we do a good rigorous job, stay involved with our clients, our potential clients which we are working with and be very close to the NRC relative to their issues and their requirements and that certainly is our intent.

Tahira Afzal – KeyBanc Capital Markets

Would you say that the fact that the empower model essentially ends up being underground, does that make it a safer option versus some of the other traditional options out there?

John A. Fees

It really does and the fact that it is underground and the fact that we don’t have the individual reactor system footprint, we kind of disbursed that in amongst the modules, it really creates a tremendous amount of design flexibility and a lot of – it really factors up the safety from our perspective relative to larger reactors.

Tahira Afzal – KeyBanc Capital Markets

Last question and that’s regarding your focus list. I’m not quite sure if I missed that number but would like to see if you can provide some color around that number?

Michael S. Taff

It was $16 billion.

John A. Fees

That’s on oil and gas.

Michael S. Taff

On oil and gas and it has a nice spread between the geographic regions that we serve.

Tahira Afzal – KeyBanc Capital Markets

So that’s up fairly materially since the last quarter or so. The incremental tick up would you say that’s also spread fairly materially or it came from one specific region?

Michael S. Taff

I’d say it’s more across the board. The one thing Tahira that I’ve noticed from where that was a year ago is I think what I would consider highly quality projects are hitting that list. It’s not that there was anything bad with what was on the list and what we were focus on bidding on but we see things that are more ultimately in our sweet spot in terms of clients, technology and projects that we – if you balance a year ago versus today I would say I like the list better even though it’s bigger. Not just for its bigness but for the quality that we’re seeing emerge on the focus project list.

Tahira Afzal – KeyBanc Capital Markets

I guess this is interesting because even though you’ve had sort of that $2 billion fall of from some government projects from the focus list, this list in essence is understated so it seems like as you said the quality is getting better. Would that be more because you’re seeing more of a mix of midsized projects and they more fully utilize both your fleet and your fabrication?

Michael S. Taff

I think that’s fair. As John said I think it’s just kind of a combination of everything. I think it’s projects that are kind of in our sweet spot that we’re interested in doing and really kind of covering the globe.

Operator

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

Graham Mattison – Lazard Capital Markets

You mentioned in your comments that you’re looking to do some acquisitions or at least potentially on the offshore side. Where would you want to add vessels? Is it more on the deep water, the shallow side or would you look to expand fabrication capability?

John A. Fees

I would say that if you take a look just at vessels, we’re probably moving in our vessel strategy more towards deep water or deeper water. But, I would say that would be the general focus and the general trend. Higher technology vessels, dynamic positioning with more advanced capabilities, a little more speed to traverse around the world. I’d say that we’re moving in our vessel strategy in that direction.

Graham Mattison – Lazard Capital Markets

Then back to just the care rules if you could clarify, you think these come in to effect next year you could start to see revenue as soon as 2010?

Michael S. Taff

I think what I said was when they come in to effect that similar to our project business there’s a fair amount of engineering. First, you’ve got to bid the jobs and win them and then there will be a significant amount of engineering and procurement involved so I would think the bulk of those revenues would not occur until ’11 or ’12 timeframe.

Graham Mattison – Lazard Capital Markets

But you could start to see the early part of it in 2010?

Michael S. Taff

It just depends on when those rules come out then as the credit markets continue to improve and then the utilities start executing some of that work.

John A. Fees

You might get some engineering and some other things but I think you’d see it more a fundamental material change in backlog more than revenue.

Operator

Your next question comes from [Will Gabriosi] – Broadpoint Capital.

[Will Gabriosi] – Broadpoint Capital

Clearly, the market reacted to your comment about margins for Q4 being back to normal levels or your view that outside of Papa-Terra there’s not much else in terms of big projects on the oil and gas side for the fourth quarter so could we start with margins? If I back out zero margin revenue for the fourth quarter and go to the midpoint of 6% to 8%, I come up with a 10% margin on the existing legacy J. Ray projects already in progress. Can you provide some color on that? Why is that at the lower end of your range or is that just typical conservatism at this point?

John A. Fees

It’s just our projection of where we think we’re going to be going in to the quarter. We have been experiencing this year if you backed out the zero margin projects a little bit better than that. But, we have in our current estimates that we’re still thinking that the 6% to 8% is a reasonable expectation.

Michael S. Taff

That’s really for Q4 Will. From a clarification standpoint, that’s what we’ve said all along. We’ve still got about $230 million or so of revenues associated with zero margin contracts that will roll off in Q4. Then, our expectations would be longer term to return to that 10% to 12% margin range.

John A. Fees

Also, I think it’s fair to say that there are certain things in our business that are very much a part of our business model are difficult to forecast. It’s hard to forecast change order profitability, it’s hard to forecast contingency recovery and it’s hard to forecast productivity that exceeds what we’re expecting.

[Will Gabriosi] – Broadpoint Capital

That was my follow up, you guys, you know change orders and close outs and things of that nature are very typical and recurring in a non-recurring sense if you will to your business so do you guys include that in your margin assumption for guidance there?

Michael S. Taff

Yes, we do. But, as you just said they are recurring non-recurring items so again that’s probably the toughest part of our business is to forecast when we’ll get a change order or a claim resolved and literally a week difference can throw it from one quarter to another as you know. So, we look at things, we try to encourage you and the investment community to look at things over a longer period but it’s all obviously hard to do because we’re graded on the 90 day period.

But, we still feel good longer term as we look in to ’10 and beyond of J. Ray being a 10% to 12% margin business with spikes within that quarter-to-quarter. I think short term what we are is just for Q4 we’ve still got a substantial amount of, from a percentage standpoint next quarter’s revenues are going to be related to these zero margin contracts. So, that’s kind of the clarification there.

[Will Gabriosi] – Broadpoint Capital

So based on what you know today, I know there are still some zero margins revenue in Q1 but if you assume that’s completed and we’re looking at Q2 through Q4 of next year based on what you know in utilization mix, geographically where you are working, can we get back to 10% to 12% next year based on what you know you will be burning and based on where you’re bidding right now assuming you have a somewhat normalized success rate? Is there anything preventing you from getting back to that level in 2010?

Michael S. Taff

I don’t think so. We look of the quality of not only the bids outstanding but look at the margin we have in our backlog today and the margin today is consistent with the margins we’ve had over the last 24 months. So, like I said, once we get through the fourth quarter we see our ability return to that range as certainly a possibility.

[Will Gabriosi] – Broadpoint Capital

So Papa-Terra being your first big Flotec win, I’d also say being really your first foray back to the Brazilian market, was there any – were you guys more aggressive on pricing to try and get that reference project or was it typical J. Ray bidding discipline and we can be comfortable with the margins on that?

John A. Fees

No, we did not lose our discipline or change our approach relative to that project.

Michael S. Taff

We feel good where we came in there both as the joint venture, the consortium share of that as John mentioned in this comments as well as the 20% scope that J. Ray will have that we’ll book in our backlog and run through our P&L?

[Will Gabriosi] – Broadpoint Capital

Then speaking of Flotec bigger picture, I’ve seen obviously news mention to exposure to the [Scarborough] and [G] projects for Flotec and I know you guys have done some work in the Gulf of Mexico with Jack St. Malo, Bigfoot, whichever of those you were involved with. It seems like there is a real story developing in the Gulf of Mexico and some of that will be TLP related work and obviously the big [Mars G] project. What’s the timing on a Gulf of Mexico recovery and how much have margins been hit by under utilization of US fabrication assets because clearly the Gulf of Mexico renaissance would seem to be something that we’d really like to see.

Michael S. Taff

I guess my view on that is we do see encouraging signs in the Gulf. We are involved with doing some kind of pre-fee type of engineering on several of the projects that you mentioned. I would see that still as a late ’10/’11 type timeframe when those jobs ultimately come to market. So when you factor in when they actually will hit our income statement you’re talking 2011, ’12, ’13 type timeframe. But, we are encouraged A) there are a lot of known projects out there. We feel good about the technology that we have within Flotec that could meet those customers’ needs from a technology standpoint so certainly we’re focused on those and optimistic that we can meet those challenges.

[Will Gabriosi] – Broadpoint Capital

In terms of – I’m not sure if you can quantify but the fabrication assets in the US have most likely been underutilized and such a recovery would have a positive impact on utilization. Has there been a noticeable negative impact from that under utilization?

Michael S. Taff

I would not consider it to be a noticeable impact relative to projects. I think it’s just that there just has not been a lot of work in the Gulf. So the impact has been more on cost management, reductions of staff, things like that than it really has been on projects because there really hasn’t been much in the way of any projects in the Gulf of Mexico. So, I think it’s still yet to be determine once that recovers what the trends’ going to be. The only thing that I know is we’re not going to lose our discipline relative to our expectations for what we ought to get out of our work.

[Will Gabriosi] – Broadpoint Capital

The mix of your $16 billion opportunity list, is it more fabrication heavy or more marine heavy?

John A. Fees

It’s more EPCI, all the way through engineering procured, install, construct and install. It’s probably more focused in that area?

[Will Gabriosi] – Broadpoint Capital

So the margin mix, if you pull $2 billion out for Gorgon and you’re replacing it with $4 billion of non Gorgon work and you’re saying the mix is heavier towards marine work than fabrication work that would indicate that the opportunity list, the margin in opportunities has grown quarter-to-quarter?

Michael S. Taff

I would say it’s more EPCI than marine which includes marine and I would say it’s more typical of our run rate margin expectations for the business.

[Will Gabriosi] – Broadpoint Capital

The Black Hills carbon capture project –

John A. Fees

We’re still waiting.

[Will Gabriosi] – Broadpoint Capital

And there’s no timeline at this point for what you think would be the DOE releasing funds?

Michael S. Taff

Our expectation was this year but we have not had any confirmation of that and it’s still working in government circles.

Operator

This concludes the Q&A portion of our call today. I would now like to turn the call back over to Mr. Jay Roueche.

Jay Roueche

Thank you all again for your participation and interest today. I want to remind you that the call did include forward-looking statements and I encourage you to see our SEC filings for more information on these. If you have any follow up questions, or if you were in the queue and time prevented us from getting to you, please give us a call afterwards. As John mentioned, we look forward to seeing many of you before yearend. Operator this concludes our call.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Good day.

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