McDermott International Inc. Q4 2009 Earnings Call Transcript

| About: McDermott International, (MDR)

McDermott International Inc. (NYSE:MDR)

Q4 2009 Earnings Call

March 2, 2010 10:00 am ET

Executives

Jay Roueche – Vice President of Investor Relations

John A. Fees – Chief Executive Officer

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

Analysts

Graham Mattison - Lazard Capital Markets

Richard Roy - Citigroup

Jamie Cook - Credit Suisse

Will Gabrielski - Broadpoint AmTech

Andrew Kaplowitz - Barclays Capital

Martin Malloy - Johnson Rice & Company

Roger Read - Natixis Bleichroeder

Stephen Gengaro - Jefferies & Co.

[Jeff Patel – Lakeshore Capital]

Operator

Good morning, ladies and gentlemen. Thank you for standing by and welcome to McDermott International fourth quarter 2009 earnings conference call. (Operator Instructions) I would now like to turn the call over to our host, Mr. Jay Roueche, McDermott’s Vice President of Investor Relations. Please go ahead, sir.

Jay Roueche

Thank you Marisol and good morning everyone. We appreciate you joining us to discuss McDermott’s fourth quarter 2009 financial results, which we reported yesterday afternoon and 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 I turn the call over, I’d like to 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 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 Securities and Exchange Commission, which are available on our website, including our recently filed Form 10-K for the year ended December 31, 2009, for a discussion of the factors that may cause our actual results to differ from management’s projections, forecasts, estimates and expectations.

I’ll now turn the call over to Mike to discuss our results for the 2009 fourth quarter.

Michael S. Taff

Thanks Jay and good morning everyone. Starting with the income statement, total revenues were almost $1.5 billion, down about $200 million from a year ago on a consolidated basis. While Government Operations had a 20% increase in its top line, the Power Generation Systems segment was down about $170 million and Offshore Oil and Gas Construction was off by almost $80 million.

Consolidated operating income of nearly $123 million in the 2009 fourth quarter was a 37% increase compared to about $90 million a year ago even with a $40 million headwind from pension, research and development, and depreciation and amortization expenses during the 2009 quarter. Additionally we had about $7 million of spinoff transaction expenses in our corporate expense in the 2009 quarter and this non-recurring expense will continue until completion of the separations.

Of our three segments, Offshore Oil and Gas Construction generated all of the increase in consolidated operating income. Power Generation Systems, with its reduced top line coupled with severance related one time charges and increased R&D expense saw the most substantial reduction in segment income.

Government Operations was down modestly but it could have been much better if not for about $14 million of charges at our nuclear fuel services subsidiary, which we acquired at year end 2008. John will discuss those operations and issues in greater detail shortly.

Below operating income, our results for the quarter were negatively impacted by a $2 million swing in the other income and expense line item compared to the 2008 quarter. Net interest income declined about $5 million. Lower interest rates earned on our cash and investment more than offset the improvement in the other Other expense, which is primarily a reduced amount of non-cash foreign currency translation losses compared to the prior year’s fourth quarter.

All in, pretax income improved by about $32 million in the 2009 fourth quarter compared to the 2008 quarter. With a majority of our income derived from our lower tax international operations, our effective consolidated tax rate dropped to about 17% overall. Last year, the consolidated tax rate was closer to 50%, a combination of more domestic earnings and contract losses in jurisdictions where no tax benefit was received.

Taking it all to the bottom line, McDermott’s reported net income was $98.7 million or $0.42 per diluted share in the 2009 fourth quarter compared to $43 million or $0.19 per share in the 2008 quarter. In total, these results represent a 130% increase in net income over the final quarter of 2008.

Overall, we feel good about the earnings for the 2009’s quarter. Between the segments, however, our results were mixed, so let me review each in a little more detail. The Offshore Oil and Gas Construction segment reported another quarter of stronger than expected results coming in at $97.6 million. This is a huge improvement over the $15 million quarter reported in 2008. Capitalizing on a number of opportunities including contract improvements, a heavy workload throughout the year and the mitigation of risks really helped to drive the quarter. In addition, we benefited from our expectation of lower future costs as we’ve seen some deflation in the industry. All in all, we delivered a very strong performance in this segment. Further, the 12.5% operating margins were outstanding, especially considering about 20% of the segment’s revenues in the quarter were derived from lost contracts. Once again, the income story was in the Middle East and Asia Pacific regions.

Government Operations segment income improved sequentially in the fourth quarter of 2009, but was off modestly compared to the same period a year ago. We generally had strong performance in our site management work, which edged equity income higher compared to the 2008 fourth quarter. This segment also recognized about $17 million in additional pension expense and depreciation and amortization expense compared to the fourth quarter of 2008. And as I mentioned earlier, the ongoing safety enhancements and related stand down of operations resulted in about $14 million of expense that offset profits elsewhere in the segment.

The Power Generation Systems segment was down sequentially and year-over-year, which is not surprising considering the continued uncertainties in the industry that we’ve talked about before. However, the results of the core business were somewhat masked by about $6.5 million of one time charges related to headcount reductions and about $8 million in additional R&D investment as compared to the fourth quarter a year ago, and even the 2009 third quarter. Further pension expense were up about $10 million as compared to a year ago.

Turning to the balance sheet, our liquidity improved sequentially by about $100 million during the 2009 fourth quarter, an increase compared to the same period in 2008. We ended the year at about $1.2 billion level in cash and investments. During the year, cash flows were positive; working capital improved by about $350 million; and shareholders equity grew by almost 40% or over $500 million. So McDermott’s financial position remains an overall strength of the company.

We are actively in the process of renewing our bank facilities in preparation for and in anticipation of the upcoming spinoff transaction. We expect to have that process complete by the end of the second quarter.

That pretty well covers our financials for the fourth quarter of 2009. I’ll now turn the call over to John for his remarks on the operational and business environment.

John A. Fees

Thanks for the summary, Mike, and good morning everyone. Thanks for joining us today. Overall I’m very pleased with McDermott’s results for the 2009 fourth quarter and throughout the entire year.

We had our share of extra effort this year from the challenging Middle East pipeline projects to the decision to spin B&W out as a separately traded public company. However, thanks to the dedication and efforts of our employees, we were able to deliver solid financial results along the way.

Granted, I always want to remind investors not to get overly excited about any 90 day span, but as Mike said we are pleased with our reported results for the fourth quarter. However, there’s no question there were some special charges incurred that muted the $0.42 per share that was reported on the GAAP. In total we identified over $35 million of pretax expenses in yesterday’s press release that really couldn’t have been forecasted by the financial community beforehand.

For the full year McDermott’s operating income was only off some $20 million compared to 2008, despite incurring about $100 million of additional non-cash pension expense and another $30 million of increased depreciation and amortization as compared to the prior year. And fluctuations in currency and interest rates resulted in a $40 million unfavorable swing below the operating line. So in the challenging environment that we endured during 2009, and frankly which hasn’t fully subsided yet, I’m very satisfied with the earnings of $1.66 per share for the full year 2009, even though it was down about $0.20 from 2008.

As we expected and indicated in the last call, new awards during the fourth quarter were light with the exception of our large government award. In total we had new bookings exceeding $1 billion fourth quarter but for the full year backlog fell about 17%. However the impact on the current year roll off is closer only to about 11%. So the backlog decline has had a larger impact on the outer years which shortens our visibility and as such, filling up 2011 and 2012 will also be the focus as we pursue work.

But turning to the 2009 fourth quarter, our Offshore Oil and Gas Construction operations at J. Ray did quite well. Both of the segments under B&W, however, were below our expectations due largely to special charges. Since the market dynamics around each of our segments is really a different story, I’ll go ahead and jump to the business specifics of each.

Starting with the Government Operations segment, the fourth quarter of 2009 saw a significant improvement over the 2009 third quarter, but was down modestly compared to the fourth quarter a year ago. However, these results are still not representative of what we expect on an ongoing basis. Throughout 2009 the Nuclear Fuel Service business, which we call NFS, and which we acquired at the end of 2008 has really been the source of the major quarterly swings. We saw a nice pickup in income during the 2009 second quarter, related to its new down blended contracts, but in the last two quarters we have had charges. In the fourth quarter the impact was about $14 million in expense related to the ongoing stand down of major operations and the voluntary implementation of safety controls and processes. Overall we were only able to achieve a small earnings stream in 2009 from this new acquisition, which is a short term disappointment to us.

To give you a little background on NFS, it has a unique franchise with an NRC Category 1 license, which to government, its Navy men and women as well as millions of Americans rely on for power. It has been generating the fuel that keeps our country’s Navy moving for decades and also down blends excess government high enriched uranium into utility fuel. However, going into our purchase, we knew there had been a past history of operational and safety issues and as such we felt it would be somewhat of a turnaround acquisition from an operations perspective. During 2009 we began implementing what we felt was an improved safety culture. However, we continue to have events which indicated further improvements were necessary.

For instance, on October 13, 2009 the NFS facility in Erwin, Tennessee experienced an unexpected exothermic reaction in the uranium aluminum line of the blended low enriched uranium or BLUE preparation facility. There were no health consequences for the public or our employees, nor was there a release of material contamination beyond the process equipment involved. In response to the event we conducted a more detailed review of NFS’s overall safety performance in cooperation with the NRC. During our standard year end week shutdown and based upon the review of the event and other safety related issues, we and the NRC concluded the plant’s operational safety performance was not to our standards. And as a result we ceased the uranium processing activities to implement further improvements. We expect that major operations will begin later this month and that the first quarter in 2010 impact will be less than what we recognized in the 2009 fourth quarter.

As many of you who have followed us for some time already know our Government Operations segment has regularly been a safe, stable operator, consistently the most solid performer of our three segments. Without question, we believe that safety is paramount and we will never waver in that regard. We believe NFS will be much improved when significant operations resume and we will continue to instill our culture that has been so successful in all of our other government work.

Excluding the financial impact of the NFS expenses, the rest of the Government Operations performed very well in the fourth quarter. We received outstanding reviews and thus income at many of the sites we manage for the government. This success is demonstrated by a record level of equity income as we trued up our accruals to actual. Outside of NFS, our other manufacturing facilities also generated solid results.

Two of our largest M&O sites, Y-12 and Pantex, are scheduled for a re-bid in the second half of the year. However, it is not uncommon to see the government give temporary extensions during the process. Whether we get extended for a period of time or the [inaudible] is scheduled, we are working hard to position ourselves for these contracts.

During our nine plus years at both sites we are very proud of our accomplishments and the success we have delivered, including receiving our highest ratings ever at these facilities in 2009, both over 92% with both rated as outstanding. There are also a number of other sites that we look to bid during the year; however, we don’t just bid them all, just the locations where we truly believe we can add significant value.

During the quarter we booked the annual awards for Nuclear Components. This year was a little lighter than the recent past, coming in at around $450 million, but that does not change our business outlook for this segment as we expect the 2010 award to be a larger and to receive some other smaller awards during the year that will hit backlog.

Some of our other efforts [inaudible] progress as well. For instance, we recently $9 million in funding from the Department of Energy in support of our medical isotope production programs. Despite the recent bump in the road at NFS, we continue to believe the government business is a real gem in the portfolio, and we will be working every day to make all our operations here even better.

Turning now to Power Generation Systems segment, it had its softest quarterly income since we reconsolidated it in early 2006. Two of the major reasons were related to the over $15 million of increased expenses compared to the 2008 fourth quarter related to the voluntary headcount reduction and R&D, primarily for the Empire initiative. These efforts are intended to adjust our business for the environment we’re currently in, as well as positioning it for a very exciting future.

During the quarter we booked about $350 million in new work, a sequential improvement, and this included a couple of commercial nuclear awards for replacement installation workers [benefit]. There are a number of other nuclear opportunities on the horizon and we have been especially pleased with the reception in the marketplace and by the regulators of our Empire modular nuclear concept. The fossil portion of our power business, which is essentially coal, has remained somewhat in a state of transition. For those of you that follow us for a while this is not a new story but rather one we’re working our way through. As you may recall, declining electricity demand, especially from the industrial customer, combined with [balto] capital markets in 2008, 2009 led to uncertainty for emissions and lower natural gas prices have produced the more challenging environment we find ourselves in.

Our facilities factors have been showing hopeful signs of a better market ahead. For instance, both Congress and the EPA have recently taken up efforts for a replacement regulation for the Clean Air Interstate Rule which could be enacted by late this year. The new regulations could help reignite the environmental retrofit market. It’s an area that we’re a leader in and it has provided good business for us in the past. A recovery in large capital projects in the U.S. and success in our international expansion would be both positive developments for the fossil group.

Beyond coal and nuclear, we are also looking for additional ways to energy, biomass and solar applications. Our renewable portfolio is still smaller in size compared to fossil nuclear, but with good growth potential ahead. An example, our innovative solar receiver that we design and manufacture has performed well during initial operations at eSolar’s Sierra Suntower Plant in southern California. Since start up, eSolar has been evaluating the performance of the tower mounted receiver, which is capable of producing enough steam to generate 2.5 megawatts of electricity with zero carbon emissions. Using a field of sun tracking mirrors which reflect solar energy onto the tube surface of our receivers mounted on 150 three foot tower, it heats water to produce steam. That steam is sent to a turbine to generate electricity.

In addition, we continue to see a number of biomass RFPs which we hope a fair number will proceed to the bidding stage. For instance, we currently have engineering releases on two biomass projects which should turn to contracts later this year.

R&D remains a priority, even with the revenues down. In 2009 we invested over $50 million in R&D dollars, primarily in our Empire initiative and our Carbon Capture technologies, with that spending to increase as we go forward.

While the fundamentals of the power industry over the next year or so may remain challenging, we do expect our R&D investments to pay future dividends. We intend to be competitive globally with diversified fuel source power offerings and have our advanced technology efforts pave the way.

Overall the segment had a good year in a tough market. We are flexing the business to meet demand, working with customers and regulators alike in positioning the business for the return of growth in the marketplace. We have evolved with the power industry over time and maintain a solid mix of recurring and project oriented work. The macro fundamentals of the power business look promising with aging plants, a growing population, environmental focus and a better worldwide economy, and we remain bullish on this segment over the long-term.

Finishing with the top performing segment, Offshore Oil and Gas Construction finished the year performing well. While we didn’t reach the level of revenues or income that we achieved in 2009 third quarter, our earnings were stronger than expected, especially consider about 20% of the revenues this quarter provided no real margin benefit. Going into 2010 we still have about $200 million of this work to complete. The challenge that we had going into 2009 is largely behind us now.

We continue to believe the vast majority of the potential liquidated damages on these projects are unlikely to be incurred. And I think once these projects are 100% complete, we’ll see this potential exposure as well as opportunities for claims and change orders get resolved to all parties satisfaction.

On our other projects, we came through and delivered. Opportunities were identified that were harvested, productivity was solid and potential risks were avoided. So we’re very pleased with the performance in total.

Our projects are still mainly derived from the Middle East and Asia Pacific markets. However, our other regions still show some indications of significant work coming to the industry in the foreseeable future. If we want our share and the other regions remain strong, the growth potential for this segment’s future workload is sizable. The only knock I could see anyone having with the segment’s quarter would be that bookings were light, coming in at about $200 million. However, we want to remain selective on projects and avoid work that has limited margin or excessive risks. Our bookings are off to a better start going through 2010 first quarter since we’ve already announced the Papa Terra award, which alone exceeds the amount we booked in the fourth quarter of 2009. And I’m also optimistic J. Ray is well positioned for other new awards this year that were [proviso].

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 within this industry.

As we look into this new year, we have about $2.4 billion of year end backlog expected to be realized in 2010. We expect the segments top line will be the weakest in the first quarter and then jump for the following quarters. This is largely because we are not expecting high vessel utilization in the remaining winter months. However, we expect full year margins to be more in line with the 10% to 12% margins we’ve discussed in the past, even if revenues don’t end up reaching 2009 levels.

Bookings and beginning new work will really determine J. Ray’s top line for the year, but which awards we win and when the work begins is always a tough element to predict. All in, the fourth quarter was an outstanding one for the segment. We’re very pleased with the full year results, particularly considering where we started.

Returning to a consolidated McDermott view, we are making good progress on the spinoff of the Babcock & Wilcox Company that we announced in December, and I really want to commend our employees for all their effort on this transaction. For many its like taking on another full time job. We are getting close to having a preliminary Form 10 to file with the SEC and expect to have that filed out this month. We have made good progress on the filling out of the management teams, with only small holes to fill. Steve Johnson has made a smooth transaction to CEO of J. Ray during the period and Brandon Bethards is doing well with his enhanced responsibilities.

This is truly an exciting event for us, but the transaction hasn’t prevented us from continuing with our growth initiatives. Over the last few months we’ve made a number of transitions. At J. Ray they completed a vessel transaction with ocean team for the subsea construction vessel, North Ocean 102 and the vessel North Ocean 105, which provides us with versatile subsea and deepwater installation equipment to support our growing subsea capabilities across the range of water depths worldwide.

In addition, J. Ray recently announced the addition of a new shallow water pipe lead vessel, the lay March 32, to its worldwide fleet. The vessel was designed to lay pipe up to 60 inches in diameter and should begin work in the second quarter of this year.

In B&W’s power business we closed on the purchase of certain assets from a Mexican business, which will provide us with additional low cost manufacturing capability. Across the pond to our waste energy business Volund, they acquired a Swedish environmental company which provides flue gas cleaning and energy recovery systems. And finally, we expect to reach an agreement in the near future on another bolt on acquisition in the environmental technology market. All these power businesses are excellent niches which provide us with new capability and access to new companies for our offerings.

So while we head towards the spinoff at a rapid pace, we remain active in our core markets. Just a very busy time for all of us right now.

That pretty much completes my prepared remarks for our operations. In summary, it was a good quarter for McDermott, filled with a lot of things highlighted by really strong results from the Offshore Oil and Gas Construction segment. Our backlog, while down a bit, is still positioned to provide good revenues for the coming year. New work is needed, but a major focus in bookings will provide visibility in 2011 and beyond. Additionally, we ended the year with a strong balance sheet and a great liquidity position.

We are headed back to New York for this week’s Davenport Conference. Then Jay and Robbie will be in Boston the following week for the UBS-C&C Conference. We had an active Investor Relations schedule during 2009 and we expect 2010 will be equally active, especially with the upcoming transaction and the new management teams.

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. And with that operator, we’ll now open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Graham Mattison - Lazard Capital Markets.

Graham Mattison - Lazard Capital Markets

I was wondering if you’d give us your bookings outlook. I might have missed it, but in prior quarters you gave us your shorter target list. Can you just give us an update on that?

John A. Fees

Yes. If you take a look at where we stand, we’re about at the same place that we mentioned in prior calls relative to bids outstanding. We have about a total of $6 billion worth of bids outstanding, about equally split between Oil and Gas and the Power business. And we’re looking at the Oil and Gas business a little differently. We were giving you sort of a two year view, about 24 months of what we considered target projects to be. The second year is moving and a little bit more volatile, so we really focused that down to a 12 month list. And that 12 month list we have about $11 billion of target projects within that 12 months, probably compares fairly favorable to the numbers that we told you in the past. The thing that I would say is a little different is I’d say that in the next 12 months there are probably what I would consider to be more core J. Ray projects in that list than existed in that last a year ago.

We had a number of things that we were bidding on in places like Abu Dhabi, modular refabrication, things that were really outside of what delivered the core of earnings in 2007 through 2008 and ‘9. And so we see a little bit more of what I would consider to be sweet spot core work in that $11 billion of focused projects coming up in the next 12 months.

Graham Mattison - Lazard Capital Markets

And then in looking at that, that’s still sort of 10 to 12% margin range.

John A. Fees

I would not change my expectations for the business at this particular point in time. I would say that there is what I would view a little bit of upward pressure on the margins in the work that we’ve got in the backlog and the projects that we’re executing. But I would not really change the view that I have, that on a run rate basis I’d still wrap my head around 10 to 12% with the possibility of some bright spots coming up based upon our performance.

Graham Mattison - Lazard Capital Markets

And then on the vessel acquisition front, I mean do you have any specific plans? Are there areas where you need to add additional vessels? Or are you pretty much with the ocean team vessels coming on, will that pretty much hold you for the next few years?

John A. Fees

Well, what we did was, we have a very comprehensive 20 year view on our fleet. And we’ve developed that based upon our existing capability and where we think the markets will continue to go and emerge. You may have heard me talk in the past about that we really try to focus on what we consider the big middle market to be and I’ve indicated in the past that I think that big middle market is going a little deeper in the water, although we provide products and services in engineering across the full spectrum of the offshore market. With that, we’ve been adding some of these vessels like the 102, the 105, directed in that particular area. I think we have a few things coming up that we’re looking at, primarily in deeper water and deeper water related activities and pipe lay. And so I would say that you’ll see our focus and our activities as we proceed down that 20 year path, the focus on that. We’ve just found this to be a pretty good time right now to look at opportunities on the vessel side as opposed to trying to buy vessels at the peak of the market, which was 2006, 2007, was kind of a bad time to buy vessels. Right now we see it as a better opportunity.

Operator

Your next question comes from Richard Roy – Citigroup.

Richard Roy - Citigroup

During your comments, you mentioned that you’re being selective on projects. Could you just comment a little bit about the competitive landscape and what you’re seeing out there?

Michael S. Taff

Well, you know, as we indicated, everything we bid and everything that we’ve booked has been at margins that we think is respectful of the returns that we should get on the business. As I indicated in an earlier comment, in addition to that approach that we’ve taken there’s been more diversity in the opportunities we were pursuing throughout 2009. Some of those things were delayed just by normal course of delays in projects. And we’ve lost some work, I think, because we’ve taken a pretty hard line on margins. I don’t really consider that to be a long-term trend; I consider it to be a short term related matter as we go into the upcoming periods, as we see more core focused J. Ray work coming up, I think we’re taking the right approach. And everything we’re booking and everything we’re putting into backlog we’re proud of. And in addition to that, if we don’t get quite the volume that we would like to get in a particular reason, we’ve shown and demonstrated in the past a strong resiliency towards being able to flex our business upward and downward and to be able to match the market relative to our capability.

So you know that’s sort of the overall view on where we see opportunities being and where we see the future looking.

Richard Roy – Citigroup

Are most of the competitive pressures in the Middle East and Asia Pacific, or are you seeing similar types of competitive pressures globally?

John A. Fees

I think we see strong competition everywhere, you know, and again the thing we’re trying to do is we’re trying to rely on our strengths. I mean, you know, there are certain preferences that I think are afforded to J. Ray because of it’s full EPCI capability. I think that we certainly have some regional strengths we rely on and in some places we have extremely low costs. And so we’re trying to really focus on those strengths and go with that going forward, but I would say that competitiveness in the business is not a single reason that we get some local [time].

Operator

Your next question comes from Jamie Cook - Credit Suisse.

Jamie Cook - Credit Suisse

First question, I’m just trying to reconcile, so it sounded like from the answer to the first question that you’re optimistic that we could see more awards move forward in 2010, so it sounds like orders within J. Ray I guess are on the upward trajectory. I’m trying to reconcile that with I think some of your prepared remarks where you said you know J. Ray revenues I think could be late or below 2009 levels. So did I hear that correctly? And the projects that you’re bidding on 2010, do they have a 2011 start date? My last question is just as I’m just trying to think about incremental costs in 2010 that we didn’t have in 2009, so how I think about I’m assuming R&D is up in 2010 relative to 2009, we have transaction fees related to this split up, if you could just sort of walk me through the major items there, just in terms of modeling purposes.

John A. Fees

Yes, Jamie, I’ll address the first piece and I’ll let Mike talk about the individual cost items that you asked us to address. If you take a look at the timing of work in J. Ray, it varies. If it’s Marine only and Marine related activity, it could very much turn from bookings to activity in the current year. A lot of the things that we do, however, are large scope projects which have a tendency to require some level of engineering procurement and have a lag time of anywhere from eight to 12 months before we’d actually start seeing work in the yards and before we’d start recognizing revenue. One of the things that we do as a company is we really don’t recognize revenue on engineering and procurement. We have a tendency to recognize it much later in the cycle. So that’s the nature of what we’re facing this year. That’s why we feel that even though we bid a lot of opportunities this year, we didn’t put a lot of that into backlog as we approached the current quarter that we’re in. And the timing associated with some of the upcoming awards may push some of that out just a bit.

Jamie Cook - Credit Suisse

So it sounds like as of today, revenues should be slightly down in J. Ray, year-over-year, based on what we know today.

John A. Fees

It still remains to be played out, but certainly the decline in backlog that we saw in the fourth quarter and the competitive nature of the market did not position us well for the first quarter.

Jamie Cook - Credit Suisse

And then just to follow up on that before we get to the costs, I’m afraid to ask this question but I’m going to ask it anyway. You mentioned margins in 2010 for J. Ray will be in the 10 to 12% range and I know there’s volatility throughout quarters, but I’m just trying to figure out whether Q1 is below the 10 to 12% range because of weather and lower utilization. Did I interpret that correctly?

John A. Fees

Yes, I think it could be. I think it could be. But again I would still, Jamie, think about the year in 10 to 12%. And as I indicated in one of my earlier remarks, I think there’s probably a little bit of more upward pressure on that than downward pressure. I think they’re very flexible upwards and kind of sticky downward, if you want to think in economic terms relative to the margins. So I would focus in on it 10 to 12% and there might be some bright spots along the way.

Jamie Cook - Credit Suisse

And then, sorry, just Mike, the incremental costs in 2010 versus ’09?

Michael S. Taff

Yes. Hi, Jamie. I think, you know, from an R&D standpoint I would think of R&D expenses similar to the run rate we had in the fourth quarter, which was around $20 million or so. So that kind of going out on a quarterly basis. And as it relates to costs related to the transaction, we noted in the 10-K which you probably haven’t had a chance to go through our 125 page document, but we noted in there that we think the total cost of the transaction will be kind of in the $60 to $80 million range. I would point out that probably 20% of that or so is probably non-cash or so. So that would be occurring over the next two or three quarters as well.

Jamie Cook - Credit Suisse

But besides those two major items there’s nothing else I’m sort of missing?

Michael S. Taff

No, I don’t think so.

Operator

Your next question comes from Will Gabrielski - Broadpoint AmTech.

Will Gabrielski - Broadpoint AmTech

You sounded pretty comfortable that the J. Ray business ramps up from a Q1 low, maybe on revenues throughout the rest of the year. So how do we reconcile that with the lower expected burn year on year? And so how much drive by work are you assuming or maintenance work are you assuming to get to that type of an expected ramp?

Michael S. Taff

You mean as far as revenues or the margins?

Will Gabrielski - Broadpoint AmTech

On revenue.

Michael S. Taff

You know I think we’ll get a fair amount of drive by work. I mean I think if you look at what’s in the 10-K we indicated about $2.4 billion of burn during the current year. We would expect to get some obviously change orders as we always do, some incremental work on the vessel utilization front. And then certainly expect some bookings in the near term that will have some benefit for 2010, but obviously a lot of the bookings will be booking over the next two to three quarters will really benefit more the ’11 and ’12 timeframe.

Will Gabrielski - Broadpoint AmTech

In terms of the prospects in the Gulf of Mexico right now, some of the deeper water work, are you guys positioned for that from an installation standpoint? And do you have any expectations on timing on when we could see the first one or two move forward?

John A. Fees

We’re bidding, Will, we’re betting a number of opportunities on some of those projects which you’re probably familiar with in the Gulf now. There’s some bids outstanding. There’s some that are in process. I think we’re well positioned for a reasonable amount of that work and we’re pursuing it.

Michael S. Taff

And it’s not just the installation work obviously. There’s significant fabrication associated with two or three of those projects as well as the installation and subsea type activity as well.

John A. Fees

And a good amount of engineering load that comes along with that, too. So we’re working on all of that.

Will Gabrielski - Broadpoint AmTech

Shifting gears to the Power business, just in terms of the visibility there right now and maybe a little bit about what you’re seeing in China with your joint venture there, can you just provide some color around that and particularly on the environmental side and whether the utilities are getting more comfortable maybe with current policy? Or what do they need to see to start moving forward?

John A. Fees

You know, I’ll comment on China just initially because its pretty easy to talk about. The plant’s loaded up. We’ve got still a full capacity operation. We expect it to continue for a number of years based upon their plans. So right now we’ve got a full load, looks pretty solid going forward. Performance of the plant has been good. Client relationships have been good. So we really don’t expect that to change from what it’s really been throughout the last several years and going into the next several.

In a domestic market, I think there’s still a transition going on here relative to the economic recovery. You know if you believe the economists, we are expecting to see GDP growth this year and next year, but we don’t expect it to be great. So we would expect their business to recover on a more stable client basis as opposed to a big spike. But the opportunities that present themselves are these. One is that there was a lot of hardware that was built and not installed prior to the economic slowdown. We’re seeing a bit of a resurgence of opportunities on a construction side, to go out and do field construction of existing hardware that has been fabricated; plant upgrades and things that are basically sitting on the ground, waiting for installation.

The other spot that’s reasonably bright for the Power business is we expect the return to the environmental rules to kick in later this year. I would not, though, expect that to turn into any meaningful revenue in 2010, but we would expect award activity, maybe very late in ’10 and early in ’11, and to be more of an ’11 framework. So that gives you some view. Parts business has been running along very well. And again we’ve broadened a nuclear offering, we’ve had a few nice hits there recently. And a combination of that with the broadening of the portfolio with solar and biomass and [inaudible] and some real work picking up there, you know, makes us feel fairly decent about where power is and where power’s going.

Will Gabrielski - Broadpoint AmTech

And margins for 2010?

John A. Fees

I would still stick with the guidance that we’ve given in the past, even with where we are on other items, such as R&D expense and so forth. I would still hang in there with the 7 to 10%.

Operator

Your next question comes from Steven Fisher – UBS.

Steven Fisher – UBS

Just coming back to the J. Ray margins, you mentioned the potential for some upward pressure on the margins there. What is driving the confidence that would be behind that upward pressure?

John A. Fees

Well, I think we really like the fact that we’ve put the problem sites behind us pretty much in the prior year in terms of the things that were really slowing us down and dragging us down. If you take a look at the balance of the portfolios of the projects we have operating, they’re operating really well. I mean I’ve really got to hand it to the operational team of J. Ray. They’ve really done a good job of working on that. They’ve been very rigorous about managing costs at a very aggressive, very detailed level. So you know I feel comfortable with where we are in the projects, they’re performing well, and again I think that there are opportunities for a few bright moments as we proceed through 2010.

Jay Roueche

And certainly as the backlog matures in age you get to the point where you have more opportunities for close outs, change orders, claims and things like that that are a core part of our business but can provide nice pickups in margin.

Steven Fisher – UBS

And it sounded like all of those factors were what played out in the fourth quarter.

Michael S. Taff

I think, Steve, that’s a fair statement. I think we had obviously the zero margin projects were down to about $150 million that was rolling through the top line, so as John said and Jay just indicated we’ve got a lot of positive things going and feel good about what’s remaining in backlog at J. Ray.

John A. Fees

Yes, as we indicated in the remarks we do have a little bit of an anchor in the first quarter with the vessel utilization right now, but we expect that to relieve itself as we go forward. So again I’m giving you more of a year view than a quarter view.

Steven Fisher – UBS

And then just a follow up on the last question on the power margins and they were below the 7 to 10% range in the quarter, partly due to the severance and partly on R&D. But you know I think even if we take out the severance you’d still be below that range and it sounds like the R&D is going to be ramping up. How do you get back to within the 7 to 10% range? And then, is there any stimulus or other incentives that could help defray some of the R&D costs on the Empire?

Michael S. Taff

There are certainly on Empire, there are a number of programs that are being pushed forward by the Department of Energy. One of the things that was exciting here recently was the announcement on the consortium of utilities that we’ve put together to be able to proceed. You know the objective in that consortium is to build one or more Empire plants by 2020 and we’re proceeding into that environment, not only going after the market but also going after some of the government programs that are coming forward. So, you know, we understand what it’s going to take to put Empire on the ground but what we don’t yet understand is how the approach that we’ve got is going to play out in terms of partnerships and some of the government programs. And that’s what we’re pursuing.

But the other thing that I would point out in the prior year is we had pretty heavy headwinds on pension expense, you know, non-cash GAAP pension expense throughout the year. And I think you might want to try to reconcile that as well as those other items against the margins.

Steven Fisher – UBS

So it sounds like the [inaudible] is the primary driver that gets you back within the 7 to 10% range?

Michael S. Taff

And again we’re trying not to focus on it on a quarterly basis number. We’re thinking about it more as a run rate number for the business in terms of what we can produce on an ongoing basis.

Steven Fisher – UBS

You mentioned that the actual charges at NFS could be less than the impact you took in the fourth quarter, so should we be expecting a reserve reversal in Government in Q1?

Michael S. Taff

No. I think what we were saying is that obviously with the plant still down, there would be a Q1 charge, but that charge I feel would be high single digits or so.

Operator

Your next question comes from Andrew Kaplowitz - Barclays Capital.

Andrew Kaplowitz - Barclays Capital

John, in your prepared remarks you mentioned that deflation in J. Ray was helping a little bit and so you know if I remember from conversations, you’ve talked about sort of buying most of your steel and other input costs up front. So I’m wondering what kind of impact that’s having on your 2010 margins? Is it significant and how is it happening?

Michael S. Taff

It’s probably less procured items, Andy, like steel that we buy up front and the deflation’s probably more related to labor costs and third party marine vessel charters. But I’ll let John elaborate.

John A. Fees

Well it really hits on both and what ends up happening is that as the impact that that could have on margins is we really don’t recognize revenue until we get to the point that we start fabrication and installation. So it’s more of a back end loaded phenomena. What it does is it does give you some amount of cushion going into the actual construction phases of the project if you’ve had a good procurement season. And it’s been a reasonable procurement season on a number of these projects due to better pricing on a lot of items.

And then if we get into the period where labor’s a little bit more attractive and you start rolling that through revenues, you can start getting some reasonable benefits. But again it’s a construction project that we do outside; it has a lot of vagaries to it; you know we’re not really at the point where we’re high-fiving it and declaring victory at this point, but we do have some things that are working in our favor in that regard.

Andrew Kaplowitz - Barclays Capital

And John as inflated started to ramp up today, it would still take a while for that to sort of run through the system and you wouldn’t look at that as an impact until 2011 or 2012? Is that fair?

John A. Fees

Yes, Andy, we very closely watch how that’s working. You may remember back when the industry was ramping up, even though we were doing extremely well it was very expensive to get vessel charters, steel was going through the roof and we had the benefit of a very strong market and we did very well in that period in spite of those headwinds. What we don’t want to do is we don’t want to come out of this market and assume those assumptions are going to last forever. And so we gauge that very carefully as we go into this period that we’re going through. That’s one of the reasons that we’ve been so focused on keeping our discipline on bidding because we really want to make sure that everything we put in the backlog is going to be very quality.

Andrew Kaplowitz - Barclays Capital

You mentioned that utilization is absolutely going to get better as the year goes on, and you’ve said it before that the new awards have been a little bit slow in the last couple of quarters, so I guess my question is when does utilization start to impact margins in a negative way? Like how long should we kind of look to see, when do we need to see new awards start to ramp up before it impacts utilization?

John A. Fees

Andy, I think there’s two pieces to that. You’re speaking about J. Ray there?

Andrew Kaplowitz - Barclays Capital

Yes. Just J. Ray.

John A. Fees

Yes. I think about that in two pieces. One I think about our vessels. Vessels are a lot tougher to flex up and down because of the fact that you have an asset that needs to be manned and crewed even when it’s not working. And so we have a tendency to be more concerned about that then we do the fab yards because we’re very good at moving the fab yards down from nothing all the way up to large amounts of work. You know we’ve done that back and forth in Indonesia a number of different times very successfully. So I worried more about the vessels. I see that issue more in the first quarter. We expect that utilization to improve as the year goes on based upon our plans.

On the fab yard side, you know again I think that we’ll manage that to the market and our success rate that we have on bids. And I really don’t expect that to be any major significant drag in terms of as we proceed into the forward periods with the available markets. Obviously you know I’d like to see some epic work hit over the next two quarters, the quarter that we’re in and the following quarter. And we have some expectations on some reasonable awards that we’re pursuing.

Andrew Kaplowitz - Barclays Capital

One other quick question on power, you know John you did have some new awards in the quarter. You know, was this more [parse] and service ramping up? Or was there other things that you really didn’t announce? I mean new awards were up pretty decently from the last quarter.

John A. Fees

You know, Andy, it gets to the strategy of diversification in the market and continuing to redefine ourselves as the market changes and goes green. I mean we’ve seen, again I mentioned we’ve had some engineering releases on a couple of biomass projects. We’ve had some decent nuclear awards on some replacement components and some field construction. And then behind that there were some small projects on the power side. And again I would expect as we go into the year to continue to pursue those opportunities but also to start seeing some movement on the coal side. Again projects that the materials on the ground, there’s some erection to be done, and then the return of the environmental work later this year. So you know we’re probably feeling more optimistic than we were a year ago in that regard.

Operator

Your next question comes from Martin Malloy - Johnson Rice & Company.

Martin Malloy - Johnson Rice & Company

Could you talk a little bit more about the commercial nuclear side? And you mentioned that you had some replacement orders for commercial nuclear units. Can you talk about the scope that you all might sell into nuclear upgrade projects and if you’ve been able to grow that versus historically what you’ve been able to sell into those projects?

John A. Fees

Yes. You know I would say, Marty, we’re sort of on the front end of that. We’ve made a decision to stand up commercial nuclear as a separate segment within the power group, a separate area in the power group back a couple of years ago. We’ve put some dedicated resources in there, we pulled from our internal resources, we brought some people along that are really strong in the industry in that regard. And we started to pursue that market. We’ve added a few niche acquisitions along the way to be able to do inspection services and those kind of things. Now what we’ve done is we’ve kind of integrated that capability and we’re pursuing it. We’ve been able to get installation of replacement steam generators, which you wouldn’t have heard us talk about before we make that strategic decision. We’re doing some other work in terms of some upgrade work inside of the plants that we wouldn’t have been doing a couple of years ago, but we’re still I would consider us very much to be on the front end of that curve.

We still have a fairly robust component business that supplies the replacement components in Canada as well as in the United States. We continue to pursue that market. There are active opportunities in that market and we’re going to continue to try to leverage that capability and the establishment of this field capability as we go forward. We think the upgrade market’s a good market. There’s some great opportunities there. We want to pursue where we think we can compete effectively and where we think we can produce reasonable margins. And again we’re sort of on the front end of that curve would be the way I would describe them.

Martin Malloy - Johnson Rice & Company

And then with respect to J. Ray, you mentioned last year on a couple of conference calls the Caspian region as the outlook was improving. Can you talk about what you’re seeing in terms of the timing of awards in the Caspian region?

John A. Fees

Still playing out. We bid some work there. We haven’t had final customer decisions on things. I know there’s one more job that we still have yet to bid. A tough competitive environment. We’re going to see how that plays out probably over the next quarter or two.

Operator

Your next question comes from Roger Read - Natixis Bleichroeder.

Roger Read - Natixis Bleichroeder

What about on the carbon reg side? I mean there’s a lot of stuff going on. Obviously EPA is trying to do one thing and Congress probably is going to try to do another, but is that having any either positive or negative impact on you at this point?

John A. Fees

Well I think the negative impact related to that whole discussion happened over the last several years and is really not a current period phenomenon. You know we were on a [filled] rate of new coal plants that started to get identified in 2005. We saw some awards. We’re still executing. We still have backlog on some of that that we’re working through. But there really hasn’t been much of that in the near term because carbon came up as an issue and then right after that the world economy fell apart. You know power demand is way off, utilities are struggling to find capital for projects, gas got very cheap in the interim. All those things kind of factored into it.

Our view right now on CO2 is we think that that’s still a good long term market for us. We have really done some great things on the technology side that we have invested in, but we really don’t see regulatory framework coming forward in the near term in this economy. Congress has tried to revitalize it several times. There’s another push going on by John Kerry to revitalize that whole effort again in the Senate, but we just don’t think that the economic headwinds on jobs and costs are going to be overcome in the near term by putting a tax on consumers to be able to deal with carbon. And the fact that power demand is down so far kind of exacerbates that to a certain degree.

Roger Read - Natixis Bleichroeder

And outside of the U.S. you’re not seeing that as a headwind for selling units in China, India or something like that?

John A. Fees

No, it’s totally the opposite. We see that they have a more fundamental purpose right now in terms of trying to provide power for people that have no power. So they’re in a totally different place, particularly in India which we think is going to be a great market for us as we proceed.

Roger Read - Natixis Bleichroeder

Looking at what happened with NFS, I understand the higher expenses that came through in the fourth quarter and some more in the first. Was there a way to quantify the revenue impact of halting uranium processing? In other words, is the $14 million inclusive of some of losing the revenue or is there an additional loss above that?

Michael S. Taff

No, it’s inclusive of that. I mean I think historically that was a $40 million per quarter, $150 million per year type unit so that’s going to kind of be the revenue impact. But as far as the P&L hit, what we’ve discussed is the full impact.

John A. Fees

You know we made money at NFS this year, just not a lot of it. And it was hampered by these particular issues. And we recognized as I said in the prepared remarks going into this that there was going to be a headwind on the operational side. We knew that. It has a history in that regard. But on the other side of it, I think we’re the best in the world at high consequence nuclear operations and making them effective and managing them very well. We have some of the best people out of what I consider to be one of the best [inaudible] in the world, taking that challenge on. And I have confidence in the people that are down there working on it so I expect to resolve it.

Operator

Your next question comes from Stephen Gengaro - Jefferies & Co.

Stephen Gengaro - Jefferies & Co.

So did you say that effectively $35, $40 million of revenue would have been added to the Government ops line if NFS was cranking along properly?

Michael S. Taff

Not in the fourth quarter, but assuming we bring NFS back online March 31, and we have a quarter of very limited sales, the revenue impact would probably be around $40 million.

Stephen Gengaro - Jefferies & Co.

Just two other quick ones. One, the balance sheet obviously it continues to improve. It looks like you’re going to generate some solid free cash in 2010. Any thoughts there for use of the cash? I mean it sounds like subsea opportunities possibly. Anything else we should be thinking about outside of the R&D?

John A. Fees

There’s really two ways to think about the cash right now. When we do the spinoff of B&W we’re going to split the assets and the liabilities between the companies and our purpose in that regard would be to have both of these companies very well financed and very capable of being able to proceed with their business plans. And in the middle of that are the business plans associated with the ongoing investment in development of both enterprises, which involves capital and sometimes involves expense on the B&W side when you think about R&D. So right now our focus on cash is continuing to invest in the businesses and also to set up these two companies as very well financed when the spin happens in the near future.

Michael S. Taff

But Stephen I think the capital program that we’ve employed the last couple of years will probably be pretty consistent with what we see in 2010 as far as CapEx and that total CapEx for the company on an annualized basis on $225 to $250 range. Something like that. And then we’ll continue to look at acquisitive opportunities within each of the business plans.

Stephen Gengaro - Jefferies & Co.

The corporate line, $28 million, that was largely up because of the spinoff costs and I guess the pension expense related to B&W. How should we think about that corporate line for 2010 on a quarterly basis?

Michael S. Taff

You know I would think of it probably consistent with the run rate we’ve had the last couple of quarters which is kind of in the $20 million range or so, absent the one time charges.

Stephen Gengaro - Jefferies & Co.

So $20 plus sort of the costs associated with the spin.

Michael S. Taff

Yes, sir.

Operator

Your next question comes from [Jeff Patel – Lakeshore Capital].

[Jeff Patel – Lakeshore Capital]

I guess gauging your comments on J. Ray and the near term bid pipeline, is it fair to say that the geographic distribution in the near term is more heavily weighted toward the Middle East and the Gulf of Mexico? And then it sounds like maybe things will pick up behind that in the Caspian and the Far East?

John A. Fees

Well I think if you look at our backlog right now in the business, 90% plus is in Asia and the Middle East and that’s where a high level of our bids continue to be outstanding. And we see opportunities ahead for both the Caspian and the Gulf.

[Jeff Patel – Lakeshore Capital]

And then kind of bigger picture, it was encouraging to see the award in Brazil hit for the first quarter. Longer term there understanding you’ve got the JV agreement with Keppel Fels, would you ultimately like the footprint to look a little bit more like it does in some of the other deepwater basins? Do you think because of the local content rules you need to have fabrication capacity on the ground there? Or just help us walk through that longer term.

John A. Fees

You know it just depends on how fast Brazil develops. If they stay with their current aggressive agenda down there, there will be spill out of the region. I mean it will be inevitable. And what we have there down in Alta Mira, Mexico, which would be a great piece of capability relative to being able to supply that region at a very low cost. We are looking at some alternatives to be on the ground in Brazil, but that’s more in a look kind of fashion. And we would expect to continue to try to pursue that with our joint venture in the short term.

Operator

This concludes the question-and-answer time for today’s program. I would now like to turn the presentation over to Mr. Roueche for any closing remarks.

Jay Roueche

Thank you all again for your participation and interest today. I know a number of people were still left in the queue at the very end so I’d encourage them or anyone else to call Robbie or me if they have additional follow up questions or need any additional clarification. Also we look forward to seeing many of you in New York and Boston later this month. And Marisol, that will conclude our call.

Operator

Thank you. Thank you for your participation in today’s program. This concludes the presentation. You may now disconnect and have a great day.

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