McDermott Q3 Earnings Call Transcript

123jump.com Staff
01 Dec, 2008
New York City

McDermott revenues rose 26% to $1.7 billion and net income declined $85.6 million or $0.37 a share from $140.4 million or $0.61 per share a year ago. The company lost $90 million related to an off-shore project. The company expects a significant non-cash expense related to pension account.

McDermott International, Inc. ((MDR))
Q3 2008 Earnings Call Transcript
November 6, 2008, 10:00 A.M. ET

Executives

Jay Roueche – Vice President of Investor Relations and Corporate Communications
John A. Fees - President and Chief Executive Officer
Michael S. Taff - Senior Vice President and Chief Financial Officer

Analysts

Andy Kaplowitz - Barclays Capital
Stephen Gengaro - Jefferies & Co.
Marty Malloy - Johnson Rice
Jamie Cook - Credit Suisse
John Rogers - D.A. Davidson & Co.
Joe Gibney - CapitalOne Southcoast
Tahira Afzal - KeyBanc Capital Markets
Will Gabrielski - American Technology Research
Brian Chin - Citigroup
Michael Hussey - Mid-Continent Capital
Alexander Bocock - Investment Management of Virginia, LLC

Presentation

Operator

Ladies and gentlemen, thank you for standing by and welcome to the third quarter 2008 earnings conference call of McDermott International. At this time, all participants are in a 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. Please go ahead.

Jay Roueche

Thank you Becky and good morning everyone. We appreciate your participation today to discuss our financial results for the 2008 third quarter, which we reported yesterday afternoon.

Joining me on the call this morning, I have John Fees, McDermott''s Chief Executive Officer and Mike Taff, Senior Vice President and Chief Financial Officer.

Before we discuss the quarter, let me remind you that this event is being recorded and a replay will be available for a limited time on our website. In addition, some of our comments today will include forward-looking statements and estimates. These comments are subject to various risks and uncertainties. Please refer to our filings with the Securities and Exchange Commission, which are available on our website www.mcdermott.com, including our recently filed Form 10-Q, as well as our Form 10-K for the year ended December 31, 2007 for a discussion of the factors that may cause actual results to differ from management''s projections, forecasts, estimates, and expectations.

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

John A. Fees

Thanks Jay and good morning. I am very pleased to be the Chief Executive Officer of this fine company, and I appreciate the confidence our Board has shown in me for this role. I also look forward to earning your confidence, support and trust as well. I''ve had the opportunity to meet many of our analysts and owners recently, and have found these discussions to be beneficial.

In the months ahead we''re planning an increased number of activities with the financial communities, so that there will be additional opportunities for this interaction.

While I would have preferred strong consolidated results for my first conference call, obviously, this is not the case. These results were not what I was expecting coming into my new role just five weeks ago. So, I appreciate that no one outside the company expected to see it.

We''ve had this quarter...what we have this quarter was two of McDermott''s operating segment''s repeating strong performances but one that is fallen short of our expectations. In a moment, I''ll let Mike provide an overview of our consolidated financials and I''ll come back afterwards to discuss the market environment and some highlights of our other operations.

But the major issue today is the offshore oil and gas construction business. What happened this quarter, the steps we''re taking and how we''ll avoid this situation in the future? So, I''m going to address this issue first.

The vast majority of the segment shortfall this quarter relates to just three projects out of an active oil and gas portfolio of about 30 major jobs. The problems with these three contracts all relate to the pipeline installation phase. The pipelines are in Qatar''s North Field, two are for LNG developments and the other four a gas to liquids project.

When originally bid, we expected to generate about $1.4 billion in revenues combined, which also included the engineering and construction scope and each of the contracts were bid with normal margin characteristics. We still have about $1 billion of revenue left to recognize on our backlog on these projects as of September 30. However, with our increased estimated cost to complete, virtually all the gross margin has been eliminated.

There are a number of common things to these projects and they share including long trunk line projects and transporting high pressure solid/gas. The majority of the cost increases on these jobs relate to three issues; namely productivity, schedule delays and excessive downtime.

First, productivity. The estimates used in our bid for all three projects were based upon similar completed successful projects. These referenced projects will perform during peak summer construction months, so they experience high productivity and few downtime days. Productivity is measured in how many joints of pipe a day we expect to accomplish.

In hindsight, this joints per day or what we call lay rates, were used for the bids -- provided were -- proved to be too aggressive and we''ve not been able to achieve production at these levels. As is typically the case in the construction business, when you start a project with a poor assumption it''s hard to recover.

The next common problem is schedule. These projects were affected by delays from preceding jobs in the queue. The delays on earlier jobs has caused us to start projects later than the bid schedules proposed and we are prioritizing our resources to minimize the schedule effect on the customers by using a different vessel than what we assumed in the bid. Either situation has or will really mitigate the financial impact as this change in assumptions increased our cost.

The final common problem is excessive downtime. We spoke about weather being a problem in the first quarter, and it was. In the two quarters since we continue to experience additional delays due to weather, mechanical issues, support vessel availability and some customer order standbys. Any of these problems alone would be a concern, but how they compound when taken together is really the issue. Let me provide some examples.

Because our productivity is less than anticipated, we are spending more days in the field, which increases our exposure to weather and mechanical downtime. These extra days spent on the job also mean the next projects in the queue have schedule impacts as well. With the schedule being compromised, we found ourselves starting projects in historically bad weather winters, which further hampered productivity and increased our downtime days. And every time a vessel goes down and what we mean by that is it stops laying pipe for whatever the reason, the interruption impacts productivity, because starts and stops never permit our cruise to build any type of momentum.

There are other issues as well, including significant inflation in the region, welling issues and regional congestion to name just a few. Cumulative effect for this quarter is we''re now forecasting on this 300 more days in total on these projects than originally bid. But the financial impact fairly evenly spread between productivity, schedule, downtime and all other issues.

Few other projects are now expecting losses of gross margin line; one is almost half-way complete and the other is in its infancy. However, the expected gross losses on these two projects are fully recorded as of this quarter in our financials to where we should only recognize breakeven gross margin on the associated revenues going forward.

On the other project, which is a combination contract including construction and pipeline installation, its profitability dropped significantly but it is still generating positive gross margin. It is almost half-way complete, and we expect the mechanical acceptance for the pipeline by March of next year. These issues have caused some ripple impact on other projects in the Middle East and we have revised our estimates in our backlog to account for this ripple effect.

So let me discuss what we''re doing. I have spent a substantial amount of time with our team here in Houston analyzing these projects. In early October, we dispatched an independent review team of senior executives to Dubai to review, reconcile and report on each stage of these projects and to recommend the best path forward.

Based upon this analysis and a further detailed review of management, we revised our estimated cost to complete the levels we have demonstrated and we believe are achievable and we have recognized all the associated losses now.

Several procedures and processes are being reworked and improved including those related to welding and estimating. There have also been a number of personnel moves implemented; both of those have strengthened the team as well as some terminations.

On certain of these jobs, we believe there may be claims we can assert to the customer that if agreed upon could potentially recover a portion of these increased costs. However to be very clear, there are no such amounts included in our financials. Bob Deason and I are days away from starting the two week trip to all of over offshore construction locations with a particular emphasis on the Middle East and these projects.

I intent to personally verify our assumptions from the decks of our vessels up to project management and while in the region I intent to evaluate these markets, meet with our customers and our employees as well.

Finally we are moving the DB16 vessel out of the Gulf of Mexico to the Middle East to help us execute our significant backlog in this very active market. It should be in the region by the end of January.

We have a number of takeaways from this experience. For the last few years, our offshore construction team regularly delivered projects with profitability levels that exceeded the margins as bid. We had outstanding execution and we were harvesting contingency and close outs to generate margins well above our target range.

I intend the whole, the segment accountable for delivering on or better than these current forecasts. Further, our customers view us as a supplier of choice, one who consistently delivers and we plan on completing a quality project in support of our clients. We recognize that we got ourselves too tight with no buffer in it and when slippage started, regardless of whether it was our fault or at the customer’s request or events outside of our control, it produces the domino effect.

In a strong market, there was no reason to get ourselves into this position. We''re working harder in 2008, expecting to generate about a 40% increase in revenues compared to last year, but it is also now clear that the segment will generate little lower profits than 2007. However, these events do not change our long-term view of the profitability in this business.

As we disclosed in the 10-Q, we are off schedule in a few projects including these three that could expose us to future liquidated damages. Other than a relatively small amount of approximately $20 million, we do not view the majority of the potential LDs is probable at this time. So, we have not reserved for it in our contract estimates. We are in active negotiations with the affected customers and we are looking to agree to a mutually satisfactory outcome.

I am confident that this experience will return us to better bidding, refresh data on what''s achievable and associated downtime to expect. I believe most customers still prefer their projects to be completed on schedule from a preferred, trusted, knowledgeable contractor that consistently delivers.

Considering the market conditions to be active going forward, as there is plenty of work available, I do not believe a more disciplined bidding approach on our part will create any issues. I also believe that we learn more from challenges and difficulties than from easy victories. These events exposed clear areas for improvement - weaknesses in the bidding and project process, bidding to better approaches going forward. By curing these issues, we''re going to be a much stronger offshore construction company in the future.

I should also remind you that ours is not a 90-day business and I also believe that McDermott is well positioned for the future. Yes, our Offshore Construction segment is large project-focused with a majority of fixed price contracts and as a result, its 90-day results will typically vary the most quarter-to-quarter. Our Government Operations business by contrast provides a very stable basic, consistent and repeatable work and our company''s largest customer continues to be the United States Government.
Our Power Generation Systems business has attributes of both segments, a nice mix of repeatable higher margin parts and service offerings combined with a large project-oriented portfolio. While I spent a lot of time this morning discussing the unusual period specific losses on the few contracts in our offshore business which we believe we have our arms around and have accounted for appropriately, it''s reassuring to note that McDermott continues to be profitable despite these projects.

In a period where many investors appear to be overly worried about the end markets of E&C companies, I very much value our positioning with our diversified customer base and portfolio which includes major projects and a base of repeatable business.

Now let me turn the call over to Mike, for a quick discussion of our financials and I''ll return for a brief overview of the markets and our other segments.

Michael S. Taff

Thanks John. In the 2008 third quarter, McDermott reported net income of $85.6 million or $0.37 per diluted share compared to last year''s $140.4 million or $0.61 per share. Obviously, the $90 million of project losses at the gross margin level in offshore construction, which John just discussed, is the main variant between the two periods.

Looking at the top line, revenues were almost $1.7 billion, approximately 26% above a year ago. This increase came predominantly from the Offshore Oil and Gas Construction segment, although it was again below what we expected from backlog roll off.

The reason we''ve been challenged to achieve our roll off schedule of late is primarily due to the issues John mentioned earlier. Our other two segments; Power Generation Systems and Government Operations, also reported revenue growth adding a combined $109 million to a year ago levels.

McDermott''s operating income was $92 million in the third quarter of 2008 compared to a $155.2 million a year ago. Segment income at Power Generation Systems and Government Operations increased a combined $44 million or 60% year-over-year, but the decline in Offshore Construction segment more than offset these improvements.

Our provision for income tax declined about $14 million, but it''s not really due to the reduction in our pre-tax income. Since our U.S. businesses were up in pre-tax income and they’re typically taxed at a standard corporate rate, and most of our losses occurred this quarter in low tax jurisdictions, our consolidated tax rate would have been higher except with number of benefits from the release of certain tax evaluation allowances and as a result of recent order activity. As most of you know, our tax rate varies quarter-to-quarter and year-to-year, dependent upon what taxing jurisdictions we are making money in.

Now a high level review from our segment finds. Offshore Oil and Gas Construction had a $19.7 million segment loss, its first negative result in a quarter since early 2004. Increasing our estimated cost significantly and taking the full expected loss on certain projects generated the $90 million charge at the gross margin level, which is before any G&A costs get applied to the projects. With over 20% of the segment''s current backlog now expected to earn no margin going forward, I would suggest as a result that you trim your margin expectations in this segment to the 6% to 8% range for the next four to five quarters, assuming no liquidated damages or further project deterioration.

However, based on the projects we are reviewing today, I see no reason however - longer term our previous target range can''t once again be achieved. It is important to note that excluding the Middle East region, the remaining projects in Offshore Oil and Gas provided margins in the quarter near the typical range for this business.

Government Operations had another strong quarter, with segment income of $34.5 million. Both our site management activities, which largely comes in as equity income and the manufacturer of nuclear components for commercial and government use continued to perform well. We also had more timing benefits on procurement contracts which brought forward about $16 million in revenues and associated profits.

Power Generation Systems is putting together a tremendous year, and had another strong quarter, far exceeding our own expectations with $84.4 million in segment income. Existing contracts in our boiler and environmental retrofit project portfolio continue to improve and we continue to see a high level of parts and service work, which is traditionally our highest margin business in this segment.

Last quarter, we increased our target segment margins to the 7% to 10% range and we''d still suggest that going forward despite what had been several quarters of exceptional performance.

Now turning quickly to the balance sheet. We ended the quarter with over $1.2 billion in cash and investments. Changes in working capital were the primary reason cash and investment declined about $100 million sequentially as we are working off some of the advance billings we built up. Despite the turmoil in the overall credit market, McDermott remains well positioned from a liquidity standpoint.

In addition to our solid cash and investment position, we have several years left on our existing credit facilities. We value our current liquidity and believe in these unprecedented markets that maintaining a conservative liquidity position is paramount. However, we will continue to evaluate McDermott''s growth initiatives.

The final issue I''ll mention is that while I generally believe our end market remain robust, we are not immune from the crisis on Wall Street. The largest risk on this crisis is to our pension plans. Through September, our planned assets declined about 12% and the markets are falling further through October. While our actuaries haven''t done all the required calculations, suffice it to say, that if these year-to-date declines hold through December 31, we would expect a sizable non-cash reduction in shareholders’ equity at year end and to incur higher pension expense next year as well. We will obviously update you at year end. But I wanted to highlight this now, as it will be an issue for all companies with pension plans.

We also fully recognize that our share price has declined about 75% from our all-time high achieved just a few months ago back in June. We''re obviously sharing this pain, but remain steadfast about our future.

I''ll now turn the call back over to John for his final comments.

John A. Fees

Thank you Mike. In my remaining comments, I''m going to focus on some major themes, but I first want to acknowledge both the Power Generation and Government Operations segments on another fine quarter. Strong project execution and a focus on operational efficiency have continued to enable excellent results.

I''m also pleased today that we have named Brandon Bethards to my old role as Chief Executive Officer of our subsidiary, The Babcock & Wilcox Company, which oversees both the government and power segments. Brandon has over 30 years with McDermott and has demonstrated success throughout his tenure. Brandon and I have had a number of successful years together and I have full confidence in his ability to succeed in this role, he is an excellent choice for these segments.

Starting with the consolidated bookings, we recorded over $1.3 billion during the quarter, pretty well spread across all segments. Oil and gas and power booked approach 0.5 billion of booking additions in the government, delivered the balance with the award of second multi-year agreement which includes the second Virginia-class submarine. These bookings kept our backlog at a solid level ending the quarter at $9.4 billion, a slight increase to a year ago.

Over half of the value of these contracts is in the Offshore Construction segment with the balance in Power and Government in that order. I feel confident that the projects that comprise our backlog will continue to proceed as there has been no discussion with customers to the contrary. And frankly, while delays on big projects occur in the very best of times, most of our work isn''t generally for projects that customers would start and stop very easily.

The overall bid environment remains sizeable. We have over $6 billion in outstanding bids at September 30, split about evenly between power and offshore construction. And this doesn''t include the remaining portions of the $2.7 billion multi-order agreements with government, which will be awarded over the next few years of spending as approved by Congress including over $1 billion we expect in this fourth quarter.

And in the month of October, I''ve had a number of very sizable bid reviews particularly in the oil and gas side. So, in the near term, I expect bids to grow. Also the focus project risk in this segment continues to expand, now exceeding $14 billion for offshore oil and gas construction.

With regard to our markets and recessionary impacts, I repeat that I value the diversity of our customers and industries we serve and as our bids indicate, the market is reasonably robust. Our oil and gas customers are the super majors in the large national oil companies. These projects are typically financed from the owner''s balance sheets. In fact, most of the super majors have been returning capital to the market by buybacks, dividends and debt requirements instead of requiring financing.

Since we are late cycle, we only get called once the commercial quantity of hydrocarbon has been discovered. So, our work is at a lower stage and typically requires only modest commodity price to be viable at that point, and again, today''s prices largely irrelevant to the decision-making process since it takes us a couple of years to complete our work. It''s really the expected price a few years out over the life of the field that really matters. While we can certainly find a few data point in the oil gas segment of certain project getting delayed from where we expected, I don''t think we can separate any of them from the normal project flow dependent on the credit crisis as of yet.

Our government business I believe is substantially immune from the financial markets and I view our power business potentially as the most at-risk as we''ve seen some delays in the domestic power projects related to the credit crisis. Since only few utilities have market caps, about $10 billion, virtually all new OEM projects require capital market participation. However, since mostly coal plans are waiting our legislation for CO2 rules, no significant spending can started on nuclear yet. New generation represents only a small portion of the bids outstanding right now.

Our power customers are really excited about environmental retrofit projects since they add cost to kilowatts. They would delay these if they could, but typically there is a regulation or settlement or something that''s driving the project any way and getting approval for postponement is tough.

Our growing participation in international projects and our parts and service offering and power should continue to do well, as taking care of existing generation is important if new builds are on the back burner. All we''re saying right now, we don''t expect the credit crisis for these delays to have a lingering effect on the power business.

I believe our segments have plenty of business ahead. I feel optimistic about our prospects and I do believe 2009 will be a transition year for McDermott as we work though the breakeven projects in oil and gas and we wait for the current power uncertainty related to CO2 and clean air to be resolved, which we expect will draw substantial business in 2010 and beyond.

However looking at 2009, about half of our current backlog, around $4.2 billion is expected to roll off next year while that top line amount will grow by early suspicion is next year''s revenues will be essentially even with the full-year 2008 levels.

That wraps up my prepared remarks for operations. In summary, we took a step backward in the offshore construction businesses this quarter, which will have a lingering impact for the next year or so and the other businesses have performed exceptionally well.

Even with the current challenges we faced, we still anticipate 2008 reported income to be one of the better years in McDermott''s history.

In December, we are planning to be in New York twice before the holidays including KeyBank''s E&C Conference, and we will also be present at New Orleans at Capital One''s Conference during the month. Also scheduled is the Lehman''s Industrial Conference in February. With several geographic options to choose from, we hope to see many of you all at these various venues.

Before we open the call for Q&A, we know our remarks went rather long this morning. So I would ask in consideration of your colleagues to try to limit yourself to a single question and a follow up and get back in the queue if necessary, so everyone has an opportunity to get their questions into us. With that we will now open up the call.

Question-and-Answer

Operator

Ladies and gentlemen, if you wish to ask a question, please press “*” followed by “1” on your touchtone telephone. If your question has been answered or you wish to withdraw your question, please press “*” followed by “2”. And your first question comes from the line of Andy Kaplowitz of Barclays Capital. Please proceed.

Andy Kaplowitz - Barclays Capital

Good morning guys.

John A. Fees

Good morning Andy.

Michael S. Taff

Good morning.

Andy Kaplowitz - Barclays Capital

So John you talked about new awards and how the pipeline in oil and gas still looks good. Could you give us a little more color on that? There are some bigger projects out there. You''ve been working in the long-term agreement for a while now. What are your bigger customers telling you about these potential projects and what gives you confidence that we''re going to see some big income across over the next couple of quarters?

John A. Fees

Well, Andy we''re working a couple of points. One is that the long-term agreement, we believe is going to be delivered to us more in pieces than in any single piece. In fact, in the quarter, there was a piece that was booked in the quarter of about $125 million and we would expect to see this over progress in the quarters as we go into the future. We continue to work on Barzan as the majority of the construction related to that has not been awarded and there are other large projects that we''ve turned bids in recently. One, we reviewed just last week; it was well over $1 billion. And so I think the activity remains pretty strong and robust and our prospect was of target projects, focused projects has actually grown in the quarter.

Andy Kaplowitz - Barclays Capital

Great. And John, we can definitely appreciate that. You are going to go and do a thorough review of the J. Ray businesses over the next few weeks. I guess as you prepare for this earnings announcement, you need to have some view on the 27 other projects that are there, to come up with your 68% margin estimate. And so how should we view that estimate going forward? How conservative do you think it is? Are you worried about any other areas of the J. Ray backlog? You know where do we go from here?

John A. Fees

You know Andy, this perspective started to develop about when some of these issues started showing up right about when I got here at the 1st of October. And what we really try to make sure we could do is really understand the depth and the breadth and how this would impact to any extent anything that we''re doing inside the company. I certainly have a lot of faith in Bob Deason and his ability to really understand this business and how this business operates.

In addition to that, we''ve certainly tested those assumptions very, very heavily. We have spent many hours and many meetings really understanding what''s going on across the entirety of the backlog. So, I think there is a level of confidence that we have that we captured. What''s going on, if the lean is any direction, it''s probably little conservative. But with all that said, we still have some more to do to get these projects moving forward on the basis that we would like to see them and we need to verify some of our assumptions a little further and that''s certainly planned over the next several weeks.

Michael S. Taff

And Andy this is Mike. As a follow up, I think what we''ve mentioned in our prepared comments and what we really looked at across the whole portfolio as you ask is that if you exclude these three projects, we mentioned these three pipeline projects, the remaining portfolio for J. Ray pretty much performed at kind of the historical margin range in that 10% to 12% range.

Andy Kaplowitz - Barclays Capital

Okay. John, and just a real quick follow up to that. If you look at these projects in the Middle East, what do you think in terms of - you said that they''d be done basically by the beginning of next year, in general. Is that when we can start focusing on the rest or--?

John A. Fees

No, the pipeline phase of these projects go on, basically they step out, but they go on through basically 2009, through 2009 and once the projects goes and dribbles up a little bit into ''10. So it''s pretty much from now through the end of next year for the pipeline phase then there are other aspects of these projects that will go beyond that.

Andy Kaplowitz - Barclays Capital

I just wanted to clarify that. Thank you.

Operator

And your next question comes from the line of Stephen Gengaro of Jefferies & Company. Please proceed.

Stephen Gengaro - Jefferies & Co.

Thank you, good morning.

John A. Fees

Hi Steve.

Michael S. Taff

Good morning Steve.

Stephen Gengaro - Jefferies & Co.

Just as a follow-up, when you both...I guess certain assets, I guess about a year ago plus, our thought was they would help efficiency and execution and I''m just trying to get a better sense for asset utilization and efficiency and how we should think about the overall business? I mean, it''s real tough to sort of think about the efficient use of your asset on these jobs and other jobs. Is it something which could snowball and get worse?

Michael S. Taff

Stephen, I don''t think so. I mean when we bought this Secunda asset, those assets are certainly being used today. I think we''ve talked in the past that there was 12 or 14 of those vessels that we acquired. A number of them are still on charter up in the Canadian market. There were really kind of four of those vessels that we really coveted; two of those are actively working in the Middle East and/or Asia Pacific market. The other two are in the process of being retrofitted. But those are not project...those are not vessels that can go out and particularly lay this type of pipes, large trunk line pipe, they''re more support vessels.

The whole idea of the Secunda acquisition was they can do...we can support our diving operations from those and do some kind of tie in work and stuff like that. So, once the pipelines have been laid, we can bring those vessels in and then kind of finish off the finishing touches and then send our more expensive vessels, the large Derrick barges on to other projects. And that’s certainly, all incorporated in the scheduling of these projects.

John A. Fees

And that''s all working in accordance with what we anticipated. What we expected from a deployment of the Secunda assets and our operations is doing what we really wanted it to do on the basis that we put the acquisition together. But the majority of the work in and around these pipelines are for core J. Ray vessels that were owned before Secunda.

Stephen Gengaro - Jefferies & Co.

Okay. And then as a follow-up; it seems like and I fear there is more to this, but it seems like there was some level of breakdown in the way these projects were bid and my sense has been the company has done a very good job over the last three plus years bidding this work well. Is that a breakdown of that...is it a break down that''s being addressed, and how should we think about the bidding process here because it seems like you bid it on pretty clean execution, you didn''t get that, there wasn''t proper contingencies built there, is that the way we have to think about it?

John A. Fees

I think the way to think about it is there are assumptions for somewhat aggressive based upon prior successfully completed projects that were executed in fairly good weather when there is not a lot of the complications and the back-to-back scheduling that we''ve seen as these projects developed. And so, I think that''s where the track came in. We have certainly taken all of that experience that we have now learned through the analysis of these projects forward into our bidding base and this we are evaluating and projects that we are considering, have fully considered the impacts that we are seeing across these types of projects.

Michael S. Taff

Yes. And Stephen, I think as John said in his prepared comments, he said, you really can view these issues in kind of the three buckets that he mentioned. One was productivity, which really gets down to how many joints of pipe we can lay a day. But the other two relates to these schedule delays, there is no doubt we had...we were planning on laying these projects all with the same vessel and we basically had this special schedule out for about a year-and-a-half period, with not a lot of slack in it and cushion. We had cushion built under but it just proved that we got behind in the first job and then we had the snowball effect and then had to bring in...substitute other vessels in.

And then the third it''s just excessive downtime. We''ve had a lot of downtime, some mechanical downtime, some by the customer and then just a nominal amount of weather in the region as well.

Stephen Gengaro - Jefferies & Co.

Okay, now that''s a helpful clarification. Thank you.

John A. Fees

Thanks.

Operator

And your next question comes from the line of Martin Malloy of Johnson Rice. Please proceed.

Marty Malloy - Johnson Rice

Good morning.

Michael S. Taff

Hey, good morning Marty.

Marty Malloy - Johnson Rice

Give us any additional comfort that you''ve been conservative with your assumptions here that the cost are not going to further increase on these projects over next four or five quarters as they move along. Big contingencies or anything you put in the current estimates?

John A. Fees

We''ve analyzed these pretty hard and we put and what we think is reasonable contingencies, we put into our estimates rates on the pipeline that we have been accomplishing in actual conditions. We''ve taken the current weather circumstances into consideration. And we have looked at whatever cost escalations we had in the region and made sure that those were fully reflected in our estimates going forward.

But that doesn''t say that things can’t go wrong and there is always a possibility on construction projects when you are working out in the weather and other events come up and other things occur. But right now, we feel that we have taken a reasonable approach to capture what we think it’s going to take to complete these projects with representative contingencies based upon the risks that we feel we face.

Michael S. Taff

And I think it''s fair to point that while many people are focused on a potential downside risk that there are upside opportunities available. Both what John mentioned with regard to the claims that we can potentially assert with customers as well as to the extent our productivity turns out to be better than our current forecast that would provide upside as well.

Marty Malloy - Johnson Rice

Okay. And on page 13 of your 10-Q, you talk about $110 million worth of LDs you''re potentially liable for. Can you explain why you haven''t recognized, I mean you don''t think you have to?

Michael S. Taff

Yes, Marty this is Mike. Good question and we really obviously looked at that very hard both internally and with our independent auditors and the audit committee of the Board of Directors and ultimately, we came to the conclusion that we didn''t feel - based on the current discussions we were having with our customers that those LDs would be probable at this time.

Additionally, we haven''t reached the trigger date on those, although we feel we know that we will reach those trigger dates if we do not get the contract amendments. At this point, we don''t feel that it is probable. We''ve had very good dialog with both of the customers primarily on the two of the projects over in the Middle East and then feel that those contracts will be...contract dates will be extended to allow us to complete the projects on time, based on those amended dates.

John A. Fees

One element here as well is that some of the onshore type of activities that these projects tie into are further behind schedule and where these complications put us in terms of our delivery to the customers. So, we''re very focused on meeting the needs of the customers and trying to meet those with some margin so that there is really no impact upon his ability to be able to move the materials and process the gas in this particular circumstance. So we feel that if we can stay ahead of where everything else is, and we''re quite ahead on many of these circumstances; that also helps mitigate our thinking relative to these LDs.

Marty Malloy - Johnson Rice

Do you expect the amendments related to these LDs to be done this quarter?

John A. Fees

Yes, we would. We expect...hope by the end of the fourth quarter that those would be complete.

Marty Malloy - Johnson Rice

Thank you.

Operator

And your next question comes from the line of Jamie Cook of Credit Suisse. Please proceed.

Jamie Cook - Credit Suisse

Hi, good morning.

John A. Fees

Good morning Jamie.

Jamie Cook - Credit Suisse

Just a follow up question on the prior one, I just...I am also trying to get more granular on your assumption as you look out to 2009. Is there any way you can help us when you think about lay rates or weather or productivity or however you can help us without giving too much information. Do you assume this gets worse in 2009? You assume it''s comparable that these conditions are the same relative to 2008, which have been challenging or is it productivity that you''ve historically achieved? I am just trying to get a feel for how conservative of an approach you''re really taking here?

John A. Fees

Jamie, let me give you some perspective on this. If you get outside of these three projects and take a look at how a typical project like this would look with lay rates, you usually see some level of productivity in the beginning that''s slow and then the productivity gains as the crew builds momentum and as the work proceeds, particularly when you get away from the beach and you get out to the open water and that''s a fairly typical profile of what you would see in these projects, and we often look at bids in that direction as well because that''s been the historical spirit experience over many, many years.

What we have done in this sort of circumstances is we''ve taken a look at what our actual experience has been, not only on productivity but these other issues of downtimes and delays. The complicating effects, domino effects related to the back-to-back schedules that we find ourselves in and we have taken that experience and we forecasted it basically flat going forward. So we''re not assuming any great games beyond our existing experience as we look forward into the balance of these projects, we pretty much -- basically flat one.

Jamie Cook - Credit Suisse

Okay. It''s fair to say you are not assuming anything gets any worse, so we are continuing a sort of that I guess most recent quarter levels, is that the way to think about it?

John A. Fees

I think that''s the best way to think of it Jamie as we basically have taken the experience that we''ve had in the last 90 days and used those as the basis of our cost estimates going forward on completing these three projects.

Jamie Cook - Credit Suisse

Okay, that''s helpful. And then just my next question, as you look out to the projects out there that you were bidding on, I mean are there any projects that sort of you need to walk away from just because the productivity issues you are having here that you are not going to be able to...you know what I mean, you just cannot...you won''t be dealing with these projects in time to bid something out that were supposed to come in line or there are any, I guess effects on the projects out there that you''re bidding on?

John A. Fees

Not material, we''ve been fortunate that we''ve been able to deploy the KP1 from Asia into this region because of the good window that we had there and now move in the 16, which we feel we can get some really good utilization in the region. We''ve actually been able to bring some additional assets and that really enhances our ability to perform in the region. So, I would say that there is no material effect on our ability to proceed on future projects and we''ve certainly factored all those experience into our thinking about the delivery of those projects.

Jamie Cook - Credit Suisse

And then just my last question John, as the new CEO of this company and the problems that we''re having, which all contractors run into this problem. But how does this make you think about doing fixed priced contracts on the J. Ray business longer term do you...should we see a shift in strategy with J. Ray? We''ve seen it somewhat move to cost plus, but do you think it''s in the interest of the shareholders to move all cost plus, or do you think that fixed price is still something that we''ll see you guys continue to move forward with?

John A. Fees

I think the mix that we have in the J. Ray side will be fairly typical of the mix going forward. Often Jamie, it''s not our decision. It''s all from the client''s decision as to whether or not he''s going to try to go to lump sum contracting or whether or not he is willing to go to some type of sharing arrangement or some reimbursable basis. Certainly, if you go to our power experience, we''ve worked really very hard with our clients to try to look at risk sharing on an ongoing basis. We''ve done that very successfully domestically in the power business and so there is no reason that we wouldn''t try to keep our wits about us and keep our philosophies consistent there, but often that''s really not our choice, it''s more the clients'' choice in terms of where they want to proceed. But we certainly understand what these risks are; we understand the variances that have occurred over the last year or so and will certainly work to the best extent we can to minimize the risk of the corporation in this bidding. All that being said, the general split that we have talked to you about in the past will probably remain about the same.

Jamie Cook - Credit Suisse

Thank you. I''ll get back in queue.

Operator

And your next question comes from the line of John Rogers of D.A. Davidson. Please proceed.

John Rogers - D.A. Davidson & Co.

Hi, good morning.

John A. Fees

Good morning John.

Michael S. Taff

Good morning, John.

John Rogers - D.A. Davidson & Co.

Just switching for a second to the power gen side. How much of your business, if you look out into ''08 and or excuse me ''09 and beyond. Do you expect to be new facilities as opposed to upgrades or retrofits of existing equipment?

John A. Fees

I would say the majority of our business going into ''09 will be related to existing infrastructure. If you take that...we are probably on a run rate basis, probably run roughly about 20% and then what we will consider to be the new business area but recognize that some of that''s coming out of backlog and I would say at the bookings level it might even be a little bit less than that. So, I would say the grand majority of the business going forward into the next year or so - it is based upon our estimates is coming predominately already out of the installed base and that will cover not only coal but nuclear as well. We would anticipate the majority of the awards that we would announce in the nuclear area are going to be service and components, steam generator replacements, things along those lines.

Now, that profile will change into the future once we see some release of the constraints that we have relative to carbon and CO2 and legislation that might occur and we''re certainly working to prepare ourselves for that environment when it happens but that''s going to be a 2010 and beyond environment not within the next year.

John Rogers - D.A. Davidson & Co.

Okay. Are there any existing boiler projects, in not only the power generation, but, something up in Canada as well that are at risk that are in backlog now?

John A. Fees

No, I would say no. I mean on any project you see things being accelerated and things being delayed. But, what we see right now I would not consider to be outside of the normal mix. Generally, these things are financed and before the first step moves of the project, the financing is generally 100% available to complete the project out. So, once these things get licensed, authorized, financed, and there still is an increasing demand for power domestically and around the world, these things are pretty solid and generally proceed.

John Rogers - D.A. Davidson & Co.

Okay, Mike if I could just follow-up. Are there any issues on covenants or anything that we should be aware of?

Michael S. Taff

No, no there is nothing at all. We have very minimal covenants on all of our debt facilities, so we''re in very fine shape here.

John Rogers - D.A. Davidson & Co.

Okay, great. Thank you.

Operator

And your next question comes from the line of Joe Gibney of CapitalOne Southcoast. Please proceed.

Joe Gibney - CapitalOne Southcoast

Good morning everybody.

Michael S. Taff

Hi Joe.

John A. Fees

Good morning Joe.

Joe Gibney - CapitalOne Southcoast

I just want a follow-up a little bit on the B&W side, along the last line of questioning there relative to - I know we''re in a bit of a malaise here relative to waiting on CO2 and then a little bit of granularity there. But, absent the oil sands, are the power gen, new unit opportunities that you guys are looking at outside of the U.S. any color there, anything new that you''re looking at outside the domestic market?

John A. Fees

If you take a look at our profile, outside of the U.S., we certainly have a great joint venture facility in China that''s very full, very active and very busy. We don''t see any weakening in that demand currently at this time. We announced in recent periods that we''ve developed a relationship in India with a licensee there. That relationship is leading not only to some licensing work in that region, but some ongoing discussions about some major power projects that we can pursue in India and so there is activity there. We have bid some jobs into Middle East for oil burning, diesel plants and we had some...we''ve been...had some traction on some bids that we put out there. So, if you take a look at the profile, we would expect that to be a more significant part of what we''re doing in the power business over the next 2 or 3 years than it has been in the past.

Joe Gibney - CapitalOne Southcoast

I appreciate it. On the government op side, just curious if you can give a little color on the margin outlook going forward relative to some of your new bookings and the Virginia-class coming through with a reasonable run rate for expectations on government ops going forward?

John A. Fees

I think there shouldn''t be anything that''s not consistent with past results.

Joe Gibney - CapitalOne Southcoast

Okay, that''s fair. And last, on relative to where we are today, CapEx outlook and any change in mindset relative to buyback now? Obviously, the hypersensitivity on the liquidity front but curious on your stance now looking where we are today? I appreciate it.

John A. Fees

We are certainly very focused on what''s happening in the liquidity and then in the markets. And right now, we are enjoying the position that we have, but that doesn''t go without saying that we are continually evaluating our options in that area and have an ongoing dialog between the management of the company and our Board of Directors relative to that...those in similar related issues. And so, I would say that that is not off the table, but we do not have anything to announce to that.

Joe Gibney - CapitalOne Southcoast

All right. Thanks guys. I''ll turn it back.

Operator

And your next question comes from the line of Tahira Afzal of KeyBanc. Please proceed.

Tahira Afzal - KeyBanc Capital Markets

Good morning gentlemen.

John A. Fees

Good morning Tahira.

Michael S. Taff

Good morning.

Tahira Afzal - KeyBanc Capital Markets

Number one, I just wanted to ask you, your thoughts around reverse announcement to set up a heavy components facility in the U.S. Is that going to impact your potential participation in the market there on the replacement cycle and perhaps whenever it happens a new nuclear cycle?

John A. Fees

I really don''t think so, I think it''s more in my mind a confirmation of work is the possibility to occur in lifecycle recognizing also that the...if you take a look our nuclear facilities that are spread between Barberton, Mount Vernon and Cambridge, Ontario, it would be very difficult to replace that for the kind of value that they announced in their announcement. So, it''s sort of I would consider to be a small step in the direction. But I think will certainly continue to be very strong in that area and I do not consider to be necessarily any type of threat or concern at this point.

Tahira Afzal - KeyBanc Capital Markets

Great. And then in India, we have seen sort of McDermott''s name mentioned in terms of headlines in terms of the nuclear build out in India. I would love to know what kind of role you are playing as of right now. Is it more of an advisory role and what you are looking to do over there potentially?

John A. Fees

We have been involved with the U.S. government in the dialog as well as a number of other nuclear suppliers out of North America and Europe looking at the potential of the market for India and we have certainly not ruled out any kind of level of participation relative to that market. And it does have some potential for us, but I would say that those discussions at this point would be what I would classify as preliminary.

Tahira Afzal - KeyBanc Capital Markets

Okay, great. And then if you were to look at what you''d highlighted earlier on John, in terms of taking a more aggressive stance in terms of the power market and trying to gain market share in the U.S. How does that stand and what will be some of the milestones we can look at in terms of seeing whether you are gaining any traction over there?

John A. Fees

Pardon, on which particular market, I did not quite get that.

Tahira Afzal - KeyBanc Capital Markets

Which segment? Your power group.

John A. Fees

On the international, I think you think--

Tahira Afzal - KeyBanc Capital Markets

Mistake.

John A. Fees

Outside of the United States.

Tahira Afzal - KeyBanc Capital Markets

Within the U.S. or do not have any market share gain plans within the U.S. either?

John A. Fees

I think if you take a look at domestic U.S. I think the predominant focus there is going to be to capture and execute the highest quantity and quality of work that we can, in the area of the existing installed base over the next 12 to 18 months. And we do have, we have very good market share there and I would not expect that to change radically either way because you generally focus in and around of the market share you have. That being said, we are experiencing a higher level of service volume on our market share than what we have had last year within ''08, so I would expect that however to be roughly consistent with what we''ve got.

Tahira Afzal - KeyBanc Capital Markets

Okay and now for the tough question. If you look at the offshore segment, and you look at some of your peers in the space, it''s generally what we’ve observed at least on the sell side is that if a project is less than halfway done, you will be likely seeing material issues going forward given the fact and I think from what I understand the problem is what you have been facing in essence over the last quarter where you have a compounding effect of all the issues that are building up. But given that has been your experience to-date, why would you not build a cushion into what your assumptions are, why would you assume sort of a flat line kind of assumption going forward and not build a cushion into that?

Michael S. Taff

Tahira, this is Mike. I think we have kind of built that cushion in. I mean, I think we feel very comfortable with the cost, the estimated cost to complete on these projects. And we''ve factored into the utilization of the vessels are...what our lay rates have been on these projects, and factored that into all three of these projects. So, I mean I think as of today, we feel very comfortable, and as John mentioned, we''ve looked at this, spent a lot of hours looking at this. We sent a special task force over to Dubai for a week plus to examine this independent group and then based on their recommendations and working with Bob Deason and his team, I think we all feel comfortable based on the current calls that we know as of today.

John A. Fees

Yes, I would say that we assess all elements and when I say flat, that recognize that we''ve got, what we consider to be reasonable project contingencies on each one of these projects and we believe that we''ve estimated until the point that we can accomplish the projects for where they are with some level of margin. So, that was our philosophy going into it, and it wasn''t inconsistent than the same philosophy we applied to when we were having issues in the construction segment, in the power business in ''07 and we were able to I think fairly reasonably capture what we thought it was going to take to execute those projects. And if you take a look at our bidding environment there and what we''ve done in corrective actions, have turned it into a great producing segment throughout 2008, so we''re not philosophically approaching this really any different.

Tahira Afzal - KeyBanc Capital Markets

Okay. Well thank you very much.

Michael S. Taff

Thanks.

Operator

And your next question comes from the line of Will Gabrielski of American Technology Research. Please proceed.

Will Gabrielski - American Technology Research

Sure, thanks. Hey guys.

John A. Fees

Good morning.

Will Gabrielski - American Technology Research

So a couple of bigger picture questions here. If I look at your stock chart now, you are back to ''05 levels and I was wondering if you could talk about what the market looks like for the next two years versus maybe what it looks like in ''03, ''05, ''06, provide some perspective on the end market so then specifically focusing on the competitive side? What are the competitors doing and is it getting more competitive on the bid side and on the capacity side, so just a landscape overview I guess today versus then and what''s different?

Michael S. Taff

I think, you know you really have to assess this from each individual business, but I mean from the oil and gas side, I think the market compared to mid-2000, ''03, ''04, ''05 is much more robust than what we''re seeing in those days. I mean I think if you just look at the level of backlog that we have at close to $5 billion, back in ''05, J. Ray''s backlog was below $1 billion, bids outstanding is in the $3 billion range for J. Ray and the focus project as John mentioned is $14 billion. I think it varies depending on what region of the world you''re talking about, so this could be a fairly lengthy conversation we could have here because you really have to analyze this since J. Ray is truly a global player and within a decade, we kind of have reached into the world that come in and out of being very busier times. But I think just in general, if you look at just the world demand for hydrocarbons, much more significant than what it was on a macro basis in our view today than it was four or five years ago. And I will let John answer the question related to the power side.

John A. Fees

Just a couple of touch stones on this. One is going back to the oil and gas business for a minute, we are continuing to see a decrease in output with an increase in demand and I can''t predict and I''m not sure anybody can predict reliably what this current global recession and economic crisis, however you want to label it, is going to have an impact on that. However, without significant capital expenditures within that being able to develop existing, known and potentially develop all resources there, that''s going to have to happen to keep that output from going down. So we really believe that there will be a good work going forward. We have not seen in fact, we have seen an increase in certain regions in terms of project perspectives and where we''re going. So, we really don''t see anything there that would lean towards anything more than a robust bidding environment and many good large projects for us to execute on.

In the government side, we''ve actually had record quarters and we are pulling in record backlogs in that particular segment for our customers who we supply nuclear components to overall on the government side. So, my expectation in that area is that we will continue to do very well on that particular side, there is a great need for our...the things that we supply to the government through that particular segment, we''ve been able to do some very good orders that give the government a benefit in terms of some consolidated buying as well as give us great insight into where we''re going over the next couple of years. We''ll be hiring in the plants and we will be increasing our workforce to be able to execute that backlog, so I think that looks robust and it looks very strong.

On the power side, I would expect this dynamic that we''re seeing of new generation versus running the existing base to be about where it is right now for the next 1 or 2 years domestically in the United States. We are...our business is low, but unique from the standpoint that when we see the newbuild OEM business down and reserve margins decrease, and there is a desire for more electrical output in the United States, we see our service business go up. And so one kind of offsets the other, ones with much higher margin than the other and so they work very well together. But, I think we are getting a pent up demand for electrical power generation that really should start hitting home over the next couple of years.

And internationally, we still see very robust circumstances internationally. And again internationally, I can’t predict yet at this point. There has been so much that has happened in the last 30 days in terms of the financial and credit markets domestically and around the world we really don''t know what the impact of any of that is and whether or not there is going to be any slowdown there. However, right now, we are seeing fairly robust demand internationally for power generation and we really believe over there next year or two, you''ll see more results from us in that area than we have in the last. So, I don''t know if that answered your question? We can promise that about an hour on that so.

Will Gabrielski - American Technology Research

Sure, that''s helpful. On the competitive side, just from when you look at your competitor in the biding process. Do you see any particular region getting a little bit more competitive or bidding a bit more aggressively, trying to take share or is still a pretty healthy environment capacity constraint today, say versus a year or two ago?

Michael S. Taff

Well, I think what we see is pretty similar to what we''ve had in the last year or so. I mean, it''s still a very competitive environment. But typically, on oil and gas side, we''re the dominant player from a global standpoint typically and our competitors tend to be regional type and then in the U.S. on the power side, John, I think the landscape there haven''t changed dramatically over the last 12 to 18 months.

John A. Fees

And recognize too that our capacity and our utilization of our capacity moves around. This year, we''re very, very full in Middle East and we''re reasonably full in Asia. Next year, Asia ramps up significantly like it did two years ago, when we had a really great result out of Asia when that happened. We see the Middle East coming down in terms of its volume; it''s very, very full right now. We see it coming down to a more reasonable level and capacity. Right now, there is not much in the Gulf. We are bidding some activities for P-Max and some others that are in and around Mexico, all the way up that there is some potential ongoing developments in the Gulf. But right now, I''d say that, that load is pretty light.

And then when we get up to the Caspian, we were very active in the Caspian, not a lot of projects up there right now but those should start developing over the next couple of years. So, as these markets move around and as the volume is around the world, the competitive situation changes a little bit as well, so we just have to monitor that and stay on top of that going forward.

Will Gabrielski - American Technology Research

Sure. One last one, if you don''t mind. Can you just talk about the government margin going forward? Obviously because I am looking a bunch of work and I think you just alluded to Q4 being above what you would normally receive in a Q4 award. Is there any shift in margin there expected on some of these new awards and particularly I guess the Virginia class, second Virginia-class sub program and then maybe other opportunities down the roads to convert may be Destroyer fleet or anything as the government focuses on that shift?

John A. Fees

We have certainly have been able to get some incentives in some of these long-term agreements that we''ve made with the government. We''ve been able to deliver on some of those incentives. You''ve seen that in some prior quarters. I would expect these forward-looking quarters to be about the same, and I would say that if we produce a better result there, it''s going to be predominantly more volume.

Michael S. Taff

The key is continuous improvement.

Will Gabrielski - American Technology Research

Okay, thank you very much.

Operator

And your next question comes from the line of Brian Chin of Citigroup. Please proceed.

Brian Chin – Citigroup

Hi, thanks for taking my question. I will keep myself to one question.

John A. Fees

Thanks Brian.

Brian Chin – Citigroup

For BWXT, I think just about everybody recognizes it''s a much more stable, less cyclical business than J. Ray and power. Does it make sense to explore strategic options to monetize that and somehow capture that value because it doesn''t look quite