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Edited Transcript of MDR earnings conference call or presentation 25-Apr-17 12:30pm GMT

Thomson Reuters StreetEvents

Q1 2017 McDermott International Inc Earnings Call

HOUSTON Apr 29, 2017 (Thomson StreetEvents) -- Edited Transcript of McDermott International Inc earnings conference call or presentation Tuesday, April 25, 2017 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* David Dickson

McDermott International, Inc. - CEO, President and Director

* Katherine A. Murray

McDermott International, Inc. - VP of IR and Treasurer

* Stuart A. Spence

McDermott International, Inc. - CFO and EVP

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Conference Call Participants

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* Alan Matthew Fleming

Citigroup Inc, Research Division - VP

* Charles Albert Edward Dillard

Deutsche Bank AG, Research Division - Senior Research Analyst

* Jamie Lyn Cook

Crédit Suisse AG, Research Division - MD, Sector Head of United States Capital Goods Research, and Analyst

* Steven Fisher

UBS Investment Bank, Research Division - Executive Director and Senior Analyst

* Synnøve Gjønnes

Pareto Securities, Research Division - Analyst

* Tahira Afzal

KeyBanc Capital Markets Inc., Research Division - Associate Director of Equity Research, MD and Equity Research Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the McDermott International First Quarter 2017 Earnings Conference Call. (Operator Instructions) As a reminder, this conference call is being recorded. I would now like to turn the conference over to Kathy Murray, Vice President, Treasurer and Investor Relations. Ma'am, you may begin.

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Katherine A. Murray, McDermott International, Inc. - VP of IR and Treasurer [2]

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Thank you, and good morning, everyone. I would like to remind you that we are recording this call and a replay will be available on our website, where you can also find our first quarter 2017 results press release and the Form 10-K we filed today. We've also posted a presentation of supplemental financial information that is available on the Investor Relations section of our website, www.mcdermott.com. Additionally, our comments today include forward-looking statements and estimates. These forward-looking comments are subject to various risks, contingencies and uncertainties, and reflect management's views as of today, April 25, 2017. Please refer to our filings with the SEC, which are available on our website, including our Form 10-Q -- 10-K for the year ended December 31, 2016, current report on Form 8-K and subsequent quarterly reports on Form 10-Q, which provide a discussion of some of the factors that may cause actual results to differ from management's projections, forecasts, estimates and expectations. Please note that, except to the extent required by applicable law, McDermott undertakes no obligation to update any forward-looking statements.

I will now turn the call over to David Dickson, McDermott's President and Chief Executive Officer, for opening remarks.

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David Dickson, McDermott International, Inc. - CEO, President and Director [3]

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Thanks, Kathy, and good morning, everyone. I am extremely pleased with McDermott's strong start to 2017. This quarter, we successfully executed several strategic initiatives, and I am happy to report that we had another profitable quarter and are raising our 2017 guidance. Profitability this quarter was driven by excellent project execution and customer alignment, driven by the One McDermott Way. The strong project execution and customer alignment led to better-than-anticipated closeouts and profitability and also lead to customer-driven change orders on existing projects.

Although we had low order intake in the first quarter driven by the macro commodity price environment, we have not seen many large awards in the marketplace yet this year. And as discussed in the third quarter last year, the pattern of awards in our industry remains unpredictable and uneven due to the uncertain timing of customer final investment decisions.

Further, we have only seen a slight reduction in the 5 quarter revenue pipeline from $21 billion last quarter to $20 billion. This is consistent with our view of the current macro environment as bumping along the bottom. We are encouraged that our bids outstanding and change-order portion of the revenue pipeline increased by almost $1 billion quarter-over-quarter, replenishing the bids outstanding category after a large order intake in the fourth quarter of 2016.

Over the past couple of years, we have continued to stabilize and optimize the business through a number of initiatives, and now we're taking strategic steps to focus on growth, while positioning for the upturn and a long-term future. As part of that strategy, we previously announced the signing of a strategic Memorandum of Understanding with Saudi Aramco for a land lease at the new maritime facility in Ras Al Khair in Saudi Arabia. We believe this strengthens our leadership position in the Middle East with not only Saudi Aramco, but all of our Middle East customers. As part of this strategic move, we plan to build a new state-of-the-art facility using the latest technology and automation and expect to eventually double our fabrication capacity in the region.

Signing of the MOU is just the first step in a multi-year process. We are working with Saudi Aramco's team through to the planning phase and currently do not anticipate any material spend before 2018 at the earliest. Also announced in the first quarter was the strategic acquisition of the vessel Amazon. The vessel is currently in Singapore, being brought up to McDermott's standards, and will then be mobilized to existing contracts. Whilst we expect to eventually upgrade the vessel with the state-of-the-art agility system to build our ultra-deepwater capabilities. Due to the versatility of the vessel, we have flexibility of timing, while we await the return of the ultra-deepwater market. We were also very excited to announce our planned implementation of a new first-of-its-kind software platform to improve efficiency and productivity throughout the life cycle of our projects. The platform will allow for standardization and digitization and eventually will have the capabilities to create a digital twin, which provides an integrated 3D model to mirror the physical state with live data and analysis of the facility. This technology will further optimize McDermott's capabilities to be a valued partner from concept to decommissioning.

Now let me provide an operational update for each of our areas. In the Middle East, fabrication in the Jebel Ali and Damman facilities continues to operate at high levels of utilization. Our marine assets in the region also continued to be active in Qatar, Saudi Arabia and the Khafji Neutral Zone. In Qatar, the RasGas Flow Assurance and Looping project continues to progress with completion of the umbilical installation scope ahead of schedule during the quarter. Installation of the KJO Hout structures was completed during the quarter with pipeline activity and hook up and commissioning remaining. We believe we have mitigated the risk on KJO Hout with a slight improvement on the loss and project completion is still expected in the second quarter of 2017.

Engineering and procurement activities on the Saudi Aramco Lump Sum LTA II project are in the final stages with fabrication well advanced and the 2017 Marine Campaign commenced. Overall progress on the 3 Saudi Aramco projects awarded in the second quarter of 2016 remain on target. The Safaniya Phase 5 and the 4 Jackets and 3 Observation Platform projects are in the engineering and procurement phases with both ahead of plan.

Also during the quarter, we achieved another significant milestone with the One McDermott Way by relocating the global and versatile DLV 2000 to the Middle East, where she is expected to remain active on existing contracts for most of 2017.

In Asia, the Lay Vessel 108 carried out subsea construction and pre-commissioning works to prepare for the arrival of the 14 facilities on the INPEX Ichthys project. Also on Ichthys, we continued working collaboratively with INPEX and the supplier to rectify the subsea connector component issue identified in January 2017, and we believe we have now mitigated some of the risks. The Woodside Greater Western Flank Phase 2 pipeline project is progressing on schedule. In India, the ONGC Vashishta project continues to achieve significant progress with the completion of the shallow water section of pipelines and umbilical installation. The NO 105 also completed the installation of the first 2 deepwater pipeline sections and continues to install the remaining 2. Following the successful completion of SURF Scope on Vashishta, the DB 30 is scheduled to mobilize at the end of April 2017 for the Brunei Shell Petroleum offshore pipelines installation. After that campaign, we plan to relocate her to the Middle East for work on existing contracts. In our Batam fabrication yard, fabrication of the modules for the Yamal LNG project is reaching the final completion stage with sailaway scheduled in April 2017. Also in Batam, the work share fabrication of 14 jackets for Saudi Aramco is progressing well, with 3 of the 14 jackets complete and sailed on a fast transport vessel to Saudi Arabia.

In Americas, Europe and Africa area, during the first quarter of 2017, detail design and fabrication of the compression platform on the Abkatun-A2 project remains on schedule. Transition of detailed engineering on Abkatun has moved from McDermott Kuala Lumpur office to the recently expanded Mexico City office, which is now fully staffed with over 100 engineers.

FEED and early detailed engineering for a Caribbean gas development continued throughout the quarter and is progressing ahead of plan. During the quarter, we were awarded the Hess Penn State subsea scope, which includes installation of a rigid pipeline that will be fabricated in our Gulf Coast Spoolbase and reeled onto the NO 105 for installation offshore. This award was strategic for McDermott because Hess is a new customer for us.

As always, we continue to focus on our Taking the Lead safety culture. And in the first quarter, we achieved an impressive 1 year without a lost time incident. And the Middle East area now has reached an exceptional 54 million man hours LTI free.

With that, I would like to turn the call over to Stuart Spence, our Executive Vice President and Chief Financial Officer, for a review of our financials.

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Stuart A. Spence, McDermott International, Inc. - CFO and EVP [4]

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Thanks, David, and good morning, everyone. Turning now to more detailed financial results, I would like to remind you that in addition to our GAAP reporting, we are also reporting certain adjusted financial information for the prior year first quarter. Net of what we believe to be one-time items, as we believe these provide a helpful understanding of the underlying performance and drivers of our business.

During the first quarter of 2017, we had no adjustments from GAAP. Our first quarter 2017 results included revenues of $519 million compared to $729 million for the first quarter of 2016. Our Asia and Middle East areas continued to contribute significantly to revenue in the first quarter, with the ONGC Vashishta project and INPEX Ichthys projects contributing $161 million combined. And in the Middle East, the Saudi Aramco LTA II Lump Sum, KJO Hout, Karan-45 and Marjan power system's replacement projects contributed a combined $209 million to revenue.

This quarter, we reported net income of $22 million or $0.08 per fully diluted share compared to a net loss of $2.2 million or $0.01 per fully diluted share for the prior year first quarter, or adjusted net income of $36 million or $0.13 per adjusted fully diluted share for the prior year first quarter, after adjusting for restructuring charges of $6 million and impairment charges of $32 million. Operating income was $56 million during the quarter. Our operating margin was 10.8%, which represents an increase of approximately 590 basis points, or 60 basis points year-over-year, on an unadjusted and adjusted basis, respectively.

The increase in margin year-over-year on an unadjusted basis is primarily attributable to the impairment of our Agile vessel in Q1 2016. On an adjusted basis, our operating margin improvement was driven by a strong cost management with significantly lower project costs and improvements in our selling, general and administrative expenses. Operating income includes unallocated direct operating expenses of $27 million. This under-absorption is a result of lower utilization of a number of our marine assets, marginally offset by an increase in the utilization of our fabrication yards.

Despite the increase in our income, our provision for income taxes was $11 million for the first quarter of 2017, down from $19 million for the same period in 2016. The decrease in the provision for income taxes was primarily driven by an increased mix of income in favorable tax jurisdictions, partially offset by low fees in certain jurisdictions where we did not recognize a tax benefit. In addition, as a result of the final settlement of certain tax matters, we recognized a $3 million tax benefit related to an uncertain tax position taken in prior periods associated with our activity in the Middle East.

Net interest expense increased from the prior year up to $18 million in the first quarter of 2017 compared to $11 million in the first quarter of 2016. The increase was primarily due to the lower -- lower interest capitalization in the first quarter of 2017 compared to '16 as the DLV 2000 joined our fleet in the second quarter of 2016. Cash provided by operating activities in the first quarter of 2017 was $48 million, a decrease compared to $59 million in the first quarter of 2016. The decrease from prior year was primarily driven by the timing of cash collections, with higher cash collections from certain customers in the prior year first quarter.

Cash provided by operating activities less CapEx led to a negative free cash flow of $14 million for the quarter, which is primarily due to the strategic acquisition of the Amazon.

Adjusted free cash flow, which adjust free cash flow by the cash received from the subsequent sale and leaseback of the Amazon, was $38 million. Our adjusted free cash flow this quarter demonstrates our continued discipline to actively manage our working capital with our customers in ASA and MEA, partially offset by activity in AEA, including the Abkatun project.

Moving to our balance sheet. At March 31, 2016, we reported a strong cash and restricted cash balance of $642 million, an increase of $29 million from the sequential quarter. This increase is primarily attributable to the $48 million of positive cash flow from operating activities that I previously discussed. Our net debt, which you will find broken down on Page 14 of the supplemental presentation, was $135 million at quarter end. During the first week of April, our tangible equity units, or TEUs, have automatically settled, and we delivered 40.8 million shares of our common stock to holders of the TEUs, with no portion of TEUs also amortized to a balance of 0.

Moving on to our segment reporting. We report financial results under 3 reportable segments consisting of the Americas, Europe and Africa, the Middle East and Asia. We also report certain corporate and other nonoperating activities under the heading Corporate and Other. That primarily reflects costs that are not allocated to our operating segments. In the first quarter of 2017, we implemented certain changes to our financial reporting structure to better reflect how we operate the business. Corporate expenses, certain centrally managed initiatives, such as restructuring charges, impairments, year-end mark-to-market pension actuarial gains and losses, cost not attributable to a particular reportable segment and unallocated direct operating expenses associated with the underutilization of vessels, fabrication facilities and engineering resources are no longer apportioned to our operating segments. Those expenses are now reported under Corporate and Other. We posted an 8-K this morning to recast our previously reported results and included additional details on this change in our supplemental presentation available in the Investor Relations section of our website on Page 8. In the first quarter of 2017, $27 million of unallocated direct operating expenses were included in Corporate and Other. As I discussed previously, the unallocated direct operating expenses were driven by lower utilization of a number of our marine assets, marginally offset by an increase in the utilization of our fabrication.

Capital expenditures for the first quarter were $63 million. Approximately $12 million of CapEx during the quarter was related to the maintenance and project CapEx, including the previously announced upgrades to our Altamira fabrication yard and $47 million was attributable to the acquisition of the Amazon vessel.

Now turning to our backlog. We reported approximately $3.9 billion at March 31, 2017, and approximately $400 million decrease sequentially. We had order intake in the first quarter of slightly under $100 million. Approximately 85% of our backlog relates to offshore operations and approximately 15% relates to our subsea operations. Of the $3.9 billion in backlog, we currently expect approximately $2.5 billion to roll off in 2017 and $1.4 billion in 2018. As of March 31, 2017, the combination of our backlog, bids and change orders outstanding and target projects, which make up our potential revenue pipeline for the next 5 quarters, totaled $19.6 billion.

Moving now to our 2017 full year guidance, which reflects our overall view of the company, the market and the status of our operations at this time. Last quarter, we provided 2017 guidance that we are now updating. We are increasing our profitability guidance substantially due to our performance in Q1 2017 with improved closeouts from project execution and customer-driven change orders received this quarter that increase the scope on existing projects.

Our 2017 revenue forecast remains $3.2 billion, with all, but approximately $200 million of the expected revenue already reported in Q1 or included in our backlog. For 2017, we are expecting operating income of approximately $265 million. We anticipate net income of approximately $120 million and earnings per share of approximately $0.42 per share. Our 2017 EBITDA is expected to be approximately $365 million. Our total expected CapEx spend in 2017 remains approximately $120 million. We previously reported it was a reasonably possible that costs on the INPEX Ichthys project could increase by an additional $10 million due to a failure identified in a supplier-provided subsea pipe connector component, which had been reinstalled. However, we have continued to mitigate the $10 million risk and now believe the range of reasonably profitable additional costs has reduced to $5 million.

Cash and restricted cash is now expected to be approximately $550 million at the end of 2017. We expect gross debt to be approximately $770 million and net debt is expected to be approximately $220 million at the end of 2017. We expect adjusted free cash flow, adding back the effect of the sale and leaseback arrangement on the Amazon, to be approximately positive $17 million. The increase in our cash flows and cash position were approximately $100 million from our prior quarter expectations is driven by the operating income improvements I previously mentioned, coupled with continued improvements to our working capital management in EMEA and AEA for the balance of the year. As a reminder, the supplemental slide deck available on our website provides additional financial information, including reconciliations of our non-GAAP measures to comparable GAAP financial measures.

Now I would like to turn the call back over to David.

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David Dickson, McDermott International, Inc. - CEO, President and Director [5]

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Thanks, Stuart. As I said in the beginning of the call, I am extremely pleased with our start to 2017. We continued to perform well operationally, driven by the One McDermott Way, which incorporates consistency in systems, processes, execution and culture. Other key examples of the impact of the One McDermott Way this quarter were progress on the jackets for Saudi Aramco and Batam, the reallocation of the DLV 2000 to the Middle East and the build-out of our engineering capabilities in Mexico. Our operational performance and relationships with key customers led to better-than-expected profitability this quarter, leading to improvements on our expectations for 2017 and increased guidance for the year.

As we continue to bump along the bottom of the macro environment and markets in which we operate, we have executed on key strategic initiatives early in the year. The signed MOU with Saudi Aramco is expected to grow our leadership position in the Middle East, a key market for McDermott. The Amazon complements our existing fleet and is expected to position McDermott to compete in the ultra-deepwater markets when those markets return.

And the new project Lifecycle Management Platform will strengthen our certainty and offering to customers, building on our new technology focus. Our strong performance through the One McDermott Way and these important strategic decisions position McDermott for sustainability and growth, not only in the next few years but for the long term.

With that, I would now like to open up the line for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes some Jamie Cook with Crédit Suisse.

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Jamie Lyn Cook, Crédit Suisse AG, Research Division - MD, Sector Head of United States Capital Goods Research, and Analyst [2]

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I guess, 2 questions. One on the guidance and then I guess second on the MOU. So Stuart, on the guidance, I understand we're raising, reflecting the first quarter B. I get that, I guess, if I were to assume you were a conservative management team with regards to forecasting earnings, where would the potential upside be when we think about '17, are there potentially more projects closeouts that are embedded in guidance? Is there opportunity for more book and burn? I'm just trying to get a sense -- more book-and-burn work. I'm just trying to get a sense for where the upside could be. And then second, I guess, David, to you on the MOU with Saudi Aramco, can you just talk about the investment required and the book of work this opens up -- the amount of work this opens up to that you wouldn't have, if you weren't in this agreement? And then sort of how do we think about this in the context of McDermott's customer concentration continuing to be solely with Saudi Aramco?

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Stuart A. Spence, McDermott International, Inc. - CFO and EVP [3]

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I will take the first one on guidance. I think what we said in previous quarters is that our portfolio project today is either moving into the higher risk marine phase or it's in the early stages of the project. Either of those stages brings a different risk profile to us. We believe that we've appropriately reflected that risk profile in the guidance update that we've given. Additionally, on additional projects or prospects from book and burn, I think we've also highlighted due to the macro environment that order intake remains very volatile and therefore, is very difficult to predict. And, again, I think that we have put into our current guidance, our current views and thoughts on where that book and burn business will be for the balance of 2017.

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David Dickson, McDermott International, Inc. - CEO, President and Director [4]

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And so, Jamie, on the MOU. So firstly, we are extremely excited that we were selected by Aramco as the EPCI contractor to develop this facility and it was a result of a very long negotiation with Aramco. As you look at our business today in the Middle East, our bottleneck will always be related to the fabrication side. So Jebel Ali, we are constrained in terms of our ability to expand just due to the, obviously, the location of the facility with Jebel Ali, so we've been looking at this for a longer period of time. How do we hope to expand that part of our business? So these opportunities came up and it was stated in the presses that development of this facility will allow us to double our fabrication capacity in the area over a period of time. You have question marks then, does this increase our customer concentricity around Aramco, I think we were clear to highlight in our -- and also within our negotiations with Aramco is that this has to be a McDermott facility, which is located in Saudi and the facility, which could be used, obviously, to support not just Saudi Aramco, but all our other customers in the area. So as you have seen, announcements coming out from Saudi, you have seen most of them or all of them so far have been some form of joint venture. And what you see with that agreement is that we will lease the land from Saudi Aramco, but the agreement will not be a joint venture, and we feel that, that was needed to ensure that we can continue to work with other customers in areas such as Qatar and UAE. In summary, we're excited about this as we see this is something, which really positions McDermott as the #1 company in the Middle East and for the long-term future.

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Operator [5]

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Our next question comes from Tahira Afzal with KeyBanc.

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Tahira Afzal, KeyBanc Capital Markets Inc., Research Division - Associate Director of Equity Research, MD and Equity Research Analyst [6]

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David, congrats to you and your team on really solid execution. First question, David, just as in a sense of follow-up to what Jaime was asking. You know, you see a lot of bid opportunities ahead of you, what is the confidence level that you can grow revenues for next year based on what you're seeing today?

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David Dickson, McDermott International, Inc. - CEO, President and Director [7]

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Well, I think, we've been fairly consistent, Tahira, on how we look at the opportunities. Our model is that we provide the numbers around revenue pipeline, which includes also the target bids and bids outstanding. And, I think if you look at the last 2 to 3 years, with the lumpiness around order intake from quarter-to-quarter is going to be with us for a period of time. And, again, you saw that obviously, what happened with us in terms of Q3 and Q4. I think from the revenue pipeline that we disclosed, you've seen from the last 3 quarters as we've been more or less -- with give or take a small amount we're kind of been bumping along the bottom and that's why we use that expression. Generally, we see offshore market -- and we stated this in the last couple of quarters, we see some activity towards the back end of '17. We don't really see a lot of big activity in the subsea deepwater market until '18 and onwards. So nothing has changed from what we have stated in the last 2 quarters.

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Tahira Afzal, KeyBanc Capital Markets Inc., Research Division - Associate Director of Equity Research, MD and Equity Research Analyst [8]

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Got it, David. And, David, it's -- when I look back in terms of change orders and the extent you're seeing and what the outlook could be, do you feel the change orders you have been seeing in the closeouts are pretty exceptional in size based on the projects you're currently executing or is that sort of within the normalized range?

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David Dickson, McDermott International, Inc. - CEO, President and Director [9]

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I would say that what we're seeing is within the normalized range.

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Operator [10]

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Our next question comes from Chad Dillard with Deutsche Bank.

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Charles Albert Edward Dillard, Deutsche Bank AG, Research Division - Senior Research Analyst [11]

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Can you walk through the margins? So what margins would have been if you were backed up by the closeouts and some of the change orders that you got during the quarter? I'm just trying to understand just what are the core operating margins are across segments and then how to think about that through the rest of the year?

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Stuart A. Spence, McDermott International, Inc. - CFO and EVP [12]

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Yes, Chad, it's Stuart. We haven't previously disclosed the respective margins that we receive on change orders versus the base contract. I think we have been consistent in the message that we believe that margins on change orders are actually higher than the base contract for a number of reasons where we add more value to the customer. I think we would also say that, that trend continues in our current backlog and business outlook.

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Charles Albert Edward Dillard, Deutsche Bank AG, Research Division - Senior Research Analyst [13]

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And then there seems to be a slower-than-expected backlog burn, at least according to my expectations, in the AEA segment in the first quarter. Can you just walk through some of the verticals and key drivers of that in that segment right now?

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David Dickson, McDermott International, Inc. - CEO, President and Director [14]

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If you look at our Americas, Europe, Africa segment, the predominant project of the backlog remains the Abkatun project. That project is progressing well, it's on schedule at the early stages of engineering and procurement. We expect that project to accelerate progress throughout the balance of the year. So at the moment, we don't feel that there is any -- anything abnormal about the backlog burn or progress in the AEA segment.

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Operator [15]

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(Operator Instructions) Our next question comes from Alan Fleming with Citi.

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Alan Matthew Fleming, Citigroup Inc, Research Division - VP [16]

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David, maybe you can talk a little bit more about the Middle East margin. I think, in the last quarter, you said that 2017 could be slightly higher than 2016's margin, given your utilization. And after a strong start, I'm just wondering how you are thinking about that now and compared to kind of during the last up cycle, where Middle East margin was in the sustainable 20%-plus range. Is that possible now? Maybe you can just give more color there.

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David Dickson, McDermott International, Inc. - CEO, President and Director [17]

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Well, I think, the answer the last part of that, Alan, is that the 20% margins in the Middle East would be very challenging at this time. We're stepping out back with where we were a few years ago. I think, our message is still the same is that the Middle East, obviously, has the opportunities and a lot of that's driven by the fact that we just have high volume of activity. Relocating 2 vessels to the area with the DLV 2000 and DB 30 is a good example of the level of marine activity, and we have the versatility that we can expand there. So I think that we're in a good position. We're executing well, but it is only the first quarter. I mean, we still got a very busy and active season to execute. We have a lot of projects to deliver. So I think a bit early to start talking about how the year could look, but certainly, Q1 has got us off to a good start.

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Alan Matthew Fleming, Citigroup Inc, Research Division - VP [18]

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Helpful. Let me ask you then about your engineering focus. Because, I think, last quarter you talked about kind of ramping up that initiative and you said that your headcount had increased 20%, I believe, last year. So maybe can you update us on where your engineering utilization is today? And how that strategy of ramping up of your focus is playing out here early in 2017?

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David Dickson, McDermott International, Inc. - CEO, President and Director [19]

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Yes. So when, I think that one of the strategic initiatives last year was to focus our management team in ensuring that engineering becomes very much the forefront of everything that we do and also taking McDermott to the FEED engineering market into the conceptual work through our io company with GE, and we've seen a lot of good progress. We've increased the number of FEED contracts that have been awarded. We are getting closer to the customer. We ramped up the headcount in engineering, it was 25%, and we've also focused on ensuring that we have engineering capabilities in the countries that we work. So big effort in Q1 in terms of Mexico, and extremely pleased with that. I've been fairly vocal for a long time is that Mexico is a place of a lot of opportunities ahead of us. And again, we built up our team in places like India. So really excited how that's progressing. It is a change for McDermott as a company. It is a shift in culture and how the company has managed or treated engineering in the past. And also for the first time this year, for many years, we started to invest some dollars in R&D and the result of that is a work that we are doing in our digital twin, which I talked about earlier. So very pleased how things are going and also very pleased from the reaction from our customers.

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Alan Matthew Fleming, Citigroup Inc, Research Division - VP [20]

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Does the level of engineering work you're seeing right now, David, making you more excited about the potential for larger EPC awards in over the next kind of 6 to 12 months?

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David Dickson, McDermott International, Inc. - CEO, President and Director [21]

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Yes, I think as we look at it with the increase in what we see in terms of FEED activity and the (inaudible) with customer, it would indicate that, as we said, we're bumping along the bottom, but the FEED, which looks like to be picking up slightly, is that's a good indication of EPCI contracts coming through whether it is in '18 or '19 onwards. But 2017 is a good indication with the level of pre-FEED and FEED engineering that's ongoing.

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Operator [22]

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Our next question comes from Synnøve Gjønnes with Pareto.

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Synnøve Gjønnes, Pareto Securities, Research Division - Analyst [23]

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Some of my questions have been answered -- or my question has largely been answered. I just wanted to touch a bit base back to the backlog. You have $1.4 billion for 2018 execution. Obviously, your order intake was a bit soft this quarter, I understand it's volatile. But, how should we think about sanctioning activity in terms of reaching that required conversion rate on the backlog moving into next year? And then secondly, I understand that the closeout on the existing projects lies within the normalized range, as you mentioned. When we do get a couple of the troublesome projects out of the backlog, should we also then expect somewhat more risk on the upside on positive closeouts also in Q2 and Q3?

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David Dickson, McDermott International, Inc. - CEO, President and Director [24]

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Let me take the first part of that, then I'll hand it over to Stuart. As I said throughout the call and we said fairly consistently is, predicting when customers are going to want contractors is very challenging today as our customers get through, obviously, more detailed and prolonged process in terms of making final investment decisions. Our measurement that we look at is, as I said earlier is our revenue pipeline, which we focus a lot of our attention and that helps us look at how things will look in the future in terms of customer awards. As I said, that remains fairly consistent for the last 3 quarters. But we've also experienced also very lumpy quarters in terms of order intake. There are some bids that are outstanding at the moment, which are also very active today and also a lot of rumors in the markets which we won't comment on. But certainly, there are a lot of projects, which are still in play. I mean, I'll pass it over to Stuart to, maybe, take the second part of that.

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Stuart A. Spence, McDermott International, Inc. - CFO and EVP [25]

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Sure. So looking at the backlog coverage we have for 2018, which currently stands at $1.4 billion of revenue, if we look backwards into 2016 at the end of first quarter, the number that we had then for 2017 was very similar to the one we have today for 2018. So really we are not in a position of having any real concern at this point in time about filling an order intake to build a revenue base for 2018.

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Synnøve Gjønnes, Pareto Securities, Research Division - Analyst [26]

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And then just quick on margins. On the existing project portfolio, as you said, you're within the normalized range on closeouts. Is there anything that should change there?

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Stuart A. Spence, McDermott International, Inc. - CFO and EVP [27]

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It's Stuart. I would think today that given the macro environment in which we operate as we describe as bumping along the bottom, there is still additional capacity in the marketplace globally. And that still puts pressure on pricing level. But I think that may, depending on how it transpires for the balance of the year, have an impact of our margin expectations.

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Operator [28]

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Our next question comes from Steven Fisher with UBS.

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Steven Fisher, UBS Investment Bank, Research Division - Executive Director and Senior Analyst [29]

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Do you guys have a base case for when you expect to put the remaining $200 million of revenues into backlog for this year? I know you just said there's some of these projects that are swirling around, we've seen some of the articles. Do you have a base case for when that could be? And then if some of those do come through, does that mean there would be potential upside to that number?

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David Dickson, McDermott International, Inc. - CEO, President and Director [30]

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I think, Steven, as you know, over the years what we've talked about is increases in revenue would obviously come from 2 areas. One is new orders. But, obviously, those projects would be at very early stages. We consider how we, obviously, recognize revenue, the area that would come from is, obviously, change orders, and we've talked before in the past about the percentage increase in revenue from change orders we've seen over the years. So I think that would be the 2 areas. We don't have any base case or any model assessment. That could occur obviously, a large part of that will come from new orders, which is all subject to customer timing. But I mean, you know the numbers that we have talked about the percentages of revenue increase that come from change orders typically in the year for us as a company and that's one of the areas, obviously, we would expect to see increase in revenues as we go through 2017.

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Steven Fisher, UBS Investment Bank, Research Division - Executive Director and Senior Analyst [31]

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Maybe a bigger picture question here. For a number of years, McDermott was forced to play defense. It seems like more and more McDermott is now playing offense. With the Amazon software platform and various JVs, how would you characterize the opportunities that you have from here to additional any notable moves on offense? Or is it now really just a matter of harvesting, which you've already done in the last year or so?

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David Dickson, McDermott International, Inc. - CEO, President and Director [32]

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I would say, Steve, that these moves have made -- have been, obviously, strategic. The MOU with Saudi Aramco was all about maintaining our position as a leader in the Middle East, and from what we're doing there we continue to be in that position for, obviously, very long time. But also, as I said, we are becoming concerned as the fabrication starts to become our bottleneck, and we needed to increase some capacity, and what we've done in the short-term is, obviously, we've moved work to Batam, and then we obviously have our alliance agreement with N-KOM in Qatar. The Aramco agreement allows us to position ourselves permanently for the longer-term. The Amazon, obviously, was opportunistic. But as we looked at the fleet of McDermott and our strategy to move into the ultra-deepwater, was the asset that was missing, and I think that we've been very fortunate and lucky that this opportunity has come up to allow us to really move into that space for, obviously, a very significant lower cost compared to the CapEx investments that were being made in these types of assets some 3, 4, 5 years ago. So we're very happy with what's happening on that. And then on the last one on the digital twin is, is it if you look at what McDermott does today, we are the last company that -- we're the company that hands over the facilities to the customer, we're the one that has all the last pieces of data and knowledge of how the facility was built. So how can you use that knowledge to create something for our customers and, obviously, for the industry that will allow us to really move forward at how we execute EPCI contracts in the future. So it's a better shift in culture in McDermott, but I also think that's also a reflection of the vision and the strategic thinking of what is a new management team, which is very much focused on the longer-term future of the company.

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Operator [33]

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Thank you. I am showing no further questions at this time. I'd like to turn the call back over to Kathy Murray for closing remarks.

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Katherine A. Murray, McDermott International, Inc. - VP of IR and Treasurer [34]

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Thank you for taking the time this morning to listen to McDermott's first quarter 2017 earnings call. As a reminder, this earnings call will be available for replay for 7 days after this call on our website at www.mcdermott.com. With that, thank you. And operator, this concludes our call.

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Operator [35]

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Thank you, ladies and gentlemen, this concludes today's conference. Thanks for your participation. Have a wonderful day. You may now disconnect.