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MDR > SEC Filings for MDR > Form 10-Q on 5-Nov-2012All Recent SEC Filings

Show all filings for MCDERMOTT INTERNATIONAL INC

Form 10-Q for MCDERMOTT INTERNATIONAL INC


5-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS

We are including the following discussion to inform our existing and potential security holders generally of some of the risks and uncertainties that can affect our company and to take advantage of the "safe harbor" protection for forward-looking statements that applicable federal securities law affords. This information should be read in conjunction with the unaudited condensed consolidated financial statements and the notes thereto included under Item 1 and the audited consolidated financial statements and the related notes and Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in our annual report on Form 10-K for the year ended December 31, 2011.

In this quarterly report on Form 10-Q, unless the context otherwise indicates, "we," "us" and "our" mean MII and its consolidated subsidiaries.

From time to time, our management or persons acting on our behalf make forward-looking statements to inform existing and potential security holders about our company. These statements may include projections and estimates concerning the scope, execution, timing and success of specific projects and our future backlog, revenues, income and capital spending. Forward-looking statements are generally accompanied by words such as "estimate," "project," "predict," "forecast," "believe," "expect," "anticipate," "plan," "seek," "goal," "could," "may," or "should" or other words that convey the uncertainty of future events or outcomes. Sometimes we will specifically describe a statement as being a forward-looking statement and refer to this cautionary statement.

These forward-looking statements include, but are not limited to, statements that relate to, or statements that are subject to risks, contingencies or uncertainties that relate to:

future levels of revenues, operating margins, income from operations, net income or earnings per share;

outcome of project awards and scope, execution and timing of specific projects;

anticipated levels of demand for our products and services;

future levels of capital, environmental or maintenance expenditures;

the success or timing of completion of ongoing or anticipated capital or maintenance projects;

the adequacy of our sources of liquidity and capital resources;

expectations regarding the acquisition or divestiture of assets;

the potential effects of judicial or other proceedings on our business, financial condition, results of operations and cash flows; and

the anticipated effects of actions of third parties such as competitors, or federal, foreign, state or local regulatory authorities, or plaintiffs in litigation.

These forward-looking statements speak only as of the date of this report; we disclaim any obligation to update these statements unless required by securities law, and we caution you not to rely on them unduly. We have based these forward-looking statements on our current expectations and assumptions about future events. While our management considers these expectations and assumptions to be reasonable, they are inherently subject to significant business, economic, competitive, regulatory and other risks, contingencies and uncertainties, most of which are difficult to predict and many of which are beyond our control. These risks, contingencies and uncertainties relate to, among other matters, the following:

general economic and business conditions and industry trends;

general developments in the industries in which we are involved;

decisions about offshore developments to be made by oil and gas companies;

the highly competitive nature of our industry;

cancellations of and adjustments to backlog and the resulting impact from using backlog as an indicator of future revenues or earnings;

the capital investment required to maintain and/or upgrade our fleet of vessels;

the ability of our suppliers and subcontractors to deliver raw materials in sufficient quantities and/or perform in a timely manner;

our ability to appropriately bid, estimate and effectively perform projects on time, in accordance with the schedules established by the applicable contracts with customers;

volatility and uncertainty of the credit markets;


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our ability to comply with covenants in our credit agreements and other debt instruments and availability, terms and deployment of capital;

the unfunded liabilities of our pension plans may negatively impact our liquidity and, depending upon future operations, may impact our ability to fund our pension obligations;

the continued availability of qualified personnel;

the operating risks normally incident to our lines of business, including the potential impact of liquidated damages;

changes in, or our failure or inability to comply with, government regulations;

adverse outcomes from legal and regulatory proceedings;

impact of potential regional, national and/or global requirements to significantly limit or reduce greenhouse gas and other emissions in the future;

changes in, and liabilities relating to, existing or future environmental regulatory matters;

changes in tax laws;

rapid technological changes;

the consequences of significant changes in interest rates and currency exchange rates;

difficulties we may encounter in obtaining regulatory or other necessary approvals of any strategic transactions;

the risks associated with integrating acquired businesses;

the risk we may not be successful in updating and replacing current key financial and human resources legacy systems;

social, political and economic situations in foreign countries where we do business;

the risks associated with our international operations, including local content requirements;

interference from adverse weather conditions;

the possibilities of war, other armed conflicts or terrorist attacks;

the effects of asserted and unasserted claims and the extent of available insurance coverages;

our ability to obtain surety bonds, letters of credit and financing;

our ability to maintain builder's risk, liability, property and other insurance in amounts and on terms we consider adequate and at rates that we consider economical;

the aggregated risks retained in our captive insurance subsidiary; and

the impact of the loss of insurance rights as part of the Chapter 11 Bankruptcy settlement concluded in 2006 involving several of our former subsidiaries.

We believe the items outlined above are important factors that could cause estimates in our financial statements to differ materially from actual results and those expressed in a forward-looking statement made in this report or elsewhere by us or on our behalf. We have discussed many of these factors in more detail elsewhere in this report and in our annual report on Form 10-K for the year ended December 31, 2011. These factors are not necessarily all the factors that could affect us. Unpredictable or unanticipated factors we have not discussed in this report could also have material adverse effects on actual results of matters that are the subject of our forward-looking statements. We do not intend to update our description of important factors each time a potential important factor arises, except as required by applicable securities laws and regulations. We advise our security holders that they should (1) be aware that factors not referred to above could affect the accuracy of our forward-looking statements and (2) use caution and common sense when considering our forward-looking statements.

Accounting for Contracts

We execute our contracts through a variety of methods, including fixed-price, cost reimbursable, cost-plus, day-rate and unit-rate basis or some combination of those methods, with fixed-price being the most prevalent. Contracts are usually awarded through a competitive bid process, primarily based on price. However, other factors that customers may consider include facility or equipment availability, technical capabilities of equipment and personnel, efficiency, safety record and reputation.


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Fixed-price contracts are for a fixed amount to cover costs and any profit element for a defined scope of work. Fixed-price contracts entail more risk to us because they require us to predetermine both the quantities of work to be performed and the costs associated with executing the work.

We have contracts that extend beyond one year. Most of our long-term contracts have provisions for progress payments. We attempt to cover anticipated increases in labor, material and service costs of our long-term contracts either through an estimate of such charges, which is reflected in the original price, or through risk-sharing mechanisms, such as escalation or price adjustments for items such as labor and commodity prices.

We generally recognize our contract revenues and related costs on a percentage-of-completion basis. Accordingly, we review contract price and cost estimates regularly as the work progresses and reflect adjustments in profit proportionate to the percentage-of-completion in the period when we revise those estimates. To the extent that these adjustments result in a reduction or elimination of previously reported profits with respect to a project, we would recognize a charge against current earnings, which could be material.

Our arrangements with customers frequently require us to provide letters of credit, bid and performance bonds or guarantees to secure bids or performance under contracts. While these letters of credit, bonds and guarantees may involve significant dollar amounts, historically, there have been no material payments to our customers under these arrangements.

Some of our contracts contain provisions that require us to pay liquidated damages if we are responsible for the failure to meet specified contractual milestone dates and the applicable customer asserts a claim under these provisions. These contracts define the conditions under which our customers may make claims against us for liquidated damages. In many cases in which we have historically had potential exposure for liquidated damages, such damages ultimately were not asserted by our customers. As of September 30, 2012, it is possible that we may incur liabilities for liquidated damages aggregating approximately $96 million, of which approximately $17 million has been recorded in our financial statements, based on our actual or projected failure to meet certain specified contractual milestone dates. The date range during which these potential liquidated damages could arise is from June 2011 to June 2013. We believe we will be successful in obtaining schedule extensions or other customer-agreed changes that should resolve the potential for additional liquidated damages. Accordingly, we believe that no amounts for these potential liquidated damages in excess of the amounts currently reflected in our financial statements are probable of being paid by us. However, we may not achieve relief on some or all of the issues.

In the event of a contract deferral or cancellation, we generally would be entitled to recover costs incurred, settlement expenses and profit on work completed prior to deferral or termination. Significant or numerous cancellations could adversely affect our business, financial condition, results of operations and cash flows.

Critical Accounting Policies and Estimates

For a discussion of critical accounting policies and estimates we use in the preparation of our consolidated financial statements, refer to Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in our annual report on Form 10-K for the year ended December 31, 2011. See Note 1 to our unaudited condensed consolidated financial statements included in this report for information on recently adopted accounting standards.

Recent Development

During the quarter ended September 30, 2012, we committed to a plan to sell three of our multi-function marine vessels, specifically the Bold Endurance, DB 16 and DB 26. As a result, we have reclassified approximately $31.4 million pertaining to these assets to assets held for sale from property, plant and equipment in our condensed consolidated balance sheet at September 30, 2012.

Business Segments and Results of Operations

Business Segments

Our business segments consist of Asia Pacific, Atlantic and the Middle East. We also report certain corporate and other non-operating activities under the heading "Corporate and Other." Corporate and Other primarily reflects corporate personnel and activities, incentive compensation programs and other costs, which are generally fully allocated to our operating segments. The following is a discussion of our segments.


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Asia Pacific Segment

Through our Asia Pacific segment, we serve the needs of national, major integrated and other oil and gas companies primarily in Australia, Indonesia, Vietnam, Malaysia and Thailand. Project focus in this segment includes the fabrication and installation of fixed and floating structures and the installation of pipelines and subsea systems. The majority of our projects in this segment are performed on an engineering, procurement, construction and installation ("EPCI") basis. Engineering and procurement services are provided by our Singapore office and are supported by additional resources located in Chennai, India and Houston, Texas. The primary fabrication facility for this segment is located on Batam Island, Indonesia. Additionally, through our equity ownership interest in a joint venture, we have developed a fabrication facility located in China.

Atlantic Segment

Through our Atlantic segment, we serve the needs of national, major integrated and other oil and gas companies, primarily in the United States, Brazil, Mexico, Trinidad and West Africa. Project focus in this segment includes the fabrication and installation of fixed and floating structures and the installation of pipelines and subsea systems. Engineering and procurement services are provided by our Houston office, and our New Orleans office provides specialized marine engineering capabilities to support our global marine activities. The primary fabrication facilities for this segment are located in Morgan City, Louisiana and Altamira, Mexico.

Middle East Segment

Through our Middle East segment, which includes the Caspian region, we serve the needs of national, major integrated and other oil and gas companies primarily in Saudi Arabia, Qatar, the United Arab Emirates (U.A.E.), Kuwait, India, Azerbaijan, the North Sea and Russia. Project focus in this segment relates primarily to the fabrication and offshore installation of fixed and floating structures and the installation of pipelines and subsea systems. The majority of our projects in this segment are performed on an EPCI basis. Engineering and procurement services are provided by our Dubai, U.A.E., Chennai, India and Al Khobar, Saudi Arabia offices and are supported by additional resources from our Houston, Texas and Baku, Azerbaijan offices. The primary fabrication facility for this segment is located in Dubai, U.A.E.

The above-mentioned fabrication facilities in each segment are equipped with a wide variety of heavy-duty construction and fabrication equipment, including cranes, welding equipment, machine tools and robotic and other automated equipment. Project installation is performed by major construction vessels, which we own or operate and are stationed throughout the various regions and provide structural lifting/lowering and pipelay services. These major construction vessels are supported by our multi-function vessels and chartered vessels from third parties to perform a wide array of installation activities that include anchor handling, pipelay, cable/umbilical lay, dive support and hookup/commissioning.


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Results of Operations (Selected Financial Data):



                                                Three Months Ended               Nine Months Ended
                                                  September 30,                    September 30,
                                               2012            2011            2012             2011
                                                                   (In thousands)
Revenues:
Asia Pacific                                $   468,200      $ 528,453      $ 1,103,699      $ 1,551,099
Atlantic                                        125,317         74,683          335,225          167,129
Middle East                                     435,228        276,758        1,206,747          910,707

Total revenues                              $ 1,028,745      $ 879,894      $ 2,645,671      $ 2,628,935

Cost of operations                              889,823        802,951        2,246,961        2,253,981
Selling, general and administrative
expenses                                         51,834         48,046          145,927          163,827
Gain on asset disposals                             (85 )       (7,811 )           (282 )         (8,107 )

Total costs and expenses                        941,572        843,186        2,392,606        2,409,701

Equity in Income (Loss) of Unconsolidated
Affiliates                                       (4,692 )       (1,492 )        (11,026 )             59

Operating income (loss):
Asia Pacific                                $    52,192      $  44,960      $   156,231      $   142,350
Atlantic                                        (10,714 )      (37,020 )        (36,749 )        (71,264 )
Middle East                                      41,003         27,276          122,557          148,207

Total operating income                      $    82,481      $  35,216      $   242,039      $   219,293

Other income (expense):
Interest income                                     996            319            4,215            1,060
Interest expense                                     -            (152 )             -              (415 )
Gain (loss) on foreign currency - net               488            504           11,185           (2,356 )
Other income (expense) - net                        242           (298 )           (288 )         (1,586 )

Total other income (expense)                      1,726            373           15,112           (3,297 )

Income from continuing operations before
provision for income taxes and
noncontrolling interests                         84,207         35,589          257,151          215,996

Provision for Income Taxes                       29,916         20,535           87,004           60,351
Total Income from Discontinued
Operations, net of tax                               -           1,187            3,497            6,459
Net Income Attributable to Noncontrolling
Interests                                         3,679          5,290            7,535           13,405

Net Income Attributable to McDermott
International, Inc.                         $    50,612      $  10,951      $   166,109      $   148,699

Three months ended September 30, 2012 vs. 2011

Revenues

Revenues increased approximately 17%, or $148.8 million, to $1,028.7 million in the three months ended September 30, 2012 compared to $879.9 million for the corresponding 2011 period. The revenue growth was attributable to the Middle East and Atlantic segments. Revenues in the Middle East segment increased $158.4 million to $435.2 million in the three months ended September 30, 2012, compared to $276.8 million in the three months ended September 30, 2011, as a result of increased fabrication and marine activity associated with one of our EPCI projects and other projects, which recently commenced fabrication and marine activities. Revenues in our Atlantic segment increased $50.6 million to $125.3 million in the three months ended September 30, 2012, compared to $74.7 million in the three months ended September 30, 2011, primarily due to increased fabrication activity experienced on certain projects during the three-month period ended September 30, 2012. Revenue improvements in the Middle East and Atlantic segments were partially offset by a decline in our Asia Pacific segment, where revenues decreased approximately 11%, or $60.3 million, to $468.2 million, driven largely by lower marine activity associated with several projects that were ongoing during the quarter ended September 30, 2011 but were completed or substantially complete prior to the quarter ended September 30, 2012.


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Cost of Operations

Cost of operations increased approximately 11%, or $86.8 million, to $889.8 million in the three months ended September 30, 2012 compared to $803.0 million for the corresponding 2011 period. The increase was primarily attributable to increased project costs in the Middle East and, to a lesser extent, our Atlantic segment, partially offset by a decrease in project costs in the Asia Pacific segment. The increases in project costs in the Middle East and Atlantic segments were driven by higher levels of project activity involving increased fabrication and marine activity. Costs of operations in Asia Pacific decreased primarily as a result of lower marine activity associated with several projects that were ongoing during the quarter ended September 30, 2011, but were completed or substantially complete prior to the quarter ended September 30, 2012.

Operating Income

Operating income increased $47.3 million to $82.5 million in the quarter ended September 30, 2012 from $35.2 million in the quarter ended September 30, 2011. Operating income in the Middle East segment increased $13.7 million, primarily as a result of increased fabrication and marine activities associated with one of our EPCI projects and other projects for which we recently commenced fabrication and marine activities. Operating income in the Asia Pacific segment increased $7.2 million to $52.2 million in the three months ended September 30, 2012, primarily due to improvements from change orders and, to a lesser extent, cost savings on an EPCI project, partially offset by reduced marine activities.

The Atlantic segment reported an operating loss of $10.7 million for the quarter ended September 30, 2012, an improvement of $26.3 million compared to the corresponding 2011 period. The improvement was driven primarily by losses on two projects amounting to approximately $38 million that were recognized in the quarter ended September 30, 2011, which were not experienced during the third quarter of 2012 and, to a lesser extent, increased fabrication activity.

We currently have two projects, one of which is in our Atlantic segment and the other of which is in our Asia Pacific segment, that we account for under our deferred profit recognition policy, under which we recognize revenue and cost equally and only recognize profit when probable and reasonably estimable, generally when the contract is approximately 70% complete. These projects contributed revenues equal to costs totaling approximately $22.2 million and $6.0 million for the three-month periods ended September 30, 2012 and 2011, respectively.

Operating Margins

Operating income and margins are frequently influenced by the finalization of change orders, project close-outs and settlements, which generally can cause operating margins to improve during the period in which these items are approved or resolved, as these items generally contribute higher operating margins. While we expect change orders, close-outs and settlements to continue as part of our normal business activities, the period in which they are recognized is largely driven by the finalization of agreements with customers and suppliers and, therefore, is difficult to predict.

Total operating margins, defined as operating income divided by revenues were 8% for the quarter ended September 30, 2012 and 4% for the quarter ended September 30, 2011. In the quarter ended September 30, 2012, we experienced increased operating margins in our Asia Pacific segment, largely as a result of improvements from change orders and cost savings on marine installation activities on one of our EPCI projects. Operating margins in our Middle East segment remained relatively flat for the quarter ended September 30, 2012.

We experienced improvements in operating margins in our Atlantic segment in the quarter ended September 30, 2012, primarily due to project losses amounting to approximately $38 million that we recognized in the quarter ended September 30, 2011. We did not experience comparable losses during the third quarter of 2012.

Other Items in Operating Income

Selling, general and administrative expenses increased $3.8 million to $51.8 million in the three months ended September 30, 2012 as compared to $48.0 million in the three months ended September 30, 2011. The increase was primarily due to higher employee benefit costs, including those associated with our bonus program.


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Equity in income (loss) of unconsolidated affiliates increased $3.2 million to a loss of $4.7 million for the three months ended September 30, 2012 as compared to a loss of $1.5 million in the quarter ended September 30, 2011, primarily attributable to increased equity losses from two of our joint ventures.

Other Items

Interest income was $1.0 million and $0.3 million for the three months ended September 30, 2012 and September 30, 2011, respectively, primarily as a result of higher cash and cash equivalents balances being placed in interest bearing accounts.

Results for the quarters ended September 30, 2012 and 2011 were not significantly impacted by interest expense, gain (loss) on foreign currency - net or other expense.

Provision for Income Taxes

For the three months ended September 30, 2012, the provision for income taxes increased $9.4 million to $29.9 million, while income before provision for income taxes increased $48.6 million to $84.2 million. The increase in the provision for income taxes was primarily attributable to the mix of earnings across jurisdictions resulting in a larger proportion of our income being taxed at higher tax rates, and losses in certain tax jurisdictions for which we do not expect to receive a tax benefit. The losses in tax jurisdictions for which we do not expect to receive a tax benefit decreased while total income before provision for income taxes increased. As a result, our effective tax rate for the three months ended September 30, 2012 was approximately 36% as compared to 58% for the comparable 2011 period.

Discontinued Operations

On March 19, 2012, we completed the sale of our former charter fleet business for cash consideration of approximately $61 million, resulting in a gain on the sale of approximately $0.3 million. Accordingly, we reported no discontinued operations for the three months ended September 30, 2012. Total income from discontinued operations, net of tax was $3.5 million for the three months ended September 30, 2011.

Noncontrolling Interests

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