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MDR > SEC Filings for MDR > Form 10-Q on 8-May-2013All Recent SEC Filings

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Form 10-Q for MCDERMOTT INTERNATIONAL INC


8-May-2013

Quarterly Report


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

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

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, 2012.

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, including timing to complete and cost to complete these projects;

anticipated levels of demand for our products and services;

market outlook for the EPCI market, including deepwater;

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 ability to dispose of assets held for sale in a timely manner or for a price at or above net realizable value;

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;


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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;

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;

natural or man-caused disruptive events that could damage our facilities, equipment or our work-in-progress and cause us to incur losses and/or liabilities;

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 we have 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 quarterly 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, 2012. 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.

Recent Developments

Acquisition

During the quarter ended March 31, 2013, we entered into a share purchase agreement to acquire all of the issued and outstanding shares of capital stock of Deepsea Group Limited, a United Kingdom-based company that provides subsea and other engineering services to international energy companies, primarily through offices in the United Kingdom and the United States. Total consideration was approximately $9.0 million, which includes cash ($6.0 million) and the delivery of 313,580 restricted shares of MII common stock (out of treasury). The transaction is being accounted for using the acquisition method and, accordingly, assets acquired and liabilities assumed are recorded at their respective fair values. The preliminary purchase price allocation has not been completed and is subject to change for a period of one-year following the acquisition. Pro forma results of operations have not been presented, as the effects of this transaction were not material to our condensed consolidated financial statements.


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Assets Held for Sale

We previously committed to a plan to sell three of our multi-function marine vessels, specifically the Bold Endurance, DB 16 andDB 26. In addition, during the quarter ended March 31, 2013, we committed to a plan to sell another multi-function marine vessel, the DLB KP1. Assets classified as held for sale are no longer depreciated.

During the quarter ended March 31, 2013, we completed the sale of the Bold Endurance and the DB 26 for aggregate cash proceeds of approximately $32.0 million, resulting in an aggregate gain of approximately $12.5 million. We remain in active discussions with several interested parties to sell the remaining vessels.

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. Factors that customers may consider include price, facility or equipment availability, technical capabilities of equipment and personnel, efficiency, safety record and reputation.

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, for each contract, we regularly review contract price and cost estimates as work progresses and reflect adjustments in profit proportionate to the percentage-of-completion of the related project 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 March 31, 2013, it is possible that we may incur liabilities for liquidated damages aggregating to approximately $93.0 million, of which approximately $11.0 million has been recorded in our financial statements, based on our actual or projected failure to meet certain specified contractual milestone dates. The dates for which these potential liquidated damages could arise extend to October 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 involved and, as a result, could be subject to higher damage amounts.

Change orders, which are a normal and recurring part of our business, can increase (sometimes substantially) the future scope and cost of a job. Therefore, change order awards (although frequently beneficial in the long term) can have the short-term effect of reducing the job percentage of completion and thus the revenues and profits recognized to date. We regularly review contract price and cost estimates as the work progresses and reflect adjustments in profit, proportionate to the job percentage of completion in the period when those estimates are revised. Revenue from unapproved change orders is recognized to the extent of amounts management expects to recover or costs incurred. Unapproved change orders that are disputed by the customer are treated as claims.

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, 2012. See Note 1 to our unaudited condensed consolidated financial statements included in this report for information on recently adopted accounting standards.


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Business Segments and Results of Operations

Business Segments

Our business segments consist of Asia Pacific, Atlantic, Caspian and the Middle East. The Caspian and Middle East operating segments are aggregated into the Middle East reporting segment due to the proximity of regions and similarities in the nature of services provided, economic characteristics and oversight responsibilities. 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. Accordingly, we report our financial results under reporting segments consisting of Asia Pacific, Atlantic and the Middle East. The following is a discussion of our segments. For financial information about our segments, see Note 8 to our unaudited condensed consolidated financial statements included in this report.

Asia Pacific Segment

Through our Asia Pacific segment, we serve the needs of customers 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 customers, 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 customers in Saudi Arabia, Qatar, the United Arab Emirates (U.A.E.), Kuwait, India, Azerbaijan, Russia and the North Sea. 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 lease 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
                                                                     March 31,
                                                               2013             2012
                                                                   (In thousands)
Revenues:
Asia Pacific                                                 $ 326,062        $ 297,035
Atlantic                                                       148,184           99,604
Middle East                                                    333,242          331,039

Total Revenues                                               $ 807,488        $ 727,678

Cost of Operations                                             712,814          597,434
Selling, general and administrative expenses                    52,226           46,611
Gain on asset disposals                                        (14,716 )           (226 )

Total costs and expenses                                       750,324          643,819

Equity in Loss of Unconsolidated Affiliates                     (4,131 )         (3,683 )


Operating Income (Loss):
Asia Pacific                                                 $  87,952        $  57,434
Atlantic                                                       (16,410 )        (11,993 )
Middle East                                                    (18,509 )         34,735

Total Operating Income                                       $  53,033        $  80,176


Other Income (Expense):
Interest income                                                    342            1,634
Gain (loss) on foreign currency-net                             (2,526 )          9,441
Other income (expense)-net                                         782             (581 )

Total Other Income (Expense)                                    (1,402 )         10,494

Income from continuing operations before provision for
income taxes and noncontrolling interests                       51,631           90,670


Provision for Income Taxes                                      27,313           28,743
Total Income from Discontinued Operations, Net of Tax               -             3,497
Net Income Attributable to Noncontrolling Interests              3,765            2,666

Net Income Attributable to McDermott International, Inc.     $  20,553        $  62,758

Three months ended March 31, 2013 vs. 2012

Revenues

Revenues increased approximately 11%, or $79.8 million, to $807.5 million in the three months ended March 31, 2013 compared to $727.7 million for the corresponding prior-year period, primarily attributable to increases in our Atlantic and Asia Pacific segments. Revenues in our Atlantic segment increased approximately 49%, or $48.6 million, to $148.2 million in the three months ended March 31, 2013 compared to $99.6 million in the three months ended March 31, 2012, influenced primarily by an increase in fabrication activities associated with project awards in the U.S. Gulf of Mexico and Mexico. Revenues in our Asia Pacific segment increased approximately 10%, or $29.0 million, to $326.1 million in the three months ended March 31, 2013 from $297.0 million in the corresponding prior-year period, driven largely by increased marine activity on three of our projects, along with increased fabrication activity on two of our other projects. This increase was partially offset by decreased activity on an EPCI project in Australia, which we completed during the quarter ended March 31, 2013. Revenues in our Middle East segment increased modestly compared to the three months ended March 31, 2012, primarily due to increased marine activities on several projects in Saudi Arabia.


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Cost of Operations

Cost of operations increased approximately 20%, or $115.4 million, to $712.8 million in the three months ended March 31, 2013 compared to $597.4 million for the corresponding prior-year period. The increase was attributable to increased project costs in our Middle East and Atlantic segments. Costs of operations in the Middle East segment increased $54.0 million, primarily as a result of cost overruns associated with marine installation activities and, to a lesser extent, fabrication activities on certain projects. The increase in project costs in the Atlantic segment of $50.0 million was driven largely by an increase in fabrication activities combined with increased marine costs due to lower marine asset utilization. The cost of operations in the Asia Pacific segment increased $11.0 million, primarily due to increased fabrication and marine activities, partially offset by efficiencies realized as a result of increased marine asset utilization. These cost of operations variances are discussed in more detail below in the discussion regarding operating income.

Operating Income

Operating income decreased approximately 34%, or $27.2 million, to $53.0 million in the three months ended March 31, 2013 compared to $80.2 million for the corresponding prior-year period, primarily attributable to decreases in our Middle East segment and, to a lesser extent, continued operating losses in our Atlantic segment. These operating losses were offset by increases in our Asia Pacific segment and, to a lesser extent, gains of approximately $12.5 million associated with vessel sales.

The Middle East segment reported an operating loss of $18.5 million in the three months ended March 31, 2013, as compared to operating income of $34.7 million for the corresponding prior-year period, a decrease of $53.2 million. The decrease was primarily attributable to a few significant factors. First, during the quarter ended March 31, 2012, one project in Saudi Arabia contributed approximately $20.0 million in operating income, with no amount being recognized in the quarter ended March 31, 2013, principally as a result of the project having been completed prior to the start of the first quarter of 2013. Additionally, the Middle East segment was impacted by changes in estimates on five projects. In total, those five projects recognized approximately $7.7 million in project losses in the three months ended March 31, 2013, as a result of increases to the estimated costs to complete these projects of approximately $38.0 million. On one of those projects, we increased our estimated cost at completion by $17.5 million, which resulted in the recognition of a $5.4 million project loss in the three months ended March 31, 2013, primarily due to changes in the project's execution plan, which resulted in additional third-party construction vessel usage and marine downtime, cost overruns on offshore hook-up activities and additional costs for project management-related activities. This project remains in a profitable position at March 31, 2013 and is estimated to be completed by the end of 2013.

On three of our other projects in the Middle East segment, we increased our estimated cost at completion by $16.7 million, which resulted in the recognition of only $1.8 million of project income in the three months ended March 31, 2013, principally driven by cost overruns associated with marine equipment downtime, including productivity, hook-up and project management-related activities. Each of those projects was in a profitable position at March 31, 2013. Two of those projects are estimated to be completed by the end of 2013, and the remaining project is estimated to be completed during the first quarter of 2014. On the remaining project in the Middle East segment, we recognized incremental costs of $4.1 million in the three months ended March 31, 2013, primarily due to cost overruns on marine installation activities. That project was in a loss position at March 31, 2013 and is estimated to be completed by the end of the second quarter of 2013. These decreases in operating income were partially offset by $5.9 million of increases in operating income recognized in the three months ended March 31, 2013 as a result of activities on newly awarded projects.

Operating income in our Asia Pacific segment increased $30.5 million to $88.0 million in the three months ended March 31, 2013 from $57.4 million for the corresponding prior year period, primarily attributable to several factors. First, we recognized improvements from the completion of one of our EPCI . . .

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