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McDermott International (NYSE:MDR)

Q1 2013 Earnings Call

May 09, 2013 10:00 am ET

Executives

Steven D. Oldham - Vice President of Investor Relations and Treasurer

Stephen M. Johnson - Chairman, Chief Executive Officer and President

Perry L. Elders - Chief Financial Officer, Principal Accounting Officer and Senior Vice President

Analysts

Andy Kaplowitz - Barclays Capital, Research Division

Steven Fisher - UBS Investment Bank, Research Division

Linda Yuan

Will Gabrielski - Lazard Capital Markets LLC, Research Division

Martin W. Malloy - Johnson Rice & Company, L.L.C., Research Division

Tahira Afzal - KeyBanc Capital Markets Inc., Research Division

John B. Rogers - D.A. Davidson & Co., Research Division

Robert V. Connors - Stifel, Nicolaus & Co., Inc., Research Division

Robert F. Norfleet - BB&T Capital Markets, Research Division

Brian Konigsberg - Vertical Research Partners, LLC

Operator

Ladies and gentlemen, thank you for standing by, and welcome to McDermott International's First Quarter 2013 Earnings Conference Call. [Operator Instructions] Now let's turn the call over to our host, Steve Oldham, Vice President, Treasurer and Investor Relations. Please go ahead, sir.

Steven D. Oldham

Thank you, Ian. Good morning, everyone. We appreciate you joining us today as we discuss our results from the first quarter 2013, which were released through our press release and in our Form 10-Q yesterday. Joining me on the call this morning are Steve Johnson, McDermott's Chairman, President and Chief Executive Officer; and Perry Elders, our Senior Vice President and Chief Financial Officer. Before turning the call over to Steve, let me remind you that this event is being recorded, and a replay will be available for a limited time on our website.

Additionally, our comments will include forward-looking statements and estimates. These forward-looking comments are subject to various risks and uncertainties and reflect management's view as of May 9, 2013. Please refer to our filings with the SEC, which are available on our website, including our Form 10-K for the year ended 2012 and Form 10-Q for the 3 months ended March 31, 2013, which provide a discussion of factors that may cause actual results to differ from management's projections, forecasts, estimates and expectations. And please note that, except to the extent required by applicable law, McDermott undertakes no obligation to update any forward-looking statement.

With that disclosure, let me turn -- now turn the call over to Steve for his opening remarks.

Stephen M. Johnson

Thank you, Steve, and thanks to everyone for joining us today. During the first quarter, McDermott reported net income of $20.6 million or $0.09 per share. Later in the call, Perry will cover our financials in detail. Those results reflect some isolated challenges on a few of our projects, and we are absolutely focused on the resolution of those issues. For example, this quarter's largest project deterioration came from a Middle East project nearing completion that has been executed well into the final phase. However, during the hookup, our customer directed us to complete significantly more punch list items than we have planned, and as a result, we incurred additional costs related to third-party support vessels. I'd note that the overall project, including this quarter's charges, is expected to perform not only above the as-bid margin but also above our long-term target margins.

On another project in the Middle East segment, we experienced unplanned mechanical downtime on a vessel, which is a risk inherent in our operations. On our Malaysian subsea project, we increased our estimates to accelerate the project to meet the client's schedule and to incorporate recent experience with the vessels to be used in this project, which is scheduled to begin late in the second quarter.

Additional cost increases were associated with a project in the Atlantic segment at our Morgan City fabrication yard due to further deterioration in labor productivity. We have changed our estimate of our cost to complete to incorporate this deterioration and believe that the completion of this project, which is estimated for the second half of this year, reduces our exposure to the difficult labor climate on the U.S. Gulf Coast.

We previously implemented various cost reduction measures in the Atlantic segment to better align our operations with anticipated business levels. We anticipate further changes, which, if implemented, would have a significant impact to the results of operations.

Recognizing the challenges inherent in this largely lump-sum turnkey project business, in the past couple of years, we have been implementing a comprehensive project execution operating model that emphasizes our key project management disciplines and uses our best practices on a globally consistent basis throughout the company. The model encompasses all phases of our projects from business development to final delivery to our customer. Key elements of the model include project planning, including risk identification and mitigation planning, interface management as well as the incorporation of clearly defined accountability across the organization.

Importantly, I am bringing in project execution personnel from outside McDermott to assure best practices from industry are brought to bear on our projects. As this model and industry best practice becomes even more pervasive in the company's culture, I expect that we will be able to improve our execution on even the most challenging projects.

At this time, I'll turn the call over to Perry to discuss greater detail for the 2013 first quarter financial results. And at the conclusion of Perry's prepared remarks, I will return for additional operational and other comments, and then we'll open the call to questions. Perry?

Perry L. Elders

Thanks, Steve. As we reported, total revenues for the first quarter 2013 were $807.5 million, $80 million or 11% higher than the first quarter of 2012. Compared to last year's quarter, the increased revenues came from all our geographic segments, and the majority of the improvement was driven by our Atlantic segment's fabrication activity. With about $2.1 billion of remaining 2013 revenues expected to come from existing backlog, we continue to be comfortable that full year revenues are at or slightly above the $3 billion range is reasonable. Gross profit in the 2013 first quarter, however, declined by $35.6 million as compared to the year ago. The reduction was primarily due to higher estimates of our cost to complete several projects, which Steve mentioned.

At March 31, 2013, 5 of the projects in our backlog were in a loss position. Of these jobs, one had no material effect on the quarter's income. Another improved modestly, and the remaining 3 deteriorated $15.1 million. Additionally, as is typical for our business, we experienced changes in forecast project profitability on a number of jobs in a profitable position in the first quarter, including both improvements and deteriorations. As disclosed in our 10-Q, during the first quarter, we had 4 jobs in the Middle East segment deteriorate in gross profit by $34.2 million. Several of these projects were in advanced stages of completion. So under the POC revenue recognition policy, the majority of the deterioration on these projects was recognized during the first quarter, effectively a cumulative catch-up to prior periods' profits recognized. We also experienced a roughly equivalent amount of profit improvement on other jobs, which were in earlier stages of completion. Thus, the first quarter improvements did not fully mitigate the deteriorations on mature jobs.

SG&A expense increased by about $5.6 million in the first quarter to $52.2 million as compared to the 2012 first quarter, primarily due to increased bidding activity. Going forward, we expect our quarterly SG&A to be in the range of where it has been for the last 2 quarters.

Operating income for the first quarter 2013 totaled $53 million compared to $80.2 million for the comparable 2012 period. Operating margins this quarter were approximately 7% and included an approximately $12.3 million gain on the sale of the DB26. This sale transaction represented an incremental 2% of operating margin. We expect full year that 2013 operating margins to be in the range of the 7% reported first quarter operating margin and expect fourth quarter to make the most significant contribution because it includes the anticipated recognition of profit on our Papa Terra project. As a result, we may experience operating income margins below the 7% full year guidance in the second and third quarters, which could be near breakeven or even a loss.

In the other income and expense line, we had a decline of $11.9 million compared to the first quarter of 2012, primarily due to net foreign currency-related losses. We strive to minimize foreign exchange impacts as a U.S. dollar reporting entity. However, as guided in prior calls, the accounting for foreign currency hedges and balances continues to generate some lumpiness in our other income and expense line due to the movement between spot and forward rates.

Our tax provision in the first quarter of 2013 was $27.3 million, resulting in an effective tax rate of 53%. We were unable to recognize benefits associated with certain losses, primarily in the Atlantic segment but also in 0 tax jurisdictions.

Also as we discussed regularly, our earnings are subject to various rates driven by tax jurisdictions where we're working. For example, several jurisdictions apply a deemed profits tax to revenue regardless of profit or loss levels. Accordingly, we expect these factors to continue to drive our effective tax rate in the coming year to over 30%, with the rate -- with the specific rate dependent upon the jurisdictional mix of profits and the extent of unbenefited losses.

Net income after noncontrolling interest was $20.6 million for the first quarter of 2013 or $0.09 per fully diluted share compared to $0.25 we reported from continuing operations in the 2012 first quarter.

Moving to the balance sheet. We ended the quarter with $502 million of cash, cash equivalents and investments, down about $202 million from the sequential quarter. As we discussed in the last call, forecasted and announced capital growth investments, along with increase in project-specific working capital, consumed cash in the first quarter and will continue to be a significant use of cash for the next few quarters.

During the first quarter, we invested $38 million in capital expenditures, similar to the amount last year. The company's CapEx priorities for the year remain unchanged and include building out the Altamira yard, increasing the capabilities of the DB30 and the 32 and construction of the LV108 and the DLV2000. We continue to expect full year maintenance CapEx to be in the range of $75 million to $100 million, and in combination with these ongoing growth initiatives, we continue to expect annual total capital expenditures in the range of $400 million to $500 million in both 2013 and 2014. Just like our customer projects, shipyard payments on the new build vessels are based on milestones, so our CapEx will be lumpy from quarter-to-quarter.

We previously communicated our plan to sell older vessels. As mentioned, we recently closed on the sale of the Bold Endurance and the DB26. We're actively marketing the DB16 and KP1, which are classified as held for sale. As such, they are no longer depreciated and are not included in standard days of activity.

During the first quarter, our debt position declined slightly to $101 million as we made quarterly principal payments on the North Ocean 102 loan, which is now classified as a current liability since it matures in the first quarter of 2014.

Let me now turn the call back to Steve for his remaining comments.

Stephen M. Johnson

Thanks, Perry. On a noteworthy positive note, we booked the significant project in the Middle East during the first quarter that we signaled during last quarter's conference call, driving McDermott's first quarter bookings to about $1 billion for a book-to-bill ratio of about 1.2. Our ending March backlog was $5.3 billion.

At quarter end, our bids and change orders outstanding were $5.6 billion compared to $7.7 billion of bids and change orders outstanding in the fourth quarter and $4.8 billion a year ago. Our bidding and change order opportunities include 1 project in the billion-dollar range, about 9 projects in the hundred million dollar-plus range, with the remaining 30 or so below $100 million.

The planned reconcept of a perspective LNG project in Australia has caused us to move about $3 billion from our bids outstanding. And with this adjustment, the majority of the bids now relate to the Middle East segment. The mix has also shifted, and our outstanding bids are balanced between conventional and subsea work. We expect several of these projects to be awarded during the second or third quarter of this year.

In addition, our list of target projects remains strong at $10.1 billion as of March 31. As a reminder, targets of those projects that we intend to bid in the future are well suited for us and that we expect to reach award stage within the next 5 quarters.

As of March 31, the combination of our backlog was bids and change orders outstanding plus target projects, which is our revenue pipeline, totals $21 billion and represents the robust activity coming in the future.

The Altamira, Mexico fabrication facility is actively working on 2 EPCI projects for PEMEX. We are progressing well on these jobs, and the yard's performance is gaining attention of our super major customers. We're confident that Altamira will be the premier fabrication facility on the Gulf of Mexico with significant cost advantages over our U.S. competitors.

Moving to the Papa Terra project, which is our only project accounted for using deferred profit recognition. We continue to target early fourth quarter 2013 for the commencement of the marine installation scope for our FloaTEC joint ventures contract and our related subcontract for the completion of the full-field development. However, this is a moving target, and there could be further changes. At this time, we expect to mobilize the DB50 to Brazil in the third quarter with work to begin in early fourth quarter.

While discussions with our customers are ongoing and it's too early to predict outcomes, we do not expect such schedule changes to adversely impact our project estimates. As a result of our customers' plans to begin marine work in Brazil in Q4, we are now working to resequence project work for the DB50 on other jobs in the Gulf of Mexico and in Trinidad.

Now, turning to the Atlantic region and looking at it holistically. While we're not yet in a position to discuss any plans that we may be considering with respect to this segment, I will reiterate that we do anticipate making decisions, wish -- pardon me, which, if implemented, would improve our longer-term financial results, albeit with short-term changes or charges to our financials as you would expect. My expectation is that we may be in a position to discuss any decisions by the time we reach the second quarter 2013 earnings call.

Turning to our subsea initiative. We continue to make strides on our goal to be a top tier subsea contractor. We're progressing with our planned vessel upgrades, divestiture of older vessels and new additions to our fleet. At the moment, we plan on hitting the pause button on further expansions to our fleet, and we'll look to leverage other relationships to complement our fleet when needed.

Beyond hard assets, proprietary expertise is critical to developing superior technical solutions to capture a bigger share of the subsea value chain. During the quarter, we acquired DeepSea Engineering group, a subsea engineering company, in order to accelerate the growth of our engineering capabilities and as a catalyst for further organic growth of our subsea group. Some of this experienced team is already engaged in the planning and execution of our existing SURF project. While others are helping us prepare for future subsea opportunities in the North Sea, Gulf of Mexico and elsewhere in the world.

To close out my prepared remarks, I'd like to make the observation that while near-term challenges exist and we are actively taking steps to address them, I believe we have the right focus and priorities. We are maintaining our rigorous bidding discipline. We are enhancing project execution and control regimes, and we are positioning our assets and human capital to take advantage of the growing subsea market.

These are significant efforts, and they are transforming the company into serving the most profitable markets with an important and needed step change in project execution discipline.

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

Question-and-Answer Session

Operator

[Operator Instructions] Our first questions comes through is from the line of Andy Kaplowitz at Barclays.

Andy Kaplowitz - Barclays Capital, Research Division

Steve or Perry, first, can you clarify comments, Perry, that you made? Did you say that 2Q and 3Q could be breakeven or even in a loss? Is that for the company or for a specific division?

Perry L. Elders

That's for the company. Yes, that's what I said.

Andy Kaplowitz - Barclays Capital, Research Division

Okay. And what's going on there? Is that the Middle East projects being in a loss position now combined with the Atlantic? Or maybe you can give a little bit more clarity on what's going on over the next couple of quarters.

Perry L. Elders

Yes. Essentially, Andy, what we're looking at is we've completed, obviously, our largest recent project in Australia, so we no longer have the benefit of that. And the forecast Atlantic losses are offsetting, at least, in insignificant part, the profit in the Middle East and Asia Pacific.

Andy Kaplowitz - Barclays Capital, Research Division

Okay. Steve, maybe we could step back for a second. Has the market itself just gone -- I mean, we know it's gotten more competitive, but has it made it difficult to get acceptable contract terms? Is that what it is? It's been the last couple of years is just you've had to take contracts that maybe haven't had as good as terms in the past. What I'm worried about is that the market of the 10% to 12% margins is gone for a while. Talk me out of that.

Stephen M. Johnson

Yes. No, I don't think that the range of 10% to 12% is gone for a while, but I would say that we are maintaining our bidding disciplines, and we are not doing anything that, I would say, would add additional risk to the portfolio of projects. We have some unique circumstances during the quarter on these projects that we mentioned in the prepared remarks, and each one of them have their own unique situations. They are productivity and orientation, and those are the types of things that you estimate at the time you bid the programs. And as with others in our peer group, we've seen deterioration in the U.S. Gulf of Mexico, so we have had to adjust. They are also related to, in one instance, in the Middle East project I mentioned, a late situation on being asked to adjust our planning and adjust our project execution plan very near the end of the program, so that wasn't a situation that was a competitive outcome. And then lastly, as we talked about in recent calls, there are some challenges inside of the business that are only related to McDermott learning to do the more difficult and challenging subsea work. So the confluence of all of those together is what you're seeing in the quarter. And as you think about the next couple of quarters perhaps, it's much more related to the roll-off of the large project in Australia just completed without the pickup yet of the INPEX project and some of the others that are in backlog. So we haven't been able to recognize those revenues and profits.

Andy Kaplowitz - Barclays Capital, Research Division

Steve, is there anything to the thesis that -- we sat here last year at this time. We all talked about this sort of revenue hole in 2013. Is it possible that the company was a little more aggressive at that time with going after and booking projects to fill this hole? Because you fill the hole nicely but it hasn't been the most profitable work. And is it possible that maybe, as you look into '14 and beyond, it seems like the backlog is there for revenue. I mean, you've got the big Ichthys project in there. So maybe this is a sort of momentary issue that could get better? I mean, how would you sort of address that?

Stephen M. Johnson

Yes, I would agree with the original thesis, which is it is a momentary flat spot, if you want to characterize it that way, until we get into 2014. It is not anemia, if you will, or a flat spot driven by being aggressive in order to fill the revenue for 2013. We maintained our disciplines, so that's not what's going on here. Those revenues that we booked last year and a little bit before for 2013, for the most part, haven't started rolling off yet. So this is a lot more about the timing issue of the Australian project and then very specific and unique situations on the programs that we mentioned in the prepared remarks.

Operator

We have another question for you. This one's from the line of Steven Fisher at UBS.

Steven Fisher - UBS Investment Bank, Research Division

So it sounds like since you're not planning, or these were customer-directed changes at the very end of the projects in the Middle East. I guess the question would be why wouldn't those be subject to a change order.

Stephen M. Johnson

Well, while -- and that's one project, Steve, in terms of customer-directed changes. While it was a customer-directed change, it was an execution plan that we put in place that we were unable to effect. So very low likelihood, if at all, that there would be any recovery from the customer in this particular case. I'd make the observation that, that project is highly profitable and really reiterate that it's highly profitable, and only in this quarter did we take a charge associated with that. But it is well above as-bid margins.

Steven Fisher - UBS Investment Bank, Research Division

And so the projects that you're bidding and winning right now in the Middle East, did they have better risk terms than these 5 projects that kind of went tough this quarter?

Stephen M. Johnson

Yes. Well, we have 2 types of projects in the Middle East, those that are EPCI projects or projects that are stand-alone basis, and they come from our customers in -- our customer in Saudi Arabia, also in the neutral zone, and also down in or in the Emirates. And those are contract terms that we negotiate with the customer at the time of submittal and beyond. There is no material degradation to the contract terms at all in those programs. And then the second classification of projects are those that are in the so-called Saudi Aramco LTA program, long-term agreement program. And those contract terms and conditions are largely very stable and very comfortable for us, and we've been doing those programs for a number of years so therefore, no deterioration on those contract terms either.

Steven Fisher - UBS Investment Bank, Research Division

Well, you mentioned that you're bringing in some project execution experts. Can you just give a little more color on where these people are coming from? Are these essentially project manager types? And I guess the broad question that investors have is just how generally can you give them the confidence that you're going to be able to execute, to normalize margins on the projects going forward?

Stephen M. Johnson

Sure. I understand the question. The broader response would be, we have been working for a couple of years here with a new operating model that I mentioned in the prepared remarks, which puts us into a position where, I would say, we are equal to best in industry in terms of project planning, project analysis, execution, forecasting and control. And that has been rolled out through the past 12 months throughout the entire organization. There are sanctified rules associated with that program that didn't exist inside of McDermott prior to that. That causes project leaders to adhere to a very prescriptive planning and execution set of protocols. With respect to the people we're bringing in, there are 2 general buckets. There are people that we're bringing in for the new subsea business line that we're creating, and these people are being brought in not only at the project execution level but also in top management or general management level. The second classification of people are the whole suite of people that would be responsible for the successful technical, financial and schedule outcome of programs. And they are project managers, project controls people, meaning planning and cost engineers, and they are project accountants, and they are all the functional people that underpin that. McDermott has had a great wealth of talent in, what I would call, technical solutions and good project execution, but we're moving into a space using the new model and people from the outside with best practices, capability and all of those functions that I've just mentioned to come to bear on our overall project execution regimes. I've done this before. I've seen this before. This is what McDermott is needed. And we've been doing it for several quarters now, and it will begin to pay results, I believe.

Operator

We have another question for you. This one's from the line of Jamie Cook at Credit Suisse.

Linda Yuan

This is Linda Yuan in for Jamie. Could you guys talk a little bit more about, I guess in Q4, how much of a ramp in sales and margin should we expect there? And then, sort of, what kind of embedded core margin should we expect for the year. I mean, taking out the gain you had this quarter, you're at 5.5%. So I mean just kind of taking that out, what should we see?

Perry L. Elders

Yes. I'd say, Linda, on both questions there, on the second question first on the margin guidance, if, as Steve mentioned, the Papa Terra project can be completed as scheduled, then we would see getting to around 7% in operating income margin for the year. There's some risk to that, as Steve mentioned. As it relates to the first question -- and so just to clarify, I'm sorry, on the first question, the 7% is for the full year, which would mean, in the fourth quarter, we would exceed that because the next 2 quarters, we expect to be below that. As it relates to the volume of revenues in the fourth quarter, I don't think you'd see a significant step-up in revenues in Q4 relative to kind of our quarterly run rate. It's just these pent-up profits as Papa Terra begins to get recognized as we do the marine installation campaign.

Linda Yuan

Okay, great. And then switching over to the Atlantic region. I mean, where are you guys relative to those expectations of achieving profitability in that region? I mean, are there any other actions or more extreme actions that you can talk to that you might consider taking to reduce those losses there?

Stephen M. Johnson

Let me kick it off and if I could park the former question and turn it over to Perry. For, really, the latter half of the year, Perry, and what could drive improvement and profitability. The overriding question is what is management contemplating with respect to the Atlantic region to eliminate the challenges that have been around for, frankly, a number of years. As I said in my prepared comments, I'm not in a position to talk about any of the plans that we're contemplating. But I will tell you that all options are on the table. We have been working for a number of months now looking through those options. And when those decisions are made, once the appropriate people are informed, then we will be in a position to discuss them. So all I could say to investors at this point in time is that management is very active with potential solutions to the Atlantic region.

Perry L. Elders

And as it relates to the forepart of the question on timing in 2013, don't expect much of an improvement in the Atlantic here for the next couple of quarters. And then the fourth quarter is profitable assuming that we hit the execution plans in terms of the marine installation on Papa Terra.

Operator

We have another question for you. This one's from the line of Will Gabrielski at Lazard.

Will Gabrielski - Lazard Capital Markets LLC, Research Division

The question I had, looking into '14, so it sounds like the next 2 quarters, you break even or lose money, and then Q4 has a chance to get better with Papa Terra recognition starting to show up in the P&L. But when you get into '14, right, you probably have the remaining end of Papa Terra there, but you also have the ramp-up, presumably, of Ichthys. Can you talk about that'll ramp and contribute to the margin? And specifically in '14, I think a big chunk of the early work also has Heerema scope and how does that impact your P&L? And how should we be thinking about that?

Perry L. Elders

So as we indicated in our prepared comments and as you can tell from the Q, we do have, in our backlog, almost $1.8 billion that would roll off into 2014. So we still have work to do to book additional business for 2014, although we've had increasing visibility to it. As it relates to the specific project and that scope, that work by Heerema would be part of, I think, our partial cost pool. So we would begin recognizing profits when that portion of the work commences. So that would progress the progress on the job...

Stephen M. Johnson

With Heerema [ph] or ourselves.

Perry L. Elders

Correct.

Stephen M. Johnson

And that begins in the second half of 2014, just to kind of bracket it for you, Will. I would also add then in addition to INPEX, the backlog in the $1.8 billion that Perry just mentioned for roll-off in 2014 includes a number of programs in the Middle East, as well as in Asia Pacific. And those programs, in my -- from my perspective, certainly in the Middle East are programs that we have brought in, in recent quarters, one of which is the Safaniya 2 program that we announced, which has rolled off this year and next year. And it should produce significant earnings power for us, as well as a number of others in the Asia-Pacific region.

Will Gabrielski - Lazard Capital Markets LLC, Research Division

Okay. You mentioned resequencing the DB50 on some of its other jobs, so you can hit the timeline associated with Papa Terra. And I'm just wondering if there is any risk we need to worry about associated with the resequencing.

Stephen M. Johnson

No, we are frankly having to work not only with Papa Terra to respond to their schedule needs, which you would recall is driven by their delay of the marine campaign, which caused us to have to then to move our vessels around. And we had booked work for the DB50 associated with that campaign. So we're having to work with other customers either to resequence or possibly even bring in some third-party vessels to assist with those programs. Those conversations are ongoing. Understandings are very clear, and we should be in a position in short order here to be able to have that all very visible for us and for all the customers. So don't consider that a major concern at all, Will.

Will Gabrielski - Lazard Capital Markets LLC, Research Division

Okay. And then lastly, so you guys burned a lot of working capital in the first quarter and -- or burned a lot of cash and working capital in the first quarter, and it sounds like you're guiding for that over the next 2 quarters as well. And I'm just wondering, when you look at your financing plan right now for your committed capital for the on order and your maintenance CapEx that you do every year, do you see any risk within your current credit agreement that we should be thinking about at this point? And then also, are you guys thinking about going to -- how are you thinking about going to market to finance some of this CapEx over the next 2 or 3 years?

Perry L. Elders

Yes. Thanks, will. You are reading our guidance correctly in terms of what we're anticipating. But I would say it this way. We're financed for our existing commitments. Now that includes a conservative estimate of future operating profits. And so we do see cash coming down as we have been guiding for the last few years that we would use this cash, but we don't see an issue yet in terms of having to access the capital market. But Steve, did you want to comment about the other?

Stephen M. Johnson

Yes, I just support that. We're funding these vessels primarily out of operating cash flow. We are focused on customer collections. I will add that to the mix. We want to make sure that we're in cash neutral, or perhaps improve upon that with customers. So we're very active there. And then as Perry indicated, we're not in a position where we're saying that we're precluded from making decisions for debt financing if needs be going forward.

Operator

We have another question for you. This one's from Martin Malloy at Johnson Rice.

Martin W. Malloy - Johnson Rice & Company, L.L.C., Research Division

On the Middle East project that according to the Q, $17.5 million increased cost to complete. That's not going to be done until the end of -- by the end of '13. What confidence can you give us that there won't be further deterioration on the project?

Stephen M. Johnson

I would say the confidence is fairly high, and the reason I say that, Marty, is that it's a onetime situation as we have investigated that cost situation. The work that's ongoing now is going well. It's going in accordance with the estimate. We're in the 90-plus percent complete range today, expected to complete in, of course, the second half of the year. But there's nothing that we can see or the project team can see that would indicate any further problems with that program.

Martin W. Malloy - Johnson Rice & Company, L.L.C., Research Division

Okay. And then looking at the 1Q new awards with $900 million, the press release for the 2 awards in the Middle East, it looks like you only booked another $100 million of new awards, scope increases, change orders. Can you talk about why that was so low, and can we expect that to pick up here in 2Q?

Perry L. Elders

Yes. Just a little bit -- it's a little bit of nuance here, Marty, but you may recall that in the last quarter, we talked about the large award in Q1 that we booked a small portion of it in Q4. So there may be more of that number attributable to other awards than you're thinking. But I think directionally, you're right, and I think as we've talked about and Steve reiterated in his prepared comments, a lot of the bids outstanding are large and lumpy. And so we had one large one come through this quarter, and that's been the case in the past, and we expect that to be the case going forward. So you may have quarters without other large ones booked in it.

Operator

We have another question for you. This one's from the line of Tahira Afzal at KeyBanc.

Tahira Afzal - KeyBanc Capital Markets Inc., Research Division

The Middle East contracts that you had to revise and revisit costs on, could you give me an idea of when they were bid and when the construction started?

Perry L. Elders

I think she's talking about the one -- you're talking about the one that deteriorated this quarter, Tahira?

Tahira Afzal - KeyBanc Capital Markets Inc., Research Division

Actually, the 5 projects you mentioned or maybe the question where you last said [ph] anything would help.

Perry L. Elders

Yes. These are projects, as we disclosed in the Q, that of the 5 projects, 4 of them will complete this year, one of them in first quarter of next year. And these would have been projects that were bid several years ago.

Stephen M. Johnson

I would say 2011 and maybe as late as early part of 2012 from the bidding standpoint, Tahira.

Tahira Afzal - KeyBanc Capital Markets Inc., Research Division

Got it, okay. And I guess the second question is in regards to Papa Terra. I mean, I know you're working on the deferred sort of revenue schedule there, and now there's a lot banking on fourth quarter profitability from that. So any -- can you give us some idea of the risk that could be in place between now and the time you report in fourth quarter that we should just track in regards to Papa Terra?

Stephen M. Johnson

Well, I think the sense of your question is could it move around in terms of timing. At least, that's one of the things that I detect from your question. We are getting very clear direction from our customers -- customer that we should move the DB50 in the third quarter to site for an October -- early October begin marine campaign work. And in fact, in response to another's question here, we are so confident of that, that, that's why we've had to go into this resequencing mode with other of our customers in order to make sure that we can have the DB50 there. So is it likely that there could be some change? Sure. We're not in control of that decision, but we're getting very clear signals about that from a timing standpoint. The vessel goes to work early part of October, so the earnings -- the revenue generation and earnings production in Q4 that we are forecasting that we've spoken about in this call, we feel relatively comfortable with.

Operator

We have another question for you. This one's from the line of John Rogers at Davidson.

John B. Rogers - D.A. Davidson & Co., Research Division

I guess, Steve and Perry, I just want to follow up on the guidance a little bit for the next couple of quarters. I mean, it looks to me like you had fairly good bookings of work that will be executed in 2013. You've already recognized the losses on the projects in the Middle East, and you said that the work that you're booking is in reasonably good margins, and yet, you're talking about 0 margins potentially in the second and third quarter. Can you just help me with that a little bit?

Perry L. Elders

Yes. The -- as I mentioned, I understand the question. Atlantic is continuing to lose money as the forecast and the profits in the Middle East and Asia don't overcome that. So we do anticipate profits in the Middle East and Atlantic, however, because of these lost projects, some of that revenue will be coming through at no margin as Papa Terra is coming through at no margin. And then finally, what we've discussed in prior quarters about the overall guidance we've given for '13, is that we just don't see a lot of opportunity on the projects that will execute this year for significant brightening related to change orders and closeouts. So without that opportunity, with more of the projects in a loss position that are wrapping up this year, we just -- we aren't recognizing margin on a good chunk of revenue for this year.

Stephen M. Johnson

I'd add, John, and take you back to my prepared comments with respect to the Atlantic region, so an ancillary comment would be, other than normal operating flow, as Perry just talked about, should we make decisions with respect to the Atlantic region. Those decisions might result in Q2 and Q3 charges that we can't forecast today. But I wanted to make sure we got that in.

John B. Rogers - D.A. Davidson & Co., Research Division

But Steve, those sorts of charges are outside of the guidance that you're talking about. Is that correct?

Stephen M. Johnson

Correct.

John B. Rogers - D.A. Davidson & Co., Research Division

Okay. And the amount of work that you have in a loss position though, $428 million, actually, it's come down a little bit what you had at the end -- or the beginning of the year.

Perry L. Elders

Yes, I mean, that's what we've disclosed in the Q, combined, and then you have to put Papa Terra with that, but yes.

Stephen M. Johnson

And just, John, most of that is this year because there's only one of those that goes into early '14.

John B. Rogers - D.A. Davidson & Co., Research Division

Okay. And in terms of Papa Terra, can you give us some range of expectations on the deferred profits that's there now? And I know there's some disclosures the Q on it.

Perry L. Elders

Yes, I think you'll -- I can't be real specific other than the 7% for the full year includes recognizing that profit in Q4. So that kind of should be able to bracket it for you in your modeling if you -- depends on how you choose to model Q2 and Q3.

Operator

And we have another question for you. This one's from the line of Robert Connors at Stifel, Nicolaus.

Robert V. Connors - Stifel, Nicolaus & Co., Inc., Research Division

Just real quick, what is the man hours and utilization rates on the barges on the quarter?

Perry L. Elders

We didn't disclose that, but I would say it's not substantially different than what we've been previously talking about for years. The yards have been operating close to capacity in terms of our standards and the high-spec vessels likewise, and then the major work barges have been operating well less than standards. So part of this challenge with respect to margins is the underutilization of those major work barges, so there really wasn't any update to provide there.

Robert V. Connors - Stifel, Nicolaus & Co., Inc., Research Division

And previously, you had said that there are about 70 days of potential work around the Papa Terra project should it not go forward. Just wondering what the status is of winning that potential work to possibly fill some of the hole in 3Q?

Stephen M. Johnson

Well, we have some work in Q3, maybe some in late Q2. But Q3, I would not say that we have filled the hole for the entire 70 days, but we've utilized some of it.

Robert V. Connors - Stifel, Nicolaus & Co., Inc., Research Division

Okay. And then is there a potential that the Atlantic region could lose some of the existing backlog with the initiatives to be taken that you're going to announce in mid-2013?

Stephen M. Johnson

No.

Operator

We have another question for you. This one's from Rob Norfleet at BB&T Capital Markets.

Robert F. Norfleet - BB&T Capital Markets, Research Division

I just -- I had a question again on looking at the margins. I guess getting back to Andy's earlier question, Steve, you kind of mentioned this is not a structural issue, as it's been underbidding, and backlog does not have just a lot of low-margin work in it. And you kind of said this is more of a temporary issue. So that being -- said, when you look at -- I know there are a lot of moving parts here. You look at some of the initiatives you need to take. But when you look at your backlog, the work that you're bidding and make some assumptions, I mean, is it possible that margins in 2014 can get back to 10%? Or from what you see today, is that going to be a significant challenge?

Stephen M. Johnson

I would say it's possible. I would say that where we are today at first quarter, we're not in a position to give guidance for 2014. But we'll go through the rest of the year and be in a better position later in the year to forecast that.

Robert F. Norfleet - BB&T Capital Markets, Research Division

Okay. And then my second question just deals with the wage rate inflation. Obviously, that you all and competitors have experienced in the Atlantic and obviously, what that's doing to your labor productivity. How are you going forward in the structure fixed price work to account for this and obviously, higher wage rates impact the profitability metrics on contracts?

Stephen M. Johnson

Yes, Rob, it's the combination of wage rates and productivity that are hurting all of the contractors on the U.S. Gulf Coast. So what you have to do in this program is to make sure you've got the proper estimate of escalation that you can foresee and reasonably foresee in the bids. In terms of wage rate and in terms of productivity, we've got a lot of experience now with what the productivity is resulting in our Morgan City fabrication yard. And we'll be using that experience if we bid further.

Operator

We have another question for you. This one's from the line of Brian Konigsberg at Vertical Research.

Brian Konigsberg - Vertical Research Partners, LLC

Just a couple of real quick questions, just on Q4, so excluding the Papa Terra gain, you expect to or the profits you expect to realize, would that still be a breakeven quarter or does that include more project closeouts and other margin-enhancing opportunities within it?

Perry L. Elders

Well, I think I understand your question. We certainly forecast Papa Terra to contribute to profit. If the question is what happens if Papa Terra doesn't contribute anything, then I think you'd have the losses from the Atlantic region to consider. But we've got profits going in the other businesses. So if Papa Terra contributes profits or at least enough profits to make it breakeven, you'd be profitable because of the profits coming through from Middle East and Asia Pac.

Brian Konigsberg - Vertical Research Partners, LLC

Yes, yes. And Steve, just a strategic question, I mean, obviously, we've had a couple of -- a bunch of tough quarters behind us and also in Q1. I mean, this just seems to be a very, very difficult business. I mean, you're having customers approach you about change orders that you're having to assume the cost on the liability on, a lot of just execution disruptions. I mean, as far as McDermott operating as a stand-alone public company, has your view of your ability to maintain this current structure changed at all over the last few quarters? Or maybe you could just touch on that a little bit.

Stephen M. Johnson

Yes, I'd be happy to. What I have said in prior quarters is that because of that business model, we are open to, as McDermott, any manner of way to get scale to attenuate the volatility on behalf of our shareholders and to grow. And that view has not changed at all. The continued volatility in the business does not give management any more comfort than it has in prior quarters. We are working hard to organically adjust that through the things that I've talked about with our operating model, et cetera. But as indicated, we continue to seek opportunities to grow, build scale for the company on behalf of shareholders.

Operator

We have a further question for you from the line of Will Gabrielski at Lazard.

Will Gabrielski - Lazard Capital Markets LLC, Research Division

I just wanted to follow up on the comment around the 7% margin being possible for the year, and maybe you can help me clarify, but I'm having a hard time getting to what would drive that. So you know you did 9 -- if you work backwards, I'm trying to figure out what the implied op income is from that. And you take the $0.09 you did in Q1, breakeven in Q2 and 3, that implies a $0.41 quarter in the fourth quarter by my math. And I'm just wondering what else besides Papa Terra gets you there, because that seems like a bit of a stretch, and maybe I'm just doing the math wrong and you can help clarify that.

Perry L. Elders

Yes. Well, I think you're taking that math maybe to the extreme, which is what we've said in terms of Q2 and Q3, is that margins below 7% maybe is a breakeven or a loss. So I think your math is taking it all the way to 0 and assuming that for both quarters. So I think you're doing the math right. I'm not sure that's the way we're guiding though. What we're guiding for the Q2 and Q4 -- or Q2 and Q3 to be lower than 7% and possibly down to a breakeven or loss.

Will Gabrielski - Lazard Capital Markets LLC, Research Division

Oh, okay, that explains it.

Operator

There's no further questions at this stage, so I'd now like to turn the call back to Mr. Oldham for closing remarks.

Steven D. Oldham

Thank you again for participating today, and we invite you to join us on Tuesday, August 6, 2013, when we plan to review McDermott's second quarter results. Operator, this concludes our call.

Operator

Thank you. Thank you for your participation in today's conference. Ladies and gentlemen, this concludes the presentation, and you may now disconnect. Have a very good day.

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