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Executives

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

Stephen Johnson - Chairman, Chief Executive Officer and President

John Roueche - Vice President of Treasury and Investor Relations

Analysts

Tahira Afzal - KeyBanc Capital Markets Inc.

Roger Read

Chase Jacobson - William Blair & Company L.L.C.

Robert Norfleet - BB&T Capital Markets

Andy Kaplowitz - Barclays Capital

Martin Malloy - Johnson Rice & Company, L.L.C.

Jamie Cook - Crédit Suisse AG

Will Gabrielski - Gleacher & Company, Inc.

Joseph Ritchie - Goldman Sachs Group Inc.

Steven Fisher - UBS Investment Bank

McDermott International (MDR) Q2 2011 Earnings Call August 4, 2011 10:00 AM ET

Operator

Ladies and gentlemen, thank you for standing by, and welcome to McDermott International Second Quarter 2011 Earnings Conference Call. [Operator Instructions] I would now like to turn the call over to our host, Mr. Jay Roueche, McDermott's Treasurer and Vice President of Investor Relations. Please go ahead.

John Roueche

Thank you, Kim, and good morning, everyone. We appreciate you joining us today to discuss McDermott's second quarter 2011 financial results, which we reported after the markets closed 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 I turn the call over, let me remind you that this event is being recorded and replay will be available for a limited time on our website. In addition, some of the comments this morning will include forward-looking statements and estimates. And these comments are subject to various risks and uncertainties, and they reflect management's view as of August 4, 2011. Please refer to our filings with the Securities and Exchange Commission, which are available on our website, including our Form 10-K for the year ended December 31, 2010, and our recently filed Form 10-Q for a discussion of the 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.

Also, throughout our comments today, any reference to company records, company history or other past comparisons relating into our continuing operations only and are typically represented by the former Offshore Oil & Gas Construction segment. With that, I'll now turn the call over to Steve Johnson, McDermott's Chairman, President and CEO, for his remarks on the second quarter and the overall business environment.

Stephen Johnson

Thanks, Jay, and good morning, everyone. We appreciate you joining us today to discuss McDermott's results for the second quarter and the overall business environment. In my view, we had a good quarter, albeit somewhat mixed. Similar to the first quarter of this year, there was quite a lot to like, and we still have areas with room for improvement. Our gross profit margins improved sequentially from 2011 first quarter, although attenuated in the operating margin by a $5 million increase in SG&A, which was largely as a result of increased sales and bidding expenses, and a $5.3 million negative swing from equity income in the first quarter to an equity loss in Q2. Together, these movements lowered operating margin by about 120 basis points compared to 2011 first quarter. Notwithstanding, I believe the results for the second quarter still keep us on pace for a good year. Highlights of the quarter include over $800 million in new bookings, generating a book-to-bill of almost 1, with another quarter of strong revenues while maintaining a solid financial position. As I just alluded to, revenues were robust at nearly $850 million, down a bit sequentially but up 35% year-over-year. Quarterly operating income was about $84 million, which resulted in an operating margin of about 10%. Net income of about $64 million produced $0.27 of earnings per diluted share. Perry will cover the financials in detail, but all in all, we're satisfied with our results for this quarter.

As I do just about every quarter, whether the results are good or they're challenging, I always remind investors not to get too excited about 90-day results. As you know, our projects are multi-year in duration, and we build our projects exposed to the environment, and we install them in water. We also use percentage-of-completion accounting, and there are usually a number of puts and takes in any given quarter associated with our predominantly fixed price portfolio of contracts. As such, it's always best to take a long-term view when evaluating our company.

Although revenues were at a high level during the quarter, interestingly, we actually had a lower number of man-hours worked as compared to both the prior year and sequential quarters. We had nearly 50% decline in fabrication for Batam Island in the Asia-Pacific segment, which offset the increased man-hours in the Atlantic segment, both at Morgan City and Altamira, Mexico. To be more specific, in our major construction facilities, we worked a total of about 3.5 million man-hours during the quarter, which is both below the 2011 first quarter and the 2010 second quarter. For the first time in a while, we were below our fabrication standards for our quarter. Similar to the geographic split of our backlog, the majority of this quarter's construction activity took place in our Middle East and Asia-Pacific facilities, but as I mentioned, we did see an improvement in the Atlantic segment, which is good news.

Our marine activity was also mixed but noticeably improving. For our major work barges, we recognized increased workdays, both compared to the year-ago and sequential quarters. The primary driver of the increased level was getting work for the DB50 in its temporary Asia-Pacific location. Our fleet utilization during the 2011 second quarter was over 70% of standard days, which is an improvement both over the 2011 first quarter and the 2010 average of 55% but still less than fully utilized.

Keeping our major construction vessels active remains a challenge for 2011, but we do continue to expect levels above last year's average for the remainder of the year, even with the DB50 in drydock. This higher activity with the large barges was partially offset by lower marine activity for our smaller vessels as compared to the sequential quarter. Clearly, as the year progresses, we'll be pursuing projects actively to fill up as much excess capacity for vessels as economically possible.

We are quite pleased that bookings improved sequentially with over $800 million of new work that we added to backlog in the 2011 second quarter. With the high level of revenues we recognized, this level of awards kept our backlog essentially flat, with last quarter at over $4.7 billion, which is an increase of about 13% over the June 30, 2011 -- 2010 level. Our expected backlog roll-off indicates about $1.8 billion revenues should be recognized during the second half of 2011 from existing projects, which would make 2011 a record year for full year revenues. In addition, we also now have almost $2.4 billion of our backlog that is expected to deliver revenues for 2012, which is about a 35% increase above where we were at this time last year.

Now while we normally talk about expected backlog roll-off, I reminded you last quarter that schedules and plans often change, which can affect the timing of revenue recognition. Often, it's due to something beyond our own control, such as customer direction, or as a result of other contractors working on a project. Last quarter, I was specifically referring to a Middle East marine campaign, which was at risk of revenues slipping from 2011 to 2012. The good news here is that we have successfully worked with the customer, and we now expect that project to continue uninterrupted. On the other hand, we've had a development in our Asia-Pacific segment, where a project has shifted, as compared to last quarter's expectations as a result of a delay in customer supplied engineering and materials. While the revenue impact for 2011 isn't overly substantial, we now do have about 1.5 million man-hours that were previously forecast to be realized in 2011 move to the right to 2012. As a result, it creates some disruption in our planned work scope for both years and, more likely than not, will result in our fab hours for Batam being below standard for the full year. We are in dialogue with this customer with respect to this matter. I would note that this is just an example of the issues that can arise in construction projects.

I mentioned earlier the impact higher sales and bidding expenses had on the company's operating margin this quarter. However, there is an upside, which is the $800 million of bookings we had this quarter combined with higher level of bids outstanding that we have now. The largest award that joined our portfolio of projects this quarter was the subsea work for the Macedon gas project in Western Australia. We were also successful in the Asia-Pacific segment this quarter winning the Kikeh deepwater subsea project in Malaysia and a transportation and installation project.

In addition, we had some good bookings in the Atlantic segment, including Hibiscus EPCI project for offshore Trinidad, pipeline work for PEMEX in the Bay of Campeche and additional scope for the West Africa Noble Alen project. So thinking about the higher sales and bidding expenses in the quarter, I would make the observation that this investment has resulted in important returns in the quarter and hopefully, in future quarters.

Of course, as a project-oriented company, we are pushing hard for more work. In that regard, we're reasonably optimistic that the market will remain strong. At June 30, bids outstanding and change orders in process increased about 50% compared to the sequential quarter, growing from $2.7 billion to over $3.3 billion. A trend we have seen in our markets in recent years has been that projects are generally getting larger in size and scope and thus, taking longer to award. While we believe that this circumstance of larger-scope projects benefits our EPCI capabilities, it does tend to make the binary event of winning or not winning result in increased lumpiness, bookings and bids in any given quarter.

In addition to these projects we've already bid, we also monitor our list of target projects at quarter-end that we see coming to market over the next 5 quarters. This target project list has remained strong at about $10 billion. So if you add up our backlog, our bids, change orders, target list, this generates a revenue pipeline potential of $18 billion. To be clear, competition remains tough in each market in which we operate, but there remain plenty of opportunities available. In that regard and in my view, we are addressing our market in the right way. Here's what I mean by that: We seek projects that fit our unique capability, including marine, fabrication, EPCI and surf. We are disciplined with respect to contract terms, scheduling, profitability, and we accept risk that we can reasonably manage or get paid for, all the while choosing to not follow an undisciplined competitor who may appear on any bid slate. As a result of this approach, I can assure you that while in any quarter we may see spikes or troughs, the quality of our backlog is always paramount, and I believe this creates the better result for our shareholders.

I've spoken the last couple of quarters about the underperforming Atlantic segment, and while we have taken steps to improve our performance and the 2011 second quarter was an improvement both sequentially and as compared to last year, our results still don't reflect where we'd like to be. We are continuing to make progress. We're winning some work like the Shell project we announced just this morning, and we're continuing to address costs. Now although we aren't expecting profits this year, we continue to expect to see ongoing improvement.

And on a related topic, I'm quite pleased that the potential flooding that we addressed in our May call turned out to be largely a nonevent for our Louisiana facility. Our local management did an outstanding job in preparation for all contingencies, including their utilization of our Intermac 600 barge to protect the Morgan City area from rising backwater. Our facility remained dry as a bone, and all in all, the preparatory and preventative work that we undertook had little financial impact in the quarter.

Before I close out, I hope you'll allow me a moment to reminisce because it's hard to believe that we just passed the one-year anniversary of the spinoff of the Babcock & Wilcox company, which transformed McDermott into a pure-play, offshore, upstream, engineering, construction and installation company that we are today. While the time has gone quickly by, I'm very pleased with the progress that our organization has made, and I'd be remiss not to thank all my colleagues for their efforts. Looking forward and having spoken with a number of our customers recently and on a regular basis, I'm even more enthusiastic about this company now than I was a year ago. I believe that we serve the best end markets in our industry. Our results have been and likely will continue to be lumpy quarter-to-quarter, however, our markets are growing. I believe McDermott has substantial opportunities ahead. While it may not be as apparent from the outside looking in to our company, we've been quite active positioning the company for growth. We've increased our presence in new regions like Brazil, and we're seeking to expand local content in other markets. Our North Ocean 102 vessel has been a great asset and a major factor in some of the recent subsea and deepwater projects we've been awarded. Her sister vessel, the North Ocean 105, is expected to come out of shipyard about this time next year, and we've already begun bidding its days. We've authorized upgrades to the DB50 starting the second half of this year, which will make it a more capable deepwater vessel, and we're planning for it to be available in early 2012 and to return to the Atlantic region. We are also upgrading our pipelay vessel, the LB32, with lift capabilities, which should increase its marketability in the Middle East. And the DB30 is planned to add a new dynamic positioning system, a rigid stinger for deepwater pipeline and a new abandonment and recovery wench. And I'm excited with these and other initiatives that we have developed for growth, mainly during the course of our first year as a standalone McDermott. And I believe we have other opportunities in the years ahead to both continue to effectively serve our existing markets and to expand our ability to serve others. We'll continue to be disciplined in the projects we approve, the capital we spend and the returns that we require. But to be clear, we do plan to be a growing company.

I'll turn the call over to Perry now to take you through the details of the quarter's financial results, after which we'll take questions. But to summarize my view, it was a good quarter. We think at the halfway point, 2011 is on a solid path for the full year. We'll continue to be lumpy quarter-to-quarter, but we have visibility for the rest of the year and a growing level of work for 2012. We're still looking to add quality work, both to fill up capacity, as well as to position us for the out years. And as always, our major focus remains on the excellent execution on the projects our clients entrust us to perform. Let me turn the call over now to Perry for the financial results.

Perry Elders

Thanks, Steve, and good morning, everyone. Total revenues for the 2011 second quarter were nearly $850 million, up about 35% from the 2010 second quarter but down about 5% sequentially. The big driver behind the year-over-year increase was predominantly the increased scope and higher levels of marine activity in the Asia-Pacific segment. As Steve mentioned, our gross margin for the second quarter was 17.2%, which was up from the 16.9% we had in the 2011 first quarter but down compared to the 24.1% we had in the comparable quarter a year ago, when we had a high level of income from contract closeouts and 0-margin projects, combined with a much lower base of revenues. SG&A expense was up to $60 million, about $5 million higher than the 2011 first quarter and $7.7 million above the 2010 second quarter. As discussed, higher sales and bid costs were the primary driver as evidenced by the significant sequential increase in bids outstanding. While gross profit margin was up compared to the 2011 first quarter, operating income margins declined as a result of the higher SG&A and the change in income/loss from equity investees. We were near the low end of our 10% to 12% operating margin expectation, and this quarter's margin generated operating income of about $84 million, down compared to a year ago and sequentially.

Our results in 2011 second quarter were largely driven by the Asia-Pacific segment, which produced the highest level of operating income of our 3 segments. The Atlantic segment generated less of a loss than either the 2011 first quarter or last year's second quarter, but as Steve mentioned, we will continue to address this segment to build workload and reduce costs. The Middle East segment saw a decline this quarter as compared to both the sequential and year-ago periods, mainly reflecting the low revenues in the segment. At the other income and expense line, which is primarily interest income, interest expense and foreign currency gains and losses, we generated other income of about $1.3 million, an improvement compared to a net expense that was recognized in the first quarter of 2011 and the year-ago quarter. The tax rate this quarter was about 20%, right in the middle of the 15% to 25% range we've discussed. This compares to about 24% in the 2011 first quarter and 13% in the second quarter a year ago. This quarter's tax rate is a result of increased income from higher tax jurisdictions in the Asia-Pacific, such as Australia, combined with losses in the Atlantic region that don't receive tax benefit. Based on our current backlog, I'd expect for the remainder of the year that our effective tax rate will probably remain closer to this level or above than the low teens that we enjoyed in the past as a result of a higher percentage of income being derived in Asia-Pacific segment as well as due to the legal restructuring of our Saudi Arabia operation.

Net income attributable to noncontrolling interest, primarily our minority interest partner in Indonesia and the North Ocean 102 vessel, was $4.1 million this quarter compared to $4 million in the 2011 first quarter and $5.5 million in the 2010 second quarter. So at the bottom line, reported net income from continuing operations less noncontrolling interest was $63.7 million for the 2011 second quarter or $0.27 per diluted share, bringing the year-to-date level to $0.56 per diluted share.

Looking ahead, we expect about the same amount of revenues just from backlog during the second half of 2011 as what we delivered in the first 6 months. We continue to expect profits from closeouts and change orders to be well less than what we earned a year ago. So similar to this point in 2011, we should benefit from higher revenues for the second half, but we continue to believe that operating margins in the 10% to 12% range for the full year is the level to expect. I believe the first half of 2011 set a good start for the year.

Turning to the balance sheet, our financial position remains strong. Our cash, cash equivalents, as well as investments, ended the quarter at $700 million, which is down about $42 million from March 31 as a result of CapEx investments. However, looking broader than just cash, our working capital, which is current assets less current liabilities, increased from around $480 million at the first quarter of 2011 to over $530 million at June 30. Total equity as a percentage of total assets grew to about 63% from 58% at year-end 2010. In addition, we maintained ample room available under our credit facility.

I mentioned earlier that our Saudi Arabia operations were being restructured, but I should note that in July, we did complete that restructuring effort. So in the third quarter, the majority of our cash and equivalents that are shown as restricted at June 30 are now unrestricted and fully available. We have also begun the process of amending and extending our current credit facility. If successful, we expect that we will achieve better ongoing pricing for our letter of credit used to secure projects and a longer maturity, among other modifications. We sincerely appreciate the banks that are evaluating this amendment to the facility.

Finally, turning to our upcoming Investor Relations activities, we have a number of items on the fall calendar. In early September, we'll be at the Barclays CEO Energy Conference in New York, and later that month, we'll participate in San Francisco for D.A. Davidson's E&C Conference. In early October, we'll be in New Orleans for the Johnson Rice Energy Conference. In addition, we expect, as always, to host a number of office visits. We do hope to see many of you at one of these upcoming venues. This concludes our prepared comments. But following the Q&A session, if you have additional questions regarding the quarter or the company, I encourage you to call Jay or Robby in our Investor Relations department. And with that, operator, we'll now open the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Joe Ritchie with Goldman Sachs.

Joseph Ritchie - Goldman Sachs Group Inc.

I guess this is probably a tough question to answer, but if you start thinking through -- taking a look at your prospect list through the remainder of the year, is it probable that you're going to maintain a book-to-bill above 1 and backlog is going to grow for the remaining part of the year? And if you could just give us a little bit more color on where you're seeing the near-term opportunities over the next couple of quarters because it looks like the market is paying very close attention to what happens over the next few months.

Stephen Johnson

Joe, this is Steve. First thing I would tell you is for the second half of the year, it is hard to predict what the timing of some of these decisions are going to be with our key customers. Having said that, there are 2 or 3 projects that could -- significant projects that could come into backlog before the end of the year, and then there maybe others that could roll out beyond that. And there could be some materiality associated with that, and those decisions are somewhat out of our control. Having said that, related to your second question, we're seeing a lot of activity in both Asia-Pacific and Middle East, and I would give a little bit more of a nod to Asia-Pacific as I think about what it may be coming forward. But there's getting some more balance as well as we think about Atlantic. So the Atlantic is giving us more opportunities in terms of bidding, and even in the prospect list, you'll see -- or we would note that there would be Atlantic, there would be Asia-Pacific and the Middle East. Bottom line to your question, hard to tell. The stated award dates for some of these projects are this year. The likelihood that they'd go into next year is anybody's guess, but some will and some won't.

Joseph Ritchie - Goldman Sachs Group Inc.

Okay, fair enough. And I guess if I kind of look at some of your key drivers of your business, you mentioned that you expect your marine vessel utilization to stay above last year's levels, but I would imagine potentially coming down in the second half of the year because of the DB50. Can you help me understand the trajectory of the man-hours on your fabrication business and whether we should see an uptick through the remainder of the year and as we move into 2012?

Perry Elders

This is Perry. On both of those points, taking the last one first on the fab yard utilization, as Steve noted in his comments, we are down in utilization, and in fact, with regard to that one job where we've got some customer delays, we expect some of the hours to shift out of '11 into 12. So we expect fab yard utilization to continue to be lower than our standards for the remainder of 2011. As it relates to vessel utilization, we were at about 70% this quarter, which is, as you noted, above last year. We do have the DB50 going in, but we have better work prospects for other vessels than we had last year. So we have the opportunity to improve slightly but not significantly in vessel utilization, I guess, is the way I'd say it. So kind of this neighborhood would be the kind of neighborhood I'd expect for the rest of the year.

Stephen Johnson

I'd add one piece of color to that, Joe, just on your question having to do with our major vessels, there is a -- and this is a positive statement. There is a lot of interest in and positive pressure on the utilization of some of our key vessels. I would cite the North Ocean 102, our DB30 and the DB50, when she comes out, so much so that we are dealing with the movement of these vessels from one project to another to make sure that we can get them to the projects in order to do the things that we need to do. I call this a high-class problem. We've got the right vessels is what this says. And particularly in subsea, I'm exceptionally pleased with how the 102 is performing, how much appetite there is for her, and that gives me great feelings about what we might be able to do with the 105 when she comes out this time next year.

Joseph Ritchie - Goldman Sachs Group Inc.

Okay, that's helpful. And just one last question. I'm sure there's plenty of people in the queue right now. Speaking specifically on the Atlantic, you announced an award earlier this morning, which is great. Can you just help me understand -- quarter-over-quarter, you saw a slight increase in profitability in that business. At what point do we get to breakeven in that business, given the visibility that you have today?

Stephen Johnson

If you're speaking specifically to the Atlantic segment, the answer that I've given for a couple of quarters here is, as you said, we don't expect it to be profitable in this calendar year. Our expectation remains that the Atlantic region will return to profitability in 2012, and what I mean by that is by the end of 2012, to be clear.

Operator

Your next question comes from the line of Steven Fisher with UBS.

Steven Fisher - UBS Investment Bank

There's obviously a lot of moving pieces, but how should we think about the headwinds and tailwinds on margin in the second half? And overall, where are you thinking relative to -- I know you said 10% to 12% for the rest of the year, but relative to the low end of the range that you're in Q2.

Perry Elders

Yes. Steven, it's Perry. What we're experiencing this quarter, Q2, is kind of what we anticipated in terms of the projects that we're working at the earlier stages. Therefore, as Steve mentioned, we have not seen the project closeouts and change orders at the same level we did last year. We see that continuing for most of the rest of this year. So there was some project closeouts and change orders in Q2, so it wasn't absent them entirely but just down substantially from last year. And so we expect to see some more for the remainder of the year but, again, down from last year, so kind of in this range, if you will.

Steven Fisher - UBS Investment Bank

Okay. So it doesn't sound like there's any particular tailwinds that can move us from where we are right now?

Perry Elders

Not in order of magnitude. Move us a percentage point but not in order of magnitude.

Steven Fisher - UBS Investment Bank

Okay. And what's your visibility of improving revenue trends in the Middle East, and is there any reason to think that the revenues should improve from here for the next few quarters? And then I guess, how good a sense do you have of when the better margins in the Middle East work will be realized? And I assume you have specific schedules for Keran and Safaniya and the U.A.E. work as we think out to 2012?

Stephen Johnson

I think, again, this quarter certainly was meaningful from a new award standpoint moving into revenue for the Middle East. Is it an anomaly? I think it probably is. The pipeline of prospects that we have coming out of our Middle East region is no less robust than it has been in recent past quarters. The drivers for us continue to be the Emirates, in particular, Abu Dhabi, more opportunities coming out of Saudi Aramco. We believe later this year and into 2012, there is no anemia in terms of opportunities coming out of the Middle East, period. It is simply a quarter result. My view is, I can tell you, our activity in bidding, our contact with our customers in the Middle East gives me a very positive signal, and it's no less than it's been for a number of quarters. So turning those to revenue takes a little bit of time, but our bidding activity is strong, and we've got more than just one to look at before the end of the year that are significant potential awards for us, Steven.

Perry Elders

And Steve, I might even add some numbers to Steve's commentary. If you look at our expected backlog roll-off on a consolidated basis for the second half of the year, approximately $700 million of that is coming from the Middle East. So we have some visibility into this level of revenue in the second quarter was at the low end.

Steven Fisher - UBS Investment Bank

Okay. And then just on the part about when you might see the closeout opportunities based on the schedules that you have. And we're thinking this is the first part of 2012, mid-2012, later 2012?

Perry Elders

Safaniya is the big one that we're kind of in the earlier stages on, and we've got a job going on in the Caspian. Several of those jobs, again, just in the earlier stages, so we would be looking to 2012 and even possibly the latter part of 2012 before we'd kind of be getting to the stage on those projects where you'd see meaningful change orders and closeouts coming through.

Operator

Your next question comes from the line of Will Gabrielski with Gleacher.

Will Gabrielski - Gleacher & Company, Inc.

Did you break out most of your bid costs by geography, how those were spread out?

Perry Elders

No, we didn't break that out, but it was predominantly in the Asia-Pacific and the Middle East regions.

Will Gabrielski - Gleacher & Company, Inc.

Okay. And I know I always beat Jay up trying to ask this question, but when you look at the operating performance in the Atlantic division sequentially, your revenue was up $12 million or $13 million. Your loss only improved by about $1 million, and I know there was some severance in there. But going forward, I guess, how flexible is the remaining costs that you have in that region, and can you sort of help articulate what you're hanging onto, capacity-wise, in anticipation of maybe a big Gulf of Mexico-related project over the next year or 2?

Stephen Johnson

Well, I'll start, and then I'm going to have Perry give you some quantitative numbers. The first thing I would observe is the cost reductions, the cost management that we did in the second quarter was towards the tail end of the second quarter. We should begin to realize the benefit of those cost reductions in the third quarter and the fourth quarter, and they should be significant. The second thing is the new work that we have booked. While some of it or much of it could move into 2012, we have the booked work, and it could have not any material revenue benefit and operating income benefit for the latter half of the year. Having said that, the larger projects that are out there in the U.S. Gulf of Mexico are probably beyond the end of this year and well into 2012. There are projects in Brazil, however, that are more near-term, so we look at the Atlantic region holistically between U.S. Gulf of Mexico, Mexico, meaning PEMEX, Brazil and, of course, the opportunistic projects in West Africa. And I would put Brazil in the first order, PEMEX next, and then the U.S. Gulf of Mexico, the larger projects, in third position in terms of likelihood short term. Perry?

Perry Elders

So that's in terms of perspective work. In terms of existing work in backlog, you recall that we've got 2 projects. A large part of our Atlantic backlog is 2 Petrobras projects: one for our vessel, the Agile; and the other is the Papa Terra project. On that project, we have a portion of the project in our backlog and the remainder in our JV's backlog. On both of those projects, you're not seeing earnings come through in 2011. And so as you know, we have Papa Terra on a deferred profit recognition, so we're recognizing cost with these [ph] revenues, but in fact, there's just not -- it's very early stages on that project, and we're kind of at around the 20% complete level, having recognized about just under $20 million of revenue on that project in the first half of the year. So that project is not contributing to profit, and we hope to be in a position to turn it back on sometime in 2012. And likewise, the other part, big part of the backlog is the Agile contract for Petrobras, which commences later this year but runs for 5 years, so it won't contribute a lot into the second half in terms of profitability.

Will Gabrielski - Gleacher & Company, Inc.

Okay. And then when you look at the market right now, it's seemly oversupplied with marine day capacity across the entire industry. Clearly, there's an uptick in activity, and you hear from all the equipment suppliers the amount of subsea orders that are going out right now, so it looks good there. Are there any weak competitors that you're looking at in the market where you can pick off some vessels and take advantage of that market and better utilize some of the marine days that are out there? Is there anything you're thinking about strategically on that front?

Stephen Johnson

The only answer I could give you at this juncture is probably. Nothing is in the works, certainly nothing I can talk about, but that is a potential source. In addition to building or leasing or buying one-offs, there's always that kind of an approach, Will.

Operator

Your next question comes from the line of Jamie Cook with Crédit Suisse.

Jamie Cook - Crédit Suisse AG

Two questions. One, can you talk about -- there's a number of large projects, obviously, that are coming forward? Can you talk about the competitive environment? We are hearing signs from some of the other E&C players that is has been improving and unit pricing has been up on a sequential basis. And then my last question, Steve, can you just sort of update us on your -- I mean, you talked about sort of potential plans on buying out smaller players on the vessel side, but what are your thoughts on Brazil? Because I thought you were also planning on making some investments there to better position yourself.

Stephen Johnson

All right, Jamie, I'll try to tackle both of them here. On the larger projects that are coming forward, I'd say we'd see similar types of dynamics going on with bidding on certain numbers of these projects. As you saw on our prepared comments, we did have increased bidding cost, and the reason we had increased bidding cost wasn't just about volumetrics of more bids. It was the complexity of and the ongoing clarification dialogue that's going on with some of these customers for these major projects, which has some expense associated with it. As we have those conversations with those customers, post-submittal of a priced and technical bid, we begin to learn more and more about what perhaps the competitors are thinking, and we begin to learn more and more about where we are situated relative to those competition or those competitors as we listen to our customers. I've got to tell you I feel pretty good about a number of them there, and part of it has to do with the fact that I believe there's rationality in the marketplace, whereas in 2010 and maybe in the first quarter of this year, there was some irrational bidding going on. I'm seeing less of that, so all I can tell you is I'm hopeful about that. And the only thing -- I can't predict awards and I can't predict win, but I would bet those awards will happen this year, 1 or 2 might slip over, as I said, responding to another question. As regards Brazil, we're moving forward. There hasn't been any formal decision with that. We believe the sun and the moon and the stars are aligning for a McDermott in Brazil. It is important for us to have presence in Brazil not only in terms of marine campaign capability with our vessels, as Perry talked about with the Agile hitting there late summer, it is important for us to have fabrication capabilities there. And we're not shying away from that at all. It's a timing issue associated with how to put this transaction together, and we're moving forward without a formal decision yet.

Jamie Cook - Crédit Suisse AG

Any color on the magnitude of spend level that will be required?

Stephen Johnson

I would tell you, if you're going to build a fully kitted-out fabrication yard as an example, one could think in the range of $150 million to $225 million total. The way McDermott would build a fabrication yard would be to do it in a just-in-time kind of mode. So we would spread that investment out over several quarters and maybe more than 2 or 3 years. So what I would say to you is that we are in a position where we're joint-venturing for that fabrication yard. We will share that cost. And because of McDermott's capability of running a fabrication yard, we will have a superior financial position to our partners if we do such a thing as this because of our capability of running the yards.

Operator

Your next question comes from the line of Andrew Kaplowitz with Barclays Capital.

Andy Kaplowitz - Barclays Capital

Steve, your business overall, I think, is going through somewhat of a transformation, more subsea work, more deepwater work in general. I know it's early days, but maybe you can give us your assessment of how it's going so far in terms of execution. It's hard for us to see what these projects look like as part of the bigger base of business, so I'm just wondering about that. And then also, Papa Terra is one of those projects. Maybe you could give us an update on that.

Stephen Johnson

I'd be happy to do it, Andy. On the subject of subsea and deepwater, I would say that the company is in transition, but I'd say we're in transition in a manner which is we're kind of sticking to our kneading, which is shallower water or midlevel water and, at the same time, growing into subsea and deepwater. The performance of our assets in the projects that we have that are so-called subsea has been nothing less than excellent, and it's largely due to not only the people that we have assigned to these programs but the equipment that we have. So I am, every quarter, more and more sanguine about our ability to perform in subsea and deepwater, and in fact, whereas maybe a quarter or 2 ago, I felt that we might have to get our ticket punched and pay a little bit in terms of reduced margins to enter this. I'm not there anymore because we had as good of gear as anybody else, and this time next year, we'll have even more. And as we add DP -- rigid stinger to the DB30 that I talked about in the prepared remarks, we'll even have more capability along with the DB50. So I'm pretty settled about our capability to compete. I see no issues at all with any of these programs. Now Papa Terra. Papa Terra, as far as I'm concerned, is in good shape. There are struggles with any of these projects that have some first-of-a-kind in terms of technology associated with them, but as I said at the end of the second quarter, staying close to that project, the challengers are known. We're past what I would consider the gating, engineering and technology issues. We are implementing the solutions to those technology issues, and I see no reason at this juncture why we would have any particular problem. Having said that, this is a huge project. There's a lot of runway in front of us. We have to perform, but I feel pretty good about it as we stand today, Andy.

Andy Kaplowitz - Barclays Capital

That's great. Steve, I know Perry's going to tell me 10% to 12%, but the margins on these deepwater projects or subsea are, I think, higher. So is it possible that you will have some tailwind from your margins if you don't have to punch your tickets, so to speak?

Stephen Johnson

Well, Perry's going to tell you 10% to 12%, and so will I. Having said that, you know what? There's always that potential sitting out there. It's a little bit too early to do anything to predict that we're going to be on the upper end of that range or ever exceed it. I would say we've got to get some of these things under our belt and see them close out before we could do anything to guide anything different. But I would just simply say to you I'm more than just pleased. I'm delighted with how we're able to perform, and I'm delighted with the pull from the customer community on that North Ocean 102, and will be on the North Ocean 105 and will be on the DB30. It's a delightful thing for me to see.

Andy Kaplowitz - Barclays Capital

Okay, that's great. You mentioned that it's the one-year anniversary of the spinoff. As you sit here now versus last year, you've got $2.3 billion in backlog for next year. But this is -- 2011 is going to be a record year for you, hopefully. So as you look at all '12 versus '11, given where you are sitting in terms of your backlog next year, how do you feel?

Stephen Johnson

How I feel in terms of ...

Andy Kaplowitz - Barclays Capital

How do you feel -- how's your confidence level about next year being a growth year versus this year?

Stephen Johnson

You know what, in the middle or early to the middle of 2010, last year, we were looking into 2011 and were predicting that it was probably going to be a flat kind of year or flattish in terms of revenue generation and maybe all the financial metrics. I'm pleased where we are in terms of revenue for 2011. 2012, at that time, was expected to be an uptick, and I see no reason why we couldn't be in a reasonable range there for 2012. It is binary though, Andy, in terms of awards for revenue production in 2012 from a profitability standpoint. As we get more and more of the subsea work into the mix, I would hope that would improve. And I now those are generic answers, but I see 2012 being an improvement over 2011 in most financial metrics.

Operator

Your next question comes from the line of Roger Read with Morgan Keegan.

Roger Read

I guess I'm going to probably hit...

[Audio Gap]

Typically, we see vessel margins blended out over time better than fab margins, and maybe you could walk me through if there's any reason that wouldn't be the case, maybe leftover of a more competitive pricing from a year ago and some of this backlog that works off comes through, or if there's something else that's in the moving parts there.

Stephen Johnson

Perry and I are both going to give a shot at it. I'll let you go first this time, Perry.

Perry Elders

Okay. Thanks, Roger. Look, you're right in that normally, we would anticipate that kind of higher vessel utilization would kind of juice the margins, if you will, and we are seeing solid vessel utilization but not exceptional. I mean, we've seen vessel utilization well north of our standards in the past, so this is good utilization. It's not incredible, so it's helping, but it's not filling us up to the top of our range. The second thing is what the real driver on the margins is the fab yard utilization comment I made earlier relates to how quickly we can recognize revenues on the projects because that's driving our percentage of completion recognition. But the actual margin percentage is more affected by the closeouts and the change orders than it is by the activity level. And because we see less opportunity for closeouts and change orders, lightening [ph] of the job, near the end of the jobs for the second half of this year as we did in this quarter, that's why our view for the last several quarters, as we've talked about the 10% to 12%, has been and continues to be to hold to that. So I think you should continue to expect these kind of margins for the next few quarters.

Stephen Johnson

I think your math is reasonable, Roger. There's no question about that. I would say that the biggest needle-mover is closeouts, and just the phasing of these projects probably wouldn't indicate that we'd have any material upside to what we have been guiding you to. But in subsequent quarters, that is likely to occur. Perry's answered about the vessels. I don't think it's a big needle-mover for the next 2 quarters of this year, although depending on what our awards are and how quickly we could go to work on some marine-only work, it could have some impact. My comment would be around fabrication. As you heard in my prepared remarks, we've got a minor issue in our Batam yard in terms of a particular project where we're subject to client engineering drawings and client-supplied material. And as I said in the prepared remarks, we're talking to this client about this issue. I would guess that we're not going to be able to compel them to provide us engineering when we'd like to have it, and we're not going to compel them to deliver materials. Their engineering service company is, frankly, not performing very well, so that won't happen. So what happens in that occurrence? Well, we get to a situation where we're in a position where we're going to have to claw back through change orders and settlements in some future quarter. And I think that's really the tale of the tape with all of the things that we talked about fab, closeouts and vessels. So I'd expect us to not move the needle too much outside of the range where we are today.

Roger Read

At least for the second half of '11?

Stephen Johnson

Yes, and that's really what I'm speaking to, the second half of '11. 2012, our expectation is that we'll resolve these issues in fabrication with the customers by this time in 2012.

Roger Read

And then if I think about large projects expected to be awarded, whether you win them or not, obviously, is still the question. But if we're awarded the projects late '11, early '12, not many closeouts this year, which would indicate a higher level of closeouts next year, just without asking specific margins guidance, how does that -- even look back historically and say we've had periods where these things overlap, would startup on projects next year tend to keep margins on the lower end, or is it such that as things pick up, the type of projects you're looking at, you could actually see margins maybe move back more towards the middle or even upper end of that kind of 10% to 13% range?

Stephen Johnson

There's the binary aspect of do we win or do we not win. There is the mix of projects that will have an effect on the outcome here and the more marine-only and, in particular, the more of the subsea projects as others have observed, that mix could improve the margins. I just couldn't predict the timing or the total here, but your rationale is not illogical.

Roger Read

And what type of projects do we need to look for in terms of having a big impact to the upside on margins? Would it be a focus on subsea or at least marine-oriented then?

Stephen Johnson

Marine-oriented, subsea and change orders and closeouts, the large EPIC projects have good marine confluence to them, too. So we'll see how those go.

Roger Read

All right. And Jay, you're going to keep us up on all those change orders when they happen then?

John Roueche

Only in a public forum.

Operator

Your next question comes from the line of Tahira Afzal with KeyBanc.

Tahira Afzal - KeyBanc Capital Markets Inc.

I don't want to belabor the margin issue, but I guess my question is a just follow-up to all the ones that have happened. I know you're being very careful about what you're saying about the second half margins, but I guess I'm still not totally clear because you've got second quarter margins at around 10%, which is the lower end of the range. When you're talking about margins staying at the levels, at the range, within the range, are you talking about staying within the 10% to 12% range, or are you saying that 10% is kind of the level you see them at in the second half? So I guess what I'm asking is, are you essentially in your -- just by recent commentary, are you indicating that they're going to be closer to the lower end of the range and there are fewer opportunities even from ship utilization to really push them to the upper end of the range, or are you just saying it's just difficult on the ship utilization to push them beyond the 12%?

Perry Elders

Yes, it's 10% to 12% is what we're saying both for the remainder of this year, and it's difficult within the 10% to 12% to predict a few basis points here because of the possibility of some of the things Steve was talking about in terms of picking up, book and burn[ph] work for the marine fleet. And there are some change orders and closeouts that could occur in the second half but certainly not the level that we've enjoyed last year. And that's why for the last few quarters, when we've been inside this range of 10% to 12% and a number of folks were asking us to give guidance outside it, we've held firm because we saw these kind of margins in our forecast. And as we look forward for the next few quarters, that's still what we see. So I wouldn't try to be more colorful than that in terms of within the 10% to 12%, what part of that range we expect to be.

Tahira Afzal - KeyBanc Capital Markets Inc.

I guess I was just trying to push my luck there, but it seems like a lot of your commentary is really, in terms of the second half, is really is in terms of not -- that it's improbable that you will exceed that range, I guess, versus really hitting the upper end or close to the upper end of the range. Would that be a correct assumption?

Stephen Johnson

Tahira, I mean, I would say it this way. The projects have a life cycle to them, as you well know, and we've commented about the fact that we're not in that portion of the cycle where there's significant closeouts and settlements, which is a material driver to the upside for margins, and we don't see that in the second half. So that would tell you that while we really believe we're in the 10% to 12% range, I don't see anything material that'll drive us materially beyond that upper end.

Tahira Afzal - KeyBanc Capital Markets Inc.

Got it. Actually, that's very helpful.

Operator

Your next question comes from the line of Martin Malloy with Johnson Rice.

Martin Malloy - Johnson Rice & Company, L.L.C.

The potential push-outs in revenues in the Asia-Pacific region that you spoke about, is that taking into account the $1.8 billion backlog that you expect to work off at -- this year?

Stephen Johnson

It is.

Martin Malloy - Johnson Rice & Company, L.L.C.

Okay. And I haven't heard much about the China FPSO JV lately. Could you talk about what's going on there and when we might see some contribution from that?

Stephen Johnson

Yes, Marty, I just visited there probably not, 3, 4 weeks ago. The build-out is nearly complete. It'll be, I think, substantially complete by the end of this third quarter, ready to work. We're doing some small work in there now that we've moved from one of our offshore projects to help get some of the labor force and get some of the equipment tested out and proven out. I am pleased with the build-out of that facility. It's well managed. The association with our partner is strong. We are now bidding work. Seeking work and bidding work, specifically, for that facility. As I'd indicated before, it'll probably be into 2012 before we see the first project.

Martin Malloy - Johnson Rice & Company, L.L.C.

Okay. And then just one last question. The Gulf of Mexico deepwater, your 2 competitors on the fabrication side for topsides have record backlogs and Morgan City hasn't been able to win one of these projects yet. Can you just talk about what you're seeing out there in the bidding environment and what might be driving that?

Stephen Johnson

Well, because of the nature of the market, meaning few projects and central fabricators being able to serve those few projects, and because of our bidding disciplines, we are at the result we are at today. That's probably the not-so-good news. The good news is there's no question in my mind that those that have won those projects in the last several quarters have full yards, and the ability to add additional work would be a question mark. I don't have any specific insight into that other than knowing what our competitors' capabilities are there. So with that as a backdrop, the question is what projects, at what pace will come forward for us to bid on, and we will be bidding not just Morgan City but we will also be bidding from our Mexican fabrication yard, which has a distinct financial advantage from a labor cost standpoint.

Operator

Your next question comes from the line of Chase Jacobson with William Blair.

Chase Jacobson - William Blair & Company L.L.C.

You talked a lot about your bidding discipline. Can you just talk about how that changes or potentially changes the win rate that you talked about on the contract that you actually bid for?

Stephen Johnson

Well, I don't know that there's any significant win rate adjustment. I would say there is disappointment from not having won some of these major programs in the Middle East and, to some degree, in Asia-Pacific. But had we won those projects, we would have had to had terms and conditions and prices below the winning bidder. And as I've said before, Chase, those are projects that we simply would not want to have. Having said that, we're very focused on our cost and our cost bases in the Middle East and the Asia-Pacific, as well as the Atlantic region, to make sure that we're not missing anything in terms of our competitiveness, in terms of our base cost to bid these programs. And I don't believe we are. We simply are disciplined around getting the right work inside the house here, and that's kind of the full-stop answer here. We've gone through these cycles 6 or 8, 9, 10 times in my career, and the winners in these cycles are ones that have strong bidding disciplines and wait for the projects to come forward that we can have, if not superior, better return and lower risk than those that are taking this work in the opposite fashion during this downturn.

Chase Jacobson - William Blair & Company L.L.C.

Okay, that's helpful. Just on the margin side, when we look at Asia-Pacific, is there any change in mix in terms of types of projects that you're working on that would maybe provide a tailwind to the margin in that segment, maybe working on a more LNG-associated projects? Would that have higher associated margins than maybe projects you've worked on in the past?

Stephen Johnson

Chase, did you say Asia-Pacific?

Chase Jacobson - William Blair & Company L.L.C.

Yes.

Stephen Johnson

Yes, possibly. The awards that we've had in the second quarter here, I think, are emblematic of opportunities in Australia, in particular, and Southeast Asia. We've had a couple of awards in Malaysia, and both categories are subsea types of awards. We look at both onshore installations like we are doing for Chevron and Gorgon, and we look for offshore installations for our fabrication facilities. As I think about our assets to do the installation work, we are beginning to be at a point where we're not disadvantaged to anybody in terms of our competitive assets to do this work. So yes, there's some LNG drivers behind this. The volume of opportunities that we have in our pipeline have been vetted. They wouldn't be in there if they didn't fit us. And as indicated in the prepared remarks, if you add the backlog as well as the targets and the prospects out there, we've got $18 billion worth of work to hopefully realize our share of.

Operator

Your final question comes from the line of Rob Norfleet with BB&T Capital Markets.

Robert Norfleet - BB&T Capital Markets

Most of my questions have been asked, but just a couple. If we look at the bids outstanding that we talked about earlier of over $3.2 billion, how should we look at the split between Asia-Pacific and the Middle East relative to what backlog is now? They're roughly in line in terms of Asia-Pacific, Middle East having about the same amount of backlog.

Perry Elders

Yes, the mix, and we've said this for the last few quarters, is -- if you compare to what we've historically recognized in revenues or even what's in our backlog, there's a bit of a shift towards the Atlantic because we've had very little revenues in the Atlantic in the last few years. So it was a bit more in Atlantic geographically than the other 2. However, still look at the majority of the bids outstanding being in the Asia-Pacific and the Middle East with, at this moment in time, and this shifts every quarter, at this moment in time, a bit more in Asia-Pacific than the Middle East.

Robert Norfleet - BB&T Capital Markets

Okay. And then one of the questions, clearly, you're getting, a number of questions on margins, understandably, and I think you've obviously discussed the issue of how closeouts -- or really, what is impacting that, but if you look at the variance in margins between the regions in the Middle East, the 600 basis points higher EBIT margin than what we're doing in Asia. So I guess I'm just trying to understand as that mix shift obviously occurs and we have more work in the Atlantic and more work coming out of Asia-Pacific, if the Middle East does get diluted, that obviously has a potential for, as we discussed, that lower-margin situation.

Stephen Johnson

I don't know that I'd look at it that way. I mean, the numbers kind of lead you to that conclusion. But we're awarded work one project at a time and one prospect at a time, and the margin and the work has a number of different elements to it. And I can tell you some of the projects that we're looking at in Asia-Pacific would take not a backseat to anything we've had in the past in the Middle East.

Robert Norfleet - BB&T Capital Markets

Okay, that's encouraging. Last question just in terms of SG&A, what should we look at in terms of the second half of the year in terms of SG&A? Obviously, it was inflated in the second quarter because of higher bidding activity.

Perry Elders

Yes, we've given guidance to the last few quarters to be around $60 million, and we hit that this quarter. We had underspent it, if you will, the quarters preceding that. So as Steve mentioned, we've got some large opportunities in front of us that we're building in the second half of the year. So we wouldn't expect it to come all the way back down to where it's been the preceding few quarters, but Steve also mentioned there's a little bit of Atlantic severance costs in here as well. So hopefully, it will moderate a little bit but maybe not all the way back down to where it was in the preceding quarters.

Robert Norfleet - BB&T Capital Markets

And the last question is on capital allocation. Stephen, I know you talked a lot about, obviously, some of the initiatives that are being undertaken in terms of the fleet, possibly the JV in Brazil and the fab yard. The share repurchase, I know it's always been low on your scale of items, though. Is that even in the top 5 at this point?

Stephen Johnson

You know we talk about share repurchase on a regular basis inside the company and with the board. It is never off the table. I would say to you that as we look into the market, which is a growing market, that we serve, the best return for shareholders that we, as a board, would say to you today is investing and enhancing the fleet towards deeper water and surf, investing in those regions of the world where we need to have a presence, example would be Brazil. And I think the analytics that we've done would say that it would far overtake a share repurchase, but I would bookend it and say we'd never take it off the table.

Operator

That does conclude today's Q&A session. I would now like to turn the call over to Mr. Jay Roueche for closing remarks.

John Roueche

Thank you, all, again for your participation and interest today. I want to remind you that the call included forward-looking statements, and I encourage you to see our SEC filings and press release for more information on these. Unfortunately, I know there were still several people who were left in the queue, so if you didn't get the opportunity to ask your question to us or if anyone has any follow-up questions, please give Rob or me a call, and we'll be happy to work with you. And we do look forward to seeing many of you over the coming months at the various conferences and office visits. And Kim, this concludes our call.

Operator

Thank you for your participation in today's conference. This does conclude the presentation. You may now disconnect, and have a great day.

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