McDermott International (MDR) David Dickson on Q2 2016 Results - Earnings Call Transcript

| About: McDermott International, (MDR)

McDermott International, Inc. (NYSE:MDR)

Q2 2016 Earnings Call

July 26, 2016 5:00 pm ET

Executives

Kathy Murray - Vice President, Treasurer and Investor Relations

David Dickson - President, Chief Executive Officer & Director

Stuart A. Spence - Chief Financial Officer & Executive Vice President

Analysts

Jamie L. Cook - Credit Suisse Securities (NYSE:USA) LLC (Broker)

Matt Tucker - KeyBanc Capital Markets, Inc.

Martin W. Malloy - Johnson Rice & Co. LLC

Andrew Kaplowitz - Citigroup Global Markets, Inc. (Broker)

Chad Dillard - Deutsche Bank Securities, Inc.

Steven Michael Fisher - UBS Securities LLC

Robert F. Norfleet - Alembic Global Advisors LLC

John Bergstrom Rogers - D. A. Davidson & Co.

Operator

Ladies and gentlemen, thank you for standing by, and welcome to McDermott International's Second Quarter 2016 Financial Results Conference Call. At this time, all participants are in a listen-only mode. Following the company's prepared remarks, we will conduct a question-and-answer session and instructions will be given at that time.

I would like now to turn the call over to Kathy Murray, McDermott's Vice President, Treasurer and Investor Relations. Please go ahead.

Kathy Murray - Vice President, Treasurer and Investor Relations

Thank you, and good afternoon, everyone. I would like to remind you that we are recording this call and a replay will be available on our website where you can also find our second quarter 2016 results press release and the Form 10-Q we filed today. We have also posted a presentation of supplemental financial information that is available on the Investor Relations section of our website, www.mcdermott.com.

Additionally, our comments today include forward-looking statements and estimates. These forward-looking comments are subject to various risks, contingencies and uncertainties and reflect management's view as of today, July 26, 2016. Please refer to our filings with the SEC, which are available on our website, including our Form 10-K for the year ended December 31, 2015 and subsequent quarterly reports on Form 10-Q, which provide a discussion of some of the factors that may cause actual results to differ from management's projections, forecasts, estimates and expectations. Please note that, except to the extent required by applicable law, McDermott undertakes no obligation to update any forward-looking statements.

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

David Dickson - President, Chief Executive Officer & Director

Thank you, Kathy, and good afternoon, everyone. As our results reflect, our excellence in project execution has resulted in a favorable quarter as demonstrated by our profitability and improvement in operating margins. Notably, we secured an exceptional order intake during the quarter, which drove substantial backlog growth and provided a solid foundation for 2017 revenue.

We were pleased to be awarded the Abkatun-A2 project, which is our largest value and size to-date project with Pemex. The platform will be located in Mexico's Bay of Campeche in 124 feet of water, and is expected to provide replacement and expansion capabilities to existing facilities. This award is a result of our customer-centric strategy to build a vertically integrated local solution in Mexico, utilizing our local project management and engineering teams in our top-tier Altamira facility, and builds upon the success of the PB Litoral project.

Also making a significant contribution to our backlog in the second quarter was the award of three large projects under our LTA II agreement with Saudi Aramco, which were previously announced. Our highly efficient, vertically integrated solution as well as our in-depth knowledge and experience in the Middle East played an important role in securing these awards.

In June, we secured the 2017 scope under the multi-year transportation and installation contract with Brunei Shell Petroleum in our Asia area. The customer confidence built during our last year's campaign with BSP was important to winning additional work and continues to expand our position in the Brunei market.

During the quarter, we took delivery of our flagship vessel, the DLV 2000, from Keppel, which was immediately mobilized on the INPEX Ichthys project. The vessel has executed exceptionally well so far, and recently lifted one of the industry's largest pipeline tie-in scopes. With the vessel now operational, we see the strength and flexibility she brings for us for the offshore and subsea market.

Turning to health, safety, environment and security, I am pleased to report this quarter mark the achievement of 35 million man-hours lost time incident free in our Batam yard, and also 35 million man-hours lost time incident free in our Middle East area. Both of these demonstrate our continued focus on health and safety. Our Taking the Lead program builds upon our long-standing safety culture and has resulted in continued industry-leading health and safety metrics.

Now, let me provide an operational update. In the Americas, Europe and Africa area, we resumed work during the quarter on the Ayatsil C project, which was previously suspended by Pemex to allow for assessment of the overall Ayatsil field infrastructure sequencing requirements. We are now focusing on fabrication of the jacket and plan for installation in fourth quarter of 2016. We believe our strong customer relationship will continue to position us to take a leadership role in Mexico, as energy reform continues to impact the country.

In the U.S. Gulf of Mexico, we successfully completed the Jack/St. Malo Phase 2 project, utilizing our DB 50 and the North Ocean 102. We also completed the installation scope on the LLOG Otis project this quarter, with the first installation of a steel catenary riser by our North Ocean 105. Both of these projects utilized our spoolbase in Gulfport, Mississippi, demonstrating its capabilities and providing a foundation for future work. Building upon our recent successes, we continue to see pipeline subsea tieback opportunities in the area.

In the Middle East area, the last remaining jacket on the Twelve Jackets project was completed during the quarter and is now ready for load-out and installation, which is expected to meet the customer's revised timing. Fabrication activity on the Saudi Aramco LTA-II Lump Sum project also continues ramping up. In addition, the fast-track pipeline related EPCI project that was awarded in the first quarter also continues to make progress offshore. The North Field Alpha jacket for Qatar Petroleum was installed this quarter along with the associated umbilical and final handover to the customer.

Recently, we also entered into an exclusive co-operation agreement with N-KOM, a world-class fabrication facility in Qatar, to pursue EPCI projects within Qatari waters, utilizing MacDermott's proven experience and execution in the country. We believe this agreement will increase our ability to deliver local, integrated solutions in Qatar, and provide us with an even higher level of capacity and availability to address growth in the Middle East market.

In Asia, the INPEX Ichthys project remains on schedule. Heerema completed their work on the project in April and the CSV 108 commenced her third campaign, carrying out various subsea construction activities in the month of June. Also on the Ichthys project, the DLV 2000 recently completed four major lifts.

In the Batam fabrication yard, we expect the first set of modules on the Yamal LNG project to be ready for shipment on schedule in the third quarter of 2016 with fabrication on the FMC Jangkrik project in the same yard also expected to be on schedule.

Our joint venture in China, QMW, recently completed fabrication of their largest LNG fabrication project to-date. The successful completion of this fast-track project demonstrates the first-class capabilities of the QMW fabrication facility.

We have made significant progress in engineering and procurement on ONGC Vashishta project. Fabrication with our partner is now expected to commence ahead of schedule. We see substantial potential in the deepwater market in East India, and I believe that Vashishta project positions us for success.

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

Stuart A. Spence - Chief Financial Officer & Executive Vice President

Thanks, David, and good afternoon, everyone. I'm pleased to share with you that we were again profitable this quarter, and our continued focus on customer relationships and operational effectiveness has paid off with a substantial growth in backlog this quarter. The backlog improvement was primarily due to the Pemex Abkatun-A2 award in Mexico, and the award of three large Saudi Aramco projects in the Middle East.

Also, during the quarter, we completed all the conditions to the amendment of our credit agreement, resulting in an extension of the LC Facility maturity date from April 2017 to early 2019, and an increase in certain spending basket capacity in addition to the previously effective changes to our debt covenant ratios. As a part of obtaining term lender consents in this process, we also prepaid $75 million of our Term Loan B and increased the annual interest rate by 300 basis points. Completing these amendments has not only resulted in McDermott having, what we believe, a more conventional credit covenant, but it has also provided greater certainty around our debt and credit structure through early 2019.

Turning back now to our more detailed financial results, I would like to remind you that, in addition to our GAAP reporting, we're also reporting certain adjusted financial information, net of, what we believe to be, one-time items, as we believe these provide a helpful understanding of the underlying performance and drivers of our business.

Our second quarter 2016 results included revenues of $707 million, compared to $729 million for the first quarter of 2016, and $1 billion for the second quarter of 2015. Our Asia and Middle East areas continued to contribute significantly to revenue in the second quarter. The INPEX Ichthys project provided $236 million of revenue in Asia, while in the Middle East, the Saudi Aramco LTA II Lump Sum and Marjan GOSP projects resulted in a combined $107 million contribution to revenue. Year-over-year, significant marine activity on the Ichthys project in 2015 by our subcontractor Heerema that did not recur in the second quarter of 2016 drove the decrease.

We continue to improve operating margins through successful project execution. Operating income was $57 million during the quarter, and adjusted operating income totaled $59 million, excluding $2 million of restructuring charges. Our operating margin, both on an unadjusted and adjusted basis, was 8%, an increase of 3% on an unadjusted basis, and 2% on an adjusted basis year-over-year. These increases primarily resulted from change orders and productivity improvements across several of our projects in all areas.

Operating income includes a $21 million impact of overhead under-absorption in the second quarter of 2016. This under-absorption is primarily driven by the utilization in our fabrication yards, specifically Altamira and Batam. Looking forward, the Pemex Abkatun-A2 is expected to provide utilization for our Altamira yard, while we continue to focus on prospects for the Batam yard.

Offshore and subsea vessel utilization both increased this quarter, primarily due to project sequencing, which resulted in active marine campaigns across all areas.

Cash provided by operating activities in the second quarter of 2016 was $17 million, a reduction compared to cash provided by operating activities of $59 million in the sequential quarter and an increase compared to cash used by operating activities of $8 million in the second quarter of 2015. Positive operating cash flow was primarily due to steady collections in the Middle East. In the Americas, we continue to see delays in payments from Pemex. As of the end of the quarter, we still had approximately $20 million of unbilled amounts related to 2015 activities with Pemex. We continue to work diligently with Pemex on cash collections.

For the first half of the year, the company reported revenues of $1.4 billion compared to $1.6 billion for the comparable period in 2015. Our operating income was $93 million with a related operating margin of 6% for the first six months of 2016. On an adjusted basis, our operating income and margin were $134 million, a 9% for the same period, excluding restructuring charges of $9 million and an impairment of our Agile vessel of $32 million recorded in the first quarter of 2016.

Our increased operating margin year-over-year is primarily a result of improved project execution and the impact of our successful cost structure initiative. Cash provided by operating activities for the first half of 2016 was $76 million compared to $26 million used in operations for the first half of 2015. The increase in cash provided by operating activities year-over-year was primarily driven by payments of overdue receivables from Pemex in the first quarter of 2016 and steady collections in our Middle East area.

Moving to the balance sheet, at June 30, 2016, we reported $583 million in cash and restricted cash, a reduction of $215 million from the sequential quarter. This decrease was primarily driven by $139 million of capital expenditures primarily related to the DLV 2000 and the prepayment of $75 million made to Term Loan B holders in connection with the amendment and extension of our credit facility, partially offset by the positive cash flow from operating activities I previously discussed.

Capital expenditures for the second quarter were $139 million, including $6 million of capitalized interest. The most significant portion of the CapEx this quarter was related to the DLV 2000. We now expect the final cost of the vessel to be $427 million, excluding capitalized interest with remaining payments of $26 million expected during 2016. This is a $5 million improvement over the estimate we provided in the last quarter. The total amount for the DLV 2000 includes $407 million of CapEx and $20 million of capitalized foreign exchange costs, which have been recorded in equity. These foreign exchange costs will be amortized consistent with the depreciation of the vessel. The remaining amount of CapEx was related to the upgrade of the CS 108 (sic) [CSV 108] to install a vertical lay and reel deployment system, project-related items and maintenance CapEx.

Now, turning to our backlog, we reported approximately $4.4 billion at June 30, 2016, an over $500 million improvement sequentially. Approximately 80% relates to offshore operations and approximately 20% relates to our subsea operations. We had a robust order intake of $1.2 billion, primarily resulting from the Pemex Aktatun-A2 project in Americas and the award of three large projects for Saudi Aramco in the Middle East.

Of the $4.4 billion of backlog, we currently expect $1.1 billion to roll off in the remaining quarters of 2016, $2.4 billion in 2017 and $900 million in 2018. The Saudi Aramco LTA II Lump Sum project makes up approximately $1.4 billion of our second quarter backlog, with $200 million expected to roll off in the remaining quarters of 2016 and $775 million expected in 2017. The Pemex Abkatun-A2 added approximately $454 million to backlog with $27 million expected to roll off in 2016, $239 million expected in 2017 and $188 million expected in 2018.

Our bids and change orders outstanding at quarter-end were $4.2 billion, a decrease compared to $4.7 billion at the end of the first quarter of 2016. The movement in bids is primarily due to the significant order intake this quarter without the immediate backfill from targets. Approximately 66% of our outstanding bids and change orders relates to our offshore operations as of June 30, 2016.

Our list of target projects totaled $12.5 billion as of June 30, 2016, compared to $13.7 billion as of March 31, 2016. Customers continue to remain cautious about their spending decisions and, as a result, we have seen a delay in backfilling of our targets. We're still actively pursuing all opportunities, where our value proposition drives competitive advantage. As a reminder, targets for those projects that we intend to bid on and we expect will be awarded to us or a competitor in the next five quarters. Approximately 69% of the value of our target projects relate to offshore operations.

As of June 30, 2016, the combination of our backlog, bids, change orders outstanding and target projects, which make up our potential revenue pipeline, totaled $21.1 billion, a slight reduction from the $22.2 billion as of March 31, 2016. The decrease in pipeline is driven by the timing and availability of target as we continue to steadily bid prospects. Additional information on the breakdown by project type, region and work scope of those various items has been provided in the supplemental presentation on our website.

Moving on to our cost restructuring programs, our McDermott Profitability Initiative or MPI program has been substantially completed with the move of the resources from our Asia area headquarters from Singapore to Kuala Lumpur occurring during the quarter. We still anticipate gross annual cash savings in 2016 of $150 million as a result of MPI, consistent with our previous projections.

Also, we initiated the Additional Overhead Reduction or AOR program in the fourth quarter of 2015, which is still expected to be completed at the end of the third quarter of 2016 and is still anticipated to result in expected in-year cash savings of $45 million and a $35 million benefit to our current year income statement in 2016. We now expect total restructuring costs to be approximately $12 million in 2016 for both MPI and AOR.

Moving to 2016 guidance, we have updated our guidance to reflect the impacts of project sequencing and improvements in projects recently completed, along with our overall view, given current market conditions, and the status of our operations. We still expect 2016 revenues to be approximately $2.7 billion, consistent with our first quarter guidance.

As a result of several close-out improvements in some of our recently completed projects, we now anticipate operating income to be approximately $126 million, and approximately $170 million, on an adjusted basis, excluding the $32 million Agile impairment loss and approximately $12 million of restructuring charges. We do, however, expect there will be a significant decline in operating income in the third quarter, with a slight improvement in fourth quarter due to updated project timing.

2016 adjusted EBITDA is expected to be approximately $256 million and has been updated to reflect the expected increase in operating income. We expect interest expense to remain at approximately $60 million and capitalized interest of approximately $14 million. We also expect taxes to remain at approximately $60 million, reflecting a more efficient mix of pre-tax income jurisdictions.

As a result of the changes I just mentioned, we are decreasing our expected net loss and loss per share to be approximately $8 million and $0.03 respectively, and adjusted net income and earnings per share to be approximately $35 million and $0.12 respectively for the full year 2016.

We now expect CapEx to be $250 million, including the DLV 2000 impacts, as mentioned before. We also expect to spend approximately $21 million in completing the CS 108 (sic) [CSV 108] vertical lay and reel deployment system in 2016. We are increasing our estimate of maintenance and project-related expenditures to approximately $52 million, an increase of $10 million from last quarter, primarily due to the investment we are making in our Altamira facility to support the Abkatun-A2 project.

We also anticipate having approximately $505 million of cash and restricted cash, and $765 million in gross debt at the end of 2016, with expected free cash flow to be approximately negative $145 million. The reduction in cash and debt is a result of the prepayment of $75 million related to the amendment and extension of our credit facility.

Our guidance is based on our current view of the business outlook. However, given the challenges in the current macro commodity environment, we may see pressure from continued CapEx spending delays by our customers, increased pricing constraints given supply excess in certain markets and our own lower utilization. For now, we intend to concentrate on what we can control, which includes continued focus on our highest value proposition opportunities, strong execution of our existing backlog, customer alignment and focus on our utilization and cost management.

Also, as a reminder, the supplemental slide deck available on our website provides additional financial information including reconciliations of our non-GAAP measures to comparable financial measures.

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

David Dickson - President, Chief Executive Officer & Director

Thank you, Stuart. Our results today clearly demonstrate another quarter of positive operational and financial results. In addition, our focus on customer interaction and strategy to deliver local, vertically integrated solutions has led to substantial order intake. As Stuart highlighted, at the end of Q2 2016, we have approximately $2.4 billion of 2017 expected revenue in our backlog, which provides a good foundation for 2017.

Looking to the future, clearly our customers remain cautious on capital spending and commodity prices look to remain more longer than the industry first anticipated. Given this current environment, we continue to remain in close dialogue with our customers and see opportunities developing in certain countries, particularly with the national oil companies, as demonstrated by our recent award in Mexico with Pemex.

In addition to our focus on building backlog and working closer with our customers, we continue to focus on operational effectiveness, including our focus on HSE and quality, cost management, and continue to develop our organization and talent.

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

Question-and-Answer Session

Operator

And our first question comes from the line of Jamie Cook with Credit Suisse. Your line is now open.

Jamie L. Cook - Credit Suisse Securities (USA) LLC (Broker)

Hi. Good evening, and nice quarter. I guess, a couple questions. One, Stuart, I think you said in the prepared remarks with regards to the outlook that now the third quarter is expected to be weaker and the fourth quarter stronger and that's a change from what you guys had said last quarter where I think the fourth quarter was supposed to be weakest. So if you could just provide some context around that?

And then, my second question, I guess, is two-fold. It's the fourth quarter in a row we've had double-digit margins in the Middle East. And given the backlog that you have in the Middle East, why wouldn't that be sustainable?

And then, the third question is within – I mean you got the nice Pemex win, but within Asia and the Americas, are there any material awards that could happen within the next six months that could help 2017, because I know that'll also have an impact on profitability? Thanks.

Stuart A. Spence - Chief Financial Officer & Executive Vice President

Thanks, Jamie. I'll take the first of three questions. On the outlook for the third quarter and fourth quarter, yes, we've had a significant change in various marine campaigns in all three of our areas relating to different projects and different customers. And that's driven the substantial kind of sequencing change for the second half. So, as we noted on the last quarter call, we were looking at Q4 being a substantial loss. Now, that's moved up to third quarter, and the fourth quarter has recovered nicely.

The second question around double-digit margins in our Middle East business, we are transitioning the portfolio of projects there from completing projects to new very large and complicated projects. So as we close out some of those projects, we are achieving a higher return than what we will recognize on the new projects as we go forward in that business unit.

And then, the third question around backlog opportunities, maybe I'll hand over to David for a general discussion of the market.

Jamie L. Cook - Credit Suisse Securities (USA) LLC (Broker)

Great. Thank you.

David Dickson - President, Chief Executive Officer & Director

Yeah, Jamie, in that area, I mean, difficult to say what's going to happen in the next three months or the next six months. As we said in the prepared remarks, what's difficult to predict is customer timing on certain awards. Now, what I would say is that in Asia, and we've said this before is, we are seeing some activity in places such as India.

We met again with the energy administrator of India less than two weeks ago, to again re-emphasize what is in the public is that the ONGC anticipates to spend something like $25 billion on the deepwater on the east coast of India. And as you know, we are well-positioned there ongoing with the Vashishta project and also with our relationship with Larsen & Toubro. So, we see some potential opportunities there. And not with ONGC, but we would anticipate we start to see some bids coming from some other companies that are operating in India, and in particular, Reliance.

The other area that we see activity is, and we've been successful just recently, is with Pemex. Having the Abkatun award is excellent and one which we had focused a lot of attention on following the lessons learned that we had from PB Litoral. But also we know that, with Altamira, we have a first-class facility. We see more activity occurring in Mexico, not necessarily just with Pemex, but we're now starting to see some activity. So with that, we see opportunities on both our Asia and AEA areas that, hopefully, over the next few years, will help to create a better balance for our portfolio.

Jamie L. Cook - Credit Suisse Securities (USA) LLC (Broker)

Okay. Great. I'll get back in queue. Thank you.

Operator

Thank you. And our next question comes from the line of Matt Tucker with KeyBanc. Your line is now open.

Matt Tucker - KeyBanc Capital Markets, Inc.

Good evening. Congrats on a nice quarter.

David Dickson - President, Chief Executive Officer & Director

Good evening.

Matt Tucker - KeyBanc Capital Markets, Inc.

Just to follow up on the outlook for, I guess, second half of the year, I guess, to what extent is the stronger guidance driven by the second quarter exceeding your expectations versus a change in your second half expectations?

Stuart A. Spence - Chief Financial Officer & Executive Vice President

Matt, this is Stuart. Really, the change in guidance is purely driven by the better-than-forecast performance for our second quarter related to the productivity improvements and some close-out and also some change orders on existing contracts, and then, the rescheduling of marine campaigns in conjunction with our customers for the second half of the year.

Matt Tucker - KeyBanc Capital Markets, Inc.

Got it. So I mean with respect to the kind of the third quarter and the fourth quarter and the way things have kind of shifted around there, I mean, overall is it basically a wash in terms of how that affects the second half? I'm just trying to get a little more clarity there.

Stuart A. Spence - Chief Financial Officer & Executive Vice President

Yes, Matt. In terms of the second half with the resequencing, it is essentially a wash from what we were previously expecting for the second half.

Matt Tucker - KeyBanc Capital Markets, Inc.

Got it. And that's largely – I mean with these awards you had here in the second quarter, which were pretty significant, I mean, it looks like those largely contribute to 2017 and pretty minimally into 2016. Is that accurate?

Stuart A. Spence - Chief Financial Officer & Executive Vice President

That's absolutely correct, Matt. We did highlight in the earnings discussion there that on Abkatun-A2, for example, out of $454 million of a contract, we only expect about $26 million to be recognized in the second half of this year.

Matt Tucker - KeyBanc Capital Markets, Inc.

Got it. So, pretty impressive haul in terms of the awards here in this quarter. I think that the concern that sometimes comes up in this type of environment is what did you have to do to win those contracts and what's maybe the margin or risk profile. So could you just talk a little bit about the factors that led you to being victorious on winning these contracts? And how confident are you that as you get to the end of these projects that you can generate the type of margins that we've been seeing here the past couple of quarters?

David Dickson - President, Chief Executive Officer & Director

Yeah, Matt. This is David. Let me take that question. So I think, obviously, the awards with Saudi Aramco, all that is under our existing LTA II, and as you know, we've been there for a long time, so we certainly know and understand our cost basis there. So I would say nothing has materially changed on how we price our work there. We're well positioned. We often talk about being vertically integrated, and it's something which puts us in a strong position in the Middle East and, in particular, with Aramco.

In terms of the award with Pemex, this was very strategic for us. And as you know, we came through a very painful lesson learned on the PB Litoral, which after we taken the initial write-down, the project was delivered in an excellent way and was able to recover some of that as the project progressed. That has now created the new benchmark in terms of internal costing and in terms of execution. So moving into this Abkatun is that, obviously, we had a lot of confidence in terms of having both our cost basis correct and our execution method, which has been obviously validated by the bid on PB Litoral.

Matt Tucker - KeyBanc Capital Markets, Inc.

Great. Thanks for the color, guys.

Operator

Thank you. And our new question comes from the line of Martin Malloy with Johnson Rice. Your line is now open.

Martin W. Malloy - Johnson Rice & Co. LLC

Good afternoon. Congratulations on the quarter.

David Dickson - President, Chief Executive Officer & Director

Thank you.

Martin W. Malloy - Johnson Rice & Co. LLC

I was wondering if you could talk maybe a little bit more about the agreement for the local fabrication content with Keppel in Qatar? Are there specific projects that you see out there that you're interested in bidding on?

David Dickson - President, Chief Executive Officer & Director

Yeah. So, Marty, this has been something that's – we've been in discussion with Keppel for some time. So N-KOM was created a couple of years ago as a new facility built in Qatar primarily on the ship building side, but also to participate in the offshore EPCI space. And as you know, we have a very good relationship with Keppel. We're obviously involved with them with other things, FloaTEC historically. Obviously, we worked with them at the DLV 2000, et cetera. And that led to a conversation, we said that if you look strategically at our business in the Middle East and where potential workload has been coming from Aramco is, we need to increase our fabrication capability for the area but also to have some presence in Qatar.

And as we look at Qatar, although we're not seeing any immediate awards, there is a lot of long-term potential in what I would call three large fields. And where those projects are, customers are getting ready to move into more the FEED stage of those. So as we look at it longer term, we see this as a means of positioning us more strategically, so that we can really participate in what could be some significant bids coming out over this next couple of years.

Martin W. Malloy - Johnson Rice & Co. LLC

Okay. And then, I have a broader industry question. We're seeing the tie-ups between Technip, FMC, OneSubsea and Subsea 7 and then GE with NOV. Can you just talk about how that might impact you and, I guess, maybe touch on your relationship with GE through the io venture and how that might be impacted?

David Dickson - President, Chief Executive Officer & Director

Yeah. So, I mean, obviously, a lot of discussion in the market was happening really what's been created with Technip and FMC to create this large merger. I would say that where we are positioned today is that we do have obviously a very good relationship with GE. We obviously have the formal relationship through our io business, which both companies are very happy with at this stage. But also a reminder is that we're also working with GE in other opportunities, Ophir project in Equatorial Guinea, but also working with GE, looking at other areas across the globe, where we feel that, with their technology, their equipment supply enhanced with our services, would make a good combination on some of the bids. So we have a good working relationship with GE and look forward to that to continue.

Martin W. Malloy - Johnson Rice & Co. LLC

Great. Thank you.

Operator

Thank you. And our next question comes from the line of Andrew Kaplowitz with Citigroup Capital Markets. Your line is now open.

Andrew Kaplowitz - Citigroup Global Markets, Inc. (Broker)

Good evening, guys. Nice quarter.

David Dickson - President, Chief Executive Officer & Director

Good evening.

Andrew Kaplowitz - Citigroup Global Markets, Inc. (Broker)

David, can you give a little more color about the bids outstanding and target projects, the $16.7 billion you have in your pipeline? Obviously, you had a strong quarter performance in terms of bookings and it took your bids outstanding down, but you did mention that you're having some trouble backfilling your pipeline. So how concerned are you about the difficulty to backfill at this point? And is this more of a 2018 issue, given the visibility that we already have into 2017 revenue?

David Dickson - President, Chief Executive Officer & Director

Yeah, I think, Andy, we give the color on our revenue pipeline and I think when you see the drop-off, that's obviously reflective of the current macro environment that we're living in. This is not just a high level generic number. We take a lot of time in building this up. And we are – as I said earlier in the call, we continue to be as close as we can with our customers, looking at specific projects, which we believe we can truly participate. So I think when you see the drop-off, I think that's a reflection of just the overall macro environment. And I think, if you look at the supplemental deck, you see again is that the smaller part of it is still really from the majors, and obviously the independents. But the majority still would be, the bids are going to be coming through the national oil companies.

And then, there's current climate. We see more awards coming from national oil companies than the majors and independents at this stage. And so, if you look at our awards more recently, particularly in this last quarter coming from both Aramco and Pemex and us preparing for some large potential bids that are going to come out from India, which are in the public domain, so, yeah, while there is a drop-off, we feel there are some good opportunities out there.

And going back to the second question is, yeah, I think, if you look at it with $2.4 billion of revenue in the backlog for 2017 is obviously we've got a lot of focus in terms of what we do for 2018. And a lot of the bids that we're going to be bidding in this next – even the bids that are outstanding today and the bids that we're anticipating over this next six months, most of that revenue results would be executed in 2018 and onward. So, yet, it's probably more of a 2018 issue than it is a 2017 issue today.

Andrew Kaplowitz - Citigroup Global Markets, Inc. (Broker)

Okay. So, look, you already have, as you mentioned, the $2.4 billion in expected revenue for 2017. Last year at this time, you only had $1.5 billion. And you don't have any more projects in loss position. So if I want to dream the dream, is it hard to start thinking about McDermott having a more normal year in 2017? I guess what I mean is a year where utilization is not as big a concern, you do something on the order of $3 billion plus in revenue and operating margins in the high-single digits. Is it hard to dream that dream yet, David?

David Dickson - President, Chief Executive Officer & Director

Well, I think, Andy, what I would say is that it's too early for us to start talking about guidance for 2017. Obviously, we are on – we have had good success for – in terms of building the backlog for 2017. But as we've said several times, timing of customer awards is uncertain. And that's one of the biggest challenges that we have today. So a bit early for guidance and maybe something that we talk about in the next quarter.

Andrew Kaplowitz - Citigroup Global Markets, Inc. (Broker)

Okay. And then one more for Stuart. Stuart, you substantially completed MPI and AOR very successfully. You've obviously talked about the uncertain timing of customer investments. So if investment is still a little lower than you'd like to see, what else can you do? Is there a sort of low hanging fruit already eaten or can you do more on the cost side, if you need to?

Stuart A. Spence - Chief Financial Officer & Executive Vice President

Andy, in general, I think McDermott has done – and I talk about the general management team – an outstanding job in right-sizing our cost structure. So we've become a far more efficient organization. We are currently structured with a cost base to execute our current backlog and an expected backlog going into 2017. Should we see a kind of a drop-off in expectation of what we would hope for 2017, there are still cost levers that we can prove within the company, more, I would say, on the variable cost side than on the fixed cost side.

Andrew Kaplowitz - Citigroup Global Markets, Inc. (Broker)

Great. Thanks, guys.

Operator

Thank you. And our next question comes from the line of Chad Dillard with Deutsche Bank. Your line is now open.

Chad Dillard - Deutsche Bank Securities, Inc.

Hi. Good evening.

David Dickson - President, Chief Executive Officer & Director

Good evening.

Chad Dillard - Deutsche Bank Securities, Inc.

So, I just want to circle back to your comments on cost absorption. So for the first half of this year, there is about $47 million of cost absorption, but how do we think about that in the back half of the year? And then can you talk a little bit more about where that's coming from, from a regional as well as a business line perspective?

Stuart A. Spence - Chief Financial Officer & Executive Vice President

Chad, this is Stuart. I think as we give our original guidance for 2016 at the end of 2015, we did highlight that given the portfolio that we were expecting to build and some of the concentrations that we were having, we were going to have almost double the under-absorption in 2016 versus 2015. And as we worked through the first half and as we built into our guidance for the second half, that structure still remains for us. So we're still looking at a pretty heavy under-absorption for the second half of this year. As we highlighted in our prepared remarks, fabrication in Altamira and Batam was a drag and the main contributor to our under-absorption in the second quarter.

As we move to the back half, the under-absorption in Altamira will ultimately be taken care of late in the second half with Abkatun. We're still looking for prospects in Batam, but we're also going to see, I think, some gaps appear some of the subsea vessel schedules for the second half. So it's a kind of a same but different mix on under-absorption for the second half.

Chad Dillard - Deutsche Bank Securities, Inc.

Got it. That's helpful. And then, it looks like you had some favorable changes and cost estimates have stepped up significantly over the last few quarters. How sustainable is this and how should we think about this going forward?

Stuart A. Spence - Chief Financial Officer & Executive Vice President

I think the – what we've done over the last kind of two years, Chad, is focus the company on execution. So after we win a project, we are focused on how can we execute as a minimum to the as-bid, but hopefully, how can we execute on a more productive or better cost position. So I think we're starting to see some of those cultural aspects come through in the execution. But I think, as we've always said over the last, kind of, year, the competitive environment in which we now operate is more competitive given the overall supply and demand dynamics. And as such, it gets harder and harder to be competitive and then beat your as-bid estimates. So we're always very cautious, I would say, on being able to predict that we over-perform our as-bid margins.

Chad Dillard - Deutsche Bank Securities, Inc.

Great. Thank you very much.

Operator

Thank you. And our next question comes from the line of Steven Fisher with UBS. Your line is now open.

Steven Michael Fisher - UBS Securities LLC

Thanks. Good afternoon. On cash flow, can you just clarify why the cash flow guidance from operations was reduced by $10 million?

Stuart A. Spence - Chief Financial Officer & Executive Vice President

Steve, this is Stuart. Yes, we just looked at the various impacts on working capital in the second half. We have a very structured bottom-up approach, and we just had some slight timing differences on milestones and when we would expect those to be received. That resulted in the very marginal downgrade to our cash flow from operations forecast.

Steven Michael Fisher - UBS Securities LLC

Okay. And since you mentioned Pemex, what are they telling you now in terms of what it will take to get paid, I think you said it was $20 million?

Stuart A. Spence - Chief Financial Officer & Executive Vice President

Yes. With Pemex, we worked with them on essentially two fronts. The first front is what is all of the documentation and approvals required to allow us to invoice. And that's what we're working through on that $20 million from 2015. And then, once we invoice, we are finding them pretty regular on meeting their kind of payment deadlines. So we work with Pemex on both fronts. We are still very confident of the ability for Pemex to meet their receivables, and we're still very confident of them as a customer for us going forward.

Steven Michael Fisher - UBS Securities LLC

Okay. I wonder if you could give a little more color on the Ichthys project. What's the expected completion timing at this point? It looked like, from your slide, it's around 80% to 90% complete. Are there still change order opportunities left there? And if you could kind of help fill in sort of the revenue, how that was tracking in the quarter, and what you expect for the rest of the year, that would be helpful.

David Dickson - President, Chief Executive Officer & Director

Yeah, Steve. This is David. So, as we said in the opening remarks, the project is progressing extremely well. So we still see completion sometime in the first half of 2017, which has been consistent for some time. Most of the equipment has been delivered. We're working with our customer. Obviously, there's two floating units to be delivered into the field which we eventually will connect up the final pipelines. Are there some future change order opportunities? I would say yes, but that would be subject just to logistics and timing and changes in sequence and things like that. But overall, we are very happy with the project, and the customer is very happy with McDermott.

And, Stuart?

Stuart A. Spence - Chief Financial Officer & Executive Vice President

Yes, Steve. On the backlog question, so at June 30, 2016, we had approximately $370 million of backlog for INPEX Ichthys. And we would expect approximately $220 million to roll off in the second half of this year, with the balance rolling off in the first half of 2017.

Steven Michael Fisher - UBS Securities LLC

Great. And if I could just ask one more, with your guidance suggesting that sizable ramp-down of operating profit in the second half, to what extent do you still see any opportunities to fill in the gaps, like particularly in Q3, with any sort of short-term work?

David Dickson - President, Chief Executive Officer & Director

Yeah. I mean, obviously, Steve, there is always opportunity. We may see what we call some [pick]-and-burn activity, and then, obviously, that's something very difficult for us to forecast. So there are some – we – potentially, there are some opportunities, but as I said, don't have the visibility on it. And as I said, that includes [pick]-and-burn items. Typically, you get the call the day before, [normalize] them the day after, so difficult for us to forecast them.

Steven Michael Fisher - UBS Securities LLC

Got it. Thanks a lot.

David Dickson - President, Chief Executive Officer & Director

Thanks.

Operator

Thank you. And our next question comes from the line of Rob Norfleet with Alembic Global Advisors. Your line is now open.

Robert F. Norfleet - Alembic Global Advisors LLC

Good afternoon. Most of my questions have been answered, but just a couple to throw out to you all. With the final spending for the DLV 2000 coming up, obviously, it looks like the kind of heavy capital spending, non-maintenance CapEx will largely be complete. So as we look into 2017, obviously, I would expect there to be a fairly material improvement in free cash flow. And if you look over the last few years, you guys have not had a lot of breathing room on the balance sheet; you clearly do now, as a result of less spending moving forward as well as the improvements with the amended credit facilities, et cetera.

So can you kind of discuss a little bit around capital allocation as it relates to some of the things you're thinking about in 2017 and beyond, whether it's additional debt reduction, buybacks, small acquisitions, because we really haven't been in a position to discuss capital allocations for the last couple years?

Stuart A. Spence - Chief Financial Officer & Executive Vice President

Rob, this is Stuart. As we look at capital allocation or liquidity management, we still remain very, very conservative. The macro environment still has a lot of uncertainty out there. We talk a lot about the prospects on our revenue pipeline. So until there's a very clear path out and recovery from this cycle, we're going to remain very conservative on our liquidity. Because of that, we remain focused on costs, we remain focused on working capital, and we also take a very conservative view on our capital spending. We've been spending the minimum on maintenance-related items to make sure assets are in full working order. And then the additional CapEx is mainly related around to project-specific items. And I think that's going to be our stance until we see a firm recovery from this cycle.

Robert F. Norfleet - Alembic Global Advisors LLC

Okay. But under that scenario, would you just let cash build, or would you look at, hypothetically, if there is a significant cash build over the next 18 months, would you likely look to reduce debt? Or just build the cash?

Stuart A. Spence - Chief Financial Officer & Executive Vice President

In the short term, Rob, our focus is on to build the cash.

Robert F. Norfleet - Alembic Global Advisors LLC

Okay. Fair. And quickly, Stuart, last quarter, you discussed some operational-type savings around supply chain initiatives. Can you kind of give us an update on that, and just what the opportunities are, and maybe give us a little bit more meat around that?

Stuart A. Spence - Chief Financial Officer & Executive Vice President

Sure. We continue to advance a lot of our supply chain initiatives in our general operations. So those are outside of the McDermott Profitability Initiative. So we are still moving and setting up all the structure to go from a project procurement model to a global procurement model. So we're working around master service agreements, commodities management. We're actually investing in some new IT systems to allow us to interface and manage and collaborate with our supply chain on a more real time on efficient basis. So we're progressing on our plan there. We haven't given specific detailed numbers on our target for savings, but we are finding – I would say, we are finding far more efficient ways to work with our supply chain. And within our project cost estimates, we are still getting a benefit to the new relationships.

Robert F. Norfleet - Alembic Global Advisors LLC

Okay. Great. And lastly, David, can you just discuss – look, I know the environment, from a bidding perspective, remains very competitive. But have you seen any changes over the last six months to nine months in terms of what customers are asking for you all to do, whether it's trying to push more risk off on the contractor, which I know is always the case, but has there been any real change in the mindset from a bidding perspective?

David Dickson - President, Chief Executive Officer & Director

No, there hasn't been. From the customer side, there hasn't been really – there hasn't been any what I would say any significant change. I haven't seen any more of risk being pushed into the contractors. I think the main thing that has happened is, obviously, we live in a very competitive environment and whilst we will remain disciplined in our building up our costs and our pricing is that we could anticipate that maybe some players might not be as disciplined, as people become obviously very hungry for backlog. So that's one of the things that's potentially out there, but certainly from the customer side, I haven't really seen any material change.

Robert F. Norfleet - Alembic Global Advisors LLC

Great. That's all I have. Thanks so much.

David Dickson - President, Chief Executive Officer & Director

Thanks.

Operator

Thank you. And our next question comes from the line of John Rogers with D.A. Davidson. Your line is now open.

John Bergstrom Rogers - D. A. Davidson & Co.

Hi. Good afternoon, and congratulations as well. Just some clarification, if I could. In terms of your most recent Pemex award, have you changed the terms or addressed the contract structure so you avoid these delays in collection? Is there anything you can do there?

Stuart A. Spence - Chief Financial Officer & Executive Vice President

Hi, John. This is Stuart. The actual structure for the contract in terms of the milestones and the documentation and the requirements for billing remain the same as our current contracts with Pemex. As you know, Pemex moved its standard payment terms from typically 30 days or 60 days to 180 days last year. So the whole industry is adjusting to that fact. We just continue to work with Pemex to ensure that there are no hurdles to receiving approval for billings and that we meet all of the documentation requirement under the contract.

John Bergstrom Rogers - D. A. Davidson & Co.

So – I mean, can you – I assume you that – you knew what these terms were as you signed the contract, so presumably priced accordingly?

Stuart A. Spence - Chief Financial Officer & Executive Vice President

Yes, I think – going into Pemex opportunities at the moment, we look at all of the risks and rewards associated with the potential opportunity and we price accordingly. Yes.

John Bergstrom Rogers - D. A. Davidson & Co.

Okay. And then, just in terms of the $150 million on MPI program, how much of that will be incremental beyond 2016? In other words, how much have you recognized of that already? Just trying to understand the impact as we think about 2017.

Stuart A. Spence - Chief Financial Officer & Executive Vice President

Sure. The bulk of the $150 million as a run rate is now in operation, so there's little incremental run rate going into 2017. And I think, as we've said consistently, we try and benefit McDermott with some of those savings, but given the macro environment, we are passing a lot of those benefits on to the customers in the form of reduced pricing in this very competitive environment.

John Bergstrom Rogers - D. A. Davidson & Co.

Okay. Okay. That's all I had. Thank you.

Operator

Thank you. And I'm not showing any further questions at this time. I would now like to hand the call back to Kathy Murray for closing remarks.

Kathy Murray - Vice President, Treasurer and Investor Relations

Thank you, operator. We appreciate you taking the time today to participate in McDermott's second quarter 2016 earnings call. As a reminder, this call will be available for replay for seven days on our website. And with that, operator, this concludes our call.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!