Chicago Bridge & Iron NV (CBI) Q4 2016 Results - Earnings Call Transcript

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Chicago Bridge & Iron Co. NV (NYSE:CBI)

Q4 2016 Earnings Call

February 28, 2017 5:00 pm ET

Executives

Philip K. Asherman - Chicago Bridge & Iron Co. NV

Michael S. Taff - Chicago Bridge & Iron Co. NV

Analysts

Michael S. Dudas - Vertical Research Partners LLC

Tahira Afzal - KeyBanc Capital Markets, Inc.

Chad Dillard - Deutsche Bank Securities, Inc.

Andrew Kaplowitz - Citigroup Global Markets, Inc.

Steven Michael Fisher - UBS Securities LLC

Justin P. Hauke - Robert W. Baird & Co., Inc.

Jerry Revich - Goldman Sachs & Co.

Anna Kaminskaya - Bank of America Merrill Lynch

Operator

Good afternoon, and welcome to the CB&I Fourth Quarter Earnings Call. Thank you for joining us today. On the call today are Phil Asherman, President and Chief Executive Officer; and Mike Taff, Executive Vice President and Chief Financial Officer. Mr. Asherman will offer commentary on the results for the quarter, and Mr. Taff will go through a detailed discussion of the financials. After that, the call will be opened for questions.

Before beginning today's call, the company would like to caution you regarding forward-looking statements. Any statements made or discussed today that do not constitute or are not historical facts, particularly comments regarding the company's future plans and expected performance, are forward-looking statements that are based on assumptions the company believes are reasonable, but are subject to a range of uncertainties and risks that are summarized in the company's press release and our SEC filing.

While forward-looking statements represent management's best current judgment as to what may occur in the future, the actual outcome or results may differ materially from what is expressed or implied in any such statements.

I'll now turn the call over to Mr. Asherman.

Philip K. Asherman - Chicago Bridge & Iron Co. NV

Good afternoon. With me today is Mike Taff, our Chief Financial Officer. Mike is going to provide the financial overview for both Q4 and the full year, followed by your questions. But first, I'd like to begin with a few comments on the period.

As usual, we begin with safety. In 2016, CB&I expended nearly 110 million work hours on hundreds of projects, offices, labs and fabrication shops spread over 85 global locations. And because of our rigorous safety methods and procedures, our lost-time incident rate, which is an accident that is serious enough for a worker to miss time on the job, was a 0.01 for the year or just eight incident cases, including all CB&I and subcontractor employees on our sites. We did loose five employees this year in an environment where U.S. construction had productivity and safety challenges because of so many new workers entering the workplace. So despite the statistics, we're absolutely focused on achieving zero incidents on every job as our goal.

But turning to results, as part of CB&I's previously announced strategy to optimize our balance sheet for future growth, we're announcing today the divestiture of our Capital Services business to an affiliate of private equity investment firm, Veritas Capital, for $755 million in cash. And with the tax benefit, the sale will result in significant cash proceeds that will be applied to debt, which will dramatically decrease our debt to EBITDA ratio by year's end. We expect an additional positive impact on our overall business by recognizing additional cost synergies and ensuring our business is more aligned with our long-term strategy in end markets. And in conjunction with the sale, we've taken a one-time non-cash impairment charge of approximately $655 million in the fourth quarter of 2016.

In addition, we included a reserve for an outstanding receivable that was a deferred payment in the sale of Stone & Webster to Westinghouse. But given the current uncertainty of Westinghouse's financial situation, we think it prudent to address this write-off now. But we still maintain our rights to collect this debt.

The cash flows continue to be a strong story with operating cash flows for the year, including advanced payments from joint ventures, in excess of $800 million. Also in 2016, we returned $235 million to our shareholders through stock repurchases and dividends; and for the year, maintained our SG&A around 3.3% and a normalized effective tax rate of 25%.

Now, since we'll be talking today about direct labor productivity as an issue that negatively impacted our performance this quarter, going forward, we no longer will take construction risk on those projects where we cannot use our own workforce, particularly in union areas of the U.S. We've experienced costly and restrictive work rules, while union labor productivity is nearly half of what we experience in those areas of the country such as the Gulf Coast, where we've trained and employed our direct hire workforce.

But overall, of the over 600 projects we're building, the vast majority of our backlog is performing very well. And despite the project charges this quarter, we're still able to post earnings and cash flows well above the average for our peer group. But we still expect more from our business model which is focused on bottom-line performance, and we're disappointed that we missed earnings target.

The key project milestones in 2016 include the completion of the ethane cracker for OxyChem and Mexichem in Ingleside, Texas; progress on the Cameron LNG Liquefaction Project in Hackberry, Louisiana and the Freeport LNG job in Freeport, Texas; advancement of the Shintech Ethane Cracker Project in Plaquemine, Louisiana; as well as the Lotte Ethane Cracker Project and the associated mono-ethylene glycol plant in Lake Charles, Louisiana; and continue construction of three combined-cycle power plants throughout the U.S. Outside the U.S. we broke ground on the Liwa Plastics Industrial Complex, which is a $3 billion strategically important project for Oman.

Now, these project milestones were achieved in part through integrated offerings from our operating groups. Our ability to combine multiple services on our large-scale projects is one of the strengths of CB&I's business model.

Now also in 2016 with our partner, Clariant, we opened a new polypropylene catalyst facility in Louisville, Kentucky that will produce next generation catalysts for CB&I's Novolen technology. We also announced our alliance with leading catalyst and technology provider, Haldor Topsoe, which will expand our licensing position for syngas opportunities, as well as the engineering and construction of plants in North America.

I'm also proud of one 2016 achievement that was a true first for CB&I, our Presidential Green Chemistry Challenge Award. The U.S. Environmental Protection Agency honored us with the award of our AlkyClean technology, which is reflective our company's commitment to the investment and implementation of technology and solutions that contribute to the positive health of the environment.

The primary headwind this year was the delay in many project awards, which we had expected to contribute 25% of our revenue for the year. We did win over $7 billion in new business for the year versus our original forecast of $10 billion to $12 billion in total new sales. But the good news is that the major prospects are still out there and we're seeing a rebound of technology sales, which is typically a leading indicator of the global energy market.

The strength of our prospects continue to be concentrated in the U.S., East Africa and the Middle East, specifically in Oman, the Emirates, Bahrain and Saudi Arabia. Other opportunistic areas include Russia, Eastern Europe and Asia Pacific with a number of interesting prospects for 2017. But we see increasing global demand for petrochemical and refining opportunities, but final investment decisions are still delayed as customers are adjusting to global commodity pricing.

Petrochemical investment has continued and is focused on ethylene and low feedstock cost, with continued development work on major U.S. and Middle East projects. We expect to announce a major ethane cracker on the Gulf Coast early next quarter, and we continue to advance our position on major refining opportunities in the Middle East.

And in fossil power, the U.S. remains our key focus for fire – gas-fired power prospects, as a consistent stream of investments are being planned in response for retirement for coal-fired facilities. NET Power is also scheduled for completion by year's end to begin pilot plant testing for emission-free power generation.

Now, we approached 2017 cautiously optimistic, and the timing of new awards is a driver for our plan. We expect much of this activity in the second half of the year, which might have a minimal impact on 2017 revenue and earnings, but obviously creates a great outlook for next year and beyond. We have a healthy backlog of $18 billion, including the additional revenue stream from our Technology and Fabrication Services groups, which can serve projects internally and sell externally around the world.

Now, I'll turn it over to Mike, who will provide you with the financial detail for the year, plus guidance for 2017. And then we'll open the call for your questions. Mike?

Michael S. Taff - Chicago Bridge & Iron Co. NV

Thanks, Phil, and good afternoon, everyone. Net cash provided by operations was very strong for the quarter and the year. If we include advanced payments from equity method joint ventures, the amounts are $168 million for the fourth quarter and $802 million for the full year. The full year cash flow figure represents a positive swing of more than $850 million as compared to 2015.

Excluding the impairment charge and the receivable reserve that Phil mentioned, net income for the fourth quarter of 2016 was $86 million or $0.85 per share, and for the full year was $438 million or $4.23 per diluted share. These figures compare to an adjusted net income of $133 million or $1.26 per diluted share for the year ago quarter and $499 million or $4.64 per share for the full year of 2015.

Fourth quarter 2016 revenue was $2.5 billion as compared to $3.3 billion in the fourth quarter of 2015 or $2.8 billion on an adjusted basis. Revenue for the full year of 2016 was $10.7 billion as compared to $12.9 billion in 2015 or $10.9 billion on an adjusted basis. The company's backlog at the end of 2016 was $18.5 billion as compared to $22.6 billion at the end of 2015.

On a consolidated basis, our results for the fourth quarter of 2016 were impacted by the following items. The $655 million non-cash goodwill impairment charge on the sale of our Capital Services business, the $148 million reserve for receivable related to our 2015 sale of the Nuclear Construction business, project charges of approximately $195 million, and a $67 million tax benefit for the reversal of a deferred tax liability. As a result, the company reported a net loss of $666 million or $6.65 per share for the fourth quarter of 2016 and for the full year a net loss of $313 million or $3.05 per diluted share.

Now, I'll review the quarterly results of the operating groups. The E&C group revenue for the fourth quarter was $1.4 billion, which is down sequentially and as compared to the adjusted year-ago quarter. E&C group reported an operating loss of $35 million excluding the receivable write-off. The operating loss was a result of charges totaling approximately $150 million for increases in cost to complete estimates.

Fabrication Services revenue for the fourth quarter of 2016 came in at $553 million, which is up 8% on a sequential quarter basis and comparable to the fourth quarter of 2015. Fabrication Services operating income was $22 million, which is down sequentially and compared to the year-ago quarter and reflects charges totaling approximately $45 million on increases in cost to complete estimates. Of course, the project charges also impacted the group's operating income margin, which came in at 4.1% in the fourth quarter.

The Technology group revenue in the fourth quarter of 2016 was $65 million, which is down sequentially and in relation to the year-ago quarter. Operating income was $29 million for the quarter, which is up modestly from the preceding quarter, but down from the year-ago quarter. Nevertheless operating income margin in the Technology group was more than 44% for the quarter, the highest level in almost two years, and is reflective of a richer mix of license revenue. You heard Phil say that Technology new awards were strong in Q4 and this certainly bodes well for future spending on energy infrastructure projects.

And then summarizing the fourth quarter performance of Capital Services, revenue was $536 million. And excluding the impact of the impairment charge, operating income was $18 million and operating income margin was 3.4%.

Turning to cash flow and related items. As you heard Phil say, we intend to use the proceeds from the divestiture of the Capital Services to reduce the company's total debt, which stood at $2.2 billion at the end of 2016. For the sake of example, that would give us a pro forma debt level of approximately $1.5 billion and a leverage ratio in the neighborhood of 2 times our trailing four-quarter EBITDA.

As I mentioned previously, operating cash flow in the fourth quarter of 2016 was $168 million, including about $10 million of advanced payments from unconsolidated joint ventures. That's almost 2 times adjusted net income. For the full year, the amount was $802 million, which includes advanced payments of $147 million, most of which was associated with a Q1 advanced payment. The full-year figure is 1.8 times adjusted net income. As I mentioned, the full-year cash flow amount represents a positive swing of more than $850 million as compared to 2015.

Debt reduction, obviously, continues to be a priority for us and the $2.2 billion of total debt at year-end represented a decline of 15% from year-end 2015, and of course total debt will decline significantly after we close on the sale of the Capital Services business.

Speaking of the company's debt, I'd also like to say that we approached our lenders in late 2016 and early 2017 to amend several of our covenants in advance of the Capital Services transaction. We were successful in this effort and the amendments were effective as of December 31, 2016. As a result, we remain in compliance with all of our financial and restricted covenants and we expect to remain so for the balance of the year.

We ended the year with a very healthy total cash position of $505 million, and that's for a year in which we reduced total debt by almost $400 million, made roughly $100 million of capital investments, and spent $235 million to purchase stock and pay dividends. Our share count at year-end was approximately where it was prior to the acquisition of The Shaw Group in 2013, roughly 100 million shares outstanding.

Our guidance for 2017 is that we expect to generate revenue between $9.5 billion and $10.5 billion, of which about 80% was already in our 2016 year-end backlog. We expect to generate diluted earnings per share of between $4 and $4.60 a share. And as we have previously indicated, our operating cash flow should be at or above the level of net income. We will update this guidance to reflect the divestiture of our Capital Services business once that transaction is completed, which is expected to be in the second quarter of 2017.

Also, as a matter of housekeeping, please note that the sale will result in a taxable gain once we close the transaction, and in turn that gain will generate a tax expense of approximately $100 million, mostly non-cash due to the use of our NOLs.

Before I turn it back over to Phil, I'd like to once again remind you that we are following a very detailed playbook to drive value at CB&I with particular focus over the intermediate term on execution, growth and optimizing the balance sheet. Phil, back to you.

Philip K. Asherman - Chicago Bridge & Iron Co. NV

Thanks, Mike. Let's open the call for your questions.

Question-and-Answer Session

Operator

Our first question is going to come from the line of Michael Dudas with Vertical Research.

Philip K. Asherman - Chicago Bridge & Iron Co. NV

Hello, Mike.

Michael S. Dudas - Vertical Research Partners LLC

Good evening, everyone.

Michael S. Taff - Chicago Bridge & Iron Co. NV

Hey, Michael.

Michael S. Dudas - Vertical Research Partners LLC

Good evening, Phil, Mike – Michael, good evening. Phil, could you elaborate a little bit more on the cost to complete issues in E&C and in Fabrication Services? How comfortable on the backlog scrub are you? And these issues that you faced are going to, I assume, ameliorate for you during 2017, but do you see that as an issue for the industry, especially down in the Gulf Coast?

Philip K. Asherman - Chicago Bridge & Iron Co. NV

Yeah. Well, if you give me a moment – and maybe I might expand a little more on that, because we've talked about labor productivity for a number of years. If you recall before the anticipated build-out on the Gulf Coast, a lot of conversation on these calls with you and our investors about where is the labor going to come from, because we're anticipating 25,000, 30,000 craft workers needed for this build-out. We immediately started our efforts in training, the hiring. Of course, we accumulated the Shaw resources in that number. And on the Gulf Coast, I think we've been pretty successful in achieving our productivity numbers for the Gulf Coast – famous Gulf Coast 1 (19:46) baseline.

What we probably didn't anticipate fully was, in union areas, particularly in the U.S. and particularly in the Midwest and somewhat towards the Northeast, the productivity of union labor was not achieving parity with what we're seeing in our own direct workforce. So, we did a couple of jobs a couple of years ago and that's what we see happening. We have not been able to mitigate those successfully. And then we've come to the conclusion that until we're at a point where we can either price it or derisk the contract, we just can't approach those jobs anymore. So, we're not going to do that.

But the jobs in question, only one job's in a loss, the other charges some dilution of the gross margin. But nevertheless we are at a phase in the jobs where we have all the engineering procurement is finished, it's just the construction and it should be finishing towards the end of this year. I would like to think that the labor charges that we're anticipating on the cost to complete estimates are conservative. And if there were some more costs, I doubt they would be – we would consider them material. And there are always discussions with the owners, but we decided to go ahead and take our estimate and our charges this quarter. But again, I think the fundamental issue is more caution on those areas where we cannot control the workforce as we do in other jobs around the United States. So, that's the bottom line on that, Mike.

Michael S. Dudas - Vertical Research Partners LLC

Appreciate that. And Mike, for you. Normalizing for all the noise in the Q4, looking at 2017, relative to your historical margin ranges with the pace of revenue flow and some of the issues that you addressed in your prepared remarks, are we still going to be within the ranges here, or how should we think about that as we're modeling out the year?

Michael S. Taff - Chicago Bridge & Iron Co. NV

Yes. I mean I think the historical margin ranges are still appropriate that we've been – with the big ones being E&C in that 4% to 7% range. We've historically, except for this quarter, been at the top end of that range. And Fabrication Services, we've been in that 10% to 12% range. And you kind of normalize this quarter, again, you're at the top end of that range if you normalize Fab Services for that. And Technology, I think, continues to be in that 30% to 40%-plus range.

Michael S. Dudas - Vertical Research Partners LLC

Terrific. Appreciate, guys. Thank you very much, and good luck with the asset sale.

Philip K. Asherman - Chicago Bridge & Iron Co. NV

All right. Thank you.

Operator

And our next question is going to come from the line of Tahira Afzal with KeyBanc Capital Markets.

Philip K. Asherman - Chicago Bridge & Iron Co. NV

Hello, Tahira.

Tahira Afzal - KeyBanc Capital Markets, Inc.

Hi. Good evening.

Michael S. Taff - Chicago Bridge & Iron Co. NV

Good evening, Tahira.

Tahira Afzal - KeyBanc Capital Markets, Inc.

I guess, more importantly, it seems like everyone is facing the same issues. Can you talk a bit more about the LNG cycle? When I look at some of the macro headline, sort of deep dives out there, some are expecting the surplus to revert in 2023 plus, some in 2022. And obviously, that influences (23:02) when the cycle comes back. Would love to get a little more of your thoughts on that?

Philip K. Asherman - Chicago Bridge & Iron Co. NV

Yeah. Well, my thoughts are – and keep in mind, in our particular industry, we're usually six months out of cycle on any down market, and we're usually six months from feeling the benefit when the market returns. And that's really what's played out here. But I will tell you – and so 2017, we're approaching a little bit conservative. If you remember that when we talked about this year, we had 25% of our revenue already in backlog, which gave us a risk of around 25% of revenue come from new awards. Obviously, those projects moved out to the right. They're still out there. But certainly, that was the shortfall on our revenue expectations. But we're approaching 2017 a bit conservatively.

We see some real traction come back in all of our end markets for 2017. Timing continues to be the issue. If we look at our overall funnel of work, we're projecting roughly around $71 billion of identified projects out there in the system, but when you bring it down through our probability analysis, there's probably $21 billion of addressable market for us in the Energy business around the world. And I can break those down sometime if you want to break down into segments.

But the point is, is that we've legitimately got a chance to get in that $10 billion to $12 billion range or more for this year in new awards. But again, the issue is timing and when we can generate revenue. So if it pushes back towards the end of the year, again, we're going to see that revenue obviously very strong for 2018 and beyond. But I think we're going to see a real rebound in the new projects towards the back of the year.

I'm hearing the same thing you are from our customers. They're seeing that oil prices, they expect to be in the neighborhood of $55, $60 a barrel. I don't think anybody wants to see it in triple digits again. I think we're seeing some real commentary around demand increasing over the next few years. I think the other important thing is the Middle East particularly and the IOCs are looking at more downstream petrochemical investment than just upstream investment. So, I think that those are important trends that are going to affect our business over the next several years. So, I agree with you. I think where you can peg that in terms of the timeline, I'm not sure, but the consensus seems to be the same.

Tahira Afzal - KeyBanc Capital Markets, Inc.

Got it. Okay. That's actually pretty helpful, Phil.

Philip K. Asherman - Chicago Bridge & Iron Co. NV

Thank you.

Tahira Afzal - KeyBanc Capital Markets, Inc.

My second question is, Sempra was – talked about yourself and Cameron LNG a bit on their call today. And while they said that the lump sum project does put a lot of the ownership at risk on cost overruns, on yourself, they did also say there are certain portions they can actually pass through as well. So, as you look to track this project a little better, can you define for us what – to some degree, what your risks are, the ones that we should assume you're on the hook for and the ones you're not?

Philip K. Asherman - Chicago Bridge & Iron Co. NV

Yeah. I think the Sempra remarks in their earnings call was very comprehensive, and there's nothing in there we disagree with. We're working hard to look at any kind of disparity in the Phase 1 schedule and to tighten those. But we're very confident in achieving the Phase 2 and Phase 3 schedules. In fact, we're quite ahead of those activities. It's probably not unusual for a job of that multiple phases to have maybe some of the schedule – incremental schedule delays, particularly with the weather we've – but nothing's in dispute. All right? We're working hard together to mitigate those issues and we feel pretty confident about the outcome.

So, the LNG jobs on both sides are going pretty well. We've – on Cameron, specifically, we've got most of the engineering done. We've bought most of the materials. A lot of it's already been delivered. Most of it's been delivered, the major equipment. And we're seeing good labor productivity. We also see a safety record down there of over 120 million – or of 20 million man hours without a lost-time incident. So, we feel pretty confident in the outcome of that job.

Michael S. Taff - Chicago Bridge & Iron Co. NV

Yeah. And Tahira, the other thing positive was their commentary on Train 4 that they do intend to go forward with that, and they're still having conversation with one partner.

Philip K. Asherman - Chicago Bridge & Iron Co. NV

Yeah. And just to get a little more – we don't have that in our forecast right now. We're going to wait for a Q from Sempra for that.

Tahira Afzal - KeyBanc Capital Markets, Inc.

If you see another rainy Texas start sort of summer/Louisiana, what does it mean in terms of the risk for – so we can track it as we go into the summer?

Philip K. Asherman - Chicago Bridge & Iron Co. NV

Well, if you can track that, let me know, because it was more than 100-year event, unforeseen in the history in that part of Louisiana to have that kind of flooding. It was a very serious event. We had over 1,500 workers, as you recall, impacted by that flooding that lost their homes, lost their cars. I think to the credit of our people, we were back in our shops and our projects by the Tuesday after the week before, getting our shops back together. But it did have an impact. We produce a lot of pipe spools out of those shops for all the LNG and other projects. So, it did have an impact.

But again, just remember, it's not a – doesn't mean there's a dispute. It means that we have to contractually record that delay and submit it to the owners. It doesn't mean they have to accept it or not. But we do have to record that as an impact on the schedule. So, it's not a matter of arguing about that, it's a matter of, okay, here's the event, we've got some delay, let's figure out how to pick up the pace. And that's really what we'd be doing. And I think Sempra was very descriptive in terms of how many particular items that we have to address and the things we're doing together to mitigate the schedule. So, it's a great job. We've got 6,000 people down there and it's a huge undertaking. But I think we feel pretty confident in its success.

Tahira Afzal - KeyBanc Capital Markets, Inc.

Got it. Thank you very much, Phil and Mike.

Michael S. Taff - Chicago Bridge & Iron Co. NV

Yeah. Thanks, Tahira.

Operator

Our next question is going to come from the line of Chad Dillard with Deutsche Bank.

Philip K. Asherman - Chicago Bridge & Iron Co. NV

Hello, Chad.

Chad Dillard - Deutsche Bank Securities, Inc.

Hi. Good evening.

Michael S. Taff - Chicago Bridge & Iron Co. NV

Hey, Chad.

Chad Dillard - Deutsche Bank Securities, Inc.

So, what gives you the confidence on the $10 billion to $12 billion award guidance that you were just speaking about? Does that include Mozambique LNG? And also, how much cost inflation are you seeing in the types of projects that you're bidding in compared to a couple of years ago?

Philip K. Asherman - Chicago Bridge & Iron Co. NV

The second other part of your question, Chad? Will you restate that? What am I seeing...

Chad Dillard - Deutsche Bank Securities, Inc.

Yeah. So also how much cost inflation are you seeing in the types of projects that you're bidding compared to a few years ago?

Philip K. Asherman - Chicago Bridge & Iron Co. NV

Cost inflation. And what was the first part?

Michael S. Taff - Chicago Bridge & Iron Co. NV

Mozambique.

Philip K. Asherman - Chicago Bridge & Iron Co. NV

Sorry. I'm getting older, Chad, sorry. Well, the Mozambique, we've got the – we think there's an outside chance they may go to FID by the end of the year, but I think we probably see that as a 2018 event. And what gets us to the $10 billion to $12 billion is really just math. When we do our forecast, it's not based on market conditions, it's based on actual projects that we see. And what we see is a potential $21 billion of key prospects out there. Now, whether they are all going to award this year is problematic. But if they do, and we apply our typical win ratios to that $20 billion, you can come to $10 billion to $12 billion – you get to the $10 billion to $12 billion. But this year we have about 80% of our revenue in backlog. So, we have less of a risk on the backside in case the market gets delayed some more. But in absolute numbers, we see that.

Now, clearly, the biggest region is the USA for us, both in LNG and power, certainly, and even in petrochemicals. So, the U.S. really dominates that picture significantly, about almost half of our potential work. But the Middle East also has a lot of potential for this year for new awards too. And then certainly, we have some external awards in our Fabrication Services and Technology. So, we've scoped it out. We're being a little more conservative this year in terms of the timing and the amount of risk we're putting in our revenue, but the work is going to be out there, we believe.

Chad Dillard - Deutsche Bank Securities, Inc.

Got you. And then of that remaining 20% of revenues that you still need to win to hit the guidance, how much is the breakdown between your underpinning work versus large-scale projects? And then also, in your Technology business, you saw a nice sequential uptick in bookings. Are you ready to call the bottom here in this segment? And could you give us a flavor for where the activity is coming from, perhaps, geographically and end markets?

Philip K. Asherman - Chicago Bridge & Iron Co. NV

Yeah. I think underpinning, because you include everything, but the major projects or anything under $40 million, that could be as much as half of that work we'd see. And the good thing about that work is it tends to be – the characteristics are quicker book and burn. So, that would be a very good thing if we can achieve that much underpinning work in 2017.

But you asked earlier about the cost inflation in projects. Very moderate. I mean the supply market has been very good for us. There is not real volatility in there. There has been some increase in prices, but easy to anticipate, and we've not been caught with any volatile commodity prices for copper, electrical and so forth. So, not too much cost inflation. Labor inflation is pretty moderate in the U.S., probably 3% per annum, and there's no surprises there. So, we've not seen – I guess the real story is we've not seen any overheating in either the supply market or the labor market that has caught us by surprise.

Chad Dillard - Deutsche Bank Securities, Inc.

Great. Thank you very much.

Philip K. Asherman - Chicago Bridge & Iron Co. NV

All right. Thanks, Chad.

Michael S. Taff - Chicago Bridge & Iron Co. NV

Thanks, Chad.

Operator

Our next question is going to come from the line of Andrew Kaplowitz with Citi.

Andrew Kaplowitz - Citigroup Global Markets, Inc.

Good afternoon, guys.

Philip K. Asherman - Chicago Bridge & Iron Co. NV

Hey, Andy.

Andrew Kaplowitz - Citigroup Global Markets, Inc.

How are you doing?

Philip K. Asherman - Chicago Bridge & Iron Co. NV

How are you doing? Good.

Andrew Kaplowitz - Citigroup Global Markets, Inc.

So, Phil, to the extent that you can talk about it, can you talk about what's going on with Westinghouse and the arbitration? Maybe anything on the timeline? And then, Mike, you took a reserve on a receivable. Are there any more receivables out there that you've put out the cash in between that transaction timing that Westinghouse still owes you on that front?

Philip K. Asherman - Chicago Bridge & Iron Co. NV

Andy, if you wouldn't mind, would you mind if I just took a minute to kind of give you some commentary on this whole situation, because there has been a lot of speculative reports out there, a lot of things in the press, I think, some incorrect statements being made. But I think it's maybe – if you give me a moment, I might be able to clarify a few issues regarding our relationships with Toshiba and Westinghouse. I think that may be helpful in putting things in perspective, if you wouldn't mind.

Andrew Kaplowitz - Citigroup Global Markets, Inc.

We'd love it.

Philip K. Asherman - Chicago Bridge & Iron Co. NV

Yeah. First, I think I want to address our overall relationship with Toshiba, which has been and remains very good. They've been a key supplier for many of our projects around the world. We spent over $200 million in the last three years for Toshiba components and equipment. We'll probably expect to spend another $50 million to $60 million with them on expected projects this year. They're our partner, supplier on NET Power, which as most of you know is a demo plant we're building in Texas with Exelon and 8 Rivers Technology to generate zero CO2 emissions. And we think this is a tactical (35:08) development and will be a game-changer in the industry.

Now, Toshiba recently delivered and we installed a 75-ton supercritical turbine on that project, which is essentially the centerpiece of that technology. And Toshiba has been the opportunity to be a primarily manufacturer on these turbines on future instillation. Plus, Toshiba is our customer as an important investor at Freeport LNG, where we're currently under construction with our partner Zachry Construction. So, I'm just – say, in our experience, Toshiba has been a great partner and has always met their commitments. And I've got to tell you, they're a resilient and an important global company. And if they say they're going to finish the work at the U.S. nuclear sites, believe them.

But now, as to the U.S. nuclear sites, we still have over 300 people out there on both sites, because post acquisition of our nuclear assets, Westinghouse asked us to continue to work on the modules we had in our Lake Charles shops and pipe supply from our plant in South Carolina. So since the divestiture in 2015, we've done this work under a T&M subcontract, have satisfied all of our commitments, which include a fabrication of the last 282 modules and over 8,000 pipe spool for the project since we closed the deal. Now, commitments were fulfilled on all sides of the arrangement. All nuclear modules have been delivered to both sites. CB&S is also – CB&I is also finishing the work on erecting the critical containment vessels for both sites, and that work has continued successfully. So, we should be completed on both sites between July 2019 and October 2019, respectively.

We're also providing labors for the module erection building and shield wall erection on a T&M basis. All of the commitments to us are being met. And most importantly, the entire site team is working together to meet the milestones and critical dates. Now, the reason I go through all this is because this single focus was the outcome of the deal that the licensees wanted. And what Westinghouse needed to meet its obligations to the licensees was control over the costs, schedule, and quality. And what we needed, if control was solely with Westinghouse, was release on all liability, past, present, and future, and that's what we got. Had nothing to do with avoidance of future construction cost increases or delays because we were never the guarantor of the contract, and under virtually every commercial scenario, we're contractually entitled to recover our costs. But as you know, the impact of our cash flow is becoming a serious issue. And we couldn't continue to fund the work while commercial issues were being reconciled between Westinghouse and licensees.

So then the dispute that came up several months post-closing was contrived by the Westinghouse lawyers and accountants and likely will be resolved by more lawyers and accountants. But I'm telling you it's cost the companies millions of dollars, both companies, and we think it's a totally unnecessary waste of money and resources. And our position remains that it's a gross overreach by Westinghouse in disputing a working capital issue that's already been addressed by the purchase agreement between the business principals.

Now, whether the dispute is settled by the court or in the arbitration, the ruling by the court wasn't the merits of the case. It was how those disputes should be resolved. And we argued that that's probably not true. But however it's going to be, it's going to be done this year, we feel, and we're just anxious to turn the page. So, hopefully, that gives you some additional context, because I think it's important to understand the projects are performing well, and we say this because we're still there. And I think it's certainly got its challenges in terms of overall cost. But it's first-of-a-kind technology. And I think you've got good serious professional people in both the owners and the contractors in Westinghouse and Toshiba that are going to address this issue. So, that's our view.

Michael S. Taff - Chicago Bridge & Iron Co. NV

And Andy, to answer your second question, we wrote off the deferred purchase price, that receivable we wrote off. And as Phil mentioned, we are continuing to work and we're current on all those receivables. As a matter of fact, that was part of our agreement. We did not get that far out over our skis on this. So, we are being paid on a current basis for the work that's being conducted today. So, the amount of accounts receivables outstanding from Westinghouse is very minimal at any time, now or in the future.

Andrew Kaplowitz - Citigroup Global Markets, Inc.

Okay. So, that's very helpful, guys. So, Phil, the bottom line there is you expect some resolution is possible this year when it comes down to it?

Philip K. Asherman - Chicago Bridge & Iron Co. NV

Yeah. I know that was the question you asked. And, yeah, we do. I can't give you timeline because it's really not in our control. But I think the arbitration discussion is continuing. I don't think we're worried about that. And we have an appeal with the court, and we'll see where that goes. But either way, I think we're going to prevail and move forward. But the reason I went through all that commentary is that I'm concerned about some of the narrative that gets created from some of the speculative reports that are coming out of all the attention on Toshiba and this issue. And we are extracted from that. So, I just wanted to clarify a few points. I hope it helped.

Andrew Kaplowitz - Citigroup Global Markets, Inc.

Yeah. No. That's very helpful. So, let me must ask you, Phil or Mike, about – when I look at the quarter, right, and then the $195 million of charges, you had had an issue last quarter, right, on the union jobs, and one in particular, and I guess that's in the Midwest. It just strikes me as a relatively large number. And I think you had said that that one project was 75% done. So, it must be advancing from there. So, where is it today? Is it going to be done within the next couple of quarters? And why such a large amount? I mean, because again it doesn't seem like it's one of your largest jobs. So, it seems like it's a large job – a large percentage of the overall cost of the project.

Philip K. Asherman - Chicago Bridge & Iron Co. NV

Andy, you're right. But I'll tell you that it's got several hundred people on it. And you're right, it's not one of our largest job. But delta of cost around the labor, if you talk about labor productivity that is 30% of what it ought to be, that's a serious, serious issue as far as productivity on that. And we've got that on a couple of jobs. Now, the other jobs, like I said, are pretty close to completion. This will probably be done in the next few quarters, a couple of quarters. And we think we've captured all the costs. We may be a little conservative on the estimate, but we've been trying for a year to mitigate that labor productivity issue and we haven't been successful. So, we wanted to go ahead and take that forecast to the end.

Hopefully, we'll improve, and we're certainly going to work to do that, because we'd like to get this done for the owner. But it's been a theme throughout the areas where we depend on all union labor for jobs. And again, it's not a commentary on unions, per se. But it's really if you look at in our industry, we lost 40% of our workforce between – the industry did, between 2006 and 2011. So, that's a lot. So, there's a huge amount of new workers in the workplace and we've trained a lot in the Gulf Coast, but we're just not seeing the production in other parts of the country. So, there's some work to do. So, we're not going to – there's other things we can do. So, we're not going to be working those jobs anymore.

Andrew Kaplowitz - Citigroup Global Markets, Inc.

Got it. But generally, these union jobs are over this year, you would say?

Philip K. Asherman - Chicago Bridge & Iron Co. NV

Yes. Yeah. Yeah.

Michael S. Taff - Chicago Bridge & Iron Co. NV

Yes. It's in the...

Philip K. Asherman - Chicago Bridge & Iron Co. NV

This is the quarter we're cleaning that up.

Michael S. Taff - Chicago Bridge & Iron Co. NV

Right.

Andrew Kaplowitz - Citigroup Global Markets, Inc.

Got it.

Michael S. Taff - Chicago Bridge & Iron Co. NV

Yeah. The one job, in particular, you're talking about is – I think it's scheduled to be completed in the third quarter, I believe.

Philip K. Asherman - Chicago Bridge & Iron Co. NV

Yes.

Andrew Kaplowitz - Citigroup Global Markets, Inc.

Okay. Thanks, guys. Appreciate it.

Philip K. Asherman - Chicago Bridge & Iron Co. NV

Yes. And remember, Andy...

Andrew Kaplowitz - Citigroup Global Markets, Inc.

Yes.

Philip K. Asherman - Chicago Bridge & Iron Co. NV

Just remember this, when we do this, it's a cost-to-complete estimate, not just this quarter. So, it's what we're forecasting to complete. So hopefully we...

Andrew Kaplowitz - Citigroup Global Markets, Inc.

Right. Cumulative catch-up. Yes.

Philip K. Asherman - Chicago Bridge & Iron Co. NV

Yeah. Absolutely.

Michael S. Taff - Chicago Bridge & Iron Co. NV

Right.

Andrew Kaplowitz - Citigroup Global Markets, Inc.

Got it, guys. Thank you.

Michael S. Taff - Chicago Bridge & Iron Co. NV

Thanks, Andy.

Operator

Our next question will come from the line of Steven Fisher with UBS.

Steven Michael Fisher - UBS Securities LLC

Thanks, Good afternoon.

Philip K. Asherman - Chicago Bridge & Iron Co. NV

Hi, Steve.

Steven Michael Fisher - UBS Securities LLC

Hey, Phil.

Michael S. Taff - Chicago Bridge & Iron Co. NV

Hey, Steve.

Steven Michael Fisher - UBS Securities LLC

Hey, Mike. Could you just reconcile some of the numbers for me on the receivable? Obviously, you're taking the reserve on $148 million. How did you actually determine that number, as I thought there was a $400-plus-million number in the arbitration lawsuit. Can you just walk through those numbers?

Michael S. Taff - Chicago Bridge & Iron Co. NV

Yeah. The $148 million, Steve, is actually what was recorded on our balance sheet. That was the deferred purchase price and we sold the business. And it's actually $160 million, but it's actually – but we accrete it, so we had to discount it back to when we thought it'd be paid in the future. The $400 million number that you're referencing related to the arbitration matter was basically the excess working capital. That's basically – that's the amount of excess working capital above the PEG (44:21) number that we calculated. Now, you may recall, we didn't record that as an asset. Potentially, we could receive that as part of what was called the waterfall as part of the transaction after the $148 million or $160 million was paid. And then at the completion of the job, assuming those projects were profitable, and then there were different mechanisms of how we and Westinghouse would share those profits, and all. So, that's really the difference between the $148 million and the $432 million number you're referring to.

Steven Michael Fisher - UBS Securities LLC

And to clarify, you are just now waiting for the arbitrator to come out with a decision? That...

Michael S. Taff - Chicago Bridge & Iron Co. NV

Well, we're just actually – we're just starting that process. It is a multi-step process, the arbitrator has been selected and that's really – we just started the process, to be honest with you, in the beginning of this year with the arbitrator being selected. And so, there will be a number of filings that each side files. And then arbitrator will review those, he'll ask questions. It'll go back and forth. And that back-and-forth process we anticipate will last through, I'd say, late summer. And we would expect a decision from the arbitrator some time probably beginning to mid third quarter.

Steven Michael Fisher - UBS Securities LLC

Okay. And then if you could just talk a little bit more about the decision to sell the Capital Services business. Obviously, you wanted an accelerated path to reducing your debt, but it seems like this is a business that's getting more interest in. Did you have strategic buyers that were interested as well, because it looks like you're selling it to private equity? And then, what's the path forward to getting debt down to – well, is 1.5 times still the right target for you? And what's the path and timing to getting to that level?

Philip K. Asherman - Chicago Bridge & Iron Co. NV

Yeah. Well, I'll let Mike talk about the timing because I think hopefully it's going to be before the end of the year, on the ratios. But well, we've been talking about this, I think, pretty much since we'd made the original acquisition of the asset. We had talked about marketing it a couple of years ago in a different form. The business requirements for the job and the similarities between the businesses, we went ahead and consolidated some of the business lines, and by doing so increased the value. But it was in a declining market. So, obviously, we're short of our original book value. But we did establish a value relative to the market. There was some strategic interest – some strategic buyers interested, but we saw – Veritas had expressed an interest before and was very aggressive in diligence and coming to the table to talk – to buy this asset.

I think, Steve, when you look at the business that we sold, I think the opportunity for it to succeed is much greater as a stand-alone business or bolted on with other similar businesses. The characteristics are they tend to be lower margin and so it can't take a lot of the overlay that a company like ours requires for that kind of business. Plus, the fact that we're Dutch, there's certain mitigation costs applied to the business that also again dilutes the margin on the business. So, I think when you release all those overlays from the business, I think it would perform much more successfully. And again, I think we've got a great team around it and a good set of customers, and I think they'll have great success with it.

We've talked about it. That particular business wasn't necessarily core to our strategy, and we made the decision that we'd rather allocate the proceeds to debt and continue to drive growth and return to our shareholders. So, I think it was a good trade.

Michael S. Taff - Chicago Bridge & Iron Co. NV

Yeah. And Steve, to answer your question related to the leverage, we still like – an optimum leverage position for us is going to be between 1 time and 1.5 times. And obviously, with this transaction closing this year and the strong cash flow year we expect, I would expect by the end of the year that our leverage ratio would be around 1.5 times or so.

Steven Michael Fisher - UBS Securities LLC

Great. Thanks, guys.

Operator

Our next question will come from the line of Justin Hauke with Robert W. Baird.

Philip K. Asherman - Chicago Bridge & Iron Co. NV

Hello, Justin.

Justin P. Hauke - Robert W. Baird & Co., Inc.

Yes. Good evening, guys. Thank you for...

Michael S. Taff - Chicago Bridge & Iron Co. NV

Good evening.

Justin P. Hauke - Robert W. Baird & Co., Inc.

...taking my question. I just wanted to clarify, on the charges and the projects, I think you said that one is now in a loss position and the other one is not, it's positive, but the gross margin is lower. I'm just curious how much of a margin drag that is in 2017? So, maybe the question is; one, did I understand that correctly? And then two, how much revenue contribution do you expect from the projects that you've taken this charge on this year?

Michael S. Taff - Chicago Bridge & Iron Co. NV

Yeah. Well, obviously, if we hit our cost estimates, they'd basically be reported at zero margin, but I don't expect there to be a significant margin drag in the E&C group or, for that matter, a couple of projects we talked about in Fabrication Services, because those projects wrap up near term. So I don't think that really will factor into your modeling much at all.

Justin P. Hauke - Robert W. Baird & Co., Inc.

Okay. I'm sorry just – so you're saying they are being booked at zero margin, but they're not expected to be material as a drag on the guidance?

Michael S. Taff - Chicago Bridge & Iron Co. NV

That's correct, I mean, based – especially, the one in the loss position, which is the larger one.

Justin P. Hauke - Robert W. Baird & Co., Inc.

Got it. Okay. And then I guess my second question is just with the discussions you've had with your lenders and the revised covenants, can you remind us the amount of liquidity that you have here and maybe what your most restrictive covenant at this point would put on your balance sheet?

Michael S. Taff - Chicago Bridge & Iron Co. NV

Well, as you know, we've got ample liquidity. We've got two different revolving credit facilities as well as some term debt and senior notes. At the end of the year, I think, we had about $2.2 billion in liquidity under the two revolving facilities and then we also have one kind of midsize uncommitted facility in all. And as it relates to the covenants, we did revise some of those, especially in light of the transaction. For example, the net worth covenant, but as well as our leverage covenant for the year was revised. So we'd expect to be in compliance with those, we are in compliance with those at year-end and would expect to remain in compliance with those throughout this year.

Justin P. Hauke - Robert W. Baird & Co., Inc.

I'm sorry, so just can you give the number as to the maximum amount of that liquidity that you could draw before you would hit your most restrictive covenant on the leverage?

Michael S. Taff - Chicago Bridge & Iron Co. NV

I don't have that right in front of me, but it's – once we issue the K, you'll be able to do that math pretty easily.

Justin P. Hauke - Robert W. Baird & Co., Inc.

Okay. Thank you very much.

Operator

Our next question will come from the line of Jerry Revich with Goldman Sachs.

Philip K. Asherman - Chicago Bridge & Iron Co. NV

Hello, Jerry.

Jerry Revich - Goldman Sachs & Co.

Hi. Good afternoon. Good evening.

Michael S. Taff - Chicago Bridge & Iron Co. NV

Good evening.

Jerry Revich - Goldman Sachs & Co.

Phil, you had alluded to – maybe providing some more context on which types of projects you expect to drive backlog growth in the back half of 2017, I'm wondering if I can take you up on that to flesh that out a bit for us?

Philip K. Asherman - Chicago Bridge & Iron Co. NV

All right. Well, let's cut it a couple different ways. If you look at four key end markets, you've got refining, got LNG, power and petrochemicals, essentially, and that would kind of cover all of our – whether it be Technology or E&C or Fabrication Services. If you look at, for example, geography, we've got about 60% of refining projects targeted for the U.S. as well as Canada and in Europe. Very small in Canada, but the real horsepower there is probably $5 billion or 61% of that target in the Middle East. And I think those projects are probably well-known to all of you.

And LNG, again, the majority of that is still some USA projects out there in terms of what we see, 61% of LNG. Power, 100% U.S., and that's about $1 billion, $1.2 billion of potential projects. And petrochemicals, again, predominantly the U.S. and probably $2 billion of potential opportunities, so – and geography, I think USA certainly is going to be the concentrated market this year with over 42% of key prospects in the U.S. and about $5 billion in the Middle East. So, those are the two areas, I think, of the world that we're going to see most of the concentration of new awards this next year. Does that help?

Jerry Revich - Goldman Sachs & Co.

That's perfect. Thank you. And, Mike, can you just clarify for the guidance for us? So you're guiding to about $2.5 billion of revenue burn for the quarter in 4Q, excluding Capital Service, you're at about $2 billion. Can you just bridge for us at which point do you get north of $2.5 billion revenue burn and which of the major projects drive that pick-up?

Michael S. Taff - Chicago Bridge & Iron Co. NV

Yeah. But just to clarify, our guidance for the year does include Capital Services for the whole year, and then we'll adjust that once that transaction occurs. So, both the revenue guidance and the EPS guidance does include Capital Services for the entire year, just because we can't predict accurately exactly when that transaction's going to close. And once it closes, we will adjust guidance at that point, and all. And then the remaining 20%, as Phil mentioned earlier, it's about $2 billion essentially at the midpoint of the guidance. We think about half of that would come from book and burn. So, that would come from Technology, Fabrication Services, and some E&C as well as Capital Services project up until the transaction occurs. And those do tend to burn pretty quickly. And then, I think it's just a matter of what projects get booked in the first half of the year. We do believe we'll have a really good first – potentially good first and second quarter of bookings that will turn into revenue in the second half of the year, and all. But as Phil said, timing is probably the biggest uncertainty. We know the project's out there. We think of those projects on the drawing board that Phil mentioned of the $20 billion in project. We all think those ultimately get across the goal line. I think it's just a matter of when.

Jerry Revich - Goldman Sachs & Co.

Okay. Thank you.

Philip K. Asherman - Chicago Bridge & Iron Co. NV

All right.

Michael S. Taff - Chicago Bridge & Iron Co. NV

Thank you.

Operator

And our final question for today will come from the line of Anna Kaminskaya with Bank of America Merrill Lynch.

Anna Kaminskaya - Bank of America Merrill Lynch

Good evening, guys.

Philip K. Asherman - Chicago Bridge & Iron Co. NV

Hello, Anna.

Anna Kaminskaya - Bank of America Merrill Lynch

First, I wanted – I just wanted to follow up also on the free cash flow conversion outlook for 2017. I think as some of your backlog has been getting burned, what does it mean for free cash flow conversion in 2017? And also, just to clarify, is the upper end of your outlook range for revenue, does that assume that you get some of the large projects in the first half of the year, because I think you provided two different comments? One said that it does not assume much of large projects being booked, and then you just mentioned that probably you assume some of those big projects going through P&L in the second half.

Michael S. Taff - Chicago Bridge & Iron Co. NV

Yeah. No. Well, what we're saying is that, yeah, to get to the upper end of that range, absolutely, we'll need some of those projects to get booked in the second half of the year. I think we're – to get booked in the first half of the year that turns into revenue in the second half. I think we are optimistic that we'll have a good first half year bookings. But again, timing is – sometimes those projects can slip a quarter or so, and all. But just looking at the pipeline and looking at the timing of that, I think we're optimistic that first half – is a decent first half of bookings for the year.

Anna Kaminskaya - Bank of America Merrill Lynch

And on the free cash flow for 2017, what do you expect?

Michael S. Taff - Chicago Bridge & Iron Co. NV

Well, I mean, I think we said at a minimum, net income as a target, obviously, we had a great year this year. For the year, at 1.8 times net income. I wish I could promise that every year, but we can't. But certainly, we set as a target free cash flow or operating cash flows equal to net income. I'd tell you what, we would be disappointed internally if it wasn't above that. But I think if we strive just as a minimum hitting that, I think certainly generates good cash flow for the business, especially when you look at the maintenance capital that we have here. Our maintenance capital on an annual basis is probably around $50 million a year. So generating operating cash flow at net income level gives us a lot of optionality as far as where to invest that or where to return that capital.

Anna Kaminskaya - Bank of America Merrill Lynch

And just wanted to follow up on the covenants for 2017, do we have to wait until 10-K, or can you provide us at least some sort of goalposts for what the leverage is expected to be by the end of 2017, based on your new covenants from the bank?

Michael S. Taff - Chicago Bridge & Iron Co. NV

What we expect – what – by the end of...

Anna Kaminskaya - Bank of America Merrill Lynch

So, what are the covenants – effective (57:56) leverage covenants that your bank has outlined based on your new covenants? I think you said a renegotiated leverage covenant with the bank.

Michael S. Taff - Chicago Bridge & Iron Co. NV

Yeah. The new leverage covenant is 3.5, and then it will go down back to I believe 3.0 once the transaction is complete. But as it stands today, it's 3.5.

Anna Kaminskaya - Bank of America Merrill Lynch

Okay. Great. Thank you very much.

Michael S. Taff - Chicago Bridge & Iron Co. NV

Okay.

Operator

Thank you. At this time, I'll turn the call over to Mr. Asherman for his closing comments.

Philip K. Asherman - Chicago Bridge & Iron Co. NV

Thank you. Well, in summary, the divestiture of our Capital Services business accelerates the pathway to de-levering our balance sheet, while anticipation of strong cash flows and earnings through next year will put us in – or this year, will put us in great position as the market conditions continue to improve.

We fully expect to see new awards gain momentum the first half of the year, and normalize from the 2015-2016 downturn. We also expect to benefit from a rational energy policy in the U.S., as the current administration implements regulatory and tax policies, which should encourage additional CapEx spending in the sector. And we're very encouraged by the tremendous opportunities in the Middle East for all of our business groups, while our Technology leads the way with new innovations in licensing as well as catalyst contracts.

So, thank you for your attention this afternoon. This will conclude our call.

Operator

Once again, we'd like to thank you for your participation on today's conference call. You may now disconnect.

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