NOTE 3—BUSINESS COMBINATION

General―On December 18, 2017, we entered into an agreement (as amended, the “Business Combination Agreement”) to combine our business with CB&I, an established downstream provider of industry-leading petrochemical, refining, power, gasification and gas processing technologies and solutions. On May 10, 2018 (the “Combination Date”) we completed the Combination.

Transaction Overview―On the Combination Date, we acquired the equity of certain U.S. and non-U.S. CB&I subsidiaries that owned CB&I’s technology business, as well as certain intellectual property rights, for $2.87 billion in cash consideration that was funded using debt financing, as discussed further in Note 12, Debt, and existing cash. Also on the Combination Date, CB&I shareholders received 0.82407 shares of McDermott common stock for each share of CB&I common stock tendered in the exchange offer. Each remaining share of CB&I common stock held by CB&I shareholders not acquired by McDermott in the exchange offer was effectively converted into the right to receive the same 0.82407 shares of McDermott common stock that was paid in the exchange offer, together with cash in lieu of any fractional shares of McDermott common stock, less any applicable withholding taxes. Stock-settled equity based awards relating to shares of CB&I’s common stock were either canceled and converted into the right to receive cash or were converted into comparable McDermott awards on generally the same terms and conditions as prior to the Combination Date. We issued 84.5 million shares of McDermott common stock to the former CB&I shareholders and converted CB&I stock-settled equity awards into McDermott stock-settled equity-based awards to be settled in approximately 2.2 million shares of McDermott common stock.

Transaction Accounting―The Combination is accounted for using the acquisition method of accounting in accordance with ASC Topic 805, Business Combinations. McDermott is considered the acquirer for accounting purposes based on the following facts at the Combination Date: (i) McDermott’s stockholders owned approximately 53 percent of the combined business on a fully diluted basis; (ii) a group of McDermott’s directors, including the Chairman of the Board, constituted a majority of the Board of Directors; and (iii) McDermott’s President and Chief Executive Officer and Executive Vice President and Chief Financial Officer continue in those roles. The series of transactions resulting in McDermott’s acquisition of CB&I’s entire business is being accounted for as a single accounting transaction, as such transactions were entered into at the same time in contemplation of one another and were collectively designed to achieve an overall commercial effect.

Purchase Consideration―We completed the Combination for a gross purchase price of approximately $4.6 billion ($4.1 billion net of cash acquired), detailed as follows (in millions, except per share amounts):

		(In millions, except per share amounts)
CB&I shares for Combination consideration		103
Conversion Ratio: 1 CB&I share = 0.82407 McDermott shares		85
McDermott stock price on May 10, 2018		19.92
Equity Combination consideration transferred	$	1,684
Fair value of converted awards earned prior to the Combination		9
Total equity Combination consideration transferred		1,693
Cash consideration transferred		2,872
Total Combination consideration transferred		4,565
Less: Cash acquired		(498)
Total Combination consideration transferred, net of cash acquired	$	4,067

Preliminary Purchase Price Allocation—The aggregate purchase price noted above was allocated to the major categories of assets and liabilities acquired based upon their estimated fair values at the Combination Date, which were based, in part, upon outside preliminary appraisal and valuation of certain assets, including specifically identified intangible assets and property and equipment. The excess of the purchase price over the preliminary estimated fair value of the net tangible and identifiable intangible assets acquired totaling $4.7 billion, was recorded as goodwill.

The following summarizes our preliminary purchase price allocation at the Combination Date (in millions):

	May 10, 2018
Net tangible assets:
Cash	$	498
Accounts receivable		879
Inventory		62
Contracts in progress		341
Assets held for sale ⁽¹⁾		71
Other current assets		240
Deferred tax assets		45
Investments in unconsolidated affiliates⁽²⁾		433
Property, plant and equipment		405
Other non-current assets		145
Accounts payable		(472	)
Advance billings on contracts ⁽³⁾		(2,278	)
Deferred tax liabilities		(17	)
Other current liabilities		(1,200	)
Other non-current liabilities		(452	)
Noncontrolling interest		(26	)
Total net tangible assets		(1,326	)
Project related intangible assets/liabilities, net ⁽⁴⁾		142
Other intangible assets ⁽⁵⁾		1,041
Net identifiable assets		(143	)
Goodwill ⁽⁶⁾		4,708
Total Combination consideration transferred		4,565
Less: Cash acquired		(498	)
Total Combination consideration transferred, net of cash acquired	$	4,067

⁽¹⁾	Assets held for sale includes CB&I’s former administrative headquarters within Corporate and various fabrication facilities within NCSA. During the third quarter of 2018, we completed the sale of CB&I’s former administrative headquarters for proceeds of $52 million.

⁽²⁾

Investments in unconsolidated affiliates includes a fair value adjustment of $221 million associated with the Combination. Approximately $118 million of the fair value adjustment is attributable to the basis difference between McDermott’s investment and the underlying equity in identifiable assets of unconsolidated affiliates, and will be amortized to Investment in unconsolidated affiliate related amortization over a range of two to 30 years based on the life of assets to which the basis difference is attributed.

⁽³⁾

Advance billings on contracts includes accrued provisions for estimated losses on projects of $349 million. See the discussions below and in Note 4, Revenue Recognition, for information concerning our acquired significant loss projects, including changes since our initial preliminary estimates reported for the second quarter of 2018.

⁽⁴⁾

Project related intangible assets/liabilities, net includes intangible asset and liabilities of $239 million and $97 million, respectively. The balances represent the fair value of acquired RPOs and normalized profit margin fair value associated with acquired long-term contracts that were deemed to be lower than fair value (excluding amounts recorded in Advance billings on contracts and Contracts in progress) as of the Combination Date. The project related intangible assets and liabilities will be amortized as the applicable projects progress over a range of two to six years within Project intangibles amortization in our Statements of Operations.

⁽⁵⁾

Other intangible assets are reflected in the table below and recorded at estimated fair value, as determined by our management, based on available information which includes a preliminary valuation from outside experts. The estimated useful lives for intangible assets were determined based upon the remaining useful economic lives of the intangible assets that are expected to contribute directly or indirectly to future cash flows.

	May 10, 2018
	Fair value		Useful Life Range	Weighted Average Life
	(In millions)
Process technologies	$	498	10-30		27
Trade names		401	10-20		12
Customer relationships		115	4-11		10
Trademarks		27	10		10
Total	$	1,041

⁽⁶⁾

Goodwill resulted from the acquired established workforce, which does not qualify for separate recognition, as well as expected future cost savings and revenue synergies associated with the combined operations. Of the $4.7 billion of estimated goodwill recorded in conjunction with the Combination, $1.7 billion is deductible for tax purposes. Given the proximity of the Combination Date to the reporting date of September 30, 2018, the allocation of goodwill for each of our operating groups is in process, and therefore has not been presented.

Significant changes in our preliminary purchase price allocation since our initial estimates reported in the second quarter of 2018 primarily related to fair value adjustments to three of our acquired loss contracts. Adjustments to the Cameron LNG, Freeport LNG and Calpine projects were approximately $744 million combined and primarily impacted Advance billings on contracts as discussed further in Note 4, Revenue Recognition. As a result of these and other adjustments to the initial purchase price allocation, goodwill increased by approximately $782 million since the second quarter of 2018. Adjustments recorded to the purchase price allocation are recognized in the period in which the adjustments are determined and calculated as if the accounting had been completed as of the Combination Date.

The purchase price allocation described above is subject to further change when additional information is obtained. We have not finalized our assessment of the fair values of purchased receivables, intangible assets and liabilities, inventory, property and equipment, joint venture and consortium arrangements, tax balances, contingent liabilities, long-term leases or acquired contracts. Our final purchase price allocation may result in additional adjustments to various other assets and liabilities, including the residual amount allocated to goodwill during the measurement period.

Impact on RPOs—CB&I RPOs totaled approximately $8.3 billion at the Combination Date. We reviewed the RPOs acquired through the Combination to ensure consistency in the application of our policies regarding revenues dependent upon one or more future events, and we made adjustments related to our purchase accounting estimates. As a result, the RPO balance on the Combination Date included the net reduction of approximately $224 million for the acquired RPOs. This adjustment to the opening RPOs was not the result of contract cancellations. Our RPO balance on the Combination Date is also reflective of the project adjustments described above.

Impact of Combination on Statements of Operations—From the Combination Date through September 30, 2018, revenues and operating income associated with CB&I totaled $2.8 billion and $168 million (excluding $61 million of Restructuring and integration costs within operating income), respectively. Additionally, in connection with the Combination, during the three and nine months ended September 30, 2018, we incurred transaction costs of $5 million and $45 million, respectively, which primarily related to professional service fees (including audit, legal and advisory services).

Supplemental Pro Forma Information (Unaudited)—The following unaudited pro forma financial information reflects the Combination and the related events as if they occurred on January 1, 2017 and gives effect to pro forma events that are directly attributable to the Combination, factually supportable, and expected to have a continuing impact on our combined results, following the Combination. The pro forma financial information includes adjustments to: (i) include additional intangibles amortization, investment in unconsolidated affiliates-related amortization and net interest expense associated with the Combination and (ii) exclude restructuring, integration and transaction costs and debt extinguishment costs that were included in McDermott and CB&I’s historical results and are expected to be non-recurring. This pro forma financial information is presented for illustrative purposes only and is not necessarily indicative of the operating results that would have been achieved had the pro forma events taken place on the dates indicated. Further, the pro forma financial information does not purport to project the future operating results of the combined business operations following the Combination.

	Three Months Ended September 30,		Nine Months Ended September 30,
	2018 ⁽¹⁾	2017	2018 ⁽¹⁾	2017
	(In millions)
Pro forma revenue	$2,289	$2,866	$7,135	$7,390
Pro forma net income (loss) attributable to McDermott	33	67	128	(270)
Pro forma net income (loss) per share attributable to McDermott:
Basic	0.18	0.37	0.71	(1.50)
Diluted	0.18	0.37	0.71	(1.50)

Basic ⁽²⁾	180	180	180	180
Diluted	181	181	181	180

⁽¹⁾

Adjustments, net of tax, included in the pro forma net income above that were of a non-recurring nature totaled $28 million and $136 million for the three and nine months ended September 30, 2018, respectively. The adjustments reflect the elimination of restructuring and integration costs ($24 million and $90 million) and transaction costs ($4 million and $35 million) for the three and nine months ended September 30, 2018, respectively, and debt extinguishment costs of $11 million incurred in the first half of 2018, that were included in McDermott and CB&I’s historical results for the three and nine months ended September 30, 2018, respectively. For the comparative three and nine months ended September 30, 2017, adjustments, net of tax, included in the pro forma net income (loss) above that were of a non-recurring nature totaled $17 million and $20 million, respectively, and reflect the elimination of restructuring costs that were included in CB&I’s historical results. These pro forma results exclude the effect of adjustments to the opening balance sheet associated with fair value purchase accounting estimates.

⁽²⁾

Pro forma net income (loss) per share was calculated using weighted average basic and diluted shares outstanding during the three months ended September 30, 2018. The effects of dilutive securities were not included in the calculation of diluted EPS for the nine months ended September 30, 2017 due to the net loss for that period.