Oceaneering International Inc (OII) 2003 Q2 法說會逐字稿

Good morning. My name is Jody and I will be your conference facilitator today. At this time I would like to welcome everyone to the Oceaneering second quarter 2003 earnings conference call. [Operator instructions] Mr. Huff, you may begin your conference.

Good morning everyone. This is Jack Jurkoshek, thank you for joining us this morning. I would like to particularly welcome those of you who may be participating in the webcast of this event which is being made available through CCBN. Joining me this morning is John Huff, our chairman and CEO who will be leading the call. Marvin Migura our CFO and Bob Magoya our treasurer. Remarks we make during the course of the call regarding our business strategy, plans for future operations and industry conditions, are forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. I'm now going to turn the call over to John.

Thank you, Jack. Good morning, and thanks for joining the call. It's a pleasure to be with you this morning. We had a good quarter. Our earnings were 33 cents which were within the guidance range given last quarter, and we met the consensus estimate. Within the context of the generally below average oil field service market conditions prevailing for the last year and a half we believe our overall performance is quite good. I still remain somewhat surprised by the lack of consistency in work offshore given the prevailing commodity prices. We're seeing more delays than I would have expected. Nevertheless, the offshore and especially deep water is definitely one of the best frontiers for our industry to lower its finding and development cost. One noteworthy point is we continue to have a positive profit contribution from all of our operating business segments. To be profitable in every segment speaks well for our niche market strategy and we're pleased with these results. Earnings were down year over year but sequentially were up significantly, 32%, as was detailed in the press release. Our ROV subsea products and offshore projects business activities picked up nicely during the quarter, and we still expect to have a very good 2003.

As a matter of interest we expect 2003 to be our second best year ever. I mention this only to show how much Oceaneering has changed over the last several years and we're as anxious as many of you to see how fast we can go in a really good market environment. We believe our quarterly earnings performance and forecast of future results continues to validate our niche strategy. Our focus on providing products and services for deep water subsea completions and mobile offshore production systems is a good way to play the life cycle from exploration through production. I believe when you compare us to larger diversified services and products companies we do extremely well. All in, I think we have created an excellent business model and executed our business strategies in a professional manner. In the second quarter or ROV fleet utilization rate was 72% up from 70% a year ago and up from 64% last quarter. Both revenues and gross margin increased sequentially due to a pickup in business within our international operations as we expected. Gross margin at over $10 million was comparable to the second quarter of last year. This is quite remarkable given the below average market for the use of floating drilling rigs and consequently the demand for ROV drilling service we specialize in. Available ROV systems remain at 125. To give you an update at the end of the quarter of our 125 systems, 107 worked during the quarter, 66 in drill support and 41 in nondrill support. This compares to 89 working a year ago, where 67 were engaged in drill support and 22 in nondrill support activities.

These are snapshot positions and should not be misinterpreted to indicate any permanent fleet mix. However, there is a clear indication of two trends at work here. The first is a definite shift to construction and production phase work. The second we are working harder to make the same profit. In fact I believe our ROV management has done an absolutely a fantastic job of meeting the challenge of a tough market. With the terms of contracts for floating drilling rigs rolling over more frequently it has been a logistical challenge to put it mildly keeping high quality systems and well trained crews available and ready when they are needed. We sell quality services and our operations are clearly our major key to long term success. Nothing replaces execution. Our subsea products segment had a good gross margin quarter. In the press release we mentioned the margins were favorably impacted by a $1.3 million due to the successful completion of a job during the quarter at lower cost than previously estimated. In many earnings releases you get to read about the one bad job that kept the company from making their earnings so we thought we'd let you know about one of our good jobs. In the subsea segment products we recognized revenue in the lump sum, percentage of completion simply means for every job we estimate the cost to complete and recognize revenue according as we incur costs.

Sometimes, our estimated costs are too high or too low although mostly or forecast. These estimates are always being reviewed and revised as appropriate and are always trued up when the job is completed. During the quarter our backlog decreased from $31 million to $26 million. Not withstanding our backlog we're expecting better results in the second half of this year based on anticipated contract awards which I will discuss further in a few minutes. Inspection revenues and gross margin grew due to the OIS acquisition. This acquisition caused an increase in SG&A expenses which was in line with what we expect. Our MOPS business had another very good quarter. All three of our MOPS units remain under contract for the entire period and we expect them to remain so for the indefinite future. Our quarterly subsea projects revenue sequentially increased 46% however gross margin declined significantly. Utilization of our ocean intervention vessels, was 91% up dramatically from 51% last quarter although we did not realize the profit margin we expected due to a variety of factors including the very competitive gulf of Mexico bidding environment for our subsea installation and diving services weather delays and a few mechanical problems on the vessels. Generally the project management of the jobs we took on was in line with our expectation. Gross margin contribution from this segment was unusually low in fact the lowest since the September 2001 quarter. We took a hard analytical look at the quarter's results and believe this quarter's performance was an anomaly based on some bad timing of weather and vessel mechanical problems. Sometimes minor mistakes at the worst times can have more repercussions than they ordinarily would cause. We definitely did not bid the margins we realized this past quarter. I'm of the opinion we will bring a much higher percentage of revenue to the bottom line in future quarters. Advanced technologies also had a good quarter. Revenue and gross margin were both up year over year and sequentially.

This business segment had its second best quarterly marriage performance since the beginning of 2001. Year over year we benefited from increases in business activities related to the space service contract most prominently the neutral buoyancy contract, animated figures for theme parks and more work from U.S. Navy on a variety of services. As always ADTECH includes a mix of routine and opportunistic jobs. Unallocated expenses increased sequentially year over year, due to a higher restricted stock expenses. Now I'd like to briefly address our balance sheet. At quarter end we had debt of $115 million and equity of 324. Our net debt to cap percentage was 21%. We spent $26 million on capex. In July we replaced our $80 million revolver with a new $100 million revolving credit facility expiring in July 2007. We borrowed $15 million under the new facility to repay the term loan and have $85 million available for future borrowings. We had $27 million in cash with net debt of $89 million at quarter end. Our balance sheet is in great shape and ready to be releveraged as soon as we find investment opportunities that will give us a fair rate of return. If you add depreciation back to our operating income during the quarter you arrive at nearly $29 million or more than $54 million of cash produced during the first six months of 2003. Please take a good look at these cash flows. Our technical niche market strategy is generating. And you should see an excellent business model being well executed. When you understand the visibility of our earnings and cash flows I think you will see a strong company with significant resources consisting of unique technically advanced assets and he can lent people who have the ability to leverage these assets as offshore markets improve.

At this time, our 2003 earnings guidance is approximately $1.40 which is the lower end of our previous guidance range. The current estimate reflects a reduced annual profit contribution from subsea products. We expect the full year contribution from our products group to fall 20 to 25% short of our original market forecast, in 2002's actual results. The full year assessment of the gross margin contribution from all of our other business segments remains pretty much unchanged from last quarter. Compared to 2002, the contribution from inspection is expected to be up significantly, ROVs and addtech should be up somewhat in subsea products and MOPS are to be down. We are incurring additional overhead cost stemming from the OIS acquisition, although we operating income contribution from our inspection business this year. It looks as if all three of our acquisitions wilt be accretive in the first year of operations. So overall the subsea products group is the main culprit causing us to lower our EPS guidance to the bottom of the range we first gave you almost a year ago. We expect the quarterly gross margin contribution from our ROV business to remain about the $10 million level during the rest of 2003, by virtue of the programs we put in place last year to improve our ROV marketing and operations. Late in this year we could see an additional increase in the profit contribution from our gulf of Mexico operations as we expect to put several systems to work in drill support service and floating production platforms.

Our outlook for gross margin contributions from our subsea products segment during the second half as compared to the first half of this year is for substantial improvement. However, compared to 2002, products margin contribution will be down significantly for 2003 in total. The shortfall in 2003 is attributable to the fact we have not been receiving our usual market share for mostly two reasons. First, a small number of very large orders representing a significant percentage of the total market demand have been awarded as part of epic jobs. We bid on those jobs unfortunately to the losing epic contractors. Second, demand has gone progressively more to steel tube umbilicals, do not have the necessary manufacturing plant and equipment. An examination of the umbilical orders placed in the first six months of this year shows almost 85% of the lengths awarded has been for steel tube based designs. In the last half of this year the total market will be more like 50-50 steal and plastic which will dramatically improved our competitive position especially given or you are current manufacturing capabilities. The way we see our order book shaping up we are projecting for the third quarter a sequential decline in gross margin contribution from the second quarter followed by a stronger second quarter. Let me kind of summarize what I've said for you and if our crystal ball is clear we're expecting '03 to be approximately 25% less than '02, the second half of '03 is going to be better than the first half of '03, the fourth quarter is going to be the best quarter of all, and by the best quarter I mean the highest revenue, the highest margins, and the highest ending backlog.

In our subsea projects segment it's more difficult to forecast due to the short lead time nature of our customers' demand requirements for mostly production phase remedial work. That being said based on book work or highly probable work we are forecasting a substantial gross margin improvement from this business segment in the third quarter. In particular, we anticipate a higher contribution from our diving services as the Ocean Quest and recently outfitted Ocean project will- available for work in the third quarter. Diving support vessels with all built in or below deck equipment and clear working decks. As we have repeatedly noted our mobile offshore production segment results for 2003 are contracted to be down year over year due to the Ocean Legend contract extension until March of 2006. Daily revenue and plating margins will remain flat due to the remaining contract term. We expect to see further improvements from profitability from our inspection business in the third quarter as we continue to integrate Oceaneering's culture into the acquired operations of OIS. For the full year we anticipate a significantly higher profit contribution as a result of the OIS acquisition. This is a business I hope we can add capital assets to in order to improve margins. I'm confident we'll do this again it's just a matter of timing. Our adtech business is expected to be up slightly from 2003. There might be some weakness in third quarter offset by fourth. In our 2003 PS outlook of $1.40 we are projecting earnings in the range of 35 to 40 cents for the third quarter. The sequential rise in third quarter earnings is expected to come from higher profit contributions from our subsea projects and inspection business segments. 2003 is still expected to be a very good year, and will likely be the second most profitable in the company's history.

More importantly we continue to see the earnings power just from our current asset base to be significantly higher in the tight market. When the mark market is there and all five of our oil field segments are performing all out we have greater leverage especially to the big growth markets of deep water and subsea completions. I believe we well see a reasonable market for our services and products in the last half of 2003 and our execution will continue to improve and be at a highly accomplished level. I'd like to talk a minute about our investment strategy and again I'd like to reiterate I think past performance is a good indication of our investment philosophy. If you followed Oceaneering for a while you should know we take a conservative approach to adding capacity and a opportunistic view. We will not change our investment strategy. We will continue to invest in technical niche markets. We will continue to be conservative. We will continue to be patient. We will not overspend for the sake of growth without adequate financial returns. We are not afraid of making big investments when opportunities for reasonable returns present themselves. In a phrase we will continue to be conservatively opportunistic. Applying existing technology in new ways, to solve problems in the deep water and subsea frontier is what Oceaneering is about. We have people strengths to earn well more than we currently see in 2003 or 2004.

The really good news is we are continuously adding capability both through small asset additions and especially through improved people considerations. With our added strategy of taking a harder look at possible acquisitions, I'm confident that our next

round of major investments will take us beyond our record earnings. We continue to believe in the strong growth products business segment driven by a rise in the use of subsea development completion technology. The number of subsea tree orders is expected to increase from around 250 this year to 325 in 2004, roughly a 30% annual growth rate. We expect additional growth rates of 25 to 30% to the – 400 to 450 range during 2005 and 2006. So we're seeing, you know, progressively growth market for subsea completion technology that requires the use of these umbilicals. More dramatically, steel tube umbilicals are expected to increase to 80% of the market next year as compared to only half of the market only a few years ago. Consequently we are acquiring one of the large eggs steal tube up umbilical market located in the U.S. and Brazil. New cabling machines for these locations will quadruple our annual steel tube umbilical capacity. We are in the process of acquiring a new facility and hope to have something definitive to announce on this shortly. The equipment in Brazil is anticipated to be up and running in the second quarter of 2004. The new facility should be open and producing product in the third quarter of '04. Total capex is estimated to be $35 million to $40 million. We are also pursuing a few good market opportunities to expand our presence in the production areas and hope to bring one of these to fruition during the last half of this year.

So far in 2003 we completed three acquisitions, OIS International inspection PLC a global provider of nondestructive testing in inspection services was closed in the first quarter. Reflange a specialty manufacturing operation to expand our subsea product offering and Nauticos abroad, to broaden our non oilfield services capability were both acquired this quarter. The total capex cost of these was about $45 million. We also repurchased 505,000 shares of Oceaneering stock in the first half that is we have repurchased 793,000 of the 3 million shares that were authorized last fall or about a quarter have been repurchased. The OIS acquisition more than tripled our market presence and the total OI revenues in 2003 from this business activities are now expected to be about $120 million. We are now the world's largest provider of high quality inspection services to the upstream oil and gas industry. I expect this acquisition to be accretive this year and more accretive within the next two years. Reflange positions us to expand our specialty subsea product offerings to include connectors, pipeline connectors, tie insystems and special purpose fittings. Nauticos brings us an immediate book of business related to the United States Navy which complements our existing services and provides us the opportunity to pursue new markets within these areas.

As we said in the press release we are now estimating 2004 earnings in the range of $1.60 to $1.75. This estimate is based on incremental earnings contributions from subsea products driven by increased subsea completion activity which will be augmented by our additional steel tube umbilical manufacturing company and more special hardware from our Oceaneering intervention engineering group. We anticipated continuation of current market condition or similar demand trends for our other five business segments. Should a substantial recovery in market demand particularly four or niche ROV or subsea products segments occur we will be able to improved on this estimate by utilizing our existing extra capacity and operating level. We will also have a full year's benefit from the 2003 acquisitions we have made today as well as probable future asset additions and acquisitions. I'd like to summarize our current status. Our results for the second quarter again demonstrated our ability to generate good earnings in a tough market. Our business strategy for the balance of 2003 and beyond remains clear. Our cash flows are strong. Our strategy is not based on a one-trick pony. The market conditions we operate under vary and it is our intent to be profitable in virtually any market scenario enable to grow under a variety of situations. We intend to profitably grow our company to help our shareholders increase their returns. I believe our hidden asset is our ability to convert our immediate financial resources and balance sheet strength into our earnings. It is our intention to be more aggressive in this area. We have clear objectives to improve our operations, outstanding people to execute our activities, and we will not be satisfied by mediocre results. I do appreciate your attention to the opening comments, and we'd be happy to answer any questions.

[Operator instructions] Your first question comes from Roger Reed.

Good morning, gentlemen.

Good morning.

Just a couple ever questions. Looking at the ROV did very well the second quarter, given the difficulty of scheduling or logistics, can you improve margins going forward or is it going to be a situation where margins are fairly flat with what we've seen, kind of the mid 20s kind of range?

I would say that margins would be flat.

Okay. And then how much higher do you think utilization can go in the second half of the year, given the shift of production and construction support as opposed to the heavy reliance on drilling you've had historically?

Our forecast is for it not to be any higher than it was in the second quarter. So you know, that's why I mentioned, you know, for those of you looking for positive comments, you know, I mentioned it's possible in the fourth quarter that we may have some additional work there's some deep water programs that are scheduled to start this fall and there's a couple of floating production platforms that we believe that we'll be on. But generally I'd say that utilization should shouldn't be a lot higher or lower, and that margins should be pretty steady.

Okay. On the subsea products side, backlog's down. You mentioned the issue with the type of projects that have come through. Is pricing better, the same, worse, how do you see that given the shift in -- towards steel and then the issue of type of projects that are out there?

Oh, well, I think the -- maybe if I could just restate the question, is there a pricing problem in the market? I don't think so. I mean, in the first half, I mean, essentially we missed one job that would have made a huge difference in the way things went for us. We have identified 14 jobs in the second half of this year that have a value of, you know, in excess of $60 million. 80% are of those are plastic jobs. We've already bid seven of them. If we get three of the 14 that we're hoping to get, we're talking about getting half of that total dollar value market. And all of those will be at acceptable margins. I mean, there's no sense in just putting crappy margins in your plan. I mean, this is a very dynamic marketplace out there that has a lot to do with delivery times and quality offering. And I'm a real big proponent that there's no sense in trying to bid against somebody. It's really just an issue of knowing what you need to be doing.

Okay. Thanks. One final question. On the unallocated expenses in the comment about restricted stock awards, what's the expectation going forward? Is that something that continues, or is it going to continue -- is it going to be variable as it has been historically?

Well, we broke it out as a line item to show the variability of it. And it's going to go up and down with the price of Oceaneering stock at the end of each quarter.

Okay. Is there any sort of hard-fast rule we should think of applying there in terms of the numbers of shares times the price?

We don't see any change in anything it is a program we have in place since 1990. There is nothing that's going to change about anything other than the variable, you know, as Oceaneering stock price goes up and down, and it’s a point to point calculation, you know, over time, you know, we'll use up the restricted stock. And -- but it's just basically volatile relative to the price of Oceaneering stock.

Okay, thanks.

)) Operator: Your next question comes from George Gaspar.

Thank you. Good morning to everyone there. Pretty good quarter, John, all things considered. Question regarding the inspection area. You mention that you're looking at an over view of about 120 million a year. In the first half, your inspection revenue stream would have been about $65 million. If you double that, that's 130. Are you low-balling it at 120 or do we expect inspection revenues to decline in the second half of the year?

What I'm trying to do strategically, George, and I'm not able to forecast that accurately, but strategically I'll just make this comment. We're trying to add a little higher value to the inspection business. We're trying to add equipment to some of these people. We're trying to exit some of the manpower type contracts with low margins. So you know, we're really concentrating on the cash contribution from this business and trying to add technology, and try to simplify the logistics of the business a little bit. And that's where we're at. We've got two guys, one of them is a fabulous salesman in this business and one of them is a great cost-cutter. And we're doing a good job integrating both companies together. And I think that the real strategy in this thing is that if Oceaneering can add some technology to the business, you know, we believe we can improve those margins.

Right. I think the focus as you said to integrate OIS into our culture is to focus more on the contribution rather than on the top line.

Yeah.

Okay. And secondly, on the MOPS area, I think you alluded to the possibility of maybe something evolving at your end. Correct me if I'm wrong. I thought you may have mentioned that.

I did. You know, I don't want to start a, you know, a big problem for anybody. It's certainly, you know, I can say this, you know, with no hesitation. I mean, you know -- those of you in particular, George, that have followed us a long time know that we're going to announce anything that, you know, requires an announcement as soon as it requires an announcement. I don't want to speculate about it. I mean, we've got, you know, several opportunities, I feel good about it. It's really -- I guess I just mentioned that to say, you know, that's always an upside at Oceaneering. You know, we've got a stable cash flow from that segment and we've got, you know, a conservative approach to adding any capacity. And so unlike, you know, some of the, “Norwegian” FPSO owners, we're not out in the marketplace speculating a lot of stuff. We mention that, I do have some hope that this year we will announce a new contract. But again, you know, I'm not going to make any promises on that.

Just a follow-on on that. Assuming that you would be able to get yourselves in a position to do a contract, how far into the future would you be looking before that might materialize on revenue stream?

Let me not speculate on that. I understand the question, and the real question I think is how much impact would it have on '04.

Right.

And the answer is, you know, it would depend by project. You know, one of them would have nice impact on '04. The others would probably be an '05 impact.

I see, okay, thank you.

Yeah, I apologize George for not giving you a better answer. But I really don't want to get into too much speculation about it.

Right, thank you.

Your next question comes from Andrew O'Connor.

Andrew O’Connor: Good morning, John, good morning everyone.

Good morning.

Andrew O’Connor: Wanted to know for your ROV operations, John, you suggested that no more than 72% fleet utilization in the third and fourth quarters. What is commensurate with your earnings guidance of $1.60 to $1.75 for full year '04?

It's in that full range. I think it -- you know, we may be a little conservative. And then hopefully it will start to improve. But we're not, you know, we're not forecasting that.

Andrew O’Connor: Okay. And then what percent utilization would it take or does it take to obtain an increase in pricing for your ROV operations?

The dynamics of that are a little different than what you probably normally of think of in a boat or a drilling rig market. Our margins are more affected by utilization than they are by price. You know, we're pretty much, I believe we're pretty much known as a quality provider of those services.

Andrew O’Connor: Sure.

We don't cut prices a lot when utilization goes down. And conversely, we don't get a lot of price increase. Now, we hadn't tested out the high end of that utilization curve. So you know, if we hit the 85%, you know, we may have a different situation. And frankly, you know, the dynamics in '04-'05 may change, because there's some you know, we've worked off a lot of our longer-term contracts that we got you know, three or four years ago.

Andrew O’Connor: So you'd have to have appreciably higher utilization to --

Definitely that. I mean, we're certainly not in that utilization range that we would see dramatic price increases.

Andrew O’Connor: Right. Okay. And then last I wanted to know, in addition to your prepared comments, you know, how would you characterize the overall tone of the market for your products and services now, relative to the end of the first quarter? Thank you.

Well, I think there's, you know, in every CEO's heart there's always optimism. Probably not as optimistic as E&P companies but nevertheless, I do see, you know, this environment of sustained high commodity prices as, you know, causing some, you know, fundamental shifts in spending. I mean, I've been as I said in my comments, I've been really surprised by the switches in the macromarket that I've seen in the last five or six years. I have been amazed at, you know, $30 oil and $5 gas, didn't drive a lot more activity in the Gulf of Mexico, for instance. Particularly in the deep water margins where you know, the Gulf is going to be, you know, really the last gas problem is for the U.S., big gas discoveries, and gas is a big part of the margin.

Andrew O’Connor: Sure.

So I've been surprised at that. I think that the North Sea is rejuvenating some. I believe that they have a little more stable policy, clearly in Norway. That's a good market. West Africa I think will continue to expand. And again, that's a deep water facility. Or deep water geographic region. Offshore Brazil I think is going to get better. I think as soon as the foreign oil companies announce some discoveries there will be a lot of renewed interest in Brazil. Again, that's a deep water market for us. So I mean, generally I'm optimistic that things will get better. And I'm not pessimistic that if we see prices in the mid 20s that the real economics for the oil companies, I mean the hurdle rates are not going to be prostituted. Their hurdle rates are I believe well constrained, and I think that we won't see as much lack of spending if oil prices do go down.

Andrew O’Connor: Okay. Thanks very much. Good luck guys.

Thank you.

Your next question comes from Brad Handler.

Good morning guys.

Good morning.

I was hoping you could -- I think I misunderstood something on the call about the mix of steel tube and thermal plastic. I was hoping you could clarify that. Your outlook for the second half of the year are 80% of the awards thermoplastic did I get that right?

I apologize for that Brad. There is a little confusion. I want to kind of clarify that. The market, the remaining market of '03 is about 50-50. Of the 14 jobs that we have identified, as jobs that we're going to go after, 80% of those are plastic jobs. And that's really what we're saying is that, you know, the market obviously has got more than 14 jobs in it. So you know, we're focused on the plastic jobs. Three of the 14 jobs are big-win jobs for us with, you know, half of that 14-job market which is $60 million book of business. So I think what I was trying to convey to everyone is, hey, look, things are not going to get better in the third quarter. We believe that we may or may not book many orders between now and September 30th. We're going to work off what we got. I'm not too concerned about that. I am concerned about orders that come in from the first of September to the middle of November. Because that gives us the fourth quarter, because there will be a lot of good front-end work on that business, and that gets us ready for 2004. I think, and I've been very consistent in trying to keep everybody apprised, that you know, backlog is a good proxy for the business, but it's not the only proxy. You know, the culprit in our earnings this year has been the products group. I think I've really said that, you know, last year several times that that's going to be the proxy from a really good year to a great year for us. And it hasn't turned into a great year. So -- but I'm real comfortable with the marketplace. Macrobasis, subsea completions, the development scenario of the future is bringing the cost down, they've got the completion systems and the workovers in good shape, they have got reliability of equipment. They've got to connect these wells in some way that they can inject chemicals into them. So I'm real comfortable that it's there. I mean, hell, I wouldn't be betting $35 million, $40 million on steel tubes. The only reason steel tubes are required is the high collapse resistance. Brazil was a sort of different market for us quasi high collapse environment. I'm confident that products is a good place.

That makes sense. I guess I'm wondering by chance if you could give a sense of the geography on the 14 jobs, just what kind of regions there are.

Let me stop through and say I want to give you as much information as I can. But you know first of all, I don't want to prejudice ourselves in any of these jobs. I would really prefer not to break out anything for you. You know, it --

Okay. Fair enough.

It's really not important. It really is not that important. While these things are not totally fungible, whether we build them in the North Sea or in the U.S. Gulf or in Brazil, they are all reachable by our plants. So it's not a big, big issue.

Fair enough, John. I was just hoping of getting a sense of where some project awards would be moving along. But that's fine.

I apologize. I would give you nor information but I feel it might prejudice our competitive position with our competitors.

Let me move on to something in the inspection area that I guess we've been pleasantly surprised to see the margin progression there and perhaps you could help us understand. As you move forward you mention trying to shift your mix of business a little bit to hire-margin stuff. Is there also some cost savings that you can continue if you examine that business?

Oh, yeah.

And where might margins kind of get to in a robust margin -- robust market?

Well, first of all let me say that again, I don't think this is -- this is a market that if you try to characterize it in a macro fashion, you would have a real hard time. Because I think at the bottom end of the market, it's got almost unlimited competition. And at the top end of the market if you can bring out proprietary inspection processes and assets, then you know, you can have a good lock in tern micro segments of the business. That's what we're headed after. Now, having said that I think what I said earlier is a good comment, and that is, we've got, you know, a really first class salesmen and we've got a first class cost cutter in charge of this thing. And bringing the cost savings down in you know your typical consolidation type of a play. We're not having two guys for one job and so forth. So I think we've got a, you know, a good position there. And I think that we will be seeing the margins improve some as we go forward in this thing. I don't know it's going to be a, you know, every quarter, steady increase. I think that, you know, we'll probably get to a plateau by the end of this year and then we'll have to start putting some capital into it to get to the next plateau.

Fair enough, thanks.

Your next question comes from Jill Carruthers.

Good morning. I was wondering if you could highlight a little bit more the 1.3 million gross marriage benefit that you recognize in the second quarter, maybe you could give some details on the project that that was related to. And if this was the same project that you received a $1.9 million benefit in the first quarter. And if not, maybe what type of project it was.

Hi, Jill, this is Marvin. I'll handle that. No, it's not the same job because it's in subsea products. The other job was in subsea projects. This was an umbilical job, and I think as John indicated, it turned out and we see it in the press release, it was just one we completed for less cost than we had previously estimated. And we felt good about it, but because we had -- the accountants tell us that if we had had perfect hindsight, we would have recognized more profit earlier, and some of that profit would have been taken out of this quarter. But the answer is, we revise our estimates continually. This job was finished in the June quarter and we trued up our costs at the end. And it represented a favorable variance in our subsea products group.

Okay. I guess on the ROV segment, I guess your outlook for the second half is, you know, pretty good, comparable to second quarter. I was wondering if your I guess accounting any pull-back with construction related support in the fourth quarter just for seasonal reasons or anything?

That's a good question, Jill. We will see some systems go to work. That's really the genesis of the comment about the deep water drilling programs particularly in the Gulf, and the production vehicles. There will probably be a shift more towards production services. We don't break production services out incidentally. We just really use drilling and construction. But I would imagine construction will moderate in the fourth quarter.

Okay. And I know Oceaneering has grown market share growth in the ROV segment over the past few years. Did y'all experience more growth in this first half of the year?

Well, we've kept out the number of systems constant at about 125 for some time now. And so we're not -- you know, we're not trying to build certainly no new speculative equipment. I guess I would answer your question this way. Our market share has been reasonably static because the market has been fairly static for the last six to nine months.

Right, okay. And just one last quick question on the subsea products area. I know you don't like it to get specific about projects or things but I know West Africa is one of the more lucrative markets out there. And over the past few months there's been some large project awards going forward as of -- for the SPFOs and subsea trees. Do you notice any umbilical awards being awarded to your competitors or anything of that nature?

You're very astute. No question West Africa is a big market forumbilicals. And you know in general, we don't sell to one company that has in-house capability to install the product as well as manufacture the product. And so, you know, when they win a lot of work, you know, it causes us problems.

Okay. Thank you very much.

Thank you.

Your next question comes from Victor Marshand.

Good morning, everyone. The first question I had was just on intervention vessels. I wonder if you could comment on what sort of utilization you guys have seen third quarter to date, and what, if any, backlog you have or what work you have scheduled for the remainder of the third quarter possibly into the fourth quarter, and also, with the margins inherent in the work that you've done, in July or going forward, you know, could we see a return to the high teen margins in the second half of this year?

Yes. I think that's the best answer. As you know, we try to keep our utilization to a quarterly reporting period. But July's been, things are going well, and I think that was really the gist of the general comments that I made earlier, that you know, third quarter's going to be better than the second quarter. And we're halfway through the third quarter so we feel pretty good about it.

The only other question I had was just on the SG&A line, what could be looking forward as a run rate going forward?

It will be flat, you know, hopefully we can bring some more cost out of the inspection business. But it won't be -- there won't be any dramatic increases.

Fine, that's all I had thank you.

Next question comes from George Gaspar.

Yes, John, a follow-up on subsea products. Actually, you know, the quarter wasn't too bad, I mean, first of all your revenue stream was up about three, $4 million from the first quarter. And your backlog was down 5. So that was a fair wash. In terms of the incoming business, did it relate to -- can you give us a percentage of what it related to on they thermal plastic versus steel?

Gosh, George, I think we took one steel tube job.

It was mostly thermal plastic.

One steel tube job and everything else was plastic.

On this unallocated, first of all on G&A expense, can you give us any guidance, maybe you mentioned but if you could again, what your G&A guidance might be going forward relative to the --

I think if you use a flat number in your model it works.

So basically going forward, that jump from 12.13 to 13.5 million is about where it's going to stay?

I would annualize that and say that's not a bad number.

Okay. And then on allocated cost review, can you just give us a number of how many options have been issued in the company, say, in the last would years, and also for this year?

For you to our proxy, I mean it's all in there George. There hadn't been anyting issued since --

Since the proxy.

-- 2002, right. So I mean, it's all in the proxy. It's pretty well documented in there and pretty easy to understand.

So the last options have been issued were -- that were indicated in the proxy is that what you're telling me?

Restricted stock funds our long term incentive plan George. We have a long term incentive plan that's funded by restricted stock. And it's all in the proxy.

Okay. All right, thank you.

Your next question comes from Joe Aguilar.

Good morning.

Good morning.

I was wondering if you could help me break down the capex a little bit through the first half of the year mar Marvin I guess $64 million total, was it $36 million of that is from acquisition, or is for acquisitions?

Actually, $43 million of it was from business acquisitions for the first six months. You'll see that in the Q that we're filing either later today or tomorrow.

Okay. And then the, you know, investment in the steel tube manufacturing capacity, how much have you spent so far?

We've committed but I don't think we've spent anything, or very little of it.

That's about $35 million still to come?

Yes.

Do you have a full year capex for '03?

No, we don't. I mean, most of it is too influenced by acquisitions. So what we haven't -- I mean, the number wouldn't have changed much. We spent $20 million on property and equipment which is including adding capacity. We bought -- replaced a diving vessel, and some other capital expenditures that are non-maintenance type. But full year run rate, I would hazard to say, because acquisitions will influence that number by way more than --

Sure, sure.

-- anything else.

the -- leaving acquisitions out of the equation, would you expect to be free cash flow positive in the second half of the year?

Yes.

Absolutely.

That's what I thought you had front end weighted capex.

What I was trying to say is that the $20 million that we spent on property and equipment should not be annualized. Because it doesn't take but -- annual rate of 15 to 20 million all in for sort of ongoing maintenance type capex as we call it. So it really is when we get opportunities to add capacity, or improve the operating flexibility.

I would add a little bit to that, Joe, just to kind of give you a little flavor. In the opening comments what I was really referring to as we are continuously adding capability is in fact sort of that phenomena. You know we're always looking at new things and trying to figure out you know, is this going to be -- could it be a new niche even. So we've got a lot of you know, expansion capital that we'll be spending in that direction. And -- but our maintenance capex, to keep the productive capacity that we have in place, you know, is in that 15, $20 million annual range. So you can say that just about everything over $20 million that we spend is additional capacity in some way.

Well, John, one of the -- I mean one of the things that obviously has taken place this year, I think that at least to my recollection is a little bit different is that you seem to be finding a lot of smaller you know acquisition targets which, you know, on the surface one or two of them don't look like a lot but over time, if you keep finding those kind of opportunities they can add up. I mean, do you still think there's a few more out there in that same target range?

I do. And I -- that's a good point. And I think you make a -- an excellent comment there Joe, is that that's really what I was referring to a few quarters ago, when I said you know, we're now inviting acquisition opportunities into our expansion mix. I mean, I hadn't been doing that before. I mean, I really had been concentrated more on creation of niche markets than I was in the consolidation of the niches that I was in. I think OIS has been a great consolidation. But the real strategic play is, can we add capital to the business, and create some proprietary technologies that move us forward from that. We think there's -- and that's probably the reason that I'm seeing more product-type things that are on the fringes of what we're doing that are easy for us to assimilate. You know, you got to manage this stuff as well as, you know, do it. And you know, we're not just flamboyant deal makers. We are trying to fundamentally improve not only our business process but our growth process. And I think we've done a pretty good job so far.

And it seems like you know the strength of your cash flow underlying allows you to go ahead and pursue these acquisitions without needing to take on any debt or raise any capital.

Exactly.

Thanks very much.

Point out at the first half, we spent $63 million in capex including acquisitions. We bought 13 million of treasury stock. And so the total of 76 on those two items, cash went down 40 million.

Right.

So I mean, we have significant cash flow, free cash flow being generated from our operations that we can fund the capex that you asked about plus more.

Yeah, that's the point I was getting at. Thanks Marvin.

Your next question comes from Tom Ascott.

Good morning, fellows. Just circling back to a point John made at the first, I was writing furiously, I might have misunderstood. The '04 estimate you have, big increase in '04 you are not forecast being any big pickup in the ROV working for floaters. And does that then imply that you do see really a pretty strong market for ROV activity in marine construction, and other you know diving support related work, nondrilling if you will?

Yeah, that's a good question. Let me clarify that, Tom. What I was really trying to say is that I think that we will see about the same thing as we saw this year. And I don't want to try to create a new microniche here for people to be concerned about. And that is that we've got some other shift, and that is that we can shift, if you think of construction as development work, it's got a, you know, kind of a two-year time frame. If you think of production work, as sort of remedial work as the infrastructure is in place offshore, that work is building up. So we're using more equipment to provide production remediation work. We've hit a pretty good lick on the construction work this quarter, and next quarter. Drilling rigs is an important part of our business. You know, we continue to do very well in the rigs readied capability above -- below 3,000 feet. And the weakness has been in that, you know, thousand to 3,000 foot water depth market in terms of being able to improve margins in that area. So I think generally, let me just say that we're not looking at any big change in '04 in our ROV segment. Although it may change within the segment. I guess that's the message I'm trying to make.

Okay, well, that's great. Thank you. And just one comment. You know, after so many periods in so many years of seeing these negative surprises in the quarter on operations, it's sure been a great pleasure to see, you know, positive, positive surprises. And I guess that attests to all the work you folks have done on execution. I guess project execution, and it's encouraging to see that. And with that I'll turn it back to you.

Thank you, Tom.

Again, I would like to remind everyone, in order to ask a question, please press star, then the number 1 on your telephone key pad. Your next question comes from George Gaspar.

Yeah, John, I'm going to second what Tom said, that very good comment. And you guys are doing a great job particularly as diversification on inspection side puts a floor under you on this cyclicalness of some of your oil field segments. A little further on what Tom was asking, on the umbilical side subsea products. In the quarter, most of it was thermal plastic. Was that because the water depths of where your orders are coming from would be more moderate in nature than may be previous for at least a short-term period?

Yes, that's a good inference there George. And again I'd say that thermal plastic is a good product. I don't want to you know, anybody to leave the conference call saying wow, thermal plastic is a dead product. It's not. It's a good product. The intermediate product, HCR is a great product with Brazil with Petrobrass. The newest product of the steel tube design it tends to be more in the ultra deep water and it tends to be more a function of the super majors. So we're obviously following that market, you know, to the steel tubes and headed in that direction. But I am convinced that you know, good, quick, low-cost stepouts from particularly fixed facilities in the Gulf or the North Sea you know that are in moderate water depths, that's great market for plastic. I mean, you know, our mantra has been and continues that we believe our customer are serious about lower their costs and we want to be part of that lower-cost solution and we will continue to make I'm sure a lot of thermal plastic umbilicals.

John, just if I could pursue something. In the last quarter call I think you mentioned that in terms of looking at the market, for subsea umbilicals, that you saw some opportunity in even thousand-foot, the shall ower depths. Do you perceive that there's more satellite well opportunity coming up to existing platforms that would allow subsea well heads to be put longer distances from shallower?

Absolutely. I think that -- in terms of a specific comment that would address the general comment I made in the opening remarks, I have been absolutely aghast at how operators have not taken advantage of the decrease in throughput in some of these platforms. Now, let me quickly caveat that by saying this is a complex area. I'm talking about in the Gulf of Mexico. Because all of these tolling agreements, you know, the operators have, you know some a lot of vested interest in not leaving any of their stranded product, whether it's liquid or gas. And so they're hesitant about taking on other people. So what I'm saying, you know, I know our customers, you know, would have a much more complicated response for, and I'm sure they would be absolutely right on target. But in general, certainly as a megaview, there is no question question that there's a lot of pods of gas out there in the Gulf of Mexico, and liquids in the North Sea, where you know, operators will be able to tie that back at very, very Los low costs to existing facilities, and they won't have this huge capital. And it's going to happen. It's just a matter of when.

Okay, thanks very much.

Let me end the call with that question, and thank you again for being on the conference call, and if you have any additional follow-up questions, Jack will be available to respond to those. I'll look forward to next quarter's call and appreciate your interest in Oceaneering. Thank you.

This concludes today's Oceaneering International conference call. You may now disconnect.