Oceaneering International Inc (OII) 2006 Q3 法說會逐字稿

Good morning. My name is Jane, and I will be your conference operator today. At this time, I would like to welcome everyone to the Third Quarter Earnings Conference Call.

[OPERATOR INSTRUCTIONS]

Mr. Jurkoshek, you may begin your conference.

Good morning, everybody. Thanks for joining us on our 2006 third quarter earnings conference call. I'd like to particularly welcome those of you who may be participating in the webcast of this event, which is being made available to the Company Boardroom service of Thomson CCBN.

Joining me this morning are Jay Collins, our President and Chief Executive Officer, who will be leading the call this morning, Marvin Migura, our Chief Financial Officer and Bob Mingoia, our Treasurer. Just as a reminder, remarks we make during the course of this 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 Jay.

Good morning, and thanks for joining the call. During the third quarter of 2006, we achieved record net income for the sixth consecutive quarter. Earnings of $38.6 million were double the third quarter of 2005 and 25% above last quarter. Our record earnings were above both our guidance range and the street estimate, as market demand for our subsea services and products remained at a very high level.

Both the year-over-year and sequential quarterly net income improvements were fairly broad based, with five of our six business segments contributing to the increases. Our ROV subsea products and inspection businesses achieved record quarterly operating income performances. Year to date we've earned more net income than in all of 2005 and are on track to nearly double the EPS for the year 2006 over 2005.

Since our last quarterly release, our earnings assessment for 2006 has improved, and we now expect to achieve record EPS in the range of $2.25 to $2.30. This is up about 10% from the $2.00 to $2.10 range we gave last quarter.

Year-over-year our ROV operating income has increased 25%. We improved our average revenue per day on hire to a record $7,500, up 22% and increased our average operating income per day on hire to nearly $2,100, up 21%. We also increased our fleet size by 11 vehicles.

Sequentially, ROV operating income increased by over 10% on a 6% improvement in average pricing per day on hire and a 4% increase in days on hire. During the quarter, we added four systems to our fleet, and as of the end of September had 186 systems available for operation. To give you an update on our ROV mix of business during the month of September, 71% worked on drill support service, 29% in construction and field maintenance, the same as in June.

Our subsea products segments had a record quarter as our umbilical manufacturing throughput improved and our specialty products group, Oceaneering Intervention Engineering, continued to generate commendable results.

Year-over-year, the 11 million improvement in products operating income was broad based and largely attributable to increased umbilical ROV tooling, valve and plant sales. Sequentially segment operating income rose on [higher] umbilical manufacturing throughput. We resolved the mechanical problems previously experienced at our Panama City plant and processed the higher workload at our Brazil facility.

At the end of the quarter, our products backlog was $281 million, up 55% from the $181 million of a year ago and up from $245 million at the end of last quarter. Our new product orders during the quarter were approximately $135 million, over 35% more than the revenue we generated. Our subsea projects business, which is conducted in the Gulf of Mexico, achieved another outstanding profit performance as we continued to benefit from the high market demand for our diving and vessel services engaged in hurricane damage work.

Sequentially, operating income was comparable to the second quarter, after taking into account the 4.5 million of profit booked in the second quarter related to customer approval of change orders and favorable cost estimate revisions related to work previously performed. Year-to-date, our subsea project business has earned nearly $50 million, almost twice as much as during the entire year of 2005.

As expected, our MOPS business had comparable results during the quarter as an increase in engineering work offset the impact of a full quarter of a lower day rate on the Ocean Legend. All three of our totally owned units were under contract for the entire period as they were last year at the same time. We expect them to remain so for the rest of this year.

The earnings contribution from our Medusa Spar investment reported as equity income from unconsolidated affiliates declined as reserves currently being produced are naturally depleting. Year-over-year and sequentially, our inspection business benefited from our efforts to secure more value added sales, and realized a cost savings of actions previously taken to reduce our operating expenses. The profitability improvements came from most of the geographical areas in which we operate.

Our ADTECH non-oil field business had a good quarter with results reflecting normal fluctuations in business activity and job mix and the transfer of the performer to our subsea projects business in April. Sequentially and year-over-year, operating income was essentially the same.

I'm now going to turn the call over to Marvin to discuss our unallocated expenses, cash flow and balance sheet.

Thank you, Jay. Good morning, everybody. Unallocated expenses were lower both year-over-year and sequentially due to lower restricted stock expense associated with long-term incentive compensation awards granted in 2002 and 1999. At last quarter's conference call, I explained that our second quarter unallocated expenses were unusually high and we expected them to be between $15 million and $16 million per quarter at the operating income line for the balance of the year.

Well, because a portion of our restricted stock expense fluctuates with the market price of Oceaneering stock, which declined 33% during the quarter, our unallocated expenses fell in the third quarter and were about 10% lower than what we had projected. Our current forecast for the fourth quarter anticipates unallocated expenses at the $16 million to $18 million level at the operating income line. Of course, this will depend upon our stock price on December 29th, the last trading day of the year.

The lower tax rate of 34% for the third quarter was primarily attributable to the expiration of statute of limitation on certain foreign tax exposures for which we had previously made provisions. The expiration of these exposures resulted in a reduction of our overall income tax expense by about 900,000. We anticipate the fourth quarter tax rate to go back to the 35.6% level.

If you add depreciation to our operating income, we generated over $81 million in cash flow in the third quarter, 70% more than the third quarter of 2005 and 20% more than last quarter. At the end of September, we had debt of $200 million and equity of $652 million. Our debt to cap percentage was 23%. Capital expenditures during the quarter totaled $44 million, of which $30 million was for maintaining, upgrading and expanding our ROV fleet. $9 million was invested in previously announced initiatives for our subsea products business.

Of the $134 million in CapEx we have invested in the first three quarters of this year, $102 million or 75% has been in our ROV and subsea products businesses, the two operations that offer us excellent future growth prospects as they are tied to deep water and subsea completion activities. We continue to look for additional accretive acquisitions and organic growth opportunities with better than cost of capital returns, and intend to use our strong cash flow and balance sheet to further grow our earnings.

Year-to-date we have generated $154 million in cash flow from operations defined as net income plus depreciation and amortization. And we have spent $134 million on CapEx. So we have spent an average of $45 million for each of the first three quarters. And we are on track to invest about the same amount of money, or maybe a little less in the fourth quarter.

Now, I'm going to turn the call back over to Jay.

Thank you, Marvin. In summary, our third quarter net income was at a record level for the sixth consecutive quarter. And we have already achieved record annual EPS performance in 2006 for the third year in a row. Our focus on providing services and products for deep water and subsea completions is a good way to play a major secular growth trend currently underway in the oil field service and product industry. Deep water is definitely one of the best frontiers for the E&P companies to add large reserves with high production flow rates at relatively low finding and development costs.

Additionally, our business is much more leveraged to oil than gas. We have seen no signs of any slow down in demand for our services and products because of customer concerns regarding natural gas prices.

Now, looking at the fourth quarter outlook, for specific fourth quarter guidance, we are projecting earnings of $0.58 to $0.63 per share. We finished the third quarter with 186 ROVs, and expect to put additional systems into service during the fourth quarter. Consequently, we expect fourth quarter ROV operating income to be higher than the third quarter.

Operating income from subsea products is expected to improve as we anticipate a continued increase in manufacturing throughput at our multiflex umbilical plants. We expect inspection operating income to decline in the fourth quarter on substantially lower revenues. This is due to the normal seasonal decline in demand for these services, particularly in Europe.

Subsea project operating income is expected to decline in the fourth quarter due to normal seasonal decline in demand and the fact we'll have two of our deep water vessels temporarily out of service. The Performer will be in the shipyard for the entire quarter for upgrades. And the Ocean Intervention I will be drydocked for five to six weeks for a Coast Guard inspection. That being said, we still expect very good fourth quarter results at about the level what we reported in the fourth quarter of last year.

Our MOPS segment results are forecast to be down due to a reduction in profit contribution from engineering work performed during the third quarter. We also anticipate that equity income from our ownership in the Medusa Spar will fall off as production is expected to decline as the reservoirs deplete. Furthermore, during October, the most prolific well suffered a mechanical failure which we do not expect the operator to make repairs before March 2007.

Now looking at 2007 EPS outlook, during 2007 we expect the market environment for our oil field services and products will continue to be characterized by robust demand and pricing power. This is being driven by high crude prices, limited non-OPEC supply growth, significant reservoir depletion rates and solid hydrocarbon demand growth. In this market we believe the trend for our customers to invest their enormous cash flows in offshore and subsea projects will continue. And consequently, our 2007 earnings are anticipated to be even better than 2006.

The current inventory of deep water fields yet to be developed, the extent to which existing floating rigs are already under firm contracts, announced new floating rig construction and the contract commitments being made for their use and the market outlook for subsea trees and umbilicals are all signs of healthy future demand for our products and services.

Given the long-term nature of deep water projects, the demand for our service and product offerings is not impacted to any measurable extent by short or intermediate term commodity price swings. Therefore, our market assessment is not being negatively impacted by the current uncertainty regarding 2007, 2008 future of natural gas prices here in the United States or in our opinion is it being negatively effected by the recent pullback in the benchmark price of oil.

We believe the economics of deep water are viable at a lower price, certainly at above $50 per barrel and probably above $40 a barrel. For example, John Hofmeister, President of Shell's U.S. operations, stated on October 18th that Shell would continue with its exploration project in the Gulf of Mexico even if oil dropped into the low '40s. He went on to say that some of their prospects remain feasible even if oil drops as low as $20 a barrel.

We like our market position, given the future demand visibility for our products and services. Consequently, as stated in the press release, we are initiating 2007 EPS guidance with the range of $2.60 to $2.90. At the mid-point, this equates the EPS growth of over $0.45 a share or 20%. This growth in EPS is anticipated to be led by profit contribution increases from ROVs and subsea products, particularly our umbilical manufacturing operations.

We have not yet completed our detailed planning process for next year, but the big picture for the 2007 versus 2006 changes we envision occurring can be recapped as follows. ROV operating income growth of $25 to $35 million as we continue to raise prices and grow our fleet. Subsea products operating income growth of $30 to $45 million as we increase throughput at our umbilical manufacturing plants and exploit continued demand growth for our other specialty subsea products.

Subsea projects operating income is expected to be about the same as in 2006. This is based on our anticipation of an escalation in deep water inspection, maintenance and repair projects and a continuation of demand for hurricane work. Let me point out that our 2007 estimate for subsea projects includes the presumption that we will secure the considerable amount of work not presently contracted. However, we are adding capacity to this segment, and the outlook is very promising.

Our inspection and ADTECH businesses will achieve comparable results to 2006. MOPS segment profit contribution will drop due to a lower day rate for the Ocean Legend. Equity income from Medusa Spar will decline significantly, perhaps by $10 million, as production from the initial zones on the existing wells is declining. These zones are now expected to produce more reserves than previously anticipated, which is delaying planned 2007 recompletions by the operator. These recompletions are expected to have higher flow rate zones.

Our SG&A expenses will increase as we continue to grow the company. On a relative basis, we expect SG&A to decline as a percentage of revenue as our top line growth is expected to grow at a faster rate in the 20% range. Depreciation and amortization expense is expected to be $10 to $12 million higher.

We're not going to give out any more detailed information on 2007 at this time. But in summary, with the exception of our MOPS business, we're expecting exceptional financial results in 2007, and record annual earnings for the fourth consecutive year. While we do not yet have a detailed capital plan for next year, we anticipate spending about $30 million on maintenance CapEx, and funding additional ROV fleet growth, completing capital projects approved by the board that we're in process [during] at the end of this year.

And above and beyond this spending, we intend to continue to invest our cash flow in organic growth and to pursue accretive acquisitions. To the extent we do not find suitable investment options, we will consider additional share buybacks in the open markets. In summary, our record results continue to demonstrate our ability to generate excellent earnings and cash flow. We believe our business strategy is working well over both the long and short-term. Our technology gives us operating leverage to take advantage of the high level of deep water and subsea completion activity currently underway.

The market outlook for our deep water and subsea service and product offerings is excellent. Broader, deeper, longer -- any way you describe the current environment, we continue to believe we are in one of the sweet spots of this up cycle. 2006 will be our best year ever, and with capacity additions in ROVs, products and projects, 2007 is projected to be even better.

We appreciate everyone's interest in Oceaneering, and we'll be pleased to answer any questions that you have.

[OPERATOR INSTRUCTIONS]

And your first question comes from the line of Scott Gill with Simmons & Company.

Yes, good morning, gentlemen.

Good morning.

Good morning.

Good morning.

Jay, just before I ask a question, please clarify your fourth quarter guidance. I thought I heard you say $0.58 to $0.63. The press release says $0.53 to $0.58. Did I just mistakenly hear what you said?

I don't know. We mean what we said in the press release, Scott. It is $0.53 to $0.58.

I'm sorry, $0.53 to $0.58. I did misspeak on that.

Okay. Let me go on to my line of questioning then. I just wanted to clarify that. Jay, could you just give us some added color on kind of your Panama City plant utilization, where it stands today and perhaps even talk about the overall subsea products capacity, where it is today and where you see that capacity heading into '07?

Sure, I'd be happy to make some comments on that. Our Panama City plant had much improved operations during the third quarter. We successfully tabled five major projects in succession on our planetary cabling machine. This totaled 95 miles of product in two very significant jobs, one job for a new field, a Wrigley Field umbilical was over 28 miles long. That's the longest single umbilical that we've ever made.

And we also finished a Petrobras America's Cottonwood project. The Cottonwood project is just now loaded out on our vessel. So it'll be installed in the Gulf of Mexico. And Wrigley will be loaded out. And the other three jobs will load out shortly. So this quick succession of these projects, completion of these projects, did require a very high level of planning and coordination and ensured a smooth delivery of these multiple projects in a short period of time.

I feel very good about this and proud of the work that our people in Panama City did to get this plant operating predictably compared to where we were at our last call. I think our customers are seeing this. And as evidence, we installed a $30 million order that we got for Mariner for their Bass Lite project. And that project is starting to be manufactured now.

So in summary, our Panama City plant is up and running. We think it's going to be a meaningful contributor to our growth in subsea products profitability this year and next year. Overall capacity -- I think we're in both oceaneering intervention and multiflex what we see is significantly more volume running through these facilities in 2007 and 2006. We really don't have, I think, a good, measurable number of capacity. But I think these things are contributing to the 20% top line growth that we see in the company. So I give you that guidance.

Okay. My last question then would be on the ROV. Can you give us some indication as to how many vehicles you plan to add in 2007?

No, I'm sorry. We just decided to continue to announce vehicles as we, as we build them every quarter. So we're going to stick with that. But again, it's pretty hard to raise our -- grow our business 20% if ROVs aren't making their fair share of contribution.

Fair comment. Thank you, very much. Good quarter.

Thanks. Thank you.

Your next question comes from the line of Stacy Nieuwoudt with Pickering Energy.

Good morning, guys.

Good morning.

Good morning.

Good morning.

Are you guys seeing any pushback on ROV pricing from your customers? On your last call you mentioned some resistance to price increases, but it seemed that that pulled through during Q3. If you could just walk me through what you're seeing now.

Well, I think our customers are very strong and powerful companies. And they always have pushback on pricing increases. And our guys fight that fight every day with our customers. I think there is no excess ROV supply at the moment. And if we're able to supply our customer, I think we will be able to continue to make gradual price increases.

I think costs are also going up. People are short. We're having to add additional training schools and recruiting costs. R&M costs are continuing to increase as well. So I would at least - as I say, we're still planning 2007. But our initial thoughts are that this is a volume year and that we are not going to see significant increased margins. At least we're not planning for that. We may achieve it. But I think it's more of a volume situation everywhere. But we continue to push pricing everywhere. And we deal with some pretty strong tough guys everywhere. So pricing increases are not easy. But I think we will continue to make pricing increases. But I would plan for flat margins at this point in time.

Okay, great. And then also on the ROV, can you kind of walk me through where you see your breakdown between construction and drill support in 2007?

Well, amazingly, this 29%, 71%, sort of a 70/30 split, has stayed very constant over the last several years. And we see opportunities in both areas. So I guess our thinking at the moment is that we'll continue to see sort of a 70/30 split in that.

The drilling rigs are obvious out there. We believe there are 18 drilling rigs that exist today that are part of the existing fleet that don't have an ROV onboard. So those are opportunities for those coming out of cold stack and 14 that are in shipyards. So those are opportunities for us as well as all the 42 new builds that are coming out in the next few years. But we also see increasing construction activities and new vessels that are - there are a significant number of new vessels coming on the market. So we anticipate, I think -- continue to see the same balance.

Okay, great. Thanks, guys.

Your next question comes from the line of Thomas Escott with Pritchard Capital.

Good morning, fellows.

Good morning, Tom.

Good morning.

Good morning.

Two things here, one on the subsea products. Obviously huge, huge ramp, nearly $6 million operating profit swing from June to September. I guess that underscores the fact that the problems there in Florida are fixed, that thing is up and running and two years of hassle and all that is behind us now. At this point, I guess the question is gross margins in that business came from a loss in that, in that plant, I guess up to now, the gross margins in that segment 23%.

As a practical matter in a manufacturing business like that, I mean, can that get up to in the '30s like the ROV business? Or is the practical limit of that margins in that segment going to be something less than the ROV part of the business?

I think everything is going to be less than the ROV business, Tom. That's just such a terrific business. Unfortunately, I wish every business had that kind of profitability in it. I think, again, flat margins in the products business is what should be modeled at this point in time. I would remind people that the largest growth in multiflex, particularly in the U.S., is going to be steel tubes where we buy in the steel tube so we don't have the chance to make the value added profit on that business.

So there are big dollar items, but we tend to make less percent margins. So one of the high growth areas is, in fact, a little bit lower margin. But we see still good opportunities in the intervention engineering business. But again, there is competition in this world out there. So I think maintaining margins and increasing volume significantly is still the name of the game in that segment.

Okay, thank you. And then on -- the ROV thing has been touched on so I'll go to another point. Medusa Spar -- obviously production dropping a lot faster than you thought. The returns on that investment obviously a lot less than anticipated from a few years ago. Two questions about it. One, is the investment in Medusa Spar now marginally, only marginally profitable for you? And is there -- is there any consideration that you could perhaps try to monetize that investment, since it's clearly not doing now and not going to be earning the returns that you had anticipated when you did that?

No, Tom, first of all, let me say that we view this as a long-term asset. And this is early days in the game. We think that although it's disappointing to see us not able to get to these higher productive zones earlier and having problems with this one well, so clearly, we're not going to make very much money in '07. But we think ultimately there will be more tiebacks to this unit and we will get to these other zones and we will do the recompletions. So as I say, it's early game. This is a very long-lived asset. So we have no plans to change our situation on this.

Okay, thank you.

Your next question comes from the line of Phil Dodge with Stanford Group.

Good morning, everybody. A question on the MOPS segment, what your medium term game plan might be for that. I mean, three years from now do you think you'll have more units, less, the same. I know you purchased an asset a while back as a potential conversion. So that obviously might be involved.

Right. Well, as you can see, we have very episodic projects. We take just a while to find projects that we really like to do in this business. We do have a tanker. We are looking for opportunities to use that tanker. We potentially could even sell the tanker if we don't find such opportunities. So we'll have both of those ideas on the table in 2007. But we are looking around. We would like to make an investment in this business if we can find the right opportunity.

Yes. So you'd like to grow if the chance is there?

Absolutely.

Yes. Okay, thank you.

Your next question comes from the line of Waqar Syed with Petrie Parkman & Company.

Good morning, gentlemen. Great quarter. First of all, off your revenue and earnings projections for '07, what proportion would you say is already contracted?

On a corporate-wide basis, I just don't have a number like that. I'm sorry.

Okay.

I know that it's more. And backlog is up. And I know that more of the ROVs are contracted. But in terms of having a number, I just don't have it.

Okay. And secondly, for the tanker, should you get a contract or upgraded it, what kind of CapEx are we looking at? And if you get a contract, how early could that be on earning revenues?

Well, first of all, these projects are long-term projects, so I would think it would take something short of a year and-a-half from the date of contract before we would start to be earning revenues on a new project. So we would have to do something very early in '07 to affect '08.

So I would suggest that it's probably unlikely to affect '08 since we don't have a project very close at the moment. So it's possible to get at the end of '08 but not as likely as '09. And with regard to projects, I really don't have a number. I guess a broad range is the project in West Africa that we worked hard on but didn't win. It would have been somewhere in the range of $250 to $300 million CapEx.

Right. But if there was a storage facility opportunity that was shorter term, it could be significantly less than that. So it really is...

That's true.

... just a very broad range of possibilities that we will look at. As Jay indicated, we're going to look at everything from finding a way to put it to work if the right opportunity is there, or monetizing it if we can't find the right opportunity. We think it's a great asset right now in our portfolio.

Now, where is this located? I know it cannot operate in the Gulf of Mexico. Is that correct?

It's actually in Portland or Seattle. It's in Oregon, in a dock in Oregon. And we could use it anyplace in the world.

Now, my understanding was that it's because it's not double hull it may not be used here in the Gulf of Mexico. Is that correct or no?

That is correct. We're not looking at [FDSO] opportunities in the Gulf of Mexico.

I'm sorry. Excuse me.

Anywhere else in the international market.

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

Okay.

[OPERATOR INSTRUCTIONS]

Your next question comes from the line of Jim Crandell with Lehman Brothers.

Good morning.

Good morning, Jim.

Jay, I stepped out for a minute, so if you commented on this, I apologize. But could you comment on the North Sea divers' strike, which supposedly started this morning and its impact on Oceaneering?

Jim, we don't do any diving in the North Sea. I, frankly, don't see it having any impact on us at all. I don't think it will impact our inspection business or our ROV business in the North Sea. So I think it'd have no effect.

Okay. Second thing, Jay, could you comment on the potential you think of consolidating acquisitions here in ROVs and to what, to what extent you think that they are possible in the environment ahead?

I don't really have any indication that any consolidating acquisitions are likely. You see many of the ROVs are owned by very large construction companies or survey companies. I did note one ROV company, [Rotech], sold us this year. We made a bid for it but were unsuccessful. So I wouldn't anticipate consolidating opportunities in this industry. But certainly, none that I am aware of at the moment, but it's always possible.

And we would definitely be interested in it, Jim, should that opportunity occur.

Absolutely.

Okay. Got you. Thank you.

You bet.

And at this time, there are no further questions.

Okay. All right. Well, thank you very much. We appreciate everyone's attendance. And I know you all know Jack, and they can follow-up with Jack for further information. Goodbye.

Take care.

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