Oceaneering International - 10-Q quarterly report FY

(Mark One)

(713) 329-4500

Not Applicable
if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ, No o.

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o, No þ.

The number of shares of the registrant’s common stock outstanding as of October 30, 2006 was 54,212,638.

All statements in this quarterly report on Form 10-Q, other than statements of historical facts, including, without limitation, statements regarding our expectations about 2006 net income and segment results, our plans for future operations, the adequacy of our working capital, our expectations about the profit contribution from our investment in Medusa Spar LLC, our expectations regarding inspection and repair work for the remainder of 2006 made necessary by hurricanes, our backlog, our anticipated tax rate for 2006 and industry conditions, are forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to various risks, uncertainties and assumptions, including those we have referred to under the headings “Risk Factors” and “Cautionary Statement Concerning Forward-Looking Statements” in Part I of our annual report on Form 10-K for the year ended December 31, 2005. Although we believe that the expectations reflected in such forward-looking statements are reasonable, because of the inherent limitations in the forecasting process, as well as the relatively volatile nature of the industries in which we operate, we can give no assurance that those expectations will prove to be correct. Accordingly, evaluation of our future prospects must be made with caution when relying on forward-looking information.

The following discussion should be read in conjunction with the Management’s Discussion and Analysis included in our annual report on Form 10-K for the year ended December 31, 2005.

We generate over 85% of our revenue from our services and products provided to the oil and gas industry. Our third quarter net income was higher than any previous quarter in our history. Compared to the second quarter of 2006, quarterly net income increased primarily due to improved performances from our ROV and Subsea Products segments and a reduction in our Unallocated Expenses.

For the fourth quarter of 2006, we anticipate net income to be slightly less than the third quarter, due to seasonal declines in our Inspection and Subsea Projects results, lower equity earnings from our Medusa Spar LLC investment, the planned drydocking of two of our vessels and an increase in our Unallocated Expenses.

For information about our Critical Accounting Policies and Estimates, please refer to the discussion in our annual report on Form 10-K for the year ended December 31, 2005 under the heading “Critical Accounting Policies and Estimates” in Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operation.

For a discussion of new accounting standards applicable to us, see the discussion in Note 9 to the Consolidated Financial Statements contained in Item 1 of this Quarterly Report on Form 10-Q.

We consider our liquidity and capital resources adequate to support our existing operations and capital commitments. At September 30, 2006, we had working capital of $242 million, including $34 million of cash and cash equivalents. Additionally, we had $130 million of borrowing capacity available under our $250 million revolving credit facility.

Our capital expenditures were $134 million during the nine months ended September 30, 2006, as compared to $96 million during the corresponding period last year. Capital expenditures in 2006 included additions and upgrades to our ROV fleet to expand the fleet and replace older units we retired. We added 11 ROVs to our fleet during the nine months ended September 30, 2006. In 2006, we also purchased (1) an oil tanker for possible future conversion to a mobile offshore production system in the event we obtain a suitable contract, and (2) the vessel from our cable-lay and maintenance joint venture. We subsequently sold this vessel in the third quarter of 2006. We also commenced improvements in our Subsea Products manufacturing facilities, including the addition of equipment to increase the capacity of these facilities. Capital expenditures in 2005 included the acquisition of Grayloc Products LLC, as well as additions and upgrades to our ROV fleet to expand the fleet and replace older units we retired.

We had no material contractual commitments for capital expenditures at September 30, 2006.

At September 30, 2006, we had long-term debt of $200 million and a 23% debt-to-total-capitalization ratio. We have $80 million of Senior Notes outstanding, to be repaid from 2007 through 2010, and $120 million outstanding under our $250 million revolving credit facility, which is scheduled to expire in January 2008. The revolving credit facility has short-term interest rates that float with market rates, plus applicable spreads. We have not guaranteed any debt not reflected on our consolidated balance sheet and do not have any off-balance sheet arrangements, as defined by SEC rules.

In the nine-month period ended September 30, 2006, our cash and cash equivalents increased $7 million. We generated $99 million in cash from operating activities, used $128 million of cash in investing activities and obtained $36 million of cash from financing activities. The cash used in investing activities was used primarily for the capital expenditures described above, and the cash obtained from financing activities was used, along with a substantial portion of the cash provided by operating activities, to pay for those capital expenditures and to finance an increase in working capital of $71 million. The increase in working capital was the result of higher accounts receivable from higher revenue, and higher inventories in anticipation of increased Subsea Products sales and spare parts for ROVs necessitated by more units and higher utilization levels.

In September 2002, our Board of Directors authorized us to repurchase up to 6 million shares of our common stock, subject to a $75 million aggregate purchase price limitation. Under this plan, we have repurchased an aggregate of 1,795,600 shares of common stock through September 30, 2006, at a total cost of $20 million. We have reissued all of those shares as contributions to our 401(k) plan or in connection with exercises of stock options. Although we have not made any such repurchases since April 2003, we may from time to time effect additional repurchases in accordance with the terms of the Board’s authorization, which remains in effect.

We operate in six business segments. The segments are contained within two businesses – services and products provided to the oil and gas industry (“Oil and Gas”) and all other services and products (“Advanced Technologies”). Our Unallocated Expenses are those not associated with a specific business segment.

Consolidated revenue and margin information is as follows:

We generate a material amount of our consolidated revenue from contracts for marine services and inspection services in the Gulf of Mexico and North Sea, which are usually more active from April through October compared to the rest of the year. In the periods presented, Subsea Projects had higher-than-normal revenue due to work made necessary by severe hurricanes in the Gulf of Mexico in 2005. Revenues in our ROV, Subsea Products, Mobile Offshore Production Systems and Advanced Technologies segments have generally not been seasonal.

The table that follows sets forth our revenues and margins for our Oil and Gas business for the periods indicated.

In general, our Oil and Gas business focuses on supplying services and products to the deepwater sector of the offshore market. In the past couple of years, we have had a high level of demand due to historically high hydrocarbon prices and hurricane damages to the oil and gas producing infrastructure in the Gulf of Mexico. We expect these market conditions to continue through 2007.

Our ROV segment revenues reflect the utilization percentages, fleet sizes and average pricing of the respective periods. Gross margins were favorably impacted compared to the previous quarter and the corresponding quarter of the prior year by an increase in the average revenue per day of ROV utilization. As compared to 2005, 2006 results reflect a higher profit contribution from our ROV business segment due to increases of our fleet days on hire and pricing. We expect our fourth quarter ROV results to be above those of the third quarter.

For our Subsea Products segment, margins improved for all periods presented. As compared to the corresponding periods of the prior year, improvements were largely attributable to increased umbilical and specialty hardware sales. Compared to the quarter ended June 30, 2006, profitability improved from higher umbilical manufacturing throughput as we resolved the mechanical problems previously experienced at our Panama City, Florida plant and processed a higher work load at our Brazil facility. We expect our 2006 Subsea Products results to improve over those of 2005 on better umbilical manufacturing results, particularly from our Brazil and Panama City plants, and higher specialty hardware sales. We expect our Subsea Products fourth quarter of 2006 profit contribution to improve due to continued improved performance from our umbilical manufacturing operations. Our Subsea Products backlog increased from $196 million at December 31, 2005 to $281 million at September 30, 2006.

For our Subsea Projects segment, our revenue and gross margin decreased compared to the second quarter of 2006 due to $4.5 million of margins recognized in the second quarter from finalization of change orders related to work performed in the first quarter and cost estimate revisions to projects previously performed, primarily in the first quarter. Subsea Projects revenue and gross margin for the periods ended September 30, 2006 were significantly higher than the corresponding periods of the prior year due to work related to hurricane damage and an escalation in demand for our inspection, maintenance and repair services on the deepwater infrastructure in the Gulf of Mexico. We expect our 2006 fourth quarter results for Subsea Projects to decline from the third quarter levels due to normal seasonality and the planned drydocking of two vessels.

Our Mobile Offshore Production Systems three main assets were working under the same contracts as in 2005. The lower revenue and margins beginning in the second quarter of 2006 were the result of a lower dayrate going into effect in mid-May for the use of the Ocean Legend, as per the renewal option terms in the existing contract.

Our Inspection margins increased compared to the corresponding periods of 2005 as a result of our efforts to provide more value-added services and to reduce our operating expenses. Inspection margins were comparable from the prior quarter. For the fourth quarter of 2006, we expect a decrease in profitability as compared to the third quarter, as a result of normal seasonality. We expect an improvement in margins for the full-year 2006, as compared to 2005, as a result of operational improvements.

Revenue and margin information is as follows:

Advanced Technologies margins for the nine months ended September 30, 2006 decreased over the corresponding period of the prior year, primarily due to the transfer of The Performer to our Subsea Projects business in April 2006. The quarterly results for the periods presented were comparable.

Our Unallocated Expenses, i.e., those not associated with a specific business segment, within gross margin consist of expenses related to our incentive and deferred compensation plans, including restricted stock and bonuses, as well as other general expenses. Our Unallocated Expenses within operating income consist of those within gross margin plus general and administrative expenses related to corporate functions.

The table that follows sets out our Unallocated Expenses for the periods indicated.

Lower compensation expense related to incentive plans, due to the decline in our stock price from the end of the second quarter, was the principal cause of the decreases in Unallocated Expenses in the three-month period ended September 30, 2006 compared to the other three-month periods presented. Expense related to the unvested portions of the tax-assistance provisions of our restricted stock plans for periods prior to 2006 fluctuates with the market price of our common stock, which rose 60% during the quarter ended June 30, 2006 and subsequently decreased 33% during the quarter ended September 30, 2006. For the fourth quarter of 2006, we expect our Unallocated Expenses to increase from third quarter levels. On January 1, 2006, we adopted Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004), Share-Based Payment (“SFAS 123(R)”), issued by the Financial Accounting Standards Board. For further information related to our stock-based compensation and our transition to SFAS 123(R), please see Note 8 to the Consolidated Financial Statements contained in Item 1 of this Quarterly Report on Form 10-Q.

The table that follows sets forth our significant financial statement items below the income from operations line.

     The amounts of equity earnings (losses) of unconsolidated affiliates are as follows:

We own a 50% equity interest in Medusa Spar LLC, which owns a 75% interest in the Medusa Spar production platform in the Gulf of Mexico. Medusa Spar LLC earns revenue on a tariff basis on oil and gas production throughput processed by the spar from the Medusa field and certain specified surrounding areas. The higher earnings for the periods ending September 30, 2006 compared to the periods ended September 30, 2005 were due to suspension of production during the third quarter of 2005 as a result of Hurricane Katrina. The decline in the quarter ended September 30, 2006 compared to the quarter ended June 30, 2006 resulted from declining production as the reservoirs being produced deplete normally. For the fourth quarter of 2006 and for 2007, we anticipate lower equity income from our Medusa Spar LLC investment from declines in production from the

currently producing reservoirs. In addition, in October 2006, the well which had been producing the highest throughput had a mechanical failure, and we do not expect the operator to complete repairs to the well before March 2007.

We own 50% of Smit-Oceaneering Cable Systems, L.L.C., a telecommunications cable-laying and maintenance venture. Due to a weakened condition of the telecommunications market, the single vessel owned by the venture was marketed for oilfield and other uses beginning in 2004. In March 2005, we purchased the cable-laying and maintenance equipment from the venture at a price equal to its adjusted book value. We purchased the vessel in the second quarter of 2006. Our completion of the purchase effectively winds up the venture. We do not anticipate a material impact on our net income from the windup of the venture.

Interest expense for the three- and nine-month periods ended September 30, 2006 increased compared to the corresponding periods in the prior year due to higher average debt levels.

Foreign currency losses, which are included in other income (expense), net, of $1.1 million and $1.7 million for the three- and nine-month periods ended September 30, 2006, respectively, related primarily to the devaluation of the U.S. Dollar against the Brazilian Real and the U.K. Pound Sterling.

The provisions for income taxes were related to U.S. income taxes that we provided at estimated annual effective rates using assumptions as to earnings and other factors that would affect the tax calculation for the remainder of the year and to the operations of foreign branches and subsidiaries that were subject to local income and withholding taxes. We anticipate our effective tax rate for 2006 to be 35.6%, less approximately $0.9 million of credits, which were primarily due to the expiration of applicable statues of limitations related to foreign tax contingencies.

Because we operate in various oil and gas exploration and production regions in the world, we conduct a portion of our business in currencies other than the U.S. dollar. The functional currency for several of our international operations is the applicable local currency. We manage our exposure to changes in foreign exchange rates primarily through arranging compensation in U.S. dollars or freely convertible currency and, to the extent possible, by limiting compensation received in other currencies to amounts necessary to meet obligations denominated in those currencies. We use the exchange rates in effect as of the balance sheet date to translate assets and liabilities as to which the functional currency is the local currency, resulting in translation adjustments that we reflect as accumulated other comprehensive income or loss in the shareholders’ equity section of our consolidated balance sheets. We recorded adjustments of $8.4 million and ($8.6 million) to our equity accounts for the nine-month periods ended September 30, 2006 and 2005, respectively, to reflect the net impact of the U.S. dollar against various foreign currencies for locations where the functional currency is not the U.S. dollar.

Our Subsea Products business in Brazil conducts much of its operations in U.S. dollars, which is its functional currency. Our foreign currency transaction gains (losses) related to Brazil were ($1,144,000) and $453,000 for the nine-month periods ended September 30, 2006 and 2005, respectively.

In accordance with Rules 13a-15 and 15d-15 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), we carried out an evaluation, under the supervision and with the participation of management, including our chief executive officer and chief financial officer, of the effectiveness of our disclosure controls and procedures (as that term is defined in Rules 13a – 15(e) and 15d – 15(e) under the Exchange Act) as of the end of the period covered by this report. Based on that evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures were effective as of September 30, 2006 to provide reasonable assurance that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.

There has been no change in our internal control over financial reporting that occurred during the three months ended September 30, 2006 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

We are currently implementing a new business management system, which we started using for our U.S. operations in July 2005 and which was implemented in our foreign locations (except Brazil) starting in 2006. We are taking all steps we believe to be necessary to monitor and maintain appropriate internal controls during the implementation.

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.