UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
For the quarterly period ended June 30, 2004
OR
For the transition period from to
Commission File Number 1-10945
OCEANEERING INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
(713) 329-4500
(Registrant’s telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year,
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 x No ¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No ¨
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Class
Outstanding at July 30, 2004
Common Stock, $.25 Par Value
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements.
OCEANEERING INTERNATIONAL, INC. & SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands)
June 30,
2004
Dec. 31,
2003
ASSETS
Current Assets:
Cash and cash equivalents
Accounts receivable, net of allowance for doubtful accounts of $2,763
Prepaid expenses and other
Total Current Assets
Property and Equipment, at cost
Less: accumulated depreciation
Net Property and Equipment
Goodwill
Investments in unconsolidated affiliates
Other
TOTAL ASSETS
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities:
Accounts payable
Accrued liabilities
Income taxes payable
Total Current Liabilities
Long-term Debt, net of current portion
Other Long-term Liabilities
Commitments and Contingencies
Shareholders’ Equity
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
See Notes to Consolidated Financial Statements.
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CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(in thousands, except per share amounts)
For the Three Months
Ended June 30,
For the Six Months
Revenue
Cost of services and products
Gross margin
Selling, general and administrative expenses
Income from operations
Interest income
Interest expense
Equity earnings (losses) of unconsolidated affiliates, net
Other income (expense), net
Income before income taxes
Provision for income taxes
Net Income
Basic Earnings per Share
Diluted Earnings per Share
Weighted average number of common shares
Incremental shares from stock options and restricted stock
Weighted average number of common shares and equivalents
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CONSOLIDATED STATEMENTS OF CASH FLOWS
Cash Flows from Operating Activities:
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization
Non-cash compensation and other
Distributed (undistributed) earnings of unconsolidated affiliates
Increase (decrease) in cash from:
Accounts receivable
Prepaid expenses and other current assets
Other assets
Current liabilities
Other long-term liabilities
Total adjustments to net income
Net Cash Provided by Operating Activities
Cash Flows from Investing Activities:
Business acquisitions
Purchases of property and equipment and other
Net Cash Used in Investing Activities
Cash Flows from Financing Activities:
Net proceeds (payments) on revolving credit and other long-term debt, net of expenses
Proceeds from issuance of common stock
Purchases of treasury stock
Net Cash Provided by (Used in) Financing Activities
Net Decrease in Cash and Cash Equivalents
Cash and Cash Equivalents - Beginning of Period
Cash and Cash Equivalents - End of Period
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
We have prepared these unaudited consolidated financial statements pursuant to instructions for the quarterly report on Form 10-Q required to be filed with the Securities and Exchange Commission. These financial statements do not include all information and footnotes normally included in financial statements prepared in accordance with generally accepted accounting principles. These financial statements reflect all adjustments that we believe are necessary to present fairly our financial position at June 30, 2004 and our results of operations and cash flows for the periods presented. All such adjustments are of a normal and recurring nature. The financial statements should be read in conjunction with the consolidated financial statements and related notes included in our annual report on Form 10-K for the year ended December 31, 2003. The results for interim periods are not necessarily indicative of annual results.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expense during the reporting period. Actual results could differ from those estimates.
Stock-Based Compensation
We use the intrinsic value method of accounting established by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, to account for our stock-based compensation programs. Accordingly, we do not recognize any compensation expense when the exercise price of an employee stock option is equal to the market price per share of our common stock on the grant date. The following illustrates the pro forma effect on net income and earnings per share if we had applied the fair value recognition provisions of SFAS No. 123, Accounting for Stock-Based Compensation:
For the
Three Months EndedJune 30,
Six Months EndedJune 30,
Net Income:
As reported
Employee stock-based compensation included in net income, net of income tax benefit
Pro forma compensation expense determined under fair value methods for all awards, net of income tax benefit
Pro forma
Reported earnings per common share:
Basic
Diluted
Pro forma earnings per common share:
For purposes of these pro forma disclosures, we estimate the fair value of each option grant as of the date of grant using a Black-Scholes option pricing model. The estimated fair value of the options is amortized to pro forma expense over the expected average lives of the options.
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Variable Interest Entities
In January 2003, the FASB issued FIN No. 46, Consolidation of Variable Interest Entities. FIN No. 46 requires a company to consolidate a variable interest entity if it is designated as the primary beneficiary of that entity. A variable interest entity is generally defined as an entity whose equity is insufficient to absorb the expected losses or whose owners lack the risk and rewards of ownership. FIN No. 46 is effective for all variable interest entities created or modified after January 31, 2003 and requires certain disclosures for all variable interest entities. In December 2003, the FASB published a revision to FIN No. 46 (“FIN No. 46R”) to clarify some of the provisions of the Interpretation and to defer the effective date of implementation for certain entities created before January 31, 2003. Under the guidance of FIN No. 46R, entities that do not have interests in structures that are commonly referred to as special purpose entities (“SPEs”) are required to apply the provisions of the Interpretation in financials statements for periods ending after March 14, 2004. The adoption of the provisions of FIN No. 46 did not have a material impact on our consolidated financial position, results of operations or liquidity. In December 2003, we purchased a 50% equity interest in Medusa Spar LLC for $43.7 million. Medusa Spar LLC owns a 75% interest in a production spar platform. Medusa Spar LLC’s revenue is derived from processing oil and gas production for a fee based on the volumes processed (“throughput”). The majority working interest owner of the Medusa field, the spar’s initial location, has committed to deliver a minimum throughput, which we expect will generate sufficient revenue to repay Medusa Spar LLC’s bank debt. The Medusa Spar LLC financed its acquisition of its 75% interest in the production spar platform using approximately 50% debt and 50% equity from its equity holders. Our maximum exposure to loss from our investment in Medusa Spar LLC is our current carrying value of $44.7 million. Medusa Spar LLC is a variable interest entity. As we are not the primary beneficiary under FIN 46, we are accounting for our investment in Medusa Spar LLC under the equity method of accounting. We recorded $2.5 million and $3.6 million of equity earnings of unconsolidated affiliates from this investment in the three- and six-month periods ended June 30, 2004, respectively.
Our prepaid expenses and other current assets consisted of the following:
Spare parts for remotely operated vehicles
Inventories, primarily raw materials
Deferred taxes
Total
Inventory is stated at the lower of cost or market. We determine cost using the weighted average method.
Our long-term debt consisted of the following:
6.72% Senior Notes
Revolving credit facility
Software vendor financing
Long-term Debt
Less: current portion
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Scheduled maturities of our long-term debt as of June 30, 2004 were as follows:
Software
Vendor
Financing
Remainder of 2004
2005
2006
2007
2008
Thereafter
Maturities through June 30, 2005 are not classified as current as of June 30, 2004, since we can extend the maturity by reborrowing under the revolving credit facility with a maturity date after one year.
Our shareholders’ equity consisted of the following:
Common Stock, par value $0.25; 90,000,000 shares authorized; 25,076,229 and 24,813,289 shares issued
Additional paid-in capital
Treasury stock; zero and 429,545 shares, at cost
Retained earnings
Other comprehensive income
Total shareholders’ equity
During interim periods, we provide for income taxes at our estimated annual effective tax rate, using assumptions as to (1) earnings and other factors that would affect the tax calculation for the remainder of the year and (2) the operations of foreign branches and subsidiaries that are subject to local income and withholding taxes.
We paid cash taxes of $11.3 million and $9.7 million for the six months ended June 30, 2004 and 2003, respectively.
We supply a comprehensive range of technical services and specialty products to customers in a variety of industries. Our Oil and Gas business consists of five business segments: Remotely Operated Vehicles (“ROVs”); Subsea Products; Subsea Projects; Mobile Offshore Production Systems; and Inspection. Our Advanced Technologies business is a separate segment that provides project management, engineering services and equipment for applications outside the oil and gas industry. Unallocated expenses are those not associated with a specific business segment. These consist of expenses related to our incentive and deferred compensation plans, including restricted stock and bonuses, as well as other general expenses.
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There are no differences in the basis of segmentation or in the basis of measurement of segment profit or loss from those used in our consolidated financial statements for the year ended December 31, 2003. The following summarizes certain financial data by business segment:
Mar. 31,
Oil and Gas
ROVs
Subsea Products
Subsea Projects
Mobile Offshore Production Systems
Inspection
Total Oil and Gas
Advanced Technologies
Gross Margin
Unallocated Expenses
Operating Income
In February 2004, we acquired the drill support ROV business of Stolt Offshore S.A. for approximately $50 million (see note 8). All of the assets that we acquired are included in our ROV segment.
Comprehensive income is the total of net income and all nonowner changes in equity. The amounts of comprehensive income for the three- and six-month periods ended June 30, 2004 and 2003 are as follows:
Net Income per Consolidated Statements of Income
Foreign Currency Translation Gains
Change in Fair Value of Interest Rate Hedge
Change in Minimum Pension Liability Adjustment
Comprehensive Income
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Amounts comprising other elements of comprehensive income in Shareholders’ Equity are as follows:
Accumulated Net Foreign Currency Translation Adjustments
Minimum Pension Liability Adjustment
In February 2004, we acquired the drill support ROV business of Stolt Offshore S.A. for approximately $50 million. This business acquisition is being accounted for using the purchase method of accounting, with the purchase price being allocated to the assets and liabilities acquired based on their fair market values at the date of acquisition. We have made the purchase price allocation based on information currently available to us and the allocation is subject to change when we obtain final asset and liability valuations. The acquisition was not material. As a result, we have not included pro forma information in this report. The results of the business acquired are included in our consolidated statement of income from the date of the acquisition.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
All statements in this quarterly report on Form 10-Q, other than statements of historical facts, including, without limitation, statements 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. These forward-looking statements are subject to various risks, uncertainties and assumptions, including those we have referred to under the headings “Business — Risks and Insurance” and “Cautionary Statement Concerning Forward-Looking Statements” in Part I of our annual report on Form 10-K for the year ended December 31, 2003. 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.
This section 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, 2003.
Executive Overview
We generate over 80% of our revenue from our services and products provided to the oil and gas industry. In 2003, we operated in what we considered to be a difficult market for oilfield services and products in general. These same market conditions persisted through the first quarter of 2004 and improved in the second quarter. The first quarter of 2004 included a $1.8 million pre-tax expense for a terminated acquisition effort in our unallocated expenses.
Compared to the first quarter of 2004, we experienced an increase in earnings from higher umbilical and specialty products demand within our Subsea Products business and seasonal increases from our Inspection and Subsea Projects segments. With the acquisition of the drill support ROV business of Stolt Offshore S.A. in February 2004, we have achieved improved ROV results. For the remainder of the year, we expect continued improvement in our Subsea Products segment during both the third and fourth quarters, and a slight seasonal decrease in our Inspection results in the fourth quarter.
Critical Accounting Policies and Estimates
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, 2003 under the heading “Critical Accounting Policies and Estimates” in Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operation.
Liquidity and Capital Resources
We consider our liquidity and capital resources adequate to support our operations and capital commitments. At June 30, 2004, we had working capital of $113 million, including $15 million of cash and cash equivalents. Additionally, we had $189 million of borrowing capacity available under our revolving credit facility.
Our capital expenditures were $85 million during the six months ended June 30, 2004, as compared to $64 million during the corresponding period of last year. Capital expenditures in the current year consisted mainly of the acquisition of the drill support ROV business of Stolt Offshore S.A. and expenditures related to our new umbilical facility in Panama City, Florida. Prior-year capital expenditures consisted primarily of the acquisition of OIS International Inspection plc, Nauticos Corporation and Reflange, Inc.
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We had no material commitments for capital expenditures at June 30, 2004.
At June 30, 2004, we had long-term debt of $163 million and a 29% debt-to-total capitalization ratio. We have $100 million of Senior Notes outstanding, to be repaid from 2006 through 2010. We have a $250 million revolving credit facility that expires 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 six-month period ended June 30, 2004, our cash and cash equivalents decreased $3 million. We generated $26 million in cash from operating activities, used $85 million of cash in investing activities and obtained $56 million of cash from financing activities. The cash used in investing activities was used primarily for the acquisition of the drill support ROV business of Stolt Offshore S.A., and the cash obtained from financing activities was used, along with the cash provided by operating activities, to pay for the capital expenditures and to finance an increase in working capital of $21 million. Much of the increase in working capital was from accounts receivable associated with increased ROV revenue associated with the ROVs acquired from Stolt and the seasonal Inspection and Subsea Projects revenue increases during the second quarter.
Results of Operations
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:
Operating margin
Gross margin %
Operating margin %
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 November compared to the rest of the year. Revenues in our Mobile Offshore Production Systems, Subsea Products and Advanced Technologies segments are generally not seasonal.
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The table below sets forth our revenues and gross margins for our Oil and Gas business for the periods indicated.
Work class utilization %
Our ROV segment gross margins reflect the utilization percentages of the respective periods and increased volume from the acquisition of 34 ROVs from Stolt Offshore S.A. in February 2004. As a result of increased construction support work, which began during the latter half of 2003 and carried through the first half of 2004, the average revenue and gross margin per day of ROV utilization was higher than the corresponding period in 2003 and that of the preceding quarter.
During the quarter ended June 30, 2004, our Subsea Products revenues and gross margins increased from the corresponding quarter of the prior year and the preceding quarter. The three-month period ended June 30, 2003 was positively impacted by $1.3 million due to the successful completion of a project at a lower cost than previously estimated. Our outlook for the Subsea Products segment is highly positive based on the projected growth in subsea wellhead completions and the level of bid activity we are experiencing. Our Subsea Products backlog increased from $41 million at March 31, 2004 to $60 million at June 30, 2004. We anticipate this segment’s results will be higher in the second half of 2004 as compared to the first half and in 2004 in total as compared to 2003. Our steel tube cabling machine in Brazil is now operational, and we expect our Panama City, Florida facility, with steel tube capability, to be operational during the fourth quarter of 2004.
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For our Subsea Projects segment, we experienced a seasonal increase compared to the preceding quarter. Our margins were slightly above those achieved in the corresponding quarter of 2003. The first half of 2003 included reductions in cost estimates totaling $1.9 million. We adjusted the cost estimates due to the favorable completion of an installation project and the settlement of a personal injury claim. We believe that for 2004 our Subsea Projects segment results will be slightly below those achieved in 2003.
Our Mobile Offshore Production Systems gross margins were flat for all periods presented, as our three main assets were working under the same contracts as in 2003. On a gross margin percentage basis, the periods of 2004 were lower than the other periods presented because 2004 revenue was higher as a result of low-margin project engineering work. We expect margins to continue at about the same levels through 2004.
Compared to the corresponding periods of 2003, our Inspection revenues and gross margins increased as a result of our efforts to secure higher value-added work, specifically by eliminating small revenue projects and securing more profitable fabrication yard and pipeline inspections, and the favorable resolution of previously-disputed receivables. Our margins were negatively impacted by the continuing restructuring costs following our acquisition of OIS International Inspection plc in January 2003.
Revenue and gross margin information is as follows:
Ended
Gross margins
Advanced Technologies revenues were higher and margin percentages were flat in the periods presented from additional work for the U.S. Navy and space-related products and services associated with the next Space Shuttle launch. We anticipate quarterly results for the rest of 2004 to be similar to those achieved in the first three months.
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 restricted stock expense varies with the market price of our common stock. Our unallocated expenses within operating income consist of those within gross margin plus general and administrative expenses related to corporate functions. The table below sets out our unallocated expenses for the periods indicated.
Gross margin expenses
% of revenue
Operating expenses
Unallocated operating expenses in the six months ended June 30, 2004 and the three months ended March 31, 2004 include the expensing of $1.8 million of accumulated transaction costs related to a terminated acquisition effort.
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The table below 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:
Medusa Spar LLC
Smit-Oceaneering Cable Systems, L.L.C.
Pro-Dive Oceaneering Co.
In December 2003, we acquired 50% of 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 surrounding dedicated blocks. The increase in earnings of Medusa Spar LLC resulted from a full quarter of production in the first quarter of 2004 and the addition of two wells put into production during the second quarter.
We own 50% of Smit-Oceaneering Cable Systems, L.L.C., which is a telecommunications cable laying and maintenance venture. Due to the current condition of the telecommunications market, the venture is currently inactive and the single vessel owned by the venture is being marketed for oilfield and other uses.
We own 49% of Pro-Dive Oceaneering Co., a venture that operates our ROVs in Canada.
Interest expense for the three- and six-month periods ended June 30, 2004 increased compared to the corresponding period in the prior year due to higher debt levels. Our debt had been incurred to fund business acquisitions, including the ROV drill support business of Stolt Offshore S.A. in 2004 and OIS International Inspection plc in 2003, additional equipment, including the Ocean Legend, and expansion of our Subsea Products production capacity. We capitalized $45,000 of interest during the three- and six-month periods ended June 30, 2004. We did not capitalize any interest during 2003.
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 2004 to be 35%.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
We are currently exposed to certain market risks arising from transactions we have entered into in the normal course of business. These risks relate to interest rate changes and fluctuations in foreign exchange rates. We do not believe these risks are material. We have not entered into any market risk-sensitive instruments for trading purposes. We manage our exposure to interest rate changes through the use of a combination of fixed and floating rate debt. See note 3 of notes to the consolidated financial statements contained in this report and note 3 of notes to consolidated financial statements contained in our annual report on Form 10-K for the year ended December 31, 2003 for a description of our long-term debt agreements, interest rates and maturities. We believe that significant interest rate changes will not have a material near-term impact on our future earnings or cash flows. 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 many 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.
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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 a $1.4 million adjustment to our equity accounts for the three-month period ended March 31, 2004 to reflect the net impact of the weakening of the U.S. dollar against various foreign currencies for locations where the functional currency is not the U.S. dollar. Subsequently, the dollar strengthened and the net effect for the six-month period ended June 30, 2004 was minimal.
Our Subsea Products business in Brazil conducts much of its operations in U.S. dollars, which is its functional currency. We recorded $1.9 million of foreign currency losses in our consolidated statement of income for 2003 related to our operations in Brazil. Foreign currency losses were $209,000 and $360,000 for the three-month periods ended June 30, 2004 and 2003 and $939,000 and $520,000 for the six-month periods ended June 30, 2004 and 2003, respectively.
Item 4. Controls and Procedures.
In accordance with Exchange Act Rules 13a-15 and 15d-15, 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 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 June 30, 2004 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 June 30, 2004 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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PART II - OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders.
(1)
Election of Class III Directors
Nominee
David S. Hooker
Harris J. Pappas
(2)
Ratification of the appointment of Ernst & Young LLP as independent auditors for Oceaneering.
Shares Voted For
Item 6. Exhibits and Reports on Form 8-K.
Registration
or FileNumber
Description
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SIGNATURES
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.
/S/ JOHN R. HUFF
/S/ MARVIN J. MIGURA
/S/ JOHN L. ZACHARY
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Index to Exhibits
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