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Oceaneering International (NYSE:OII)

Q2 2012 Earnings Call

July 26, 2012 11:00 am ET

Executives

Jack Jurkoshek - Director of Investor Relations

M. Kevin McEvoy - Chief Executive Officer, President and Director

Marvin J. Migura - Executive Vice President

Analysts

Jonathan Donnel - Howard Weil Incorporated, Research Division

Brian Uhlmer - Global Hunter Securities, LLC, Research Division

Kurt Hallead - RBC Capital Markets, LLC, Research Division

Edward Muztafago - Societe Generale Cross Asset Research

James D. Crandell - Dahlman Rose & Company, LLC, Research Division

Tom Curran - Wells Fargo Securities, LLC, Research Division

Stephen D. Gengaro - Sterne Agee & Leach Inc., Research Division

Darren Gacicia - Guggenheim Securities, LLC, Research Division

John D. Lawrence - Tudor, Pickering, Holt & Co. Securities, Inc., Research Division

Joshua W. Jayne - Simmons & Company International, Research Division

Alan D. Laws - BMO Capital Markets U.S.

Operator

Good morning. My name is Sarah, and I'll be your conference operator today. At this time, I would like to welcome everyone to the 2012 Second Quarter Conference Call. [Operator Instructions] I would now like to turn the call over to Mr. Jack Jurkoshek. You may begin your conference.

Jack Jurkoshek

Good morning, everybody. I would like to thank you for joining us on our 2012 second quarter earnings conference call. As usual, a webcast of this event is being made available through the StreetEvents Network service by Thomson Reuters.

Joining me today are Kevin McEvoy, our President and Chief Executive Officer, who will be leading the call; Marvin Migura, our Executive Vice President; and Cardon Gerner, our Senior Vice President and Chief Financial Officer.

Just as a reminder, remarks we make during the course of the call regarding our earnings guidance, 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.

And I'm now going to turn the call over to Kevin.

M. Kevin McEvoy

Good morning, and thanks for joining the call. I'm happy to be here with you today to review our Q2 results and second half outlook.

Our record second quarter EPS of $0.67 was up 43% over the first quarter of this year, and up 29% compared to the second quarter of 2011. As expected, operating income margin improved sequentially in each of our operating segments. We achieved best-ever quarterly ROV and Asset Integrity in operating income. Year-over-year and sequentially, all of our business segments achieved higher operating income led by ROVs, Subsea Projects and Asset Integrity.

We are well-positioned to participate in the next growth stage of deepwater and subsea completion activity, and our outlook for 2012 remains very positive. We continue to believe we will achieve record results for the year and are narrowing our 2012 EPS guidance range to $2.55 to $2.65. Our previous guidance was $2.45 to $2.65. So the new guidance is up slightly at the midpoint. Compared to the first half, we anticipate achieving higher operating income during the second half of 2012, principally due to the ROV and Subsea Products businesses.

ROV profits are expected to be up on an increasing days on hire in most operating areas, notably in the Gulf of Mexico and off Africa, and a slightly higher operating margin as we benefit from the additional days work and a favorable change in geographic mix. For Subsea Products, we are forecasting profit improvements for each of our major product lines during the second half of the year, led by higher demand for our Subsea Hardware. For the year, we continue to forecast higher operating income for all of our segments relative to 2011.

During the quarter, we purchased 400,000 shares of our common stock at a cost of about $19.4 million. And as announced in April, we increased our regular quarterly cash dividend to $0.18 from $0.15 a share. These actions underscore our confidence in Oceaneering's financial strength and future business prospects.

For 2012, we anticipate generating at least $565 million of EBITDA. Our balance sheet and projected cash flow provide us ample resources to invest in Oceaneering's growth, and we intend to do so.

We are raising our 2012 CapEx range estimate, excluding acquisitions, by $75 million, $50 million of which is for additional ROVs. Our total year estimate is now $275 million to $300 million. Of this amount, $175 million is anticipated to be spent on adding systems to our ROV fleet and vehicle upgrades, and $90 million is for enhancing our Subsea Products' capabilities. Our focus in 2012 continues to be on earnings growth and investment opportunities, both organically and through acquisitions.

I'd now like to review our second quarter oilfield segment results. Year-over-year and sequentially, ROV operating income increased on higher demand for both drilling and vessel-based support services. The 13% year-over-year improvement in ROV days on hire was on the strength of higher demand in the Gulf of Mexico and off Africa. Sequentially, the 7% increase in days on hire was primarily due to increased demand in the Gulf of Mexico.

Our fleet utilization rate during the quarter was 81%, up from 76% in the second quarter of 2011 and up from 79% in the first quarter of 2012. We continue to expect that our fleet utilization for the year will be 80% or more compared to 77% in 2011.

Operating margin during the quarter was 31%, the same as the year ago and up from 29% last quarter. We continue to anticipate our ROV operating margin for this year will be slightly higher than the 30% we achieved in 2011.

During the quarter, we put 13 new ROVs into service and retired 3. At the end of June, we had 280 systems available for operation, up from 262 a year ago. Seven of the new ROVs went into drill support service and 6 went to work on board vessels. Our fleet mix during the quarter was 75% in drill support and 25% on vessel-based work, the same as in the second quarter of 2011 compared to 78% and 22% last quarter.

We now anticipate adding 25 to 30 vehicles to our ROV fleet in 2012, 7 to 12 during the remaining half of the year. During the first half of the year, we retired 5 vehicles and currently do not expect to retire anymore during the rest of the year.

Now turning to Subsea Products. Year-over-year and sequentially, second quarter operating income rose on the strength of increased revenue and profitability from tooling. Products operating margin of 19% for the quarter was the same as the second quarter of 2011, and up from 17% last quarter. For the year 2012, we now anticipate that Subsea Products margin will be comparable to what we achieved in 2011. We continue to expect a record segment operating income for the year.

Our Subsea Products backlog at quarter end was $621 million, up from $402 million at the end of March and $405 million a year ago. Sequentially and year-over-year, the substantial backlog increase was attributable to 2 large Petrobras available contracts we secured during the quarter that added over $190 million for our products' backlog.

Subsea Projects operating income was higher year-over-year and sequentially due to the field support vessel service contract with BP offshore Angola.

Asset Integrity operating income improved year-over-year and sequentially on higher service sales in all of our major geographic areas we serve, most notably in Norway due to the acquisition we made in late 2011. As anticipated, this segment's margin returns to its historical double-digit range, and we expect it to remain there in the remaining quarters of this year.

In summary, our second quarter results were up significantly both sequentially and year-over-year, and we look forward to realizing another year of record EPS performance in 2012. Our focus on providing products and services for deepwater and subsea completions positions us to participate in a major secular growth trend in the oilfield services and products industry. We were pleased with our cash flow generation result of $149 million of EBITDA during the quarter. Capital expenditures for the quarter totaled $68 million, of which $43 million was invested in ROVs.

Now looking to the third quarter, we are projecting EPS in the range of $0.75 to $0.80. We expect our third quarter EPS to be up year-over-year on operating income improvements from ROVs, Subsea Products and Asset Integrity. I would like to remind everyone that last year's third quarter results benefited from an $18.3 million pretax gain on the sale of a mobile offshore production system reported in Subsea Projects and the recognition of $4.9 million of tax benefits principally related to prior years.

Sequentially, we anticipate quarterly operating income improvements from our ROV and Subsea Products segments: ROVs, due to an increase in days on hire in most operating areas, notably in the Gulf of Mexico and off Africa, and a slightly higher operating margin as we benefit from the additional days worked due to a larger fleet size and a favorable change in geographic mix; and for Subsea Products, on higher profit contribution from each of our major product categories, led by Subsea Hardware and tooling.

Looking beyond 2012, we remain convinced that our strategy to focus on providing services and products to facilitate deepwater exploration and production remains sound. We believe the oil and gas industry will continue to invest in deepwater as it remains one of the best frontiers for adding large hydrocarbon reserves, with high production flow rates at relatively low finding and development cost. A late 2011 industry report forecast total annual worldwide exploration and development spending to grow nearly 50% by 2015, while capital expenditures on deepwater projects are projected to more than double. Therefore, we anticipate demand for our deepwater services and products will continue to rise and believe our business prospects for the next several years are promising.

At the end of the quarter, there were a total of 92 new floating rigs on order. 57 of these rigs are not contracted to work for Petrobras in Brazil, and we expect all of them to go to work for other operators. On these 57 rigs, 11 ROV contracts have been let and we have won 10 of them, leaving 46 ROV contracting opportunities left to be pursued outside of Petrobras in Brazil.

At the end of June, 94 of the 136 existing high-spec drilling rigs, consisting of dynamically positioned fifth- and sixth-generation semis and drill ships, were not contracted to Petrobras in Brazil. We had ROV contracts on 69 of these for a market share of 73%. If all 57 of the non-Petrobras rigs I mentioned are placed into service, this fleet of 94 will grow 61% to 151 rigs. So the visibility of the secular growth outlook for this market remains very promising. And looking forward, we see no reason why we will not continue to be the dominant provider of ROV services on these rigs.

Each additional floating rig represents an opportunity for us to put another ROV to work in drill support service. As the use of floating rigs grows, we believe it is inevitable that discoveries will eventually drive orders for Subsea Hardware to levels not previously experienced, and demand for ROVs to support vessel-based activities will follow. There is no industry source of information to track vessel-based ROV demand. However, there has been a measurable trend regarding the total size of the ROV fleet with respect to the size of floating rig fleet.

At the end of 2000, the total ROV fleet size as a ratio to floating rigs was 2:1. Since then, the estimated size of the worldwide ROV fleet has doubled, while the size of the floating rig fleet has grown only 50%. Consequently, the ROV fleet size relative to floating rig has risen to a ratio of about 3:1. Given that the number of ROVs to support drilling has remained fairly stable at slightly over 1 per rig, the faster rate of ROV supply growth is by default attributable to the increased use of vessels -- vehicles on vessels.

If the recent trend ratio of 3:1 persists and all 90-plus new floating rigs on order are delivered, future vessel demand for ROVs may grow by more than 180 vehicles. We estimate Oceaneering's market share of the global vessel-based ROV fleet at about 20% and see no reason why we would not at least maintain this share in the future.

Quest Offshore's latest Subsea Hardware forecast for the period 2012 to '16 includes an 80% increase in tree orders over the previous 5 years. In 2012, subsea tree orders are projected to be about 550, an all-time high, eclipsing the previous record of 462 trees in 2006 by about 20%. While we don't make trees, orders for subsea trees drive demand for a substantial amount of ancillary subsea production hardware that we manufacture. For example, Quest is forecasting nearly a 60% increase in umbilical orders for the 5-year period 2012 to '16 compared to the previous 5 years. Furthermore, renewed industry and regulatory emphasis on safe and reliable operations is providing additional opportunities for us to demonstrate our capabilities.

With our existing assets, we are well-positioned to supply a wide range of the services and products required to support the safe deepwater efforts of our customers. We believe Oceaneering's business prospects for the long term remain promising. Our commanding competitive position, technology leadership and strong balance sheet and cash flow enable us to continue to grow the company, and we intend to do so.

In conclusion, our results continue to demonstrate our ability to generate excellent earnings of cash flow. We believe our business strategy is working well over both the short and long term. We like our competitive position in the 2012 oilfield services market and are leveraged through a resumption in the growth of deepwater and subsea completion activity that is currently underway.

The longer-term outlook for our deepwater and subsea service and product offerings remains favorable. Renewed industry and regulatory emphasis on reliable deepwater equipment with redundant safety features has caused our customers to be even more focused on risk reduction. This elevates the importance of the utility and reliability of our ROV services and related product line offerings and reinforces the benefit of our value sell. For 2012, we're anticipating that we will achieve another record year of EPS performance. We think this distinguishes Oceaneering from any other oilfield service companies.

We appreciate everyone's interest in Oceaneering. I'll now be happy to take any questions you may have.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Jon Donnel from Howard Weil.

Jonathan Donnel - Howard Weil Incorporated, Research Division

I have a question regarding the increase in the ROVs you're scheduled to be delivering this year. Is that driven by the fact that you had the 6 that were delivered for vessel use during the second quarter? Or is there additional vessel opportunities here in the second half of the year?

M. Kevin McEvoy

I think it reflects the fact that additional opportunities are coming available that we didn't foresee earlier, and it would be primarily on the vessel-based side, although there are some existing rigs that we're having some success on as well.

Jonathan Donnel - Howard Weil Incorporated, Research Division

Okay. And when these new vehicles are delivered to the vessels, do those come under any sort of term contracts? Or are they still essentially just at the -- sort of the call-out market based on when the vessels are going to be working?

M. Kevin McEvoy

It's a combination. I mean, it's kind of all over the map depending on where it is and who it's for. I really couldn't give a definitive answer on that. It's a combination.

Jonathan Donnel - Howard Weil Incorporated, Research Division

Okay. And then regarding the product segment, obviously, huge order rate this quarter with even excluding the Brazil and Belco [ph]. It looks like you're still pretty close to record levels in bookings. So I was wondering if there had been any mix shift there in terms of maybe some higher demand for the tooling or IWOCS products and services? Or this is still just sort of consistent with what we've been seeing for the last few quarters?

Marvin J. Migura

I think it's the latter, Jon. I think this is consistent, and I think most of it is in umbilicals. I do not foresee right now a different mix than what we saw and what we talked about last quarter.

Jonathan Donnel - Howard Weil Incorporated, Research Division

Okay, and then just the addition of the umbilical is obviously -- the large orders just will obviously flow through as we go through '13 and impact margins that way.

Operator

Your next question comes from the line of Brian Uhlmer from Global Hunter.

Brian Uhlmer - Global Hunter Securities, LLC, Research Division

I just had a couple of quick questions. Number one, with -- on the products order, obviously, a great quarter. If I back up the umbilicals, is getting $200 million just a standard run rate outside of the large orders? Is that something that we can project moving forward? And number two, with the bigger awards, how should we look at modeling our backlog revenues, our backlog for the product segment?

Marvin J. Migura

Yes. I mean, if you look at -- if we can stay flat, then we have -- this quarter, we had $192 million, call it $200 million of revenue. If we didn't have that $190 million, we would have stayed pretty flat at around $400 million. So I would think $200 million of order intake is getting to be pretty good and pretty recurring. And then think on your second question, we really expect the work on the 2 big orders to start in the second half, but predominantly in the fourth quarter.

Brian Uhlmer - Global Hunter Securities, LLC, Research Division

Okay, perfect. So it's sustainable. And as we look out into '13, and obviously, for your guidance, you're roughly flat in Q3 and seasonally down in Q4. Could we think that 2013 would be up versus 2012? Is it too early to tell on the products? I hope I didn't miss that in your guidance.

Marvin J. Migura

No, we're just -- we're not going into '13 yet. But we'll do that next quarter. We're not going to do it a quarter early.

Brian Uhlmer - Global Hunter Securities, LLC, Research Division

Well, I'll call that a semi-question, so I'll ask a 2.5 one here. On the BP project, what percent was that ramped up in the quarter? You worked 100% for the last 2, 3 weeks of the quarter, and how much did that contribute in Q2 and then we're fully ramped up for Q3, and we're not expecting any type of additional vessels or any indications for another option in the third quarter. Is that correct?

M. Kevin McEvoy

Well you kind of asked 2 questions there. I think, first of all, we are seeing the run rate now for that contract. And secondly, we see, at this point in time, no suggestion of any additions there.

Marvin J. Migura

Brian, the job ramped up earlier than what we thought. So no, it's not the last 2 or 3 weeks of the quarter that we hit our run rate. I would say the quarterly run rate's indicative of what we expect. And now, the variability in projects is going to come and depend on how the Gulf of Mexico is doing. And you didn't ask, but that's still a pretty soft market for -- it's stronger than it was a year ago for deepwater vessels, but it's still soft to very soft for the diving market.

Operator

Your next question comes from the line of Kurt Hallead from RBC.

Kurt Hallead - RBC Capital Markets, LLC, Research Division

So I think we all understand that you get a very strong -- a very long runway out in front of you with respect to what's going on in the offshore market and deepwater in particular. So I'm just kind of curious here guys, you've always taken a measured approach to your pricing dynamics, especially in the ROV. And just kind of curious as to given this small run rate for us, whether or not you feel a little bit more confident that you'll be able to push pricing a little bit more than you have in maybe prior cycle periods. Let me start there.

M. Kevin McEvoy

Okay. I'd say that we get asked this question a lot. ROV pricing is pretty sensitive, and we, I think, have done a pretty job of increasing price in order to maintain margin in the face of cost increases that we get around the world in labor and higher-spec equipment, higher CapEx cost. But we do not see any big opportunity to really push pricing to get much higher margins here. There is some ability to do that on the vessel side of the business, on the call-out part, when the market gets tight. And it is improving in that regard as we have been saying in the last couple of quarters here. And so that is a place where there is some opportunity, and that is about it, I think.

Marvin J. Migura

Kurt, I don't think there's an inflection point on the horizon.

Kurt Hallead - RBC Capital Markets, LLC, Research Division

Couldn't be any more clear than that? I appreciate that. On the other comment you made about the 3:1 ratio, I think it's pretty interesting. You said it's a little bit more than 1:1 on the freight front, and obviously, increasing on the vessels. So in that context, I guess I'm just trying to gauge here, we got a good visibility on the number of freights that are coming. How do we get a handle on the number of vessels that are coming? Number one. And number two, I think you gave somewhat of a mixed read here. You said good for deepwater vessels, but not so good for diving. And how did that play into this the 3:1 ratio, whether vessel versus diving.

M. Kevin McEvoy

Okay. Well, the diving comment was strictly a Gulf of Mexico comment, so I'll try and address the 3:1 issue first. I mean, the vessel market is -- there really is no place like a Quest or Petrodata that you can go to track this stuff. And so it's pretty difficult for us to predict that. The only thing that we have tracked over time is, obviously, the number of world-class ROVs in the worldwide fleet. And we know how many rigs there are. And we know that historically, and as we see it currently and moving forward, the average number of ROVs on a rig is one in a very small fraction because there's only a few rigs that would have more than one. So basically, 1 for 1. So that at least starts to give us some idea about how the vessel market is growing, and so that's why we have tried to put that out there. It's the best that we have, and we're -- I can assure you that, that is an important part of the market for us and we track every opportunity that we become aware of. And typically, it's going to be very short turnaround projects or contracts, and so you don't have a long visibility of them like you do with a drilling rig that's under construction. So that is an attempt to try and get a little more clarity around it. And unfortunately, there is no really good way to track that in order to predict how it's coming. However, I think, notionally, if the 3:1 ratio stands, that suggests that there should be some pretty good opportunity growth out there in the marketplace. Going to the diving comment, I mean there's a lot of -- there's confusion, I guess, depending on what you're following about the Gulf of Mexico. Obviously, it has strengthened dramatically on the drilling rig side, and is, by all accounts, set to exceed pre-Macondo levels by a fair margin if everything comes to pass. So that is fine. Everything's happening well there. But as far as the non-drilling rig activity in the Gulf, it's still a bit slow. It is better on the ROV vessel support side of that business, as Marvin said. But on the diving side, it is still very weak. And just generally speaking, utilization is still a little on the weak side, generally, so pricing is not where we would like to see it. But it is improving.

Operator

Your next question comes from the line of Ed Muztafago from Societe Generale.

Edward Muztafago - Societe Generale Cross Asset Research

I just wanted to touch base again on the BP contract. I guess Quest is saying that the second phase of that is likely to be awarded in the second half of this year. And just really wondering, does the current scope of your Block 18 and 31 project include the phase 2? Or does that represent some incremental work opportunities for you all?

M. Kevin McEvoy

I think that really relates to hardware orders, and the contract that we have is supporting both fields with the 2 vessels that are currently operating. There is the option, as we've said, for BP to ask for a third vessel at some time. But at the moment, that is not being considered. We have not had any discussions about that. And I think what they're waiting to see is are 2 vessels enough to be able to service the requirements that they have there going forward and will I need a third one. So there is no second phase, if you will, for us. That really is a hardware issue and...

Edward Muztafago - Societe Generale Cross Asset Research

Okay, that's very helpful. I guess, the -- you also noted the incremental $90 million of CapEx that's going towards the products business. Can you talk to us a little bit about, is that directed in any specific area per se? Whether it's -- I assume it's not umbilicals, but maybe you can give us a little bit more granularity on where that CapEx is going to be directed.

Marvin J. Migura

It is. There is some in umbilicals. And in fact, if I could find my note, about 40% of that incremental investment is being made to increase the capability of our umbilical plants, particularly in Brazil and Scotland. In Brazil, this is to produce and test umbilicals, so there's test equipment being involved, to incorporate higher pressure hoses to serve the pre-salt field developments. And in Scotland, there's an evolving customer need for longer and heavier umbilicals with more elements. So we need some additional storage capacity. So we're talking about capabilities to improve the type of umbilicals that we're building. And then another 35% of that incremental amount or of this year's amount is to support our rental tool operations.

Edward Muztafago - Societe Generale Cross Asset Research

Okay, okay. And so I guess what I'm wondering there on the umbilical side since there is a fair amount of that CapEx directed towards it, are you starting to see a little bit more optimism in the umbilicals business that maybe things may tighten up in that business maybe going into 2013?

M. Kevin McEvoy

I think it really is a capability issue, not a capacity issue. I mean, In Brazil, for example, the pre-salt umbilicals are much larger diameter, a lot heavier. And so we just needed to increase our capability of pulling that stuff through our plant, so to speak. And so it really is to match up with the new cross sections that are being ordered by Petrobras there.

Marvin J. Migura

Yes, there's product capacity increase CapEx.

Edward Muztafago - Societe Generale Cross Asset Research

Yes, yes, that was clear. And that's why I just kind of wanted to vent out what your thoughts were there in terms of where things tightening quicker than maybe you had originally thought. It clearly sounds like this is more directed at very specific usage or type.

Marvin J. Migura

Correct.

Operator

Your next question comes from the line of Jim Crandell from Dahlman Rose.

James D. Crandell - Dahlman Rose & Company, LLC, Research Division

Just as in clarification because I either forgot it or I missed it. But in the project business, how long does the work for BP go offshore Angola?

M. Kevin McEvoy

That, Jim, was a 3-year contract, and it does have options for 2 1-year extensions.

James D. Crandell - Dahlman Rose & Company, LLC, Research Division

Okay. And the visibility and the work for the Ocean Patriot in the Gulf of Mexico, at this point, how far does its work go, and what is the visibility of that vessel?

M. Kevin McEvoy

Well, as we said earlier, the demand in the Gulf for those, for the diving side, the shallower water asset, is pretty weak. And so it is working. Most of our vessels are working. We have reasonable utilization, but pricing is not what it -- what we would like it to be. That's for sure. But the vessel is working. It has been operating pretty consistently since we put it in the field.

Marvin J. Migura

And it's not term work. It is call-out work. So there's not much visibility to any of our Gulf of Mexico vessel utilization.

James D. Crandell - Dahlman Rose & Company, LLC, Research Division

Okay. And then my second question, you're 2 big umbilical orders that you said, are either of those going to be serviced out of your facility on the Gulf Coast?

M. Kevin McEvoy

No. those are booked out of our Niteroi plant in Brazil.

James D. Crandell - Dahlman Rose & Company, LLC, Research Division

Okay. Am I right to think about that business as doing well in all regions except for the Gulf of Mexico where you're suffering from sort of low utilization there?

M. Kevin McEvoy

That would be correct.

James D. Crandell - Dahlman Rose & Company, LLC, Research Division

And how do you see that -- is there any indication that, that can be changing over the next 6 months?

M. Kevin McEvoy

Over the next 6 months, I wouldn't say so. But I think we certainly can see a lot of more increased opportunity with these deepwater developments that are happening in the Gulf of Mexico now. So I think that's a very good sign. There's been a very pretty good lack of that up until now. And so the outlook looks good, but I think it's a late '13, '14 idea. But it look -- it would appear that there are enough projects in line there that, that could be somewhat of a game changer for our plant in the Gulf here.

Operator

Your next question comes from the line of Tom Curran from Wells Fargo.

Tom Curran - Wells Fargo Securities, LLC, Research Division

Subsea Projects in the Gulf of Mexico. Which historical quarter did Q2 come closest to resembling?

Marvin J. Migura

Two. We always say it came pretty close to resembling...

Tom Curran - Wells Fargo Securities, LLC, Research Division

Or you could just tell me -- well, how about prior to 2012? Or if you could just tell me what the year-over-year changes for revenues and EBIT margin for the Gulf of Mexico for Subsea Projects?

Marvin J. Migura

I would have to say that year-over-year, Q2, Gulf of Mexico projects was pretty flat.

Tom Curran - Wells Fargo Securities, LLC, Research Division

Okay. At both the top line and for EBIT margin?

Marvin J. Migura

I won't go there. I'll just talk about the bottom. I'll talk about [indiscernible] result.

Tom Curran - Wells Fargo Securities, LLC, Research Division

Okay, great. And then turning to Subsea Products, given the surge we've had here in Multiflex's backlog as well as the run rate you're expecting going forward, how has margin come in, thus far, relative to what you're expecting? And then the second part for Subsea Products would be if orders were to positively surprise over the next -- over the second half of 2012 for any of the other businesses, which seems the most likely and why?

M. Kevin McEvoy

Well, I guess on the umbilicals side there, I mean margins are as expected. I mean, capacity is still pretty huge out there, and so margins aren't really changing much in that regard. So really, it is a volume throughput business at the moment. And obviously, with these orders and with the backlog that we've been tracking there, it has been better. In terms of increases, tooling is really where we see the opportunities for the second half of the year.

Marvin J. Migura

If there were orders to surprise.

M. Kevin McEvoy

Yes, if there were to surprise.

Tom Curran - Wells Fargo Securities, LLC, Research Division

And would that most likely be BOP-related, a continuation of the secular uptrend in safety and redundancy-related spending we see post-Macondo or somewhere else?

Marvin J. Migura

It's pretty broad-based.

Tom Curran - Wells Fargo Securities, LLC, Research Division

Okay. And then I'm just going to cheat and squeeze one more in here. For Asset Integrity, what's the expectation going forward in terms of the EBIT margin run rate? And should we still see seasonality there?

M. Kevin McEvoy

We do expect that there will always be seasonality there. We expect the run rates in terms of margin percentages to be more consistent with our historical results.

Marvin J. Migura

Yes. So historically, Q2 and Q3 are close. And in Q4, soft. And Q1 is the weak quarter and the seasonal weakness. So I would expect within 100 basis points, that could be the case.

Tom Curran - Wells Fargo Securities, LLC, Research Division

A similar pattern going forward in 100 basis points.

M. Kevin McEvoy

Yes.

Operator

Your next question comes from the line of Stephen Gengaro from Sterne Agee.

Stephen D. Gengaro - Sterne Agee & Leach Inc., Research Division

Just as a follow-up, on the Subsea Projects side, given the vessel utilization for BP, how should we think about those margins? I mean, should they remain pretty healthy around these levels given the high levels of utilization? Because this is obviously a big step change here. But how should we sort of think about that going forward?

Marvin J. Migura

For -- I'm sorry, projects, right?

Stephen D. Gengaro - Sterne Agee & Leach Inc., Research Division

Yes, exactly right. For projects.

Marvin J. Migura

I think we're going to see the same seasonality that we always have seen in project margins. And I mean, I think the project margins for Q2 were a little better than what we expected, and it's just going to depend upon the level of activity in the Gulf of Mexico to see if that's sustainable. I think the run rate for BP Angola will be steady. But as we talk to a lot, there's not much visibility in the Gulf of Mexico. So I expect there to be a considerable amount of variability to our margins, depending upon vessel utilization. And right now, we said diving is weak and ROV's vessel-based activity in the Gulf is okay, but nothing to write home about. I hope that helps. We're not going to give -- I can't get more specific than that because as everybody knows, this is our first year with Angola, so we're learning as we go.

Stephen D. Gengaro - Sterne Agee & Leach Inc., Research Division

Okay. And as you talked about the big sequential rise, first quarter, second quarter, is that -- that's BP Angola, but that's some just seasonality in the Gulf as well there?

Marvin J. Migura

Absolutely, Stephen. Yes. I mean that -- and again, the activity came early so...

M. Kevin McEvoy

In Angola.

Marvin J. Migura

In Angola.

Operator

Your next question comes from the line of Darren Gacicia from Guggenheim.

Darren Gacicia - Guggenheim Securities, LLC, Research Division

I wanted to ask you first, when I'm looking at Subsea products, obviously, umbilicals are flowing through. Is there any way you can give some kind of color on sort of what -- how sort of umbilical margins play through versus other products and kind of what the mix of other products is within the other elements to that? And what the mix is in the overall with kind of other products and umbilicals? Just to kind of get a sense on how that may progress as those large products start to flow through?

M. Kevin McEvoy

Well, we really don't give that granularity. I mean, we have said that umbilicals have a lower margin than the other product businesses in general. And so that mix really does determine what the margin is. But beyond that, we don't really get into that detail.

Darren Gacicia - Guggenheim Securities, LLC, Research Division

Sure. Is there any way to kind of get a sense of how the new umbilical awards will actually flow through numbers over the next -- how should we look at them kind of flowing through over the next handful of several quarters?

M. Kevin McEvoy

Well, nothing -- I mean, not much is going to flow through in this year. I mean, very little amount, which will probably be indiscernible from the external world. So those are primarily played out over the next -- through '13, '14, and some into '15.

Marvin J. Migura

I think we do expect more umbilicals, particularly out of Brazil, in Q4. And -- but I mean, just as a -- what we'll do is annually we will disclose, continue to disclose, what percent umbilicals were of the prior year. And then as Kevin said, umbilicals, because of the high input cost of the steel tubes that we incorporate into our umbilicals, have the lowest margins. And then the other ones, you could go with IWOCS as being probably the most profitable followed by tooling and then Subsea Hardware. And the mix doesn't vary that much, but it's -- with the increased throughput of umbilicals, which is the lowest margin percentage, then you have some -- that's why we're always saying that we expected, with increased throughput, umbilicals to drive down our margin year-over-year for 2012 over '11. This quarter, we said it's going to be comparable. So we did increase our expectations for profitability of products marginally.

Darren Gacicia - Guggenheim Securities, LLC, Research Division

Got it. And so if I'm -- so as I think about the mix and I think about IWOCS, for instance, if you have an increase in drilling activity, especially in the Gulf of Mexico, on what kind of timing lag should that increase the IWOCS portion of the mix?

Marvin J. Migura

It's extremely difficult to gauge because it really depends upon when they start completing, how they complete it, whether it's -- right now, the deepwater is totally driven by majors, and they have a different outlook on how they do that compared to independent. So that is the lead lag factor of products versus drilling is very difficult to forecast or imagine.

Darren Gacicia - Guggenheim Securities, LLC, Research Division

With kind of hand on the rail, would you say it's probably in the uptick or kind of a net flat for '13?

Marvin J. Migura

Flat for our outlook. We don't comment on '13. But it's flat for the last half of the year.

Operator

Your next question comes from the line of John Lawrence from Tudor, Pickering, Holt.

John D. Lawrence - Tudor, Pickering, Holt & Co. Securities, Inc., Research Division

Kevin, in the past, you've said some positive comments on Australia. Will this be a meaningful market for you for you over time? Or is it just too early to tell down there?

M. Kevin McEvoy

We believe it's going to be a meaningful market over time. I mean, it is evolving, obviously, and there are -- and there's a lot of big project work right now. It takes a long time to -- for that to get executed. The real opportunities for us are on the hardware side, and hopefully, on the intervention side once all the stuff is installed and has been operating. So we're still very positive on Australia. And -- but you're right, it is going to be an over time kind of development.

John D. Lawrence - Tudor, Pickering, Holt & Co. Securities, Inc., Research Division

Okay. And are there more acquisition targets down there? Or is it just organic growth going forward?

Marvin J. Migura

We're not going to comment on acquisitions in any specific area, likely or not. What we will say is that our focus is on organic growth and geographical expansion.

M. Kevin McEvoy

And historically, that is where the bulk of our growth has come. Last year, if anything, was a bit of an anomaly in that regard. But historically, virtually, all of our growth has come from just organic growth.

Operator

Your next question comes from the line of Joshua Jayne from Simmons and Company.

Joshua W. Jayne - Simmons & Company International, Research Division

Just one quick one on the ROV side, drill-support. Could you update us on your Gulf of Mexico outlook, how many ROVs you had on the rigs working today, and then on the rigs to be delivered at the balance of the year?

Marvin J. Migura

Sure. We didn't think anybody was going to ask that. We were kind of wondering. We got so many variations, so okay here we go.

M. Kevin McEvoy

Okay, at the time of our last earnings call, we were on 31 of 32 rigs under contract in the Gulf of Mexico. As of yesterday, there were 34 of rigs under contract in the Gulf, and we had ROV contracts on 31 of them. Just by comparison, we had ROVs on 31 of the 36 rigs that were under contract in the Gulf pre-Macondo.

Marvin J. Migura

So 3 more rigs came in, and we did not have ROVs on those 3.

M. Kevin McEvoy

A little more there. There's 5 known additional rigs firmly scheduled to come in to the Gulf by the year end, 2 are new rigs and 3 are existing, and we have ROV contracts on 4 of them. So by the year end, if all happens as scheduled, we anticipate that there's going to be 39 rigs working in the Gulf, and we expect to have ROVs on 35 of them.

Operator

Your next question comes from the line of Alan Laws from BMO Capital Markets.

Alan D. Laws - BMO Capital Markets U.S.

I got just a couple of follow-ups here. You just sort of mentioned that last year was sort of an anomaly for you in the acquisition front, and that you were able to close on a few. Could you maybe talk a little bit about what your pipeline or opportunity set looks like for additional M&A? You've always been pretty good at adding earnings power through this even if it's just a small number.

Marvin J. Migura

Nothing's really changed in the pipeline. I think what makes it why it was an anomaly is because we are able to find one that we thought fit our niche market strategy, and we invested $230 million in one deal. It's still the case that we keep looking for companies that meet our niche strategy and kind of fall under our umbrella. And right now, if anybody has anything that has a word subsea in it or can imagine as being subsea is it's pretty much hoarding it. So the opportunity set isn't anything that we can say, well, we've got x number, or the -- we don't have a hole in our arsenal that says, "We'd really like to have this product, and we're going to go out and get it for strategic reasons." So we continue to be opportunistic, and we're looking. But we're not going to comment on it any further. It's just not a lot of acquisitions that we're interested in that meet those criteria and are accretive.

Alan D. Laws - BMO Capital Markets U.S.

All right, great. Another follow-up here on the margins and products. You seem like in a good mood, so any of you will answer this. But what was the magnitude of the difference in margins between umbilicals and tooling? Since you won't give us the exact, what I'm sure was, is there, I guess, a 50% more, 20% more?

Marvin J. Migura

We're not in that good of a mood. But we really don't want to go to subsegment. I mean it truly is -- all of these things end up fitting together in the greater scheme of things, and it really is better to look at products as of segments, as opposed to trying to dissect into each product line.

Operator

[Operator Instructions] And your next question comes from the line of Ed Muztafago from Societe Generale.

Edward Muztafago - Societe Generale Cross Asset Research

Just had a couple of quick follow-up questions if you don't mind. Can you maybe help us understand a little bit better how the umbilical or big umbilical awards ship to P&L? Can you tell us, did those ship on like a completed contract? Or is that more of a unit completion type basis that you shipped the umbilical dock?

Marvin J. Migura

It's a percentage of completion accounting. So it depends upon the cost and the physical flow. It's not on a shipment basis.

Edward Muztafago - Societe Generale Cross Asset Research

Okay. So presumably, these don't cause a lot of margin volatility from one quarter to the next. It's somewhat smoothed out over a longer period. I guess the...

Marvin J. Migura

Presumably, yes, unless something doesn't go the way we expect, yes.

Edward Muztafago - Societe Generale Cross Asset Research

That's fair. And then just when you guys sort of look back over the history of your business for vessel-based work, does the strength or weaknesses of the lease sales, in particular, the shallow water, tend to be a good sort of proxy as to where that business may be, let's call it 12, 24 months down the road?

Marvin J. Migura

Not really. I mean, much longer term, obviously, healthy lease sales are good for the industry. And eventually, something's going to come off it. But typically, by the time somebody goes and drills a prospect and then has a discovery and then does something about it, I mean, several years are going by there.

Edward Muztafago - Societe Generale Cross Asset Research

Yes, yes. Very long lead time, I understand.

Marvin J. Migura

Yes.

Operator

And there are no further questions in queue.

M. Kevin McEvoy

All right. Thank you very much.

Marvin J. Migura

Take care.

Operator

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

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