NPK International Inc (NPKI) 2003 Q4 法說會逐字稿

Good morning and thank you for joining the Newpark conference call this morning.

With us today are Mr. Jim Cole, Newpark's Chairman and CEO, and Mr. Matt Hardey, Newpark's CFO.

I would like to remind all parties that you will be on listen-only until the question and answer segment and now I'd like to introduce your first speaker, Mr. Hardey, you may begin.

Thank you very much.

Good morning.

And on behalf of the Newpark team, welcome to our fourth quarter and fiscal 2003 earnings conference call.

Please be aware that certain of our comments today will constitute forward-looking statements within the meaning of section 27-A of the 1933 Securities Act.

We ask that you review the press release disclaimer for reference to those portions of our recent public filings that disclose the risk factors and uncertainties that affect the company and the markets that we serve.

As you all know, we posted results last night in line with our preannouncement of several weeks ago.

I have to think back quite a long ways to come up with a year where I feel like we put in more effort for less result and promise you that everyone here is happy to be looking at 2003 in our rear view mirror, at last.

We began working back in 1997 to diversify Newpark's revenue base, both from a product and a geographic perspective.

Over the ensuing six years, we've developed new sources of revenue.

Those outside the Company's traditional Gulf Coast market and new products that were not part of the mix in 1997.

These nontraditional sources of revenue have grown to 45% in the 2003 total from about 3% in 1997.

When we began that effort, none of us could have foreseen the weakness that has plagued the Gulf Coast market, with the exception of a brief period in 2001, since 1988.

In a few minutes, Jim will discuss with you some of those details, much of which you will find in the updated investor presentation on our web site.

It contains various charts and graphs that may be of use in your understanding Newpark's progress in that area.

Historically, 1997 saw peak levels of Gulf Coast land market activity at 2001 peak offshore activity.

We do not expect to revisit those activity levels, at least in terms of the number of rigs working.

Since that time, since 1997, we constantly talk about the trend toward deeper drilling and this trend is continuing in our Gulf Coast business mix and should continue to do so.

We expect that larger projects become more the norm rather than the exception.

But certainly there will be fewer projects in total.

Jim will have more to say about that direction and the individual markets we serve in his comments.

To briefly review some of the numbers, we reported a fourth quarter loss of 4 cents a share on revenue of $95 million in the fourth quarter with a majority of that loss resulting from items that we view as out of the ordinary, including, among other things, an unusually high effective tax rate in the period.

That brought the full year earnings down to a penny on 373 million in revenue.

EBITDA on that revenue total was $41 million, practically unchanged from the level of 2002.

Capital expenditures in the year just finished were slightly over 22 million, just above our depreciation and amortization of 21.3 million.

The working capital net of restricted cash on the balance sheet increased by less than 10 million year-over-year, concentrated in changes in inventory, about half of which will be permanent related to our Bayright inventory.

This was offset in part by a 13 day reduction in days outstanding of accounts receivable affected by year-end.

And we believe that there's room for some further improvement in that and we will continuing to focus on that in 2004.

Bank borrowings at year-end were 52.5 million, including, as referenced in the release, $8 million borrowed to fund a restricted cash account that secured a letter of credit at the end of the period.

With the new credit facility in place, that transaction will be unwound shortly and borrowings reduced by the $8 million.

As you saw in the release, we've entered into an $85 million three year credit facility that we believe is well suited to our needs and should reduce our effective interest cost by about 1% during 2004.

The second benefit of avoiding in the future any significant financial ratio issues that, as you may recall, had become troublesome in both 2002 and 2003.

One final note related to the number.

Through this period we've been including revenue from environmental services projects in Canada within our drilling fluids segment.

In mid-2003, the management reporting for that unit was moved to the environmental services segment to facilitate better transfer of technology and ideas across those markets.

We'll be conforming our financial reporting as of January 1, 2004 to reflect that functional change.

The change as respects 2003 would have been about $11 million in revenue and about $1 million in operating profit moving from drilling fluids over to environmental.

And similar amounts in prior periods.

Those of you who need that data for you models, if you will just drop me an e-mail, I have an analysis of it I will be glad to forward that to you.

And with those details attended to, Jim will now walk you through the operations of the company.

Thanks, Matt.

I believe that 2004 will begin to show the work effort that's gone on for the last few years as we realigned the Company and products and in geographic markets.

And as he pointed out that we've gone from an almost exclusive Gulf Coast business with two business lines to three principal business segments and almost equal revenue balance between the traditional market and the new markets.

Over the past six years, we have introduced a number of products.

The most noteworthy are the high-performance water-based fluids, DeepDrill, FlexDrill and FlexDrill is simply the same ingredients a DeepDrill have, but only added in increments as needed rather than as a total mix.

We've also introduced the Dura-Base matting over the last several years and we've also expanded drilling fluids further off this Gulf Coast base.

In 2003, 45% of our revenues were in the non-Gulf Coast non-oilfield markets, which are the new markets.

The good news is we've had success entering key markets.

And as Matt pointed out earlier, the bad news is the Gulf Coast market has been in a slump the last number of years and basically think that it's going into a whole different way of business and most people in the industry and the analysts fully recognize that change.

But we are very optimistic about that because of the size of the project versus the number.

Let me give you a quick summary of 2003 in those key markets.

In the Gulf Coast market, and these are the key markets, they won't quite add up to 100% because we have some small items, but these are the three key business segments.

Our revenues were 190 million, operating income of 6 or 3% in our traditional Gulf Coast market.

I would say that that would rank on the very low, as performance in that market, and we'll talk about what we think is coming in 2004 for that market in the moment.

The non-Gulf Coast markets did 168 million and made $19 million operating income or 11%.

That's not a high-achieving but it's certainly much stronger.

We believe that both should improve strongly in 2004.

In the Gulf Coast, that 190 million should increase by at least 30% this year.

Now, we do not expect activity to grow 30%, if we said that, I think most people would hang up right now and I probably would hang up with you.

In fact, the activity level through the first almost two months of the year, is down slightly, one 1 or 2%, from last year's levels at the same time.

But the projects are getting better.

On that 30% increase, and I'm going to come back and tell you why we believe that's a possibility, we should achieve at least a 40% operating margin.

That's off of last year's base of 190 million and an operating income of 6.

The non Gulf Coast market should be up at least 20% and carry a similar operating margin because over the last few years we've put a lot of investment in those markets and we had the start-up costs and investment costs have been made so we should see at least a 40% operating leverage in those markets.

Across the Company, we should see good operating leverage this year, investments have been made and it's time now to begin to bring the results of this company back on a positive basis.

Let me talk quickly about the three segments.

The first I will discuss is drilling fluids and if you adjust the environmental business out, which we have now realigned with the environmental out of fluids, it was nurtured and built in drilling fluids, particularly in Canada and in the Rocky Mountain area.

The 231as reported in the (inaudible) segment would be $216 million, after that re-organized revenue.

We believe that fluids this year can grow approximately 30%.

In revenue off of that base.

And that that base ought to bring with it about a 30% operating leverage, which has been standard for that market.

Now, the key to this business is not chasing rigs, it's chasing technology with our high-performance water-based fluids and as we've been working on that over the last four to five years, I think we will begin to see the results.

In 2003, as a point, we work for 70 customers with that technology on 250 wells.

We have historically, as you prove a product, you get the one off.

The one off is in reference to you do a well, everybody studies it and then you wait.

But as you develop that, the result is that going into this year we have 22 companies now that we have contracts or prime relationships.

That's more than two times that we had the year before.

That's double.

And of those 22, 16 of those are in the Gulf Coast.

And generally when you're using this type of technology, there are better wells.

And so this should be, and must be, this year, our largest growth market and we think that growth in that market will be at least 35 and possibly 40% over 2003 levels.

And that's primarily based on the new relationships and the people going to work on deeper projects.

The growth is not going to come from the number of rigs, again, it will come from market penetration.

Every one of those, I think without exception, the new accounts were taken from another company that did not solve the problems needed or the technical problems that were being addressed by the operator.

And so it is through market penetration and in our growth in this Gulf Coast market for the year, we have basically deducted a substantial amount of revenues which was in El Paso because they were our second largest customer last year.

So, we've netted that down if anyone was wondering.

We've always had a good position with El Paso.

And of the 22 customers, 15 are primarily led by the water-based fluids, either FlexDrill or the DeepDrill, and very importantly, as we continue to come up the latter, five of those are with major oil companies.

And that's a new first for us.

So, we began to work our way into some of the larger companies, which are always seem to come last in the cycle and we're beginning to work in on those.

The most profitable fluid area for the Company is in the central region, which is the Oklahoma/west Texas and Rockies markets.

And last year in the first quarter we averaged 51 rigs working in that market.

And the rigs are going deeper there, also, but not as pronounced as the Gulf Coast, but they're headed deeper.

In the first quarter this year, from the 51 last year, we averaged 81 rigs and we were 90 last Friday.

And so we're seeing a pretty good uptick in activity in that market and believe that the first quarter revenue of last year's 11.2 will be up in the 60% range plus maybe 65% this year and the income of reported last year of 1.9 for that region will be up even stronger.

And our technology has really made a mark in those markets.

The FlexDrill, particularly, has really helped in that market penetration in the central region.

So, as we look at the year and if I took you back to last year, we reported $53.9 million of revenues and drilling fluids last year. 3.4 will be deducted if you were to take the environmental out so on a basis of the 50.5 million reported last year, we should begin the year at approximately plus 30% and I think that as the Gulf Coast kicks in this year and the deep water and the larger projects kick in, we should hold or expand that growth.

We're looking for drilling fluids to be our most substantial uptick this year in revenues and income and primarily because the work that's been done over the last three years in developing the technology.

And we get start to get a payday for the efforts that so many people have worked on.

The second product line is matting, matting and the integrated services around that.

And I will break it down into three parts very quickly, where we're looking to perform this year.

The Gulf Coast rental business that we did $22,500,000 last year, we're looking for similar volume this year of not a growth, but a similar volume on the 16.3 million square feet lane.

But on the 86 cents per square foot that we had reported in 2003, we believe that that will be up at least 30% in pricing this year, we're already strongly headed that way and we should average at least 30% this year.

And it's not because activity's picking up, it's because the industry is running out of inventory.

With the tightness of capacity pricing is stepping back up and we'll be the beneficiary of that and so based on that that would be a very substantial increase in profitability without any investment.

Pricing always comes through very handily to the bottom line and we're already well on our way to achieving that as we speak.

The other growth for us is we've been nurturing the non oilfield rentals.

This is the utilities, entertainment, other markets across the country and in 2003, we did 1.6 million in that market.

This year we think we'll do at least three times that amount.

Major projects all over the country.

It's going to be a growth area for our company for the next several years.

And that is the second area of growth.

In the composite mat sales, we sold 4800 units last year, covering marketing costs we made very minimal amount of money.

We'll see a nice uptick this year because we have really penetrated the world markets in that and I'll describe that to you shortly.

And let me stop now and give you a quick trimmer course on Dura-Base mat.

I'm going to do this quickly, but we produced just under 100,000 mats in its history.

We purchased 97, meaning that a little under 3000 mats are still at the manufacturing facility to be purchased.

We're, again, that joint venture partner on that manufacturing. 39,000 of those are in our rental inventory on the Gulf Coast, we have 23,000 for resale and we sold 35,000.

In the last three years, we've sold 35,000 mats.

We have nine key markets around the world and we've talked about those over the years.

We have sold mats into every one of those markets, the largest being Western Canada, the second largest being our distributor and rep organization, South America, Mexico, military, Alaska, Indonesia, Russia and the utility industry.

Now, if we've actually placed units in the market, of the 35,200, we've made about $20 million contribution out of that with a margin about 50% and that's out our marketing expenses and start-up costs that we've done entering those markets.

But more importantly, what did we learn, as you can always theorize about a market.

But it's always different when you get there and you learn a lot.

And what we've learned is that there's no mat system like the Dura-Base in the world.

That's been tested by the government and everywhere we go.

There is none like it.

The capacity at lola plant is unique.

There's nothing like it in the world.

But the good news is the Dura-Base is overbuilt for many markets.

The bad news, it's overpriced because it's too good.

We're selling a Mercedes-Benz in Chevrolet markets sometimes.

And we've also learned that some markets will only support rental, not sales, and some of them would surprise you, the one we're moving into the first quarter was Mexico because they love the mat and they've had great success using it, but in the way they budget and PEMEX and other organizations in Mexico, they'd much prefer to rent.

Another surprise is in the places in the domestic government market that, while they want the mat, rental would be much better.

And so we're basically talking to them about going to a rental program in governmental work in domestic applications.

We don't want to rent in Iraq.

That would be kind of a tough way to get it back.

But in the U.S.

And also that the long life of the Dura-Base mat is at odds with the short-term planning horizon typically used in the oilfield industry, but we have developed some methods we think that can bridge that gap beside rental.

So, that's what we've learned and we have solutions for that as we approach various of these - but one of the solutions is that we're looking to expand our product base and the current Mercedes or the top of the line, very heavy-duty, wide temperature variations, all the wonderful things we have with the current mat, we can build a Chevrolet, with very strong, very useful but doesn't need the temperature extremes.

That Chevrolet could be produced for slightly more than a wood mat, but we can make the margins that we would make out of the Mercedes because we could lower the cost, substantially.

And so this is what we're working toward but we couldn't have learned this without going into the market and actually getting them on the ground and then having people use them and study the result.

Every mat with exception of maybe 10 to 20 mats are still in service and they're performing very well.

We are very pleased with our Dura-Base and its acceptance in the market.

We are now applying the solutions of rental of the type of mat to those markets.

We also learned that people wanted a very small mat to use in lighter applications and we're rolling out the Bravo mat this year.

It's been in production, start-up, the last year and we'll roll that out this year.

Our third business segment is our environmental and today it's primarily a Gulf Coast operation.

Last year we received 3.6 million barrels and we produced the reported income.

We think our barrel this year will be up by about 10% to about 4 million.

There are two drivers to that.

We, again, do not believe there will be increased activity.

Some of the depth of wells and the types of fluids used will assist in that growth but primarily the larger piece is litigation driven remediation and so we have a lot of litigation tied to major properties that are now coming to the market that have been working the last several years toward culmination and we'll see some more remediation driven work this year.

So, we think about 10% up and that 10% would generate about 3 cents difference for the company.

So, we'll take it.

But more importantly, we've begun to work in the water treatment business and the regulation coming on drinking water and we're expanding our norm permits for later and I think we're testing some of the new technologies for water that will be for later.

We look at environmental business as probably going to have potential of being a very large business, but we have to prove that with some of the new regulations and technologies that we're taking to the marketplace.

In summary, I think that the hard work of the last several years should begin to bear fruit in 2004 and I think we're in the markets, we've got the tools, it's time to produce.

And with that, we'll open it for questions.

Thank you.

At this time, to ask a question, please press star 1 on your touchtone phone.

John Tasdemir, you may ask your question.

Hey, good morning, guys.

Good morning, John.

Let me start with the drilling fluid business.

Obviously you're growing the business, you showed about 19, 20% top line growth in '03 versus '02.

But the operating income was basically flat for '03.

And going forward into '04, you're expecting another improvement in the top line, also in your operating income.

Can you kind of walk me through why operating margins didn't move in line with - why you didn't show the incremental margins that you're expecting next year?

Or this year?

I think that one is, John, we had actually a decline in the Gulf Coast market where we had the largest infrastructural costs and so that hammered the margins pretty badly and that's what we'll have the biggest result this year.

We didn't stop, by the way, developing the technologies, we didn't punt.

We kept driving the ball down the field and so we paid the price due to do that, but our biggest decline was in the Gulf Coast and it hurt us the most.

So let me ask this another way.

The environmental component that's non, I guess, Gulf Coast --

Right.

That was about $15 million for this year.

Did that grow significantly in '03?

Was that a big component of that growth?

Yes it grew a bit.

But no it wasn't a big component of the growth.

It's been a business, primarily started in Canada and is that the composting and it expanded down into the Rockies but as we get into the water treatment and some of the technologies, rather than as an adjunct to the drilling fluids where it was nurtured, it fit better to be part of the environmental because really the development of technologies and new ideas.

And no, that's not part of the equation.

I gave you the equation.

It's basically Gulf Coast and the cost of pounding the technology forward because we've been on the lip of these contracts and these market penetration and so we didn't slow down last year.

We pounded away and the result will be these 22 contracts and that's, I think, the reward for last year's disappointment, we can start to see it in 2004.

I gotcha.

And of those I guess 22 customers, tell me again, how many did you have at the start of last year?

Nine.

Okay.

Even worse than that, John, it didn't work.

We had them, but they were very spotty and really didn't work.

I kind of recall.

There were a couple of big projects that kept getting pushed off --

They got pushed and pushed and pushed.

So, we're getting them this year.

But along those lines, you said you had a record December in the drilling fluid business and you think January's continuing to be strong.

I mean when you say that you expect 40% growth, will we start to see that in the first quarter?

Will the numbers start to show that?

We sure expect them to.

So, it's not second half of the year, it's kind of throughout the year that you expect that growth.

The slowest grower has always has been the Gulf Coast.

That's where we have the big projects but it seems to take a month or two to get projects going.

But we started more rapidly in the central region.

You will see the biggest growth in that because it happened quicker, but we'll see pretty strong growth in the Gulf Coast, but you will see that more as you go into the second/third quarter, but the fastest growth will come out of the central region, but across the Company you will see increases.

Okay.

Let me skip to the mat business real quick.

Can you give me a sense of, excluding extraordinary items in the quarter, what type of operating income you would have posted in the mat business?

Why don't we let Matt pull it because it's so blended in.

Okay, I will talk to him about it later.

If that would be alright.

Matt, you can pull it out.

I can chase that detail down for you, John.

Because there are pieces that fell across -- we didn't break out of the extraordinary, but we can pull that out and my gut reaction is that the - well, he'll give it to you, I don't want to hip shoot you on it.

Okay.

And final question, do you guys care to take a shot at kind of first quarter guidance at all?

Or do you want to us do that?

I'd prefer not to.

On the first quarter.

I think it's time for money to talk and BS to walk.

I think we've got to put some numbers down and so let's --

All right.

It's not going to be very long.

John, after our track record the last couple of years, if we told somebody what it was, they wouldn't believe us anyway.

Let's just do it.

Fair enough.

All right, guys, I appreciate it.

Corey Greendale, you may ask your question.

Good morning.

Morning, Corey.

Jim, I don't think General Motors listens to your calls so I think your Chevy metaphor is safe.

Wanted to start by asking about the fluids business.

The 30% margin you were talking about, I just want to clarify, you're talking about margin on incremental revenue?

Yes.

Do you have thoughts, given the kind of structural changes that going on, what the number would look like in other segments?

Well the matting would be better, in particularly, in that the growth would come into the segments.

It would be primarily pricing and that primarily comes pretty close to 100%.

And the utility or the non-oilfield growth comes at a high margin.

It would be in the 70% range.

But the matting would probably be more, after marketing and everything, more in the 30% range so --

Sales.

The sales of composite mats.

So, across the mix it ought to be in matting.

You could be safe at 50%.

And for the E&T environmental?

It comes through at about 70. 70%.

Okay.

And then I just wanted to clarify in the fluids, in the 22 customers, the five majors, are those all relatively new additions?

I mean how many of those were there a year ago?

One.

One.

And they weren't active for most of the year.

Last year.

And then this may also be getting into detail you want to get into offline, but the items that you discuss in the preannouncements, the litigation issues, the higher bad debt, all of those things, can you sort of draw some line around those, some idea of the quantity in the quarter?

Sure.

Sure, Corey.

I can outline it for you briefly.

What we had in the period first was a million dollar increment to reserves for credit losses, for bad debts, principally coming out of a single bankruptcy case up in Canada that took an adverse turn in the quarter, reducing our expected recovery in that case.

And that was the bulk of the change.

The litigation issues, we had, as you know, an ongoing dispute with our partner in the pricing of the mats in the manufacturing joint venture.

That was litigated in the period and so we had about $400,000 of costs that were unusual that all came through in the quarter.

And an additional 300,000 related to some settlements from other past disputes in the fluids business that also were finalized in the quarter.

So, about 700,000 in total legal and settlement costs.

Then we had another dispute that we're pursuing against some former employees that ran several hundred thousand dollars and added to the legal pile.

Finally, the combination of all of those and lower earnings for the year forced us to provide larger than expected taxes in the period.

As you know, there are a lot of nondeductible items and as your earnings drop your nondeductible items become a bigger percentage of the total.

So, the effective tax rate was significantly higher in the period, or the benefit rate wasn't there on the loss.

So, we had about 1.2 million of taxes in the period.

I tell you, those are the biggest items although they were several smaller ones around it.

There's another pieces 100 here, 200 there, but we just basically looked at everything that could be an issue and we put it in.

We got it in there.

Are there any updates you can give on any of the litigation issues?

Not at this point.

And I just wanted to ask about the Mexican JV, sort of how that's going to be structured and what, from where you stand now, you're seeing as the opportunity there?

The structure on the Mexican JV leaves Newpark in a control position, operating the business, and owning the mats, but our Mexican partners are key to our penetration of that market.

We have, in the last year or so, besides selling 1500 mats in Mexico, we've quoted a large number of mats for sale and as Jim eluded to, the capital constraints that they face make rental more attractive.

We initially expect to put about 10,000 mats in that market and more as the market develops.

But it will be strictly a rental basis on the non-oilfield model.

In otherwards, rental starts the day the mats leave the facility, continues till they come back.

It should be a very good margin business and we look forward to joining that market this quarter.

I'll add to that , we have met all through from the operational level to the regional district level to the senior executives at PEMEX in Mexico City.

They have all confirmed that based on the budget constraints, meaning for capital expenditures, that rental is the way to penetrate the market and they are assisting us at the senior levels of the oil company at PEMEX in this endeavor because the mats provide a couple of things beside -- they have some environmental issues in several key areas but they have major productivity areas throughout the market and they have today more land rigs running in Mexico that can use mats than we have in the Gulf Coast market.

That doesn't mean you can take the mats in the Gulf Coast and equal Mexico, but Mexico has a pretty substantial potential but that will have to be done a step at a time and we'll begin that step here within the next month or two.

I guess I'll turn it over, thanks.

Allen Seymour, you may ask your question.

Yeah, what is the opening up of Libya mean for your mat business?

I think nothing for mats.

But it probably more a fluids event than a mat event.

Okay.

Thanks.

Janet Clay, you may ask your question.

Hi.

What was CapEx for the fourth quarter?

Just a second, Janet.

I happen to have it right here, knowing you'd ask.

Of course!

CapEx in the fourth quarter was $3.9 million.

And what are you projecting for next year total CapEx?

We're believing that short of a massive round of growth, which we don't forecast at this point, we would look for CapEx to be somewhere between 12 and $15 million.

Okay.

Let me make this point, one of the largest component of CapEx was the requirement in Houston that we move up our measure ferrite grinding facility to a new facility because we were working on the Port of Houston's property and our lease came down and we had to move.

And that was about 1/3 of last year's CapEx.

And so we won't repeat that again this year.

So, we think that Matt's answer is in line for this year.

All right.

And now that you have the new bank credit facility in place, what are your thoughts regarding the public bonds that you have outstanding?

We've done a lot of thinking about them, Janet, and I think that there's two pieces here.

First, the Company has got to perform, as Jim indicated, and start generating the kind of cash flow that we have been expecting it to do in the last two years.

I would say that when that occurs two things will happen.

First, we'll have surplus cash and second, at some point there are a couple of strips of warrants outstanding that would very likely be exercised.

We think that the combined proceeds of that may, in fact, give us a pretty good run at getting rid of them before their maturity.

That doesn't take into account potential changes in the rental business that might, in fact, leave us looking at a longer term space of capital to match up with those rental assets if we, in fact, expand the rental business in Mexico and other markets.

But at that point our intention is not to let those bonds go beyond their current maturities.

What's the magnitude of those warrants?

The aggregate proceeds from them, of course, you'd have to have a stock price up around $15 to make it really attractive for all of them.

About half of them are $21 million of proceeds would come in at 850, 850 strike price.

Uh-huh.

And the remaining $20 million at about $10.04.

So, I think somewhere up about 12, 14, $15, they'd very likely both would come in.

Okay.

All right, thank you.

Again, to ask a question, press star 1 on your touchtone phone.

Operator, if that's it, we'll close the call.

Yes, I'm showing no further questions at this time.

Folks, we sure appreciate your joining us today.

And those of you for whom we deferred answers on one or two minor items, please give me a call or drop me an e-mail.

We will be available today to take followup questions as necessary.

Thanks very much for joining us.

We'll talk to you next quarter.