Oil States International Inc (OIS) 2003 Q3 法說會逐字稿

Welcome to the Q3 2003 Oil States International earnings conference call. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded. I would now like to turn the program over to your host for today's conference, Mr. Brad Dodson, Vice President of Corporate Development. Please proceed sir.

Welcome to the Oil States International third quarter 2003 earnings conference call. Our call today will be led by Douglas Swanson, Oil States' President and Chief Executive Officer, and Cindy Taylor, Oil States' Senior Vice President and Chief Financial Officer.

Before we begin, I would like to caution listeners regarding forward-looking statements. To the extent remarks today contain information other than historical information, we are relying on the safe harbor protection afforded by federal law. Any such remarks should be weighed in the context of the many factors that affect our business, including those risks disclosed in our Form 10-K and our other SEC filings. I will turn it over to you, Doug.

Thank you Bradley, and thank you for joining us in this earnings conference call. Oil States International is pleased to announce that we completed the third quarter of 2003 with strong operating and financial results, led by continued strength in North American land drilling activity, strength in our offshore products group and the impact of the acquisitions completed during the third quarter of 2002. EBITDA during the quarter was up 18.8 percent to 23.9 million, compared to 20.1 million generated in the third quarter of 2002. Net income was 23 cents per share compared to 21 cents per share reported in the third quarter of 2002, an increase of 11.2 percent. The effective tax rate was 26.6 in the current quarter compared to 22.6 in the third quarter of 2002. Our strong -- our performance was strong despite continued weakness in the shallow water Gulf of Mexico. We had strong asset utilization during the quarter, with the exception of our workover units, which continue to suffer from weak demand. U.S. rig count was up 27.6 percent year-over-year and up 5.8 percent from the second quarter of 2003. Canadian rig count was also up subsequently, and was up from the third quarter of 2002 by 54.6 percent.

During the quarter, we were unable to implement price increases due to the mix of drilling activity that was concentrated on shallow land drilling rather than deep land drilling for our Gulf of Mexico shallow water drilling. However, we continued to focus on our business plan: and growth strategy, and spent approximately 11.4 million on capital expenditures and completed one small rental tool acquisition during the quarter. I will now turn over the agenda to Cindy Taylor, who will go through our financial results.

Thanks Doug. For the third quarter of 2003, we reported operating income of $16.7 million on revenues of 177.2 million. Our EBITDA totaled 23.9 million for the quarter. These results compare to 14.2 million of operating income on revenues of 154.6 million for the third quarter of last year. The third quarter 2002 EBITDA totaled $20.1 million. Our current quarter performance represents a 14.6 percent year-over-year increase in revenues and an 18.8 percent improvement in EBITDA. Sequentially, our revenues were up 8.3 percent and our EBITDA was up 7.3 percent, due to improvements in virtually all of our business lines. Our net income totaled $11.3 million, or 23 cents a share for the current quarter, compared to 10.2 million, or 21 cents per share for the same quarter last year. As Doug mentioned, the third quarter net income in 2002 was benefited by a 22.6 percent effective tax rate, while our current quarter earnings reflect a 26.6 percent rate. As we have mentioned before, this low tax rate is due to the partial utilization of our net operating loss carry-forward.

As Doug mentioned, our third quarter results reflect benefits from improved North American drilling activity, continued strong performance from our offshore products segment and contributions from acquisitions that we were able to complete in the third quarter of last year. As Doug mentioned, our capital spending totaled $11.4 million during the quarter. We are projecting to spend an additional 18.7 million during the fourth quarter of this year, which will bring our annual capital spending to approximately $45.5 million. Our balance sheet remains very strong with a net debt to capitalization ratio of 20.5 percent as of the end of the quarter. We did reduce our debt level somewhat during the quarter by strong cash flow that was generated from our operations, which, of course, was partially offset by the capital expenditures that we mentioned, as well as amounts paid for the small rental tool acquisition which totaled $2.1 million during the quarter. Our current cash borrowing rate remains at less than 3.5 percent and we still have approximately 35 to for $40 million of availability under our existing credit facility. I do want to mention that we are currently in the process of syndicating a new bank credit facility, which will provide expanded availability as well as additional term. The proposed facility is structured as a 4 year commitment for $225 million, with a $25 million accordion feature tagged onto that. This credit facility is expected to close in just a few days at the end of this month. We do want to point out that our fourth quarter earnings will be negatively impacted to the tune of 2 cents per share, due to the write-off of un-amortized debt issuance cost associated with our existing credit facility.

At this time I'm going to turn the discussion back over to Doug, who's going to go through detailed summaries of activities in each of our business segments, as well as provide you with some thoughts as to our market outlook going forward. And then we will open it up for questions and answers at the end of that.

Thank you Cindy. What I would like to do is go through our three business segments with you. The first one is our well site services segment. Revenues in the third quarter were 56.6 million, up 27.8 percent from the third quarter 2002. Our EBITDA was 12.5 million, up 40.6 percent from the 8.9 million in the third quarter 2002. And our EBITDA margin was 22.1 percent compared to 20 percent a year ago. Looking at this increase in EBITDA of 3.6 million on a year-to-year basis, 2 million came from our accommodations business, 1.3 million came from the rental business, and the drilling generated an additional 300,000, and workover was breakeven compared to (indiscernible) no change. All well site services business lines reported improved EBITDA on a year over year basis.

We have 4 product lines within our well site services group. The first one I will go through is our well site accommodations in modular building businesses. Revenues in the third quarter were 29 million, up 39.8 percent from the 20.7 in 2002. Our EBITDA was 5.9 million, up 51.9 percent from the 3.9 million in 2002. And our margin was 22 percent -- 20.2 percent in the third quarter of 2003, compared to 18.6 percent a year ago. We had strong activity in that the average man days served was up to 4279, compared to 3304 in the third quarter 2002. We had increased camp rental in Canada. At the same time, our building leasing -- number of buildings under lease was down in the third quarter of 2003 in the US compared to 2002. Again, looking at the contributions -- in Canada year-over-year comparisons were strong due to contributions from our large camps and the favorable exchange rates. We are expanding our rental fleet in Canada. We've just started to do that in the third quarter and we are continuing to do it in the fourth quarter, through capital expenditures and building new equipment. In the US Gulf of Mexico, our EBITDA was up on a year over year basis due to cost reduction measures taken. But the rental activity remained fairly weak during the quarter due to general weakness in the shallow water Gulf of Mexico activity.

The next business segment is our work-over segment. We had -- revenues were up 7.5 percent in 2003 to 7.7 million. Our EBITDA was flat at 1.2 million compared to 1.2 million a year ago. We had margins of 16 percent in the third quarter of 2003 compared to 17.3 percent one year ago. Year-over-year activity was flat, in that our utilization was 29.8 percent in the third quarter of 2003 compared to 29.9 one year ago. This was down from 31.2 percent in the second quarter of 2003. Our average dayrate was $9600 a day in the third quarter 2003. That's the same rate as we had in 2002, but down from the $9900 a day we had in the second quarter of 2003. Our operating costs also increased. There were $7300 a day in the 2003 quarter, compared to $7200 a day a year ago and $6700 a day in the third quarter of 2002. Our net margin for the third quarter was $2300 a day compared to $2700 a day in the second quarter of 2003 and $2900 a day one year ago.

Looking at our rental (indiscernible) -- activity was strong during the quarter, in that we had a great number of (indiscernible) items out on rent. In addition, we obtained contributions from the acquisitions completed last year. However, we did not have any significant pricing power. Due to the mix of activity, it was concentrated in shallow land activity rather than: Gulf of Mexico and deep land drilling:. Nevertheless, we had significantly improved year-over-year operations. Our revenues were (technical difficulty) to 10.5 million from 8.3 million a year ago. And our EBITDA was up 1.3 million, or 75 percent, to 3 million, from 1.7 million in the previous year. Our margin was 28.7 percent in the third quarter of 2003, compared to 20.6 one year ago. In looking at a sequential comparison, our revenue was up slightly to 10.5 million from 10.4 million in the second quarter; however, our EBITDA was up $500,000 to 3 million, compared to 2.5 million in the second quarter 2003, a 20 percent increase. Our margin increased to 28.7 percent compared to 20.4 percent in the second quarter of 2003. We are continuing to expand our rental fleet through acquisitions and additional capital spending efforts to upgrade the quality of our equipment.

The last business segment in our well site services are shallow drilling rigs. We have significantly improved year-over-year comparisons. Our revenues were 9.4 million in the third quarter of 2003, up 16.6 percent compared to 2002. Our EBITDA was 2.4 million, up 16 percent from the 2.1 million a year ago. Our margins for the third quarter of 2003 were 26.1 percent compared to 26.2 percent a year ago. On a sequential basis, comparisons on revenue, revenue was up 3.7 percent but revenue was down 8.3 percent -- excuse me, EBITDA was down 8.3 percent. Our EBITDA in the third quarter was 2.4 compared to the second quarter of 2.7 million. Our margins were 26.1 percent in the third quarter of 2003 compared to 29.5 percent. This decrease in EBITDA and margin was due to higher costs associated with operations during the third quarter. Our utilization during the third quarter of 2003 was 91.6 percent. That compared to 90 percent a year ago and 95 percent -- excuse me, 90 percent in the second quarter of 2003 and 95 percent one year ago. Our average day rates were flat; they were 7400 compared to 7400 in the second quarter 2003, but up from 7100 in the third quarter of 2002. Our cash margins in the third quarter 2003 were $2100 a day, up from 2000 a year ago but down from the $2300 a day we experienced in the second quarter of 2003. Again, this was due to higher costs incurred in the third quarter of 2003, primarily higher repair costs. Utilization and backlog visibility remain strong in both Texas and Ohio. We have growing commitments that now extend us into the first quarter of 2004. In addition, we have commenced building 2 additional land rigs which will be very similar to the ones we are now operating. One of them should be completed at the latter part of December and the other one early in 2004.

The next business segment I will go through is our offshore products group. Our offshore products group had record revenues and EBITDA in the third quarter of 2003. Our revenues were 59.3 million, up :6.9 percent from the third quarter of 2002. Our EBITDA was 10.9 million compared to approximately 10.9 million a year ago. And our EBITDA margin was 18.4 percent compared to 19.6 percent a year ago. Sequentially, our EBITDA was up $400,000 to 10.9 million from the 10.5 in the second quarter of 2003, and our EBITDA margins were up slightly in the third quarter 2003, to 18.4 percent compared to 18.3 percent in the second quarter of 2003. Our backlog at September 30 is 72.7 million. This compares to 104 million one year ago and 80.2:: million at the end of the second quarter of 2003. Our EBITDA margins have declined slightly. Our EBITDA margin for the first nine months of this year is 16.6, compared to the 17.6 margin we had in 2002. However, we've seen increasing EBITDA margins in the last two quarters. In the first quarter our EBITDA margin was 13 percent. It increased to 18.3 percent in the second quarter of 2003, and was 18.4 percent in the most recent quarter. Our backlog of 72.7 million was down approximately 10 percent from the second quarter of 2003. Approximately 78 percent of this backlog is scheduled to ship during the fourth quarter of 2003.

Our last business segment is our tubular services segment. Revenues in the third quarter were 61.3 million, up 11.8 percent from the third quarter 2002. Our EBITDA was 1.9 million, up 16.7 percent from the 1.7 in 2002. Our gross margins were 5.9 percent in the last quarter, up 6.4 -- excuse me, down from 6.4 percent in the third quarter of 2002. In the third quarter of 2002, we had a significant amount of international sales that were a higher margin. Our EBITDA margin for the third quarter 2003 was 3.2 percent, compared to an EBITDA margin of 3.0 in the third quarter of 2002. On: a sequential basis, our EBITDA was 1.9 million this quarter, up from the 1.5 million in the second quarter of 2003. Our inventory at the end of the quarter was 72.7 million. That's up from the 56 million one year ago, and about the same as the 72.6 million we had at the end of the second quarter. In terms of tons shipped, we have shipped 1800 tons in the third quarter compared to 60,900 tons in the second quarter of 2003 and 59,200 a year ago. Our order book continues to increase. Our backlog at the end of the third quarter was 69.2 million. This compares to 43.2 million one year ago and 66.8 million at the end of the second quarter. We're holding our inventory flat during this last quarter and we will be looking to decrease our inventory as we go forward, towards the end of the year. Our purchase prices are still at the mid year 2000 levels, of about $788 a ton, compared to the same amount this year. We are currently holding three to for months of inventory, based upon current levels of sales. And approximately 60 percent of our inventories are committed to customer orders at the end of the quarter. Looking at the marketing conditions, improving the rig count continues to be focused towards shallow land, drilling activity requiring more carbon grade pipe. Prices remain at low levels but mills are continuing to implement previously announced increases. The inventories have continued to increase in absolute numbers, but month supply on the ground has remained approximately the same.

In looking at the balance of 2003, key drivers for our Company are deepwater infrastructure development and North American Gas -- North American Natural Gas drilling activity. About 85 percent of our revenues are attributable to North America. Looking at our three business segments -- first, I will go through well site services. Drilling utilization in strong, and should continue through: the fourth quarter of 2003. Canadian drilling activity is picking up and the winter outlook is very robust, as we've seen strong indications that there will be accelerated activity in Canada. And depending upon the weather, it could commence as early as in the fourth quarter of 2003.

Rental tool contribution increased year-over-year, due to acquisitions we completed in 2002. The rig count also impacted that, and the improvement: of our equipment helped our revenue. Pricing should improve with an increase in Gulf of Mexico activity and deep gas drilling. Work-over demand was weak in the Gulf of Mexico during the third quarter, and could remain weak in the fourth quarter. We are continuing to spend on growing our businesses, both through capital expenditures and acquisitions. In our offshore products group, looking at the outlook there, our backlog position is weakening. Both in absolute numbers and the actual backlog we have and the mix, but we see strong -- this is due to strong sales in the first nine months of 2003.

Quoting activity has slowed somewhat for deepwater production facilities equipment, but it has increased for sub-sea pipeline work. In looking at the fourth quarter, EBITDA margins will be negatively impacted by the product mix and integration of costs associated with the consolidation of two manufacturing facilities, and an acquisition completed in October of 2003. We are continuing to spend capital to grow our business lines, both through capital expenditures and acquisitions. In tubular services, we expect to realize improved earnings during the remainder of 2003, with an increase in program activity. Gross margins should approximate approximately 6 percent. On a consolidated basis, we expect continued improvements in activity in the tubular services and well site services segments during the fourth quarter. The balance of 2003 should be strong for our offshore products segment, given its strong backlog position -- and the expected shipments; however, EBITDA margins could be reduced to the 12 to 15 percent range due to the mix of shipments. And also due to these integration costs involved with these two consolidation of manufacturing facilities. Our fourth quarter earnings should be in the range of 19 to 23 cents per share. Before the two cent per share charge (technical difficulty) earnings for debt restructuring. Again, this is due to lower expected margins by our offshore products group, which could be offset by increased activity in Canada. Looking at 2004, our outlook remains strong. However, with the extent of our growth in 2004 we'll be dependent upon improvements in Gulf of Mexico and deepwater development activity.

We would be pleased to answer any questions you might have.

(CALLER INSTRUCTIONS). (OPERATOR INSTRUCTIONS). Bill Herbert, Simmons & Co.

Could you guys run through a little bit slower, if you will, with respect to what's going on in Oil States, the integration of the manufacturing facilities? And precisely what is the mix issue that's resulting in the lower margins for the fourth quarter?

What you have seen, obviously, has been a reduction in our backlog, which we've been (multiple speakers) predicting would occur. We had a little bit of a degradation going, obviously, into the first quarter. Held it flat through the second, then we went down about 10 percent this quarter. We attribute that more to timing of awards right now than any kind of overall trend. The last half of '04,'05 still look they're going to be very active, but we kind of see a window here where that backlog has declined, and we can seek further declines in the fourth quarter. It's a little bit hard to tell right now. But what we have also said -- you know, we had some fairly proprietary products through our OSI UK facility, where we do the (indiscernible) connectors for our TLP, as well as our (inaudible) the percentage weighting of our total backlog has gone down this year, because of the high-quality sales that we have had in the first nine months of this year. So that is the mix issue that we are talking about, and again, backlog is down in absolute dollars and mix does seem to add as a long-term trend but we do see a little bit of a window here that (multiple speakers) to have to work through.

And the consolidation issue?

In addition to that, our subsidy pipeline facility, as you'll recall, we applied the operations (indiscernible) from (indiscernible). We combined those operations. They outsourced a lot of their manufacturing. We tried to bring that in-house, and our facility was just not sized appropriately for the expanded operations. We have expanded our operations south of town at our (indiscernible) Ventures facility to accommodate consolidation of both of those operations going forward. And as is always the case, this is the period where we are moving in and and integrating those two operations together. There will be some efficiencies during the closure of one facility and moving into the new. But here again, we see this as a one quarter event, just from overlap and moving type costs.

Bill, there is one other thing. We're also consolidating some of the facilities that we acquired last year with applied hydraulics over in Louisiana, that will adversely affect the absorption in that area. In addition, as I mentioned, in addition we also had a small acquisition we completed that will incur some onetime charges in the fourth quarter that will affect the offshore products group.

Absent these relatively sort of transient issues for the fourth quarter for Oil States, and given what the less content we have now, with respect to the higher margin products, with respect to the connector products, etc. What is a reasonable normalized margin to expect going forward during this sort of lull, in terms of orders, flat to down backlog and sort of less calories in your backlog now that some of the higher quality revenues have already unfolded?

I think we are still looking around 15 percent as a baseline there. That's absent some of the absorption issues. We still look pretty good. Our backlog margins are currently only down a couple percentage points due to mix. So it's not a dramatic issue all the same, but it's somewhat of an issue.

Switching gears for a second here, more of a thematic question. Gulf of Mexico is obviously troubling for the industry, and resulting in some weakness for you as well. Assuming that the Gulf of Mexico, what we are seeing today is what we are going to get for the foreseeable future, perhaps a bit improved but not demonstrably improved and not even coming close to prior cycle peaks. Is Oil States well sized for that kind of environment going forward? Or do we have -- or are we burdened by too much capacity with respect to what the Gulf of Mexico is likely to yield going forward?

No. We don't have overcapacity.

Excess capacity not only in terms of, perhaps, equipment and services, but also people -- is what I am referring to.

I think we're right sized for the operation. If we had an increase in Gulf of Mexico activity, we would see a higher utilization. Some of our equipment was actually had some capital expenditures to acquire. (indiscernible) the Gulf of Mexico work. But I think that we have the capacity to handle increased volume. What we have seen, I think, would be higher revenue per ticket or rental item, and higher margins on that offshore work.

I guess what I am trying to articulate here is an environment where its modest, measured not frenzied, not approaching past cycle peaks. Are we optimally sized for that kind of environment? In other words, it's going to improve but it isn't going to improve hugely. Also, we're not going to wish with the step function improvements.

The only thing I might expand on that, where the offshore market impacts us the most. (indiscernible) let me go through about three business lines. Tubular services, which is, of course, a distribution business; the cost structure there is really not at issue. The same sales and administration people handle a 200 million volume or $350 million volume, so people -- they are used to your investment in inventory, which we manage very closely to rig count expectations, as you know. In the other key areas, our rental tool area -- and there again it's not a people issue, it's a lack of pricing issue. And one could argue utilization of equipment, but we don't feel like we have any significant excess equipment out there. We just had a lot of severe pricing pressure, as opposed to ability to raise prices in that market. And again, as you know we are aggressively looking to consolidate that market to improve that environment going forward. The other area, too areas, I guess, the accommodations rental in the Gulf of Mexico. That is an area where currently we do have excess capacity in terms of equipment investment. There is not ongoing operating costs of any significance associated with that, we just have underutilization and lack of pricing of the existing equipment. So one could argue that if there was a long-term secular trend, we could cut we could cut our investment to optimize the investment in that fleet possibly. Then of course, workover ?

That's sort of a continued struggle.

It's a continued struggle. We've cut our cost from a people and operating cost perspective, as aggressively as we probably can, and keep a quality operation along the way. There again, if we saw no hopes of (indiscernible) -- again, we are trying to relocate those assets internationally to the extent that we can. If we didn't prove to do that, there again on a longer-term basis, we could reduce the investment more so than the ongoing cost of maintaining.

Finally, with respect to -- you made mention of the fact that your credit facility is going to be expanding. Give us a sense as to what the opportunities set you are encountering from an acquisition standpoint, in terms of just the general deal flow. And I guess I will leave at that.

Deal flow has improved quite a lot from what we saw at the early part of the year. There were kind of an isolated few opportunities that weren't as necessarily strategic for us. And part of it could be our concerted effort to try to close acquisitions, but also there are more opportunities and things to look at. We had kind of set some internal targets to try to close about 50 to 75 million of acquisitions a year, particularly these smaller pull through type acquisitions that we have characterized ourselves with last year. And we've only closed now a couple of small ones this year, and those have been in the last 30 days or so. But the backlog of opportunities looks very good. And you are absolutely correct, the point of expanding that facility was to create the opportunity to take advantage of -- particularly these smaller type acquisitions for cash.

Let me add one thing there. In looking at these acquisitions, I think we are going to be concentrating on acquisitions that would be in the well site services group and the offshore products group, rather than the tubular services group.

Will Foley, Sidoti & Co.

A lot of my questions were just asked, but I guess the one question I would have would be on the tubular services division. Just looking forward to next year, if we have, I guess, a land rig count that kind of continues in the same kind of range where we are at the moment, then let's say we get a modest improvement in the offshore -- say 115,120 rigs. What kind of outlook does that suggest for the tubular division from here?

If you are assuming that the rig count, I guess under those assumptions, you are going to have a rig count that would be 1100 or so or higher. And based upon that we, obviously, we think we would maintain or increase our market share, and we would have a higher revenue for 2004 than 2003. And I think if those conditions were to exist, we might see some modest margin improvement.

The improvement in the offshore, let's say, the modest improvement that was referred to? Would that be meaningful, or is that -- is that significant?

As Cindy pointed out with respect to the tubular services group, we can handle increased activity without any incremental cost. So any increased margin we have will fall down to the bottom line, in any increased activity.

Ted Grace, Goldman Sachs.

Just a couple of questions. Thinking back to the second quarter call, it's my recollection that you the you thought third quarter results at tubular services would be up both revenue and pricing, due to customer commitments. No question that volumes came through. I'm just wondering if you could speak to pricing and what we can look forward to in the fourth quarter?

I'll take that. Obviously, we reported our volumes, so you can see that we had pretty good volume increases. We had modest price increases over the quarter. It was not dramatic, and again, the key to having any significant change in our pricing was going to be attributable to improvements in that offshore rig count. We have some (indiscernible) and modest improvements rather than anything significant. So that has led to some deep volume improvements with the overall increase in total rig count and just a little bit on the pricing side. In terms of fourth quarter outlook, I would say we see a similar environment with improvement, but not dramatic improvement, but we are looking to be sequentially up fourth quarter over third, in terms of our revenues.

Okay. And then, you made some dimension to your purchasing intentions in the fourth quarter. It would be down sequentially, can you give us --?

Yes. We are looking to slightly reduce our inventory in the fourth quarter, due to the tax reasons, property tax reasons, and just planning for them going forward.

My second question is, from a strategic perspective, could you speak to the holes that you would like to fill in the offshore products business, in the products Services or niches that are of particular interest?

From acquisitions?

Either acquisitions or organic initiatives.

We kind of touched on it. Our primary focus for growth right now is in well site services an in our offshore products area. The well site services is kind of prone for consolidation right now, particularly in the rental tool area. From an acquisition perspective, and I think that creates better discipline in the market to control and work with and have a broader geographic footprint than what we currently have. In terms of the other areas, we think we are better off primarily doing our own capital expenditure program and doing step-out expansion in that manner, particularly on the drilling rig equipment side. There again, we like what we do. We do it very well. It's common types of equipment and common geographic areas. And so and again, we've increased our rig count by 4 rigs or roughly 40 percent, since going public already. And we've maintained consistent utilization through the expansion of that asset by these two additional rigs, or just another component of that. In the past we've focused on used equipment. It's hard to find used equipment? There is less and less out there. In this case, we are kind of doing more of a new component build rig for these two. That's also true for the accommodations, both in Canada and the Gulf. Most of our opportunities there are through (inaudible) capital spending and that's been a larger amount of our focus, particularly in Canada, where a lot of our opportunities are not in the traditional kind of side-by-side rentals that the (indiscernible) development (inaudible) it's demanding the new configurations of equipment that we've been able to put in the marketplace, (indiscernible) economic return. Obviously, in the workover side of the business, we're not doing expansions there right now because we suffer from underutilization of our capacity. In offshore product, we are looking more towards product line acquisitions or smaller pull through type acquisitions for larger company, similar to what we did with (indiscernible) last year. Those are a little harder to come by and find right now, just because of the size of the Company and the quality that's required to operate in that environment. Many times we've faced competitors that are larger than us, or they are not willing to digest quality product line, so it's a goal of hours, but it's a little more difficult to achieve.

The question is more aimed at that latter category, could you even provide some help understanding which product lines would be -- or are the most interesting in the offshore product side?

Clearly, any type of connector-type equipment would be of interest to us. Either for casing type connectors or the installation connectors of what we do is of interest to us there. We've done now one or two -- a couple of acquisitions, I guess, on the (indiscernible) product side. Which, again, that's another market that is favorable for consolidation that would help us overall. And we made a claim acquisition, that was largely done from a defensive measure in a way to help ensure facility utilization through the cycle, more so than necessarily the growth profile of the Company that we want to do going forward. But the key focus is on offshore infrastructure development, both on the floating topsides and on the subsidy, top-line side.

Let me go back to your question about the inventory reductions at tubular services. Our goal is to have a slight reduction, a 10 to 15 percent reduction in that inventory prior to year-end. We are doing that for two reasons, again. I mentioned that we have to have the (indiscernible) the wrong taxes on the that, property taxes on that, at year-end. In addition, we did not see an uptick in the Gulf of Mexico and deep land drilling activity. Our inventory turns this year have not been at the same level they were in prior years, and so I think we're more rightsizing our inventory for expected activity. Again, their short lead-time in acquiring the inventory from the mills. So we don't think we are at risk in that area, but I think it's a slight adjustment, you might say, due to the lack of strong demand in the Gulf of Mexico, and also to reduce our tax liability at year-end.

Ken Sill, Credit Suisse First Boston.

A couple of questions. One on the outlook for Q4, I guess I am a little bit surprised or deranged, because looking at how things are playing out, you have got reasonable offshore products, locked in with as much of the backlog being converted to revenue in the fourth quarter. Well site services, probably up seasonally a little bit, on the accommodation side work-over and drilling, I'm assuming your kind of flattish. What would cause you to kind of increase or decrease your guidance for Q4? Is Canada going to be the swing factor for the fourth quarter?

I think it is Ken, and really the breadth of that range is literally due to that. We don't know for sure the quantification of what our margins are going to be, obviously, in offshore products. The volumes are going to continue to be good. We know margins are going to suffer, and that's a pretty broad range, that has a pretty significant impact on our EBITDA. That could be partially if not largely, made up by activity in Canada. But for us, again, the key is the timing of the start of the winter. Our camps and most of our winter leverage comes from Northern Territories, where the ground has to freeze regardless of how badly people want to get on location, they are going to be limited by the weather. So that is always a swing factor that we just can't predict.

At one point you guys had indicated there were people talking about paying fees to reserve equipment in camps and stuff. Is that still potentially going to happen, or is that fading a little bit here?

No, we still see strong indications of high level of activity in this winter season. People are talking about putting out equipment in November and December. Historically, when they've done that, and held equipment, they've had to pay rental fees for that and some standby fees just to maintain the equipment. This is a possibility. We're not sure whether it will materialize or not, but our optimism regarding Canada is not at all dampened from the previous calls that we've had. And we expected a very strong winter, based upon conversations with the operators in that area.

Switching gears a little bit, you are building a couple of drilling rigs. Could you give us a reference on how much those are costing to assemble, and what is the capability of those rigs?

We are looking at capital costs of maybe $2.5 million per rig. These are rigs that are very similar to our existing 15 rigs. They have a little greater depth capability. They're semi automatic hydraulic rigs. They will probably drill in the 6 to 9000 foot range. As you know, we have a high utilization on these rigs. We get good cash margins on them and expect a very significant and a very good rate of return on these assets. And again, we expect -- hopefully one will be in service in December, the end of December; and one, hopefully, in January.

Which markets are those targeted for?

They will be in the Permian Basin.

Bill Brady, Presidio Management. Do we have Bill Brady on the line? We'll move to the next question if Bill (multiple speakers) --

What kind of revenue would be consistent with 19 to 23 cents for the fourth quarter?

Based on everything that we've looked at -- we normally don't give out revenue projections -- but with the lower margins, I would say you're somewhere in the 190 to 195 million range.

And the 19 to 23 would be based on mix of margins and so forth?

Correct.

Richard Friary, Delphi Management.

I was wondering if you could quantify the impact that acquisitions had on your revenue growth and your operating income growth this quarter?

We have that somewhere. Bear with me just a second to try to put my hands on that.

Also along the same lines, what do you think you can grow both of those lines over time going forward?

You were talking about revenues and what?

Operating income.

Obviously, it depends on whether you are talking about the cyclical nature of the business or you're talking about acquisitions, which is a question mark that I would say -- what we are seeking to do is we've talked about 50 to 75 million in acquisitions a year, and we're looking to have those have kind of an average payback period or EBITDA period of five years. So at the higher level, that implies EBITDA of about $15 million. Which (indiscernible) anywhere from depending on which year it is, of 10 to 15 percent EBITDA growth on its own, and then it depends on the cycle that you are through, in terms of what we have from our base order of business.

What are some of the criteria you use for these acquisitions? How do you value them?

We look to value our acquisitions, it is a cyclical business, so we always do look towards there historical performance; obviously, revenues, but the key there for us is the EBITDA and free cash flow. And we set minimal kind of payback periods that we look at, as well as calculating the internal rate of return, such that we want it to -- one, be accretive; and two, exceeded our weighted average cost of capital over the period.

We're looking at full cycle earnings; we are looking at paybacks in generally 4 to 5 years, and returns that equal -- exceed our cost of capital.

Did you ever get a hold of the number of the impact on revenues?

These are approximated numbers, because nearly all of the acquisitions that we've made are integrated into our business lines. If we try to track it on an estimated basis, but it looks like it was in the range of 13.5 to $14 million of acquisition revenue in our Q3 earnings.

What about in the operating income line, do you have any way of breaking that out?

We really don't. The overall revenue is somewhere in that kind of 8 to 9 percent range. And they are (indiscernible) kind of mirror acquisitions to our (indiscernible) product line, with similar margins.

Mary Safri (ph), with Carl Poisenheimer (ph) & Co.

Hello. I'm thinking as I am listening to all of this, and wondering how easy or difficult would it be for you to move assets abroad? You mentioned something in connection with, I think it was with rental tools? No -- workover tools.

It was our workover assets, which again, those type of assets are used on a worldwide basis. It's a matter of securing a contract that justifies the economics of moving the equipment. Our accommodations are another example that are well-suited to international operations, both from the perspective of the leasing of the unit as well as the catering and management of the facilities. We've worked internationally in the past and are doing so currently, and would like to broaden the penetration that we have in that market. Obviously, the key there is the geography as to whether you are in a developed area that can support manpower fairly readily, or in a remote area. Of course, that's where we come into play and benefit the most. The land rigs that we have we are not likely to move internationally, although we certainly could. We could also acquire a package of rigs and work them internationally. We've done it, obviously, in the past. But one of the strengths of what we do is concentrating our operations in a known geography with known drilling characteristics, such that we get the efficiencies that we've been able to achieve. I guess those are kind of --

What about the connector stuff?

That offshore product is a global operation already. We manufacture predominantly in the United States and the UK; however, we have (indiscernible) offices worldwide. Our products will go where the development is. We have significant activity in the Gulf of Mexico, Brazil, West Africa and Southeast Asia, currently. It's probably more weighted today or the last year or so in the Gulf of Mexico, but that is where the majors have been developed in the deepwater fields.

Do you see this shifting in the next year or so, or is your sales-force very flexible, looking at different opportunities wherever?

Absolutely. In the deepwater area, we do see a migration. I won't say necessarily a shift, but there has been a lot of development in the Gulf of Mexico. We see a lot of future opportunities, particularly in West Africa and Southeast Asia, going forward. I think there is probably the greatest magnitude of international expansion in that segment. There are opportunities within the well site services segment, but we have to target those and identify those, and we're focused on trying to do that. The tubular services, the distribution business -- that's a U.S. distribution business. And although we look for international opportunities, it's less likely that we'll see much of magnitude there.

(OPERATOR INSTRUCTIONS). Fred Frome (ph), Franklin Resources.

I just was wondering about, with all these rigs going into the Gulf of Mexico, how much of that business you can get if there is any upgrade business that's necessary, or maintenance on some of those rigs versus what you would have gotten in the US Gulf?

(indiscernible) saying the exodus of rigs from the Gulf of Mexico. Is there going to be increased business?

Not necessarily. I guess would there be decreased business for you? Can you expect to get any -- some of that business down there, to the extent there is some?

We have not seen any increase in business due to the upgrading of rigs leaving the Gulf of Mexico. I think if there is upgrade it will be very minor, and it hasn't had any impact on us to date. We're not counting on it, going forward.

How much of the offshore business is sort of upgraded work or maintenance work versus the new builds?

Most of what we do currently, we've not had any significant rig equipment building or re-furb cycle since the 1997/1998 era. We do have product lines that are geared towards that obviously -- a wench line, a mooring equipment line, some of our accommodations actually go on these deeper water drilling rigs. But I would say the magnitude is to the tune kind of $20 million (indiscernible) currently. That was certainly a larger contributor in the 97/98 arrow when there was activity. But as you know, there just hasn't been much to speak of in recent periods.

So not much impact one way or the other, then, with the rigs leaving the Gulf?

No. The ones that aren't leaving are the ones we read about, are primarily jack-up rigs. And the modifications they have are really very minor that they need to do this international work.

There are no further questions at this time. Mr. Swanson, please proceed with your closing remarks.

Thank you. We appreciate you dialing in, and we look forward to visiting with you at the end of next quarter. Have a good day.

This concludes your Oil States International earnings conference call.