Oil States International Inc (OIS) 2006 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to your third quarter 2006 Oil States International earnings conference call. My name is Jeanne. I'll be your conference coordinator today. At this time, all lines are on a listen-only mode, and towards the end of the conference call, we'll be taking questions. At this time, I'll send the call over to your host, Mr. Bradley Dodson, VP and CFO. Please proceed.

Thank you. Welcome to the Oil States third quarter 2006 earnings conference call. Our call today will be lead by Douglas Swanson, Oil States CEO, and Cindy Taylor, Oil States President and COO.

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

Thank you, Bradley, and good morning. We are pleased to announce that Oil States International completed the third quarter of 2006 with strong results, led by strength in our Offshore Products group and our Well Site Services segment. Our business lines, that are driven by North American drilling activity, all performed very well, benefiting from high activity levels during the quarter.

Net income was $0.99 per share, an increase of 64% when compared to the $0.60 per share reported in the third quarter of 2005. We significantly outperformed our previous guidance range, due largely to improved contributions from our rental tool operations and our Offshore Products segment.

All of our business segments reported improved sequential results, except for Tubular Services, where we had fairly flat results. Our Offshore Products segment was up sequentially in revenue 17.5% and EBITDA 6.8%. Our Offshore Products EBITDA margin ran very strong at 17.4% for the quarter, benefiting from high levels of absorption in addition to increased product sales. Sequentially, our Well Site Services segment was fairly flat on revenues, but EBITDA increased 14.2%, due to primarily increased contributions from our rental tools.

At this time, I'd like to turn the meeting over to Bradley Dodson, who will go through our financial results.

Thank you, Doug. For the third quarter of 2006, we reported operating income of $75.5 million, revenues of $479.5 million and EBITDA of $93.9 million. These results compare to $51.3 million of operating income, on revenues of $394.1 million and EBITDA totaling $64.1 million in the third quarter of 2005. Third quarter 2006 results represent a 21.6% year-over-year increase in revenues and a 46.5% year-over-year improvement in EBITDA. Our revenues were up 3.5% sequentially, while EBITDA increased 11.7%. Our net income for the third quarter of 2006 totaled $50.1 million, or $0.99 per diluted share.

As Doug mentioned, our current quarter results reflect the benefits of improved Offshore Products activity, coupled with strong North American drilling and completion activity, key contributors to Well Site Services growth with the expansion of our drilling rigs fleet, and capacity additions in our other product lines.

Our Tubular Services segment did very well during the quarter due to continued strong demand for OCTG. OffShore Products revenues and EBITDA increased, due to higher activity levels and increased cost absorption.

Stock-based compensation expense recorded during the quarter totaled $1.6 million, or $0.02 per diluted share, which was recorded as SG&A expense. Our effective tax rate during the quarter was 34.1%, due to lower foreign taxes in the quarter, primarily in Canada. We expect our rate to be approximately 35% in the fourth quarter of 2006, resulting in an annual effective rate of approximately 35.4%.

Total debt at the end of the third quarter was $404.9 million, an increase of $8.9 million from Q2 levels, as cash flow from operations was offset by capital spending and share repurchases made during the quarter. Our debt capitalization ratio was 33.5% as of September 30, 2006. Our capital expenditures during the third quarter totaled $47.6 million. In addition, we repurchased $7 million of our stock during the third quarter, at an average price of $28.15 per share.

At this time, I'd like to turn the discussion over to Cindy Taylor, who will review the activities in each of our business segments.

Thank you, Bradley, and good morning, everybody. I'd like to start with our Well Sites Services segment. In this segment, we were up sequentially in revenues and EBITDA, due primarily to increased contributions from our rental tool operations. Our Canadian rental tool operations were subject to normal seasonal declines during the second quarter, and began to recover in the third quarter. In addition, our U.S. drilling operations and our rental tools increased sequentially, as well. On a quarterly year-over-year basis, our revenues in Well Sites Services were up $12.9 million, or 9%, and our EBITDA increased $23.5 million, or $61%.

Our accommodations business represented 33% of our Well Site Services segmental EBITDA during the quarter, the majority of which was generated in Canada. Our accommodations revenues decreased 5% year-over-year, but our EBITDA increased $7.4 million, or 57%. Our EBITDA margins improved from 19.3% in the third quarter of 2005 to 31.8% in the current quarter, due to the mixed shift from manufacturing revenues in 2005 to a greater percentage of higher margin rental and service work in 2006 and improved manufacturing margins.

Our rental tool business represented 37% of our Well Site Services segmental EBITDA during the quarter. On a year-over-year basis, rental tools revenues increased 33% and EBITDA increased $8.4 million, or 58%. These increased compare favorably to the 15% year-over-year increase in the North American rig count, due to capacity expansion and price increases. Sequentially, our revenues increased 14% and EBITDA increased 25%, demonstrating very strong incremental margins.

Drilling services results include the results from our workover services segment, subsequent to the sale of that business to Boots & Coots on March 1, 2006. We made that change given the relative small amount of workover services contributions going forward.

Our land drilling operations represented 30% of our Well Site Services segmental EBITDA during the quarter. On a year-over-year basis, land drilling revenues increased 55% and EBITDA increased $9.8 million, or 112%. Sequentially, our drilling revenues and EBITDA increased by 15% and 14% respectively, generating incremental EBITDA margins of 46%. Our average daily revenues were up $500 per day on a sequential basis, but our daily cash margin per rig was down $200 a day, due largely to the impact of cost increases, both labor and some extraordinary rig repairs. Of our 32 rigs that are operating, the majority are drilling for oil.

Now, I'd like to go through some high level comments in our Offshore Products segment. In this segment, our revenues increased 18% sequentially, while EBITDA increased $1.2 million, or 7%. The revenue increase resulted from high activity levels in all of our manufacturing facilities. Our EBITDA margins came in at a strong 17.4% during the quarter, compared to near record levels realized in the second quarter of 2006, at 19.1%.

Also promising was the backlog increase of 15% in the quarter, bringing the total to $321.2 million from the prior record backlog of $280.6 million reported in the second quarter of this year. The sequential backlog increase was primarily attributable to the receipt of additional connector orders for the [Shinze] project, which was about $8.4 million, additional winch work from Noble, conductors for projects in Azerbaijan, as well as increases in our pipeline products and other drilling equipment.

Key contributors to revenue during the quarter included work on Noble [inaudible] winch order, strong drilling riser FlexJoint activity, and strong activity in our pipeline products and other drilling and marine equipment.

Taking you through our last segment, Tubular Services. Here, as Doug mentioned, our revenues were fairly flat sequentially, as was our EBITDA contribution. However, we did realize year-over-year improvements in volumes, due to strong customer demand and rig count expansion. Our volumes were up 15% year-over-year. Our order books declined 6% during the current quarter, primarily due to the timing of the award of program work, which typically gets spliced in the June/July timeframe.

Our inventory increased by $10.1 million during the quarter, due to a slight average price increase. Our tonnage in inventory at September 30th totaled 171,591 tons, which was down 2% from tonnage held at June 30th, 2006. Our average price per inventory increased during the quarter, due to the announced new price increases in the May/June timeframe that took effect during the quarter. The average cost of inventory at September 30th was $1,626 per ton, which compares to $1,541 per ton at June 30th, which is an increase of 5 to 6%.

Approximately 64% of our OCTG inventories were committed to customer orders at the end of the current quarter. Overall, OCTG industry inventories increased slightly during the quarter on a months-of-supply basis, and of course, total inventory tons have increased. Average inventory on the ground totaled approximately a 5.4-month supply, based on information from the OCTG situation report.

At this time, Doug is going to close our prepared comments with some summary comments, as well as our outlook.

I'd like to go through the outlook for the 2006 fourth quarter. In Well Site Services, our accommodation results were stronger in the quarterly primarily due to stronger manufacturing profit contributions in Canada and from our U.S. accommodations business. The outlook remains very bright for the oil sands-related accommodations given activity in the region and the significant capital investments we've made there.

Land drilling utilization pricing remains strong, but utilization could weaken somewhat during the fourth quarter, due to holiday and end-of-year shutdowns. Our 29th rig began working in August, and we acquired three additional rigs from Eagle Rock during the quarter, bringing our total fleet size to 32. We also announced the construction of two additional rigs for 2007 delivery, pursuant to two-year contracts for operations in the Rockies.

Rental tool contributions are likely to remain strong in the U.S., but could weaken in Canada due to concerns over natural gas pricing and storage levels, in addition to potential delays in the start of the winter mobilizations due to weather.

In our Offshore Products segment, third quarter revenues and EBITDA increased sequentially, evidencing improved activity levels and cost absorption. Our backlog position is up significantly from prior record levels obtained at June 30th. Floating activity remains high.

Key project potential and markets includes connector work for other production facilities, additional mooring system updates for other rigs, particularly the remaining two mobile Eagle rigs, conductors for use in Azerbaijan, and VOP stack integration. The outlook for the fourth quarter of 2006 and for all of 2007 is very robust for Offshore Products.

In Tubular Services, our sales had a greater mix of carbon-grade products compared to last year, due to growth in U.S. land rig count compared to that of the Gulf of Mexico. Our margins were slightly down from the first half of 2006. We expect to continue to realize strong shipments and revenues during the fourth quarter with current activity levels. However, fourth quarter margins are likely to be flat to slightly down due to higher industry-wide inventory levels and distributor de-stocking.

Looking at our guidance for the fourth quarter. Our guidance range for the fourth quarter is estimated at $0.87 to $0.92 per diluted share. Our depreciation and amortization should be approximately $15.2 million in the fourth quarter due to the CapEx planned to be spent. Our effective tax rate is estimated to be 35% for the fourth quarter, and our capital spending for 2006 is expected to total $154 million.

We'll be pleased to answer any questions you might have at this time.

[Operator instructions] We'll take our first question from Stephen Gengaro, Jefferies & Company. Please proceed.

Thank you. Good morning, everybody.

Morning, Stephen.

The main question I had was on the Offshore Products division. Obviously, you had another nice build in the backlog. Does that continue to be more of a high value-added product line? Can you give us some color on the backlog there?

You know, we have, quite frankly, high activity levels across the board, Stephen. It's both production, infrastructure, subsea and drilling and marine equipment, and we look at our overall mix, and it had improved in the first half of 2006 relative to kind of recent history, and the mix remains about the same as it was in backlog as of June 30th, in terms of the relative margin potential in that backlog. So the key message is it's strong levels of backlog across the board.

And then as a follow up - and thank you - is the margin performance in Offshore Products. It may just have been [inaudible] a little bit high. What are your expectations there over the next - maybe just even in general terms, over the next several quarters?

You know, it's always complicated because of the - like I said, the mix issues and the timing of projects that come into our revenue stream in that period of time, but we're looking at margins that are comparable to what we're seeing right now. If you'll recall, in connection with the second quarter call, we had indicated that those were higher than expected, largely because of higher margin service mix in the second quarter, so the margins coming in where they did this quarter were on the strong end of what we expected given that mix, and we see this environment continuing based on what we have on backlog.

Great. Thank you.

Thank you, Stephen.

And we'll take our next question from Bill Herbert, Simmons & Company.

Hi. Good morning.

Good morning, Bill.

Good morning, Bill.

Doug, you answered part of my question with regard to the outlook for Tubulars and OCTG. I mean, we're looking at sort of a seasonal de-stocking issue as a result of avoiding the [inaudible] drilling adjustment fears. Some have even mentioned fear of softening steel prices in '07. Beyond Q4, realistically, what's the outlook internally on the OCTG side?

Let me respond first, but what I'd indicated in our comments is we still see strong demand. Our inquiries and our backlog continue to be replaced. Now, we do think that there could be pricing pressure because of the increase of inventory and the de-stocking, but I think on a longer term, we think with the high rig activity level that there will be a lot of tubular goods consumed, and then we expect to have strong volumes and stable pricing going forward in 2007.

Do margins ever get back up to where we were earlier?

You know, Bill, they can, but a lot of it is going to depend upon, as you know, the level of inventory on the ground, and when we were enjoying those double-digit margins - and we said back then that we were down in kind of the 4 to 4.4 months of supply with particular tightness on alloy type products, and we're just not there right now. The Gulf was down hard post-hurricanes, and really it's recovered modestly, but it's kind of flat, I'd say, at this stage, and you've really got to see inventory on the ground, I think, change for us to go back to those double digit types of margins we saw in 2004 and 2005.

And again, as you're aware, with the dynamics in the business, if the price of tubular goods - of our costs go up and we see increases in price like we saw in 2004 and 2005, it just creates an environment where we can get higher margin.

Right. And with regard to inventory management strategy, you mentioned that two-thirds - I think it's what you mentioned, that two-thirds of your inventory is essentially committed to specific drilling programs. You guys have been relatively conservative with [inaudible] managing inventories YTD. What's the strategy going forward?

Well, as indicated in the second and third quarter, about 64, 65% of our inventory is committed. We have not reduced our inventory. Our inventory has remained relatively flat. We think that we'll continue to do that. We don't see a significant increase or decrease in our inventory levels.

Bill Herbert. Okay. And then last question: outlook for Canada in general, please? I know that on the accommodations business, if you will, a decent chunk of that is heavy oil and [inaudible] related, but we do have some exposure to specific gas-related businesses as well in terms of your overall portfolio. Walk us through your thinking with respect to Canada, in general.

I'll try to pick that up and ask Doug to tag in with any additional comments. Right now, I think you're hearing it from other services companies as well as us that Canada is just kind of floppy right now. You see it in the rig count, and it's a combination of wet weather and operators deciding what to do with their programs, and there's obviously questions and concern over the timing of the kickoff of the winter. There always is at this time of the year, but I would just kind of characterize it as a little sloppy right now. It affects our rental tools in the fourth quarter probably a little more than our accommodations, simply because we work in the more remote, extreme regions in the north that require ground breaks to really leverage our accommodation fleet that supports drilling operations. I think the real question is what does the first quarter hold for the drilling rig count up there, and right now I would - our sense is that it's going to be strong, but not as strong as it was last year, just based on the feedback that we're seeing coming from the marketplace right now.

You say "your sense," but that's based upon specific dialogue with customers, and Q1 looks reasonably well behaved, just not as strong. I mean, it's more than just a feeling, right?

Yes. It's based on discussions. At this stage, it's kind of a critical time, where we start negotiating and locking up our equipment with our customers, so it is very specific commentary. It's tempered a bit by commentary that's coming from some of the drilling rig companies. Precision is one in terms of - I think their issue is more one of pricing, it sounds like, than expected utilization in the quarter.

Okay. Thanks a lot.

Historically, Bill, in our accommodations business, most of the equipment doesn't go to work until after the first of the year, and we have 90 days - the first 90 days of the year are critical to us. In some years, we get a bonus with exceptionally cold winter and the equipment goes out early. We had some of that last year. We're not experiencing it this year, but we're still optimistic about the first quarter. One other factor is what we're doing in the oil sands area, is that we've spent over $70 million in capital expenditures to replace the PTI lodge and increase our capacity with a new Beaver River executive lodge. These projects will be completed - are completed now. And actually, one little expansion of Beaver River executive lodge will occur in the first quarter. But we'll be benefiting from the increased revenue and contribution from these facilities, and it's our plan to continue to expand our presence in the oil sands area by providing additional facilities for the construction workers that will be working there.

That's very helpful. Thank you.

Thank you, Bill.

And we'll take our next question from Jeff Tillery of Pickering Energy Partners.

Hi. Good morning.

Hi, Jeff.

Just to stay on accommodations for a second. For the past couple of years, we've seen margins fall off sequentially in Q4. Margins were very high here in Q3. What are your expectations here for the fourth quarter in the accommodations business?

Right now, we think they're going to remain at a high level. They may come in around 250 bps. We had some favorable contributions on the manufacturing side of our business that helped us in our margins realization in Q3, largely just an adjustment on a percentage of completion basis with some of our manufacturing efforts for third parties in the region. So, again, we think that the mix is pretty good going into Q4, high overall margins, but in maybe 250 bps from Q3.

All right. Thank you. On the Offshore Products business, revenue was also very strong this quarter. How do you think about the revenue run rate in Q3 relative to your capacity in that? Are you at capacity? Near capacity? Kind of what are your thoughts along those lines?

Our revenue was about $110,000 - our revenue was $110,000 a month in the quarter, and I think we can do $125,000 a quarter without adding any additional roofline.

Is any additional roofline planned at this point?

None is planned at this time, but we have other outsourcing opportunities to expand our capacity.

Yes. We're looking at outsourcing, and we're also looking at facility layout and machinery upgrades kind of as lower hanging fruit than adding roofline to work through our backlog.

So I think what I get from the bottom line is we have expansion opportunities in our existing facilities and are actively exploring outsources and other opportunities to expand our capacity without significant capital expenditures.

All right. My last question. The equity income line from Boots & Coots was pretty strong in the quarter. Any reason to not think that will continue, or was that kind of just a very good quarter on their part?

First of all, our equity and income comes from a variety of sources, one of which is Boots & Coots. We have other equity affiliates that are contributing there on the P&L statement, so it is other than that. Right now, a lot of the service-oriented business lines, which all of the pickup is, for the most part attributable that are doing well, so it's reasonable to think that the - since they're in related business lines, if we're doing well, our equity affiliates are also doing well, so I do think it's reasonable to see that you'll have a stronger level of activity. Of course, overall, it's not that significant to our overall results.

All right. Thank you, guys.

And we'll take our next question from Kenneth Sill, Credit Suisse.

Good morning.

Good morning, Ken.

Good morning.

I wanted to dig into the drilling business a little bit. The margins came in a little bit down on costs and labor. Is there going to be a pop back in margins in the fourth quarter?

Is there going to be a what?

Will you recover some of the margin you lost in Q3 and Q4?

What we experienced, Ken, is that in July, some of our competitors raised the labor rates for the field hands significantly, and we instituted an increase in the pay package in July that cost us about $600 per day. What we've seen is that we were able to pass that on 100% to the operators so that we didn't suffer any detriment. However, for the quarter, as you can see from our margins, we're down slightly, and that's due, as Cindy indicated, to repair costs associated primarily with the acquisition of those three rigs in August. But basically what we're seeing in day rates now is basically flat right now, as we're holding our day rates. We are working at clawing back some of these cost increases that we provided to the field personnel. These increases were in a variety of forms, including fuel supplements when gasoline was over $3.00 a gallon, so we were able to claw some of that back, and hopefully that will solve the bottom line.

Okay. And then looking at your contract visibility, are any of your rigs on term contracts? What does that look like right now?

We typically do not carry term contracts in our fleet, Ken. The exception on occasion is with a couple of customers in the Rocky Mountains region. At this time, I think we have one, if not two, rigs on term contracts across the entire fleet of 32 rigs. That's not typically our mode. What we do particularly - well, really across all the regions is take multi-well commitments, if you will. We need the efficiency of being able to have identified locations to move to to keep our utilization up, so we have multi-well commitments, but they're not true term contracts.

Okay. Thank you.

Thanks, Ken.

[Operator instructions] We'll take our next question from [Charlene Quender] with Pilot Advisors.

Hi. Thanks. Congratulations; it was a great quarter.

Thanks, Charlene.

I don't know if you already said it, but the split - either revenues or in cash flow, whatever is easier - and the accommodations between oil sands and the rest of the business? Do you have that handy?

You know, we haven't - I don't have that at the tip of my fingers at this stage for you, Charlene. My instincts tell me it's gone up a little bit from prior quarters because - well, no, we had manufacturing revenues in the second quarter for CNRL, so it may not be the case. We're trying to kind of pull it out and see. Bradley's going to try to pull it together quickly.

Okay. I'll just ask a couple of other quick questions.

I think it's about the same.

It's about the - not majorly different than last quarter.

No, and as Doug mentioned, and maybe what we ought to say just a little bit more, we're in a - and we've said we've got to do this before - we're in a bit of a state of transition with some of our more significant facilities; we've had [inaudible] our PTI lodge, which accommodated roughly 1,400 workers in the region, and it successfully [inaudible] down. That's replaced with our Athabasca lodge, which just came up last week to accommodate roughly 1,000 workers, and it'll be fully up to accommodate 1,100 workers in a couple of weeks. In addition, our Beaver River executive lodge is also coming up. So there's some transition there, but on balance, it's kind of a push in this quarter on a relative contribution basis.

And then as we look into '07 and maybe beyond, I mean, are there further plans for capacity expansion?

We are planning - this is an extremely bright area for us vis-à-vis our potential for growth, and organic growth at that. And as you'll recall, I think we committed about $70 million of our capital budget this year to the - particularly to the two major facilities that I just mentioned. We designed those to be scalable for future growth, meaning that the core facilities - your kitchen, rec rooms, common facilities - are there to handle a greater number of total population, and we do expect that we will be expanding both of those built facilities given strong demand that we've seen for the rooms that we've opened up. We are also aggressively looking for additional opportunities to commit capital to these types of facilities in support of the oil sands operations.

The oil sands contributed 31% of Q2 revenues and 34% of Q3 revenues.

34% of segment revenues.

Yes.

Gotcha. And then just if you have it handy as well, the - I know it's usually in the Q, but either the gross profit dollars or margins by segment? Or I can get that offline.

We'll be filing a Q this week. I think it's probably better -

So it'll all be in there. Okay, thank you. Congratulations again.

Thank you.

Thanks, Charlene.

At this time, I'm showing no questions. I'll turn the call - we have a question here from Matt McGeary, Sentinel Asset Management.

Good morning.

Hi, Matt.

I'm just curious about guidance for the fourth quarter. It looks a little bit tepid. I just wonder how much of that is - are you guys seeing some clear evidence that we're going to see some slow downs, or are you just trying to be prudent given the current background environment?

I think it's a combination of the two. Where we do think we're see - it's hard to say if Canada right now is a slow down in activity because of customer decision-making or whether it's weather-related. You hear both, but you just have to look at the rig count, and it's clearly evident that the rig count is pulled in, and we're seeing that particularly in our rental tool operations, and that's kind of the primary area that's a bit of a question mark to us. And again, in that macro environment, it does seem to be pretty much limited to Canada. There might be pockets of the U.S. where there's some shifting of work, but overall we're pretty optimistic in total, but Canada is the biggest thing. And I think Doug indicated in his commentary that we expected Tubular Services margins to be flat to slightly down. And those are the two points.

Well, and the third one, though, we talked about also is the utilization of those land rigs, particularly in West Texas, where they - unlike the big rigs, our rigs, the operators will shut them down for the holiday seasons - for Thanksgiving, Christmas and New Years, so we historically have utilization that would not be as high during that period of it as it would be in, for example, the third quarter.

Great. Just remind me how much you have left on the buyback.

We have done $40 million to date. The total is $100 million, so we should have $60 million left.

Okay. Everything else has been answered. Thank you.

Thank you, Matt.

And there are no further questions at this time. I'll turn the call back over to the presenters for closing remarks.

Well, we appreciate you calling in today, and thank you very much, and have a good day.

Ladies and gentlemen, thank you for joining us on the call. You may now disconnect.