Oil States International Inc (OIS) 2007 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Second Quarter 2007 Oil States International Earnings Conference Call. My name is Jaquila and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of this conference. (OPERATOR INSTRUCTIONS) I would now like to turn the call over to Mr. Bradley Dodson, Vice President and CFO. Please proceed, sir.

Thank you. Welcome to the Oil States second quarter 2007 earning conference call. Our call today will be led by Cindy Taylor, Oil States' President and Chief Executive Officer.

Before we begin, we'd 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 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 now turn it over to Cindy.

Thank you, Bradley. Good morning and thanks to all of you for joining us today. We are pleased to announce that Oil States posted strong second quarter results at the high end of our previous guidance range led by record results in our Offshore Products segment. For the second quarter of 2007, Oil States reported revenues of $499.3 million, EBITDA of $98.4 million, net income of $52.2 million and earnings of $1.03 per diluted share.

Our earnings per share of $1.03 include a $0.17 per share gain recognized from the sale of a portion of our investments in Boots & Coots common stock during April. Excluding the Boots & Coots gain, our earnings totaled $0.86 per diluted share compared to the $0.88 per share reported in the second quarter of 2006. Our second quarter results benefited from our exposure to two longer-term growth markets.

Our Offshore Products business benefited from increased demand for deepwater capital equipment and our accommodations operations continued to benefit from increased activity in the Canadian oil sands region. The strength of these businesses, coupled with strong overall U.S. drilling and completion activity helped us to mitigate the effects of a significantly weaker year-over-year Canadian drilling and completion market, with softer Tubular Services margins as well. Tubular Services, while down year-over-year in margins, showed sequential improvement both in tonnage shipped and in gross margins realized.

Subsequent to the completion of the second quarter, we announced two acquisitions, which will expand our rental tool operations in the United States. Total consideration paid for these two acquisitions was $111 million. These acquisitions are consistent with our strategy of expanding our product and service offerings in the North American completion and production services market.

Bradley is going to take you through more details of our overall consolidated results and then I will come back on the line and conclude our prepared remarks with a discussion of our individual segments, as well as our market outlook.

Thank you, Cindy. For the second quarter of 2007, excluding the Boots & Coots gain, we reported operating income of $68.5 million, revenues of $499.3 million, and EBITDA of $85.6 million. Our net income for the second quarter of 2007 totaled $43.8 million, or $0.86 per diluted share, excluding the Boots & Coots gain.

The comparable second quarter 2006 results were $70 million of operating income on revenues of $463.4 million, with EBITDA totaling $84.1 million. The second quarter of 2007 results represent an 8% year-over-year increase in revenues and a 2% year-over-year improvement in EBITDA, without the gain.

Our total debt at the end of the second quarter was $343.6 million. This balance was $45.4 million lower than our first quarter balance, as cash flow from operations more than offset the $63.7 million of capital expenditures made during the quarter.

As a result, our debt to cap ratio declined to 26% at June 30, 2007. As Cindy mentioned, we closed two acquisitions subsequent to the end of the quarter for primarily cash consideration, which was funded by borrowings under our credit facility. Pro forma for these acquisitions, our debt to cap ratio approximate -- was approximately 32%.

Based on our Company's closing stock prices at the end of the second quarter, the contingent convertible requirements of our $175 million of convertible notes have been met. Therefore, the notes are convertible at the option of the holders. As such, the notes are classified as current debt as of June 30th, 2007. Because the recent trading prices for the notes have been in excess of their implied conversion value, it would be uneconomic to convert the notes at this time. Therefore, based on current market conditions, we do not currently expect any significant amount of the notes to convert over the next 12 months.

During the second quarter of 2007, Oil States also sold 14.95 million shares of Boots & Coots common stock in an underwritten public offering for net proceeds of $29.4 million. The Company recognized a pretax gain related to this offering of $12.8 million or $0.17 per diluted share after tax in the second quarter. The Company continues to account for its remaining 11.5 million share investment in Boots & Coots under the equity method of accounting.

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

Thank you. I will lead off with our Well Site Services segment. Our Well Site Services segment was down sequentially 16% in revenues and 29% in EBITDA primarily due to seasonal activity declines in Canada. The second quarter is a typically slow period for Canadian drilling activity due to spring break-up conditions. However, second quarter break-up in Canada was much more severe this year with Canadian drilling activity down over 50% year-over-year, which negatively impacted our Canadian rental tools and accommodations operations, which support traditional drilling related activity. However, continued strength in the oil sands area helped to mitigate this tough year-over-year rig count decline.

Our accommodations revenues decreased 34% sequentially and our EBITDA decreased $20.6 million or 53% due to slower Canadian drilling activity. EBITDA margins declined from 41.8% in the first quarter of 2007 to 29.9% in the second quarter of 2007, but were up from 26.3% reported in the second quarter of 2006.

Revenues and EBITDA from our oil sands accommodations increased year-over-year by approximately 31% and 24% respectively. Oil sands activity contributed over 70% of the accommodations EBITDA reported in the second quarter of 2007. Our expansion plans for our Beaver River, Athabasca, and Wapasu Creek lodges continues on budget and on schedule. These expansion plans will increase our room capacity in these three main lodges by over 50% by this time next year from current capacity as of June 30th, 2007.

On a sequential basis, our rental tools revenue decreased 5% and EBITDA decreased $3 million or 13%, again due to the seasonally weak Canadian activity. However, we did report year-over-year growth in revenue and EBITDA of 9% and 5% respectively, demonstrating our strong and growing presence in key markets in the United States. Sequentially, our drilling revenues and EBITDA were up 19% and 18% respectively, as our activity in West Texas and the Rockies improved from first quarter levels. Our average daily revenues were up $300 a day on a sequential basis, but our cash margins were $200 a day lower due primarily to variable costs associated with rig moves and repair and maintenance activity.

If we look to our Offshore Products segment, here our revenues increased 17% sequentially and EBITDA increased $6.5 million or 32%. Our EBITDA margins increased to 19.9% from 17.2% reported in the first quarter of 2007. Record revenues and margins during the second quarter of 2007 were primarily driven by strong TLP and connector sales. In particular, we recognized strong margins in both the [Neptune and Shenji] projects.

Our backlog grew to a new record level of $402.2 million at June 30, 2007, up from the prior record level of $373.4 million reported at March 31st, 2007. The 8% sequential backlog increase was primarily attributable to the receipt of orders for both drilling and pipeline related equipment.

If we switch to our last segment, Tubular Services, here Tubular Services revenues were up 14% sequentially due to higher OCTG shipments. In the second quarter, tonnage shipped was up 17% from first quarter to 120,000 tons. Gross margins also improved sequentially during the second quarter to 6.4% from 6% realized in the first quarter of 2007. We were successful in reducing our inventory by 12% during the quarter in an effort to improve our turn rate and return on invested capital. OCTG industry inventories also improved during the quarter, with month supply on the ground moving to five months based upon OCTG situation report estimates.

As we look forward, our Well Site Services, the outlook for our accommodations business remains very bright for oil sands related accommodations given activity in the region and the significant capital investments that we continue to make. Our rental tool contributions should remain strong in the United States and will be augmented by our two recent acquisitions. We expect this strength to be modestly offset by continued weakness in Canada.

Land drilling utilization continues to strengthen. Our third quarter utilization is expected to average 90% up from 83% reported this most recently completed quarter. Overall, we expect our Well Site Services EBITDA margins to expand to 37% or 38% in the third quarter. The outlook for offshore products remains robust. Our backlog position set yet another record this quarter and was -- up 8% from the prior quarter and quoting activity remains high. Our quarterly results will continue to be impacted by our capacity issues in the products and service mix delivered within given quarters, but the overall activity outlook looks very strong.

We expect gross margins in our Tubular Services segment to be flat or up sequentially, as industry inventory levels have decreased on a month supply basis, and pricing appears to have stabilized. We continue to believe that industry consolidation at the mill level will lead to a stronger environment prospectively.

Considering all the above factors, our earnings guidance range for the third quarter 2007 is estimated at $0.95 to $1.01 per diluted share, as disclosed in our press release.

This does conclude our prepared comments. Jaquila, would you open the call up for questions and answers please?

(OPERATOR INSTRUCTIONS) And your first question comes from the line of Bill Herbert with Simmons & Company. Please proceed.

Thanks, good morning.

Good morning, Bill.

Cindy, touching on the capacity issues at Offshore Products, I know partly it's a function of mix and what have you, but based upon where pricing is today, what is the revenue generating capacity of that business on a quarterly basis now?

Well, we obviously have been guiding to quarterly revenues in the range of $125 million. We obviously exceeded that [by] $135 million and we are looking to expand that. But, right now, we are looking to stay in that $125 million to $135 million range in the near term. The way we can obviously expand that is do more outsourcing work, where we can lay off some of the capacity that we are doing to external parties. We are not adding roofline at this standpoint. We are upgrading machining and we are adding high bay as an example in South Houston operations. All of those things will help us over time. But, in the near time, I am thinking we are going to stay in that range.

Realistically, with respect to your, I guess, capacity expansion plans, while they aren't defined as of yet, what kind of expansion are you contemplating?

Well, again, the -- you can get expansion through the machining upgrades and the facility upgrades that I have talked about.

And how much though?

It's hard to say, maybe 10% come from those types of activities and we are also working with third party vendors, both in the United States and overseas where we can leverage some of our product delivery by having starting out outdoors as well as just utilizing other facilities, bringing then our project management team to execute work in other facilities.

Now, with regard to outsourcing, does that have a margin impact?

Ideally, it's been into our job and it works very efficiently unless for some reason delivery times or quality are not what we expect. That is always a risk that you encounter when you enter these outsourced arrangements, but we wouldn't be doing this obviously if we don't think that it would help us overall, and at least keep our margins at the high levels that we are at now. Again, there is a risk there that we have to manage of course. We are more comfortable with operations where we can actually move our own people, our engineers, project managers and welders on site and control it on a day to day basis in that fashion.

Speaking of margins, we had a very sort of accommodating mix for the quarter. What should be reasonable expectations going forward on the margin front?

On a quarterly basis, I am looking anywhere from 16% to say 20% depending on mix. The third quarter I don't really think will be quite as strong largely because of the leverage we got from Neptune and Shenji, but they will still be very good.

Okay. And then, switching gears for a quick second, PTI, you mentioned that 70% of the EBITDA came from oil sands in the quarter, so about $13 million or something like that versus $25 million last quarter. What was the revenue from oil sands again in the quarter?

I think Bradley has that, we have in Canadian dollars, so I think he's going to do a quick conversion now.

Excellent.

It is about $30 million U.S.

Okay, so $40 million last quarter and $30 million this quarter. And then, kind of you -- for very good reasons, you continue to invest in that business. And I guess, looking at my notes here, at the time we did an update kind of in early June, you were running 2100 rooms and at the end of Q3, you thought you will be at 2500, and by the end of Q4 at 3000 rooms. Can you give us an update as to where you guys are with respect to that ramp?

Well, and again the rooms that we talk about are our major lodge facilities and as I mentioned, all three of those fortunately are remaining on track. But, in terms of room delivery as well as costs, now when I talk about cost, I am talking about Canadian dollar costs, which is our functional currency obviously up there. On a U.S. dollar basis, it's inflated because of exchange rate movements. But, again, on a Canadian dollar basis, which is the key there, they are remaining on track and on budget. And the one thing I'll point out, I know you know this, but for benefit of every one else, there is kind of two elements that are oil sands driven. We would normally not expect any decline in revenues or profitability in the lodges. But, again, remember that we have the 49 man dorms that's the core drilling operations that is seasonal, although still tied to the oil sands related activity, and that is why you can see some sequential movement. The lodges themselves both with capacity utilization and the capacity additions are showing continuing growth.

Last one from me, each -- I think last time we talked about this, each incremental room associated with these projects is expected to generate kind of $9000 to $10000 per room is revs and sort of margins of about 45%. I mean, is that still a reasonable assumption?

There is nothing that's changed vis-a-vis our profitability outlook.

But, I guess you were just touching costs, so I just wanted to make sure that in light of that, you -- we were still relatively comfortable about that margin outlook.

Yes.

Okay, that's all I have. Thanks a lot.

Thank you so much, Bill.

And your next question comes from the line of Stephen Gengaro with Jefferies & Company. Please proceed.

Hi, good morning.

Good morning, Stephen.

Good morning.

A couple of questions, if you don't mind, the first -- you have made in the last months or actually I think it's August now, but July two acquisitions and a seemingly what appeared to us to be pretty attractive valuation levels. Can you give us sort of an overview of what you are seeing on the acquisition front right now in terms of prices and what potential suitors are looking for?

I will kind of lead this off and then ask Bradley to add some comments. But, we are obviously very excited with the addition of the Well Testing acquisition and the Schooner acquisition and obviously, we welcome their employee base and are very excited about getting them integrated into our rental tool operations and we see some great prospects there. Because these are relationships that we have built and developed over the course of at least a year and trying to find obviously a transaction that makes sense to the selling parties and to us as well. And again, we think aside from valuation, there is some really good opportunities that we can mutually explore there, and generally speaking, we are always very active. Even though we didn't close acquisitions last year, we are certainly making a lot of contact introductions and we are always trying to make strategic acquisitions, which obviously that takes a little more time to fully assess and analyze opportunities. But, by doing that and laying that groundwork, we are able to execute on a fairly routine basis these types of growth in pull-through acquisitions, and I'll let Bradley just finish with kind of other things that we are looking at right now.

And we are right now in the U.S., we are focused on trying to build out the completion -- production and completion services that we offer, really our rental tools, our isolation tools are really related to the work-over completion and re-completion into the spectrum, much more related towards that and then in the drilling end, we think with the complexity of the wells and some of the high activity levels and the decline rates overall on the gas side, but that can be a very nice growth market for years to come, particularly even potentially in a flat rig count environment. And so, as a result, what we are trying to do is building our service offerings so that from cementing through production, we can offer more and more to our customers, particularly in the shale plays and in the Rockies and in West Texas.

Okay, and then just as a follow on, on the distribution side, there was a consolidation on that front earlier, probably about a month ago. What are you seeing in the -- any dynamics changing on the distribution side in the U.S. market?

You are right, there is -- that we had a lot of supplier consolidation at the mill level and there is beginning to be some distribution consolidation that's going with that, and I think again we view this consolidation as leading to a structurally better market overall, so again, highly supportive of it. But, just generally speaking, those are the macro dynamics and for us individually, if you look at the sequential growth in our tonnage shipped, our margin improvement, the overall reduction in inventory on the ground are encouraging metrics to us as we go into the second half of the year. So, I think all of this plays together in what I view as a structurally better market both at the mill level and the distribution level. I think again, the one other point, the consolidated mills rightfully will be asking for more and more supply capabilities, working capital capabilities from their distribution group. Again, being one of the largest, if not the largest and of course we think have right geographic reach penetration and resources. We think that bodes well for us vis-a-vis overall competitive market positioning.

Okay, now that's helpful commentary. And then, finally, on the Offshore Products side, I know you adjust the revenue side, is there any material mix shifts we should be aware of in the second quarter from a margin perspective, or you think it's pretty consistent?

They are really pretty consistent. Our overall backlog is in great shape, not only in terms of the absolute volume and backlog, but the margins and backlog. We are leveraging really all of our major manufacturing facilities, which -- where you get hurt, where you have underutilization in one significant facility or product line and we are just not seeing that right now. So, our outlook there is very good and again, our challenge is delivering more, faster to our customers and doing so very efficiently. And those are the types of initiatives that we are working on there. There is a few acquisitions we are looking at there, but they are a bit more limited just because of our size relative to the broader markets of competitors that are supplying products and service in the deepwater environment, but there is some one-off small opportunities that we are looking at.

Very good, thank you.

Thank you.

And the next question comes from the line of Jeff Tillery of Pickering Energy Partners. Please proceed.

Hi, good morning.

Hi, Jeff.

Good morning.

In the Tubular Products business, the percentage of inventory committed, I think it's 76% in the press release and it's higher than -- I remember than in the past quarters, is that a strategic decision on your part, or can you provide some color around what's going on with inventories in your distribution business?

Really, Jeff, if we look at our history, I would say that range has been anywhere from kind of 65% to 80% plus or minus in terms of how we strategically manage that inventory, but there is no -- nothing structurally different in how we are marketing now. We did take inventory down, but we are highly focused on return on invested capital in this business and the way you do it is maintaining the most efficient inventory, and I think I told you at the end of last year, we weren't particularly satisfied with our turn rate in that inventory largely because of sluggishness coming from the post-hurricane build-up of alloy product in the Gulf and other things there. So, the message there is good financial management of that inventory, returns on invested capital, and that is a critical part of that segment's goals and objectives. I mean, a lot of the variability in our results is market driven. But, they can perform very well on a return on invested capital basis if they manage that inventory well, and that's really the message from what we've done this quarter. And I applauded them for their success in what they accomplished this quarter.

I apologize if I missed this, but did you give us a volume in terms of tons in inventory, I heard a dollar amount -- within the press release?

I do have that, bear with me one second, Jeff. Our overall value of inventory is $221.7 million, again a 12% decrease from where we were last quarter, but tonnages in inventory is 138,876 tons.

And my next question, you gave some guidance around land drilling utilization in the third quarter. Could you comment on either pricing or expected cash margins?

Right now, we are in a -- the pricing differences that we had quarter to quarter is really more, if we shifted a rig from one market to the other and largely because (inaudible) which is reimbursed by the operator. So, kind of a static plus or minus day rate environment, unless we had differences in our moves. We do think cash margins is going to come up maybe $200,000 or $300,000 a day in the third quarter because we felt like the types of cost increases we had were not fixed. In other words, there were higher variable costs associated with less efficient or longer rig moves, because of operator changes, if you will, as well as some -- more one time R&M on our rigs, so again, a good environment. We had targeted -- we hope to get to more like 89% utilization in the second quarter and we made it up to 83%. A lot of that is kind of switching from operator to operator and wet weather more than anything. But, if we look at our rig chart, which has the customers commitments back to it, we feel pretty confident that we will get -- if not reach 90%, get close to that level in the third quarter with modestly improved cash margins.

All right. And my last question, just maybe asking a little bit differently on the M&A side, you guys have been historically acquisitive, but not made any acquisitions in kind of the past two years up until this month. What is -- anything structural changed, evaluations improved, or is it just a function of opportunities that you came across in the short-term, could you just provide a little more color around kind of what in the end got you back on acquisition front versus kind of a period of at least inactivity in terms of closing deals?

Well, really for us, I mean, we focus on both organic growth and acquisition growth, and as I mentioned, these two relationships have been developed over the course of the year. And 2006 was a bit of a different market, it was a high growth market for ourselves and a lot of companies, and several of these businesses had emerging product service offerings that were growing at a significant rate or projected to grow at a significant rate. And to a certain degree, it's gaining more confidence in the products and the sustainability of the earnings in a high growth environment, which we felt like through the passage of time and the development of our relationships with these companies and their people that it clearly demonstrated their market strength and were viable acquisition candidates. And it goes both ways, they were in confidence in our Company and our ability to serve the marketplace and grow with the Company, when you are selling a business that these entrepreneurs have built generally from scratch over the course of years. But, they are obviously very cautious and they want to ensure that they are selling the business and they are really transferring their employees into good hands. So, generally again, the way we do it, these are not kind of brokered deals necessarily, they are long term relationship based, and we just can't predict quarter by quarter when we are going to close them.

All right, thank you.

And your next question comes from the line of Victor Marchon with RBC Capital Markets. Please proceed.

Thank you and good morning.

Hi, Victor.

Hi, Victor.

The first question I had was just on the accommodations side on oil sands, I am wondering if you could just remind us regarding the expansion, a part of that is going to be in the third quarter and there's going to be one lodge with the rest of it coming in the first quarter of '08, is that correct?

Right, we will, by the end of the third quarter, will have gotten up to the capacity levels at Beaver River and Athabasca that we had previously stated. So, we'll get Beaver River up to -- little over 700 rooms and we'll get Athabasca up to around 1550 of rooms from 1300 now, and Beaver River is around 500 right now. So, that's the expected expansion in Q3 and then we will basically refocus back on Wapasu Creek, which in Q4 will probably add another 200 rooms to bring it up to a little over 750, if we stay on schedule, and then we will have a very busy first quarter as we take that 750 number up to 1350.

What have you guys seen -- have you guys looked at or in discussions on additional needs for rooms up there going forward post what you have on plan, or is it a little bit too early for that?

We are definitely actively looking for new opportunities. I think I have mentioned before that we have been trying to -- one of the big limitations there is land access and we have been trying to target land access rights in the southern portion of the development area we term as the (inaudible) that areas, and we are working currently with the groups up there in terms of gaining lease access and we are optimistic that we will be able to secure future sites there. But, I would say that's the biggest question right now, the customer demand, we had a lot of discussions with and feel very secure that the demand environment is there. The next step would be trying to gain rights to the lease access, which we are actively doing and have some favorable movement on but have not yet secured.

And from a start to finish, if that was successful, what's the time frame for that or would that be?

You'd see us probably commence building early next year, but the other limitation is capacity in our manufacturing facilities, not only ours but the industry as a whole. But, we will be in a better position early 2008 relative to manufacturing capacity as well.

And what would that take, about a year to get fully functional or something less than that or more?

It kind of depends on the size of the facility. We can usually get -- our team does a very good job of meeting their schedules. And as I think you have seen in the past 18 months, and it usually takes about six months from start to kind of an initial operating level. But, to get 1000 rooms or something of that size up and running, you are talking almost 12 months.

Yes, it will ramp up though.

It will ramp up.

As you have seen with our other facilities like Wapasu.

And the last question I have was just quick on the backlog in Offshore Products. Do you guys have a split on second half versus '08 of the $400 million plus of backlog?

I do.

Yes, we just have to grab a piece of paper on that and calculate the percentage. It will start obviously shifting out now that we are at mid-year, but --

About 50% of it is due in the second half.

Okay, I appreciate it, thank you.

Thank you.

(OPERATOR INSTRUCTIONS) And your next question comes from the line of Ken Sill with Credit Suisse. Please proceed.

Good morning, Cindy and Bradley.

Good morning, Ken.

Good morning.

One of the follow-up on the land rig business real quickly, so I can understand the margins being up with more utilization and less moves and stuff. How contracted are your rigs for the rest of this year, and are you seeing any split between kind of leading edge rates? I know you guys are really in kind of a niche, but what's going on with pricing there?

We -- as you know, our rig, we have a handful that are on true term contracts, those are generally in the Rockies as a rule. What we have is a backlog of operator commitments that are generally multi-well for efficiency both from our standpoint and also from theirs, and we base our projections off of those operator commitments, which are -- obviously look very strong or we wouldn't be projecting 90% utilization and most of that variation comes in the Rockies just because it's hard to achieve 100% utilization in that market. Overall, our rates are holding and we don't see any issues there. And again, if you see variability in that average day rates right now, it's not our base rate, it's generally in the variable portion of the moves that factor into that average day rate analysis. But, we feel like our drilling rigs are in a good place right now and a steady state environment -- rate environment.

Okay, and then on your guidance, does that include anything from the recently announced acquisitions, or will that be added to once those deals close?

That does include those acquisitions.

It does?

Yes. We -- I guess the Well Testing was out about a month ago and we are not sure if First Call picked them up or not, but obviously the most recent acquisition on Monday doesn't have that.

But, that -- the one you guys announced this week, when is that going to close or it has?

Today. We got a busy day.

Okay, so that will come into the rental business as in the guidance?

Correct.

All right, and Tubular Services volumes were really good sequentially, do you think the volumes will be there? I mean, you are talking about margins being kind of flat. I mean, I guess you are saying flat to up sequentially, is that a revenue margin thing or is it just kind of similar?

Well, I was speaking to margins on that. The volumes tend to vary month to month sometimes, I must say, all over the place, but we are looking for fundamentally better market, I don't know for exactly if $214 million of revenue, but we are in that general vicinity.

Okay. Well, that's all I have got, thanks.

Thank you.

Thank you.

There are no further questions in queue at this time. I would now like to turn the call back over to Miss Cindy Taylor for closing remarks.

Okay, thank you so much. I won't keep you any longer, but thank you so much for your continuing support of the Company and dialing into the call today, and look forward to working with you in the future. Thanks.

Thank you for your attendance in today's conference. This concludes the presentation. You may now disconnect. Good day.