Oil States International Inc (OIS) 2009 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Oil States International second quarter earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note that this conference is being recorded.

I will now turn the call over to Mr. Bradley Dodson, Vice President and Chief Financial Officer. Mr. Dodson, you may begin.

Thank you. Welcome, everyone, to the Oil States second quarter 2009 earnings conference call. Our call today will be led by Cindy Taylor, Oil State's President and Chief Executive Officer.

Before we begin, we would like to caution 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, and thanks to all of you for dialing in to our call this morning.

During the second quarter, the combined strength of our accommodations and offshore products business helped support our results in the second quarter given they are longer-term contracts and backlog in support of multi-year oil-related projects. These two businesses comprised over 80% of our segmental EBITDA and collectively delivered year-over-year growth, partially offsetting what was a very difficult quarter for our North American natural gas leveraged businesses.

North American drilling and completion activity continued to deteriorate in the second quarter of 2009, with the rig count down over 50% year over year and 39% sequentially. These lower activity levels have led to a decrease in demand for our land drilling services, for our oil country tubular goods and for our rental equipment, hurting both utilization and pricing.

We have taken considerable measures to address our cost structure in light of these changes in North American activity. We have significantly reduced our headcount in those businesses and have implemented pay freezes or pay reductions. In addition, we are aggressively reducing working capital and have reduced our capital expenditures significantly.

Excluding the goodwill impairment charges discussed in our earnings press release, Oil States generated revenues of $456.3 million, adjusted EBITDA of $60.2 million, and earnings per share of $0.42 for the second quarter of 2009.

During the second quarter, we were successful in closing a joint venture in Brazil with Uniao Engenharia in support of our activities with Petrobras. The joint venture will leverage the strong local manufacturing expertise, relationships and facilities of Uniao, while making Oil State's innovative deepwater technologies more readily available in the region.

We were also successful in securing a CAD 30.2 million contract with the Canadian Department of National Defense in connection with the 2010 Vancouver Olympics.

Our liquidity position has continued to improve with profits from operations, working capital reductions and adjustments made to our cost structure and capital spending.

Throughout the remainder of this call, we will update you on our financial results and market outlook. At this time, Bradley will take you through more details of our consolidated results and financial position, and then I will conclude our prepared remarks with a discussion of each of our segments and close with our market outlook.

Thank you, Cindy. Throughout this call, we will be excluding the $94.5 million goodwill impairment charge taken in the second quarter of 2009. During the second quarter of 2009, we reported operating income of $31.3 million on revenues of $456.3 million. Our net income in the second quarter of 2009 totaled $21 million, or $0.42 per diluted share.

The comparable second quarter 2008 results were $91 million of operating income on revenues of $631.4 million. The year-over-year decreases in profitability were primarily due to the 50% year-over-year decline in North American drilling activity.

Depreciation and amortization in the second quarter of 2009 totaled $28.6 million, compared to $25.7 million in the second quarter of 2008. This increase was due to CapEx and acquisitions made over the last 12 months. D&A is expected to be $29.1 million in the third quarter of 2009.

Net interest expense totaled $3.9 million in the current quarter and $5.2 million in the second quarter of 2008. Third quarter net interest expense is expected to be $3.6 million.

The effective tax rate in the quarter was a tax benefit of 5%, compared to a tax expense rate of 33.8% in the second quarter of 2008. The current quarter benefit was negatively impacted by the nondeductible portion of the goodwill impairment charge. Excluding the goodwill impairment, the effective tax rate in the second quarter would have been 24%, which was lower than the second quarter of 2008 due to proportionately higher foreign net income, which is taxed at lower statutory rates, coupled with the domestic benefits derived from estimated tax losses. We expect the effective tax rate for the second half of 2009 to be approximately 21%.

During the second quarter, we reported cash flow from operations of approximately $173 million and spent approximately $20 million on capital expenditures. As a result, our net debt at the end of the second quarter came down to $188 million, compared to $342 million as of March 31, 2009.

As of June 30, 2009, our debt-to-cap ratio was 16% and our total debt-to-LTM EBITDA was less than one time. As of June 30, 2009, the Company had over $400 million available under its credit facility. Our current CapEx forecast for 2009 is $137 million, which is down 45% from the $247 million spent in 2008.

At this time, I'd like to turn the discussion back over to Cindy, who will review the activities of each business segment.

Thank you, Bradley. Our well site services segment generated revenues of $152.9 million and EBITDA of $40.7 million in the second quarter of 2009, compared to $230.8 million and $73.3 million, respectively, in the first quarter of 2009. The sequential declines in revenues and EBITDA were primarily due to normal seasonal declines in Canadian activity associated with spring break-up coupled with significantly lower US drilling and completion activity.

On the positive side, we continue to enjoy strong utilization levels in our major oil sands lodge facilities. During the second quarter of 2009, accommodations generated $88.4 million of revenues and $34.8 million of EBITDA, which were up 9% and 34%, respectively, from the second quarter of 2008. Our current quarter results benefited from increased oil sands accommodations capacity, particularly at our Wapasu Creek facility.

Excluding the goodwill impairment charge, our rental tools business generated $53.6 million of revenues and $5.7 million of EBITDA in the second quarter of 2009. Our rental tool business was negatively impacted by the precipitous decline in North American drilling activity and certain customers' decisions to postpone well completions. Reduced activity coupled with pricing pressures led to the 58% sequential decline in EBITDA.

Our drilling revenues and EBITDA were $10.9 million and $200,000, respectively, compared to $17.3 million of revenues and $3 million of EBITDA generated in the first quarter of 2009. The sequential decline in revenues and EBITDA was primarily the result of reduced utilization in each of our three primary drilling markets, with overall utilization decreasing to 21% from 32% in the first quarter of 2009. However, activity appears to be improving in the Permian Basin starting in late June, and day rates appear to be stabilizing as well, albeit at lower levels.

In our offshore products segment, we reported revenues of $122.5 million and EBITDA of $20.3 million in the second quarter of 2009. Revenues decreased 4% sequentially, due primarily to reduced elastomer revenue, which is more directly tied to overall US drilling activity, and a lower drilling and connector products sales.

EBITDA margins declined sequentially to 16.5%, from 18.7% in the first quarter of 2009. The second quarter margin was negatively impacted by $1.2 million of foreign exchange losses, compared to $800,000 of foreign exchange gains realized in the first quarter. In both quarters, the foreign exchange activity was primarily related to movement in the US dollar relative to the pound sterling.

Our backlog at June 30, 2009, declined 5% sequentially to $303 million, due primarily to the cancellation of a anchor handler, towing, supply wench order. However, net new orders received in the second quarter increased to $108 million, up 29% from the $84 million of orders received in the first quarter of 2009.

In the tubular business, year-to-date industry OCTG consumption is about 30% below the same period a year ago. However, industry prime pipe inventories have fallen approximately 244,000 tons over the last quarter given US mill production curtailments and lower import volumes. However, industry inventories still remain at approximately a 12-month supply on the ground, which is continuing to pressure pricing and margins.

For the second quarter of 2009, our tubular services segment reported revenues of $180.9 million and EBITDA of $6.8 million. Revenues decreased 41% sequentially, due primarily to decreased US drilling activity and lower overall OCTG pricing. Our gross margins were 5.3%, compared to 8.7% in the first quarter of 2009.

Now, if I could, I'd like to transition and give you some thoughts as to our outlook going into the third quarter. As it relates to our North American natural-gas-driven businesses, activity in our drilling markets continued a decline in the second quarter.

However, as you will recall, approximately two-thirds of our drilling rigs are tied to oil-related activities. With higher oil prices, we have seen some improvement in our Permian Basin drilling operations early in the third quarter of 2009. We currently have 15 rigs running in total and are forecasting utilization levels of 36% in the third quarter of 2009.

Activity for our rental tool business is primarily tied to completion and production services activity in North America, and will generally track movement in the rig count. As a result, we expect rental tool revenues to stabilize in the third quarter at levels in line with our second quarter actuals.

Likewise, shipments of oil country tubular goods from our tubular services segment should follow trends in the US rig count. Industry OCTG inventories are beginning to decline, but remain at an historically high level of roughly 12-month supply on the ground.

Domestic mills continue to significantly constrain production, and imports are beginning to decline. Second quarter imports were estimated at 386,000 tons, down 63% from the first quarter of 2009. However, given the continuing overhang of pipe on the ground, we expect the OCTG distribution market to remain very competitive throughout the remainder of 2009. As a result, we are currently expecting that our gross margins in tubular services will approximate 3% to 5% in the third quarter of 2009.

In our accommodations business, we continue to work diligently on negotiations with Esso Imperial on the Kearl accommodations contract. In the meantime, we have secured short-term contracts with Imperial for approximately 835 beds for six- to nine-month term at our existing lodge facilities. These short-term commitments are likely to expand in terms of headcount as Imperial ramps up their activity levels, and will be replaced by longer-term contracts if we are successful in our negotiations.

In our offshore products segment, our backlog remains at healthy levels with continued good mix and margins. However, our backlog declined 5% from the first quarter of 2009, primarily due to the wench cancellation that we mentioned earlier.

In terms of our outlook, we believe that the activity curtailments will help the industry work through the excess gas inventory over time. However, the third quarter 2009 will continue to be negatively impacted by lower drilling and completion activity in the United States. In the near term, our oil sands and deepwater exposed businesses will continue to drive our profitability and our capital allocation decisions.

Overall, we are in a good financial position with a strong balance sheet, and remain ready to expand our operations when opportunities arise.

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

Yes, thank you. We will begin the question-and-answer session. (Operator instructions). The first question comes from Arun Jayaram from Credit Suisse. Please go ahead.

Yes, good morning, guys. Nice quarter.

Thank you, Arun.

Cindy, I was wondering if you could comment a little bit on your expectations for rental tool margins. You did mention that you expect this segment to be stable -- or you're seeing things stable today, but could you give us a sense of where you think margins could look like for the third quarter?

Yes, I'll kind of give you a little bit of a feel for that. What we experienced in the second quarter, of course, was significant activity declines, utilization declines, and it really was evident in the month of May, the significant impact that that had also from a pricing perspective. There's a lot of discounting going on relative to our price book, and our May results really showed -- reflected that.

We've been continually making cost-savings measures and adjustments in the business, and we had to step that up just a bit mid-quarter. And what we're looking at going into the third, we feel like a lot of that rate of decline, if you will, in terms of activity is behind us. I don't know whether I can say price has stabilized, but certainly that rate of decline has trended downward at this stage.

And so what we're looking at going into Q3, particularly with a flat-to-improving rig count, would be that we can mirror, if not slightly improve, our results in that business segment given some of the unusual items that hit us in that particular quarter. So our margins -- we tend to look at EBITDA margins, and it looks like for the second quarter our EBITDA margins were 10.6%, and I would say we'll be flat to up from that level if things play out, I think, in Q3 as we expect they will.

That's helpful. Given the -- you secured some work on a temporary basis with Imperial. Would you anticipate your results in accommodations, obviously excluding seasonal factors, to be kind of consistent with what you had last year, with a little improvement?

I'm sorry, would you repeat that?

You mentioned that you received some short-term work from Imperial for 835 beds for six to nine months. Based on that award, do you expect for accommodations, considering, obviously, seasonal factors, to be consistent with what you did last year on a year-over-year basis?

I'd honestly have to go back in last year and just be sure that the mix hasn't changed appreciably, Arun. What we're looking at right now, of course, is the third quarter -- you're coming out of break-up, but you don't have a lot of the seasonal business contributing to you. And our mix is probably somewhat comparable, although we've got expanded capacity, particularly at that Wapasu Creek facility. So, I'd almost have to go back to last year, because a lot of times we can have a different mix in there that --.

Well, I think one of the biggest factors that'll hurt us year over year will be the currency, so you've kind of got a 10% pickup year over year just based on that. And then I think, in my opinion, that the conventional business has been -- the non-oil sands business has been very difficult this year. I think part of the reason we did -- the margins were as strong as they were in the second quarter was that the team up in Canada has done a great job of adjusting their cost structure quickly and not allowing that conventional business be such a drag on margins. And I think it's a little bit of mix, given that conventional is down and you've got higher-margin oil sands work playing a bigger factor.

So, I would say, absent the currency, I think we could show some improvement year over year. I think with the currency movement and having kind of a 10% headwind, so to speak, I think it'll be difficult to show year-over-year improvement.

That's helpful. And just to -- can you give us, Bradley, for Q2 what the revenue was from oil sands and the EBITDA contribution just from oil sands?

Sure. For Q2 '09, oil sands accommodations generated $71.2 million of revenues and $35.6 million of EBITDA.

Okay. Just a couple other questions. Did I hear the tax rate correct? For the back half of the year, you guided to a tax rate of 21%. Did I hear that --?

That's correct.

And is that 21% sustainable through 2010 if the mix between foreign and US mix is similar?

No, it should be in the high -- if the mix between foreign -- this is purely a preliminary estimate, but -- because we haven't gone through that, the normal process to forecast that. But I would guess if the mix was the same, we'd be in the high 20s in terms of 28%, 29%, 30% effective rate for 2010, assuming the foreign/domestic mix was the same, where some of the deferred tax benefit from the goodwill impairment is flowing through in the back half of the year, which is what's impacting that rate in the second half.

Okay. My last question is -- Cindy, you've obviously put some rigs together -- put them back to work in West Texas. Are the margins similar to what you had in the June quarter, or are they a little bit better than that?

Well, the June quarter was a tough quarter because of utilization. As you'll recall, that's 21%, that hurts us from a cost absorption perspective. So, going back, I don't know where we floored, but there was a time we might have worked anywhere from seven to eight rigs, so 15 rigs back to work helps us from a cost absorption perspective as we go forward.

So, with that -- albeit, pricing has declined as work has rolled off, so you have a combination of some price declines, but I think that will be mitigated by improvements, obviously, on the absorption side with a higher number of rigs working. So, if you look at our EBITDA contribution percentage, we would expect that to be up somewhat from what we experienced in Q2.

Okay, that's helpful. Thank you, guys.

Thanks, Arun.

The next question comes from Stephen Gengaro from Jefferies & Company. Please go ahead.

Thanks. Good morning. Two things to follow up on. One, on the offshore product side, you had that -- it looked like a pretty healthy order flow in the quarter. Can you kind of give us an update on what you're seeing right now and your outlook there?

I certainly can, Stephen. We did have a pretty good order flow, and we looked at a lot of the backlog additions that we had during the quarter, and it's very high quality. We had some continuation of awards of drilling rights or flex joints (inaudible), which is some of our high-end work. We were awarded (inaudible) on a very good order out of Petrobras in Brazil on the Tupi project. And we also had some production-related infrastructure for BP and other connector products that came in. So, all of those things tend to be good backlogs for us.

We had gone through a period of backlog declines from peak activity that was realized in 2008, as you know. And we have been, obviously, aware that there have been several project deferrals and rebidding more than anything else, I would say, given the massive issues that have occurred in the economy, along with reductions in steel prices and other things.

So, we believe that there's a significant backlog of key project potential out there. It has been my view that a lot of that is likely not to be awarded until later this year or early 2010, but there's certainly a lot of bidding activity going on.

So, we have long-term optimism, as you know, for this business. There will be some near-term declines, not only for us, but for other competitors in the space, just given this lag of awarding activity that started somewhere around the second, third quarter '08. But, again, the longer term -- I think it's as positive as it can be. But most everybody in this business has experienced some level of backlog decline over the last six to nine months.

And as a follow up to that, can you give us a little bit more color on this arrangement you have in Brazil and how that impacts your position there?

I can. Obviously, Petrobras is a major player in deep water with their activity. They've done a very successful job outlining their five-year plan and getting funding for that five-year plan. We've had a longstanding presence in Brazil, but most of that has been on the repair, remanufacture and service side of the business, working for major drilling -- international drilling contractors, although we've also had work on the production infrastructure side generally for companies like Shell and others. And so we've worked for Petrobras as well.

As you know, they have a significant push for local country content and development in-country, and we both believed and felt like we would not be as effective with our product offering without a greater presence in Brazil as it related to the sub-sea side of the business. We have been looking for a partner for the last, I'd say, two years, and had developed a longer-term relationship with Uniao in-country and have previously operated under a teaming agreement in close contact with Uniao and Petrobras. And clearly the preference was a more formal arrangement via the joint venture.

This whole process led to us being awarded two projects within the last six months or so, one being the (inaudible) [Maceio] project, and the other recent one is Tupi. We were awarded those under the teaming arrangement and will be supplying our content. And what we've booked into backlog currently is our content on those projects. Uniao has separate content, largely associated with more fabrication and integration work. The higher technology portion of the projects will still be done by us in our Houston-based facilities.

Over time, that will develop and grow into more of a joint venture bidding process with close interaction with our partner in Brazil.

Okay, that's very helpful. And then just one follow up on the tubular side. Is there -- I'm just trying to think how to phrase this, but is there a mix issue where -- if you look at the inventory on the ground right now, is -- I know the number is extremely high, but does that number include enough type that people actually need and want, as opposed to lower end product? And is there any impact there on your business?

Well, right now there is a lot of inventory on the ground, but if there is any kind of firming, it would be on the alloyed premium grades, as you would expect. A lot of that may be P110, heavy wall material, special grades yields, connectors, et cetera, that are not always readily available in the marketplace, and I suspect that's what the US mills are -- what work they have right now is probably along those lines, some of the more commoditized products. There's plenty of that around.

Okay. Thank you.

(Operator instructions). The next question comes from [Dmitry Dyan] from Goldman Sachs. Please go ahead.

Good morning.

Good morning.

Good morning, Dmitry.

I wanted to follow up on the tubulars. Looking at that in '99 and in 2002, margins in this -- operating margins in this business actually were negative, and considering that we're still working through higher priced inventory, do you think that as the cycle goes on, we could potentially see negative operating margins again or something is structurally different now?

I don't have my '99 and '02 numbers in front of me. What I can tell you is we've never had a negative gross margin that I know of, even for a quarter, certainly not for a year. I don't know what you're referring to as operating margins. We also don't carry much depreciation in this business. So I'd have to go back and see what those numbers actually were. But, the key for us obviously is trying to maintain gross margins that are positive, which thus far, in an extremely difficult environment, we've always been able to do. We've prided ourselves on our long history in this business, and we -- to date, we've never taken an inventory write-down, which would be suggestive, obviously, of a difficult -- more difficult market than we see.

If your comments were right, I can tell you 1999 was a tough market. It was also before this company was taken public. So, I'm not sure what numbers you're looking at, because that was previous private ownership. We were public in February of '01. '02 was a weaker market for sure, but many things have changed since that time in terms of industry consolidation, a lot of which we did during the period 1999 -- or the former owners of this business did in 1999, where we took four preeminent distributors of oil country tubular goods and combined those in the summer of 1999.

In addition to that, the supply forces have consolidated very significantly, as you know, over the last couple years, so I do think there are some differences in the marketplace today than what existed dating back to 1999.

Okay, thank you.

The next question comes from David Griffiths from Copia Capital. Please go ahead.

Hi, guys.

Hey, David.

Could you talk for a minute about how much of your inventory or forward kind of committed buys from the mills are kind of backed by purchase orders? I think in the past you sort of talked about 80% to 85% is actually backed by legally binding purchase orders. And then could you also talk about pricing in tubulars and how we should see that flow through your P&L as you work off some of these purchase orders and then you sort of have to sell more in the stock market, where it seems like pricing is kind of in the mid to high teens type level?

I will attempt to answer that, and please follow up if I've missed anything. The way that we look at the business, we don't really isolate on forward purchase orders. However, I'll tell you we're not buying speculative inventory, so that's a very high percentage number. The way we look at it is inventory on the ground plus in-transit inventory plus forward purchase orders to evaluate our exposure against existing commitments that we have with our customer base.

That percentage encompasses all of those pieces, and it's either -- I think it was 79%, is my recollection, for the quarter, which is down a little bit from the earlier level of roughly 85 I think that we entered the year, as you would expect given that most of what was being bought in the first six months were people that had already made commitments and were taking pipe that they were already committed to take.

Right.

There was very little speculative type buying that occurred during the first six months. So, we feel as good as we can with that roughly 79% committed inventory, and we're working through not only our excess but excess industry inventories to get this into a better balanced market over time. We have publicly stated that we think it'll take us at least through the end of the year, given that there's 12-months' inventory on the ground to get there.

Okay. And then could you comment on how we should see pricing flow through the P&L maybe for the rest of the year as the stock market for OCTG is kind of in the $1,500 to $1,700 a ton range? Can you kind of talk about what you think you'll see flow through your P&L, as some of this inventory on the ground that's already committed will probably sell at higher prices than currently on the stock market, I'm assuming.

I think if I hear you're question correctly, you're right, the commitments that we have in place are purchase orders, so they're binding commitments on our customers. As a rule, they're going to be higher than what a distressed sale -- most of what you see today, there's no standard mill pricing out there because there's very little production, so most of what you see are distressed sales of pipe. But, yes, I realize price should be higher, as long as those commitments continue to be honored as they have been, and so I would definitely see that.

Again, earlier on the call, we guided to gross margins in the 3% to 5% range for Q3. This is a very spot-based business, so it's hard for me to even give you much beyond that for Q3. I wouldn't be ready to give you Q4 until we see market conditions at that time.

Okay. And then finally, do you have any thoughts around the amount of Chinese imports that are still sitting on the docks in Houston? I've talked to some industry observers, and they've sort of commented that, yes, while there may be 12 months of inventory on the ground, maybe a quarter of that will never actually get put in the ground because it's lower quality Chinese pipe that people don't really want. Do you have any thoughts around that?

Actually, Chris Cragg, who runs that business, is in the room with me. I'm going to ask him to address that question.

Yes, I think you're exactly right. There are some industry observers who have watched the Chinese imports and the pipe that's actually on the ground. We've seen a lot of that pipe not be properly stored, not be properly maintained. And I agree with you, I think there is a percentage of that that will not be run a down hole.

We're starting to see in the marketplace some differentiation between the Chinese mills as far as what customers will accept. And so I think we'll continue to monitor the impact of the trade suits and, again, to see which of that pipe on the ground will actually be run. And I think all those factors are going to help stabilize the overall overhang that exists today.

Thanks, guys. Thanks very much.

Thank you.

Thanks, David.

There are no additional questions at this time. Please go ahead with any additional comments.

Well, I just want to thank all of you for dialing in to our call this morning. I know it's a very busy day in terms of earnings release, and so we appreciate your attendance. Thank you so much.

Thank you for participating in the Oil States International second quarter earnings conference call. This concludes the conference for today. You may all disconnect at this time.