Tenaris SA (TS) 2003 Q2 法說會逐字稿

Good morning. I am Sue Nutt, Investor Relations representative for Hydril. Welcome to Hydril's conference call to discuss the financial results for the second quarter of 2003. Before we begin, I have a few words about forward-looking statements. To the extent our remarks today reflect our expectations about Hydril's business or performance for any future period, 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 discussed in our annual reports on Form 10-K for the year ended December 31, 2002. Today, Chris Seaver, Hydril's Chief Executive Officer, and Mike Kearney, Hydril's Chief Financial Officer, will make brief presentations reviewing the results for the quarter, which will be followed by a question-and-answer session. Mr. Seaver.

Good morning. Considering market conditions, we had a very good quarter. Revenue was $54.5 million, down 5 percent sequentially and down 15 percent year-over-year. Operating income was $10 million, down 6 percent sequentially and down 19 percent year-over-year. Net income was $6.2 million or 27 cents per diluted share, down from 28 cents last quarter and 32 cents a year ago. For each of our segments, Premium Connection and Presser Control, I would like to review the key drivers and then discuss the operational and financial progress we made during the quarter.

Our Premium Connection business is driven primarily by deep formation drilling and also by deepwater drilling. In the U.S., we look at the deep formation rig count, or rigs drilling at targets deeper than 15,000 feet, and the deep water rig count, measured as rigs under contract in the Gulf of Mexico drilling in greater than 1500 feet of water. In the second quarter, the deep formation rig count averaged 131, up 4 percent sequentially, and the deep water rig count averaged 26, up 4 percent sequentially. Internationally, while the correlation with demand for our products is not close, we look at the international rig count, which averaged 765, up 3 percent sequentially.

For the quarter, Premium Connection revenue was $28 million, down 11 percent sequentially, and operating income was $7.2 million, down 12 percent. These results are primarily due to reduced demand in some international markets due in large part to political instability. For the past two years, Latin America and West Africa have been very good markets for us. However, due to political instability, they have been weaker year-to-date than expected and we see this trend continuing through year end. In addition, although the deep rig count in the U.S. was up slightly in the quarter, this was not reflected in our shipments, as distributors have been very cautious. During the quarter, in order to better serve what we believe will be a growing market in eastern Canada, we purchased a machine shop in Nova Scotia. This strategic purchase will allow us to provide a presence in an area with growth potential.

Safety and quality are very important to us at Hydril. During the quarter, our Westwego facility, across the river from New Orleans, surpassed 1.5 million man hours without a lost-time accident since November, 1997. In addition, The Westwego plant, as well as our Houston and Aberdeen plants, received their renewed ISO 9001-2000 qualifications, so that now all of Hydril's major full-length threading facilities are ISO 9001-2000 qualified.

Moving to the Pressure Control segment, the aftermarket of this segment is heavily influenced by the level of offshore drilling and also by the level of U.S. drilling, so we track this business by looking at worldwide offshore rig count and the total U.S. rig count. In the second quarter, the worldwide offshore rig count averaged 343, up 6 percent sequentially, and the total U.S. rig count averaged 1028, up 14 percent. The capital equipment portion of this segment is only slightly influenced by these indicators. It is much more heavily influenced by rig upgrades and new builds, particularly deepwater rig upgrades and new builds. For the quarter, Pressure Control revenue was $26.5 million, up 2 percent sequentially, while operating income was $5.8 million, up 10 percent. These results are primarily due to higher levels of aftermarket revenue as rig counts have increased and better margins on some specific capital equipment projects as they near completion. Because of the mix of our capital equipment backlog, we expect the operating margins in this subsegment to decline somewhat in the third quarter.

At the end of the quarter, our capital equipment backlogs stood at $19 million, down from $23 million at the end of the first quarter. During the quarter, we received capital equipment purchase orders totalling $7.8 million compared to $3.6 million in the first quarter. Although none of these bookings were a single large order for a deepwater drilling system, we believe it may be indicative of a gradually improving capital equipment (technical difficulty) driven by increased rig activity. During the quarter, we received our first purchase order for two Quik-Loq ram BOP (indiscernible). These units are now in production and will ship this year. We also received two patents for this innovative technology. We continue to see interest in this equipment and we believe there are other opportunities for more orders before year end. On SubSea MudLift drilling, we are working intensively with one operator and we should know by the end of year if we will have sufficient commitment to proceed to build a full system. Now Mike Kearney will review our financial results.

Good morning. As Chris stated, total revenue for the quarter was down 5 percent sequentially. Our gross margin for the second quarter was 40 percent, up from 39 percent last quarter. This increase in gross margin was primarily driven by increased Pressure Control aftermarket revenue. Total SG&A expense was unchanged in the quarter, although corporate administration increased due to the timing and level of certain public company expenses and some tax consulting expense. Operating income was $9.7 million, down 6 percent from last quarter. Operating margin remained unchanged at 18 percent due to improved gross margins on slightly lower sales.

Net interest expense for the quarter was $320,000 compared to $305,000 for the first quarter. As you recall, the remaining $30 million of our private placement debt was due June 30th. We paid it off at that time with existing cash, so our net interest in the second half of the year will reflect the payoff of this debt. Net income for the second quarter was $6.2 million or 27 cents per diluted share compared to $6.5 million or 28 cents for the first quarter of 2003.

Moving to the balance sheet, during the 12 months ended June 30, 2003, the Company repaid $60 million in debt from available cash on hand and is currently debt free. Cash and short-term investments totaled $54.6 million at June 30, 2003. Total stockholders' equity at the end of the quarter was $202 million compared to $187 million at December 31st, 2002. Capital spending of $2.1 million for the quarter was primarily to support manufacturing operations. We are likely to spend 9 to $10 million this year on capital expenditures. That wraps up the financial overview. Now I'd like to turn it back over to Chris for a few comments regarding our outlook for the remainder of 2003.

Turning first to our Premium Connection segment, as I mentioned earlier, the deep-formation rig count and the deepwater rig count were up 4 percent in the quarter. While the deep-formation rig count has been up, the year-to-date increase has not been as strong as many expected and it seemed to stall in the first quarter due in part to some specific operator issues. It was 154 last week, which was well above the second quarter average of 131. We expect the U.S. deep-formation rig count to remain at this new higher level, and, therefore, our U.S. revenue to improve slightly through the remainder of the year. (technical difficulty) end of July and I should note that this increased level of drilling has not yet been reflected in distributor inquiries or orders.

Internationally, while the correlation with demand for our products is not close, we look at international rig count, which averaged 765 in the second quarter, up 3 percent sequentially. We expect our third quarter international Premium Connection revenue to be down significantly, due mainly to lower Eastern Hemisphere shipments. Eventually, we expect our Eastern hemisphere to improve, but not until the fourth quarter. So, overall, we expect our Premium Connection revenue and operating income to be down in the third quarter and then to improve substantially in the fourth quarter.

Our Pressure Control aftermarket business is also tied to rig count levels, primarily the worldwide offshore rig count and secondarily to the total U.S. recount. In the second quarter, the worldwide offshore rig count was up 6 percent, while the total U.S. rig count was up 14 percent. We believe the worldwide offshore rig count will not increase in the near-term, due in part to the number of deepwater rigs rolling off contract between now and the end of year. And we expect the total U.S. rig count to increase at a slower rate in the third quarter. Consequently, our aftermarket revenue should be about the same in the third quarter and the same or slightly higher in the fourth quarter.

Our biggest customers operate deepwater rigs. Their ability to secure adequately profitable contracts for these rigs influences their attitude toward purchasing equipment for upgrades. There continue to be opportunities for capital equipment project orders, but we do not expect any large orders to be placed for deepwater projects before year end. Roughly three-quarters of our capital equipment revenue comes from capital equipment projects in our backlog, which stood at $19 million at the end of the second quarter. Many of our capital equipment projects are nearing completion, with substantially all of them expected to ship (technical difficulty) the end of the year. This existing backlog will result in our capital equipment revenue being up somewhat through the end of the year, but lower in the first half of next year. The combined effect of all of this should result in operating income for this segment being relatively unchanged from the first half for the remainder of the year.

With regards to the Street's expectations, we believe our results for the year will be slightly below the Street's range for the following reasons. We believe the industry activity levels are not in line with current and expected future commodity prices. This continuity reflects the uncertainty our customers have about their businesses and reduces our expectations for near-term results, but increases our expectations for demand for our products in 2004 and beyond, as the deep-formation and deepwater drilling is deferred into next year.

Second, Pressure Control aftermarket sales are highly influenced by rig activity levels. We believe the rates of increase seen recently in the worldwide offshore and total U.S. rig counts are not sustainable. The offshore rig count should be negatively affected by the number of deepwater rigs rolling off contract in the next few quarters. On the domestic side, we believe that the total U.S. rig count will continue to rise, but at a reduced rate. Our aftermarket business levels should reflect this reduced rate of increase. Third, we believe some international markets are experiencing disruption due to political instability and unrest. This weakness will negatively affect our Premium Connection business for the remainder of the year. Operator, we are now ready for questions.

(CALLER INSTRUCTIONS) Jeff Kieberts (ph) of Salomon Smith Barney.

It's Andy Hoffman (ph). I'm trying to understand the disconnect between the deep rig count rising and your not seeing inquiries. Any way to quantify inventory levels at your distributors or what you might expect if you continue to see 150 plus deep rigs? Mark.

We follow as best we can the inventory held by our distributors of our threaded product. And in continuing -- while we thought three months ago that we had reached the bottom of inventory levels, we were mistaken. There continues to be distributor destocking and no restocking or replacing stuff in inventory but no (indiscernible) increases in distributors' inventories based on expected increase drilling. Our distributors are very nervous in general terms. They are following the gas injection rate weekly. And every time it exceeds the previous year's gas storage injection rate, they are all nervous and they are defraying.

Have you seen inventory levels this low even in 1999?

In '99 we didn't keep statistics.

Would you believe that the level now has gotten to anything like that?

It's down where we last saw it in 2001.

Also, if you can talk a little bit about the international issues, we knew that Venezuela has been a problem. For one, you had a big order, which is not repeatable. But can you talk a little further about West Africa and eastern hemisphere being down significantly, because it sounds like this is a relatively material difference from what you had expected maybe three or six months ago.

It is. So first, with respect to Venezuela, let me tell you we had a large order at the end of the first quarter which was paid promptly by Pedavesa (ph) without dunning. And so, we don't expect any material business from Venezuela before the fourth quarter. In general, Nigeria -- you've heard about drill rigs being occupied in Nigeria. In general, drilling in Nigeria has been lighter than we expected, and since they order roughly 9 to 12 months ahead in Nigeria, they have used up the inventory they previously ordered in (indiscernible). The rig counts lower in Nigeria than everybody expected, including the operators. It's like 11 now compared to the 23 that was expected for this time. And so they are using up now inventories that they purchased and that we shipped towards the end of last year and in the beginning of the first quarter. The rest of the Eastern Hemisphere is, as far as our expectations for next quarter, is generally light everywhere. So it's unexpected to us. We expect it to come back in the fourth quarter.

What is generally your biggest international areas for revenues?

It's split up all over. There is no specific market that dominates.

One quick question for Mike. The corporate EBIT line was a bit higher this quarter. I wasn't sure from the way you described it if it's going to come back down or if it's going to stay up at this level?

It should come back down. We are planning that it will come back down to $3.1 million range. However, as I mentioned, we are looking at several tax strategies, and it just depends on the level of pursuing those strategies. But excluding anything we do on the tax front, it should be around 3.1 million for the next two quarters.

Thank you.

Rob McKenzie (ph) of Friedman Billings and Ramsey.

Good morning. Kind of a follow-up question to what Andy got at. In prior calls, you have given some range of earnings guidance. I think the last guidance was $1.24 to $1.30. Would you care to comment on how your revised outlook here for the different segments of your business impacts your prior guidance range.

Without getting into specific segments -- I mean, I think Chris already went over that in terms of the general guidance. But the range of the Street was $1.20 to $1.30 yesterday. And we're saying that we think that we will be below that range, meaning the low end of that range, but probably only slightly. I think -- it's a slippery slope to give specific guidance, but let's just say $1.20 seems to be the high end of the new range, but hopefully not too much below that.

Fair enough. Switching more towards the capital structure, recognizing that you are now fully debt free. Can you explain to us your strategy for going forward in terms of where you see your capital structure evolving over the next year and what drives it there specifically? Do you have any acquisitions planned in particular or something in the works and/or are you reconsidering dividend and/or possible share buybacks?

We're looking principally to reinvest in new, superior products, first, internally, and secondly by acquiring product lines that are closely related to our existing products that have superior performance and technology differentiation. You remember that we reorganized the management of the Company in June in order to be able to better do this. And so at this time, we are -- the Board is not considering buybacks or dividends, but will readdress that issue next year.

Could you comment on where you see the internal opportunities taking place? SubSea MudLift drilling was an area that held out some hope in prior periods, but it looks like that may be longer time in developing than some thought. Is that part of the area or are there other areas that are up and coming we should know about?

That is one area and we should know by the end of the year whether that will be a significant use of cash. In addition, we have R&D projects on both halves or sides (ph) of our business which we don't quantify. And we are beginning to look at product line acquisitions or extensions related to our existing business, but we don't have anything to report at this time.

We know -- you've asked this question before in terms of the use of cash. And to be honest, we certainly would like to grow both internally as well as externally. But a phrase that we use around here, we are not going to become garbage collectors. We are going to have high-quality acquisitions. Of course they are tough to find. But we see pitch books all the time and we just haven't seen anything yet that drives us to make a move.

Thanks very much.

Ken Field (ph) of Credit Suisse First Boston.

Good morning, guys. Couple of follow-ups on the stuff that we've been talking about here. You know, with the deep rig count in the U.S. actually ticking up here and hoping that will hold in -- I think everybody has been unpleasantly surprised by the lack of high margin activity -- how quickly in the past and how quickly do you expect in the future the orders to come back on the Premium Connections business? Is this something that could happen relatively quickly or do you think this is going to be a relatively measured response from the distributors as they see the activity picking up and sustaining?

In the past, when the sentiment in the industry was uniformly positive, the pickup would have happened concurrently -- the pickup and demand from our distributors would have been concurrent with increase in the rig count. These days, the sentiment in the industry is not uniform, not uniformly good. There are a lot of people who are worried about commodity prices for the future. I believe even you cut your estimate, didn't you, for gas price?

Yes, we did.

So that is making distributors nervous, very nervous. So we would have expected it by now. The rig count started up at the beginning of June, and was 148 or something like that -- 140 something at the end of June, and now it's 154. And by all rights, the increase in demand from our distributors should have started already. It can turn on a dime. I think one-- my personal view is one or two weeks of warm weather in the South East and Midwest will flip the gas injection numbers over and everybody will be happy again. But it hasn't happened yet. So we are surprised and it continues to be deferred. We don't know the answer.

Did you ever think you'd be unhappy with the gas price in the $3.50 to $4.50 range?

No, I thought we'd be rolling in clover right now. I'm stunned.

On the Quik-Loq orders, that sounds like that's progressing pretty nicely. Last quarter, you said you might get some orders; now you've got a couple. How significant or how big are the Quick-loq orders in terms of revenue, or do want to share that with us?

We are not going to give the exact number, but they are not material. Please remember that on a project basis, 3/4 of our business is projects. We have a revenue potential for a deepwater rate of something in the 16 to $18 million range, and for a jackup it's a fifth of that. And so the order that we got for two Quik-Loqs is a portion of a jackup order. So it's not going to knock your socks off, or ours, unfortunately.

It's better than a stick in the eye, right?

Much better than a stick in the eye, and we love our customers and all of the business they give us.

So essentially what you're saying is that Q3 could get pretty ugly here -- ?

On the Premium Connections side, the Q3 is going to be down.

And then Q4 recovering?

It should recover, yes.

And then next year really depends on the follow-through on everything?

Yes.

One final question for Mike. Depreciation, is that going to be flat, go up a little bit in the second half?

That should be flat, pretty much at the run rate we set, 12 to 13 million for the full year. We were two down (ph) for each of the first two quarters. It should tick up just a little -- 3-1, something like that. Essentially flat, but up very slightly.

Thank you.

(Indiscernible) of Simmons.

Actually this is Scott Gill (ph) with Simmons & Company. Mike, with respect your earnings guidance here kinda below the 120 mark that consensus has. If we look at the first two quarters, that's about 55 cents in earnings. If we're lower here in the third, let's call at 25. That gets us to 80. That would imply a pretty robust recovery in the fourth quarter of maybe 35 cents or more. Is that what you're indicating or does that seem a little bit strong for fourth quarter?

That's basically the way the math works. And does imply things really clicking in the fourth quarter. That is our anticipation right now. It does take some things to change in the marketplace.

It takes the deeper count to be (technical difficulty) hang in there and the distributors to buy to replace their inventory.

And on the international Premium Connection side of the business, while we're seeing some bookings for the fourth quarter, things have to happen. The pipe has to show up, the rigs can't be occupied by terrorists -- things have to happen. But overall, we believe it is a realistic scenario that we can have a very strong fourth quarter.

And how do people like us monitor the progress of that? We look at the deep rig count and see that it's up, but how can we monitor whether or not the distributors are actually ordering pipe from you or buying pipe and what's happening in the international markets? How do we monitor that from -- ?

On the international market, it's impossible. Let me rephrase that. If you hear about Civil War in Venezuela and Nigeria, that is a tip. But absent something egregious like that it's impossible to do because the markets are very specific and there is no general indicators. There are no general indicators.

And then my last question, if we look at the margins in Premium Connections U.S. versus international, which segment has the better margins and can you kind of give us a feel for what the spread and margin is between international and U.S.?

It varies a lot by specific markets and we'd like not to go into the detail.

Fair enough. Thank you, gentlemen.

Gary Russell (ph) of Steifel Nicholas (ph).

Good morning. Several of my questions have been addressed already. A couple of quick ones. You mentioned, Chris, that you would expect Venezuela specifically to pick up in the fourth quarter. Do you have visibility on that or is that kind of speculation along with the rest of the Company in general?

We expect it to pick up some -- not to the level of the first quarter. But we have some visibility on it. We are talking to people, they say they are going to buy, but we do not have the purchase order in hand.

Gotcha. That's helpful. And Mexico, can you comment on that at all? How are things going for you there?

Mexico is getting better and better. We just upgraded our most recent internal estimate for the remainder of the year for Mexico. It looks like business is strong there and continuing to get better.

Okay. Back to the international disruptions in the second quarter and through the rest of the year. Can you quantify that for us to any degree, in terms of percent of revenues or cents per share, maybe the combination of Nigeria and Venezuela, how much of that hurt you?

No, I don't have that detail with me. Even if I did, it's too much detail to give out.

Lastly, the other income line, was that primarily foreign exchange?

No, the other income line is real estate -- it's (indiscernible) nonoperating real estate and we sold a small piece of land in Louisiana, surplus excess property, and had a gain of about $140,000.

Last question, back to the point of the distributors -- the pipe distributors slowing down some of their purchases, can you give us a feel for when that behavior began to change? Did that impact second quarter at all or was that shift more recent? And that's all I have.

It impact -- our expectation was that demands (technical difficulty) would parallel the rise in the rig count. And the rig count started up in June. And contrary to our expectations, distributors destocked in June rather than restocked. We are now at the end of July and still no sign of restocking. So that more threaded pipe, more of our Premium Connections are going in the ground every month than we are shipping. So we expect it to turn around anytime, as long as there is a positive outlook, generally speaking, in the industry. As long as there is a lot of question about the future price of gas, and spot pieces of information about people cutting back, like Anzaraco's (ph) recent announcement -- it makes the distributors very nervous because they are investing capital and they are expecting to turn that inventory 3 or 4 times a year, and if they can't do it, they can't make money. So the answer is, any time now we think, but we can't guarantee it.

And the negative impact beginning back in June?

Yes.

That's all I have. Thanks very much, guys.

Jeff Kieberts with Salomon Smith Barney.

Hi, it's Andy again. I'm going over what you are saying with the guidance. Now, let's say we are down significantly and let's say it is 25 cents, like Scott said. That would imply to get to $1.15 to $1.20 that you need to do 34 to 39 in the fourth quarter. And given what you said about the offshore rig count, I'm having trouble seeing how that would happen. Can the Premium Connection business improve that much that even on flat rig counts offshore you can get that high?

So let me just (indiscernible) ... we expect our Pressure Control segment to be flat. We expect our Premium Connection segment to be down in the third quarter and then up substantially in the fourth quarter.

And that would be because of the restocking by the distributors for the most part?

Yes, they will finally -- well, offset, that is, they will start to buy pretty soon and that by the fourth quarter, they will be buying at least at the consumption rate and the international business will have returned.

So it's also an international business --

Correct.

This is not based on the politically sensitive areas; it's just based on the areas have been relatively weak activity?

Specifically, we expect the eastern hemisphere to be weak in the third quarter and then come back.

Thank you very much.

That concludes our second quarter conference call. Thank you for your participation.

This concludes today's conference call. You may now disconnect.

(CONFERENCE CALL CONCLUDED)