Civeo Corporation (CVEO) Q2 2014 Earnings Report, Transcript and Summary

Welcome to the Civeo Corporation's Second Quarter 2014 Earnings Conference Call. My name is Hilda, and I will be your operator for today. [Operator Instructions] Please note that this conference is being recorded. I will now turn the call over to Ms. Carolyn Stone. Ms. Stone, you may begin.

Thank you. Good morning, and welcome to Civeo's Second Quarter 2014 Earnings Conference Call. Our call today will be led by Bradley Dodson, Civeo's President and Chief Executive Officer; and Frank Steininger, Senior Vice President and Chief Financial Officer. Before we begin, we would like to caution listeners regarding forward-looking statements. To the extent that our remarks today contain information other than historical information, please note that we are relying on the Safe Harbor protection afforded by federal law. Any such remarks should be weighed in the context of the many factors that affect our business, including those risks disclosed in our Form 10 and other SEC filings. I will now turn the call over to Bradley.

Thank you, Carolyn. Good morning to all of you and thank you for joining us today for Civeo Corporation's initial earnings conference call as an independent company. On the call today, I'll provide an overview of the second quarter results. Frank will walk through the specific results of the quarter, and then I will discuss each segment and the near-term outlook, concluding with an update of our strategic initiatives, including our evaluation of a possible REIT conversion. We reported second quarter results last night that were in line with our guidance. On a sequential basis, our Canadian segment reported results that reflected seasonally lower activity levels for the mobile and open camps with the Canadian spring break-up and modestly lower occupancy levels at the Canadian lodges. Our Australian segment reported results that reflected the expected softer occupancy levels due to the current mining environment there, partially offset by increases in the Gunnedah Basin at our Boggabri and Narrabri Villages. Our U.S. segment's results were lower sequentially, primarily due to third-party sales, but adjusted EBITDA increased due to improved mobile and open camp activity. On a consolidated basis, we reported revenues of $227 million, adjusted EBITDA of $77 million and adjusted EPS of $0.30 per diluted share. In addition, we recently announced our first quarterly dividend payment to be paid on August 29 to shareholders of record on August 15. At this time, Frank will walk you through the details of our consolidated results and our financial position. Frank?

Thank you, Bradley. During the second quarter of 2014, we reported operating income of $16.2 million on revenues of $227 million. Our net income for the second quarter of 2014 totaled $13.9 million or $0.13 per diluted share. This included the following items: a $0.12 per diluted share after-tax loss from transition costs, debt extinguishment costs and an impairment of an intangible, all of which were incurred in connection with the spin-off from Oil States; a $0.03 per diluted share after-tax loss from severance costs associated with the termination of an executive; and a $0.02 per diluted share after-tax loss from the impairment of assets that are in the custody of a nonpaying customer in Mexico, for which the return or reimbursement is uncertain. Including -- excluding these costs, adjusted operating income, net income and earnings per share would have been $33.8 million, $31.9 million and $0.30 per diluted share, respectively. These results compare to operating income of $51.6 million on revenues of $243 million in the second quarter of 2013. Our net income for the second quarter of 2013 totaled $33 million or $0.31 per diluted share. In the second quarter, we recognized a tax benefit of $4.9 million that resulted in an effective rate of a negative 52.4% in the second quarter of 2014 compared to an effective rate of 25.4% in the second quarter of 2013. The difference in our effective tax rate from the prior year was largely due to the reduction in our estimated effective rate for the full year of 2014 to 14.6%, resulting from the change in earnings mix from our different tax jurisdictions and the impact in our corporate structure as a result of the spin-off from Oil States. Our gross and net debt levels totaled $775 million and $490 million, respectively, at June 30, 2014, representing a debt to capitalization ratio of approximately 37%. Our leverage ratio was 2.1x at June 30. During the second quarter of 2014, we reported strong cash flows from operations of $155 million, and we invested $142 million in capital expenditures, the largest component of which related to the newly constructed McClelland Lake facility in Canada. As of the end of the second quarter, we had total liquidity of approximately $929 million, comprised of $643 million available under our credit facilities and $286 million of cash on hand. As Bradley stated, we recently announced our first dividend payment. We will be paying a $0.13 per share cash dividend on August 29 to shareholders of record of August 15. In terms of our third quarter 2014 consolidated guidance, we expect depreciation and amortization expense to approximate $43 million and net interest expense to approximate $6 million. Our 2014 consolidated effective tax rate, as I said, is expected to be approximately 14.6%. Moving on to guidance in regard to CapEx. We plan to spend $300 million to $350 million in total capital expenditures for the full year 2014. That is down from our prior guidance of $225 million to $275 million. The majority of this spending is in Canada, with a major component being our McClelland Lake Lodge. The reduction in forecast in capital spending is due to the timing of expenditures and the timing of customer commitments for those additional rooms. At this time, I would like to turn it back over to Bradley, who will begin with the discussion of each of our segments, the outlook for the third quarter and an update on our strategic initiatives. Bradley?

Thank you, Frank. I'll start with the Canadian segment. I'm proud to announce that on May 22, we successfully opened our eighth lodge in Canada, the McClelland Lake Lodge. At the end of the quarter, we had 617 rooms operational and now -- and we now expect to have 1,997 rooms available by year end. We have decided to increase the rooms available at McClelland Lake from the initially announced 1,561 rooms, due to demand in that area. Consistent with our investment strategy, the McClelland Lake Lodge investment is supported by a 3-year contract. Moving to operations. Our Canadian segment revenues were down sequentially by $24 million from the first quarter of 2014 to $156 million. Adjusted EBITDA decreased from $62 million to $51 million. The revenue decrease primarily relates to lower mobile camp activity, with the Canadian spring break-up, coupled with reduced third-party manufacturing. The EBITDA decrease was driven largely by the same items. The Canadian dollar exchange rate was relatively unchanged sequentially, having very little impact on our sequential results. Lodge revenue was essentially flat sequentially, as the drop in revPAR was offset by an increase in available rooms. Lodge occupancy was as expected in the second quarter, with the exception of one of our lodges that was impacted by the utilization of rooms for our construction crews working on the McClelland Lake Lodge. Moving to Australia. Second quarter results reflected the full quarter impact of the reduction in our customer room commitments, coupled with lower overall customer spending due to weak met coal prices. Our average available rooms were relatively flat sequentially, but our occupancy was down approximately 14%. Sequentially, our Australian segment revenues were down approximately $1 million as favorable Australian dollar movements were offset by lower occupancy. Adjusted EBITDA decreased by $5 million from the first quarter of 2014 to $25 million. In addition to the lower occupancy, a portion of this decrease was driven by repair and maintenance costs associated with the water treatment facility. During the quarter, in Australia, we moved 114 underutilized rooms from Dysart to Boggabri, where we expect to have stronger demand in the near term. We continue to manage the operational and capital spending in Australia in light of the current met coal pricing and customer spending outlook. Lastly, moving to the U.S. Revenues were modestly lower, and adjusted EBITDA was up $1 million sequentially due to improved U.S. mobile camp and open camp activity. We did record a $2.6 million asset impairment related to offshore assets on rent in Mexico, which has been excluded from adjusted EBITDA. In terms of guidance -- in terms of consolidated guidance, we expect our third quarter of 2014 revenues to range between $220 million and $230 million on a consolidated basis, with EBITDA margins is expected to range from 33% to 34%. The Canadian segment is expected to have relatively flat revenues sequentially and improved margins as lodge revenues are expected to improve, offset by lower contract camp activity. We are ramping up operations at McClelland Lake Lodge and expect to reach operational efficiency in the fourth quarter of 2014. In Australia, our outlook is consistent with our prior commentary. We expect the third quarter results in Australia to be comparable to the second quarter results. Likewise, in the U.S., we expect comparable results in the third quarter. Lastly, moving on to a strategic update. Our strategic plan focuses on growth initiatives and the appropriate capital allocation plan that we believe will drive enhanced value for our shareholders. With the spin-off complete, we are 100% focused on the execution of our strategic plan, which includes initiatives to drive growth organically, augmented by strategic acquisitions. With respect to organic growth, we are pursuing expansion in our core markets, with near-term opportunities in Canada. Consistent with this plan, we opened our eighth lodge, the McClelland Lake Lodge, which is supported by a 3-year customer contract. This property adds close to 2,000 rooms to our capacity this year. We are pursuing opportunities in the in situ region of the oils sands play, as well as those in the British Columbia LNG market. Longer term, we also expect to capitalize on additional organic growth opportunities in Australia. Our acquisition strategy will focus initially on our core markets, which present attractive opportunities. While we are one of the largest third-party providers of workforce accommodations in Canada and Australia, we still see room to increase our market share through either acquiring third-party competitors or customer-owned rooms. With approximately 75% to 80% of the existing rooms in our core markets held by either customers or competitors, acquisition growth is a real opportunity for Civeo. We believe we can be a consolidator in our markets. As we have done in the past, we will be disciplined and focus on accretive acquisitions, which exceed our cost of capital, creating value for our shareholders. As we did in Australia, we will also seek out acquisitions as a way to enter new geographic markets. However, as we have said in the past, this geographic expansion does take longer to execute. In addition to organic growth initiatives and acquisition strategy, our board and management team regularly assess opportunities that may be available to thoughtfully grow the company and enhance its capital structure, improve its strategic direction and operate in the most efficient corporate structure. Over the past 18 months, our board and management have undertaken an extensive evaluation of a possible REIT conversion. We have been working with independent tax and financial advisors to prepare a detailed analysis of the conversion opportunity for our board. Given the size of our international operations, such an evaluation is a complex matter and takes time. We currently expect to provide an update on the conclusion of our review by the end of the third quarter of 2014. There can be no assurance that our review will lead to a decision to implement a REIT transaction or if that decision is made, that such a transaction will be implemented. With respect to our capital allocation, while we work with our board to define our long-term strategy, we have taken a number of steps that we believe will drive value for our shareholders. Part of the rationale for the spin-off was that the business of Civeo, given its take-or-pay contracts, can support increased leverage relative to a typical oilfield services company. As a result, with the spin-off, we increased our leverage to 2x. This both gives Civeo -- this both moves Civeo to a more appropriate capital structure while affording ample additional leverage capacity to pursue the growth plans I just outlined. Our current credit agreement limits our leverage to 3.5x, and we are actively working to establish a long-term leverage target with our board. Another component of the spin-off rationale was that our business is well suited to be a yield vehicle for our shareholders. To illustrate our commitment to returning capital to our shareholders, we set an initial dividend prior to the spin-off. Based on consensus EPS estimates for 2014, we have a payout ratio of 51% and would expect that to grow over time. Given that the board's primary focus has been to evaluate the rationale of a potential REIT conversion, we'll finalize our long-term capital allocation plans following the decision on our corporate structure. In closing, we are excited to be an independent company, with a broad base of operations, ample organic and inorganic growth opportunities and a strong financial position to fund that growth and return capital to our shareholders. As we continue to execute our strategic plan, we remain focused on growth and delivering long-term value to our shareholders. That completes our prepared comments. Hilda, would you please open the call for questions at this time?

[Operator Instructions] The first question comes from Stephen Gengaro from Sterne Agee.

The -- I guess the 2 key questions I would ask you to start with is the change in the tax rate, can you give us -- it's -- I guess it's just mix of business and change in the spin-out. But what is it going forward? Is it -- should we look for that in the rest of this year and '15 as well?

Yes. Given the mix of where the earnings are coming from, given that all the debt sits in the U.S. today, given the changes with the spin-off, a tax rate -- effective tax rate in the range of 15% -- 14.5% to 15% is reasonable for this year as well as next year.

And I guess, without -- I guess, I'm going here and [ph] you obviously can't. Does that -- does a REIT change that to your knowledge at this point?

The REIT would have rates that would be more comparable to kind of a 22% to 25% rate as we would then be moving some of the...

Current leverage.

Leverage around and would impact it.

Yes. Moving some of the current leverage out of the U.S.

Okay, okay. That's helpful. And then just on the business outlook, up in Canada specifically. We've heard that there's a couple of contracts that may be out there for bids. Can you comment on sort of current opportunities for new work up there in general?

Well, in the oil sands region, we're primarily contracted. Where, as I've -- as we both mentioned, we're very pleased to have McClelland open ahead of schedule, we've got the 3-year contract supporting that. We've got good contract coverage at the majority of the other lodges. So there are -- I would say we're in a very good position. We have third-party competitors there that are not in as good a position. So there are vacancies up there, but we're generally in a pretty good position. In terms of bidding activity, most of our focus in the near term has been on British Columbia, both for mobile camp opportunities to support the drilling and pipeline side of that, as well as for lodge opportunities on the coast to support the infrastructure. The other area that we're focused on is more on the in situ region, where much like the Anzac Lodge, we see opportunities for what we call a middle market lodge, somewhere around 500 rooms, plus or minus. And we're pursuing several of those. So not knowing which specific opportunities you're talking about, that's what we're focused on.

Okay. And then just one quick follow-up. You mentioned in the release the lower average daily rates in the Canadian lodges year-over-year. Are -- why is that? And are they stable?

At this point in Canada, we did have the contract step-down, which impacted us. But generally, that's behind us. I would expect the rates in Canada to remain fairly stable for the rest of the year, assuming that occupancy, again, that, that interplay between the occupied rate and the unoccupied rate, assuming that the occupancy levels stay fairly consistent, which is our current assumption, I would expect that the average daily rates in Canada to remain stable for the balance of the year.

The next question comes from Blake Hutchinson from Howard Weil.

First, Bradley, on considerations around converting to the REIT structure. Understanding there's still a lot of details to be worked out. Can you help us with just, at this point, if you come to a conclusion by the end of the third quarter, is the reality of converting to the REIT structure by January 1 kind of drop-dead date out of the picture at that point and kind of the realities and maybe misconceptions of grandfathering into a January 1 start date? So just more timing if you were to elect to go forward with this.

Well, at this time, we're working through both the -- whether we should turn into a REIT, as well as what are the implications on our -- primarily in -- well, operational and administrative functions in order to support that. We've engaged a third-party to help us with that coordination. But -- and so we're working diligently through that. At this time, we're not prepared to give a timing if we were to go into a REIT, given that we haven't made that decision yet. But if that -- as we've said in the past, we obviously recognize that sooner rather than later is always -- is the preference of our owners, and we would certainly do everything in our power to achieve that.

But I guess, I mean, for us following along, is it more important that you meet the criteria for the operational and administrative functions by year end? Or is it more important to have filings and responses, et cetera?

Well, in terms of that, it's a requirement that operationally we're prepared to act as a REIT by year end. Because in order to effectuate the conversion, you have to be compliant on January 1 with REIT regulations, both in terms of the separation of the qualifying, nonqualifying earnings, as well as being in compliance with the distributions, et cetera. So that's a requirement there. In terms of the filings, there is some ability that you don't have to have the filing done by year end. Obviously, that would be preferable. The PLR process with the IRS is iterative. So typically, you have a good idea where you stand. Our current opinion is that from an IRS standpoint, this is fairly straight down the middle, what we do relative to fitting into the current REIT guidelines. So the ruling piece of it would not be a requirement by year end. It'd be preferable, but it wouldn't be a requirement.

Okay, that's very helpful. And then just help us understand as well, I think another point of conjecture out there with regard to Australian results and fundamentals. Big move-down sequential in utilization, but revenues stayed relatively flat. There is some currency impact there. But can you just talk about, in whatever terms that you like to qualify, the impact of any termination payments running through and how those should run through? And I guess more to the point, is that not really the case in those -- the results we see this quarter kind of just match up very closely to your occupancy and current fundamentals?

Well, what we're seeing in Australia right now in terms of rate is, even if you back out the exchange rate is, yes, we're having lower occupancy at several locations, as we've talked about, and that is with the room commitments. And quite frankly, it's playing out as expected. What we're benefiting from is that while the general macro environment down there is very difficult from a mining perspective, given where met coal prices are -- and that's our primary focus. I mean, 90% of our rooms are tied to met coal. We are benefiting from activity, as I mentioned, in the Gunnedah Basin. We worked this quarter to expand our exposure there without expending a lot of capital by moving some of the rooms from Dysart to Boggabri. So we're benefiting from good rates in the Gunnedah region, which is helping to offset some of the lower occupancy we're seeing in the Bowen Basin.

[Operator Instructions] We have a follow-up question from Stephen Gengaro.

So just a follow-up so I understand this better. The -- in Australia, the termination payments that you had from the contracts, how do they impact the quarter? And how do they sort of flow through the rest of the year?

So depending on which contracts the adjustment -- the room commitments adjustments were made, the termination payment that were largely received upfront will then be from a booked revenue standpoint be recognized over the remaining term of the contract. Those contracts, some of them end in the middle part of next year, some of them extend into 2016. But I guess just to be specific, the magnitude of this is a few million dollars a quarter. It's not a huge...

Not a significant.

It's not a significant amount. So even if you say those would end tomorrow, the results would be down because it's 100% revenue, 100% earnings. But it's only a couple of million dollars.

Okay. So there was no sort of excessive positive in any of the parts of the first half of the year is the way I understood it. I just wanted to make sure that I was clear.

No. There wasn't a kind of onetime or pop as it relates to the customer commitment reductions.

We have a question from Maharth Kapur from Crédit Suisse.

A small competitor of yours recently mentioned that they were seeing increased competitive activity in the Alberta oil sands region and some effects on pricing due to that. I just wanted to get your sense on that if you were seeing something similar or if this was just specific to that smaller peer company?

The -- as I mentioned, there are areas in the Athabasca oil sands where there are available rooms. And depending on a customer's -- or a competitor's pricing mentality, there have been -- we have seen reductions in rates that competitors are offering. But we -- given where we stand from a contracted position, we haven't felt the need to do so ourselves. And we've seen and expect to see comparable occupancy in our lodges for the third quarter. Well, Hilda, if there -- are there any further questions?

At this moment, I'm not showing further questions.

Well, we thank everyone for joining us on the call today. We're excited to have our first call as Civeo and excited about the opportunities that we have in front of us, both operational in terms of organic growth and the opportunity to continue to use acquisitions to augment that, coupled with, obviously, some very exciting corporate structure decisions to be made, so we look forward to updating everyone on the third quarter call.

Ladies and gentlemen, this concludes today's conference. We thank you for participating. You may now disconnect.