My name is Megan and I will be your conference operator. I would like to welcome everyone to Oceaneering Second Quarter 2020 Earnings Conference Call. [Operator instructions] With that, I will now turn the call over to Mark Peterson, Oceaneering's vice president, corporate development, and investor relations.

Thanks, Megan. Good morning, and welcome to Oceaneering's second-quarter 2020 results conference call. Today's call is being webcast, and a replay will be available on Oceaneering's website. Joining us on the call today are Rod Larson, president and chief executive officer, who will be providing our prepared comments; and Alan Curtis, senior vice president and chief financial officer. Before we begin, I would just like to remind participants that statements we make during the course of this call regarding our future financial performance, business strategy, plans for future operations and industry conditions are forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Our comments today also include non-GAAP financial measures. Additional details and reconciliations to the most directly comparable GAAP financial measures can be found in our second-quarter press release. We welcome your questions after the prepared statements.

Good morning, everybody. And thanks for joining the call today. So before I start with the prepared remarks, I want to take time for a thank you to our Oceaneering employees, our customers and our fellow offshore service providers for coming together the way they have in the second quarter to work safely and perhaps in ways that we may not have previously envisioned. This is the spirit that's made this industry great. And together, we're going to continue to make a difference and make the industry better and safer than ever before. So thanks again to everybody. Now to my prepared remarks. Today, I'll review the details of our second-quarter 2020 results. I'll provide you with the general outlook for the second half of 2020, and I'll give you an update on our expense reduction activities. After that, I'll make some closing remarks and open the call to your questions. So for our second-quarter summary results, considering all the uncertainties surrounding the crude oil markets and the COVID-19 pandemic, we were satisfied with our adjusted operating results. For the quarter, we generated adjusted earnings before interest, taxes, depreciation and amortization, or adjusted EBITDA, of $40.5 million, exceeding consensus estimates. And we generated $26.9 million of free cash flow. These positive results were partially attributable to our actions to substantially reduce structural costs in light of an expected continuation of lower demand for our services and products. The positive effect of these cost reductions is reflected in our 9% consolidated adjusted EBITDA margin for the second quarter of 2020, which declined by only 14 basis points as compared to the first quarter of 2020, despite a 20% decrease in revenue. I am also happy to say that these benefits have been widespread, with each of our operating segments, except asset…

[Operator instructions] Our first question is from Sean Meakim with JP Morgan. Your line is open.

Good morning, Sean.

Good morning. So thank you for the clarification on the D&A portion of the cost-out program versus the $85 million level to date that was in the release. I think that's helpful. Could we maybe just dive in a little more into the cost-out program, what are the major buckets that are left to get to your current target? And then, what else do you see is out there? We're still in a challenging environment for offshore for the next six quarters, which I think there's a reasonable chance that's the case. What other incremental opportunities are you evaluating pursuing? How do we think about the next opportunity set besides what you've laid out here so far?

Great, Sean. Well, I appreciate the question. I'll start with when you ask kind of where the major buckets are. It is fair to say that they are quite evenly distributed across all of our segments. So everybody -- and I think that shows in the second quarter where sort of the margin maintenance appeared everywhere. So I think the good news is evenly spread. Maybe there's a little less in the government side of AdTech, just because we actually see some opportunities there, and that strength came through this quarter as well. So we haven't been as aggressive there because there's actually good bid activity there. So maybe a little less so there, but the rest is pretty widespread. When I think about what's left out there to get. I think some of it is timing. When we -- we talked about facilities as one of the examples. Some of the facilities, while we've identified them, they just take a while to go get because we've got lease terms, and we're looking at sub leases and things like that. So stuff like that is harder to get as opposed to the compensation reductions and some of the other things we've done, which were sort of the quicker gets. And so I think that's out there. When you ask me what's left, I think the good news is that we've still kind of got the tools in our hand. And so if we see continued challenges through the back half of the year or next year, I think we're ready. And I would expect it to be pretty targeted around any sort of regional or segment declines we see. Places like if we see that you can't afford to stay in a certain region because we just sort of drop subscale, those actions would need to be taken. And that's actually been a big part of the success so far as being very surgical around regional operations, going in and looking at the whole of the activity there for Oceaneering, consolidating as best we can and then making the hard decisions about whether that consolidated aggregated result still suggest that we should be there. So I think that stuff continues to happen. And that's where I would see we pivot if we need to do more. And again, to go capture the rest is what we're after. Alan, you're nodding a little bit. Would you add anything?

Yes, no, you hit the nail on the head. I had my notes down here as well. And I said the next thing we're looking at, obviously, is regional locations, facilities. We started in the Far East as we announced, I think, two calls ago. So it's continuing to evaluate, make certain that we're in the right places to support the levels of business. If they're suboptimal, we're taking a harder look at each of those locations. And process enablers as well. I think that's something the team has been working on throughout the organization, whether it's in the back office or whether it's on the front lines, it's how can we be more efficient at what we do. As Rod indicated, operational excellence has long been a tenet here at Oceaneering, as well as the quality tenets, and we're going to continue to try and focus on that.

Got it. So then just thinking about the free cash flow guidance. It would be great just to maybe unpack, what do we think is a good operating free cash flow number. So maybe excluding working capital and tax items, and kind of what that breakeven level is for an operating free cash number. And then, just one other component to that is the CapEx guidance. So CapEx guidance is $45 million to $65 million for 2020. You spent $38 million year to date. So really, what you're saying is second-half '20, CapEx has a range of $7 million to $27 million. Can you talk about what drives that range there for the back half of the year?

I'll start on the CapEx side. Obviously, it's going to be more maintenance CapEx-driven. I mean, as Rod indicated, we did get the first system on the drill pipe riser successfully working on contract. So we're very pleased with that and obviously,, capitalized it. So there's very little growth CapEx in the back half of the year. As we flex up, there could be some. We have a little bit left on some of the drill pipe riser that we're still completing. But most of it is going to be maintenance CapEx. We're still working on the freedom vehicle that we've been highlighting on a couple of calls, that is still going to have some CapEx associated with it, as well as maybe a little bit on the Liberty or some of the Isurus-type systems, kind of the next-generation ROVs that we're continuing to invest in and then the technologies associated with them. So I think the $7 million is probably more on just a pure maintenance. And if we had some other interest, we could flex it up a little bit if we need to. So that kind of go toward the midpoint in the $55 million range is kind of where we're guiding. Looking at free cash flow. Obviously, you can pull out the CARES Tax Act. We got $16 million to $34 million. That is kind of a onetime event this year that we're looking at. So we're uncertain as to the timing of when all of that cash will come in, certainly driving for it this year. But we are subject to what the IRS' ability to get all of this process at the same time. So part of that could roll over or bleed over into '21 as well. The other components, notwithstanding working capital, which is one of the bigger levers that comes out, Sean, is just working capital on reduced levels toward the back end of the year should free up cash.

All right. Fair enough. Thank you.

Our next question is from Taylor Zurcher with Pickering, Holt. Your line is over.

Thank you, and good morning. I wanted to ask first on subsea products. Bookings this quarter were expectedly low, and the revenue was down quite a bit sequentially, but the backlog position is still very healthy. And I am just curious if you could help us think about the revenue progression in that segment over at least over the back half of the year just coming out of backlog.

Yes. When you look at the second quarter, Taylor, it was down a little bit, as you noted, and a lot of that had to do with the timing of the receive materials coming from some third-party suppliers. We still expect that will be executed here in the back half of the year is more timing than anything. So when I look at the back half of the year, it's going to be certainly going back to a more traditional 70%, 75% manufactured products and probably 25% to 30% service and rental. So it will be skewed more back to a manufactured products revenue stream in the back half of the year as we put more into the umbilicals in the backlog that we're going to be executing from backlog as we talked about in the call notes.

Okay. And a follow-up is more high-level and it's on the ultra-deepwater activity environment in general. I mean, clearly, the pandemic's created the sort of perfect storm for deepwater activity to plummet over the past few months. And at these sort of commodity prices, we're probably still headed lower from here. But it does feel like we probably overcorrected to the downside a bit just given some of the logistical headwinds in place from COVID-19. And so I am curious if you think that's the case as well and if there's any markets out there where maybe there's a few rigs that had to go on standby or temporarily idled as a result of the pandemic that you might see return to work over the back half of the year.

Yes, I'll take that, Taylor. Hey, one of the things, I think you're right. And that really speaks to our hesitance to give guidance because I think there's room for this market to move either direction, right? And so while, I don't think we see a whole lot of things other than the delay we called out in -- that we called out in the work in Angola or some of the things that we face in the entertainment business in trying to go back to work in China with entertainment vehicles, we've got upside. We've got upside on the government side. So I think our uncertainty really lies in the market dynamics, which I think everybody is facing right now. You call it well. There could be a -- we could have overshot the mark in deepwater and examples I would use, we saw effects in Norway, for example, where Norway, I would say, they stumbled for a short time, but now Norway is working very well. Brazil, while they've had probably even more disruption because we've had times when they went out to the rig. They found one COVID case. They clear the whole rig. They clean everything out. They test everybody, and they go back to work. They're down for 10 days to two weeks. And then, they go back to work. And we feel like the work in Brazil is going to persist. So maybe less affected by commodity price than other places. So there are places in the world that we think are more resilient. I think that -- both from COVID and commodity price. So it's a little bit difficult to see where this is going to settle out. But I do think that you're onto the right message that while it could get worse, we could also see other places resolve and continue to work. So that's what we're watching as well.

Great. Well, thanks for the answer.

Your next question is from Mike Sabella with Bank of America. Your line is open.

Hey, good morning.

Good morning.

I was kind of wondering if maybe we could dust off part of the discussion around possible debt tenders here. Maybe the window is never open for bonds. Bond prices have come down a little bit again recently. Do you guys think there's another opportunity to move here? And if not, how do we think about kind of optimal capital structure for Oceaneering over the next couple of years just with all the cash sitting on the balance sheet.

I'll take the first part, at least, and maybe let Alan take that second one. But I think, yes, we're still leaning in. I mean, we're still looking for opportunities. Our debt that comes -- has a 24 maturity especially, we just think that if there's a good price on that or if there's opportunity to move. And of course, there's a number of ways to address that debt. But we're getting everything that we can do and again, watching the market to see when that opportunity arises. So that could be a good side of a soft market for us and some others that have the wherewithal to act. So I think that is definitely on the watch, so to speak. Alan, do you want to talk about debt structure generally?

No. I think really it is, is there an opportunity to act? But I think at the same time, how does the revolver play into the debt structure? How do we maintain liquidity? How do we get beyond the 24s? Certainly, looking at each and all of those things over the next, I'll say, 24 months, with the revolver coming up in January of '23. So we're very pleased with our liquidity position today, but we recognize we need to address that not too far out from where we are today, just to make certain that we can see an upside in this market. We do see that we will have to go back to the markets and revenue will return. As we indicated in the call notes, we are working on how do we improve the top line, not just take cost out at Oceaneering. So while we are generating from working capital today, I do see down the road, it is something that we need to be able to have the flexibility to address this increasing revenues at the same time. So I think that's one of the key elements we're trying to blend into our overall discussion on debt is looking at the upside that could be coming in the coming years.

Got it. And could we just, I guess, a point of clarification on the cost cuts. And I am sorry if you gave it already. But the $85 million number, was that kind of a run rate heading into third quarter? Or is that what you all realized to your benefit on, say, call it, EBITDA in 2Q? And if it was kind of a quarter end, how much of that -- is there any sort of just straight carryover impact into 3Q that we should be considering?

Yes. So when we talk about that, Michael, we're really talking about the cost-saving initiatives we've taken. And like any of the things we do, if we go and make a, for example, a compensation reduction in the second month of the quarter, we don't realize the full benefit of that. So there is different -- there's varying degrees of that. So when we get to $85 million, that $85 million really represents an $85 million annualized cost out for Oceaneering. How much of that we'll realize in the quarter kind of depends on when it happens in the quarter. And so when you get into the third quarter, we'll start to see more of these things get realized, we'll also see more of these things get initialized. So there's a growing wave here of things that are happening. And we expect that by year-end, whatever number we come up with, whether that $85 million, if we get to the top of our range, including the decreased depreciation expense, if we get to the top end of that range, we do expect that most of that annualized number would be realized in 2021.

Your next question is from Ian MacPherson with Simmons. Your line is open.

Thanks. Good morning, Rod. On AdTech, my notes may have been screwed up from last quarter, but the performance in Q2 was good to better than I have been expecting. And recognizing that the government side is the much bigger piece of it, do you see a repeatability more or less or even in the same ZIP code of the first-half results from AdTech looking into the second half, notwithstanding the fact that some of your entertainment business is still experiencing COVID headwinds in the second half?

No. I think, Ian, what we can expect is that nothing happened in Q2 that isn't repeatable in the sense that I think our cost cuts on the commercial side are durable. I don't know that given everything that's going on with COVID that I can say that the -- especially the entertainment business is going to have a strong recovery in the back half of the year, unless some -- we have some pretty major good news coming out of, especially out of China. So that one kind of looks like we're steady state to Q2. Then on the government side, the government businesses have been strong. We've got good bid activity there. We've got strong performance within the business. So yes, I think Q2 is repeatable, if not beatable.

Good. That's helpful. Thanks. And then, the main value drivers in oilfield being ROV and products for the time being. For ROVs, for example, contemplating a continued glide down with activity as rig count probably suffers a little bit in the second half. The EBITDA decrementals that we saw from Q1 into Q2, which is kind of 45% decrementals, taking your margins down 2 points. To me, that's how I would think about modeling the decrementals going forward, which would put me into kind of 27%, 28% EBITDA margins later this year. Does that make sense to you? Or do you think that with the cost-outs that maybe you could do a little better than that?

I think that, again, and when we talk about cost-outs and I know the question came up earlier, when we get to the level of close to $85 million we've taken out, we're talking about process improvements. We're talking about some other things, not just headcount cuts, for example. And so I think we'll continue to work on that. I don't think it will be a lot worse, but we got to really count on more incremental benefit from our cost improvement maybe is the way to put it when we talk about process change. We got to keep after that. Because, like you said, there's a trend there that we got to get ahead of.

Thanks for the color and insights today. Appreciate it.

[Operator instructions] Your next question is from Vebs Vaishnav with Scotiabank. Your line is open.

Hey guys. Good morning and thank you for taking my questions.

Hi, Vebs.

Can we speak about just the governance, what you have around the debt today and how you stand? And is there like any adjustments that are allowed in those covenants?

Yes, Vebs, with our debt covenants, we have a debt-to-total cap, which is on an adjusted basis, as you just indicated. So the impairments that we've taken in the last couple of years are added back to the overall equation. So as the covenant stands, it's on a total debt-to-total cap adjusted at a 55% level. If you do the math, we're probably in the low 30% range.

And it also means that we have access to our revolver, the full amount of our revolver as an anecdotal way of looking at it.

If we speak -- can you speak about the Angola project work? It seems like it's been pushed back from 2Q into -- like can you speak about when can we expect that to come -- start happening? And also –

Yes, Vebs, but -- yes. Go ahead, finish the question.

Also, I was just going to ask about like the hedges just given like one of your larger pier has had many issues with Angolan kwanza. Just what hedges are in place?

Sure. So I'll start with the -- certainly, I mean, our biggest thing there is actually the customer wants to do the work, we want to do the work, but mobilization right now has been challenged just trying to bring -- it's a pretty big spread. It's there. But we've got people that need to come in. We need to get them mobilized in Angola, and then we need to have sort of a window that we believe that you're going in and you're working on, in some cases, live wells. You need to believe that you're going to be able to finish the work. You don't want to get started and not be able to finish. So we're looking for that window where we believe the situation, the COVID situation in West Africa is stabilized to the point where we're comfortable that we'll be able to execute the whole project. So that's more of a -- that's more of a win but I can't tell you for sure whether it will be -- I think it's going to be tough for us to complete in 2020 but we're open that we can at least get it started. But again, that one's pretty wide open based on COVID, which is very hard to predict. From the hedge standpoint, I would tell you that most of our contracts, especially in West Africa, our currencies are matched to our cost pretty well, so there's a built-in hedge in the contract. So we don't believe that whether this -- when this contract is executed that we'll be left with any undue kwanza exposure because I think we're pretty well matched in currency as to what we'll spend and we'll receive.

Got it. I think, that's helpful. And maybe if I can squeeze in one more. So it sounds like, obviously, third quarter is typically seasonally strong but obviously, given the macro, we don't really know. But it sounds like in the Energies business in each of the business, it could be modestly down from 2Q to 3Q, maybe Products is flat to modestly up and advanced technologies, maybe it's flat to modestly up. Is that a fair way of looking or characterizing the three next quarter?

Yes, I think so. Yes, go ahead Alan. Jump in.

No, no, I think you called it and I think products being up certainly somewhat of a little bit of a slide form Q2 into Q3 on some of the raw materials that we didn't get in Q2 that we anticipated to put into the production process. So we anticipate those will happen in Q3, which will drive top line but very little bottom-line impact at all just because of the nature of the materials we're putting in. So it could impact top line, but I wouldn't drive a lot of profit from it.

And, like advanced technologies, like the government business can offset the commercial aspect?

I think what I would look at is very similar to kind of the Q2 aspect where we had low levels of entertainment and commercial business. Similarly, I would think it would be led in Q3 by the government businesses.

Our final question comes from Blake Gendron with Wolfe Research. Your line is open.

Hey, thanks, guys, for not forgetting me on here. Just want to swing back to ROVs and specifically on the margin, it looks like 800 bps of margin degradation from pricing at least if implied day rate is sort of a proxy for pricing. Obviously, offset by a lot of the cost-out that you continue to take from that business. If I look at first-half margins, though, relative to an implied day rate, that's an all-time low. The margins on the EBIT side are fairly high for ROVs on the first half versus, certainly, the 2018 through. You've rationalized the fleet. It's more capable. It's probably lower cost. But appreciating you are adding some auxiliary services now just to maybe sweeten the deal. And then, in the context of the drillers likely not taking any lower pricing just because they can't, I am just wondering, modeling on the implied day rate and how that impacts the margin, what we should expect even in the worst-case scenario for activity in deepwater. Just some of the puts and takes and your thoughts around ROV margins would be really helpful.

Sure. So let me start with the day rate. We scrubbed the day rate pretty hard because, like you said, if you kind of take out the drop in number of days, it looks like we got a hit on day rate. And that's actually not the case. We held day rate really well. But we consider an active day even when we're on standby. And so what we did have this last quarter, and as you might expect, COVID-related, were we were moving people in and out. They had trouble on the rig getting people in and out. Even if they were Oceaneering. And so we had more standby days, either getting the rig mobilized or demobilized. And so those standby days, go into the mix at a lower rate. So it looks like a lower price, but it really -- we haven't had to make price concessions. And unfortunately, I think we're in that rig category where you just can't go much lower. So that's been pretty stable. Going forward, I think we're just going to have to keep challenging ourselves to do better. I mean, some of the things that we can do to deliver the same value to the customer. We've been touting of what we can do remotely, meaning we can have fewer people on the rig because you mentioned the sweeten the deal, we can have guys that do two jobs, they can operate the tooling. They can operate an RWOCS or an IWOCS system. They can do some of the communications work. They can do some of the survey work. So being able to have multipurpose players that reduce the cost to the customer. They also reduce the cost to Oceaneering and we share in the benefits. I think that's where those kinds of things are the things we're really going to have to push to drive margin in the future, along with like the technology side of remote operations. So those things are important. And I believe they're achievable because, again, there's benefit to both us and the customer. And when we talk about that kind of scraping the bottom on price. That's one of the benefits we can -- one of the cost benefits we can give the situation without it necessarily being a lose-lose situation.

Got it. That's helpful. Did want to revisit the cost-out program and just put a fine point on maybe some of the language around what you mentioned. So $85 million, appreciating that you already have the depreciation piece in hand. The $85 million, is that of today or is that quarter end? And then, when you say initiated, is that the processes are in place and maybe you're not realizing the full $85 million? Or have you already realized the full $85 million? I guess, I am just asking in the context of my notes here. I think you previously mentioned $54-or-so million annualized at the end of the first quarter. So just trying to understand from a timing perspective, it seems like you're getting out ahead Of the cost cut time line. And then, I am wondering, too, if we kind of stay in this unpredictable environment, if there's upside to that all-in $160 million number moving forward?

No. So you're on the right track. So when you think about the $85 million, think about $85 million being at the end of the quarter, we had processes in place to capture $85 million annualized. But we didn't get the full goodness of that all through Q2. So when you take those things, they should add more goodness in Q3 than they did in Q2, plus we want to add more to the $85 million identified. So it's a growing number. And the way I would think about it is if we hit the $160 million, including the depreciation expense reduction, if we hit the full $160 million, that's something that we should be able to realize most of, if not entirely, in 2021. So as that number grows, it is sort of a leading edge, but we keep adding to that. We keep adding to the mix of what's in there, plus we get to realize more and more of the benefit of that in each subsequent quarter. So you got it. The other thing I would say is, what about the $160 million? I think if we see challenges and we start to see -- and I think we mentioned this earlier on the call, but we need to be very specific about we need to go back to regions, we need to go back to contracts. We need to improve processes, not just cutting cost, but improving efficiencies. So some of those process improvements take a little bit longer to ramp up. Sometimes a facility, we got to run out the lease expenses. So we can move out, we can shut off the lights, we cannot have all the care and maintenance, but it takes a while to get out of the full expense of a facility as an example. So all of those things, what I think going forward is, if the market gets tougher, surely, there's going to be more opportunities where we can say, this has gone upside down, we can take that cost out. We can continue to be very surgical about going out and taking out places where it's no longer a viable option for us to be there or it's just subscale.

So Blake, I want to try and be clear, though, when we're looking at in Q1, we identified it as being $70 million, that moved to $85 million. We're trying to say these are structural. This is not the variable cost associated with going and performing a job. That would be even a bigger number. So we're trying to be focused on what is sustainable cost out, structurally driven cost that, as Rob said, would not return in 2021.

Got it. Yes, no, that makes sense. I just want to make sure it was point in time and not quarterly average. And then, to your point about variable costs on top. I mean, even if you pull out those structural costs, the decrementals are still really good in the second quarter. So definitely understood on that and appreciate the commentary. If I could sneak one quick one in here, just on energy transition. Obviously, it's topic du jour while activity levels and the outlook are still relatively subdued. Can you just remind us, specifically in projects, where you play in some of the renewable space, and maybe what some of your leading edge conversations are with customers or potential projects in that.

No. So projects is a place -- one of our biggest operations, though, is ROV support to that. So we are supporting a lot of the big vessels that are out there doing wind projects, particularly in the North Sea. So the European sector, we've got great relationships with the major contractors there. So that's been good. You probably remember we bought Ecosse, which is route clearance. So that's got some trenching and some boulder removal or boulder clearance and things like that. So we've got work there. Projects as well, I think we are highly transferable skills and we have some highly transferable skills to go into that marine environment so we look at more of that. I think survey is probably one of the place we participate in most. And our survey group has been more involved in the, say, the East Coast United States work than some of the other groups. So that's kind of the point end of the spear there for us. And then, asset integrity. I mean, as we get into more IMR and inspection work for installed base, and that installed base continues to grow, we believe that we'll be able to apply more of our asset integrity and asset management skills to that part of the work. But it is growing. Our relationships are growing. We invest in that side of the business in the sense of finding people that are more familiar with that part of the business and so that we can go out and pursue more of the work. But I think penetration has been good. And I think it's -- and generally, it's a good thing for the oilfield because we've got so much experience in marine construction that we could actually accelerate the transition there and get offshore wind going faster than if we just depend on sort of a new group of players. So mostly good news for our sector.

Excellent. Excellent. Really appreciate the update, guys. Thanks.

Thanks, Blake.

We have no further questions at this time. I turn the call back to Rod Larson for closing remarks.

Great. Well, since there are no more questions, I just want to wrap up by thanking everybody for joining the call. And this concludes our second-quarter 2020 conference call. Thanks, everybody.

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