Oil States International, Inc. (OIS) Q1 2019 Earnings Report, Transcript and Summary

Hello and welcome to the Oil States International First Quarter 2019 Earnings Conference Call. My name is Raina, and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] Please note that this conference is being recorded. I will now turn the call over to Patricia Gil, Director of Investor Relations. You may begin.

Thank you, Raina. And good morning and welcome to Oil States' first quarter 2019 earnings conference call. Our call today will be led by Cindy Taylor, Oil States' President and Chief Executive Officer and Lloyd Hajdik, Oil States' Executive 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 protections afforded by federal law. Any such remarks should be weighed in the context of the many factors that affects our business, including those risks disclosed in our Form 10-K along with other SEC filings. This call is being webcast and can be accessed at Oil States' website. A replay of the conference call will be available 1.5 hours after the completion of the call and will be available for one month. I will now turn the call over to Cindy.

Thank you, Patricia. Good morning to all of you and thank you for joining us today to participate in our first quarter 2019 earnings conference call. Following a volatile fourth quarter in 2018 regarding commodity prices, we entered the first quarter with a heightened level of uncertainty. However, as the first quarter progressed, our outlook improved given commodity price increases and a relatively stable, if not improving level of customer spending activity. All of our business segments completed the quarter at or near the high-end of our previous guidance and our margins held up well. Our Well Site Services and Downhole Technologies segments experienced improved product and service demand as the quarter progressed. We were particularly encouraged by our offshore manufactured products bookings of $144 million which will add to a 1.63 times book-to-bill ratio for the quarter, evidencing improving global offshore demand which creates better visibility for the balance of the year. Lloyd will take you through additional details of our consolidated results and also provide highlights of our financial position. I will follow with more details by segment and provide additional comments on our guidance and market outlook.

Thanks, Cindy, and good morning, everyone. During the first quarter, we generated revenues of $251 million, while reporting a net loss of $15 million or $0.25 per share. Our first quarter EBITDA totaled $21 million with an EBITA margin percentage of 9%. Reported EBITDA was negatively impacted by $! Million of severance charges. We recognized an effective tax rate benefit of 1.9% in the first quarter. The effective tax rate benefit was lower than the statutory rate due to certain non-deductible items impacting the rate. During the first quarter, we generated $34 million in cash flow from operations and spent $18 million in capital expenditures. We generated $16 million in free cash flow which we define as cash flow from operations, less capital expenditures, and utilized our free cash flow to pay down our standing borrowings under our revolving credit facility by $16 million. As of March 31, our net debt leverage ratio was 3.6 times, and our senior secured leverage ratio was 1.2 times, well below the allowable maximum ratios of 3.75 times and 3.25 times respectively. At March 31, our net debt-to-book capitalization ratio was 17% and our available liquidity position at the end of the first quarter was approximately $148 million, inclusive of cash on hand totaling $15 million. In terms of our second quarter 2019 consolidated guidance, we expect depreciation and amortization spend to total $32 million. Further we expect net interest expense to total $4.8 million and corporate expenses are projected to total $12 million. Total capital expenditures for the full year 2019 are still expected to range between $65 million and $70 million consistent with previous guidance. For the second quarter, our estimated income tax provision will primarily be dependent upon the level of pre-tax results realized compared to the level of non-deductible items in our tax provision. Longer-term, we expect our effective tax rate to trend towards the U.S. corporate tax rate of 21%, as our U.S. operations returned to profitability. And at this time, I'd like to turn the call back over to Cindy who will take you through the details for each of our business segments.

Starting with our Well Site Services segment, we generated $108 million of revenue, which was at the upper-end of our guided range and $13 million of EBITDA in the first quarter of 2019. These results were negatively impacted by disproportionately lower utilization of our land drilling rigs, as customers temporarily shut down their drilling programs, following the material decline in crude oil prices in the fourth quarter of 2019. Utilization of our land drilling rigs averaged only 12% in the first quarter of 2019, compared to 30% in the fourth quarter of 2018. In our Completion Services business, we experienced a 7% sequential revenue decline, which was concentrated in the Mid Continent region and the Permian Basin. EBITDA was negatively impacted by $752,000 of severance cost as we continue to streamline our operations to improve the efficiencies of our service offerings. With revenue declines in both the Drilling and Completion Services businesses, along with the severance cost incurred, our segment EBITDA margin averaged 12% in the first quarter of 2019, compared to 15% reported in the fourth quarter of 20198. While our margins declined sequentially, they were slightly ahead of the midpoint of our guidance. In our Downhole Technologies segment, we generated revenues of $54 million and EBITDA of $9 million with an EBITDA margin of 17% reported in the first quarter. Segment results were positively impacted during the quarter by increased demand for completions, interventions and perforating products which led to improved manufacturing facility cost absorption with higher levels of throughput. Further, the non-recurrence of patent defense costs for litigation, which wrapped up in the fourth quarter of 2018 also positively impacted the sequential EBITDA margin comparison. Given press on the integrated gun systems in the market, we wanted to provide you with an update on our technology and progress to market. Field testing and early commercialization efforts continues on our integrated gun system, addressable switch, and other associated downhole tools. GEODynamic patented and proprietary systems is provided completely assembled with the entire complement of components required for our plug-and-perf operation. All that is required at the wellsite location is removing shipping thread protectors and screwing the guns together before running the system downhole. We believe that our design makes for the site and what is efficient perforating system available and is certified to be intrinsically safe by Franklin Applied Physics. Operators continue to request GEODynamics best-in-class perforating technology, combined with the safety and efficiency provided by fully factory-loaded systems. We have expanded our engineering and product development staff and have commissioned our gun loading facility with a multi-year ramp in production planned into 2020. This system further builds on our industry-leading perforating offering through GEODynamics and reinforces our commitment to help operators make better wells. Our technical solutions group is providing tailored support to our wireline and operator customers, delivering our product offerings from our manufacturing location to the wellsite. This group is an investment in our future and affords us the opportunity to deploy both personnel and integrated product solutions directly to the wellsite to ensure product quality and performance is maintained. This group continues to work in support of field trials for our newer technology, ultimately as trialed products are brought to market, the group will generate revenue sufficient to offset their costs. We expect to recover market share and sales in our Engineered Perforating Solutions business once our proprietary integrated gun system is fully commercialized. In our offshore manufactured product segment, we generated revenues of $88 million, EBITDA of $11 million and a segment EBITDA margin of 12% during the first quarter. This 8% sequential decrease in segment revenue was driven by lower military product sales and service revenues partially offset by higher projects-driven product sales. We retained a major project award during the first quarter for a production facility content destined for South America. Our orders booked in the first quarter totaled $144 million resulting in a 31% sequential increase in backlog and a book-to-bill ratio of $1.63 times. This is our highest reported backlog level attained since June of 2016. Conversations with our customers regarding deepwater offshore project sanctions for 2019 continue to be constructive and visibility to our additional project awards is developing measurably. I would now like to share our thoughts on our market outlook for the second quarter. Our consolidated second quarter results are expected to improve sequentially driven by higher levels of drilling and completion related activity in the U.S., as well as greater contributions from our Offshore/Manufactured Products segment. Our outlook for U.S. spending activity by our customers is predicated on a supported commodity price environment given WTI crude prices which have recovered 45% from year end to a price of $55.66 per barrel. Further, improved project-driven activity within our Offshore/Manufactured Products segment is expected to lead to sequentially higher revenues for this segment. With this supported commodity price environment, we are estimating that second quarter 2019 revenues for our Wellsite Services segment should range between $119 million and $126 million with segment EBITDA margins expected to average between 14% and 16%. These estimates reflect improved utilization levels for our land drilling business as our customers have already begun to resume their drilling programs, following the temporary shutdown in the first quarter, along with increasing levels of completion activity in the U.S. shale plays and international regions in which we operate. For our Downhole Technologies segment, we currently estimate that our revenues will range between $53 million and $56 million with segment EBITDA margins averaging 17% to 19% in the second quarter. In our Offshore/Manufactured Products segment, we are forecasting that second quarter revenues for the segment will also increase sequentially and range between $92 million and $100 million buoyed by a higher starting backlog level, which will begin to convert into revenues. Segment EBITDA margins are expected to average 12% to 14% depending on product and service mix. To conclude, our second quarter revenue and EBITDA at the midpoint of our guidance ranges is up sequentially for all of our businesses. As discussed, we continue to believe the opportunity set for major deepwater projects sanctions is trending positively in 2019, as evidenced by the significant deepwater project award we booked in the first quarter. This award, coupled with a favorable outlook for additional project FIDs will benefit our Offshore/Manufactured Products segment. U.S. customer spending trended up as we progressed through the first quarter, setting the stage for a sequential improvement in our Wellsite Services and Downhole Technologies segment. We remain focused on developing technology advancements across all of our segments helping our customers make better wells while carefully controlling power cost generating positive free cash flow and generating positive returns on our invested capital. That completes our prepared comments. Raina, would you open up the call for questions and answers at this time please?

Raina, would you open up the call for Q&A?

[Operator Instructions] Our first question comes from Praveen Narra of Raymond James. You may begin.

Hey, good morning everyone.

Hi, Praveen.

Hi. I guess, we will get started just on the change in the macro environment in terms of oil prices going –moving higher. Can you talk about how your customers post budgets and kind of progressed, obviously it sounded like March was better than the rest of the quarter, but how are you thinking about 2Q and second half of the year in terms of what kind of indications you are getting?

Well, and I realize that’s kind of a different set here, when I talk about Wellsite Services and Downhole Technologies were really primarily driven by U.S. land shale play activity. And of course, that’s whatever time get your arms around, what I can say is, when the I can say is when the prices collapsed in Q4, every customer associated with know with reassessing their budgets of plans really doing scenario planning. It was most evident for us with our land drilling operations we can drill these wells very quickly. They tend to be a little more discretionary and generally when increased prices fall below 50 you see a significant quick reduction in activity. That being said, we also saw a slowdown in our completion services, not to the degree we thought. But as we progressed through the quarter, we fairly quickly realized that whatever happened to crude prices whether that was driven by technical price, et cetera, we saw relief fairly quickly by the end of January anyway. And again, more people were really solidifying their plans and so as you suggested, we would see continual improvement throughout the quarter with obviously March exiting in a higher rate than we had in January. And of course, it’s now April 25th, we are roughly one month into the quarter, but at this time we are seeing a continuation if not modest improvement of exit rate in Q1 for land and we are seeing that indication by the customers that we work for that that’s really going to change and go reverse itself in Q2. So that’s the best guidance. I mean, that’s, it’s a tough part about shale land the visibility is just shorter. And – but I can only tell you what we had experienced in the conversations that we’ve had and I would also tell you as it relates to Wellsite Services, of course drilling we are already seeing quite a lot of those rigs go back to work. So the guidance that’s embedded for Wellsite Services again disproportionately down on drilling. On the way back up, it will be disproportionate weighted towards drilling which is again pretty significant utilization decline in Q1 that appeal already fairly significant recovery back to fourth quarter levels. As it relates to Manufacturing/Offshore Products, these are longer lead time as you know. Visibility for us is really what projects are in the market, which FIDs are out there but bookings and quoting activity project awards are significant for us. Having a book-to-bill ratio of 1.63 times really bolsters our confidence and both our – I’ll call it soft book-to-bill ratio that we provided last quarter both in terms of absolute dollars as well as timing of receiving those awards and backlogs really fuels our major project works that has been buoyed for us quite frankly the last couple of years. So, it ‘s hard for me not to feel a little more enthusiastic about our outlook for the balance of 2019 relative to where we've been over the last couple of years.

Right. That’s super helpful. I guess, if we could switch to integrated gun quickly. I guess, just to make sure in terms of full commercialization, so it sounds like you expect that to be done in Q2. And could you also, I guess, talk about the pace of the production ramp up as that reaches into 2020?

Well, I want to be clear that, first of all, we through GEOdynamics acquisition and their long history on engineered perforating solutions we are already a leader in this space. We already lead in terms of the components that are integrated into the gun system. So, I don’t necessarily think of this as revolutionary branding product as much as it is. Much enhanced delivery system. So what we are – in other words, we have – I think the best shaped charge in the business. So that’s going to be integrated. We manufacture both long guns and short guns, that is going to be part of the package. What is less, I would say known at this point is the switch and the packaging of that integrated gun. And so, I feel good about where we are. We are in field trials and we did field trials. Some of them are absolute 100% successes. Some of them require a little bit of tweaking and so, we are kind of working through that in the current quarter and do expect commercialization fairly soon whether it’s late this quarter, early third quarter, again. As you said, as you see in our first quarter results, we actually showed some improvement on perforating solutions without having the integrated gun. We just firmly believe that our customers are looking for the improved reliability, operating efficiencies and ease of running, which means packaging products we already have into that integrated gun system. But I do think we are on track.

Perfect. Thank you very much and congrats on the good quarter.

Thanks, Praveen.

Our next question comes from Ian Macpherson of Simmons. Please go ahead.

Thanks. Good morning. I believe congratulations are in order this morning, Cindy.

Thank you. Any day, thanks to you.

Yes. For sure. The – I would infer, correct me if I am wrong that the majority of the step-up in your orders in the first quarter pertain to the large production facility package booking or was there also a step-up in your, call it, base load orders in addition to that?

So, I have – just it’s general agreement. Of course, this was a significant order for us and a welcome one on many fronts, one because of its size, but two it is weighted towards our most proprietary products if you will, kind of our core production infrastructure, floating production infrastructure products are good. I will tell you though that our base business would have yielded a book-to-bill ratio North of one even without it. But not by a tremendous amount, but if you look back the last couple of years, we’ve been at or slightly above a one-to-one book-to-bill for the last couple of years without any major project awards and so now having that it really did elevate that book-to-bill ratio for north of 1.5 times.

Okay. That's very helpful. Thanks. And then, it sounds like you are more comfortable and encouraged with the 1.3 to 1.5 target for this year and there are other significant awards that are in place for you later? Can you talk to what the gestation period looks like for the one that you just got and other going forward and how we should think about your conversion, how the backlog going forward relative to, I guess, the recent standard?

Yes, well, I think we are in great shape, number one, with a much busier in our manufacturing facilities in past year. And so they are eager to get to work and we will be very attentive to quality, timely delivery and on-budget type performance for the orders that we are getting. So, I will say, it’s obviously good news. When we talk about our subsea production infrastructure, these are obviously – require a lot of front-end engineering and materials procurement. We will start to recognize revenues this year, but it won’t be immediate because of that fact. We do percentage of completion but the front-end engineering then lend a lot to revenue recognition. The good news is, other areas of backlog build, particularly our standard connector products is a little bit shorter duration in terms of revenue recognition and most of the sequential improvement in revenues and EBITDA that we guided to is really driven by standard connectors at this point as opposed to a lot of revenue recognition from this large order, if that answers your question, Ian?

Absolutely. But generally speaking, the bigger POC projects will convert typically within the couple of years?

Yes, normally, I would say, 18 months or less. I haven’t studied this one particular order at this point. But normally, I would say 18 months or less for that one. The good thing is though, again it starts fairly immediately lending itself to engineering cost absorption and down the road, of course, manufacturing facility cost absorption.

Very good. Thanks, Cindy.

Thank you, Ian.

Thank you. Our next caller is Stephen Gengaro from Stifel. Please go ahead.

Thanks. Good morning everybody. I guess, Cindy, two questions. To start with on the Offshore/Manufactured Products side, the order flow you are seeing right now and I know there is sort of an overhead absorption positive that we hopefully see as you see this backlog unfolds on the income statement, but how is the pricing looking right now as far as what you are bidding on versus kind of what you have seen over the last year?

Pricing, this is kind of one of the issues we have in the sense that the more that we are weighted towards our proprietary products, I would say, the less pricing pressure that you are getting, because these are more project-oriented economics, not necessarily individual components, price competition. We have tried to be responsive to the needs of our customers in terms of providing the most cost-effective equipment that we can. We have also reduced our cost in the process. We’ve seen that through streamlined manufacturing and to some degree of course headcount reductions over the last three or four years. So, again, for this type of product, I just generally say with that combination of events, we expect similar margins to what you have witnessed in our history.

Okay. Thank you. And then, my second question and it might be for Lloyd and you removed from - sort of disclosure the completion service job tickets and average revenue per ticket which quite honestly always confused me anyway. But that being said, when you look at your – the Completion Services piece of Wellsite, how should we think about that revenue growth relative to either rig count growth or frac stage growth? Will it be sort of in line-ish? Will it be a little better? And then, could you remind us kind of what portion of that business is U.S. land?

I am going to start with that and just explain why we did take that disclosure out and it's exactly what you just said. We were probably as confused as you are. And then, you say why is that, everything is changing and what we are and everybody else is trying to do is create efficiencies within our own operations and generate free cash flow and to the extent that we might have held the ticket open for weeks as an example, across month where billings occur. And so, yes, you have a greater number of tickets, but do you really have a greater number of revenues. We acquired Falcon. So our mix of ticket count is also different today than it was kind of pre the Falcon acquisition. And then our customers have changed. They are truly focused on every day, every hour of efficiency. They are not necessarily going to hold equipment out from one well to the next, which they might have done quite frankly in prior periods. And so, we recognize what you do is that this is not really lending itself to meaningful information for us or for analysts whereas it used to and used to correlate to drilling rig count. And then with the really change in completion activity, we said it correlated more to well count, which aren't really readily available or is as accurate as probably the rig count is. So, again, we never takeaway information. We think it’s useful to you. We felt like this was not only not useful, it might even be confusing. [Call Ends Abruptly]: