ION Geophysical Corporation
Q3 2013 Earnings Call Transcript

Published: 9 Nov 2013

[Operator:]

Good morning, ladies and gentlemen, thank you for standing by. Welcome to the ION Geophysical’s Third Quarter Earnings Call. During today’s presentation, all parties will be in a listen-only-mode. Following the presentation, the conference will be opened for questions. (Operator Instructions) This conference is being recorded today, November 7, 2013. I would now like to turn the conference over to Karen Abercrombie, Vice President of Corporate Communications. Please go ahead.

[Karen Abercrombie:]

Thank you, Douglas. Good morning and welcome to ION Geophysical Corporation’s third quarter 2013 earnings conference call. We appreciate you joining us today. As indicated on Slide 2, our hosts today are Brian Hanson, President and Chief Executive Officer and Greg Heinlein, Senior Vice President and Chief Financial Officer. Before I turn the call over to them, I have a few items to cover. We’ll be using PowerPoint slides to accompany today’s call. They are accessible via a link on the Investor Relations page of our website iongeo.com. There you will also find a replay of today’s call following the call. Information reported on this call speaks only as of today November 7, 2013, and therefore you are advised that time-sensitive information may no longer be accurate at the time of any replay. Before we begin, let me remind you that certain statements made by ION during this call may constitute forward-looking statements which are based on our current expectations and include known and unknown risks, uncertainties and other factors, many of which we are unable to predict or control that may cause our actual results or performance to differ materially from any future results or performance, expressed or implied by those statements. These risks and uncertainties include the risk factors disclosed by ION from time-to-time in our filings within the SEC, including our Annual Report on Form 10-K and then our Quarterly Reports on Form 10-Q. Furthermore, as we start this call, please refer to the disclosure regarding forward-looking statements incorporated in our press release issued yesterday. And please note that the contents of our conference call this morning are covered by these statements. I’ll now turn the call over to Brian Hanson who will begin on Slide 4.

[R. Brian Hanson:]

Thanks, Karen, and good morning everyone. The first nine months of the year has certainly been disappointing. Our year-to-date revenues were down 6% and the third quarter was particularly challenging especially in our multi-client business. During the quarter, we recorded $182 million in restructuring charges and special items, including $73 million associated with our lawsuit with WesternGeco. In a moment, Greg will take us through those restructuring charges along with rest of our third quarter financials. But first I’d like to share some perspectives on the quarter, starting with an update on the lawsuit. Last month the presiding judge entered an order on supplemental damages and ruled at the damages for the additional digits and units, both an unsold overseas inventory and units sold since the trail date should be calculated by combing the jury’s previous reasonable royalty with lost profits damages award per unit. As a result the U.S. GAAP dictates, we increased our loss contingency accrual from $120 million to $192 million recording an additional $72 million non-cash charge to cover the supplemental damages and interest. We have made good progress pursuing incremental support for the appeal bond and are working with our underwriters to firm that up now. While we are disappointed by this new development, we’re very highly confident and securing the boding soon, and we believe more than ever that we have a strong merit in our defenses. We look forward to appealing the judgment, a process that could take up to two years after judgment has answered. Now I’d like to walk you through some of the operational aspects of the quarter, starting with our multi-client business within our Solutions segment. The third quarter was a particularity soft quarter for multi-client sales, recognizing only $17 million of revenue. The overall industry have seen a softening in new venture activity and underwriting, which we believe has been caused in part by reduction and proprietary surveys and excess marine seismic data acquisition capacity, creating incentives for contractors to keep their fleets utilized in multi-client programs, intensifying competition. As a result, this year we have consistently delaying our investments and new programs and sanctioned only when we saw appropriate underwriting levels. In addition, data library sales are always somewhat unpredictable, but we haven’t experienced a quarter this soft since the second quarter of 2010. Of course in total that year turned out to be great. So the looming question one has to ask is, what will the fourth quarter bring to bear? This year we have seen data library sales pushed out quarter-after-quarter, primarily due to delays in key licensing rounds in Tanzania and Greenland. While many of the deals that were delayed are either now closing or look promising, the previously mentioned competitive contractor market could put pricing pressure on our Q4 push. There is also uncertainty in the fourth quarter around the nature of our perspective customers in the sales pipeline. The pipeline itself has never been more robust, but the complexion of customers has shifted from the typical IOCs to more non-traditional independents, which have historically not been our bread and butter. Generally we have prophesized that our traditional IOC customers are taking a spending pause, acquiring exploration dataset as they focus on cash flow and return to investors in the short-term, while the smaller independents are positioning themselves to take advantage of this pause and capitalize on potential upcoming asset sales. This uncertainty makes it very hard to predict the fourth quarter with the level of confidence I’d like to have. That said, we have a healthy geographically diverse library, and we’re appropriately positioned for upcoming license rounds this fourth quarter and through 2014. To point out just a few, off the Canadian coast of Labrador where a round is expected to take place next year we recently completed acquisition of a 6,500 kilometer survey. In Greenland, we have over 17,000 kilometers of 2D data and a 50,000 square kilometer of gravity gradiometry data, positioning us well for both the Kanumas awards anticipated this fall, and the ordinary round of words expected in the first half of 2014. We expect traction for our new 12,000 kilometer survey offshore Australia’s northwest shelf, where 31 blocks are on offer. Moving to Africa, as we’ve mentioned on previous calls, we are currently managing the Tanzania licensing round for the Tanzania Petroleum Development Corporation. The round was officially announced last month for which we have before 20,000 kilometers of 2D data offshore East Africa. This data is also relevant for the upcoming Kenya round, which was delayed to next year. In Brazil, while the reduction in scope of the first ANP pre-salt bid round was a bit of a disappointment, we are well positioned with 30,000 kilometers of Brazil span data for the upcoming pre-salt round expected to take place either next year or in 2015 and we have another 34,000 kilometers of Greater Brazil span data relevant from the 13th round slated for 2015. In addition, we’re also well positioned for upcoming license rounds in the Caribbean, the Gulf of Mexico, Indonesia and Sri Lanka. Turning to our Systems segment, in our second quarter I mentioned that we’ve installed new leadership in our Systems segment and we’re taking a hard look at managing the division for profitability. In the third quarter, we restructured this segment, adjusting it for long-term competitiveness and profitability. We introduced refurbishment programs targeting our huge installed base of legacy towed streamer products, which should expand margins. We also reduced the cost structure of our legacy towed streamer product line shifting our focus including all of our R&D efforts to the seabed market where we see the greatest opportunity for ION. We also streamlined the cost structure of our land censor geophone business to allow us to be more cost competitive in the price sensitive geophone market. Overall, we reduced our systems divisions headcount by about a third, and reduced our annualized operating costs by approximately $12 million, which will begin to show up in our fourth quarter operating results. These changes were difficult. It’s never easy to let good people go. I’m glad it’s behind us. But these actions were necessary in accelerating our strategic shift from being a manufacturer of products for seismic contracts to leveraging our key technology and higher value integrated solutions we provide directly to E&P companies such as shooting seismic in the arctic and building an integrated seabed company. We believe this segment is now well positioned for profitability moving forward. I should also mention that in the third quarter, our another joint venture initiated restructuring program in response to the continued softness in the land market and competition among land equipment providers. This restructuring is intended to enable the business to operate profitably at the lower revenue levels in the $165 million to $180 million range. Greg will spend on this later in the call. Our data processing business had solid revenues driven by strong demand in Europe, the Middle East, and the Gulf of Mexico as well as continued demand for our broadband processing solution WiBand. However, as we indicated on our second quarter call, we were unable to recognize $7 million of revenue for work performed for a large customer as we are working on final execution of the new contract when worked through the amount allocated under the previous one. We will be able to recognize those revenues once the contract is executed which we expect to occur in the fourth quarter. We continued to expand our data processing infrastructure to accommodate increasing customer demand for higher end solutions, recently relocating our Houston data center and increasing our compute capacity by 50%. Next, I’d like to provide a brief update on our OceanGeo seabed JV. While we are still holding our ownership in this JV of 30%, we’ve made some good progress on securing backlog and expect to have some positive news on increasing our ownership soon. As we mentioned on our second quarter call, we’ve been assisting OceanGeo to aggressively move into the international market getting them pre-qualified tour for E&P companies through the tender cycle, and are tendering for more than $1 billion of potential work. We firmly believe that the market for Seabed seismic continues to develop, and customers are being very supportive of our efforts. With that, I’ll turn the call over to Greg to take us through the financials, then I’ll provide a few closing remarks.

[Greg Heinlein:]

Thank you, Brian. Good morning, everyone. Before I get into our operating results by segment, I would first like to provide an overview of the significant charges that we took this quarter resulting from our restructuring and the WesternGeco legal reserve. We reported a third quarter GAAP net loss of $202 million, a loss of $1.29 per diluted share. Included in this net loss there are several restructuring and other special charges totalling $182 million impacting our diluted earnings per share by $1.16. Excluding these charges, our net loss was $20 million, a loss of $0.13 per diluted share. These restructuring and other special charges included $31 million impacting our cost of sales, of which $25 million related to inventory and severance charges within our system segment, and the $6 million partial write-down of the land program in our solution segment. $11 million impacting our operating expenses of which $9 million related to the write-down of our receivables and equity in the OceanGeo joint venture, plus $2 million of system severance charges. $73 million impacting other expenses primarily related to increase in our legal reserve on the WesternGeco lawsuit. $62 million related to establishing a valuation allowance on our net deferred tax asset. This one will take a little explanation, because of the large litigation reserves, and the other third quarter charges, a full valuation allowance was established in the third quarter to reduce deferred tax assets to zero. This means that our effective tax rate should be significantly lower for the next couple of years, as we expect to begin utilizing our net operating losses that have been fully reserved. Finally, $5 million related to the full conversion of our preferred stock in ION common shares. Our preferred shares are not callable, nor do they have a maturity and we have been paying interest on these since 2005. As we prepare our capital structure for greater flexibility, we felt it was prudent to convert these from this $5 million representative present value on approximately 5 years of future dividends. Of the total $182 million of special charges only $16 million required using cash. It’s important to note that regarding our write-down of OceanGeo, we continue to assist the JV in securing new programs as quickly as possible. During October and early November we provided $4.5 million of additional financing to ready them for upcoming contracts. However, until OceanGeo lands its next project award, we felt it was appropriate to write down our prior investments. With that, the remainder of this call will be focused on our core results excluding the restructuring and other special items. Turning to Slide 11, our third quarter revenues were $79.8 million down 41% over the third quarter last year. All three of our segments contributed to this decline. Solution segment revenues were $43.4 million down 53%. System segment revenues were $26.3 million down 16%, and Software segment revenues were down $10 million, down 23%. I am sorry, Software segment revenues were $10 million, down 23%. Our operating loss for the quarter was $14.6 million as adjusted for restructuring items compared to an operating income of $25 million in the third quarter of last year. This decline in operating income was primarily due to the significant decrease in revenues within our Solution segment. Now let’s take a closer look at our third quarter performance starting on Slide 12. Our third quarter solution segment revenues were down 53% year-over-year due to a 73% decline in our combined new venture and data library revenues, and an 8% decline in our data processing revenues. The decline in our new venture revenues was attributable to the overall softening and underwriting of new programs, while data library revenues declined year-over-year due to further delays and licensing rounds in key geographic locations. As suggested in our second quarter call, our data processing revenues were impacted by approximately $7 million of unrecorded revenues tied to a customer contract pending final execution. Heading back to this work performed in Q3 our third-quarter data processing revenues would have been up 17% over the third quarter 2012. Our multi client investment during the first nine months of the year was $69 million compared to $106 million spent in the same period last year. We do expect to increase multi client program investments in the fourth quarter related to our expanding three North American land programs, as well as several new 2D marine programs that are adequately underwritten. We now anticipate our full year investment will be in the range of $100 million to $120 million. Turning to Slide 13, similar to what we had experienced last quarter, we saw a decrease in software segment revenues due to the continued impact from consolidation in our customer base. Our year-to-date software segment revenues are down 16% compared to last year. A bright note, we continue to see increased demand for our 4D survey optimization services resulting in another record quarter for our service revenues. Overall, operating margins remained good at 62%, compared to 70% in the prior year. Moving to the next slide, Systems segment revenues decreased 16% to $26 million. This decrease is primarily related to a decline in revenues associated with new positioning system sales, partially offset by an increase in repair replacement sales to our existing customer base. We experienced a decrease in Systems segment operating margins as adjusted to 14% down from 20%. As a result of our third quarter restructuring, we will expect our operating margins in our Systems segment to increase by 800 to 1000 basis points moving forward. Overall, we have reduced our Systems operating cost by approximately $12 million per year. Turning to Slide 15, INOVA’s revenue in the second quarter was $61 million and they reported a net loss of a $0.5 million resulting in a small equity loss to our third quarter results. Overall, INOVA experienced a 29% increase in revenues compared to the prior year period attributable to further increased sales of Q3i cable based system. INOVA’s operating margin in the second quarter was a positive 3% compared to a negative 8% one year ago. For INOVA’s third quarter, we estimate revenues to be in the range of approximately $38 million to $42 million, which would be an approximate 60% increase to the third quarter one year ago. We expect our operating margins to be break-even. As Brian mentioned, during the third quarter, another initiated a restructuring plan in response to continued softness in the LAN market. This restructuring which reduced INOVA’s workforce by about 20% is intended to enable the business to operate profitably in those $165 million to $180 million revenue range and should reduce the their annual operating cost by about $7 million. As we report INOVA on a one fiscal quarter lag, our share of INOVA’s restructuring charges will impact our fourth quarter results. Turning to Slide 16, as of September 30, our cash balance stands at $88.6 million, down from $109.5 million from the second quarter. Cash from operations was a negative $6 million due to the low revenues overall, partially offset by reductions in our multi-client investments and collections on our accounts and unbilled receivables during the quarter. Turning to Slide 17, we have full availability under our $175 million credit facility, which when combined with our cash on hand, brings our total available liquidity to $263.6 million at September 30. Our net debt increased $297 million during the quarter primarily attributable to the $21 million decline in our cash balance. We are prudently managing our business to generate positive cash flow, we are comforted by the full availability we have under our credit facility and the almost $90 million of cash on hand at the end of September. Before I turn the call back to Brian for closing remarks, I wanted to provide some very brief thoughts on our reserves for the WesternGeco litigation. In total, we have reserved a $192 million for this matter, which is an incredibly large number given the size of this product’s historical revenues and operating impact. To put it in perspective, the monetary damages on each [indiscernible] recently assessed by the court are nearly 2.5x our average historical sales price for that product. We’re well along our process of securing incremental bonding should it be necessary to cover the full amount of the award, private proceeding with RPO. Within the courts recent orders the possibility to petition the court for a partial reduction in damages as a result of the recent settlement between [indiscernible] and WesternGeco. We look forward to initiate an appeals process to resolve the lawsuit as soon as possible. With that, I’ll turn it back to Brian.

[R. Brian Hanson:]

Thanks, Kurt. Our financial performance this year has been very disappointing due to the competitive dynamics the seismic market is clearly soften and we’ve undertaken some integral realignment and restructuring that have caused some significant maybe non-cash charges. Nonetheless, we remain confident in our long-term strategy. Let me briefly recap some of the discussion from our second quarter call pertaining to our growth strategy. First, we have restructures our systems segment, adjusting it to operate more profitably with reduced revenues and introduced the new business model around re-commissioning the installed base. Second, our focus is on the lucrative seabed market and I am putting our industry leading equipment to work in a service model and we’re striving to do that with support of E&P customers currently evaluating our funds. In addition, all of our systems R&D efforts are now focused on Georadar acquisition and driving acquisition efficiencies. Third, we’re expanding our E&P facing relationships in our software segment. Our launch of new NarwhalTM ice management system at the Society of Exploration Geophysicists show in September was extremely well received. We have two commercial projects underway in the Canadian Northwest passage and offshore basin island and we look forward to providing more updates on Narwal in the coming quarters. We are still smartly but conservatively investing in our multi-client business and are appropriately positioned for upcoming license and grounds in key areas of the world. While these are not yet played at first this year, we remain confident in the near-term value. In addition, we are well equipment to enter and grow in the 3D marine market with our recently announced alliance with Polarcus for 3S multi-client program through which we have accessed Polarcus’ world-class seismic fleet. Next, our data processing business continues to grow nicely. We expect additional growth through geographic expansion in South East Asia and the Middle East as well as from organic growth in our core regional centers in Northern Europe, Huston, and Denver. And finally, we continue to invest in our 3D ResSCAN and micro seismic offerings from conventionals with two programs already sanctioned for 2014. So far its been a rough year. We have great people pursuing some fantastic programs and new offering and we remain condensed our evolution to a service provider and trusted advisor E&P companies will build a quality, consistent and more predictable business in the next 12 to 18 months. With that, I will turn it back to the operator for Q&A.

[Operator:]

(Operator Instructions) Our first question is from the line of Georg Venturato with Johnson Rice & Company. Please go ahead.

[Georg Venturato:]

Hey good morning, guys.

[Unidentified Company Representative:]

Good morning Georg.

[Georg Venturato:]

I wanted to start on the new venture side, obviously it sounds like you’ve got some nicely under written work for Q4 but you do mention the delay in investments and new programs I guess just looking out beyond 4Q, can you talk a little bit about what you potentially got in the backlog of programs that are for 2014 or how do you kind of look at that at the moment?

[R. Brian Hanson:]

Yes that's a great question George and I can tell you that I will be looking heavily at the fourth quarter and seeing – there is a little bit of noise in the industry and I’m very much interested to see how that fourth quarter plays out but for 2014 we have a number of programs on the docket but it’s a struggle getting underwriting levels that are adequate and we’re not going to show a lack of discipline, or we are not going to up there in 2014, and execute programs and take significant risk. It’s not our model and so hesitant to do that. I can tell you that for 2014, you have two fairly meaningful land programs that are already sanctioned. Those programs to be sanctioned with underwriting levels that are north of 80%, and that's the kind of discipline we’re going to impart to next year. I wish I had a crystal ball that can tell you what underwriting activities are going to be like next year but time is going to show that to us.

[Georg Venturato:]

Okay, yes, that was kind of my follow-up question, but I think you answered in terms of, how do you adjusted your threshold in terms of underwriting that's needed for these projects, but it sounds like the answer is you should have pretty stay there with where you have been in the past?

[R. Brian Hanson:]

No George, I even say that we were probably going to take that out a little bit more, we’re going to be focused on generating positive cash flow in 2014 not taking unnecessary risk and we just see that if you look at the activities in the third quarter, a lot of the competition in multi-client seems to be really taking a lot of risk in the programs. That is not our model.

[Georg Venturato:]

Okay and then on the OBC side, obviously the road down the receivables with that business with JV at the moment. I know you’re tendering for a number of projects out there and sounds like timelines coming up to hear back, can you remind us of what you, I guess building the tender project, could you remind us maybe the number that you need to feel comfortable from a backlog standpoint or move forward with the JV, but maybe on a dollar value and kind of an a number of projects that would represent.

[R. Brian Hanson:]

So I think the – I’m not sure it’s so much a dollar value, George, as much as it’s seeing a clear path by keeping the crew busy. And I think we clearly see that. the reason I say that is that there are a few programs that we believe going to be awarded very soon that will comfortably provide a six months, five or six months window of work. And then on the hills of that there are several programs that are very large multi-year programs that could potentially still be for the pipeline to keep that crew busy, certainly through the end of 2015 and probably in the 2016. And I believe that looking at the nature of the programs and the design to the survey that are very conducive to [Indiscernible], so I believe the business is really well positioned to win those awards. So I’d say, our confidence level is increasing around building that nice backlog but I think we’ll know more by the end of this quarter.

[Georg Venturato:]

All right, I appreciate the answers Brian I’ll get back in the queue.

[Operator:]

Thank you. Our next question is from the line of Joe Maxa with Dougherty and Company. Please go ahead.

[Unidentified Company Representative:]

Joe, you must be on mute.

[Joe Maxa:]

Hello, guys. Can you hear me?

[Jack A. Cuneo:]

Here we go. Good morning, Joe.

[Joe Maxa:]

Okay. Sorry about that. Good morning. Yes, I wanted to follow-up on the seabed side, and I'm really thinking about the Calypso product. Is that still on track for commercial availability by – was it at the end of the first quarter?

[Jack A. Cuneo:]

Yeah, great question, Joe. We are actually – we actually have a one full array at 1.12 kilometer array that has been constructed and it’s on its way down to – we put on a vessel and we put through its final test inside by side with current DSO system. We’d expect that that would be completed by the middle of December and then we’ll role into a full manufacturing process and that [indiscernible] the speed of that process will be dictated by the nature of the surveys that were awarded and the amount of kits that’s going to be required on the vessels. But certainly, Calypso will be, yes, it absolutely will be available commercially for years first quarter of 2014.

[Joe Maxa:]

And thinking of how that's funded, you're adding more money into OceanGeo now. Are they going to be able to, I mean is the joint venture going to be able to pay for that and how much risk are you taking in developing this product?

[Jack A. Cuneo:]

We’ll get into more specific details when we provide an update on OceanGeo. I can tell you that for the Calypso line itself, we pretty much have already invested in a majority of the inventory to construct the systems. We’ve invested in the manufacturing facility, that’s all built up. So the real question is how much incremental investment is needed to build the system to provide to the joint venture and the answer to that is entirely subject to the nature of the surveys that we’re awarding. So on one hand, it could be very little. On the other hand, there is some huge surveys out there that are multiyear surveys that may require a little bit more capital to be injected. But overall, in both scenarios, it’s not a stupidly unrealistic number, it’s very appealing.

[Joe Maxa:]

Okay. And then I wanted to just discuss a little bit of your alliance with Polarcus. When do you see this starting to materialize. Obviously, there have been concerns in the market out there, but what have your discussions been and what are you guys thinking about today?

[Jack A. Cuneo:]

Yeah, so really, it really depends on the quality of the program that you put together relative to being able to attract underwriting. We really believe that that’s what we bring to the party with Polarcus, we can – we’ve got quite a bit of Geophysical expertise that will let – that will bring to bear on that. So what we’re doing today with Polarcus is, our mutual teams are working through the various opportunities that we’ve identified. We’re prioritizing them. We’re trying to rank them. And then mutually we’ll select programs and pursue underwriting levels. So I would expect that’s probably going to be the first quarter of 2014, before we actually get the work on a program.

[Joe Maxa:]

All right. Thank you very much.

[Operator:]

(Operator Instructions) Our next question is from the line of Rudy Hokanson with Barrington Research. Please go ahead.

[Rudy Hokanson:]

Good morning. I was wondering if you could talk a little bit more about the competitive nature of your software versus the competition. It came up in the second quarter, and, you know, I was just wondering if you can may be flesh that out a little bit, and if you're making any investment there, or if you are seeing may be deterioration slowed down. Any kind of guidance on that?

[Unidentified Company Representative:]

Sure and first, I’d step back and remind you that our strategy is one where we’re, shifting our focus of our business away from marine contractors, and trying to provide solutions and offerings for E&P clientele.. We are deliberately intending to become what we call first check business, versus the second check business were a contractors paid by E&P and then pays us. And so our investments in the software side of the house are on building out an offering that E&P clientele will value. So that’s where we are investing, and that’s where we were growing and that in our first offering that we are rolling out is the Narwhal offering, which I mentioned on this call, we’ve officially launched in September. It’s commercial we got two active programs along with it today and so we see a quite bit of growth opportunity there. And if you want more information on is the Narwhal, it’s was actually an interesting video on it YouTube we put out there. The legacy part of our software business the command and control part that the contractors use is we are very well entrenched in that area. There is one competitor of ours CGG, is has developed an offering of their own and they are slowly converting their fleet over to their offering and so. That’s where you’ve seen the decline on our business, the rest of the marketplace is actually quite solid.

[Rudy Hokanson:]

Okay thank you very much.

[Operator:]

And there are no further question at this time, please continue.

[R. Brian Hanson:]

Okay. Well thank you for taking the time to attend our conference call. We look forward to talking to you in the fourth quarter call.

[Operator:]

Ladies and gentleman that does conclude our conference for the day, if you like to listen to replay of today’s conference please dial 303-590-3030 or 800-406-7325, and enter the access code 464-4944. We like to thank you for your participation. And you may now disconnect.