ION Geophysical Corporation
Q2 2015 Earnings Call Transcript

Published: 10 Aug 2015

[Operator:]

Greetings, and welcome to the ION Geophysical Second Quarter Earnings Conference Call. At this time, all participants are in listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Ms. Karen Abercrombie, Vice President of ION Communications. Please go ahead, ma’am.

[Karen Abercrombie:]

Thank you, Jerry. Good morning and welcome to ION Geophysical Corporation’s second-quarter 2015 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 Steve Bate, Executive Vice President and Chief Financial Officer. Before I turn the call over to them, I have a few items to cover. We will be using slides to accompany today’s call. They are accessible via link on the investor relations page of our website, IONGeo.com. There, you will find a replay of today’s call. Moving on to slide 3, the information reported on this call speaks only as of today, August 6, 2015 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 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 the statements. These risks and uncertainties include the risk factors disclosed by ION from time to time in our filings with the SEC, including on our annual report on Form 10-K and on our quarterly report on Form 10-Q. Furthermore, as we start this call, please refer to the disclosure regarding forward-looking statements incorporated into our press release issued yesterday. And please note that the contents of our conference call this morning are covered by these statements. I will now turn the call over to Brian, who will begin on slide 4.

[Brian Hanson:]

Things, Karen. And good morning, everyone. On our last call we observed that our first quarter was soft due to a delay in customers setting their budgets. We said we anticipated our second quarter to be soft as well, with customers taking a wait-and-see attitude towards allocating their delayed budgets. However, we anticipated the second half to pick up. Our second quarter looked a lot like our first-quarter, with customers slow to initiate work, but our second half looks somewhat stronger, primarily as a result of our BasinSPAN program in Mexico. Yesterday, we reported a second-quarter net income of 56 million, or $0.34 per diluted share. Our second-quarter results were positively impacted by special items totaling 101 million, or $0.61 per diluted share, primarily related to a further partial reversal of our reserves associated with our lawsuit with WesternGeco, which I will speak about later. Excluding special items, our second-quarter adjusted net income was a loss of 45 million, or $0.27 per share, on revenues of 37 million. We expected going into 2015 we would be a net consumer of cash and we ended the second quarter with cash and cash equivalents of 117 million, consuming about 53 million in cash before financing activities, about half of that in Q2. As mentioned on the last call, we expected the second-quarter cash flow to be fairly consistent with the first quarter as our customers figure out how to prioritize the allocation of their budgets, with activity expected to pick up in the third quarter. With a focus on cash preservation, we continue to strategically reduce costs while maintaining our core competencies. During the quarter, we took action to further reduce our employee headcount. Since December, we have reduced our full-time headcount by about 25%, which coupled with the 10% salary reduction we implemented in Q1, will yield an annualized savings of about 40 million. In addition, in Q2 we initiated actions within our OBS services business to minimize our costs while at the same time maintaining our full ocean-bottom capabilities. A lot of our cost in Q2 was associated with keeping our OceanGeo crew in a fully active state while we awaited the start of our next project. We are actively in negotiations on three projects and anticipate the crew going back to work in the fourth quarter or the first quarter next year. In the meantime, we have cold-stacked the vessels and our crew and have taken other actions which collectively will dramatically reduce our quarterly ocean Geo cash burn rate to as low as 3 million by the fourth quarter. Despite the extended market downturn and uncertainty, we see significant long-term potential for OceanGeo and technologies to improve ocean-bottom survey productivity and we expect demand for ocean-bottom production surveys to continue even through what we believe will be an extended period of contraction in exploration and production budgets. Our 53 million cash burn in the first half of the year was prior to our realizing the full savings associated with our expense reduction programs, including salary and headcount reductions and our OBS cost reductions. While there still remains some uncertainty in the multi-client side of our solutions segment, we are starting to see an increase in customer activity. In early July, we begin acquisition of the first phase of MexicoSPAN, an industry-funded program encompassing more than 22,000 kilometers of deep-image 2-D data. Combined with our existing programs, MexicoSPAN will deliver the industry’s only complete basin-wide, regional view of the Gulf of Mexico. While this program will positively impact our second-half results, we still expect exploration spending in the second half of 2015 and 2016 to be far below 2013 and 2014 levels. We are maintaining our spending discipline, sanctioning programs only with sufficient client underwriting. Our data processing business seems to have plateaued over the past two quarters, and the current sales pipeline signals that it will probably run at these levels for a while. We are not seeing the normal down-cycle behavior of customers reprocessing existing data sets. In addition, our systems and software businesses have also plateaued in the past quarter as seismic contractors have dialed back their spending to minimum levels. We do not expect further deterioration in these lines from Q2 levels, nor do we expect them to rebound in the near future. As I mentioned earlier, we have reduced our reserve associated with the WesternGeco lawsuit. While the process is not yet complete, we are pleased with the decisions by the U.S Court of Appeals who, in early July, reversed in part the original judgment holding that the District Court erred by including lost profits in their judgment. As a result of this decision we have reduced our legal contingency by $102 million from $124 million to $22 million. As expected, WesternGeco has requested a rehearing with the U.S Court of Appeals, but the reduced judgment is a big win for us and a lift to our liquidity going forward. Steve is going to walk through the financials, and then I will wrap up before taking questions.

[Steve Bate:]

Thanks, Brian. Good morning, everyone. As anticipated, our second-quarter results were fairly consistent with our first quarter, with revenues declining by over 70% year over year. Our second-quarter solutions segment revenues were down year over year by over 60%, which was not a surprise as many of our E&P customers only finalize their 2015 budgets during the second quarter. As Brian mentioned, we expect an increase in our solutions segment revenues in the back half of the year compared to the first half. Our systems and software segments experienced decreases in revenues of 66% and 36%, respectively, attributable to a continued decrease in investment capacity from 2014 to 2015. Our ocean bottom services segment contributed no revenues this quarter, as the crew has been idle since completing a survey in the fourth quarter of 2014. We have cold-stacked the vessels and our crew, reducing our cash burn rate, but continue to maintain our ability to quickly mobilize the crew. As a result of the decline in revenues, our overall gross and operating margins for the quarter were negative at 28% and 111%, respectively. Our adjusted EBITDA was a negative $29 million, and our adjusted earnings per share were a loss of $0.27. Our cash balances stood at $117 million at June 30th, and we continue to have no outstanding borrowings under our revolving credit facility. Our net debt, defined as total debt less our cash balances, was $71 million at June 30th. Earlier this month, we amended our credit facility with PNC Bank, who is now the sole lender. The amended credit facility has improved financial covenants and borrowing capacity of $40 million. As Brian mentioned, the appeals court significantly reduced our damages to an estimated $22 million, down from $124 million, and accordingly our litigation reserve was reduced by $102 million in the second quarter. The surety bond related to the litigation that we have in place is unsecured and will remain outstanding until the case is completely resolved. The significantly reduced judgment, coupled with our amended credit facility, improves our liquidity position and gives us more flexibility in how we invest cash into our businesses. With that, I will turn it back to Brian.

[Brian Hanson:]

Thanks, Steve. We have patiently endured the first half of the year as we watched our customers’ behaviors and firmed up our opinions on how the cycle was going to unfold. We are now operating under the thesis that we are in a cycle that resembles behaviors of the down cycle of 1999 to 2004. During that period, budgets were significantly reduced, reserve replenishment was not the theme, but harvesting production and conversion of reserves to cash was the focus. Expiration as a percentage of E&P CapEx budgets declined from a high of 26% in 1998 to a low of 16% in 2004 and did not increase until the need to replenish reserves came back into focus. That cycle was a protracted five-year run until it turned around. We believe this cycle began in 2013. Accordingly, the production side of the E&P business is where one needs to position for the next few years. As such, this year we are focused on ensuring the exploration side of our business is properly scaled and has appropriate cost controls to free cash flow for 2016 and beyond. Our plan is to grow the production side of our offerings, including a focus on ocean-bottom work, which is primarily 4D production-type surveys, and our software and services offering around simultaneous operations. Although in the first half of 2015 we have seen significant use of cash, as we have carried the ocean-bottom crew and figured out the levels at which the rest of the core business stabilized, we have now cold-stacked the crew and continue to have a strong focus on cost controls that should enable us to return to positive free cash flow territory for 2016. With that, I will turn it back to the operator for Q&A.

[Operator:]

Thank you we’ll now begin the Question-and-Answer Session [Operator Instructions] We have a question from Rudy Hokanson, Barrington Research. Please go ahead.

[Rudy Hokanson:]

I was wondering could you talk a little bit about the outlook on various geographies, aside from the Gulf of Mexico, where you think that there might be activity picking up maybe out into 2016 or areas that you are bidding on right now?

[Brian Hanson:]

I would say the decline in activity is pretty evenly spread globally. There’s not one glimmer of light out there with the exception of what’s going on in the Gulf of Mexico for Mexico.

[Rudy Hokanson:]

Okay. As you have been cutting back on the ocean bottom right now in terms of what the carrying cost is going to be, can you give us an idea was that running at about a 10 million a quarter rate when you had first ramped up? Or what’s the 3 million relative to?

[Steve Bate:]

Yes, it was running north of 10 million.

[Rudy Hokanson:]

Okay. Thank you. Those are my primary questions right now.

[Operator:]

We have question from Ariel Rothman, Tegean Capital. Please go ahead.

[Ariel Rothman:]

I take it from your remarks you are talking about focusing on returning to positive free cash flow in 2016. And I take that to mean you expect, I guess, continued cash burn in the second half of this year. Do you have any kind of estimate for the magnitude of the cash burn in the second half of the year? Or is that-- or will we not be burning cash in the second half of 2015?

[Brian Hanson:]

No, we will definitely burn some cash in the second half of the year. The hard thing to predict is how the fourth quarter is going to unfold in our business. Traditionally, the fourth quarter is being fairly strong because any excess budgets the oil companies have, they tend to allocate them to the purchase of data. So the fourth quarter could be anything from a use of cash to a positive contributor of cash. Given that, I’d say the third quarter is probably going to be comparable to the first two quarters or maybe just a little bit less.

[Ariel Rothman:]

Okay. Thank you very much. That was helpful.

[Operator:]

We have a next question is from Phyllis Camara, Pax World Funds. Please go ahead ma’am.

[Phyllis Camara:]

I was reading you guys put out an 8-K today about the new bank facility. And it seems like they were talking about they wanted an appraisal of the multi-client data library. Did I read that correctly? And can you talk about what you are expecting from that?

[Steve Bate:]

Sure, Phyllis. This is Steve. They are as part of the borrowing base calculation, there is an appraisal of some of the assets that are in the borrowing base. The data library appraisal is ongoing. It should be completed shortly, and the borrowing base should get finalized by the end of the month. The borrowing base moves around a little bit month to month based on how the assets in the borrowing base move around. But we would expect the data library to make a full contribution, as stated in the 8-K.

[Phyllis Camara:]

Okay. And do you expect the 40 million -- is that already lower than your borrowing base right now? Do you expect the $40 million to change that you’ve got available?

[Steve Bate:]

The 40 million is the total availability under the facility. I would expect our borrowing base to run in that 30 million, 40 million range as we get the appraisals in by the end of the month.

[Phyllis Camara:]

Okay. Then the availability could possibly decline a little bit?

[Steve Bate:]

I think the borrowing base can grow. The 40 million is the total capacity of the revolver.

[Phyllis Camara:]

Okay.

[Steve Bate:]

Right. And the borrowing base -- our current estimate is that will be in the upper end of our capacity in the borrowing base calculation when we finish it.

[Phyllis Camara:]

Okay, okay. Thanks. And then I think you may have answered part of the question. On the 40 million that you are taking out of costs, can you define what that’s coming from? Like for the second quarter, we may see a cash burn, but -- or the third quarter, we may see the cash burn similar to first and second, but then we will see an additional potentially one quarter of 40 million out in the fourth quarter and then that will carry through into 2016, where costs will be lower from 2015 to 2016? Is that what we’re expecting?

[Steve Bate:]

Phyllis, I think maybe the best thing for us to do is to give me a call after this and we can walk through some of those numbers. I think Q4, as Brian said, is really dependent on what the revenue levels come in at. But I can help you walk through what our expectations are for the back half.

[Phyllis Camara:]

Okay. That’s it for me, then. Thank you.

[Operator:]

[Operator Instructions] We now have a question from Mr. Ken Funston of Funston Asset Management Company. Please go ahead.

[Ken Funston:]

Thanks for having the questions. By the way, I’ve called the Company a few times and never received a return call. Are you going to begin returning calls when investors call?

[Brian Hanson:]

Sure. I’ll tell you what; give me a call right after this, and we’ll connect and I’ll try to figure out what happened there. But certainly we will return your call.

[Ken Funston:]

Okay. Thanks a lot. My question is partly a little bit; let me say on the 40 million, so that’s a max. That’s the maximum. What you are saying is the availability of your drawing power is going to be determined by the asset appraisals.

[Steve Bate:]

Absolutely that’s correct.

[Ken Funston:]

Okay. So I’m sure you realize that on the message boards and other places there’s predictions of the bankruptcy of ION. And some people point to the fact you are going to need asset sales and your bond maturity, which I believe is in 2018; that you don’t have anything worth selling anymore. How do you respond to the idea that bankruptcy is in the future for you, and this bond maturity that’s still three years out?

[Brian Hanson:]

I think, first of all, I don’t spend any time on message boards. The credibility of that content is subject. So anyway, step back and think about what ION is. ION is a highly scalable Company. It primarily is a business of people and intellectual property. And what we are not similar to the peer group that we run in, we’re not a Company that has a lot of steel and assets that are very hard to scale. And so if you just step back and think about that, once you figure out what level of activity the business is going to run at, you can very easily scale to that level of activity. And that’s what we’ve done this year right? The first half of the year was really a period of decline when we tried to figure out just how much the business was going to decline. And that sets us up for a thesis on how we think this is going to continue over the next few years. So we have embarked upon a path of continually scaling our business to where we think it’s stabilized. Our opinion today is our business is stabilized and actually has upside growth potential once our crew goes back to work. So it’s easy for us to turn the corner and by 2016 have this scale to a free-cash-flow-generating business. All of that being said, if you also step back and look at how much cash we have, add this additional borrowing capacity on it. We have a lot of liquidity we are sitting here with 150 million, 160 million of liquidity. And the two worst quarters we had in the history of our business were Q1 and Q2, and we only burned 50. So if you just operate under the thesis that the 50 declines and goes to zero and we move into cash-flow-generating-territory, we are still going to have lots of liquidity when we move into 2016 and beyond. So we are not contemplating bankruptcy in any form or fashion.

[Ken Funston:]

And the maturity in 2018?

[Brian Hanson:]

Years out there.

[Ken Funston:]

Thank you, gentlemen.

[Brian Hanson:]

Middle of 2015. I wouldn’t comment on anything three years away from now.

[Operator:]

Ladies and gentlemen, there are no further questions. I’d like to turn the conference over to Mr. Brian Hanson, CEO of ION, for closing remarks. Please go ahead sir.

[Brian Hanson:]

Thank you for taking the time to attend the conference call. And we will look forward to talking to you on our Q3 call.

[Operator:]

This concludes today’s conference. Thank you for your participation. You may disconnect your phones at this time.