ION Geophysical Corporation
Q3 2014 Earnings Call Transcript

Published: 9 Nov 2014

[Operator:]

Good morning, ladies and gentlemen and 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. And I would now like to turn the conference over to Ms. Karen Abercrombie. Please go ahead, ma’am.

[Karen Abercrombie:]

Thank you, Anna. Good morning and welcome to ION Geophysical Corporation’s third quarter 2014 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 will be using 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. Moving on to Slide 3. Information reported on this call speaks only as of today, November 6, 2014 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 includes 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 with the SEC, including in 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 in our press release issued yesterday and please note that the contents of our conference call this morning are covered by those statements. I will now turn the call over to Brian who will begin on Slide 4.

[Brian Hanson:]

Thanks, Karen and good morning everyone. Yesterday, we reported third quarter revenues of $107 million, up 33% over third quarter 2013. Our total year-to-date revenues were $373 million, up 13%. Despite our growth in revenues, which was primarily driven by OceanGeo, we reported a net loss of $25 million in the quarter or $0.15 per share. As expected, our base business revenues, margins and operating income were impacted by the sustained slowdown in exploration spending by oil and gas companies. Seismic in particular has been hit hard with forecast of declining spending through 2015. With predictions of reduced global oil demand caused by a slowdown in global economic growth, geopolitical tensions and regional economic sanctions, this reduced seismic spending is likely to continue through 2016. Although our third quarter results were disappointing, our third quarter is typically our weakest and is not reflective of our expectations for the fourth quarter. We mentioned a potential slowdown in exploration spending on our third quarter call a year ago. Since then, we have been proactively managing through it. We have reduced costs in our systems and data processing businesses and have continued to maintain discipline regarding the exposure we will take on our new venture programs. We have steadfastly executed our strategy of leveraging our innovative technologies to develop and deliver solutions to our E&P company customers and we are focused on generating positive cash flow. The energy business is cyclical, but we are a completely different company today than we were going into the last downturn 5 years ago. We are a lot stronger and better positioned, whereas in 2009, our business was largely centered around our land and marine equipment businesses, which generated half of our revenues. Today, over 80% of our revenues come directly from our E&P company customers. In 2009, our equipment businesses, especially the land business consumed a lot of cash. As an example of how much we have weatherproofed our business, over the past 12 months, we have generated net cash flows before financing activities of $61 million compared to 2009 when we had a use of cash before financing activities of $40 million. Although we are a negative earnings territory, we are positively generating cash and at the end of Q3 had cash balances of $130 million and total available liquidity of about $200 million. We have diversified our portfolio to include offerings that span the entire E&P lifecycle. Our deliberate entry into the production-oriented ocean bottom services business is a prime example. Year-to-date OceanGeo has had both excellent operational and QHSE performance as well as solid financials with net profits in each quarter and contribution of significant cash. Our strategy was to get our crew into West Africa, an area with significant tendering activities OceanGeo was currently completing a survey there and has just completed negotiating another program that should carry us through the fourth quarter. In addition, we are actively negotiating another large tender there which should provide OceanGeo with a substantial backlog for a good portion of 2015. With several active tenders in the region, we feel we are well-positioned with the crew in West Africa to generate significant long-term backlog in that area of the world. Whereas the market for towed streamer acquisition has softened, the market for ocean bottom is quite robust. As we have mentioned before, we are extending our offerings into the 3D market. In collaboration with Polarcus we recently completed acquisition of the multi-client 3D seismic survey offshore Ireland. This was the first survey under previously announced multi-year strategic alliance with Polarcus to jointly develop, execute and market 3D multi-client seismic programs globally. The survey was an industry funded opportunity in advance of an upcoming licensing round and represented a key opportunity for us to enter the 3D multi-client market, a natural extension of our traditional 2D BasinSPAN expertise. We see this market as a growth opportunity for us and are continuing – and are currently working to secure client commitments for additional 3D multi-client programs in other areas of the world. Our software segment revenues were up 9% in the third quarter and up 16% for the year. Our core command and control software products remain solid and we are diversifying our software portfolio to include E&P systems for managing simultaneous operations or SimOps, another example of extending our solutions into the latter stages of the exploration and production lifecycle. SimOps is an integrated visualization and data management solution companies can use to manage simultaneous operations in both seismic and production environments. Our Narwhal for ice management was the first application of this technology, but we are seeing a broadening of the footprint of opportunities for this application to include production operations. We now have two Narwhal deployments underway and we have recently signed a contract for our first production SimOps engagement. We see tremendous growth potential in our software segment with SimOps, a market we estimate to be in its nascent state in the neighborhood of $1 billion. SimOps has the potential to be exponentially larger than our traditional command and control software business. While our data processing business has been under some pressure this year as in prior downturns, we would expect companies to move into a data reprocessing mode GX Technology’s sweet spot as a pullback from seismic acquisition. So in summary, while we had a disappointing third quarter, we are confident we are well-positioned for the eventual upturn from both the portfolio and financial perspectives. I am going to turn the call over to Greg now to go through the financials. And then I will come back and wrap up.

[Greg Heinlein:]

Thanks Brian. Good morning everyone. Our third quarter revenues were $107 million, a 33% increase over the third quarter of last year. This increase was predominantly due to revenues contributed by OceanGeo. Our consolidated gross margins increased to 27% compared to an adjusted 19% in the third quarter 2013 and our operating margins were a negative 5% compared to an adjusted negative 18% last year. This increase in both gross and operating margins was driven primarily by the mix of revenues from new venture programs within solutions segment over a very weak third quarter last year. Our adjusted EBITDA for the quarter was $13 million compared to a negative $4 million one year ago. This year-over-year increase was primarily the result of an improved mix of revenues in the solutions segment. Overall, we reported a net loss of $25 million or $0.15 per share, compared to an adjusted net loss of $20 million or $0.13 per share during the quarter of last year. Our improved income from operations was offset by an increase in our income tax expense relating to our non-U.S. businesses, including OceanGeo as well as a valuation allowance taken against U.S. losses from which we cannot currently benefit. Turning to Slide 7, our third quarter solutions segment revenues were $46 million, a 6% increase from third quarter 2013. Within the solutions segment new venture revenues were $18 million, up 54% from third quarter 2013. Data library revenues were $3 million, down 37% and data processing revenues were $24 million, down 8%. While new venture revenues were up, all businesses within our solutions segment were impacted by the continued softness in exploration spending. Solutions had an operating loss of $6 million, a negative 13% operating margin, up from an adjusted operating loss of $13 million and a negative 29% operating margin in the third quarter of 2013. While an operating loss, the improvements in operating margins was due to the mix of new venture revenues and a result of reducing our cost structure in the second quarter. Our year-to-date investment in our multi-client library was $57 million compared to $86 million in the same period a year ago. Turning to Slide 8, our software segment revenues increased 9% compared to third quarter 2013. This was primarily led by increases in Orca and Gator licensing revenues from various global customers. Our software segment operating profit was $6 million, with a 56% operating margin compared to $6 million and a 62% operating margin in the third quarter of last year. This decrease in operating margin was due to an increase in research and development for our next generation software products. As Brian mentioned, while not a significant contributor to our third quarter revenues, we now have two Narwhal deployments in production and recently signed our first production SimOps engagement agreement. Moving on to the next slide, systems segment revenues were $25 million, a decline of 6%. This year-over-year decrease was due to a reduction in sales of land geophone strings, while new positioning system and repair and replacement revenues were relatively flat compared to the third quarter of last year. Systems operating profit was $3 million with a 12% operating margin compared to an adjusted operating profit of $4 million, a 14% operating margin for the third quarter of last year. This decrease in our systems operating margin was primarily due to our continued development of our next generation ocean bottom systems. Turning to Slide 10, ocean bottom services segment revenues were $25 million related to work performed in OceanGeo’s project, Offshore West Africa. Work began in late July and was completed in early November. Ocean bottom services operating profit was $2 million, a 7% operating margin in the third quarter. As Brian mentioned, West Africa is an area with significant tendering activity and OceanGeo is in active negotiations with clients on potentially longer term projects. Turning to Slide 11, INOVA’s revenue in their second quarter was $11 million, a significant reduction from their second quarter of 2013. INOVA recorded a net loss of approximately $11 million, of which our 49% share was approximately $5.6 million impacting our third quarter results. INOVA continues to be impacted by a soft land seismic market and has experienced significantly reduced equipment purchases by BGP. We currently estimate INOVA’s third quarter results in terms of both revenues and operating loss impacting our fourth quarter to be fairly consistent with their second quarter results. Turning to Slide 12, as of September 30, our cash balance stood at $130 million and our net debt defined as total debt less our cash balances was $56 million. During the first nine months of the year, we generated $37 million of free cash flow compared to a use of free cash flow of $21 million in the period one year ago. Our adjusted EBITDA was a positive $90 million, a 68% increase over the first nine months of 2013. In August, we entered into a new credit facility with a group of Western banks replacing our previous facility with China Merchants Bank, which was scheduled to mature in 2015. The lenders under this new facility have currently committed $80 million of revolving credit subject to a borrowing base, but the facility allows for an additional $95 million of indebtedness through a combination of revolving credit capacity and term loan up to $175 million in total. As of September 30, we had not drawn any loans under this new facility. With that, I will turn it back to Brian.

[Brian Hanson:]

Thanks, Greg. While it feels like we are on the decelerating side of the downturn, we are maintaining our cautious outlook and anticipate this slowdown will continue through 2016. Fortunately, as I said earlier, we saw it coming and have been proactively managing our business, focusing on generating cash, exercising spending discipline across all our businesses, and continuing to diversify our portfolio deeper into the E&P lifecycle. With that, we will turn it back to the operator for Q&A.

[Operator:]

Thank you, sir. We will now begin the question-and-answer session. (Operator Instructions) And we will take our first question from Mr. Joe Maxa with Dougherty & Company.

[Joe Maxa:]

Thank you and good morning.

[Brian Hanson:]

Good morning, Joe.

[Greg Heinlein:]

Good morning, Joe.

[Joe Maxa:]

Hi, a question on the OBS side, I mean having some success I did notice that the operating profitability of that segment was weaker compared to the last couple of quarters on similar revenues, so I want to address that, get maybe a little color. And then going forward in the 2015, it sounds like a lot of opportunities, do you – what do you expect that op margin to be and just wondering how can – if it’s just competition that’s driving down that profitability or maybe just a little more color and then if there is possibility of perhaps adding the second crew to generate additional revenues if it is the strong market?

[Brian Hanson:]

Yes, sure. Joe, first of all I will tell you what happened with the profitability in the third quarter was when we went into – when we originally tendered for that job in West Africa, we did it under assumption we are going to roll Calypso on that crew. And when we transitioned over there we started the job with VSO, which is less efficient. So we had the incremental efficiencies built into our code for Calypso. And we didn’t – ultimately we didn’t put Calypso on that job, we didn’t want to interrupt the job so shot that VSO was less efficient, so we had a little bit of margin pressure. It wasn’t because of anything competitive, it was just our assumption of what technology we are going to use on the job. The jobs that we are going to – we have also since then made a decision that we are going to keep running that crews a VSO crew in West Africa for a while. And the reason we are going to do that is a lot of tenders that we are working on are based on 4D surveys that were originally shot with VSO. So what we are hearing loud and clear from our customers is they want the same technology to repeat the survey. They don’t want to introduce any variables into it. So we are going to continue to roll into 2015 with VSO in West Africa. And Calypso is actually slated now to move – to go on to the second crew as we go through crew expansion. And we believe that second crew although we are not going to say where we are going to roll it out. We have targeted an area that’s more of a deepwater environment and very conducive to Calypso with its hardened engineering that suited for 2,000 meter water depths. So that’s why you have some – a little bit of margin pressure. We don’t see that margin pressure moving forward because we are going to be coding all these projects with the assumption we are using VSO.

[Joe Maxa:]

I see and your intention or it appears you maybe able to use this Calypso in 2015?

[Brian Hanson:]

I think when I would take a look at our experience in the length of time it takes to tender and get permits and get everything lined up I think that our best opportunity for rolling out a second crew is probably very late 2015 or very early 2016. It just takes time. And if you go back and look at our history and how long it took us to boot up with crew one and get internationalized and get it up to QHSE’s specs and functioning well, it took us over a year to do that.

[Joe Maxa:]

Okay. I wanted to follow-up on a different topic on the data library sales obviously Q3 has been weak two quarters, two years in a row, last Q4 you had very strong sales, what are your initial signs looking at Q4 for this year?

[Brian Hanson:]

Well, I will tell you, it’s hard for us to, always hard for us to gauge how the quarter is going to roll and it’s so subject to discretionary funding. I will tell one of the – there are a few other things we are looking at. One is there are a few tradeshows that we attended around this time of year August through November and they are usually fairly good indications of what kind of activities levels we should – that we should expect. And we are getting mixed messages. So in two of those shows it was very positive and one of those shows was negative. And so it’s a little bit hard to read the tea leaves there. The second thing is with the recent sanctions with Russia and Exxon and Shell having to pull out of that market, we are hypothesized that you might see a little bit extra capital budgets that haven’t been spent that may free up for the fourth quarter. But we are in a little bit of a storm here, so it’s hard to predict.

[Joe Maxa:]

Right, okay, that’s helpful though. Thank you.

[Operator:]

And we will now take a question from George Venturatos with Johnson Rice.

[George Venturatos:]

Hi, good morning, Brian and Greg.

[Brian Hanson:]

Good morning George.

[Greg Heinlein:]

Good morning George.

[George Venturatos:]

Also I wanted to start on the ocean bottom services side of the business, it sounds like that extension is likely in place that puts you with work through most of 4Q. When you look at the tender opportunities for ‘15 what’s kind of your expectations for start dates there? Do you see any potential gaps as we roll off that existing contract? And then also just maybe a little more detail on the size in terms of some of the tender opportunities that are out there and when you may hear back on those awards?

[Brian Hanson:]

Sure, George. I would think the way that our tendering activity based on where we are at in the process with these guys, I would expect that there will be very little gap between ‘14 and ‘15 and where there will – if there is a gap, it will be because we are proactively doing something, some back deck work or something like that, that just – that’s needed. So, I think the way these projects are teeing up there looking like they are fairly seamlessly going to flow together, but we do have – we do have some initiatives that we want to do in the back deck of that crew. And so we may see a few weeks of downtime to do those, but nothing meaningful. As far as the size and timing, I mean, these are pretty significant awards and just the next two, which we are very actively involved in negotiating now, the next two awards will take us well into 2016. They are large and they are very meaningful. And both of those awards are as I mentioned before, they are both awards, where VSO was the technology used for the prior surveys in both cases and so VSO was the preferred technology for the next survey.

[George Venturatos:]

Understood, understood. Good to hear. On the multi-client side, obviously you spoke about the challenging environment out there, with the $57 million year-to-date invested, and apologies if I missed this, but does previous guidance of $70 million to $90 million for ‘14, does that still stand and how do you feel about that kind of full year range?

[Brian Hanson:]

Yes, I think our previous guidance still holds. It feels like we are going to be in the lower end of that range so, George and I would expect that you are probably going to see something comparable for next year as well.

[George Venturatos:]

Okay, great. Thanks a lot guys.

[Operator:]

(Operator Instructions) We will now move to Mr. Chris Bamman with Sidoti & Company.

[Chris Bamman:]

Good morning, gentlemen.

[Brian Hanson:]

Good morning, Chris.

[Chris Bamman:]

Can you hear me?

[Brian Hanson:]

Yes.

[Chris Bamman:]

Yes. I was just curious just given all the weakness in exploration spending that’s really hurting your multi-client library is any of that market share loss or is it just really a lot just due to the weak spending?

[Brian Hanson:]

Yes, probably two comments on that. When it comes to the data libraries themselves, Chris, certainly not market share loss, we have a very robust library and it’s in the areas in the basins in the world, where people have interest. And I think it’s still a little too early in the year to rule out a good data library year. A lot of the data library activity traditionally is a Q4 event. Q3 is always very soft. So, I wouldn’t pass judgment on the year until we see how it comes in.

[Chris Bamman:]

Okay, that’s helpful. Thank you. And then just one other question, I believe you said on the third quarter conference call that you had to pay an additional $5 million to Georadar if you got some backlog. Did you have to pay that money?

[Brian Hanson:]

I – at this point in time, I don’t think we are going to have to pay that money. I think the way everything is lining up that the way that we have got that agreement structured, I don’t think there is a lower – there is a low probability we will be paying it.

[Chris Bamman:]

Okay, thank you.

[Brian Hanson:]

You are welcome.

[Operator:]

Okay. Mr. Maxa, please go ahead with your follow-up.

[Joe Maxa:]

Yes. Greg, on the taxes, I mean, can you give us a little more color what happened there? I mean, I certainly wasn’t expecting that type of rate and what should we be looking at going forward, how should we model the taxes?

[Greg Heinlein:]

Yes, good question, Joe. So, every company that has tax obligations to both domestic and foreign governments determines estimates on profitability of where they will end up paying for the year. Our assessment at this point in time is that our U.S. operations will remain in a loss and we can’t take the benefits of those losses to reduce our taxable expense. So, what we end up doing is paying taxes in foreign jurisdictions and those taxes on what I will call negative pre-tax income makes it look like a large percentage of taxes being paid. The reality is that all sort of catches up with itself based on our assessment where we are at today in the third quarter, which makes it look very high in the fourth quarter depending on where things shake out and going forward in 2015. There will be a point, where we will realize the benefit of those U.S. losses and so we should have a more normalized rate in the – what I will call in the 20% to 25% range generally speaking.

[Joe Maxa:]

I see, okay. Okay, that’s helpful. And then just a little discussion on INOVA, weak quarter, weak quarter expected, weak through 2016 perhaps, I mean, what are your thoughts on maintaining that relationship or is there a potential to move on?

[Brian Hanson:]

Yes. Joe, I think there is – I think we need to take a good hard look at the equipment side of our business now in general given that we are primarily an E&P facing company irrespective of the whether it’s INOVA, whether it’s our marine business or whatever, we have to evaluate how those businesses are contributing to Ion. Some of them are really good positive cash generators for us and there is other areas that are not. So, we are in the process of evaluating those.

[Joe Maxa:]

Okay, that’s it for me. Thank you.

[Brian Hanson:]

Thanks, Joe.

[Operator:]

And it appears there are no further questions. I would like to turn the conference back over to Mr. Hanson for any additional or closing remarks.

[Brian Hanson:]

Okay. Well, thanks for taking the time to attend the conference call. We look forward to the fourth quarter conference call.

[Operator:]

And ladies and gentlemen, this concludes the ION Geophysical’s third quarter earnings call. If you would like to listen to a replay of today’s conference, please dial toll free at 1-888-203-1112 and enter pass code 9061808 or you may dial toll at 1-719-457-0820 and enter pass code 9061808. We would like to thank you for your participation and you may now disconnect.