Oceaneering International Inc Q3 FY2020 Earnings Call

My name is Cynthia, and I will be your conference operator. I would like to welcome everyone to Oceaneering's Third Quarter 2020 Earnings Conference Call. With that, I will now turn the call over to Mark Peterson, Oceaneering's Vice President of Corporate Development and Investor Relations.

Thanks, Lindsay. Good morning, and welcome to everyone to Oceaneering's Third Quarter 2020 Results Conference Call. Today's call is being webcast, and a replay will be available on Oceaneering's website. With me on the call today are Rod Larson, President and Chief Executive Officer, who will be providing our prepared comments; and Alan Curtis, Senior Vice President and Chief Financial Officer. Before we begin, I would just like to remind participants that statements we make during the course of this call regarding our future financial performance, business strategy, plans for future operations and industry conditions are forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Our comments today also include non-GAAP financial measures. Additional details and reconciliations to the most directly comparable GAAP financial measures can be found in our third quarter press release. We welcome your questions after the prepared statements. I will now turn the call over to Rod.

Good morning. Thanks, Mark, and thanks, everyone, for joining the call today. Today, I'll review the details of our third quarter results, and I'll provide you with outlook commentary and guidance for the fourth quarter of 2020 and for the full year of 2021. And after my closing remarks, we'll open the call for questions. So to start with, I'm pleased to report that our third quarter 2020 results reflect the benefit of previously disclosed cost improvement initiatives, and the recently announced realignment of our segments. Despite continuing energy and entertainment market headwinds, we generated free cash flow and both adjusted earnings before interest, taxes, depreciation and amortization, or EBITDA, and adjusted operating income improved as compared to the second quarter of 2020. I'm proud of how our employees have stepped up to the challenges brought on by the global pandemic, operating model changes and cost improvement initiatives, all the while continuing to deliver quality services and products to our customers safely and with minimal logistical delays. Now looking at our third quarter 2020 financial results. Our adjusted operating results exceeded our initial expectations and consolidated adjusted EBITDA of $45.1 million exceeded published consensus. Overall, we were encouraged by the performance of our energy businesses and the stable contribution from our Aerospace and Defense Technologies segment, or AdTech. Compared to our adjusted second quarter 2020 results, consolidated adjusted operating income for the third quarter 2020 improved by $5.1 million as efficiency gains from our cost-out efforts are meaningfully enhancing our bottom line results. Each operating segment reported positive adjusted operating income and adjusted EBITDA. Sequentially, the adjusted operating results for each of our segments, except Subsea Robotics, improved as compared to our second quarter 2020. Our cash position of $359 million at September 30, 2020, increased by $25.3 million from June 30, 2020, as we generated $19 million of free cash flow, largely driven by positive contributions from operations and working capital and ongoing capital conservation. Now let's look at our business operations by segment for the third quarter of 2020. Subsea Robotics adjusted operating income declined by $1.3 million on flat revenue as compared to the second quarter 2020, primarily due to lower contributions from our tooling and survey businesses. Due to this lower contribution, Subsea Robotics' adjusted EBITDA margin declined to 31% for the third quarter 2020 as compared to 32% in the second quarter 2020. For the third quarter 2020, the revenue split between our remotely operated, or ROV, business and our combined tooling and survey businesses as a percentage of our Subsea Robotics revenue was 83% and 17%, respectively, the same as the prior quarter. Our third quarter ROV performance was comparable with the second quarter 2020. As of September 30, 2020, our ROV fleet count was 250 systems, the same as June 30, 2020. Our fleet utilization during the third quarter 2020 was 59%, the same as the prior quarter. Based on hire were 13,601 in the third quarter as compared to 13,501 in the second quarter. Average ROV revenue per day on hire was marginally lower, declining 1% sequentially, primarily due to the changes in geographic mix. Our ROV fleet use mix during the quarter was 56% in drill support and 44% in vessel-based activity as compared to 64% and 36%, respectively, in the prior quarter. The average number of working, floating rigs during the third quarter 2020 was 85 as compared to 96 during the prior quarter, which led to fewer days on hire for drill support services. However, this decrease was offset by an increase in days on hire for vessel-based services. During the quarter, our drill support market share decreased to 57%, with ROV contracts on 76 of the 133 floating rigs under contract at the end of September. This compares to a 62% drill support market share with ROV contracts on 86 of the 139 floating rigs contracted at the end of June. Subject to quarterly variances, we continue to expect our drill support market share to generally remain in the 60% range. Turning to manufactured products, sequentially, third quarter 2020 adjusted operating income improved slightly on a 10% increase in revenue. Much of the revenue increase was attributed to percentage of completion revenue recognition on certain lower-margin project components in our umbilical manufacturing business. During the third quarter, COVID-19 had limited impact on our energy manufacturing business, but continued to adversely affect manufacturing timing in our nonenergy entertainment business. Overall, for year-to-date 2020, reduced order intake in our energy-related manufacturing business is primarily attributable to a significant decrease in final investment decisions undertaken by our oil and gas customers due to low oil demand and pricing. Our manufactured products backlog at September 30, 2020, was $318 million compared to our recast June 30, 2020 backlog of $380 million. During the third quarter, order intake was $49 million. Our book-to-bill ratio year-to-date was 0.4 and for the past 12 months was 0.5. Sequentially, Offshore Projects Group adjusted operating results improved on flat revenues. Call-out work during the third quarter was relatively consistent with the second quarter 2020, with improved results benefiting from the cost-outs and operating synergies implemented in connection with our new operating model. The impacts of COVID-19 continue to delay the Angola light well intervention project, but we are optimistic that this work will begin to move forward either late in the fourth quarter 2020 or early in the first quarter of 2021. For Integrity Management & Digital Solutions, adjusted operating results improved sequentially on flat revenue. These results were largely due to improved execution as second quarter adjusted results were impacted by nonrecurring costs on certain completed projects. Our Aerospace and Defense Technologies segment reported slightly higher sequential adjusted operating results for the third quarter 2020 on slightly higher revenue. AdTech represented approximately 19% of our consolidated revenue for the third quarter, and we appreciate the relative stability of these businesses considering the challenges currently faced in our energy businesses. As previously announced, we were awarded two meaningful contracts during the quarter, one in our space systems business, where we will be teaming with Dynetics in support of developing a human Lunar Landing System for NASA and one in our Defense Subsea Technologies business where we will be operating and maintaining the U.S. Navy's submarine rescue systems for up to five years, assuming annual contract renewals. Unallocated expenses for the third quarter 2020 were lower than the second quarter 2020, due primarily to lower accruals for incentive-based compensation. Capital expenditures for the third quarter 2020 totaled $8 million as we continue to exercise strict capital discipline. For the nine months ended September 30, 2020, we generated $32.4 million of cash flow from operating activities and spent $45.8 million on capital expenditures, resulting in a net use of cash of $13.5 million. At the end of the third quarter, we had $359 million in cash and an undrawn $500 million unsecured revolving credit facility, providing us with strong liquidity. Now I'll address the outlook for the fourth quarter of 2020. With the onset of lower seasonal offshore activity and customer budget exhaustion negatively affecting our energy businesses, we believe our fourth quarter 2020 results will decline sequentially. We are expecting lower operating results in each of our segments except Manufactured Products. Unallocated expenses are expected to approximate $30 million. During the fourth quarter, we expect to generate positive free cash flow, which will benefit from positive changes in working capital and Cares Act tax refunds. By segment, for our Subsea Robotics segment, we are expecting lower revenue and operating results due to fewer utilization days in connection with reduced seasonal demand for vessel-based ROV services, tooling services, and survey services. We believe that the working count for floating drilling rigs has largely stabilized over the past few months, and we will not see a marked decline in working count during the fourth quarter. We are forecasting our overall ROV fleet utilization for the quarter will decline to the low 50% range, and we project EBITDA margins will decline to the high 20% range. For Manufactured Products, we expect higher revenue and operating results due to increased throughput on certain percentage of completion projects in our umbilical manufacturing business. We project operating margins to remain in the mid-single-digit range. Order intake is expected to remain at subdued levels in our energy manufactured products and entertainment businesses. For Offshore Projects Group, we expect a decline in revenue and operating results, primarily attributable to lower anticipated levels of call-out work being performed in the U.S. Gulf of Mexico. For Integrity Management and Digital Solutions, we expect modestly lower revenue and operating results during the fourth quarter. For Aerospace and Defense Technologies, we expect operating income to be flat to slightly down on higher revenue. The revenue increase was primarily attributable to the startup of several new projects across our AdTech businesses, with the implied lower operating margins resulting from start-up costs and change in project mix. For the full year of 2020, we expect to generate adjusted EBITDA in the range of $165 million to $175 million. We are narrowing our guidance range for capital expenditures to $50 million to $60 million. We affirm guidance on cash tax payments in the range of $30 million to $35 million and our expectation of Cares Act and other tax refunds in the range of $16 million to $34 million. We continue to expect generating positive free cash flow for the full year of 2020. We announced the plan at the end of first quarter 2020 to reduce annualized expenses in the range of $125 million to $160 million by the end of 2020, inclusive of $35 million to $40 million of reduced depreciation expense. We estimate that since launching this plan, approximately $100 million of annualized cost reductions have been initiated, exclusive of depreciation, with additional savings expected to be achieved through the fourth quarter of 2020. We continue to estimate that the cash costs associated with these actions will approximate $15 million for 2020. And now looking ahead to 2021. We anticipate that the oil sector will face continuing headwinds in 2021 due to uncertainties around demand recovery and the resulting softness in energy commodity prices. Despite this backdrop, we currently expect our consolidated activity levels and EBITDA performance in 2021 will closely resemble 2020. We also expect to generate significant free cash flow in 2021, which will also benefit from a working capital release associated with final project milestones in our Manufactured Products segment. We will continue to review our forecast as we develop a definitive operating plan for 2021, and we will update our expectations during the year-end reporting process. And in conclusion, this has been a challenging year for all of us. Oceaneering has responded to these challenges by instituting significant structural cost reductions and reorganizing our business segments to capture operating synergies and operate profitably in a lower activity market. Thanks to the hard work of our dedicated team, these actions are showing quantifiable results as evidenced by our expectation to meet or exceed 2019's adjusted EBITDA performance in 2020 and maintaining or improving this performance in 2021 despite continuing energy market headwinds. We remain focused on generating free cash flow, preserving, and improving our liquidity and balance sheet remains a high priority. The firm capital discipline policy we adopted in 2020 is delivering results, which we expect will provide meaningful free cash flow in the future and gives us the flexibility to address our revolving credit facility maturity in January 2023 and our $500 million senior notes maturity in November 2024. We appreciate everyone's continued interest in Oceaneering, and we'll now be happy to take any questions you may have.

Our first question comes from Ian MacPherson with Simmons Energy.

Thanks for the overview, always very helpful and well organized. What really strikes me is the call for flat results next year, particularly robotics. You're witnessing a down sloping year from Q1 to Q4 of 2020 and the rig contracting forensics have obviously been very anemic. So you see this business much more clearly than outsiders, like I do. So what gives you comfort on that? And then also on products as well, you've had a 0.5 book-to-bill year-to-date. So how do you see that stabilizing into next year as well? I think those are the two biggest pieces I'd like to get maybe some more insight into if you can provide it for me.

I'm really glad you asked because we've been discussing how to give a better understanding of our consolidated results, which consist of different components. Regarding robotics, I want to highlight the strength in our AdTech division and other areas of our business that are somewhat independent from energy, all of which contribute to our performance in 2021. Specifically for robotics, it is not just a matter of drawing parallels to how the first quarter performed in 2020; instead, we see it as a starting point. The transition from Q3 to Q4 into 2021 makes sense, and we don't anticipate any significant increase in working rigs. However, we do believe we can bridge the gap between contract and working rigs, potentially securing additional contracts that would provide a boost. This perspective stems from our discussions with customers and their willingness to construct budgets around offshore activities, which has given us confidence. Yet, I want to clarify that we do not expect a substantial V-shaped recovery, and the same applies to our Manufactured Products division. We are optimistic about continuing to secure orders but do not foresee a significant rebound in FID in 2021. We expect to complete some important work in the first half of the year and then tackle smaller projects in the latter half, but nothing drastic is anticipated. Overall, our outlook aligns with industry sentiment without presenting any significant contrasts.

Yes. And Rod, I'd add just a quick comment. It also ‘21 benefits from the full year of the cost improvement initiatives that we've executed on during 2020. So that also factors into the overall decision with our guidance.

Exactly. Thanks, Alan.

Yes. And then on AdTech, is that more of a likely grower for you in '21 based on the recent contract wins and what you expect to garner going in down?

We see some successes already and other opportunities emerging. While we don't anticipate significant growth, we expect consistent performance, which makes us less vulnerable to the concerns regarding the offshore market.

Our next question comes from the line of Sean Meakim with JPMorgan.

So to start, yes, I mean, kudos for your willingness to provide some expectations for next year, most have not been willing or able for obvious reasons. So just to build on that discussion, so we talk about the confidence around free cash flow in the next year and working capital being a big piece of it. So if we could, I mean maybe from Alan, and Rod, I'd love to hear your thoughts, too, it would be nice to hear your expectations for free cash or maybe operating cash flow and how that translates into free cash '20 and '21 ex working capital and/or one-time items like the Cares Act. So if you were to kind of strip those pieces out, which no doubt you'll take the cash where we can get it at this point in the cycle. Where do we stand on an operating cash flow normalized basis for 2021? Does that make sense?

Yes. Let me begin, and Rod can add if he wants. The guidance we're providing regarding significant free cash flow for next year does not factor in any funds from the Cares Act. We expect to receive most of that this year in 2020. Could it extend into 2021? Yes, but we aren't relying on that for driving significant free cash flow in 2021. The key elements that will contribute to significant free cash flow are: first, our expectation to maintain EBITDA at a level similar to this year, which is a major factor, and secondly, the release of receivables as working capital related to milestone events on our two current umbilical projects. The timing of those payments has been a slight cash negative for us this year, but it will turn positive next year. This will be another significant factor in driving free cash flow.

Yes. I prefer to keep it simple. If we consider that we identified $100 million in cost savings for 2020 and assume it was evenly distributed over the year, we realized only a portion of those savings this year. Simple calculations suggest that we likely didn't even achieve half of that amount contributing to our results this year. If we think about a full year of those savings for next year, the cost reductions will have a significantly greater impact next year than they did this year.

I appreciate that. Could you explain the decision-making process behind the CapEx guidance for this year? With only one quarter remaining, I thought we would just adjust around the midpoint without decreasing it. I'm curious about the $30 million unallocated amount for the fourth quarter and whether there's any seasonality involved. What do you consider the appropriate run rate for unallocated expenditures and your thoughts on CapEx as we look ahead to next year?

Yes. I would look at, first off, the unallocated. I think $30 million is probably a reasonable run rate until we get a definitive plan in place looking at '21. When I look at the CapEx guide, certainly, we have looked at growth versus maintenance CapEx. We see that we've had some growth CapEx in 2020 as we had the drill pipe riser contract that we were completing. We could go a little bit lower. Obviously, if you just took off the growth CapEx that we had in 2020 from where we are at this point in time. I would say, though, we do still see reason for investment in our Digital Solutions within our Integrity Management and Digital Solutions. We see opportunity there. We see opportunity with some of the Isurus-type vehicles within the ROV space as well as what we're doing with our freedom vehicle. So there will continue to be some element of growth CapEx required as we move forward.

Our next question comes from the line of Taylor Zurcher with Tudor, Pickering & Holt.

Thank you for the details on Q4 and 2021. My first question is about the cost-out program. You've clearly made significant progress this year. Including deep depreciation, amortization, and depletion, you seem to be in the middle of your initial cost-out target range of $125 million to $160 million that you shared earlier this year. Do you have an estimate of where you expect to be by the end of the year regarding this cost-out program? It appears you are discovering additional ways to enhance that target and achieve those savings quicker than you expected. What are your thoughts on the total annualized cost-out figure as we conclude 2021?

I anticipate that we will achieve a significant portion of our remaining targets for 2020 in the fourth quarter. We have a lot of work ongoing, and as you pointed out, this process is akin to peeling an onion. As we address issues, we discover more problems, but we also improve our ability to handle them. Therefore, the potential for finding more increases as we progress. It's a diminishing return, where we focus on the most significant issues first, but there are still many smaller ones that continue to emerge. I believe we will accomplish most of our 2020 goals this year, while also continuing to search for improvements in 2021. It's an ongoing opportunity, provided we maintain our strong team and a proactive mindset within the company.

Understood. And then for 2021, it doesn't sound like you're forecasting really much in the way of V-shaped recovery at all in Subsea Robotics. I think in one of the previous questions, you said you had just caught up with a number of your customers. I was wondering if you could just characterize the tone of those conversations? Is it a bit mixed or some are getting back to work and others are still down for COVID or whatever other reasons they may be down? But what's the general tone you're hearing from your customers right now with respect to offshore activity and spending plans over the next 12 months?

So I would say kind of just general tone. Very little being shut off as COVID. And they all are global operators, right? They go through a lot of tough things going on in the world, generally not all at the same time like right now, but they know how to operate in tough conditions. So they're back to work largely. As far as they see that there's underinvestment going on so far this year, there's a fair amount of economic recovery happening around the world. So they believe that, that underinvestment and recovery could support prices and certainly at a point that supports continued offshore work. But they're also being very focused on where they work. They say there's not a lot of rank wildcat type exploration. They're going to chase leveraged oil as they speak, things close to infrastructure that allow them to get maximum benefit from the infrastructure that's already installed. And so they're very focused, but they believe that it's a good time to make investment. And for us, we like that because that kind of work, single well tiebacks, things like that, near-field tiebacks, that's good work for Oceaneering. So we're encouraged by what they're saying.

Our next question comes from the line of Mike Sabella with Bank of America.

I was kind of wondering if we could talk to a little bit about the outlook for maintenance spending at the customer base next year. A lot of what we hear from your guide. There's still a bit of hesitancy to kind of step into these big, long-cycle projects. It seems that maintaining production with as little capital as possible is key. Can you just talk to us about how you think maintenance spending kind of as a whole trends over the next year if commodity prices kind of remain range bound at your current levels?

Let me break down maintenance spending into two main aspects: production maintenance and integrity management. Integrity management is crucial, primarily due to the need to maintain our license to operate. With the current focus on ESG, any mistakes or loss of mechanical integrity can be costly. Therefore, there will be continued investment in this area, although it needs to be done more efficiently since it primarily serves to avoid costs rather than generate revenue. We are eager to contribute to improving this process. I view this as a positive trend in integrity management. Regarding production management, we aim to focus on the cost-effective barrels that are already connected to the flow line. It's essential to maximize our efforts in light well intervention and flow remediation using our subsea equipment. This strategy will be particularly effective if we see some price support, allowing us to optimize our budget without committing to long-cycle projects. Overall, I believe these areas will present solid opportunities in the coming year.

Perfect. As we consider capital allocation moving forward for Oceaneering, we're also continuing to build cash. Is there anything we can do at this point to improve capital efficiency and the structure of our capital? Is there a way to utilize that available cash effectively in the near term?

I'll let Alan answer a little bit, but I'll just jump in with. We were looking at a lot of things. I mean obviously you look at what's going on. If the debt starts trading at a discount, what things can you do out there in the market? So yes. And like we've said pretty obviously, that is a lot of that cash is sitting there with the expectation it's going to be used to retire a significant portion of our 2024 debt maturities. So it's still a goal. It's still something we're watching. So I think that's where we're looking right now.

Our next question comes from the line of Kurt Hallead with RBC.

I appreciate you guys going out on the limb and taking a stab at 2021. Kudos.

Thank you.

I understand you provided a broad overview, which is essential as we look towards 2021. However, it raises the question about the performance of your different segments. When considering flat year-on-year EBITDA overall, you've noted some positive trends for AdTech and Manufactured Products. Based on that, is it reasonable to think that AdTech and Manufactured Products could experience year-on-year growth in segment EBITDA, while the other segments might remain flat or slightly decline?

Kurt, we need to wait for more details on where things are headed, but you correctly identified the AdTech aspect from Rod. We believe that year-on-year, there could be factors outside the energy sector with the recent contract awards that might be advantageous. Regarding Manufactured Products, what I gathered was that we have contracts that we will be processing through their backlog in the first half of the year, and the second half may present more challenges. Therefore, we are not trying to raise expectations for Manufactured Products for next year. It’s more about the timing of when that revenue may come in. For the Offshore Projects Group, we initially expected to execute a light well intervention project in 2020, but that now seems likely to shift into 2021. This could provide a bit of a boost as we move into next year. There will be various moving parts, and we still need to sort through the details to offer clearer guidance.

I appreciate that. In light of the incremental free cash flow expected in 2021, you touched on the previous question to some extent. As you consider it further, when you're building cash on the balance sheet, can you provide some insight into whether you're viewing this as a potential refinancing opportunity for the debt or if you're actually considering reducing some of that debt as you progress through 2021?

I think all of the above. I think it is going to be the flexibility and optionality that the cash will provide us. We will look at the markets and what they may bring to us and what would be right to do at the time. So we actively review that.

Our next question comes from David Smith with Heikkinen Energy Advisors. Are you considering this as a potential refinance opportunity for the debt, or are you aiming to reduce some of that debt load as you progress through 2021? Rod Larson, President and Chief Executive Officer, responded that they are considering all of the options. He believes the flexibility and choices that the cash will offer are important. They will evaluate the markets and determine the best course of action at the right time, actively reviewing the situation.

I'll reiterate what everyone else has said about the '21 guidance. Very helpful, and appreciate it. I did want to ask, with the segment realignment we got a better view at some of the products and service lines. And I was a little surprised at how negative mobility solutions margins were in the first half. And I understand there is uncertainty around the COVID outlook and when that business picks back up. But I wanted to ask about your approach to eliminating losses from that subsegment and whether it's possible to get those margins to breakeven without theme parks getting back to normal.

It's an interesting situation and quite complex. Most of our mobility solutions business has traditionally been tied to the entertainment sector, which has faced significant challenges recently, especially in the theme parks during the first half of the year. This caused a major slowdown in operations. Additionally, much of our work in the first half was concentrated in China, and we encountered difficulties there as well. Currently, we have a limited presence in China, and that remains a significant hurdle. In response to these challenges, we implemented substantial cost reductions in the business where feasible without compromising our capabilities. On the other side, the remaining part of our business is smaller and has been more project-focused. We have shifted towards developing more standardized products. Following the global pandemic, there's been increased interest in integrating mobility solutions into manufacturing plants to reduce human interaction and ensure continuous operations. We've also worked with hospitals, reflecting growing interest in these solutions. However, we must carefully assess which opportunities are genuine and which ones are just speculative inquiries, as it’s crucial not to pursue unviable prospects. It’s a two-sided business, and we anticipated that there might be some misunderstandings or inflated expectations about these segments, which we expect will generate questions as we move forward and provide more clarity.

I appreciate the color. And the other one, a follow-on question. It looks like your vessel-based ROV activity was higher in Q3 than at any point since 2015. Just wondering if you could give any color around that pickup and whether anything in your '21 outlook includes higher vessel-based ROV activity compared to '20?

I would just say that relationships keep getting better with the vessel operators. And for a while, it's a little bit challenging sometimes for us because we were vessel operators in a big way, and they saw us as a competitor. And so it was a little bit difficult to reconcile. But now that, number one, we're doing more of our vessel operations on spot higher and short-term charter as well. I think we're starting to resolve those relationships. And we just picked up a significant contract with a vessel operator. So the relationships are getting better, our placement on board, vessels owned by others is getting better. And I think that's just a sign of how we're building that part of the market for our customers.

There are no further questions in queue at this time. I'll now hand the call over to Mr. Rod Larson for closing comments.

Well, thanks, everybody, for all the great questions. And since there are no more, I'd wrap up by thanking everybody for joining the call. And this concludes our third quarter 2020 conference call.

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