Oil States International, Inc Q3 FY2023 Earnings Call

Good day, everyone, and welcome to the Oil States Third Quarter 2023 Earnings Call. Today's call is being recorded. I would now like to turn the conference over to Ellen Pennington. Please go ahead, ma'am.

Thank you, Lisa. Good morning, and welcome to Oil States third quarter 2023 earnings conference call. Our call today will be led by our President and CEO, Cindy Taylor; and Lloyd Hajdik, Oil States' Executive Vice President and Chief Financial Officer. Before we begin, we would like to caution listeners regarding forward-looking statements. To the extent that our remarks today contain information other than historical information, please note that we are relying on the safe harbor protections afforded by federal law. No one should assume that these forward-looking statements remain valid later in the quarter or beyond. Any such remarks should be weighed in the context of the many factors that affect our business including those risks disclosed in our Form 10-K along with other SEC filings. This call is being webcast and can be accessed at Oil States' website. A replay of the conference call will be available for 2 hours after the completion of this call and will continue to be available for 12 months. I'll now turn the call over to Cindy.

Thank you, Ellen. Good morning, and thank you for joining our conference call today, where we will discuss our third quarter 2023 results and provide our thoughts on market trends in addition to discussing our company-specific outlook comments. Our third quarter results benefited from growth in offshore and international spending with significant sequential and year-over-year increases in offshore project activity and backlog conversion. However, our quarterly performance was tempered by an industry-wide decline in U.S. well completions, which has been ongoing since the first quarter of 2023. We believe U.S. activity declines were triggered by weaker commodity prices in effect earlier this year. Our third quarter consolidated revenues and adjusted EBITDA increased sequentially by 6% and 23%, respectively, driven by higher offshore and international activity. Year-over-year consolidated revenues and adjusted EBITDA grew by 3% and 7%, respectively. The sequential and year-over-year improvements reflect significant project-driven growth within our Offshore/Manufactured Products segment, where revenues increased 18% sequentially and 16% year-over-year, totaling $111 million in the third quarter, the segment's highest revenue level since the fourth quarter of 2016. Segment backlog increased for a fifth consecutive quarter totaling $348 million as of September 30. We are benefiting from our customers' increased investments in traditional and alternative energy offshore projects outside the United States. We received two notable project awards in the third quarter, including a production facility equipment order destined for Brazil and a contract for our Merlin Deepsea Mineral Riser System designed for use in harvesting seabed minerals at extreme water depths. The segment's bookings totaled $129 million, yielding a quarterly book-to-bill ratio of 1.2x. Our continued investments in technology and innovation were recognized earlier this month by Gulf Energy with our Active Seat Gate Valve receiving the 2023 Gulf Energy Information Excellence Award for best production technology. This proprietary valve technology provides operators with exceptional sealing performance while substantially reducing the amount of heavy grease used during valve operations and personnel involved in intervention at the wellhead. We generated cash flow from operations of $14 million in the third quarter, invested $2 million in net capital equipment and have no short-term debt outstanding. With cash on hand totaling $53 million at September 30, and no significant debt maturities before 2026, our financial position remains very strong. We expect to further enhance our liquidity position in future quarters. We remain encouraged by the continued expansion in offshore activity, coupled with future benefits to be gained from our new product introductions, including our managed pressure drilling system, our Merlin Deep Sea mineral riser system, and our active seat gate valve technology, among others. This international offshore-focused investment cycle is expected to extend years. As it relates to U.S. land-based activity with currently improved commodity pricing, we expect U.S. activity to recover in 2024 from current levels. Lloyd will now review our results of operations and financial position in more detail.

Thanks, Cindy, and good morning, everyone. During the third quarter, we generated revenues of $194 million, adjusted consolidated EBITDA of $23 million and net income of $4 million or $0.07 per share. Reported third quarter net income included facility consolidation charges of $1.6 million, which were incurred as we prepare selected facilities for sale. This represents our fifth consecutive quarter of positive net income. Our Offshore/Manufactured Products segment generated revenues of $111 million, adjusted segment EBITDA of $24 million, and operating income of $18 million in the third quarter. Revenues reported in the third quarter are at the highest level since the fourth quarter of 2016. During the third quarter, we recorded charges of $1.6 million associated with our ongoing consolidation and relocation of certain manufacturing and service locations in an effort to gain operational efficiencies and reduce future costs. Adjusted segment EBITDA margin in the third quarter was 22% compared to 17% in the second quarter. Regarding our facility planning, we consolidated certain facilities in Houston and are in the process of strategically relocating our Asian manufacturing and service operations from Singapore to Batam, Indonesia. Accordingly, we have reclassified 2 facilities as held-for-sale assets at September 30. Given these plans, our capital expenditure investments for 2023 are now expected to total approximately $35 million as a result of our plans to purchase land and begin construction on a new facility in Batam. Proceeds from the sales of our facilities in Singapore and Houston, which are expected to close in late 2023 or early 2024 are expected to range between $35 million and $40 million, exceeding the costs associated with the new facility in Batam. Backlog increased sequentially for a fifth consecutive quarter totaling $348 million at September 30, an increase of 35% from September 30, 2022. The current quarter-end backlog is at its highest level since the fourth quarter of 2015. Third quarter bookings totaled $129 million, yielding a third quarter and year-to-date book-to-bill ratio of 1.2x. In our Well Site Services segment, we generated revenues of $60 million, operating income of $3 million, and adjusted segment EBITDA of $10 million in the third quarter. Adjusted segment EBITDA margin was 16% in the third quarter compared to 18% in the second quarter. In our Downhole Technologies segment, we reported revenues of $23 million, an operating loss of $4 million, while adjusted segment EBITDA was essentially breakeven for the quarter. Lower revenues and margins in the quarter were driven by reduced customer demand for completion products and lower manufacturing volumes, driven by the continued reduction in frac spreads coupled with competitive market conditions experienced during the third quarter. During the third quarter, we generated cash flows from operations of $14 million and invested $2 million in net CapEx to support future growth. As of September 30, no borrowings were outstanding under our revolving credit facility and amounts available to be drawn totaled $85 million, which, together with cash on hand, resulted in available liquidity of $137 million. Now Cindy will offer some market outlook and concluding comments.

Thanks, Lloyd. The tight commodity markets of 2022 took a turn in early 2023. Softening global demand and resultant elevated inventories caused oil prices to drop during the first quarter of 2023. This was followed by a strong reaction by the OPEC+ countries with announced production cuts, which has resulted in significantly improved commodity pricing with Brent and WTI averaging $87 per barrel and $82 per barrel, respectively, in the third quarter. However, U.S. land-based activity has thus far lagged the commodity price improvement. Global oil and gas inventories are normalizing and are now below their 5-year seasonal average for crude oil but remain above the 5-year average for natural gas leading to lower natural gas prices year-over-year, thereby tempering expectations for growth in drilling and completion spending on U.S. land activity for the balance of 2023. We are executing well given the current market environment and our growing revenues, adjusted EBITDA and free cash flow on the strength of our offshore and international operations. Revenues in our Offshore/Manufactured Products segment are expected to continue to grow as a result of strong order flow, increased levels of backlog and execution of major project milestones. We expect our Well Site Services and Downhole Technologies segments to continue to perform in line with market activity indicators which has softened for U.S. land activities in the second half of 2023 and appears to be bottoming with expected improvements in 2024 as support is gained from a strong commodity price environment. We remain focused on optimizing our operations and pursuing profitable activity in support of our global customer base. As market opportunities unfold, both in the U.S. and in international and offshore markets, we will continue to focus on core areas of expertise with the deployment of our recently enhanced equipment to further differentiate our product and service offerings. Now I would like to offer some concluding comments. Initially, the industry responded to higher commodity prices with accelerated shorter-cycle investments in the United States, which the industry clearly benefited from in 2022. In 2023, we are experiencing an increase in investments in long lead-time projects in international markets and deepwater basins around the world based upon the longer-range outlook for commodity prices. Strong macro fundamentals are pointing to a multiyear upcycle, which should drive growth in revenues, earnings, and free cash flow generation. Our core competencies are well entrenched in the markets we serve, and we continue to bid on potential opportunities supporting our traditional subsea, floating and fixed production systems, drilling and military customers while also bidding to support multiple new customers and projects involved in developments such as deep-sea minerals gathering, fixed and floating offshore wind developments, carbon capture and storage, geothermal applications and other renewable and clean tech energy opportunities. These new energy transition opportunities create strong potential for us to expand our product and service offerings and our revenue base. Oil States will continue to conduct safe operations and will remain focused on providing technology leadership in our various product and service offerings with value-added products and services available to meet customer demand globally. Market-leading technologies will extend the runway for a sustainable competitive advantage. That completes our prepared comments. Lisa, would you open up the call for questions and answers at this time?

We'll take our first question from Stephen Gengaro with Stifel.

Just what I wanted to start with was the offshore manufactured products. The margins were stellar in the quarter. And I imagine some of that's mix and execution. How should we think about sort of the range of outcomes for OMP margins as we go through 4Q and into next year?

You're right. Our margins were very strong. As you know, we've kind of guided to high teens EBITDA margins over the course of a longer period of time on a single quarter basis. They were strong, and we had some strong project execution. We talked about our major project work. We also had good contributions from higher service revenues, which, as you know, you commented on mix. Service revenues oftentimes carry higher margins. So there are several positive factors that lifted our overall margin profile. And of course, part of it is a higher revenue base, better absorption. So a lot of things went right in the quarter. As we look out, I don't want you to think it's going to be north of 20% every quarter, but we are averaging up every single quarter, generally speaking, on our overall margins in that segment, and you've seen that progression throughout the year. I'm looking at my schedule, we were about for this particular segment, 16% in Q1, 17% in Q2, again, a bit of an anomaly at 22% in Q3, but we're looking for those high teens margins in Q4 and moving forward, if that's helpful.

That is helpful. Regarding the same segment, the backlog has been increasing. I believe it's up 13% from the end of last year. Is that a reasonable indicator of how the project-driven business might perform over the next year? When considering potential revenue growth for 2024 in this segment, particularly in the project area, should we use that as a guideline for how the backlog is being realized?

It is currently focused on major projects, particularly in terms of backlog, and there will always be fluctuations due to timing. However, a significant amount of our activity is driven by our subsea technology, especially related to production infrastructure, which has mostly originated from Brazil and Guyana. This is expected. There will consistently be variations in award activity from quarter to quarter. Our aim is to strengthen the baseline level of award activity through new product introductions, such as our MPD systems, for which we have initiated some early contracts and are seeing considerable interest moving forward. While it's challenging to make predictions on a quarterly basis, overall, we are targeting a book-to-bill ratio of 1 or better, supported by much higher revenues each quarter. I will provide more specific guidance on book-to-bill ratios after we complete our planning for the next earnings call. Higher revenues require higher bookings to maintain that level, and there is nothing that suggests we cannot achieve this over time. Nevertheless, there may be ups and downs from quarter to quarter based on when our customers issue those awards.

Great. You didn't mention this year's full-year guidance, which would also indicate the fourth quarter. For the fourth quarter, the consensus seems to be around $29 million to $29.5 million. Is that a reasonable estimate given what we currently know about the U.S. land aspect? I understand there is seasonality that can be difficult to predict.

Sure. I didn't focus solely on the fourth quarter, but our annual first call consensus was around $91.5 million. We experienced a weaker third quarter in U.S. land-based activity, though this was more than compensated for by strength in our international and offshore segments. It’s important to have better knowledge and insights than the market when discussing guidance. What I do know is that crude inventories are significantly lower than earlier this year—about 60 million barrels less. While natural gas levels are above the 5-year average, they have tightened considerably. The market is showing improvement, but we need to question whether we'll see a lift in U.S. land-based activity in the fourth quarter due to the holiday season or whether this will be delayed until 2024. Based on my experience, I wouldn't expect a boost in U.S. land activity around Thanksgiving and Christmas. However, 2024 appears strong. Crude prices were around the $70 range earlier this year, but now they're in the mid-80s, with expectations for over $90 next year. This indicates an improvement in commodities. Although natural gas may lag slightly, the outlook for a 20% increase in natural gas exports, driven by LNG and exports to Mexico, suggests positive fundamentals. Globally, and particularly for U.S. land, 2024 looks promising, but I remain cautious about significant improvements in the fourth quarter for U.S. land activity.

We'll take our next question from Jim Rollyson with Raymond James.

On the move from Singapore to Batam and just kind of some of the general consolidation activities you're looking at, maybe frame up how to think about the ultimate benefit. You mentioned the cost which ultimately is paid for by the sale of existing facilities. But just how do we think about that? Is it a margin improvement? Just kind of how to think about why you're making the moves in terms of what that's ultimately going to drive from a margin standpoint?

No. Clearly, it is geared around margin improvement. And there's these kind of independent things, but the real Southeast Asian move is into a lower-cost labor manufacturing environment into Batam. And we will keep a presence, obviously, in Singapore, but a lot of the work on the machining and manufacturing side will be done in Batam. And the goal there is absolutely to, one, increase the top line, our ability to bid has been hampered by higher cost in our Singapore operations, so expand the revenue and improve the margin. That is kind of the subset of Southeast Asia. In doing so, we'll have facility proceeds; they won't fully offset the new facility in Batam, but they will certainly help. Separately, we have multiple facilities all over Houston, which I think you know. And we've already been almost idled in one of those facilities. There is a lot of interest in that facility. We've had multiple bidders come in. And so we feel comfortable saying we expect to sell that in Q4 or early 2024. Those proceeds, quite frankly, just become corporate proceeds to us. And so the sum of both Singapore and Houston will exceed the new investment that we will make in Batam.

Perfect. Regarding Downhole Technologies, margins have been negatively impacted by weaker U.S. completion activity. As activity reaches its lowest point this quarter and we anticipate a recovery next year, how should we evaluate the recovery in margins? Is there a specific revenue level that you typically associate with returning EBITDA to positive figures? Are there internal measures you can take concerning the cost structure? Or are you incurring higher costs because this is seen as a temporary dip? I’m trying to understand how this segment may evolve over the next few quarters if we do see the recovery we are all hoping for next year.

Yes, Jim, I want to be clear. Are you talking about well site or geo?

Yes. Downhole.

I want to clarify that we are essentially at breakeven in the Downhole Technologies segment for Q3. There are two key things that need to occur. This quarter, there's a noticeable difference among other service companies, depending on whether they have long-term contracts, like pressure pumpers, or how the spot market is doing, which have behaved quite differently. Our products business and many of our wireline customers are primarily spot-based providers. When several frac fleets shut down, the demand for downhole tools decreases as well. So it's a combination of factors, but the main concern for this business right now is revenue. We are still investing in new technology, and we've maintained our engineering and R&D costs, as we see no reason to cut these expenses during a softer quarter because we believe in the long-term potential of this business. To boost performance moving forward, we need to see a recovery in activity, especially spot-based activity, and some of the new technology we plan to introduce domestically in 2024 will also assist in this regard. Furthermore, we aim to improve our international reach as well. These are the main strategies we have to drive better profitability for the business. As discussed in our recent Board meeting, we believe it wouldn't take much—just 2 to 4 frac fleets coming back online—to have a significant positive impact on our top line. We are confident that we can enhance profitability in 2024.

We'll take our next question from Luke Lemoine with Piper Sandler.

Cindy, you had very nice orders in 3Q in OMP, the Merlin order, and the production facility order. And you talked about those being at least $50 million each, which leaves a lot of room for various other orders in 3Q. Can you maybe talk about kind of what comprises the rest of that mix? And then maybe what you see for more standard orders over the next 6 to 12 months outside of kind of large things like Merlin or production facility.

Yes. I mean, we've always said we get a lot of broad-based almost recurring type orders, and those are on our high-end conductor casing connectors as an example of routine orders. We've got a very good fixed platform and crane business line that enjoys strong orders. We have military work, et cetera. So it's kind of hard to isolate. We typically just call out larger orders, which are the two. But then there's always going to be a lot of our diverter valves, our production valve order technologies that are recurring and to some degree, short-cycle orders as well. So it's kind of hard for me to glom on to any one major driver. I'd say they're broad-based, both product line and geography, quite frankly.

We'll take our next question from John Daniel with Daniel Energy Partners.

I got a question, Cindy, you referenced military customers. I'm just curious, any signs orders from that group are poised to rise just given current geopolitical climate?

We have a lot of bidding and quoting happening. I can't directly link it to the geopolitical environment, but orders are indeed increasing. Many of these orders tend to be large and can extend over several years. Therefore, I expect to see a rise in military orders. This is an adaptation of core technology we've implemented in the oil and gas sector, particularly some of our elastomer and flex joint technologies used in military applications for decades. There are solid reasons for these improvements.

Okay. And then here's the dumb guy question for me because I don't know much about seabed minerals, but what's the opportunity set there in harvesting that?

I believe they are very strong, although we are still in the very early stages. We've discussed this previously, and there has been significant media coverage about the Clarion Clipperton Zone, which essentially can be described as a remote area in the deepwater Pacific. However, this zone is regulated by an international seabed authority, which means progress there is slower compared to sovereign international waters, where we are experiencing more bidding opportunities since one country manages the permits in those regions. The recent order we received this quarter is an example of this. Other nations are also exploring these possibilities. Therefore, it seems that activities in sovereign-controlled international waters may progress more quickly than in the Clarion Clipperton Zone, though both areas are rich in resources needed for the alternative energy transition, including battery technology, wind, and solar. It is essential to access these resources, especially since many countries currently rely heavily on China for these metals and minerals, which hold a large share of global supplies. As a result, diversification has become a top priority. Additionally, energy security and meeting domestic demands are crucial for these nations, indicating that they will likely push to advance these efforts, especially when it is within their own jurisdiction. Moreover, there is a growing concern over the environmental impact of open pit mining globally. While thorough environmental assessments will be necessary for seabed activities, it appears that the environmental risks associated with this mining will be lower than those from open pit mining, which is vital for supporting the energy transition.

All right. Would you be willing to hazard a guess as to how many systems in that 5 to 7 years could be an opportunity for you?

Unfortunately, I can't do that. I wouldn’t.

John, I'll also point out. On our website, we have an animation of the Deepsea Mineral Riser System in operation. So I encourage you to go take a look at that.

Yes. I will do that. Thanks, guys.

And there are no further questions at this time. I'd like to turn the call back over to Cindy Taylor for closing remarks.

Thank you so much. Thanks for joining us today. I appreciate the interest. As always, it’s a busy day with a lot of companies reporting. I will leave my thoughts that we're headed into kind of a multiyear improved environment for the conventional oil and gas business led by international and deepwater. I certainly think the U.S. will be robust last year, U.S. land activity robust next year as well, which sets it up for a fundamentally strong outlook for our company and for that of others in the space. I do think that for our size, we are differentiated because of the higher technology products that we've had working in deepwater basins around the world for many decades, quite frankly. And are doing and making a lot of inroads towards introducing those technologies and transitioning those into new applications, which I think, again, for our size is a bit unique, and you're seeing that realized, not just talked about, but realized in our revenue stream right now and in our backlog and bookings. And so I hope that translates into strong growth from our company and therefore, strong returns for our shareholders. I do hope you have a good remainder of the earnings season, and we will be available to work with you on any follow-up questions you might have. Thank you.

And that concludes today's presentation. Thank you for your participation. And you may now disconnect.