U.S. Markets close in 5 hrs 21 mins

Edited Transcript of OIS earnings conference call or presentation 29-Jul-19 3:00pm GMT

Q2 2019 Oil States International Inc Earnings Call

Houston Aug 1, 2019 (Thomson StreetEvents) -- Edited Transcript of Oil States International Inc earnings conference call or presentation Monday, July 29, 2019 at 3:00:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* Cynthia B. Taylor

Oil States International, Inc. - President, CEO & Executive Director

* Lloyd A. Hajdik

Oil States International, Inc. - Executive VP, CFO & Treasurer

* Patricia Gil

Oil States International, Inc. - Director of IR

================================================================================

Conference Call Participants

================================================================================

* Coleman Wayne Sullivan

Wells Fargo Securities, LLC, Research Division - Senior Analyst

* Connor Joseph Lynagh

Morgan Stanley, Research Division - Equity Analyst

* George Michael O'Leary

Tudor, Pickering, Holt & Co. Securities, Inc., Research Division - MD of Oil Service Research

* Ian MacPherson

Simmons & Company International, Research Division - MD & Senior Research Analyst of Oil Service

* James Marshall Adkins

Raymond James & Associates, Inc., Research Division - MD of Equity Research & Director of Energy Research

* Kurt Kevin Hallead

RBC Capital Markets, LLC, Research Division - Co-Head of Global Energy Research and Analyst

* Sean Christopher Meakim

JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst

* Stephen David Gengaro

Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Analyst

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Good morning, and welcome to the Oil States International Second Quarter 2019 Earnings Conference Call. My name is Dinara, and I'll be the operator for today's call. (Operator Instructions) Please note that this conference is being recorded. I will now turn the call over to Ms. Patricia Gil, Investor Relations. Patricia, you may begin.

--------------------------------------------------------------------------------

Patricia Gil, Oil States International, Inc. - Director of IR [2]

--------------------------------------------------------------------------------

Thank you, Dinara, and good morning, and welcome to Oil States' Second Quarter 2019 Earnings Conference Call. Our call today will be led by Cindy Taylor, Oil States' President and Chief Executive Officer; Lloyd Hajdik, Oil States' Executive Vice President and Chief Financial Officer; and we are joined by Chris Cragg, Oil States' Executive Vice President, Operations.

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. 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, and a replay of the conference call will be available 1.5 hours after the completion of the call and will be available for 1 month.

I will now turn the call over to Cindy.

--------------------------------------------------------------------------------

Cynthia B. Taylor, Oil States International, Inc. - President, CEO & Executive Director [3]

--------------------------------------------------------------------------------

Thank you, Patricia. Good morning to all of you, and thank you for joining us today to participate in our second quarter 2019 earnings conference call.

Our reported results for the second quarter showed sequential improvements in 2 of our 3 business segments with consolidated revenues and EBITDA up 6% and 24%, respectively. In particular, our Offshore/Manufactured Products segment was a standout in the quarter, exceeding the upper end of our previously provided revenue and EBITDA margin guidance ranges.

In addition, we received 2 notable project awards during the second quarter, leading to a 21% sequential increase in backlog, which totaled $283 million at June 30, resulting in a 1.6x book-to-bill ratio for the quarter. Our June 30, 2019, backlog level is the highest it's been in 3 years.

In our Well Site Services segment, revenues increased 7% sequentially due to stronger international activity levels in our completion services business coupled with some recovery in our land drilling operations.

In our Downhole Technologies segment, results for the quarter were negatively impacted by the ongoing development of our integrated perforating gun system, the cost of field trials and $1.4 million of inventory write-off due to product design changes.

Our cash flow from operations in the quarter was strong at $32 million. A portion of that cash flow was used to repay $21 million of our revolving credit facility debt outstanding. Lloyd will take you through additional details of our consolidated results and also provide highlights regarding our financial position. I will follow with more details by segment and provide additional comments on our guidance and market outlook.

--------------------------------------------------------------------------------

Lloyd A. Hajdik, Oil States International, Inc. - Executive VP, CFO & Treasurer [4]

--------------------------------------------------------------------------------

Thanks, Cindy. Good morning, everyone. During the second quarter, we generated revenues of $265 million while reporting a net loss of $10 million or $0.16 per share. Our second quarter EBITDA totaled $26 million with an EBITDA margin percentage of 10%. Reported EBITDA was negatively impacted by $1.3 million of severance and facility closure charges as we continued to adjust our cost structure and rightsize our global operations to better align with the industry outlook. We also reported $1.4 million of inventory write-offs due to product design changes associated with the continued development of our integrated perforating gun system.

During the second quarter, we generated $32 million in cash flow from operations and invested $14 million in capital expenditures. On a year-to-date June 30 basis, we have generated $34 million of free cash flow and have paid down $37 million in outstanding borrowings under our revolving credit facility.

At June 30, our net debt to book capitalization ratio was 17% and our available liquidity position at the end of the second quarter was approximately $108 million, inclusive of cash on hand totaling $12 million. Regarding our common stock share repurchase program, our Board of Directors extended the program for 1 year to July 29, 2020. We have a $120 million remaining available under the repurchase authorization.

In terms of our third quarter 2019 consolidated guidance, we expect depreciation and amortization expense to total $32 million. Further, we expect net interest expense to total $4.8 million and corporate expenses are projected to total $12 million. We are lowering our total capital expenditures for the full year 2019 to range between $60 million and $65 million compared to prior guidance of $65 million to $70 million.

At this time, I'd like to turn the call back over to Cindy, who will take you through the details for each of our business segments.

--------------------------------------------------------------------------------

Cynthia B. Taylor, Oil States International, Inc. - President, CEO & Executive Director [5]

--------------------------------------------------------------------------------

Thank you, Lloyd. Leading off with our Offshore/Manufactured Products segment. We generated revenues of $102 million, EBITDA of $16 million and a segment EBITDA margin of 16% during the second quarter. This represented a 16% sequential increase in segment revenues and a 45% sequential increase in segment EBITDA. Our improved results were driven by an increase in project-driven revenue and short-cycled product sales coupled with improved facility cost absorption at the higher revenue levels. Our incremental EBITDA margins were strong at 35% as a result.

As I mentioned in my introductory comments, we received 2 notable project awards during the second quarter of 2019, which included production facility equipment destined for Southeast Asia and connector products destined for the Middle East. Our orders booked in the quarter totaled $163 million, resulting in a 21% sequential increase in backlog and a book-to-bill ratio of 1.6x.

At June 30, our backlog totaled $283 million, which is our highest reported backlog since June 30, 2016. Customer conversations remain constructive, and visibility for additional project awards is developing favorably as we progress into the second half of 2019 and into 2020.

In our Well Site Services segment, we generated $116 million of revenues, $18 million of EBITDA, and our segment EBITDA margin averaged 16% in the second quarter 2019 compared to 12% reported in the preceding quarter. These results benefited both from higher international activity and improved margins in our U.S. operations. Utilization of our land drilling rigs averaged 20% in the second quarter of 2019 compared to 12% in the earlier quarter.

In our completion services business, our revenues grew 3% sequentially, which was driven primarily by international activity. Our incremental completion services EBITDA margins were 119% sequentially, reflecting our cost reduction initiatives and an improved mix of international and Gulf of Mexico work. Over time, we believe that completions-related activity in international markets will continue to grow, and we are proactively expanding our completion services offerings abroad.

In addition to growing internationally, we are focused on research and development efforts within the completion services business and are currently developing step out technology offerings responsive to customers’ needs. By continuing to invest in our product lines that are tied to well completions and longer lateral lengths in U.S. unconventionals, we are able to maintain a leadership role in the equipment and services that we offer to the industry.

One such product line that is pushing the limits of completions technology is our Tempress HydroPull tool and bottom hole assembly, which holds the record in West Texas, where it milled out 94 frac plugs in a single coil tubing run. All 94 plugs were milled out in 66 hours without tripping out of the hole and without short trips, resulting in significant well cost savings for our customers.

In our Downhole Technologies segment, we generated revenues of $47 million and EBITDA of $4 million with an EBITDA margin of 8% reported in the second quarter. In addition to the impact of the sequential decline in revenues during the quarter, segment results were negatively impacted by ongoing unabsorbed costs associated with field trials for our integrated gun system coupled with $1.4 million of inventory write-offs due to product design changes. These design changes are considered one-off items and part of the field trialing, testing and development of new products. As trialed products are brought to market, our technical solutions group will become more billable and should generate revenue sufficient to offset their costs. We expect to recover market share and sales in our engineered perforating solutions business once our proprietary integrated gun system is fully commercialized.

Field testing and early commercialization efforts continue on our integrated gun system, addressable switches and other associated downhole tools. Delays are inherent in bringing new technologically advanced products to market. We continue to incorporate key field trial learnings to improve the ultimate integrated gun system, which we plan to commercialize in the fourth quarter. This is a 1-quarter delay due to product design changes.

I would now like to share thoughts on our outlook for the third quarter. We expect to continue to show sequential growth in the third quarter despite a North American land market that is expected to be slightly down. The majority of our revenue and EBITDA growth in the third quarter is expected to be generated by our Offshore/Manufactured Products and Downhole Technologies segments.

In our Offshore/Manufactured Products segment, we are forecasting that third quarter revenues for this segment will range between $100 million and $110 million, buoyed by our higher starting backlog level, which will begin to convert into greater major project revenues, along with improved demand for our short-cycled products. Segment EBITDA margins are expected to average 15% to 17% depending on product and service mix.

We estimate that third quarter 2019 revenues for our Well Site Services segment should range between $114 million and $121 million with segment EBITDA margins expected to average 15% to 17%.

For our Downhole Technologies segment, we currently estimate that our revenues will range between $46 million and $52 million with segment EBITDA margins averaging 14% to 17%.

To conclude, we continue to invest in research and development efforts across all of our business segments in an effort to bring efficiencies to the industry and to our customers. While modestly increasing expectations for the third quarter compared to the second quarter, carefully controlling our costs and continuing to generate positive free cash flow, we strive to generate sustained returns for our stockholders in a challenging market environment.

Before we close, I would like to highlight what I see as the near-term drivers of improvement for Oil States. First, expanding backlog in our Offshore/Manufactured Products segment provides revenue visibility into the future. Also, by generating a higher baseline of revenues in this segment, we are better able to absorb our costs and deliver improved margins.

Second, international contributions will become increasingly important to each of our segments in the months and years to come. We are positioning our operations to capture incremental revenue outside of the United States.

Third, we need to recover market share in our Downhole Technologies perforating business and we are focused on doing so.

Lastly, we have been a technology leader within our industry for years and continue to invest in research, development and new product initiatives. These initiatives span multiple product lines and should bear rewards over the longer term.

That completes our prepared comments. Dinara, would you open up the call for questions and answers at this time?

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) And our first question from Marshall Adkins from Raymond James.

--------------------------------------------------------------------------------

James Marshall Adkins, Raymond James & Associates, Inc., Research Division - MD of Equity Research & Director of Energy Research [2]

--------------------------------------------------------------------------------

So it seems like on this offshore theme, we have -- we're setting up for kind of a sustained ability to grow in a relatively flat commodity price environment. We've heard from the bigger guys that they're looking at offshore international continue to grow for the next couple of years. Is that what's feeding the improvement in this business, number one? And number two, could you talk about the margin improvement via pricing versus absorption?

--------------------------------------------------------------------------------

Cynthia B. Taylor, Oil States International, Inc. - President, CEO & Executive Director [3]

--------------------------------------------------------------------------------

And thanks for your questions. I think they're absolutely great ones. I think if you just kind of track the industry right now, we spent 3 to 4 years of customers kind of derisking their CapEx investment dollars, and that created a shift away from deepwater activity. Those customers really tried to high-grade their project, rebid projects and lower their overall completed cost of the product -- project in order to respond to lower commodity prices, which most people believe will sustain themselves at some level over the course of time.

I think what's really happening right now is customers have landed on key projects that they think are very economic at lower commodity prices, and those are now beginning to come to market. And we've always enjoyed high-technology positioning and proprietary products that we've always felt if we could just get a little bit of tailwind from improving activity, that we'd do pretty well. And I think that is clearly reflected in our backlog, which is up to a 3-year high at least. We're not forecasting we go back to peak levels we attained in 2014. But over the course of that 3 to 4 years, we've also had to be responsive in terms of repositioning manufacturing capacity to capture near-term demand. We've brought some newer products to market that are a little more land sensitive. The good thing is we have those in our suite now, and we're enjoying improvements in backlog more centered towards our major project work, which again gives us visibility at least for about 12 months in terms of revenue generation and, important for us, cost absorption.

Like many companies, we haven't sat around and waited for the market to return. We've done a lot of cost rationalization, facility streamlining such that we feel like as the market does recover, our margins should be resilient and respond to that. And I think we're already seeing that with the 35% sequential incremental that we had in offshore products even though this is fairly early days in terms of backlog build and revenue generation.

So I clearly feel like we do have a runway for improved, sustained higher revenues, better cost absorption, better margins as we continue to build out that backlog. But again, we do hope that we retain that baseload of short-cycled work and service work as well.

--------------------------------------------------------------------------------

James Marshall Adkins, Raymond James & Associates, Inc., Research Division - MD of Equity Research & Director of Energy Research [4]

--------------------------------------------------------------------------------

So you're making it sound like a lot of the improvement in margins is through better absorption. But you have some of these new products. Are you getting any pricing traction at all there? Or is it just all absorption and throughput?

--------------------------------------------------------------------------------

Cynthia B. Taylor, Oil States International, Inc. - President, CEO & Executive Director [5]

--------------------------------------------------------------------------------

Well, to be honest with you, we're continuing and we have every year to invest in research and development efforts. We've had many kind of -- and I'm speaking specifically to offshore products. This permeates every segment in every business, really. But as it relates to offshore products, we've had new product introductions, but most of our backlog development to date has been existing technology. Even though we may have upgraded that existing technology, I would say any kind of new product deliveries that we've been working on is yet to bear fruit.

--------------------------------------------------------------------------------

Operator [6]

--------------------------------------------------------------------------------

Our next question comes from Ian MacPherson from Simmons.

--------------------------------------------------------------------------------

Ian MacPherson, Simmons & Company International, Research Division - MD & Senior Research Analyst of Oil Service [7]

--------------------------------------------------------------------------------

Cindy, I think you were looking for 1.3 to 1.5 book to bill for products coming into the year, and you're well ahead of that. And you mentioned that you have positive visibility for orders in the second half as well. Would you be willing to share an updated target based on the visibility for the second half? Or is it too early?

--------------------------------------------------------------------------------

Cynthia B. Taylor, Oil States International, Inc. - President, CEO & Executive Director [8]

--------------------------------------------------------------------------------

Yes, it's always worrisome to know what quarter our backlog awards hit, but I would just generally say we would probably take out the low end of that range and up it just a little bit. I don't want to go to 1.6 at this time, so maybe 1.4 to 1.5. But clearly, biased to the upside based on the first half. I always say book-to-bill is a factor of 2 things, though, which are bookings and billings. And if I keep growing my revenue, the target obviously moves up as well.

--------------------------------------------------------------------------------

Ian MacPherson, Simmons & Company International, Research Division - MD & Senior Research Analyst of Oil Service [9]

--------------------------------------------------------------------------------

Yes, sure. On downhole, that was the one thing that was kind of well outside of expectations, at the low end in the second quarter. I know that you see some pathway towards normalization. But besides, I mean, you've talked about the underabsorption and the write-down issues on the margin side. But with the revenues down 25% sequentially in the second quarter, what else was at play besides just this slow roll with the commercialization of integrated gun? Is there pricing pressure that is showing up? Or do you think of this as the market share within the quarter that you think you can recapture?

--------------------------------------------------------------------------------

Cynthia B. Taylor, Oil States International, Inc. - President, CEO & Executive Director [10]

--------------------------------------------------------------------------------

I mean that's the tough thing. There's a number of things. And the downhole side of the market is changing rapidly in response to what customers are looking for at the wellsite. I'm pretty sure, you heard that from all the competitors in the space throughout the first half of this year but maybe more particularly on second quarter conference calls. So with that as an example, we've all moved from long guns to short guns.

And so the short guns, everybody's talking about most of the key third-party competitors are offering that, including Oil States. But what that means, you have to lighten up on the long gun inventory you have at reduced pricing.

So part of that is, yes, that's all about pricing. At the end of the day, it's also responding and staying ahead of market technology changes that even my mix of customers has changed. And so there are some good things in the sense that we have high-quality technology. We've been a market leader on technology along the space. And I clearly think that we can keep up or stay ahead of those changes in the market.

But all those things you mentioned have a factor. But I still probably point to a couple of things, which is, number one, the market changes around perforating systems moving more from individual product sales to more system sales, and the fact that we're still -- we're working on what we think will be one of the best solutions for the market. That doesn't always work perfectly, as I've communicated to investors before.

But the good thing is our field trials are progressively improving. We did make some design changes along the way. It did lead to a large write-up of inventory that we had built up in order to conduct an appropriate level of field trials. But again, I view that as kind of a one-off item.

The other thing is just kind of a customer base. And you've got E&Ps contracting directly. Sometimes we work with wireline companies. There's a certain amount of vertical integration going on in the market, so we have to pivot just a little bit around that shift in customer mix. And they all kind of on the margin have some impact. But I guess I would just like to leave all of you with a thought. Number one, this is a key technology that our customers want. We are very committed to delivering top-end technology to our customers. Right now, the whole segment is 18% of my revenue base. And so while I am very focused on bringing a top-quality integrated gun to market, it's certainly not all about what this company is built upon, and even the segment has many product lines, not just obviously integrated gun.

--------------------------------------------------------------------------------

Ian MacPherson, Simmons & Company International, Research Division - MD & Senior Research Analyst of Oil Service [11]

--------------------------------------------------------------------------------

That's helpful. And did I hear you say before that the commercial ramp is now Q4, not Q3 for the integrated system?

--------------------------------------------------------------------------------

Cynthia B. Taylor, Oil States International, Inc. - President, CEO & Executive Director [12]

--------------------------------------------------------------------------------

Yes. We believe so. And in addition to, we've had multiple customer contacts and feedbacks about our systems. And we are just cautious that we want it to be a very high-performing system before we bring it to commercial sales, obviously. I do think that the process we went through delayed us about a quarter. And maybe I'll just add a point of emphasis on that. We don't have any revenue in our third quarter guidance that is predicated on integrated gun sales.

--------------------------------------------------------------------------------

Operator [13]

--------------------------------------------------------------------------------

Our next question comes from Cole Sullivan from Wells Fargo.

--------------------------------------------------------------------------------

Coleman Wayne Sullivan, Wells Fargo Securities, LLC, Research Division - Senior Analyst [14]

--------------------------------------------------------------------------------

You guys mentioned growing more internationally in completion services. How much investment do you see is needed to achieve that? And then does that impact or buy us higher any 2020 CapEx levels to get that versus '19?

--------------------------------------------------------------------------------

Cynthia B. Taylor, Oil States International, Inc. - President, CEO & Executive Director [15]

--------------------------------------------------------------------------------

What we're really doing is not that CapEx intensive. We're working with some partners in various regions as opposed to spending a lot of CapEx for on-the-ground facilities. We've been in many of these markets really working on a consigned equipment and rotating personnel basis. We are finding improved go-to-market strategies. And we're also beginning to leverage some of our tools that have not really been deeply penetrated in international markets.

So as Lloyd mentioned, we're actually modestly reducing our CapEx guidance range as opposed to increasing it. And as I commented in my notes, part of Well Site's success in terms of incremental margins was largely associated with a better mix of international and Gulf of Mexico work relative to our very key base North American activity.

--------------------------------------------------------------------------------

Coleman Wayne Sullivan, Wells Fargo Securities, LLC, Research Division - Senior Analyst [16]

--------------------------------------------------------------------------------

Okay. And you guys had good, strong free cash flow this year. With the movements in downhole tools over the back half and North American headwinds, how do you kind of see working capital trending over the second half? And then also any kind of initial peek into how you guys are thinking about 2020 CapEx versus '19?

--------------------------------------------------------------------------------

Cynthia B. Taylor, Oil States International, Inc. - President, CEO & Executive Director [17]

--------------------------------------------------------------------------------

Yes, I'm going to let Lloyd give you specific comments there. I would just generally say that if we have ebbs and flows, it's generally around mix of segmental contribution towards working capital. And so what does that mean? Well, I have 1.6x book-to-bill ratio, so I fully expect as offshore products begins to increase top line revenues, you'll have some working capital needs with that. But I'll also leave you with the thought that makes me as happy as I can be because that segment happens to be my highest free cash-flow-generating business that I have. And so if I have a little working capital over time as we expand that business, I'm fine with that. But I'm going to let Lloyd to really answer your question.

--------------------------------------------------------------------------------

Lloyd A. Hajdik, Oil States International, Inc. - Executive VP, CFO & Treasurer [18]

--------------------------------------------------------------------------------

Yes. I think she did answer the question exactly. No, I'm forecasting a slight working capital build in third and fourth quarter but certainly expect to be free cash flow positive for the second half of the year. And we'll target a free cash flow like we did in the first half of the year largely designated to further debt reductions.

--------------------------------------------------------------------------------

Coleman Wayne Sullivan, Wells Fargo Securities, LLC, Research Division - Senior Analyst [19]

--------------------------------------------------------------------------------

Okay. And then any initial kind of peek on 2020 CapEx levels off of '19?

--------------------------------------------------------------------------------

Lloyd A. Hajdik, Oil States International, Inc. - Executive VP, CFO & Treasurer [20]

--------------------------------------------------------------------------------

Not yet.

--------------------------------------------------------------------------------

Operator [21]

--------------------------------------------------------------------------------

Our next question comes from George O'Leary from Tudor, Pickering, Holt.

--------------------------------------------------------------------------------

George Michael O'Leary, Tudor, Pickering, Holt & Co. Securities, Inc., Research Division - MD of Oil Service Research [22]

--------------------------------------------------------------------------------

First question, just curious, it seems like overall completion activity in the U.S. for the second quarter was up modestly, albeit tailing off at the end of the quarter. Just what we've seen from other folks who have perforation businesses and they're selling similar tools to what you guys sell is generally, it seemed like volumes were lower in the quarter. And I'm not even just thinking about someone taking share but just volumes for perforations, for guns and energetics and all that stuff seemed to have been a little bit lower.

So I'm just curious, do you guys typically see customers if they're going to slow activity kind of destock their own internal inventory? Was that part of what was playing out this quarter? Or is it really just share gains by one player or another, someone kind of pushing more aggressively into the market? Just curious how customers behave as they -- as completions activity, it looks like, it may have lowered in that business.

--------------------------------------------------------------------------------

Cynthia B. Taylor, Oil States International, Inc. - President, CEO & Executive Director [23]

--------------------------------------------------------------------------------

Yes, I'm going to just kind of say we had a mixed result there with some share gains in non-perforating product lines because I think you're really focused solely on perforating. But if I look at some of our other product lines, whether it's downhole plugs, as an example, Toe Valve, decommissioning products, there actually were some increases there. So I wouldn't just isolate on perforating.

And I really don't think that customers hold a lot of inventory of perforating. It could be that all of them have some out in distribution channels or some out on the field. But I don't think that inventory stocking or destocking is really an item there. I'd have to say if there's some kind of modest industry kind of delay, it's probably one customer specific.

(technical difficulty)

--------------------------------------------------------------------------------

George Michael O'Leary, Tudor, Pickering, Holt & Co. Securities, Inc., Research Division - MD of Oil Service Research [24]

--------------------------------------------------------------------------------

Cindy?

--------------------------------------------------------------------------------

Operator [25]

--------------------------------------------------------------------------------

This is the conference operator. Please stand by.

--------------------------------------------------------------------------------

Cynthia B. Taylor, Oil States International, Inc. - President, CEO & Executive Director [26]

--------------------------------------------------------------------------------

We apologize to everybody on the phone call. Every phone line apparently has gone down so...

--------------------------------------------------------------------------------

Operator [27]

--------------------------------------------------------------------------------

Our next question comes from Kurt Hallead from RBC.

--------------------------------------------------------------------------------

Kurt Kevin Hallead, RBC Capital Markets, LLC, Research Division - Co-Head of Global Energy Research and Analyst [28]

--------------------------------------------------------------------------------

I guess the follow-up question I have would be along the lines of the North American market. It's pretty clear that the offshore business had some pretty good momentum as does international, and clearly, a lot of question marks around the dynamic -- the shifting dynamics in the North American market.

As we move beyond, let's just say, the third quarter, Cindy, and we start just thinking kind of through cycle dynamics, do you see some really structural changes in place in how you guys are going to have to run your business and the overall cost structure of the business? And so when you're having conversations about bringing on new technology, like you already mentioned, is the discussion with the client base going to have to be a little bit different to make sure that you actually get compensated for the technology you're bringing? Any insight on that would be really helpful.

--------------------------------------------------------------------------------

Cynthia B. Taylor, Oil States International, Inc. - President, CEO & Executive Director [29]

--------------------------------------------------------------------------------

No, Kurt, those are just fantastic questions, and we're not alone obviously in doing everything that we can to respond to what I'll just characterize as a fairly challenging market environment. And we've all probably both benefited and also been guilty here. When crude prices are really high, customers spend fairly at will trying to grow production. And I always say it's one of the greatest success stories in the United States in terms of crude oil production. But the reality is I think we as an industry have been so successful to some degree that we've gotten ahead of ourselves just in terms of productivity. And I know you know, you followed the industry as long as I've been in it, that what's really happened is growth in U.S. production has exceeded global demand and it's created an out-of-balance situation, and fairly small movements in terms of that supply-demand balance obviously have a significant impact on price.

Whether it's us or our customers, I'll just say we've got religion. And what does that mean? Shareholders have had significant underperformance from the industry as a whole now for a number of years, and we're all committed to making this work at lower crude oil prices overall. And I think we've demonstrated technical capability to do that.

But to answer your question, it's multifaceted, but number one, we think of R&D investment much like CapEx, meaning you need to budget it precisely. You need to know that target market and you need to assess it to see if it achieved the returns that you expected it to.

We don't want to stop investing in technology. That has been our differentiator as a company for well before I was associated with it. And so we will continue to do that. But clearly, we do look like -- look for a payback on those investments. I would say the other kind of characteristic you're hearing from everybody is we probably ought to be targeting CapEx or I'll call mid-cycle activity. We tend to always target CapEx towards the peak and on paper, it looks like a great return. But when you have the extreme cycles that we've had to live with over the years, I think you have the question, did you really get the returns that you thought you would?

But I challenge any business to lose 50% to 80% of their revenue that this industry has done from '14 to '16 and now recovering off of that, and say that you came out unscathed. But we as a company have been constantly streamlining our cost structure, facility rationalization for all of our segments quite frankly geared towards mid-cycle returns. We are investing in higher technology when it helps our customers be more efficient, make more better wells and, therefore, become more cash flow generating on their own. They have to be healthy for us to be healthy at the end of the day.

So again, I'd say the other macro shift that we've been frustrated with, when you leave a real differentiated market that is deepwater, highly technical, highly challenging, to some degree international, and shift all the activity to land, it is more competitive. And particularly, you've got 50% of the land rig count in one -- it's a big basin but one basin in the United States, it's not the best profile. But we've responded to it, and we're coming out of it and I think generating the sustained free cash flow that you would want us to.

I do also think that some of the private equity participation in this market is going to wane. What's a frustration to us has always been having the technical capabilities, the reputation, the quality procedures, and yet having customers freely give money to what I'll call lower-end, PE-backed startups in a given basin has been frustrating.

So I think we'd like to see far more competitor characteristics in the market. And I think our customers feel like they have plenty of support out in the market, and of course, they've taken advantage of it through price negotiations. But I think they also recognize that the industry as a whole has to be healthy and generating sustainable ROIC for anybody to do well. So while it's been painful for many, I clearly think that the trend line in terms of what you'd call sustainable improvement is underway.

--------------------------------------------------------------------------------

Kurt Kevin Hallead, RBC Capital Markets, LLC, Research Division - Co-Head of Global Energy Research and Analyst [30]

--------------------------------------------------------------------------------

That's a really thoughtful and extensive answer, Cindy. I know business dynamics are challenging, not in terms of what you're facing, but obviously what investors are facing as well. So I appreciate all that color and insight.

--------------------------------------------------------------------------------

Operator [31]

--------------------------------------------------------------------------------

Our next question comes from Stephen Gengaro from Stifel.

--------------------------------------------------------------------------------

Stephen David Gengaro, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Analyst [32]

--------------------------------------------------------------------------------

Two things, if you don't mind. I guess I'll start with offshore. And obviously, you had a really good quarter and I might have missed this earlier. But when you're looking out now for the next few quarters, and I guess also the bookings in the quarter, how does the pricing structure look like in that business? And how should we be thinking about the potential order flow/book to bill as we go forward here for the next few quarters?

--------------------------------------------------------------------------------

Cynthia B. Taylor, Oil States International, Inc. - President, CEO & Executive Director [33]

--------------------------------------------------------------------------------

Well, this is obviously in contrast to our Well Site Services segment. There's a greater material content obviously in the Offshore/Manufactured Products segment. To some degree, these are all specifically engineered projects. We do all of the material spec well in advance, lock in prices. And I have been -- well, I think we've been capable and successful in bringing costs down to operators. It's really not at the expense of margins. There are clearly times, though, where we've done some internal reengineering of our products that bring down pricing for us and, therefore, for our customers as well. We had to do that obviously to be responsive to the market. But our margins hold in that scenario. And so I just haven't felt like we've had to go out and buy backlog, if that is the genesis of the question.

--------------------------------------------------------------------------------

Stephen David Gengaro, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Analyst [34]

--------------------------------------------------------------------------------

I mean it was more -- I wasn't implying that at all. I was really just thinking about your margins have advanced in offshore products. You won a lot of work. Obviously, activity seems to be improving. I'm just curious how we think about the margin trajectory going forward.

--------------------------------------------------------------------------------

Cynthia B. Taylor, Oil States International, Inc. - President, CEO & Executive Director [35]

--------------------------------------------------------------------------------

Well, again, our incrementals were strong at 35%. I think our overall margins for the segment came in at 16%. Earlier in the year, we have guided exit rate in the high teens. And so it kind of tells me we are a little bit ahead of the game in terms of achieving that with 16% coming in, in the second quarter. So we're pretty happy about the progression there.

The other thing I'll just generally say is top line matters. When we're below $100 million of revenue in a quarter, cost absorption is not exactly where we would have it be. But if we can continue to accelerate that top line, we believe our margins will respond accordingly.

--------------------------------------------------------------------------------

Stephen David Gengaro, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Analyst [36]

--------------------------------------------------------------------------------

Great. And then as a follow-up, the -- what I've heard in the field over the years was that the geodynamics downhole ballistics were at the very high end of the spectrum. And then, obviously, the market is moving to the integrated systems. But as you get there and as you get a product rolled out, I mean, it would seem that you'd start to see pretty good traction. And I was just curious, is it really the delivery system and the integrated system that's that critical even with what I've always perceived to be kind of industry-leading or certainly at the very high end of the spectrum as far as the downhole ballistics are concerned?

--------------------------------------------------------------------------------

Cynthia B. Taylor, Oil States International, Inc. - President, CEO & Executive Director [37]

--------------------------------------------------------------------------------

Well, yes. I mean, first of all, I would just generally say that we and others would agree that we do think that the shaped charges are very, very important in terms of response to this downhole. And we do believe we are a leader with respect to our shaped charge technology. So I'm going to agree with that. We do still sell those. We sell guns into the [facility] charges individually and a lot of the other associated perforating equipment.

You heard it wholeheartedly from majors to our more direct competitors, though, that the field delivery system preference is more of an integrated gun basis. But I'll tell you, and Stephen, I know you've done extensive research on this and understand it, there is great variety in what the industry is characterizing as an integrated gun system. And there are some commonalities in terms of what people are speaking of, but there are differences as well. And I think that's where we are. We're trying to not only offer kind of a generic integrated gun system but improve upon what the market is looking for. And that's where we've had technical challenges during the quarter that we're working on.

But if you just want to cite what does an integrated gun mean, I mean, you're going to focus on the characteristics of it being an intrinsic on-the-site offering at the wellsite factory, loaded with little to no wiring on location. That's a pretty broad spectrum, though, of capabilities and characteristics of a gun and there are many other things that go along with it.

But to summarize, the market is generally -- I don't want to use the word general in telling you they want more of an integrated offering. But in contrast, if you have a wireline company who's already invested in gun loaders and gun loading facilities, their product specification needs may differ from an operator that just wants a fully delivered, highly integrated system that perform the best in the market. And so it may be that the market evolves around kind of versions of an integrated gun system. And again, with the research you've already done, I think you appreciate and understand that.

--------------------------------------------------------------------------------

Operator [38]

--------------------------------------------------------------------------------

Our next question comes from Sean Meakim from JPMorgan.

--------------------------------------------------------------------------------

Sean Christopher Meakim, JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst [39]

--------------------------------------------------------------------------------

So I appreciate the commentary on the top line for downhole. That was probably my biggest question out in the release, so thank you for that feedback. As we look to 3Q and the guidance that you put out, can you just talk about how you built that range and your comfort level given all the moving pieces in the power system market as well as the generally broader uncertainty in North American activity as we get through 3Q?

--------------------------------------------------------------------------------

Cynthia B. Taylor, Oil States International, Inc. - President, CEO & Executive Director [40]

--------------------------------------------------------------------------------

Are you speaking to a specific segment?

--------------------------------------------------------------------------------

Sean Christopher Meakim, JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst [41]

--------------------------------------------------------------------------------

Yes, sorry. So the downhole top line in the second quarter was the biggest question, I think, out of the release this morning. You gave a lot of feedback on that, and I appreciate some of the moving pieces in the second quarter. I was hoping to then maybe unpack how you built the range for your top line guidance for downhole in the third quarter given all those moving parts within the power systems business, that market, as well as there's plenty of uncertainty just in terms of how activity is going to trend through the quarter in North America. So I was hoping to get more detail there, please.

--------------------------------------------------------------------------------

Cynthia B. Taylor, Oil States International, Inc. - President, CEO & Executive Director [42]

--------------------------------------------------------------------------------

Okay. I will certainly do that. And we gave you a range obviously, and the low end of that range is kind of nonheroic, I will call it. The upper end of the range would suggest pretty good movement from where we were in Q2. And I would really focus on kind of 3 things that impact both revenues and margins. Number one, we continue to think we're growing market share in some of our non-perforating product lines. And so we've got some embedded growth. And this is really you can say that that's not just hoped for, what we are right now is having customers come in and line up products early in the quarter. Now does that mean that sustained through the quarter? No.

But we believe that some of our non-perforating revenues will grow sequentially Q2 to Q3 even if the North American market softens a bit and that's based on customer indications early in the quarter. That's number one.

Number two, I keep mentioning this technical solutions group. There has been a significant unabsorbed cost throughout the first half of this year. And this is more obviously, it's a little bit of top line, but it has more margin implications that if we can get a little better absorption at our cost associated with that technical solutions group, it'll obviously improve our margins profile, which again we guided to better margins.

Clearly, the non-recurrence of a $1.4 million write-off of product design-changed inventory benefits margins. And then the last thing that I probably should have mentioned, in the course of doing the development of the integrated gun system, obviously part of that is development of an integrated switch. And so we do think we will bring that switch to market individually as a product with beginning revenue in Q3.

So those are kind of the 3 major elements that lead to improved sequential margins for downhole. And suffice it to say, none of us were satisfied with the second quarter for the downhole technology segment. We are highly focused on improving performance in that segment. But those are kind of the 3 major areas really in addition to some improved manufacturing cost efficiencies as well.

--------------------------------------------------------------------------------

Sean Christopher Meakim, JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst [43]

--------------------------------------------------------------------------------

That was very helpful. That's exactly what I was looking to understand. In Offshore/Manufactured Products, so given all the efforts to improve the business through the downturn, some of the shifts in mix that are taking place, you're now growing backlog pretty significantly. You're at a 3 year high. How does throughput cycle times look this time around compared to last cycle? Just curious how we should be thinking about that from a modeling perspective now that you're starting build backlog, you continue to do so this year, how does throughput cycle times look? How should we think about that progression going forward?

--------------------------------------------------------------------------------

Cynthia B. Taylor, Oil States International, Inc. - President, CEO & Executive Director [44]

--------------------------------------------------------------------------------

Yes. Right now, the major product backlog that we're building is comparable to the lead times that we've had in the past because our key connector products and it's also our production infrastructure. So right now, the trend lines are similar in terms of the forward 12-month revenue generation, short cycle. And service, you're very familiar with. They're not very backlog intensive. So you will model short cycle and services I would say somewhat flat sequentially depending on ebbs and flows there.

We've talked in the past that we have some military work and there is the likelihood we gained some incremental military backlog that tends to be more multiyear focus. But we can update you on that if and when that order is received.

--------------------------------------------------------------------------------

Operator [45]

--------------------------------------------------------------------------------

Our next question comes from Connor Lynagh from Morgan Stanley.

--------------------------------------------------------------------------------

Connor Joseph Lynagh, Morgan Stanley, Research Division - Equity Analyst [46]

--------------------------------------------------------------------------------

I was wondering if we could, Cindy, go back to your comments around the challenges in earning returns in North America, in the U.S. in particular. I guess could you discuss, are there any areas of your product portfolio where you feel that these businesses aren't earning their cost of capital and you have some potential to step back or at least cut costs further? I mean, obviously, I assume this is more on the completion services more than anything, but just thoughts on that.

--------------------------------------------------------------------------------

Cynthia B. Taylor, Oil States International, Inc. - President, CEO & Executive Director [47]

--------------------------------------------------------------------------------

Yes. And again, we're really focused on every product line and every business line to return 2 things: number one, free cash flow generation and ROIC at the end of the day. And to some degree, our earnings before interest and taxes, our EBIT, is burdened by heavy CapEx from earlier years.

You heard Lloyd talk about an update to our 2019 CapEx being a little bit lower. And I can just assure you, I don't know how else to manage a business other than focus on return on invested capital. But I'll also tell you, with the dramatic commodity price swings and activity decline, it's been a challenge to rightsize the ship responsive to that. There are a couple of areas that we're focused on, but most particularly, we'll continue to do a review.

Our drilling services is a small business line. But when we kind of have a gut check at 12% utilization in the first quarter, we did improve it in the second quarter to 20. But we're really trying to find ways, and that's a very, very small piece of well site services. But it is indicative of your question that just says, can every business that you're in be rightsized to achieve sustainable ROIC?

And we're doing everything we can. We even had continual severance and cost reduction initiatives in this quarter. It was more weighted again towards offshore products this time. But in our Well Site Services business, we rationalized even more costs late last year, early this year. But I think that's why we had over 100% incrementals in the business in Q1 and Q2.

So I can only assure you, it is not for lack of effort in this office in terms of returning to sustainable ROIC. I will also tell you that I think if any service company of our size can do it, we can.

--------------------------------------------------------------------------------

Connor Joseph Lynagh, Morgan Stanley, Research Division - Equity Analyst [48]

--------------------------------------------------------------------------------

Yes, yes, makes sense. Maybe just sticking with that theme. So you called out international as an area where you see potential opportunity. Can you give us a feel for how big in completion services international is today and where you see the opportunity for that to be over the next couple of years here?

--------------------------------------------------------------------------------

Cynthia B. Taylor, Oil States International, Inc. - President, CEO & Executive Director [49]

--------------------------------------------------------------------------------

Yes, we generally bucket that as non-North America, so we'll throw in the Gulf of Mexico with that. In Q1, the combined contribution of international and Gulf of Mexico was 16% of completion services revenue. In Q2, it was 18%. And so that's kind of what it is today. And obviously, we're focused on introducing incremental products. It is certainly true in our Well Site Services segment, but I'll tell you we are also in the early stages of introducing our Downhole Technologies to gain more international traction as well. That is a longer-term process. They’re not immediate, but it is something that we think is value-creating.

--------------------------------------------------------------------------------

Operator [50]

--------------------------------------------------------------------------------

Our next question comes from Ian MacPherson from Simmons.

--------------------------------------------------------------------------------

Ian MacPherson, Simmons & Company International, Research Division - MD & Senior Research Analyst of Oil Service [51]

--------------------------------------------------------------------------------

That was actually mine. I wanted to get into what the third quarter outlook might entail for Lower 48 completion services compared to international/Gulf of Mexico/drilling services. Those numbers helped. But I guess, the kernel of my question is, does your middle of your guidance range contemplate Lower 48 completion services flat or down or what?

--------------------------------------------------------------------------------

Cynthia B. Taylor, Oil States International, Inc. - President, CEO & Executive Director [52]

--------------------------------------------------------------------------------

I would say, right now, we want to see that continuing mix a little bit more weighted towards international and Gulf of Mexico. We too see at least a flattening, if not a modest softening, of the North American rig count. Our customers, as you've heard, are definitely focused on generating free cash flow and controlling their capital spending. There's no ways about it.

But everything is not the same for every customer. So when we go out and give guidance, we're really -- we have weekly meetings with customer by customer, who's adding rigs in various basins, who's dropping rigs in various basins. But if I take all of that into context, and I have to -- we obviously know the rig counts dropped about 21 rigs since quarter end. That's about 2%. So I don't think we're talking about big numbers here. But it's hard to exit the quarter and not say that North America is going to be modestly softer in Q3, at least as best as we see it today.

--------------------------------------------------------------------------------

Operator [53]

--------------------------------------------------------------------------------

Our next question comes from Stephen Gengaro from Stifel.

--------------------------------------------------------------------------------

Stephen David Gengaro, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Analyst [54]

--------------------------------------------------------------------------------

Cindy, can you just remind us when we think about your U.S. land exposure, the businesses which are exposed to -- well first of all the percentage of completion intensity versus just sort of wells drilled? And what you're sort of seeing on the completion intensity front right now?

--------------------------------------------------------------------------------

Cynthia B. Taylor, Oil States International, Inc. - President, CEO & Executive Director [55]

--------------------------------------------------------------------------------

Well, I think I mentioned on the call, right now, everybody tends to focus on leading-edge wells and the horizontal footage. There's kind of a catch up for other operators moving towards leading edge. And so I think there's still some tailwinds there in terms of horizontal footage, stage count and importantly, for us, I'll just call it clusters per stage. And there's a lot of technology assessment trialing going on to try to mitigate parent-child type communication interference. So there's just a lot going on.

But I do think the fundamental tailwinds of higher intensity are there for our Downhole Technologies segment. And even in Chris' business, a majority of the personnel and equipment are more on the surface, I will call it. But nonetheless, there are leading-edge equipment such as the Tempress tool that really does gain market -- significant market share as you get in the longer laterals, the more torturous type downhole environments. And so it becomes a differentiator for that.

We're investing obviously in various equipment to make the customers' wellsite, one, safer; and two, more efficient. I call it decluttering the wellsite around bridge manifolds. We're investing in some other technology that I probably won't talk about because they're IP that we plan to file behind some of it. But while it's not a direct correlation, the more complex wells I think do speak to our higher-end equipment and personnel offering, which again, we believe we have.

--------------------------------------------------------------------------------

Operator [56]

--------------------------------------------------------------------------------

And our last question comes from Emily Boltryk from Scotia Howard Weil.

At this time, I'm not showing any further questions.

--------------------------------------------------------------------------------

Cynthia B. Taylor, Oil States International, Inc. - President, CEO & Executive Director [57]

--------------------------------------------------------------------------------

All right. Dinara, thank you for hosting our call today. Again, we're going to apologize for the technical interruption from the phone provider, but I appreciate you staying on so that we could kind of fully discuss the results of our segments, the results of the quarter before we close the call.

I do kind of ask that you all just kind of step back. And we've seen a lot of kind of emotional investing over the last couple of years towards North America and almost emotional away from it towards more deepwater and international. We believe that we have a great balanced offering with penetration in all of our segments that comes from these segments. And while I know many of you view this as a challenging or modestly disappointing quarter for us, I hope you will keep it in context a strengthening in offshore products. I think we're doing absolutely what you want us to do in terms of backlog development, top line growth and improved margin. In our Well Site Services segment, they too had very improved -- resilient revenues, improved margins, very, very strong incrementals in our completion services product line and some differentiated offerings that we've tried to more fully deploy into the market.

Downhole Technologies again was kind of the lone disappointment this quarter, but the investments we're making in R&D and product development, I do believe, pay off in the long run. And I would not like to leave the strength of our company from a free cash flow generating standpoint. I think that is a differentiator for our company as well. It has been for the last several years. And I do feel confident that we'll be able to turn this towards a better ROIC-generating performance over time.

That does complete our comments. And again, I thank you for joining us today and look forward to future conversations with you.

--------------------------------------------------------------------------------

Operator [58]

--------------------------------------------------------------------------------

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating, you may now disconnect.