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Oil States International, Inc. (NYSE:OIS)

Q4 2008 Earnings Call Transcript

February 20, 2009 11:00 am ET

Executives

Bradley Dodson – VP, CFO & Treasurer

Cindy Taylor – President & CEO

Analysts

Jeff Tillery – Tudor, Pickering & Holt

Victor Marchon – RBC Capital Markets

Kevin Pollard – JP Morgan

Charles Minervino – Goldman Sachs

Arun Jayaram – Credit Suisse

John Daniel – Simmons and Company

Joe Gibney – Capital One

Operator

Good morning, ladies and gentlemen, and welcome to the Oil States International fourth quarter earnings call. At this time all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note that this conference is being recorded.

I will now turn the call over to Mr. Bradley Dodson. Mr. Dodson, you may begin.

Bradley Dodson

Thank you. Welcome to the Oil States fourth quarter 2008 earnings conference call. Today, our call will be led by Cindy Taylor, Oil States President and Chief Executive Officer.

Before we begin, we would like to caution listeners regarding forward-looking statements. To the extent the remarks today contain information other than historical information, 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 and our other SEC filings.

I will now turn the call over to Cindy.

Cindy Taylor

Thank you, Bradley, and thanks to all of you for dialing into our call this morning. Excluding the goodwill impairment charges discussed in our earnings press release, Oil States posted strong fourth quarter 2008 earnings, surpassing first call estimates and our previous guidance range. Sequentially, our results benefited from strong contributions from our Offshore Products and Accommodations businesses. These sequential EBITDA improvements were offset by declines in our early cycle businesses, including drilling services and our tubular services businesses, which were impacted by the U.S. rig count declines in the fourth quarter. These activity declines were caused by lower commodity prices and the accelerating global economic recession.

Our Accommodations operations continue to grow with expanded capacity in the oil sands region, hindered in part however by a sequentially weaker Canadian dollar. Offshore Products had a good quarter sequentially with revenues up 18% and EBITDA up 12%.

As a result of our goodwill assessment, we recorded an impairment of $85.6 million during the fourth quarter, which represented the write-off of 100% of our drilling and tubular services goodwill, the majority of which existed at our IPO date. Excluding this impairment, Oil States reported revenues of $901.1 million and EBITDA of $162.9 million, representing year-over-year increases of 55% and 72% respectively.

The year 2008 set many records for our company. However, our very strong results have been overshadowed by the crisis in the credit markets, lower commodity prices and declining stock price. Given this environment, we will update you on our market outlook, our liquidity and our capital spending plans for 2009.

At this time, Bradley will take you through more details of our consolidated results and financial position and then I will conclude our prepared remarks with a discussion of each of our segments and close with our market outlook.

Bradley Dodson

Thank you, Cindy. Throughout this call we will be excluding from our discussion of EBITDA, the $85.6 million goodwill impairment taken in the fourth quarter of 2008. For the fourth quarter of 2008, we reported operating income of $135.5 million on revenues of $901.1 million.

Our net income for the fourth quarter 2008 totaled $86.8 million or $1.74 per diluted share. The comparable fourth quarter 2007 results were $71.6 million of operating income, on revenues of $581 million. The fourth quarter 2008 results represent a 55% year-over-year increase in revenues and an 89% year-over-year increase in operating income. These increases were primarily due to improved earnings from our Tubular Services segment and our Canadian oil sands Accommodations.

Depreciation and amortization in the fourth quarter of 2008 totaled $26.9 million, compared to $21.4 million in the fourth quarter of 2007. This increase was due to capital expenditures and acquisitions completed over the last 12 months. D&A is expected to total $28.3 million in the first quarter of 2009.

Net interest expense totaled $2.8 million in the current quarter and $4.3 million in the fourth quarter of 2007. First quarter interest expense of 2009 is expected to be $4 million. This projected sequential increase in net interest expense in the first quarter of 2009 is primarily due to the adoption of APB 14-1 under which the Company will recognize $1.7 million of non-cash interest expense related to our existing convertible notes.

Excluding the goodwill impairment, the effective tax rate in the quarter was 34.9% compared to 30.1% in the fourth quarter of 2007. The higher tax was due to proportionally higher U.S. income in the fourth quarter of 2008. We expect the effective tax rate in the first quarter of 2009 to be approximately 32% as we recognize proportionately more foreign sourced income.

During the fourth quarter, we reported operating cash outflow of $48.3 million as we invested $176 million in working capital during the quarter. In addition, we spent $40.7 million on capital expenditures in the fourth quarter. As a result, our net debt at the end of the fourth quarter was $449.7 million. As of December 31, 2008, our debt-to-capitalization ratio was 28% and our total debt to LPM EBITDA was less then one time.

Since December 31, 2008, the Company had – at December 31, 2008, the Company had $196 million of availability under its credit facility. Since then, we've received $21.2 million related to the repayment of the Boots & Coots subordinated notes, and received a payment for the settlement of an oil sands contract. As a result, our current availability under our facility is approximately $280 million.

We currently have two tranches of debt, a $500 million revolving bank credit facility and $175 million worth of convertible notes. The $500 million credit facility matures in December 2011 and is supported by 11 syndicate members. Our convertible notes have a cash coupon rate of 2 3/8%, and have an initial put call date of July 2012. In light of the current market conditions, we are reviewing all capital expenditures. The CapEx budget for 2009 is $147 million, down 41% from the $247 million spent in 2008.

At this time, I would like to turn the discussion back over to Cindy, who'll review the activities of each business segment.

Cindy Taylor

Thank you, again. I'll start with our Well Site Services segment. In this segment, we generated revenues of $235.7 million and adjusted EBITDA of $80.1 million in the fourth quarter 2008, compared to $249.2 million and $87.5 million respectively in the third quarter of 2008. The sequential declines in revenue and EBITDA were primarily due to lower drilling earnings and a non-recurring gain booked on the sale of Boots & Coots common stock of $3.5 million during the third quarter. We remain at high utilization levels in our four major oil sands facilities. During the fourth quarter of 2008, Accommodations generated $94.6 million of revenues and $35.3 million of EBITDA compared to $105.4 million of revenues and $33.9 million of EBITDA generated in the third quarter of 2008.

Our Rental Tools business generated $97 million of revenues and $30.5 million of EBITDA in the fourth quarter of 2008, which was up from $91.7 million recorded in the third quarter and EBITDA of $30 million. Our Rental Tool business benefited from relatively strong completion activity in the U.S. throughout the quarter, despite the declining U.S. rig count, which accelerated at the end of the quarter.

Our drilling revenues and adjusted EBITDA were $44 million and $14.2 million respectively, compared to $52.1 million of revenues and $20.1 million of EBITDA generated in the third quarter of 2008. The sequential decline in revenues and EBITDA was primarily the result of lower activity levels in all three of our drilling markets, including Texas, Ohio and the Rockies.

Our overall utilization decreased to 79% from 92% in the third quarter of 2008. Our average daily revenues were down $700 per day sequentially, and our cash margin per day decreased $1,400 per day.

If I can move now to Offshore Products, in this segment we reported revenues of $141.4 million and EBITDA of $25.6 million, compared to revenues of $120 million and EBITDA of $22.9 million reported in the third quarter of 2008.

Revenues increased 18% sequentially due to stronger rig, vessel and subsea pipeline equipment revenues and profits. Our year-end backlog declined sequentially to $362.1 million from $420.5 million at September 30, 2008. This backlog decline is a combination of slower orders in the fourth quarter and a strengthening of the U.S. dollar.

Our Tubular Services segment generated continued strong quarterly revenues and adjusted EBITDA of $524 million and $63.9 million respectively in the fourth quarter of 2008 compared to revenues of $445.6 million and EBITDA of $68.8 million in the third quarter of 2008.

Revenues increased 18% sequentially due primarily to mill price increases during the quarter. Our gross margins were 12.8% in the fourth quarter of 2008 compared to 16.6% in the third quarter.

Now I'd like to transition and just give you some summarized comments as to our market outlook, particularly for the first quarter of 2009. As it relates to our North American natural gas driven businesses, the market for North American natural gas drilling and completion activity has changed dramatically since our last earnings conference call.

Our customers in the U.S. have announced significantly reduced spending for 2009 as lower commodity prices and ill liquid capital markets have impacted their capital spending plans. As a result, the U.S. rig count has declined by almost 700 rigs since its peak in last September. The effects of this decline have already impacted our early cycle businesses, notably our Drilling and Tubular Services businesses.

We have experienced a material decline in the utilization of our drilling rig fleet, and have experienced pricing pressure. We currently have 12 rigs operating and are forecasting utilization of approximately 30% to 35% in the first quarter, which is down from 79% utilization in the fourth quarter. All three basins where we provide drilling services are experiencing significantly reduced activity levels.

Likewise, shipments of oil country tubular goods from our Tubular Services segment will follow trends in the U.S. rig count. We reported continued strong results in the fourth quarter as we shipped previously committed orders. We expect to continue to benefit from our current order book into the first quarter.

Imports of OCTG, particularly from China, flooded the U.S. market in the fourth quarter. As a result of increased imports, coupled with a declining rig count, industry inventories are estimated at seven months plus supply on the ground, compared to approximately four months supply in October 2008. This expanded inventory level will put pressure on tubular pricing and our margins during 2009 as the industry absorbs this inventory.

We currently expect our gross margins in Tubular Services to approximate 8% to 9% in the first quarter of 2009. Activity for our Rental Tool business is tied to completion and production services activities and will follow the overall decline in U.S. drilling activity. As such, we expect Rental Tool revenues to be down 20% to 25% sequentially in the first quarter of 2009.

In anticipation of the declining rig count in the U.S., we began making adjustments to our call structure in Drilling and Rental Tools in the fourth quarter of 2008. We have significantly reduced our headcount in the drilling area in light of our utilization trends and will continue to execute our facility consolidation plans for our rental operations. As it relates to Tubular Services, our focus is on managing customer commitment while working our inventory down. We expect to reduce our OCTG inventory significantly over the first half of 2009.

As it relates to our Accommodations business, since our last call, there have been several announcements by oil sands operators who have announced deferrals or cancellations of planned oil sands projects or expansions. These announcements have lowered our expectations for our oil sands Accommodations business and we now expect our oil sands lodge activity to be flat to slightly up year-over-year, excluding the effects of the weakening Canadian dollar.

As it relates to Canada, there has been a significant weakening of the Canadian dollar relative to the U.S. dollar, which will negatively impact the translation of our Canadian earnings into our reported U.S. dollar results during the first quarter by approximately $29 million in revenue and $9 million in EBITDA.

The first half of the conventional winter drilling season in Canada has been difficult, with activity down significantly year-over-year. As a result, we expect a year-over-year decline in our conventional Accommodations business, which historically has accounted for approximately 15% of our first quarter Accommodations earnings.

In our Offshore Products segment, our backlog remains healthy with continued good product mix and margins. However, that backlog is down 14% from September 30, 2008. Our backlog position declined during the fourth quarter for drilling related equipment, as we delivered products to our customers.

As far as guidance goes, an overall statement, historically, our Company has fared relatively well during cycle corrections, given the diversity of our operations. We believe that our exposure to deepwater activities and to oil sands developments will mitigate some of the near-term downward pressure in North America, given their longer-term project horizons and economics. In light of all of the above factors, our earnings guidance range for the first quarter 2009 is estimated at $0.96 to $1.06 per diluted share.

That does conclude our prepared comments. Jamie, would you open up the call for questions and answers.

Question-and-Answer Session

Operator

(Operator instructions). Our first question comes from Jeff Tillery from Tudor, Pickering & Holt. Please go ahead.

Jeff Tillery – Tudor, Pickering & Holt

Hi, good morning.

Bradley Dodson

Morning, Jeff.

Cindy Taylor

Hi, Jeff.

Jeff Tillery – Tudor, Pickering & Holt

The first question is on the oil sands business. What's changed over the past few months has been more on the new project side. But I wanted to understand how you see potential risks to your utilization in the lodges as we go through 2009. You obviously have a good feel for the first quarter, but do you see more '09 utilization risk today than you did two months ago? And then I think you're generally thinking that the primary risk was as these projects roll off and as new projects were supposed to take in place in 2010. That’s still the case?

Cindy Taylor

Jeff, I do believe that's still the case. We have good utilization as I mentioned in all of our major lodge facilities currently. They're supported either by ongoing construction and development activities or operating type activities that at this stage of their development, we don't believe those will be cut at this stage. What has happened is a lot of the prospective work has been either delayed, deferred or canceled depending upon their nature, which has taken out a lot of our gross set thoughts and projections for the year. But at this stage, we're tracking each of our facilities on a month-by-month basis. And we continue to think we'll have good utilization in those facilities. And there are some projects that look like they will move forward that could give us longer-term upside for 2009. We just don't expect to know the answer to that until probably second quarter.

Jeff Tillery – Tudor, Pickering & Holt

Okay. Other than the prospective new lodge for the contract what was terminated, have there been any of the other longer-term contracts where the customer has terminated those?

Cindy Taylor

We have had to my knowledge, no contract cancellations at all. And what we had, as you recall, we announced a new project sometime during 2008 for a new facility and that project was publicly delayed and put on hold. We had a binding contract with the customer that they honored and we reached an acceptable negotiation on that for both parties and we are in good position and have maintained a relationship with the customer such that if that project moves forward, we anticipate that we would be in a very good position to manage that facility.

Jeff Tillery – Tudor, Pickering & Holt

In the Q1 guidance does that include any benefit from the settlement of that contract?

Cindy Taylor

It's not really a settlement. We are going to book a sale of the facility. We had planned to have higher CapEx and an operating type rental arrangement. And in lieu of that, we'll book a sale of the facility.

Jeff Tillery – Tudor, Pickering & Holt

Okay. And then in the Tubular Services business, could you give us a feel for where current market pricing is relative to kind of average dollar per ton shipped in the fourth quarter?

Cindy Taylor

It's a little hard to say. A lot of what is being sold today is pursuant to customer orders that existed during 2008, so it would be anecdotal really to talk about what pricing is. It feels like right now, clearly, it's held up because past order book is working its way through the system. So beyond that, it would differ for every size, weight and grade. But for the most part, pricing is still more held up by past orders.

Jeff Tillery – Tudor, Pickering & Holt

And my last question, at this point do you see any risk to the inventory base from a write-down perspective if current market pricing is going down? Do you see any risk that you'll have to book any impairment to the existing OCTG inventory?

Cindy Taylor

We clearly don't see that today and obviously we would have booked that if that were the case. But we have a strong customer base that we believe are going to be viable over the long-term and we have a strong order book, which is supported by committed orders. So – and we're booking profitable sales at this date. So there's no indication that that is the case. I will tell you, we do need to work down that inventory as does the industry as a whole and before we get back to a more stable base of inventory on the ground.

Jeff Tillery – Tudor, Pickering & Holt

Okay. Thank you very much.

Operator

Thank you. Our next question comes from Victor Marchon from RBC Capital Markets. Please go ahead.

Victor Marchon – RBC Capital Markets

Thank you and good morning.

Cindy Taylor

Good morning, Victor.

Bradley Dodson

Good morning, Victor.

Victor Marchon – RBC Capital Markets

The first question, just to follow up on the oil sands and I apologize if I missed this. Cindy, you were talking about the Fort Hills contract. What is the status of that now? Is that – I believe you had said that's in a – you guys had reached an agreement. Can you just talk to that? And I apologize if I missed this.

Cindy Taylor

What we did, we had a binding contract with the Fort Hills venture, which they were negotiated in good faith and we came to a settlement that allows them to effectively put the project on hold and defer that with the option to pick it back up at a later date. In doing so they agreed to buy the capital that we had in place so to speak that we had invested pursuant to that contract and we have worked out suitable terms for both parties such that if the project does move forward we believe we're in a good position to be the operator of the facility.

Victor Marchon – RBC Capital Markets

Great, thank you. And just on offshore products on the backlog, can you give some sense as to the revenue flow through in the first half of the year versus second half?

Cindy Taylor

Well, right now we're looking at really a fairly strong year for offshore products. It will be masked a little bit by the currency issues that are plaguing everyone. The U.S. dollar has strengthened relative to most foreign currencies. We do have operations in the UK, Singapore and Brazil. So once translated, those numbers look to be smaller. But overall, our backlog position although it's down a little bit from September 30, still it's at very high historic levels overall and there is some good project potential out there. The answer to your question in looking at H2 versus H1, that it's going to be key for us as you know to rebook our backlog in the first half of this year to effectively answer that question.

Victor Marchon – RBC Capital Markets

So for the most part, majority of its going to be booked in the first half of the year?

Cindy Taylor

We've already – again we got a strong backlog relative to historic norms that should carry us well into or through 2009. We deliver probably 85% of our backlog in the forward 12 months. And my only statement there, as I book revenues in Q1 and Q2, I need to book work to build a further backlog going into 2010.

Victor Marchon – RBC Capital Markets

Right. Okay. And just on the margins is the sort of the high teen type of range still hold for what you guys have in your backlog today?

Cindy Taylor

Yes, Victor, as we mentioned, we've got – that backlog is a good product mix and continuing good margins. So as long as we execute, we're in good shape.

Victor Marchon – RBC Capital Markets

Great. That's all I had. Thank you.

Cindy Taylor

Thank you.

Operator

Thank you. Our next question comes from Kevin Pollard from JP Morgan. Please go ahead.

Kevin Pollard – JP Morgan

Hey, good morning.

Bradley Dodson

Good morning, Kevin.

Kevin Pollard – JP Morgan

I guess I wanted to go back to the subject of the inventory in the Tubular Business again. It's quite a bit larger than it’s ever been and even in the preceding quarter. I'm wondering how much of that is volume-driven versus just driven by the inflation and the average unit price.

Cindy Taylor

Kevin, I'll start with that. What we do is really look at that inventory trend and move it sequentially, so I'm thinking about 930 compared to 12-31. In that, we experienced a 32% increase in tons and a 43% increase in price. So it's a combination. And what – the market probably doesn't see that we see. There was historically high order book from our customer base based on the activity in the second quarter, early in the third quarter. A lot of the U.S. mills were struggling to keep pace with the demand and therefore, some of that product delivery was delayed. There was also an influx of foreign pipe that came into the market to try to meet that demand in the U.S. that was present in second quarter and third quarter. A lot of that pipe hit the market during the fourth quarter, particularly a lot of pipe from China.

So what's happening now is that inventory is – was trying to bring the market back to balance where we were critically short last year. But with the lag effect coupled with an accelerating rig count decline, you've now built significant inventories on the ground. That's why so many of the mills have taken out capacity, significant capacity in late fourth quarter and into the first quarter, knowing that there is going to be a period of de-stocking necessary in this reduced rig count environment.

Kevin Pollard – JP Morgan

Okay. So if I look at some of the third party published prices for OCTG, down 10% or so in January and probably at least as much again in February so far. Is there any risk there, holding such a high inventory level that you're going to get caught with the falling prices below the cost of the inventory, where maybe you run it through the – I don't know how exactly it would work out, but you –

Cindy Taylor

Kevin, I'll let Bradley elaborate further, but most of our inventory is committed to purchase orders, approximately 85% of that. So as long as those customers are viable customers that honor their purchase order commitments –

Kevin Pollard – JP Morgan

And the price is fixed on those commitments?

Cindy Taylor

Yes.

Kevin Pollard – JP Morgan

Okay.

Cindy Taylor

Yes, we don't expect to have issues there. We do have a small portion that's non-committed, but most of that is pursuant to program work and/or contracted type work. So, again, we feel fairly comfortable. The caveat there, if something happens to one of our major customers that's unanticipated, that could cause a problem. But again, our customer base is very strong and we just don't foresee problems today. That being said, we do have a high inventory level. We were diligently focused on managing that with our customers to get the market in a better balance. But I think the point what you're talking about published price declines, anybody that's selling new pipe and/or had speculative type pipe are probably trying to move that as reduced prices.

Kevin Pollard – JP Morgan

And so if you had 85% of that inventory was committed, you're really exposed on maybe 15% of that.

Cindy Taylor

Yes. But the reality is we look at –

Kevin Pollard – JP Morgan

To the falling price stock prices.

Cindy Taylor:– every customer, every string and there are different – not all OCTG is one in the same. A long lead time deepwater string may not be under price pressure as more of the routine size, weights and grades that are consumed in the North American basin, so.

Kevin Pollard – JP Morgan

Okay. Thanks for the clarity around that. If I could switch over to offshore products, where you have the currency exposure affecting the revenue and backlog, are your costs primarily in those same currencies so you have a natural hedge? Or would the margins be at risk?

Cindy Taylor

No, yes, the answer is yes.

Kevin Pollard – JP Morgan

Okay.

Cindy Taylor

If we don't have a natural hedge at times, we are obviously willing to put hedges in place to protect that. We don't go at risk for currency for the most part.

Kevin Pollard – JP Morgan

Okay. And last question. Could you talk a little bit about what you're seeing on the pricing front in the rental tool business. I mean I would think with the revenue declining in line with the rig count, you guys start to be seeing some pretty severe price pressure. Can you modify that any for us?

Cindy Taylor

Well – and realize what I said, we'll follow the same trends as the rig count, but the differences are, we are very much – we have to look basin by basin. We got about 60 operating locations today and some are down, but a lot of the ones that are down are your more vertical drilling areas, low pressure type work where we don't have as much revenue content per ticket. A lot of the activity in some of the key shale areas such as the Fayetteville, Haynesville, Barnett, Appalachia, et cetera, are flat to growing and are pretty good. So we really haven't seen much in the way of pricing pressure in those markets yet. Some of the lower areas we're seeing pricing pressure where utilization has come down. But we don't think this business comes down proportionately as much as the overall rig count just because of service intensity in some of these key shale plays where we offer products and services.

Kevin Pollard – JP Morgan

Okay. Thanks, I'll let someone else –.

Cindy Taylor

Thank you.

Bradley Dodson

Thank you.

Operator

Thank you. Our next question comes from Charles Minervino from Goldman Sachs. Please go ahead.

Charles Minervino – Goldman Sachs

Hi, thank you. Good morning.

Bradley Dodson

Good morning.

Charles Minervino – Goldman Sachs

Just a couple questions here. First, I was wondering if you could just give us a little bit more color on the goodwill impairment. I guess it goes back to some things that took place back towards the IPO. Can you just give us a little bit color on what now and why has that changed now that you need to take an impairment charge?

Bradley Dodson

Well, the goodwill was booked in several transactions. The IPO, because of the consolidation of the four companies that created Oil States International, there was some goodwill created. And the biggest chunk of that was created in Tubular Services, approximately $39 million or $40 million in the IPO. The rest of the goodwill was from subsequent acquisitions. The – in terms of why now, it's a pretty formulaic answer, given the guidance under FAS 142. We assess it annually. We use combination of both trading multiples which, as you know, trading multiples have been significantly down year -over-year.

And then also the income approach come up with what we believe to be the fair market value of these reporting units and then compare that to the carrying value of the reporting unit as a whole to determine if there is an indication of goodwill impairment. Going through that test as well as do annually, we determined that there was an indicator of impairment at those two reporting units. Went to step two under FAS 142 and quantified that the entire amount of the goodwill in those reporting units was impaired.

Charles Minervino – Goldman Sachs

Okay. That's very helpful. Second question, the utilization on the land rigs, I think you said 30% to 35% in the first quarter. Can you give us a sense – would you have an expectation of when that utilization picks back up or is that something we should really be thinking about as the steady state at least for the next couple quarters until we start seeing a rebound in the broader rig count?

Cindy Taylor

Well, of course I don't have great visibility for when it comes back. But, as you know, we're not a broad based driller. We have selected assets, selective markets. Permian is more of oil driven market. We have 22 rigs operating there and utilization is down very hard, not just for us but for the whole areas of operations. The key there is going to be when we get a better crude oil price. There is such dislocation right now, given excess supplies of crude oil that people are not actively working there. Historically, we've held pretty well in that market because we are a lower cost provider of services in that market but there has to be some base level of activity there to create that demand.

The Rockies, we have 10 rigs working there, about five are working today. And again, it's got a different driver, obviously, than the Permian but those are the two macro markets that are there. I feel like and this is my opinion only, that the crude oil metrics come in line a little bit quicker than natural gas, particularly as it relates to the Rockies. So I don't know if my predictions will be right or not, but I'm certainly not looking for improved utilization of any magnitude before the second half of '09.

Charles Minervino – Goldman Sachs

Okay. And then just one last question. I think in one of the previous questions, you said that your OCTG customers, it's basically 85% contracted. How often are those contracts renegotiated? Are those annual or every few months? Can you just give us a little bit more color on if that needs to correct itself in the coming months in some way?

Cindy Taylor

Well, the word is committed, not contracted. That just means there is either a program or a purchase order for which that pipe is tied to and relates to. And so what has happened, program work in particularly is normally let on a six-month basis, so you have major initiatives generally in January and July for those programs. There has been virtually no program work let at all going into 2009. And so we have an aberration there, which just simply means that the order book is way down and inventories are way up at this stage.

Charles Minervino – Goldman Sachs

Got it. Thank you very much.

Operator

Thank you. Our next question comes from Arun Jayaram from Credit Suisse. Please go ahead.

Arun Jayaram – Credit Suisse

Good morning.

Bradley Dodson

Good morning, Arun.

Arun Jayaram – Credit Suisse

Bradley, I was wondering if you could help us understand a little bit or delve a little bit deeper into the currency issue. Give us a sense of what currently or how much of your revenues generate from Canada. And I guess it would be helpful if for every 5% depreciation in the Canadian dollar, what kind of impact would that have to the earnings power?

Cindy Taylor

Well, you just need to watch the currencies really. But – we disclose our Canadian base revenues. If you take U.S. dollars and just gross them up by the then exchange rate, and then you take the new rate, that order of magnitude evaluation currently is about 20%. And so that's the – Bradley gave very precise numbers for the Canadian business because it is a larger contributor to our earnings as compared to some of the other international basins that we operate in.

Arun Jayaram – Credit Suisse

Okay.

Cindy Taylor

And again, it's not – our Canadian dollar business is all Canadian dollar driven. So if I look at – we manage off Canadian dollar statements translated into the U.S., we deem these to be long-term, permanent investments. So it's not a cash reduction or anything like that.

Arun Jayaram – Credit Suisse

Is it a translation, right?

Cindy Taylor

It's translation. And as somebody mentioned on the phone earlier, our costs are denominated in Canadian dollars so the profit margins are intact. The differential is it just looks smaller on translation in our financial statements than it did last year.

Arun Jayaram – Credit Suisse

That's fair. The second question, couple moving pieces thinking about the – sooner there is a satisfaction of existing orders. And I just wanted to understand, Cindy, in the period where you're likely going to have some inventory destocking in the back half of the year, can you help us with – how do you think margins play out in the second quarter and third quarter given that scenario? And are you seeing any new orders at this point given the sharp pull back in the rig count?

Cindy Taylor

We clearly do have some new orders. They're just at a lower level, obviously than what we've experienced in the past. There will be destocking. The beauty for us is the distributor will generate a lot of free cash flow in this environment as we work that inventory down and then what we need to do is gradually rebuild an inventory. After you get through this destocking period commensurate with activity level that's going to be in place, and we think obviously that as we rebuild those inventories, they're going to be at lower prices than what they were last year. There is certainly every indication of that. So again, if we manage it well, as we have done in the past, we will be profitable and have good margins. They just won't be the double-digit margins that we experienced last year.

Arun Jayaram – Credit Suisse

Do you think, Cindy, that margins could remain in the mid-single digits type of range?

Cindy Taylor

Yes.

Arun Jayaram – Credit Suisse

Okay. That's very helpful. And last question, you noted or – Rental Tools actually had a very good quarter. Obviously, we'll see some declines beyond that. Can you comment a little bit on which product lines are holding in better as that maybe Stinger [ph]?

Cindy Taylor

Well, as you know, we're very oriented towards completion production services type activity. That will generally lag the rig count just a bit as you can figure, and again the rig count really started falling off kind of early to mid-December, so again a very strong fourth quarter. Bradley gave very precise guidance in terms of what we look like that we will be down in the first quarter. But certainly, the high end, high pressure technology generally speaking, and definitely Stinger's product line will remain in strong demand as long as these key resource plays continue at the pace that they are currently.

Arun Jayaram – Credit Suisse

Okay. Bradley, also what are your expectations for CapEx? I may have missed this.

Bradley Dodson

We said that the CapEx expectation was $147 million for the year of '09 and that it will be a little front-end weighted because of some of the expenditures, particularly in Canada but we didn't give specific first quarter guidance.

Arun Jayaram – Credit Suisse

Okay. That's all I got. Thank you very much.

Cindy Taylor

Thank you.

Operator

Thank you. Our next question comes from John Daniel from Simmons and Company. Please go ahead.

John Daniel – Simmons and Company

Good morning.

Cindy Taylor

Good morning, John.

John Daniel – Simmons and Company

Couple quick ones for you. In the press release, you mentioned about having the liquidity to capitalize on opportunities that I'm sure you're going to see here in this slowdown. At this point though, are you seeing anything in the way of M&A deal flow or is it completely dead?

Bradley Dodson

There are some deals out there and we've got our corporate development staff continuing to beat the bushes and look for opportunities and begin that dialogue. I think that right now in terms of the deals that we've historically done, which have been sourced internally through our efforts and also our divisions efforts in terms of looking for companies, entrepreneurs that have built companies with interesting technology, interesting market niches, I don't think that activity decreases. While they've been very apparent in the stock prices and have obviously begun to become apparent in the drilling activity and the rig counts, I'm not sure that they've really seen it flow through to their operations yet for the North American businesses. So I think for right now, while we're continuing the efforts, I don't think conversations will proceed very quickly for the next – until the second half of this year.

John Daniel – Simmons and Company

Fair point. But the companies that are being shopped at this point, are they all distressed companies?

Bradley Dodson

Yes.

John Daniel – Simmons and Company

One more on the land drilling business. You hear a few anecdotal stories about rigs working at cash break-even levels. Are you seeing that as a risk at this point for your business?

Cindy Taylor

Absolutely.

John Daniel – Simmons and Company

Okay.

Cindy Taylor

I think when you – just like us, if you take utilization down from 90% in Q3 to 30%, absorption of cost is a challenge. And – so we're proactively managing our own situation and a lot of our competitors are doing the same thing. But absolutely, there's pressure from a utilization perspective and pricing. The key is managing your cost structure.

John Daniel – Simmons and Company

Okay. In speaking to that, I've heard – there have been a few companies that have talked about doing things such – obviously you let go people as rigs get released. That makes sense. Are you at point yet where you had to go through across the company and do wage rate reductions, things like that?

Cindy Taylor

Yes.

Bradley Dodson

More in the sense of bump back programs to keep your key personnel, but keep them busy and change that some of the operating fixed cost structure into more variable costs as you move forward.

John Daniel – Simmons and Company

Sure. Okay. Well, thanks, guys. That's all.

Cindy Taylor

Thank you.

Operator

Thank you. Our next question comes from Joe Gibney from Capital One. Please go ahead.

Joe Gibney – Capital One

Thanks, good morning.

Cindy Taylor

Good morning, Joe.

Bradley Dodson

Good morning.

Joe Gibney – Capital One

Just wanted to follow up on the drilling side a little bit. Bradley, relative to the some of the headcount reductions there that you talked about and rating in the CapEx a little bit more, are you still slated to receive that one new build rig still? I think it was April was the original target for a 1,000 horsepower rig. Is that still on the board?

Bradley Dodson

It's still on the board. When we looked at this and started making our efforts to cut CapEx, we already had purchase commitments out for 80% of what was left to be spent. So we're going to honor those purchase commitments and complete the rig.

Joe Gibney – Capital One

Okay. And relative to the rental consolidation side, any other areas that you're considering bumping up right now? Just give a little bit of color of what those initiatives are relative to consolidating certain locations. That would be helpful.

Cindy Taylor

I guess the one major thing that we are going to have to make a decision in the next couple of months has to do with our manufacturing capabilities and capacity in the Canadian marketplace. We have two manufacturing facilities that employ quite a lot of personnel and have the capabilities obviously to construct a lot of the facilities that either we or our customers utilize. But with the delays and deferrals of so many of the construction projects and upgrade projects, that manufacturing capacity is at risk. We'll have to make a call – clear determination by May or so of this year. And again, there is one particular project out there that if it comes to fruition will mitigate that need. But otherwise, we will have to likely consolidate some of that manufacturing capacity this year.

Joe Gibney – Capital One

Okay. That's helpful. And then, last one Bradley. On the buyback side relative to current authorization, just give us an update there.

Bradley Dodson

We've – the number we've got still authorized is around $59 million remaining.

Joe Gibney – Capital One

Thank you. I appreciate it. I'll turn it back.

Bradley Dodson

Thanks, Joe.

Operator

(Operator instructions). And I'm showing that we have no further questions.

Bradley Dodson

Thank you, everyone. We appreciate the participation in our call and we'll look forward to seeing you – talking to you on the next call.

Cindy Taylor

Thank you.

Bradley Dodson

Thank you.

Operator

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

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