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Executives

Steve Krablin – Chairman, President and CEO

Jay Mitchell – CFO

Analysts

Marshall Adkins – Raymond James

Chris Glycine – Simmons & Company

Terese Fabian – Sidoti & Company

Blake Hutchinson – Howard Weil

Stephen Gengaro – Jefferies

Victor Marchon – RBC Capital Markets

Jeff Spittel – Madison Williams

Joe Gibney – Capital One

Mark Rogers – Gagnon

Brian Uhlmer – Pritchard Capital

T-3 Energy Services, Inc. (TTES) Q2 2010 Earnings Call Transcript July 30, 2010 11:00 AM ET

Operator

Good day, ladies and gentlemen and welcome to the T-3 Energy Services second quarter 2010 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. (Operator instructions) As a reminder, today's conference call is being recorded.

I'd now like to turn the conference over to your host, Mr. Steve Krablin, President and CEO. Please go ahead, sir.

Steve Krablin

Good morning and welcome to our teleconference to review our financial results for the second quarter of 2010. I'm Steve Krablin, CEO of T-3 and with me today is, Jay Mitchell, our CFO.

I would like to remind everyone that during our call, we may make certain forward-looking statements with respect to sales, earnings and other matters. These statements are based on our current assumptions and expectations and are subject to risk and uncertainties. Actual results may differ materially from the results predicted. A complete explanation of forward-looking statements, as well as numerous risk factors and uncertainties are discussed in depth in our Annual Report on Form 10-K and in our other SEC filings, and I encourage each of you to refer to these disclosures. T-3 does not intend to publicly update any forward-looking statements.

Thanks to the hard work of our employees, our second-quarter results were good even though we found ourselves in a very difficult and challenging environment. Many customers’ decisions went into more or less a short-term paralysis during the quarter due to uncertainty about certifications and the requirements that were being developed for pressure control equipment in response to the Gulf incident.

In spite of this uncertainty, we had our fourth consecutive quarter of increased bookings and our second consecutive quarter of backlog growth, and of course we had sequential revenue and earnings improvement. Jay is going to take us through the details.

Jay Mitchell

Thank you very much Steve. I’m going to take a few moments, as Steve said, to go through the numbers. As everyone has seen in the press release, T-3 earned $3.3 million or $0.25 per diluted share from continuing operations for the quarter. This is up from $2.0 million or $0.15 per diluted share in the first quarter, and as Steve mentioned bookings are continuing to recover. They are up to $15.8 million and we sequentially increased our backlog 6% to $42.1 million, up from $39.7 million at the end of last quarter. Consolidated revenues for the quarter were $48.4 million, up $3.4 million or 8% from the first quarter.

We did this on flat pricing, and we had a strong mix across all our business units. I will provide some more details about the business mix in a few moments. We had – the mix between products and services remained relatively constant with the first quarter. We had 82% of our revenues from products. Within that products revenue we did have a shift proportionately to some of our well head products, which tend to be somewhat lower margins than the products in our other business units. However, every individual business unit increased their margins for products this quarter.

As you know we do report in one segment. I want to give a little bit more detail about some of the individual business units we have underneath that one segment. At PCG, this is our pressure control group with BOPs and all the related pressure control equipment; revenues for the quarter were 32.5 million or 67% of total company revenues. That is up about $0.5 million sequentially. The revenues did continue to be produced in the offshore and international markets, but we are seeing a shift to domestic and onshore users.

Approximately 40% of our revenues were destined for offshore use this quarter compared with just under 50% in the first quarter of 2010. Q2 revenues were 51% going to the non-North America, compared with 60% in the first quarter. Again, quarterly pricing was flat, but the mix was somewhat favorable. We sold particular products that had higher standard prices per unit, and we benefited from some quick turn items, which do tend to have better pricing as well.

We are doing some things to help take advantage of some of the quick turn items that may be available for sale at some point in the near future, and I will address that in a few moments when I talk about the balance sheet. In the pressure control group, our bookings were impacted as Steve mentioned earlier by the Deepwater Horizon incident, which caused our customers to re-evaluate their capital equipment needs and servicing requirements in light of the expected new rules and regulations for the industry.

In practice, what this did for us was it caused us to have great falloff in our bookings during the month of May, and going forward, we are seeing a slight shift in the type of bookings we are actually receiving. We had increased bookings for service and certification work. Currently we have approximately 40 BOPs in line for NTL work right now that is less than $1 million in total value, but does represent both deepwater and shallow water right now. Approximately a fifth of the dollars in our backlog for NTL work relate to deepwater BOP items.

Importantly, for going forward we are seeing a shift in PCG, sales, bookings and backlog to US land. Sales to US land for the quarter increased 16% sequentially, and more importantly if you look at our backlog for pressure control, US land represents approximately 30% of the pressure control backlog at the end of the quarter, which brings total land in the backlog to about 70% right now. That is North America and international.

Looking at our well head business unit, revenues were up 27% to $12.9 million – I beg your pardon, we are up 20% sequentially, and represent 27% of total company revenues right now. Again, overall pricing for the quarter was flat. This quarter’s revenues were all North America, which is consistent with where we were in the first quarter. The mix was favorably affected by a couple of items. We had some refurb work in Canada, where we actually refurbed the frac manifold that we’ve sold back in the fourth quarter of last year, and we had benefits of the sales of some quick turn items both on the service and product side right now.

In our third business unit, pipeline valve group, revenues there were 3.0 million, or 6% of total company revenues. There we benefited from a favorable product mix as well, including items we sold into the geothermal market and some aluminum bronze products as well.

Moving down the income statement to the gross profit line, we had 30% was our margin this quarter compared with 35% in the previous sequential quarter. That is a slight increase. Looking at the SG&A numbers, the total quarterly SG&A was $12.7 million, relatively flat, actually down slightly from where we were in the first quarter, where we had slightly lower legal and environmental expenses.

The equity and earnings line related to our joint ventures, remember we have joint ventures in Mexico and Dubai, increased nicely to $0.5 million, as we saw nice inroads being made at our joint-venture in Dubai for Middle East sales. We do anticipate these numbers will be somewhat lumpy in the future, but we expect to be at or near this level for the foreseeable future right now.

Putting these numbers together, we came up with operating income for the second quarter of $2.2 million. The quarter’s sequential incremental margins were 65%, and break out by business unit as follows. PCG had a 171% incremental margin, well had 39% incremental, pipeline valve had 80% incremental margins. Again, that speaks to the favorable mix we talked about earlier.

In income tax expense, we saw our rate was 33% for the quarter. That is in line with what we anticipate for the rest of the year, and what we anticipate for the full year. The balance sheet, accounts receivable, DSO is 61 days right now, in line with where we would expect it to be, but we did see our inventory actually increase by close to $5 million. Our inventory turns increased slightly to 2.1 from 1.8, but still the total inventory numbers higher than we would normally like them to be.

As I mentioned earlier in the call, we are trying to take advantage of some quick turn sale items, we believe may be available for us. And as a result have increased our inventories at our pressure control group to be able to sell items that we think maybe needed for quick turn sales at some point in the near future.

Right now, this should be the end of the increasing for the inventory, and I expect that number to be flat sequentially as we move forward. Because of the increase in the inventory, our cash flow was somewhat less than you may have anticipated. Operating cash flow for the quarter was right at break even, CapEx for the quarter $1.9 million. So our free cash flow was a negative $1.9 million. Our liquidity remained strong. We had cash of $7.8 million and zero debt on the balance sheet.

I will make a couple of housekeeping items before I turn the call back over to Steve, our share count increased slightly to 13.2 million. During the quarter, we granted annual equity awards. These new equity awards will slightly increase our 123 (NYSE:R) comp and slightly increase our SG&A number. If you look at where we anticipate that would be, it will be more in line with where our first quarter number was than where our second quarter number was. Again not a big difference, but where we anticipate things going forward.

Finally, you will see that we filed a shelf registration today. This was done for prudence and there is nothing imminent coming from this right now that we anticipate. The shelf registration replaces our recently expired shelf from January 2007, which expired in January of this year. The new shelf as you will notice is for half of the amount of the old shelf, and again as I mentioned is done for prudence more than anything else.

With that I will turn the call back over to Steve, and then we will open up for some questions after that.

Steve Krablin

Thanks Jay. Certainly we have had a lot of changes in the quarter. I know for one thing that I never have to explain to anybody what a BOP is anymore. But we do expect long-term changes in our market, and while not final, the directions of the new rigs are taking shape, and they are – I think it is pretty certain that they are going to include additional requirements – requirements for additional equipment.

This process has been a collaborative effort of everyone in the industry, and we are participating on committees dealing with the government on these regulations, as well as others are. And we certainly expect the final regs will have requirements for additional shear rams [ph], casing rams, and additional redundancy in pressure control systems.

We believe this plays to our strength with the additional equipment requirements. We sell relatively little to new offshore rigs, but we are quite successful in refurbishing equipment for these rigs, and selling additional equipment or replacement equipment to existing rigs. So, we see that we will be on a more level playing field with the three larger BOP providers in providing additional equipment.

And when you think about inspections or certifications, as you go down that road that is us. I mean that is what T-3 has been doing for many years. We certainly have capabilities not only for our own equipment, but for everyone else’s equipment to provide that type of service. So, I think that will be a good area for us.

And I also believe that these regulations or similar regulations are going apply to land rigs. On top of that, it looks like there could be a movement of a lot of E&P dollars, especially from the independents moving from the offshore markets to land. And while we participate in both the offshore and onshore markets, again land is relatively better for us. So in response to what we are seeing in the marketplace, as we said, we have added some inventory. This is in anticipation of some quick turn orders for our customers.

We’re also having additional success promoting a tool that we have been using for about a year now. We refer to it as the SPEC tool. This is an acronym for seal performance evaluation calculator. What this is, is a proprietary process and related software that allows us or our customers to take key measurements of their BOPs, and then compare these measurements to a database of information that lets them estimate, or us estimate how long that equipment can continue in service before it needs to be refurbished, or alternatively it needs to be refurbished right then.

In other words, it is an objective tool that replaces what has been done by many people subjectively trying to guess when the equipment really should come in for service and major refurbishment. I guess one other thing to mention right from the pressure control side on the frac manifold that we have talked about on several of our last conference calls.

We still expect to get an order for another frac manifold this year. I know I have said that several times, but we continue to have a lot of interest from customers in this. This is a manifold as we have talked to that is particularly applicable to horizontal drilling. Translate that into any of the shale plays, and a lot of the customer interest now is in heads that are for 4 to 8 wells. The one we sold last year was a 16 well head. We were servicing a 16 well head.

These smaller pads we would expect to obviously have a smaller price tag. You know, they are going to be $3 million or $4 million each instead of the $6 million, $7 million type that we had a year ago. But they will also bring, we believe, additional well head work with this, which can add another million dollars or so to our revenues by being the natural person to provide some of these other equipment, while we have also been working with the customer on a frac manifold.

We mentioned that our bookings have increased for each of a last four quarters, and I think it is fair to say that based on July, what we are seeing in the market place right now that we expect this to continue, this trend to continue in the third quarter and also into the fourth quarter.

And I guess, as well as we are commenting on the future we also expect that our revenues and earnings trend, which has been increasing each quarter will also continue for the rest of 2010.

With that, we will turn it over to questions.

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes from Marshall Adkins of Raymond James. Please go ahead.

Marshall Adkins – Raymond James

Good morning guys. Let us obviously within condo [ph], that’s the elephant in the room here. I have had a lot of investors express concern that you are going to be squeezed out of the market from the big three as OEM equipment goes to just those guys. Comment on that and it appears to me that while maybe you get a small piece of the pie, the pie is going to heck of a lot bigger going forward for well control equipment than what was before, and certainly the maintenance related stuff is going to be a lot higher than that, (inaudible). So, could you just kind of give us some your perception on that?

Steve Krablin

Sure Marshall. You know, first off, I mean being squeezed out of the market, when T-3 got into the – became an OEM provider of equipment, it wasn’t a good market. And you know, it turned out that many of our customers wanted an alternative, wanted someone who was perhaps more interested in service and in working with specific customer needs, as opposed to selling a product.

I think the same factors that got us into the marketplace will keep this in this marketplace. I think we’re out of choice, and I think that there is a pretty strong feeling with a number of customers that T-3 does these things better for them. Obviously that is subjective, but they feel that it is better for them then what they get in other places. So, I don’t really think that we will lose share, and in fact, I think a stronger case to be made, we will actually even be moving up in shares.

So that will play out over the next few months and years, but I certainly wouldn’t give in to the argument that we are going to be squeezed out I think you said by these other players.

Marshall Adkins – Raymond James

All right. Correct me if I am wrong, but you know, a lot of your entry into the business was facilitated by some of these hybrid BOP systems maybe that are (inaudible), and you know, for maintenance and upkeep, people said, hey, let us get together and work on everything. And that was yours. Was that the case, and does that play into your hand as we go forward on more maintenance with BOPs?

Steve Krablin

Well, it certainly was the case that we did work in major refurbishments. The major refurbishments is you know something that is costing 50%, 60% of the cost of the new equipment, and we could do that on the entire stack of equipment. This is going back to the history of the company prior to 2003 or 2004 when we started our own products. That has also continued throughout the current period. We are still able to do this.

We have our own design packages, all of the engineering data for competitors products, and so if you have a stack that has T3 rams, and a GE annular, you know, you can bring it to us and we will work on ours, we will work on Tamarind [ph], we will work on Shafer [ph], we will work on the GE.

So it still continues and we can do that. Now it is because that expertise in all of these areas that we started making our own equipment and really found that there was a desire by customers to not just refurbish and get back exactly what they had, but to have a tweaker or some other idea incorporated into the equipment, and that is really the strength that T-3 had. We were small and hungry, and well, still are small and hungry. And you know, will work with customers to make the modifications that may not make sense for someone who’s just selling products.

Marshall Adkins – Raymond James

All right, excellent. Last question, does that maintenance work fall into the backlog, and it does seem like your backlog is going up. So, it sounded like a lot of that was land related, could you just give us a little more color there?

Steve Krablin

Yes, that maintenance for the NTL work does fall into the backlog. As I pointed out, there is somewhere right now in the neighborhood of millionish dollars and about 40 BOPs. There are a number of other BOPs that are on location right now that customers are considering making decisions for, as well as the number that are still on the rigs that people are evaluating, whether it is necessary to bring in for any type of work.

Included in this, we have multiple subsea stacks, in addition to a large amount of surface equipment. So as the deals come in and we get firm orders, we will put those into the backlog just like everything else.

Marshall Adkins – Raymond James

But it still sounds like the land OEM is driving the backlog more than that business, is that fair?

Steve Krablin

Hands on, absolutely that is what is happening right now.

Marshall Adkins – Raymond James

Okay, thanks guys.

Steve Krablin

Yes, thanks Marshall.

Operator

Our next question comes from Chris Glycine of Simmons & Company. Please go ahead.

Chris Glycine – Simmons & Company

Thanks. Good morning.

Steve Krablin

Good morning Chris.

Chris Glycine – Simmons & Company

Just to expand upon the previous line of questioning, in a typical quarter what is the mix of freshly sold equipment that comes into in terms of T-3 OEM versus competitor products?

Steve Krablin

You are talking about for service right now, and just on the servicing, not of the – in a typical quarter, until very recently what was coming in was almost 100% competitor product. And that is just from the nature of how long we have been selling BOPs, and how much work was actually happening. Right now, we are up to the 80% to 90% of what is coming in that still were to be competitor type BOPs, but some around 10% to 20% are actually our products, where we have been working on as well.

Chris Glycine – Simmons & Company

Do you expect that number to increase given the fact that your base, your products has expanded significantly over the last couple of years?

Steve Krablin

I would expect that the number, I would expect those numbers actually to increase, although I guess technically that will get you over 100%. I think the service revenues that we have for our own BOPs coming back will increase because we should benefit from our own BOPs coming back. Also, we further expect that there will be further increased service work that is going to be required out of the regulations, and I think some of the successes we are having with this SPEC tool, and some of the other things we are doing right now will increase the amount of work we are getting on competitors BOPs as well.

Chris Glycine – Simmons & Company

Okay, and going forward, what do you think is the typical revenue opportunity for the maintenance upgrades for BOP versus the certification work?

Steve Krablin

I think that is pretty hard for us to know that answer. I mean, one of the things that we are finding now is that as you are inspecting and certifying this equipment, a lot of the older equipment, the records may not have been kept up all that well as to where the equipment has been used, where it has been serviced, what kind of maintenance has been done on it. A number of companies have grown by acquisition, and they may not have the history of this type of equipment. And any time you don’t have the history of this, it makes the inspection process become more complicated, more thorough.

You have to – you can’t rely on any of the paperwork that has been generated or kept. So that is to the extent that that is a problem for some people, and you are going to force things into the refurbishments. Maybe they have had some major refurbishments, and maybe that is 50% to 60%. You know, it really makes sense to do a 50% to 60% refurbishment on a 20-year-old piece of equipment, or is it now time to really bite the bullet and change out that ram cavity or whatever is being refurbished or considered for that.

You know, I think again in this industry the equipment is, although it has been on rigs for a long time, it doesn’t mean this equipment doesn’t work, but it does require a lot of repair. At some point in time you decide well, I’m spending so much money on my old car, I better buy a new one. I think the same logic will come through here.

Chris Glycine – Simmons & Company

Okay, thanks very much.

Steve Krablin

Okay, thanks.

Operator

Our next question comes from Terese Fabian of Sidoti & Company. Please go ahead.

Terese Fabian – Sidoti & Company

Thank you. Steve, you gave a good rundown on some of the requirements that may be added to pressure control equipment, and I guess it has go through the regulatory review, but is it possible do you think these will be introduced by year end?

Steve Krablin

I would be shocked if they weren’t introduced by year-end. Personally, I think it is very soon. I think it is a matter of a month or so, not several months.

Terese Fabian – Sidoti & Company

And do you then expect that work for you would be picking up at that time, or shortly thereafter unlike in the capital equipment production?

Steve Krablin

Well, certainly – well, I think it is actually going to be picking up even before the regulations come out. And we have seen it even in the month of July, because it is now getting closer enough I think that people can begin to get a true feel for what is the requirement going to be. I mean, I think there was a time and if you go back to May, where you had people speculating that well, all this work has going to have to go back to the original OEM. That is just not the case. I think there is no indication in my mind that that is going to be a requirement, and it would be a nonsensical requirement if it was, because okay, I can really charge a lot of money if you can’t take it to anybody but me.

You know, so I just don’t see that as being the answer. I think there will be requirements that people doing the work have to be API certified, have to be qualified, have their own design packages and engineering packages to be able to do the work. So I think this could bring a lot of pressure on to just the others machine shop, but I don’t think it is going to affect us at all. In fact, I think it’ll be a benefit to us.

Terese Fabian – Sidoti & Company

If I could just ask a follow up on that, in terms of US standards and international standards, are they very different on pressure control equipment and do you expect to see some overlap over there?

Steve Krablin

In the offshore market, there were requirements over the regular testing of the equipment, but really no requirements over the specific repair cycle or official certification. Obviously that is going to happen. In many places, Canada is one that is added on my experience back into the 70, and has had requirements for recertification of all BOPs, we mean land BOPs every three years.

It is my belief that that type of requirement, if not initially imposed will be imposed in the US as well. And certainly that has been in requirement. Somewhat similar to that had been in some of the bills that are being discussed at this time. So, I think that there is a trend towards making certain you are lowering the risk profile of the industry, in particular in this area. And I think that those will also over time become the requirements in the US.

Terese Fabian – Sidoti & Company

Okay, thank you. I will queue up for my next question.

Operator

Our next question comes from Blake Hutchinson of Howard Weil. Please go ahead.

Steve Krablin

Good morning, how are you?

Blake Hutchinson – Howard Weil

Good, good. Just kind of exploring your commentary with regard to the kind of pause from your customer base, we have been in that $45 million to $50 million type bookings run rate for a few quarters now. I mean, was the pause substantial enough, and did you have an amount where you were sub $10 million or something like that in bookings, and any color you can provide in terms of how dramatic that pause was?

Steve Krablin

Yes, I prefer to not give monthly booking numbers. They do tend to jump around. What I will say is that obviously in an ideal quarter, you would see it, a third, a third, a third between the three quarters, and we looked at something that was closer to maybe about a fifth to maybe a quarter of bookings in the second quarter, and certainly a disturbing trend if you were looking at the direction things were going.

Blake Hutchinson – Howard Weil

Okay, that is – that color is helpful. I get you there. So – and then I guess you also referenced the fact that you are doing – you are seeing more quick turn items falling through the income statement. Does that suggest to us, despite the fact that bookings are flat that we can still think about third quarter being up from here, or should we think about third quarter being a flattish quarter given bookings, and then you are kind of proceeding with the growth rate from there.

Steve Krablin

Just to give a little color on that, we’re seeing a few things happen simultaneously. The first one is as you pointed out the shift to some of these quick turn items, where we think there will be some opportunities first into the higher priced items that do help out the mix somewhat. Secondarily, we are seeing a shift towards US land, where we do tend to sell lower value type items.

These are maybe lower standard cost, when you are selling the type of thing, just because they are smaller diameter, lower pressure type items that can see –- one that helps the mix, one that hurts the mix that are kind of happening simultaneously. I guess I would go back to what we said earlier in the call, which we do anticipate that we will see revenues, bookings and overall company performance improving throughout the rest of the year. So, Q3 should be up at least slightly from where we are right now in Q2.

Blake Hutchinson – Howard Weil

Great, I appreciate the color, and thanks for the help guys.

Steve Krablin

All right, thanks Blake.

Operator

Our next question comes from Stephen Gengaro with Jefferies. Please go ahead.

Stephen Gengaro – Jefferies

Thank you. I guess two follow ups, the first, sort of pigging back on the last question, I may have missed it, because I dropped off for a second, but the incrementals were kind of charge in the quarter on I guess in pressure control, how should we think about that going forward, a more sort of normalized mid-30s number?

Steve Krablin

We have – again, we didn’t have a huge shift in the overall revenue numbers. We do tend to think about our incrementals somewhere in that 40% type range. We have said 35% to 45%. I realize we hit a home run, it went out of the quarter, mix in any particular quarter can drive that up or down and we certainly benefited from that been driven up a bit this quarter.

Stephen Gengaro – Jefferies

Okay, that’s helpful and then the second question, you talked about inventories a bit, but when you sort of I mean, it’s sort of only sounds like your thought process is that you’re going to see regulations in place that are beneficial to your business. Is there anything you are doing or can do to be able to react quicker than maybe your peers once you get sort of crystallization of what those regulations call for.

Steve Krablin

I don’t know that we are doing anything that’s unique that other people aren’t doing. I mean, we certainly are, you know, adding spare parts, the shearing rams this type of thing to inventory. We are purchasing, you know, anything that would be a longer lead time associated with the pressure control equipment going ahead and making some purchases on that because we, you know, are confident that there’s going to be additional equipment required. Again, you know, should we be wrong on that it would be something that we could still use anyway. So this is a few million dollars, but I feel quite confident that the other people in the industry are smart enough to anticipate this as well. I don’t think it is unique to us.

Stephen Gengaro – Jefferies

Okay, very good. That’s helpful. Thank you.

Operator

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

Victor Marchon – RBC Capital Markets

Thank you. The 40 BOPs you guys have talked about in backlog, pause as you had said, was that all recertification work?

Steve Krablin

Yes, the 40 BOPs I was talking about are BOPs that are on the ground for recert work. These are not new BOPs to be delivered. That simply are, I guess, certification work for the NTL. That is what those BOPs relate to.

Victor Marchon – RBC Capital Markets

And a dollar value for those 40?

Jay Mitchell

The amount is somewhere in the neighborhood of just under $1 million, round numbers.

Victor Marchon – RBC Capital Markets

And the second one, just was on the SPEC tool what you guys had mentioned, is that something that could be a rental item, that is you know, on-site over time or is it more part of you know, testing. You know, when you go out to test you know, test the BOP?

Steve Krablin

This is more of a service being offered in order to help our customers, you know, plan their needs and timing of refurbishment and knowing, having a better idea what the status of their equipment is. So it’s not something that we are selling for to get value on its own, as much as a service we’re offering that then allows us to be a preferred vendor for the refurbishment of this equipment.

Victor Marchon – RBC Capital Markets

All right, great. Thank you guys. That’s all I had.

Steve Krablin

Thanks.

Jay Mitchell

Thanks Victor.

Operator

Our next question comes from Jeff Spittel of Madison Williams. Please go ahead.

Jeff Spittel – Madison Williams

Thanks, good morning guys.

Steve Krablin

Good morning.

Jeff Spittel – Madison Williams

I guess just following up on the recertification and potential mandate, Jay, I think you and I have talked about this last time we spoke. Can you remind us again, I guess in a place like Canada they talk about mandating in every three years. Can you talk about how that compares to what typically goes on in the US?

Jay Mitchell

Sure. Right now there is no mandate in the United States for stripping down and redoing BOPs. There are API certifications, which recommend that you do strip down and remanufacture BOP every 3 to 5 years. In the United States in general, we find with our customers people tend to do this every 5, sometimes 6 years. So roughly half as often as you might do in Canada. Now when something does come in in the United States right now, it tends to have more work, because this has been used for a longer period of time. But the overall dollars that are spent are slightly less or certainly less than the United States than they are in a place like Canada or Saudi or Norway, where you are actually required to refurbish and remanufacture BOPs on a more regular basis.

Jeff Spittel – Madison Williams

Okay, so the over simplifying and say, you know, you’re doubling the service intensity because of a reduced scope if you're doing it more often that clearly, they’re probably be a benefit there for you right?

Jay Mitchell

Directionally you’re correct, it maybe a little bit oversimplifying, but the direction is right.

Jeff Spittel – Madison Williams

Okay, great. And I guess, we’ll leave the dead horse alone for now, the mid stream piece of the business, I understand it’s relatively small with all the activity going on in the shale plays. You’re starting to see some evidence that there could be some infrastructure constraints and a little bit more development as you get into 2011, and talk about how you think about that factor in any business?

Steve Krablin

If you are looking at the pipeline valve business, we actually are somewhat pleased to see that we finally got that business, which you point out is, around 5% to 6% of our total revenues got up to over $1 million a month this quarter. I think more importantly, when you look at what the guys are saying there, we’re starting to feel more optimistic about the orders and the work that will be coming in at some point in the future.

There are projects that were discussed back in 2007 that have been on hold ever since you know, 2007, 2008 that are beginning to be discussed again, and even some of that work has started to come in. So, on a go forward basis, I think it is going to still be incremental, but hopefully we’ll see that business continue to rebound, and certainly getting over the million dollar mark for those guys is something that is psychologically beneficial and we’re feeling a whole lot better about the margins there right now.

Jeff Spittel – Madison Williams

Very good gentlemen. Thanks very much. I appreciate it.

Steve Krablin

Thank you Jeff.

Operator

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

Joe Gibney – Capital One

Thanks, good morning guys.

Steve Krablin

Good morning Joe.

Joe Gibney – Capital One

Just wanted to circle back to another question on the service business, out of the roughly 80% of your service that comes from servicing competitor third-party equipment. How much of that typically is subsea stack service work ballpark figure?

Jay Mitchell

You know, that can bounce around from time to time, and I do not know that answer for where we are at this point in the game. I do know for the NTL work, the dollar is roughly 20% of the work we’re doing is for subsea deepwater type items. I would imagine it’s somewhere in that range. I know for new equipment the – what we saw at the subsea is substantially less and from an overall revenue standpoint, our pressure control group, it is somewhere in the neighborhood of about 5%, plus or minus.

Joe Gibney – Capital One

All right. That’s helpful. And just for clarity, Jay, if you can repeat this, the percentage of your PCG backlog that was US land and then total land was at 30% US and then total land represented 70 inclusive of international. Is that correct?

Jay Mitchell

Correct. That is correct.

Joe Gibney – Capital One

Okay. And last, Steve, if you can just talk a little bit about shearing capabilities, one of your larger competitors was out yesterday talking a little bit about their shearing capabilities, the ability to shear large tool joints, and really the next generation [ph] from a shearing technology standpoint, you guys have certainly had some inroads within shearing yourselves, just curious if you could talk a little bit about what you guys can bring to the table from a technology standpoint?

Steve Krablin

We like everyone else and certainly are also you know, working with new customers and you know, making some designs like that, and trying to improve the capabilities of this. There is a lot of talk in the industry and inside T-3 about you know, coming up with an ultimate shearing device. We have, you know, basically the same types of equipments and we have some of the better, you know, the higher capability casing shears right now.

So you know, there is a lot of that is going on. I am a little reluctant to guess what our competitor is specifically referring to but you know, this is a process that they have been working on for years, we’ve been working on for years, and essentially, you know, to me the low-pressure design aspect of some of them may be more of a selling tool as opposed to something that in most cases actually – obviously if you have a leak in pressure control equipment being able to do something with low pressure might be of benefit, but I still don’t know enough about it to comment in any great length.

Joe Gibney – Capital One

Well, I appreciate it guys. I will turn it back. Nice quarter.

Steve Krablin

Thanks Joe.

Operator

Our next question comes from Terese Fabian of Sidoti & Company. Please go ahead.

Steve Krablin

Hi, Terese, how are you?

Terese Fabian – Sidoti & Company

Hi, how are you? Thank you for taking my questions. I have a – actually I wanted to ask you about the frac manifold. Obviously, it must be going well because you’re expecting to have additional orders for systems, but what impact are you seeing up in Canada?

Steve Krablin

As far as –

Terese Fabian – Sidoti & Company

Operation performance that you guys expected. You said that you have some revenue from refurbishment, was that in your expectations, is that going to be recurring on these systems?

Steve Krablin

We said the refurbishment was really an enhancement adding some additional pumping capabilities to the fracing capabilities that were already there. So it was a, you know, an evolving design change or you know, a second-generation if you will type improvement on this. You know, this is something that is evolving as you know, we would incorporate that kind of thing into the next system, I feel certain or our customers, obviously the customer wants it, and is willing to pay for it. So it’s not something that was initially anticipated it would come this quickly, but it’s something that has evolved more.

Terese Fabian – Sidoti & Company

Okay, that’s good. And then –

Steve Krablin

The system is working great. I mean, there still is nothing, but getting [ph] reports out of the operating part of the system.

Terese Fabian – Sidoti & Company

That’s what I was wondering. Can you quantify like what kind of savings the operator is getting using the store, what’s the advantages to them are?

Steve Krablin

The information that we have on this is that this is a payback to the customer of months, not years. So, it’s a very quick payback, and, you know, while it is good business for us, it’s really good business from them.

Terese Fabian – Sidoti & Company

Okay, thank you.

Steve Krablin

Thanks.

Operator

Our next question comes from Mark Rogers of Gagnon. Please go ahead.

Steve Krablin

Hi Mark.

Mark Rogers – Gagnon

Thank you. I was – hi, how are you guys? I was wondering if I could continue on the service side of the equation, what do you think the capacity is right now for the three major BOP manufacturers to handle servicing their own equipment if that was to be a mandate?

Steve Krablin

You know, I think we’d just be guessing on that. You know, we perhaps would be guessing on you know, how much work is actually going to need to be done. You know, what we’re actually seeing is that a lot of the equipment is in fine shape. I mean, it’s not like everything is coming in, and we are saying, oh, gee, we have to, you know, spend $100,000 on it. It’s more the act of getting it in and going through the steps and verifying and certifying as opposed to saying, oh, gee, this is junk. It isn’t junk. Most of this equipment is quite good, and so it’s hard to even guess what the requirements might be, and I certainly don’t know what the capacities of anybody else are, but I’m guessing this is not a capacity constraining issue for the industry.

Mark Rogers – Gagnon

Okay, and just a question on the SPEC tool, is this just so I can understand this better, is this a tool that is sort of like a series of measurements that you put into a software program or is this – right, go ahead.

Steve Krablin

It’s – instead of, you know, someone taking measurements and then saying you know, it’s got a little wear, it’s like the guy looking at the brakes on your car and saying well, you know, it looks like you might be able to go 10,000 more miles. Well, this is something that instead of just guessing at it, these measurements will say you know, based on the wear that you have had, it looks like you’re going to go 18,000 more miles.

You know, it’s something that’s objective as opposed to, oh, it looks you are still good. So it’s really – it’s more of a tool to help our customers make better decisions, than you know, spend anything else, and it’s just a way to be a little bit more objective in a subjective area.

Mark Rogers – Gagnon

Absolutely. Is there any proprietary aspects to this tool that could maybe put you in a position to be sort of take the lead at the, you know, certification process was more standardized?

Steve Krablin

Well, you know, this is really something that is working off of our experience with, you know, being able to work on everyone’s BOP. So, it is this database of knowledge that you know, I hate to say it’s unique, but it certainly is something that we have because we want to work and do work on everybody else’s BOP. So, this isn’t just about our BOP, this is data on everyone’s, and so because we do that type of work and have for many years, we have all the designs and drawings and engineering packages for this. Now each of them have their own, so you could easily collect all this data and have something that would be as good as what we have. It’s just that they don’t.

Mark Rogers – Gagnon

Interesting, and just one more question on the frac matter – go ahead. I’m sorry.

Jay Mitchell

I was going to say, and the things we are actually comparing is through our years of experience looking at other people’s BOPs, looking at our own BOPs. It’s not only what the original item was supposed to be, but how much wear we have seen, and at what point we would find that that wear actually turns out to be a problem, and comparing it back to the information we have and comparing it back to industry standards and those things are all linked up. That’s what the SPEC tool is designed to do. So you can come back and say, okay, yes as Steve says, roughly 10,000 miles is left on your brake. So the equivalent there of the BOPs, you’ll be able to do this much more. We think to be able to go this much longer without having an issue.

Mark Rogers – Gagnon

Okay, that helps a lot of understanding, thanks. One question on the frac manifold, you said you’re getting a lot of interest still on the tool, you expect another order, in the interest, could you characterize the interest a little bit as far as coming from the same size operator as your current partner on the project or partner on the product, you know, how many players are interested, are you talking to one, two, five, ten. Just a little more color on that would be helpful, thanks.

Steve Krablin

There is you know, half a dozen, you know, 5 or 10 type number that are seriously interested in this type of equipment, and you know, we’re actively quoting, finding their needs and you know, providing information for you know, that we would consider true near term interested people.

Mark Rogers – Gagnon

That sounds great. Thank you.

Steve Krablin

Thank you Mark.

Jay Mitchell

If there are no more questions, we ought to be wrapping up pretty quick.

Operator

I’m showing we do have one final question from Brian…

Jay Mitchell

Okay, let’s take one more, great.

Operator

From Brian Uhlmer of Pritchard Capital. Please go ahead.

Steve Krablin

Hi Brian, how are you?

Brian Uhlmer – Pritchard Capital

Hi, we will take this offline, if you want. But I just – I will ask a quick one. You know, you guys mentioned about that machine shop, I don’t know if you are talking about the one in (inaudible) or in general. Speaking of that, I mean, if you’re saying there’s going to be issues for guys like that are you going to see incremental capacity that they are going to be able to acquire. Kind how do you look at that plan in light of what has happened recently.

Steve Krablin

You know, certainly that you know, if in fact this causes pressure on the smaller wins there, there may be things that we can do I think in most circumstances, we’d be more interested in people that in you know, trying to acquire capacity, and part of you know, what the issues with be when we – the early capacity issue will be around people not around the lack of equipment, you know, no one is really – I don’t believe running three shifts at this point in time. So it’s a matter of getting the people. So there may be opportunities there where you’re still getting good qualified people that are being squeezed a bit in some of those areas, still pretty much speculating on that kind of thing at this point.

Brian Uhlmer – Pritchard Capital

Okay, and then one final one on kind of on the dollars per rig, I guess, kind of correlate orders, did you say that you know, that this caused a temporary slowdown in even the land guys ordering during the quarter. Just because they were waiting to see if this played out and affected them. Did that have any effect on your opinion?

Steve Krablin

It really more affected the offshore guys. Now, some of the land guys as you know also have offshore equipment, and we do tend to sell to them in both capacities. So we saw slowdowns from most, if not all of our customers that are – of US based operations. Still, on an incremental basis throughout the quarter we saw that US land did improve, and that was sort of, although there was a pullback from everybody that was I believe US land improved without exception throughout the entire quarter, and our total sales to US land went up by about 16% over where we were in the first quarter, and they’ve increased to an even greater proportion of the backlog than they were in the past as well.

Brian Uhlmer – Pritchard Capital

Okay, thanks. That’s – your hour is up. So, at last, I will let you wrap it up. Thank you.

Jay Mitchell

Okay.

Steve Krablin

Okay, well, we certainly appreciate everyone calling in. You know, we were pleased with the quarter, especially under the circumstances and as we mentioned are expecting future growth throughout the balance of 2010, and we look forward to visiting with you in about another three months. Thanks for calling.

Operator

Ladies and gentlemen that does conclude today’s conference. You may all disconnect and have a wonderful day.

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Source: T-3 Energy Services, Inc. Q2 2010 Earnings Call Transcript
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