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ION Geophysical Corporation (NYSE:IO)

Q2 2014 Results Earnings Conference Call

August 7, 2014 11:00 a.m. ET

Executives

Karen Abercrombie - Vice President, Corporate Communications

Brian Hanson - President and Chief Executive Officer

Mike Morrison - Vice President, Corporate Finance

Analysts

Joe Maxa – Dougherty & Company

Chris Bamman - Sidoti & Company

Operator

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the ION Geophysical’s Second Quarter Earnings Call. During today’s presentation all parties will be in a listen-only mode. Following the presentation, the conference will be opened for questions. (Operator Instructions) This conference is being recorded, Thursday, August 7, 2014.

I would like to turn the conference over to Karen Abercrombie, Vice President, Corporate Communications. Please go ahead, ma’am.

Karen Abercrombie

Thank you, Casey. Good morning and welcome to ION Geophysical Corporation’s second quarter 2014 earnings conference call. We appreciate you joining us today. As indicated on Slide 2, our hosts today are Brian Hanson, President and Chief Executive Officer, and Mike Morrison, Vice President, Corporate Finance, who is standing in for our Chief Financial Officer, Greg Heinlein.

Before I turn the call over to them, I have a few items to cover. We’ll be using slides to accompany today’s call. They are accessible via a link on the Investor Relations Page of our website, iongeo.com. There you’ll also find a replay of today’s call.

Moving on to Slide 3. Information reported on this call speaks only as of today, August 7, 2014, and therefore you’re advised that time sensitive information may no longer be accurate at the time of any replay. Before we begin, let me remind you that certain statements made during this call may constitute forward-looking statements, which are based on our current expectations and include known and unknown risks, uncertainties and other factors, many of which we are unable to predict or control, that may cause our actual results or performance to differ materially from any future results or performance expressed or implied by those statements. These risks and uncertainties include the risk factors disclosed by ION from time to time in our filings with the SEC, including in our Annual Report on Form 10-K and our Quarterly Report on Form 10-Q. Furthermore, as we start this call, please refer to the disclosure regarding forward-looking statements incorporated into our press release issued yesterday and please note that the contents of our conference call this morning are covered by those statements.

I’ll now turn the call over to Brian who will begin on Slide 4.

Brian Hanson

Thanks, Karen. Good morning, everyone. Yesterday we reported second quarter net income of $1.2 million or diluted earnings per share of about $0.01 on revenues of $121 million. These results included a gain from the sale of our marine source product line which I will discuss later in the call.

Our revenues for the second quarter and first half of the year were slightly above our 2013 revenues. In the second quarter, we benefitted from revenues contributed by OceanGeo, our ocean bottom seismic acquisition service company on their project in Trinidad, and also from record second quarter revenues in our software segment. Excluding OceanGeo, our second quarter revenues were down year-over-year driven by a significant decline in revenues within our solutions segment.

Consistent with several of our industry peers, our second quarter results reflect a slowdown in oil and gas company spending on exploration and seismic acquisition. I will share second quarter operational highlights starting with our ocean bottom services segment then Mike will cover the financials and I will wrap up with a look ahead.

I mentioned in previous calls, we are executing our strategy of leveraging our key technologies to provide E&P companies with integrated solutions. Our ocean bottom seismic business is a prime example of that. In July, we increased our ownership in OceanGeo to 100%. Later in the call, Mike will review the economics of this transaction. OceanGeo contributed $26 million in revenues in the second quarter or perhaps as important, their key component in our vertically integrated holistic OBS offering. Through OceanGeo, we are putting our Calypso technology to work and we are seeing significant pull-through opportunities for data processing work as well.

In the second quarter, OceanGeo completed a five-month survey at offshore Trinidad for Petrotrin on time, on budget and with no QHSE incidents. In May, OceanGeo was awarded a contract by a major European oil and gas company to acquire a 3D ocean bottom seismic survey offshore West Africa. This award is in keeping with our strategy of deploying OceanGeo's crew into the West African region where they are engaged in a sizable tender activity.

Unlike what we are seeing in the towed streamer side of the business, the ocean bottom seismic market is strong. OBS acquisition services expenditures have grown by over 400% since 2006 and we anticipate continued growth driven by several factors, including the need for superior data for production seismic and life of field management, improving economics for OBS techniques and the need to acquire high quality seismic in heavily congested production fields where OBS is often the only choice. There are currently an estimated $2.3 billion in unawarded OBS projects around the world, with high concentrations of activity in West Africa, Brazil and the Far East.

Since April 1, $137 million in new OBS projects were identified, $481 million of new contracts were awarded and $273 million in identified projects moved into the tender process. OceanGeo is actively pursuing tenders for work that would occur through 2015 and into 2016.

Our second quarter solutions segment revenues were $63 million, down 29% year-over-year. We gained traction on a number of programs in the second quarter. In early May we mentioned we had completed the first phase of our WestraliaSPAN program of Australia's North West shelf and we are planning phase two. In the second quarter, we completed phase two, providing ultra deep imaging of the varied geologies within this highly perspective region.

During the second quarter, we also kicked off to new programs. A 7,000-kilometer survey of the Comoros Islands, adding to our extensive East Africa portfolio. And we commenced the acquisition of a new 4,000 square kilometer 3D, multi-client survey offshore Ireland. We continued to take advantage of a soft contractor market to utilize available vessels to meet client needs when underwriting is adequate. We continue to maintain our high standards for underwriting new projects. Whereas some of our peers have reduced the requirements for underwriting, some to as low as 50% or less, we are limiting our exposure to 30%. Holding off and moving forward with programs that are less than 70% underwritten, either by oil company clients or through partnerships with contractors such as Polarcus or both.

Despite the reduced level of new venture activity in the first half, we sanctioned a number of programs that will be executed in second half of the year and are starting to see improvements in our new ventures program pipeline. Based on our level activity in the first half, we are revising our guidance on our full year new ventures investments to spend $70 million to $90 million, down approximately $20 million from our earlier guidance.

Our data processing revenues for the first half of the year were up 3% over the first half of last year. However, we have seen a slowdown in the second quarter in our data processing business, consistent with the decline in exploration spending and therefore the need for processing. Based on our current backlog, we expect our data processing business to remain soft for the remainder of 2014 with our data processing revenues in the second half of the year predicted to be flat compared to second half 2013.

We have already taken early action to reduce our data processing cost structure during this period. Despite the softening in the processing market, we are seeing some uptake of our new full waveform inversion technology on a worldwide basis, including large projects for several major oil companies. We are using this technology to drive high-fidelity earth models to deliver better images and help our clients reduce subsurface risks.

Our software business had another nice quarter, up 25% from the second quarter of last year. A result of strong Orca and Gator licensing. In addition to maintaining solid penetration of our traditional tier one contractor customer base, we are penetrating the second tier contractor base as well. Our second quarter systems segment sales were $22 million, down slightly from the second quarter of last year. Our spares and replacement business for our positioning line remains solid. Our new positioning product sales are soft given the weakness and excess capacity in the contractor market.

Consistent with our strategy of focusing our systems R&D efforts on ocean bottom seismic acquisition technologies which we are putting to work in service model through OceanGeo, in May we sold our marine source product line to Mitcham. Through this transaction, we were able to monetize these non-strategic assets over their book value.

Our systems division personal are focused on ensuring Calypso is optimally performing on OceanGeo surveys. Amidst the slowdown, we are managing the business conservatively, focusing on cash flow generation while steadfastly executing our strategy.

With that, I will turn the call over to Mike.

Mike Morrison

Thanks, Brian. Good morning, everyone. Overall, our second quarter revenues were $121 million, a slight increase over second quarter 2013. This increase was due to revenues contributed by OceanGeo, along with the second quarter record revenue by our software segment. However, these increases were primarily offset by the reduction in revenues within our solutions segment.

Our consolidated gross margins increased to 31% compared to 30% in second quarter 2013 but our operating margins were down to 3% compared to 6% last year. This decrease in operating margin was driven primarily by the decline in data processing revenues within our solutions business. Our adjusted EBITDA for the second quarter was up 6%, primarily due to the gain from the Source product line sale.

Overall, we reported net income of $1 million or $0.01 earnings per share, compared to a net loss of $71 million or $0.45 per share during the second quarter 2013. As Brian mentioned, our second quarter results include a non-reoccurring gain on the sale of our Source product line. Also, our second quarter results last year included a charge related to the WesternGeco legal matter. Excluding these special items, our second quarter 2014 adjusted net income was a loss of $5 million or $0.03 per share, compared to adjusted net income of $400,000 or breakeven earnings per share in the second quarter of 2013.

Turning to Slide 11. Our second quarter solutions segment revenues were $63 million, down significantly from second quarter 2013, a result of the continued softness in exploration spending by E&P customers. Within the solutions segment, the new venture revenues were $25 million, down 24% from second quarter 2013, data library revenues were $14 million, down 37% and data processing revenues were $24 million, down 30%.

Due to these revenue declines, Solutions had an operating loss of $1 million or negative 2% operating margin, down from $11 million or 12% operating margin in second quarter 2013. This decrease in operating profit and margins was primarily driven by a decline in our multi-client business and western hemisphere data processing revenues. As Brian mentioned, we have focused a great deal on our processing cost structure and have reduced our annualized data processing cost by $5 million to $8 million, which should begin to realize starting on the third quarter of this year.

Turning to Slide 12. Our software segment achieved its best second quarter sales as revenues increased 25% compared to the second quarter 2013. This record was primarily led by increases in Orca and Gator licensing revenues. While we have not closed any next generation software deals with customers, we continue to have good interactions as we build out our E&P software product line. Our software segment operating profit was $6 million or 53% operating margin, compared to $5 million or 59% operating margin in second quarter 2013. This decrease in operating margin was due to an increase in research and development for our next generation software products.

Moving to Slide 13. Systems segment revenues were $22 million, a decline of 6%. This year-over-year decrease was due to reduced new marine positioning systems sales that were partially offset by an increase in repair and replacement revenues. The weakness in our new positioning product sales in consistent with other areas of our business, reflecting the overcapacity in the marine contractor market. Systems operating profit increased to $4 million or 16% operating margin, compared to $2 million or 6% operating margin for second quarter 2013. This increase in our systems operating margin was primarily due to our cost reductions we took last year.

Turning to Slide 14. Ocean bottom services segment revenues were $26 million, related to work performed on OceanGeo's five-months project in Trinidad, completed at the end of May. In June, OceanGeo began mobilizing for its next project offshore West Africa and began acquiring data in July. Ocean bottom services operating profit was $6 million, or 25% operating margin. Looking ahead into the third quarter, OBS should generate positive operating results with this awarded project taking us into the fourth quarter.

We are actively engaged in discussions for additional contracts to complete fourth quarter's utilization. As Brian mentioned, we increased our ownership in OceanGeo to 100% acquiring the remaining 30% from Georadar. As part of this purchase, we paid Georadar $6 million of cash and agreed to pay an additional $5 million contingent in part upon OceanGeo being awarded a future significant project in 2014. Since early 2013, we have invested a total of $41 million in OceanGeo, through a combination of cash purchases, working capital loans and debt forgiveness. As of the closing date of acquiring the final 30% interest, OceanGeo's cash balance totaled approximately $24 million, for a net ION investment of $17 million.

Turning to Slide 15. INOVA's revenue in their first quarter was $27 million, up 20% from the first quarter 2013. INOVA recorded a net loss of approximately $4 million, of which our 49% share was approximately $1.8 million impacting our second quarter results. Even though revenues increased year-over-year, overall the land equipment business is also experiencing soft spending and pricing with contractors, including reduced purchases by BGP, INOVA's majority owner. For INOVA's second quarter, we estimate revenues to be in the range of approximately $9 million to $11 million, a $50 million decrease from their second quarter 2013. We expect INOVA to report a second quarter operating loss in the range of $11 million to $12 million, which will impact our third quarter results.

Turning to Slide 16. As of June 30, our cash balance stood at $158 million. During the quarter, we paid down the full outstanding balance of $50 million on our revolving line. We generated $14 million of free cash flow, attributable to the Source product line sale and excluding the repayment on our revolver, we generated $10 million of net cash flow during the quarter.

Turning to Slide 17. At June 30, we had full availability under our $175 million credit facility. Our net debt decreased $11 million to $33 million, down from $44 million at March 31, this decline in our net debt was due to continued collections during the quarter along with proceeds from the Source product line sale. We continue to scrutinize every decision in this soft environment with a focus to building cash liquidity.

With that, I will turn it back to Brian.

Brian Hanson

Thanks, Mike. To reiterate what we said in the first quarter, this industry wide slowdown in exploration spending, especially among the larger E&P companies who have traditionally comprised our core customer base, continues to impact our business, mostly likely throughout the remainder of this year and into 2015.

Historically, if E&P companies have had discussions discretionary funds, they would allocate them to acquiring data sets in the fourth quarter. But we are less optimistic that this will occur again this year. As we have mentioned over the last two quarters, we have seen a broadening in our customer base for our multi-client programs. We are cautiously hopeful that the pause in spending by the larger oil companies will be mitigated to some effect by an increase in spending by NOCs and independents like we saw at the end of 2013.

Having said that, we are managing the business from an extended slowdown lasting through 2015. Despite another slow start to the year similar to 2013, we have gotten good traction on some key 2D programs in E&P hotspots around the world, including in Australia's North West shelf, offshore East Africa and in Latin America. We are now actively participating in the 3D multi-client space with our program in the Porcupine Basin in Ireland. Our new full waveform inversion techniques are garnering significant interest among major oil and gas companies despite the softness in the data processing market. And we are fully committed to the growing OBS market through OceanGeo, the acquisition services component of our holistic OBS offering.

While our multi-client offerings such as our BasinSPANS library have traditionally been skewed to the earlier exploration phase of the E&P lifecycle. OBS is typically used later in the development and production phases. We are excited that through our OBS solution we are diversifying our portfolio to have more balance throughout the E&P lifecycle.

With that, I will turn the call back over to the operator for Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Joe Maxa with Dougherty & Company/

Joe Maxa – Dougherty & Company

You talk about managing the business for an extended slowdown, which obviously makes sense. Can you give us a little more color on potential additional cost cuttings? And I'm also curious if you are thinking about divesting INOVA? That seems to be a drag as well.

Brian Hanson

No, Joe. As far as additional cost cuttings, I can tell you that we -- as you have followed it through 2013 and earlier of 2014 on the processing side, we pretty much have already restructured our business units. So, no, I see no need for additional restructurings or cost cuttings. I think we tightened the belt. We hunkered down very early on. We saw this storm brewing somewhere in the late second quarter, early third quarter of 2013. So we have already prepared ourselves to weather it out. So I see it less as cost cutting and more, just very conservative business decision making. So we are not going to take unnecessary risk. We would, in normal high growth times, we take a little more risk in our business but we are not going to do that through this slowdown. So our heads are down and we are conservatively reviewing our decisions making and we are not taking risk and we are managing the business for cash.

Joe Maxa – Dougherty & Company

Right. And on OceanGeo, I know you talked about a lot of opportunities out there, how is it looking for the fourth quarter? Do you think you will be able to land a project to keep that crew active? And if not, what should we be thinking about as far as idling costs related to the crew?

Brian Hanson

Yes. Actually business development activity is going very well, Joe, and I am optimistic that not only will we secure work in the fourth quarter for the fourth quarter, but that there is a high probability we will secure work in the fourth quarter that will take us well into 2015. So I am not as concerned on the ocean bottom side with business development activities right now as I am around execution. And we are in the stage where -- we are at the commercialization stage of Calypso. And as you cut your teeth on all new products, there is always problems and always challenges. So I think those risks in the fourth quarter with OceanGeo and the financial performance but I think it's more around effectively executing around our technology than it is around business development.

Joe Maxa – Dougherty & Company

So lastly, around Calypso. Should we anticipate you replacing the older system? Or is this, again, still just kind of a partial perhaps and then in Calypso on perhaps a second crew, as you gain, if it goes that direction?

Brian Hanson

Yes. Our plans right now are to augment the equipment that’s on the crew right now with Calypso. So today, what we are going to do is increase the capacity of equipment by adding additional Calypso arrays. And then over time what we are going to do is we are going to, in a methodical way we are going to manufacture Calypso arrays and replace the BSO arrays on that crew. And then ultimately we will focus on production for the crew too.

Operator

(Operator Instructions) We will take our next question from Chris Bamman with Sidoti & Company.

Chris Bamman - Sidoti & Company

It's been no secret that exploration spending has been soft. You guys have talked about it in the past. However, has it become worse or slower than perhaps you expected? Are you perhaps maybe losing market share? Can you maybe talk a little bit about that dynamic?

Brian Hanson

Yes, sure. Well, I would say that it's probably slowed down faster on the exploration side than anybody in the industry would have expected it was going to. So all of our peer groups -- if you are watching our peers results too, they are experiencing the exact same slowdown. It happened fairly quickly. So a couple of observations. One is, on our processing side, we saw the slowdown hit in Q2 at a rate faster than we have never seen it before. Although it feels pretty much like we have bottomed out on that. The other thing that I can tell you, if you took the results of our processing business for our third party processing business and you line it up over top of PGSs, we have the exact same performance.

So meaning that, we are not seeing a shift in market share at all. It's just that E&P spending is down an estimated 17% over prior year. I should say exploration spending is down 17% over prior year. So those areas of our business that are highly exposed to the exploration side of the equation, to have seen that softness. And as such, you know that’s why we said we think the back half of the year in data processing business will be from 2013.

Now equal and opposite to that, the production is side is not necessarily experiencing that same slowdown and so that’s why we are seeing so much activity on the ocean bottom side of our business.

Chris Bamman - Sidoti & Company

Okay, that's helpful. Thank you. And just one more thing. I believe you said you were limiting your exposure to 30%. Does that imply that the most you would underwrite in a project is 30%?

Brian Hanson

Yes, precisely.

Chris Bamman - Sidoti & Company

Has that, I think when I last spoke to Greg, I thought it was like around 25%. Is this really, I mean have you lowered the bar a little bit just to try and capture business?

Brian Hanson

No. I think the way that we -- we have changed our approach a little bit and so the way we would have historically done it, is we would look at the exposure on a portfolio basis, Chris. So if we had a couple of projects in the portfolio that were over performing, than we would take more risk on a couple in the portfolio that were underperforming. And in general, that portfolio we ran at a 25% underwriting. What we are doing this year, which I would think is much more conservative, is we are looking at each individual project and each project cannot have any more exposure than 30%. So as that project goes into the portfolio and if it over performs, than that blended exposure reduces. Does that make sense?

Chris Bamman - Sidoti & Company

Yes, it does. Thank you.

Operator

(Operator Instructions) And there are no further questions at this time. Please go ahead.

Brian Hanson

All right. Well, thank you for taking the time to attend our conference call and we look forward to talking to you during our third quarter call.

Operator

Thank you. Ladies and gentlemen, this concludes the ION Geophysical’s second quarter earnings conference call. If you would like to listen to a replay of today’s conference, please dial toll free 1-888-203-1112 or toll, 719-457-0820. The conference center would like to thank you for your participation. You may now disconnect.

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Source: ION Geophysical's (IO) CEO Brian Hanson on Q2 2014 Results - Earnings Call Transcript

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