ION Geophysical Corporation (NYSE:IO)
Barclays 2012 CEO Energy/Power Conference
September 5, 2012 7:45 a.m. ET
Brian Hanson - President and Chief Executive Officer
Well, good morning everyone and welcome today to the 26th Annual Barclays CEO Energy Conference. I hope everyone has found yesterday productive, I am sure today will be equally productive, if not more. So kicking off the presentations this morning is Brian Hanson, the CEO of ION Geophysical. Brian was named CEO in December of 2011, he previously served as the company's CFO from May 2006.
We like the seismic part of the business, we like ION’s stock which we think has considerable upside at the exploration cycle as it gains momentum. Prior to joining ION, Brian was with Fisher Scientific, Alliance Imaging, and Culligan Water Conditioning. Please welcome back to the CEO Energy Conference and speaking for the first time as CEO, Brian Hanson.
Thanks, James. It’s a pleasure to be here this morning to talk about ION. We have to get our necessary forward-looking statements disclosure out of the way. So today what I want to talk a little bit about is first, walkthrough a little bit of an overview on the company for those of you who are not familiar with ION. We are going to talk a little bit about the basis of our strategy and then we will cover some highlights for 2012. A quick snapshot of financial performance and then we can open it up for some Q&A.
So who we are? We are a technology company. Where we invest our money is in people, in developing R&D, what we are not is an asset heavy company. So we do that in order to become a leading provider of geophysical solutions to the industry and we do that through both developing equipment and services and bundling those in the execution of solutions for our oil company customers.
We were founded in 1968. We were originally Input/Output, which we rebranded in 2007 to ION Geophysical. We went public in ’92. We converted over to the New York Stock Exchange in ’94, our ticker is IO. We have approximately 1100 people in the world. We work in over 20 countries. And of those 1100 people, it’s a very highly technical mix. We have over 65% of the population of the company are technical people. And if you break those down you will find that we have over 200 people who are masters educated and a little over 80 PhDs in the business. So we are very much thought heavy in our company.
Our 2011 revenues were $450 million and we have quite a global presence for a little multinational of our size. We are literally located all over the world. We have processing centers in a number of locations including Calgary, Denver, Houston, Mexico, Trinidad, Brazil, London. We have opened new centers in India, Beijing and Cairo. We have a presence in Nigeria, Angola, Russia. So quite a footprint for a processing business. In addition, we have equipment manufacturing and service locations in both North America, Europe and we have an international headquarters in Dubai. So a pretty broad footprint.
To talk a little bit about the specific offerings that we have, first is our GXT branded business which is seismic data processing. Primarily GXT is a leading re-processor of data that typically already has been shot. Mostly have been shot by the large marine contractors in the industry. And where we focus our efforts in GXT is developing unique algorithms that really differentiate ourselves from other processing houses and try to really drive up the image or the resolution of the image for the oil companies.
In addition to that, our GeoVentures business has really developed a very successful offering around integrated geophysical programs. We have a broad spectrum of programs today. If you went back and turned back the clock and looked at that business in 2005 and 2006, it was primarily shooting 2D, large exploration type surveys in the Gulf of Mexico. And since then it’s expanded that BasinSPAN offering globally. And so now we have shot BasinSPANS all over the world in many of the hot basins, including off Brazil, East and West coast Africa, Australia, down in Indonesia, and have a very considerable offering in the arctic with program both in the Chukchi, the Beaufort off Greenland. And in addition we have shot in the Russian Arctic. In fact we got as close to 200 kilometers to the North Pole last year.
And coming out of that offering has been the development of quite a significant data library. So we have a very broad data library today that we can offer to oil companies as they are looking for information or data in specific areas of the world where we they want to get a little bit more understanding of the regional geology. In addition to that the GeoVentures business two year ago introduced their ResSCAN offering, and I will talk a little bit more about that. But that’s more on the development side of the house. It’s specific to shales and tight gas sand plays and it really is all about well optimization and completion techniques.
We have a survey design and software services business. Our Concept Systems business is really the operating system that’s used on marine seismic vessels today to shoot seismic. And today it’s located on over 65 high end vessels shooting marine seismic work. And in addition to that we are in the equipment business. So we have always been pioneers of the next generation of technology whether it’s been used on land or in marine. Our marine business is located in Harahan, Louisiana, and it has a broad spectrum of product offering from towed streamers to positioning devices used on the vessels, and a seabed offering.
Our land business is a joint venture with BGP called INOVA. We own 49% of that joint venture. And INOVA is truly an example of east and west coming together as we have joined forces with BGP to run that business. BGP as you may not know is the world’s largest land contractor. They are owned by CNPC or the China National Petroleum Corporation which is primarily owned by the Chinese government.
So with that let me talk a little bit about our strategy. This slide needs no introduction I am sure to anybody following the oil service spaces. Global demand increases and there is more constriction on spare capacity. We are out there working harder and harder in order to identify -- in order to identify more findings. And as you have the rise in exploration budgets and the more complexity around the type of exploration work we are doing, it really just speaks well to seismic offerings. And to James point it’s an interesting place to play because our technology has become more and more relevant in the space as contractors and oil companies struggle with the economics to develop their reserves.
And so our strategy is very specific. First, we never want to lose focus of the fact that we are a technology company. And what that means is we invest in people and we invest in capability. What we don’t do is invest in assets such as land crews or marine vessels. We are asset light. And that’s a very critical differentiator in the way that we go to market versus some of our competition which is more asset heavy and really has to deal with the issue of capacity utilization as they are running their business. We can go where we believe our technology is most relevant. And we can evaluate the opportunities on a project by project basis.
And we certainly do have a history of innovation. We participate across all aspects of the exploration cycle. From planning an acquisition, for example developing the capability of shooting in near ice and under ice conditions or developing the operating system on vessels so that they can optimize that valet of activity to marine seismic, represents in this 3D wide azimuth world. All the way through to developing the technology that’s pulled behind the vessel or laid on the bottom of the ocean or is used in the field with land crews through to the processing side of the house and the interpretation where we are constantly developing novel algorithms such as full wave processing. And our latest offering which is WiBand, the broadband solution which I will mention in a minute.
Now where we do we focus our effort? We focus our effort primarily in four focus areas. First, challenging environments. We want to go and acquire data where others haven’t had success acquiring it before. And so we are going to go into areas that are obstructed, transition zone areas. And a real successful offering we have developed over the last few years has been in the Arctic. In fact we have built our Arctic business now shooting in near ice and under ice situations with 2D applications to over $260 million offering. We have data sets now that are in multiple areas around the global arctic. And continue to invest heavily in R&D to develop that offering and would expect to see some significant advancements in our capabilities in the arctic in the near future.
We also focus on unconventional reservoirs. We have been out working in tight gas sands for many years and actually really helped the Chinese developed some of their tight gas sands in the 2005 to 2008 timeframe. And we have picked up that capability and created an offering called ResSCAN that we now do in the North American shale plays. And it really is a -- it’s a development type approach. What we are doing is utilizing our full wave capability, or shooting surveys with full wave to capture both the P-wave and the converted wave data. And then using our processing capability to really tweak out much better understanding of the lithology of the reservoir so that oil companies can do a better job of selecting the location of their wells. And we are helping them integrate rock physics and geological understanding of the reservoir in order to drive better completion techniques and minimize the fracking they are doing.
That business now has grown to a considerable business, and I will give you an example of that, but we have a number of good projects on the go since 2010. And then basin exploration. We really cut our teeth on the GeoVenture side of the house. It was going to the basins in the world that are of interest and shooting long 2D data sets. They gave a good general understand of the overall geology of that basin to oil companies so that they could then further refine their approach and determine whether they wanted to participate in lease rounds, do further 3D exploration activity. So the approach was all about getting a general understanding of the geology of the basin. And we have really developed an offering now that truly is global there.
And then complex geologies. So the GXT side of our business is filled with a lot of very smart people who continue to tackle tough processing challenges and we have really become leaders in processing data, both subsalt and sub basalt. And had quite a bit of success with our offering both in the Gulf of Mexico and now working more and more off the coast of Brazil.
So let me give you an example. I am going to give three examples of the execution of our strategy. This first example is the ResSCAN offering where we have taken our offering by pulling up a complete program together for North American shale plays. We turnkey the seismic services that are offered in these shale plays and then we use our, both the equipment that is unique to us that we develop through the INOVA business. We pull that into the project and we use our processing capability to really optimize the processing techniques and in the end create a very usable data set for all companies to make good solid decisions as they are attempting to produce on these wells.
And that’s so relevant today. We have got such pressure on the commodity price. The more that we can help them with effective production, the more successful they are. So it speaks well to embracing seismic. Today this program which was launched in 2010, is quite broad. We have three significant projects with over 600 square kilometers under production as we speak.
Another example is the work that we are doing off the coast of Tanzania. We have not only gone in in this area of East Africa, where there is eight or nine blocks that are coming up for lease around, we have gone in and advance and we have shot four different SPAN programs to create a robust data set. We have also gone and completed a refraction study. We integrate that data and offer it to oil companies and we worked very closely with the Tanzanian government so that we are managing our leasing round. So not only are we managing the leasing round but we have a data offering for oil companies who want to participate to make the best decision on which blocks they may be interested in.
And a last example of our Arctic strategy is really pulling together the horsepower of the entire business in order to not only develop the equipment that’s necessary to shoot 2D seismic, near ice and under ice, but also developing the processing capability to eliminate the noise that’s created by the ice cap and modifying our command and control systems so that we can optimally control the equipment as it’s moving under ice conditions. And as a result of that, we have really developed a successful arctic program and have quite a robust library in that area too.
It’s our intention as we continue to invest in this business, to not only take our 2D offering to a broader areas of the arctic, but also to expand it and create the ability to shoot 3D in near ice conditions as well. This has turned out to be quite a significant business for us. At this point in time we have sold over $260 million worth of programs.
So with that I would like to talk a little bit about just some of the highlights of 2012 and how they are relevant to some of our businesses. The GeoVentures business has quite frankly just had a very solid year. And I think if you look at this map which you see, the bubbles on this map are really active projects that we have been selling. We have put together a turnkey this year and the size of the bubble really represents the size of the project. Now what's really interesting when I look at this, is we used to be very regionally concentrated, as business has matured so nicely that you can see that we are in a lot of different places for shooting active projects this year alone. Of note is Greenland, a couple of different areas in North American shales, we are off the coast of Brazil. We have got projects going on both the east and west coasts of Africa. We are shooting off of Australia.
So we have a very robust offering. It truly is global in footprint. And every year that we invest in this business, we tend to invest more and more. And as a result the data library that we tend to build is increasingly more robust.
The data processing business has healed nicely since the events of Macondo. If I went back and took a look at that business pre-Macondo, we had about two-thirds of our business concentrated on the Gulf of Mexico. We deliberately set out to expand that business internationally a few years ago and really put some horsepower behind it with the events of Macondo. Because it dropped off the revenue activity in that business fairly dramatically. As a result today we truly have a footprint that is very international and by the end of the year we would expect about 75% of our mix of revenues to be international, and 25% in the Gulf of Mexico. And that even contemplates the Gulf of Mexico coming back. The Gulf of Mexico is coming back. We are seeing activity levels and project work increase.
So overall that business is improving nicely. It’s had five sequential quarterly improvements. It’s back to as strong a level as it’s ever been historically and it really feels like it’s positioned nicely to grow. We are back to flying an airplane with all seats filled. And our struggles today are more now, how do we continue to expand our computing infrastructure and how do we continue to recruit in good quality geophysicists to help growth that business.
In addition we have launched at the EAGE, which is a trade show in June in Europe, we launched our broadband solutions which is called WiBand. It’s being very well received. Really, it’s all about trying to eliminate the noise that is created by the reflection of the sound source of the water column. And most of the large contractors out there today have developed their broadband solution of one sort or another, whether it’s WesternGeco or CGG or PGS.
What's unique about our ours is that it really applies to data that’s being acquired by flat streamer production. And what I mean by that is you don’t need to have novel technology, you don’t need to have novel equipment or a novel acquisition technique in order to execute a broadband strategy. We can take existing data sets and we are doing it through processing methodology and we can pretty much have the same outcome. So we are pretty excited about that, it’s being received very well. We are already working on over 20 projects around the globe for oil companies with this.
And then marine seismic. That business has been a little bit difficult this year. The contractor community has been under a lot of pressure for day rates and they have really been chasing the capacity game. It is tightening. It looks like a lot of the vessel capacity has been taken up for the third quarter and pretty much most of the fourth quarter as I understand it. Looks like day rates as well are raising and it looks we are seeing as much as 15% increase in day rates for Q4 work. That’s a positive. The negative for our business has been that they have really been operating under shoestring budgets and have been capital constrained through 2012.
So the marine side, the equipment side of our business has really not had its best year. When we look at the increased activity though and the increase in day rates, we would expect that that would translate into repair and replacement revenues as we move into first part of next year. So we are optimistic that the business will come back. What we are really excited about with this business is looking out what's happening in the seabed side of the house.
The seabed market, and I have got his graphic or the picture here, the seabed market has really exploded over the years. We look at it back in 2006 it was north of $200 million of revenue. Today that business is a $1 billion business. And if I look at the capacity out there, there is really a limited number of crews that are out in the world that can shoot the seabed data. But at this point, over the last three or four years, the quality of that data has really proved itself to be significantly superior to towed streamer data to the oil companies. So there is an increase in activity for fairly large surveys that are on the drawing boards for both ’13 and ’14.
The problem is that these crews are all tied up now. And so we are seeing capacity pretty much being wrapped up through ’13 and some crews into ’14. And there is still a number of significant projects on the drawing board that are either out or coming out for tender. So we see this as a really great time for expansion of crew capacity in seabed, and it just happens to also coincide with the launch of our next generation seabed system called Calypso, which we rolled out in June at the EAGE. And once again it was received very well by both the oil companies and contractors. So we are pretty excited about that side of our business. We expect that this will translate into at least one or two systems sales over the next 12 months.
And then to talk a little bit about INOVA. INOVA Geophysical, the joint venture that we have with BGP. If I really step back and took a look at where that business has come from and where it is today, the land equipment market was hit very hard at the end of 2008 and really hadn’t recovered. There was quite a bit of crew consolidation that occurred in the industry through 2009 through 2011. There was quite a bit of excess equipment out there. And it took quite a little while to work through that. And also crews really struggle with day rates and profitability. So there wasn’t a lot of extra money floating around to purchase equipment.
So the INOVA business really focused its activities on R&D and developing the next generation of a series of products. And quite frankly successfully launched the majority of those products towards the end of ’11 or the first half of 2012. And they include both a cable less system called Hawk, a new cabled system which is a high channel count system really targeting very efficient operations in the Middle East, called G3i. And a small footprint source vehicle, a vibrator called UniVib. They have all been rolled out and the first half of 2012 has been represented as commercial success for these systems. We are starting to get some traction.
So we have got about 25,000 channels of G3i out there, and sold the first large Hawk system as well in the second quarter of the year. So it feels like they are starting to see some commercial success. Revenues and profitability are turning in that business. First half is about a $100 million business and actually in the black at $5 million to $6 million, which is a considerable turnaround from 2011 where they lost $35 million to $40 million for the year. So business is healing, positioned very well with its new product offerings.
And so with that I would like to just give a quick snapshot on the financial performance to give just a very high level feel for how the company is doing this year. Generally speaking, our revenues are up 20% over the prior year. What's exciting to me is we are getting margin expansion. We are getting a little bit leverage with our offerings out there, full 4 points, from 36% to 40% for the first half of the year compared to the first half of last year. Also as we stated in our outlook call at the end of 2011 we had an objective of trying to smooth out earnings a little better from the first half of the year to the second half of the year with a goal of 25% of earning in the first half. And we are quite comfortable we accomplished that. We have actually delivered $0.13 in the first half of the year as compared to, if you turn back the clock to 2011, it was really a fourth quarter story. In 2011 we only put $0.02 on the board for the first half of the year.
So that really is a reflection of the activities in our business. The fact that we are doing more work on land than in marine that we have an offering now that we can do 12 months in a year versus very heavily focused in the summer seasons. So all in all we are very pleased with the first half of 2012.
So now just to sum up. The industry certainly remains robust, activity levels are high. I think everybody tends to look over their shoulder a little bit with some of the economic and political issues that are going on in the world. But overall, certainly the first half of the year has been characterized by, I would say us working just about as hard as we could to keep up with the activity.
International activity is very strong. We are feeling pretty good about our first half but we do expect that they will have solid year-over-year growth for 2012 in total. We also continue to expect to spend $130 million to $150 million in our multi-client business this year. Well on track with that. Our guys seem to have more good ideas than we are going to give them capital for. And then we remain positive on our outlook to achieve the year-over-year quarterly improvement for the balance of the year.
With that we have a few minutes, if anybody has any questions?
I will kick it off real quick. Brian, Schlumberger recently introduced a new streamer technology, this IsoMetrix family of technologies. And it’s made quite a stir in the seismic industry. Given that they traditionally don’t sell marine products to their competition, I would think that this would set you up pretty nicely to see some type of increase in activity in the marine side, just based on one of their new technology introduction. I wonder if you could address that.
Yeah, absolutely. There has really only been a couple of significant changes in marine technology in the last 20 years. And this truly is what I would consider the next significant change in technology. They are coming up with a four component offering that is absolutely very interesting. So I think that Schlumberger is certainly leading the field here. I think they are really driving technological differentiation. They are making their competition very nervous. We obviously are very much a technology company that develops competing product for their competition to use. And if you think about where our skill sets are, we are experts in the development of sensor technology. The four component streamer truly is the evolution of sensor technology in it. It’s also about processing capability and understanding new information that you are acquiring and how to process that to get a better image and once again our skill set is very much in that area.
So I think your point is pretty much on home there. We are definitely and have had a very active R&D program about coming out with the next generation offering for marine towed streamer. And we are the guys in the industry who typically come up with a solution to compete with Schlumberger.
So how do you determine where you are going to put your capital? I know mentioned you probably have more ideas than you are going to give capital. So how do you prioritize that and how do you determine what to invest in?
Well there’s two ways that we allocate capital. One is, we are allocating capital to new venture programs which are multi-client type programs. And the second thing that we do is, and separately from that is we allocate capital into R&D projects that are setting up for the next offering. And really in my mind we segregate the two. And the reason I say we segregate the two is that we have an almost a base level of capital in the business that we need to constantly reinvest into R&D. We typically try and do that in the range of 6% to 7% of revenue. So that pool that has developed that 6% to 7% revenue pool, we will take that out and then we have a fairly rigorous process called a product development and commercialization process where we go through when we have ideas. And we really evaluate what is the market potential for this idea. So understanding the opportunity, understanding the complexity of what we are trying to take on and the capital that would be required. And we benchmark those against each other.
And so the best ideas are the ones that we are going to deploy capital in. And then we will embark down the road of our R&D and it’s staged. So they have to go through certain gates to continue to get funding in order to developing the offerings. So that would be an approach that we would use if we are developing a next generation streamer or a next generation sensor that could be used abroad across seismic. In the case of our new ventures business, it really comes down to evaluating the program itself, the uniqueness of the program, how novel the offering is, in order for us to determine if we are going to take any risk at all.
And then if we are going to take risk, how much? Is it 10% or 15% or 20% of the project. And then the other real true test is how much money that your company is going to put up in advance. So we want to see their checkbooks. And if they pull out the checkbooks and underwrite those projects, we will typically look at them and if we like the risk profile and then sort of the novelty of the project, we will put some capital into it. And we have a very limited bucket that we define every year of how much capital that we are going to allocate in that direction.
Let me give you an example of one where we take risk. If you are looking at -- we have taken some risk off Greenland. So we have shot a number of projects of Greenland including a gravity gradiometry study recently. And that really was, if you think about the challenge of the oil companies up in Greenland and the upcoming license round in ’12 and ’13, their problem is access to data. And there really is no true 3D data set up there because of the ice conditions. But we have been able to use our technology to go out and shoot some 2D data sets. So we shoot these broad lines. And then we have shot 35,000 square kilometers of gravity gradiometry data over that.
Now we are going to integrate that data in order to give a data set that really by de fact is a good proxy for a 3D data set for an oil company to look at and get an understanding of that geology part of the lease round. That is an example of really trying to deliver a solution to a problem that’s a real problem that someone is struggling with. And as a result we will take more risk. We will put some of our capital in there because we are going to get a much better return on that. An area where we would not, for example, if I now went to the exact extreme, would be if we are down shooting a 2D project in the Gulf of Mexico, because we are not differentiated. Everybody is in the gulf, shooting. So if oil companies want us to do a project there, we are going to look for underwriting.
So, Brian, in addition to the change that Schlumberger has caused in the market, there is also just some pretty significant pricing power for seismic right now. You mentioned 30% increase in to the fourth quarter in pricing, I think so far this year we have seen already 20% maybe 2Q and 3Q. That’s going to lead to newbuild at some point. The newbuild market has been slow so far, but we all know it’s going to happen. Are you getting more increase at this point? Is there more activity, more conversations about [central] newbuilds?
We are not getting increase right now but we are not -- we are a little bit later in the cycle for newbuilds. We are seeing activity increase around it by company. But here’s I think what's going on. At this point in time there is a real unknown whether this offering that WesternGeco is coming out with is going to completely change the way that towed streamer are going to be done. So if it will do what they claim it will do, and it could very well do it, they are going to be able to eliminate this concept of having a huge ramp for them. So if you are PGS and you are also developing these huge vessels, the massive streamer capability, the maybe an obsolete model. You may not need to develop these $250 million or $300 million vessels when you can get away with the $175 million vessel and a smaller streamer count.
So I think there is a little bit of that uncertainty going on. I think obviously WesternGeco has committed capital to building vessels for their new offering. At this point in time capacity is tightening and I think we are, if you segregate the market and look at PGS, CGG and WesternGeco and how they really dominate the majority of the market and then go down a tier and look at who is playing in that tier. You have Fugro, Polarcus, and then and you have got smaller I guess really fragmented with COSL and BGP and stuff. And the reality is Fugro is on the market and without understanding what's going to happen to Fugro, they could be acquired versus building out extra vessels. On Polarcus, until they get some kind of a differentiated offering I can't see them adding more capacity. They need technology to compete.
You talked about ocean bottom for a couple of quarters now. We have been waiting for a sale. What was the delay in that marketing unit sale to come through?
It’s a long cycle and I think -- if you think about ocean bottom, it’s not like you are an operator in the F-10 vessels and you are going to add an 11. You may have on crew, you may have no crews. And so you are talking about making a significant investment to getting into something new to you. And so if I look at who has got crews out there today, you know you have got WesternGeco has a crew, and RXT has a crew. So there is smaller operators really doing a one or two crew type application. And then you have a number of people in the industry who are looking at, they are going that’s interesting space to get into but I am not going to allocate capital to get into it until I see that there is a serious amount of backlog or work for me to do. So I think the trigger, James, is going to be when they bid on these large surveys and they are able to secure survey that gives them a year or year and half worth of work, that are $150 million project awards. That’s when they will say okay, it’s time to get in to queue and get the crew ramped up and dedicate $50 million or $70 million of capital to do it.
Final questions for Brian? Okay, Brian will be available for the breakout session in Liberty 1 and 2. Thanks, Brian.
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