Geokenetics, Inc. Q2 2008 Earnings Call Transcript

Geokenetics, Inc. (GOK)

Q2 2008 Earnings Call

August 7, 2008 11:00 am ET

Executives

Richard F. Miles - President, Chief Executive Officer and Director

Scott A. McCurdy - Chief Financial Officer and Vice President

Analysts

Pierre Conner - Capital One Southcoast, Inc.

[Louisa Herman] - Dahlman Rose & Co.

[Ken Frasolus - Oberice Management]

[Christopher Bootsic] - Raymond James

Presentation

Operator

Welcome to the Geokenetics second quarter 2008 earnings and operations conference call. (Operator Instructions) I will now turn the call over to Scott McCurdy, the company’s Vice President and Chief Financial Officer.

Scott A. McCurdy

In accordance with the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995 Geokenetics, Inc. cautions that statements made today in this conference call which are forward looking and which provide other than historical information involve risks and uncertainties that may materially affect the company’s actual results of operations. All statements other than statements of historical fact made during this conference call that address activities, events or developments that Geokenetics expects, believes or anticipates will or may occur in the future are forward-looking statements.

These statements include but are not limited to statements about the business outlook for the year, backlog and bid activity discussed during this conference call, related financial performance, and statements with respect to future benefits. These statements are based on certain assumptions made by Geokenetics based on management’s experience and perception of historical trends, current conditions, anticipated future developments, and other factors believed to be appropriate.

Such statements are subject to a number of assumptions, risks and uncertainties many of which are beyond the control of Geokenetics which may cause actual results to differ materially from those implied or expressed by the forward-looking statements. These include risks relating to financial performance and results, job delays, impact from severe weather conditions, and other important factors that could cause actual results to differ materially from those projected or backlog not to be completed as described during this conference call or in the company’s press releases or reports filed with the Securities and Exchange Commission.

Backlog consists of written orders and estimates of Geokenetics services which it believes to be firm; however, in many instances the contracts are cancellable by customers so Geokenetics may never realize some or all of its backlog which may lead to lower-than-expected financial performance. A discussion of these and other factors including risks and uncertainties as set forth in the company’s Form 10-K for the year ended December 31, 2007 and the company’s Form 10-Q for the three and six months ended June 30, 2008.

Any forward-looking statements speak only as of the date on which such statement is made and Geokenetics undertakes no obligation to correct or update any forward-looking statement whether as a result of new information, future events or otherwise. During this conference call, Geokenetics will make references to EBITDA which is a non-GAAP financial measure. A definition and reconciliation of this non-GAAP measure to the applicable GAAP measure can be found in Geokenetics’ current earnings release, a copy of which is located on our website www.geokenetics.com.

I would now like to turn the call over to Dick Miles, the company’s President and Chief Executive Officer.

Richard F. Miles

This morning I will begin by briefly recapping our second quarter, provide an outlook on third quarter activity, and highlight some of our growth opportunities for the remainder of 2008. I will then answer questions following our presentation of financial results and discussion of operating activities. I would also like to remind everyone at this time that we will not be giving guidance.

I mentioned in our last call that I was convinced Geokenetics was well positioned for strong growth in 2008. We began to see evidence of this in the first quarter, and I believe this has continued into the second quarter despite it being our seasonally low quarter.

Highlights for the quarter include: Total revenues in the second quarter increased to $113.6 million, a 59% increase over last year’s second quarter. In Canada we experienced the seasonal thaw and of our five crews, one worked part of the quarter and approximately two crews of equipment were mobilized to international operations. In the United States we operated eight crews in Central Texas, Oklahoma, Arkansas and the Texas-Louisiana Gulf Coast region. We also saw an increase in the amount of work being performed under term contracts. In Latin America we operated between four to six crews each month primarily in Colombia, Brazil and Bolivia. In the Eastern Hemisphere we operated between three to four crews each month in five different countries. During the quarter our new transition zone crew initiated operations in Australia before moving to New Zealand, and we also mobilized a crew into Mozambique. We commenced crew start-ups in Angola, Malaysia and Suriname during the quarter and with two of these being in the transition zone environment, it will bring our total crew count of shallow water crews, transition zone and OBC to five during the fourth quarter of this year.

We continue to show improved results in our data processing division, the result of our commitment to being a leading provider of high-end data processing and interpretation services. Demand from E&P companies for better subsurface images in frontier and harsh environments is strong and our order book continues to grow. Our backlog at June 30, 2008 was $430 million up from $321 million at June 30, 2007 and only slightly down from $470 million at March 31 this year. Approximately 66% of our backlog is related to international business excluding Canada, demonstrating increasing demand and strong market acceptance of our crews operating outside North America. We are seeing increased market penetration into fast-growing international markets with our transition zone and OBC crews. The international market place offers substantial growth opportunities that will continue to support our growth.

We have continued to upgrade and expand our data acquisition capability by investing $25 million during the second quarter to increase channel count in our shallow water capabilities primarily in international operations. As of June 30, 2008 we had a total channel count of 121,000 an increase of 13,000 channels or 12% from year-end 2007. Increased channels expand our footprint and improve our job productivity ultimately increasing profitability. I will go into greater detail later on how these factors and others further position Geokenetics for continued improvements in market share, revenues and profitability in the quarters ahead.

First, however I would like to turn the call back to Scott McCurdy, our Chief Financial Officer, who will recap our second quarter and first half 2008 financial results.

Scott A. McCurdy

I will first address the second quarter and then cover the six months ended June 30, 2008. Today we reported revenues of $113.6 million for the second quarter ended June 30, 2008, a 59% increase over the $71.6 million for the same quarter last year. For the three months ended June 30, 2008 revenue consisted of $44.1 million from North America data acquisition, $66.4 million from international data acquisition, and $3.1 million from data processing. The increase in revenues is attributable to higher activity levels in each of our segments primarily driven by North American and international data acquisition as a result of improved weather, crew upgrades in the US and international expansion effort.

Direct operating costs of $91.6 million consisted of $33.8 million from North American data acquisition, $55.5 million from international data acquisition, and $2.3 million from data processing resulting in gross margins which exclude SG&A and non-cash depreciation charges of 23% for North America data acquisition, 16% for international data acquisition, and 26% for data processing. Overall gross margins increased significantly to 19% in the second quarter of 2008 compared to 10% in the same quarter last year.

EBITDA for the second quarter ended June 30, 2008 was $12.4 million which was up significantly from the $1.0 million we reported in the second quarter last year. EIBTDA was up over last year in data processing as well as North America and international data acquisition due to higher activity levels and the impact of US crew upgrades and increases in channel capacity.

For the second quarter ending June 30, 2008 we reported a net loss of $1.8 million or $0.18 per diluted share compared to $15.5 million or $1.95 per diluted share for the same quarter last year. The reduction in the net loss was a result of increased activity levels and the fact that the 2007 quarter included a one-time $6.9 million loss on the redemption of our floating rate notes.

Moving on to the six months ended June 30, 2008 today we reported revenues of $233.7 million for the first half of 08, a 28% increase over the $182.6 million for the same period last year. For the six months ended June 30, 2008 revenue consisted of $105.8 million from North America data acquisition, $121.9 million from international data acquisition, and $6 million from data processing. Again, the increase in revenues was attributable to higher activity levels in each of our segments primarily driven by North America and international data acquisition as a result of improved weather and crew upgrades in the US and our international expansion efforts.

Direct operating costs of $184 million consisted of $80.9 million from North America data acquisition, $98.5 million from international data acquisition, and $4.6 million from data processing resulting in gross margins which exclude non-cash depreciation charges and G&A of 21% overall, 24% for North America data acquisition, 19% for international data acquisition, and 23% for data processing.

EBITDA for the six months ended June 30, 2008 was $30.9 million, up from the $19.6 million we reported in the first half last year. EBITDA was up over last year in all segments due to a strong Canadian winter, increased US demand and the impact of our crew upgrade, improved contract terms, and increasing international activity levels.

For the six months ended June 30, 2008 we reported income to common stockholders of $0.7 million or $0.07 per diluted share compared to a loss to common stockholders of $10.3 million or $1.53 per diluted share for the same period last year. Net income was up due to improved performance as well as the fact that the 2007 period included a $6.9 million one-time charge for the redemption of our floating rate notes.

Capital expenditures for the second quarter were $25 million bringing our year-to-date investments to $50.7 million. Total debt including our revolving credit line and capital lease obligations at June 30, 2008 was approximately $103.3 million, up sequentially from $92 million as of March 31, 2008. At June 30, 2008 our debt made up 34.5% of total capital, up from 31.9% the previous quarter. The sequential increase in debt is primarily a result of investments made in the second quarter to increase and upgrade revenue generating capacity.

Subsequent to quarter end on July 28, 2008 we closed on the sale of 120,000 shares of our Series B convertible preferred stock and 240,000 warrants for a gross purchase price of $30 million. This transaction immediately delevers our balance sheet and we expect to use these proceeds to fund the remainder of our capital expenditure plan for 2008 and working capital needs.

I will now return the call to Dick.

Richard F. Miles

We continue to be optimistic about our growth prospects in 2008. While we did experience typical seasonal decline in Canadian activity with the completion of the winter season early in the quarter, our strong performance in US and international operations significantly offset the negative seasonal impact of Canada.

Canadian idle costs were reduced by better planning to redeploy equipment from Canada to international markets. We expect to operate one crew for approximately one month of the third quarter in Canada.

In the US we plan to operate all eight crews during the third quarter and we expect strong utilization for the rest of the quarter and the year barring any unexpected severe weather conditions. One of these crews is currently performing a survey in Colorado utilizing the new ion FireFly system that is being provided by the client. This allows us to experience firsthand in a real job environment the benefits and differences of operating one of the next generation four-way wireless systems.

International demand for our services is high. We currently have crews operating in or mobilizing to nine countries and have begun mobilizing for a large land project in Angola expected to commence in the fourth quarter of this year.

Our data processing segment continues to improve, and I am very pleased with their performance in both the first and second quarters of this year. They have just recently won a large $2 million project, the largest contract they have secured in many years. Our data processing segment is making great inroads with both existing acquisition clients and new clients as well. Now that we have returned this segment to profitability we remain committed to growing and improving this critical part of our business.

We continue to invest in new equipment and increase our channel count. During the first half of 2008 we increased our channel count to 121,000 channels, up 12% from year-end 07. Our capital investments will provide additional revenue-generating capacity and greater operational efficiency in the field which we expect to improve margins over the long term.

Through the second quarter we have invested over 63% of our planned $80 million capital budget for 2008. We expect the bulk of our remaining investments will be targeted to international markets for strengthening our competitive advantage in the high value niche of transition zone and shallow water data acquisition. Our global footprint enables us to redeploy cash flow generated from our strong US land acquisition operations into faster-growing international opportunities.

Our order book remains near record levels. At quarter end our backlog totaled $430 million, 29% higher than the $321 million recorded at the end of the second quarter 2007 but slightly down from our quarterly record of $470 million at the end of March 2008. Overall, despite seeing some decrease in our US backlog due to increased pricing pressure for projects during the second quarter and our efforts to move toward term contracts and reduce third party costs, we are very confident with our backlog level, the quality and expected profitability of opportunities in it, and believe this provides great visibility into future quarters.

The demand for seismic services in the US is still strong. The issues the industry faces remain unchanged with permitting delays and weather heading the list. As a rule of thumb, anywhere from four to six months is required from job award to commencement of operation and in certain areas particularly where dynamite is the source even longer can be required to fully permit the area for a timely operation. Given that our backlog was on average in excess of one year for each of our eight crews in the US at the end of the first quarter and since several of our competitors were in the critical four to six month backlog range, there was some pressure for them to reduce prices that we did not experience. During this time we also took the opportunity to renegotiate some of our existing contracts and shift third party survey drilling and permitting to our customers which has further reduced our revenue backlog but more importantly, lessened our risk and should increase our expected margin.

Today we are operating five of our eight domestic crews on term jobs with commitments of continuing four of them on term at least until year end. In addition we had two projects canceled in Australia that were scheduled to take place in the third and fourth quarters of this year. We are entering the whale migration season in Australia and had planned for significant down-time in the third quarter, which would have either resulted in us moving the crew temporarily or being idle for part of the quarter. With these cancellations we are now planning on moving the crew to Angola for a large project that is expected to last in excess of nine months and should commence at the end of this quarter. We had previously expected to start this project towards the end of this year or early next year.

The opportunities we are working on internationally continue to increase in size. This fact along with our already secure backlog makes us very optimistic for 2009 and we fully expect to be awarded new job orders in the coming months that should continue to keep our international backlog at near record levels for some time to come.

The long-term business fundamentals for our seismic data acquisition and processing services remains robust as exploration and production companies continue to look to replace their production with meaningful finds. As oil and gas companies increasingly take their search for larger oil and gas reserves into increasingly difficult to operate environments, our expertise operating in frontier and environmentally sensitive areas, transition zone and shallow water gives us a competitive advantage. Our international experience and customer acceptance working in countries outside of North America exposes us to significant growth opportunities not available to other companies. Our strong base of business in the United States’ land seismic market provides good cash flows for reinvesting into fast-growing transition zone OBC opportunities outside North America.

We continue to maintain a strong balance sheet to support our growth strategy. We believe we have sufficient cash on hand, cash flow and borrowing capacity to fund our capital investment plans. Today we have the people, the equipment and the financial capacity to fulfill our rising order book. I’d like to thank our employees for their continued commitment to safety, quality and support of our growth plans and customers for their continued faith in our abilities and our shareholders for their continued support.

That’s the end of our prepared remarks.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Pierre Conner - Capital One Southcoast, Inc.

Pierre Conner - Capital One Southcoast, Inc.

First on North America, given your outlook for the quarter compared to what you just accomplished, are we thinking that North America revenue numbers will be fairly flat quarter-to-quarter? In other words, it looked like you at 8.5 crews running in the second quarter and is that essentially where you’re guiding us or is there some other revenue growth potential sequential in there?

Richard F. Miles

No, we’re not guiding you. I think North America is pretty strong. We’ve got that strong order book. We’ve got the same eight crews pretty much doing the same thing. We’re very pleased that we’ve got four of them on term which basically eliminates all of the risk from us and the other four should keep going. The storm that just blew through affected one crew just very slightly so we’re pretty much on track.

Pierre Conner - Capital One Southcoast, Inc.

That’s US. If I understand right, you did have as many as five crews in Canada and now down to one crew. Is that where you expect to be longer term and you’ve completely redistributed that equipment or is this only temporarily? I’m not sure I understand what your plan is there?

Richard F. Miles

The busy time is in the winter season which sort of starts towards the end of December and if it’s a really good cold season, lasts until the middle of April. The plan is to get back to the five crews that we had operating in the first quarter of this year; hopefully have five crews operating in the first quarter of next year. We’re already getting good indications there’s a lot of interest particularly with our multi-component systems that we operate up there. So it will be back to where we were before I would think.

Pierre Conner - Capital One Southcoast, Inc.

I didn’t understand if you were actually leaving that market in some degree. Moving over to internationally, again adding up what you indicated you were able to accomplish during the quarter and what you are expecting, it looks to me that’s some 20% more sort of crew days with what’s planned to be working. Is that the magnitude if I go through the paragraph and add up what you’ve indicated?

Richard F. Miles

Well, there are some slowdowns and end of some jobs and start-up of other jobs so it’s all, as we’ve gone through many times before, it’s all a matter of timing with the international crews. My reference to the jobs getting bigger is still happening and that’s still a very positive thing because the utilization will be up. It’s the utilization of all of those crews which will probably be better in the third quarter than the second quarter but by how much at this point in time it’s hard to tell. We’ve got a couple of crews getting started in tough areas that I expect will end up starting in the fourth quarter.

Pierre Conner - Capital One Southcoast, Inc.

Back to US, to understand the perspective on the pricing competition a little more. I guess this has to do with the long term, short term nature because it isn’t necessarily what we’d heard from competitors that are working larger 3D jobs. If you could explain, is this the shorter term, smaller channel count in-fill jobs where there was competition to keep crews busy but yet backlogged longer or are there getting to be more channels and crews in the US than there is demand?

Richard F. Miles

No, the demand is still strong and I expect the demand to continue. In our particular case, as I said, we had if you look to that backlog, we had a year’s worth of backlog and then if you look to our margins and our results, we were not doing as well as some of our competitors which would lead you to believe that maybe our pricing was a little bit on the low side. We didn’t change much. We may have increased our pricing a little bit. The number of jobs coming in was pretty much the same. Some of the jobs that we had bid on previously with some of our customers that we expected to get, we were advised by our customers that there were a lot lower prices than ours and they were taking those, which is fine. Our backlog is still very strong. We’ve got enough backlog to keep our eight crews busy for probably the next nine months.

Pierre Conner - Capital One Southcoast, Inc.

Maybe I understand it better then. So it’s not an issue of the industry was discounting harder for those jobs; you just basically increased your prices.

Richard F. Miles

Yes. I think they were offering a temporary discount to fill out their backlog because some of them were getting a little bit on the low side. But there are a lot of opportunities. All of these shale plays that are coming out particularly on the East Coast, we see a lot of work and we’re seeing a lot of bids. So I don’t want to tell anyone that the bids are not coming because there are a lot of bids out there.

Operator

Our next question comes from [Louisa Herman] - Dahlman Rose & Co.

[Louisa Herman] - Dahlman Rose & Co.

With regard to the crew in Australia, the two jobs that were canceled for the third and fourth quarter, I just want to confirm that these are going to be pushed into 09 and not just completely canceled.

Richard F. Miles

Those are still under discussion. We got into some pretty severe weather conditions. The whales migration actually whoever is in charge of conserving whales has done a good job because the amount of whale traffic has increased dramatically and our contract had us covered for that, so we didn’t suffer that but we were not being as efficient as the client would like. We had planned to be down for part of that period anyway but it’s come on us early. We’ll be leaving there to go to Angola because we have a tremendous opportunity in Angola. And we’re still in discussions about how to address the work in Australia for next year. We did purchase some more ocean bottom cable channels to allow us to split that crew into two. We’ve got several opportunities in the Far East and Australia, and once we figure out which of those we’re going to address we’ll be able to address the Australia problem. But the amount of work that’s there, I expect we’ll be back during 2009.

[Louisa Herman] - Dahlman Rose & Co.

So this was an OBC crew?

Richard F. Miles

Yes.

[Louisa Herman] - Dahlman Rose & Co.

Can you just give us a little color on the type of demand that you’re seeing for this type of OBC crew? I know you just said you split into two so that seems like there is a lot of demand for it.

Richard F. Miles

We haven’t actually split into two yet. That was our plan but with the problems we were having in Australia, we’ve moved it to Angola. But we have a list of opportunities that we see that could keep three to four of these types of crews busy. They’re not all coming to fruition at the same time. Some of these have been bid and we’re waiting on award from the oil companies. So we’ll have a much better view on what we plan to do in 2009 with ocean bottom cable in particular by our next conference call. We’ll have hopefully been awarded some more jobs and will be figuring out how to address that.

[Louisa Herman] - Dahlman Rose & Co.

With the increase in channel counts, can you just tell us are you going to be just distributing these specific crews internationally or are you going to maybe increase the number of your crews that are out there?

Richard F. Miles

They go where they’re needed. Internationally every job we bid is custom fit to the requirements. We’re currently on a job in Bolivia that has 12,500 channels on it and we have a crew in New Zealand with 1,000 channels on it. So every job is different and managing the channels, particularly the electronics and moving them around efficiently in and out of countries some of which are more difficult to export than import and some which are more difficult to import than export, so that is where we lose our utilization and we end up with lower margins than we would like. What we’re seeing still in the international arena is more and more jobs in the same area in the same country and much larger jobs in the same country. So we still believe we have quite a way to go to improve our utilization but we have the opportunity to improve the utilization which will improve our results going forward.

Operator

Our next question comes from [Ken Frasolus - Oberice Management].

[Ken Frasolus - Oberice Management]

A question quickly regarding backlog. Last quarter you said that the backlog excluded a $59 million Argentinean contract that had been delayed. So two questions. Number one, does backlog still exclude that contract? And number two, if so, what is the status of that contract?

Richard F. Miles

We define backlog as assigned contracts or a written letter of intent that we have been awarded that work. That we took out because we were not making any progress in the negotiations, and that is still the case. That is not in our current backlog. In the client’s mind he has not awarded that job to anyone else but they still haven’t got all their permits in place, so we have determined that that’s probably not going to happen any time soon.

[Ken Frasolus - Oberice Management]

How much of that is related to the strikes and everything occurring down there?

Richard F. Miles

Well, I’m sure that’s a lot of it. That is a job that we actually won over a year ago with year ago pricing, so even if he got all of his permits in order and said, “Okay, I’ve got my license. I’ve got my permits,” we would then have to renegotiate the price because they have pretty healthy inflation in that part of the world.

Operator

Our next question comes from Pierre Conner - Capital One Southcoast, Inc.

Pierre Conner - Capital One Southcoast, Inc.

If you’d want to give us some comments on the FireFly system, tell us where you are in terms of laying out that system? How do you feel about the margins you’re able to get with that job? Is it cutting down on labor such that you can be more efficient?

Richard F. Miles

I was expecting a question like that Pierre.

Pierre Conner - Capital One Southcoast, Inc.

I didn’t want to disappoint you.

Richard F. Miles

Well thank you. The equipment is supplied to us by the client and we’re there on a term job for them. So it’s almost like getting a free look and a practice run at it. The guys in the field are very excited by the potential of the system. It’s a lot lighter than they’re used to so that’s good. But it’s too early to draw any conclusions from that. One of our concerns is if you get into a position where you want to buy a system like that and you’ve got to bid it competitively against some of the older systems, you’ve got to understand everything that it does and how it actually works. So it’s a great learning experience for us that we’re getting paid for.

Pierre Conner - Capital One Southcoast, Inc.

So at this point you’re not able to really garner any of the potential benefits associated with having this cable system? It’s more of a practice run and compare this system maybe with others as well.

Richard F. Miles

Yes. And I’m actually going to visit the crew the end of next week so if you run into me at the SEG, I’ll be an expert on it by then.

Pierre Conner - Capital One Southcoast, Inc.

We’ll look forward to that absolutely.

Operator

Our next question comes from [Christopher Bootsic] - Raymond James.

[Christopher Bootsic] - Raymond James

The press release seemed to suggest that good weather played a part in the quarter. I was wondering if it was substantially better weather than normal, slightly better. What sort of impact did the good weather have on margins?

Richard F. Miles

Really the good weather was normal weather. We were comparing it to the second quarter of last year that had awful weather. Last year 23% of the quarter we were down for weather and we build into our numbers somewhere in the range of 5% to 6% down for weather which is about what we had. It was basically what we expected.

[Christopher Bootsic] - Raymond James

Understanding your focus on improving efficiency and the increasing channel count these past few quarters and given that margins are already in the low 20s, could we see further margin expansion in the second half say maybe to the mid-20 range?

Richard F. Miles

In the US we’re going to hold what we’ve got because we’re on term work which again we like because it takes the risk out of it. Internationally the margin is more affected by utilization of crews and we still have some crew movement which will affect the margins in a negative way. Not any worse than the second quarter and hopefully not as bad as the second quarter. All the time we’ve got movement until we really settle down, we will certainly continue to increase our margins I believe but it’s more on utilization than anything else.

Operator

There are no further questions at this time.

Richard F. Miles

Thank you all again for joining us today and your interest in Geokenetics. For those interested, we will be presenting at Enercom’s Oil and Gas Conference next Tuesday, August 12, in Denver, Colorado at 10:30 AM Mountain Time. More information can be found on our website. If you have any additional questions or comments, please feel free to contact either Scott or myself. And we look forward to speaking with you when we announce our third quarter in November. Thank you.

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