Parker Drilling Company (NYSE:PKD)
Q1 2015 Earnings Conference Call
May 6, 2015 11:00 AM ET
Jason Geach – VP, Investor Relations and Corporate Development
Gary Rich – Chairman, President and Chief Executive Officer
Chris Weber – SVP and Chief Financial Officer
Walt Chancellor – Macquarie
Taylor Zurcher – Tudor, Pickering, and Holt
Daniel Burke – Johnson Rice & Company
Good day everyone and welcome to the Parker Drilling’s First Quarter 2015 Earnings Release Conference Call. Today’s call is being recorded. At this time, I would like to turn the call over to you Jason Geach, Vice President of Investor Relations and Corporate Development. Please go ahead.
Thank you, operator. Good morning and thank you for joining the Parker Drilling 2015 first quarter conference call. This is Jason Geach, Vice President of Investor Relations and Corporate Development. Joining me today are Gary Rich, Chairman, President and CEO; and Chris Weber, Senior Vice President and Chief Financial Officer.
In the course of our comments today, we may make statements regarding management’s expectations for the company’s future performance we believe will be informative to our shareholders. These statements are considered forward-looking statements within the meaning of U.S. securities laws. Each forward-looking statement speaks only as of the date of this call, and actual results may differ materially due to various factors we referenced in our public filings and other factors addressed during this call, including changes in market conditions affecting our industry.
We will also refer to non-GAAP financial measures, such as adjusted EBITDA, non-routine items, and operating gross margin excluding depreciation and amortization expense, which we will refer to as gross margin during this call.
Please refer to the table of our recent press release or on the company’s website for a definition of adjusted EBITDA and a reconciliation of this measure to the comparable GAAP measure, and for further information regarding non-routine items. Please take note of this caution about forward-looking statements as we proceed today.
Our next comments are from Gary Rich. Gary?
Thank you, Jason. And thanks everyone for joining us today for this update on Parker Drilling. I’ll start with the review of recent activities. Chris will then discuss the first quarter’s financial results in detail. After that I’ll come back and share our outlook for the business.
First, a few words on the transition in our Investor Relations team. Rich Bajenski, who has led our Investor Relations program for nearly seven years, has told us he’s going to retire. He will be leaving us at the end of this month. Rich has done an outstanding job leading our Investor Relations function, putting his knowledge and experience to use in developing a strong presence for Parker in the investment community. His professionalism and tireless efforts representing Parker are much appreciated. We wish him a safe and enjoyable future.
I’m therefore pleased to introduce the new leader of our Investor Relations program, Jason Geach, who you heard at the beginning of this call. Jason has been with Parker for over seven years and most recently served as the Vice President of Latin America operations. Prior to leading our Latin America business, Jason supported international rental tools, corporate development and operations finance. He has over 17 years of experience in the energy sector encompassing both upstream and downstream segments. Please join me in welcoming Jason to this new role. Welcome, Jason.
I also want to take the opportunity to note the change in our segment reporting structure we announced in April. The new structure aligns our reportable segments with our two core business lines, drilling services and rental tools services, and reflects our current organizational and management structure. Our discussions today will be in line with that structure.
Now here are my thoughts concerning the first quarter performance and recent business activity. While we experienced significant declines in the U.S. markets for rental tools and barge drilling services in this past quarter, we increased our international and Alaska drilling fleet utilization and achieved growth in our international O&M and project management services. In addition, we benefited from cost reductions throughout the business. Also we generated sufficient cash from operations and working capital to allow us to reduce debt by $30 million while preserving a strong cash balance.
We achieved this by maintaining a clear focus on lowering our cost base, sustaining our utilization, managing our cash and liquidity, and preserving our ability to respond when conditions improve. We responded quickly and decisively to the severe downturn in the U.S. drilling activity that began late in the third quarter of 2014. As the downturn in market activity deepened and spread, we continue to make adjustments. Some of the measures we have taken include significant reductions in our workforce, primarily in the affected businesses but across all the areas of the company. On a consolidated basis we’ve reduced our employee headcount by approximately 10% and we expect it to be down approximately 13% by midyear.
We’ve implemented expense and cash flow management initiatives including vendor concessions, a general wage freeze and in select areas wage cuts. We’ve also made changes to our incentive compensation program, focusing individual goals on cost, cash flow and liquidity management. We are prepared to make further changes to address market conditions, as well as to take advantage of opportunities as they occur.
The impact of this down turn has not been uniform across our business, with some geographies and operations being affected more than others. This overall balance is reflected in the results we reported this quarter. In our drilling service business, declines in the drilling in the U.S. Gulf of Mexico inland water market impacted our barge drilling activity while our international and Alaska operations were less affected.
In the U.S. Lower 48 Drilling segment, we’ve experienced a significant reduction in drilling activity in the Gulf of Mexico inland waters. This market reacted quickly to last year’s drop in oil prices, industry utilization remains at low levels and there has been a significant decline in dayrates. While operators have plans to drill, current low oil prices and the uncertainty about future prices have stalled their drilling activity. As outlined in the prior quarter’s earnings conference call, we have responded to the decline in demand with substantial reductions in personnel and operating and overhead expenses.
We reduced our workforce by 70% from its peak in this business. Also we have clustered our idle rigs and are maintaining them with a skeletal crew at low cost, while keeping them fit for an eventual return to service when called upon. We have continued to bring down our idle rig cost. Currently our average monthly cash cost per idle rig is approximately $80,000, down from the $90,000 to $120,000 per month, when we initiated our current approach to fleet management.
In our international and Alaska operations, we’ve benefitted from the start-up of our new two rig extended reach O&M contract in Abu Dhabi late in the fourth quarter, a new procurement management services project and cost reductions.
Our utilization heads up slightly as we continue giving three previously idle rigs ready to go work in the second quarter, one in Colombia, one in Guatemala and one in the Kurdistan region of Iraq. Our Drilling Services business, ended the quarter was a $495 million backlog. In our rental tools business, the continuing decline in U.S. land drilling left to reduce rental demand and continued price compression.
The utilization index for our U.S. rental tools tubular goods fell to $75.00 for the 2015 first quarter, from $94.6 for the prior quarter. In response to this downturn in demand, we have reduced our field workforce and lowered our overhead expense through cost reductions and general concessions. We’ve experienced some weakness in overall revenues in our international rental tools business, primarily due to reduced operator activity in the Kurdistan Region of Iraq in the North Sea.
However, the business produced solid earnings this quarter, as a result of our continued efforts to reduce operating costs. During the quarter, we continue to strengthen our financial position. We generated solid cash flow from operations during the period, allowing us to reduce debt by $30 million is still close a quarter with a strong cash position of a $113 million, up from the $108 million at the year end. In addition we have mended our credit facility in January, upsizing our revolver and extending this maturity, providing increased liquidity and financial flexibility. Overall the business conditions we experienced in the first quarter were in line with what we had prepared or anticipated. As a result of our continued focus on managing cost and cash flow, we remain in sound financial condition.
Chris will now provide additional information about the quarter and then I will turn to offer some thoughts on the outlook for our business and further actions we are taking the response to the declining business conditions. Chris.
Thanks, Gary. For the first quarter, we reported revenues of $204.1 million, adjusted EBITDA of $53.4 million or 26.2% of revenues, and net income of $3.2 million or $0.03 per diluted share.
I will start my review with our drilling services business, where revenues declined 15% to $128 million in the 2015 first quarter from a $150.8 million in the 2014 fourth quarter. Gross margin decreased 1% to $35.5 million from $35.9 million, and gross margin as a percentage of revenues increased to 27.7% from 23.8%.
Revenue for reimbursable expenses decreased $5.4 million, compared with the 2014 fourth quarter. Excluding revenues for reimbursable expenses, drilling services revenues declined 14% and gross margin as a percent of revenues increased to 32.8% from 28.5%. Regarding our drilling services business segments, U.S. lower 48 drilling reported first quarter revenues of $14.1 million, 56% lower than 2014 fourth quarter revenues of $32.1 million.
Gross margin declined to $100,000 from the prior quarter’s $10.8 million. The decline in financial results reflects the impact of the sharp decline in U.S. drilling. During the quarter, operators in the inland waters of the Gulf of Mexico made substantial reductions in drilling activity. Our average fleet utilization declined to 21% for the first quarter from 53% for the preceding quarter and dayrates were lower.
International and Alaska drilling, reported first quarter revenues of $113.9 million, a decrease of 4% from the 2014 fourth quarter’s $118.7 million. Gross margin increased 41% to $35.4 million from the prior quarter’s $25.1 million, and gross margin as a percentage of revenues increased to 31.1% compared with the prior quarter’s 21.2%. Revenues from reimbursable expenses decreased $4.6 million, compared with the fourth quarter. Excluding revenues from reimbursable expenses, segment revenues were unchanged, gross margin increased 41% and gross margin as a percentage of revenues increased to 37.2% from 26.4%. The increase in gross margin is due to the start up of our two new rig O&M project in Abu Dhabi late in the 2014 fourth quarter, the contribution of the new procurement and management services project and reduced operating expenses including foreign exchange benefits in certain locations.
Also contributing to the result to the first quarter, where early contract termination, and demobilization fees and reserve adjustments. We estimate these added approximately three percentage points to the segment’s first quarter margin.
Now, I will turn to our rental tools business. Rental tools reported revenues of $76.1 million in the 2015 in first quarter, an 18% decrease from $92.4 million in the fourth quarter. Gross margin decreased to $29.3 million from $39.3 million. And gross margin as a percentage of revenues declined to 38.5% from 42.6%.
Revenues for U.S. rental tools decreased 22% to $45.9 million from $58.8 million. Gross margin declined to $21.3 million from $31.8 million and gross margin as a percentage of revenues decreased to 46.4% from 54.2%. The decrease in revenues and gross margin reflect the impact of the sharp decline in the U.S. land drilling market on rental tools demand and pricing.
Revenues for our international rental tools decreased 10% to $30.2 million, compared with $33.6 million in the prior quarter. Gross margin increased to $8 million from $7.5 million, and gross margin as a percentage of revenues rose to 26.6% from 22.3%. Our international rental tools overall revenues declined primarily due to reduced operator activity in the Kurdistan Region of Iraq and the North Sea further progress in operating cost management allowed to raise the gross margin level of this business.
Regarding other financial items, first quarter G&A expense was $10.8 million. This includes the incremental expense associated with the implementation of the latest phase of our new ERP system. We expect G&A expense in the second quarter to be approximately $10 million and to range between $38 million and $40 million for the full year.
For the 2015 first quarter, we reported an income tax benefit of $200,000, primarily due to discrete items in the quarter. We expect our full year cash rate to be approximately 30%. Capital spending year-to-date was $33.5 million and approximately $24 million for rental tools, primarily for deepwater equipment to service contracts currently underway or soon to start, $8million for drilling operations and the remainder for corporate purposes.
Total debt outstanding at quarter-end was $585 million $30 million lower than at year-end. Including a cash balance of a $113 million our net debt position was $472 million or 41% of net capitalization. Measured as the multiple of EBITDA, total debt was 2.2 times the prior four quarters adjusted EBITDA, down from 2.3 times at the end of 2014.
In January we amended and extended our credit facility, upsizing our revolver from $80 million to $200 million, extending its term to 2020 and paying off our outstanding $30 million term loan with a $30 million draw on the revolver. Since then we paid off the $30 million revolver loan.
Our liquidity at the end of the quarter was $301 million, including the $113 million cash balance and approximately $188 million available under our revolver.
That ends the financial review. I’ll turn this back to Gary for comments on the outlook. Gary?
Thanks Chris. Given the continuing uncertainty in market conditions, I’ll offer operational guidance and comment on conditions that may affect our business, but in most cases without specific financial estimates.
In overview, we believe energy market conditions will continue to remain weak. We expect ongoing changes in market conditions and the effect of our responses to continue to impact our results from operations in upcoming quarters.
Let’s start with the outlook for our Drilling Services business. In our U.S. lower 48 drilling segment, our U.S. Barge Drilling operation was the first to feel the impact of lower oil prices, beginning in the 2014 third quarter. This has continued into this year with a further drop in utilization and dayrates. At current commodity prices, we expect average utilization and dayrates will decline from 2015 first quarter levels with quarterly utilization averaging around 15% to 20%. We are managing the barge rig fleet in the segment’s operating personnel and overhead costs with the expectation that the activity will remain at low levels for a while now. Under these conditions we expect a small loss in the second quarter for this segment of between $2 million and $4 million.
Our international and Alaska drilling operations are in markets traditionally less volatile than the U.S. land drilling market. So they are not immune to this industry wide decline. In our Latin America region, we currently have two previously contracted rigs without work in Mexico. One was reported in our last conference call. A second is awaiting potential well assignment so may be released this summer. But we also have two rigs due to begin drilling in the next few months, one in Guatemala the other in Colombia. There are few opportunities to re-engage rigs as they come up contract later this year.
In our Eastern Hemisphere fleet, we have several rigs rolling up contract in the coming months, including two of our rigs in the Kurdistan Region of Iraq. Due to the recent sharp decline and drilling in the Kurdistan Region, we anticipate some utilization gaps may develop in that market. Meanwhile, we expect our arctic-class rigs operating in Alaska and our major O&M contracts to remain reliable sources of revenues, earnings, and cash flow.
Based on current activity and contracts in place, we expect rig fleet utilization for our International and Alaska drilling operations to be approximately 60% in the second quarter and to be between 50% and 60% during the second half of the year. In addition, we may experience some further pressure on dayrates. With lower utilization and the absence of the first quarter’s contributions for all determination and the mobilization fees and reserve adjustments, we expect revenues for the International and Alaska drilling segment to be approximately 15% to 20% lower in a second quarter than in the first and for gross margin as a percentage of revenues to be in the low-to-mid 20% range.
Turning now to expected conditions for rental tools, for the U.S. rental tools operations, our activity in the land drilling market will continue to be affected by declines in the rig count. Our U.S. rental tools utilization index is expected to continue to follow the trend in rig count and we expect continued pressure on pricing. First quarter gross margins for this business are near where they were in the 2008, 2009 downturn. While we will strive to limit further erosion of gross margin, we are focused on maintaining our presence in the market by leveraging in our strengths, service levels, product quality, and customer efficiency and by being competitive on price is necessary.
Our international rental tools business is subject to the same conditions, as other international drilling service providers. However, we expect our large presence in the Middle East and the improving operating performance of our business to lead the better results in 2015, when compared with 2014. We are closely managing our cash flow and expect another year of positive free cash flow after capital spending.
Our 2015 capital spending plan is unchanged at approximately $110 million, primarily focused on supporting growth opportunities in our rental tools business and for maintaining our rig fleet pretty efficient and safe operation.
Our management team has deep experience in managing through the industry cycles and is prepared to meet the challenges ahead. We will continue to employ our experience and our expertise to help customers safely manage cost and mitigate operational risks. We believe customers now more than ever will value our focus on operational execution and on providing, innovative, reliable and efficient solutions that enhance their abilities to meet their business objectives.
That concludes my comments. Operator we’re going to take a few questions from the audience.
[Operator Instructions] We will take our first question from Walt Chancellor from Macquarie.
Hey, good morning.
Good morning, Walt.
I wanted to start with cash flows as we move forward in 2015. Certainly encouraging to see the debt reduction. As you produce free cash flows moving forward, is that going to be the target as well to further reduce debt or do you plan to maintain some cash balances or hold those free cash flows for some optionality moving forward? Just like to get your philosophy as we move through 2015.
This is Chris. With regards to cash flow we’re likely to let that build on the balance sheet just for buffer purposes and optionality.
Okay, great. And then Chris, while I have you here, it looks like you enjoyed some benefit from a reduction in working capital in Q1. Do you expect those benefits to roll off here as we move through 2015? Or do you expect to see a little bit more help there?
We could see a little bit more help in the second quarter, but then I think it’s going to flatten out.
Okay, great. And moving to the rentals business, 61% decrementals as I measure it, in Q1. That’s pretty similar. It’s almost spot-on with what you experienced in Q1 2009. It looks like you ended that year – and I realize it was just a U.S. business at that time, at about 75% decrementals for the full year. I guess how do you see the remainder of the year playing out? I know you said you’d hope to stem those margin declines, but any guideposts there would be helpful for us.
Yes, well, this is Gary. The margins on the U.S. sides are still going to show some decrementals as we walk forward and I think it will pretty tough to hold them to that 60% range. I think the biggest change will happen in Q2, after that we anticipate it’ll probably stabilize a little bit, but the 60% you’re quoting is a average between the International and the U.S. domestic market, right.
That’s correct, yes.
And so we actually had a – our margins actually increased in the international tools business in Q4.
Is the hope to further drive those margins up, or is that a level you’d be happy with at this point?
We remain committed as we’ve done before – said before to get in the mid-30% range for that international rental tools business by the end of the year.
Great. And I guess that certainly adds a little bit of credibility with the first-quarter performance, strong performance there. And certainly one more for me. On the international drilling outlook in the Eastern Hemisphere, you mentioned some potential utilization gaps from the Kurdistan rigs. So I presume then that you feel pretty good about the contracting outlook for the rigs in Kazakhstan at this point? And do you think you’ll be able to keep those fully utilized through 2015?
Yes, we feel pretty confident about the rigs in Kazakhstan. In Kurdistan I mean, it’s – is there a just a lot of other challenges there for our customer community; it’s not a reservoir issue, it was other factors that were influencing activity in Kurdistan.
Okay, great. I will hop back in the queue. Thank you.
Thank you, Walt.
We’ll go next to Taylor Zurcher from Tudor, Pickering, and Holt.
Hi, good morning guys.
So, first question have to do with just trying to delve into early terminations a little bit. So, I know terminations impacted margins a little bit here in the quarter, and just wondering what provisions in your contracts are there as it pertains to early terminations? And particularly for the rig you mentioned in Mexico that’s supposed to go on contract in the coming months, or maybe next month, you said. Will that rig recoup any kind of payment? And for all your rigs internationally, just in general, what kind of provisions do you have in place on the early termination side?
Great question. Difficult to answer, because every contract is negotiated separately. We try as much as possible to get early term commitments in each of these contracts, and the two in Mexico happen to have those, and I’m glad they did. The rigs in other markets – it depends on how long they’ve been in those markets. Sometimes you don’t get early term agreements when they’ve been in there for sustained periods of time. I’m not sure if I’m answering your question.
Yes, that’s great. Thanks a lot, that’s some good color. And then secondly, kind of unrelated, but I think last quarter you mentioned with the skeleton crews you are keeping on your barge rigs in the GoM, you were expecting somewhere between $90,000 and $120,000 per month cash costs, and now you’re looking at $80,000. Is there any more room to cut there? That seems like a pretty low level already, but given that utilization looks pretty bleak moving forward, any more costs to cut there?
We are kind of in that conundrum where any further cuts will put at risk the condition of the rigs when they are called back into service and the amount of CapEx that we would have to spend to get them ready to go to work again. And so, yes, we could technically, but you are starting to talk about costs of do we take the insurance off the rigs? Do we totally de-man them and not do any upkeep that keeps them from deteriorating and those sorts of things. And right now we feel that, with the way we’ve worked it down to the $80,000 is a good balance, looking at where we think the market is going to go in the future.
Awesome. Thanks a lot. Well, that’s real helpful. I’ll turn it back.
[Operator Instructions] We’ll go next to Daniel Burke from Johnson Rice.
Gary, just back on the domestic side of the rental tools business, I guess one thing that at least we perceive as a little different now for you guys versus 2008-2009 is a little bit more participation on the Gulf of Mexico front. Could you update us on your prospects there? And then also, I guess, curious, we saw that the Gulf of Mexico is maybe helping prop margin on the US rental tools side. So what does that – what can we infer if that’s the case? If it is the case about where US land rental margins are now versus 2008-2009?
That’s a great question, and there are multiple facets to it. I’ve never experienced a downturn that was as significant or as abrupt as the one that we’re going through now in U.S. land. And that’s really created a competitive environment that’s brutal. Fortunately, we do have some of that offshore activity that you referred to, particularly on the deepwater side and for all intents and purposes, that business is staying relatively steady. We’ve had to agree to some price concessions in that segment, but pretty nominal, relative to those that we’re having to live with on the land side. So, if we didn’t have that mix that we have today or that favorable mix on the deepwater side, you would see our margins on the US side dip lower than I think what we had experienced in that previous cycle.
Okay. That’s helpful. Then maybe a couple on actually O&M side. You mentioned a new procurement contract. Any more color you can share there? And then secondly, I was curious on the drill service backlog, can you give a rough split of what portion of that resides on the rig site and what portion on the O&M side?
The second part of that question I will let these guys think about I answer – try to answer the first part of because I’m not sure what that split is. Now saying that, I forgot – what was the other part of your question. Dan.
Yes, sure. It was a simpler part – I thought you had mentioned a new procurement contract on the – I didn’t know if it was a one-time thing or if that’s a part of the model going forward. Probably pretty nominal value, but since you guys mentioned it, I wanted to see if I could get some more color there.
Yes, it’s not going to be a big mover in terms of our financial performance in the short term, but it’s a continued evidence of the business model or strategy that we’re pursuing, where we utilize the technical services capability we have, internal to the organization, to work with clients and very project-specific situations where they need to have rig equipment that is optimized for those specific applications. Similar to what we’ve been doing before in Russia and also to some extent up in Alaska, it’s a continuation of that, which then ultimately leads to good opportunities for us when it comes to actually assigning O&M contracts down the road.
Okay, well, great. That’s helpful. I appreciate the answers.
Daniel the O&M question, about $200 million of the backlog is associated with O&M work.
Thanks, Chris. I appreciate it.
We’ll take a follow up from Walt Chancellor from Macquarie.
Just one bit of housekeeping in the Q2 guidance. Gary, you mentioned the $2 million to $4 million loss in the lower 48 business, if I recall correctly. Was that gross margin, or are we talking EBIT, after depreciation?
Okay. All right. That’s it for me. Thank you.
All right. Thanks Walt.
And this concludes the question-and-answer session. I would like to turn the call back over to Jason Geach for any additional or closing remarks.
That ends our call. I would like to thank you for your time today and for your interest in Parker Drilling. If you have any questions about material covered in our announcement and this conference call, please contact by telephone or email. Goodbye and have a great day. Thanks.
This does conclude today’s conference. We thank you for your participation.
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