ION Geophysical's (IO) CEO Brian Hanson on Q3 2017 Results - Earnings Call Transcript

ION Geophysical Corp (IO) Q3 2017 Earnings Conference Call November 2, 2017 10:00 AM ET

Executives

Rachel White - IR

Brian Hanson - CEO, President and Director

Steven Bate - CFO and EVP

Analysts

Andrew Whittman - T.A. McKay & Co.

David Steinberg - DLS Capital Management

Operator

Greetings, and welcome to the ION Geophysical Third Quarter Earnings Conference Call. [Operator Instructions]. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Ms. Rachel White. Thank you, you may begin.

Rachel White

Thank you, Matt. Good morning, and welcome to ION's Third Quarter 2017 Earnings Conference Call. We appreciate your joining us today. As indicated on Slide 2, our hosts today are Brian Hanson, President and Chief Executive Officer; and Steve Bate, Executive Vice President and Chief Financial Officer. Before I turn the call over to them, I have a few items to cover. We'll be using slides to accompany today's call. They are accessible via a link on the Investor Relations page of our website, iongeo.com. There you will also find a replay of today's call.

Moving on to Slide 3. Information reported on this call speaks only as of today, November 2, 2017, and therefore, you are advised the time-sensitive information may no longer be accurate at the time of any replay. Before we begin, let me remind you that certain statements made during this call may constitute forward-looking statements, which are based on our current expectations and include known and unknown risks, uncertainties and other factors, many of which we are unable to predict or control that may cause our actual results or performance to differ materially from any future results or performance expressed or implied by those statements. These risks and uncertainties include the risk factors disclosed by ION from time to time in our filings with the SEC, including in our annual report on Form 10-K and in our quarterly reports on Form 10-Q. Furthermore, as we start this call, please refer to the disclosure regarding forward-looking statements incorporated in our press release issued yesterday. And please note that the contents of our conference call this morning are covered by these statements.

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

Brian Hanson

Thanks, Rachel. Good morning, everyone. In our last quarter call, we provided you with details in all of our segments and spent a considerable amount of time bringing you up to speed on the extensive activities we focused on through the downturn and where each of those segments is positioned and where they're heading.

If you're not clear on any part of the structural positioning of our business, we recommend you go back and review the second quarter transcript.

In this call, rather than a deep dive by segment, we'll focus on a few key topics. We'll discuss upcoming license rounds, how our data library is well positioned, an update on the progress of our E&P advisor's license for our management work and an update on our software business. Then I'll sum up the call focusing on our expectations for the fourth quarter. If there are any topics untouched you'd like to address, please feel free to raise and join the Q&A.

First, let's discuss the financials. As I said on the last call, we have targeted opportunities less dependent on cycle recovery such as select geographic areas and production optimization offerings, where capital is flowing and we are seeing these efforts pay off. Similar to the strong momentum of the first and second quarters, our third quarter revenues increased 33% sequentially, driven by continued strong sales of our 3D multi-client reimaging programs as well as new programs we launched this year. Excluding $30 million of ocean bottom seismic services revenue generated from our crew in the third quarter of 2016, our revenues of $61 million are up 26% from the third quarter of last year.

Our adjusted EBITDA for the third quarter was $27 million, double the adjusted EBITDA generated in the first half of this year. This brings our adjusted EBITDA for the first 3 quarters to $41 million. Our third quarter net income and adjusted EBITDA is as high as it's been since the first half of 2014. This is the first time since 2014 that we have reported 5 consecutive quarters of breakeven or better adjusted EBITDA. We reported net income of $5 million in the third quarter compared to a net income of $2 million last year.

We stated in our second quarter earnings calls that we expected our revenues and EBITDA to improve sequentially as the year unfolded, partially driven by the significant backlog we built, both of which are reflected in the third quarter results. Our second quarter revenues improved on the first quarter by 41%, and our third quarter improved on the second by 33%. The third quarter turned out to be even stronger than we anticipated. We still believe the fourth quarter will be strong, and I'll speak more to that in my summary comments.

Moving on to our next topic. We ended the quarter with continued strong backlog of $40 million compared to $48 million sequentially and $34 million at the end of last year. As programs progress, they move from work-in-progress onto the shelf in our data library. When this occurs, activity shifts from backlog to revenue recognized in the quarter it's transacted in. As such as we continued to complete programs and build our data library, we expect backlog to reduce, becoming a less meaningful metric moving forward. Just to be clear and as a reminder, we sanctioned no programs for the 2-year period of June 2015 to May 2017 with the exception of the Campeche reimaging program.

In 2017, we sanctioned 6 programs to date, which drove the surgeon backlog, which should now begin to level off as we build a consistent pipeline of new projects. This quarter, we experienced an increase of over 400%, a new venture of revenues compared to the third quarter of last year. This increase in revenue and sanctioned programs demonstrates our renewed interest in clients underwriting programs to obtain data in advance of license rounds and to evaluate new discoveries.

Today, we'll focus on 5 of the 6 new programs sanctioned in 2017. There has been a significant uptick in offshore licensing round activity, with 94 active announced or anticipated rounds to start in 2017 to 2019. In fact, more than 65 rounds are active or expected to launch in the next 9 months. For those of you who are following along with our slides, we've included a slide where you can see the positioning of license rounds and our data. You can see the geographic distribution of these licensed rounds on this slide. This includes 16 of the 29 offshore license rounds deferred through the downturn starting in 2014, and I further indicated that the market is picking up. Our programs are well positioned for upcoming bidding activity, which was evident by the activity in our data room at AAPG ICE, one of the largest geological trade shows held in London in October.

We showcased our extensive data library in a private room where we spoke to numerous oil companies and host governments over the course of the trade show. Our programs are relevant to 60 of the 94 current or anticipated offshore licensing rounds in 2017 to 2019. For example, officials in Uruguay postponed the launch of the third round, initially anticipated to start in 2014, due to the low oil price environment and pending hydrocarbon legislation changes.

With improved contract and bidding terms, Uruguay's third round has seen significant interest from several large independents and super majors since launching on September 18. Qualification for the round ends April 6, 2018, and the opening of offers is scheduled for April 26, 2016.

ION's extensive 13,000 kilometer data set offshore Uruguay includes 2,800 kilometers of Uruguay's SPAN data acquired in 2012 and recently reimaged in 2016 and 10,200 kilometers of dense legacy data we reimaged and integrated into our basin SPAN in 2016.

New venture revenues came from diverse geographic areas in Mexico, Brazil, Panama, [indiscernible] Libya, Peru and across the Caribbean.

Now, I'd like to add some color to specific programs. We continue to believe we will see strong demand for years to come on our 3D multi-client Campeche reimaging program due to the regional framework it provides to inform Mexico investment strategies in upcoming bid rounds and beyond.

In July, the Mexican National Hydrocarbons Commission, CNH, announced blocks through the next offshore round, around 2.4, which will be held in January 2018. The Campeche program is relevant to around 2.4 and the other 2 license rounds the CNH plans to hold in 2018. After that, the CNH plans to hold twice yearly oil auctions moving forward. Round 2.4 as well as these future auctions will continue to drive incremental Campeche data sales, both in 2017 and for multiple years to come.

Due to client demand, we are actively pursuing 2 extensions to the program. As a reminder, our first new multi-client program this year was acquired in the second quarter offshore Gabon. Fast-track products have already been delivered and final processing and interpretation reports are scheduled to be completed by the end of the first quarter 2018, where the program will shift into our data library as we discussed before in the section on backlog.

Our second new multi-client program this year is in Brazil. Picanha is another large 3D multi-client reimaging program and like Campeche, it will provide a valuable regional framework for license rounds for multiple years. We discussed this program in detail last call. But as a reminder, the Picanha program will be relevant to at least 7 of the 11 license rounds Brazil announced. There will be 4 rounds in '17, 4 in '18 and 3 in '19, which will make this program relevant for multiple years to come. Round 14, the second round of '17 just completed in September, was considered a great success. Following round 13's worst result in a decade, this marked the reestablishment of the sector in Brazil with the largest total signature bonus in history of $700 million and the 2 biggest block offers.

37 blocks covering 25,000 square kilometers were awarded to 17 companies from 8 countries, fetching a record-breaking $1.2 billion in signing bonuses. The success of the auction reflects the regulatory changes made by the Brazilian government, which created a more business-friendly regulatory environment. Exxon Mobil vastly expanded its presence in Brazil, winning 10 blocks in the round. Exxon Mobil is in a consortium with state owned Petrobras on 6 of those blocks and the Campos Basin where Petrobras will service as the operator.

Two more auctions were held by EMP this year, the second and third pre-sought rounds on October 27. These rounds were also considered a big success by the EMP as 6 of the 8 offered blocks were acquired, generating approximately $1.9 billion in signature bonuses and approximately $235 million in investment commitments.

In 2018 and 2019, 3 bid rounds will be held each year; 1 for maturities, 1 for pre-sought and 1 for exploration blocks. We believe the Picanha program is well positioned to benefit from the renewed interest in Brazil and upcoming license rounds.

Our third new program commenced during the third quarter when acquisition began on a new 2D multi-client program offshore of Panama, the last of the 3 programs sanctioned in the first quarter. It's the first seismic survey acquired there in approximately 30 years. Shortly after the program started, we announced a 50% extension due to strong client interest and prefunding to evaluate offshore Panama in advance of the anticipated inaugural license round. The client-driven survey provides a regional framework, typical of basin SPAN programs to evaluate the overall regional geology and hydrocarbon potential. The new extension provides more detailed coverage that will allow E&P companies to specifically evaluate blocks ahead of the expected license round. Building on recent exploration success offshore Colombia, immediately adjacent to Panama's Caribbean coast, E&P companies are become increasingly interested in high-quality seismic data in this area to evaluate the hydrocarbon prospectivity in the region.

The expanded program will be approximately 9,000 kilometers and is the only modern data available offshore Panama. Initial deliverables will be available in the fourth quarter, and complete interpretation of the data will be available by mid-2018 to guide investment strategies. This program highlights the need to continue to acquire data and select frontier areas where limited data exist today as compared to programs where we can gain access to legacy data to reprocess it such as Mexico and Brazil.

For our fourth new multi-client program this year, we are expanding our data library in another area offshore Mexico with a new 3D multi-client broadband reimaging program in the Western Gulf to Mexican Ridges. This program reprocesses and reimages 8 surveys, covering approximately 28,000 square kilometers from the Mexican National Hydrocarbons Commission, CNH, data library. The program is fully funded and fast-track data is available now for the Deepwater license round, round 2.4, in January 2018. Our regional expertise in the Gulf of Mexico enabled us to provide cost-effective, high-quality imaging to improve prospect identification and derisk multiple exploration opportunities in the basin. In addition, we are currently in discussions with clients to extend the program.

The fifth new multi-client program this year is the reimaging project offshore Argentina and a relatively underexplored petroleum system. For almost 10 years, ION's ArgentineSPAN was the only data set available. The knowledge gained from working this data enabled us to confidently add and interpret approximately 32,000 kilometers of vintage data. ION secured the seismic and well data from an E&P operator with exclusive licensing rights. We plan to provide a full interpretational report detailing the exploration history, the geologic framework and an inventory of potential leads to jump-start exploration efforts there in advance of expected license rounds.

Last quarter, we described the fundamental shift in our E&P advisors' group, which has expanded their focus to more broadly advised host governments, oil and gas companies and private equity firms. As we said, the group was recently awarded their third license round management contract. And this host government advisory will conduct a technical evaluation of distressed fields for rejuvenation in a major oil province as well as evaluations of new exploration blocks to be offered. In a world of heightened competition globally to attract the E&P investment, this advisory service is designed to help host governments promote their assets to attract maximum investment. This is a long-term, multi-year engagement where last quarter we told you we expected to recognize a couple of millions dollars of services revenue in the fourth quarter and has the potential for significantly more success-based revenues in 2018.

The government has since expanded the scope of this -- of our consultancy work and as such, we expect greater services revenue in the short term, but now expect the success-based revenues to push out into 2019.

We are on track to complete the first phase of license round evaluation this year. The host government asked us to expand our current scope of work to include approximately 20% additional distressed fields in our technical evaluation. The incremental work increases our project volume and service revenues in the short-term. However, it also delays subsequent stages of our evaluations. As a result, we would expect our services revenues to be higher in 2018 due to project expansion and the timing of success-based revenues to happen early 2019. We still anticipate the success-based revenues in the range of 4x to 7x 2017 service revenues.

We're very excited about being able to offer this capability to governments as they maximize the value of their acreage.

Our E&P Operations Optimization segment continues to operate consistently as we described in detail in the second quarter. What I'd like to do today is share a couple of additional Marlin case studies that drive home the value of the offering. We have now successfully completed over 60 deployments of our offshore operations management software, Marlin. As a reminder, akin to modern air traffic control systems, Marlin integrates a variety of real-time data sources that enables multiple stakeholders to share and visualize vessel-route plans, for see and avoid conflicts between vessels and fixed assets, optimize schedules and measure and improve asset performance. We added 2 new clients during the quarter, and we continue to receive great client feedback on the value it delivers. Marlin supports our effort to diversify our offerings more broadly in the E&P market and beyond into a much larger Marine logistics market.

While today we're taking it to market as a service, we are actively transforming Marlin from a software-based service offering into a shrink wrap software solution that can be deployed more broadly to optimize offshore operations. We are currently targeting to commercialize this shrink wrap software solution in the second quarter of 2018. That said, several E&P operators are using terminal installations of current Marlin software to oversee their remote operations around the world from their corporate offices.

I'd like to share a case study example of the value we're providing with Marlin. Marlin helped 2 cruise navigate a complex area densely congested with over 20 installations and platforms in Southeast Asia. It's the first time ION has integrated its 2 leading command-and-control systems into Marlin to accommodate a hybrid survey, enabling both towed streamer and ocean bottom seismic operations to be visualized simultaneously. By giving the crew confidence to operate at night in this busy field, we enabled our customer to double the productivity of its operation, making it possible to complete a survey in a very short time window available. In addition, Marlin provide visibility on diving operations and barge transit on either very little or no advance notice.

Marlin was installed in our clients offices, both onshore and offshore in multiple countries, enabling remote monitoring and collaboration. After the project, Marlin's post mission playback provided insight into the operations that were previously unknown and forming an audit of operations and continuous improvement initiatives. And I'll quote David Crowley, President and Chief Executive Officer of Geokinetics who said, "Integrating Marlin or [indiscernible] on a recent hybrid towed streamer ocean bottom nodal project acquired by Geokinetics provided improved visualization of the entire operation, and we developed the confidence to operate within congested oilfield infrastructure beyond daylight hours, increasing production and reducing the overall project duration for our client."

We also deployed Marlin on our PanamaSPAN program, which enabled us to safely and efficiently navigate one of the busiest maritime transit routes in the world near the Panama Canal. Marlin enabled greater collaboration allowing underwriters to tune into what's happening in the field real time from their offices to monitor program progress and key statistics. This is the kind of significant economic impact for making an operations.

In addition, we're beginning to evaluate alternate markets outside of oil and gas for Marlin such as supply vessel, offshore wind farms and port management. For example, we're in the early stages of entering the offshore wind farm market having recently completed an exhaustive study on Marlin's applicability for wind farm management. The results of this study indicate Marlin is highly applicable to both the construction and ongoing operation and maintenance of wind farms. We're also actively seeking the right partnerships in these markets to enhance our offering and to accelerate our adoption. The collaboration we announced during the quarter with PlanSea to improve the efficiency of offshore supply vessel logistics is a great example of selecting the right partnerships. By embedding PlanSea's powerful logistics optimization algorithms into Marlin, we aim to provide a comprehensive real-time solution for marine logistics management that significantly reduces costs and risks. As I said before, we believe that Marlin has a potential to develop into a very nice software business for ION.

With that, I'll turn the call over to Steve to walk us through the financials, and then I'll wrap up before taking questions.

Steven Bate

Thanks, Brian. Good morning, everyone. Our total third quarter revenues were up 33% sequentially, but decreased 22% compared to the third quarter of 2016. Excluding OBS services revenues from last year, our revenues were up 26% compared to the third quarter of 2016.

Revenues in our E&P Technology & Services segment increased by over 44%, and revenues in our E&P Operations Optimization segment decreased by 28%. Our OBS services segment had no revenues in the third quarter of 2017 as our operations remained idle during the quarter. The third quarter of last year reflected $30 million of OBS revenues related to the Nigeria project.

Within our E&P Technology & Services segment, our new ventures revenues were $44 million, an increase of over 400%. Our data library revenues were $5 million, a decrease of 77%, and our imaging service revenues were $3 million, a 43% decrease to the third quarter of 2016. Similar to last quarter, the decrease in imaging services revenues reflects the continued reallocation of resources to high-return multi-client programs. The imaging revenue for multi-client programs are reflected as part of new ventures revenues, whereas revenues from proprietary imaging programs are reflected as part of imaging services. The Imaging services group was fully utilized with a large portion of our capacity dedicated to high-return multi-client programs.

In our E&P Operations Optimization segment, our devices revenues decreased by 39% and our optimization software and services revenues were essentially flat compared to the third quarter of 2016. Our income from operation was $10 million during the third quarter of 2017 compared to $12 million in the third quarter of 2016. Our net income was $5 million this quarter or $0.41 per diluted share compared to $2 million or $0.14 per diluted share in the third quarter of 2016.

Our adjusted EBITDA was $27 million in the third quarter of 2017 compared to $24 million 1-year ago. This represents our fifth consecutive quarter with a breakeven or better adjusted EBITDA. Net cash flow from operations during the quarter was $6 million compared to $16 million during the third quarter of 2016. Including both investing and financing activities, we consumed total net cash flows of $3 million in the third quarter of 2017 compared to the generation of cash of $10 million in the third quarter of last year.

During the third quarter, we invested heavily in working capital, which should translate to significant cash generation in the fourth quarter. We experienced a significant increase in our accounts and unbilled receivables resulting in a combined balance of $65 million at September 30, 2017, which is up $27 million from 1 quarter ago and up $31 million from the end of last year. Fourth quarter collections and the expected year-end customer spending on data libraries will result in significant cash generation during the fourth quarter.

Our liquidity was $52 million at the end of the third quarter. Our cash balance excluding borrowings under our credit facility was $30 million at September 30. The combination of finishing the third quarter with $52 million in liquidity, combined with harvesting significant working capital in the fourth quarter, will dramatically strengthen our liquidity by year-end. This will more than sufficiently provide the capital required to take out our third-lien indentures of $28.5 million, which mature May 15, 2018. Due to the terms on our current revolving credit facility and our second-lien indentures, we're unable to call the third-lien bond private maturity. So we'll reserve $28.5 million of our liquidity to satisfy this maturity on May 15, 2018.

With that, I'll turn it back to Brian.

Brian Hanson

Thanks, Steve. I said it before we are in each business in the larger E&P market. Over the last 18 months, we've surgically targeted select geographic areas and production optimization opportunities less dependent on cycle recovery where our differentiated technologies bring significant value. These efforts have certainly paid off for the first 3 quarters of 2017 and are setting up what appears to be a solid fourth quarter. We told you on the last call that we expected the third quarter to be stronger than the second and the fourth quarter to be stronger than the third. We're pleasantly surprised how the third quarter even stronger than the anticipated. We still expect to finish the year strong, driven in part by the backlog we've built and expected year-end customer spending on data libraries.

At AAPG ICE in London in October, clients clearly telegraphed year-end budget money being available for properly positioned programs. As we indicated earlier on the call, we believe our library is exceptionally well-positioned and that's expected to be direct beneficiaries of these year-end funds. As such, we believe the range for the fourth quarter results will be somewhere between, a, easily exceeding the second quarter on the low end; and b, comparable to the third quarter, potentially exceeding it or modestly coming in shy of it. The range is entirely driven by the amount of year-end funds available.

With year-to-date adjusted EBITDA of $41 million, coupled with a good fourth quarter, we believe we will deliver solid adjusted EBITDA on a full year basis compared to prior full year results of $11 million in 2016.

Today, we believe we have sufficient liquidity to retire our third-lien indenture in May of 2018, combined with the additional liquidity generated in the fourth quarter by harvesting working capital and enjoying year-end data library budget money, we believe there will be very little risk associated with retiring this indenture. Since the downturn of our industry in 2014, we have diligently reduced the leverage in our company from $191 million to $155 million at the end of the third quarter. With the further reduction of this third-lien indenture, we see our leverage dropping to a low of $126 million. We believe strong adjusted EBITDA generation coupled with significant deleveraging of the business over the past few years should significantly and directly benefit shareholders.

With that, we'll turn the call back over to the operator for Q&A.

Question-and-Answer Session

Operator

[Operator Instructions]. We have a question from Andrew Whittman from T.A. McKay & Co.

Andrew Whittman

Great quarter guys. Just kind of looking at the increase in liquidity in Q4. Do you some sort of directional sense, kind of range as to where you think liquidity will end the year?

Steven Bate

No, I don't know that we would give out a range. We do expect a significant increase though. But I don't think we'd address it with a range.

Brian Hanson

We typically don't give guidance. And I think what you got in my summary comments was probably the strongest directional information I've given in probably 10 years.

Operator

Our next question is from David Steinberg from DLS Capital.

David Steinberg

The only question I had which is on your increasing accounts receivable. Is there any extension in receivable time, quality, number of customers? Give me any better color that -- obviously, it would be an increase because business is picking up significantly. Is there anything else you can shed on that at all?

Steven Bate

No, Dave. I think it's reflective of the increase in the volume of business. The profile of our AR balances is really unchanged from prior...

David Steinberg

So we should all basically be real comfortable with the accounts receivable. It's a good sign in that sense. I would gather from that versus the delayed payments or something.

Steven Bate

Yes, absolutely. I think that's exactly the way to think about it.

Brian Hanson

Yes, the good news is Exxon and Shell typically pay the bills to us.

David Steinberg

Okay, listen, guys, it's just -- it's going from where you're at to where you're at now, it's just such a big swing that I'm just crossing the t's and dotting the i's.

Operator

And our next question is from James West from Evercore ISI.

Unidentified Analyst

This is Blake on for James. Can you guys hear me now? So I appreciate that you guys are diversifying away from the cyclical part of the business. But you know in capturing the fact that OBS was a pretty big needle mover prior to the downturn. Just wanted to get your thoughts on that business more broadly, the outlook for 2018 and beyond and maybe where you guys see that crew fitting into the broader portfolio as we think about the out years?

Brian Hanson

Yes, Blake. We didn't really talk a lot about the OBS business on this call because not a lot has changed since the deep dive we did on the second quarter. I mean all the elements of OBS are still there. We're still in process developing the 4Sea system, where we have our commercialization time line still as expected. We've -- we are out tendering with 4Sea for projects late '18, early '19. All of the elements of that are still in place. So if you really want a lot of detail, I'll just point you to look back to the second quarter script because it's all absolutely still intact.

Unidentified Analyst

Got it, appreciate that. And my second question really quickly, the backlog as you guys add to it, how do we think about the timing in terms of that going to hitting the P&L? You guys mentioned, obviously, once a project goes to WIP, goes onto the shelf and then hits the P&L. But as it grows, the project may be duration flanked then shorten, that sort of thing. But in general, how can we think about the speed at which you guys turn that backlog into revenue?

Brian Hanson

Yes, I think we're starting to talk a little bit about just the backlog as a metric because I think what you're going to see over the next probably 12 to 24 months that more and more of these projects that we're doing will get on the shelf. And so, right now, we're -- a portion of the revenue that we end up -- when we transact in the quarter, we end up having a call backlog because we're still work-in-progress on a lot of these programs with final deliverables in '18. That's going to become less and less as those programs get on the shelves. So I'd expect a slow maturation of that backlog metric and we'll just -- I can't give you an exact view on it until we see this sort of unfold. But we'll talk about it as it happens and try to keep you -- trying to be transparent on what -- how meaningful backlog as a metric is to the business. The good news is, if it's not in backlog, it's going to be revenue going right to the P&L. So it's either a backlog or revenue recognized in the quarter.

Operator

[Operator Instructions]. And if there are no further questions, I'd like to turn the floor back over to management for any closing comments.

Brian Hanson

All right. Thank you for taking the time to attend the call. And we look forward to talking to you on the fourth quarter call in February.

Operator

This concludes today's teleconference. Thank you for your participation. You may disconnect your lines at this time.