OIL STATES INTERNATIONAL, INC quarterly report, Q3 FY2012

Oil States International, Inc. — Q3 2012 Form 10-Q

Reporting period: Three and nine months ended September 30, 2012; comparisons are with the corresponding 2011 periods. The company supplies products and services to oil and gas and mining customers through well site services, accommodations, offshore products, and tubular services.

Financial performance

Metric	Q3 2012	Q3 2011	Nine months 2012	Nine months 2011
Revenue	$1,080.7 million	$902.6 million	$3,270.8 million	$2,483.4 million
Operating income	$154.3 million	$144.5 million	$527.8 million	$354.4 million
Net income attributable to Oil States	$103.8 million	$91.9 million	$350.1 million	$228.2 million
Diluted EPS	$1.87	$1.67	$6.32	$4.15
Gross margin	25%	26%	26%	25%

Q3 revenue increased 20% year over year and attributable net income increased 13%. For the first nine months, revenue grew 32% and attributable net income grew 53%. Operating margin was approximately 14.3% in Q3 versus 16.0% a year earlier, and approximately 16.1% for the nine-month period versus 14.3%.

Segment trends: Q3 revenue rose across all segments. Accommodations revenue increased 20%, offshore products 36%, and tubular services 20%; well site services rose 5%. Accommodations and offshore products led nine-month operating income growth. Tubular services remained lower-margin and its Q3 operating income was reduced by unusual adjustments.
Cash flow and investment: Nine-month operating cash flow was $446.0 million, up from $223.1 million. Capital expenditures were $331.8 million, compared with $371.2 million; operating cash flow less capital expenditures was approximately $114.2 million, versus negative $148.1 million in 2011. Cash and equivalents were $163.6 million at September 30, 2012, versus $71.7 million at year-end 2011.
Liquidity: Current assets were $1.801 billion and current liabilities $572.5 million. The current ratio was approximately 3.1. Management reported $437.7 million available under U.S. and Canadian facilities, plus AUD$264 million available under the Australian facility; $40 million of letters of credit reduced facility availability.
Debt: Total debt was $1.187 billion, including $600 million of 6.5% senior notes due 2019; long-term debt and lease obligations were $1.154 billion. Cash less total debt implies net debt of approximately $1.023 billion. Debt equaled 33.2% of debt plus equity, down from 37.5% at December 31, 2011. The company reported compliance with all debt covenants.

Material changes and significant events

On July 2, 2012, the company acquired Piper Valve Systems for $48 million, funded through its U.S. revolving credit facility. Piper’s results are included in offshore products from the acquisition date; Q3 offshore backlog included $17 million from Piper.
The $174.99 million principal amount of 2⅜% convertible notes was converted in July. Holders received cash up to principal and 3,012,380 common shares valued at $220.6 million. Shares outstanding increased accordingly.
The Australian accommodations subsidiary replaced its AUD$150 million facility with a AUD$300 million revolving facility, maturing December 10, 2015.
The board authorized a new $200 million share repurchase program, expiring September 1, 2014. No repurchases were made under it through September 30.
Other comprehensive income was affected by a $40.5 million nine-month foreign currency translation gain, compared with a $61.4 million loss in 2011.

Outlook, commentary, risks, and unusual items

Capital spending outlook: Management expected 2012 capital expenditures of approximately $500–$550 million, with about two-thirds allocated to accommodations expansion in Canada and Australia. The estimate was reduced from earlier expectations because some spending shifted to the first half of 2013. Management said cash, operating cash flow, and available borrowings should meet liquidity needs over the next 12 months.
Demand outlook: Offshore products backlog reached a record $597 million at September 30, up from $514 million a year earlier. Management anticipated further deepwater award opportunities over the following 12 months. Canadian oil sands and Australian mining investments supported accommodations demand. North American activity was shifting toward oil and liquids-rich drilling as natural gas prices remained weak.
Market and operating risks: Results depend on commodity prices, customer spending, rig activity, OCTG prices and inventory, and global economic conditions. Management noted lower U.S. drilling activity over the prior three months, downward pressure on OCTG prices, and possible further pressure on WTI prices if U.S. production outpaces transportation capacity. Natural gas oversupply could continue to constrain prices and gas-directed drilling.
Other risks: Approximately 30% of nine-month sales originated outside the U.S.; currency weakness could reduce reported results. Floating-rate debt was approximately $578 million; a 1% rate increase would raise annual interest expense by about $5.8 million. New or more stringent Gulf of Mexico contractor regulations could increase costs and liabilities.
Unusual items: Q3 included $7.5 million of unfavorable out-of-period adjustments in tubular services—$3.1 million lower revenue and $4.4 million higher cost of sales—equal to $0.10 per diluted share after tax. Management attributed these to customer-credit and returned-inventory accrual corrections, system design and implementation issues, and other cost accruals; it judged prior-period statements and estimated full-year 2012 results not materially misstated. Nine-month results also included a $17.9 million favorable accommodations contract settlement and a $2.5 million gain on insurance proceeds for a drilling rig lost in a fire.
Management said disclosure controls were effective at the reasonable assurance level. It also disclosed that accounting-system implementation issues contributed to the out-of-period adjustments. Legal proceedings were described as not expected to have a material adverse effect, although outcomes cannot be assured.

Important facts for investors to verify

Whether the $7.5 million tubular-services adjustments are fully resolved and whether related customer credits, returned inventory, and control changes could result in further corrections.
How much of nine-month earnings growth reflects recurring operating performance versus the favorable contract settlement and insurance gain.
Execution, utilization, and returns on the planned $500–$550 million capital program, particularly accommodations expansion.
Conversion of the record offshore backlog into revenue and cash, and whether margins hold given project-specific charges.
Working-capital needs, especially rising inventories and receivables, alongside borrowing levels, interest-rate exposure, and covenant headroom.
Exposure to falling OCTG prices, commodity-price shifts, foreign exchange movements, and possible new Gulf of Mexico regulation.