TGS ASA

OSE:TGS

Earnings Call Transcript 2020-Q3

[Kristian Kuvaas Johansen, Chief Executive Officer]

Good morning, good afternoon and good evening, depending on where in the world you're listening in from. Welcome to the presentation of TGS Q3 2020 earnings. As we indicated last quarter, Q3 turned out to be one of the most challenging quarters for the E&P industry and, in particular, companies exposed to exploration. COVID-19, global demand for oil and gas and the consistently low oil price are all factors outside our control. That means that management needs to focus on areas we can control, and these factors would include cost discipline, cash collections and the corresponding free cash flow as well as client service and interactions. I'm therefore very pleased to report a 64% year-on-year reduction in cash operating costs, a positive free cash flow in Q3 and a balance sheet that allows us to continue to pay a dividend of $0.125 to our shareholders. Before we move on to the presentation of Q3, I would like your attention on our forward-looking statements. And as always, I ask you to read these carefully. Moving to the highlights of the quarter. Our net revenues have already been reported earlier this month. The composition of sales, however, shows that late sales amounted to about $61 million in Q3. Prefunding came in at about $17.4 million. And then cost and CapEx are reset now to reflect challenging market conditions. And as I mentioned in my introduction, Q3 2020, our personnel and other operational costs are down 64% year-on-year. Our forward run rate is also reduced, so we expect that going forward, we will see a cost of about 40% lower than if you compare it to 2019 pro forma figures. And although in line with hopefully improvement in the market, the cost may come up slightly. And we think that a significant part of the 40% cost reduction that we've been through is actually permanent and not temporary. The dividend is maintained at USD 0.125 per share. This is supported by a strong balance sheet and cash generation capabilities. As I said, even in Q3, which will make the history books as one of the most challenging quarters in history for oil and gas, TGS managed to report a positive free cash flow. The weak market conditions are expected to continue into 2021. COVID-19 continues to cause uncertainty in all markets. And until we have more clarity on vaccines and the further development of the virus, we need to be cautious. We're now going to look at the operational highlights for Q3. The operational highlights show that we only had 3 operations in the quarter. This is in line with our strategy communicated after Q1, where we expected investments to be very front-end loaded for the year, and as a result, free cash flow to be more back-end loaded with lower outflow related to new investments. Going forward, you will continue to see TGS invest countercyclically, but the cash outflow will be lower due to lower cost of supply, more extensive use of risk sharing and a slightly more focused investment strategy in terms of geographic exposure for the future. In Q3, we completed the recording phase of engagement. This is an ultra-long offset sparse node project in the Green Canyon area of the U.S. Gulf of Mexico. It's a highly prefunded project following the very successful Amendment Phase 1 project in Mississippi Canyon in 2019. Also we finalized acquisition of a 5,600 square kilometer Atlantic Margin 20, which we call AM20. This is a 3D multi-client project in Norway. The survey is an extension of the Atlantic Margin seismic programs acquired between 2017 and 2019. And for those of you who follow the market closely, you may have seen announcement of oil and gas discoveries in this area very recently. TGS' first-ever regional airborne Enhanced Full Tensor Gravity Gradiometry, eFTG multi-client survey, was initiated in Q3. The survey will cover an area of approximately 120,000 square kilometers on the upper Egypt region and will also acquire magnetic and LIDAR data, in addition to eFTG. This will provide unique high-resolution imaging of the region with increased accuracy and higher resolution to enhance exploration activities. In line with our strategy of improving our technologies across the board, we're also pleased to report progress on a few critical R&D achievements this quarter. The first image to the left is related to testing of 2 different low-frequency source technologies as part of our continued investment in OBN projects in the U.S. Gulf. OBN testing has also been carried out in Norway, where we have combined the recorded OBN data with conventional 3D streamer data to improve imaging. So these tests that I'm referring to here are critical in building improved velocity models with FWI and optimizing and expanding future applications. The second picture is from our ARLAS cross-section tool, where we are combining ML-based well log prediction with powerful visualization to gain unique subsurface insights. And then finally, the third picture is from a quality assurance project, where we, together with one of our key clients, have developed a toolkit to improve efficiency and quality control for imaging projects. All these projects are examples of how TGS is actively gaining momentum to improve efficiency and quality by leveraging recent developments in artificial intelligence as well as more traditional imaging technologies. We continue to be focused on supporting a sustainable future at TGS. By providing quality data and insights in the most resource-efficient manner possible, we're contributing to minimizing the industry's environmental footprint. This year, we have introduced several initiatives reducing emissions and further enhancing contributions to social development as well as improving the ESG reporting to shareholders as well, or other stakeholders. The efforts have been recognized in The Governance Group's annual ESG ranking, which recently gave TGS an A- rating. The energy transition offers interesting opportunities for TGS, and we see a growing interest for alternative uses of TGS products. The world's largest library of subsurface data, combined with strong competencies in areas such as geoscience, data management, data processing and analytics, position TGS well to contribute with insights related to carbon capture, utilization and storage, CCUS, and offshore mineral exploration as well as to the renewables energy industries. We've already had several product development projects directed towards CCS, renewables and DSM, and the fact is that some of these have already generated revenues for TGS. In the future, our ambition is to capture a greater part of this rapidly growing market that is very complementary to our asset-light business within the more traditional oil and gas market. With that, I want to hand it over to Fredrik Amundsen, who's going to go through our financial slides.

[Fredrik Amundsen, Chief Financial Officer]

Thank you, Kristian. As always, we point out that the implementation of IFRS 15 and the change revenue recognition principles has led TGS to focus on segment reporting. This provides the best picture of the performance and value creation of the business. In our earnings release, we provide 2 sets of accounts, but our focus in this presentation is on segment reporting. With the market conditions that continued to be challenging throughout the quarter, we are pleased to see a 10% growth in late sales quarter-on-quarter. USD 61 million were down 71% compared to Q3 2019 pro forma numbers, which did include significant transfer fees. During Q3, our acquisition activity came down and was focused on mature markets in Norway and Gulf of Mexico, where we generally require lower prefunding levels. Prefunding revenue reported was $17 million. Proprietary revenue accounted for $2.5 million of the sales in the quarter and was focused solely on proprietary imaging services. The total revenue is coming in at 71% below Q3 last year. The operating cost for the quarter was $18 million and includes cost of goods sold. Adjusted for cost of goods sold, which fluctuate based on proprietary activity in each quarter, our personnel and operating expenses was down 64% from Q3 2019. The Q3 2020 figures includes $2 million in severance costs due to a reduction in headcount. This additional cost is offset by a net cost reduction related to our long-term incentive plans. It's also reduced for a downward revision of the expected credit loss and a credit in relation to a favorable settlement of a legal dispute. As Kristian pointed out, we expect our forward run rate to be approximately 40% below the 2019 pro forma figures. Amortization came in at $78 million in Q3, of which $53 million is straight line amortization. Impairments recognized was $8 million, all in relation to our U.S. onshore portfolio. This makes the reported amortization and impairments $86 million for the quarter. Subsequently, the Q3 EBIT comes in at negative USD 28 million. Operational investments in the quarter was $54 million, with an average prefunding of 32%. The prefunding level is influenced by an investment portfolio focused on the mature markets, as mentioned on the previous slide. The income statement show EBITDA of $62.2 million and an operating result of negative $27.9 million. Financial items include an exchange loss of $2.2 million and interest expense of $1 million. The interest expense is largely tied to buildings and equipment leases. The reported net income for the third quarter was negative $25.8 million. As TGS finalized adjustment to the Spectrum purchase price allocation within the 12-month window of acquisition, goodwill increased $3.4 million when comparing Q2 2020 reported to Q3. The adjustments mainly is an effect of changed historic tax balances and is recorded at the time of transaction, August 14, 2019, and the numbers are restated accordingly. Strong cash collection and a reduction in other current assets through Q3 was offset by reduced other current liabilities as acquisition activity scaled down and the company paid revenue share to its partners. Cash flow from operating activities came in at $62 million and free cash flow after investments in the multi-client library was $4.5 million. This compares to a negative $36 million in Q3 2019. After capital expenditure in our imaging business and the quarterly dividend payment, we recognized a net change in cash of negative $19 million for the quarter. With a cash balance of $180 million and a positive free cash flow in one of the most challenging quarters in the company's history, we are delivering on our plan. Based on the strong cash position, the Board has resolved to maintain the dividend of USD 0.125 per share in Q3. The dividend will be paid November 19, and the stock goes ex-dividend November 5. With that, I hand it back to Kristian, who will take you through the management perspectives forward.

[Kristian Kuvaas Johansen, Chief Executive Officer]

Thank you, Fredrik. I will now share some of our views on the outlook for our business and our markets. So first of all, let me state the obvious. COVID continues to cause a lot of uncertainty in the oil markets, and I think that's well illustrated if you look at the production/consumption balance on the left-hand side of this slide. So you see obviously a sharp drop in consumption and demand for oil and gas in Q2 of 2020. And although OPEC makes significant cuts, you still see that production is significantly higher than consumption in Q2. And as a result of that, if you move over to the right-hand side, you see that in Q1 and Q2, you have a significant amount of stock build in the market. Despite the fact that EIA expects there to be some draws on these stocks in Q3 and Q4, you will see that we haven't really reduced the inventories completely that we built up in Q1 and Q2, and inventory levels continue to be high. But we expect -- or EIA expects a more balanced market for 2021, where you see that production and consumption will pretty much follow each other for the next couple of quarters, according to EIA. TGS has a business model with countercyclical qualities. And as you see, in terms of our free cash flow or historical free cash flow on the left-hand side, you see that cash inflow has consistently been higher than cash outflow. And whenever you've seen a drop in inflow, you see a corresponding drop in outflow, which has secured a strong cash flow for many, many years. So again, we have a lean and adjustable cost base. We have an asset-light business model with very few capital commitments, a countercyclical investment philosophy, which means that unit cost of investments are correlated with cycles and let us benefit from the fact that in down cycles, we can actually continue to shoot the same amount of data for a lower dollar value. So again, TGS has a track record of creating robust cash flow under all cyclical conditions that allows for continued dividend payments even during down cycles. And I think 2020 will be similar to previous years. You will see that we're able to cut our outflow quite significantly, as you've seen in this presentation today. And again, that's going to secure a free cash flow, or positive free cash flow, for the future. We are strengthening our cash flow capacity going forward by making significant cuts in terms of our cost base. So the cost and CapEx is basically reset to reflect the market conditions that we're part of right now. We've implemented significant cost-cutting measures, and we'll see a full impact of that from Q4. So the cash OpEx run rate is expected to be, as I said, about 40% lower than the 2019 pro forma and around 30% lower than the last 12 months, where we've already seen, obviously, impacts on -- positive impacts of the cost-cutting that we've done previously in this year. So again, 40% lower than 2019 pro forma and about 30% lower than the last 12 months is what we expect in terms of run rate going forward for TGS. In terms of investment considerations for 2021, obviously, these are still early days. We're in the process of budgeting for 2021. But I think there's a couple of things to be said. First of all, if you look at the graph on the left-hand side of the slide, you see that there's a very strong correlation between multi-client investments or our multi-client investments and 3D vessel day rates. And there is this, obviously, that we -- our philosophy is that we should invest relatively flat in terms of data amounts. So the amount of data that we acquire year-after-year hasn't really changed all that much, but the monetary value of the data has changed quite a bit, and it obviously varies with the 3D vessel rates. So at the peak of the cycle, if you look back on 2012 to 2015, obviously, we paid much more for vessels, and we invested more in terms of dollar value. But the fact that our investment dropped significantly after 2015 is not only due to taking a more cautious stand on new investments, it's partly due to vessel rates coming down to a level of about 50% of the peak. And that's pretty much what you should expect to see in 2021 as well. We are going to benefit from lower vessel day rates, which again is going to lead to lower unit costs. We're going to do more investments through risk share arrangements. As you all know, TGS and Spectrum had great relationships to some of our Chinese suppliers, where we have had strong collaborations in the past, where we share some of the risks. And as a result, our net investment is lower, but we invest the same amount of data through these arrangements. This is something both TGS and Spectrum has done successfully in the past, and you will probably see a more active use of risk share in 2021 as compared to 2020. And then last but not least, I mean, given the current market, you will probably see a more focused investment strategy for TGS. It doesn't mean that we completely stop investing in frontier data, but it means that we are certainly much more concentrated and focused in terms of the geographies that we continue to invest. And that leads me to the 2020 project schedule, and you see that as we planned for and as we communicated to the market after Q1, we had a very heavy investment burden for the first quarter or the first 1.5 quarters. It's a very front-end loaded investment profile for the year. Then we obviously had COVID and we had a drop in the oil price and a more challenging market. And you see how we're able to cut down our capital commitments quite rapidly in late Q1 or early Q2, ending up with 2 projects basically for the summer of this year, which are both very strategic to TGS, it's the Engagement OBN and the Norway AM20. And then you see a few projects that have started since then. We have the airborne survey in Egypt that I talked about earlier today. We're completing the Nigeria SeaSeep later this year. We've also announced an extension or a continued 3D activity in Malvinas in Argentina, and that project is going to start in November. And then we have a few projects that we are still evaluating very closely for either December this year or January next year. So we are certainly going to continue to invest. You will see that even in 2021. We're going to invest quite significant in terms of data amounts. But based on the 3 factors that I just referred to on the previous slide, you will see that the dollar value of these investments will come down. Our backlog is actually turning positive. So we're increasing our backlog with about 4% from Q2 to Q3, so we're at the level of $102 million in backlog. And you see that number is not too far off from what we had in late 2018 and early 2019. So actually, quite a healthy backlog going into Q4 and 2021. So in summary, we had net revenues of about $81 million in Q3, we had late sales totaling $61 million and we had prefunding of about $17.4 million. In addition to that, we had a few million dollars in proprietary revenues. The Q3 2020 cost and CapEx is reset to reflect challenging market conditions. So Q3 2020 personnel and other operational costs are down 64% year-on-year. The forward run rate is reduced by about 40% compared to 2019 pro forma figures. Dividend is maintained at USD 0.125 per share, and this is supported by strong balance sheet and cash-generating capabilities. The weak market conditions are expected to continue into 2021. And obviously, COVID-19 continues to cause uncertainty in all markets. So we are executing on a revised plan developed after Q1. The market has developed pretty much as we expected, and our cost-cutting measures are according to our plan. We have a good plan for how to continue to be cash flow-positive, continue to distribute cash to our shareholders and, at the same time, take advantage of the down cycle, as you've seen from TGS many times before. With that, I would like to thank you for your attention. Hope that you stay healthy and continue to look forward to see you in person as soon as regulations allow us to do so. Thank you very much.