TGS ASA (TGS) Earnings Call Transcript & Summary

Good morning, everyone, and welcome to TGS Q2 2020 earnings release. My name is Kristian Johansen, and I'm the CEO of TGS. With me on this earnings call, I have our CFO, Fredrik Amundsen. Q2 must be one of the most extreme quarters in history, and particularly for companies delivering services to the energy sector. Throughout the quarter, we and our clients have been working remotely for the most parts. Client budgets have been completely scrutinized. At the same time, we've carried out a significant cost-cutting program, where, unfortunately, lot of our colleagues have left the company. I want to express my sincere gratitude for our employees' patience, hard work and understanding during a very challenging period for TGS and the industry. Just a brief reminder to read our forward-looking statement before we go on with the presentation of the Q2 highlights. So Q2 2020 revenues were down 55% year-on-year, obviously, hit by the COVID crisis. As we pre-announced on the sixth business day this quarter, in line with our practice, TGS had net revenues of $96 million in Q2. Negative market conditions caused by COVID-19 and supply side issues among the largest producers, had a significant impact on our revenues, which are down 55% from last year, as I said. However, in light of the crisis and the fact that clients cut discretionary spending to an absolute minimum, we're quite pleased about the late sales revenues this quarter. Although $55 million is extraordinarily low compared to pre-crisis late sales, it actually compares quite well with Q1, when we had $63 million. Secondly, our quarterly dividend is maintained at USD 0.125 per share. Our cash collections in the quarter were strong, and our operational cash flow was close to $100 million. Despite very high investments in the quarter, our cash balance remains about $200 million. This allows us to continue to pay dividend of USD 0.125, which we plan to pay this quarter as well. Number three, further cost efficiency measures implemented. We announced a major cost program after our Q1 earnings. A lot of this has already taken place, and you will see that we're charging our Q2 accounts with close to $30 million in impairments to the multi-client library and about $18.3 million of extraordinary costs related to office closures, severance and other restructuring charges. These extensive cost measures, which includes a 10% to 20% reduction of executive salaries, new salaries for almost the entire workforce and a bonus freeze throughout the organization, put TGS in a unique position with a competitive cost base with lots of flexibility going forward. Challenging market conditions in the short term. Looking at the market, we believe it will continue to be very challenging for the remainder of 2020. While we continue to believe that there will be some year-end standing, the year-on-year comparisons will continue to look extremely challenging. Talking to clients, the 2021 budgets will be highly dependent on the near-term oil price developments. And with the current price of Brent between $43 and $44, we don't plan for a major increase in E&P spending for 2021 either. A lot is obviously dependent on the COVID-19 developments. And I think it's fair to say that short-term visibility has never been lower and short-term uncertainty never been greater for our industry. However, long-term drivers are intact. Growth in exploration required to meet future oil and gas demand. So global demand for oil is expected to reach 100 million barrels per day sometime in early 2021. And most analysts expect demand to remain around the 2019 levels for the next 2 decades. With that outlook and the significant understanding that we're witnessing today, there is a great chance that you will see higher oil prices and increased pressure on exploration activity in the future. This industry will remain critical to serve the needs of a growing population and a large middle class for the foreseeable future. We all need to become more efficient, we all need to reduce our carbon footprints and complying with the regulations for ESG. Exploration for oil and gas will never stop. It will continue to be cyclical, however. Further cost efficiency measures implemented. As I mentioned on the previous slide that we've taken several measures to reduce our cost level in line with the unprecedented market conditions. This slide shows some of the key actions that have been taken. A thorough rightsizing has resulted in a number of employees dropping from close to 700 by Q1 to below 500 today. Part of the exercise has been to trim the organization with fewer management layers and a more efficient operating structure. Secondly, we have not only frozen our bonus payments, we've also taken salary reductions. Executives have taken a temporary reduction of up to 20%, while all employees have taken a minimum of 3% reduction in salaries. Further, we have established a team that review every single vendor contract with aim to reduce scope and costs, and we've already seen the results of this. And finally, the result is that we expect the cost level in Q4, when all the measures are effective of below $22.5 million. This is about 40% lower than Q4 of last year, and we should be well on track to meet the previously communicated cost targets that we announced after Q1. In the next section, I'll cover the operational highlights, talking about some of the major projects that impacted Q2 and 2020. Further, I will touch on a few technology and R&D breakthroughs we've had with our clients quite recently. As you see from this slide, TGS in Q2 had 5 3D seismic vessel, 1 2D vessel, 1 OBN crew, 1 multibeam vessel and 1 land crew in operation. Starting with the Eastern Hemisphere on the right-hand side of the slide, TGS commenced acquisition of the 5,600 square kilometer Atlantic Margin 20 3D multi-client project, offshore north-west Europe. The survey is an extension of the Atlantic Margin seismic programs acquired between 2017 and 2019. In the MSGBC Basin, TGS completed acquisition of a 2,000 square kilometer Senegal NORD OUP 3D multi-client survey. In Nigeria, TGS completed a multibeam portion of the country's first regional multi-client multibeam and seafloor sampling study. Moving to the Western Hemisphere and starting at the bottom with Argentina. The acquisition of the 17,800 square kilometer Malvinas 3D multi-client project in the Malvinas Basin continued during the quarter. In Brazil, TGS in partnership with BGP, completed acquisition of the 3,400 kilometer Potiguar Phase 3 2D multi-client survey. In addition, TGS continued acquisition of the expanded 22,500 square kilometer samples multi-client 3D program. Then in the U.S. Gulf of Mexico, TGS in collaboration with Schlumberger, commenced acquisition of Engagement's second ultra-long offset sparse node project in the Green Canyon area of the U.S. Gulf of Mexico. And then last but not least, onshore North America, TGS completed the acquisition of the 623 square kilometer Kuukpik 3D Phase 2 multi-client survey in the North Slope region of Alaska. Some of the key projects for 2020 are highlighted on the next 2 slides. For Q1 and Q2, we've had 2 vessels operating in the Malvinas Basin in Argentina. The program covers approximately 17,800 square kilometers are prospects captured in the successful offshore round one last year. The Malvinas 3D survey, combined with well data, 2D seismic and interpretation products in the region, position TGS as a leading player in a region with an unmatched data offering. I won't rule out that we will return to Malvinas later in the fall or possibly next year to acquire more data. In Q2, we also completed acquisition of a 17,200 square kilometer of 3D data in the sample spacing in Brazil. This survey designed to evaluate highly prospective presalt acreage in the largely underexplored outer area of the basin is outside the current exclusive economic zone, where blocks are expected to be included for round 17, which is currently scheduled for the first half of 2021. Further to Brazil, we completed acquisition of approximately 14,100 square kilometers in the outer basin of samples. The original survey was designed to provide contiguous 3D coverage for evaluating acreage ahead of successful round 16. Since then, we've seen continued benefits in connection with farm-in farm-out processes and for providing larger regional understanding of this highly prospective area. Moving on in the U.S. Gulf of Mexico, we commenced acquisition of our second sparse node project called Engagement. From the initial results of the first survey we did last year called Amendments, we learned that the combination of ultra-long offsets and full waveform inversion delivers significant imaging uplift in an area characterized by complex geology and multiple salt bodies. We, therefore, believe these 2 surveys mark the start of a series of programs in the U.S. Gulf of Mexico and we're already in advanced discussions with prefunders on additional projects in the Gulf. If we move on, in Norway, we started acquisition of 5,600 square kilometer 3D survey in the Atlantic Margin zone on the Norwegian Sea. This is an extension of our program acquired between 2017 and 2019. And the survey covers ATA acreage as well as open acreage in prospective areas to the west. Finally, we completed the acquisition in Q2 of 632 square kilometer 3D multi-client project in the North Slope region of Alaska. This fully prefunded project adds to TGS 1,600 square kilometer library in this historically productive region. Technology plays an ever-increasing important role in our business. While location of your data continues to be critical and the ability to sell and market the data set is still important, you can't succeed unless you provide multi-client data and the quality of proprietary. Clients want cheaper data, better quality and faster delivery. As a result, TGS has defined imaging quality and reputation is one of the key strategic priorities for the period of 2019 to 2021. A new team headed up by a former processing executive from one of our super major clients have already made significant progress in improving our imaging product. Applying dynamic matching full wave inversion, FWI, on the ultra-long offset data on our OBN surveys in the U.S. GOM has already received great feedback from clients and a number of technical papers are being drafted on the results of these advancements in technology and R&D. The second picture shows SaltNet, which is a software tool that allows interpreters to integrate machine learning to generate quality interpretations in a forward-thinking manner. This is a cutting-edge tool developed by TGS and a step towards drastically reducing cycle time in seismic processing. Last but not least, you may have noticed from social media that TGS has entered into the E&P information business by providing production forecasts, insights and analysis. From a position of the largest owner of well logs and other subsurface data, TGS is uniquely positioned to make a gradual transition from being a pure data provider to an energy information company. Advancements in machine learning and AI technologies will hopefully make this transition even quicker and smoother. With that, I want to hand it over to our CFO, Fredrik Amundsen, who will cover the financial slides of the presentation. Thank you.

Thank you, Kristian. As previously, we point out that the implementation of IFRS 15 and 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 segment reporting. Considering the unprecedented weak market conditions, we are pleased to report multi-client late sales of $55 million for the second quarter. Late sales were down 67% compared to Q2 2019 pro forma numbers, but only $8 million behind Q1 this year. During Q2, we completed several of our projects and can report prefunding revenues of $38 million, $5 million below Q2 2019. Proprietary revenues accounted for a smaller portion of sales in the quarter as we had no proprietary acquisition ongoing and our imaging services largely focused on multi-client library. Total revenue is coming in 55% below Q2 last year. For Q2 2020, TGS reports $48.2 million in nonrecurring items. These items relates to previously announced cost-cutting initiatives and impairment of the library. Routinely, TGS assessed the sales forecast related to our multi-client library, considering changes to each individual survey, carrying a book value. Changes can be general as seen through COVID and subsequent effects on oil price and our clients' near-term spending, but also specific for selected surveys influenced by political change, or the attractiveness of specific regions for our clients. TGS have reviewed its full portfolio and recognized $29.8 million of impairments in Q2. The impairments are specific and focused on Mexico and onshore surveys. In total, the impairments are less than 4% of the book value of the multi-client library. In relation to the completed cost-cutting program, the company recognized $6.8 million in severance costs and accrued for $5.6 million in costs related to office closures. In addition, the company wrote down leases related to closed offices in the amount of $4.4 million. All in all, nonrecurring items related to restructuring totaled $16.8 million. The company also reflected $1.6 million in expected credit loss provision in accordance with IFRS 9 in the second quarter. The severance cost, the onerous contracts and lease impaired -- leases impaired will be paid as they come due. The reported operational cost for the quarter was $26 million, excluding nonrecurring items and is expected to come down further once the cost initiatives takes full quarterly effect from Q3. Amortization is highly influenced by the $30 million in impairments recognized in Q2 as well as the underlying straight-line amortization and totals $130 million for the quarter. Here, the Q2 EBIT comes in negative at 36%, adjusted for nonrecurring items recognized in the quarter. Year-on-year investments are down 41%. However, we are pleased to see significantly stronger prefunding level at 49% of investments versus 33% in Q2 2019. TGS has through the first half of 2020, completed 66% of its guided annual investments of $325 million. The unadjusted income statement shows EBITDA of $56.3 million and an operating result of negative $83.6 million. Financial items include an exchange loss of $6.6 million, largely related to currency exposure in Brazil and tax positions in Norway. The reported net income for the second quarter was negative $73.6 million. Strong cash collections towards the end of Q2 reduced other current assets quarter-on-quarter. This was partly offset by an increase in unbilled revenue booked to the same line item. Unbilled revenues are revenues recognized on a percentage of completion basis and invoiced at specific milestones in each individual project. These revenues will be collected over the next quarters as projects are completed. As mentioned, we had a strong cash collection in Q2, which provided a good cash flow from operating activities of close to $100 million. With significant tailwind payments for our investments and a relatively high level of cash investments in hardware for our processing business, net change in cash was negative $50 million. As the majority of cash outflow related to our investing activities is behind us, we believe that the cash balance will remain around current levels, even if the challenging market prevails. Based on the strong cash position, the Board has resolved to maintain the dividend of USD 0.125 per share in Q3 2020. The dividend will be paid August 13 and the stock goes ex-dividend, July 30. With that, I hand it back to Kristian, who will take you through the management perspective forward.

Thanks, Fredrik. As mentioned previously, the short-term outlook is characterized by low visibility and highly dependent on the further development of COVID-19, actions of OPEC and, of course, the price of oil. The long-term outlook hasn't really changed that much. And EIA continues to believe that we will quickly get back to a level of 100 million barrels per day and thereafter, stay flat or slightly increase over the next 2 decades. So let's start with the short-term outlook and then get back to some of the key drivers and make us convinced that this industry remains attractive for our key stakeholders, such as investors, employees, suppliers, customers and even governments. As I said, the market -- the near-term market is very challenging. The following bar chart illustrates the market. On average, E&P companies have revised their 2020 budgets down by 25%, leading to a 26% reduction relative to 2019. Discretionary or so-called uncommitted spending is down significantly more than overall spending. As you know, exploration spending could sometimes be classified as discretionary spending and seismic is perhaps the most discretionary of them all. Most planned near-term seismic purchases have therefore been put on hold for now. The majority of licensing is related to obligations related to block awards and potentially farm-in and farm-outs. Longer term, we clearly see a more balanced market. The graph on the left-hand side shows that consumption in Q2 dropped to below 85 million barrels a day. This is the lowest level we've seen in more than a decade, and it obviously puts a tremendous pressure on the oil price. The good news is that Q3 is expected to be back at the Q1 level. Before we expect to hit that 100 million-barrel threshold by summer of 2021, as you see from the graph. This is actually in line with the pre-COVID levels. Global oil supply has been scaled down significantly with a time lag of about 2 to 3 months versus consumption. Supply is expected to recover at a slower pace and demand resulting in a more balanced market going forward according to EIA. As you see on the bar chart on the right-hand side of the slide, after 2 quarters of record high stock build, EIA expects 6 consecutive quarters of stock draw, which is obviously very positive for the balance and the future price of oil. A few weeks ago, Wood Mackenzie posted a report called the future of exploration in a low-carbon world, where the conclusion is that more oil and gas resources are needed to meet future demand. That's the heading on the slide says. The chart on the left-hand side shows 3 different scenarios, each categorized by a color, blue, green and gray. The blue area shows the amount of oil that can be supplied by existing fields already in production. This is basically the decline rate, which is expected to be around 8% per year for oil and 6% for gas as you see on the right-hand side. The green area shows the supply gap, if we were to base demand expectations on the 2-degree scenario. The gap here would be around 50 million barrels per day in 2040 of additional supply needed. However, Wood Mac and quite a few other analysts don't believe that the 2-degree scenario is very realistic. And they have created their own scenario, which is broadly consistent with a 3-degree global warming view. This is a gray color. Under this scenario, the supply gap will be around 95 million barrels per day, which is higher than the production year-to-date of 2020. On the right-hand side, you see the same analysis for gas, and it shows a very similar outlook. So the conclusion is that even when taking the most optimistic energy transition scenarios into account, substantial amounts of new oil and gas production are required for meeting demand and compensating for the current decline. Some of you will probably say that this is well known, but there is still a lot of oil and gas already discovered that has, for different reasons, not reached the production stage. So why would companies continue to explore? The next slide will tell you why. The bar chart shows a point forward cost of oil and gas supply by development status. The gray is for gas and the blue is for oil. As expected, the point forward cost of proven developed resources are by far the lowest. This is quite obvious. However, if you look at the other categories such as onstream, incremental, oil and gas under developments, and PFD, oil and gas, you'll see that oil and gas exploration is actually very competitive. The reason is that the alternatives have higher development costs. Explorers, on average, find better resources than the legacy assets that still await developments. To simplify that, you could say, these assets have been undeveloped for a reason. They're too expensive. Going over to our project schedule for 2020. You see it's quite similar to what we presented after Q1, and we told the market at the time that we will take a kind of a wait and see approach to see how the market develops in line with the COVID statistics. So you see that for Q3, we're going to be active continuing our engagement survey, OBN survey in the U.S. Gulf of Mexico, which I have talked about today. We're also going to be active in the Atlantic Margin in the Norwegian Sea of Norway, you will see we're going to have a vessel in July and August. Other than that, we're going to have a CCA program with a coring part of the program. It's going to take place in August and September. That's pretty much what we have planned for Q3. And for Q4, as you also saw after Q1, we don't have any activity planned. It doesn't mean that we're not going to do anything in Q4. In fact, we have already talked about plans of perhaps going back to Argentina, either in Q4 this year or Q1 next year. That's quite likely that we will do. We're also in discussions with clients on both onshore and offshore projects starting sometime in late Q3 or early Q4 and will have an impact on Q4. So for those of you who look at this project schedule and compare to our investment guidance for the year, I can confirm that if we don't do anything more than what we have on this slide, will probably fall short of the $325 million investment guidance, but we think there will be more projects coming on board in Q4. So we still think that we're going to meet our investment guidance for 2020. That brings me to the backlog. And you see, as expected, the backlog is down in Q2. And if you look at Q2 compared to Q4 of last year and Q1 is quite a significant drop. It doesn't really worry us too much. I mean we -- as I said, we were still in discussions with our clients on projects that could possibly start in Q4 or early next year. And secondly, if you look at this in a historical perspective, look back on Q2 of 2018, where we only had $86 million of backlog, we still had pretty high investments for the remainder of 2018 and for 2019 as well. We're not too concerned about that, and we think that over time, we will continue to build backlog in line with an expected improvement of the market in general. So in summary, our Q2 2020 revenues were down 55% year-on-year, hit by COVID crisis. But again, if you look at the numbers and if you look at the quality of the sales, we're actually quite pleased about our late sales in Q2 that were nearly as good as they were pre-COVID for Q1 this year. Cash-generating capabilities allow us for a dividend or the dividend to be maintained at USD 0.125 per share. We have further cost efficiency measures implemented. So we think that in Q4, you will see the full impact of all the cost-cutting programs that we have been busy carrying out in Q2 and possibly part of Q3 as well. We see a very challenging market condition in the short term. We think that's going to last for -- certainly for the next quarter or 2, but then the long-term drivers are still not really changed all that much. We see a growth in exploration is required to meet future oil and gas demand. So with that, I want to thank you very much for your attention today, and I hope to see you again soon, physically, sometime in Q3. Thank you very much.