Good morning, and welcome to the Oil States International Second Quarter 2019 Earnings Conference Call. My name is Dinara, and I will be the operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions]. Please note that this conference is being recorded.

I will now turn the call over to Ms. Patricia Gil, Investor Relations. Patricia, you may begin..

Thank you, Dinara, and good morning and welcome to Oil States' second quarter 2019 earnings conference call.

Our call today will be led by Cindy Taylor, Oil States' President and Chief Executive Officer; Lloyd Hajdik, Oil States' Executive Vice President and Chief Financial Officer; and we are joined by Chris Cragg, Oil States’ Executive Vice President, Operations. Before we begin, we would like to caution listeners regarding forward-looking statements.

To the extent that our remarks today contain information other than historical information, please note that we are relying on the Safe Harbor protections afforded by federal law.

Any such remarks should be weighed in the context of the many factors that affect our business, including those risks disclosed in our Form 10-K along with other SEC filings. This call is being webcast and can be accessed at Oil States' Web site.

And a replay of the conference call will be available one and a half hours after the completion of the call and will be available for one month. I will now turn the call over to Cindy..

Thank you, Patricia. Good morning to all of you and thank you for joining us today to participate in our second quarter 2019 earnings conference call. Our reported results for the second quarter showed sequential improvements in two of our three business segments with consolidated revenues and EBITDA up 6% and 24%, respectively.

In particular, our Offshore/Manufactured Product segment was a stand-out in the quarter, exceeding the upper end of our previously provided revenue and EBITDA margin guidance ranges.

In addition, we received two notable project awards during the second quarter leading to a 21% sequential increase in backlog which totaled $283 million at June 30th resulting in a 1.6x book-to-bill ratio for the quarter. Our June 30, 2019 backlog level is the highest it’s been in three years.

In our Well Site Services segment, revenues increased 7% sequentially due to stronger international activity levels in our Completion Services business coupled with some recovery in our land drilling operations.

In our Downhole Technologies segment, results for the quarter were negatively impacted by the ongoing development of our integrated perforating gun system, the costs of field trials and $1.4 million of inventory write-offs due to product design changes. Our cash flow from operations in the quarter was strong at $32 million.

A portion of that cash flow was used to repay $21 million of our revolving credit facility debt outstanding. Lloyd will take you through additional details of our consolidated results and also provide highlights regarding our financial position.

I will follow with more details by segment and provide additional comments on our guidance and market outlook..

Thanks, Cindy, and good morning, everyone. During the second quarter, we generated revenues of $265 million, while reporting a net loss of $10 million or $0.16 per share. Our second quarter EBITDA totaled 26 million with an EBITDA margin percentage of 10%.

Reported EBITDA was negatively impacted by 1.3 million of severance and facility closure charges as we continue to adjust our cost structure and right-size our global operations to better align with the industry outlook.

We also reported 1.4 million of inventory write-offs due to product design changes associated with the continued development of our integrated perforating gun system. During the second quarter, we generated $32 million in cash flow from operations and invested $14 million in capital expenditures.

On a year-to-date June 30 basis, we have generated $34 million of free cash flow and have paid down $37 million in outstanding borrowings under our revolving credit facility.

At June 30, our net debt-to-book capitalization ratio was 17% and our available liquidity position at the end of the second quarter was approximately 108 million, inclusive of cash on hand totaling 12 million. Regarding our common stock share repurchase program, our Board of Directors extended the program for one year to July 29, 2020.

We have $120 million remaining available under the repurchase authorization. In terms of our third quarter 2019 consolidated guidance, we expect depreciation and amortization expense to 32 million. Further, we expect net interest expense to total 4.8 million and corporate expenses are projected to total 12 million.

We are lowering our total capital expenditures for the full year 2019 to range between 60 million and 65 million compared to prior guidance of 65 million to 70 million. At this time, I’d like to turn the call back over to Cindy who will take you through the details for each of our business segments..

Thank you, Lloyd. Leading off with our Offshore/Manufactured Products segment, we generated revenues of $102 million, EBITDA of $16 million and a segment EBITDA margin of 16% during the second quarter. This represented a 16% sequential increase in segment revenues and a 45% sequential increase in segment EBITDA.

Our improved results were driven by an increase in project-driven revenue and short-cycle product sales, coupled with improved facility cost absorption at the higher revenue levels. Our incremental EBITDA margins were strong at 35% as a result.

As I mentioned in my introductory comments, we received two notable project awards during the second quarter of 2019, which included production facility equipment destined for Southeast Asia and connector products destined for the Middle East.

Our orders booked in the quarter totaled $163 million resulting in a 21% sequential increase in backlog and a book-to-bill ratio of 1.6x. At June 30th, our backlog totaled $282 million which is our highest reported backlog since June 30, 2016.

Customer conversations remained constructive and visibility for additional project awards is developing favorably as we progress into the second half of 2019 and into 2020.

In our Well Site Services segment, we generated $116 million of revenues, $18 million of EBITDA and our segment EBITDA margin averaged 16% in the second quarter 2019 compared to 12% reported in the preceding quarter. These results benefitted both from higher international activity and improved margins in our U.S. operations.

Utilization of our land drilling rigs averaged 20% in the second quarter of 2019 compared to 12% in the earlier quarter. In our completion services business, our revenues grew 3% sequentially which was driven primarily by international activity.

Our incremental completion services EBITDA margins were 119%, sequentially reflecting our cost reduction initiative and an improved mix of international and Gulf of Mexico work.

Over time, we believe that completions-related activity in international markets will continue to grow and we are proactively expanding our completion services offerings abroad.

In addition to growing internationally, we are focused on research and development efforts within the completion services business and are currently developing step-out technology offerings responsive to customers’ needs. By continuing to invest in our product lines that are tied to well completions and longer lateral length in U.S.

unconventional, we are able to maintain a leadership role in the equipment and services that we offer to the industry. One such product line that is pushing the limits of completions technology is our Tempress HydroPull Tool and Bottom Hole Assembly which holds the record in West Texas where it mills out 94 frac plugs in a single coiled tubing run.

All 94 plugs were milled out in 66 hours without tripping out of the hole and without short trip resulting in significant well cost savings for our customers. In our Downhole Technologies segment, we generated revenues of $47 million and EBITDA of $4 million with an EBITDA margin of 8% reported in the second quarter.

In addition to the impact of the sequential decline in revenues during the quarter, segment results were negatively impacted by ongoing unabsorbed costs associated with field trials for our integrated gun system coupled with $1.4 million of inventory write-offs due to product design changes.

These design changes are considered one-off items and part of the field trialing, testing and development of new products. As trialed products are brought to market, our technical solutions group will become more billable and should generate revenues sufficient to offset their costs.

We expect to recover market share and sales in our engineered perforating solutions business once our proprietary integrated gun system is fully commercialized. Field testing and early commercialization efforts continue on our integrated gun system, addressable switches and other associated Downhole tools.

Delays are inherent in bringing technologically advanced products to market. We continue to incorporate key field trial learnings to improve the ultimate integrated gun system, which we plan to commercialize in the fourth quarter. This is a one quarter delay due to product design changes.

I would now like to share thoughts on our outlook for the third quarter. We expect to continue to show sequential growth in the third quarter despite a North American land market that is expected to be slightly down.

The majority of our revenue and EBITDA growth in the third quarter is expected to be generated by our Offshore/Manufactured Products and Downhole Technologies segments.

In our Offshore/Manufactured Products segment, we are forecasting that third quarter revenues for the segment will range between $100 million and $110 million buoyed by a higher starting backlog level which will begin to convert into greater major project revenues along with improved demand for our short-cycle products.

Segment EBITDA margins are expected to average 15% to 17% depending on product and service mix. We estimate that third quarter 2019 revenues for our Well Site Services segment should range between $114 million and $121 million with segment EBITDA margins expected to average 15% to 17%.

For our Downhole Technologies segment, we currently estimate that our revenues will range between $46 million and $52 million with segment EBITDA margins averaging 14% to 17%.

To conclude, we continue to invest in research and development efforts across all of our business segments in an effort to bring efficiencies to the industry and to our customers, while modestly increasing expectations for the third quarter compared to the second quarter, carefully controlling our costs and continuing to generate positive free cash flow, we strive to generate sustained returns for our stockholders in a challenging market environment.

Before we close, I would like to highlight what I see as the near-term drivers of improvement for Oil States. First, expanding backlog in our Offshore/Manufactured Products segment provides revenue visibility into the future.

Also by generating a higher baseline of revenues in the segment, we are better able to absorb our costs and deliver improved margins. Second, international contributions will become increasingly important to each of our segments in the months and years to come.

We are positioning our operations to capture incremental revenue outside of the United States. Third, we need to recover market share in our Downhole Technologies perforating business and we are focused on doing so.

Lastly, we have been a technology leader within our industry for years and continue to invest in research, development and new product initiatives. These initiatives span multiple product lines and should bear rewards over the longer term. That completes our prepared comments. Dinara, would you open up the call for questions and answers at this time..

Yes, absolutely. Thank you. We will now begin the question-and-answer session. [Operator Instructions]. Our first question comes from Marshall Adkins from Raymond James. Please go ahead. Your line is open..

Good morning, Cindy and guys. So it seems like on this Offshore theme, we have – we’re setting up for kind of a sustained ability to grow in a relatively flat commodity price. We’ve heard from the bigger guys that they’re looking at Offshore and international continuing to grow for the next couple of years.

Is that what’s feeding the improvement in this business? Number one.

Number two, could you talk about the margin improvement via pricing versus absorption?.

Yes. Good morning, Marshall, and thanks for your questions. I think they’re absolutely great ones.

I think you know if you just kind of track the industry right now, we’ve spent three to four years of customers kind of derisking their CapEx investment dollars and that created a shift away from deepwater activity that customers really tried to high grade their project, rebid projects and lower their overall completed costs of a project in order to respond to lower commodity prices which most people believe will sustain themselves at some level over the course of time.

I think what’s really happening right now is customers have landed on key projects that they think are very economic at lower commodity prices and those are now beginning to come to market.

And we’ve always enjoyed high technology positioning and proprietary products that we’ve always felt if we could just get a little bit of tailwinds from improving activity that we do pretty well. And I think that is clearly reflected in our backlog which is up to a three-year high at least.

We’re not forecasting we go back to peak levels we attained in 2014. But over the course of that three to four years we’ve also had to be responsive in terms of repositioning manufacturing capacity to capture near-term demand. We’ve brought some newer products to market that are a little more land sensitive.

The good thing is we have those in our suite now and we’re enjoying improvements in backlog more centered towards our major project work, which, again, gives us visibility at least for about 12 months in terms of revenue generation and important for us cost absorption. Like many companies we haven’t sat around and waited for the market to return.

We’ve done a lot of cost rationalization, facility streamlining such that we feel like as the market does recover our margins should be resilient and respond to that.

And I think we’re already seeing that with the 35% sequential incremental that we had in Offshore products even though this is fairly early days in terms of backlog build and revenue generation.

So I clearly feel like we do have a runway for improved, sustained higher revenues that are cost absorption, better margins as we continue to build out that backlog. But again, we do hope that we retain that base load of short-cycle work and service work as well..

So you’re making it sound like a lot of the improvement in margins is through better absorption, but you have some of these new products.

Are you getting any pricing traction at all there or is it just all absorption?.

Well, to be honest with you we’re continuing and we have every year to invest in research and development efforts. We’ve had many kind of costs – and I’m speaking specifically to Offshore products. This permeates every segment and every business really.

But as it relates to Offshore products, we’ve had new product introductions but most of our backlog development to date has been existing technology even though we may have upgraded that existing technology, I would say any kind of new product deliveries that we’ve been working on is yet to bear fruit..

Okay. Thank you..

Thanks, Marshall..

Thank you. Our next question comes from Ian Macpherson from Simmons. Please go ahead. Your line is open..

Yes. Thanks. Cindy, I think you were looking for 1.3 to 1.5 book-to-bill for products coming into the year, you’re well ahead of that. And you mentioned that you have positive visibility for orders in the second half as well.

Would you be willing to share an updated target based on the visibility with second half or is it too early?.

It’s always worrisome to know what quarter backlog awards hit, but I would just generally say we would probably take out the low end of that range and up it just a little bit. I don’t want to go to 1.6 at this time, so maybe 1.4 to 1.5. But clearly biased to the upside based on the first half.

I would say book-to-bill is a factor of two things which are bookings and billings and if I keep growing my revenue, the target obviously moves up as well..

Yes, sure. On Downhole, that was the one thing that was kind of well outside of expectations at the low end in the second quarter and now that you see a pathway towards normalization.

But besides – you’ve talked about the under absorption and the write-downs issues in the margin side, but with the revenues down 25% sequentially in the second quarter, what else was at play besides this slow role with the commercialization of the integrated gun? Is there pricing pressure that is showing up or do you think it was just market share within the quarter that you think you can recapture?.

Yes, that’s the tough thing. There’s a number of things and the Downhole side of the market is changing rapidly in response to what customers are looking for at the well site. I’m pretty sure you’ve heard that from all the competitors in this space throughout the first half of this year, but maybe more particularly on second quarter conference calls.

With that, as an example, we’ve all moved from long guns to short guns. And so the short guns, everybody’s talking about. Most of the key third-party competitors are offering that including well sites. But with that means you have to lighten up on the long gun inventory you have at reduced pricing.

So part of that is yes, that’s all about pricing at the end of the day. It’s also responding and staying ahead of market technology changes that even my mix of customers has changed. And so there is some good things in the sense that we have high quality technology.

We’ve been a market leader on technology along this space and I clearly think that we can keep up or stay ahead of those changes in the market.

But all those things you mentioned have a factor, but I’d still probably point to a couple of things which is number one, the market changes around perforating systems moving more from individual product sales to more system sales and the fact that we’re working on what we think will be one of the best solutions for the market.

But that doesn’t always work perfectly as I’ve communicated to investors before. But the good thing is, our field trials are progressively improving. We did make some design changes along the way. It did lead to a large write-off of inventory that we had build up in order to conduct an appropriate level of field trials.

But again, I view that as kind of a one-off item. The other thing is just kind of the customer base and you’ve got E&Ps contracting directly. Sometimes we work with wireline companies. There’s certain amounts of vertical integration going on in the market. So we have to pivot just a little bit around that shift in customer mix.

And they all kind of on the margin have some impact. But I guess I would just like to leave all of you with a thought. Number one, this is key technology that our customers want. We are very committed to delivering top end technology to our customers. Right now, the whole segment is 18% of my revenue base.

And so while I am very focused on bringing a top quality integrated gun to market, it’s certainly not all about what this company is build upon. And even the segment has many product lines not just obviously the integrated gun..

That’s helpful. Thanks.

And did I hear you say before that the commercial ramp is now Q4 and not Q3 for the integrated --?.

Yes. We believe though – and in addition to we’ve had multiple top customer contacts and feedbacks about our systems and we are just cautious that we want it to be a very high performing system before we bring it to commercial sales obviously. I do think that the process we went through delayed us about a quarter..

Okay. Thank you..

And maybe I should add a point of emphasis on that. We don’t have any revenue in our third quarter guidance that is predicated on an integrated gun..

Got it..

Thank you. Our next question comes from Cole Sullivan from Wells Fargo. Please go ahead. Your line is open..

Hi. Good morning..

Hi, Cole..

You guys mentioned growing more internationally in completion services. I’m assuming that meant that you see the need to achieve that.

And then does that impact or bias [ph] higher any 2020 CapEx levels to get that versus '19?.

What we’re really doing is not that CapEx intensive. We’re working with some partners on various regions as opposed to spending a lot of CapEx for on-the-ground facilities. We’ve been in many of these markets really working on consigned equipment and rotating personnel basis.

We are finding improved go-to-market strategies and we’re also beginning to leverage some of our tools that have not really been deeply penetrated in international markets. So as Lloyd mentioned, we’re actually modestly reducing our CapEx guidance range as opposed to increasing it.

And as I commented in my notes, part of Well Sites significant success in terms of incremental margins was largely associated with a better mix of international and Gulf of Mexico work relative to our very key base North American activity..

Okay. And you guys have had good strong free cash flow this year.

With the movements in Downhole tools with the back half and North American headwinds, how do you kind of see working capital trending over the second half? And then also any kind of initial peak into how you guys are thinking about 2020 CapEx versus '19?.

Yes, I’m going to let Lloyd give you specific comments there. I would just generally say that if we have ebbs and flows, it’s generally around mix of segmental contribution towards working capital.

Now what does that mean? Well, I have a 1.6x book-to-bill ratio, so I fully expect as Offshore products begin to increase top line revenues you’ll have some working capital needs with that.

But I’ll also leave you with the thought that makes me as happy as I can be because that segment happens to be my highest free cash flow generating business that I have. And so if I have a little working capital over time if we expand that business, I’m fine with that. But I’m going to leave Lloyd to really answer your question..

Yes, I think she did answer the question and exactly. No, I’m forecasting a slight working capital build in third and fourth quarter and certainly expect to be free cash flow positive for the second half of the year. And we’ll target the free cash flow like we did in the first half of the year largely designated to further debt reductions..

Okay.

And then any initial kind of peak on 2020 CapEx levels off '19?.

Not yet..

Okay. Thanks. I’ll turn it back..

Thank you. Our next question comes from George O’Leary from Tudor, Pickering, Holt. Please go ahead. Your line is open..

Good morning, Cindy, Lloyd and Chris..

Hi, George..

Good morning..

First question, just curious, it seems like overall completion activity in the U.S. for the second quarter was up modestly, albeit tailing off at the end of the quarter.

So just what we’ve seen from other folks who have perforation businesses and they’re selling similar tools to what you guys sell? Generally it seemed like volumes were lower in the quarter and not even just thinking about someone taking share, but just volumes for perforations for guns and energetics and all that stuff seem to have been a little bit lower.

So just curious, do you guys typically see customers if they’re going to slow activity, kind of destock their own internal inventory? Was that part of what was playing out this quarter or is it really just share gains by one player or another, someone kind of pushing more aggressively into the market? Just curious how customers behave as completions activity it looks like it may have lowered in that business?.

Yes, I’m going to just kind of say we had a mixed result there with some share gains in non-perforating product lines because I think it really focused solely on perforating. But if I look at some of our other product lines, whether it’s downhole plugs, as an example, toe valves, decommissioning products, there actually were some increases there.

So I wouldn’t just isolate on perforating. And I really don’t think that customers hold a lot of inventory perforating. It could be that all of us have some out in distribution channels or some out on the field. But I don’t think that inventory stocking or destocking is really an item there.

I’d have to say if there’s some kind of modest industry kind of delay, it’s probably one customer specific -- [Technical Difficulty].

Cindy?.

This is the conference operator. Please stand by. This is the conference operator. We are having some technical difficulties. Please stand by. Thank you for your patience..

George?.

I don’t know if he’s still on..

Would you like me to go on to the next question?.

That would be great. We apologize to everybody on the phone call. Every phone line apparently has gone down..

Not a problem. Our next question comes from Kurt Hallead from RBC. Please go ahead. Your line is open..

Hi. Good morning..

Hi, Kurt..

Thank you for all the color you have provided so far, Cindy. And I guess the follow-up question I have would be along the lines of the North American market. It’s pretty clear that the Offshore business has some pretty good momentum as does international and clearly a lot of question marks around the shipping dynamics in the North American market..

Yes..

As we move beyond let’s just say the third quarter, Cindy, and we start just thinking kind of through cycle dynamics.

Do you see some really structural changes in place and how you guys are going to have to run your business and the overall cost structure of the business? And when you’re having conversations about bringing on new technology, like you already mentioned, is this discussion with the client base going to have to be a little bit different to make sure that you actually get compensated for the technology you’re bringing? Any insights on that would be really helpful?.

No. Kurt, those are just fantastic questions and we’re not alone obviously and doing everything that we can to respond to what I’ll just characterize as a fairly challenging market environment. And we’ve all probably benefitted and also been guilty here. When crude prices are really high, customers stand fairly at will trying to grow production.

I always say it’s one of the greatest success stories in the United States in terms of crude oil production. But the reality is I think we as an industry have been so successful to some degree that we’ve gotten ahead of ourselves just in terms of productivity.

And I know you know, you followed the industry as long as I’ve been in it that what’s really happened is growth in U.S. production has exceeded global demand and it has created an out of balance situation and fairly small movements in terms of that supply/demand balance obviously have a significant impact on price.

Whether it’s us or our customers, I’ll just say we’ve got religion and what does that mean? Shareholders have had significant underperformance from the industry as a whole now for a number of years and we’re all committed to making this work at lower crude oil prices overall and I think we’ve demonstrated technical capabilities to do that.

But to answer your question, it’s multifaceted. But number one, we think of R&D investments much like CapEx, meaning you need to budget it precisely, you need to know that target market and you need to access it to see if you’d achieve the returns that you expected it too. We don’t want to stop investing in technology.

That has been our differentiator as a company for well before I was associated with it. And so we will continue to do that. But clearly we do look for a payback on those investments. I would say the other kind of characteristic you’re hearing from everybody is we probably ought to be targeting CapEx for what I’ll call mid-cycle activity.

We tend to always target CapEx towards the peak and on paper it looks like a great return. But when you have the extreme cycles that we had to live with over the years, I think you have to question did you really get the returns that you thought you would.

But I challenge any business to lose 50% to 80% of the revenue as this industry has done from '14 to '16 and now recovering off of that and say that you came out unscathed. But we as a company have been constantly streamlining our cost structure, facility rationalization for all of our segments frankly geared towards mid-cycle returns.

We are investing in higher technology when it helps our customers be more efficient, make more better wells and therefore become more cash flow generating on their own. They have to be healthy for us to be healthy at the end of the day.

So again, I’d say the other macro shift that we’ve been frustrated with when you leave a real differentiated market that is deepwater, highly technical, highly challenging, to some degree international and shift all the activity to land, it is more competitive and particularly you’ve got 50% of the land rig count in one – it’s a big basin but one basin in the United States, it’s not the best profile but we’ve responded to it and we’re coming out of it and I think generating the sustained free cash flow that you would want us to.

I do also think that some of the private equity participation in this market is going to wane which is a frustration to us. It’s always been having the technical capabilities, the reputation, the quality procedures and yet having customers freely give money to what I’ll call lower end piggyback startups in a given basin has been frustrating.

So I think we’d like to see firmer competitor characteristics in the market and I think our customers still – they have plenty of support out in the market and of course they’re taking advantage of it through price negotiation.

But I think they also recognize that the industry as a whole has to be healthy and generating sustainable ROIC for anybody to do well. So while it’s been painful for many, I clearly think that the trend line in terms of what you call sustainable improvement is underway..

That’s really thoughtful and expansive answer, Cindy. I know business dynamics are challenging, not in terms of what you’re facing but obviously what investors are thinking as well. So I appreciate all that color and insight. Thank you..

Thank you, Kurt..

Thank you. Our next question comes from Stephen Gengaro from Stifel. Please go ahead. Your line is open..

Thanks and good morning, everybody. Two things if you don’t mind, I guess I’ll start with Offshore and you obviously you had a really good quarter and I might have missed this earlier.

But when you’re looking out now for the next few quarters and I guess also the bookings in the quarter, how does the pricing structure look like in that business and how should we be thinking about the potential order flow/book-to-bill as we go forward here for the next few quarters?.

Well, this is obviously in contrast to our Well Sites Services segment. There’s a greater material content, obviously, in our Offshore/Manufactured Products segment. To some degree, these are all specifically engineered projects. We do all of those material specs well in advance, lock in prices.

And I have been – well, I think we’ve been capable and successful in bringing cost down to operators. It’s really not at the expense of margins. There are clearly times when we’ve done some internal reengineering of our product that bring down pricing for us and therefore for our customers as well.

We had to do that obviously to be responsive to the market. But our margins hold in that scenario. So I just haven’t felt like we had to go out and buy backlog is the genesis of the question..

It was more – I wasn’t implying that at all. I was just sort of thinking about your margins have advanced Offshore products, you won a lot of work. Obviously, activity seems to be improving.

I was just curious how we think about the margin trajectory going forward?.

Well, again, our incrementals were strong at 35%. I think our overall margins for the segment came in at 16%. Earlier in the year we had guided exit rate in the high teens. And so it just kind of tells me we are a little bit ahead of the game in terms of achieving that with 16% coming in, in the second quarter.

So pretty happy about the progression there. The other thing I’ll just similarly say is top line matters. When we’re below $100 million of revenue in a quarter, cost absorption is not exactly where we would have it be. But if we can continue to accelerate that top line, we believe our margins will respond accordingly..

Great. Thank you. And then as a follow up, what I’ve heard in the field over the years was that the geodynamics Downhole ballistics were at the very high end of the spectrum. And obviously the market’s moving to the integrated systems. But as you get there – as you get a product rolled out, it would seem that you’d start to see pretty good traction.

And I was just curious, is it really the delivery system and the integrated system that critical even with what – I’ve always perceived to be kind of initially leading or certainly at the very high end of this spectrum as far as the Downhole ballistics are concerned?.

Well, yes. First of all, I would just generally say that we and others would agree that we do think that the shape charges are very, very important in terms of response to this downhole and we do believe we are a leader with respect to our shape charge technology. So I’m going to agree with that. We do still sell those.

We sell guns into the [indiscernible] charges individually and a lot of the other associated perforating equipment. And you’ve heard it wholeheartedly from majors to our more direct competitors though that the field delivery system preference is more of an integrated gun basis.

But I’ll tell you and Stephen I know you’ve done extensive research on this and understand it, there is great variety in what the industry is characterizing as an integrated gun system. And there are some commonalities in terms of what people are speaking of, but there are differences as well and I think that’s where we are.

We’re trying to not only offer kind of generic integrated gun system but improve upon what the market is looking for. And that’s where we’ve had some technical challenges during the quarter that we’re working on.

But if you just want to say what does the integrated gun mean? You’re going to focus on the characteristics of it being intrinsic on the site offering at the Well Sites factory loaded with little to no wiring on location.

That’s a pretty broad spectrum though of capabilities and characteristics of the gun and there are many other things that go along with it. But to summarize, market is generally – I’m going to use the word generally in telling you they want more of an integrated offering.

But in contrast if you have a wireline company who’s already invested in gun loaders and gun loaded facilities, their product specification needs may differ from an operator that just wants a fully delivered, highly integrated system that performs the best in the market.

And so it may be that the market evolved around kind of versions of an integrated gun system. And again, with the research you’ve already done I think you appreciate and understand that..

Great. That’s very helpful. Thank you..

Thank you..

Thank you. Our next question comes from Sean Meakim from JPMorgan. Please go ahead. Your line is open..

Thank you. Good morning..

Good morning, Sean..

So I appreciate the commentary on the top line for Downhole. That was probably my biggest question out of the release, so thank you for that feedback.

As we look to 3Q and the guidance that you put out, can you just talk about how you built that range and your comfort level? Given all the moving pieces in the power system market as well as the generally broader uncertainty in North American activity as we get through 3Q?.

Are you speaking to a specific segment?.

Yes, sorry. So the Downhole top line in the second quarter was the biggest question I think out of the release this morning. You gave a lot of feedback on that and I appreciate some of the moving pieces in the second quarter.

I was hoping to then maybe unpack how you’ve built a range for your top line guidance for Downhole in the third quarter given all those moving parts within the processing business or that market as well as there’s plenty of uncertainty just in terms of how activity is going to trend through the quarter in North America.

So I was hoping to get more detail there please..

Okay. I will certainly do that. And we gave you a range obviously and the low end of that range is kind of non-heroic, I will call it. The upper end of the range would suggest pretty good movement from where we were in Q2. And I would really focus on kind of three things that impact both revenues and margins.

Number one, we continue to think we’re growing market share in some of our non-perforating product lines. And so we’ve got some embedded growth. And this is really – you can say that that’s not just to hope for. Where we are right now is having customers come in and lineup products early in the quarter.

Now does that mean that’s sustained through the quarter? No, but we believe that some of our non-perforating revenues will grow sequentially Q2 to Q3 even if the North American market softens a bit and that’s based on customer indications early in the quarter. That’s number one.

Number two, I keep mentioning this technical solutions group that has been a significant unabsorbed cost throughout the first half of this year and this is more – obviously, it’s a bit of top line but it has more margins and locations that if we can get a little better absorption of costs associated with that technical solutions group, still obviously improved our margins profile which again we got it to better margins.

Clearly, the non-recurrence of a 1.4 million write-off are product design, changed inventory benefits margin. And then the last thing that I probably should have mentioned in the course of doing the development of the integrated gun system, obviously, part of that is the development of integrated switch.

And so we do think we will bring that switch to market individually as a product with beginning revenue in Q3. So those are kind of the three major elements that lead to improved sequential margins for Downhole. And suffice it to say none of us were satisfied with the second quarter for the Downhole Technologies segment.

We were highly focused on improving performance in that segment. Those are kind of the three major areas really in addition to some improved manufacturing cost efficiencies as well..

Thank you for that. That was very helpful. That’s exactly what I was looking to understand. In Offshore/Manufactured Products, given all the efforts to improve the business through the downturn, some of the shifts in mix were taken place. You’re now growing backlog pretty significantly. You’re at a three-year high.

How does throughput cycle times look this time around compared to last cycle? Just curious how we should be thinking about that from a modeling perspective now that you started to build backlog and continue to do so this year, how does throughput cycle times work? How should we think about that progression going forward?.

Yes, right now the major product backlog that we’re building is comparable to the lead times that we’ve had in the past because of our key connector products and it’s also our production infrastructure. So right now the trend lines are similar in terms of the forward 12-month revenue generation, short-cycle and service you’re very familiar with.

They are not very backlog intensive. So you will model short-cycle and services I would say somewhat flat sequentially depending on ebbs and flows there.

We’ve talked in the past that we have some military work and there is a likelihood we gained some incremental military backlog that tends to be more multiyear focused, but we can update you on that if and when that order is received..

Very helpful. Thank you for that feedback..

Thank you..

Thank you. Our next question comes from Connor Lynagh from Morgan Stanley. Please go ahead. Your line is open..

Thanks. Good morning, everyone. I was wondering if we could, Cindy, go back to your comments around the challenges in earning returns in North America and U.S., in particular.

I guess could you discuss – are there any areas of your product portfolio where you feel that these businesses aren’t earning their cost to capital and you have some potential to step back or at least cut cost further? Obviously I assume this is one at least in services if anything, but just thoughts on that..

Yes, and again we’re really focused on every product line and every business line to return two things. Number one, free cash flow generation and ROIC at the end of the day and to some degree our earnings before interest and taxes, our EBIT is burned by heavy CapEx from earlier years.

You heard Lloyd talk about an update to our 2019 CapEx being a little bit lower and I can just assure you. I don’t know how else to manage a business other than focus on return on invested capital. But I’ll also tell you with the dramatic commodity price swings and activity declines, it’s been a challenge to right-size the shift responsive to that.

There are a couple of areas that we’re focused on, but most particularly we continue to do a review. Our drilling services is a small business line. But when we kind of have the gut check at 12% utilization in the first quarter, we did improve it in the second quarter to 20.

But we’re really trying to find ways – and that’s a very, very small piece of Well Sites Services. But it is indicative of your question which is that can every business venture be right-sized to achieve sustainable ROIC? And we’re doing everything we can. We even had continual severance and cost reduction initiatives.

In this quarter it was more weighted again with Offshore products this time. And in our Well Sites Services business we’ve rationalized even more costs late last year, early this year. But I think that’s why we had over 100% incremental in the business in Q1 and Q2.

So I can only assure you and it’s not for lack of effort in this office in terms of returning to sustainable ROIC. I will also tell you that I think if any service company of our size can do it, we can..

Yes, makes sense. Maybe just sticking with that theme, so you called out international as an area where you see potential opportunity.

Can you give us a feel for how big in completion services international is today and where you see the opportunity for that to be over the next couple of years here?.

Yes, we generally bucket that as non-North America, so we’ll throw in the Gulf of Mexico with that. In Q1, the combined contribution of international and Gulf of Mexico was 16% of completion services revenue; in Q2, it was 18%. And so that’s kind of what it is today. Obviously, we’re focused on introducing incremental products.

It is certainly true in our Well Sites Services segment, but I’ll tell you we are also in the early stages of introducing our Downhole Technologies to gain more international traction as well. That is a longer-term process. They’re not immediate. But it is something we think is value creating..

Okay, I appreciate it. Thank you..

Our next question comes from Ian Macpherson from Simmons. Please go ahead. Your line is open..

Thanks for the follow up. That was actually mine. I wanted to get into what the third quarter outlook might entail for Lower 48 completion services compared to international/Gulf of Mexico/drilling services? Those numbers helped.

But I guess the kernel of my question is, does the middle of your guidance range contemplate Lower 48 completion services flat or down or what?.

I would say right now we want to see that continuing mix a little bit more weighted towards international and Gulf of Mexico. We too see – at least the flattening is not a modest softening of the North American rig count. Our customers, as you’ve heard, are definitely focused on generating free cash flow and controlling their capital spending.

There’s no ways about it. But everything is not the same for every customer. So when we go out and give guidance, we’re really – we have weekly meetings with customer by customer who’s adding rigs in various sites and who’s dropping rigs in various sites.

But if I take all of that into context, I’d have to – we all know the rig count’s dropped about 21 rigs since quarter end. That’s about a 2%. So I don’t think we’re talking about big numbers here, but it’s hard to exit the quarter and no say that North America is going to be modestly softer in Q3, at least as best as we see it today..

Makes sense. Thanks again, Cindy..

Thank you, Ian..

Thank you. Our next question comes from Stephen Gengaro from Stifel. Please go ahead. Your line is open..

Thanks and thanks for taking a follow up. Can you just remind us when we think about your U.S.

land exposure, the businesses which are exposed to the percentage of completion intensity versus just sort of wells drilled and what you’re sort of seeing on the completion intensity front right now?.

Well, I think I mentioned on the call, right now everybody tends to focus on leading edge wells and the horizontal footage. There’s kind of a catch up for other operators moving towards leading edge.

And so I think there’s still some tailwinds there in terms of horizontal footage, stage count and importantly for us I’ll just call it clusters per stage. And there’s a lot of technology assessment trialing going on to try and mitigate parent-child type communication interference. But there’s just a lot going on.

And I do think that fundamental tailwinds of higher intensity are there for our Downhole Technologies segment. And even in Chris’ business, the majority of the personnel and equipment are more on the service, I will call it.

But nonetheless they are leading edge equipment such as the Tempress tool that really does gain significant market share as you get in the longer laterals, the more torturous type downhole environments. And so it becomes a differentiator for that.

We’re investing obviously for some various equipment to make the customers well site; one, safer and two, more efficient. I call it de-cluttering the well site around bridge manifolds. We’re investing in some other technology that I probably won’t talk about because of IP that we plan to file behind some of it.

But while it’s not a direct correlation, the more complex wells I think do speak to a higher-end equipment and personnel offering, which again we believe we have..

Great. Thank you..

Thank you. And our last question comes from Emily Boltryk from Scotia Howard Weil. Please go ahead. Your line is open. Emily, you may be on mute..

Dinara, you might want to move on. It sounds like she might have dropped..

Thank you. At this time, I am not showing any further questions..

All right. Dinara, thank you for hosting our call today. Again, we’re going to apologize for the technical interruption from the phone provider. But I appreciate you staying on so that we could kind of fully discuss the results of our segment, the results of the quarter before we close the call.

I do kind of ask that you all just kind of step back and we’ve seen a lot of kind of emotional investing over the last couple of years towards North America and almost emotional away from it towards more deepwater and international.

We believe that we have a great balance offering with penetration in all of our segments that comes from these segments. And I know while many of you view this as a challenging or modestly disappointing quarter for us, I hope you will keep it in context strengthening in Offshore products.

I think we’re doing absolutely what you want us to do in terms of backlog development, top line growth and improved margin.

In our Well Sites Services segment, they too had very resilient revenues and improved margins; very, very strong incremental in our completion services product line and some differentiated offerings that we’ve tried to more fully deploy into the market.

Downhole Technologies, again, was kind of the lone disappointment this quarter, but the investments we’re making in R&D and product development I do believe pay off in the long run. And I would not like to leave the strength of our company from a free cash flow generating standpoint. I think that is a differentiator for our company as well.

It has been for the last several years. And I do feel confident that we’ll be able to turn this towards a better ROIC generating performance over time. That does complete our comments. And again, I thank you for joining us today and look forward to future conversations with you..

Thank you. Ladies and gentlemen, this concludes today’s conference. Thank you for participating. You may now disconnect..