Last Friday, two days after I posted my comparison of Dawson Geophysical (“Dawson” and Ticker: DWSN) and TGC Industries (“TGC” and Ticker: TGE), TGC reported financial results for its first quarter of 2007. For the quarter, TGC reported earnings of $0.13 per diluted share on revenues of $18.6 million compared to year-ago earnings of $0.17 per diluted share on revenues of $14.8 million. Since reporting earnings, shares of TGC traded up by as much as 25% before pulling back a bit.
So let me get this straight….earnings decreased 25% and shares traded up 25%. Where’s the logic?
Two major factors led to the lower earnings result in the first quarter of 2007 compared to the year-ago quarter. First, bad weather in January and February resulted in five of TGC’s eight crews sitting idle for an average of 15 days. I don’t know how many weather days there were in 2006 but the weather across the nation was unquestionably more favorable in 2006. While TGC has some level of weather protection built into its contracts, the weather provisions typically don’t cover 100% of expenses or lost profits.
Second, TGC’s depreciation expense nearly doubled to $3.3 million from $1.7 million in the year-ago quarter. The higher depreciation expense comes as a result of $23.6 million in new equipment purchases in the last year. In the fourth quarter 2006 conference call, management indicated that the depreciation expense in 2007 would likely run about twice that of 2006. With regards to depreciation, it is important to note that depreciation is a non-cash expense. As such, the deprecation expense is an add-back on the cash flow statement. A cash flow statement was not made available with the press release.
In my opinion, TGC moved up after the earnings report because the negative factors noted above were already priced into TGC’s shares. Furthermore, I suspect many investors feared the weather impact was going to be greater than what was actually reported. According to Yahoo, the one analyst covering TGC had an EPS estimate of $0.10 for the quarter. TGC beat the $0.10 estimate by 30% and the market is now looking towards the more favorable spring and summer weather conditions. With the additional crews and equipment that TGC put into service in the last year, TGC is in a position to post a strong Q2 and really start to see returns on their capex spending over the last year.
Here are some of my notes from the earnings release and conference call:
While margins were down from the year ago level, gross margins, operating margins, EBITDA margins, and net profit margins were higher than the prior two quarters. I assume that the lower percentage of dynamite work in the first quarter of 2007 compared to the prior two quarters contributed to the margin improvement. Looking into 2007, management expects dynamite work to be consistent with the first quarter at 25%.
EBITDA was up from $6.4 million in the year ago quarter to $7 million in Q1. EBITDA margins were down from 43.2% in the year ago quarter to $37.4 million in the current quarter. Assuming nicer weather in the second quarter and crews operating at normal capacity, EBITDA margins should return to year-ago levels.
Management expects demand in the seismic data industry to continue for several years. All crews are booked through the second quarter with some booking well into the third and fourth quarter of 2007. For the most part, customers are unwilling to schedule work much past 2007.
60% of TGC’s business is repeat business. The high level of repeat business is a clear sign customers are happy with the results they are getting from TGC. Keep this point in mind as I will discuss it again when discussing the possibility of a buyout.
TGC’s backlog is roughly 25% dynamite and 75% vibration. TGC expects to be able to complete the shot-hole drilling associated with the dynamite work with its in-house shot hole drilling business, which should result in higher margins on the dynamite work.
The company is operating 2 crews on term contracts and 6 crews on turn-key contracts. Turn-key contracts have higher margins but less protection from bad weather conditions. If there is good weather throughout most of the quarter, this will work in TGC’s favor.
Crews are currently operating in Louisiana, South Texas, the Barnett Shale, Kansas, and Oklahoma. On the call, the CEO indicated they were preparing for work in a particular region and a crew would be moving into that region in the near future. I could not make out what region he was talking about. If someone could understand what region he mentioned please let me know.
TGC implemented a small price increase in the fourth quarter of 2006. The first quarter of 2007 saw some of that benefit. The price increase has not had a negative impact on demand.
I don’t know if anyone noticed but the CEO threw in a comment that they won a couple of nice contracts just yesterday, meaning the day before the earnings call.
In my last post, I mentioned that TGC ordered two shot-hole drill rigs, 4,000 channels and 6 vibration vehicles. The company took receipt of the 4,000 channels and the 6 vibration vehicles in the first quarter. Management expects the drill rigs to be delivered in the second quarter. Spending on the above equipment was $10 million and management expects to increase capex spending as opportunities present themselves.
TGC management takes adding a new crew very seriously. They will add crews when and if there is the right opportunity with the right client. Management needs to have 6 to 12 months of work dedicated to the new crew before they will consider adding the new crew.
At the end of the year, management will be reviewing its Opseis Eagle equipment to make a determination on whether or not they should replace the equipment in 2008. It sounds like management is likely to replace one of the Opseis Eagles in 2008 and then consolidate the Opseis equipment into one crew. Again, management will make that decision at the end of 2007.
When a caller asked TGC management if they have considered acquiring some of the one or two crew firms that were out there, management gave two reasons why they were not. First, these small operations typically have outdated equipment that dates back to 1994 and 1995. This equipment does not meet TGC’s standards. Second, management indicated that these firms don’t really have any exclusivity contracts or relationships with larger E&P companies that would make it worth their while. TGC management indicated that GeoKinetics was making some of these smaller acquisitions and they just assumed let them.
Now for a little buyout speculation that is purely speculative and based on nothing but management’s comments about being an acquirer of some of the smaller operations that are out there. TGC has six relatively new Aram ARIES and it has purchased most of its equipment in the last couple of years. Furthermore, TGC has a high percentage of repeat business. Adding new crews is difficult because of equipment lead times and a lack of skilled labor. Given the quality of TGC’s equipment and its high level of repeat business, it seems like TGC would make for a nice acquisition.
Well, that’s all I have to say about that.
Regards
Tuff
Sources
Q1 2007 Earnings Press Release
Q1 2007 Conference Call
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