Blame It On The Rain

In the lip-synched words of Milli Vanilli

“Blame it on rain yeah yeah
You can blame it on the rain
Get
Ooh, ooh (ooh)
I can’t, I can’t. I can’t, can’t stand the rain
I can’t, I can’t. I can’t, can’t stand the rain”

Monday morning, TGC Industries (Ticker Symbol: TGE) reported second quarter net income per diluted share of $.08 on revenues of $21.7 million. On average, analysts were expecting $.15 per share on revenues of $18.78 million. Investors looking for a reason as to why TGE missed per share estimates by such a wide margin need to look no further than the above lyrics.

The Mid-continent and Southwestern United States experienced abnormally rainy weather, which included severe flooding in some parts, during the quarter. While weather is an easy yet questionable scapegoat for disappointing earnings results when it comes to homebuilders and retailers, there is no denying the negative impact of bad weather on seismic data acquisition companies. Bad weather leads to idle crews, which in turn leads to lost revenue and costly downtime.

Revenues

Despite the weather, revenues for the quarter increased 45.8% from the year-ago quarter. Revenues were higher as a result of the company operating eight crews in the second quarter of 2007 compared to seven crews for two months and six crews for one month in the 2006 quarter. Furthermore, 40% of revenues in the quarter were attributable to dynamite contracts compared to 20% in the year-ago quarter. Dynamite contracts are characterized by higher revenues and lower margins compared to vibroseis contracts. The words “dynamite” and “vibroseis” refer to the energy source employed to send seismic waves beneath the earth’s surface.

On the conference call, Mr. Whitener, CEO, discussed the dynamics of dynamite contracts versus vibroseis contracts from a numbers perspective. In his example he described a situation where TGE might get paid $30,000 per square mile of vibroseis work and $42,000 per square mile of dynamite work. The additional $12,000 of revenue from the dynamite work would go towards third party costs including explosives, drilling, and additional surveys. Thus, revenues are higher from dynamite work but so too are cost of revenues. To this regard, it is important to note that TGE acquired a shot-hole drilling company in 2006. With this acquisition, TGE added the capacity to provide its own drilling services to one of its dynamite crews, which in turns provides slightly higher margins and flexibility for that crew. During the quarter, two to three crews were working on dynamite contracts.

Gross Margins

Gross margins for the quarter slipped to 31.7% from 43.7% in the year-ago quarter (Ouch!). Gross margins fell as a result of the higher percentage of dynamite work and the rainy weather that impacted all eight crews for an average of eleven days per crew during the quarter.

TGE negotiates weather provisions with its customers that cover some of the expenses associated with a crew idled as a result of bad weather. These provisions cover some but not all of the costs of the idled crew and obviously do not cover the lost revenue. In some parts of the world, seismic companies have been able to negotiate full weather protection but that is not and likely will not be the case in the United States. Providers of seismic data acquisition services and customers will continue to share in the cost of weather disruptions. Geokinetics, another competitor in the U.S., recently announced that weather would have a negative impact on its second quarter results and I expect Dawson to suffer a similar fate when it reports its results on August 2.

There are two types of contracts that TGE will enter into with its customers, either term or turnkey. In my original post comparing TGE and DWSN, I discussed the differences between the two contracts:

“A turn-key contract is a fixed fee contract for each unit of data produced. A term contract is a fixed fee contract for each unit of labor (hour, day, or month) worked. While turn-key contracts offer greater upside profit potential, the downtime provisions are usually less favorable. With term contracts, there is less upside profit potential but the revenue stream is steadier and the downtime provisions are usually more favorable.”

According to management, TGE had one crew operating on a term contract for the entire quarter and one crew operating on a term contract for part of the quarter. The other six crews were on turnkey contracts for the entire quarter. As TGE has a high percentage of turkey work, bad weather is apt to have a greater impact on its earnings results than its competitors to the extent those competitors have a higher percentage of term contracts. For investors interested in DWSN, the latest information I have from Dawson was that they were operating on 50% term and 50% turnkey contracts. Again, keep in mind that turnkey contracts have higher upside potential when the weather is more favorable.

Back to the numbers….With revenues of $18.78 million and a gross margin of 31.7%, gross profit were $6.9 million compared to $6.5 million in the year-ago quarter.

EBITDA and Operating Income

Selling, general and administrative expenses for the quarter totaled $926,500, in the range of the last couple of quarters. After subtracting out SG&A expenses from the $6.9 million of gross profit, I get EBITDA of $6 million compared to $5.8 million a year-ago.

Depreciation expense for the quarter was $3.5 million compared to $2.2 million in the same quarter of 2006. The higher depreciation expense was a result of the $22.5 million in new equipment purchased in the last year. Equipment purchased in the last year went towards supporting an eighth crew and adding vibration vehicles and recording channels to existing crews.

Operating income for the quarter was $2.5 million compared to $3.6 million in 2006.

Drilling Down to EPS

Quickly moving down through the rest of the numbers, interest expense of $191,280 was in-line with prior quarters. The tax rate on the quarter of 41.04% was in the range of recent quarters and up a bit from the 39.68% in the year-ago quarter.

Net income for the quarter was $1.3 million or $.08 per diluted share compared to $2.1 million or $.12 per share in the same quarter of 2006.

Clearly the bottom line results were disappointing but considering the number of lost days during the quarter along with the higher depreciation expense, the fact that TGE was able to come out with $.08 in earnings per diluted share was impressive.

Backlog

Backlog at the end of the quarter remained high at $60 million. Some crews are booked into 2008 with other crews booked through late October early November of 2007. Management expects the market for seismic data acquisition services to remain strong for several years to come. Obviously, TGE isn’t loosing revenue but revenues are merely being pushed back into later quarters..

Of the $60 million in backlog, 20-25% is dynamite work and 75-80% is vibroseis work. The high level of vibroseis work in the backlog should bode well for margins in future quarters.

For the remainder of the year, six crews will continue to operate on turnkey contracts, one crew will operate on a term contract and the last crew will bounce back and forth between the two contract types. Based on the CEO’s comments on the conference call, it sounds like two crews will be operating on term contracts for the third quarter.

Crews are positioned in mostly the same locations as the second quarter. While two crews in South Texas continue to experience weather issues, crews in other locations have been less impacted in July than the prior two months.

My Take

Rain happens. Anyone who followed the weather in the regions where TGE’s crews were located in the last quarter knows that the weather was bad and management isn’t trying to pull a fast one. While the weather made for a disappointing quarter, demand remains strong and eventually TGE will get a quarter with normal weather conditions. With its strong backlog and increased operating capacity, TGE is well positioned to capitalize on the strong demand for its services. Furthermore, despite the negative impact of weather, high level of dynamite work and the drop in net income, EBITDA increased by 3% over the year-ago quarter. At a share price of $9.10, TGE is trading at an EV/EBITDA of less than 6. As a point of reference, DWSN is trading at an EV/EBITDA of 8.5. While I don’t expect a snap back in TGE’s share price, continued improvement in the weather over the course of the quarter will help give TGE shares a lift.

Conference Call

I covered most of the information from the conference call in my above rambling but I will note the couple of points that I didn’t mention.

Most of the work in the gulf coast is dynamite work.

The company has spent most of their $10 million of its planned equipment purchases. As always management indicated that they would revisit their capital expenditures plans on an ongoing basis. When asked if their next move would be to replace some of the older recording systems or add another crew, management indicated they would likely add another crew.

Well, that is all for now.

Regards,
Tuff


TGC Industries, Inc. (Public, AMEX:TGE)