RigNet Inc
Q3 2018 Earnings Call Transcript

Published: 9 Nov 2018

[Operator:]

Good day, ladies and gentlemen, and welcome to RigNet Third Quarter 2018 Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host, Lee Ahlstrom, CFO. You may begin, sir.

[Lee Ahlstrom:]

Thank you, Nicole. Good morning, everyone, and welcome to RigNet's Third Quarter 2018 Earnings Call. A copy of our earnings press release with supporting schedules, including the schedules which reconcile the non-GAAP metrics we'll discuss today, the GAAP metrics, is posted to our website www.rig.net, under our Investor Relations page. For those of who would like the release in PDF format, we've posted that as well. Before we get started, I'd like to make you aware that we will be making forward-looking statements today. Any statements that are not historical facts, including statements related, but not limited to market expectations and future plans for the rest of 2018 and beyond, are forward-looking statements that involve certain risks, uncertainties and assumptions. These include, but are not limited to risks associated with the general nature of the oil and gas industry, customer and other third-party interactions and other factors detailed in the risk factors section of RigNet's most recent annual report on Form 10-K and in our other filings with the Securities and Exchange Commission. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those indicated. RigNet disclaims any duty to update the information presented on this call. And now I'd like to turn the call over to Steve Pickett, RigNet's Chief Executive Officer and President. Steve?

[Steven Pickett:]

Thank you, Lee. And thank you to everyone who's joining today's call. I'm very pleased to be here in Houston with Lee, who joined us in August as our CFO. Lee has a strong background in oil and gas, has global experience, prior public company CFO experience, M&A experience and is an engineer, who's come up to speed on our technology offerings quite quickly. Lee, welcome.

[Lee Ahlstrom:]

Thank you. Glad to be here.

[Steven Pickett:]

This morning, I'll open up with a general update on our progress in executing our growth strategy and I'll summarize some of the key wins we achieved during the quarter. Then Lee will go through some of the financial highlights. Following that, as always, we'll open it up for questions. Yesterday, after the close, RigNet reported a net loss of $2.8 million or $0.15 per share, based on revenues of $64.8 million, which were up nearly 8% from the second quarter. This is our second consecutive quarter of delivering top line growth and our third consecutive quarter with improved earnings. Adjusted EBITDA and non-GAAP measures we defined in our press release and one of our key performance metrics was $8.7 million, up just under 8% from the second quarter. This was our second consecutive quarterly increase in adjusted EBITDA. Revenue increased across each of our three reporting segments, both sequentially and versus the prior year period, showing healthy activity across all three segments. We're particularly pleased with the growth in the Apps & IoT segment, where revenues were up 13.5% from the second quarter and almost 50% from third quarter 2017. Let me take a moment to remind everyone of our overall strategy, which is driving the ongoing transformation of RigNet from a company that's historically been seen as an oil field services company to a company that is a holistic, digital transformation solutions provider. To begin with the base business, managed communication services will continue to be core to serving our global customers who rely on us in more than 50 countries to deliver consistent and reliable communication services. As you know, RigNet is highly leveraged in the energy vertical. Though we've -- although, we've diversified a way from only serving offshore rigs and now have over 6,000 midstream pipeline sites where we are providing SCADA, an Internet of Things solution. These pipeline sites are not included in our reported site count because individually, each one is a small contributor. Although in total, the contribution is meaningful, and we hope to continue to grow in this area. Additionally, we now serve 332 production sites, including both FPSOs and fixed platforms. In speaking with our customers, there's growing enthusiasm that the energy industry, particularly offshore is in the early stages of recovery and we share that enthusiasm. However, in spite of our growth, utilization of rigs across both jack-ups and floaters, is up only year-over-year. And although we expect improvement going forward, we aren't forecasting hockey stick shaped growth in this sub-segment. We're focused on driving network efficiencies across our business. Network efficiencies improve the scale. So as we move ahead, we'll look to continue acquisitions that help us build that scale, whether in energy, where we're holding -- where we hold a leading market share position or in different verticals allowing us to diversify or even within specific geographic areas. We're also taking advantage of unique opportunities to expand and improve our network. For example, on our second quarter call, we announced we're investing along with a major telecommunications partner to enhance our existing Gulf of Mexico infrastructure to provide 4G and 5G capabilities to the existing network. I'm pleased to report that the buildout is progressing well, although some weather delays in September had nudged capital spending somewhat to the right, meaning that we will see that spend mostly come from in the fourth quarter of this year and the first quarter of 2019. Beyond the core business, we continue to make great progress in building of our Apps & IoT segment, growing revenue 13.5% sequentially and almost 50% versus third quarter 2017. Although, Apps & IoT comprises many solutions, including AVI, which stands for advanced video intelligence, SCADA, an IoT service, MetOcean in value-adding connectivity and entertainment options for crews on our customers' assets. Let me focus on 2 of the product areas that generate the most excitement around RigNet. The first is Intelie, our advanced real-time, machine learning and AI platform, which we acquired in March of this year. Intelie is an incredibly robust, adaptable technology platform that is already making significant impacts in the oilfield, though, this application is by no means restricted to oil and gas. The company, which just celebrated its 10th birthday, counted Petrobras, the Brazilian national oil company, as one of its first major and continuing customers. Petrobras has publically stated that this type of real-time, machine learning artificial intelligence has saved them $100 million per year by reducing their complex, ultra deep water planning process from 90 days to less than 10 days and by helping to manage drilling performance in real-time as they drill through the challenging salt layer in their pre-salt wells. As we've introduced Intelie to our customers, they are recognizing the potential for significant, positive impacts on their business by improving safety, increasing top line revenues and by controlling costs. And I'm -- excuse me, in fact, the majority of our meetings around Intelie result in a proof-of-value trial or commitment. And I'm pleased to report, that we secured new commitments from both offshore customers and an onshore fracking customer during the quarter. The fracking win, based on a newly developed capability, represents the first time we've delivered a solution to this market. Additionally, during the quarter, we announced via our social media channels that Intelie was selected for Shell's GameChanger program, to develop its digital decision assistant, a virtual decision assistant module that helps engineers make data-driven decisions for real-time drilling operations in longer-term, data-intensive projects such as well construction. The second product area that we're excited about is related to Cyphre, our cybersecurity platform. Cyphre represents some of the most sophisticated hardware-based encryption available anywhere in the market today. It provides best-in-class encryption on all network types and is easily integrated with existing technology. Like Intelie, Cyphre is not oil and gas specific. We've already announced both AT&T and Singapore-based telecommunications provider, SingTel, as channel partners to distribute Cyphre in verticals outside of energy. We're also very pleased to announce that Cyphre has been accepted into the Cryptographic Module Validation Program at the National Institute of Technology and Standards, often referred to NIST, where we anticipate we will be certified under FIPS 140-2, sometime in 2019, marking an important milestone for use of Cyphre products in government and regulated industries. Our Cyphre capabilities have helped catalyze the growth of what we believe is now for leading bundle of cybersecurity solutions in the energy sector, including best-in-class data protection, network protection, key management, IoT security, border security, and as we will announce to the market next week, an AI-based intrusion detection system that's backed by a global security operation center. All of these are delivered to our managed communication services and IoT customers as a service, allowing them to pay for these critical capabilities on a variable cost basis. We believe our investment in Intelie, Cyphre and other Over-the-Top applications will enable us to capture opportunities in multiple vertical markets and can drive a growth rate that's higher than the managed communications market alone. Before turning the call over to Lee. Let me comment on our System Integration, or SI business. As many of you know, RigNet struggled with SI for a period of time. Failing to deliver results which were satisfactory to shareholders or to ourselves. We increased our attention on this part of the business and are very pleased with the results. By providing focused oversight and improving our bidding and cost management practices, we've not only managed first to stabilize and then grow the margins on this business, we've improved relationships and gained credibility with customers, enabling us to more than double the project backlog in SI quarter-over-quarter to $41 million. The business itself is always going to be what we call lumpy in a sense that it's project-driven based on the macro environment. This makes it a bit difficult to predict revenues too far out, but we believe we're punching above our weight class in this segment and winning more than our fair share of bids. With that, let me ask Lee to make a few comments on the financials.

[Lee Ahlstrom:]

Thanks, Steve. Well expanding on what Steve mentioned earlier, consolidated quarterly revenue was $64.8 million, up 27.4% compared to $50.8 million in the prior year quarter and up 7.9% from $60 million in the prior quarter. All of our segments reported revenue increases. Managed communications services revenue was $44.9 million for the quarter compared to $40.2 million in the prior year quarter and $41.7 million in the prior quarter. A majority of the increase quarter-on-quarter was due to equipment sales which, as I think you know, results in a smaller margin versus our traditional bandwidth sales. This is probably the right place to make a few comments about site count, which was 1,350 up by 53 sites quarter-over-quarter and by 175 sites year-over-year. Now referring back to Steve's comment, we simply haven't seen offshore rig activity increase that significant. Of course, you're aware that we lost a Noble work this year, and through September, we've had about nine Noble rigs roll off. But if you look at our drilling rig category count at year-end 2017, which was 182, we've certainly more than made up for the lost Noble business given our rig count of 191 at the end of Q3. In general, the Noble changeover has perceived more slowly than we originally anticipated and we currently expect that it will not be complete until sometime in 1Q, 2019. So there will be some revenue impact in Q1 and Q4 of '18, unless we're able to secure additional opportunities to replace those rigs. Our other three site count categories, production, maritime and other, which is mostly onshore North America. All grew during the quarter and we would highlight the McDermott win announced in September as one of our significant achievements. They have a global fleet of 11 offshore construction vessels that we're providing not only managed comms to, but Over-the-Top solutions as well. These OTT solutions were a key differentiator in McDermott's selection of RigNet. Apps & IoT revenue was $7.5 million for the quarter compared to $5 million in the prior year quarter and $6.6 million in the prior quarter. The main drivers here were increases in SaaS revenues as well some equipment sales. Steve talked a little bit about Systems Integration, but revenue for the quarter was $12.4 million, up 120% from $5.6 million in the prior year quarter and 5.5% from the $11.7 million in the prior quarter. At June 30th, project backlog in the SI business was $19.6 million. During the quarter, we worked off about $9.3 million of backlog, but we added net wins and change orders totaling $29.4 million, bringing our total project backlog for the SI business at September 30th to $39.7 million or more than double the backlog at June 30. Now in addition to the SI backlog and activity we just described, we also won an additional service project of $2 million for which we will be recognizing revenue under a percentage of completion methodology. For this project, as of September 30, we had recognized about $0.3 million of revenue with the remaining backlog of $1.7 million. Now this brings our total backlog for all of our POC projects to $41.4 million as of September 30. Gross margin for SI did decline from 33.7% in Q2 to 26.6% to Q3, and margins in Q2 were primarily higher as a result of several change orders, which we received at a high margin levels as well as some cost savings recognized on several projects and as they near completion during Q2. Q3 margins are more aligned with our normalized expectation. SG&A expenses totaled $16.6 million in Q3 compared to $13.4 million in the prior year quarter and $19.7 million in the prior quarter. Recall that in the second quarter there was an increase in the fair value of the TECNOR earnout of $2.8 million, driving SG&A higher for Q2. So Q3's cost were lower without that, but were partially offset by a $0.8 million decrease in the fair value of the TECNOR earnout in Q3, which reduced that fair value to zero. Debt net loss attributable to common stockholders was $2.8 million or $0.15 per share in the current quarter as an improvement compared to both net loss of $4.2 million or $0.23 per share in the prior year quarter and a net loss of $4.3 million or $0.23 per share in the prior year quarter. Adjusted EBITDA was $8.7 million in the quarter compared to $7.8 million in the prior year quarter and $8.1 million in the prior quarter. We are very pleased with the continued growth of this metric, which we believe, is an important indicator of the health of the company. Capital expenditures were $6.5 million compared to $5.9 million in the prior year quarter and $6.6 million in the prior quarter. CapEx spend for the quarter was substantially composed of success-based commitments with certain large customers. Steve has already mentioned the buildout of our LTE network in the Gulf, we had expected to see that CapEx begin to ramp up in Q3, but we experienced some delays, largely weather based which has pushed the spending a bit to the right. So we still expect the project to be completed within Q4 and Q1. The LTE project CapEx, along with the purchase of our new facility in Lafayette, Louisiana, that will enable us to consolidate 3 separate legacy facilities, means that Q4 is expected to be a heavy quarter in terms of CapEx, and we anticipate that this Q4 CapEx spend will be close to $15 million. Finally, let's turn to the balance sheet. As of September 30, 2018, cash was $20.7 million, net working capital, excluding cash was $35 million and our outstanding debt was $71.2 million, including both current and long term. Our working capital increased largely due to a buildup in AR, where some systems issues over the summer put us a bit behind on collections with customers. However, I believe we're back on track on that front and I expect to see improvement by year-end. So with that, let me turn it back over to Steve.

[Steven Pickett:]

Thank you, Lee. Before opening up the line to questions, I want to take a moment to thank RigNet's employees for delivering a very strong quarter. Thank you also for working safely and delivering a zero incident quarter, ensure focus and dedication that's helping drive the transformation of RigNet in becoming a leader -- leading provider of digital transformation solutions to our customers in more than 50 countries around the world. And the Board and the management team, very much appreciate you. Lets open it up for questions now, please. Operator Thank you. [Operator Instructions] And our first question comes from Allen Klee from Maxim Group. Your line is open.

[Allen Klee:]

Yes, hi. You commented on the Nobel contract rolling off a little slower. Can you provide any more color on that? If all else being equal, what the impact of that might be over the next two quarters?

[Lee Ahlstrom:]

This is Lee. No, I'm not going to give you any guidance on that other than to say, I think, Q4, we do have a little bit of a heavier impact in terms of the number of rigs rolling off. I think the transition to our competitor, in terms of providing services has not gone as smoothly as perhaps anticipated. And I think part of it is also a bit driven by when rigs are available in port to make those changes. So I think that's really all the color we're going to provide on where we are on that. I think the important thing really for us was the replacement of the Noble business as we saw in our offshore drilling count.

[Allen Klee:]

Okay. Thank you. And then in terms, you made some comments towards the end on collections and how you might think of that improving going forward? Could you just -- I missed some of that, if you go into some of that a little more?

[Lee Ahlstrom:]

Sure. Over the summer, we had some issues with our system, particularly -- and this is probably more detailed than you want to know, but calculating sales tax on various invoices that needed to go out, which then caused us to actually recycle some of that. We're now in the build -up in AR seeing that roll through the AR. We expect to get back on track with collections here and resolving all of those outstanding invoices probably from from May and June as our customers get those into their systems and improve those and start submitting the cash associated with it.

[Allen Klee:]

Okay.

[Lee Ahlstrom:]

So I really kind of a onetime issue for us over the summer that we're now back on track on.

[Allen Klee:]

Okay. Great. And then for the Gulf of Mexico, what you're doing there to move to 4G and 5G? Your -- how much of the CapEx of the total amount you plan -- have you already spent on that? And how much is left over the next two quarters? And then is there a way for us to think about when this is built out? What you see is the incremental opportunity?

[Lee Ahlstrom:]

Let me take the CapEx and then I'll turn it over to Steve to sort of talk about the opportunity. On the CapEx side, we had thought that, that was going to ramp up more significantly in September. I believe we that announced at the end of August or early September. And so the weather in the Gulf really pushes back on that. So the total project cost around that LTE buildout was going -- or is going to be close to $7-ish million. We expect between $5 million and $6 million here in Q4 and then the rest in Q1. I think we only booked about $200,000 in CapEx on the LTE project in Q3?

[Steven Pickett:]

And to add some color to that, in terms of the network, it'll be the only 4G and 5G network available, but will be new in terms of what we can deliver to our customers is that fact that it provides mobility services as well as point-to-point services today. We just deliver point-to-point services using a WiMAX capability. It'll also be enable to support both 600 megahertz and 700 megahertz and those tend to be frequencies that allow for much better propagation of the signal into hard-to-reach places. Think about offshore assets where there's a lot of metal, 600 and 700 megahertz ought to penetrate that into those structures better than something that's operating at a much higher frequency. So once the buildout has began, I would expect, maybe beginning in 2020, we ought to begin to see some incremental revenue related to roaming, opportunities that would be out there with -- particularly, with customers who have never been RigNet customers in the past.

[Allen Klee:]

Okay. Thank you. And it was interesting to hear you say that you felt that the Application and Internet of Things segment should have a faster growth rate than Managed Services. It looked like this particular quarter, is it true that this is kind of a clean quarter in that you didn't have any acquisitions that were closed within the middle of it? So is this kind of a good kind of run rate to kind of start at?

[Steven Pickett:]

Well, Allen, it is a quarter where there weren't any acquisitions. The last acquisitions we closed were in April. So to use your term, it's clean from that point of view.

[Allen Klee:]

And also with Systems Integration, is this also -- generated a segment operating margin of around 18%? And I know that it's a lumpy business, but does that feel like that's a reasonable level longer term?

[Lee Ahlstrom:]

So, this is Lee, Allen. I think my calculation around segment margin, just taking the revenue less the cost was close to 26.2%. So I'm not sure what you're including to get down to the 18%, but I would say that we would expect sort of mid-20s based on the calculation I just gave you as a reasonable run rate for the segment. Obviously, will go -- it can go up and down, but that's not a bad place to be for the business. And remember to, that we think about -- while the SI margins are certainly below what we'd expect on both the MCS and the Apps & IoT business, we look at the SI business as our gateway drug, right? We go into these projects with the idea of providing the equipment, building out the networks and trying to get in a position where when there is an offering for ongoing communication services at a plant or facility, we are in the catbird seat to be able to capture that business.

[Steven Pickett:]

And by the way to add to that, we're also seeing situation today given our Over-the-Top capability our Apps & IoT capability, that there are situations where we have opportunities to pull through revenue in that category as well from the SI base.

[Allen Klee:]

Okay, great. Maybe one more just on the -- would you talk about your partnerships with AT&T and SingTel to -- on your -- how have those gone so far? What's your view of the opportunity that they can increase that business?

[Steven Pickett:]

More slowly than we'd like. But we certainly recognize that it takes time to get a sales force fully trained and it takes a little while to get momentum around new customer wins that end up building momentum across a broader cross-section of the sales team. The SingTel selection was the one that we announced most recently. We announced that on our last quarterly call and the engagement there has been surprisingly robust in the early days here.

[Allen Klee:]

Okay. Great. Congratulations on the quarter. Thank you.

[Steven Pickett:]

Thank you, Allen.

[Lee Ahlstrom:]

Thank you, Allen.

[Operator:]

[Operator Instructions] And our next question comes from Walt Chancellor from Macquarie. Your line is now open.

[Walter Chancellor:]

Good morning. I guess, just to get started on Apps & IoT, you've had some success there, solid revenue growth in the quarter. I'm just curious to how the selling effort is evolving there as you're trying to get better penetration among customers that, maybe in pretty nascent stages of adopting these technologies?

[Steven Pickett:]

At this point, our sales force is fully trained. Of course, over time, they'll become more and more expert on these new capabilities. But no doubt, your comment is quite relevant. These are relatively new capabilities for us. And I'd say, we're -- to use a baseball analogy, we're in early innings as it relates to getting this rolled out to our customers and driving the kind of revenue growth that we think is possible overtime.

[Walter Chancellor:]

Okay. And to switch gears financially in Managed Services, gross profit has been in that high 30% range, hovering 39%, 38%. I guess, what are the near-term puts and takes as you think about that business? Are you expecting pressure due to pricing and some rollovers? How do we see that evolving, I guess directionality over coming quarters?

[Steven Pickett:]

This quarter, we -- as Lee commented on, we did see the margins decline, but that was largely related to a bit heavier quarter in terms of our hardware sales, but we're not -- well, Lee, maybe I can have you comment from there?

[Lee Ahlstrom:]

Yes, I think – good morning, Walt. I think we always have puts and takes in the business, right? We always have customers who are going to roll on and roll off, so we're out battling that on a daily basis. We are in spite of the remarks we made earlier about not being overly seeing a huge increase in the number or rigs, there are more tenders out there and that's a good sign. So we would look to that to be a driving factor for anybody who's providing communication services to the oil and gas industry. So from a -- we will also have some satellite capacity that rolls over next year. So we'll be renegotiating there. So yes, as we're renegotiating with customers on price levels, we're also renegotiating on our bandwidth purchases to capture synergies and drive those cost lower as well. So I don't think there's anything particularly unusual that changes the margin profile of the MCS business in the coming quarters.

[Walter Chancellor:]

Okay. Fair enough. I guess, just one final one for me. The onshore frac crew win for Intelie. Just curious of what the competitive landscape for that sort of offering looks like? And what the broader penetration is for an offering like that among that subsector? It's obviously a critical part of the U.S. onshore story. So just trying to understand what the competitive landscape looks like there and what the opportunity can be?

[Steven Pickett:]

Yes, so a couple of comments. One, no doubt it's a large addressable market for us and this is our first entry into that market with a real-time machine learning capability. So no doubt it's competitive, but we're very pleased with how quickly we were able to get the capability introduced in the market and get our first win closed. It's actually a win that will result in this capability being deployed across the fracking sites that they're currently operating.

[Lee Ahlstrom:]

And if I might add just a little bit of color to that. What's really interesting to me, when you think about the application that's being -- that Intelie is being used for here, the company is going to be monitoring pressure performance on its trucks over time, right? So just like you have issues in your car perhaps, where you need to change out your oil, we're going to helping them optimize the change out of valves and seats and things like that on the pumps to prevent a catastrophic failure in the middle of an operation, say, but also to prevent them from doing all of these change outs too early. It used to be, you changed out your oil in your car every 3,000 miles. Well, now you don't need to do that anymore, right? You got a little sensor that pops on at 6,000 or 7,000 miles in your car and if you were to keep changing it out every 3,000, you'd be spending a lot of extra money. So we believe that we can help our customer here increase both their top line revenue, but also help them cut their costs as well. And when you look at it from that perspective, we think there's broad application, not just at fracking, but some of the other onshore services as well.

[Walter Chancellor:]

Really, appreciate that color Lee. Thank you for your time.

[Lee Ahlstrom:]

Thank you, Walt.

[Steven Pickett:]

Thanks, Walt.

[Operator:]

Thank you. And I'm showing no further questions at this time. I would now like to turn the call back to Lee Ahlstrom, CFO, for any further remarks.

[Lee Ahlstrom:]

All right. Thanks, Nicole, and thank you to everybody who joined us today on the third quarter earnings call. I'll be available in the office later on if you have any follow-on questions that weren't addressed today. And we, of course, invite you to join us in March 2019, when we expect to report our fourth quarter and full year 2018 earnings. Have a good day.

[Operator:]

Ladies and gentlemen, thank you for your participation in today's conference. This concludes today's program. You may all disconnect. Everyone, you have a great day.