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RigNet Inc  (NASDAQ:RNET)
Q3 2018 Earnings Conference Call
Nov. 09, 2018, 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, ladies and gentlemen, and welcome to RigNet Third Quarter 2018 Earnings Conference Call. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session, instructions will follow at that time. (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 -- Chief Financial Officer

Thank you, Nicole. Good morning, everyone, and welcome to RigNet's third quarter 2018 earnings call. Copy of our earnings press release with supporting schedules, including the schedules, which reconcile the non-GAAP metrics we'll discuss today to GAAP metrics is posted to our website www.rig.net under our Investor Relations page. For those of you 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?

Steve Pickett -- Chief Executive Officer and President

Thank you, Lee. And thank you to everyone who is 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 has come up to speed on our technology offerings quite quickly. Lee, welcome.

Lee Ahlstrom -- Chief Financial Officer

Thank you. Glad to be here.

Steve Pickett -- Chief Executive Officer and President

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, a non-GAAP measure 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 and 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 oilfield 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 communications services. As you know, RigNet is highly leveraged in the energy vertical, although we've diversified away from only serving offshore rigs and now have over 6,000 midstream pipeline sites, where we are providing SCADA and 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 is growing enthusiasm with 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 jackups and floaters is up only slightly year-over-year. And although we expect improvement going forward, we are forecasting hockey-stick shaped growth in this sub-segment. We're focused on driving network efficiencies across our business. Network efficiencies improve with scale, so as we move ahead, we'll look to continue acquisitions that help us build that scale, whether in energy, 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 are investing along with a major telecommunications partner to enhance our existing Gulf of Mexico infrastructure to provide 4G and 5G capabilities to existing network. I'm pleased to report that the build-out is progressing well, although some weather delays in September have nudged capital spending somewhat to the right, meaning that we will see that spend mostly come 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 our apps and IoT segment, growing revenue 13.5% sequentially and almost 50% versus third quarter 2017. Although apps and IoT comprises many solutions including AVI, which stands for Advanced Video Intelligence; SCADA in IoT service; MetOcean in value-adding connectivity and entertainment options for crews on our customers assets. Let me focus on two 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 publicly stated that this type of real-time machine learning and artificial intelligence has saved them $100 million per year by reducing their complex ultra-deepwater 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 Intelli 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. In fact, the majority of our meetings around Intelli 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 in 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, a cyber security 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 Intelli, 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 as 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 the leading bundle of Cyber Security 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 the 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 bit.

With that, let me ask Lee to make a few comments on the financials.

Lee Ahlstrom -- Chief Financial Officer

Thanks, Steve. 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 communication services revenue was $44.9 million for the quarter compared to $40.2 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 comments, we simply haven't seen offshore rig activity increase that significantly. Of course, you're aware that we lost a Noble work this year, 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 282, 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 proceeded more slowly than we originally anticipated. And we currently expect that it will not be complete until sometime in 1Q '19. 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 are 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 as 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 30, 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 30 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 a 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 26.2% in Q3. Margins in Q2 were primarily higher as a result of several change orders, which we received at high margin levels, as well as some cost savings recognized on several projects as they neared completion during Q2.

Q3 margins are more in line with our normalized expectations. 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 earn-out of $2.8 million, driving SG&A higher for Q2. So Q3 costs were lower without that but were partially offset by a $0.8 million decrease in the fair value of the TECNOR earn-out in Q3, which reduced that fair value to zero. GAAP net loss was $2.8 million or $0.15 per share in the current quarter compared to both net loss of $4.2 million or $0.23 per share in the prior year quarter and a net loss of $4.2 billion 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. As Steve has already mentioned the build out 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 three 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. 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.

Steve Pickett -- Chief Executive Officer and President

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 in delivering a zero incident quarter. Ensured focus and dedication, that's helping drive the transformation of RigNet in becoming a 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. Let's open it up for questions now please.

Questions and Answers:

Operator

(Operator Instructions) And our first question comes from Allen Klee from Maxim Group. Your line is now open.

Allen Klee -- Maxim Group -- Analyst

Yes, hi. You commented on the Noble 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 -- Chief Financial Officer

Hey, Allen, good morning. This is Lee. No, I'm not going to give you any guidance around 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 ports 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 -- Maxim Group -- Analyst

Okay, thank you. And then you made some comments toward the end on collections and how you might think of that improving going forward, could you just -- I missed some of that, if you'd go into some of that a little more?

Lee Ahlstrom -- Chief Financial Officer

Sure. Over the summer, we had some issues with our system, particularly and this is probably more detailed that you want to know but calculating sales tax on various invoices that needed to go out, which then caused us to have to recycle some of that, we're now in the -- maybe buildup in AR seeing that roll through the AR and we expect to get back on track with collections here and resolving all of those outstanding invoices 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 -- Maxim Group -- Analyst

Okay.

Lee Ahlstrom -- Chief Financial Officer

So it was really a one-time issue for us over the summer that we're now back on track on.

Allen Klee -- Maxim Group -- Analyst

Okay, great. And then for the Gulf of Mexico, what you're doing there to move to 4G and 5G, how much of it had CapEx of the total amount you planned 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 -- Chief Financial Officer

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 announced that at the end of August or early September and the weather in the Gulf really pushed us back on that. So the total project cost around that LTE build out was, is going to be close to 7-ish. We expect between 5 and 6 here in Q4 and then the rest in Q1. I think we only booked about $200,000 of CapEx on the LTE projects in Q3.

Steve Pickett -- Chief Executive Officer and President

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 the 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 will also be enabled 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 into those structures better, than something that's operating at a much higher frequency. So once the build outs begun, 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, particularly with customers who have never been RigNet customers in the past.

Allen Klee -- Maxim Group -- Analyst

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 looks like this particular quarter -- is it true that this is kind of a clean quarter and 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?

Steve Pickett -- Chief Executive Officer and President

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

Allen Klee -- Maxim Group -- Analyst

And also with the systems integration, 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 -- Chief Financial Officer

So, this is Lee, Allen. I mean, 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, can go up or down, but that's not a bad place to be for the business. And remember too, that when you think about -- while the SI margins are certainly below what we'd expect on both the MCS and the SI and IoT business. We look at 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.

Steve Pickett -- Chief Executive Officer and President

And by the way to add to that. We're also seeing situations today given our over-the-top capability or apps and 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 -- Maxim Group -- Analyst

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

Lee Ahlstrom -- Chief Financial Officer

Well, 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 on our last quarterly call, and the engagement there has been surprisingly robust in the early days here.

Allen Klee -- Maxim Group -- Analyst

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

Steve Pickett -- Chief Executive Officer and President

Thank you, Allen.

Lee Ahlstrom -- Chief Financial Officer

Thanks, Allen.

Operator

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

Walt Chancellor -- Macquarie Capital -- Analyst

Good morning. Just to get started on apps and IoT, you've had some success there, solid revenue growth in the quarter. I'm just curious 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?

Steve Pickett -- Chief Executive Officer and President

At this point, our sales force is fully trained, of course, over time to become more and more expert on these new capabilities. But you are in no doubt, your comment is quite relevant. These are relatively new capabilities for us. And I'd say 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 over time.

Walt Chancellor -- Macquarie Capital -- Analyst

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, directionally over the coming quarters?

Steve Pickett -- Chief Executive Officer and President

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

Lee Ahlstrom -- Chief Financial Officer

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 back 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 of 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 is providing communication services to the oil and gas industry. So we will also have some satellite capacity that rolls over next year. So we'll be renegotiating there. So yes, as we are renegotiating with customers on price levels, we're also renegotiating on our bandwidth purchases to capture synergies and drive those costs 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.

Walt Chancellor -- Macquarie Capital -- Analyst

Okay, fair enough. I appreciate that color. Yes, just one final one from 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 sub-sector, it's obviously a critical part of the US onshore story. So just trying to understand what the competitive landscape looks like there and what the opportunity to be?

Steve Pickett -- Chief Executive Officer and President

Yes, So 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 are 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 and that they are currently operating.

Lee Ahlstrom -- Chief Financial Officer

And if I might add just a little bit of color to that. What's really interesting to me, and when you think about the application that Intelie has been 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 your engine(ph) oil, we are going to be 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 changed at your oil and your car every 3,000 miles. Now, you don't need to do that anymore, right. You got a little sensor the 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 to cut their costs as well. And when you look at it from that perspective, we think that it's a broad application not just at fracking but some of the other potential onshore services as well.

Walt Chancellor -- Macquarie Capital -- Analyst

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

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 -- Chief Financial Officer

Alright. 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 the program. You may all disconnect. Everyone have a great day.

Duration: 36 minutes

Call participants:

Lee Ahlstrom -- Chief Financial Officer

Steve Pickett -- Chief Executive Officer and President

Allen Klee -- Maxim Group -- Analyst

Walt Chancellor -- Macquarie Capital -- Analyst

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