McCoy Global 2019 Second Quarter Managements Discussion and Analysis
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MANAGEMENT’S DISCUSSION AND ANALYSIS
June 30, 2019
The following Management’s Discussion and Analysis of Financial Results (“MD&A”), dated August 13, 2019, should be read in conjunction with the cautionary statement regarding forward-looking information and statements below, as well as the audited consolidated financial statements and notes thereto, for the years ended December 31, 2018 and 2017. The annual consolidated financial statements have been prepared in accordance with International Financial Reporting Standards (“IFRS”). All amounts in the following MD&A are in Canadian dollars unless otherwise stated. References to “McCoy,” “McCoy Global,” “the Corporation,” “we,” “us” or “our” mean McCoy Global Inc. and its subsidiaries, unless the context otherwise requires. Additional information relating to McCoy Global, including periodic quarterly and annual reports and Annual Information Forms (“AIF”), filed with Canadian securities regulatory authorities, is available on SEDAR at sedar.com and our website at
FORWARD-LOOKING INFORMATION AND STATEMENTS
This MD&A contains certain forward-looking statements and forward-looking information (collectively referred to herein as “forward-looking statements”) within the meaning of applicable Canadian securities laws. All statements other than statements of present or historical fact are forward-looking statements. Forward-looking information is often, but not always, identified by the use of words such as “could”, “should”, “can”, “anticipate”, “expect”, “objective”, “ongoing”, “believe”, “will”, “may”, “projected”, “plan”, “sustain”, “continues”, “strategy”, “potential”, “projects”, “grow”, “take advantage”, “estimate”, “well-positioned” or similar words suggesting future outcomes. In particular, this MD&A contains:
Forward-looking statements relating to McCoy Global’s:
• business strategy;
• future development and organic growth prospects;
• impact of re-structuring plans and cost structure;
• competitive advantages; and
• merger and acquisition strategy.
Forward-looking statements respecting:
• the business opportunities for the Corporation that are based on the views of management of the Corporation and current and anticipated market conditions; and
• the perceived benefits of the growth and operating strategies of the Corporation; which are based upon the financial and operating attributes of the Corporation as at the date hereof, as well as the anticipated operating and financial results.
Other forward-looking statements regarding the Corporation are located in the documents incorporated by reference in this MD&A and are based on certain key expectations and assumptions of the Corporation concerning anticipated financial performance, business prospects, strategies, the sufficiency of budgeted capital expenditures in carrying out planned activities, the availability and cost of labour and services and the ability to obtain financing on acceptable terms, which are subject to change based on market conditions and potential timing delays. Although management of the Corporation considers these assumptions to be reasonable based on information currently available to them, they may prove to be incorrect.
By their very nature, forward-looking statements involve inherent risks and uncertainties (both general and specific) and risks that forward-looking statements will not be achieved. Undue reliance should not be placed on forward-looking statements, as a number of important factors could cause the actual results to differ materially from the beliefs, plans, objectives, expectations, anticipations, estimates and intentions expressed in the forward-looking statements, including those set out below and those detailed elsewhere in this MD&A:
• oil and natural gas price fluctuations;
• domestic and foreign competition;
• replacement or reduced use of products and services;
• international operations;
• ability to effectively manage growth;
• business mergers and acquisitions;
• supply chain;
• reliance on key persons workforce availability;
• legal compliance;
• breach of confidentiality;
• safety performance;
• foreign exchange;
• availability of financing;
• selling additional common shares;
• customers’ inability to obtain credit/financing;
• material differences between actual results and management estimates and assumptions;
• impact of the United States-Mexico-Canada Agreement;
• Greenhouse Gas (“GHG”) regulations;
• change in U.S. administration;
• international trade relations;
• conservation measures and technological advances;
• terrorist attack or armed conflict;
• sufficiency of internal controls;
• insurance sufficiency, availability and rate risk;
• information security; and
• challenges by taxation authorities.
Readers are cautioned that the foregoing list is not exhaustive. The reader is further cautioned that the preparation of financial statements in accordance with IFRS requires management to make certain judgments and estimates that affect the reported amounts of assets, liabilities, revenues and expenses. These judgments and estimates may change, having either a negative or positive effect on net earnings as further information becomes available, and as the economic environment changes. The information contained in this MD&A, including the documents incorporated by reference herein, identifies additional factors that could affect the operating results and performance of the Corporation. We urge you to carefully consider those factors.
The forward-looking statements contained herein are expressly qualified in their entirety by this cautionary statement. The forward-looking statements included in this MD&A are made as of the date of this MD&A and the Corporation does not undertake and is not obligated to publicly update such forward-looking statements to reflect new information, subsequent events or otherwise unless so required by applicable securities laws.
DESCRIPTION OF GAAP MEASURES AND NON-GAAP MEASURES
Throughout this MD&A, management uses measures which do not have a standardized meaning as prescribed by IFRS and therefore are considered to be additional or non-GAAP measures presented under IFRS. EBITDA is a non-GAAP measure defined as net earnings (loss), before:
• depreciation of property, plant and equipment;
• amortization of intangible assets;
• income tax expense (recovery); and
• finance charges, net.
Adjusted EBITDA is a non-GAAP measure defined as net earnings (loss), before:
• depreciation of property, plant and equipment;
• amortization of intangible assets;
• income tax expense (recovery);
• finance charges, net;
• provision for (recovery of) excess and obsolete inventory;
• other losses (gains), net;
• restructuring charges;
• share-based compensation; and
• impairment losses.
The Corporation reports on EBITDA and Adjusted EBITDA because they are important measures used by management to evaluate performance. The Corporation believes Adjusted EBITDA assists investors in assessing McCoy Global’s current operating performance on a consistent basis without regard to non-cash, unusual (i.e. infrequent and not considered part of ongoing operations), or non-recurring items that can vary significantly depending on accounting methods or non-operating factors.
Adjusted EBITDA is not considered an alternative to net earnings (loss) in measuring McCoy Global’s performance. Adjusted EBITDA does not have a standardized meaning and is therefore not likely to be comparable to similar measures used by other issuers. Adjusted EBITDA should not be used as an exclusive measure of cash flow since it does not account for the impact of working capital changes, capital expenditures, debt changes and other sources and uses of cash, which are disclosed in the consolidated statements of cash flows.
OUTLOOK AND FORWARD-LOOKING INFORMATION
For the second quarter of 2019, McCoy reported revenue of $11.5 million, a sequential revenue decline of 23% from the first quarter of 2019. Despite this decline, McCoy reported a nominal Adjusted EBITDA loss for the quarter, alongside $2.2 million of operating cashflows, primarily driven by improved working capital efficiency in line with our strategic objectives. Market uncertainty in December 2018 and early 2019 drove delays in project approvals for many customers, specifically in international and offshore markets, and as a result impacted second quarter revenues because of longer lead time requirements on many of these higher specification orders. Revenues for the quarter were further impacted by $1.8 million of completed orders that were not shipped due to delays in collecting payment from certain Eastern Hemisphere customers without credit terms. This timing difference in revenue recognition negatively impacted gross profit, net earnings (loss) and Adjusted EBITDA for the second quarter, however this was positively offset by supply chain and operating efficiencies. McCoy booked $17.0 million in orders during the second quarter of 2019, which represented a sequential increase of 68% over the first quarter of 2019. As at June 30, 2019 the Corporation reported backlog of $15.4 million, which will positively position McCoy for the second half of 2019.
The US land market saw further softening in drilling activity resulting from a combination of oil price volatility and operators moving toward prioritization of cash flows and less focus on growth. The average quarterly rig count dropped 12% since the first quarter. Looking forward, we anticipate drilling and completion activity will continue to decline during the second half of 2019 and likely into 2020.
For the remainder of 2019, international and offshore markets highlight an area of opportunity for McCoy as this sector continues its gradual recovery. McCoy’s engineering capabilities and technology offerings position the Corporation to partner with a diverse range of customers as a solutions provider to address complex challenges and drive new revenue opportunities.
McCoy has continued to focus on developing new technologies, and during the first half of 2019, the company invested $1.3 million in its ‘Digital Technology Roadmap’ McCoy has partnered with a leading global technology developer in this initiative, and the project remains on time and on budget. McCoy anticipates launching the first of these new product solutions prior to the end of 2019. This roadmap is a key priority for McCoy as the industry moves towards a focus on data driven solutions. In addition to progress made on our ‘Digital Technology Roadmap’, we have continued to introduce and deliver new products to market, including the next generation of the McCoy Torque Turn (“MTT”) monitoring and control software product. Along with ATEX certification for hazardous environments, the MTT has many improved functions and features and has received positive customer response. Finally, the development of McCoy’s next generation wireless Data Sub is set to perform test rig trials during the third quarter of 2019 with the expectation to field trial and commercialize before year end. This Data Sub will provide customers with patented, unique technology advances that will continue to set McCoy apart as technology leaders.
The increased emphasis on capital discipline from our customers is driving the need for increased efficiency through innovative technologies. As such, McCoy remains focused on driving its profitability and managing working capital to improve cash flow and return on capital, while continuing to address our customers’ most challenging needs through McCoy’s investments in data driven technologies.
Management uses active rig counts as well as number and length of wells being drilled as data points to monitor and set expectations of the future performance of the Corporation. Generally, these metrics are leading indicators of demand for McCoy Global’s products and services, although there are many factors that may impact any correlation.
A summary of historical and forecasted rig and well counts, which includes both land and offshore, obtained from Spears & Associates Drilling and Production Outlook, June 2019, is as follows:1
A summary of historical and forecasted footage drilled, which includes both land and offshore, obtained from Spears & Associates Drilling and Production Outlook, June 2019, is as follows2:
The demand for McCoy Global’s products and services is related to drilling activity levels and customers’ capital and operating budgets, which in turn are influenced by oil and natural gas prices and expectations as to future price trends. The availability of existing capital equipment adequate to serve drilling activity requirements, or lack thereof, further drives demand levels for McCoy’s capital equipment products.
Industry fundamentals strengthened through much of 2018, giving rise to higher drilling activity and to some degree, customer spending primarily in North America. However, in the fourth quarter of 2018, oil prices declined sharply which led to increased uncertainty surrounding our customers’ 2019 capital budgets, and customers generally taking a more conservative approach to capital outlays for the beginning of the year.
In the North American land market, competition, cash constraints, pricing pressure and market uncertainty have continued to influence customer decisions on well-construction equipment purchases through the first half of 2019. McCoy continues to respond to this challenging market environment by investing in data driven technologies to improve efficiency for its customers, while also investing in its rental fleet and strategic finished goods inventories to support the changing purchasing landscape.
International and offshore markets have continued their gradual recovery and customers have begun to re-invest in equipment to meet demand and look to new technologies to drive efficiency. McCoy continues to have a strong product presence in the offshore and international markets. McCoy also remains in a strong position to take advantage of growth due to its large, global installed base of technologies including land and offshore applications.
Backlog is a measure of the amount of customer orders the Corporation has received and is therefore an indicator of a base level of future revenue potential. Backlog is not a GAAP measure and, as a result, the definition and determination of backlog will vary among other issuers reporting a backlog figure.
The Corporation defines backlog as orders that have a high certainty of being delivered and is measured on the basis of a firm customer commitment, such as the receipt of a purchase order. Customers may default on or cancel such commitments, however the commitment may be secured by a deposit and/or require reimbursement by the customer upon default or cancellation. Although backlog reflects likely future revenues, cancellations or reductions may occur and there can be no assurance that backlog amounts will ultimately be realized as revenue, or that the Corporation will earn a profit on backlog once fulfilled. Expected delivery dates for orders recorded in backlog have historically spanned from one to six months.
McCoy Global’s backlog as at June 30, 2019 totaled $15.4 million (Q1 2019 - $9.9 million), an increase of $5.5 million or 56% from March 31, 2019.
The book-to-bill ratio is a measure of the amount of net sales orders received to revenues recognized. The ratio is an indicator of customer demand and sales order processing times. The book-to-bill ratio is not a GAAP measure and therefore the definition and calculation of the ratio will vary among other issuers reporting the book-to-bill ratio. McCoy Global calculates the book-to-bill ratio as net sales orders taken in the reporting period divided by the revenues reported for the same reporting period.
Set out below are orders received, revenue and the book-to-bill ratio:
Orders received are those orders in a period which have been included in backlog. Orders received are typically booked in $USD. For each reporting period, orders received are converted to $CAD at an average foreign exchange rate for the period. As a result, orders received can fluctuate from one reporting period to another because of foreign exchange volatility.
STRATEGY AND CORE BUSINESS VISION
McCoy Global Inc. is incorporated and domiciled in Canada and is a leading provider of equipment and technologies designed to support wellbore integrity and assist with collecting critical data for the global energy industry. McCoy Global’s core products are used predominantly during the well construction phase for both land and offshore wells during both oil and gas exploration and development.
The Corporation is engaged in the following:
• design, production and distribution of capital equipment to support wellbore integrity and to support capital equipment sales through aftermarket products and services such as technical
support, consumables, and replacement parts;
• design, production and distribution of data collection technologies used in rugged applications for the global energy industry as well as in construction, marine and aerospace;
• repair, maintenance, and calibration of the Corporation’s capital equipment and similar competitor products; and
• rental of the Corporation’s capital equipment.