Mitcham Industries Takes Off

Summary

• The company is in the midst of a strategic reorientation away from their traditional lease business and towards their more promising marine technology products.
• Some benefits are already visible in the form of good growth in their marine technology business and rising gross margins.
• The Q4 results were depressed by one-off factors.

Mitcham Industries (NASDAQ:MIND) is undergoing an interesting transformation, refocusing their business away from their equipment leasing segment towards their marine technologies segment with their Klein (acquired at the end of 2015) and Seamap businesses.

Our investment thesis is that despite worsening results (until recently) investors are not sufficiently appreciative of the opportunity this transformation offers although in the last couple of days that suddenly changed quite a bit.

At first sight, that transition is not going too well for shareholders, but when we started researching and writing, the shares suddenly doubled, although they have given back a bit since. We think investors realize the company isn't going out of business, as they seemed to have feared:

The performance the past 5 years isn't terribly promising but at least there has been a considerable improvement in net income:

Data by YCharts

Basically their equipment leasing, which used to be their prime focus, is slowly liquidating by selling off equipment and replacing it with less new equipment. The company spelled out the reasons for the strategic reorientation in the 10-K:

over the past several years there have been a number of developments that have had an adverse effect on that business. These developments include the following:

• uncertainty in prices for oil and natural gas and the resulting decline in exploration activity by oil and gas companies;
• an excess of rental equipment or equipment capacity in the seismic industry;
• increased competition for the sale or rental of seismic equipment, particularly land seismic equipment;
• decreased pricing for the purchase or rental of seismic equipment; and
• financial difficulties encountered by many of our customers in the seismic industry.

Covid-19

Company facilities in Malaysia and Singapore suffered temporary closures, giving management limited access to receive and make shipments, but this has now opened up.

It's pretty obvious that the energy sector has been hit pretty hard, and they are significant customers of the company's business, in particular their leasing segment, but other customers aren't nearly as affected, Q4CC:

I mean a lot of our activity on the traditional seismic products, the senior products, for lack of a better term, are really non oil and gas related applications. They are survey companies or research institutes, governmental research institutes. So a lot of what we have been doing recently, a lot of the pending orders we have are non oil and gas or non exploration related. So certainly not impact to a greater degree.

Their Seamap business has a big installed base of customers which generate a constant flow of demand for parts, service and support.

Q4 and FY2020 results

The Q4 results a good month ago missed on revenues, coming in $2.3M short at $13.26M, which was still 7.5% higher than the quarter a year ago and up 24% sequentially, driven by Sealink and even the leasing business (coming in at $4.2M in Q4), the latter due to a seasonal uptick with a land project in Europe getting underway.

Their marine product technology segment was up 30% to $8.77M versus the same quarter last year with Klein up from $1.3M in Q4 2019 to $1.7M in Q4 2020. Seamap did have a good quarter, producing $7.1M in revenues, up from $4.9M in Q4 2019 (Q4CC):

Our Seamap subsidiary had a good year with deliveries of our BuoyLink 4DX RGPS systems and SeaLink towed streamer system exceeding our initial expectations. The BuoyLink 4DX greatly enhances the precise surface RGPS positioning capabilities for streamers and seismic sources that are necessary for 3-D and 4-D surveys.

However, things could have been considerably better as a $2M delivery was pushed into this fiscal year as a customer revised their requirements. Covid-19 is likely to push this order out to Q2 FY2021

The leasing business revenues decreased from $5.5M in Q4 2019 to $4.5M this quarter but the leasing business itself was up, there were just less sales of equipment due to the push-out of a $1M sale to an Asian customer. Management adds that they have recently concluded a similar sale to a US customer, so these kind of liquidation transactions keep on occurring.

Sequentially there was a big 71% increase, but this is seasonal. For the fiscal year 2020, there is the following revenue split, from the 10-K:

The marine part is growing (the decline in FY2019 was due to the sale of SAP (Seismic Asia Pacific Pty Ltd.). And here is a further split from their marine technology segment, also from the 10-K:

The growth is in Seamap, but the company is expecting Klein to join in the fairly near future, 2-3 quarter with their side-scanner business.

Growth

A year ago their subsidiary Klein introduced the MA-X, a new side scanner with (Q4CC):

superior image quality and greatly enhanced efficiency, bringing a highly compelling value proposition to both military and commercial operators in the seafloor imaging market.

In February the company introduced the µMA-X The 10-K is more specific about how this MA-X technology sets them apart:

We believe MA-X is revolutionary technology. Traditional side scan sonar imaging creates a nadir gap in the center of the image. This gap in data requires overlapping survey lines which leads to significant additional survey time to achieve 100% coverage. For the operators of autonomous underwater vehicles ("AUV"), this translates into extended mission duration. Traditional "gap-filler" solutions tend to be expensive or of low image quality. A cost-effective gap-filler solution has long been sought by the industry. The µMax has reduced size and power requirements and is targeted at the unmanned undersea vehicle ("UUV") market.

The company has been engaged with trials, and received one contract from a leading autonomous underwater vehicle manufacturer already, which is installing the MA-X on its next generation vehicles.

Meanwhile, the Navy is evaluating their smaller µMA-X and getting them as a reference customer would give the technology quite a boost.

Margins

Here is the best case for the strategic shift from the lease business to the marine technologies business, a steady improvement in gross margins:

Data by YCharts

Marine technology produced a gross profit of $4.4M in Q4, double that of a year ago, producing a 50% gross margin. Gross profit in the licensing business was $1.2M, down from $1.9M a year ago indicating a gross margin of 28.5% in Q4.

G&A was $5M, basically flat while R&D was $408K in Q4 up from the $302K last year but down sequentially from the $629K in Q3 and are largely related to the delivery of the µMA-X.

The company made a $2M provision for uncollectible receivables and recorded an impairment of $760K with respect to certain intangible assets, adding greatly to the operating loss of $2.9M in Q4.

Adjusted EBITDA remained positive, albeit only just at $124K, down from $198K in Q3 but up from $111K in Q4 2019.

Cash

Data by YCharts

This isn't a pretty picture and to some extent a little surprising given the fact that they are slowly liquidating their lease business.

They don't have a lot of cash, just $3.1M, but they have no debt and:

• Most of their cost are flexible, they could retreat, so to speak.
• They could apply for one of the (foreign and domestic) government assistance programs.
• They could accelerate the liquidation of the lease business, selling off assets (they sold $1.9M of equipment in FY2020 and since the remaining stock is fully depreciated, any sales add entirely to cash. In Q1 2021, there was already another $1M sale).
• The company could reduce or eliminate the ($2M) dividend on the preferred shares.

So we're not overly worried here, and neither does management seems to be. Dilution has been minimal in the common but really substantial in the preferred stock:

Data by YCharts

That $22.1M preferred stock figure is the dollar amount they represent on the balance, not the number of outstanding shares, from the 10-K:

As of April 28, 2020, there were 994,046 shares of Series A Preferred Stock outstanding with a liquidation preference of $25.00 per share. The quarterly dividends on the outstanding Series A Preferred Stock are approximately $559,000. The 994,046 shares represent 100% of the Series A Preferred Stock available for sale through our at-the-market program. However, in response to unexpected demands on our liquidity, such as may arise from the COVID-19 outbreak, we could suspend the quarterly dividend on the Series A Preferred Stock.

Valuation

Data by YCharts

Given the mishap in Q4, the pushed out orders and the reservations, we think the shares are still fairly reasonably priced. Their marine business has promising technology and earns good gross margins already,

Conclusion

While the company's liquidity is a little low, they do have options here to address that problem. In the meantime, their marine business is growing nicely but most of that growth has come from Sealink. There are reasons to expect Klein to join in that growth fairly soon on the basis of their promising MA-X technology products.

Q4 results would have been much better if a $2M order hadn't pushed out and without the reservations for uncollectible receivables and equipment write-downs (together $2.76M).

One could also consider the preferred shares (MINDP), after all, they're yielding a whopping 12.75% at the moment, although the company might cut or even eliminate that dividend altogether, which is a bit of a risk.

Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Comments

[QQkazzoo]

Thank you for this article! So what attracted me to this company was this MA-X technology. Could you comment more on this? How can this affect this company? Is this the only type of this kind of technology that can close the nadir gap? If the Navy wants it what kind of money could this bring into this company?

[Uncorrelated]

I've been in the preferred for a couple years now and bought more and some common as well after listening to the last quarterly call (I think it was me and 2 analysts...). I liked what I heard about strategic changes in the business, the guys struck me as intelligent and straightforward and I think they were very transparent and realistic about the negative impact of the revenue deferral mentioned in this article. It just seems like a well-run company with enough cash reserves to make the transition from primarily drilling-oriented services and even though I'm up 80% on the common shares, I'm not selling. I consider this a long-term hold. And yes, the preferred is cumulative. My 2018 preferred divvys were qualified so taxed at the LTCG rate and 2019 was apparently ROC since it was reported on my 1099-div as non-dividend distribution so it's been great in my taxable account. It's redeemable June 2021 but I hope they don't!

[Shareholders Unite]

Thanks for the added color, uncorrelated.

[Gino Verza]

Shareholders Unite.
Another great article in the less-traveled road. Love to read them. Thank you.
I am unfamiliar with the name. Based only on a cursory look, my concern is that the unwinding of volatile and potentially credit-impaired lease assets negates/constraints the opportunity in the marine business. As I recall from my experience in wholesale lease financing unwinding impaired/volatile lease assets is a long, laborious and expensive process. Thank you again.

[Shareholders Unite]

Thanks Gino, appreciated. As far as I know, the assets they have to lease have been fully written down, so that risk seems to be limited..

[bambi1]

Certainly they could suspend the preferred share dividends if they wanted to ( and I believe they are cumulative) but preferred dividends can’t be cut.