During the period, we have focused our resources on the
expansion of services and market acceptance for SR2020 and Crest
and, in the case of Strata, on further diversification away from
its established Canadian stronghold into the more stable and larger
US and Middle Eastern markets. In addition, we have assisted all
three IOGT portfolio companies in their continued technical
development to maintain their presence in high added-value segments
of their respective sectors.
Our focus is to add shareholder value by developing the
portfolio companies into differentiated organisations that are at
the forefront of service excellence.
The H1/2013 period has provided mixed results for the three
companies: Crest has exceeded plan but both Strata and SR2020 have
experienced disappointing sales.
At the time of this report, Strata has its highest level of
equipment utilisation for 18 months, with a full order book and
anticipated sales at an annualised rate of over US$30 million.
However, the slower than anticipated recovery of sales during the
first half of 2013 has resulted in Strata breaching its bank
covenants, resulting in its senior debt provider seeking additional
coverage through a combination of cost savings and new capital.
Continued working capital support for SR2020 due to lower than
forecast sales combined with Strata's inability to repay its
outstanding loan to IOGT by the year-end have caused a significant
reduction in IOGT's forecast cash reserves.
Portfolio update
Strata
Strata has for many years been one of the leading providers of
underbalanced drilling (UBD) services in its home Canadian market,
where it has the dominant market share. Strata has established an
enviable reputation amongst the major Canadian oil and gas
companies with its patented rotating flow diverter (RFD) equipment
and the quality and efficiency of its service provision.
During 2012, Strata established UBD services in Kurdistan for
HKN. Operations in this region have continued to expand, with two
new long-term contracts due to commence in H2/2013.
An important development has been the increasing and
industry-wide acceptance of managed-pressure drilling (MPD)
services; these enable operators to increase drilling efficiency
and safety by drilling close to balance with the formation
pressure, with constant positive control of drilling fluids. Strata
has developed a service package centred on its proprietary RFDs and
automated drilling chokes. Strata's MPD services have started to
gain market share in the US where, in concert with the appointment
of a local country manager, the company is expanding operations
with several major US operators. MPD is particularly attractive to
operators in the booming shale drilling sector in the US, where
safety and efficiency are coming under intense scrutiny.
This greater geographical diversification should allow Strata to
mitigate the impact of downturns in the potentially more volatile
Canadian home market.
Performance for H1/2013 has still been affected by the aftermath
of the dramatic slump in drilling activity in Canada during
H2/2012. Revenues for the six months to 31 May 2013 were C$10.3
million with EBITDA of C$0.3 million. The slow first six months
means that the full-year revenue outturn is likely to be flat
compared to FY/2012.
However, Strata forecasts that H2/2013 will show a significant
improvement, with high current levels of equipment utilisation in
all three operating regions. The outlook for the next 12 months is
stronger, with monthly revenues, many already contracted, forecast
to exceed significantly those of the previous twelve-month
period.
The company has until recently continued with its development
programme for offshore MPD technology. Two prototype RFDs for
deployment to fixed platforms and jack-up rigs are ready for field
testing. The RFD system for use on floating rigs is ready for
fabrication and is scheduled for field testing in 2014. Both types
of offshore RFD equipment will provide Strata with added technical
differentiation and the potential to penetrate the lucrative
offshore market. Currently however, work on the offshore technology
development has slowed due to Strata's cash shortage.
With high equipment utilisation anticipated for the next 12
months, successful expansion into the US and Middle East, and
proprietary offshore technology close to field testing, Strata's
future looks most promising if its short-term cash flow issues can
be resolved. We are working assiduously with both Strata and its
lenders.
Crest
Crest currently focuses on providing nitrogen-purging services
to national oil companies and other operators in the Middle East.
Crest is headquartered in Dubai and has an operations base in
al-Khobar, Saudi Arabia, from which it serves Saudi Aramco.
Crest continued to increase revenues at a rapid rate during
H1/2013, with revenues for the six months of US$1.3 million
compared to total revenues in 2012 of just over US$1.0 million.
Based on current activity levels, full-year revenues are expected
to exceed US$2.2 million. Margins remained high and Crest was
EBITDA positive during the first half. As in 2012, this revenue was
earned exclusively from operations in Saudi Arabia by providing
nitrogen-purging services using Crest's membrane
nitrogen-generation units.
During the six months, Crest continued to own two units: a
single, high-capacity (2000 scf/m) membrane nitrogen unit that was
deployed to major pipeline-purging projects and on power-station
infrastructure-purging operations and a smaller (580scf/m) unit,
which is on a long-term contract and assigned exclusively to
nitrogen-purging operations on power-station infrastructure in
Saudi Arabia. Although Crest has periodically deployed rental
equipment on operations, it does not seek actively to pursue a
business model based on significant usage of rental equipment,
which carries lower margins with more cash-flow risk.
Crest has again had to decline offered work due to lack of
available equipment. An increase in Crest's asset base would enable
it to meet at least part of this excess demand. However, to take
advantage of that demand will require further capital investment.
Furthermore, current high utilisation levels of equipment restrict
Crest's ability to tender for new work in H2/2013 because it cannot
be certain when existing contracts will finish. Without investment
in new equipment, Crest is likely to achieve lower revenues and
working capital in the second six months.
Crest is actively developing further business activities in the
upstream sector, such as well intervention and drilling support. It
is also in the process of qualifying to provide nitrogen services
in Gulf countries other than Saudi Arabia.
SR2020
SR2020 provides borehole seismic acquisition and processing
services in the US. Its headquarters are in Brea, California, where
the company's geophysicists undertake seismic-data processing for
both its client borehole seismic data acquired by its own equipment
and for data sets acquired by third parties. SR2020 processes both
conventional and borehole seismic data from third parties,
particularly specialising in difficult situations such as sub-salt
surveys.
SR2020 has an operations base in Houston, Texas from where its
proprietary tubing-conveyed borehole seismic-array equipment is
deployed.
SR2020 enjoyed a three-fold increase in income during 2012.
However, revenues of US$0.9 million in H1/2013 were disappointing.
Reduced acquisition revenue, which was caused by a shortage of
equipment, resulted in lower associated processing income. The key
new acquisition equipment ordered from USSI in 2012 has been
further delayed, with delivery not now expected until later in
H2/2013. As a result, SR2020 expects full-year revenues to remain
flat compared to 2012. Additional capital is required to purchase
the new equipment and achieve sales growth, although SR2020 has
continued to strengthen its sales team to provide better customer
awareness of its capabilities.
We remain confident that SR2020 has the potential to provide
shareholders with a significant return on investment. However, we
believe that SR2020 is likely to need two years building its client
base, including with a number of repeat customers, and deploying
additional capital to build its sales, marketing and acquisition
capabilities before its intrinsic value can be realised.
Conclusion
Progress has not been as we had expected in our year-end report.
Disappointing sales revenues at Strata and SR2020 have created
issues that have had an associated negative impact on the cash
flows of IOGT. Working closely with the Board, we have taken and
will continue to take steps to correct the position. As explained
in the Chairman's letter, the Board has concluded that additional
shareholder funds are required to enable orderly exits from the
portfolio companies.
Linton Capital LLP
30 August 2013
David Sefton Michael Goffin Roland Wessel
Investment manager Investment manager Investment manager
Condensed balance sheet
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