Pason Systems Inc

TSX:PSI

Earnings Call Transcript 2018-Q3

[Operator]

Good morning. My name is Lisa, and I will be your conference operator today. At this time, I would like to welcome everyone to the Pason Systems Inc. Third Quarter Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] The contents on today's call are protected by copyright and may not be reproduced without the prior written consent of Pason Systems Inc.Please note the advisory is located at the end of the press release issued by Pason Systems yesterday, which describe forward-looking information. Certain information about the company that is discussed on today's call may constitute forward-looking information. Additional information about Pason Systems, including the risk factors relevant to the company, can be found in its Annual Information Form.Thank you. I would now like to turn the call over to Marcel Kessler, President and CEO, and Jon Faber, CFO. You may begin your conference.

[Marcel Kessler, President, CEO & Director]

Good morning, and welcome to Pason's Third Quarter 2018 Conference Call. I will start with the highlights of third quarter performance. Jon will dive into the details of our financial performance. I will close with a brief perspective on the outlook for the industry and for Pason, and we'll then move on to the Q&A.Pason achieved strong results in the third quarter. Our teams continued to perform very well in all geographies. We generated revenue of $82.3 million, an increase of 28% compared to the same quarter last year. The main drivers of revenue growth were increased drilling activity and market share gains in the United States, higher activity levels in all of Pason's international markets and growth in product adoption.Adjusted EBITDA was $42.5 million for the quarter, an increase of 62%. Adjusted EBITDA as a percentage of revenue was 52% compared to 41% 1 year ago. The drivers of this improvement were the significant increase in revenue with very high incremental margins based on recorded net income for the quarter of $24.4 million or $0.28 per share compared to $7.4 million or $0.08 per share in the prior year quarter.At September 30, our working capital position stood at $235 million, including cash and short-term investments of $184 million. There is no debt on our balance sheet and we are maintaining our quarterly dividend at $0.18 per share. At the beginning of this year, we began reporting our revenue along 5 product categories to better reflect the changing nature of Pason's business.The first category drilling data contains all products and services, associated with acquiring, displaying, storing and delivering drilling data. Revenue in this segment increased 32% in the third quarter compared to the prior year period and accounted for 51% of our total revenue. The increase was driven by a 12% increase in total US land drilling activity and US market share gains from 59% to 61%. Drilling industry days in Canada were flat.Internationally, drilling activity increased in all major markets with Argentina, Australia and the Andean region leading. Mud management and safety, our second category includes products such as the Pit Volume Totalizer, the Gas Analyzer, the Hazardous Gas Alarm and the Electronic Choke Actuator. In the third quarter, this category generated 27% of total revenue. Communications, the third category included satellite -- includes satellite and terrestrial Internet bandwidth, wireless rig site, voice and intercom services and accounted for 9% of total revenue. Revenue in this segment is showing lower growth because of the transition from satellite to terrestrial bandwidth with lower pricing and better user experience for customers.Drilling intelligence includes Pason's product offerings targeted at enabling our customers' drilling optimization and automation efforts. It contains products such as auto drillers. The abbl Directional Advisor, the ExxonMobil Drilling Advisory System and Pivot, a system for improving slide drilling. Drilling intelligence is our highest growth segment as revenue increased 73% in the third quarter compared to the prior year and accounted for 9% of our total revenue. Our level of confidence in the successful commercialization of new drilling intelligence products continues to grow. There are currently over 150 drilling rig installations of new drilling intelligence software across North America.Finally Analytics and other includes our Verdazo Discovery Analytics product suite, and other revenue streams. This segment is not as directly correlated to drilling activity and accounted for 4% of our revenue.I'm now turning the call over to Jon.

[Jon Faber, Chief Financial Officer]

Thank you, Marcel. Pason posted excellent financial results in the third quarter of 2018. Our US and international business units posted strong revenue gains on both the year-over-year and sequential basis. In the face of continued industry challenges, our Canadian business unit increased revenue by 9%. With continued discipline over cost control and significant operating leverage adjusted EBITDA margins reached their highest level since 2014. Consolidated revenue of $82.3 million represented a 28% quarter of 2017 and was up 21% sequentially from the second quarter. For the first 9 months of the year revenue of $224.4 million was up 25% from the same period of 2017. Adjusted EBITDA in the third quarter was up 62% year-over-year to $42.5 million. Sequentially, adjusted EBITDA increased by $13 million from the second quarter. For the 9 month period, adjusted EBITDA of $106.7 million represented a 51% increase. Adjusted EBITDA margins in the third quarter came in at 52%, marking the highest quarterly margins since the fourth quarter of 2014.Year-to-date adjusted EBITDA margin was 48% up from 39% in the same period of 2017, reflecting the growth in revenue with high incremental margins. Incremental adjusted EBITDA margins for the 9 months of the year compared to the same period of 2017 came in at 81% and remain consistent with our expectations of being able to achieve incremental margins above 75%. Net income for the quarter of $24.4 million was up $17 million from the third quarter of 2017 and up $18.9 million sequentially from the second quarter.Year-to-date net income stands at $42.2 million, up 109% from the first 9 months of 2017. Capital expenditures in the quarter, including capitalized portions of our R&D and IT investments, totaled $4.9 million consistent with the second quarter and down 10% sequentially from the prior quarter -- from prior year rather. Free cash flow in the third quarter totaled $26.9 million, up $15.9 million from the same period of 2017 and up 16% from the second quarter. For the 9 months ended September 30, capital expenditures totaled $15.4 million and free cash flow came in at $68.9 million. We continue to expect to spend up to $25 million in capitalized expenditures in 2018. At the end of the third quarter Pason had positive working capital of $235 million, including $184 million of cash and short-term investments.I'll turn now briefly to each of the operating segments. Our US business unit posted third quarter revenue of $54.2 million, up 33% from $40.7 million in the same quarter of 2017. Measured in US dollars, quarterly revenue increased 28% year-over-year. Sequentially, revenue increased by 8% from the second quarter of the year.Year-over-year revenue growth in the US was driven by increased industry activity and 11% increase in revenue per EDR day and an increase in market share from 59% to 61%. Revenue per EDR day in the US business unit exceeded $700 for the first time in Pason's history. Our strongest areas of revenue growth were drilling Intelligence, which was up 67%, and drilling data which increased 42%. Year-to-date strong growth in these categories drove a 35% increase in revenue compared to the first 9 months of 2017 or 37% measured in US dollars. US business unit revenue for the first 9 months of the year totaled $148.6 million. Exhibiting the significant operating leverage in our business, the US business unit operating costs increased by $1.2 million compared to a $13.5 million increase in revenue. As a result, segment gross profit for the third quarter increased 63% to $31.7 million. Sequentially, this segment gross profit increased by 10%. For the first 9 months of the year US segment gross profit was up 71% compared to 2017 at $83.8 million.Our Canadian business unit represents our second largest segment. Industry conditions in the Canadian business unit remain challenging. Industry activity in the third quarter was consistent with the third quarter of last year, while year-to-date industry activity is down by 6% compared to 2017. Despite the challenging conditions, our Canadian business unit posted a 9% year-over-year increase in revenue in the third quarter and a 2% increase on a year-to-date basis.Revenue for the quarter came in at $20 million, up 8% sequentially from the second quarter due to the seasonality of Canadian drilling activity. For the first 9 months of the year, revenue was $54.1 million in the Canadian business unit. The successful introduction of products in our drilling intelligence category has been the leading driver of an impressive 12% increase in revenue per EDR day in the year-to-date period. Revenue from the drilling intelligence category more than doubled in the third quarter compared to the same quarter in 2017 and is up 46% on a year-to-date basis compared to the prior year. Revenue changes in other product categories were largely reflective of activity mix during the quarter. Our competitive position in Canada remains strong with market share for the first 9 months of the year coming in at 86%. Segment gross profit increased by 74% in the third quarter to $10.1 million and is up 27% year to date.Our international business continues to post strong revenue growth. Revenue in the third quarter of $8.2 million was up 46% from the same period in 2017. Sequentially, revenue increased 11% from the second quarter. Year-to-date international business unit revenue of $21.8 million is up 30% compared to 2017. We have seen revenue growth in each of our international regions on both sequential and year-over-year basis. Gross profit for the international segment of $2.9 million in the quarter was up from $281,000 in the same period in 2017 and up 75% sequentially from $1.7 million in the second quarter. The international business unit posted $5.2 million in gross profit for the first 9 months of 2018, up more than ten-fold from $482,000 from the same period of 2017.In summary, Pason again posted exceptional financial results in the third quarter and remains well positioned going forward. Our US business produced market share gains and posted the highest revenue per EDR day in its history. Our Canadian business has managed to offset a 6% decrease in industry activity in the first 9 months of the year by maintaining our strong competitive position in the market and increasing revenue per EDR day by 12%, largely through delivering compelling new technologies to our customers.Our international business unit continues to post strong revenue growth in each of its operating regions and has returned to much higher levels of profitability. The investments we have made over the past few years in developing new technologies are coming to fruition. We are commercializing new, less capital intensive technologies, which are directly helping our customers achieve their objectives of improving the efficiency, effectiveness and safety of drilling operations. With strong revenue growth, significant operating leverage and reduced capital intensity, our cash flow generation capabilities remain excellent. Our balance sheet remains strong and we are maintaining our quarterly dividend at $0.18 per share.I will turn the call back to Marcel for his comments on our outlook.

[Marcel Kessler, President, CEO & Director]

Thank you, John. We have increased our investment in R&D and IT in the first 9 months of this year with a focus on machine learning algorithms, particularly for the new drilling intelligence and mud management products. We are planning on some incremental further increases going into 2019 in this area. Our capital expenditures will be relatively modest going forward with a larger portion of development efforts focused on software and analytics. We intend to spend up to $25 million in capital expenditures in 2018 and currently expect to spend approximately $30 million in 2019.Our flexible IT and communications platform can host additional new Pason and third-party software at the rig side and in the cloud at very limited additional cost. In the United States, there are concerns for drilling industry activity in the coming few quarters given takeaway constraints across several basins, especially in the Permian in Texas and New Mexico. However, we have not yet seen any signs of a slowdown on the ground and we believe drilling activity levels are plateauing, rather than declining significantly. It is generally expected that the Permian takeaway constraints will be addressed in the next 12 to 18 months. In Canada, we expect activity levels in the upcoming winter drilling season to be somewhat lower than last year.We continue to be quite concerned about the medium-term outlook for the Canadian energy industry as the ongoing crude oil and natural gas takeaway capacity issues and significant price differentials create an environment of extreme caution for Canadian E&P companies. In aggregate, we expect drilling activity across Pason's core markets to be largely flat in 2019 compared to 2018. Our market position, as Jon pointed out, remains strong. We are a service provider of choice for many leading operators and drilling contractors with Pason equipment installed in over 65% of all active land drilling rigs in the Western Hemisphere. Going forward, we expect to drive growth through higher product adoption and incremental market share gains.And we now be happy to take any questions.

[Operator]

[Operator Instructions] Our first question comes from the line of Greg Colman from National Bank Financial.

[Greg R. Colman]

I wanted to start by focusing on incremental margins, as has been highlighted on this call and many before, they were very strong in the quarter. We've previously talked about $250 million in run rate revenue, at the level up to which you continue to see higher incrementals, but after that there would be a step up in costs as you sort of move into a larger, a larger cost pool. But, we are now firmly through that $250 million on a run rate basis and we're continuing to see strong incrementals, I'm wondering if perhaps I misunderstood that level and the incremental margin contribution or if you have a new estimate as to the revenue, peak revenue level or high revenue level where incrementals will start to slow down, I suppose.

[Jon Faber, Chief Financial Officer]

Hi, Greg. Good question. I don't know that I would have any sort of peak revenue of which I think our view on that 75% numbers were measured over time would compress. Our view is that the growth in revenue we're seeing, particularly as it relates to new revenue streams, more software based, particularly in the drilling intelligence sphere and potentially in the mud management and safety sphere, those are higher incremental revenue opportunities. So, that 75% while you're quite correct, we had originally communicated at a revenue level around the $250 million, I think we've also talked about not see it compressed, as we move forward and there is not a peak revenue where I could point to compress.

[Greg R. Colman]

That's interesting especially with the shift over to software. So to put it in a different way, if we look out in the very long-term. If shift over to more sort of higher-margin software business continues, it's probable for us to continue to see your EBITDA margins climb towards in aggregate that 75% level?

[Jon Faber, Chief Financial Officer]

Directionally, it would be moving that way. I think that's right. Now, there obviously strategic decisions we make around certain of our costs, which aren't necessarily directly tied to activity, particularly if you think about investments in R&D as an example where the success we see with the new products and the opportunity we see to maybe do more may introduce on costs in some of those areas. So I certainly don't think we're ever going to get to that level as the kind of company consolidated margin level, but clearly it should be trending upwards over time as we have more software-based offerings.

[Marcel Kessler, President, CEO & Director]

Where we stand today. I don't think we see a step-up in fixed cost anytime. So we even though would drive that.

[Greg R. Colman]

Okay, moving into sort of a little bit more drilling down on the specific segments. Your drilling Intelligence division, as you highlighted showed very strong growth. I'm wondering if you can give us an idea of the market penetration that DI is experiencing now in your overall fleet versus the total number of rigs you've got EDRs on?

[Jon Faber, Chief Financial Officer]

So, the few products in there, and I think when you look at the, particularly, in the North American market, we've talked in prior calls as well, very different market for drilling intelligence products in the initial stages in Canada and the US, as it relates to the rig fleets and the composition of mechanical rigs versus AC rigs. So, we have had some initial success now in some AC rig environments with some of the products. I would say that that penetration rate is still quite low, but we do have some. The Canadian side, we obviously had seen continued growth in particularly in the mechanical rig side and I think that that growth rate will also probably slow a little bit from this rate, because you got some of the easier rigs first, if you will.But, when we think about the growth in drilling intelligence, the caution we continue to cast around not being able to draw a line up to the right would continue the ability for us to penetrate further in drilling intelligence products both requires us to increase the addressable market by integrating with more rig types or new products, and then further penetrating the addressable market through conversations with customers that can take different amounts of time based on the customer. So, I think it is a more of a step change function over time. Obviously, we're quite delighted that some of that would have come in this quarter, but it's always very difficult for us to forecast when we see that next incremental bump in the drilling intelligence side.

[Marcel Kessler, President, CEO & Director]

So maybe to give you a rough estimate here. So we currently have 150 active installs of new drilling intelligence software. Now there will be a few rigs there are a couple of new product on there at the same time, but that probably translates into a penetration of approximately 10% give or take, of our current EDR footprint.

[Greg R. Colman]

Got it, okay. Staying on staying on drilling intelligence from minute there. Is the margin contribution at the current level, from DI, additive or dilutive to the overall corporate EBITDA margins?

[Jon Faber, Chief Financial Officer]

It would be additive. There are certainly some upfront costs around the integration with new rig types, but in terms of field level cost, there's not a lot of incremental costs as we're able to sort of activate that products and maintain it with the same very skilled technicians that we would have for the existing product suite.

[Greg R. Colman]

And is that additive only as of this quarter or is it -- has it been additive for some time now?

[Jon Faber, Chief Financial Officer]

It would have been additive for some time, I would suggest.

[Greg R. Colman]

Got it. And then just 2 other quick ones don't want to dominate the questions here on CapEx, you talked about up to $30 million in 2019. If we're thinking long-term sort of steady state, is that a good, still a good level to be thinking up for annual steady state CapEx just running into the long-distant future?

[Marcel Kessler, President, CEO & Director]

Yeah, I think that's right. Maybe already 35, yes.

[Greg R. Colman]

Got it, okay. And then finally on the balance sheet, you've got about a $185 million cash and effective equivalents, growing sizably as you got good free cash flow too, is that a 585 level what management the boardings is necessary to maintain a decent buffer in a cyclical business or is your sort of safe level of cash and cash equivalents, the threshold much higher, much lower than that?

[Jon Faber, Chief Financial Officer]

I think the buffer to withstand the volatility is not that high. We have more cash than we would require for what we would see is required buffer against movements in the industry. The question we have of course is with the excess amount of what I will call less productive cash. Are we able to deploy that into higher growth opportunities or do we return some of that to shareholders via through special dividend, share buybacks, those sorts of questions that we've talked about on prior calls. We certainly see opportunities to deploy that capital, potentially for higher growth and we've had the opportunity over the last month or so to engage in conversations with some of our larger institutional holders around their preferences around capital allocation, which has been helpful in the conversation that we have at the Board as well. We don't think it's a decision we would make in isolation without soliciting some insights from some of our longer term and larger institutional holders.

[Greg R. Colman]

So no change sort of in the policy sitting on the cash balance for now, value-adding opportunities, and slow but steady dividend growth, which is why you've shown in the past?

[Jon Faber, Chief Financial Officer]

Correct.

[Operator]

Our next question comes from the line of Daine Biluk, from CIBC Capital Markets.

[Daine Biluk, Associate]

There is a solid improvement quarter-over-quarter in drilling data revenue per EDR day for the US. Can you share what sort of peripheral product adoption you witnessed and was a handful of large customers driving the change or was it fairly broad-based?

[Marcel Kessler, President, CEO & Director]

So it is fairly broad-based and the product, it would also be fairly broad-based across the product suite. So there are 1 or 2 single products that drove it, and it would have been a combination of selective price increases, as well as growth in product adoption.

[Daine Biluk, Associate]

Okay, so fair to say. Certainly not something specific to Q3, something that all certainly continue into 2019.

[Jon Faber, Chief Financial Officer]

Certainly in terms of the where we will be at this level, we talked in prior calls as well about the pricing situation in the US unfolding over time and then the third quarter would probably represent a bit more of the run rate environment on the US pricing side, so again it wouldn't necessarily continue a trend line up to the right, we see continued opportunities for product adoption, there probably is some more opportunities for pricing selectively, but there has been a run-rate effect here catch up on some prior quarters.

[Daine Biluk, Associate]

Okay, that's good color. Is your latest new product, Pivot, on trial with any customer rigs today? And can you share in general where the pricing points for Pivot would be?

[Marcel Kessler, President, CEO & Director]

Answer to the first question, yes. It's in trials with several customers. They are commercial trials and not just technical, they are being paid. In terms of price points, that is still a fully established commercial, will be of the order of a couple of hundred dollars per day. But it's still not completely set in stone in terms of the ultimate price list.

[Daine Biluk, Associate]

Okay.

[Marcel Kessler, President, CEO & Director]

And maybe just to add to that. Excuse me for interrupt, really there are 2 types of Pivot software. The one that I'm talking about is called Pivot Oscillator. It's currently being deployed and then there is one a bit further out in development. The Pivot to Phase Control which you would have seen our investor presentation maybe last quarter that is still in technical development. So there are 2 different products here, the one that's commercially activity is the Oscillator.

[Daine Biluk, Associate]

Okay. Looking internationally to 2019. Based on current customer conversations, what countries or regions do you anticipate could see the most meaningful improvement in activity?

[Jon Faber, Chief Financial Officer]

International, was that the question?

[Daine Biluk, Associate]

Yes.

[Marcel Kessler, President, CEO & Director]

We anticipate the current trend of where we see most growth, so it's in Latin American region, Argentina in terms of activity level looks good for Pason going forward foreign exchange challenges notwithstanding. We continue to see momentum in the Andean region too. We believe that Brazil and Mexico will continue to be challenged for the time being and then we do expect fairly robust growth in the Middle Eastern region.

[Daine Biluk, Associate]

Okay, perfect. And then just last question from me. On the incremental 20 rigs running drilling intelligence software in North America were those almost exclusively weighted to Canada?

[Marcel Kessler, President, CEO & Director]

No, actually, there will be a more weighted to the US.

[Operator]

Our next question comes from the line of Elias Foscolos from the Industrial Alliance.

[Elias A. Foscolos, Equity Research Analyst]

Couple of questions to follow up on. Just from an overall industry perspective, we've seen productivity per well in the Permian kind of flatten out. We have not seen as you pointed out Marcel sort of a change in rig counts. Are you seeing an increase in drilling intensity going on there? I wondered if you could give us some color on that.

[Marcel Kessler, President, CEO & Director]

I don't think we really have seen a significant change one way or another. The Permian in terms of intensity and drilling practices, obviously it's a very busy region with the tremendous focus in many ways, but we haven't really seen a significant change.

[Elias A. Foscolos, Equity Research Analyst]

Okay. In focusing on revenue per EDR day, I'm going to dive back into a question that was asked earlier. We saw a very big sequential uptick and you said it was quite broad-based and yet at the same time we're seeing drilling intelligence becoming a larger share of your income and it is more accretive to EBITDA. So, I guess what I'm getting at is in a flat type drilling environment, just tying into an earlier comment too, you were saying, revenue per EDR day would sort of remained flat. I would think that it might tick up a bit as adoption picks up.

[Jon Faber, Chief Financial Officer]

I would think a flat environment revenue per EDR day tick up a bit and we didn't work something quite profitably earlier we give the impression that we thought revenue per daily flat. I think our view at industry activity is likely to be fairly flat, but in that context, revenue per EDR day is likely to grow a little bit through some product adoption and again, there may be some opportunity selectively in some pricing conversations as well.

[Elias A. Foscolos, Equity Research Analyst]

Okay and 1 last question on -- again, I'm going to focus on the drilling intelligence. Internationally that didn't show the year-over-year uptick and I think you commented on it. Is there a rig configuration that's causing that to occur or is it --

[Jon Faber, Chief Financial Officer]

Recall in prior years, we had seen downward trends in revenue when we reported on a product name basis especially in the legacy electronic auto driller, which is more relevant to mechanical rigs. So as we're seeing some of the international markets move to a little bit more AC rigs, we're seeing that trend still play out in the international markets, where in some of the legacy auto driller revenue would be declining and now we'll be putting pressure on drilling intelligence in the international markets.

[Elias A. Foscolos, Equity Research Analyst]

Okay.

[Marcel Kessler, President, CEO & Director]

So maybe for further clarification. The drilling intelligence product suite as we reported contains mostly new product, but 1 legacy product, which is the older auto driller on mechanical rigs, which is obviously declining and the biggest impact there in the international segment.

[Operator]

[Operator Instructions] Our next question comes from the line of Ian Gillies from GMP.

[Ian Brooks Gillies]

Good morning, everyone. With respect to the international segment coming out of maybe a bit of a different way, I mean do you feel like you've reached economies of scale in all your operating areas? Margins are kind of where you expect them to be or do you still think there's significant growth moving ahead and they could catch up with Canada and the US? Or s there anything hampering International's ability so it wouldn't be able to catch your other segments?

[Jon Faber, Chief Financial Officer]

You asked 2 questions there. You asked, do we think it continue to increase, do we think it can catch up to the North American? Do we think it continue to increase? Yes. Do we think it will catch-up for the North American? Probably not, just given the geographic dispersion drilling activity in the international. But I do think we do have operating leverage still in the international business.

[Marcel Kessler, President, CEO & Director]

But of course volume in any international market helps tremendously, like North America, right, it's still largely a fixed cost business and the individual markets are significantly smaller than where we are in the US and Canada, much more fragmented. There's additional challenges there, import-export of equipment additional costs. So we will not reach the margin levels that we are able to achieve in North America.

[Ian Brooks Gillies]

Okay. The other specifically related to the cash position and a potential return to shareholders, is a share buyback or a substantial issuer bid I mean an option given the relative returns of reinvestment into the business given relative to where Pason's I guess valuation metrics maybe or how you may view the business?

[Jon Faber, Chief Financial Officer]

I think both are opportunities. We do see opportunity to invest further in the business. We do think some element of share buybacks, particularly around offsetting dilution from exercise of options maybe part of the capital allocation program going forward.

[Operator]

Our next question comes from the line of Jeff Fetterly from Peters & Company. Your line is open.

[Jeffrey Eric Fetterly, Principal and Oilfield Services Analyst]

On the Canadian side, if I look at Q3 operating margins compared to Q1, you're obviously a little bit higher, revenue was down 15%. Can you help us understand, is it just a mix with the drilling intelligence contributing in a more meaningful profitability fashion or were there other products, dispersions in there that we should think about?

[Jon Faber, Chief Financial Officer]

Mostly from the drilling intelligence space, again that's a very high incremental margin type of opportunity that would have been ramping in the first quarter and more run rate in the third quarter and so that would have helped quite a bit on the margin side.

[Jeffrey Eric Fetterly, Principal and Oilfield Services Analyst]

On the US side, your comment in the prepared remarks around market share gains. Can you give us some context around either rig mix as you see that playing out, but also from a customer operator standpoint or contractor standpoint. Are there any lumpy opportunities that you see in the US in coming months or quarters?

[Jon Faber, Chief Financial Officer]

We talked for a few quarters around the growth in US market share being somewhat contractor-led and some of those contractors do work with large operators, where opportunities to gain market share would be perhaps more lumpy. And I think the discussions with those operators in particular will be driven first and foremost by some of these new products on the drilling intelligence and mud management and safety side. And so, the ability to win some business through the product side, and the nature of those customers being larger in making the decisions a few rigs at a time versus 1 rig at a time for the types of products, we're talking about. I think it would be potentially a little bit lumpy for any gains from the area.

[Marcel Kessler, President, CEO & Director]

I think that's right. Especially on the operator side there might be 1 lumpy opportunity left on the contractor side, but then probably a few lumps from the operator side are possible.

[Jeffrey Eric Fetterly, Principal and Oilfield Services Analyst]

Sorry just so understand that you're starting to see your belief that either drilling intelligence or some of the peripheral products could be pull-throughs to bring EDR or the broader products suite into certain operators or contractors?

[Marcel Kessler, President, CEO & Director]

I think - -I think that exactly right. I think further market share gains in the United States are dependent on the success of the new drilling intelligence products and maybe on some of the new mud management and safety products. And that [indiscernible] EDR on there, essentially the hosting platform for that software.

[Jeffrey Eric Fetterly, Principal and Oilfield Services Analyst]

Last question just on R&D your commentary around accelerating R&D and IT spending, your CapEx is trailing behind guidance or that $25 million level that you mentioned for this year, you've seen only a modest increase in R&D expenditures for 2018. Do you expect that those will step up in both cases, both Q4 and into 2019, or are those more sort of ambitious targets that you're tracking behind?

[Jon Faber, Chief Financial Officer]

So I think the CapEx side in particular, we do expect the fourth quarter look more like the fourth quarter of last year, which you'll recall was more in the order of $9 to $10 million, which should bring us close to that $25 million we're talking about. So that that would address the capital side. On the R&D and IT investments side, R&D we are capitalizing a little bit more again now than we would have the last couple of years, particularly around some of these automation products, where the confidence level we have around those products is such that we now have to capitalize instead of bringing them straight to the income statement.

[Marcel Kessler, President, CEO & Director]

On that point, so your first 9 month increase that you see there, which is I think in a few percentage points is often misleading right given that the growing portion has been capitalized. The actual growth is higher than that.

[Jon Faber, Chief Financial Officer]

If you take the expense item, Jeff and add the deferred development costs from the cash flow statement, you'll get a more reflective cash spend in the R&D side, which would be up more closer to the 10% that we've been talking about it in prior calls.

[Operator]

We have no further questions in queue, I will turn the call back to the presenters for closing remarks.

[Marcel Kessler, President, CEO & Director]

Well, thank you everybody.

[Jon Faber, Chief Financial Officer]

Thanks very much.

[Operator]

This concludes today's conference call. You may now disconnect.