Small Cap ION Geophysical Corporation: Will It Outperform?

Small cap ION Geophysical Corporation (NYSE: IO) jumped 24.92% yesterday after earnings and appears to have finally undergone a reversal near the end of December as the Company seeks new markets beyond oil and gas plus achieve clarity on an ongoing lawsuit.

ION Geophysical develops and leverages innovative technologies, creating value through data capture, analysis and optimization to enhance critical decision-making, enabling superior returns. ION Geophysical has been a technology leader for 50 years with a strong history of innovation and while the traditional focus for its cutting-edge technology has been on the E&P industry, the Company is now broadening and diversifying its business into relevant adjacent markets such as offshore logistics, military and marine robotics. Currently, ION Geophysical is organized into three business segments: 

E&P Technology and Services creates digital data assets and delivers services that improve decision-making, mitigate risk and maximize portfolio value for E&P companies. Operations Optimization develops mission-critical subscription offerings and engineering services that enable operational control and optimization offshore. Ocean Bottom Integrated Technologies integrates a variety of ION's advanced technologies to accelerate data capture and delivery. 

In the Wednesday Q4 earnings release, the President and CEO was quoted as saying:  

"While our fourth quarter revenue improved sequentially, driven primarily by the success of our Brazil 3D reimaging programs, we experienced geopolitical headwinds that further delayed Mexico and Panama data sales.  In addition, typical year-end spending didn't materialize in the way we anticipated for key customers, likely due to the commodity price slide experienced in the fourth quarter of 2018."

"We continue to expect near-term oil price volatility and for E&P capital preservation to take priority over reserve replacement, with very focused exploration spending.  That said, the international market is anticipated to grow for a second consecutive year and we are seeing increasing momentum across all our E&P and adjacent market businesses.  We believe market fundamentals will continue to improve as it becomes increasingly critical to meet production demand in the next decade.  In 2019, we expect an increase in new program development, the completion of our 4Sea commercialization and greater adoption of Marlin in both E&P and adjacent markets.  As usual, we expect 2019 to be back-end loaded given the timing of client budget spending, license rounds and new program activity."

In the earnings call, he added:

While long-term oil and gas fundamentals remain strong, near-term exploration spending continues to be lumpy and unpredictable. We expect continued near-term volatility in oil prices and a cautious backdrop for E&P spending in 2019, especially in the early part of the year as customers evaluate their budgets. Analysts are projecting E&P spending to increase another 8% in 2019, following 8% growth in '18 and 4% growth in '17. At this point, we don't know the potential impact the commodity price volatility may have on 2019 budgets and are not going to know until late into the first quarter. However, early indications from of our customers are that budgets will be flat or up, so there should be an overall improvement.

While we do not provide guidance, we currently anticipate 2019 will be a significant improvement on 2018 subject to E&P budgets levels increasing as expected.

He also provided extensive commentary regarding an ongoing legal case that has impacted the Company (Note that WesternGeco is owned by Schlumberger):

This past June, the Supreme Court overturned the Federal Circuit Court of Appeals ruling about throughout lost profits in our case. The Federal Circuit Court had taken up positioning cases before ours, the foreign lost profits were categorically unavailable under the Patent Act and they applied that precedent in our case. The Supreme Court's decision ruled that, that was not the correct reading of the Patent Act. What the Supreme Court did not do was ruled that lost profits were recoverable by WesternGeco in our case. The Supreme Court sent the case back to the Federal Circuit to consider some of our other arguments.

As we've explained in some of our prior filings in press releases, for the last few years, we've been fighting the lost profits jury award on two fronts: one front was the litigation that went up to the Supreme Court; the other front was an administrative process called an IPR or inter parties review that was before the Patent and Trademark Office. In 2015, the Patent and Trademark Office ruled that 4 of the 5 patent claims that the jury could have found supported an award of lost profits in our case were avoid because the patents underlying them never should have been granted to WesternGeco in the first place.

The Federal Circuits Court most recent decision in our case, the decision they issued on January 11, has joined together the two fronts where we were fighting lost profits. In that most recent decision, the Federal Circuit court ruled that the jury's lost profits award in our case cannot stand if it could have rested on infringement of any of those 4 invalid claims. So the Federal Circuit Court remanded our case, we went all the way up to the Supreme Court back to the District Court to determine if we are entitled to a new trial on lost profits. In that same opinion, the Federal Circuit court also held that the lost profits award can only be reinstated by the District Court if the existing trial record establishes that the jury must have found that the technology covered by the one remaining patent claim was essential for performing the surveys upon which lost profits were based.

Aside from ION Geophysical Corporation specific issue, here is a look at the performance of possible benchmarks such as the iShares U.S. Oil & Gas Exploration & Production ETF (XOP) and the iShares US Oil Equipment & Services ETF (IEZ):

Crude oil prices have been up since the start of the year thanks to an output cut decision by OPEC and Russia for the first six months of the year, US sanctions against oil rich Venezuela and hopes of a U.S.-China trade truce. Given that ION Geophysical Corporation is diversifying into other markets and a lawsuit cloud is lifting, I would expect shares to outperform peers and alternative investments in the E&P or oil services sectors.