Pason Systems Inc

TSX:PSI

Earnings Call Transcript 2021-Q1

[Operator]

Good morning. My name is Christine, and I will be your conference operator today. At this time, I would like to welcome everyone to the Pason Systems, Inc. First Quarter 2021 Earnings Call. [Operator Instructions]Please note that the contents of today's call are protected by copyright and may not be reproduced without prior written consent of Pason Systems Inc. Please note that the advisories 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. Mr. Faber, President and CEO, you may begin your conference.

[Jon Faber, President, CEO & Director]

Thank you. Good morning, and thank you for attending Pason's first quarter 2021 conference call. I'm joined today in Calgary by Celine Boston, Pason's Chief Financial Officer, who will start today's call with an overview of our first quarter financial and operating performance. I will close with a brief perspective on the outlook for our industry and for Pason, and we will then take any questions.I'll now turn the call over to Celine.

[Celine Boston, Chief Financial Officer]

Thank you, Jon, and thanks to those attending today's call. Pason's first quarter results demonstrate our superior technology and service capabilities, resulting leading competitive position and strong operating leverage in industry conditions that, although still challenging, continued to improve from the lows experienced in 2020. One year ago today, global drilling activity was falling rapidly as oil prices plummeted and even reached negative prices for the first time ever. At the time, we took the difficult but necessary steps to adjust our cost structure while continuing to invest in critical technology and service to meet the demands of our customers.These measures have proven effective as we are now seeing the early stages of what we believe to be a global recovery in drilling activity, and our first quarter results demonstrate our position of strength coming into these improved industry conditions. Pason generated $42.6 million of revenue in Q1 2021, which in comparison to the first quarter of 2020, represents a 42% reduction year-over-year and represents a stark difference in pre-pandemic activity levels last year versus the ongoing headwinds associated with the COVID-19 pandemic on our industry.Sequentially, first quarter revenue represents a 30% improvement from Q4 2020 and all business units contributed to this increase. North American industry days, although still well below pre-pandemic levels and 45% down year-over-year improved by 33% sequentially. Accordingly, Pason's North American business unit generated $34.6 million of revenue in the first quarter, which was a 31% sequential improvement from the fourth quarter.Our company was fortunate to have minimal business impacts from the severe weather conditions experienced in Texas during the first quarter. Revenue per industry day of $720 was only down 2% year-over-year and was unchanged from the fourth quarter of 2020 as our competitive position remains strong. As a reminder to listeners, we have comparatively higher market share and revenue per EDR day in Canada. Therefore, our revenue per industry day metric will fluctuate with the seasonal nature of the Canadian drilling industry.International revenue of $7.1 million decreased 24% from $9.2 million in the prior year period, but was up 23% sequentially as industry activity continued to improve across our major operating regions. Energy Toolbase, our emerging business in the solar and energy storage market continues to leverage its leading economic modeling and proposal generation software package to generate additional sales of intelligent energy management control systems.Reported revenue in this segment was $0.9 million in the first quarter, consistent with the prior year period and continues to be primarily comprised of subscription-based software licenses for solar energy planning tools. Pason generated $13.2 million in consolidated adjusted EBITDA in the first quarter, representing a 60% reduction from Q1 2020 as many of our costs are fixed in nature. Sequentially, Pason grew adjusted EBITDA margin from 25% in Q4 2020 to 31% in Q1 2021, as we've been able to absorb most of the increased activity levels within our existing cost structure and therefore, continue to demonstrate strong incremental margins.Since the lowest point of the downturn in Q3 2020, we've generated 73% incremental adjusted EBITDA, consistent with levels seen coming out of the 2015-2016 downturn. As a reminder, incremental margins will fluctuate as the industry recovers, as certain costs will be incurred in anticipation of future revenue increases. And furthermore, we anticipate will be impacted by Canadian seasonality in the second quarter. In the quarter, Pason recognized $2.9 million in government wage assistance, primarily related to the Canada Emergency Wage Subsidy. And as a reminder to listeners, the benefit of which is excluded from our calculation of adjusted EBITDA. We plan to participate in the government's recent announcement of the extension of this program through to September 2021, and we'll await further details surrounding eligibility and measurement.Pason generated $9.2 million in free cash flow in the first quarter, driven by our strong operating leverage through improving activity levels and the continued discipline on capital expenditures and working capital investments in the quarter. Our balance sheet remains strong and incredibly well-positioned with $151.4 million in cash and cash equivalents at the end of the quarter and no interest-bearing debt. We are maintaining our quarterly dividend at $0.05 per share, and will continue to balance our commitment to shareholder returns while preserving financial strength to support long-term success.In summary, our first quarter results continue to reflect our strong market presence, our significant operating leverage through improving activity levels and our pristine balance sheet. We are emerging from the depths of the downturn from a position of excellent competitive and financial strength.I will now turn the call back to Jon for his comments on our outlook.

[Jon Faber, President, CEO & Director]

Thank you, Celine. As I noted in the President's message accompanying our MD&A, the context in which we sit today could not feel more different than a year ago. A year ago, we were on the front end of the rapid decline in industry activity as the world shut down in order to slow the spread of COVID-19. Nobody could predict how challenging things would get nor when things might stabilize and ultimately begin to recover.We took action to ensure not only the continued viability through the deepest parts of the downturn, but to expand our competitive position by maintaining our critical technology and service capabilities. After bottoming in the third quarter, the industry began to recover through the end of 2020. Drilling activity continued to improve through the first quarter of 2021.The U.S. land rig count exited the quarter 21% higher than the end of the fourth quarter, and by the end of the quarter, had reached 400 rigs for the first time since April 2020. In Canada, seasonal drilling activity still lagged pre-pandemic levels, but was stronger than originally expected and peaked at 175 active rigs. The outlook for drilling activity in the coming quarters continues to improve. Analysts are now calling for the U.S. rig count to reach 500 by the end of the year and push towards 600 by the end of 2022.Leading indicators of land drilling activity continue to trend positively. Global oil demand now sits at 95% of pre-pandemic levels. U.S. land production remains approximately 15% below pre-pandemic highs, and the inventory of drilled and uncompleted wells continues to decrease. Oil prices remain above $60 per barrel. Rig counts remain almost 50% below pre-pandemic levels, while oil prices are at pre-pandemic levels as oil companies continue to show disciplined capital constraint.As activity continues to pick up, we remain able to absorb much of the increase within our existing cost base. Since the bottom of the current downturn in the third quarter of 2020, we have posted incremental adjusted EBITDA margins of 73%. We expect these strong incremental margins to continue, so as we continue to look out 18 to 24 months in our planning, we will begin to see additional operating costs, particularly in the area of field personnel and repairs in anticipation of future activity gains.In addition, we are making additional investments in our research and development efforts to maintain and grow our leading technology position. As customers look to technology to drive improved drilling performance, we expect these investments to generate gains in both market share and price as we deliver additional functionality for the benefit of customers. We also continue to invest in development efforts within Energy Toolbase. As we build out our integrated platform of tools to model, control and monitor energy storage assets, we are beginning to see increased demand for control systems.Our sales pipeline and bookings continue to grow. We expect to spend up to $15 million in capital expenditures in 2021, and will continue to make the necessary investments in working capital as activity levels improve. Our product development initiatives continue to be aligned with the efforts of customers to increasingly utilize automation and analytics technologies to improve drilling performance. As we allocate capital, we continue to balance investments in maintaining our leadership position in our existing drilling-related markets to position ourselves for future growth in new and growing markets, such as solar and energy storage and to return capital to shareholders.We remain committed to providing unmatched service quality and technology innovations, and our resolve has strengthened as the industry increasingly looks to better utilize technology in its efforts.And we would now be happy to take any questions.

[Operator]

[Operator Instructions] Your first question comes from the line of Michael Robertson from National Bank Financial.

[Michael Storry-Robertson]

Congrats on a pretty solid quarter. It was good to see some meaningful free cash flow generation despite the challenged rig count environment. Was wondering if maybe we could kick it off with an update on how you see your capital allocation priorities shaking out moving forward. Probably safe to say there will be an increase in CapEx as activity levels continue to stabilize. But just wondering how you'd like to allocate any excess cash flows in the coming quarters, be it NCIB, dividend, et cetera?

[Celine Boston, Chief Financial Officer]

Sure. Thanks, Michael. So I mean we continue to think about capital allocation as appropriately balancing the investments that we make in the business with appropriate shareholder returns and M&A opportunities. So I mean, we said that we'll be spending up to $15 million in capital expenditures in the year, and that's going to be refreshing some of our existing technology platform, making some investments in additional equipment to meet those increasing activity levels, as you mentioned.We will continue to make investments in ETB platform, and we have some commitments, as you know, to intelligent wellhead systems for our minority investment in that completions technology business and an opportunity to take on some more of that business over time as well. As it relates to shareholder returns, starting with the dividends, recall that we sized the dividend for our expectation of medium-term activity levels, right? So 500 to 600 U.S. land rigs, and we're not quite there yet.So in this environment, we still continue to expect to pay out a lower amount of free cash flow as a dividend and probably prioritize more flexible mechanisms for capital allocation. So we like the flexibility that the share repurchase program allows us in the context of today's environment and at a minimum, we probably plan to offset potential dilution on stock-based compensation in the year.

[Michael Storry-Robertson]

That's helpful color. I appreciate that. Sort of just as a follow-up, you mentioned IWS. Is there an updated time line for the put option payments with respect to that transaction?

[Jon Faber, President, CEO & Director]

Well, the expectation has always been that the last $10 million would probably go out in the next year or 2, and it's all subject to the activity increases that we would see from them, right? Now you recall it's a minority investment. So I can't talk a lot about the details of the business, but we fully expect to be allocating one of the put options of $5 million in the second quarter, which is an indication of some activity that they would have there. And then the last tranche then would be subject to what their requirements would be based on activity.

[Operator]

Your next question comes from the line of David Anderson from Barclays.

[John David Anderson]

So U.S. land rig count has kind of flattened out here a bit. We've seen most of the growth has really come from the privates. And kind of looking in the back part of the year and really maybe over the next 12 months, what matters to you more? Do you need to see kind of the large-cap E&Ps? Is it the majors? I know you kind of [ once approved ] -- because you really saw into the rig contractors, but how do you kind of generally think about that? Like what's better for your mix?

[Jon Faber, President, CEO & Director]

It's probably from an overall kind of share perspective, it doesn't make a big difference who's more active. But what I would say is some of the larger companies are more focused on the deployment of new technologies to advance their efforts. So when we think about kind of adoption of some of the new technologies and maybe revenue per EDR day, that would probably be -- benefit a little bit more if we had some of the larger people more active. But in terms of actual activity, it probably doesn't make a big difference to us.

[John David Anderson]

Right. But -- so you've gotten here so far basically on the back of these privates who maybe aren't using as much technology and sort of maybe if the next leg is more large caps and majors, then you're thinking that actually should be better for you. A fair way to think about it just because we want to use in more technology? Yes.

[Jon Faber, President, CEO & Director]

Yes, I think it's fair to think about it that way, Dave, probably not instantaneous in terms of what the revenue is because some of these technologies require some integration work, but I think that, that would be a driver towards some of that growth in revenue per day.

[John David Anderson]

Yes, I would think so, too. And then on kind of the international side, we saw it was up 23% sequentially. Can you just kind of talk about that business a little bit more? What regions are you targeting here? Where do you see the highest growth? We've been hearing kind of a whole bunch of mixed things from the service guys this quarter, all of which is kind of positive, but it's hard to kind of get a feel for -- it seems like the growth is kind of all over the place. I'm just wondering if you could kind of walk through a little bit what you see on the international side and then kind of maybe also what you're targeting on the international side because it's a bit more of a fragmented business out there.

[Jon Faber, President, CEO & Director]

Yes. Maybe I'll simplify international into 3 regions, how we think about it. And when I call it 3 regions, there's sometimes more than just 3 countries. But Argentina is our largest international market and that's part of the broader Lat Am area. That is and has been a market that's increased simply by the relaxation of some of the slowdown in restrictions they would have had around COVID, right? If you think of Argentina specifically, they essentially shut down for a period of time. And so that activity has come back.And so I would say there it's kind of growth from restart of prior activity levels. We probably see the most activity in terms of quoting on new projects and new opportunities in the Middle East region. Now that's a smaller region for us today. But that's probably where we have the most activity in terms of what I would call new activity as opposed to recovery of existing prior activity. And then Australia is more of a, I'll call it, a bit steady as she goes, and I mean that in a very positive way for Pason because we have good market share there, but it's probably more of a steady at where it's been kind of current levels.

[John David Anderson]

So I guess sort of a similar question in terms before, but what about the technology intensive, I don't know if that's the right word. But I'm just sort of kind of curious, if I think about Argentina, I would think that kind of maybe a low-tech area, but the Middle East, where is that? I would think that would be kind of maybe a little bit higher technologically intensive. I guess what's the word?

[Jon Faber, President, CEO & Director]

Yes. Yes, interesting, probably when you talk about the newer technology, Dave, both of those markets have increased interest and adoption and trials of the newer technologies, but coming from different places, right? So what I would say in the South American markets, it's more of kind of existing customers we've been working with adopting newer technologies on top of Pason stuff they're already using. And some of the Middle East markets, probably building up a little bit more share in customer base on the strength of the technologies.

[Operator]

Your next question comes from the line of Cole Pereira from Stifel.

[Cole J. Pereira, Associate]

So on the R&D expense side, you'd previously highlighted that you expect this to get back to pre-COVID levels. So I mean it was $7 million this quarter. I mean is it fair to think about that this kind of scales up until it gets to about, call it, $7.50 to $8 million per quarter?

[Jon Faber, President, CEO & Director]

Cole, we have seen real opportunities to do a little bit more on the R&D side, particularly as we talked about working with some of these larger operators. And so will it grow? Yes, it will continue to grow to the area you're talking about, likely at least. But I wouldn't necessarily want to put a cap on it. It's not going to be capped based on a number. It's going to be capped on running out of good ideas and on the ability to commercialize those ideas at the pace that we can develop them. So I think in the short to medium term, what you're talking about is probably a fair thing to say. But we are going to be investing more on the R&D side and the technology side as the business becomes more focused on the technology as a real driver of share price.

[Cole J. Pereira, Associate]

Okay. Great. No, that's very helpful. So I appreciate that. In a similar vein, so corporate service expense was, call it, $3 million this quarter. How should we be thinking about how that evolves throughout the rest of the year?

[Jon Faber, President, CEO & Director]

So corporate services expenses is fairly flat when you talk about the number of people we would have, right? So when you talk about it being up kind of a year-over-year basis, what you really have is just the difference in terms of some of the incentive compensation plans, which we expect to have payouts in 2021 where we didn't have them in 2020. But in terms of actual sort of people, we don't really have much growth on the corporate services side. And so kind of where we would have been this quarter is a pretty good postal code to play in if you think about the next few quarters.

[Operator]

[Operator Instructions] Your next question comes from the line of Keith MacKey from RBC.

[Keith MacKey, Analyst]

I just wanted to ask about the international segment. As noted earlier, revenue pretty strong sequentially. And pre-depreciation gross margins were also pretty high. Given some of the -- some of what we've been hearing about the international segment, particularly maybe some labor disruptions in Argentina, how should we be thinking about international sequentially for Q2? And I guess beyond, like, do you expect Q2 to be higher than Q1? And do you expect these pre-depreciation gross margins in the high 40s to remain? Or should that revert back down a little bit as Q2 unfolds?

[Jon Faber, President, CEO & Director]

So I think we expect Q2 to be better than Q1, to answer the question directly. Now the pace of growth will slow at some point, right, because we're talking about kind of restart of activity in some of the bigger markets we play in being one of the big drivers. And so that will slow down a little bit. And while we're sort of feeling more encouraged in some of the North American markets, at least about the COVID situation, some of the international markets are very challenging still. And that will probably be a bit of a restraint on the activity levels in some of the international markets.When you talk about the margins, like our international business has done a wonderful job being very conscious about the cost they've incurred. But like our North American business, as activity picks up, we probably will see some of those operating costs come back in anticipation of revenue increases as well, right? So because the business tends to need to make some of the OpEx investments ahead of the activity, it wouldn't be unrealistic to think that those margins might compress a little bit, at least in the short term, as they continue to position for the increasing activity.

[Keith MacKey, Analyst]

Got it. Okay. That's fair. My last question, I just wanted to touch on the revenue per industry day. As Q2 goes, Canada is certainly doing better than it did last year. U.S. looks like it might a little bit as well. So should we expect that kind of mid-$650s range or mid-6 range for Q2 as far as North American revenue per industry day?

[Celine Boston, Chief Financial Officer]

Yes. That sounds in the ballpark, Keith. As you know, that will be impacted by seasonality in Canada and just the relative proportion of rigs in Canada with those numbers generally being higher than the U.S. market. So that sounds in the ballpark.

[Operator]

There are no further questions at this time. I'll turn the call back over to Jon Faber for closing remarks.

[Jon Faber, President, CEO & Director]

Thank you very much for taking the time to join us this morning. We appreciate your continued interest and support. And if you have any further questions, Celine and I always welcome your calls. Thank you very much. Have a great day, and we look forward to speaking to you at the next quarterly conference call.

[Operator]

This concludes today's conference call. Thank you, everyone. You may now disconnect.