Pason Systems Inc

TSX:PSI

Earnings Call Transcript 2022-Q1

[Operator]

Good morning. My name is Grant, and I'll be the conference operator today. At this time, I would like to welcome everyone to Pason Systems Inc. First Quarter 2022 Earnings Call. [Operator Instructions] The contents of 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 conference issued by Pason Systems yesterday, which describe the 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 on its annual information form.

Thank you. Mrs. Boston, you may begin your conference.

[Celine Boston, executive]

Thanks, Grant. Good morning, and thank you for attending Pason's 2022 First Quarter Conference Call. I am joined on today's call by Jon Faber, our President and CEO. I'll start today's call with an overview of our financial performance in the first quarter. Jon will then provide a brief perspective on the outlook for the industry and for Pason, and we will then take questions.

We're very proud of our first quarter results, which not only reflects a continuation of improved industry conditions, but also reflects our strong competitive positioning, significant operating leverage and pristine balance sheet. As we look back to the first quarter of last year, we came into 2021 with recovering industry activity levels in most of our operating regions. Particularly in North America, we saw land drilling grow off the lows experienced in the third quarter of 2020. Since then, activity levels have continued to grow as we saw 57% improvement in average North American land rig counts in the first quarter of 2022 in comparison to the first quarter of 2021.

Within that landscape, the company maintained its leading competitive position in North America and continued to benefit from improved pricing conditions in comparison to the challenging environment throughout the downturn. Accordingly, revenue per Industry Day in North America grew by 16% year-over-year from $720 in the first quarter of 2021 to $835 in the current quarter, representing the fourth consecutive quarter of sequential growth and a new record quarterly level for the company. This is also a result that is well ahead of the $738 generated during pre-pandemic activity levels in the first quarter of 2020.

It is worth noting that revenue per Industry Day in North America will fluctuate with seasonality effects of drilling activity in Canada. Both revenue per Industry Day and reported revenue benefited from a strong winter drilling season in Canada in the first quarter.

Pason generated consolidated revenue of $74.5 million in Q1 of 2022, a 75% improvement over the first quarter of last year. North American revenue was $62 million for the first quarter, a 79% improvement from the first quarter of last year and a result that outpaced the improvement in underlying industry conditions. Activity levels in international end markets also improved and revenue generated by the international business was $10.7 million in the first quarter, a 51% improvement from the first quarter of 2021.

Energy Toolbase, our emerging business in solar and energy storage market continues to make progress. This segment generated $1.8 million in the first quarter of 2022, the highest quarterly level of revenue achieved for this segment and a 95% improvement from the level seen in the first quarter of 2021. Reported revenue for Energy Toolbase begins to incorporate revenue generated by control systems and related hardware sales.

Pason generated $33.4 million in consolidated adjusted EBITDA in the first quarter of 2022, a significant improvement from the $13.2 million generated in the first quarter of last year and a result that represent 44.8% of revenue. As the industry recovers and our outlook remains positive, we will continue to make investments and incur certain costs in anticipation of future revenue increases, primarily as it relates to equipment repairs and people. Further, we continue to grapple with difficulties in predicting timing on deliveries of capital [indiscernible] purchases, and as a result, are remaining especially proactive with repairs of existing fleet and technology, which will impact adjusted EBITDA margins throughout the remainder of 2022.

That said, when we compare the first quarter of 2022 to our results in the first quarter of 2020, prior to the drastic fall in activity levels, we are very proud of the fact that with 15% less North American land rig, we have generated the same amount of revenue and adjusted EBITDA. Many of our operating costs remain fixed in nature, and our first quarter results demonstrate our operating leverage with 79% incremental adjusted EBITDA margin sequentially and 63% year-over-year. As we've previously communicated, incremental margins will fluctuate as the industry recovers and we incur certain costs in anticipation of future revenue increases.

Further, as we return to pre-pandemic adjusted EBITDA margin, the seasonality effects of the Canadian drilling industry will impact adjusted EBITDA margins in the coming quarters like we've seen in prior years. As such, we expect that our first quarter adjusted EBITDA margins will be on the higher end of the expected range in the coming quarters.

Net income attributable to Pason for the 3 months ended March 31, 2022, was $18.6 million or $0.23 per share, a significant increase from the $4.3 million or $0.05 per share generated in the first quarter of 2021. Our balance sheet remains strong and incredibly well positioned with $172 million in cash and cash equivalents at the end of the quarter and no interest-bearing debt.

We continue to make investments in our core business to support increased levels of activity. In the first quarter of 2022, Pason spent $4.5 million in capital expenditures relating to maintaining and refreshing our existing technology. Also, as revenue levels have increased, we've made corresponding investments in working capital while remaining diligently focused on maintaining strong collection trends. Further, in the first quarter, Pason collected a longtime outstanding receivable from the IRS in the amount of $12.5 million.

Resulting free cash flow in the first quarter was $23.6 million, a 157% improvement from the $9.2 million generated in the first quarter of 2021. Pason returned $8 million to shareholders through dividends and share repurchases during the first quarter, which reflected our increased quarterly dividend level of $0.08 per share.

In summary, we are very proud of our first quarter results, which reflects our leading market presence, our strong operating leverage through improving activity levels and our pristine balance sheet. We continue to be in a position of excellent competitive and financial strength.

I will now turn the call over to Jon for his comments on our outlook.

[Jon Faber, executive]

Thank you, Celine. As Celine noted, our first quarter financial results reflected both the continuation of the growth in industry activity that we have seen since the industry bottomed in the third quarter of 2020 as well as Pason's continued strong competitive position. Pason's North American revenue per Industry Day of $835 in the quarter marked the first time in the company's history that this important metric broke through the $800 level. It is worth noting that both industry activity and revenue per Industry Day are favorably impacted by a higher proportion of drilling activity in Canada during the Canadian winter drilling season. We expect that activity will continue to grow in The U.S. and international markets in the coming quarters, while the second quarter will be seasonally weaker in Canada.

Pason is well positioned to participate in the industry's growth, as customers increasingly look to utilize data to improve their operational performance through the use of automation and analytics technologies. Our confidence in continued industry growth in the short to medium term is rooted in a review of supply and demand fundamentals. Global oil demand has largely recovered to pre-pandemic levels. While there are growing concerns about weakening demand from COVID-19 lockdowns in China, high prevailing levels of inflation, and the potential impact from central banks moving to raise interest rates, supply indicators continue to point to more significant shortages.

Supply has to come from the inventory of previously produced oil sitting in storage, either in the form of refined products or crude oil awaiting refinement from current production -- from new production from wellbores that have already been drilled and which are awaiting completion or from newly drilled wells.

U.S. oil storage levels of crude and petroleum products are currently sitting at their lowest level since the end of 2008. And with 26 days of refinery demand cover, crude oil days of supply is down 20% from a year ago. The United States recently announced a plan to release up to 1 million barrels a day from the strategic petroleum reserve for up to 6 months in response to elevated oil prices putting further pressure on storage levels. If that plan were fully implemented, the strategic petroleum reserve would be drawn down to its lowest level since 1984.

Oil production in The United States remains approximately 10% below pre-pandemic levels. The inventory of drilled but uncompleted wells has now decreased every month for the past 21 consecutive months and is at the lowest level it has been in more than 8 years.

While the U.S. land drilling rig count has increased by approximately 20% year-to-date, it remains approximately 25% below the 2019 average rig count. Supply and demand fundamentals are constructive for oil prices and drilling activity in the coming quarters. A significant supply response seems unlikely given current challenges around the availability of labor, supply chain disruptions and underinvestment in larger long-term development projects over the past 5 years. We believe that hydrocarbons will play an important role in helping meet the world's growing energy demand for many years, alongside the continued development of alternative and renewable technologies.

In our solar and energy storage efforts, we are seeing revenue increases as the control system installations are commissioned, and our pipeline of projects continues to grow. Across our business, we will make the necessary investments to position ourselves to realize future revenue gains. Our operating costs, most notably personnel and equipment repairs, will see increases as a result of anticipated further activity gains and prevailing inflation rates. We will invest in research and development efforts that drive continued market share and pricing improvements as we deliver additional value and functionality for customers.

We continue to plan to spend approximately $30 million in capital expenditures in 2022, though global supply chain shortages and disruptions are impacting delivery schedules. We will continue to evaluate our capital programs in the context of future opportunities to evolve our product and service offering while navigating continued supply chain challenges.

We are pursuing opportunities to mitigate the impact of supply chain disruptions by strategically increasing our inventory of equipment components and parts, further in advance of anticipated repairs and equipment builds. This will impact near-term working capital requirements while enabling us to be responsive to continued industry growth and to maintain the product and service advantages, which underpin our leading competitive position.

Our balance sheet remains strong, and our free cash flow generation continues to improve. We will continue to allocate capital by making investments in maintaining our leadership position in our existing drilling-related markets, positioning ourselves for future growth in new and growing markets and returning capital to shareholders.

We remain committed to returning capital to shareholders through our regular quarterly dividend, which we are maintaining at $0.08 per share and through share repurchases.

We are focused on ensuring that Pason is an innovative, profitable and responsible company. And we would now be happy to take any questions you might have.

[Operator]

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

[Michael Storry-Robertson, analyst]

Congrats on another solid quarter here. Jon, in your prepared remarks there, you just touched on the possibility of increasing inventory of equipment components to help navigate the supply chain disruption. Would you foresee that as likely becoming as a sort of a new normal as a buffer against potential future disruptions? Or do you think once the bottlenecks and availability issues moderate, you sort of revert to business as usual?

[Jon Faber, executive]

Well, I think we'll revert as the supply chain situation normalize. I guess we'd have to see what that normalized environment look like, right? So what we're really talking about here is taking a longer period of time for our view of how much equipment we need to be ready to supply through repair or new builds and just kind of using a longer planning window. And as the supply chain situation improves, we would shrink the planning window back to the historical time period we would have used.

[Michael Storry-Robertson, analyst]

Got you. And do you sort of have like a rough dollar value in mind as it would relate to your current business level?

[Jon Faber, executive]

Yes. I think we have a sense here that it's probably going to be in the order of, I'll call it, initially $10 million to $15 million. Now the question, of course, is when we can actually receive the parts that we order, right? So how much will actually hit the balance sheet will be a function of the delivery schedules, which is tremendously difficult to forecast. So it's not immediately clear exactly when that will hit, but that's kind of the -- where we think we're sort of headed towards here.

[Michael Storry-Robertson, analyst]

Got it. Got it. That's helpful color. I appreciate that. Switching gears, you often touch on what kind of rig count you're currently structured for. I appreciate that it's still a relatively small portion of the overall top line. But given the recent growth of the solar and energy storage segment, I was wondering if you could provide some similar color around the current structure of that business? And as it continues to grow, how much do you think you could push that with the existing structure and what level, I guess, you think you would think about taking measures to increase capacity?

[Jon Faber, executive]

Yes. Interesting question, Mike, when we look at the core drilling-related business, of course, we use an 18- to 24-month view of what the rig count might do to sort of plan while we need capacity wise from an operating perspective, if you think about equipment and people primarily. Much of the business on the Energy Toolbase side or much of the capacity is technology related. We certainly have a growing operational team as we work to commission more projects. But I would say it's probably a little bit early for us to think about sort of a forecast for the overall industry and informing the capacity levels. The capacity levels are more informed by the growth we're seeing, right?

And so with that control system business, the growth is going to be a function of the installed base of energy storage assets that are out there. And so part of what we're doing in that business is helping get more energy storage assets out there and layering our control systems on top of that. But it's so early stage in that industry and in that business that it's not really a function of what the overall industry is doing as much as our growth rate that informs capacity questions.

[Operator]

Your next question comes from Keith MacKey from RBC Capital Markets.

[Keith MacKey, analyst]

So Celine, like how you pointed out that Q1 essentially matched the first quarter of 2020 from a -- certainly from a revenue and EBITDA standpoint, I know there's been some differences in the mix between the Canadian and U.S. rig count across those 2 quarters. But what else is there that might maybe suggest the underlying EBITDA generation potential of the business has changed versus 2 years ago?

[Celine Boston, executive]

Yes. Good question, Keith. I think the key driver is a couple of things. If you think about top line revenue for us today, we've seen some significant improvements over the last few years. We've talked a little bit about the fact that a lot of that is U.S. market share driven. And to the point where we've achieved record market share levels for the company, that we've been able to sustain those. I think from a cost structure perspective, too, if you look at the difference between the first quarter of 2020 and the first quarter of 2022, thinking back to the first quarter of 2020, although it was a reflection of higher activity levels, even before the news of COVID-19 started spreading more widely, I think there is lots of uncertainty around kind of near-term outlook for the industry with some talks around some pricing worries on Russia [indiscernible].

So I think within that landscape, we were already kind of in a tightening of cost structure scenario where that we in contrast in this quarter, we're looking at kind of building cost base mode from a more positive outlook, which when you think about it in that way, it actually makes it more impressive that we're back to pre-pandemic margins in this context.

[Keith MacKey, analyst]

Got it. And how about the international margins in that context? Cash gross margins in that segment pretty strong this quarter. How should we be thinking about that going forward?

[Jon Faber, executive]

Yes. The international business, the cost structure, we were able to take some cost out of there, as we went through the pandemic. While we will see cost increases come back as a result of activity continuing to increase in most of those international markets, I don't think there's anything abnormal that I would sort of point to as any expectation other than regular additions to the cost as the -- or the revenue side grows.

[Keith MacKey, analyst]

Got it. And one final one. Certainly, a strong cash balance and have had so for quite some time. With industry activity improving, margins expanding, when maybe -- does cash build take a backseat to some other uses of cash, whether it be increased shareholder returns, acquisition, organic growth or other?

[Jon Faber, executive]

So if I can change your question maybe a little bit, Keith. Cash build isn't a priority. I think cash build is a function of your ability to execute on ideas you have in a specific time, right? So when you look at -- the first priority for capital allocation is always, first and foremost, to make sure that the existing drilling-related business maximizes its performance in the sphere of opportunity that it has, right? And so I think in that area, we've probably been challenged to make the investments we would want to buy some of these supply chain concerns. So we'll make some investments both on the inventory side to try to address some of those. And some of our aspirations on kind of new equipment builds have probably been slower than we might have hoped as a result of the supply chain side.

We've always sort of said if we saw opportunities either organically or inorganically to add value to shareholders, we would look at those. And the timing of those and the -- both the identification and the pursuit of those is always a little bit uncertain, right? So there's always a bit of a cash build effect while you're looking at opportunities. And then we continue to prioritize return to shareholders, both through the regular dividend and through share repurchases. Albeit at a lower percentage of overall free cash flow than historically, we would have talked about this, I think, in the last few quarters with a view towards having capital available for pursuing opportunities.

[Keith MacKey, analyst]

Got it. Maybe just one follow-up on that. If I were to ask it a slightly different way. Do you have a minimum cash balance in mind? Or is it, as you say, just an output of how the business is going?

[Jon Faber, executive]

Well, we would have a minimum cash balance in mind if the business didn't change in any way, shape or form. But when you're looking at opportunities to do things that may change the profile of the business, right? So I think historically, we've said for the business today as it is, we believe it should be a net cash business because there's very significant operating leverage. And it's probably somewhere in the order of $50 million to $75 million that you would want for the existing business to withstand the volatility of the industry. Now beyond that, it's a question of what is the profile of the business in terms of what's the appropriate capital structure.

[Operator]

Your next question comes from Cole Pereira from Stifel.

[Cole Pereira, analyst]

You had some good commentary on the gross margin front in terms of having to be more proactive with R&M. I'm just trying to figure out between that inflation, I mean, was that much of a factor in Q1 results? Or say, if we were at similar activity levels later in the year, are we going to see some degradation versus Q1?

[Celine Boston, executive]

Yes. It's a good question, Cole. I mean we've said in recent quarters, we will be incurring more costs than I mean, particularly as it relates to repairs. We did see repair costs in the first quarter, but I'd say probably not to the extent that we were hoping and some of that's just the difficulty of timing predictability and repair costs. So those have -- those are impacted similarly to capital expenditures by supply chain challenges that we're seeing across all sectors. So there will be some catch-up in the coming quarters on repair costs. So I mean what I'll say is it's probably hard to envision that we'll match first quarter margins in the next couple of quarters and then especially when you layer on the seasonality effects of the Canadian business as well.

[Cole Pereira, analyst]

Okay. Perfect. That's helpful. And so some commentary around the larger revenue number from pricing gains, product adoption, market share gains or maintenance. I'm just wondering, can you sort of rank those in order of magnitude? Or was it kind of fairly equal across the board?

[Jon Faber, executive]

It's always a function of all of those. So I would say bigger driver likely came from what we would think of as kind of revenue per EDR day more so than market share, if you think about this quarter. Like clearly, the market share has gotten to the highest level in the company's history, and we've been able to consolidate and hold on to those gains. But it's probably a function more of a more favorable pricing environment but also a more favorable adoption environment. So one of the things we see in significant downturns is that people will get by with a little bit less equipment, and we sort of get a readoption effect on some of the existing equipment in addition to the adoption of new products. So I'd say it's probably been more a function of both a more favorable pricing environment and an adoption environment as things get better.

[Cole Pereira, analyst]

Okay. Great. That's helpful. And coming back to some of the comments on supply chains and labor. We've obviously heard this from a number of your peers. And I mean the general message seems to be that it might moderate growth, but it's not going to fully stop it. I mean, is that sort of consistent with how you're thinking about your business?

[Jon Faber, executive]

I think that's very consistent with how we think about it. And in fact, the greatest moderator today feels like it might be the labor for some of our customers, right? Equipment supply chain, we probably have a different challenge than some of our customers simply because we have a competition for much more technology types of equipment and components. But I would say that the overall industry growth rate has moderated at this point, I think, by the labor availability, particularly for some of our customers.

[Operator]

[Operator Instructions] Your next question comes from John Gibson from BMO Capital Markets.

[John Gibson, analyst]

Congrats on strong quarter. Just on your revenue per day number, can you maybe quantify how much of the increase is due to pricing increases versus same market share or product development?

[Jon Faber, executive]

So I think I'd just reference back to the answer I just provided to Cole that probably a little bit more came from the things that drive revenue per day, kind of both a more favorable pricing and adoption environment, more so than market share in this quarter. We've sort of held on to the market share gains we've had, but we're probably a little bit flatter on the market share side and a little more coming from pricing and adoption.

[John Gibson, analyst]

Okay. Great. And I'm going to stick with pricing here. In previous quarters, you kind of spoke to it still being below pre-pandemic levels or where are we at now relative to pre-pandemic or even relative to prior peak activity levels?

[Jon Faber, executive]

It's always a little bit tricky to say because you're looking at sort of the realized price you're getting and the number of pieces of equipment that people are taking in. That's really how we think about the revenue per day more so than independently versus list price. Clearly, the pricing environment has become more favorable as we've been able to get back to closer prices than we would have seen before, but it's always a function of both of those.

[John Gibson, analyst]

Got it. And sorry to keep harping on this. But we're hearing from some of your drilling peers that they can push pricing from here despite pretty significant increases lately. Is this also the case for Pason?

[Jon Faber, executive]

Well, it's never been the case for us, John, that we look to push it as far as we can because of the environment, right? We've always tried to be quite disciplined both in terms of prices going up and prices going down. And we've looked more so to deliver additional benefits and features for customers. I do think all supply or service sectors and frankly, probably across the entire economy is going to have to look to see prices go higher as a result of just prevailing inflation rate, the cost of business is going higher. But I don't think we would look to sort of exploit an opportunity more so than keep pace with the -- what's going on inflation-wise and then deliver additional features and functionality for customers for more price.

[Operator]

There are no further questions at this time. Please proceed.

[Jon Faber, executive]

Thanks so much. I appreciate you taking the time to join our call this morning. As always, we appreciate your interest and your support. If you have any further questions, feel free to reach out to Celine or myself. And otherwise, we'll look forward to speaking to you after the second quarter.

[Operator]

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.