Pason Systems Inc

TSX:PSI

Earnings Call Transcript 2020-Q2

[Operator]

Good morning. My name is Takan, and I will be your conference for today. At this time, I would like to welcome everyone to the Pason Systems Inc. Second Quarter 2020 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 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. Kessler, you may begin your conference.

[Marcel Kessler, Non]

Thank you. Good morning, and welcome to Pason's Second Quarter 2020 Conference Call. With me here in Calgary today is Jon Faber, our Chief Financial Officer. I will start with the highlights of the second quarter. 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 will then take any questions. Highlights. The simultaneous drop in demand and the increase in supply of crude oil towards the end of the first quarter of this year led to a dramatic decline in oil prices. As a result, we saw large cuts to E&P capital expenditures with disproportionately higher cuts for drilling and completions. The number of land drilling rigs active across North America dropped by 3 quarters in just 3 months. Activity drops across Latin America mirrored those in North America, while activity in Australia and the Middle East was somewhat more resilient. Pason's second quarter financial results reflect this extraordinarily challenging environment. Revenue for the quarter was $26.8 million, a decrease of 63% from the second quarter of 2019. The company posted an adjusted EBITDA loss of $848,000. Free cash flow decreased 8% to $30 million. Pason recorded a net loss for the period of $4.5 million or $0.05 per share. In response to market conditions and the uncertainty regarding the trajectory of our industry, Pason reduced capital expenditures by over 80% in the second quarter compared to the previous year. In addition, we executed significant operating expense reductions during the period. Pason's balance sheet remains in pristine condition. As a result of the significant reductions in CapEx and the release of working capital as the business shrank during the period, cash and short-term investments increased from the first quarter and stood at $176 million on June 30. There is interest-bearing debt on our balance sheet. I will now turn the call over to Jon for a more detailed look at the financials.

[Jon Faber, President, CEO & Director]

Thank you, Marcel. Pason's second quarter financial results reflected the drastic downturn in industry activity as a result of the global COVID-19 pandemic. North American drilling industry activity decreased by 64% from the second quarter of 2019, and many international markets also saw significant activity decreases. Consolidated revenue of $26.8 million was down 63% from the second quarter of 2019 and down 64% sequentially from the first quarter. Pason posted an adjusted EBITDA loss of $848,000 compared to positive adjusted EBITDA of $30.7 million in the second quarter of 2019 and $33.3 million in the first quarter of 2020. The notable items between the adjusted EBITDA loss in the quarter and positive EBITDA of $5.8 million were restructuring costs incurred in the quarter, offset by government assistance programming related to the current pandemic and the previously announced termination of our lease in Colorado. Capital expenditures of $800,000 were down 81% from 2019 second quarter CapEx of $4.2 million. The significant reduction in capital expenditures, together with a $25.5 million decrease in working capital from the end of the first quarter, contributed to free cash flow of $29.9 million in the quarter. In the second quarter, Pason recorded a $4.5 million net loss compared to net income of $9.2 million in the second quarter of 2019. For the first half of the year, consolidated revenue totaled $100.8 million, down 35% from the prior year period. Adjusted EBITDA for the 6-month period was $32.5 million, a 55% decrease compared to 2019. Free cash flow of $52.8 million for the first half of 2020 was up 60% from the prior year, driven by lower capital expenditures and a release of working capital. Net income attributable for Pason for the 6 months ended June 30, 2020, of $12.4 million or $0.15 per share was down 56% from the comparable period a year ago. I will turn to a review of the financial results of each of our business units. Drilling industry activity in the United States was down 63% from the second quarter of 2019. Pason's revenue for the U.S. business unit of $21.1 million was down 61% from the prior year as a 280 basis point increase in market share offset a 7% decrease in revenue per EDR day. Sequentially, U.S. revenue decreased 53%. U.S. segment gross profit decreased by 82% from the second quarter of 2019 to $5.2 million as a result of the revenue decrease and the company's largely fixed cost structure. Segment gross profit decreased by 77% sequentially from the first quarter. In Canada, the year-over-year decrease in industry activity was more pronounced at 73%. As a result, Canadian revenue decreased 71% to $2.7 million in the second quarter. Sequentially, revenue was down 86% from the first quarter of 2020. Reported market share was 690 basis points higher year-over-year in the second quarter at 94% while revenue per EDR day decreased by 18% to $1,060 per day. During periods of very low oil and gas drilling activity, the contribution of other drilling activity to our Canadian business unit distorts our reported metrics. Specifically, these rigs served to increase reported market share while putting downward pressure on reported revenue per EDR day. Year-over-year, cash operating costs decreased by $2 million in the second quarter against the $6.5 million revenue decrease. As a result, the Canadian business unit posted a segment gross loss of $3.4 million. For the 6-month period, revenue decreased 19% to $22.4 million and segment gross profit decreased 35% to $5.7 million. International revenue of $3 million was down 70% from the second quarter of 2019 and down 67% sequentially from the first quarter as many international markets saw significant decreases in drilling activity, most notably Argentina. Revenue of $12.3 million for the first 6 months of the year was 36% lower than the same period of 2019. A segment gross loss of $1.3 million in the quarter was down from segment gross profit of $3.4 million in the second quarter of 2019. The year-to-date, International Business unit segment gross profit totaled $1.6 million, down 75% from the prior year. In summary, our financial results for the second quarter were reflective of the challenging conditions, which continue to face our industry. In that context, we continue to carefully manage both our operating and capital cost outlays. In the second quarter, we undertook a restructuring of our business to adjust to anticipated lower activity levels for the foreseeable future. Given the nature of our business and our cost structure, we are not scaling our business to match the anticipated trough levels of activity and have made the strategic decision to retain critical organizational capabilities through the deepest depths of the current crisis in order to strengthen our competitive position as the industry recovers. We reduced capital expenditures to $800,000 in the second quarter, down 81% from 2019 levels. We continue to expect we will spend up to $10 million on capital expenditures in 2020. The appropriate management of our strong balance sheet remains our top priority through the current economic crisis. Our Board of Directors has declared a quarterly dividend of $0.05 per share. As at June 30, we had positive working capital of $182 million, including $176 million of cash and cash equivalents. We expect to face extremely challenging industry conditions over the next few quarters. However, we do so from a position of excellent competitive and financial strength. And I will now turn the call back to Marcel for his comments on our outlook.

[Marcel Kessler, Non]

Thank you, Jon. As Jon alluded to, we expect that oilfield activity, especially in North America and South America, will remain very low in the second half before a slow recovery starts in 2021. We are fully prepared for that. With our leaner organization and clean balance sheet, Pason is well positioned. We will continue to allocate capital to safeguard the long-term prospects of Pason's core drilling-related business of Energy Toolbase, our foothold in the solar and energy storage market. Our EDR market share in the United States is now firmly over 65%, a great base to build from when the industry recovers. On the product side, customers continue to be impressed with Pason DAS, our drilling automation package. Drilling performance improved considerably when the optimization system is used. Our PVT smart alarms are gaining traction with key customers, and the new DataHub dashboard has been introduced with great feedback from users. We continue to invest significant resources in R&D, it and technical support to respond to customer requests, improve existing products and develop new products. We believe that this environment provides an opportunity for Pason to become even stronger by leapfrogging competition in terms of technology and service. Energy Toolbase has made good progress with positive momentum on software subscriptions and new battery control systems sold. With the industry-leading software package to model the economics and build proposals for solar and energy storage, that means battery projects, combined with the iEMS control system and energy DataHub products. Energy Toolbase is well positioned for meaningful long-term growth in this promising market. Finally, I should mention that this is my 36th and last quarterly Pason conference call. On July 22, we announced that I will retire as President and CEO effective October 1. I will succeed Jim Hill as Chair of our Board of Directors. Jon Faber has been appointed to succeed me in the CEO role. Jon joined Pason as Chief Financial Officer in 2014. Over the past 6 years, in addition to the finance function, Jon has successfully led supply chain, IT and important elements of software development. I am fully confident that with our passionate employees under Jon's tenacious leadership, our unique platform and our financial strength, Pason will achieve long-term success. I am humbled and grateful for the 9 years I was able to serve Pason as President and CEO, and I look forward to continuing to support our great company as Chair of the Board. It is worth mentioning at this point that none of the leadership changes were driven by the belief that the past year on or the radio allocating resources needs to change significantly. As a result, we do not expect any abrupt changes to our strategy. That said, we are living through unprecedented upheaval in our industry that is creating new challenges and new opportunities. We will keep our finger on the pulse of our customers and the industry and react as needed to counter these challenges and these attractive opportunities. We will now be happy to take any questions.

[Operator]

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

[Michael Storry-Robertson]

Congrats on your last call here. And Jon, congrats to you as well on the appointment. Diving right in, it looks like your U.S. market share has been creeping up over the last few quarters. I just wanted to talk about the competitive landscape there. Given the severity of the downturn and expected duration, do you anticipate somewhat less competitive environment coming out of the downturn? Is that happening already? I'd love to hear your thoughts there.

[Marcel Kessler, Non]

So I think you're right, Michael. It's Marcel here. We saw our market in the United States creep up, but it's probably not so much a result of abstaining new customers or new rigs. But it seems that if the financial strength of our customer seems to allow our customers to continue drilling where some of our competitors seem to have a bit weaker balance sheets. So simply or primarily a result of customer mix. We do not really anticipate the competitive intensity in the United States to decrease.

[Michael Storry-Robertson]

Okay. That's a helpful answer. You had previously mentioned expectations for Q4 2020 as being the most challenging quarter for you guys. Do you -- has that the viewpoint changed fundamentally? Or would you still sort of go with that? Or has it gotten better or worse?

[Marcel Kessler, Non]

I think it had. It's not gotten worse. I think our perspective has probably shifted a bit, in that we believe that drilling activity, at least in North America, will stay pretty flat from where we are today. So based on what we can see today, we don't expect a further decline. So I think -- yes, I think it's probably -- we are -- we expect to be around the low point now.

[Michael Storry-Robertson]

Okay. That's good to hear. Last one for me. Just want to ask how we should think about the impact of the CEWS going forward.

[Jon Faber, President, CEO & Director]

Yes. Michael, it's Jon. So those programs continue to be in place. I think the only thing I would note is that given the timing of when the program was announced and some uncertainty around who would qualify for what, we did end up accruing the March payments in the second quarter. So we actually had 4 months accrued in the quarter as opposed to 3. And I think you would expect to be a little bit lower by virtue of the fact that we would have a slightly smaller employee base on the Canadian side today as well. So I think the bigger impact -- so short answer is we'll likely be a little lower going forward, more so because we'd have 3 months accrued instead of 4 and some impact as well from a slightly smaller employee base.

[Michael Storry-Robertson]

Got it. All right. Well, that's great. And congrats again. I'll turn it back.

[Marcel Kessler, Non]

Thanks, Michael.

[Operator]

[Operator Instructions] The next question comes from Matthew Weekes of Industrial Alliance Securities.

[Matthew Weekes, Equity Research Associate]

So looking at the cost savings that you managed to achieve on the cost side and in terms of direct costs in that, it was kind of -- the previous commentary was sort of that after the reductions made in the last downturn, there probably wasn't as much to give this time around. Are you at all surprised by the amount you were able to kind of restructure on the cost side when you kind of stepped back and looked at the organization?

[Jon Faber, President, CEO & Director]

I don't know what I'd say we're necessarily surprised. I think there's certainly -- or different parts of the business where we felt we had more degrees of freedom than some others perhaps. And the other thing that's, of course, quite abnormal in a pandemic, particularly, is that some costs, which would otherwise be essentially fixed almost become variable through the most deepest parts of the crisis. But I would expect that build would look a bit more fixed again going forward. So there's probably that affect in there as well.

[Matthew Weekes, Equity Research Associate]

Okay. And looking at sort of international revenue and basically the commentary was that, for the most part, in the quarter, it was -- it sort of mirrored activity in North America. Is this something that really you expect kind of going forward with projecting a pretty flat market here kind of through the remainder of the year. Also kind of expecting similar in the international markets and then a slow recovery in 2021?

[Jon Faber, President, CEO & Director]

So the international market is a few different areas, of course, right? I would say that Saudi Arabia and Australia would have been somewhat more resilient, still down, but more resilient. And in South America, in some countries, it was quite a bit slower than even North America, more significant declines. And given that the South American countries continue to be a larger part of our international business, we would expect that, that would continue to be quite low for a while based on what we see today, again, with that similar sort of trajectory and time line that you mentioned you would see on the North American side.

[Operator]

Your next question comes from John Gibson of BMO Capital Markets.

[John Gibson, Analyst]

Historically, you've maintained a bit of a larger fixed cost base to downturns and already keep your service offering. I know you touched about it in your preamble there, but we've seen some commentary from producers that North American activity levels will be structurally going forward. So I guess my question is, how much are you willing to stack our price on the margin side, at least in the short term, to maintain a fairly large operating footprint? And at what point would you look to reduce for prints in certain areas? And then lastly, do you share the view that North American will be -- or North America will be structurally lower going forward?

[Jon Faber, President, CEO & Director]

Again, maybe take those in reverse order. So the question do we share the view that will be structurally lower, I think we'd share the view that it will be structurally lower than it was coming into 2020, but it's not that it's going to stay at the current level, right? So we do think it will improve from here, but likely not to call it, exit 2019 levels at any point in the foreseeable future, right? Now the restructuring exercise we went through, we really sort of imagine what that lower than 2019, but better than today type of environment might look like and look to get an appropriate cost structure for that type of environment. So what I mentioned in the comments that we didn't sort of restructure the business to the trough. We do expect we're going to consume some cash over the next few quarters through the depths of the crisis. As we restore back to that, I don't want to call it a normalized environment, but an environment that's better than today, but lower than exit 2019.

[John Gibson, Analyst]

Okay. Great. That answers my question. Like would you put a number on where you think the rig count will get back to? I mean, I know it's impossible to say, but like where have you sort of structured your business, I guess, relative to exit 2019 level?

[Jon Faber, President, CEO & Director]

I think if you read a number of commentaries from people in the industry, I see ranges anywhere from, call it, 400 to 600. And we would sort of be consistent with that range, right? Don't be going to put a specific number, but I think that's the type of a range that we could see in the foreseeable future. That's the appropriate planning horizon.

[John Gibson, Analyst]

Okay. Great. That answers my question. Secondly, just on the pricing concessions, can you give an order of magnitude? And was this competitor or a customer having?

[Jon Faber, President, CEO & Director]

So to be clear, John, there wasn't that much in terms of new pricing concessions in the quarter. There certainly was some, but what you see, particularly on the Canadian side, is the disproportionate contribution of non-oil and gas rigs. And what you see on the U.S. side is more of a regional mix of where the activity slowdowns were. So certain regions where the rigs are drilling larger, deeper, more complex wells that tend to draw more pace on product, those regions would have slowed down more significantly. So it's much more an impact of mix than it would have been around price. It's not today that price was any a factor, but the price is not very much of a factor relative to mix.

[John Gibson, Analyst]

Okay. Great. And then just lastly, on the acquisition front, have your plans changed a little bit? Or in other words, like do you expect to be less aggressive just going forward over the next few quarters as you do maybe burn a bit of cash? Or are you still looking at select opportunities in the same way?

[Jon Faber, President, CEO & Director]

Well, as my comments were earlier, we are prioritizing careful management of the balance sheet through the depths. So I don't think we'd do anything through the depths of the downturn, but we also think that opportunities that will present themselves coming out of the depth may be unique opportunities to transact. So we would always be looking at potentially doing things, but I think the likelihood of doing anything in the depths is very, very low.

[John Gibson, Analyst]

Okay. Great. And again, congrats to you, Marcel. All the best in the future.

[Marcel Kessler, Non]

Thank you, John.

[Operator]

[Operator Instructions] Your next question comes from Jeff Fetterly of Peters & Co.

[Jeffrey Eric Fetterly, Principal and Oilfield Services Analyst]

A couple of clarification questions for you. First, on the Middle East side, you touched on it a minute ago in terms of the resiliency in Saudi, but where does your operational base or asset base sit in the Middle East today? And how has it been trending?

[Marcel Kessler, Non]

So the Middle East for us is really 2 fairly distinct businesses. The first one is Saudi Arabia itself, where we are operating in a 50-50 joint venture with a local partner. And that's where we have seen most resiliency for the overall drilling activity and for Pason's business as well. Now that said, it was actually quite unprecedented that Saudi Aramco did decrease drilling somewhat or is going to, which hasn't really happened in a long, long time, but not nearly as what we would have seen in North America or South America. And the rest of the Middle East, we operate through an entity essentially called Frontier, where we primarily serve that through a small business development office located in Dubai, but then the equipment and the technicians are essentially deployed from North America. So it's a frontier operation with no local infrastructure as such. And it would cover markets such as Oman, the United Arab Emirates, Kuwait, Iraq, out of that operation. So there's really no fixed cost base associated with that as such, and that revenue would have seen much bigger declines more along the lines of what we would have seen in North America.

[Jeffrey Eric Fetterly, Principal and Oilfield Services Analyst]

And on the Saudi side, from a market share standpoint, how have you been trending?

[Marcel Kessler, Non]

We have been trending up, but we are nowhere near the market share as what we would have in the U.S., Canada or Argentina.

[Jeffrey Eric Fetterly, Principal and Oilfield Services Analyst]

Okay. The second question, on IWS, has the commercial deployment gone on that side?

[Marcel Kessler, Non]

So IWS, just as a reminder for other people listening in, is an investment we made last year. It's a minority investment we have in that company. It's a revolutionary new technology for the completion space. And as many of the people on the call will know, if anything, completions will hit even harder than drilling here in this downturn. So the number of axe in the system has gone down significantly. Now that said, we believe fundamentally that the technology remains very valuable, the workflow it enables is very important, and that the medium to long-term prospects are attractive for that business. But they have fallen on pretty hard times, again, even harder than drilling, really, given this downturn.

[Jeffrey Eric Fetterly, Principal and Oilfield Services Analyst]

Given the completion crews are starting to reactivate and, obviously, the cost sensitivity that's in the market, is there a better opportunity today for market penetration with IWS than you had seen in the past?

[Marcel Kessler, Non]

I believe so. I think actually coming down of the downturn, given there will be continued cost sensitivity, I believe that it's actually probably a unique opportunity in time for IWS to grow over the next year or 2.

[Jeffrey Eric Fetterly, Principal and Oilfield Services Analyst]

Okay. And last question, you specifically referenced Energy Toolbase in some of your prepared remarks. I'm curious, is there a way that you see the ability to accelerate Energy Toolbase, especially given what's going on in some of the end markets that they serve?

[Marcel Kessler, Non]

The short answer is yes. It is a question of capital allocation, which we are going to discuss, the Board and the management will discuss here as for the summer. It is a complex space, though. So Energy Toolbase is primarily active in the United States. The regulatory environments, there are 50 quite distinct regulatory environments around power generation, the use of unconventionals, incentives for selling back into the grid through wholesale markets or retail incentives. So it is not easy to essentially accelerate across the board. So we'll have to take our spaces and shoes where we want to deploy our skills. ETB is still a very small company, but, traditionally, they have been active primarily in California and some other select markets in the southeast. Now they're looking to go within a foothold in the Northeast, primarily Massachusetts and New York. But it's almost a state-by-state deployment at this stage.

[Jeffrey Eric Fetterly, Principal and Oilfield Services Analyst]

And how broad from a overall coverage standpoint would Energy Toolbase's platform be in terms of states covered or market right now?

[Marcel Kessler, Non]

So there are several distinct offerings to. So the legacy ETB software as a service platform, which is software used primarily by solar and energy storage developers to model the economics and build proposals for new projects or for retrofits, in some cases, that is pretty universally applicable across the United States. And Energy Toolbase has quite a distinct skill essentially in having the relevant rate tariffs for the various state utilities in their platform. So that is applicable to many, many states. In terms of the control systems, that's where it gets a bit more complicated, where the control systems actually take charge of the battery, charge it or discharge it according to whatever objective the asset owner or manager has, whether it be demand charge reduction, whether it be time of use optimization or whether it be to optimize some regulatory incentive in terms of providing power back to the grid. That's where sometimes customization is required. So it really depends on the product.

[Jeffrey Eric Fetterly, Principal and Oilfield Services Analyst]

We just lost extension from that. Notwithstanding your comments, Jon, about protecting balance sheet through the downturn, is there a need, a desire or an opportunity to put some of your cash to work into these existing investments in the near term, either adding to your position in IWS or accelerating anything on the ETB side?

[Jon Faber, President, CEO & Director]

I would say there's certainly a willingness. Whether it's a need, I guess, it becomes a need when you see the right opportunity in those spaces. But clearly, when we think about the medium to longer term and where the businesses has opportunities to grow, we have opportunities within the core business with the existing products and with existing customers and existing markets. As we start to talk with some of these other industries, there may be things that we can do to flesh out either customer relationships, product offerings, markets we serve, et cetera. And so we would entertain those, absolutely. But again, I'd call it a willingness as opposed to feeling it's a need at the current moment.

[Jeffrey Eric Fetterly, Principal and Oilfield Services Analyst]

Marcel, best of luck. Congratulations on the transition.

[Marcel Kessler, Non]

Thank you, Jeff.

[Operator]

There are no further questions at this time. I will turn the call back over to the presenters.

[Marcel Kessler, Non]

Thank you, everybody, and have a great weekend.

[Operator]

This concludes the conference. Thank you, everyone. You may now disconnect.