Pason Systems Inc

TSX:PSI

Earnings Call Transcript 2021-Q2

[Operator]

Good morning, ladies and gentlemen. My name is Michelle, and I will be your conference operator today. At this time, I would like to welcome everyone to the Pason Systems Inc.'s Second Quarter 2021 Earnings Call. 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. [Operator Instructions] I would now like to turn the conference over to Mr. Jon Faber. Please go ahead.

[Jon Faber, President, CEO & Non]

Thank you, Michelle. Good morning, and thank you for attending Pason's Second 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 second quarter financial performance. I will then close with a brief performance on the outlook for the industry and for Pason, and we will take any questions you might have. And I'll now turn the call over to Celine.

[Celine Boston, Chief Financial Officer]

Thanks, Jon, and thanks to those attending today's call. I'm pleased to report on Pason's second quarter results, which represents the first quarter since the pandemic started where the prior year comparative quarter also represents the headwinds our industry has faced throughout the last 18 months. Within this context, our second quarter results reflect a significant improvement in industry conditions from the lows experienced in 2020. We took the difficult but necessary steps to adjust our cost structure in the second quarter of last year, while continuing to make critical investments in technology and service to meet the demands of our customers. These measures have proven effective, as we've grown our competitive position to record levels and as a result grown revenue at a faster pace than the improvements seen in industry activity, all while continuing to demonstrate capital discipline and strong operating leverage. Pason generated $43.6 million of revenue in Q2 of 2021, a 62% improvement over the second quarter of last year, which represented the steep drop-off in drilling activity seen at the start of the pandemic. North American industry days, although still well below pre-pandemic levels, increased by 37% during the second quarter of 2021 compared to the same second quarter of 2020. During that time, Pason continued to grow its competitive position in the United States, while defending its leading position in Canada, resulting in record North American market share for the company in the second quarter. Accordingly, revenue per industry day grew by 13%, from $643 in the second quarter of 2020 to $728 in the current quarter. Given this improvement, Pason's North American business unit generated $34.9 million in revenue in the second quarter, a 52% improvement from the second quarter of last year and a result that outpaces the improvement in industry conditions. International revenue of $7.8 million represents an increase of 157% from the $3 million generated in the same quarter of 2020. Industry conditions in international end markets have improved greatly from the almost complete stop in drilling activity that was witnessed in the second quarter of last year in certain operating regions for Pason. 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 opportunities of intelligent energy management control systems. Reported revenue in this segment was $0.9 million in the second quarter, consistent with the prior year period and continues to be primarily comprised of subscription-based software licenses for solar energy planning tools. Also of note, despite expected seasonality in Canada, causing the second quarter to generally be a softer result, Pason's overall revenue increased sequentially from $42.6 million in the first quarter to $43.6 million in the second quarter, driven by the sequential growth seen in the international and U.S. end markets, coupled with the continued improvement in revenue per industry days. Pason generated $12.8 million in consolidated adjusted EBITDA in the second quarter, a vast improvement from a loss of $800,000 in the second quarter of last year. As the industry recovers, we are incurring certain costs in anticipation of future revenue increases, primarily as it relates to equipment repairs and people. However, many of our operating costs remain fixed in nature, and our operating leverage remained strong. Second quarter results reflect 81% incremental adjusted EBITDA margins experienced year-over-year. In the quarter, Pason recognized $3 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 October 2021. On a year-to-date basis, Pason generated $86.1 million in revenue compared to the $100.8 million of revenue that Pason generated during the first half of last year. Adjusted EBITDA for the 6-month period was $26 million compared to $32.5 million generated during the first half of 2020. Although results have improved significantly from the lows experienced in 2020, a comparison of year-to-date results continues to reflect the significant change in industry conditions since the first quarter of last year. Our balance sheet remains strong and incredibly well positioned, with $135 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 second quarter, Pason generated $5.7 million in free cash flow, which reflects the investments made in working capital and equipment in the quarter. We also continue to evaluate opportunities outside of North American land drilling. And in the quarter, we used $7.1 million to grow our minority interest in Intelligent Wellhead Systems, a private North American completions technology and service company, for which we made our initial minority investments in 2019. Also in the second quarter, Pason funded 1 of the 2 remaining $5 million put option associated with our minority investment in that business. Pason returned $7.2 million to shareholders through dividends and share repurchases in the second quarter. We are maintaining our quarterly dividend at $0.05 per share, and we'll continue to balance our commitment to shareholder returns while preserving financial strength to support long-term success. In summary, our second quarter results reflect our leading 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 & Non]

Thank you, Celine. Pason posted excellent second quarter financial results, and we look forward to carrying that momentum into the coming quarters. Our outlook for growth continues to improve as we feel confident in both our strategic position and our competitive position. Pason sits at the center of the flow of much of the drilling data in the oil and gas industry. As customers look to leverage data through the use of automation and analytics technologies, Pason is well situated to contribute to those efforts. The investments we made through the deepest parts of the downturn to retain our service and technology capabilities have allowed us to grow our North American market share to the highest level in the company's history, as U.S. market share continues to increase while Canadian market share holds its leading position. Revenue per EDR day remains below pre-pandemic levels in each of our operating regions, but continues to improve from the low points of mid-2020. As industry activity levels continue to grow through the remainder of 2021 and through 2022, our stronger competitive position, increasing product adoption and improving price environment will continue to drive revenue growth. The ongoing COVID-19 pandemic continues to create uncertainty around the near-term picture for oil demand, and uncertainty around supply levels from OPEC plus countries will also serve to temper growth in industry activity. That said, forecasts point to global oil demand exceeding pre-pandemic levels in 2022. Sustained lower levels of U.S. production decreasing storage inventories and a consistent decline in the inventory of drilled but uncompleted wells, all point to the need for increased levels of North American land drilling in the future. Industry analysts continue to call for U.S. rig counts to reach 500 by the end of the year and to grow through the 600 rig count level in 2022. The Canadian rig count currently sits above 150 rigs, ahead of its August 2019 level 2 years ago and is also expected to grow further through 2022. We have seen significant growth in industry activity in our international markets since the lowest point of the COVID-19 pandemic. At this point, we expect further growth to be much slower in the near term as various jurisdictions contend with additional variants and increasing case counts from the virus. Celine made reference to our robust incremental adjusted EBITDA margins. We continue to expect these incremental margins to be strong as we see revenue levels improve, though we will incur the necessary costs to position ourselves to both participate in increasing industry activity levels as well as to further expand our technology leadership. We expect to see increases in our operating costs, primarily around personnel and equipment repairs, in anticipation of further activity gains. Our research and development investments will also see increases in the coming quarters as we see evidence of these investments resulting in market share and pricing improvements, while we continue to deliver additional value and functionality for customers. Consistent with our experience emerging from a downturn a few years ago, we expect to generate incremental adjusted EBITDA margins in the order of 75% on an additional $50 million to $100 million in revenue from the lows experienced in 2020. Given our need to spend in anticipation of future activity, the incremental margins on a quarterly basis will fluctuate significantly, with margins being more compressed in earlier quarters before expanding again as industry levels and activity levels deliver. We expect to spend up to $15 million in capital expenditures in 2021 and we'll continue to make the necessary investments in working capital as activity levels improve. Pason's strategy continues to include making investments for future growth outside of oil and gas drilling, and we made further progress in this area during the second quarter. During the quarter, in addition to providing a further $5 million for growth capital as part of our original investment into Intelligent Wellhead Systems, we had the opportunity to deploy an additional $7.1 million to purchase existing outstanding shares and increase Pason's minority ownership stake. We continue to be impressed with the IWS technology offering and are encouraged by the increasing pace of adoption it is experiencing in the field. We also continued our development efforts within Energy Toolbase, where we are building out an integrated platform of tools to model, control and monitor energy storage assets. During the quarter, the team released a significant next generation of its industry-leading economic modeling and proposal generation tool. The sales pipeline and bookings for our control systems also grew further in the quarter. We will continue to allocate capital by balancing investments and 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 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, National Bank.

[Michael Storry-Robertson]

Congrats on a strong quarter. In your prepared comments, you touched on product adoption being one of the drivers of the increase in day rates. I was wondering if that is a function of a potential change in client mix? Or is it something that you're seeing more broad-based across your entire customer base?

[Jon Faber, President, CEO & Non]

Say it's more broadly across the customer base. Now clearly, we talked in the last few quarters about clients increasingly looking to use the data that's provided in different ways in their office operations and some of their field-based automation efforts. And I would say that as we're seeing that increased use of technology relying on data, that then increases the adoption of products, both that capture, aggregate and transmit the data, as well as the delivery of that data to the systems and technologies they're using.

[Michael Storry-Robertson]

Got it. Got it. That's helpful. The release also noted some near-term pressure on margins related to inflationary pressures. Is the bulk of that coming through on the labor side as activity levels would continue gradual increase?

[Celine Boston, Chief Financial Officer]

Yes. Thanks, Mike. That's correct. So raw materials is not so much a problem for our business, but we're likely to see the impact on cost of people side of things in our business specifically, particularly software engineering skill sets who, as you know, are a crucial part of our labor force and highly sought after in this market.

[Michael Storry-Robertson]

Got it. And I guess assuming the continuance of a gradual recovery here, do you foresee those inflationary pressures keeping even the margins, sort of, relatively flat to what we've seen in recent quarters? Or do you think your inherent operating leverage will be enough to overcome those headwinds?

[Jon Faber, President, CEO & Non]

That's probably a question of just how much the revenue increase is, right? I think it's certainly a case where some of those pressures are from the fact that we're investing for future activity. And so those types of costs coming ahead of activity compress margins. But it's not a significant amount of costs that we're incurring for increased activity. So I think with reasonable increases in revenue, it should be sort of offset that pressure on the operating margins.

[Michael Storry-Robertson]

Yes, if I'm understanding correctly, I guess it would be sort of transient in nature once that increase in activity level was realized?

[Jon Faber, President, CEO & Non]

The costs aren't probably quite as transient. Maybe some of the repair costs are a bit more onetime to get the equipment kind of ready to get in for stuff that wasn't maybe ready to go. But some of those other costs, the costs won't be transient, but the margin compression will be because they won't further, kind of, increase as the revenue increases.

[Michael Storry-Robertson]

Yes. Sorry, I should have clarified. I meant on the margin side, not on the cost side. All right. That's really helpful.

[Operator]

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

[John Gibson, Analyst]

Congrats on a strong quarter. Can I start with pricing across North America. I realize that you're still seeing some pressure from the downturn. But I'm just wondering if you've seen any signs of life on the pricing side of it?

[Jon Faber, President, CEO & Non]

So when we think about North America, I'll sort of bifurcate Canada and the U.S. a little bit because if you could, from the previous quarters, we would have talked about very different dynamics on the pricing pressure in those 2 regions that we operate. I think the Canadian market saw more pressure through the worst parts of the downturn, and that is loosening or lightening a bit. So the Canadian market is probably becoming a little bit more constructive in terms of pricing. I think the other opportunity that's more meaningful for pricing, if you think going forward, is the ability to realize price for some of the new features or products that we're able to deliver for customers. So the opportunity to realize value from the product side is probably more instructive for future pricing, but there is probably a little bit less pricing pressure on the Canadian side in particular.

[John Gibson, Analyst]

Got it. Just regarding your comments about increased U.S. market share, did you gain some new contractor customers or producers? Or was it more of a factor of your current contractors or customers putting more rigs back to work?

[Jon Faber, President, CEO & Non]

Well, there's really 3 things that drive market share. One is the fact that people who we've long had a good presence with represent more of the market today. We've been growing our share of those customers as a second function. So there's a sort of a double effect there where you get more share with somebody who is getting more share themselves. And then we have picked up some new customers as well.

[John Gibson, Analyst]

Okay. Great. As we look to approach 500 rigs in the U.S., I'm just wondering if there's an inflection point where you would need to add fairly significant costs back to the business? Or will it be more of a gradual build?

[Jon Faber, President, CEO & Non]

It's really not an inflection point, John. I think there's certainly around how regional the activity levels are. And to the extent that they tend to be very focused in an area like the Permian, that probably means you're staffing up a little bit more on a regional basis. But because we tend to add a technician for a number of rigs, not on a one-to-one relationship, it's not really an inflection point on the cost side. And that's why we say we're pretty comfortable that measured over a good chunk of revenue, those incremental margins are in the neighborhood of 75%. And it's honestly hard to see how they become much off of that even as you push past those levels.

[John Gibson, Analyst]

Okay. Last one for me. I have to ask this. When you look at free cash flow allocation, particularly in spite of the modest rising activity levels and your stronger performance financially. I'm just wondering how you're thinking about share buybacks, dividends and -- compared to maybe proceeding further growth strategies.

[Jon Faber, President, CEO & Non]

Well, I think the 2 priorities from a capital allocation side are to continue to ensure the current and long-term growth prospects for Pason; and to continue to protect our shareholders' interest in exposure to that growth i.e., reduced dilution, right? So from a buyback perspective, we tend to think about reducing the dilution from options. And from a dividend perspective, we think about, kind of, maintaining that regular return of capital to shareholders, and we're very focused on the current and long-term growth for Pason.

[Operator]

[Operator Instructions] Your next question comes from Cole Pereira of Stifel.

[Cole J. Pereira, Associate]

Just wanted to start on the margin side. It sounds like there's some potential for maybe some modest contraction. But can you just indicate whether that's more of a North American situation, or maybe some international as well?

[Jon Faber, President, CEO & Non]

It's probably more on the North American side. Now the international markets, we do think while growth is probably going to be slower for the near term here based on continued challenges around COVID in some of the international markets, where there's much bigger challenges than we maybe feel in some of the North American markets on that side. So there will be some growth to come in the international in the future, at which point we'll have to address what costs we need to incur. But that comment around some of the pressures on margin for future activity and participation, and that is really around repair costs, maybe some field personnel on the North American side as industry activity increases. And we're really seeing results from the R&D investments that we've made in the last number of years and the last number of months. And so we are looking to continue to invest on the R&D side because we've seen that deliver value. And that will create some additional cost on the R&D side ahead of the delivery of the products.

[Cole J. Pereira, Associate]

Okay. Great. That's helpful. Maybe thinking about Q2, specifically, North American margins were very strong. Was this just kind of an operating leverage outcome? Or are there some other factors we should be thinking about?

[Celine Boston, Chief Financial Officer]

No, that's absolutely the right way to think about it, Cole.

[Cole J. Pereira, Associate]

Okay. Perfect. And maybe turning to the IWS investment. Can you add some color around what you maybe, might need to see to increase your interest to be a majority owner? And how you maybe think about growing this part of the business alongside the existing Pason suite?

[Jon Faber, President, CEO & Non]

I guess what I would say is that we have been very intentional about scaling our additional investments in that business, around seeing sort of milestones in the progress of the business, right? So the fact that we were able to -- well, first of all, there's opportunity to purchase more shares, that needs to present itself. That, combined with some milestones we've seen in the development of the company, would have encouraged us to make the investment this quarter. The fact that we're putting more growth capital into that business through the put options suggests the sort of traction that, that business is having. And so we feel there will probably be milestones coming where we might want to further increase our position. But given it's a private company, I'm going to retain the ability to not say much more than that, Cole. But clearly, we're excited about the traction that they've had, and we are encouraged to own more of it as it continues to be successful.

[Operator]

Your next question comes from David Anderson of Barclays.

[John David Anderson]

I want to get back to the comment you were giving about market share before. And if we think about next year in '22, you kind of put out there, maybe 600 rigs by year end next year, which I would agree with. So let's say we have 100 rigs or so adding next year. I'm just curious how you're thinking about those 100 rigs. I mean, obviously, a portion of them, you already have equipment on, so your existing customers coming back to work. But I'm just thinking about the rest of them. How much of that is an opportunity to gain share? Is it more that there's an incumbent who has kind of a similar, sort of, I guess, a competitor -- a competitive offering on the rig? Or are these rigs, they don't have anything like that on them, that they're almost kind of virgin rigs, so I guess, to a certain extent in terms of -- in terms of how they're generating data and in terms of how they accumulate data.

[Jon Faber, President, CEO & Non]

No, there will be competitive offerings on those rigs as they come back. I think the opportunity for us to participate disproportionately to our current market share in that growth would come from the desire of customers who are active to increasingly use technologies around automation and analytics, which rely on high-quality data to feed them, right? So the fact that we've grown market share in the U.S., that's been really important. We're seeing that the active operators and contractors are people who are really looking to deploy technology, and we can really facilitate what they're doing either with our technologies or, in a lot of cases, they're using our data to feed other technologies they're using. And there's real opportunities there for us.

[John David Anderson]

But I guess I'm just kind of curious, is it more of the opportunity to kind of knock off a competitor? Or are these basically kind of opportunity -- kind of new opportunities altogether, in terms of kind of that business that you're going after?

[Jon Faber, President, CEO & Non]

Well, I think it's both at the end of the day, right? The rigs that are running today, I think we can continue to chip away that market share further, and I think we have an opportunity to disproportionately participate as rigs come back, provided its people focused on technology.

[John David Anderson]

Okay. And then going back to the IWS investment you have in there. I'm just curious what are the other parts of this, in terms of other opportunities you see around kind of out there in terms of maybe on the software side or hardware side. As you get more further into digital, it seems to be -- there's a lot of smaller companies out there that are doing other types of work like IWS. Are you looking for other opportunities around that set? Do you see yourself kind of participating in there and kind of building that kind of opportunity center on the software side more? Is that an opportunity you see out there? Maybe just a little bit, kind of, your vision in the next couple of years of kind of how this all shakes out because, geez, there's so many companies that are offering, so many different things these days. I'm just wondering how you're sorting through this.

[Jon Faber, President, CEO & Non]

Well, your comment is about there's so many companies says something about the barriers to entry in that part of the business probably, Dave, right? So I think the real opportunity for Pason has been for a long time and will continue to be -- to be that real infrastructure of high-quality data to feed a variety of different things that people are doing with software. As you get closer to the software side and more into the back office of the operators and contractors, it becomes much more fragmented. I think the opportunity is for us to deliver and serve data to those parts of the market. And we have some offerings in there, but I think the real opportunity is to participate in helping enable a lot of those technologies, and then it's also directly competing against a lot of those technologies.

[Operator]

[Operator Instructions] There are no further questions. So I'll turn the conference over to Jon Faber for closing remarks.

[Jon Faber, President, CEO & Non]

Thank you very much for taking the time to join us this morning. We appreciate your continued interest. And if you do have other questions that you weren't able to ask on the call, certainly feel free to reach out to Celine or myself, and we would welcome your calls. Thanks very much. Have a great day, and we look forward to touching base again after the third quarter.

[Operator]

Ladies and gentlemen, this concludes the conference for today. Thank you, everyone. You may now disconnect.