Pason Systems Inc

TSX:PSI

Earnings Call Transcript 2022-Q2

[Operator]

Good morning. My name is Joanna, and I will be your conference operator today. At this time, I would like to welcome everyone to the Pason Systems Inc. Second Quarter 2022 Earnings Call. [Operator Instructions] Thank you.

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 that the advisory is 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. Ms. Boston, you may begin your conference.

[Celine Boston, executive]

Thanks, Joanna. Good morning, everyone, and thank you for attending Pason's 2022 Second Quarter Conference Call. I'm 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 second quarter. Jon will then provide a brief perspective on the outlook for the industry and for Pason, and then we'll take questions.

Our second quarter results reflect a continuation of improved industry conditions and also reflect our strong competitive positioning, operating leverage and balance sheet. Pason generated consolidated revenue of $74 million in the second quarter of 2022, a 69% improvement over the second quarter of last year. With this revenue, Pason posted $31 million in adjusted EBITDA, which represented 42% of revenue, a significant increase from the $13 million or 29% of revenue generated in the second quarter of 2021.

All of the company's business segments contributed to the strong quarterly results. North American revenue was $60 million for the second quarter, a 71% improvement from the second quarter of last year and a result that once again outpaced the improvement in underlying industry conditions. Revenue per industry day in our North American business unit was $801 in the second quarter, which, although down slightly from the new record set in the first quarter of this year of $835, was still over the $800 mark for the second time ever in the company's history.

As we mentioned in previous calls, revenue per industry day in North America will fluctuate with seasonality effects of drilling activity in Canada, and we saw this effect in the second quarter when comparing to the first quarter record level. That said, second quarter revenue per industry day of $801 represents a 10% increase from the levels seen in the second quarter of 2021, for which the increase is driven by improved product adoption, along with a more favorable pricing environment as activity levels have continued to recover.

Similarly, activity levels in international end markets also improved, and revenue generated by the International business unit was $12 million in the second quarter, a 58% improvement from the second quarter of 2021. It's also worth noting that in the second quarter, our International business unit generated the highest level of quarterly revenue since 2015.

Energy Toolbase, our emerging business in the solar and energy storage market, generated $1.7 million in the second quarter of 2022 in revenue, a 94% improvement from the levels seen in the second quarter of 2021. Similar to the first quarter, reported revenue for Energy Toolbase begins to incorporate revenue generated by control system and related hardware sales. Quarterly revenue for this segment will fluctuate with the timing of commissioning of control systems.

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. Specifically, we continue to be especially proactive on the repair of our existing fleet and technology as we grapple with ongoing difficulties in predicting timing on deliveries of capital equipment purchases.

Further, we are managing inflationary effects on certain components of our cost structure. That said, our second quarter adjusted EBITDA of $31 million or 42% of revenue does near pre-pandemic levels and in fact, is very similar to levels that we saw in the second quarter of 2019, with 23% less North American land rigs.

Net income attributable to Pason for the 3 months ended June 30, 2022, was $18.5 million or $0.23 per share, a significant increase from the $5.3 million or $0.06 per share generated in the second quarter of 2021. Year-to-date, Pason generated $148 million of revenue, a 72% increase from $86 million in the corresponding 2021 period.

Adjusted EBITDA for the 6 months ended June 30, 2022, was $64.3 million or 43% of revenue compared to $26 million or 30% of revenue for the first 6 months of 2021. Accordingly, net income attributable to Pason in the first half of 2022 was $37 million or $0.45 per share, up from $9.5 million or $0.12 per share. A comparison of year-to-date results continues to highlight the improved industry conditions, higher levels of revenue generated per operating day and strong operating leverage.

Our balance sheet remains strong and incredibly well positioned to make strategic investments within our core business. We ended the quarter with $187 million in cash and cash equivalents and no interest-bearing debt. In support of increased levels of activity, we continue to make investments in our core business. We mentioned last quarter that we would be making strategic and proactive investments in inventory levels of components and supplies in an effort to mitigate the impacts of ongoing supply chain challenges.

In the second quarter, that included $2.4 million in inventory investments, and we expect to continue with this strategy in the coming quarters. Further, in the second quarter of 2022, Pason spent $6.5 million in net capital expenditures relating to maintaining and refreshing our technology platform. Resulting free cash flow in the second quarter was $19.1 million, a 237% improvement from $5.7 million generated in the second quarter of 2021.

We remain committed to shareholder returns and, in the second quarter, returned $8.1 million to shareholders through dividends and share repurchases. In summary, we are very proud of our second quarter results, which reflect 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. Our second quarter financial results reflected our strong competitive position and the continuation of the steady growth in activity as the industry has recovered since bottoming in the third quarter of 2020.

As Celine noted, our consolidated revenue and adjusted EBITDA in the quarter were nearly identical to our results in the second quarter of 2019 despite industry activity being 23% lower in the second quarter of 2022 as compared to the same period in 2019. We expect to build on the advancements that we have made in our business over the past few years. We are well-equipped to provide the drilling data and technologies that our customers are increasingly using to deploy automation and analytics to improve their operational performance.

In recent months, the macro environment has become more challenging as central banks attempt to bring down high prevailing levels of inflation by raising interest rates while trying to avoid putting economies into recession. The world is wrestling with a global energy crisis with significant shortages and elevated prices in many countries. And at the same time, geopolitical instability has placed an increased focus and attention on where commodities are sourced.

Oil prices have become more volatile as traders weigh the implications of supply shortfalls against the potential demand destruction from an economic slowdown. Against that more challenging backdrop, we remain confident that the North American land drilling activity will continue to trend slowly and steadily higher in the coming quarters. Global oil demand is now similar to pre-pandemic levels. And while there are growing concerns about potential demand impacts from a recessionary environment, supply factors may overwhelm those demand impacts.

In previous cycles, high oil prices have led to significantly oversupplied markets. In the current situation, however, major sources of supply are below pre-pandemic levels and trending lower. U.S. storage levels of crude oil and petroleum products are at levels last seen in 2008.

Since the beginning of April, the United States has released approximately 800,000 barrels per day from the Strategic Petroleum Reserve to help meet demand. However, that program is currently scheduled to end in late September. Today, the reported inventory in the Strategic Petroleum Reserve sits at the lowest level since May 1985, more than 37 years ago.

U.S. land production remains almost 10% below pre-pandemic levels. The inventory of drilled but uncompleted wells, something we call DUCs, in the United States has decreased for 24 consecutive months to its lowest level in more than 9 years. The pace of decline has significantly slowed over the past few months, suggesting that the DUC inventory may be plateauing at a minimum level.

There is a finite limit to how much supply can come from drawing down on storage and uncompleted well inventories. Any new wells being prepared for production to slow the drawdown of inventories to meet demand will require new drilling. As a result, we expect land drilling activity to steadily grow over the coming quarters.

In our solar and energy storage efforts, we expect a growing number of control system installations and increasing recurring monthly revenue from subscriptions to our economic modeling software package to contribute to revenue growth. Across our business, we will make the necessary investments to position ourselves to realize future revenue gains.

Our operating costs will see increases in anticipation of further activity gains and prevailing inflation rates. We will invest in research and development efforts that drive continued market share and pricing improvements. 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.

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 remain focused on ensuring that Pason is an innovative, profitable and responsible company.

And we would now be happy to take any questions.

[Operator]

First question comes from Keith MacKey at RBC Capital Markets.

[Keith MacKey, analyst]

Just maybe wanted to start off, Jon, curious for your thoughts on where you see North American rig counts trending through 2023. I know you expect them to gradually improve. But maybe if you could put a little bit more of a range or a finer point on what you expect to see in the market.

[Jon Faber, executive]

Yes. Of course, my crystal ball is no better than yours, Keith, right? So I think if we're talking about the U.S. land market in particular, which is, of course, the vast majority of our activity, we would have seen a world prior to the pandemic that was in that higher 800, lower 900 sort of range. I can see us getting back to that range. The question is how quickly.

And I think that's ultimately going to be constrained a little bit by the availability of labor and equipment. And so to the extent that, that remains a rate limiter on the growth rate, I think continuing to see that the type of pace we've seen on average in the last few months is probably more realistic. So that will be a slower pace than we saw earlier in the recovery, but it is gradual, slowly trend up to the right.

[Keith MacKey, analyst]

Yes. Got it. And rig providers are starting to talk a little bit more about activating longer-idled AC rigs and as they get deeper into their stacks and potentially some more substantive upgrades. As that rig count sort of trends up, can you maybe just talk about what you think could be your potential market share as these newer rigs come back to work? Do you have a sense of where Pason is already installed, and what the opportunity might be to participate in any of these new sort of rigs that are going back to work?

[Jon Faber, executive]

Yes. I think our share of the people who are talking about reactivating, Keith, will be such that we would expect our share of the new rigs firing up to be about the same as the rigs that we've seen active in the market recently. So I don't know that I would see a material change in market share up or down from the reactivation of rigs.

[Operator]

[Operator Instructions] Next question comes from Michael Robertson at National Bank.

[Michael Storry-Robertson, analyst]

Congrats on the solid quarter. You had mentioned in your commentary that one of the factors supporting the stronger revenue per industry day was product adoption. I was just wondering if maybe you could wrap some more color around some of the -- like the particular products that you're seeing stronger adoption rates with that's driving that. And maybe if you could speak to what kind of ballpark penetration those have in the market right now to understand how much further that adoption could go.

[Jon Faber, executive]

Yes, sure. There's probably 2 categories, Michael, around what that product adoption increase looks like. I'd say, some of the product adoption increases are, what I'll call, the readoption of some products that may have come off through more challenging environments. One of the things, when customers are looking to bring their spending down, is they'll look at trying to do as much with a little less equipment. And so when things get a little better, they tend to take some of those products back. So we call that kind of a readoption effect.

And that effect has probably largely played out today. So I don't know that there's a significant amount of readoption type of opportunity. So maybe the specific area I'd call out around kind of revenue growth as it relates to newer product types of adoption is really in the data delivery space that we talked about within our drilling data segment, and that's really customers looking to bring the data into their systems through a variety of mechanisms. And so I think that has more running room than the readoption effect has.

[Michael Storry-Robertson, analyst]

Got it. Got it. That's really helpful color. Any updates on your free cash flow prioritization here? Assuming we're looking at industry activity levels continuing to climb, just wondering how you're thinking about where you would put that to work.

[Jon Faber, executive]

I think one of the best places for us to put our capital to work today is in the business. We think there's real opportunities for further investment within our existing business. I mentioned some of the space where customers are -- increasingly have a focus on, how do they get that data moving around into the various systems that they're using. And I think there's real opportunities for further investment in the business, first and foremost.

Then when you start to look at the returns to shareholder questions, I think we've articulated in the past that our desire is to be a bit more flexible in our capital allocation or return -- shareholder returns than we were in the past. So a little bit less focused on the regular dividend, which we expect will continue to increase, but a more significant use of repurchases than we would have had in the past because that's a more flexible mechanism to scale up and down as other opportunities for investment show up.

So as free cash flow improves and continues to get a little better, that makes more available for that return to shareholder side as well. And as I said, continued growth in the regular dividend, but also probably a little more use of the repurchase side.

[Operator]

Thank you. There are no further questions. You may proceed.

[Jon Faber, executive]

Thanks very much for joining our call this morning. If you have any follow-up questions, you're certainly welcome to reach out to Celine or myself. And otherwise, we'll look forward to speaking to you after the third quarter results in November.

[Operator]

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