Pason Systems Inc

TSX:PSI

Earnings Call Analysis

Pason Systems Reports Strong Revenue Growth Despite Market Challenges

Pason Systems Inc. reported a 13% increase in Q2 2024 revenue to $95.9 million, despite a 13% decline in North American drilling activity. The completion segment achieved record revenue of $13.7 million, and international markets saw a 2% revenue rise to $15.3 million. Depreciation and amortization expenses doubled to $12.9 million due to recent acquisitions and investments. As a result, net income dropped to $10.9 million from $25.5 million. However, the company maintains a strong balance sheet with $71.2 million in cash and no debt, positioning itself well for future growth.

Resilient Revenue Growth Amid Declining Industry Activity

Pason Systems Inc. reported a robust financial performance for the second quarter of 2024, generating $95.9 million in revenue, a 13% increase from $84.7 million during the same quarter in 2023. This solid growth is notable, especially considering a 13% decline in North American industry drilling activity during this period. The North American drilling segment posted a revenue per industry day of $993, marking a 9% rise from the prior year, which highlights Pason's ability to outperform market conditions.

Segment Performance and Strategic Growth Drivers

Despite the challenging backdrop, individual segments performed well. The North American drilling segment achieved $63.8 million in revenue, down only 5% from the previous year. Internationally, revenue grew 2% to $15.3 million, showcasing strong demand and improved revenue metrics in other markets. Pason is strategically focusing on increasing average revenue per industry day and expanding international revenue. Alongside this, they are pushing into technology markets, particularly within completions and solar energy, which are expected to show substantial growth in the coming years.

Impact of Acquisition and Cost Management

Pason’s recent acquisition of Intelligent Wellhead Systems (IWS) has been a game-changer, resulting in a record $13.7 million in revenue from the completions segment. However, the acquisition has also led to increased depreciation and amortization costs, now totaling $12.9 million for the quarter, compared to $5.8 million year-over-year. The total gross profit for the completions segment was $1.4 million, reflective of investments made to support growth. The company is managing its fixed cost structure to accommodate these changes and remains optimistic about the long-term growth effects.

Free Cash Flow and Shareholder Returns

Pason generated free cash flow of $8 million during the quarter, down from $18 million in the same quarter last year. Nevertheless, the company remains in a sound position, reporting total cash of $71.2 million with no debt. They returned $13.1 million to shareholders through dividends and share repurchases, maintaining a regular dividend at $0.13 per share, demonstrating a commitment to shareholder value while pursuing growth.

Outlook: Market Dynamics and Growth Potential

Jon Faber, CEO of Pason, expressed confidence in the company's ability to grow revenue per industry day by over 6%-7% annually, reflecting strong demand for high-quality data from customers. While there are challenges in the natural gas market and ongoing M&A activity creating some near-term headwinds, the management remains optimistic about future growth, particularly in completions and the adoption of new technologies, such as the mud analyzer, which could enhance operational efficiency. The expected growth trajectory may shift towards 2025 for some segments but illustrates Pason's long-term potential.

Segment Specific Insights into Completions and International Markets

The utilization of new technologies in completions, especially in relation to IWS, positions Pason favorably as more companies focus on data-driven methods. Despite recent challenges in demand, Pason expects customer activity to rebound by 2025, bolstered by strong customer retention rates and an increasing user base. Internationally, markets like Argentina and the Middle East are underscored for their growth potential despite varying local conditions. As these markets stabilize, they could offer significant revenue opportunities, reinforcing Pason's strategic positioning.

Earnings Call Transcript 2024-Q2

[Operator]

Good morning. My name is Sylvie, and I will be your conference operator. 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.

At this time, I would like to welcome everyone to Pason Systems Inc. Second Quarter 2024 Earnings Call. [Operator Instructions]

Thank you. Celine Boston, CFO, you may begin your conference.

[Celine Boston, executive]

Thank you, operator. Good morning, and thank you for attending Pason's 2024 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 and Jon will then provide a brief perspective on the outlook for the industry and for Pason, and we will then take questions.

I'm pleased to report on Pason's second quarter 2024 results, which incorporate results from newly acquired intelligent wellhead systems and also demonstrates our continued ability to outperform industry drilling activity. Pason generated $95.9 million in revenue in the second quarter, a 13% improvement from the $84.7 million generated in the second quarter of 2023, despite a 13% reduction in North American industry drilling activity in that same period.

I'll start with an overview of segment performance for the quarter. Against a challenging industry activity backdrop, Pason's North American drilling business unit generated revenue per industry day of $993, which represents a 9% increase from the level seen in the second quarter of 2023. With the 13% decline seen in industry activity, mostly driven by the U.S., the North American Drilling segment generated revenue of $63.8 million for the second quarter, which was only 5% lower than the second quarter of 2023.

The segment's cost base remains mostly fixed in nature, and depreciation and amortization expenses grew year-over-year with increased capital expenditures in recent quarters, resulting in segment gross profit of $34.1 million in the second quarter of 2024 compared to $40.8 million in the second quarter of 2023. Our international drilling segment generated $15.3 million in quarterly revenue, which represents a 2% increase from the second quarter of 2023, with strong industry activity and improved revenue per day across the segment's end markets.

The segment also saw slightly higher depreciation and amortization in Q2 of 2024 with resulting gross profit of $7.3 million compared to $7.4 million in the second quarter of 2023. Our completion segment includes results from Intelligent Wellhead Systems, a completions technology business that we fully acquired and began consolidating results for on January 1 of this year. In the second quarter of 2024, Pason's Completions segment had 29 active jobs, up from 28 in the first quarter of 2024 and a revenue per IWS Day of $5,003 (sic) [ $5,103 ], also an increase from the first quarter of 2024. These increases occurred against a challenging industry condition backdrop in the completion sector in the second quarter.

Reported revenue for the segment was a new quarterly record at $13.7 million. Gross profit for the segment of $1.4 million represents operating expense investments made for the rapid growth IWS has seen along with $5 million in depreciation and amortization expense associated with the property and equipment and intangible assets that were acquired on January 1, 2024.

Energy Toolbase, which is reported within our solar and energy storage segment generated $3.1 million in quarterly revenue, an increase of 31% from the 2023 comparative period with increased control system sales year-over-year. The segment's revenue will fluctuate with timing of control systems decrease. Sequentially, Pason's results were impacted by the seasonal decline in Canadian drilling activity, coupled with a decline in U.S. drilling activity as well. Revenue fell 8.5% quarter-over-quarter as a result despite a 13% decline in North American industry drilling activity quarter-over-quarter.

Consolidated adjusted EBITDA in the second quarter of 2024 was $33.1 million or 34.6% of revenue compared to $37.9 million or 44.7% of revenue in the second quarter of 2023. Adjusted EBITDA margin in the second quarter was impacted by lower industry activity levels in the North American drilling segment over our mostly fixed cost base, along with the addition of lower margin revenue from IWS given its current stage of maturity and growth. We will continue to manage our fixed cost structure towards our expectation of upcoming activity levels and with the acquisition of IWS this year.

Further, we will make the necessary investments in our cost base to deliver on further revenue growth and create opportunities for long-term free cash flow generation. As we've seen many times in Pason's history, growth in industry activity levels in the company's North American drilling segment would highlight the significant operating leverage within the business. Depreciation and amortization for the company has increased from $5.8 million in the second quarter of 2023 to $12.9 million in the current quarter. This increase is attributable to higher levels of CapEx in recent quarters with growth-related investments within our drilling segment and newly acquired completions segment, along with the depreciation and amortization associated with the fixed assets and intangibles capitalized as part of the IWS acquisition earlier this year.

As a result, net income attributable to Pason for the 3 months ended June 30, 2024, was $10.9 million or $0.14 per share compared to $25.5 million or $0.32 per share generated in the second quarter of 2023, Our balance sheet remains strong and coupled with our free cash flow generation allows us to make growth-related investments while returning meaningful levels of cash to shareholders. Net capital expenditures in the second quarter of 2024 totaled $17.9 million, which included the addition of capital expenditures of IWS' business as we make investments to support their growth trajectory. Resulting free cash flow in the second quarter of 2024 was $8 million compared to $18 million in the second quarter of 2023.

With this free cash flow and cash on hand, we returned $13.1 million to shareholders through our quarterly dividend and share repurchase program and ended the quarter with total cash, including short-term investments of $71.2 million with no interest-bearing debt.

In summary, we continue to be well positioned for growth with our established and resilient position within drilling and our growing position in completions in solar and energy storage.

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

[Jon Faber, executive]

Thank you, Celine. Our financial results for the second quarter of 2024 highlight the resilience of all 3 areas of our business, namely oil and gas drilling, completions and solar and energy storage. Consolidated revenue in the quarter was 13% higher than the prior year period despite North American land drilling activity being down 13% over the same period.

While Pason would benefit from growing North American land drilling activity, our ability to deliver meaningful growth and strong financial results is not fully dependent on higher activity levels. There are 3 important ways in which we look to position ourselves to outpace underlying North American land drilling activity. First, we look to outpace underlying industry activity through growth in North American revenue per industry day. Second, we look to grow international revenue. And third, we are generating increasing revenue from higher growth markets, including technology offerings in the completions market and in solar and energy storage.

Our North American Drilling segment displayed the strength of its competitive position again by posting revenue per industry day of $993 in the quarter, up 9% compared to the second quarter of 2023. We continue to see strong product adoption and improved price realization, and we anticipate that growing demand for high-quality data will result in continued growth and adoption of our core product offering.

During the second quarter, we began to receive additional deliveries of mud analyzer units, which provide customers with continuous real-time readings of critical drilling mud parameters, and we are beginning to deploy these to the field to early positive market feedback. We've also seen greater traction among our automation products in 2024, most notably the Drilling Advisory System and Toolbase control. Our second important area of growth is in international markets where we generated $15.3 million in revenue in the second quarter.

Market dynamics and geopolitical conditions and their impact on near-term activity will vary across our international markets. But across all markets, we continue to see favorable trends of growing technology adoption and a greater use of drilling data in planning and operations. The third growth area is our investments in higher growth markets, namely completions and solar and energy storage. In completions, we see strong growth over the short to medium term as companies more fully utilize data-driven technologies. IWS generated $13.7 million in revenue in the second quarter, representing another all-time high for the business on the strength of $5,103 in revenue per -- per IWS Day.

We continue to be encouraged by the profile of IWS' revenue growth. While the company has been disproportionately exposed to the effects of a challenging natural gas market and significant M&A activity in the E&P sector, which has resulted in slowing activity among existing customers, IWS continues to hold their share within those customers while adding new customers. With a growing customer base and strong customer loyalty, we expect to benefit as customers who have slowed their completions programs begin to increase their activity, which we anticipate seeing heading into 2025.

Over the medium term, increased use of technology within the broader completions market and further gains in product adoption are expected to drive further revenue growth. We're also bringing together the unique expertise and experience of Pason and IWS to develop a compelling data aggregation and data delivery offering for the completions market.

In order to access the full benefits of data-driven technologies, the completions market will need access to reliable, consistent, high-quality data and we believe that Pason's long history of providing drilling data to customers gives us a unique ability to meet this need and completions. ETB posted revenue of $3.1 million in the second quarter, up 31% year-over-year from the same period of 2023, driven primarily by the sales of additional control systems.

As a reminder, quarterly revenue for ETB will fluctuate as a result of timing of control system deliveries. As storage attachment rates to solar projects increase and as customers look to optimize the performance of those storage assets, Energy Toolbase has seen strong growth in its bookings and in its pipeline of sales opportunities for energy management control systems. Our priorities with respect to capital allocation remain focused on pursuing attractive growth opportunities while returning meaningful capital to shareholders. We continue to expect capital spending of between $75 million and $80 million in 2024. We will continue to pursue disciplined returns over time through our regular quarterly dividend, which we are maintaining at $0.13 per share.

Outside of the regular dividend, our primary focus in 2024 remains making the necessary investments to position ourselves for higher levels of free cash flow in our drilling and completions related businesses. In the first half of 2024, we spent $6 million on share repurchases as well. We evaluate our capital program with a focus on increasing revenue, generating free cash flow and creating value for shareholders over time rather than simply in response to prevailing near-term industry conditions.

Our balance sheet remains strong. At June 30, we had $71.2 million in total cash, including short-term investments and positive working capital of $113.5 million. The strength of our business allows us to make the required investments to secure our position as the leading provider of drilling data and technologies to pursue additional sources of revenue outside of oil and gas drilling and to return meaningful capital to shareholders.

We would now be happy to take any questions.

[Operator]

[Operator Instructions] And your first question will be from Aaron MacNeil at TD Cowen.

[Aaron MacNeil, analyst]

Jon, you've already touched on a lot of these themes in your prepared remarks, but a big theme from the Investor Day was growth both in relative and absolute terms. We've obviously seen industry conditions deteriorate. You mentioned the M&A theme. But I just wanted to take your pulse and see if your view had materially changed on potential growth trajectory for average revenue per industry day or IWS and the mud analyzer growth in.

[Jon Faber, executive]

So I guess I'll maybe break those into -- you talked about kind of the 2 areas growth in revenue per industry day of which mud analyzer is part of that question. And then the other question you had was around IWS. So I'd say -- but take a look at the core drilling-related business, we continue to have confidence in our ability to grow that metric in north of the 6% to 7% that we've historically done over the last 15 to 20 years on an average or a compounded annual basis. That's always a function of both price and product adoption. I think when you get to more challenging environments, the product adoption opportunities are still very much there. The pricing opportunities are probably a little bit more challenged in a more challenging industry environment. We still have confidence in our ability to grow that metric.

The truth is there's just a lot more demand for data and we're well positioned from a product adoption and technology basis to see some of those opportunities realized. Our confidence in the IWS revenue trajectory hasn't changed. I think I made a comment in the previous quarter, I said our confidence around the deliverability of the revenue is very high, but we can't be quite as confident about is the timing of when that revenue delivers. And so it might be helpful, Aaron, if I maybe just paint a little bit of a picture when we talk about the impact of the natural gas market and M&A and the fact that IWS is just much more exposed to those dynamics, which have been real near-term headwinds in terms of the revenue growth side.

So if we look at the natural gas side, the natural gas price has been weakening of late and we've seen recently announcements of expected delays for the Golden Pass LNG project. So that will likely have an impact on the natural gas market side. On the M&A side, maybe just to paint a picture for you, we had 29 average jobs at IWS in the quarter. So as you can imagine, that implies that IWS has tens of customers, not hundreds of customers. More than half of IWS' top 10 customers are acquirers in announced large-scale M&A transactions. And so that is in the medium term, very positive for us, and we feel quite encouraged about the opportunity to expand our activity when you have large-scale M&A acquirers as your customers.

Now what has happened is that activity levels for all of those customers has decreased as they're going through the M&A transaction, sorting out which assets are going to be prioritized, what's the sequence of the capital program on a pro forma basis. All normal things that we see happen in M&A transactions. But over the medium term, we think it's incredibly good news for IWS what that pro forma of the M&A transaction market sort of looks like for us.

The challenge you have with a small business that has tens of customers is that when a customer slows their activity by 3 or 4 fleets, you need to make that up by getting 3 or 4 new customers one fleet at a time. And the sales process and the sales intensity and the sales effort for a new customer to go from 0 jobs to 1 is quite different than getting a customer go from 2 jobs to 3, for example.

So if I break down revenue. And that's why in my comments, I said we're quite encouraged by the profile of the revenue growth. If you look at revenue, it's a function of customer activity and customer activity has been challenging based on M&A and natural gas, particularly for IWS.

The other things you look at are customer retention, which is very high at IWS, customer acquisition, where they're adding new customers every month, and customer spending where you've seen that revenue per IWS Day continues to be very strong. So the question for us is not whether there's deliverability of revenue, whether the trajectory of revenue is meaningfully higher at IWS, the question is whether it delivers in a 2024 world or it's more of a 2025 world. And when you look at what's happening in terms of timing of M&A transactions either closing or the establishment of pro forma capital programs or the expectations around the timing of the natural gas market conditions improving that probably implies it's looking more like it's not going to occur in the second half of 2024, but more of a 2025 story.

[Aaron MacNeil, analyst]

Makes sense. Maybe just a quick follow-up. Another big theme out of sort of Q2 reporting is just the outperformance of the international energy service markets versus North America. So a couple of things, I guess. Do you feel like you're in the right international markets to sort of benefit from that trend? And is there the potential that we could see Pason expand its international footprint in the near to medium term?

[Jon Faber, executive]

I don't know that you'll see our footprint change significantly in the medium term, Aaron. I think when you talk about the markets we're in, I would say 1 of our larger markets is in Argentina, and that market is going through some change with change of government and change of prioritization of the types of assets that YPF intends to focus on. And so there are probably some areas of the market there where on the, I'll call them, the lower end of the market in terms of revenue opportunity, we see less activity, but we see a greater focus on the types of jobs that tend to draw higher product adoption for Pason.

The other upmarket that, of course, is an important market going forward is the Middle East. And we think the value proposition of Pason is significantly enhanced when you look at the Middle East and you incorporate things like the solutions that IWS provides and the mud analyzers. So as we look at the sort of medium term, we're encouraged about the opportunities in those markets. In the near term, the conditions in each market will be different, of course.

[Celine Boston, executive]

Yes. Aaron, I'll just add to that a little bit. I think just in the context of looking at reported revenue results in 2024 versus 2023, I know you know this. But in 2023, there was quite a bit of, we'll call it, noise as it relates to some of our Argentinian operations and foreign exchange and inflationary impacts, particularly in the fourth quarter of last year that made that number probably a little bit more elevated than what we call normal course that you're seeing closer to this year. So that's just something to keep in mind as you're looking at 2024 results over 2023 as well.

[Operator]

[Operator Instructions] And your next question will be from Keith MacKey at RBC.

[Keith MacKey, analyst]

Can you just talk a little bit more about the rollout of mud analyzer. I know it's a part of the forecasted increase in revenue per industry day. But can you talk about how the rollout of that is going, manufacturing, customer adoption, all of those factors?

[Jon Faber, executive]

Yes. So on the mud analyzer side, the manufacturing and the pace of deliveries is very much consistent with what we expected. We expected we would have close to 50 units around this time of the year, growing towards close to 100 by the end of the year. So that delivery on the capital side or the equipment side continues to be very much in line with expectations. If you recall in some of the conversations, Keith, we've indicated that with the mud analyzer, that's a product that's been developed in partnership with Exxon, who, of course, has recently acquired Pioneer and they have an ambition to have that on all of their rigs over time.

So there are units that are going out to them. There are also units going out to other customers. I think the 1 thing that maybe surprised us is we now have units in the Canadian market that we probably came a little quicker than we expected based on some customer demand, and that's going to push a little bit of effort around cold climate development sooner than we expected. And then for some of the other ones, this is a very new technology. And so it does take some time to work with customers to introduce them to what the technology does, what the types of data feeds that they can get off of the analyzer or how they might use them in their operations. And so there is a sales process around that that's different with the new technology than simply rolling out a new version of something that's already in the market.

[Keith MacKey, analyst]

Okay. Very helpful. And I'm going to take a stab at asking you if you can quantify the impact of the mud analyzer on Q2's revenue per industry day?

[Jon Faber, executive]

Well, it would be very minimal on Q2. And again, because of the profile of customer mix as you roll out the earlier units and of course, it's different pricing for technology partners versus the broader market in the early days, I don't think it's going to be significant in terms of revenue per industry day in 2024. But it will continue to roll out into the market and establish market presence and get more customer exposure and market exposure, which is, of course, also a priority.

[Keith MacKey, analyst]

Perfect. And just given the slowdown in general activity and the impact that has on the revenue trajectory for completions in IWS, can you talk about what any of this might mean for your capital expenditures and free cash flow for this year?

[Jon Faber, executive]

Again, we're building on the CapEx side for -- in anticipation of activity levels that we continue to believe will show up as these -- as customers go back to work, particularly if you talk about those who are active on the M&A side, and of course, the other side is not only do we expect that they'll increase their fleets, those fleets will also be larger by virtue of the fact that they're acquiring other businesses with a view towards deploying technology to those fleets.

So to the extent that we expect actually probably a little bit more activity in the medium term than we might have with those customers based on the fact that they've scaled up, I don't think you'll see the capital side on the IWS slow down significantly in 2024. We always form a view of what we're going to need for kind of the medium term as it relates to that side. And we will have to spend some time thinking about how do we think about the 2025 build schedule as we get some more clarity on what the timing of some of that return to work looks like.

[Celine Boston, executive]

And maybe just to add to that, Keith, as well, as you think about working capital side of things, you asked about free cash flow as well, less of a ramp in 2024 as it relates to revenue, requires less working capital investment. So you don't necessarily see that same adjustment that you see potentially to adjusted EBITDA to the free cash flow side of things.

[Operator]

[Operator Instructions] And at this time, Mr. Faber, it appears we have no other questions. Please proceed.

[Jon Faber, executive]

Perfect. We appreciate those who were able to join us this morning for the call. We look forward to speaking with you again in November, following the release of our third quarter results. Until then, if you have any further questions, certainly don't hesitate to reach out to Celine or myself, and we'd be happy to set up some time to connect and answer those questions. Thanks very much, and have a terrific day.

[Operator]

Ladies and gentlemen, this does indeed conclude your conference call for today. Once again, thank you for attending. And at this time, we do ask that you please disconnect your lines.