Pason Systems Inc

TSX:PSI

Earnings Call Transcript 2021-Q3

[Operator]

Good morning. My name is Chris, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Pason Systems Inc.'s Third 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. Thank you. [Operator Instructions] Thank you. Mr. Faber, you may begin your conference.

[Jon Faber, President, CEO & Non]

Thank you, Chris. Good morning, and thank you for attending Pason's Third 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 third quarter financial performance. I will then close with a brief perspective on the outlook for the industry and for Pason, after which we will take questions. 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 third quarter results, which represent a vast improvement from the historical lows experienced by the company during the third quarter of last year. Since bottoming in August of 2020, U.S. land drilling activity has consistently improved, and we've seen similar trends in all of our major end markets. Our goal throughout the downturn was to minimize losses, while continuing to make critical investments in technology and service. We also aimed to protect our enviable balance sheet while prudently allocating capital to shareholders and making strategic investments in future growth. Our third quarter results demonstrate strong execution on these fronts. Our leading competitive position has resulted in record North American revenue per industry day, and we continue to demonstrate significant operating leverage and free cash flow conversion in the context of improving activity levels. Pason generated $57.7 million of revenue in Q3 2021, a 150% improvement over the third quarter of last year, which represented drilling activity lows seen during the pandemic. North American industry days, although still well below pre-pandemic levels, increased by 124% during the third quarter of 2020 (sic) , compared to the third quarter of 2020. During that time, Pason continued to grow its competitive position in the United States while defending its leading position in Canada. Pricing conditions within each end market also improved. Accordingly, revenue per industry day grew by 15% from $667 in the third quarter of 2020 to $765 in the current quarter, representing a record level for the company, meeting the previous record of $738 in the first quarter of 2020. We'd like to remind listeners that North American revenue per industry day will fluctuate with seasonal changes in activity levels in North America. Third quarter revenue per industry day benefited not only from strong market share and improved pricing conditions, but also benefited from an increased proportion of Canadian industry days in comparison to the third quarter of 2020. Resulting North American revenue was $46.1 million for the third quarter, a 152% improvement from the third quarter of last year and a result that outpaces the improvement in underlying industry conditions. Industry conditions in international end markets also improved significantly from the levels experienced in the third quarter of 2020. As a result, revenue generated by the International business unit was $10.4 million in the third quarter, a 169% improvement from the third quarter of 2020. Energy Toolbase, our emerging business in the solar and energy storage market continues to make progress. Reported revenue in this segment was $1.2 million in the third quarter, the highest level ever achieved for this segment, which continues to be primarily comprised of subscription-based software licenses for solar energy planning tools, but begin to incorporate revenue generated by control system and related hardware sales. Pason generated $22.4 million in consolidated adjusted EBITDA in the third quarter of 2021, a significant improvement from a loss of $1.1 million in the third quarter of last year. As the industry recovers, we continue to incur 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 remains strong. Third quarter results reflect 68% incremental adjusted EBITDA margins experienced both year-over-year and sequentially. In the quarter, Pason recognized $2.2 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 have participated in this program until its recent termination in October of 2021. On a year-to-date basis, Pason generated $143.9 million in revenue compared to the $123.9 million of revenue that Pason generated during the first 9 months of last year. Adjusted EBITDA for the 9-month period was $48.3 million compared to $31.3 million generated during the first 9 months of 2020, for which close to 100% was generated in the first quarter of 2020 prior to the pandemic-related impact on industry conditions. Although activity levels continue to be well below pre-pandemic levels, a comparison of year-to-date results demonstrates the recovering industry conditions coming out of the downturn. Our balance sheet remains strong and incredibly well positioned with $147 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 third quarter, Pason generated $16.3 million in free cash flow, which reflects the investments made in working capital and equipment in the quarter. Pason returned $7.2 million to shareholders through dividends and share repurchases in the third quarter. We are maintaining our quarterly dividend at $0.05 per share, and we'll continue to balance our commitment to shareholder returns while exploring opportunities for growth outside of North American land drilling and preserving financial strength to support long-term success. In summary, our third quarter results reflect our leading market presence, our significant 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 back to Jon for his comments on our outlook.

[Jon Faber, President, CEO & Non]

Thank you, Celine. We were very pleased with Pason's third quarter financial results. The results this quarter reflect both significantly improved industry conditions as compared to a year ago as well as our strengthened competitive position as a result of maintaining investments in our service and technology capabilities through the most challenging quarters of the downturn. Maintaining those capabilities allowed Pason to achieve the highest revenue per industry day in the company's history, driven by year-over-year gains in market share, increased product adoption and better price realization. Going forward, while we expect revenue per industry day to remain strong, the pace of increase is likely to moderate. From that position of strength, we expect to fully participate in the continued growth in industry activity in the coming quarters. 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. While the increase in North American rig counts we have witnessed over the past few quarters has not fully tracked higher oil prices, we expect to see industry activity continue to steadily grow. The industry recovery is unlikely to be sharp as E&P companies continue to exercise discipline in their capital spending and prioritize capital returns to shareholders and as the industry continues to grapple with challenges related to the availability of labor and supply chain disruptions. That said, supply and demand fundamentals point to higher oil prices in the short to medium term, and commentators are increasingly talking about the potential for a global energy crisis due to oil and gas shortages. In the United States, Pason's largest market, oil production remains approximately 10% below pre-pandemic levels. The inventory of crude oil and petroleum products is the lowest it has been in more than 5 years and the number of drilled, but uncompleted wells has decreased by 40% from its peak in June of 2020. Our international operations posted its highest reported revenue since the first quarter of 2015, and we expect continued strength across our international markets. In addition to maintaining a strong base of subscribers for its economic modeling and proposal generation tool, Energy Toolbase is starting to translate increased bookings from the sale of its control systems into revenue. Our significant operating leverage will drive high incremental margins as revenue levels continue to improve, though we will incur the necessary costs to position ourselves for further growth as industry activity levels increase and 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 and as a result of prevailing inflation rates. Our research and development efforts are resulting in market share and pricing improvements as we deliver additional value and functionality for customers, and we will continue to make meaningful investments in this area. We expect to spend up to $15 million in capital expenditures in 2021, before returning to a more sustainable level of capital expenditures of approximately $25 million in 2022. I would note that the timing of capital spending between the remainder of 2021 and 2022 will be heavily influenced by ongoing global supply chain challenges. Our balance sheet remains strong, and our free cash flow generation continues to improve. We will continue to allocate capital by balancing 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 focused on ensuring that Pason is an innovative, profitable and responsible company, and we would now be happy to take any questions.

[Operator]

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

[Michael Storry-Robertson]

Jon and Celine, congrats on a great quarter. Given the tightness in the labor market you touched on there and the need to increase headcount ahead of anticipated growth and activity levels, how confident are you in Pason's ability to ultimately pass related cost increases on? And what kind of lag do you expect to see there?

[Jon Faber, President, CEO & Non]

Mike, it's Jon. I think at the end of the day, the labor challenges are more pronounced for some of our customers, right? If you think of the ratio of employees per rig site, we would have one employee who looks after a number of rig sites where customers will have a number of employees on any one rig site. So their challenge is more pronounced. So I don't know that we feel directly a labor shortage challenge in the same way. I think we have the ability both through how we're able to scale the organization, how we're able to rotate people through areas of activity, that we will be able to address the demands from customers to service rigs wherever they might be. I think the pace of growth for the industry as it relates to the labor challenges are more likely to become from the side of customers facing the challenges around labor.

[Michael Storry-Robertson]

Got it. Appreciate the clarification there. My other question was related to the free cash flow that you guys generated in the quarter which was very strong. And given the increase in activity levels that you've seen to date and expectations for a supportive environment looking out to next year, how are you thinking about the prioritization of potential excess free cash flow uses at the moment?

[Celine Boston, Chief Financial Officer]

Yes. So I mean continuing to reiterate kind of what Jon said earlier, I mean, continuing to balance investments in our existing business, focusing on maintaining our leading market position there, I certainly feel that there's lots of opportunities in our core business, balancing that with shareholder returns and then the opportunities to invest in future growth. I think, as it relates to returning capital to shareholders, you'll recall that we sized the dividend last year for a drilling activity level in the 500 to 600 U.S. land rigs, which really is a world that we've just recently entered. So I'd say you can expect some modest growth in the dividend as our free cash flow profile improves with those continued improvements in industry conditions, but we'll still be in favor of a more flexible approach which utilizes the share repurchase program over that time as well.

[Operator]

Your next question comes from Cole Pereira, Stifel.

[Cole J. Pereira, Associate]

Congrats on the strong quarter. I just wanted to start with some of Celine's comments on opportunities outside of North America land drilling. I mean, just given where the cash position is, I mean, do you see much out in the market that you really find as an interesting opportunity? Or do you see more value in just continuing to grow some of your existing ancillary businesses?

[Jon Faber, President, CEO & Non]

So I guess we don't think of it as an either/or question, Cole, as much as a both and question. Right now, the ability to execute on things that are very directly related to your existing business, you can do that much more quickly, right? So I think we have opportunities, specifically within our business, when we talk about things we can do on the research and development side, there will be some stuff probably on the capital expenditure side as we look over the next couple of years related to things directly within the core business, or when you look at some of the investments we have in things like Energy Toolbase or our minority investment in Intelligent Wellhead Systems. Again, our ability to deploy capital and affect programs more quickly in those areas is easier because they're closer to home and we have an involvement already. We continue to look, are there things outside of those where we could participate meaningfully? And while we spend time looking at them and thinking what would make logical strategic sense for Pason, the timing around being able to execute on those is quite different because it involves actually getting exposed to the opportunity before you can start to exploit the opportunity.

[Cole J. Pereira, Associate]

Okay. Perfect. That's helpful. And I guess maybe coming back to Celine's comment on the dividend. So it sounds like maybe as we surpassed that 500 to 600 level, you might look at bumping the dividend, albeit at a more modest pace. I mean, how are you kind of thinking about what the right level for the dividend is maybe in terms of what metrics you would look at?

[Jon Faber, President, CEO & Non]

Yes. So when we thought about the dividend a couple of years ago, we would have talked about when we resized it, we were looking to end up in a world in a return to normal, whatever that might mean, where the dividend would be a lower percentage of free cash flow than it had historically been to allow ourselves flexibility, to look at other growth-related types of investments. And so that philosophy hasn't changed at all. So the dividend now is a smaller percentage of free cash flow. And as Celine would have noted, as free cash flow grows, we think there's the opportunity to grow the dividend as well while keeping it at a much lower percentage of free cash flow than it historically would have been.

[Cole J. Pereira, Associate]

Okay. Perfect. That's helpful. And then just quickly, I mean, on supply chains, obviously, it has the potential to impact your pace of R&M and some maintenance capital spending. But I mean, fair to say, yes, obviously, it could be an issue, but maybe not to the point where it might impact Pason's utilization?

[Jon Faber, President, CEO & Non]

Yes. It's a great point,Cole. I think when you think about -- we talked about the labor availability question was probably more of an impact for some of our customers. The same is probably true on the equipment side as well when we think about supply chain. We're not immune from supply chain challenges, but we don't have the same types of requirements as it relates to traditional materials. So when we think about supply chain impacts today, it might be related to fleet, right, where you may actually have to simply decide you're going to run vehicles longer and incur more repair expense for longer periods of time as opposed to your normal refresh cycle, just in terms of access to fleet types of things. Or there's some things on the product side where we may aspire to get a new product into the market sooner, and we just have to delay some of our hopes and aspirations a little bit based on availability of supply chain more so than actually causing interruptions in our day-to-day business. I think the day-to-day business interruptions, either people or supply chain, are more of an impact for our customers and are more likely to impact pace of growth rather than our ability to respond to people looking to have us do work for them.

[Operator]

[Operator Instructions] Your next question comes from Keith MacKey, RBC.

[Keith MacKey, Analyst]

Jon, Celine, just curious about the margins in Q3 and the incremental margin outlook. I guess in general, how many -- or how much of the incremental cost that you would have or expect to incur were built into Q3 margins? And how should we be thinking about incremental margins over the next, say, 12 months as the industry continues to add rigs? Is that 70%, 75% range still a good target to be in as things ramp up? Or are there going to be incremental costs that might change things from that level?

[Celine Boston, Chief Financial Officer]

Yes. Keith, the -- we still feel good about the 70% to 75%. Now I think we'll reiterate earlier comments in that, it won't -- it's measured over time, right? Like it won't necessarily be seen every quarter sequentially or every quarter year-over-year. Most of our cash OpEx and G&A continues to be fixed, and it's really primarily people costs. So couple of dynamics at play that we've previously alluded to, as we've done in the last few quarters, we will continue to be making investments in anticipation of future activity levels. So we'll see that in additional people in the field, in additional investments in R&D and some higher repair costs. And then Jon commented on the near-term inflationary pressures potentially on cost of people going up a little bit, and we're going to have to make investments in that here in the near term. So I think the margins that you saw on adjusted EBITDA in the third quarter were very strong, and I think we feel good about being able to maintain those levels and growing slightly into 2022 in the context of improving activity levels.

[Keith MacKey, Analyst]

Perfect. Okay. And just on Energy Toolbase. So you commented about starting to see some hardware revenue come in from prior bookings. Maybe just give us a little bit of context on how we should expect that to progress over 2022? And should we then even start to think about that segment contributing positively on a gross margin basis through 2022 as well? Or is it still more of a longer-term -- longer-term ramp?

[Jon Faber, President, CEO & Non]

Yes. So I think you asked 2 questions there, Keith. The question around revenue growth, as these control system bookings start to translate into revenue, you would have just seen the very early stages of that this quarter, right? I think we should see some increased momentum on that side here in the next few quarters when we look at what we have in terms of bookings and what our expectations are around delivery dates and commissioning dates and those sorts of things for projects which drive revenue realization. So I think we should see a little bit of acceleration from that in the coming quarters. Now your question around whether it will be a positive contributor to profitability in 2022, I would say it's a longer-term view for that, right? We're making real investments on the research and development side, product development. And we're going to continue to make those investments in 2022 at a level that it will very likely be ahead of what we'll see from the margin that comes from these projects on the control system side.

[Operator]

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

[Jon Faber, President, CEO & Non]

Thank you very much for taking the time to join us this morning. As always, we appreciate your continued interest and support. And if you have other questions, you're certainly welcome to reach out to Celine or myself at any point. Thanks very much, and have a wonderful day.

[Operator]

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