Pason Systems Inc

TSX:PSI

Earnings Call Analysis

Pason Revenue Grows Amid Drilling Slowdown

In Q3 2023, Pason's revenue reached $93.1 million, slightly surpassing the previous year, bolstered by record results from Energy Toolbase, which achieved a stunning 293% revenue boost. Despite a 14% dip in North American industry drilling activity, the company notched a 12% uptick in revenue per day, keeping North American revenue losses to a slim 4%. International revenue would have climbed 14% year-over-year without the distortions from hyperinflationary accounting in Argentina. The company's net income rose 19%, with cash flows also slightly improving. A strong balance sheet, reflected in $178.4 million in cash and no debt, supports Pason's continued investment in growth ventures like Intelligent Wellhead Systems and renewable energy sectors. For 2023, capital expenditures are set at roughly $45 million as Pason sustains its leadership in drilling data and technologies.

Maintaining Solid Performance Despite Market Fluctuations

Pason Systems Inc., showcasing resilience against market headwinds, reported a slight revenue increase to $93.1 million in Q3 2023 compared to $92.5 million in Q3 2022, underscoring its strength in a challenging environment. Notably, the North American business unit set a new revenue per industry day record at $975, despite a 14% dip in drilling activity. This reflects strong product demand, competitive positioning, and a favorable pricing context. However, gross profit for this segment declined by 12% to $42.9 million due to increased depreciation tied to recent capital expenditures.

International Expansion and Segment Diversification

Internationally, Pason faced a minor revenue contraction to $15.3 million, yet when adjusted for inflationary impacts in Argentina, revenue rose 14% year-over-year. The Energy Toolbase segment, catering to the solar and energy storage markets, celebrated a historic quarter with a staggering 293% revenue jump to $5.6 million, thanks to burgeoning control system sales—though future project delivery timings may induce fluctuations. These results hint at Pason’s strategic advancement beyond its core drilling operations into burgeoning energy sectors.

Fiscal Prudence and Growth Investments

Financial prudence is evident as Pason rounded out Q3 totally debt-free with a robust $178.4 million in cash reserves. The company doesn't lose sight of growth prospects, injecting $5 million into Intelligent Wellhead Systems and on track to allocate an additional $5 million in Q4. This is part of a broader investment strategy in emerging technologies aligned with energy storage initiatives encouraged by new government policies. The continued support of shareholder returns is evidenced by $51.9 million dispersed via dividends and share buybacks in the first three quarters of 2023, with a commitment to maintain the quarterly dividend of $0.12 per share.

Optimistic Outlook Amidst Shifting Industry Dynamics

The current outlook is tinged with optimism as Pason anticipates a late-year upswing in rig counts, progressing into 2024. The driver is a combination of robust oil demand, dwindling inventories, and obligatory drilling activity needed to balance supply-demand equations. Meanwhile, the company's capital investment for 2023 remains pegged at approximately $45 million, primarily to enhance key components of its hosting platform and prepare for revenue amplification, with a similar outlay forecast for 2024.

Earnings Call Transcript 2023-Q3

[Operator]

Good morning. My name is Ludi, and I will be your conference operator today. At this time, I would like to welcome everyone to the Pason Systems Inc. Third Quarter 2023 Earnings Call. [Operator Instructions] The contents of today's call are protected by copyright and may not be reproduced without the prior written consent of Pason Systems inc. .

Please note that advisory is located at the end of the press release issued by Pason Systems yesterday, which describes 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. Celine Boston, CFO, you may begin your conference.

[Celine Boston, executive]

Thank you, Ludi. Good morning, everyone, and thank you for attending Pason's 2023 Third 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 third quarter. Jon will then provide a brief perspective on the outlook for the industry and for Pason, and we'll then take some questions.

I'm pleased to report on Pason's third quarter 2023 results, which highlights the company's ability to deliver on strong financial performance despite a modest decline in activity levels. Pason generated consolidated revenue of $93.1 million in the third quarter of 2023, which was slightly ahead of the $92.5 million generated in the third quarter of 2022. With this revenue, Pason generated $42.3 million in adjusted EBITDA, which represented 45.4% of revenue.

All of the company's business segments contributed to this quarterly results. Compared to the third quarter of 2022, our North American business unit saw a 14% decrease in industry drilling activity. However, the business unit generated revenue per industry day of $975 in the third quarter of this year, a new quarterly record and a 12% increase from the same quarter of 2022. This result continues to highlight the company's strong competitive position, the growing demand for our products and technologies and a more favorable pricing environment than seen in the third quarter of the prior year.

Resulting North American revenue was $72.2 million in the third quarter, only a 4% decrease from the third quarter of 2022 despite the 14% reduction in industry activity. Gross profit for the business unit was $42.9 million in the third quarter of 2023, a 12% reduction from the $49 million generated in 2022 and reflects higher levels of depreciation and amortization with the increased investments the company has been making and capital expenditures in recent quarters.

Cash operating costs titled Rental Services and Local administration for the Business Unit only increased by 2% year-over-year, highlighting the business units mostly fixed cost base. Similarly, revenue generated per day in our international end markets also improved year-over-year. Reported revenue for our International business unit was $15.3 million in the third quarter of 2023, down slightly from $15.8 million in the comparative 2022 period. Excluding the impacts of hyperinflationary accounting for the company's Argentinian subsidiary in each respective period, revenue would have increased by 14% year-over-year.

Reported segment gross profit was $7.3 million in the third quarter of 2023 for the business unit, slightly down from the $7.8 million generated in the third quarter of 2022. Energy Toolbase continues to grow its presence in the solar and energy storage industry and posted a record quarterly result of $5.6 million, which represents a 293% increase from Q3 of 2022. The segment had increased control system sales in the quarter, which will fluctuate with timing of deliveries on future projects.

Sequentially, U.S. rig counts declined throughout the third quarter, with the recovery in Canadian rig counts coming out of spring breakup mostly offsetting these declines. Resulting North American industry activity was flat sequentially, while revenue per industry day increased by 7%. This improvement in revenue per day coupled with the record results from Energy Toolbase resulted in consolidated revenue increasing by 10% quarter-over-quarter and adjusted EBITDA followed suit and increased by 12% from Q2 to Q3.

Our third quarter results continue to highlight our mostly fixed cost base, which is currently in place to support higher levels of activity than seen in the third quarter of 2023. We will continue to manage our fixed cost structure towards our expectation of upcoming activity levels, and we'll work to manage inflationary effects on our business. These effects along with changes in foreign exchange, sales contribution from Energy Toolbase and the relative mix of rigs within our end markets could have an impact on quarterly margins in the coming quarters.

Net income attributable to Pason for the 3 months ended September 30, 2023, was $27.7 million or $0.35 per share, a 19% increase from the $34.2 million or $0.42 per share generated in the third quarter of 2022. The decline year-over-year reflects the lower industry activity levels, along with higher levels of depreciation and amortization expense on increased capital expenditures in recent quarters along with higher stock-based compensation expense, which reflects the mark-to-market on the company's cash settled stock-based compensation plans.

Year-to-date, Pason generated $276 million in revenue, a 15% increase from $240.6 million in the corresponding 2022 period. This compares to underlying North American land drilling activity that was essentially flat on average year-over-year. Adjusted EBITDA for the 9 months ended September 30, 2023, was $132.6 million or 48% of revenue compared to $110.6 million or 46% of revenue for the first 9 months of 2022.

Accordingly, net income attributable to Pason in the first 9 months of 2023 was $89 million or $1.10 per share, up from $71.4 million or $0.87 per share. A comparison of year-to-date results reflects the company's operating leverage with higher levels of revenue generated per operating day, improved industry conditions in the first quarter of 2023 and the effects of a strengthening U.S. dollar.

Our balance sheet remains strong and incredibly well positioned to make strategic investments while returning meaningful cash flow to shareholders. Pason generated $31.7 million in cash flow from operations in the third quarter, a slight increase from the third quarter of 2022. In the third quarter, Pason spent $6.7 million in net capital expenditures in support of our core business, representing the ongoing refresh of our technology platform and the maintenance of our fleet.

Also in the third quarter, we approved and funded $5 million of the $10 million that was remaining under the company's preferred share financing agreement with Intelligent Wellhead Systems and approved the funding of the final $5 million subsequent to quarter end. We remain committed to shareholder returns and in the third quarter returned $15.6 million to shareholders through dividends and share repurchases. We ended the quarter with no interest-bearing debt and $178.4 million in total cash.

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

[Jon Faber, executive]

Thank you, Celine. Our third quarter results again demonstrated our ability to generate financial and operational results that outpace underlying drilling industry activity. Our revenue increased 1% from the prior year, while North American land drilling activity was down 14% over the same period. We maintained our leading market position, and our North American revenue per industry day increased 12% year-over-year to $975 for the quarter, driven by higher levels of product adoption and improved price realization.

Our International business unit had a solid quarter as well. While reported revenue decreased 3% from the prior year, revenue was up 14% before considering the effects of hyperinflationary accounting related to our operations in Argentina. Energy Toolbase posted its highest quarterly revenue on record at $5.6 million, driven by the installation of additional energy storage control systems and growth in revenue from our economic modeling software tool.

We continued to see strong growth in our pipeline of control system opportunities, but the timing of booking and deliveries can fluctuate meaningfully between quarters. We are making the necessary investments in operating and capital costs to strengthen our capabilities in areas that directly impact our service and technology advantages and provide capacity for additional revenue growth. We continue to expect that we will see a return to steady growth in North American industry activity.

Recently reported North American land rig counts show signs of plateauing around current levels, and we expect rig counts will begin to increase later this year and into 2024. Ultimately, the economic forces of supply and demand established the prevailing direction of industry activity. Global oil demand remained strong, while storage and the inventory of drilled but uncompleted wells remain at or near multiyear lows.

Any efforts to increase supply will require additional drilling activity and as such, our outlook for continued growth in land drilling remains positive. Pason sits at the center of the drilling data ecosystem on the majority of rigs in the Western Hemisphere as customers use more automation and analytics technologies, data requirements are increasing. We are ensuring that we have the capabilities to manage additional sources of data, higher volumes, throughputs and speeds of data and additional data transmission and storage protocols.

We continue to expect capital spending of approximately $45 million in 2023 as we renew and extend the capabilities of important parts of our hosting platform, and we currently anticipate that our 2024 spending will be at a similar level. As always, we will 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.

We continue to make investments in growth-related opportunities outside of our core drilling-related business. The growth trajectory of Intelligent Wellhead Systems has been impressive. During the third quarter, we funded an additional $5 million as part of our previously announced preferred share financing arrangement with IWS and the final $5 million tranche will be deployed in the fourth quarter. Energy Toolbase is also showing positive momentum as demand for energy storage is growing as government policies incentivize the deployment of additional energy storage assets.

We remain committed to returning capital to shareholders through a regular quarterly dividend and through share repurchases. We returned $51.9 million to shareholders in the first 3 quarters of 2023 through a combination of regular dividends and share repurchases, and we are maintaining our quarterly dividend at $0.12 per share. Our balance sheet remains strong with cash and short-term investments of $178 million and no debt. 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 and to return meaningful capital to shareholders. Our demonstrated ability to generate revenue growth that outpaces the growth in underlying industry activity and our high operating leverage will allow us to deliver strong financial results as rig counts begin to increase. And the momentum within both Energy Toolbase and Intelligent Wellhead Systems gives us further confidence in even greater growth in the future.

And we would be happy now to take any questions that you might have.

[Operator]

[Operator Instructions] Your first question comes from the line of Aaron MacNeil from TD Cowen.

[Aaron MacNeil, analyst]

On IWS, the continued investment subsequent to quarter end and your reference to growth in the prepared remarks is noted. But I guess I'm wondering if you can provide a bit of an operations update there. Like what's the company working on? Have there been any recent commercial successes? And what sort of projects or initiatives are your investment funding today?

[Jon Faber, executive]

Yes. So there's only so much you can say on Intelligent Wellhead Systems, Aaron, because it's a private company. But I think I can probably provide some commentary to give you a sense of our confidence in that business and why we've probably accelerated our investment of capital a little bit ahead of our initial expectations. That business is growing really well and has over the last number of quarters. The pace at which we're putting in capital is related to the pace of growth that we're seeing in the revenue opportunities facing that company.

And so we want to make sure that we're well positioned to get in front of those opportunities. The business today is active in every U.S. basin. So that's -- that would be a positive operational indicator that I think I'd be prepared to share, but not much more in terms of number of jobs in various areas. The other thing we've sort of talked about, I think, in the past is if you look at IWS today, that business generates a day rate that is about 3x the order of what Pason generates on a daily basis. And the completions market is approximately 1/3 of the drilling market, if you look at historical relationships between drilling rigs and completion frac spreads.

And so if you have 3x the day rate today with a fairly new business in a market that's about [ 1/3 ] time size, we see a market opportunity that it would be roughly the same size as what Pason faces in the drilling market. And so we want to ensure that we're well positioned to pursue that opportunity. And so that's really what's driving the quantum and the pace of investment we're making in the IWS business.

[Aaron MacNeil, analyst]

Makes sense. I guess 1 follow-up there. And I guess this relates more to your capital allocation than the company itself. But how does your investment in IWS compete for capital with your organic growth opportunities in the core business and Energy Toolbase?

[Jon Faber, executive]

Yes. Sure. So as we think about the IWS opportunity, we sort of think about the allocation of capital 2 ways, right? One is the acceleration of the business, so call that capital into the business. And then we've also been deploying capital to increase our ownership in the business over time, right? So if you look at the historical investments we've made, some would have been new money to the business and some would have been purchases of shares from other existing shareholders.

So we do have the opportunity to acquire the remainder of that business. There's a pre-established mechanism to do that. We could do that comfortably within the cash balance that we have today, but we are certainly preserving cash for the opportunity both to consider that opportunity as well as to continue to accelerate its growth.

[Operator]

Your next question comes from the line of Keith MacKey from RBC.

[Keith MacKey, analyst]

First, wanted to start out just, Jon, on your comments regarding the likelihood for increases in rig counts in North America through 2024. I appreciate your comments on the oil supply-demand storage macro, and we certainly, I would say, are in a similar camp. But can you just talk a little bit about what you're seeing in terms of what your business and how it's setting up for incremental demand? Are you seeing an increased or accelerating level of inquiries as new rigs are needed to go back to work? Or what is it in your business that you'd say is helping underpin that confidence in next year's outlook?

[Jon Faber, executive]

Yes. Sure. Thanks, Keith. I think the short answer, of course, is that we do have pretty good visibility on the shorter term, right? I think if you wanted a longer-term view, you probably need to talk to the drillers themselves and look to the CapEx programs announced by some of the E&P companies. But we sort of see the near term in terms of what our technicians are installing on or uninstalling, right?

And so that gives us some measure of confidence around the plateauing and starting to move up to -- move upward from where we are today. I guess the other thing to maybe think about is simply the question around, it probably went a little lower than we might have anticipated if we were honest about where we saw things a few quarters ago. And there's probably a couple of drivers there, Keith. I think one is there's been a difference between what we're seeing in the behavior of the private companies versus the public companies, right? And that may or may not be related to interest rates and how companies fund themselves.

But we do see a difference there between privates and publics. And I guess the other thing is, as you look at consolidation in the industry, it certainly wouldn't be abnormal to both see companies that may be targets, essentially kind of put themselves into a state of kind of status quo while we go through that process. And also on the back end of some consolidation, it's not abnormal to see the pro forma rig count between the 2 companies go down a little bit in the short term as they reprioritize inventory and high grade their prospects.

[Keith MacKey, analyst]

Yes. Got it. Makes sense. Can you just talk a little bit about the competitive environment for Pason, you certainly had a very strong market share in U.S. and Canada the last several years, and you mentioned pricing stronger year-over-year, which isn't true for a lot of different service lines out there. Can you just talk about the competitive dynamics leading to that and where you ultimately see pricing go from here? And I know adoption is a key part of that conversation as well, so maybe if you could kind of weave all that in, it would be great.

[Jon Faber, executive]

Yes, sure. I guess what we would say helps us from a competitive position as you think about -- I think you touched on the prospects for both the pricing side and the product adoption side is really the fact that companies are trying to do more with data, right, particularly around automation and analytics.

And so when you're trying to do more with data, there's probably at least 2 things you care a lot about. One is the quality of the data and that means a lot of different things. But we'll just broadly call it data quality. And then the other side is, what I'll call more, the consistency of the data. So if we're trying to put in place programs across multiple rigs, multiple fleets, multiple regions, to the greater extent that, that data kind of looks the same, it's easier to employ these automation and analytics technology. So that's really been to our benefit given we've sort of had the leading position in the data space in drilling for a very long time.

[Operator]

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

[Cole Pereira, analyst]

So assuming that we're going towards a steadier ramp in the rig count than we would have seen a year or 2 ago, I mean, should we assume it's a fairly limited incremental OpEx burden and your revenue per industry day is stronger. So is it really that out of the question I think that your margins could be stronger than they would have been last year at the same activity level?

[Celine Boston, executive]

Yes. I'd say from a modeling perspective, Cole, we don't expect any significant changes to our fixed cost base for the expected levels of activity that we see in the short to medium term. There's some variable costs associated with our solar and energy storage segment like we saw in the third quarter. But outside of that, our cash operating costs have hardly changed since the third quarter of last year. And since that time, rig counts, like we saw in the first quarter of this year, were close to 200 rigs higher in North America.

So we can certainly observe higher levels of activity within our existing fixed cost base today. I think if you think about margins going forward, we think about Q2 and Q3 levels of this year being sustainable until we see some of that growth in U.S. rig counts. And then clearly, we're capable of generating higher margins once that growth begins with a significant operating leverage in our business.

[Cole Pereira, analyst]

Got it. And then just some interesting, political developments in Latin America lately. Can you just talk about the outlook and how you kind of think about that business near term?

[Jon Faber, executive]

Yes. I guess, Cole, we wouldn't want to be considered experts on geopolitical situations. And I guess what I would say is that there's certainly certain factions and certain prospective governments that would be more favorable to oil and gas development than others.

That business -- to the extent that there's some that want to sort of moderate the pace or slow the pace or even decrease the amount of oil and gas investment of course that would be sort of a net negative to us. But we have also seen a trend the other way that people are trying to do more with more advanced technologies on the technology side. So look, our view is that there's growth opportunities down there. But it's -- there's probably both headwinds and tailwinds, and I would not be the expert to say which of those will be greater at any given point in time.

[Operator]

And there are no further questions at this time. I would like to turn it back to Jon Faber for closing remarks.

[Jon Faber, executive]

Thanks so much, Ludi. We appreciate people taking time to join us for the call this morning. As always, if you have more questions, don't hesitate to reach out to Celine and myself. And otherwise, we will look forward to talking to you after the fourth quarter and full year results in late February.

[Operator]

Thank you, presenters. And ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.