Pason Systems Inc

TSX:PSI

Earnings Call Transcript 2019-Q4

[Operator]

Ladies and gentlemen, thank you for standing by, and welcome to the Pason Systems Fourth Quarter and Full Year Results Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. 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.I would now like to hand the conference over to your speaker today, Marcel Kessler, President and CEO. Thank you. Please go ahead.

[Marcel Kessler, President, CEO & Director]

Thank you. Good morning, and welcome to Pason's Fourth Quarter 2019 Conference Call. With me here in Calgary today is Jon Faber, our Chief Financial Officer. I will start with the highlights of the fourth quarter. Jon will dive into the details of our financial performance. I will close with a brief perspective on the outlook for the industry and for Pason, and we will then take any questions. The price for a barrel of WTI crude oil remains between USD 50 and USD 60 for most of the fourth quarter of 2019, and most operators constrained E&P capital spending within cash flows. As a result, Pason's operating environment across North America deteriorated in the period. Drilling industry activity decreased by 24% in the United States and by 23% in Canada compared to the same period in 2018. These headwinds were partially offset by higher activity in Pason's international markets, market share gains in the United States and continued growth in product penetration in all geographies. Revenue per EDR day for the quarter was USD 732 in the United States, a 4% increase from the fourth quarter of 2018 and CAD 1,292 in Canada, a 9% increase. Pason generated revenue of $68.4 million in the period, a decrease of 17% compared to the same quarter of last year. Adjusted EBITDA was $26.6 million for the quarter, a decrease of 32%. Adjusted EBITDA as a percentage of revenue was 39% compared to 48% 1 year ago, highlighting our largely fixed cost structure. Pason recorded net income for the quarter of $10.4 million, down from $20.7 million in the fourth quarter of 2018. Capital expenditures for the quarter were $5.6 million and free cash flow was $20 million. At December 31, 2019, our working capital position stood at $184 million, including cash and short-term investments of $161 million. We are maintaining our quarterly dividend at $0.19 per share.And I will now turn the call over to Jon for a more detailed look at the financials.

[Jon Faber, Chief Financial Officer]

Thank you, Marcel. Pason's fourth quarter results were impacted by reduced drilling activity in North American markets. Consolidated revenue decreased 17% compared to the fourth quarter of 2018. Gains in revenue per EDR day in both Canada and the United States helped to mitigate a 24% decrease in U.S. land drilling activity and a 23% activity decrease in Canada. In the United States, market share increased to 62%, and revenue per EDR day increased by 4% to $732 per day. In Canada, we saw revenue per EDR day increase 9% year-over-year to CAD 1,292, while reported market share decreased to 85% in the quarter. On a sequential basis, revenue per EDR day was slightly lower in both markets and Canadian market share increased, while U.S. market share held relatively steady. Our International business unit reported a 14% increase in revenue for the quarter. However, I would note that revenue was positively impacted by approximately $800,000 in the quarter as a result of applying accounting for hyperinflation to our Argentinian subsidiary. Adjusting for the impact of hyperinflation, international revenue was up 5% in the quarter compared to the same quarter of 2018. Consolidated revenue of $68.4 million was down 5% sequentially from $72.2 million in the third quarter. Drilling data remains our largest revenue category, accounting for 53% of revenue. Growing demand for our data delivery products helps mitigate revenue declines from decreased industry activity in this category. Mud Management and Safety revenue represented 29% of revenue in the quarter, with activity-driven decreases somewhat offset by increased adoption of certain peripheral products. Communications revenue contributed 6% of revenue in the quarter. The revenue decrease in this category remains the largest, owing to pricing changes effected early in 2019 as well as a greater proportion of drilling activity in areas where adoption rates for this category are lower. Changes to our cost structure in this category through use of lower cost communications technologies have allowed us to protect category margins despite the revenue decrease. Drilling intelligence revenue accounted for 7% of fourth quarter revenue. Revenue in this category decreased as a result of the overall decrease in North American land drilling activity. The year-over-year revenue decrease was more significant in the United States, where the activity slowdown was most pronounced among mechanical rigs, which had a higher adoption rate of drilling intelligence products. Revenue in our analytics and other category contains product and service offerings, which are less closely correlated to drilling activity. Revenue in this category increased 21% year-over-year and represented 5% of total revenue. Adjusted EBITDA for the fourth quarter of $26.6 million was down 32% from the fourth quarter of 2018 and down 15% sequentially from the third quarter. For the full year, adjusted EBITDA of $129.6 million was down 11% from 2018, while revenue was down 4% to $295.6 million. Net income of $10.4 million for the fourth quarter or $0.12 per share was down 49% from the fourth quarter of 2018 and down 32% sequentially. Full year 2019 net income of $53.8 million or $0.63 per share was down 15% from 2018. Research and development expenses were relatively unchanged on both a year-over-year and sequential basis. For the full year, R&D expense increased by 13%. The increase in R&D expense was driven largely by a greater proportion of total spending hitting the income statement. Taking account of both R&D expense and capitalized development costs, total spending increased by 2%. Capital expenditures in 2019 totaled $24.2 million, up 1% from 2018. We expect CapEx to remain at a similar level in 2020. Pason generated free cash flow of $20 million in the fourth quarter, up 20% from the fourth quarter of 2018 and down $13.1 million sequentially. 2019 full year free cash flow of $86 million was up 1% from 2018. In 2019, we acquired an 80% interest in Energy Toolbase for USD 20 million. And committed CAD 25 million for a minority investment in Intelligent Wellhead Systems, $10 million of which was invested in 2019. I will now turn to a brief review of the results of each of our business units. Our U.S. business unit revenue decreased 20% in the fourth quarter compared to the fourth quarter of 2018, driven by a 24% decrease in industry activity. Market share was relatively unchanged on both the year-over-year and sequential basis, while revenue per EDR day increased 4% year-over-year in the fourth quarter, with increased adoption of data delivery products in our drilling data category and certain peripheral products in our Mud Management and Safety category, serving to offset declines in drilling intelligence driven by the disproportionate decline in mechanical rigs. For the full year, U.S. revenue of $202 million was down 1% from 2018. Operating costs for the quarter decreased 3% year-over-year and sequentially in the U.S. as we adjusted to lower drilling activity expectations in certain operating regions. As a result, segment gross profit for the U.S. business unit decreased by 36% to $20.5 million in the fourth quarter. Gross profit of $105.3 million for the full year was down 9% from 2018. The Canadian business unit continued to perform additively in the context of challenging industry conditions in the fourth quarter. Pason's revenue for the quarter was 21% lower than in 2018 while industry activity was down 23% for the same period. For the full year, a 30% decrease in industry activity drove a 23% decrease in revenue. In previous quarterly calls, we noted that we expected the greater proportion of cost-focused operators in the active customer mix to result in downward pressure on market share, while new products and service offerings provided support to revenue per EDR day. Those trends continued in the quarter, where market share of 85% was down from 91% in the fourth quarter of 2018, while quarterly revenue per EDR day was up 9% from prior year levels. We continue to expect market share will be more volatile than the years past, owing to the proportionate impact of the gain or loss of any one rig within the context of lower industry activity. Sequentially, revenue increased 3% in Canada. Operating costs were down 22% in Canada in the fourth quarter and 20% on a year-to-date basis, largely as a result of reduced purchasing costs in our Communications category. Segment gross profit for the Canadian business unit of $4.5 million was down 47% from the fourth quarter of 2018, and full year gross profit of $17.5 million was down 43%. Our International business units saw good year-over-year growth in the fourth quarter. In reviewing the results of our International business, I would note that Argentina is our largest operating region in this business unit, and I want to draw your attention to the commentary in our MD&A filed on SEDAR, which details the impact of accounting for hyperinflation on the quarterly and annual financial results. Reported revenue of $10 million was up 14% from the fourth quarter of 2018. For the full year, reported revenue was up 24% to $37.7 million. Quarterly segment gross profit in the International business unit of $2.7 million was up 5% from a year ago, while full year gross profit of $12 million was up $4.2 million from 2018 levels. Pason's 2019 results reflect continued outperformance in the context of challenging industry conditions. We are defending our strong market positions while seeking opportunities to grow revenue per EDR day through delivering enhanced functionality to our customers. We continue to prudently manage both our operating costs and capital expenditures with a view to sustaining our profitability without impairing our ability to fully participate when industry conditions improve. We returned $87 million to shareholders in 2019, $63 million through our regular dividend and $24 million through share repurchases. We are maintaining our regular quarterly dividend at $0.19 per share. We invested $34 million in the year to strategically position ourselves for medium- to longer-term growth through investments in Energy Toolbase and Intelligent Wellhead Systems. Our balance sheet remains strong. At December 31, we had $184 million of positive working capital, including $161 million of cash and no interest-bearing debt.I will now turn the call back to Marcel for his comments on our outlook.

[Marcel Kessler, President, CEO & Director]

Thank you, Jon. We believe that capital discipline by our customers will remain a prevailing theme in the North American land market going forward. In the United States, we expect industry activity for the year to be similar to that experienced during the second half of 2019, which would imply a modest increase from current levels. Canadian drilling activity has started 2020 significantly ahead of expectations. However, I don't need to tell you that there is currently massive uncertainty regarding potential demand impacts from Covid-19 and the resulting trajectory for oil and gas prices. In this environment, we are maintaining flexibility for our go-forward plans, which gives us the means and confidence to address any activity scenario. Our capital expenditures will be relatively modest going forward with a large portion of development efforts focused on software. As Jon pointed out, we intend to spend up to $25 million in capital expenditures in 2020, which includes the capitalized portion of R&D. Our new product offerings continue to gain momentum with customers. DataLink, Pason's data delivery solution for automated delivery of large and complex data sets from the field to corporate databases and applications, is currently being utilized on over 300 active drilling rigs. ExxonMobil DAS / AutoDriller, Pason's drilling automation software package, has been deployed on over 270 drilling rigs for construction of over 1,700 oil and gas wells since launch. Drilling performance is improving considerably when the optimization system is used in terms of higher rate of penetration. That means faster drilling and minimized damaging vibrations leading to longer life of the drill bit. We expect to be able to deliver growth through higher product adoption going forward. As Jon highlighted as well, in September 2019, we announced an acquisition of an 80% interest in Energy Toolbase, or ETB, a U.S.-based software-as-a-service company. ETB provides an industry-leading software package to model the economics and build proposals for solar and energy storage, that is battery projects. ETB product is utilized by distributed energy project developers primarily in the United States. There are currently 1,100 active ETB software licenses with 1,800 users and the numbers continue to grow. Over the past 2 years, Pason Power has been building a foundation in the solar and energy storage market through its iEMS control system and the Energy DataHub products. With the combined capabilities of Pason Power and ETB, we are positioning ourselves for meaningful long-term growth in the solar and energy storage market. We remain focused on maintaining our distinctive technology position and unique capability set. Pason's highly capable and flexible IT and communications platforms can host additional new Pason and third-party software in the field and in the cloud. Our service capabilities are unrivaled as our expertise in user interface design and ruggedization for field users. These strengths, along with our exceptional workforce and strong balance sheet, are the foundation for our ability to continue to deliver significant value to our customers and achieve long-term success. We will now be happy to take any questions.

[Operator]

[Operator Instructions] The first question comes from Alex Furmanski of Unison Asset Management.

[Alexander Furmanski;Unison Asset Management LLC]

The first one on the capital allocation front. Obviously, you've done 2 acquisitions this year. One is outside of your core business. I would argue your shares are trading at what's pretty attractive levels. How are you thinking about capital allocation on a go-forward basis, given the net cash on your balance sheet? How attractive your shares are in relation to prices of potential acquisitions? That's number one. And number two, can you just remind us of the levers you have to pull if activity continues to slow to adjust your cost base to a slowing environment?

[Jon Faber, Chief Financial Officer]

Sure. Alex, it's Jon. First, on the question on the capital allocation side. I think our capital allocation has been fairly consistent for quite a bit of time here where obviously, there's the organic CapEx program, where we've talked about up to $25 million in 2020. The maintenance of the regular dividend continues to be a priority, and that's in the order of mid-$60 million. And then we've been more active on the share repurchases in the fourth quarter and continue to look at share repurchases as an attractive form of capital allocation. And well, as you noted, we made a couple of investments, both the acquisition of 80% of ETB and a minority investment in Intelligent Wellhead Systems. You'll note in the financials that, that investment in Intelligent Wellhead Systems does involve future capital investments, so that $25 million was an upfront commitment, $10 million of that was made in 2019. And so there'll be further allocation of capital to that. And as well, both of those are fairly early-stage entities that we expect to have some amount of operating losses to fund over the next couple of years. So that would be another form. We would always look at things on the M&A side that we continue -- can see as attractive, but that would have to pass a fairly high strategic hurdle, not just on the financial side. So the capital allocation hasn't really changed very much. Marcel, I don't know if you have much to add to capital allocation question.

[Marcel Kessler, President, CEO & Director]

I was going to take the second one.

[Jon Faber, Chief Financial Officer]

Sure. Okay. Go ahead.

[Marcel Kessler, President, CEO & Director]

So on the question, the levers that we have if activity continues to deteriorate significantly. As we have pointed out in our remarks earlier, our cost base is fixed to a significant degree, at least in the short term, and it's primarily compensation-related costs. So we don't have that much in the way of purchase costs. There are really 3 groups of employees we have at Pason: the field services organization, R&D and IT, and all others. And I think at this point, we are not ready to make any cost in this space. We don't think that's necessary. But I would like to point out that if you look at the last significant downturn in 2015 and '16, Pason was able to stay free cash flow positive before the dividend in every single quarter.

[Jon Faber, Chief Financial Officer]

And I guess the other thing I'd add to that, Alex, is when you talk about the available levers, and we talked about this on the last conference call as well, we took significant costs out of the system in the early part of the downturn. So in through '15 and '16 that we didn't reintroduce as things were getting better. And so we continue to have a very lean organization and continue to retain some capacity to absorb activity increases in areas where we think the activity increases would show up.

[Operator]

Your next question comes from Matthew Weekes of Industrial Alliance Securities.

[Matthew Weekes, Analyst]

So I just wanted to start kind of zeroing on U.S. margins a little bit. It was mentioned in the MD&A that costs in that segment would have been lower if it weren't for the Energy Toolbase kind of Pason Power results and as well as FX. I was just wondering, going forward, is that mostly due to kind of onetime integration costs of Energy Toolbase? Or as you pursue more growth in this area, is this the kind of cost structure we can expect a little bit going forward?

[Jon Faber, Chief Financial Officer]

I don't think we'd expect any changes to the cost structure going forward. I think that comment would simply reflect it, and I mentioned earlier that we would have a little bit higher cost than revenue in the Energy Toolbase side of the business today. And so when we take on that business, we will continue to see that, that would continue a little bit. So I don't think there's any significant change there.

[Matthew Weekes, Analyst]

Okay. So there were kind of some impacts from integration a little bit in the quarter then? Just to be clear.

[Jon Faber, Chief Financial Officer]

Well -- but I would say that, that's just the impact of that organization growing a little bit by virtue of combining the 2 entities. I won't give any integration-specific costs.

[Marcel Kessler, President, CEO & Director]

So you have some impact of integration-specific cost in corporate services as it relates to the transaction in terms of legal fees and other advisory fees, not in the U.S. business unit specifically.

[Operator]

Your next question comes from Michael Robertson of National Bank Financial.

[Michael Storry-Robertson]

A couple of quick ones here. I understand the put options related to the IWS transaction are exercisable at their discretion. But do you have a best guess of the ballpark timing for the remaining 2 put options? Would you think that would be like a 2020 event or 2021?

[Jon Faber, Chief Financial Officer]

So you'll note in the subsequent events, Michael, that they have sent us notice on one of the put options already?

[Michael Storry-Robertson]

Yes.

[Jon Faber, Chief Financial Officer]

And I think sort of the way that business appears to be unfolding, we would expect we may see another one later this year. So I would anticipate potentially 2 or 3 today based on what I would know, maybe in 2020 and then the further in '21.

[Michael Storry-Robertson]

Okay. That's very helpful. And last one, we're noticing some interesting revenue growth for the analytics division. I guess that it's small. And I understand there's some lumpiness in Q4 given the ETB acquisition. But it's interesting, nonetheless, as it's a standout relative to the other segments. Could you provide any color -- or extra color on what's driving that? Because there's something in particular that's gaining traction? Or is it just that it's less correlated to industry drilling activity?

[Marcel Kessler, President, CEO & Director]

Yes, the main drivers that it's less correlated. And I think the specific increase is related to Verdazo, our analytics company here in Canada. They were able to show some growth year-over-year on the revenue side. Now I wouldn't necessarily want to create an expectation given the Canadian environment that they're operating in that's sustainable going forward at that growth rate. But the main driver here was growth in Verdazo revenue.

[Operator]

Your next question comes from Daine Biluk of CIBC Capital Markets.

[Daine Biluk, Associate]

So I guess to start off, nice to see continued improvements in product adoption and that translate to higher revenue per EDR day, but maybe just thinking about a bit of a headwind maybe on that side of things. With the heightened focus among your clients felt within cash flow, I think we talked a little bit before about the possibility of certain clients removing one or 2 products from their Pason bill in order to save costs. Has that happened much through Q4? And have you seen any of that in Q1?

[Jon Faber, Chief Financial Officer]

We would have seen that as one of the headwinds to revenue per EDR day, as you say. So we tend to work with clients in terms of their total spend when they want to sort of engage in conversations around kind of pricing. We'll also look at the adoption question and see if there's parts of the product mix that we might be able to streamline with them.

[Daine Biluk, Associate]

Got you. So and then fair to say that, that unfolded kind of how you expected, no surprises, and there's enough adoption in with other core clients that have offset that?

[Jon Faber, Chief Financial Officer]

That would be truth today, yes. Now as we continue to sort of phase it into the market, of course, that becomes more challenging to sort of see or even grow in -- or even maintain the revenue per EDR day side. The adoption question does become more of a challenge in more challenging environments.

[Daine Biluk, Associate]

Right. Fair enough. Okay. That's good color. Thoughts around allocations to the NCIB? And is the higher spend in Q4 something we should expect to carry over into 2020?

[Jon Faber, Chief Financial Officer]

Well, we did see opportunities sort of following mid-November, the share price weakened and gave us opportunities to repurchase some shares. I think we would continue to look to be active on the NCIB. But as you can appreciate, the real-time commentary here around what markets are doing in the face of Covid-19, we'll probably want to sort of get a sense of what the market is doing before we get too aggressive. But clearly, we see the shares as being attractive as somebody mentioned earlier.

[Daine Biluk, Associate]

Right, right. Absolutely. No, that makes perfect sense. Specific to your disclosures you provided on Energy Toolbase, are you able to share the cadence of growth in its software licenses? I mean, you mentioned the 1,100 active licenses. Where would that number have been when you acquired your stake? And any sort of comments you can say on your expectations around rate of growth?

[Marcel Kessler, President, CEO & Director]

I don't think we want to disclose that quite yet for competitive reasons. And so -- and I think the information that's disclosed is probably as far as we are able to go today.

[Daine Biluk, Associate]

Yes, that's understandable. Thought I'd ask nonetheless. But last one for me guys. Given the 2 recent acquisitions, I mean, how should we be thinking about your annual R&D spend? Is like a $40 million-plus kind of the right number to be thinking?

[Jon Faber, Chief Financial Officer]

The numbers we would have had in the fourth quarter now are fairly reflective of where we're at. Now when you roll into a new year, there's a little bit of inflationary pressures on compensation, which is a substantial portion of that cost base. But the fourth quarter would have reflected both the ETB side as well as that migration we've made towards more OpEx-based investments on the IT side. So I'd say with the slight inflationary pressures, that the fourth quarter is a pretty good run rate.

[Operator]

[Operator Instructions] There are no further questions at this time. This concludes today's conference call. Thank you for your participation. You may now disconnect.