Pason Systems Inc

TSX:PSI

Earnings Call Transcript 2020-Q4

[Operator]

Good morning. My name is Amy, and I will be your conference operator today. At this time, I would like to welcome everyone to the Pason Systems Inc. Fourth Quarter 2020 Earnings Conference 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 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. Jon Faber, President and Chief Executive Officer, you may begin your conference.

[Jon Faber, President, CEO & Director]

Thank you, Amy. Good morning, and welcome to Pason's Fourth Quarter 2020 Conference Call. I'm joined today in Calgary by Celine Boston, Pason's Chief Financial Officer, who will start today's call with a detailed overview of our financial performance in the fourth quarter. I will then provide a brief overview on the outlook for the industry and for Pason, after which we will take any questions. And I'll turn the call over to Celine.

[Celine Boston, Chief Financial Officer]

Thanks, Jon, and thanks to all those attending today's call. 2020 was an immensely challenging year for Pason, for our employees, our customers, our industry and our world with the ongoing impacts of the COVID-19 pandemic. Rig counts reached their lowest levels in Pason history, and we responded by adjusting our cost data to meet the level of activity we expected in the medium term. This allowed us to retain critical technology development and service capabilities to ensure we fully participate as the industry began to recover.The fourth quarter continued to represent challenging industry conditions, although improved from the lows experienced in the third quarter, with recent macro development gradually improving rig count. North American land drilling activity was down 58% from the fourth quarter of 2019, but improved by 34% sequentially from the third quarter. Pason generated consolidated revenue of $33 million and adjusted EBITDA of $8.2 million or 25% of revenue during the fourth quarter of 2020. I'll start by providing further details on the company's revenue by business unit. Revenue for the North American business unit was $26.3 million, a decrease of 54% from the 2019 comparable period. Our competitive position in North America remained strong. Despite the 58% decline in drilling activity year-over-year, revenue per industry day increased by 8%. This was achieved through a combination of increased market share and continued traction with some of our newest automation and data delivery product offerings in Q4 with improving activity levels. It should be noted that we have comparatively higher market share and revenue per EDR day in Canada. Therefore, our revenue per industry day metric will be seasonally higher at times when Canada is more active. Revenue for the international business was $5.7 million in the fourth quarter, a decrease of 42% from 2019 comparable period as activity levels in the company's international markets experienced similar reductions in activity witnessed in North America. Energy Toolbase, our emerging business in the solar and energy storage market, continues to leverage its leading economic modeling and proposal generation software package to generate additional sales of intelligent energy management control systems. Reported revenue in this segment was $700,000 in the fourth quarter and continues to be primarily comprised of subscription-based software licenses for solar energy planning tools. While the number of accounts in the fourth quarter was consistent with Q4 2019, we saw a decrease in the average seats per account as customers scaled back spending during the pandemic. On a consolidated basis, Pason's $33 million of revenue in the fourth quarter represented a 52% decrease over the comparable 2019 period, and fourth quarter adjusted EBITDA of $8.2 million was a decrease of 69% over Q4 2019. Sequentially, fourth quarter revenue represented a 42% increase from the lows experienced in the third quarter as rig counts in both the North American and international business units improved. As this improvement occurred, we were able to absorb much of the increased activity within our existing cost base. Sequentially, the benefits of our operating leverage through improving activity levels were evident as adjusted EBITDA improved by $9.3 million from the third quarter on a $9.7 million increase in revenue.Incremental margins will fluctuate as the industry recovers, as certain costs will be incurred in anticipation of future revenue increases, and fourth quarter incremental margins likely represent the high end of the range we may see on a quarterly basis. Free cash flow in Q4 was negative $3.1 million, driven by working capital investments in the quarter as the business recovered. For the full year, Pason generated consolidated revenue of $157 million and adjusted EBITDA of $39.5 million compared to revenue of $296 million and adjusted EBITDA of $130 million in 2019. We carefully managed capital expenditures during 2020 and reduced CapEx by 79% from $24 million in 2019 to $5 million in 2020 in response to lower activity levels in the year. With the benefit of pre-pandemic first quarter results, reduced capital expenditures and strong working capital releases, the company diligently managed accounts receivable collections through the downturn. Free cash flow for the year came in at $54 million.In 2020, we returned $50 million to shareholders through our quarterly dividend and share repurchases. Our Board of Directors has declared a quarterly dividend of $0.05 per share payable on March 30, 2021.Pason's balance sheet remains strong and incredibly well positioned with $149 million in cash and cash equivalents at the end of the year and no interest-bearing debt. In summary, our fourth quarter results continue to reflect our strong market presence, our significant operating leverage through improving activity levels and a pristine balance sheet. We are entering 2021 from 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 & Director]

Thank you, Celine. Drilling activity has continued to increase from the lows it hit in mid-August. Forecast for 2021 rig activity continue to vary. Uncertainty remains as new variants of the COVID-19 virus emerge, while at the same time, vaccination rates increase. There will likely be some short-term impacts from the recent winter storm, which destabilized the power grid in Texas. OPEC production levels and compliance increasingly come into focus as a driver of oil supply as oil prices increased past $60 a barrel, and the potential nuclear deal between the U.S. and Iran could return additional supply to the market. U.S. production continues to be approximately 15% lower than pre-pandemic levels a year ago. The inventory of drilled but uncompleted wells in the United States has been steadily decreasing since the summer and is currently at levels last recorded in late 2018. The EIA currently forecast global oil demand to grow by 5% to 6% in 2021 and to fully recover to pre-pandemic levels in 2022. Recovering demand will need to be met by additional supply. And as a result, consensus forecasts call for at least 500 to 600 land drilling rigs in the United States within the next 2 years. We are able to absorb much of this increase within our existing cost base and should continue to post strong incremental margins as a result. That said, while we recognize that our near-term operating leverage is attractive to investors during times of industry recovery, we remain focused, first and foremost, on longer-term free cash flow generation and returns on invested capital. As the industry continues to consolidate and focus on the adoption of technology to drive further increases in the efficiency and effectiveness of drilling operations, Pason is well positioned to benefit. We see opportunities to generate additional revenue through increased R&D investments, and we will make the necessary investments to expand our competitive technology leadership.As we said during our third quarter conference call, competitive gaps tend to expand the most and persist the longest based on relative levels of investment through times of crisis. We currently expect to spend up to $15 million in capital expenditures in 2021, and we will make the necessary investments in working capital as activity levels improve. We continue to invest in our efforts in the solar and energy storage space. Energy Toolbase is rolling out a significant new release of its industry-leading software offering for the economic modeling of solar and energy storage projects, which provide streamlined workflows and additional features for its users. The sales pipeline for our intelligent energy management system is building as we refine our commercial approach to the market. We see opportunities for growth, both within our core drilling-related service business as well as from our investments in the completion space through a minority interest in intelligent wellhead systems and in the solar and energy storage space for Energy Toolbase. Equipped with exceptional people, an inspiring culture, innovative products and an unwavering commitment to our customers, Pason will seize on these opportunities. And we would now be happy to take any questions.

[Operator]

[Operator Instructions] Your first question comes from the line of Michael Robertson with National Bank Financial.

[Michael Storry-Robertson]

Just a couple of quick ones here. I was hoping if you could maybe provide some color on the current pricing dynamics. I appreciate that activity levels are still very depressed and likely competitive on your side. But also with commodity prices rising, I was just wondering if you're able to sort of take part in that.

[Jon Faber, President, CEO & Director]

Mike, it's Jon. I sound a bit like a broken record from prior quarters, I think, I often sort of talk a little bit about the differences between the Canadian and U.S. markets. The Canadian market outlook is a bit more challenged when you think about some of the challenges that we've seen in terms of egress takeaway capacity and those sorts of things, and so I think that continues to be a bit of a headwind on the Canadian side. Whereas the U.S. side, we never really saw quite the same intensity on the pricing pressure side. Now I would say, broadly across both markets, things are probably easing a little bit relative to where we would have been at the worst of the pandemic. But I would expect we continue to see more pressure on the Canadian side than the U.S. side. And again, recall, Mike, that we haven't sort of seen quite as much compression on the pricing side as some other service companies. And so I don't necessarily expect that we'll be able to take a lot back because we don’t necessarily have as much that we would have given up on the way down either.So we do think there's some opportunities as the focus becomes more on the technology side to look at some of the ways we offer the product, both from a pricing and just the commercial construct. But beyond that, I don't know there will be a significant change on the pricing side.

[Michael Storry-Robertson]

Got it. That's helpful color. Last question for me, switching gears. I just wanted to -- you touched on the sort of refined commercialization you're going through right now for ETV. I was wondering if there's -- whether it's like a specific geography that you're sort of targeting with that. Or how should we be thinking about that?

[Jon Faber, President, CEO & Director]

Not so much geography, Mike, as much as if you think about the project in totality, as people would look at these installations of solar and putting energy storage with it. The way that they bring together the pieces of the overall project is sometimes differently in terms of the parts they source either together or separately. And so when we look at different commercial approaches, we think about how we might best align with different ways that the customers pull together those projects as a total offering.

[Operator]

Your next question comes from the line of Matthew Weekes with IA Capital Markets.

[Matthew Weekes, Equity Research Associate]

And I was just wondering, looking at sort of the cost structure a little bit and you say it's your intention to continue investing in R&D to stay competitive. Looking at sort of the operating expenses going forward is a good way to look at it sort of Q4 annualized sort of continuing to run at that rate and then assuming maybe in the cost of sales side, kind of a similar structure except without CEWS?

[Jon Faber, President, CEO & Director]

Well, Matt, I think some of the reintroduction of costs, as things come back, are somewhat lumpy. So you can't necessarily just kind of have some straight trajectory or plateauing of any of the costs specifically, right? So if you look at coming out of the prior downturn, we would have talked about the overall incremental EBITDA margins likely somewhere in the 75% range over a range of $50 million to $100 million of revenue. And that continues to be the case. So on a quarter-to-quarter basis, obviously, we're quite a bit ahead of that this quarter. That implies that we'll have some future quarters where we're below that number. And that really comes around the timing of some of the cost coming back. For example, things like repair expenses where you might increase some repair expenses in anticipation of the next level of activity growth. So you can't necessarily just build a straight pattern on the cost side. It's more though of over a range of $50 million to $100 million of revenue, where we should see that north of 75% show up.

[Matthew Weekes, Equity Research Associate]

Okay. That helps a lot. And just another question. I think I'll just ask sort of about the long-term sort of outlook and maybe some things that you might consider in doing what sort of balance sheet flexibility, given sort of the free cash flow outlook, pretty good. Are there any sort of additional investments you're looking at right now that are sort of related to what you're doing in solar and energy storage or exploring new avenues? Or is there sort of any investment ideas that are in sort of early stages right now that you might be pursuing going forward?

[Jon Faber, President, CEO & Director]

No specific ideas that we're going to be able to speak to. But what I would say is, generally, when we think about capital allocation longer term, we have talked about sizing the cost structure to an activity level that we expect in the medium term, right, that 500 to 600 U.S. rig type of environment. And in that environment, we expect to have additional free cash flow, but we'll maintain flexibility around capital allocation to look at the types of opportunities that you'd be talking about here. Can we either scale capabilities we have within the drilling-related services on the completion side, where we, of course, have the minority investment with intelligent wellhead systems? Or are there things we can bolt on to the initiatives in the energy and solar storage space as it relates to additional product, additional capabilities, additional markets and those sorts of things?

[Operator]

Your next question comes from the line of Cole Pereira with Stifel.

[Cole J. Pereira, Associate]

Maybe just following on the last question. As we think about free cash flow, would it be fair to say that you guys are prioritizing more growth and maybe, say, M&A, over something like share buybacks or dividend increases?

[Jon Faber, President, CEO & Director]

I think the question around M&A versus share repurchases, and of course, share repurchases really is M&A just of your own stock, but I think the question of that is actually related to what opportunities you see the most to generate the most value, right? And that's a little bit impossible to predict. But clearly, there is a prioritization around either repurchases or additional M&A to bolster product offering and opportunities over straight growth of the regular dividend when we think about having flexibility in capital allocation.Our expectation is in the medium term, we would pay out a lower percentage of free cash flow as dividends to retain some of that flexibility. But what we ultimately do in terms of repurchases versus M&A will depend on the types of opportunities that exist, either if you get our own share prices, and that's attractive to own more of our own company or there's other opportunities in the M&A space.

[Cole J. Pereira, Associate]

Okay. Great. In the quarter, you had some nice North American market share capture. Can you talk about your line of sight for near-term changes in this metric, maybe absent the seasonality in Canada?

[Jon Faber, President, CEO & Director]

Well, the near term is always a little bit tricky because it's not just seasonality in Canada. It's also a question of which specific operators and contractors pick up more or less rigs in a quarter. I think, as we think slightly longer term, we certainly feel good about the prospects for market share in the U.S. as it relates to the consolidation results in less companies that care more about technology, and we think that's better for Pason.And to your point, typically, we've had lower market share in Canada, or in U.S. rather, higher in Canada, which means that the blended rate is higher in Canada this year. We think we do have opportunities on the U.S. side.

[Cole J. Pereira, Associate]

Okay. Great. That's very helpful. And then maybe internationally, some strong growth this quarter. Do you kind of have line of sight to maintain or increase the Q4 revenue and activity levels in these markets?

[Jon Faber, President, CEO & Director]

I think the line of sight will increase, maybe not quite as quickly, right? So much of the international growth is simply a relaxation of some of the restrictions that some jurisdictions still had around COVID. And so the relaxation of those gives you a little bit of a hyper normal sort of growth in the quarter. But I do think we have continued growth opportunities in the international across most of the markets we would be in.

[Cole J. Pereira, Associate]

Okay. Great. And then there's some commentary earlier on it. But as you think about improved ancillary product adoption, how should we be thinking about the drivers of that? Is it kind of just activity improvement overall? Is there sort of some other package for how you think about growing that?

[Jon Faber, President, CEO & Director]

Well, if we think about that focus on technology that customers have, that tends to then drive some additional adoption of some of the ancillary products as they're trying to make data available to more people either on-site or back in the back office, right? So that really is a driver of increased adoption of some of those existing products. And typically, when we come out of downturns, we see some additional adoption because when we go into the downturns, we often try to work with customers to -- if you think what they're spending with Pason, reducing that by maybe taking a little bit less product, more so than giving it up on the price side, because we always believe it's a little bit easier to get back adoption than price. And so we usually see a little bit more adoption coming out of the bottom of downturns on that basis as well.

[Operator]

[Operator Instructions] Your next question comes from the line of Keith MacKey with RBC.

[Keith MacKey, Analyst]

Just a question first on CEWS. What are you thinking about CEWS for the first and second quarters of the year?

[Celine Boston, Chief Financial Officer]

Yes. So we plan to continue to participate in the program as it's available to us. But as you know, given that the claim amount is largely driven by a formula based on period-over-period revenue declines, we do expect that claim to be lower in the context of improving revenue levels. So you can expect to see less than the $2.2 million that we collected in Q4.

[Keith MacKey, Analyst]

Got it. Okay. And just on the overall EBITDA number then, given where rig counts have gone since Q4 and you talked a little bit about some costs returning on a lumpy basis. But looking at those factors in combination, should we be thinking about $8 million as a jumping off point? Or will there be a possibility that things might step back from there?

[Jon Faber, President, CEO & Director]

On the EBITDA side, it's going to be probably a question of what the relative activity looks like on the Canadian side, right? So -- because, obviously, it's always busiest in the first part of the first quarter. But I would say if you think about the overall cost, we are going to be reintroducing some costs in anticipation of either -- there's 2 related issues, right? There's the issue around expectations of future activity where we'll have some cost build in anticipation, and then there will be opportunities that we see to increase in R&D investments to generate additional benefits for customers that we'll be able to monetize. But activity increases are going to overwhelm those cost increases in the short term, I would expect. And as you know, most of our revenue, ex those considerations, tends to flow through to EBITDA. So that should be positive.

[Keith MacKey, Analyst]

Got it. Okay. And one final one. You mentioned, I think it was an earlier question or maybe at the end of your prepared remarks, about opportunity to change some of the commercial dynamics of how you offer products. I think it was on the drilling side. Can you maybe just give a little bit more color into that? Like are you talking about just changing the revenue model? Or is it moving to any kind of performance-based contract? And can you maybe just give a little more color on the considerations of all of that?

[Jon Faber, President, CEO & Director]

It's not necessarily the revenue model or sort of the commercial construct and much as some of the peripheral products or some of the non-peripheral products, Keith. The benefits that customers get for those products are sometimes different for different customers. And so sometimes we can adjust the value proposition differently for different customers to probably better realize the value that different customers see.

[Operator]

Your final question comes from the line of John Gibson with BMO Capital Markets.

[John Gibson, Analyst]

I just have one, and it kind of builds on Cole's question about the ancillary products. You had some commentary in the release about your drilling advisory system. I'm just wondering if you could talk about inroads to new customers and particularly on the higher spec rate classes in the U.S.

[Jon Faber, President, CEO & Director]

So John, with the higher spec rig classes, we've always talked about in the drilling intelligence base, particularly drilling advisory systems, there's quite a bit of integration work with the control systems. And so as you start to work with additional fleets, there's some more integration work. And what I would say is that we're moving forward on a few more integrations with some different types of rig fleets, and so that should start to unlock additional opportunities for growth in the drilling advisory side.

[Operator]

This concludes our question-and-answer session. I will turn the call back over to Jon Faber for closing remarks.

[Jon Faber, President, CEO & Director]

Thank you very much, Amy. Thank you very much for taking the time to join us this morning for our call. We appreciate your continued interest and support. Our hope is that each of you will stay safe and healthy in the days and weeks ahead, and we look forward to speaking again after the release of our first quarter results. In the meantime, if you have any further questions, Celine and I would welcome your calls. Thanks very much, and have a great day.

[Operator]

This concludes this conference call. On behalf of Pason Systems, we would like to thank everyone for your participation. You may now disconnect.