Pason Systems Inc

TSX:PSI

Earnings Call Transcript 2021-Q4

[Operator]

Good morning. My name is Miranda, and I will be your conference operator today. At this time, I would like to welcome everyone to Pason Systems, Inc. Fourth Quarter 2021 Earnings Call. [Operator Instructions] The contents of today's call are protected by copyright and may not be reproduced without prior written consent from Pason Systems, Inc.Please note, 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 on its annual information form. Thank you. Mrs. Boston, you may now begin your conference.

[Celine Boston, Chief Financial Officer]

Thanks, operator. Good morning, and thank you for attending Pason's Fourth Quarter 2021 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 fourth quarter and 2021 fiscal year. Jon will then provide a brief perspective on the outlook for the industry and for Pason, and we will then take questions. 2021 represented significantly improved industry conditions across all of our major end markets. Our financial results demonstrate our strong operating leverage and continue to reinforce the decisions made through the downturn to maintain and build our service and technology platform, strengthening our competitive position through the recovery. Pason generated consolidated revenue of $62.8 million in Q4 of 2021, a 92% improvement over the fourth quarter of last year, which represented the beginning of recovering industry activity levels.North American industry days, although still well below pre-pandemic levels, increased by 83% during the fourth quarter of 2021 compared to the fourth quarter of 2020. The company held onto its record North American market share in the fourth quarter and continued to benefit from improved pricing conditions in comparison to the challenging environment throughout the downturn. Accordingly, revenue per industry day grew by 6% year-over-year from $721 in the fourth quarter of 2020 to $767 in the current quarter, representing a new record quarterly level for the company and a result that is well ahead of the $738 generated during pre-pandemic activity levels in the first quarter of 2020.Resulting North American revenue was $50.5 million for the fourth quarter, a 92% improvement from the fourth quarter of last year, and a result that outpaces the improvement in underlying industry conditions. Industry conditions in international end markets also improved. Revenue generated by the International business unit was $11.2 million in the fourth quarter, a 95% improvement from the fourth 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 fourth quarter, the highest quarterly level achieved for this segment, which continues to be primarily comprised of subscription-based software licenses for solar energy planning tools that begins to incorporate revenue generated by control system and related hardware sales.Pason generated $24.2 million in consolidated adjusted EBITDA in the fourth quarter of 2021, a significant improvement from the $8.2 million generated in the fourth quarter of last year. As the industry recovers and as our outlook continues to improve, we are making investments and incurring certain costs in anticipation of future revenue increases, primarily as it relates to equipment repairs and people. Further, as timing on deliveries of capital equipment purchases are difficult to predict, given the ongoing supply chain challenges all industries are facing, we are remaining especially proactive with repairs of existing fleet and technology, which has put some pressure on our fourth quarter adjusted EBITDA margins. However, many of our operating costs remain fixed in nature, and our operating leverage remains strong as our fourth quarter adjusted EBITDA results represents 38.5% of revenue generated in the quarter, a result that nears pre-pandemic adjusted EBITDA margins. As we've previously communicated, 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 demonstrated this effect, as we scale our operations to support higher levels of activity.On an annual basis, Pason generated $206.7 million in revenue, compared to the $156.6 million of revenue in 2020. Adjusted EBITDA generated in 2021 was $72.5 million or 35% of revenue, compared to $39.5 million or 25% of revenue in 2020. Resulting net income attributable to Pason for the 12 months ended December 31, 2021, was $33.8 million or $0.41 per share, a significant increase from the $6.6 million or $0.08 per share generated in 2020. Although activity levels continue to be well below pre-pandemic levels, a comparison of annual results demonstrates the recovering industry conditions coming out of the lows experienced in 2020. Our balance sheet remains strong and incredibly well positioned with $158.3 million cash and cash equivalents at the beginning -- at the end of the year and no interest-bearing debt. We continue to make investments in our core business to support increased activity levels. In 2021, Pason spent $10.9 million in capital expenditures relating to maintaining and refreshing our existing technology. Furthermore, as revenue levels have increased, we've made corresponding investments in working capital, while remaining diligently focused on maintaining strong collection trends. Resulting free cash flow in 2021 was $55 million, which reflects these investments made during the year. Pason returned $25 million to shareholders through dividends and share repurchases during 2021. As we look to signs of continued recovery, we are increasing our quarterly dividend to $0.08 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, we are very proud of our fourth quarter and 2021 results, which reflect our leading market presence, our strong 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 over to Jon for his comments on our outlook.

[Jon Faber, President, CEO & Non]

Thank you, Celine. As Celine noted, our fourth quarter financial results reflected Pason's strengthened competitive position together with the continuation of improved drilling industry conditions. Through the depth of the downturn, we made the decision to maintain and to grow our leading service and technology capabilities. In 2021, these capabilities gave customers the confidence to award Pason its highest North American market share in the company's history, and we exited 2021 with record quarterly revenue per industry day. We expect to build on that position of strength heading into 2022, and as industry activity remains poised to continue its path of continued steady growth in the coming quarters. Customers are looking to automation and analytics technologies to improve their operational performance, and Pason remains optimally positioned to provide the high-quality drilling data on which those technologies rely. Leading indicators of drilling activity suggests that the growth witnessed over the past year will continue. Oil prices remain over $90 per barrel for the first time in 7 years, and industry analysts expect prices will break through $100 per barrel this year. The Energy Information Administration is calling for oil demand in 2022 to surpass 2019 levels. Meanwhile, oil production in the United States remains approximately 10% below pre-pandemic levels. Crude oil and petroleum product inventories are at their lowest levels in more than 5 years. The United States have been releasing oil from the strategic petroleum reserve in response to elevated oil prices, putting further pressure on storage levels. OPEC + countries are falling short of their target production levels and industry analysts estimate that OPEC+ spare capacity is decreasing. The inventory of drilled but uncompleted wells has decreased every month for the past 18 months and is now the lowest it has been in 8 years. U.S. land drilling activity was flat or increased in 50 out of 52 weeks in 2021. While the U.S. land rig count has increased by an average of 5 rigs per week since the start of 2021, it remains approximately 290 rigs below the 2019 average rig count. Supply and demand fundamentals are constructive for oil prices and for drilling activity in the coming quarters. A significant supply response seems unlikely given current challenges around the availability of labor, supply chain disruptions, and underinvestment in larger long-term development projects over the past 5 years. E&P companies remain committed to disciplined capital spending within cash flow. As their free cash flow sees significant increases at higher oil prices, they are able to maintain strong balance sheet, return capital to shareholders, and increase capital programs. Pason is well equipped to participate in the continued industry growth. In our solar and energy storage efforts, we expect revenue to increase as the growing backlog of Control Systems sales are converted into revenue as projects are commissioned. Across our business, we will make the necessary investments to position ourselves to realize future revenue gains. Our operating costs, most notably personnel and equipment repairs, will see increases as a result of anticipated further activity gains and prevailing interest rates.We will invest in research and development efforts to drive continued market share and pricing improvements, as we deliver additional value and functionality for customers. Our 2021 capital program came in at approximately $11 million with certain equipment purchases delayed by supply chain shortages and delays. As a result, we expect to spend up to $30 million in capital expenditures in 2022, which includes $5 million of planned expenditures carried forward from 2021.We will continue to evaluate our capital programs in the context of future opportunities to evolve our product and service offering while navigating continued supply chain challenges. Our balance sheet remains strong, and our free cash flow generation continues to improve. We will continue to allocate capital by making 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. As our cash flow generation and outlook improves, we are able to increase shareholder returns, and as such, we are increasing our quarterly dividend from $0.05 to $0.08 per share. Our regular dividend payments represent a lower percentage of free cash flow than they did prior to the pandemic. And moving forward, we will continue to balance growth in the dividend with maintaining flexibility in our capital allocation to allow us to pursue attractive organic or inorganic growth opportunities.We remain focused on ensuring that Pason is an innovative, profitable and responsible company. And we will now be happy to take any questions.

[Operator]

[Operator Instructions] Your first question will come from Michael Robertson with National Bank Financial.

[Michael Storry-Robertson]

Congrats on another solid quarter here. I was wondering if we could start with the Solar and Energy segment. I was hoping if you could give us an idea of how sticky those subscription relationships tend to be maybe in terms of average subscription length or maybe the level of turnover you tend to see?

[Jon Faber, President, CEO & Non]

So the subscription side of the business, Mike, that's the economic modeling and the proposal generation tool. That business is quite sticky, right? So those are solar project developers largely, who are using that for a lot of the proposals that they're putting out for projects, and we've seen very low turnover in that part of the business.

[Michael Storry-Robertson]

That's great. Sounds like some nice recurring revenue there. The other thing I wanted to touch on this morning. You noted some increased market share. I was wondering if you could provide some more color on what you're seeing there and if it was being driven by clients with which you've had existing relationships representing a bigger percentage of the active rig count? Or is that from making inroads with new clients or maybe a combination of both?

[Jon Faber, President, CEO & Non]

Yes. So again, I think we pointed in the past the various things that drive market share. One, of course, is we've been a net beneficiary of consolidation where companies who have had a preference for Pason have acquired companies where we may have had lower penetration. And so as a result, we end up picking up a little bit more market share when those people consolidate the industry. We have certainly had some cases where we've grown our share of our customers. So where somebody gave us a share of their business and now they're giving us a larger share of their business. And then we've had, on balance, I would say, more -- if you think about winning and losing logos, we've probably won more than we've lost on the logo side. I think one of the prevailing themes that we're hearing when we think about the market share gain, to answer a question you didn't directly ask Michael, is the growing move to use data drives a lot more interest in some of these data delivery products and some of those office-based types of products that we've been spending quite a bit of time and effort on the last few years. And so I think that's been really helpful in, when you think about getting larger shares of customers, getting more customers and kind of being a prevailing provider on the back of consolidation. A lot of that has been driven by the data delivery side.

[Michael Storry-Robertson]

Got it. That's really helpful color, Jon. I appreciate that. It sounds like there's a few different angles there. Maybe just a follow-up to that. Are the gains in market share you're seeing relatively broad-based or are there standouts in terms of particular geographies or basins?

[Jon Faber, President, CEO & Non]

I don't know if there's any particular standouts. I think clearly, if you went back 5 years, we've had significant inroads in the Permian, right? The fact that we've been able to grow market share to the highest level we've ever seen. And when historically, we would have had lower market share in the Permian, really speaks to outperformance within that particular basin or market. Outside of that, I don't know that I would point to any specific types of customers or basins.

[Operator]

Your next question will come from Cole Pereira from Stifel.

[Cole J. Pereira, Associate]

So labor availability across the space remains an issue, as you outlined. But I'm wondering if you view labor shortages for the contract drillers as a bigger impediment to growth for Pason specifically?

[Jon Faber, President, CEO & Non]

Yes. That's a great question, Cole. I think the challenges around labor, as you've highlighted, are prevailing across the whole space for energy services companies. And clearly we think that, that is one of the things that sort of mitigates the growth rate and makes it a little more sustainable, maintainable, the steady growth rather than rapid growth in response to oil prices. I think the mere fact that a drilling contractor has multiple people on location where we have one technician on multiple locations would imply that the labor availability challenges of some of our customers are probably a bigger challenge in terms of growth than our own availability of labor.

[Cole J. Pereira, Associate]

Okay. Perfect. That's great color. As well, just wondering if you're able to maybe put some bookends on how we should be thinking about R&D expenses moving forward?

[Jon Faber, President, CEO & Non]

Yes, great question. I think if you look at R&D, we've clearly been putting more into R&D, as we've seen opportunities to -- for live products, we mentioned today, the delivery side is driving a lot of the market share side, but there's some other things on the R&D side where I think we're getting real traction and opportunities to commercialize things, and that shows up as new revenue through market share or through product adoption or price. We see more of that.So we'll continue to make investments there. I think if you look at the second half of 2021, that's probably a good sort of baseline to think that we'll grow off of, as we think of kind of run rate effects and then maybe some future growth off of that as opposed to just looking at a full year year-over-year.

[Operator]

Your next question comes from Keith MacKey from RBC Capital Markets.

[Keith MacKey, Analyst]

I imagine it varies by product and geography, but how close has pricing come to returning to pre-pandemic levels.

[Jon Faber, President, CEO & Non]

So it is the low prepandemic levels in, I would say, all geographies still. So we've been able to get some price back now. We don't generally think of kind of restoring price without bringing some additional functionality, feature and benefit to customers. So it's always a little bit challenging to say how much it will come back on a like-for-like basis, because we're trying to evolve the product to justify the ask for a little bit more on the price side. So it's a bit of a tricky question, but a little bit below the prepandemic levels.

[Keith MacKey, Analyst]

Got it. Fair enough. And just curious, what is the pathway for EBITDA margins to get back to that mid-40% range that we saw kind of 2018 to 2019? Do rig counts need to return to those -- the levels we saw then? Or do you think you can get margins back to that level in a lower rig count environment?

[Celine Boston, Chief Financial Officer]

Yes, Keith. So I mean, as we said before, back in the second quarter of 2020, we did size the business for about 500 to 600 U.S. land rigs. And obviously, we've clearly now exceeded that level and our outlook continues to grow well beyond that. So I mean, we will see some margin compression as we do scale for that next level of activity. We did see that in the fourth quarter, and we do expect to see some continued pressure on incrementals in the next couple of quarters. But look, we see that as a good problem to have, given what it means for future results, and we still feel that it's very reasonable to believe that we can chip away at getting back to pre-pandemic adjusted EBITDA margins in the low to mid-40s throughout the course of, I'd say, this year and next, as we're kind of thinking towards an 800 to 900 U.S. land rigs again.

[Keith MacKey, Analyst]

Got it. Okay. Okay. Perfect. And one last one for me. Can you just maybe break down the $30 million CapEx spend as far as the $5 or so million carryover, maybe $10-or-so million of maintenance? And then what is the additional growth allocated to, and if you could just kind of break that down as far as your -- what you're planning to get for that CapEx expense?

[Jon Faber, President, CEO & Non]

Well, a number of things that show up in our CapEx, Keith, right? So of course, you have equipment. And when you think about equipment, there's kind of the refreshing of the existing equipment with similar equipment. There's the evolution of equipment to kind of next generation, if you will, and then there's the rollout of new pieces of equipment. And so there's a little bit in each of those categories. And then the other part is, frankly, around things like trucks or fuel technicians where means the fact you look at the global vehicle shortages and supply chain issues, that has had an impact on our ability to sort of maintain our normal cycle of vehicle replacement over time. And so we probably have a bit of a backlog of spend on things like trucks as well. So I don't know that there's any 1 sort of particular product or category that would sort of stand out relative to the others. It's fairly broad-based against those 4 categories if you think of trucks, that equipment, being kind of like-for-like next-generation and new type of product. And I don't know, if Celine has a little more color to put on that.

[Celine Boston, Chief Financial Officer]

No, I think is the majority of that $30 million is maintenance, Keith.

[Operator]

[Operator Instructions] Your next question would be coming from John Gibson from BMO Capital Markets.

[John Gibson, Analyst]

Congrats on the solid run here. First off, just internationally, your numbers continue to move up. Are you seeing market share wins and pricing gains in various international markets? Or is it more just to do with generally higher activity levels?

[Jon Faber, President, CEO & Non]

I guess I wouldn't necessarily call it pricing gains as much of activity type mix. So in some of the international markets, we have a mix of kind of drilling activity and workover activity, where we're involved in both. And as the mix moves a little bit more towards drilling, that would benefit us in terms of the revenue we would see. So it's not so much of price, but it is clearly a driver of revenue per day based on the type of work they're doing. And so that's been a beneficiary. And we've had some market share gains in some of the international markets, but I think it's probably more a question of overall -- just the activity levels increasing and then something around activity type mix.

[John Gibson, Analyst]

Got it. And then last, just on the dividend, it was obviously nice to see the increase this quarter. Previously, you've kind of guided to moving the dividend up in tandem with rising activity levels and obviously, financial performance. So can we assume the strategy will continue, particularly given where rig counts are tracking? And then maybe, I guess, more specifically, where do we need to see activity levels move in order to see another increase?

[Jon Faber, President, CEO & Non]

So if you say the strategy continuing, you have to be careful to clarify what you mean by the question, John, right? So we reduced the dividend by 75%, one of the things we talked about was that we expected the dividend would represent a lower percentage of free cash flow going forward than it had in the past, to allow ourselves more flexibility in capital allocation. So that strategy, I think, will continue. And we intend to look at growth in the regular dividend against what is growth in free cash flow over the cycle that we would see kind of moving forward look like. So I don't think we'll just instantly respond to annual changes in free cash flow, more taking a look at what do we think a cycle looks like, and what's appropriate for growth of the dividend in that context while maintaining it as a lower percentage of free cash flow than it would have been pre-pandemic.

[John Gibson, Analyst]

I guess if you can get more specific, what would be that sort of percentage that you're looking at now of free cash flow versus pre-pandemic levels?

[Jon Faber, President, CEO & Non]

I don't think the Board just established at what level the next dividend move would happen. It's something we look at every quarter to say what is our outlook and what do we feel is the appropriate dividend. So I don't think it would be appropriate for me to give you a specific level, the Board hasn't had that conversation around a specific level.

[Operator]

There are no further questions at this time. Please go ahead.

[Jon Faber, President, CEO & Non]

Great. Thanks very much for joining us on this morning's call. We appreciate your interest as always. And if you have any follow-up questions, certainly feel free to reach out to Celine and myself at your convenience. And otherwise, we look forward to speaking to you again after the first quarter results. Have a great day.

[Operator]

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