Pason Systems Inc

TSX:PSI

Earnings Call Analysis

Pason Demonstrates Robust 2023 Performance Despite Industry Challenges

Pason reported strong fourth-quarter and full-year results for 2023, overcoming a dip in North American industry activity. Notably, despite a 5% decrease in year-over-year drilling activity, the company achieved the highest revenue ($369 million) and adjusted EBITDA ($171.5 million) since 2014, marking a record performance since that benchmark year. This demonstrates an impressive 10% and 7% increase compared to 2022, outpacing industry trends by capitalizing on demand for automation and analytics in drilling data.

Impact of Foreign Exchange and Mixed Quarterly Results

Pason's annual net income was affected by a considerable foreign exchange loss of $14.2 million, mostly due to the Argentinian peso devaluation. The fourth quarter of 2023 saw a slight dip in consolidated revenue to $93.3 million and a $38.9 million adjusted EBITDA, which translates to a margin of 41.7%. Despite North American business unit revenue falling by 9% due to a decrease in drilling activity, a rise to $998 in revenue per industry day—a record high—softened the impact. International business unit revenue saw a 25% increase, benefiting from a stronger U.S. dollar.

Rapid Growth in Solar and Energy Storage Sector

Energy Toolbase, Pason's segment in solar and energy storage, experienced explosive growth with a 107% increase in quarterly revenue, totaling $4.8 million. Discrepancies in quarterly industry activity levels were mitigated by the rise in revenue per industry day and strong international performance, leading to stable consolidated revenue from Q3 to Q4.

Operational and Margin Advancements Amidst Inflation

Faced with inflationary pressure in 2023, Pason upheld a mostly fixed cost base aimed at supporting increased activity levels. Cost considerations included more lower-margin solar and energy storage sales and equity accounted losses due to the rapid growth of Intelligent Wellhead Systems (IWS). If these equity accounting losses were excluded, Pason's adjusted EBITDA margin would have been about 44%.

Strong Balance Sheet Fuels Investment and Shareholder Returns

Throughout 2023, Pason delivered on strategic investments and shareholder value. With $38 million in net capital expenditures, which was under the $45 million CapEx guidance, the company generated a free cash flow of $97 million. This represented a significant 38% increase from 2022, allowing for a generous $66.5 million return to shareholders through dividends and share repurchases. Pason's cash balance remained robust at $172 million, with no interest-bearing debt, setting a solid foundation for future investments.

2024 Outlook: Strategic Direction and Capital Allocation

Pason is looking forward to 2024, buoyed by strong drilling results, expanding into solar and energy storage, and the acquisition of IWS for integral growth. A steady U.S. land rig count is anticipated through H1 2024, with expectations for a gradual increase afterwards. The company aims to outperform in drilling revenue, is well-received for its new drilling mud analyzer, and foresees IWS contributing an extra $20-$25 million to revenue. Capital expenditures are projected between $75-$80 million for the year, taking into account delayed deliveries from 2023. The company plans to maintain its focus on organic growth investments while increasing its regular quarterly dividend to $0.13 per share, signifying confidence and commitment to delivering value to shareholders.

Enhancing Customer Value Through Integrated Offerings

Pason's executive team highlighted the strategic directive for IWS, focusing on digital valve control and data aggregation opportunities, with plans to leverage skills and knowledge from both Pason and IWS. The goal is to enhance the value delivered to existing customers and attract new customers by providing comprehensive data management solutions across drilling and completion phases. Pason seeks sustained growth in revenue per industry day through the ongoing adoption of data-driven technologies and rollouts of new products. Despite increasing operational expenditures, the company doesn't necessarily require equivalent revenue growth to maintain high margins and return on capital because of the scalable nature of their operations.

Earnings Call Transcript 2023-Q4

[Operator]

Good morning. My name is John, and I will be your conference operator today. At this time, I would like to welcome everyone to the Pason Systems Inc. Fourth 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 advisers 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.

Celine Boston, CFO, you may begin your conference.

[Celine Boston, executive]

Thank you, John. Good morning, everyone, and thank you for attending Pason's 2023 Fourth 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 fourth quarter and for the 2023 year. Jon will then provide a brief perspective on the outlook for the industry and for Pason, and we will then take questions.

I'm pleased to report on Pason's strong fourth quarter and full year 2023 results, despite more challenging industry conditions. Our 2023 results highlight our strong competitive position, the growing demands for drilling data as our customers increasingly invest in automation and analytics technologies and our ability to outperform underlying drilling activity while generating meaningful free cash flow.

In 2023, Pason generated $369 million in consolidated revenue and $171.5 million in adjusted EBITDA. These results were 10% and 7% ahead of 2022 annual results, respectively, against North American industry activity that declined 5% year-over-year. These are the highest annual levels achieved by Pason since 2014, which was a record year for Pason. And as another reference point, these annual levels exceed what was generated for both revenue and adjusted EBITDA in 2018 when North American land drilling activity was 42% higher.

Net income attributable to Pason for the year was $97.5 million, and was impacted by a $14.2 million foreign exchange loss recognized in the fourth quarter, primarily associated with the significant devaluation seen in the Argentinian peso and the associated impact on Pason's cash and working capital balances held there.

From a quarterly perspective, Pason generated consolidated revenue of $93.3 million in the fourth quarter of 2023 compared to $94.4 million in the fourth quarter of 2022. With this revenue, Pason generated $38.9 million in adjusted EBITDA or 41.7% of revenue.

I'll now provide an overview of the fourth quarter by business unit. Compared to the fourth quarter of 2022, our North American business unit saw a 19% decrease in industry drilling activity. However, the business unit generated revenue per industry day of $998 in the fourth 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 fourth quarter of the prior year.

Resulting North American revenue was $70.5 million in the fourth quarter, only a 9% decrease from the fourth quarter of 2022, despite the 19% reduction in industry activity. Gross profit for the business unit was $39.9 million in the fourth quarter of 2023, down from the $51 million generated in 2022, and reflects higher levels of depreciation and amortization with the increased investments the company has been making in capital expenditures in recent quarters as well as some inflationary effects on elements of our cost base and slightly higher repair costs, which the company caught up on in the fourth quarter of 2023.

Similarly, revenue generated per day in our international end markets also improved year-over-year. Reported revenue for our International business unit was $17.9 million in the fourth quarter of 2023, up 25% from the level generated in the comparative 2022 period. Pason's International business unit benefited from a stronger U.S. dollar in the current quarter with many contracts linked to changes in the U.S. dollar versus local currencies.

Many expenses are similarly linked to the U.S. dollar and were also impacted by the strength seen in the currency in the fourth quarter. Reported segment gross profit was $7.7 million in the fourth quarter of 2023, up from $5.9 million generated in the fourth quarter of 2022.

Energy Toolbase continues to grow its presence in the solar and energy storage industry and posted a quarterly revenue results of $4.8 million, which represents a 107% increase from Q4 of 2022. The segment had increased control system sales in the quarter, which will fluctuate with the timing of deliveries on future projects.

On a sequential basis, U.S. rig count stayed steady during the fourth quarter, while Canadian drilling activity saw expected seasonal declines. Resulting North American industry activity was down 5% sequentially, while revenue per industry day increased by 2%. This improvement in revenue per day, coupled with strong results internationally and from Energy Toolbase resulted in consolidated revenue remaining stable from Q3 to Q4.

Our fourth quarter results continue to highlight our mostly fixed cost base, which has been impacted by inflationary effects in 2023, and is currently in place to support higher levels of activity than seen in the fourth quarter of 2023. Adjusted EBITDA margin in the fourth quarter was also impacted by a higher amount of lower-margin solar and energy storage sales and the inclusion of equity accounted losses related to supporting IWS' rapid pace of growth. Excluding these equity accounting losses in the fourth quarter, adjusted EBITDA margins would have been 44%.

We will continue to manage our fixed cost structure towards our expectation of upcoming activity levels and with the acquisition of Intelligent Wellhead Systems on January 1, 2024. We will make the necessary investments in our cost base to deliver on further revenue growth and create opportunities for long-term free cash flow generation.

Net income attributable to Pason for the 3 months ended December 31, 2023, was $8.5 million or $0.11 per share, a decrease from the $36.3 million or $0.44 per share generated in the fourth quarter of 2022. The decline year-over-year reflects the lower industry activity levels, higher levels of depreciation and amortization expense on increased capital expenditures in recent quarters, along with the foreign exchange loss recognized on cash and working capital held in Argentina with the significant devaluation in the Argentinian peso seen at the end of 2023.

Our balance sheet remains strong and incredibly well positioned to make strategic investments while returning meaningful cash flow to shareholders. Throughout 2023, we continue to make the necessary investments to deliver on opportunities to increase revenue generated per day and invested $38 million in net capital expenditures, a result that was lower than the $45 million CapEx guidance provided for 2023, with $5 million in asset deliveries that were delayed until early January of this year.

Resulting free cash flow in 2023 was $97 million, a 38% increase from the $70.5 million generated in 2022. With this free cash flow, we returned $66.5 million to shareholders through our quarterly dividend and share repurchase program. We also funded the remaining $15 million in preferred share subscriptions for our investment in Intelligent Wellhead Systems, ending the year with a cash balance of $172 million and no interest-bearing debt.

In December, we exercised our call option to purchase the remaining outstanding shares in Intelligent Wellhead Systems, not previously held by Pason, effective January 1, 2024, for a total consideration of $88.3 million, and the assumption of approximately $7 million of net debt. This transaction was funded with cash on hand subsequent to December 31, with no dilution to our shareholders.

In summary, we are very proud of our 2023 results and are well positioned entering 2024 with our established position within drilling, our growing position in solar and energy storage and significant opportunities for growth within completion through our recent IWS acquisition.

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

[Jon Faber, executive]

Thank you, Celine. Our financial results throughout 2023, again, demonstrated our ability to generate financial and operational results that outpace underlying drilling industry activity. Our 2023 consolidated revenue was 10% higher than the prior year despite North American land drilling activity being down 5% over the same period. In the fourth quarter, our revenue was 1% lower from the prior year period, while industry activity was down 19%.

Our strong competitive position is evidenced by increases in North American revenue per industry day throughout the year, reaching $998 in the fourth quarter, up 12% year-over-year, driven by higher levels of product adoption and improved price realization.

Revenue per industry day, which is a metric that tracks our growth over and above underlying industry activity has grown at a compound annual growth rate of 11% from the fourth quarter of 2020 in the midst of the COVID-19 pandemic.

Our International business unit posted its highest annual revenue in the company's history in 2023 at $63.8 million. Energy Toolbase also saw strong revenue growth in 2023, generating $15.7 million in revenue, up 118% from 2022 levels, on the strength of increased subscription revenues and additional control system installations. And of course, we recently completed the largest acquisition in Pason's history, with the acquisition of the remainder of Intelligent Wellhead Systems.

We see opportunities for meaningful growth in all areas of our business as we enter 2024, and I'll speak to each of those in turn. With respect to our drilling-related business, the U.S. land rig count, as reported by Baker Hughes has remained within a tight band around 600 rigs since the start of the fourth quarter of 2023. And we expect activity to remain at this level through the first half of 2024 before beginning to slowly increase in the later part of the year.

Even within a relatively flat industry environment, we expect to be able to maintain our established pattern of outpacing the industry with our drilling-related revenue. Customers continue to adopt more data-driven technologies, which is driving increased demand for high-quality data, which Pason is well suited to deliver. We have also experienced a very positive early market response as we have begun rolling out an innovative new drilling mud analyzer to provide continuous real-time readings of critical drilling mud parameters.

Turning to completions. IWS represents a meaningful opportunity for material revenue growth outside of oil and gas drilling. IWS generated revenue of approximately $45 million in 2023, representing a compound annual growth rate in excess of 85% since Pason's initial investment in 2019.

We've been impressed with the profile of IWS' revenue growth as they have demonstrated impressive capabilities in the acquisition of new customers, retention of existing customers and expansion of its product and service offerings. We anticipate that IWS could add an additional $20 million to $25 million to its revenue in 2024, scaling up through the year, driven primarily by its automation offerings and, of course, subject to industry conditions.

We see a tremendous opportunity in the area of data aggregation in the completion space. Pason's history of data aggregation in the drilling industry over many decades, together with IWS' growing presence in the completions industry, provides us with unique advantages to work with customers to solve the challenges and provide compelling solutions in this area, and we're beginning work in this area in 2024.

As with our drilling-related business, our efforts to provide both automation and data aggregation technologies for the completion space are supported by a best-in-class field service and support organization. As IWS continues to grow rapidly, we are making the necessary operational working capital and capital expenditure investments. Over time, as IWS achieves greater scale, we anticipate that margins and returns on capital could approach similar levels to those of our drilling-related business.

Turning to solar and energy storage. We see favorable tailwinds for Energy Toolbase, arising as the deployment of energy storage assets increase. In particular, we are seeing strong growth in our pipeline of opportunities for our control systems. The timing of deliveries and the associated revenue with control systems can vary significantly between quarters, but we anticipate meaningful growth in Control Systems sales in 2024.

At the same time, we are increasing the functionality of our leading economic modeling and proposal generation software tool to address the unique requirements of additional end markets. Our priorities with respect to capital allocation remain focused on pursuing attractive growth opportunities while returning meaningful capital to shareholders.

With the acquisition of IWS, we now expect capital spending of between $75 million and $80 million in 2024. As a reminder, we had anticipated capital expenditures of approximately $45 million in 2023, and we funded $25 million in IWS under a preferred financing -- preferred share financing arrangement between December 2022 and December 2023.

Our anticipated 2024 capital expenditure program includes approximately $5 million in anticipated 2023 capital expenditures, which were impacted by the timing of deliveries.

In 2023, we returned $66.5 million to shareholders, with $38.5 million in dividends and $27.9 million in share repurchases. We will continue to pursue disciplined returns over time through our regular quarterly dividend, which we are increasing to $0.13 per share.

We maintain flexibility in our approach to shareholder returns by evaluating share repurchases in the context of attractive organic growth investments to generate additional free cash flow. We 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.

Our balance sheet remains strong with no debt and cash at December 31, 2023, of $172 million, of which $88 million was deployed to complete the IWS acquisition effective January 1. And we also assumed approximately $7 million in net debt at the closing of the IWS transaction.

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 outside of the oil and gas drilling industry and to return meaningful capital to shareholders. We will now be happy to take any questions.

[Operator]

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

[Aaron MacNeil, analyst]

Jon, I can appreciate that it's early days, but what are your sort of initial directives for the IWS team? I know you mentioned the handful of priorities, but is the primary focus on rapidly rolling out the digital valve control offering? Or are you eager to sort of layer on that data aggregation opportunity you mentioned?

And maybe as a follow-on, are you sort of redeploying anyone from Pason to IWS? Or hiring externally in order to sort of facilitate the expansion of the business?

[Jon Faber, executive]

Good questions, Aaron. I probably wouldn't say it's just directed to IWS. It's directed to both Pason and IWS because to your point, there is a lot of opportunity to cross-pollinate in certain areas.

So I'd say across the broader organization, the first priority, of course, is to remain focused on the drilling-related business. That's the majority of the business today, and we have to make sure we keep our eye on that ball. The second priority is to continue the acceleration of growth, primarily based on the digital valve control offering and other automation technologies.

And then the third priority is starting to work on this data aggregation piece, which will take people from both Pason and IWS. I think there's unique knowledge related to completions and what customers are trying to achieve that IWS would have and their unique capabilities and expertise that Pason has around how to manage complex data sets in a challenging operating environment.

So where we're seeing that cross-pollination of people today is more at some of that technology development as it relates to that aggregation. And for the areas of the business that I would say are much more on the front lines of interacting with customers, whether that's operational or commercial, it's much more -- the folks who have been focused on drilling, making sure they keep their eye on the ball and the folks who have been focused on IWS, making sure they continue the momentum that they've had over the last couple of years.

[Aaron MacNeil, analyst]

Makes total sense. You mentioned in your prepared remarks that you continue to expect growth in the revenue per industry day figure. I obviously saw the rollout of the new drilling mud analyzers. So I guess I'm just wondering, how impactful could that new offering be to the metric in '24? And what other products or services are in the pipeline that would help you sort of augment continued growth in that figure?

[Jon Faber, executive]

Yes. Again, good question. I think for 2024, the mud analyzer isn't going to significantly move the needle on the revenue side because it's early days of adoption. I think over the medium term, there's a very significant opportunity with the mud analyzer. We're very excited about that particular product, but it's not necessarily going to have its maximum impact in 2024. It will have more probably a capital impact in 2024 as you build for 2025 and beyond, to be quite honest.

As it relates to 2024, growth in revenue for Industry Day, there's a few things that will impact that. One is, of course, the run rate effects of what we've seen happening in product adoption and pricing through 2023, carrying through 2024.

And then we've mentioned a number of times, the increased use of data drives a lot of product adoption in areas of data delivery, which we're quite excited about. And we do have a few other things on the new product side, which, again, are probably at the same magnitude or scale of a mud analyzer, but there are some things that would be additional product opportunities as well.

[Operator]

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

[Cole Pereira, analyst]

Just back on the IWS front, if you're willing to say, is there any material customer overlap with the existing drilling business? And longer term, could you kind of think you could present a combined offering to customers?

[Jon Faber, executive]

Yes. Of course, I'm willing to say, Cole, what's fascinating is that in some areas, there is customer overlap. But in some areas, where they have pockets of strength, I would say those are areas where we might have had more challenges historically on the Pason side. And in areas where they haven't been able to get quite as much early traction, we have a very strong relationship on the Pason side.

And so there is reciprocal opportunities to facilitate some conversations. And some of those conversations, the opportunities in the eyes of customers are more exciting as they think about the opportunity to take a more holistic look at the data management space over drilling and completion.

So bringing the 2 together allows us to have opportunities with different customers on both sides of the customer bases. But they're not a direct overlap, notwithstanding what our market share has been for a long time. There are opportunities for us to expand that in the drilling business even through some of the IWS relationships.

[Cole Pereira, analyst]

Okay. Got it. That's helpful. And you've been relatively successful at getting some pricing increases despite flat to down rig count. I mean you touched on it a little bit, but how are you kind of thinking about additional pricing increases from here if there is an opportunity? And what's kind of really the driver there?

[Celine Boston, executive]

Yes. Good question. So we think about pricing increases probably in 2 different ways. One is like-for-like pricing increases just to kind of capture inflation. And then the other would be pricing increases that are associated with delivering new functions or features or improved functions or features on our technology offering.

So I think certainly see lots of opportunities in the latter category continuing into this year. On the first category, that's a little bit more subject to industry conditions and what's happening from that perspective.

[Operator]

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

[Keith MacKey, analyst]

Jon, Celine, just wanted to start or continue along with the IWS topic. You mentioned that you could ultimately see it rivaling the drilling business in terms of the margin and return economics. Jon, can you just walk through a little bit more about what underpins that confidence you have in the size of that market? And anything you can say on the timing in getting there would be helpful as well.

[Jon Faber, executive]

Sure. So I think your question was around the size of the market. So at a high level, the way we look at that is that the IWS revenue per activity day, similar to how we would think about revenue per EDR day, if you will. Not quite at the industry day level, but their own activity days. That's about 3x what Pason's would be. And the completions market historically has had a relationship of about 2.5 drilling rigs to 1 frac spread.

So if I simplify those numbers and just say, the average price capture per day is about 3x in a market that's roughly 1/3 of the size. That implies a market opportunity that would be similar to what we face in the drilling industry.

Of course, that's what the current product offering from IWS. We've made reference to the fact that we think there's opportunities to expand the product and service offering. And so it will take time to be able to address the size -- or the share of the market that we have on the drilling side to be able to achieve similar types on the revenue side.

We probably don't need the same revenue to achieve the same types of margins and return on capital, to be honest. When you think about the revenue opportunity on a job site versus the operational effort required to support that, the operational effort to support is greater, but it's not necessarily 3x.

And then when we think about the relationship between capital and revenue and utilization of assets, that all feels very familiar to us in terms of how it looks on the IWS side versus the Pason side.

But it's going to take some time, Keith, right? If you think about the ability to grow that revenue, we've said, obviously, within the context of the industry, but we think IWS could probably add $20 million or $25 million to revenue this year.

It's going to take a few years of more than that in terms of dollar growth in revenue to be able to get to the revenues that would get us to that kind of margin and return on capital profile. So it's a few years before you can get there, but the onus is on us to both kind of grow the revenue within the existing operational capacity and grow the operational capacity to scale revenue faster.

[Keith MacKey, analyst]

Got it. No, that's very helpful. And just secondly, on IWS, again, think it's worth asking, even in a public forum, even if you may not be able to say very much, and we've certainly had questions on it. But there is some active litigation going on with IWS and 1 of its competitors. So can you just talk a little bit about what's giving you the confidence to proceed with buying the rest of the business in light of that ongoing litigation?

[Jon Faber, executive]

Sure, Keith. I'm obviously going to be a little bit limited in what I can say because the matters before the courts. And so I probably can't give a lot of color on the specifics around where our confidence would come from.

What I would say probably at the outset is that IP litigation is, of course, not particularly uncommon in oilfield service and technology. And it's particularly common when success in the marketplace draws the attention of competitors, right?

So there's probably 2 areas that I can speak to in the context of the limitations I would have. The first is I would remind folks that Pason has been involved with IWS since 2019. And so we've been familiar with this matter for a long time, and we received a significant amount of advice and opinions from external legal counsel as part of our due diligence prior to making the decision to acquire the rest of the business.

The other thing I think I can do today is provide a brief update on the status of the case. That is a matter of public record. So where we are today, the courts have granted a stay of the litigation proceedings while we await a decision from the U.S. patent office as to whether they will undertake a review of the validity of the competitors' patents.

Beyond that, there's probably not a lot more that I can say at this point, but I would say that we're confident that our disclosure on the matter appropriately reflects our assessment of both the likelihood and the materiality of the situation. We're confident that we operate within our own intellectual property rights and within publicly available IP. And I think it's fair to say that there are likely some folks who are probably not as excited about Pason bringing 40 years of expertise and experience to the completions industry as we are.

[Keith MacKey, analyst]

Fair enough. And just one final one, if I could slip in the third, just on capital allocation. So CapEx going up a little this year. I think that's well understood. You've announced an increase to the dividend. What do you think that will mean for buybacks in 2024 relative to 2023?

[Celine Boston, executive]

Yes. So we've always been quite clear about the fact that 1 of the things we really like about the buyback program is the flexibility element to the program, and it allows us to kind of scale up or down, depending on other attractive investment opportunities that we see.

So I'd say specifically, as it relates to 2024, we certainly see an opportunity to invest in very attractive investments on both the drilling side and the completion side. And so the flexibility element of the share repurchase program will certainly be a factor as we think about making those investments.

[Operator]

[Operator Instructions] There are no further questions at this time. I will now hand the call over to Jon Faber. Please continue.

[Jon Faber, executive]

Thanks very much, John. I was reflecting this morning, tomorrow will mark my tenth anniversary at Pason. It would have been today if it wasn't 29 days in February this year. And I am more excited about where this business is today than I've been at any point in the 10 years I've been here. So I really do appreciate the continued support of all of our stakeholders for the business, shareholders, our suppliers, our employees, our customers, and we look forward to speaking to you again after our first quarter results in May. Thanks very much for joining us today.

[Operator]

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.