Pason Systems Inc.

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 Payson Systems Inc. 4th Quarter 2023 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star, then the number 1 on your telephone keypad. If you would like to withdraw your question, please press the pound key. Thank you. The contents of today's call are protected by copyright and may not be reproduced without the prior written consent of Payson Systems, Inc. Please note, the advisor is located at the end of the press release issued by Payson Systems yesterday, which described forward-looking information. Certain information about the company that is discussed on today's call may constitute forward-looking information. Additional information about Payson systems, including the risk factors relevant to the company, can be found in its annual information form. Still in Boston, CFO, you may begin your conference.

Thank you, John. Good morning, everyone, and thank you for attending Payson's 2023 fourth quarter conference call. I'm joined on today's call by John Faber, our President and CEO. Hello. I'll start today's call with an overview of our financial performance in the fourth quarter and for the 2023 year. John will then provide a brief perspective on the outlook for the industry and for Payson, and we will then take questions. I'm pleased to report on Payson'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, Payson 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 Payson since 2014, which was a record year for Payson, 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 Payson 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 Payson's cash and working capital balances held there. From a quarterly perspective, Payson 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, Payson 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. Growth 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. Payson'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 result 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 counts 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's 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 1st of 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 Payson for the three months ended December 31st, 2023 was $8.5 million or 11 cents per share, a decrease from the 36.3 million or 44 cents 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 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 Payson, 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 31st 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 John for his comments on our outlook.

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 Payson'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 Payson 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 Payson's initial investment in 2019. We've been impressed with the profile of IWS's revenue growth, as they've 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 to 25 million to its revenue in 2024, scaling up through the year, driven primarily by its automation offerings and of course subject industry conditions. We see a tremendous opportunity in the area of data aggregation in the completion space. Payson's history of data aggregation in the drilling industry over many decades, together with IWS's 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 tool base 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 system 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 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 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 1st. 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 would now be happy to take any questions.