Marcel Kessler - President and CEO Jon Faber - CFO

Greg Colman - National Bank Financial Jon Morrison - CIBC World Markets

Thank you. Good morning, and welcome to Pason's second quarter 2017 conference call.

With me here in Calgary is Jon Faber, our Chief Financial Officer. I will start with the highlights of second quarter performance.

Jon will dive into details of our financial and operational performance. And I will close with our perspectives on the outlook for the industry and for Pason, and we will then take any questions.

As you know, the second quarter of each year generally has the lowest drilling activity in Canada due to spring breakup, when many areas are not accessible because of ground conditions. As a result, financial performance in the second quarter is usually weaker than in the first.

This was again the case this year. However, due to higher drilling activity in the United States, in Canada and in certain international markets, especially Australia and the Andean area, as well as lower operating costs, Pason's financial performance improved significantly from the second quarter of 2016.

Revenue was up 105% to $55.8 million. Income for the second quarter of 2017 was $6.9 million or $0.08 per share compared to a loss of $11.3 million in the previous year period.

At June 30th, 2017, our working capital position stood at $197 million, including cash at $167 million. There is no debt on our balance sheet and we are maintaining our quarterly dividends at $0.17 per share.

The key drivers of financial performance were; one, higher drilling activity in the United States, especially in Texas, Oklahoma, and Louisiana as well as in Canada; two, an increased U.S. market share; and three, a significant reduction in operating costs and depreciation.

The impact of previously implemented cost reduction program is highlighted by comparing this quarter results with the second quarter of 2015. While revenue was essentially at the same level, EBITDA increased from $7.5 million in the second quarter of 2016 to $21.1 million in the second quarter of 2017.

And our net income was also much improved. We expect to continue to reap the benefits of our lower fixed cost structure into the foreseeable future.

I am now turning the call over to Jon Faber for a more detailed look at the financials.

Thank you, Marcel. As Marcel indicated, the company posted strong financial results in the second quarter on the back of increased industry activity, a growing share of the U.S.

market, and efforts taken over the past two years to reduce and control costs. Consolidated revenue increased 105% as compared to the second quarter of 2016 and totaled $55.8 million in the quarter.

Sequentially, revenue decreased 6% from $59 million in the first quarter, due to the seasonality of the Canadian business unit. Adjusted EBITDA of $19.4 million in the second quarter represented an increase of $20.8 million from adjusted EBITDA of negative $1.5 million in the same period of 2016 and was down from adjusted EBITDA of $24.9 million in the first quarter.

Adjusted EBITDA margins of 35% in the second quarter were down from 42% in the first quarter, owing to the operating leverage in the business as well as increased operating costs incurred to meet increasing activity levels, particularly in the U.S. business unit.

The company posted net income of $6.9 million in the second quarter compared to an $11.3 million net loss in the second quarter of 2016 and net income of $7.2 million in the first quarter of 2017. Free cash flow for the second quarter totaled $19.6 million, a $22.1 million improvement from the prior year period and down 31% sequentially from the first quarter.

For the first six months of the year, consolidated revenue came in at $114.8 million, representing a 57% increase over the same period of 2016. Adjusted EBITDA of $44.3 million was up $37 million from the first half of 2016 and net income of $14 million compared to a net loss of $22.2 million in 2016.

Results in the U.S. business unit continued to be strong in the second quarter.

Revenue for the quarter totaled $39.2 million, up 139% from the second quarter of 2016 and up 31% sequentially from the first quarter. U.S.

revenue growth was driven by increased industry activity as well as year-over-year growth in both market share and revenue per EDR day. U.S.

market share was essentially unchanged from the first quarter while revenue per EDR day increased 4% sequentially. While we continue to incur personnel and equipment repair related costs associated with growth and activity levels in the U.S.

business unit, the significant operating leverage in the business drove strong growth in operating profit with operating profit margins expanding by almost 1,200 basis points compared to the first quarter, generating operating profit of $18.7 million. Year-to-date, the U.S.

business unit generated $29.5 million of operating income on revenue of $69.2 million, representing a $27.7 million improvement in operating income on the back of a $29.1 million increase in revenue. Our Canadian business unit also had an excellent quarter, posting a 110% year-over-year improvement in revenue to $10.5 million this year as compared to $5 million in the same period of 2016.

Sequentially, revenue decreased 56%, owing to the seasonality of oil and gas drilling in Canada. Strong growth in industry activity was the primary driver of the year-over-year revenue increase.

Our market share in Canada was unchanged from the first quarter of the year. While we continue to see the run rate effects of pricing concessions made throughout the last year, Canadian revenue per EDR day increased 7% sequentially to $1,044 per EDR day from $975 per EDR day in the first quarter of the year.

The Canadian business unit posted an operating loss of $725,000 in the second quarter, a $4.6 million improvement from the second quarter last year. For the first six months of 2017, the Canadian business unit posted revenue of $34.5 million, up 66% from 2016 and operating profit of $11.5 million, up from an operating loss of $2.4 million in the first half of 2016.

The international business unit contributed revenue of $6.1 million in the second quarter, up 6% year-over-year and up 20% sequentially from the first quarter of the year. Activity levels in Argentina, our largest contributor to international revenue, was down year-over-year, but improved sequentially from the first to second quarter.

While activity in other areas, including Australia and the Andean region, were stronger on both a year-over-year and sequential basis. Operating profit of $337,000 for the quarter was a $473,000 improvement from the first quarter of the year and up $527,000 from the same period of 2016.

For the first six months of the year, revenue of $11.2 million was down 8% from 2016 levels while operating profit improved by $1.6 million to $203,000. Finally, I'll turn to capital expenditures in the balance sheet.

Capital expenditures in the first six months of the year totaled $6.2 million, including $5.1 million in the second quarter. This is down 46% from capital spending in the first half of 2016.

We continue to expect to spend up to $25 million on capital expenditures in 2017, as we continue to invest in providing an industry-leading hosting platform of computing power and communications infrastructure at the rig site for the deployment of software-based products and drilling algorithms. As at June 30th, we had positive working capital of $197 million, including a cash balance of $167 million.

We continue to have no debt on the balance sheet and we're maintaining our dividend at $0.17 per share. I'll turn the call back to Marcel.

Thank you, Jon. And I will close with a brief perspective on the outlook.

Since the beginning of the year, our growth in drilling activity in North American land has exceeded our expectations. The U.S.

land rig count now stands at about 930 and at 216 in Canada. However, we believe growth will be muted going forward.

We don't expect to see immediate reductions in operator capital budget and thus, drilling activity, but as always, operator capital budgets will be impacted by future commodity prices and the potential to return to lower commodity prices may create headwinds to continued growth in industry activity. In addition, in Canada, we still have pipeline and LNG uncertainty.

Pason's two main objectives for 2017 remained unchanged. One is to fully participate in the industry's upturn, while continuing growth of the cost base; and two, to become a key enabler of drilling automation and big data of strategies.

We continue to invest approximately $30 million annually in R&D and IT. We continuously enhance the functionality and performance of existing products.

New product development efforts are focused on products that directly improve the efficiency, effectiveness and safety of drilling operations and wellbore quality. Examples of this include our ePVT adaptive alarms and Digital Trip Sheets, our AC AutoDriller, the abbl Directional Advisor, and the deployment of the advanced Exxon Drilling Advisory System.

We are building on the acquisition of Verdazo Analytics to provide customers with a holistic platform to analyze drilling, production and operational data. The deployment of an enhanced Live Rig View web service to our cloud-based offering benefits office-based users of Pason data.

As Jon mentioned, our capital expenditures will be relatively modest going forward with a larger portion of our development efforts focused on software and analytics. Our already capable and flexible rig site IT and communications platform can host additional new Pason and third-party software without additional CapEx.

Pason's market position remains strong and the outlook for our new products and services looks promising. We are a service provider of choice for many leading operators and drilling contractors with Pason equipment installed in over 65% of all active land drilling rigs in the Western Hemisphere and a growing presence in the Middle East.

And we'll now be happy to take any questions.

Hi guys, congrats on the quarter.

Thanks Greg.

Just a couple of quick ones for you here. First, I'd like to start by talking about revenue per EDR day.

We saw some modest but directionally positive growth sequentially there. I'm wondering what is the driver behind that?

Is that just sort of noise in the numbers, you just call it within the margin? Or was it product mix changing in favor of more expensive services?

Or was there a pricing increase in there?

So, there was certainly no pricing increase in there yet. It would have been a collection of an increased production of some of the newer products.

So, some of the products I mentioned, including the new features for the ePVT, abbl Directional Advisors, some AC AutoDriller revenue would have played a positive role in there.

Got it, okay. Mainly, -- okay.

And Marcel, I just want to pick on one word is there, which was yet -- trying to reconcile that with sort of a more cautious outlook in your prepared remarks. Is that something that you're kind of contemplating or is working at the system now?

It's nothing worth contemplating. It's not in the works yet and I think if it were to materialize will be more likely to happen in the U.S.

than in Canada at the -- in the short to medium term.

Got it. Switching over to sort of more cash and capital intensity style stuff.

The commentary in the prepared remarks about sort of a $25 million to $30 million all-in capital budget, would that be -- if we're just thinking longer-term here, is that a good number for us to be using basically indefinitely absent any kind of M&A? Or is that capital budget kind of artificially compressed because you have a surplus of equipment that hasn't really been utilized over the past years at the low rig count that we would expect it to kind of trend up maybe not in 2017 or 2018, but kind of beyond that?

Good question, Greg. I think the $25 million might be a little bit low relative to sort of run rate in a "normal environment " because to your point around excess equipment, but I think something in the neighborhood of $30 million sort of go forward is quite reasonable considering that much of the platform is moving towards more software-based and the amount of hardware products that we use to host the functionality of the overall system is reduced, vis-à-vis, historically, what we would have had out there.

Okay. So, maybe if I'm thinking DCF style modeling, a longer term, $30 million would be a good place to go.

Jon, would there be any longer cycle kind of hardware upgrades that we need to be thinking about again, looking at quite long kind of five, 10 years that would be bumping up burst of capital intensity?

No, I think that $30 million is a bit of an average. You recall that we made a significant investment of CapEx in 2014 to the order of $120 million, which represented really a refreshing of much of the platform.

And so, there may be some lumpiness with the replacement cycle in some of that CapEx. But I think that the $30 million as an average is quite good.

Okay, great. So, that kind of leads to my next question, which has to do with cash balance and free cash flow generation, which is, you kind of couple quarters here where we've seen the balance sheet go back on the growth mode, net of all expenses and always spending, including the dividend and everything.

And per your prepared remarks, comparing this quarter back to 2015, obviously, your cash costs, your expenses have been lowered. What are the thoughts right now as to the use of that presumably now growing balance sheet, especially in the context of a business, which has lower capital intensity from prior cycles?

So, the question around the dividend is always reminiscent around the quarterly base, on the basis of cash balance, cash flow generation, and the outlook. And to Marcel's prepared remarks, the outlook for 2018 is quite uncertain.

So, I think it will be a little bit premature for us to look at growth of the dividend. But clearly, we're comfortable with the current dividend -- at the level of that today.

What were other uses of now growing in sizable cash balance, being is it just something that you're looking as kind of war chest for opportunities in the future? How do you think of your waterfall of what do we do with the money?

There's a collection of things you can do, of course. M&A is always a potential use of cash now that's opportunistic.

And I think we're doing a lot more in terms of partnerships and those license agreements and those sorts of things to access technology. So, that's more likely investment in some of those technology developments.

The question around share buybacks may become relevant at the point that you have a more confident outlook and a view that you might have more cash than you want on the balance sheet. And at some point in the future, with confidence around industry conditions, we may revisit the regular dividend growth as well.

Okay. Thanks for walking through the -- process.

That's it from me.

Thank you, Greg.

Good morning all.

Hi Jon.

Good morning Jon.

Marcel, you talked about the ongoing pricing competitive pressures in Canada, but your market share remains fairly stable. So, is it fair to assume that you're just electing to discount price to maintain market share?

And is it fair to assume that, that's going to be the go-forward strategy as well?

So, I don't think there really has been a material change over the last quarter or two in terms of competitive pressure, pricing intensity in Canada. I would say it's just that, as tough as it has been in 2016, I don't think we have made further material pricing concessions in Canada.

And I think as evidenced also by the sequential increase in revenue per EDR day that we have seen. So, I don't think we are willing or able to really engage in a significant price war in Canada.

I think on the select bases, we make some concessions for very large customers. But by and large, we try to compete on service quality and product functionality.

Okay. So, you're just referencing it as an ongoing headwind, not arising intensity by any means?

No, it's -- I would say, it's -- unlike the U.S, where we have seen some easing of that pressure, especially in the southern states, the drilling activity has really picked up and therefore, supply has become an issue in some cases. That's still -- that's clearly not the case in Canada.

It's just that hasn't really changed, but it hasn't increased, either.

Okay. Jon, how meaningful is the non-energy exposure in the quarter in terms of EDR rental days?

Like can you give any sense of what percent of your Canadian EDR rental days were outside of upstream energy?

That's becoming much less of a contributor as oil and gas drilling increases. So, it wouldn't have been that significant of a contributor to the 2017 market share.

When you look back to 2016, when there is so little drilling activity, it would have been much more meaningful. And that's why, if you look at how we calculate market share, it would have gone in excess of 100%.

But that's more of 2016 effect, it really didn't have much effect in 2017.

Okay. You don't want to probably share a number for non-energy though EDR days?

No, we don't disclose that.

Okay. On the strength of the Andean region, is that all Colombia and Peru?

Maybe a bit of Ecuador, but these will be the three countries here.

Okay. Can you just give a quick update on the Verdazo integration and how you're thinking about the business expanding into the U.S?

And is it fair to assume that an accelerated sales cycle is a likely scenario, given that you already probably on every producer's approved vendor list in the lower 48 and you've already got a sales group that can lien and roll that product probably quicker than you developed in Canada?

Well, I think -- I wish it were as easy as that. It's a different -- so that's the current that the legacy Verdazo product is focused on the production side of things, production and operations.

And as you know, that's a very different division or group within all operators, very distinct from the drilling group. So, even though our business development and sales groups in the U.S.

have access to most drilling teams in the lower 48; that is not the case for the production site. So, we may be able to open doors and have easier access, but it's not quite as simple as it sounds.

But that said, obviously, I think with Pason's help, the markets entering the U.S. should be quicker and more feasible.

So, that is one push. The other push is, obviously, to integrate the drilling data set with the existing production and operations based assets that Verdazo already has and to provide a more holistic platform to analyze drilling data to have drilling completions, production operations.

And ultimately, what I've described as probably the Holy Grail of analytics for the oil is to correlate the drilling and completions practices with the lifetime production of the well or the [Indiscernible]. So, that is the ultimate goal here in our analytics space.

It's also a multiyear process. So, there is no new product out there yet, but it's work in progress.

Jon, you referenced the sequential rise in revenue per EDR day on the quarter. And specific to Canada, would you expect that to inverse in Q3 as it's a function of rig mix?

Or you believe that ancillary products are accelerating within Canada?

There is a rig mix question. So, it's always a little bit hard to predict exactly which rigs will come to work.

I think it may be stable. It may go down a little bit due to rig mix.

And whether that will be offset with some further adoption is a question.

Okay. On the year-over-year incremental margins in the quarter, can you give any idea of how much of the bump is related to 3PS not being in the quarter?

Like I realized that you had much better fixed cost absorption. But is it fair to assume that the year-over-year gains in the back half of the year will be more muted since the majority of your expense cutting probably took place right around mid-2016?

Yes, and I think the incremental margins are likely to continue approximately the same level that we're at today. The 3PS contribution wasn't that significant.

And as you can appreciate some of the costs around personnel, repair were probably a little bit heightened in the early stage of the ramping up. And so as the industry sort of -- the growth slows a little bit, you would see a little bit less of that continued growth for anticipation of increased activity.

So, those incrementals may hold.

Okay. So, you're not expecting incrementals to slow in the back half of the year even though a lot of your cost cutting was in mid-2016?

Well, so in the second quarter, a lot of that cost cutting would have been reflected. The first quarter would have -- that wouldn't have been the case because that significant amount of cost cutting happened at the end of the first quarter in 2016.

So, there's a more significant incremental margin impact from cost cutting in the first quarter. The second quarter, the cost base was much more apples-to-apples.

Okay. Marcel, can you give an update on the expansion in the Middle East and high level what you're seeing country-by-country for adoption rates right now?

So, I'll talk about the Saudi Arabia JV first. So, I think as discussed on the previous call, we did after a couple of years of business development that would get our first direct contract in Saudi Aramco.

The installing on a number of rigs there started here in the second quarter. We would currently be on close to 30 drilling rigs in the kingdom.

That would be about 15% market share of the rigs currently drilling in Saudi Arabia. So, that is a good news story.

It's taking longer than we expected, but it's moving in the right direction. As for the other countries, they -- I'm not going to speak country-to-country there.

I think we've had some success acquiring some rigs, some additional work in Oman recently. We are making some progress in the United Arab Emirates and working on Kuwait, which has just announced a significant increase in rig building and drilling programs for the next few years.

So, that's really the area of focus. Kuwait, Oman, United Arab Emirates, Qatar, in addition to the joint venture in Saudi Arabia.

So, it's -- I would say, slow and steady growth at the moment.

Okay. Last one just for me.

You made reference of the ePVT, AutoDriller on the AC side, abbl and then the Exxon Drilling Advisory System seeing success. Can you wrap any numbers around what those successes look like?

I can assume ePVT is the strongest, but how many rigs are now running in AC AutoDriller? And what's the line of sight to improve in the next six to 12 months?

We're not disclosing those numbers yet. It is also a mix of technical trials, which are not paid, and paid trials depending on the region or country.

So, we're not talking about the detailed numbers here.

Okay. Is it fair to assume that the Drilling Advisory System is being tested on multiple customers, operations outside of just Exxon?

That is clearly the case. And also, it involves North America and internationally.

Okay. Appreciate the color.

Good quarter. I'll turn it back.

Thanks Jon.

Thank you, Jon.

There are no further questions? Thank you all very much for your time.

We wish you a nice day.