Marcel Kessler - CEO Jon Faber - CFO

Ian Gillies - GMP Jon Morrison - CIBC Capital Markets

Thank you. Good morning, and welcome to Pason's Third Quarter 2017 Conference Call.

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

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

We are pleased with Pason's third quarter results. Pason generated revenue of $64.6 million in the quarter, an increase of 16% from the second quarter and up 67% from the third quarter of the previous year.

The main drivers of revenue growth were increased drilling activity in the North American land market and market share gains in The United States, both sequentially and year-over-year. The revenue growth in the quarter was negatively affected - negatively impacted by a stronger Canadian dollar relative to the U.S.

dollar. Revenue from the International business unit was flat with improvement in Australia and Andean region, offset by a decrease in activity in Argentina.

Adjusted EBITDA was $26.2 million, an increase of 35% from the second quarter and 208% from the same period in 2016. Adjusted EBITDA as a percentage of revenue was 41%, up from 35% in the second quarter.

The drivers of this improvement were the significant increase in revenue with high incremental margins and cost-reduction programs that was executed during the downturn. Pason recorded net income of $8.8 million compared to $6.9 million in the second quarter and a loss of $7.1 million in the third quarter of 2016.

In addition to the factors outlined earlier, the significant decline in depreciation expense led to the increase in income. Free cash flow for the quarter was $11 million.

And at September 30, our working capital provision is at $191 million, including cash of $159 million. There is no debt on our balance sheet and we are maintaining our quarterly dividends at $0.17 per share.

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

Thank you, Marcel. As Marcel noted, we are pleased with our financial and operating results in the third quarter.

We have been able to grow our competitive position in the U.S. market, while maintaining our positioning in both the Canadian and international markets.

Consolidated revenue in the third quarter totaled $64.6 million, a 67% decrease from $38.6 million in the same quarter of 2016. Revenue growth was primarily driven by increased industry activity in both the U.S.

and Canadian markets analog with an increase in U.S. market share.

at strengthening Canadian dollar during the third quarter serve to offset some of the revenue gains. Year-to-date, consolidated revenue of $179.4 million, is up 61% from $111.6 million in the first 9 months of 2016.

Adjusted EBITDA of $26.2 million was a 208% year-over-year improvement from $8.5 million a year ago and a 35% sequential increase from $19.4 million in the third quarter. Year-over-year incremental EBITDA margins of 68% in the quarter were compressed by cost incurred to meet to the increasing activity levels, particularly in the areas of equipment repairs and personnel related costs.

Sequential incremental EBITDA margins from the second quarter of 2017 were 77%. Adjusted EBITDA for the 9 months ended September 30 were $70.4 million, is up $54.6 million from $15.8 million in 2016.

The year-to-date incremental EBITDA margins of 81% remains consistent with our expectations of being able to achieve incremental margins in excess of 75% during a recovery in top line revenue performance. Capital expenditures in the quarter of $5.4 million were up $4 million from the third quarter of 2016 and were little changed sequentially from the second quarter.

To date, we have spent $11.6 million on capital expenditures, including capitalized portions of R&D and IT investments. We expect to spend approximately $20 million for the full year in 2017.

Free cash flow for the first 9 months of $59.1 million represents a $53 million improvement over free cash flow of $6.1 million in the first 3 quarters of 2016. Net income in the first 9 months of the year of $22.9 million was a $52.2 million improvement from a net loss of $29.3 million.

And I'll remind you that the 2016 loss included restructuring costs of $10.9 million. I will begin a brief discussion of segmented results by looking at the U.S.

business units. We improved our competitive position in the U.S.

market during the quarter with market share increasing to 58% from 56% in the third quarter of 2016. Market share also grew sequentially from 55% in the second quarter of 2017.

Year-to-date, U.S. market share 56% is up from 53% in the first 9 months of 2016.

Revenue per EDR day of $647 per day was a 2% decrease sequentially from the second quarter as a result of changes in customer mix the quarter. Year-to-date, revenue per EDR day of $648 is up slightly from $632 in 2016.

Quarterly revenue for the U.S. business unit of $40.7 million represented 63% of consolidated revenue and was up 82% year-over-year from the same period of 2016 and up 4% sequentially from the second quarter of 2017.

The U.S. revenue as recorded in Canadian Dollar was negatively impacted by the strengthening of the Canadian dollar during the third quarter.

For the 9 months ended September 30, U.S. business unit revenue of $109.8 million was a 76% increase from $62.3 million in the first 3 quarters of 2016.

Operating profit for the U.S. business unit for the first 9 months of $48.9 million was up $42.7 million over the same period of 2016.

Our Canadian business unit contributed $18.3 million of revenue in the third quarter, representing 28% of consolidated revenue. This was a 70% improvement over revenue of $10.8 million in the third quarter of 2016 and a similar improvement sequentially from the second quarter of 2017.

Our competitive position in Canada remains very strong. Market share of 89% has been unchanged in each of the last 4 quarters and is consistent with a market share we experienced through the 2012 through 2015 period.

Reported market share in 2016 was distorted by the disproportionate contribution of non-oil and gas activity during the downturn in oil and gas drilling. Revenue per EDR day has stabilized.

A quarterly revenue per EDR day of $1,041 was essentially unchanged from the second quarter of 2017. Year-to-date revenue of $52.8 million from the Canadian business unit was a 67% decrease from $31.6 million in 2016.

Operating income of $17.3 million in the first 9 months of the year was up $19 million from an operating loss of $1.7 million in the same period of 2016. International business unit revenue of $5.6 million during the third quarter was unchanged from the third quarter of 2016 and was down sequentially from revenue of $6.2 million in the second quarter of 2017.

Year-to-date, revenue of $16.8 million is down 5% from revenue of $17.7 million in the first 9 months of 2016. Despite the slight revenue reductions, the International business unit posted an operating profit of $484,000 for the first 9 months of 2017 compared to an operating loss of $3.7 million in the same period of 2016, representing a $4.1 million improvement.

Our balance sheet remains strong. At the end of the third quarter, we had positive working capital of $191 million.

Despite the negative impact from an increase in noncash working capital and foreign currency translation effects from his strengthening Canadian dollar in the quarter, our cash balance at September 30 stood at $159 million. We continue to have 0 debt on the balance sheet and we are maintaining our quarterly dividend at $0.17 per share.

I'll now turn the call back to Marcel for a brief perspective on the outlook for the industry and for Pason.

Thank you, Jon. Our customers have learned to operate in a low over longer commodity price environment.

Operators around the world remain highly focused on the costs and efficiency of the drilling operations. In addition, and analytics are rapidly growing priority for many E&P companies.

In the context of drilling, there is a significant value to be unlocked by correlating drilling and completion practices with the lifetime production of the well Also, many drilling contractors are looking to differentiate their service offering from their competitors through new technology. In response to these evolving customer needs, we had recently increased our investment in R&D and IT with further growth plans going into 2018.

We are continuously enhancing the functionality and performance of existing products and growing development efforts are focused on being a key enabler of the Big Data analytic strategies and of drilling optimization and automation efforts. Many of 4 products that directly improve the efficiency, effectiveness and safety of drilling operations and wellbore quality.

Examples of this include our ePVT adaptive alarms, our AC AutoDriller, the [indiscernible] directional adviser and the deployment of the advanced Exxon Drilling Advisory System. We are building on our acquisition of analytics to provide customers with a holistic platform to analyze drilling completions, production, financial and operational data.

Going forward, our capital expenditures will be relatively modest with a larger portion of development efforts focused on software and analytics. We intend to spend approximately $20 million in closing capital expenditures in 2017 and up to $25 million in 2018.

Our highly capable and flexible IT and communications platform can host new Pason and third-party software both at the rig site and in the cloud the reduction in oil in the third quarter highlights that the oil market is now in balance. As a result, we have seen upward movement in oil prices.

Comments from several OPEC countries as well as from Russia suggest that the reduction of existing production cuts - extension, sorry, extension of the production cuts beyond the current agreement is a possibility. Further upward movement in oil prices and subsequent growth in global E&P investment are possible in the medium term.

This would further stimulate drilling activity worldwide. Pason's market position remains very strong.

We are the service provider of choice for many leading operators and drilling contractors with Pason equipment installed on over 65% of all active land drilling rigs in the Western hemisphere, that is currently over 800 drilling rigs. We are uniquely positioned to participate in the industry's growth.

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

With respect to incremental margins in the U.S., they've been slowing throughout the year, but as we think about the U.S. rig count moving to '18 those incremental margins, do you think you have enough people in place now that they kind of stay where they are as we move forward?

Or is there amount of cost you are going to need to continue to add where we may continue to see some degradation in those financial metrics?

Look at the incremental EBITDA margins last couple of quarters, the compression has come from increased and personnel related costs, that's been driven by increases in activity specifically Pason activity. And sometimes may be gets little bit in our U.S.

market share that the shift a lot of drilling in the U.S. is happening has changed over the last number of years.

There is a substantial amount of activity particularly in the Permian now where we've had significant increases in our regional market share, and so we've had quite a bit of tramping around activity in regions where we've gained a lot of market share and that's driven some of these personnel related costs. So as the rig count now kind of a little bit, it's likely that we can sort of see some of those costs stabilize or perhaps even retrieve on the repair side.

But it's largely the last couple of quarters, driven by this very regional effect of market share growth.

Thanks, Jon. That's helpful.

And may be following on that a little bit, I mean when I think of Pason, I think of an asset business, your highlighting Can you maybe just provide some additional detail around the nature of and why that's happening?

You will recall the mix of that the platform hardware equipment needed installed and deploy in a number of software products. And so, as we talk about a new product, we talk a lot about becoming less capital intensive because of this more software-based element.

But as we're gaining incremental rigs we're putting equipment back to work to work equipment installed, there is a hardware hosting platform that we have to deploy to those. And so, some of the repair expense would be driven by that hosting platform component of the product portfolio.

And to add to that, I think, it's fair to say that we have not spend much on repairing and maintaining through downturn. So much of that hardware infrastructure service et cetera were simply now warehoused over the last of 2 years waiting for increased activity and now that activity has picked up.

So as many of those products need a bit of a refresh, a clean-up, may be new software installed before they be allowed to the field and that's the main drivers of increasing apparent mated and spent.

Okay. That's helpful.

You noted in the release that you expect CapEx to decline in '18 relative to '17 or something along those lines. But given the focus on software, should we be thinking about an increase in R&D expense are run rate R&D expends more closely associated with what we saw in Q3 or some additional items in that number in this quarter?

Just to clarify on CapEx, we said we will spend approximately $20 million in 2017 and up to $25 million in 2018. So, it's not the reduction.

It's probably a small increase. In terms of R&D spend, I think we are planning on the order of a 10% increase in R&D spent some of which is already included in the fourth quarter, maybe half of that and other of will hit the run rate in Q4 and Q1 '18.

Okay. And last one from me, I think, it's the first quarter seen any mention of completions related or completions in drilling activity in Pason's commentary and its MD&A.

And so strategically moving forward, is Pason looking way to try and add software to gain some exposure to the compression side of the business or into that?

So that comment is specifically as it relates to the software package, which is analytics and told for Big Data and its fundamentally agnostic to the data source. Traditionally, Verdazo has been focused on the productions, operations and financial side of the business and we are now looking to add the completion and drilling side of the business.

But it's that software package that we're talking about now in terms of completions. There are no plans that this is going to start in the field around the completion site.

It's the back-office analytics part around completions.

Really impressive EBITDA margins, again, year-over-year also sequentially. Do you think there is room for a few more legs up on EBITDA margins moving forward wax our resort of nearing a feeling, so to speak?

We talked about agreement at EBITDA margins from the trough. We could talk about this notion around incremental margin in excess of 75% and we that would be somewhat lumpy over the various quarters as it unfolded and in excess of that and quoted a little below that.

I think that can change it continues to be a good target north of 75% incremental EBITDA margins going forward.

Okay. It's very helpful.

Absent any like to rig count increases or sort of like a flattening environment, do you guys think that like the PSI intensity per week, so to speak, still has room to grow? Or is it also sort of capping of?

So, I think, really there are several segments here. I think in terms of drilling data, let's go into the rig site as such in terms of the acquisitions of data, that is closely correlated with overall record, and I think that will recounts do.

In terms of data management, at the of data into back-office systems of the customers into EDR systems, I think, we believe there is a significant growth opportunity there both in terms of increasing the data to our customers back-office systems and also in terms of analytics platform. So that's the data side.

Then, in terms of the rig side, we believe there is room for growth around the area that we call drilling intelligence So everything around drilling optimization, drilling automation, that's where the comes in. All that is fairly early stages of trial and deployment.

So, we expect there is room for on the back of his in terms of more data, more analytics and to the field in terms of new software to improve and enhance the quality of the network.

May be additional comment I'll make here, Michael. We can talk quite a bit about our customer mix being more contractors and operators and you would've noted this quarter a little bit of pressure on revenue from customer mix.

You know we've had some significant dates or the contractor side, which sometimes presage incremental operating revenue coming alongside. And so, to the extent that mix again rebalances, that would increase the intensity of some of the Pason products at the rig side as well.

Can you talk about the competitive landscape in the U.S. right now?

And does the recent M&A in the oilfield instrumentation market, such as Trinidad purchasing rig concern you all that traditional customers are trying to get in your backyard?

So obviously, the recent acquisition of by Trinidad, that's not really affected market share yet in U.S. or anywhere, but we'll have to see how that plays out.

They're competitive situation in the U.S. has not been changed for a significant number of years.

It is essentially duopoly situation with 1 large drilling contract and on their own system as the third player. So, it has been very, very stable.

Okay. In terms of the international market, would you expect any step changes in Middle East market share are the number of Pason products per week in an international market in 2018 that would give you any form of structural growth about went beyond just the simple current cyclical recovery in drug activity?

So, we certainly are working towards and hoping for a significant increase in market share in the Gulf area. Now the business development cycle in this market is typically locked, but we have reasons to believe that there should be a significant uptake in Pason activity in the areas around the globe.

Can you give an update on some of the early trials and adoption rights is that you're seeing for some of the new products, such as ePVT, the Exxon advisory system, and you call it the last 3 or 6 months that we haven't talked about recently?

I don't think we are able to discuss this. They are all in various different stages of trials, like some of the newest products are technical field trials.

Other are in very early stages of commercial adoption, but maybe a dozen customers that are paying for the product, but they're all in different stages. I don't think we are dead position to talk about it in this call today.

I'll ask in a different way. Is the path to revenue recognition and had are behind of your expectations call it versus 6 to 12 months ago?

I'll answer it differently. I think in terms of a lot of these products, it involves a lot of behavioral changes and how some of the workflows happen at the rigs.

And so, we haven't necessarily had a very sort of near term defined revenue expectation as much as qualitative indications that pierce the somewhat flawed option and changes at the rig site. Clearly, increasing our investment Authority site is supported by some of these what we're seeing on trials of various products.

Okay. Can you share with us what you expect in the AutoDriller based on the early times you did with his customers?

So, we believe that the is actually more of a middleware that is required for many installations to host a more powerful drilling optimization or automation algorithm. So, we don't believe that it will be much of a stand-alone product per se, but the required, let's call it left for example, the Exxon algorithm and automation.

Just a follow on Ian's question, are the rising and fuel costs that you mentioned in the release, something that was particularly inflated in Q3? Or is your point of remind investors that as activity rises, so do costs and it would be naïve to think abetting criminals can kind of sale forward at 75 plus percent every quarter as activity levels rise from here?

Certainly not those costs, whatever I think Pete in the third quarter. Because a lot of that work has been done ahead of the increased activity, and of course, the activity now is splattering a little bit.

So, we wouldn't be necessarily incorrect some of those at the same level going forward providing the regional basis of some of these things doesn't change and the overall account doesn't change.

I realized I ask this question every quarter, but are the competitive pressures in Canada any different today than they were 3 months ago?

No, I don't think so. We haven't really seen any change, any material change in Canada for the last two quarters actually.

Last one just for me, are you contemplating higher pricing across products in 2018 given the rise your seat in North American activity levels?

The short answer is, yes for selected products, especially in The United States.

Thank you, everyone, and have a great day.