Pason Reports Second Quarter 2014 Results

CALGARY, Aug. 6, 2014 /CNW/ - Pason Systems Inc. (TSX:PSI) announced today its 2014 second quarter results.

Performance Data

Q2 2014 vs Q2 2013
The Company generated consolidated revenue of $103.9 million in the second quarter of 2014, up 26% from $82.4 million in the same period of 2013. Growth in US market share, increased rig activity in all of its major markets, continued robust growth in Communications, Software, and the Gas Analyzer categories, strong market acceptance of the new Pason Rig Display (PRD), and a strengthening of the US dollar relative to the Canadian dollar all contributed to revenue growth in the second quarter.

Consolidated EBITDA was $46.0 million in the second quarter, an increase of $73.8 million from the second quarter of 2013, due to strong operational performance, combined with the fact that in the second quarter of 2013 the Company recorded an additional litigation provision as a result of the AutoDriller lawsuit settlement.

Net income increased by $57.0 million to $17.6 million ($0.21 per share) in the second quarter of 2014 from a net loss of $39.4 million ($0.48 per share) in the prior year period. Earnings were positively impacted by market share growth in the US, increased rig activity, and the appreciation of the US dollar relative to the Canadian dollar. Earnings for the comparative period were impacted by the litigation provision that was recognized in the second quarter of 2013.

President's Message

The second quarter is usually the weakest for Pason due to the seasonality of Canadian drilling activity. However, drilling industry days in Canada were up 35% in the second quarter of 2014 compared to the previous year due to a longer winter drilling season and a drier-than-usual spring break-up. Drilling industry days in the United States also increased by 5% during the period.

Against this backdrop, Pason demonstrated strong operational and financial performance. Total revenue increased 26% from the previous year period to $103.9 million, representing record second quarter revenue for the Company. In addition to a favorable market environment in North America, this growth was driven by an increase in US market share, continued growth in product penetration, new revenue in frontier and offshore markets, and a strengthening of the US dollar relative to the Canadian dollar. The changes in foreign exchange rates were responsible for about 15% of the revenue increase.  All of Pason's major product categories generated revenue growth above industry activity, led by a year-over-year increase in the Communications category of 55%.

EBITDA for the second quarter was $46.0 million, compared to negative EBITDA in the previous year period due to a significant litigation provision. The Company recorded net income of $17.6 million, or $0.21 per share, compared to a net loss of $39.4 million, or $0.48 per share, in the second quarter of 2013.

Capital expenditures for the second quarter were $18.3 million, up from $14.2 million the previous year, as deployment of new hardware, including Rig Display and components of the EDR evolution, continued. On June 30, our cash position stood at $144.6 million, plus $12.4 million held in trust for the payment of the dividend in July. There is no debt on the balance sheet.

We are increasing our quarterly dividend by 13% to $0.17 per share.

United States

The US segment, our largest business unit, includes our US rental business and 3PS Inc., our Austin-based sensor manufacturer.

The number of drilling industry days in the second quarter of 2014 was up 5% from the second quarter of the previous year and up 6% from the previous quarter. Revenue for the period increased 23% to $71.8 million. Revenue growth above industry day growth was achieved through an increase in market share, higher product penetration and a favourable movement in the exchange rate. EDR market share for the second quarter averaged 61%, up two percentage points from the previous quarter and up four percentage points from a year ago. On average, 1,074 US land rigs were operating Pason equipment during the second quarter of 2014, compared to 969 in the same period of 2013.

Average daily revenue per rig increased by 7%, from US$603 to US$643 from the previous year and by 2% from the previous quarter. Communications and EDR peripherals again showed above average growth rates during the period.

Our US business unit was able to generate an operating profit of $40.2 million in the second quarter, an increase of 40% over 2013. Operating profit was 56% of revenue compared to 49% for the previous year, as the business unit was able to effectively leverage its fixed cost structure and control variable costs.

Canada

Drilling activity in Canada was significantly higher in the second quarter of 2014 than in the previous year, with industry days up 35% due to favorable weather conditions. Revenue for the second quarter increased 46% from the prior year period to $19.8 million. Market share was 90%, up three percentage points from the previous year period. On average, 180 Canadian land rigs were operating Pason equipment compared to 130 the year before.

Average daily revenue per rig increased 5% year-over-year to $1,195. Communications, Gas Analyzer and Software showed above average growth rates during the period.

Operating costs increased by 20% year-over-year, primarily due to the acquisition of an additional segment of satellite bandwidth. Our Canadian business unit was able to generate an operating profit of $4.5 million for the second quarter of 2014 compared to $0.3 million the year before.

International

Our International business unit, which includes our businesses in Latin America, Australia, and Offshore & Frontier regions, also had a solid quarter. Revenue increased by 19% to $12.3 million for the period compared to the previous year period, and was up 10% from the previous quarter. Australia, Argentina and the Middle East/North Africa and Offshore demonstrated strong growth. This was partially offset by the devaluation of the Argentine Peso.

The International business unit was able to generate a quarterly operating profit of $3.5 million, an increase of 218% over the previous year, and up 19% from the previous quarter. The International Business Unit was thus able to generate 12% of Pason's total revenue and 7% of operating profit.

Outlook

Analyst outlooks for drilling industry activity in North America are modestly positive for the remainder of 2014 and going into 2015 driven, in part, by LNG-related gas drilling activity in Canada and the United States.

We expect that some of the new products and product enhancements, both on the hardware and software sides, will continue to gain traction in the North American market. This includes the new Rig Display (a ruggedized 19-inch touch screen computer) and the enhanced Pit Volume Totalizer (ePVT). We also expect continued growth in the Gulf of Mexico, the Middle East, and other frontier regions.

We plan for an increase in our R&D, IT and Corporate Services costs as we make important investments in our technical infrastructure and systems, as well as in our business development capabilities. Our capital expenditure forecast for the next 12 months is up to $125 million, $92 million of which is directed towards new hardware that can generate incremental revenue or save operating costs. Our cash-generating capacity and our cash position are more than sufficient to cover new business development, planned equipment upgrades and the dividend.

(signed)

Marcel Kessler
President and Chief Executive Officer
August 6, 2014

Management's Discussion and Analysis

The following discussion and analysis has been prepared by management as of August 6, 2014, and is a review of the financial condition and results of operations of Pason Systems Inc. (Pason or the Company) based on International Financial Reporting Standards (IFRS) and should be read in conjunction with the consolidated financial statements and accompanying notes.

Certain information regarding the Company contained herein may constitute forward-looking statements under applicable securities laws. Such statements are subject to known or unknown risks and uncertainties that may cause actual results to differ materially from those anticipated or implied in the forward-looking statements.

All financial measures presented in this report are expressed in Canadian dollars unless otherwise indicated.

Additional IFRS Measures
In its interim condensed consolidated financial statements, the Corporation uses certain additional IFRS measures. Management believes these measures provide useful supplemental information to readers.

Funds flow from operations
Management believes that funds flow from operations, as reported in the Consolidated Statements of Cash Flows, is a useful additional measure as it represents the cash generated during the period, regardless of the timing of collection of receivables and payment of payables. Funds flow from operations represents the cash flow from continuing operations, excluding non-cash items. Funds flow from operations is defined as net income adjusted for depreciation and amortization expense, non-cash stock-based compensation expense, deferred taxes, and other non-cash items impacting operations.

Cash from operating activities
Cash from operating activities is defined as funds flow from operations adjusted for changes in working capital items.

Funds flow from operations and cash from operating activities were impacted by the Company's accounting for the litigation provision. Before 2013, the Company recorded it as a non-cash add back to arrive at funds flow from operations. In 2013, the provision and settlement was treated as a change in working capital to calculate cash from operating activities.

Non-IFRS Financial Measures
These definitions are not recognized measures under IFRS, and accordingly, may not be comparable to measures used by other companies. These Non-IFRS measures provide readers with additional information regarding the Company's ability to generate funds to finance its operations, fund its research and development and capital expenditure program, and pay dividends.

EBITDA
EBITDA is defined as net income before interest expense, income taxes, stock-based compensation expense, and depreciation and amortization expense.

Free cash flow
Free cash flow is defined as cash from operating activities plus proceeds on disposal of property, plant and equipment, less capital expenditures and deferred  development costs.

Overall Performance

Electronic Drilling Recorder (EDR) and Pit Volume Totalizer (PVT) rental day performance for Canada and the United States is reported below:

Electronic Drilling Recorder
The Pason EDR remains the Company's primary product. The EDR provides a complete system of drilling data acquisition, data networking, and drilling management tools and reports at both the wellsite and customer offices. The EDR is the base product from which all other wellsite instrumentation products are linked. By linking these products, a number of otherwise redundant elements such as data processing, display, storage, and networking are eliminated. This ensures greater reliability and a more robust system of instrumentation for the customer. Revenue generated from the EDR increased 27% for the second quarter of 2014 compared to the same period in 2013 and 20% on a year-to-date basis. These increases are attributable to continued growth in demand for EDR peripheral devices, the roll-out of the Rig Display in Canadian and US markets, an increase in US market share in 2014 over the second quarter of 2013 (61% versus 57%), a strengthening US dollar relative to the Canadian dollar, and increased revenue in International markets. Industry activity in the US market increased 5% in the second quarter of 2014 (3% on a year-to-date basis), while second quarter Canadian rig activity increased 35% compared to the same period in 2013 and 11% year to date. Canadian EDR days increased 39% in the second quarter of 2014 and 8% year to date compared to the same periods in 2013, while US EDR days increased by 11% for the second quarter of 2014 and 7% year to date.

During the first half of 2014, the Pason EDR was installed on 94% of all active land rigs in Canada and 60% of the land rigs in the US, compared to 96% and 57% respectively in the same period of 2013.

In addition, the Company continues to increase revenue in its International business unit.

Pit Volume Totalizer
The PVT is Pason's proprietary solution for the detection and early warning of "kicks" that are caused by hydrocarbons entering the wellbore under high pressure and expanding as they migrate to the surface. PVT revenue for the first six months of 2014 was impacted by an increase in product penetration in both the US market and International markets. During the first six months of 2014, the PVT was installed on 98% of rigs with a Pason EDR in Canada and 77% in the US, compared to 98% and 74% respectively, in the same period of 2013.

Communications
Pason's Communications rental revenue is derived from the Company's automatically-aiming satellite system. This system provides high-speed wellsite communications for email and web application management tools. Pason displays all data in standard forms on its DataHub web application, although if customers require greater analysis or desire to have the information transferred to another supplier's database, data is available for export from the Pason DataHub using WITSML (a specification for transferring data among oilfield service companies, drilling contractors, and operators). The Company continues to complement its satellite equipment with High Speed Packet Access (HSPA), a high-speed wireless ground system that requires lower capital cost, less service, and lower cost per Internet kilobyte, benefiting Company margins.

Communications revenue increased by 38% in the first half of 2014 compared to the same period in 2013  in large part due to increased product penetration in the US market, and the strengthening of the US dollar relative to the Canadian dollar.

Software
The Pason DataHub is the Company's data management system that collects, stores, and displays drilling data, reports, and real-time information from drilling operations. The DataHub provides access to data through a number of innovative applications or services, including:

• Live Rig View (LRV), which provides advanced data viewing, directional drilling, and 3D visualization of drilling data in real time via a web browser.
  
  
• Mobile Viewer, which allows users to access their data on mobile devices, including iPhone, iPad, BlackBerry, and Android.
  
  
• WITSML, which provides seamless data sharing with third-party applications, enhancing the value of data hosted by Pason.
  
  
• Additional specialized software, including remote directional.

During the first six months of 2014, 97% of the Company's Canadian customers and 91% of customers in the US were using all or a portion of the functionality of the DataHub, compared to 96% and 89%, respectively, in the same period of 2013.

AutoDriller
Pason's AutoDriller is used to maintain constant weight on the drill bit while a well is being drilled. During the six months ended June 30, 2014, the AutoDriller was installed on 74% of Canadian and 45% of US land rigs operating with a Pason EDR system, compared to 71% and 46%, respectively, in 2013.

Gas Analyzer
The Pason Gas Analyzer measures the total hydrocarbon gases (C1 through C4) exiting the wellbore, and then calculates the lag time to show the formation depth where the gases were produced. The Gas Analyzer provides information about the composition of the gas, and further calculates geologic ratios from the gas composition to assist in indicating the type of gas, natural gas liquid, or oil in the formation. The Company continues to realize increased product penetration for this product.  During the first six months of 2014, the Gas Analyzer was installed on 60% of Canadian and 24% of US land rigs operating with a Pason EDR system. The penetration in Canada is an increase of approximately 8% in market share over 2013 levels while the US experienced an increase of 1%.

Other
Other is comprised mostly of the rental of service rig recorders in Latin America, the Electronic Choke Actuator, Hazardous Gas Alarm products,  Mobilization revenue, sales of sensors and other systems sold by 3PS,  and spare parts sold by Pason Offshore.

Discussion of Operations

United States Operations

US segment revenue increased by 23% in the second quarter over the 2013 comparable period (18% increase when measured in USD).  For the first six months of 2014, US segment revenue increased by 21% over the 2013 comparable period (14% increase when measured in USD).

Industry activity in the US market during the second quarter of 2014 increased 5% from the prior year and 3% year to date while revenue from the rental of instrumentation increased by 26% and 23% for the three and six month periods respectively over 2013 levels.  EDR rental days increased by 11% and 7% respectively for the three and six months ended June 30, 2014 over the same time periods in 2013, while revenue per EDR day in the second quarter of 2014 increased to $704, an increase of $87 over the same period in 2013.  On a year-to-date basis, revenue per EDR day increased to $698, an increase of $92 over the same period in 2013.

Market share gains, increased usage of communication services, and a favourable movement in the exchange rate all contributed to revenue growth in the US segment. US market share was 60% during the six months ended June 30, 2014, up from 57% in the same period of 2013.

Segment profit, as a percentage of revenue, was 56% for the second quarter of 2014 compared to 49% for the corresponding period in 2013, an increase of $11.5 million. On a year-to-date basis, segment profit as a percentage of revenue was 54% compared to 47% for the corresponding period in 2013, an increase of $21.1 million.  The US business unit  was able to increase its operating margin primarily by leveraging its fixed cost structure and controlling variable costs.

Canadian Operations

Canadian segment revenue grew by 46% for the three months ended June 30, 2014 and 14% year to date compared to the same periods in 2013. This positive growth is a result of a 35% increase in the number of drilling industry days in the second quarter compared to 2013 levels, combined with greater penetration of the Gas Analyzer, along with a market share increase to 90% from 87% in the comparable period of 2013.  EDR rental days  increased 39% in the second quarter and 8% in the first six months of 2014 compared to 2013 levels.

The Canadian business unit was able to increase its revenue in the first six months of 2014 due to a shorter spring break up period in the second quarter along with increased product adoption, notably EDR peripherals, the Gas Analyzer and AutoDriller.

The factors above combined to resulted in an increase in revenue per EDR day of $56 to $1,195 during the second quarter of 2014 compared to 2013.  On a year-to-date basis, revenue per EDR day increased $58 to $1,136.

Operating costs increased by 20% in the second quarter of 2014 relative to the same period in 2013, primarily due to a $0.8 million increase in satellite bandwidth costs, as an additional segment was added to improve the customer experience at the rig. Segment operating profit for the second quarter of 2014 of $4.5 million is an increase of $4.1 million over the same period in 2013.  On a year-to-date basis, operating costs increased by 16% which was attributable to the increase in satellite bandwidth discussed above and increased field support related costs. Segment operating profit of $34.9 million is an increase of 14% over the prior year.

International Operations

Revenue in the International operations segment increased 19% in the second quarter of 2014 and 16% for the six months ended compared to the same periods in 2013, with increased revenue from each of the Company's rental products.

Operating profit increased by $2.4 million for the second quarter of 2014 over 2013, an increase of 218%. For the six months ended, operating profit increased by $3.5 million, an increase of 116% from the same period in 2013.

A number of factors influenced these results:

• Australia revenue increased 13% and 21% for the three and six month periods ended June 30, 2014 as drilling activity continues to increase across the region, accompanied by increased penetration of the company's rental products, most significantly EDR peripheral devices and the Gas Analyzer.
  
  
• Latin America revenue increased 10% in the second quarter and 3% year to date compared to prior periods as the Company saw increased activity in Argentina with revenue increases of 41% and 36% for the three and six month periods respectively.
  
  
• The Company continues to increase its customer base in areas the Company has identified as "frontier markets" including the Middle East and North Africa (MENA) regions. These new markets, combined with increases in market share in the Gulf of Mexico, resulted in an increase in second quarter revenue of 85% over the same period in 2013 and 92% on a year-to-date basis.

Corporate Expenses

Q2 2014 vs Q1 2014
The first quarter of the year is typically the strongest for Pason due to the seasonality of Canadian drilling activity while the second quarter is usually the weakest. Consolidated revenue was $103.9 million in the second quarter of 2014 compared to $123.2 million in the first quarter of 2014, a decrease of $19.3 million or 16%. The Canadian segment earned revenue of $19.8 million in the second quarter as compared to $47.9 million in the first quarter of 2014, a decrease of $28.1 million. This decrease was offset by revenue growth of  $7.6 million in the US market and $1.1 million growth in the International segment.

Sequentially, EBITDA decreased 35%, from $70.5 million in the first quarter of 2014 to $46.0 million in the second quarter of 2014, while funds flow from operations decreased to $44.3 million in the second quarter from $56.3 million in the first quarter of 2014.

Net income decreased by 15% to $17.6 million ($0.21 per share) in the second quarter of 2014 from $20.8 million ($0.25 per share) in the prior quarter. Net income decreased to a lesser extent compared to the other key financial metrics due to the significant stock-based compensation expense recorded in the first quarter of 2014 due to the significant increase in the Company's share price during that quarter. The effective tax rate for the second quarter of 2014 is significantly lower than the first quarter because of the relatively low amount recorded for the non-deductible, non-cash expense of the expensing of common share options under the Black-Scholes pricing model.

Second Quarter Conference Call
Pason will be conducting a conference call for interested analysts, brokers, investors and media representatives to review its second quarter results at 9:00 am (Calgary time) on Thursday, August  7, 2014. The conference call dial-in number is 1-888-231-8191 or 1-647-427-7450. You can access the seven-day replay by dialing 1-855-859-2056 or 1-416-849-0833, using password 58978571.

Pason Systems Inc. is a leading global provider of specialized data management systems for drilling rigs. Our solutions, which include data acquisition, wellsite reporting, remote communications, and web-based information management, enable collaboration between the rig and the office. Pason's common shares trade on the Toronto Stock Exchange under the symbol PSI.

Additional information, including the Company's Annual Report and Annual Information Form for the year ended December 31, 2013, is available on SEDAR at www.sedar.com or on the Company's website at www.pason.com.

Operating Segments

The Company operates in three geographic segments: Canada, the United States, and International (Latin America, Offshore, the Eastern Hemisphere, and the Middle East). The amounts related to each segment are as follows: