Pason Reports its 2011 Third Quarter Results

CALGARY, Nov. 4, 2011 /CNW/ - Pason Systems Inc. (TSX: PSI) announced today its 2011 third quarter results.

Performance Data

President's Message

Operations Review

The third quarter experienced a robust demand for drilling rigs aided by excellent weather conditions. As a result, drilling activity in North America was up strongly over 2010 with the Canadian drilling industry posting a 36% improvement and the United States drilling industry up by 19%. This surge in drilling activity propelled Pason to record third quarter results. Revenue for the quarter was up 29% to $88.7 million with even greater leverage for EBITDA and cash flow. EBITDA jumped 59% to $55.0 million and cash flow rose 54% to $41.3. Earnings increased impressively by 140% to $28.5 million but was aided by non operating activities such as foreign exchange gain of $6.3 million and recovery of stock based compensation expense of $1.3 million. Earnings per diluted share was $0.35 compared to $0.15 in 2010.

United States segment operating results improved modestly over last year's very strong third quarter with profit of $22.3 million compared to $21.2 million in 2010. As prices were raised in the second quarter of 2010 there was no benefit from unit pricing when comparing this quarter to last year. Revenue per U.S. industry day at $283 was flat with the prior year number of $284. The U.S. rig count continues to climb with another 100 rigs added in the third quarter bringing the active fleet to about 1,950 land rigs. Pason topped 1,110 rigs at the quarter end which represents 57% of the rigs carrying some Pason equipment. Revenue gains continue to come primarily from growth in communications and auto driller rentals. Revenue from newly acquired 3PS is limited to about $1.0 million per month until we begin our rollout of torque sensors for drilling applications, which should start in the first quarter of next year.

Canada had stronger results because of a greater increase in industry drilling days plus the benefit of the late 2010 price increases which were not in effect for the comparable 2010 third quarter. Segment operating profit was almost double the prior year at $16.4 million for the quarter compared to $8.4 million recorded in 2010. Revenue increased by a solid 54%, led mainly by a 73% gain in electronic drilling recorder rentals. However, our profits were also aided by good cost control resulting in only a modest 17% rise in operating costs. Our revenue per industry drilling day, again helped by the price increase of late 2010, increased to $815 for the quarter versus $716 in 2010.

International revenue and operating leverage continues to improve with revenue of $7.0 million up from $5.0 million in 2010 and segment profit of $1.0 million versus a loss of $0.5 million in the prior year. Results in the International segment continue to benefit from recording the full revenue being achieved in Latin America, since the buyout of our former distribution partner. Further, while not providing meaningful profit yet, the activity levels in Mexico and Australia have at least rebounded from their collapses in 2009 and 2010. While our main interest from the Petron purchase of several years ago was to augment domestic US rentals, we continue to benefit from sales of equipment with revenue of $4.6 million for the first nine months of this year.

As announced last quarter, we have ceased operation of mobile water cleaning plants and have several exit possibilities under discussion. We would expect eventual proceeds to come within $2.0 million of our equipment carrying costs, which we have reserved for in this quarter's results. We do however continue to operate our fixed water treatment plant in Colorado built with the expertise acquired from the Auxsol purchase. The plant is profitable and becoming more efficient each quarter while we consider options for this part of our water treatment business.

Outlook

While there is some concern for the impact of low natural gas prices on drilling in the latter half of 2012, overall drilling activity levels are expected to be relatively unchanged next year. We are beginning to ramp up a major enhancement of our electronic drilling recorder platform and capabilities. We currently forecast that our capital expenditure budget for the next 12 months will be $101.6 million, of which $9.2 million will be for EDR upgrades, $18.8 million for torque sub rental equipment and $18.4 million for the new gas analyzer. On balance from our total capital expenditure budget of $101.6 million we would expect $68.2 million would be directed towards equipment that can generate incremental revenue and $33.4 million would be for maintenance capital.

We are confident that our projected cash flow can comfortably cover our capital expenditure budget and an increased dividend. Accordingly the Board of Directors has approved an increased semi-annual dividend to $0.20 per share.

On behalf of the Board of Directors,

(signed)

Jim Hill
Chairman, President & Chief Executive Officer
November 2^nd, 2011

Management's Discussion and Analysis

The following discussion and analysis has been prepared by management as of November 2, 2011 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 quarterly report are expressed in Canadian dollars unless otherwise indicated.

Overview of the 2011 Third Quarter

Overall Performance

Electronic Drilling Recorder

Consistent with prior years, the Pason Electronic Drilling Recorder ("EDR") remains the Company's prime 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 rig site 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. The EDR generated a 27% increase in revenue for the third quarter of 2011 compared to 2010 and an increase of 36% on a year to date basis versus the prior year. These increases are due to increased rig activity in the Company's major markets, price increases in both Canada and the U.S., and expanding demand by customers for EDR peripheral devices.

During the first nine months of 2011, the EDR was installed on 96% of all active rigs in Canada and just under 60% of the rigs in the U.S.

In Canada, until the start of 2011, industry days used to calculate market share were based upon a twenty-four hour period. As a result, since the adoption of the Company's new billing policy described below, Canada was reporting slightly lower market share figures than was actually the case. Starting in 2011, the industry drilling day now recognizes these partial days and brings this method of activity reporting in line with how the Company bills.

In the U.S. the opposite impact is occurring. The Company is tracking EDR rental days under the new partial billing method but the industry days that are reported are still calculated on a twenty-four hour basis. The Company's calculated U.S. market share for 2011 was 57% but management believes this is understated by almost two points because of the inconsistency between Pason's method of tracking rental days and how the industry calculates drilling days.

The method in which the Company bills its customers has impacted both the Canadian and U.S. market share figures. Previously, the Company billed for an entire day's worth of rentals regardless of whether the equipment was activated for the entire twenty-four hour period or not. To address customer concerns, the Company implemented a change to bill in increments, recognizing the fact that during the initial start up or tear down of a rig the equipment is only utilized a portion of the day.

This partial billing process has been in place in Canada since 2009 and was rolled out to the U.S. market beginning in 2011.

The Company believes that there was no underlying change to the Company's relative competitive position in either country.

Pit Volume Totalizer

The Pit Volume Totalizer ("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.  Revenue increases for this product were in line with the rise in drilling days in North America, and revenue was enhanced by further penetration in the U.S. During the first nine months of 2011, the PVT was installed on 98% of rigs with a Pason EDR in Canada and 69% in the U.S., compared to 98% and 65%, respectively, in 2010.

Communications

Pason's communications rental revenue is derived from the Company's automatic 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 Internet DataHub, 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 amongst oilfield service companies, drilling contractors and operators).  During 2010, the Company began complimenting 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. In Canada, HSPA has been installed on 90% of the rigs, and on average 85% of these rigs will benefit by HSPA because they have local cell coverage.

Total Gas System

The Pason Total Gas System ("TGAS") measures the total hydrocarbon gases (C1 through C5) exiting the wellbore, and then calculates the lag time to show the formation depth where the gases were produced.  This complex system provides a more accurate gas sample than competitor systems. For the first nine months Pason's TGAS was installed on 42% of Canadian and 17% of U.S. land rigs operating with a Pason EDR system. The market penetration in both countries is an increase of approximately 2% points over 2010 levels.

Automatic Driller

Pason's Automatic Driller ("ADR") is used to maintain constant weight on the drill bit while a well is being drilled. During the first three quarters of 2011, Pason's ADR was installed on 78% of Canadian and 46% of U.S. land rigs operating with a Pason EDR system compared to 76% and 36% respectively in 2010.

Hazardous Gas Alarm System

Pason's Hazardous Gas Alarm System monitors both lower explosive limit gases (LEL) and H₂S where both readings and an alarm system are integrated with the EDR.  During the first nine months of 2011, Pason's Hazardous Gas Alarm System was installed on 18% of Canadian rigs, up from 15% for the same period in 2010, and 6% of U.S. land rigs operating with a Pason EDR system, an increase from 2% of U.S. land rigs in the same period in 2010.

Discussion of Operations

United States Operations

U.S. segment revenue increased by 15% in the third quarter of 2011 over the 2010 comparable period (18% increase when measured in USD), which compared with U.S. drilling industry days that were up 19% over the third quarter of 2010. For the first nine months of 2011, revenue increased 28% versus 2010 results (33% increase when measured in USD), compared to an increase in U.S. drilling industry days of 24%.

Revenue was impacted by the following factors:

• better pricing. Prices increased by approximately 30% in the second quarter of 2010 and have held steady since .The net impact of average weighted pricing, when comparing the first nine months of 2011 to 2010, was to increase revenue by approximately 12% in USD.
• more products on each rig.  Revenue was increased by more products on each rig, primarily with gains in ADR rentals, which contributed to approximately a 4% revenue gain for the first nine months of 2011.

The factors explained above resulted in third quarter revenue per industry day of $283 (USD$272) in 2011 compared to $284 (USD$275) in 2010 and $150 (USD$138) in 2009. The U.S. business unit realized year to date revenue per industry day of $264 (USD$270) for 2011, compared to $255 (USD$246) for 2010 and $180 (USD$158) for 2009.

The majority of the increase in "Other" revenue relates to sales realized by 3PS, Inc., the U.S. based company acquired in August of 2011.

Segment profit, as a percentage of revenue, was 46% for the third quarter of 2011, compared to 51% realized in 2010 and a loss of 19% in the third quarter of 2009.

For the first nine months of 2011, segment profit, as a percentage of revenue, was 47%, compared to 39% generated in 2010 and the loss of 4% realized in 2009.

The benefit of the increase in revenue for the three and nine months ending September 30, 2011 was reduced by increases in operating costs from 2010 levels:

• an increase in rental service costs and repairs to support the increase in rig activity of $1.8 million for the quarter and $5.5 million year to date.
• increase in net operating expenses of Auxsol, the U.S. water treatment subsidiary, of $0.8 million year to date.
• increase in depreciation expense for the quarter and year to date of $1.6 million, due in most part to the continuing increase in capital expenditures as well accelerating the depreciation rate on the Company's TGAS systems, which are being phased out by the new gas analyzer.

Canadian Operations

Canadian segment revenue rose 54% for the three months ended September 30, 2011, a significant increase over the change in the number of Canadian drilling industry days of 36%. On a year to date basis, revenue increased 43% compared to industry days increasing by 25%.

The improvement in revenue for both the third quarter and the first nine months of 2011 was due to:

• an increase in EDR rental days of 39% for the third quarter of 2011 and 30% for the first nine months compared to the corresponding period in 2010 and ,
• improved pricing. Prices were reduced by approximately 20% in the second quarter of 2009 and did not rise again until a 10% price increase was applied in the fourth quarter of 2010. The net impact of average weighted pricing, when comparing the third quarter and year to date 2011 to 2010, was an increase to revenue of approximately 10%.

The factors explained above resulted in third quarter revenue per industry day of $815 in 2011 compared to $716 in 2010 and $675 in 2009.  For the first nine months of 2011, revenue per industry day was $788, compared to $687 in 2010 and $720 in 2009.

The segment profit for the third quarter of 2011 of $16.4 million is almost double the $8.4 million profit in 2010 and a significant improvement over the $1.9 million profit in 2009. The results for the third quarter of 2011 were impacted by the following items:

• an increase in rental service costs to support the increase in rig activity of $1.4 million for the quarter.
• $2.5 million increase in depreciation expense relating mostly to an impairment loss on the water treatment assets located in Canada as well accelerating the depreciation rate on the Company's TGAS systems, which are being replaced by the new gas analyzer.
• increase in the inventory obsolescence reserve of $0.8 million, which is included in depreciation and amortization expense.

Segment profit, as a percent of revenue, was 43% for the first nine months of 2011, up from 39% or over 10% when compared to 2010 levels, and a significant improvement from the 16% realized in the first nine months of 2009. The profit for the first three quarters of the year was impacted by the following factors:

• legal costs increased by $1.8 million as the Canadian trial for the ADR litigation took place in 2011.
• $3.8 million of net expenses relating to water treatment.
• increase in the inventory obsolescence reserve of $1.5 million.
• increase in rental service and repair costs of $4.0 million due to the increased rig activity.

International Operations

Revenue in the International operations improved 42% from the third quarter of 2010, while operating profit increased by $1.5 million. For the first nine months revenue increased by 42% while operating profit increased by $2.7 million over the same period in 2010.

A number of factors influenced these results:

• at the close of 2010, the Company purchased the distribution rights and operating companies of its Latin American partner. This purchase increased both revenue and operating profit as the Company now benefits from 100% of the operating results. This increased segmented operating profit by approximately $1.5 million for the first nine months of 2011.
• drilling activity in Mexico collapsed during the second half of 2010 and while the rig count is increasing in 2011 the operating profit is lower than the results achieved in 2010. Operating profit is down $0.6 million for the first nine months of 2011 compared to the same period in 2010.
• results in Australia continue to improve with activity reaching levels not seen since the flooding in late 2010. As a result this segment is close to a break even point for the first nine months of 2011, a significant turnaround from the losses incurred during the first half of 2011.
• our International segment includes Pason Offshore, which represents the offshore portion of the business acquired from Petron. In the first quarter of 2011 a decision was made to only offer Pason equipment for rent in lieu of Petron systems which were historically sold.  Progress has been made with Pason equipment being installed on offshore rigs both in the Gulf of Mexico and internationally.  Offshore operating profit has increased by approximately $1.4 million for the first nine months of 2011 versus 2010.

Summary of Quarterly Results

Variations in Pason's quarterly financial results are due in part to the seasonality of the oil and gas service industry in Canada, which is somewhat offset by the less seasonal nature of U.S. and International operations.  The first quarter is generally the strongest quarter for the Company due to strong activity in Canada when location access is best during the winter.  The second quarter is always the slowest due to spring break up in Canada when many areas are not accessible due to ground conditions, and therefore, do not permit the movement of heavy equipment.  Activity generally increases in the third quarter, depending on the year, as ground conditions have often improved and location access becomes available; however, a rainy summer can have a significant adverse effect on drilling activity.  By the fourth quarter, often the Company's second strongest quarter, access to most areas in Canada become available with ground freezing.  Consequently, the performance of the Company may not be comparable quarter to consecutive quarter and should be considered on the basis of results for the whole year, or by comparing results in a quarter with results in the same quarter for the previous year.

Current Quarter versus Q3 2010

The active rig count in both Canada and the U.S. improved over the third quarter of 2010, resulting in gains in all of the Company's key metrics. Revenue increased 29%, EBITDA and funds flow from operations were up 59% and 54% respectively.

Net earnings increased to $28.5 million or $0.35 per share compared to $11.9 million or $0.15 per share in the third quarter of 2010. The third quarter consolidated results were impacted by the following items:

• increase in depreciation expense of $3.5 million, attributable mostly to the write-down of the Company's Canadian water treatment assets and the accelerated depreciation on the Company's TGAS systems.
• stock-based compensation expense decreased by $4.9 million compared to the third quarter of 2010 due to a reduction in the Company's stock price.
• as required by generally accepted accounting principles, gains and losses from foreign exchange changes relating to monetary assets and liabilities must be taken into earnings in the period in which they occurred.  The weakening Canadian dollar against the U.S dollar resulted in a foreign exchange gain of $6.3 million. The equivalent amount in the third quarter of 2010 was a gain of $0.1 million.
• corporate services costs primarily relate to personnel located in the corporate headquarters who directly support the Company's field operations and perform other corporate functions.  The increase in corporate operating expenses from 2010 of $0.6 million is mainly due to higher expenses as a result of more resources dedicated to the Company's growth strategy.

Current Quarter versus Q2 2011

As expected, revenue and operating profit was much higher in the third quarter of 2011 versus the second quarter due to spring break-up occurring in the second quarter in the Canadian operating area. The Canadian business unit realized a profit of $16.4 million compared to a loss of $1.3 in the second quarter.

The U.S. business unit operating profit of $22.3 million was up $2.5 million to the results achieved in the second quarter. Revenue was up 15% while operating profit, as a percentage of revenue, was 46% versus 47% in the previous quarter. The U.S. unit continues to invest in staff and infrastructure to realize on the opportunity of increasing market share and product penetration in a changing operating environment.

Liquidity and Capital Resources

At September 30, 2011, the Company's liquidity position and change over the prior year is detailed in the table below.

(1) 2010 comparative figures have been restated to conform to International Financial Reporting Standards.

The Company's cash balance was down from the prior year. The reduction in cash is a combination of an increase in dividends, capital expenditures, the repurchase of Latin American rights in 2010, and the purchase of 3PS, Inc. in August of 2011. The Company benefited from both higher cash flow from operations and an increase in the exercise of Company stock options, which totalled $2.2 million for the first nine months in 2011 compared to $0.2 million in the first nine months of 2010.

Contractual Obligations

Contractual obligations relate to minimum future lease payments required primarily for operating leases for certain facilities and vehicles.

During the first nine months of 2011 the Company purchased 0.9 million stock options for a total cash consideration of $3.3 million.

At September 30, 2011, the Company had no capital lease obligations, and other than the operating leases detailed above, it has no off-balance sheet arrangements.

The Company has a $5.0 million committed revolving credit facility available.  At September 30, 2011, no amount had been drawn on the facility.

Disclosure of Outstanding Share and Options Data

As at November 2, 2011, there were 81.9 million common shares and 4.6 million options issued and outstanding.

Third Quarter Conference Call

Pason will be conducting a conference call for interested analysts, brokers, investors and media representatives to review its third quarter results at 9:00 a.m. (Calgary time) Monday, November 7, 2011.  The conference call dial-in number is 1-888-231-8191, conference ID # is 1271333.  You can access the 7-day replay by dialing 1-855-859-2056, password 1271333.

Pason is a leading international provider of specialized rental and sold oilfield instrumentation systems for use on land and offshore rigs.  The Company's tightly integrated package of products and services, including data acquisition, wellsite reporting software, remote communications and Internet information management tools, maximizes rig uptime and minimizes operating costs.

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, 2010, is available on SEDAR at www.sedar.com or on the Company's website at www.pason.com.

Condensed Consolidated Interim Financial Statements and Notes

Condensed Consolidated Interim Balance Sheets

Condensed Consolidated Interim Statements of Operations

Condensed Consolidated Interim Statements of Comprehensive Income

Condensed Consolidated Interim Statements of Changes in Equity

Condensed Consolidated Interim Statements of Cash Flows

Operating Segments

The Group has three reportable segments, as described below, which are the Group's strategic business units. The strategic business units offer the same services, but are managed separately. For each of the strategic business units, the Group's senior management reviews internal management reports on a monthly basis.

Information regarding the results of each reportable segment is included below. Performance is measured based on operating profit as included in the internal management reports. Operating profit is used to measure performance as management believes that such information is the most relevant in evaluating the results of certain segments relative to other entities that operate within these industries. Inter-segment pricing is determined on an arm's length basis.

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