Pason Reports its 2011 Second Quarter Results

CALGARY, Aug. 8, 2011 /CNW/ - Pason Systems Inc. (TSX: PSI) announced today its 2011 second quarter results.

Performance Data

(1) 2010 comparative figures have been restated to conform to International Financial Reporting Standards.
(2) EBITDA is defined as earnings before interest expense, income taxes, stock-based compensation expense and depreciation and amortization expense. Funds flow from operations is defined as earnings adjusted for depreciation and amortization expense, stock-based compensation expense, future income taxes and other non-cash items impacting operations as presented in the Consolidated Statements of Cash Flows. These definitions are not recognized measures under International Financial Reporting Standards, and accordingly, may not be comparable to measures used by other companies.

President's Message

Operations Review

The oil and gas industry continues to actively pursue shale gas plays and new oil targets. This resulted in increases in drilling activity throughout North America, which helped Pason announce record second quarter revenue. Revenue was $62.4 million, up 22% from the $51.0 million recorded in 2010 while EBITDA at $25.9 million improved by 20%. Cash flow was $22.9 million, up 22% from the prior year and earnings continued to rebound from the slump of two years ago, with a second quarter result of $8.2 million versus $6.2 million last year. Earnings per share for the quarter was $0.09 up 12% from the $0.08 earned in 2010.

As is always the case in the second quarter, which is a generally inactive quarter in Canada, Pason's results were dominated by activity in the United States. The U.S. business unit improved on its segment profit, achieving $19.8 million for the quarter compared to the $14.0 million earned in 2010. The US rig count has continued to slowly rise towards the peak of 2008 with currently about 1,850 active land rigs of which Pason is installed on just under 1,100 rigs or about 58% of the US rig fleet. This calculated market share is down slightly from the same time last year due partly to Pason now billing and tracking utilization on an hourly basis, where industry days are still only available on a days basis. The remaining market share not using Pason is highly motivated by software features available to the customers' office workers. This will obviously be a strong focus of Pason's software development projects for the next few years. On the rigs that Pason is installed, average daily revenue has climbed from about $400 a day last year to $460 in this year's second quarter. This increase is due to continuing progress in adding more Pason peripheral products to our base electronic driller recorder installation. Auto drillers, hazardous gas and the new remote directional drilling product showed the most improvement. Revenue per industry day, despite gains in products per rigs, was at $259 versus $263 last year. This drop was due to the increasing value of the Canadian dollar versus the U.S. dollar. In U.S. dollar terms revenue per industry day increased by 4%.

In Canada, second quarter drilling activity is virtually shut down due to spring thaw and road conditions that hamper the movement of drilling rigs. In this quarter we hope to simply breakeven and not give up any of our profit earned from the first quarter. We reported a loss of $1.3 million compared to a smaller loss of $0.3 million in 2010. The loss is attributable to net expenses for our water business as well recording an additional provision for inventory obsolescence. Our Canadian revenue was up 29% to $12.9 million from the prior year which was a very strong result given just a reported 9% increase in industry activity. Clearly our approximate 10% price increase in the fall of 2010 had some impact but the movement of the CAODC to calculating industry activity based on hours probably understates the year over year improvement in Canadian activity. It is encouraging that Canadian drilling activity did rise despite the flooding in Saskatchewan which would indicate that the third quarter activity should be very strong. Revenue per Industry day for the quarter was $773 compared to $652 last year.

International revenue increased to $7.5 million from $5.4 million last year primarily because we are now reporting 100% of the revenue earned in Latin America as it is now fully owned by Pason. Profit improved to $1.0 million compared to $0.3 million from last year.  We continue to work towards strengthening our sales and general management talent in a number of countries. We have seen good gains in Colombia and Mexico recently, plus some recent opportunities for field tests of our equipment in two Middle East countries.

Although the Canadian spring hampered the movement of our mobile water treatment plants, we did continue to engage in extensive conversations with potential customers. The issue of cleaning and recycling water from hydraulic fracturing is now a serious focus in most oil and gas companies but the direction in which the Industry is moving towards is not favorable to Pason. We have always stated that if the water treatment solution involved largely mobile plants that this would play to the strengths of Pason. If, however, the desired solution took more of a fixed plant direction then that engineering and procurement based solution requires different skills than offered by Pason. Unfortunately, during the second quarter customer discussions moved markedly towards fixed plant solutions and as a result we have decided not to increase our investment in this new product space. There is still a market for some mobile plants to act as a pilot solution before the greater investment in a fixed plant is made. We expect these opportunities to pay out the investment we have made to date in mobile plants. We do have a fixed plant in Colorado that was built using the expertise acquired in the Auxsol acquisition. This plant is now operating at breakeven and continues to attract more water volume.

At the end of July we agreed to purchase 3PS, a private Texas company, for cash consideration of USD$25 million. This company has used proprietary strain gauge technology to develop a revolutionary torque sensor for assembling casing strings. We believe this technology can be highly valuable in drilling applications. The drilling industry previously has had to work with just relative indicators of drilling torque. This was adequate in the past but now that directional and horizontal wells are pushing the design limits for drill pipe and rig power, it is extremely important to have an actual torque indicator if critical failures are to be avoided. We believe the 3PS technology will provide a valuable addition to the rental suite of products and sensors offered by Pason

In the United States, the rig count shows no signs of a decline and in Canada the CAODC is predicting a busy third quarter and a fourth quarter that should rival the normally strongest first quarter. With our infrastructure of field servicemen, product suite and ongoing RD projects, we are well positioned to capitalize on these opportunities.

On behalf of the Board of Directors,

(signed)

Jim Hill
Chairman, President Chief Executive Officer
August 4, 2011

Management's Discussion and Analysis

The following discussion and analysis has been prepared by management as of August 4, 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").

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 Second Quarter

(1) 2010 comparative figures have been restated to conform to International Financial Reporting Standards. 2009 figures are presented in accordance with the Company's previous accounting framework, Canadian generally accepted accounting principles.

(2) EBITDA is defined as earnings before interest expense, income taxes, stock-based compensation expense and depreciation and amortization expense. Funds flow from operations is defined as earnings adjusted for depreciation and amortization expense, stock-based compensation expense, future income taxes and other non-cash items impacting operations as presented in the Consolidated Statements of Cash Flows. These definitions are not recognized measures under International Financial Reporting Standards, and accordingly, may not be comparable to measures used by other companies.

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, despite being the Company's most mature product, still generated a 23% increase in revenue for the second quarter of 2011 compared to 2010 and an increase of 42% on a year to date basis versus the prior year. These increases are due to increased pricing in both Canada and the U.S. and expanding demand by customers for EDR peripheral devices.

During the first six months of 2011, the EDR was installed on 93% 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 58% but management believes this is understated by almost three 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 days 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 half of 2011, the PVT was installed on 98% of rigs with a Pason EDR in Canada and 69% in the U.S., compared to 97% and 64%, 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 70% of these rigs will benefit by HSPA because they have local cell coverage. The Company was providing communications services on most of the rigs with a Pason EDR in both Canada and the U.S.

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. Pason's TGAS was installed on 40% of Canadian and 17% of U.S. land rigs operating with a Pason EDR system in the first half of 2011. 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 six months of 2011, Pason's ADR was installed on 75% of Canadian and 45% of U.S. land rigs operating with a Pason EDR system compared to 75% and 34% 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 six 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 5% 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 18% in the second quarter of 2011 over the 2010 comparable period (25% increase when measured in USD), which compared favourably with U.S. drilling industry days that were up 22% over the second quarter of 2010. For the first six months of 2011, revenue increased 36% versus 2010 results (44% increase when measured in USD), compared to an increase in U.S. drilling industry days of 27%.

Performing better than the market increase is a result of the following factors:

• better pricing. Prices were 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 half of 2011 to the first half of 2010, was to increase revenue by approximately 15% in USD.
  
  
• more products on each rig.  Revenue was increased by more products on each rig, primarily with gains in PVT and ADR rentals, which contributed to approximately a 5% revenue gain for the first six months of 2011.

The factors explained above resulted in second quarter revenue per industry day of $259 (USD$268) in 2011 compared to $263 (USD$257) in 2010 and $165 (USD$142) in 2009. The U.S. business unit realized year to date revenue per industry day of $264 (USD$270) for 2011, compared to $239 (USD$230) for 2010 and $200 (USD$167) for 2009.

The majority of the decline in "Other" revenue relates to geological services which the Company no longer provides.

Segment profit, as a percentage of revenue, was 47% for the second quarter of 2011, an improvement over the 39% realized in 2010 and a loss of 25% in the second quarter of 2009.

For the first six months of 2011, segment profit, as a percentage of revenue, was 48%, a significant improvement over the 32% generated in 2010 and the 1% realized in 2009.

The increase in operating costs from 2010 levels is mostly attributable to the following factors:

• an increase in rental service costs to support the increase in rig activity of $1.8 million for the quarter and $3.3 million year to date.
  
  
• increase in net operating expenses of Auxsol, the U.S. water treatment subsidiary, of $0.3 million for the quarter and $0.7 million year to date.
  
  
• the increases above were off-set by a reduction in costs due to the Company no longer providing manned geological services. This resulted in lower second quarter costs of $0.4 million and lower six month costs of $1.4 million.

Canadian Operations

Canadian segment revenue rose 29% for the three months ended June 30, 2011, which was a significant increase over the change in the number of Canadian drilling industry days of 9%. On a year to date basis, revenue increased 37% compared to industry days increasing by 20%.

The improvement in revenue for both the second quarter and the first six months was due to:

• an increase in EDR rental days of 15% for the second quarter of 2011 and 25% for the first six 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 second quarter of 2011 to 2010, was an increase to revenue of approximately 14%. The year to date impact of the price increase was to raise revenue by approximately 10%.

The factors explained above resulted in second quarter revenue per industry day of $773 in 2011 compared to $652 in 2010 and $648 in 2009.  For the first six months of 2011, revenue per industry day was $771, compared to $671 in 2010 and $742 in 2009.

The segment loss for the second quarter of 2011 of $1.3 million is slightly larger than the $0.3 million loss in 2010 but an improvement over the $4.8 million loss in 2009. The results for the second quarter of 2011 were impacted by the following items:

• increase in legal costs of $0.4 million, mostly attributable to the ADR litigation.
   
  
• $0.8 million of net expenses relating to water treatment, including $0.4 million in depreciation.
  
  
• increase in the inventory obsolescence reserve of $0.8 million, which is included in depreciation and amortization expense.
  
  
• repair cost increases of $0.4 million due to increased rig activity.

Segment profit, as a percent of revenue, was 39% for the first six months of 2011, approximately the same percentage for 2010, and a significant improvement from the 15% realized in the first six months of 2009. The profit for the first half 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.
  
  
• $1.5 million of net expenses relating to water treatment.
  
  
• repair cost increases of $1.1 million over the similar period in 2010.

After taking these costs into account, all other operating costs increased by approximately 4% over 2010 levels.

International Operations

Revenue in the International operations improved 38% from the second quarter of 2010, while operating profit increased by $0.7 million. For the first six months revenue increased by 42% while operating profit increased by $1.2 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 $0.8 million for the first six 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 $0.8 million for the first six months of 2011 compared to the same period in 2010.
   
• second quarter results have improved over 2010 levels as a result of increasing drilling activity in Australia.  Activity has resumed, reaching levels not seen since the flooding in late 2010.  However equipment related expenses during the first half of the year resulted in a drop of approximately $0.7 million in profit for the first half of 2011 compared to 2010.
  
  
• our International segment includes Pason Offshore, which represents the offshore portion of the business acquired from Petron. The rental portion of this business unit was significantly impacted by the reduction in Gulf of Mexico drilling activity caused by the BP oil spill. This reduction in rental revenue has been more than off-set by an increase in sold systems to drilling contractors who insist on a purchased solution.  In addition, the Company has benefited from cost savings initiatives implemented during the past twelve months. All of these factors, combined with lower depreciation and amortization charges as a result of the write-downs the division took in the fourth quarter of 2010, have combined to increase operating profit in Offshore by approximately $2.0 million for the first six months of 2011 versus 2010 results.

Summary of Quarterly Results

(1) 2010 comparative figures have been restated to conform to International Financial Reporting Standards. 2009 figures are presented in accordance with the Company's previous accounting framework, Canadian generally accepted accounting principles.

(2) EBITDA is defined as earnings before interest expense, income taxes, stock-based compensation expense and depreciation and amortization expense. Funds flow from operations is defined as earnings adjusted for depreciation and amortization expense, stock-based compensation expense, future income taxes and other non-cash items impacting operations as presented in the Consolidated Statements of Cash Flows. These definitions are not recognized measures under International Financial Reporting Standards, and accordingly, may not be comparable to measures used by other companies.

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 Q2 2010

The active rig count in both Canada and the U.S. improved over the second quarter of 2010, resulting in gains in all of the Company's key metrics. Revenue increased 22%, EBITDA and funds flow from operations were up 20% and 22% respectively.

Net earnings increased to $8.2 million or $0.09 per share compared to $6.2 million or $0.08 per share in the second quarter of 2010. The second quarter consolidated results were impacted by the following items:

• increase in net expenses related to the water cleaning initiative of $1.1 million for the second quarter of 2011.
  
  
• stock-based compensation expense decreased by $1.8 million compared to the second quarter of 2010.
  
  
• 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 strengthening Canadian dollar against the U.S dollar resulted in a foreign exchange loss of $1.1 million. The equivalent amount in the second quarter of 2010 was a gain of $1.3 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 $0.9 million is mainly due to higher expenses as a result of more resources dedicated to the Company's growth strategy.

Current Quarter versus Q1 2011

As expected, revenue and operating profit was lower in the second quarter of 2011 versus the first quarter due to spring break-up in the Canadian operating area. The Canadian business unit realized a loss of $1.3 million compared to a $20.8 million profit in the first quarter. Taking into account the drop in rig activity, costs associated with the water initiative and an additional allowance against inventory, all key metrics were in line with previous second quarter results.

The U.S. business unit operating profit of $19.8 million was almost identical to the results achieved in the first quarter. Revenue was up 3.6% while operating profit, as a percentage of revenue, was 47% versus 48% 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.

The International business unit increased its operating profit by $0.5 million, as rig activity continues to improve in most markets and the Company's Offshore unit returns back to profitability.

Liquidity and Capital Resources

At June 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 slightly from the prior year. The small reduction in cash is a combination of higher cash flow from operations, off-set by increases in dividends, capital expenditures and the repurchase of Latin American rights in 2010.  The Company also benefited from greater exercise of Company stock options, which totalled $2.1 million for the first half of 2011 compared to $0.2 million in the first 6 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 six months of 2011 the Company purchased 0.9 million stock options for a total cash consideration of $ 3.1 million.

At June 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 June 30, 2011, no amount had been drawn on the facility.

Disclosure of Outstanding Share and Options Data

As at August 4, 2011, there were 81.9 million common shares and 4.7 million options issued and outstanding.

Accounting Changes

Convergence with International Financial Reporting Standards

Canada's Accounting Standards Board ratified a plan that resulted in Canadian GAAP being converged with IFRS ("IFRS") on January 1, 2011.  The Company was required to report its financial results under IFRS effective January 1, 2011, with quarterly comparatives for 2010.  Management completed a detailed assessment, with involvement and input from the Company's Board of Directors (including the Audit Committee) and its external auditors. The Company focused primarily on the areas with the highest potential impact to the Company: including the choices under IFRS 1 (First Time Adoption), capital assets, impairment of assets and stock-based compensation. The areas with the greatest impact were the retroactive application of IFRS and stock-based compensation expense.

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 a.m. (Calgary time) on Tuesday, August 9, 2011.  The conference call dial-in number is 1-888-231-8191, conference ID # is 72041473.  You can access the 7-day replay by dialing 1-800-642-1687, password 72041473.

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 Balance Sheets

Certain 2010 comparative figures have been restated to conform to IFRS.

Condensed Consolidated Interim Statements of Operations

Certain 2010 comparative figures have been restated to conform to IFRS

Condensed Consolidated Interim Statements of Comprehensive Income

Certain 2010 comparative figures have been restated to conform to IFRS

Condensed Consolidated Interim Statements of Changes in Equity

Certain 2010 comparative figures have been restated to conform to IFRS.

Condensed Consolidated Interim Statements of Cash Flows

Certain 2010 comparative figures have been restated to conform to IFRS.

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:

Pason Systems Inc.

Pason Systems Inc. is a leading provider of instrumentation systems to land-based and offshore drilling rigs worldwide. The company's rental solutions, which include data acquisition, wellsite reporting, remote communications, and web-based information management, maximize rig uptime, improve work efficiency, and minimize operating costs. Pason's common shares trade on the Toronto Stock Exchange under the symbol PSI.