Calfrac Well Services Ltd.
Q3 2021 Earnings Call Transcript

Published: 2 Nov 2021

[Operator:]

Good day and welcome to the Calfrac Well Services Ltd. Third Quarter 2021 Earnings Release and Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mike Olinek, Chief Financial Officer. Please, go ahead.

[Mike Olinek:]

Thank you, Madison. Good morning and welcome to our discussion of Calfrac Well Services third quarter 2021 results. Joining me on the call today is Lindsay Link, Calfrac's President and Chief Operating Officer. This morning's conference call will be conducted as follows. Lindsay will provide some opening commentary, after which I will summarize the financial position and performance of the company. Lindsay will then provide an outlook for Calfrac's business and some closing remarks. After the completion of our prepared remarks, we will open the conference call to questions. In the news release issued earlier today, Calfrac reported its unaudited third quarter 2021 results. Please note that all financial figures are in Canadian dollars, unless otherwise indicated. Some of our comments today will refer to non-IFRS financial measures, such as adjusted EBITDA and operating income. Please see our news release for additional disclosure on these financial measures. Our comments today will also include forward-looking statements regarding Calfrac's future results and prospects. We caution you that these forward-looking statements are subject to a number of known and unknown risks and uncertainties that could cause our results to differ materially from our expectations. Please see this morning's news release and Calfrac's SEDAR filings, including our 2020 Annual Report for more information on forward-looking statements and these risk factors. Lindsay, over to you.

[Lindsay Link:]

Thanks, Mike. Good morning and thank you everyone for joining our call today. Before Mike provides the financial highlights of the third quarter, I'll offer a few opening remarks. As you have seen, our third quarter results were strong, driven by increased utilization in all our operating divisions. In the United States, the third quarter is typically a strong quarter and this year was no exception. Canada improved from the second quarter seasonal slowdown, despite weather disruptions in Central and Northern Alberta that affected fracturing crew utilization during September. Fracturing and coiled tubing activity also improved in Argentina and Russia on a sequential basis. Putting this third quarter utilization growth into perspective, when we compare it to the same period last year, our North American active fracturing fleet count has increased over 60%, while fracturing job count has more than doubled. On a company-wide basis, active fracturing fleet count has increased by almost 50% and fracturing job count has increased over 130%. Coiled tubing jobs have also increased 80% year-over-year. These results have been because of the hard work of all of our teams at Calfrac and I believe that our -- all of our operations are positioned for a relatively strong fourth quarter and even stronger 2022. Our customers continue to show fiscal discipline, as commodity prices have risen during 2021, by opting to return excess cash flow to shareholders and pay down debt, instead of reinvesting in it for production growth. We anticipate that capital spending in 2022 will increase year-over-year in North America, in order to keep oil and gas production near current levels. As the quarter progresses our clarity for next year increases and Calfrac will be ready to respond to market conditions as they evolve, with the same focus on safety and service quality, that is the cornerstone of our business. Before I pass the call to Mike, I'm excited to highlight some recent company technology and ESG initiatives to better understand the recent equipment emission developments. We are performing a study to determine the actual GHG impact from current pressure pumping technologies in the market. This fact-based study will assist in the reduction of Calfrac's current and future GHG emissions footprint and will incorporate a thorough analysis of all available options after consideration of the often competing objectives of reducing GHG emissions versus a hearing to Tier four specifications. In Argentina, Calfrac is deploying a proprietary friction control technology to further optimize chemistry and reduce fuel consumption by significantly lowering pressure during pumping operations. Lastly, Calfrac is continuing to execute on its data strategy through its recent investments in equipment analytics technology that is providing actionable preventative maintenance insights in order to reduce unscheduled downtime and lower operating costs. Now I will pass the call over to Mike who will present an overview of our quarterly financial performance. Mike?

[Mike Olinek:]

Thank you Lindsay. Our third quarter results showed a significant improvement from the second quarter due to strong equipment utilization and a disciplined focus on cost control. Consolidated revenue in the third quarter increased by 131% year-over-year to CAD295.8 million. The improved revenue was mainly due to the fracturing job count increasing by 132%, resulting primarily from higher activity in all operating divisions. Adjusted EBITDA reported for the quarter was CAD35.6 million compared to CAD8.5 million a year ago. Operating income also increased by 345% to CAD35.6 million from operating income of CAD8 million in 2020. This improvement in profitability was largely due to better utilization in all of its operating divisions. The net loss for the quarter was CAD1.5 million, compared to a net loss of CAD50 million in the same quarter of 2020. The higher operating results combined with lower interest expense and a deferred tax recovery partially offset by higher depreciation in the third quarter of 2021 contributed to the improvement in the company's reported net loss. For the three months ended September 30, 2021, depreciation expense increased from the corresponding quarter of 2020 by CAD1.5 million to CAD33.2 million. The increase in third quarter depreciation expense was primarily due to the year-over-year increase in capital expenditures relating to major component purchases, which have a shorter useful life and a corresponding higher rate of depreciation. Interest expense during the third quarter of 2021 decreased by CAD9.9 million from the same period in the prior year due to the significant reduction in long-term debt that resulted from the company's recapitalization transaction that was completed in the fourth quarter of 2020. Calfrac spent a total of CAD25.2 million on capital expenditures in the third quarter, compared to CAD2.8 million in the same period of 2020. This increase was due primarily to the change in the amount of active equipment between the two periods. Calfrac's Board of Directors increased its 2021 capital budget by CAD5.5 million to approximately CAD61 million in order to support a preexisting equipment build commitment in Argentina and acquire fracturing assets in that country at a significant discount to replacement cost from a competitor that was exiting that market. An outflow of CAD40.3 million during the third quarter for working capital requirements was largely driven by higher accounts receivables resulting from the significant increase in activity from the second quarter in both North America and Argentina. During the third quarter of 2021, CAD0.3 million of the 1.5 lien notes were converted into common shares and an immaterial quantity of warrants were exercised. Also, the company opted to pay its September 1,5 2021 interest payment on the 1.5 lien notes in cash rather than utilizing the payment-in-kind option. To summarize the balance sheet as at the end of the third quarter, the company had working capital of CAD179.5 million including CAD6 million in cash. At September 30, 2021 the company had used CAD0.9 million of its credit facilities for letters of credit and had CAD180 million of borrowings under its credit facilities, leaving CAD44.1 million in potential borrowing capacity at the end of the third quarter. As at September 30th, Calfrac was in full compliance with all covenants under its credit agreement during the covenant relief period and under the indentures covering the 1.5 lien and second lien notes. I'll turn the call back to Lindsay to provide our outlook.

[Lindsay Link:]

Thanks Mike. I will now present an outlook for Calfrac's operations across our geographical footprint. We think that the current market for our services is strong and strengthening every day. However as evidenced by the tempered rig count in the United States, the oilfield service recovery will be a more gradual journey than in past cycles. We're continuing to see cost pressures that are in lockstep with frac pricing escalation that is making tangible net profit increases difficult to achieve over the longer term. In our US division our franchise delivered strong improvement during the third quarter and is well positioned to deliver through the fourth quarter with 9 active fleets. We think that our existing footprint is sufficient to supply our long-standing clients, but still gives us optionality to access incremental work. Calfrac will continue to examine opportunities to take advantage of any improvement in spot market pricing. The fourth quarter is expected to outperform the same period in 2020, but the operating and financial results will be impacted by a slowdown of activity in December resulting from the exhaustion of capital by some of Calfrac's core lines. In Canada, the third quarter unfolded with a fast start in July, but lower activity in September due to weather-related issues impacted the overall performance. While rig and frac activity in Canada accelerated in the third quarter it is expected to slow down towards year-end as customer capital budgets are exhausted. However, we expect the recent strength in commodity prices will help tighten the Western Canada fracturing market in 2022. Spot market pricing has improved in recent months but we are committed to operating 4 fracturing fleets in Canada, until financial returns improved significantly to justify additional allocations of capital. I'll now turn to Calfrac's international operations. The third quarter represented the sixth consecutive strong quarter in the company's Russia division. The driver of the improvement came -- in the second quarter came from larger fracturing stages and cost control discipline. As is typical for the fourth quarter, we anticipate that the onset of winter will slow down activity due to weather-related well access issues. As a result, operating margins will be affected by higher usage of diesel fuel and the shift to usage of Arctic fuel. Calfrac continues to proceed with the extension of its existing fracturing and coiled tubing contracts and expect that these contracts will be renewed before the end of the year. Our operations in Argentina improved significantly from the second quarter primarily due to increased utilization and the great work done in the Vaca Muerta shale play. During the quarter, we acquired fracturing equipment from a competitor exiting the market at a significant discount and have already put it to work. We expect the demand for our services in this market to remain strong for the remainder of the year and into 2022. There's increased optimism for 2022 as the rebound in oil and natural gas prices continue. I'd like to thank all of our team for their efforts. I'm proud to be part of this team as we move forward. Madison, please open the line for questions.

[Operator:]

[Operator Instructions] And we'll go ahead and take our first question from Waqar Syed with ATB Capital Markets. Please go ahead.

[Waqar Syed:]

Thank you for taking my question. Lindsay in the -- for the Canadian market if pricing starts to move in line with what your expectations are, can you add the fifth crew on January 1 or labor or other issues may prevent that from happening?

[Lindsay Link:]

Good morning, Waqar. We have made the decision not to add that fleet January 1. It probably has a three-month start date. Labor additions would make it a difficult start. And as we put forward, the quality of our service and the safety that we provide would make it difficult. A good portion of the Q1 activity is already scheduled where it stands. I don't know Mike if you wanted to add something on that.

[Mike Olinek:]

Yes. Good morning, Waqar. Good question. I think where we stand on the Canadian fleet and any changes to that fleet I think we're really looking as a leader in the marketplace here to lead by example. And so I think where we're at is certainly filling out the workbook with the – our current complement of four large crews. We think that's a good footprint for Q1 just based on visibility. Certainly looking where we can to add fleet capacity should returns I think come more in line with where we think they need to be on a longer-term perspective. And so really from a Q1 start perspective, that's really not in our active plans to date. The labor challenges in Canada are certainly – have been talked about a lot. I think the labor market is still continuing to be very tight and it's definitely a factor. We've proven though that that's something that we can overcome. But really what we're looking at from an allocation of capital perspective Waqar is that Calfrac is going to maintain its current footprint until we see pricing move I think upwards and see financial returns back to where we want them to be for our shareholders.

[Waqar Syed:]

Great. And then just from an activity perspective in the first quarter as you do year-over-year comparison first quarter 2022, your fleet count is not changing. So from a utilization perspective relative to this year's first quarter, do you think you can get more out of the same four fleets?

[Mike Olinek:]

Yes. I mean Waqar, I think where we're at right now with four large fleets, I think we can get more utilization. Last year started off a bit slow and we started really with three fleets. We have the ability to toggle up to four. So we do see upward potential in our revenue for Q1 of 2022 just based on four large fleets.

[Waqar Syed:]

Great. And then just a quick question on Argentina. You acquired some assets there. Are these complete crews, or is it just you're going to use them as spare parts for your fleets, or does your size of your fleet or offering actually increase in Argentina with this acquisition?

[Lindsay Link:]

No, they were complete fleets. Argentina in the South where most of this equipment was acquired, our relatively small footprint frac fleet but they were complete and we are putting them together. There was additional horsepower that could augment pumpdown services. There were blenders and hydration units also included in the fleet. It was a very I think hard to pass up offering.

[Waqar Syed:]

Yes. That makes sense. So with this acquisition, I think in the past there have been some talk about that you may divest your interest in Argentina. With this acquisition, should we now assume that that's not happening, or is that still something that could still be a possibility?

[Mike Olinek:]

Waqar, I mean I think the optionality around international operations always exists but it's obviously a market-dependent exercise. I think what we thought from a strategic point of view on capitalizing on this asset purchase was really to build out our footprint down south, able to improve our market share in that market of Argentina. And so we think it's very accretive. And certainly we thought the actual price of the equipment, given its age was a very good opportunity for Calfrac.

[Waqar Syed:]

Okay. And just one last question. Like in the third quarter working capital was a big consumer of cash close to almost CAD 40 million. What's your expectations for Q4 for working capital and for free cash flow?

[Mike Olinek:]

Yes, I mean I think there's a couple of things that play around that number. Certainly in Q3, I think our working capital build exceeded our expectations and that really was a function of just timing of accounts receivable collections. And so our belief is topline revenue in North America will likely drop with the seasonal downturn in activity. So, ultimately, I think from a working capital perspective, it will move to being a cash inflow from an outflow that it experienced in Q3. I think as we look at free cash flow there's a number of moving parts with respect to that. It's obviously our capital expenditures. Also our working capital as you mentioned is an inflow and then obviously, our operating cash flow income out of the operations which should drop down with the topline revenue dropping. But ultimately, I think we're targeting a breakeven kind of position may be a slight modest negative.

[Waqar Syed:]

Okay. Thank you very much.

[Mike Olinek:]

Thanks Waqar.

[Operator:]

[Operator Instructions] We can go ahead and take our next question from Cole Pereira with Stifel. Please go ahead.

[Cole Pereira:]

Hey, morning guys. Thanks for taking my question. So, one of your peers highlighted in Canada that it hasn't really recognized any material net pricing increases, but expect to do so in 2022 as the market tightens. I mean is that fairly consistent with your expectations for Q1? And are you able to quantify how much you think net pricing would need to move up before you think about activating another crew?

[Mike Olinek:]

Good morning Cole. Yes. So, on the first question as far as net pricing and where we see the trending going for Q1 is our belief is that the supply/demand balance in Canada is going to be extremely tight in the first quarter. That, I think in and of itself, should justify I think a movement upward as far as net pricing. We're not going to talk about I think specific percentages on where net pricing will go or needs to go. Other than to say we believe the supply/demand balance is probably going to be the tightest that we've seen in a number of years and as a result that usually bodes well as far as pressure pumping returns. So, we see that certainly moving in the right direction.

[Lindsay Link:]

I think Cole as well it is net pricing is definitely an important factor. It also is the amount of white space. So, activating a fleet that is 50% utilized with a -- even a 20% price increase may not be financially appealing. But activating a fleet with maybe an 80% utilization and a 10% price increase might be attractive. So, there still is utilization has been very important for us. As we indicated earlier, we're going to have four large fleets which is a large improvement year-on-year for us from last year and that allows us the step of the fifth fleet in a much more orderly fashion.

[Cole Pereira:]

Okay, great. That's super helpful. Thanks. And so I mean in the US, it sounds like while the market not might not be as tight in Canada, it sounds like it continues to improve. I guess can you talk about maybe the line of sight for net pricing increases into Q4 and Q1 2022?

[Mike Olinek:]

Yes, I think Cole our commentary on the US market is very similar to the Canadian market on net pricing. Our sales group has a hard enough time trying to get net pricing. I'm not going to talk specifics on the call. I think what we're seeing though is that the market is tightening in some of the markets that we're a part of. In the US, I think we've got a very strong customer base continuing to expand that customer base. And so I think where we're seeing net pricing improvements, I think that will be realized in the US as well. I think it really is an industry. I think it needs to go up significantly from where it is to really justify, an appropriate full-cycle return in the pressure pumping industry. And I think, we're seeing steps towards that in the spot market today where we're gaining some momentum. But ultimately, input cost increases are offsetting that almost on a real-time basis. So I think really, where we're seeing improvements and we do believe, we're going to get those improvements. It is a step function as we walk through a year just as it always is in our market. But certainly, I think all the market signals are there to see that we get improved returns. You saw the benefit of improved utilization out of the US business in the third quarter. I think we'll see a bit of a pause in that, in the fourth quarter, but certainly a strong start to the year. And I think a strong book of work in 2022 as the year evolves.

[Lindsay Link:]

Yeah. Cole, I mean, I think it's again a twofold answer. You can get the initial price improvement. It obviously is a net price improvement. But as Mike indicated, there are cost pressures. So it will be maintaining that net price improvement over the course of the year, which probably isn't likely it's going to – you're going to get the net price improvement, it's going to degrade, and then you're going to go back and seek another price in there as small costs improve not just large input costs like products and labor.

[Cole Pereira:]

Okay. Great. I appreciate the color. That's all for me. I’ll turn it back. Thanks.

[Lindsay Link:]

Thanks, Cole.

[Mike Olinek:]

Thanks, Cole.

[Operator:]

All right. We'll go ahead and take our next question from Keith MacKey with RBC. Please go ahead.

[Keith MacKey:]

Great. Thanks and good morning, and thanks for putting me on the today. Just wanted to first start off by asking in the US, can you just maybe run through what your effective utilization was on those nine fleets? Just curious as to how close to flat out you were running with those fleets. And absent any price increases or new fleets how much more do you think you could get out of your current active footprint?

[Lindsay Link:]

I think we prefer that we had nine fleets running probably eight fleets being fully utilized. So if you do that kind of math, it's around – we still have 15% to 20%, white space that we could have – we've put it stepped up on there. There were still a number of days that took place either due to weather, or some I'll call it almost startup operations that affected the quarter.

[Keith MacKey:]

Got it. Okay.

[Lindsay Link:]

Sorry, Keith, I was just asking, if there was more to the answer. But I think that's what we had. We still expected we could have stepped up significantly. And of course, that step-up would have fell through significantly as well.

[Keith MacKey:]

I see. I see. Got it. Can you give us maybe any color on your current positioning of your fleets in the US?

[Mike Olinek:]

Yeah, Keith, I mean, I think really where our focus has been and we re-pivoted here late in the second quarter is really to focus on areas in the Northern US that we felt that we have a strong market share presence in. So we're not going to work on specific fleet count as far as where we're located, but it's areas of strength that we would have had in the past around the Bakken, Marcellus and Colorado plays.

[Keith MacKey:]

Got it. Thank you. And one last one for me. You did mention early on in the prepared remarks about your analysis on ESG fuel type options and equipment. Just curious, what types of options you're considering. And how might your thoughts be different from some of your competitors where the market seems to be going to Tier 4, dual fuel, or electric. So maybe if you could just kind of elaborate on how you're thinking about the market and where you may be thinking about it differently than a lot of your peers?

[Lindsay Link:]

Well, Keith, it's a great question. It's a very long question to try and get through on our conference call, happy to give more color after the call on it. The answer is, we're looking at electric, at the turbine direct drive, and traditional diesel, or diesel dual fuel. There's almost as many questions that get raised with each of the technologies. A lot of people often talk about Tier 4 and GHG and interchange the -- what they actually mean. And of course, they are much different in their answers. And do take a lot of input in there. We are concerned with the amount of cost that you are talking about reinvesting into a frac operation. And then what do you get out? And does the customer actually -- the end customer actually appreciate what you're actually delivering to them? So as you know, I mean, there are a number of papers. There's a number of marketing blurbs on who has the best. And then when you actually do the deep dive into it, it turns out it depends on what kind of gas you use, whether it's field gas, whether it's compressed gas as to whether it's economical. And then the one that's making a lot of news in the press today and yesterday is regarding methane and methane slippage that is occurring as far as a greenhouse gas. So those have to be taken into account as well. So while it may not seem like the person is doing lots we are generating just enormous amount of detail that is making what you used to think was a pretty straightforward easy answer and through actually a more -- almost a holistic approach to what is the right answer to get to. I do want to -- I do -- I will say this. Tier 2 diesel is still a very efficient way of working from a greenhouse gas perspective.

[Mike Olinek:]

And so Keith, I'll add on to that question or that response really from a financial perspective. I think where Calfrac is aligning itself of its customers is we're certainly willing to look at new equipment choices that align with a customer's values around greenhouse gas emissions and limiting those. But financially, we're also looking for commitments from our customers on that in new investment because like anything else that's I think a fairly significant decision for the enterprise and we have to manage through evaluating our positions on reinvestment looking at the financial returns on the other side of it. So ultimately, contract or support by a customer to that investment would be something we would be looking into as well.

[Keith MacKey:]

Perfect. Appreciate the detailed answer. That’s it for me. I’ll turn it back. Thank you.

[Mike Olinek:]

Thank you.

[Operator:]

[Operator Instructions] We'll go ahead and take our next question from John Gibson with BMO Capital Markets. Please go ahead.

[John Gibson:]

Good morning, all. Thanks for taking my questions. Most of my stuff has been answered, but I had two sort of follow-ons in it. And the first is just more for clarification. You had eight fleets running in the US, but nine fleets active. I'm just wondering is the ninth fleet good to go, or could we see some -- maybe some follow-on costs in Q4 as that fleet starts up again?

[Mike Olinek:]

So I may have confused the answer. We had nine fleets working in the quarter. But with white space and that it effectively ended up being that you had eight fleets working at all times. So eight fleets working. One down for one week due to maybe weather that's where I'm getting the eight fleet. The nine fleet is operational.

[John Gibson:]

Okay. Got you. And then just kind of corresponding to the release, do you expect the sort of more active work on all nine fleets, or should it be sort of similar utilization as compared to this quarter?

[Mike Olinek:]

We were active -- very active in October and expect to be active in November. As you know the Christmas season combined with budget exhaustion does typically make December a less active month, and that's actually where we were going with that -- those statements.

[John Gibson:]

Okay. Got you. And last one for me. Just in terms of labor in the US, are you seeing challenges across all regions, or are there pockets of areas that are maybe a little bit easier to stack fleets as you see increased demand?

[Mike Olinek:]

No, I don't think it's ever easy, John. I think there are more difficult areas. The more remote you are, you have people that have to move. And as a person who has went cross-border at least two dozen times over the last year, it's not the most pleasant task to be doing air travel anywhere whether it's the US or Canada. So people do are probably a little more resistant to rotating as they have been, but I think we're still a great industry. It's a great team environment. We've managed to give back a lot of the salary and incentives that we've had in the past. So I think we're slowly actually turning the corner on getting our -- getting new employees the desire to come work for us. It has been difficult, but we have an active training program, and while there is a lot of movement, I think everyone has read about the great resignation on there. We're not immune to that, but we're still a very good industry to work in. I think we just need to get the active recruiting machine back up and running for that, but by no means will it ever be easy.

[John Gibson:]

Got it. Thanks a lot. I’ll turn it back. Thanks.

[John Gibson:]

Thank you.

[Operator:]

All right. It appears there are no further questions at this time. Mr. Olinek, I would like to turn the conference back to you for any additional or closing remarks.

[Mike Olinek:]

Thanks very much. Yes, I just want to thank everyone for joining us for the call today, and look forward to our call in Q1 to talk about our Q4 results. Thanks very much and have a good day.

[Operator:]

And this concludes today's call. Thank you all for your participation. You may now disconnect.