Calfrac Well Services Ltd.
Q2 2021 Earnings Call Transcript

Published: 1 Aug 2021

[Operator:]

Good day and thank you for standing by. Welcome to the Calfrac Well Services Ltd. Second Quarter 2021 Earnings Release and Conference Call. [Operator Instructions] I would now like to hand the conference over to your speaker today, Scott Treadwell. Please go ahead.

[Scott Treadwell:]

Thanks, Sasha and thank you everyone for joining us this morning and welcome to our discussion of Calfrac Well Services second quarter 2021 results. Also on the call today are Lindsay Link, Calfrac’s President and Chief Operating Officer and Mike Olinek, our Chief Financial Officer. This morning’s conference call will be conducted as follows. Lindsay will provide some opening remarks, after which Mike will summarize the financial position and performance of the company. Lindsay will then provide an outlook for Calfrac’s business, and closing remarks. After the prepared remarks, we will open the call to questions. In a news release issued earlier today, Calfrac reported its unaudited second 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, 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, Scott. Good morning and thank you everyone for joining our call today. Before Mike provides the financial highlights of the second quarter, I will offer a few opening remarks. As you have seen, our results in the second quarter were behind both those posted in Q1 and our expectations due in large part to operational disruptions and fleet changes in the United States, although operations in both our international divisions were strong and are expected to continue that trend. Despite spring breakup in Canada, our operations here delivered very good results and I believe that all of our operations are positioned for a strong second half of the year. To all our staff, no matter where you work, I would like to thank you all for the hard work and dedication that you bring everyday. In the United States, I can tell you that through the first half of the year, our capacity to generate revenue and cash flow has been masked by external issues like weather and client schedules. As these issues move into the rearview mirror, we expect significant improvement south of the border. I will provide some incremental detail on the second quarter in the United States. On short notice, 3 of our operating fleets were impacted by schedule changes in June due to a number of issues. These issues are unfortunately a normal part of our business. But to have nearly half our operating fleets impacted at the same time is not difficult. Not only do these changes remove revenue and profit from our results, but we cannot simply stop paying our field staff or cancel repairs as all of these fleets went back to work before the end of June and are expected to continue through the months ahead. Additionally, we shifted 1 fleet between basins, which drove some incremental costs. Finally, we accelerated the reactivation of our eighth and ninth fleets, incurring costs to prepare the equipment and the people. The timing of the schedule issues was magnified by the reactivations and the redeployment, but results in July have validated the moves we’ve made to strengthen and focus our franchise. In general, the outlook for our industry has continued to improve over the last few months, with oil and gas prices reaching levels that appear to signal the need for further increases in drilling and completion activity in North America. Our customers have rightly not chased these increases in commodity price, preferring to make smaller adjustments to programs now in anticipation of a more significant increase in capital spending in 2022. Our customers’ cash flows have accelerated meaningfully, yet we do not expect to see that incremental cash go into development programs. We believe that the restraint being shown by our clients underpins a rationality to supply that has not been evident in global oil markets for many years. While we expect to see increased demand for our services, Calfrac will, like our clients, not simply chase the market. Having moved to 9 active fleets in the United States, I believe our footprint is now sufficient to supply our longstanding clients, but retain some optionality to access incremental work. The current economics of spot market work in North America do not support adding equipment to this segment. And so Calfrac will continue to focus our best and closest partners while examining opportunities to take advantage of any improvement in spot market pricing. We are still a few months away from having real clarity on 2022 plans. So rather than procrastinate, I will simply say that Calfrac will be ready to respond to market conditions as they evolve, with the same focus on safety and service quality that is a cornerstone of our business. Now, I will pass the call over to Mike, who will present an overview of our quarterly financial performance.

[Mike Olinek:]

Thank you, Lindsay and thank you everyone for joining us on today’s call. Our second quarter results showed a deterioration from the first quarter due to the seasonal slowdown in Canada, along with unplanned schedule gaps and reactivation costs in the United States. Consolidated revenue in the second quarter increased by 127% year-over-year to $207.3 million, with all operating areas showing significant improvement due to higher utilization levels. Adjusted EBITDA reported for the quarter was $4.4 million compared to a loss of $5.2 million a year ago. Operating income also increased by 183% to $6 million from a loss of $7.3 million in 2020. This improvement in profitability was largely due to the increased revenue generated by all of the company’s operating divisions, offset partially by approximately $4 million in reactivation and redeployment expenses in the U.S. as well as the impacts of unplanned gaps in our schedule during June. The net loss for the quarter was $30.5 million compared to a net loss of $277.3 million in the same quarter of 2020. During the second quarter of 2020, the company recorded an impairment of $173.7 million to PP&E and $27.9 million impairment of inventory. In addition, lower depreciation and interest expense in the second quarter of 2021 also contributed to the improvement in the company’s reported net loss. For the 3 months ended June 30, 2021, depreciation expense decreased from the corresponding quarter of 2020 by $14.8 million to $31.4 million. This decrease was driven primarily by the $227 million impairment to PP&E that was recorded in the first half of 2020, as well as lower levels of capital spending on items with shorter useful lives and corresponding higher depreciation rates. Interest expense during the second quarter of 2021 decreased by $11.4 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. Calfrac spent a total of $14.6 million on capital expenditures in the second quarter compared to $10.2 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 2021 capital budget remains at $55 million and the company will monitor market conditions and adjust spending as required. Working capital provided cash inflow of $15.8 million, largely driven by the timing of payments and receipts. During the quarter, the company completed the rescission of approximately $1 million of its 1.5 lien notes and an immaterial quantity of warrants, were exercised. Subsequent to the quarter, the company converted approximately $0.3 million of face value of 1.5 lien notes into shares. To summarize the balance sheet as at the end of the second quarter, the company had working capital of $152.2 million, including $20.7 million in cash. At June 30, 2021, the company had used $0.8 million of its credit facilities for letters of credit and had $155 million of borrowings under its credit facility, leaving $69.2 million in potential borrowing capacity at the end of the second quarter. As at June 30, 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 will now 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. In general, it appears that the commodity markets globally are signaling ongoing tightness in the physical markets, along with concern for the long-term supply demand balance as chronic underinvestment and ongoing economic recovery have become the focus of market participants. It appears the maturation of the North American oil and gas industry has firmly taken hold. Clearly, producers have shifted their collective approach to a focus on returns over growth. Additionally, maturation of the reservoirs is a never ending – is never ending, with most observers agreeing that the industry is no longer capable of producing the level of multiyear production growth delivered over the last 10 years. In short, I believe that resources are getting more valuable. And the reaction to that change in value is far more rational than in the past. While we may not see the rapid and massive activity gains of the past, I do believe that our industry is entering a phase of sustained value creation. In our U.S. division, I have spoken about the issues that impacted the second quarter and noted that I feel our franchise is well-positioned to deliver meaningful improvement in the results through the second half with 9 active fleets. The third quarter is expected to show a significant improvement over even the best months of the first half of the year based on improved and more consistent utilization, better pricing and improved fixed cost absorption. Recent improvement in natural gas pricing in the Northeast has shifted our outlook for that region to one of cautious optimism and we are looking for opportunities to add clients in that region. I expect that as the summer concludes, we will see elevated bid activity supporting 2022 programs in all areas of the United States and we will have much more clarity on the final months of the year at that time. In Canada, the second quarter unfolded as we expected with lower activity in April and early May, giving our people and equipment a chance to recharge after a busy first quarter. Through the final weeks of the quarter, activity rebounded significantly with June producing results in line with the first quarter. This rapid restart of activity signals to me that the demand for our services will be robust through the second half of this year, and our frac calendar supports that view. We expect activity levels in the remainder of the third quarter to resemble the first quarter and continue at that level into the fourth quarter. We will market 4 fracturing crews through the remainder of 2021 based on current frac dates from our major clients. For 2022, we currently expect to deploy a fifth fracturing fleet, as well as a fourth coiled tubing crew and will finalize those plans by October. The incremental frac capacity will be required to service communicated activity increases from our major clients with the coiled tubing addition plan to focus on callout work. Pricing in the Canadian market has begun to move upwards. But as I have previously stated, inflation has driven almost all of the increase to date. There is simply too much equipment in the spot market. And while increased activity will serve to bring balance to the segment, producers are not communicating a high level of concern around frac crew availability in the near-term. I do expect that further tightness in the Canadian market will serve to push net pricing higher, but I do not believe that will have a material impact on the profitability of the Canadian pumping space until 2022. I will now turn to Calfrac’s international operations. In the second quarter, our operations in Russia improved significantly over the prior period, as the transition to non-winter operations was completed as expected. Work volumes remained robust during the quarter, with job mix and cost management driving a large improvement in profitability. The third quarter is typically the busiest in Russia and work schedules indicate a similar trend this year. While pricing changes are only seen during contract renewal, work volumes and efficiency should support further margin improvement in Q3. Our operations in Argentina showed modest improvement sequentially in the second quarter as work programs continued. While operations in Neuquen are by far the largest, our operations in the southern part of the country continued to deliver excellent operating results and returns on a relatively modest asset base. I expect activity levels to trend higher through the remainder of 2021, with higher oil prices providing a significant economic tailwind to operations in the southern part of Argentina in particular. Demand for shale fracturing services remains strong, and Calfrac’s position in this segment should provide us opportunities to grow our footprint and cash flows in the near to medium term. The last 15 months have been full of challenge for our industry and our company. I’d like to thank all of our team for their efforts in helping us through this period. It truly does look like better days are ahead, and I’m proud to be part of this team as we move forward. Back to you, Scott.

[Scott Treadwell:]

Thanks, Lindsay. This concludes the prepared remarks. Operator, we will turn it back to you to manage the Q&A.

[Operator:]

[Operator Instructions] Your first question is from the line of Cole Pereira with Stifel.

[Cole Pereira:]

Hi, good morning everyone. Just wanted to start on the commentary about the Canadian fleet addition in 2022, so obviously, the market is still slightly oversupplied now, but demand should take a step higher next year. However, obviously, also a risk that too many fleet additions could cut into pricing. So, I guess are you fairly confident at this point that even with that addition, you can still get higher pricing for that fleet into 2022 as well as the rest of your operations?

[Scott Treadwell:]

Yes, Cole, I think it’s important to differentiate that the fleet we are contemplating adding for 2022 is only designed to service existing clients who have talked to us about increased programs for next year. So, in terms of the overall market, yes, there will be higher demand and obviously, from our position, higher supply. But in terms of the spot market, which is really where pricing turns in the Canadian market, at least in a functioning market, the planned addition of a fifth fleet is going to have no impact on that. So, we don’t anticipate it creating any headwinds for our ability to move pricing in a constructive market. And if the market changes between now and let’s say, the fourth quarter and we don’t need to add that fifth fleet and can still support our major clients, then that’s the decision we will kind of take at that time. I think we wanted to be clear that that’s not written in stone. It certainly looks like that’s the way the cards are going to fall here in 2022, but it’s not – it’s certainly not set in stone. But if nothing changes on our client side, that’s the way it will play out for us.

[Cole Pereira:]

Okay, got it.

[Lindsay Link:]

Just a follow-up on Scott’s comments, that fifth fleet is actually a relatively modest reactivation cost on it. So, it won’t take us very long to either stop or start that fleet based upon the coming months’ activity.

[Cole Pereira:]

Okay, got it. That’s helpful. Thanks. And for the fourth spread that you are reactivating for this quarter, I mean, earlier you had commented you thought utilization would be quite spotty. But obviously, activity has kind of surprised the upside. So, can you just comment at all on what you expect the utilization for that fourth spread to be into the back half of the year?

[Scott Treadwell:]

We don’t give guidance, so I won’t be too specific. But I can give you two points. First and foremost, we wouldn’t go back to that fourth spread unless there was demand that we couldn’t service any other way. And we look at the business from the core clients onwards. And so with our core clients’ programs for the second half of the year, some of them are a little more kind of Q1, Q3 weighted. And so you get back to kind of that Q1 footprint where we were running four crews. It’s really more of a return to that kind of level. And so, again, I don’t think you would see us run a fourth crew if we were expecting it to be 50% utilized. The spot market has never been a big piece of our Canadian business, and I don’t think you will see that – it’s certainly not the plan for 2021. If the spot market pricing was 10% or 15% higher than it was, that might be a different answer. We might have a bit of speculation in our footprint, but it’s just not – doesn’t make economic sense to have that much capacity in a speculative market segment. And so, it’s really all spoken for.

[Cole Pereira:]

Okay, great. Thanks. And so I mean for the quarter, U.S. EBITDA was negative $3 million, but obviously a lot of one-time items. So, let’s call it, $5 million on a normalized basis. I mean, is this kind of a reasonable baseline going forward? And then maybe there is some upside from the near-term fleet additions or are there other factors we should kind of think about?

[Scott Treadwell:]

Yes. Again, I won’t speak specifically about numbers. I think maybe what you are adding back might be a little light. I think there – the impact of that schedule disruption was pretty significant. And, honestly, it would probably take some forensic accounting to get the exact number. But I think the U.S. on a quarterly basis, even if you ex out those items, it’s probably – I think we would be expecting that as an absolute minimum and likely something much better than that. On a monthly basis, we have seen the U.S. perform at a level that would support something better than that. Obviously, I am not going to give you that kind of detail. But I think we have got some confidence that the U.S. can improve over even a normalized Q2 level, not just from the addition of the two incremental fleets and the removal of kind of one-time items, but just more consistent utilization and hopefully, it looks like some pricing moving to the upside as well.

[Cole Pereira:]

Okay. Got it. And I guess, maybe on that note, can you just give some color around how pricing conversations have been going for the next few quarters in the U.S.?

[Scott Treadwell:]

I think we will – what I will say is we won’t – I won’t comment too specifically on pricing. We try not to negotiate pricing in public. Find that to be, in general, kind of counterproductive. I would say generally, all of the conversations have been collegial and understanding and moving in the right direction. But I don’t want to give the impression that you just knock on a customer’s door and they give you more money. They have got shareholders that they are accountable to as well. And so they have to make sure they are doing due diligence. If they have to spend more money, they need to know why. And part of that is we don’t make enough money as a service industry to support investment in our assets over the long-term. But part of it is also around inflation. So, I would say it’s multidimensional from that perspective, but it’s been relatively positive. And I think if the macro doesn’t change, you will continue to see those positive conversations unfold. But I want to be very clear, you have to bring value to the table if you are going to move pricing higher on a net basis unless you are going to just lag everybody. So, that’s where we are really focused, is making sure we have got something to bring to our customer if we are talking about trying to move price higher.

[Lindsay Link:]

Especially net pricing.

[Scott Treadwell:]

Net pricing. Yes, absolutely.

[Lindsay Link:]

As Scott alluded, Cole, cost pricing is a relatively quick discussion on there. But that is to be expected when you are running small margins as it is. No one can really argue that if you have a cost increase that you need to capture that back because there isn’t margin to absorb that cost.

[Cole Pereira:]

Okay, got it. That’s helpful. Thanks. That’s all for me. I will turn it back.

[Lindsay Link:]

Thanks Cole.

[Operator:]

Your next question is from the line of John Gibson with BMO Capital Markets.

[John Gibson:]

Hi guys. I will start in Argentina. I am just wondering and apologies if I missed this. Have operations largely resumed in the Q or are you still seeing some issues with the customer there?

[Scott Treadwell:]

No. We had a little bit of disruption during the quarter with some labor issues, but by and large, field operations are pretty much back to pre-pandemic levels.

[Lindsay Link:]

Yes. There still is some COVID impact, individual crews or maybe a redeployment of crews to take on. Argentina as a country is still battling the pandemic in a pretty earnest way.

[John Gibson:]

So, I was more referencing in the release you talked about a wellbore issue with a customer. And I am just wondering if that’s largely been sorted out.

[Scott Treadwell:]

Yes. Those things tend to be days or weeks. And at the end of the day, you move on to another pad if they can’t resolve it. And so that’s definitely in the rearview mirror when you are thinking about Q3 and Q4, that’s absolutely fine.

[John Gibson:]

Okay, got it. Also in your release, you spoke to Q3 and Q4 trending in the direction of Q1 this year in Canada. Obviously, you had some weather issues during the quarter in Q1. Just wondering if we could assume some modestly higher margins in Canada going forward relative to Q1 obviously pending better quarters, but just in terms of weather?

[Scott Treadwell:]

I would be a little bit careful. I think we have been relatively clear that net pricing in Canada has not been a big positive development through the first half of the year. I don’t want to say it’s not there at all, but there is definitely not as much positive pricing movement in Canada as there has in the U.S., albeit U.S. from a lower level. You can probably get some margin improvement from consistent utilization and efficiency. But that’s typically measured in maybe a couple of hundred basis points. If you are talking about getting 4% or 5% margin improvement, you really need pricing to come in. And let’s remember, we are – in summer, there is a lot of demand for labor. There is a lot of demand for fuel. There is demand for steel. So, I would kind of caution about getting too aggressive on margins moving up. Not that we know anything today, but there is probably some inflationary pressures that we don’t see that will pop up at some point before the end of September.

[John Gibson:]

Okay. Maybe I will add on to that, the labor question. Obviously, you guys reactivated a bunch of equipment in North America to start the year. Just wondering if you are seeing issues on the labor side, or were you able to staff those incremental fleets relatively easily?

[Lindsay Link:]

I mean nothing is easy, but we have a very active recruiting and training program. We have had that for probably since we started as a company. We can do an intake of new personnel and at least give them a good chance on field readiness in a relatively short period of time. But without a doubt, what other companies have said, and I think we have said, it is a challenge right at the moment to get especially certain kinds of experience. CDL-licensed employees are in high demand from a number of different sectors. And so it does make it a challenge. But to-date, we are meeting that demand on there. And we continue to evaluate the marketplace, but we are very aggressive in the hiring market, using all the different forms of technology to make that happen.

[John Gibson:]

Have you seen some cost inflation in order to do so, just on the labor side?

[Lindsay Link:]

No. I mean the – we are keeping costs relatively consistent with where they have been. Where the employees, I think, are seeing the benefit is in, again, higher utilization, so either in overtime or bonuses depending on which country you are in from a – for an increase. But relatively to the stage count, that doesn’t change the number a whole lot.

[Scott Treadwell:]

And, John, I think from a labor inflation perspective, what we would do, and I think probably most of the industry would do is if we were raising labor rates to attract people, the first thing you would do is would be to pay your people that had worked for you today more and then potentially have hiring incentives and things like that as well to kind of sweeten it for the people who work for you today. And then that obviously leads to higher wages when they come in the door. But we certainly wouldn’t raise rates for new employees without considering what’s going on with our existing employees.

[John Gibson:]

Okay, got it. Thanks. Last one for me. We are hearing from your peers that incremental equipment in Canada will require upgrades to dual-fuel or Tier 4. Just wondering where your parked equipment in Canada sits in terms of its dual-fuel capabilities. I know you spoke to minimal upgrade requirements or activation CapEx for that fleet. And are you seeing demand for upgraded equipment to Tier 4 status as we move forward here?

[Lindsay Link:]

Okay. Just a couple of parts in there, I think we are satisfied with our level of dual-fuel deployment in Canada. So, I don’t think that we – for the next fleet that we would be talking about it’s going to be a dual-fuel. For Tier 4 and that – while there is always demand from our clients to have us add more horsepower into the marketplace, which would again probably seem to keep pricing in a depressed level. I think everyone has also been pretty cautious on redeploying more capital to that level. The Tier 4 is a great improvement from the – on the offering that’s out there. But it is basically $1 million to upgrade a frac pump on each of those. So, it does make it a challenge to get that cost recovery. And there is some substitution benefit and maybe there is limited environmental benefits on there, especially in remote areas. So, we are evaluating. We are – we have a small amount under construction, not here in Canada, but it’s a well-proven technology, but we are still waiting – we haven’t seen the demand to justify full fleet conversions.

[John Gibson:]

Got it. I appreciate the first half results.

[Lindsay Link:]

Thanks John.

[Operator:]

[Operator Instructions] At this time, there are no further questions, so I would like to turn the call back over to Scott Treadwell for any closing remarks.

[Scott Treadwell:]

Thanks, Sasha. Thanks everybody for your interest today. The management team will be around if you have any follow-ups and we look forward to speaking to you when we release our Q3 results later this year. Thank you very much.

[Operator:]

Thank you, ladies and gentlemen. This does conclude today’s conference call. We thank you for participating, and ask that you now disconnect.