Calfrac Well Services Ltd.
Q1 2021 Earnings Call Transcript

Published: 30 Apr 2021

[Operator:]

Hello and thank you for standing by, and welcome to Calfrac Well Services Limited First Quarter 2021 Earnings Release and Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Mr. Scott Treadwell, Vice President of Capital Markets and Strategy. Please go ahead.

[Scott Treadwell:]

Thank you. Good morning and welcome to our discussion of Calfrac Well Services first 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 Link:]

Thanks, Scott. Good morning and thank you everyone for joining our call today. Before Mike summarizes our financial position and results, I'd like to offer a few opening remarks. In general, the first quarter showed more positives than negatives, but is ongoing evidence of the challenges facing our space. While activity either met or exceeded our expectations globally, it was impacted by weather in Canada, Russia and the United States. While we are used to weather impacting operations in Canada and Russia, the February storm in the United States had a significant impact on that division both in terms of lost revenue and profit due to slower operations and delays as well as a number of unforeseen costs such as diesel fuel increases as refineries curtailed operations. As always our people improvised, adapted and overcame these challenges and delivered the safe and productive service that Calfrac is known for. I'd like to give my thanks to everyone in the field and our support personnel once again for a job well done. As a general comment, the improvement and relative stability in commodity prices has brightened the outlook for activity in the months ahead, but we continue to believe that the rapid acceleration seen in 2017 is not going to happen in 2021. Our customers whether private, public or nationally owned have largely embraced the idea of allocating capital to generate excess returns rather than excess volumes. As always, we will see some producers grow faster than others, but we believe that at least for the remainder of 2021 activity growth will be measured. This approach will be a benefit over the long-term as it will help create the foundation for sustainable operations. But the discipline underpinning it must also be mirrored by oilfield service market participants. Certainly input cost inflation may impact capital spending in the latter part of the year, but I do not expect to see significant upward revisions to spending plans this year. For 2022, I would expect more of a step function change in spending, but again set against the overarching theme of capital discipline. 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 for today's call. Our first quarter results showed further sequential improvement driven primarily by higher activity in North America offset marginally by adverse winter storms that disrupted our operating cadence most notably in the United States. Consolidated revenue in the first quarter decreased by 21% year-over-year to $241.6 million as lower activity in North America was partially offset by higher activity in Calfrac's international division. Adjusted EBITDA reported for the quarter was $11.9 million compared to $6.8 million a year ago. Operating income also increased by 127% to $12.9 million from $5.7 million in 2020. This improvement in profitability was largely due to better utilization for Calfrac's operating fleets in Canada, Russia and Argentina combined with cost reduction measures that were implemented across the company during 2020. The net loss for the quarter was $22.4 million compared to a net loss of $122.9 million in the same quarter of 2020. During the first quarter of 2020, the company recorded a debt exchange gain of $130.4 million, which was offset by $114 million deferred tax expense that was related to the de-recognition of the company's deferred tax asset and a $54 million impairment of PP&E and other assets. In addition, lower depreciation and interest expense in the first quarter of 2021 also contributed to the improvement in the company's reported net loss. For the three months ended March 31, 2021 depreciation expense decreased from the corresponding quarter of 2020 by $31.7 million to $31.6 million. This decrease was driven primarily by $227.2 million in impairments to PP&E that were 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 first quarter of 2021 decreased by $16.9 million from the same period in the prior year due to the significant reduction in long-term debt that resulted from the company's recently completed recapitalization transaction. Calfrac spent a total of $11.6 million on capital expenditures in the first quarter compared to $29.3 million in the same period of 2020. This decrease 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 grew sequentially by $8.6 million mainly as a result of higher revenue in all operating areas. During the quarter, the company received approximately $0.1 million from the exercise of warrants. And subsequent to the quarter, the company completed the rescission of approximately $1 million of its 1.5 Lien Notes. To summarize the balance sheet as at March 31st, the company had working capital of $170.1 million including $14 million in cash. On March 31, 2021, the company had used $0.8 million of its credit facilities for letters of credit and had $150 million of borrowings under its credit facilities, leaving $139.2 million in potential borrowing capacity at the end of the first quarter. As at March 31st, Calfrac was in full compliance with all covenants in its credit agreement during the covenant relief period and under the indentures covering the 1.5 Lien and Second Lien Notes. I'd like to also remind our fellow shareholders that Calfrac's Annual General Meeting will take place in a virtual format this year. The meeting will still take place on May 4th at 3

[Lindsay Link:]

Thanks Mike. I will now present an outlook for Calfrac's operations across our geographical footprint. We see commodity market caught between two opposing and very impactful drivers. First, the rollout of vaccines has allowed some countries to return to more normal activities like driving and flying to see family. This combined with unprecedented volumes of stimulus spending has many observers expecting significant growth in demand for energy in the months ahead. On the other hand other countries have struggled to roll out vaccines at scale and as a result have been hit by a third or fourth wave of infections including varying strains. This has caused the tightening of restrictions in many areas and raised questions about the timing of a global return to normal. Add to this the lack of vaccines for developing nations and the timing of forecasted demand growth is more uncertain. Our view is that the market is acting rationally to directionally align supplies with demand, while continuing to return inventories to a more normal range. I believe that the market will continue to see lumpy event-driven moves, but that the overall direction is positive. In our U.S. division, operations experienced a general improvement in activity disrupted, of course, by the winter storm in February. This storm caused operations to slow in North Dakota and Pennsylvania and resulted in significant delays in Colorado and Texas. In addition, the price of fuel and availability of trucking were impacted resulting in a significant erosion of field profitability. Some of these cost increases can be recaptured as part of a normal course discussions with customers, but that process is typically commenced at the end of each quarter. Our U.S. operations saw stronger utilization and profitability in March and that trend bodes well for the second and third quarters. Our frac calendar continues to fill up and for the most part, we expect all seven crews to work consistently over the summer. It appears that in this market segment, pricing remains well-below what we feel is sustainable and appropriate. Pricing does appear to be moving higher, but so are a number of input costs. So we will continue to work hard to capture as much of the upside as we can. I expect that the U.S. division will generate positive operating income in the second quarter and that profitability should improve in the third quarter as well. Visibility on activity levels into the end of the year is still murky but I'll reiterate my thought that I would expect to see more of a step function increase in activity as 2022 begins. In Canada, the first quarter unfolded as we expected with small weather disruptions offsetting what was otherwise a quarter of nearly full utilization. Financial performance was similarly strong and reflects the current state of the Canadian market. The second quarter began very well with some first quarter works spilling into April. And while current activity levels are likely near the lows for the quarter, we expect larger programs to pick up in the first half of May and continue through June. Our visibility for second half activity has improved as expected and I believe that our utilization will remain high through a good portion of the remainder of the year. We will manage our footprint between three to four crews as needed to give our field staff the work they need, while efficiently servicing our core clients and realizing substantial sustainable returns to do so. I spoke about pricing in the Canadian market on our fourth quarter call and that commentary still stands. However, what is now apparent to us is that a number of service companies had equipment consistently sitting idle through much of the quarter and we're able to service work on a very short notice and did so without increasing price. This is of particular concern given current unsustainable pricing levels. An oversupply of equipment in the busiest part of the year adds to the difficulty in moving pricing for our services much ahead of input cost inflation. Calfrac's focus will remain on driving high utilization on whatever equipment is deployed rather than revenue growth or market share, unless those results are accompanied by improved field profitability. Let me be clear, we will provide the same excellent service to our clients as we always have but we will not market equipment that we do not see being utilized consistently. I'll now turn to Calfrac's international operations. In the first quarter our operations in Russia continued to build off the strong momentum seen in 2020, although severe cold in winter resulted in the loss of approximately 10 operating days during the quarter. As the quarter progressed, our operations resumed and we maintained high utilization through the end of March. The shift away from ice bridges to barges and pontoon bridges is largely complete and we expect our operations in Russia to deliver strong performance through the second and third quarters. The ongoing shift to multistage conventional wells along with increase in overall field efficiency support the view that performance in Russia can continue to improve in future periods with the key to that success being Calfrac's proven ability to execute. Our operations in Argentina continued to perform well during the first quarter with limited disruptions outside of a change in customer mix for our large shale fracturing crew. Improving field productivity and overall demand for services are the keys to deliver further improvement. And I think Calfrac will benefit from both in the quarters ahead. We expect work volumes to improve modestly in future periods and we are seeing increased demand for smaller fracturing services, as well as coil tubing and cementing. We have had discussions with clients about the possibility of deploying a second large fracturing spread to the country, but I do not envision that as likely in 2021. To wrap up I'd like to thank everyone at Calfrac for their efforts in delivering a safe and efficient service to our clients and for being part of a great team. Back to you Scott.

[Scott Treadwell:]

Thanks Lindsay. Operator that concludes the formal part of the call. We'll open it up to questions now.

[Operator:]

[Operator Instructions] Your first question comes from Waqar Syed from ATB Capital Markets. Your line is open.

[Waqar Syed:]

So first of all Lindsay what was kind of the run rate in March in the US revenue run rate versus like the average monthly run rate that you saw in the first quarter in the US?

[Scott Treadwell:]

Waqar it's Scott. That's a little bit too granular in terms of where we exited but I can certainly tell you March was definitely the best month of the quarter even normalizing for the weather impacts we saw in February.

[Waqar Syed:]

Okay. And then in terms of kind of margins in the US, like how do you expect them to kind of trend going forward like incremental margins and overall margins? Any guidance there?

[Scott Treadwell:]

I wouldn't classify it as guidance, but I would say our US business - the US marketplace the way we look at cost versus capital probably support something in the mid-single-digit range for EBITDA at this point in time and that doesn't contemplate any pricing increases. And so obviously there's not much difference between mid-single digit and zero. And so any change in utilization has a very significant impact in terms of what you delivered to the bottom line.

[Waqar Syed:]

Sure. Now in the press release there was a comment on Argentina that there was some revenue that was -- from your subcontract the revenue is kind of showing up in your financials. Could you maybe explain that -- what's going on there?

[Scott Treadwell:]

Yes. So in Argentina as well as in Russia, but Argentina is more of the subcontractor model. Especially for large fracturing jobs you're required to provide a number of services or you're responsible for those services. In the large frac operations that would tend to be flowback and wireline would be the two big ones. And so, those go through our invoicing and so they're recorded as revenue but they're obviously subcontractors. And that's not really a significant change. It may be a bit more significant in that we've had higher utilization for that part of the business, but there's no change to the model.

[Waqar Syed:]

Sure. Great. Thank you very much.

[Scott Treadwell:]

Thanks Waqar.

[Operator:]

And your next question will come from Cole Pereira from Stifel. Your line is open.

[Cole Pereira:]

Morning everyone. Some of the commentary on needing to see pricing increases to add additional spreads. I mean maybe this is too high level, but are you able to kind of quantify what you might need to see on a percentage basis in both Canada and the US?

[Scott Treadwell:]

Well I'll give you kind of the overall commentary and Lindsay might be able to give you some more color. But we're certainly not going to discuss sort of detailed pricing in the public forum. That's something for our sales group to do with our clients. I think the way you would think about it structurally is that, there is today a level of profitability for existing equipment. And if it costs you more money to bring equipment back, you can't use today's profitability to pay off tomorrow's capital investment. There has to be an incremental return that makes that capital worthwhile because otherwise what you've seen certainly in Canada and in the US is that, it makes sense if you look I can spend $2 million because the fleet makes $5 million a year, but that any fleet that's active would make $5 million a year. And so there's not much sense in adding to what's at best a balanced market but likely a little oversupplied just using today's economics. So that would be the structural way to think of it.

[Lindsay Link:]

And I think the fleets are very efficient when they're not impacted by weather. So there's not lots of profitability to squeeze out of efficiency anymore because we're already very efficient. So we're really looking at net price increases. Obviously the market is on -- I'll call it a steady state upward. So these increases probably are not going to occur in one step change. They'll be gradual, but we're expecting them to be net increases of any cost inflation.

[Cole Pereira:]

Okay. Got it. That's helpful. Thanks. Also wondering are you able to differentiate -- in the U.S. if you're seeing kind of a wide dispersion in pricing between different basins?

[Scott Treadwell:]

I don't think there'd be significant differences across basins. What I would say is between market segments dedicated versus spot. What we've seen and this commentary applies to Canada as well, when there's equipment that has a gap and there is a work program that fits that gap the bidding is as aggressive as it has been in the last few years because you can kind of get the logic that this spread either doesn't work or it does work and so I take less money to fill that hole. And that's the logic that kind of works against kind of getting any significant pricing increase as you move forward. But I don't know that there's massive basin differences other than kind of job scope and preference for domestic or white proppant things like that, different models in terms of comp rentals with a per-stage pricing. But the US market is relatively efficient. So if there's a pricing disruption in one area, it will tend to cause ripples everywhere.

[Lindsay Link:]

Yes. I think not so much in the basin-by-basin, but the equipment rental model to a full service and product supply model, does give you a difference in overall profitability that you can extract. And of course when you were doing just a rental-only model and we were in the -- I'll call it low periods of activity that model gets very -- gets squeezed really hard because the only source of revenue and profitability comes off the equipment itself, yet you're fully set up to run all products and chemistry and stuff. So definitely the rental model has a lot of ways to go for improving our profitability.

[Cole Pereira:]

Okay. Got it. And then just one last one for me. So, one of your Canadian competitors is talking about upgrading a fleet to Tier 4 engines. Just curious, if this is something you could maybe see Calfrac doing over the medium term, whether it be in Canada or in the US?

[Lindsay Link:]

Yeah, I think it's mainly an engine swap out. It's something we definitely have evaluated. It's not cheap by any means based upon the overall cost of a frac pump. It typically – on a Canadian basis, it's probably CAD 1 million a unit US$800,000 now, and to go into basically Tier 4 dual fuel pump. So that's a lot of expense. I believe kind, it's almost a half fleet that's being renovated or rejuvenated on there. And it comes down to are you going to get the return for the effectively $10 million investment from the client. There definitely can be an improvement in biofuel substitution, with some of the new equipment and that benefit needs to go into paying for the capital expenditure on that unit. So if those things line up, we can definitely do that. We've looked at it we have the engineering drawings to do it, and the manufacturers, or the rebuild facilities are set to do it for you.

[Scott Treadwell:]

And Cole, the only thing I'd probably add to that is that, as you look at new equipment you have to sort of differentiate between incremental improvement and sort of step change in design. Obviously, Tier 4 DGB is an incremental improvement, but it's still a diesel engine driving a gearbox and a power end fluid end. So it's – in general, it's essentially the same as we've done for sort of 30 or 40 years. But what I would say is that, more critical or equally as critical I guess as the ESG considerations and the financial considerations is understanding the relevance of that equipment in the medium to long term. The application is going to dictate a lot of how equipment evolves in our industry. That's going to be the customer, if they have natural gas and the specs of that natural gas their infrastructure to deliver that. They may have a preference for a certain kind of power generation. And so I think you need to consider all of that, before you would make a move because I think we've seen in a lot of industries in oilfield services there are advances in technologies that look really promising, but don't turn out to be the complete right answer. And so I think there's still education to be done both for us and our industry and the customers to understand what outcomes we're trying to get to and then understand the right engineering to get there. So as Lindsay said, we're I think absolutely considering, examining, whatever words you want to use about these new options. But I think our preference, would be to make sure we get it right the first time and deliver some real step change improvements not just to us but to our customers and to their returns and ESG impact.

[Cole Pereira:]

Okay. Great. That's all for me. I’ll turn it back. Thanks, guys.

[Scott Treadwell:]

Thanks, Cole.

[Operator:]

[Operator Instructions] Your next question comes from Keith MacKey from RBC. Your line is open.

[Keith MacKey:]

First, I just wanted to start out with your capital budget for this year $55 million and I believe there was $5 million in there for dual-fuel upgrade. Just curious, if that's been done, or if it's still in the works and broadly speaking where might that equipment be deployed?

[Lindsay Link:]

Yes. It absolutely is undergoing. It's being done. We release some units, we do on a unit-by-unit basis. And it's both being done in the US and in Canada. So when it's released into Canada, I mean, it goes anywhere in the Canadian market. And in the US side, we have fleets in Pennsylvania and Colorado, and the ability to do that in Texas. So we typically, will just put it where it needs to go. I think we expect that by the end of this quarter, all of the conversions that we've put forward to be done will be completed.

[Keith MacKey:]

Perfect. Thanks for that. Final question is it looks like the interest on the payment-in-kind notes was paid in cash this go around. Just curious, if you could give us some insights into the Board thought process on making that decision, and whether it's then safe to assume that that the cash payment will be used going forward.

[Mike Olinek:]

Hey, Keith, it's Mike here. Yeah, you're correct in the sense that we made the payment in cash here in the first quarter. So I think that decision is made on a visibility on cash flow and where we are from a liquidity standpoint and in discussion with the Board. And that will be made in advance of every payment as we go forward here. So I think ultimately we understand the implications on either side, and we think that the financial stability of Calfrac has certainly been greatly improved past the recap transaction. And we'll look to make those decisions on a quarter-by-quarter basis or semiannual basis.

[Keith MacKey:]

Got it. Okay. Perfect. Well, that's it for me. Thanks very much.

[Scott Treadwell:]

Thanks, Keith.

[Operator:]

I have no further questions in queue. I'll turn the call back over to the presenters for closing remarks.

[Scott Treadwell:]

Thanks, operator. Thank you everybody for joining us today. As you all know, our AGM is next week. We look forward to talking with some of you then. Thank you.

[Operator:]

Thank you everyone for joining us today. This will conclude today's conference call. You may now disconnect.