Calfrac Well Services Ltd.
Q4 2019 Earnings Call Transcript

Published: 9 Mar 2020

[Operator:]

Ladies and gentlemen, thank you for standing by, and welcome to the Calfrac Well Services Limited Fourth Quarter 2019 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. [Operator Instructions] I would now like to hand the conference over to your speaker today, Scott Treadwell, Vice President of Capital Markets and Strategy. Thank you. Please go ahead, sir.

[Scott Treadwell:]

Thank you, Lynn. Good morning, and welcome to our discussion of Calfrac Well Services fourth quarter and full year 2019 results. Also on the call today are Lindsay Link, Calfrac's President and Chief Operating Officer; and Michael Olinek, our Chief Financial Officer. This morning's conference call will be conducted as follows. Lindsay will provide some introductory remarks, after which Mike will provide an overview of the financial performance of the company. Lindsay will then close the presentation with an outlook for Calfrac's business. After the presentation, we will open the call to questions. In our news release issued earlier today, Calfrac reported its fourth quarter and its full year 2019 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 our news release and other regulatory filings, including our 2018 annual report for more information on forward-looking statements and these risk factors. Lindsay, over to you.

[Lindsay Link:]

Thank you, Scott. Good morning, and thank you for joining our call today. Before Mike summarizes the financial performance in the quarter, I'd like to offer a few opening remarks. As we expected, the fourth quarter was characterized by a further slowdown in producer activity across all of our operating areas. In North America, program completion and weather were primarily responsible for the slowdown. While weather in Russia and a change of government in Argentina drove changes in activity in those countries. Calfrac sales and marketing teams were busy securing work programs for 2020 in the fourth quarter. And although industry pricing needs to increase from the low level it has fallen to, I’m pleased overall with our results in securing work across the platform for the equipment that we have elected to actively market. One point I’d like to emphasize is Calfrac’s safety performance. We take our commitment to safety seriously. It is a promise to our employees and their families that everyone goes home safely after work. In 2019, Calfrac was able to deliver outstanding safety performance globally with significant improvement in our North American operations, resulting in all-time record performance measured in recordable and lost time injuries. There’s always room to improve, and Calfrac will never accept injuries as a cost of doing business. But I want to use this platform to not only broadcast our success in this regard, but to personally thank everyone at Calfrac for their efforts in achieving an outstanding result. Now I will pass the call over to Mike, who will present an overview of our quarterly financial performance.

[Michael Olinek:]

Thank you, Lindsay. And thank you, everyone, for joining us for today’s call. Before covering our fourth quarter financial performance, I would like to summarize our recently closed exchange offering. Due in part to significantly discounted trading prices for Calfrac’s unsecured bonds, the company opportunistically launched an exchange offering in February, which allowed unsecured note holders to tender into a Dutch auction within a range between 55% and 60% of the face value of their unsecured bonds into new secured notes. These new notes bear a coupon of 10.78% and mature in March 2026. We were very pleased with the results, and the company upsized the offering from a maximum of US$100 million to US$120 million. At that level, the offering was more than 3 times oversubscribed at an exchange ratio of 55%. As a result, Calfrac’s debt load was reduced by over $130 million, with a reduction in annual interest costs of over $7 million. I would like to thank all of the Calfrac team, as well as our advisers that were involved with this successful transaction. But as we move forward, we remain focused on further debt reduction between now and the refinancing of our notes that are due in 2026. Consolidated revenue in the fourth quarter decreased by 36%, year-over-year, primarily due to lower activity levels and pricing across all our operating divisions magnified by year-end slowdowns in North America. Adjusted EBITDA reported for the quarter was $26.9 million compared to $62.9 million a year ago. Operating income was down 66% to $21 million from $62 million in 2018. These weaker results were mainly driven by lower activity and pricing in North America, as well as restructuring costs booked in the quarter. Offsetting these items were $10.9 million of 2019 operating expenses that were reclassified to capital expenditures due to a change in capitalization thresholds as well as $5.2 million in lower overhead costs. In Canada, fourth quarter revenue was down 50% from the same quarter in 2018 due to a smaller operating footprint and lower pricing for Calfrac services. Calfrac's Canadian operations had a total of 236,000 active horsepower and 11 coiled tubing units in its operations in the fourth quarter, down 18% and flat, respectively, from the prior year. Operating income in Canada during the fourth quarter decreased by 79% to $3.4 million, and this decline was primarily due to lower pricing and activity as well as the incurrence of $0.7 million in restructuring charges. This decrease was offset by $0.7 million of operating expenses that were reclassified to capital expenditures and $1.1 million in lower divisional overhead costs. In the United States, fracturing job count was up 8% from the prior year, although lower pricing and change in the supply of sand and chemical has more than offset the higher activity levels, leading to a 33% decline in revenue from the fourth quarter of 2018. The company's United States' operations generated operating income of $23.6 million during the fourth quarter of 2019 versus $51.5 million in the same period in 2018. This 54% decrease in operating income was mainly due to lower pricing and lower fixed cost absorption offset by $10.2 million of operating expenses that were reclassified to capital expenditures, and $0.6 million in lower divisional overhead cost despite a restructuring charge of $0.8 million that was recorded during the quarter. Revenue from Calfrac's Russian operations of $24.2 million was 3% lower in the corresponding period of 2018. This decrease in revenue was largely driven by lower field activity as the onset of winter weather slowed equipment utilization rates. The operating loss for Calfrac's Russian operations during the fourth quarter was $2.1 million as weather disruptions and higher winter operating cost impaired profitability. Calfrac's Argentinian operations generated revenue of $32.1 million during the fourth quarter of 2019, a decrease of 35% from the prior year. This decrease was primarily due to year-end slowdowns combined with uncertainty surrounding the changing government that occurred in December. The company's operations in Argentina reported operating income of $5.8 million compared to $4.4 million in the fourth quarter of 2018. This result was aided by a $3 million reversal of accrued stamp taxes associated with previously terminated work agreements, which decreased divisional overhead costs. The company's corporate division recorded total cost of $9.7 million during the fourth quarter, a decrease of $0.6 million from the prior year. This decrease was primarily due to lower compensation expenses, offset by $1.9 million of restructuring costs that were recorded in the fourth quarter. The company also recorded interest expense of $21.5 million during the quarter, which was $0.5 million above the prior year due to the adoption of IFRS 16. For the 3 months ended December 31, 2019, depreciation expense increased by $20.4 million to $68.9 million from $48.5 million in the corresponding quarter of 2018. This increase was primarily due to depreciation on assets placed into service in the United States, the adoption of IFRS 16 at the beginning of 2019 and the revision to the company's capitalization thresholds in the fourth quarter of 2019. In January 2020, Calfrac's Board of Directors approved the company's 2020 capital budget of $100 million. This capital budget reflects the reduced footprint of Calfrac's operations in North America, along with sustaining capital for the company's international divisions. To summarize the balance sheet, the company had working capital of $248.8 million at December 31, which included approximately $42.6 million of cash. In addition, Calfrac used $0.8 million of its credit facilities for letters of credit and had borrowings of $148 million on its credit facilities, leaving approximately $226 million in potential borrowing capacity at the end of the fourth quarter. As at December 31, 2019, the company was in full compliance with its financial covenants. I would now like to turn the call back to Lindsay to provide our outlook.

[Lindsay Link:]

Thanks, Mike. I will now present an outlook for Calfrac operations across our geographical footprint. Given our footprint in the United States, winter weather impacts our pace of operations more than most in the first quarter. Almost half of our operations take place in areas where conditions can slow operations in the first quarter, with some customers not ramping up activity until late February or early March. That has been the case to date in the first quarter. And while it will impact results, we expect the exit rate for our United States division to be more reflective of good utilization of the 14 fleets we are marketing today. Natural gas markets in the Lower 48 have deteriorated since the latter part of 2019. And as a result, Calfrac has redeployed one fleet out of Pennsylvania to support operations in Texas. While work volumes appear solid on the remaining fleets, we continue to stay in close contact with our clients and will respond as conditions evolve. We have seen further retirements of equipment in the U.S. pressure pumping market, a development, which is both overdue and prudent. However, from our perspective, much of the departed equipment was no longer capable of performing services due to operating and maintenance practices. While the exit of nameplate capacity helps sentiment, an increase in activity is needed to fully tighten that supply-demand ballot. Given the recent headlines and oil price response, we do not expect that increase to occur in the near term. In Canada, I would describe market conditions as stable but with both upside and downside potential. To the upside, improved natural gas fundamentals should reduce risk for gas producers and could potentially spur a substantial increase in activity. To the downside, global macro headlines and current oil prices may influence producer spending patterns in the month ahead. Having reduced our footprint to five fleets from eight in early 2019, I feel our operation in Canada is right-sized and well positioned. However, we continue to communicate with our clients to ensure the industry navigates this period of uncertainty together. Activity in the fourth quarter was broadly in line with our expectations with a small amount of work either deferred or removed from the schedule. To date, in the first quarter, we have seen both high levels of demand, as well as some project delays due to weather conditions. Our calendar remains full through the end of the quarter. However, with the onset of road bans, this will impact programs in the Southern Basin. Our second quarter programs are also strong with a focus in the Grand Prairie area through April and May before the summer programs commence likely in the first part of June. We have visibility on a number of programs through the summer and beyond, and expect utilization to remain strong on our marketed assets. And we will seek opportunities to increase pricing in order to improve returns if conditions are supportive. Now a few words on Calfrac's international operations. In Russia, the fourth quarter was below our expectations as weather conditions impacted the timing of the switch from fortune bridges to ice bridges in our main operating area. This delay, which further impacts first quarter operations is typical of winter in Siberia. Our Russian footprint has been temporarily reduced to manage current activity levels. But we continue to forecast strong activity levels in the second and third quarters. Our results in Argentina were as expected, especially in light of the uncertainty that accompanied the election and resulting change in government. With no major policy changes seen, activity levels have improved through the first quarter. And outside of client and program specific schedules, we don't expect utilization to be meaningful difference than in 2019. To wrap up, our fourth quarter results were once again an accurate reflection of the state of the North American energy markets. We continue to see pricing, industry pricing at levels that cannot sustain the investments required to provide the pressure pumping services that are integral to North American exploration and production. While the service sector is only part of the industry, it is vital in insuring the safe, responsible and efficient development of the resources. Thank you all for -- very much for joining us today. I will now turn the call back to the operator for questions.

[Operator:]

Thank you. [Operator Instructions] Your first question comes from Waqar Syed from AltaCorp Capital. Your line is open.

[Waqar Syed:]

Thank you for taking my question. Just some general housekeeping questions first, like, of the 14 fleets that you have in the U.S., how they're geographically positioned in the different basins?

[Scott Treadwell:]

Hi, Waqar. It's Scott. So the way it shakes out today is that we've got 3 operating in Pennsylvania, we have 5 operating in North Dakota, 2 operating in Southern Colorado, and then the last 4 in Texas.

[Waqar Syed:]

Okay. Great. And then as we look into the first quarter for Canada, you expect EBITDA to be appreciably higher than what we saw in the first quarter of last year?

[Scott Treadwell:]

Well, we don't talk specifically about numbers. What I would say, though, is the activity levels seem to be in that same kind of ballpark. Obviously, we still got a few weeks left in March, and this is when weather can really do some damage to programs. But certainly, the book looks pretty similar to where we were last year. And obviously, pricing has moved and our footprint has changed. So there are lots of moving parts before you get to EBITDA, but from a high level, there's not a lot of difference.

[Waqar Syed:]

Okay. And then just on - I think we briefly touched on the impact of coronavirus. But have the discussions now with the E&P companies changed at all? Is it still too early in terms of activity for second half in Canada or ongoing activity in the U.S. owing to the recent developments with oil prices?

[Scott Treadwell:]

Yes. I think it's a bit too soon.

[Lindsay Link:]

We've had a few conversations, Waqar, and it's Lindsay. And while we've also had our own internal plan for how to deal with the coronavirus and the risk that might be associated with it, they are just starting to come in as to what you may see as a potential risk both on location and probably off. I think, as you know, working in the field isn't actually a high risk, we wear lots of PD&E [ph] but in the office that it can spread pretty quickly. We're not - we're taking all steps that we can to ensure that we are as prepared as people can be and as industry can be.

[Waqar Syed:]

And are you hearing of any supply chain issues with products that you buy, or those are consumed in the well that are being impacted because of some of the shutdowns in China?

[Lindsay Link:]

No, not at this time. I mean, we have a very robust supply chain, and we are in contact with - especially with our Chinese and India type suppliers. And right now, we are -- we have not seen an impact to date. Not yet.

[Waqar Syed:]

All right, great. Thank you very much. Appreciate the answers.

[Operator:]

[Operator Instructions] Your next question comes from Anthony Linton from National Bank. Your line is open.

[Anthony Linton:]

Hey. Good morning, guys and thanks for taking my questions. I guess, just first, it looks like you guys moved some horsepower out of Canada and into the U.S. in the quarter. Could you provide some color on what drove that decision to move the fleets down? Especially in the release, it sounds like you guys are seeing undersupply in Canada.

[Scott Treadwell:]

Yes. Look, I think the border is relatively transparent for Calfrac for our equipment. I mean, people are always a little more challenging to move in some cases. But equipment for us, it can move back and forth relatively easily. There is certainly some advantages in the U.S. to making sure each basin, each district has a more homogenous equipment fleet, and sometimes that might mean taking something out of Canada and replacing it later. We've got a repair facility down in BB that can do some major work at lower cost than we get third parties. And so when we've got some idle equipment, it's really just about making the best use of it, whether it's operational or on the maintenance side. So I certainly wouldn't read anything into it. If market conditions improved in Canada to the point where pricing moved higher and then that led to a discussion around reactivating equipment, driving the equipment from Texas to Red Deer is the least of our worry in doing that.

[Anthony Linton:]

Okay. Got it. I guess you kind of touched on my next question there. With the undersupplied market in Canada, are you seeing any pricing increases?

[Scott Treadwell:]

I think there's been certainly some chatter around it, and you're always trying to keep your ear to the ground. We've said this a few times, we won't go and negotiate in public with their customers. I think we've got very good relationships with that group, certainly the ones we service. There's going to be some programs where, because of timing, it has to happen at a certain point, and the market is just really tight and there may be opportunities to move pricing. There may be other ones where it's more of a scheduling thing and you can level load and keep pricing the same. So I wouldn't paint with a broad brush, but certainly Lindsay's comments of, we're certainly going to keep an eye on it. We said pretty consistently, the returns in our business aren't sustainable. And so part of that has to be looking pricing for our services. And when the opportunity is there, we'll certainly look at it.

[Anthony Linton:]

Okay. Got you. On the liquidity side, under the borrowing base, we've seen decreases the last two quarters. Is that all from AR coming down? Or is there something else driving that?

[Michael Olinek:]

Yes, it's Mike here. Principally, that is shrinkage in the AR balance for sure. Yes.

[Anthony Linton:]

Okay, got it. And then just moving through 2020, are you kind of expecting that to stay level? Or do you -- is there going to be some seasonality there?

[Michael Olinek:]

Overall, it will be fairly level. But your point on seasonality is well taken, especially as we enter into Q2 in Canada. There could be some small reductions as we get into that quarter. But overall, I think the largest step-down - and I mentioned it a bit in my call notes, is the change in sand and chemical being provided by clients in the U.S. that was a big factor here in the fourth quarter. And I think that's stabilized now going forward, but that is also one of the reasons for the decline in AR.

[Anthony Linton:]

Okay. Got you. And then just one last one for me. The $11 million impact from the accounting change, is that sort of the run rate we should be thinking about moving forward? And then because that's going over on to CapEx, is that built into that $100 million CapEx budget? Or is it going to be over and above that?

[Michael Olinek:]

The $100 million capital budget certainly incorporates this accounting change. So yes, we don't expect any sort of change to the announced capital budget as a result of that. And the run rate should be fairly clear if you annualize that $10 million over the course of four quarters.

[Anthony Linton:]

Okay. Got it. That’s it from me. Thanks a lot guys.

[Michael Olinek:]

Thanks, Anthony.

[Operator:]

Your next question comes from Ian Gillies from Stifel. Your line is open.

[Ian Gillies:]

Morning, everyone.

[Lindsay Link:]

Morning, Ian.

[Ian Gillies:]

Following on, I guess, the liquidity theme. I mean outside of asset sales, and you've talked about working capital management, but is there much in the way with respect to CapEx? Have you been able to identify any way to maybe flex that number down or make it a smaller percent of revenue moving forward?

[Michael Olinek:]

Yes, Ian, I think we've talked about the flexibility with our capital budget as market conditions change, both up and down. And so we're constantly looking at what we can do to manage capital as best we can given the outlook for our cash flow in the business. So we certainly are cognizant and focused on that. I mean we've got supply chain that is obviously focused on trying to get as lower cost for each of our key components. So there is many things that we can do, and we're certainly looking at that as one way to kind of walk the changes in cash flow up or down.

[Ian Gillies:]

Yes. In Canada, I mean you highlighted the expectation for strong activity levels through the second quarter and can you maybe just highlight how you're intending to manage that from an operational perspective and get set up on lease sites just in the event that maybe it comes early and so on and so forth?

[Scott Treadwell:]

Yes. I mean, look, the nice thing about Canada in Q2 is when you're working on pads, the road bans become less of an impact because you travel so much less during the quarter. It can impact your hauling sand and chemicals. But I think I can speak that our operations group, our supply chain and our transport group as well as third parties, they've done this for a while. They know how to run with half loads and make sure that they can get sand where it needs to go. In extremis, you can pre spot sand or have some storage where your off of ban - roads that are banned, but I don't think there's anything that our team in Canada can't handle. So I think it's pretty normal course, and certainly compared to the last couple of years, I think preponderance of pad work, makes it, if anything, a little bit easier than years past. Now obviously, weather can make fools out of all of us. So we'll see how it plays out. But yes, the pads do take a lot of stress off the operation.

[Lindsay Link:]

And maybe - and I can add. Scott did a very good job about talking about Calfrac side, but the customer base that we have in Q2, they're also very well familiar with working within spring breakup. So this is nothing unusual for them as well. So we work very much in partnership with these major E&Ps to ensure the ongoing nature. And of course, these wells only really make sense when you're very efficient. And so both the customer and ourselves are working that way even in Q2.

[Ian Gillies:]

Okay. Thanks very much. I’ll turn it back over.

[Lindsay Link:]

Thank you.

[Operator:]

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

[Scott Treadwell:]

Okay. Thanks very much, everybody, for your interest and time this morning, and we look forward to catching up with you at the early part of May. The management team will be around for the day if there is any follow-up questions that anyone has. Thanks very much.

[Operator:]

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.