Calfrac Well Services Ltd.
Q2 2018 Earnings Call Transcript

Published: 25 Jul 2018

[Executives:]

Fernando Aguilar - President and CEO Michael Olinek - CFO Scott Treadwell - VP, Capital Markets and Strategy

[Analysts:]

Sean Meakim - J.P. Morgan Taylor Zurcher - Tudor Pickering Holt Greg Colman - National Bank Financial Evan Templeton - Jefferies John Watson - Simmons & Company International Ian Gillies - GMP FirstEnergy Jon Morrison - CIBC Capital Markets Howard Goldberg - Janney Montgomery Scott LLC

[Operator:]

Ladies and gentlemen, good morning, and welcome to Calfrac Well Services Ltd. Second Quarter 2018 Earnings Release and Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. I would now like to turn the conference over to Mr. Fernando Aguilar, President and Chief Executive Officer. Please go ahead.

[Fernando Aguilar:]

Thank you, Dan. Good morning and welcome to our discussion of Calfrac Well Services' second quarter results. Joining me today on the call are Michael Olinek, Calfrac's Chief Financial Officer; and Scott Treadwell, our Vice President of Capital Markets and Strategy. The morning's conference call will be conducted as follows

[Michael Olinek:]

Thank you, Fernando and thank you everyone for joining us for today's call. Consolidated revenue in the second quarter increased by 67% year-over-year, primarily due to a 36% increase in fracturing job count in North America. Adjusted EBITDA reported for the quarter was C$81.9 million compared to C$39.9 million a year ago. Operating income was up 81% to C$66.5 million from C$36.7 million in 2017. These improved results were driven mainly by significantly higher and more consistent utilization in the United States and Canada. In Canada, second quarter revenue was up 18% from the same quarter in 2017, mainly as a result of improved fracturing activity and higher pricing. The number of fracturing jobs increased due to better utilization, mainly as a function of the company having more equipment active in the field as compared to the second quarter of 2017. In addition, the number of coiled tubing jobs increased by 37% from the second quarter in 2017, primarily due to the company activating an additional two large coiled tubing units from the United States combined with job mix and higher overall activity. Revenue per coiled tubing job decreased by 9%, however, from the same period in 2017, mainly due to changes in job mix. Operating income of C$11.2 million fell 15% from 2017, largely due to the broader scale of operations and the full reinstatement of compensation of a scale back during the past number of years, which led to lower fixed costs absorption. In the United States, the company completed the reactivation of its 17 fleet at the end of the quarter, but it will not commence operations until early August. With 87% more equipment in the field than in 2017, revenue in the United States increased by 122% to C$342 million, while operating income increased by 174% to C$69 million. Fracturing job count in the United States was up 62%, while fracturing revenue per job increased by 41%, driven primarily by the growth of operations in Texas, which have larger average job sizes. The 4% depreciation in the U.S. dollar versus the Canadian dollar partially offset the improvement in revenue. The company's United States operations generated operating income of C$69 million during the second quarter of 2018 compared to C$25.2 million in the same period in 2017. The improved profitability was driven by higher utilization and pricing as well as better fixed costs absorption, but was offset by C$5 million of reactivation costs during the quarter as well as an increase in personnel costs due to reinstatement of compensation of a scale back during the downturn. Revenue from Calfrac's Russian operations of C$25 million was 21% lower than the C$31.5 million reported in the corresponding period of 2017. The decrease in revenue was largely attributable to a 30% reduction in fracturing jobs due to ground conditions in Siberia as well as a 10% decrease in number of coil tubing jobs completed. The decrease in activity and revenue in the company's Russian division resulted in breakeven operating income performance, as most fixed costs were not adjustable in any meaningful sense during periods of lower activity. However, SG&A costs were reduced by 20% from prior year levels due mainly to lower operational headcount. The 11% depreciation of the Russian ruble also contributed to the decrease in results as reported in Canadian dollars. Calfrac's Argentinian operations generated total revenue of C$45.7 million during the second quarter of 2018, an increase of 60% from the prior year. The revenue increase was mainly due to higher work volumes across the division, but particularly in the Vaca Muerta shale play. The company's operations in Argentina reported operating income of C$2.1 million compared to a loss of C$2.2 million in the second quarter of 2017. Improved utilization and cost control at all levels were the main drivers of the improved profitability. The company's corporate division recorded total costs of C$14.9 million during the second quarter, up C$10.7 million from the prior year. A C$6.7 million increase in stock-based compensation accruals were the primary driver of this increase although higher personnel costs were also a contributing factor. The company recorded interest costs of C$43.1 million during the quarter compared to C$22.1 million in 2017. The increase was largely due to costs incurred or recorded as part of the debt financing undertaken during the quarter. Specifically, the company paid a make-whole premium of C$10.4 million related to its 2020 senior unsecured notes and recognized additional expenses related to the write-off of unamortized debt issuance costs related to its extinguished debt that totaled C$10.8 million. During the quarter, the company announced and executed a series of financing transactions as follows; first, we amended our credit facilities to exercise C$100 million of accordion capacity, which increased the total facility capacity from C$275 million to C$375 million. Next, we successfully issued $650 million in senior unsecured notes maturing in June 2026 with a fixed interest rate of 8.5% payable semiannually. We then used the proceeds of this issuance to conduct a tender offer, followed by the redemption of all our previous $600 million senior unsecured notes that were due in December 2020. With the remaining proceeds of this issuance as well as cash on hand, including the previously disclosed release of segregated funds that were being held as a possible equity cure and funds from our expanded syndicated credit facility, the company's second lien term loan was repaid in full at face value plus accrued and unpaid interest on June 10th. In executing these transactions, we have addressed the structure of our balance sheet and will now focus on reducing its size. The majority of our indebtedness does not mature until 2026. And the new notes provide Calfrac with the option to repay up to 10% of the principal with the proceeds of asset sales, should an agreeable transaction present itself. As well, we have removed the second lien from our capital structure without incurring any meaningful make-whole payment, lowering risk to equity holders in periods of low cash flow. Finally, we have repositioned our debt structure to allow us to lower our debt balance significantly at no incremental cost, as our free cash flow generation accelerates into 2019. It remains our goal to lower the company's total debt levels to two to two and a half times mid-cycle EBITDA, which we believe is approximated by the range covered by current 2018 and 2019 estimates. We will then seek to grow our cash balance, which will allow the company to execute on accretive transactions during industry down cycles. The majority of Calfrac's historical growth has followed this strategy and we aim to position the company to resume this approach in the years ahead. To summarize the balance sheet, the company had working capital of C$361.6 million at June 30th, which included approximately C$13 million of cash. In addition, Calfrac had used C$0.9 million of its credit facilities for letters of credit and had borrowings of C$215 million on its credit facilities, leaving C$159.1 million in potential borrowing capacity at the end of the second quarter, subject to borrowing base limitations. As of June 20th, 2018, the company was in full compliance of its financial covenants. I would now like to turn the call back to Fernando to provide our outlook.

[Fernando Aguilar:]

Thank you, Mike. Before I give you a detailed outlook, I would like to update our view on industry fundamentals in North America. Much has been written about the impact of recent acquisitions in the global oil market as well as Permian Basin takeaway issues which has impacted that area. Our view remains that under investment in long-cycle, low-decline production has begun to manifest itself in the low [Indiscernible] capacity in the global market and this stage in our view for an extended period of elevated prices that will be required if this production where it's used to resume growth and reduced supply risk globally. Closer to home, the lack of pipeline capacity in the Permian is certainly topical, but I will take a moment to remind everyone that the production growth in the region is a result of strong returns available in North American light oil resource plates. The Permian is certainly well-positioned on several fronts, including lower regulatory friction in the growing capital, with many other basins including the Montney in Canada, in terms of returns at current pricing. We believe that activity will respond to constrained pipeline capacity, but in most cases, capital will redirect to our basins where returns are strong and all constraints are not as limiting in the near-term. Calfrac's strategy of expanding its footprint into multiple basins with top tier clients was designed to insulate our company from events such as those in West Texas over the last few months. While some of our work there may move to other basins, Calfrac began operations in the Permian less than one year ago. And as a result, our market share in the region is approximately 2% versus nearly 4% in the United States overall. Additionally, much of our work in the area is with clients that have secured pipeline capacity for production growth through the next 12 months. We certainly see a long-term potential of the Permian Basin, but we'll maintain a prudent approach to deploying our assets to deliver the required returns, but also mitigate the risks inherent to -- in our business. The addition of incremental fleets in the U.S. land market has caused substantial amount of noise in the marketplace, but we believe that quality crews remain in short supply in all areas of the market. Our commitment to delivering safe and efficient service to our clients while continuing to produce innovations in [Indiscernible] and monitoring as well as chemistry on supply chain will not change. In Canada, our outlook remains measured, but the fundamentals north of the border continue to improve. Industry experts expect that the incremental cash flow this year for Canadian producers would reach C$20 billion. And while not all of that will go back into development, we believe that prudent capital allocation will direct a significant portion of that capital into further production growth. Today, activity in the Montney and Duvernay areas appears reduced through much of the remainder of the year, driven by strong condensate economics, but also increased activity by several large producers who previously focused capital spending in the oil sands or across North American or global asset base. We expect that in addition to our work with core clients in all resource plays, the demand is to keep all our equipment busy into the fourth quarter. Cost inflation continued during the first half of the year, with fuel and chemical seeing the largest increases. We have and will continue to pass through these cost increases as contemplated in our pricing agreements, but we do not expect net pricing gains in the Canadian market in the near-term. As expected, our operations in the United States did not suffer the same level of downtime due to some delivery issues as experienced in the first quarter. This was due in part to the company beginning operations from a [Indiscernible] facility in New Mexico, which has further expanded our logistics ability in that region. We did experience some periods of lower utilization during the quarter, but these were predominantly related to client completion schedules and third-party services. The outlook for the company's operations in the United States is solid based on our strong performance and diverse client and basin exposure. Today, 16 of our 17 spreads are active with the 17 set to begin work in the very near-term. However, with some clients adjusting programs are now realizing a faster pace of complications and plan, we expect that as many as three of our crews in the United States will experience periods of lower utilization during the third quarter. Our crews remain in demand and we believe that any gaps in the schedule should be short in measure. While there remains a great deal of noise regarding the supply/demand balance in North American pressure pumping market, the underlying fundamentals remain strong and supportive of our view, a view held by many peers and investors of ongoing tightness in the market for an extended period. Now, I would like to discuss Calfrac's international operations. In Russia, the second quarter was below our expectations as ground conditions were much more challenging than is typical, resulting in substantially delays to client work programs through April and May. While much of the work has been simply deferred to the third quarter, weather will ultimately dictate how much of the delayed work will be able to be completed before winter weather slows the pace of activity. Revenue in Argentina was flat sequentially in the second quarter as activity levels overall were largely unchanged. Profitability levels improved materially due in large part to improved cost control at the field and district level. We expect that with continuing high levels of activity in the Vaca Muerta, our operations should experience continuous improvement -- continued improvement in profitability in the quarters ahead. Thank you all very much for joining us today. And now I will turn the call back to Dan for questions.

[Operator:]

Ladies and gentlemen, we will now conduct a question-and-answer session. [Operator Instructions] Your first question comes from the line of Sean Meakim with J.P. Morgan. Please go ahead.

[Sean Meakim:]

Thanks and good morning.

[Fernando Aguilar:]

Good morning Sean.

[Michael Olinek:]

Good morning Sean.

[Sean Meakim:]

So, Fernando, it seems like increasingly, 3Q may be the best year of the quarter for you across North America. I'm thinking Canadian E&Ps are focusing more on may be drilling first half completions. Second half, not to overgeneralize, but in the U.S., there's maybe a similar dynamic, you don't have the breakup issue. So, we're seeing completions programs in the U.S. consistently running ahead of plan. Does that give you any sense of more risk that your crews could get released more frequently in the fourth quarter? Just could you see greater seasonality in the fourth quarter compared to maybe last year? I know in the prepared comments, you talked about Canada maybe being lesser, but how about in the U.S. 3Q to 4Q?

[Fernando Aguilar:]

Yes. Sean, so we've been experiencing in the last two to three quarters is the completion companies and the completion business in North America continued improving the efficiencies and productivity. In the previous upturn, we saw that happening to companies and in this upturn, the companies are basically more stable to those levels of productivity compared to what was happening in the past two completions. So, we see that completion efficiency getting to a very high level. That is generating this company we are making today. That basically will happen if we continue with this level of budgets in the market today. And that what is being reflected by comments coming from some of you guys and also some of our competitors where we see -- where we saw that situation happening in the third quarter last year, especially here in the Canadian division, and we can basically experience the same thing. We believe that the strong commodity prices are basically going to, as is printed in the notes, that we will have these additional cash that have been generated, and we'll see how the customers are going to spend money in the fourth quarter. But it is very true that that efficiency and productivity gains in the market today is taking that Q4 visibility a little bit uncertain as we speak.

[Scott Treadwell:]

Sean, just to add to that, it's Scott. I think the way we try to approach it obviously is you can't control your customers' budget, but you can control how well you execute in the field. We always try to be at the top end of the execution when we're working for our customers. And if that accelerates their program, obviously, there is potential issues to come with that. But at the same time, most of our customers are running multiple spreads. And if you're the most valuable or most productive spread, the chances are you're going to get more work. So, as I said, we don't control the size of the budget, but we do have some influence over our market share with the clients that matter to us.

[Sean Meakim:]

Right. Those are all helpful points. Thank you for that feedback. So, on the quarter, I mean cash burn was pretty light for a 2Q. Working capital needs were pretty restrained. How are you looking at free cash for the back half of the year? Maybe just walk through some of those moving pieces in terms of working capital, CapEx, and just how we think about free cash going through the back half of the year?

[Michael Olinek:]

All right, Sean. Thanks. Mike here. Yes, as you mentioned, I think Q3 is probably going to be the best quarter that we have in 2018. So, there will be some working capital requirements, but I think they're going to be relatively muted. I mean obviously, Canada's coming out of the spring breakup, so there's going to be an uptick there for requirement. On the CapEx side, we see that being fairly level with where we've been in Q2. And I will remark that obviously as we get into the back half, we do believe that free cash flow is something that we're going to generate for the business. So, we're up to I think all of our fleets being up and running and active. So, from a cash flow generation point, we see free cash flow being a real possibility here in H2.

[Sean Meakim:]

Can we say it was enough -- sufficient magnitude to would be free cash flow positive for the year or hard to say at this point?

[Michael Olinek:]

I think at this point, we believe that to be the case for sure. Just the quantum is a little uncertain, just given where activity levels land up in Q4.

[Sean Meakim:]

Fair enough. Okay. Thanks very much.

[Fernando Aguilar:]

Thank you, Sean.

[Operator:]

Your next question comes from the line of Taylor Zurcher with Tudor Pickering and Holt. Please go ahead.

[Taylor Zurcher:]

Hey thanks. Good morning guys.

[Fernando Aguilar:]

Good morning.

[Michael Olinek:]

Good morning Taylor.

[Taylor Zurcher:]

Morning. I know you guys don't want to provide concrete guidance for Q3. But as we think about all the moving pieces for Q3, you had some idle or I guess some white space in the calendar during Q2 in Texas and New Mexico. In Q3, you'll have some more white space and then you also have the 17 frac spreads coming to work in August. So, as we combine those three factors together, is it reasonable to assume that we should see a further topline growth at least in Q3?

[Michael Olinek:]

Yes. So, Taylor, I think the way to think about it is more on the activity side. We won't get into the numbers, but I think the calendar looks, in terms of frac days, about the same as it did in Q2. And you're thinking about it the right way, we had some white space in Q2, we have some in Q3, but we're adding another spread. And if you net it all out, we don't see a material change in our activity job count in the third quarter.

[Taylor Zurcher:]

Okay, that's helpful And then for the three frac spreads that you called out that might have some white space in Q3, I guess two questions there; one, which basins in place are those three frac spreads currently working in today? And then two, you talked about in your prepared remarks that you think you can fill the utilization gaps for the spreads if they are released. So as we think about supply/demand dynamics in the U.S. right now as you retender that work, or if those frac spreads trade hands, is it reasonable to assume -- or how should we think about pricing on the recontracting side for those three frac spreads moving forward?

[Fernando Aguilar:]

Yes. So, Taylor, what is happening is basically one of these fleets is in the Permian, but the market as a whole is having this volatility as we speak when we look into the different basins. But as Scott was mentioning earlier, the number of frac days between the two quarters are basically remaining very similar. Another point that is very important is to mention the quality of fleets that are out there. And some of the opportunities that we have to place the additional fleets, the 17 and also the other one that we have some holes as you mentioned in your question, are related to quality, so replacing competitor that are not performing very well. But when you have a situation like this and you have a weakness in some of the areas, pricing is going to be reflected. So, we don't foresee or forecast any price increases in the quarter, but we can see that as we get into a more stable market getting into the last quarter of the year into 2019, there will be a possibility of having that continuous work for the customer that are going to get into a new year plans. So, in other words, you see some activity and the equipment related to those activity in different areas that is going to give opportunities to replace competitors, number one, but also it doesn't mean that the market is fully saturated.

[Taylor Zurcher:]

Okay, got it. And just a follow-up. So, one frac spread in the Permian, where would the other two be, are those in the Northeast?

[Scott Treadwell:]

No, not in the Northeast. We've got one in North Dakota and one in Colorado. And those ones, I think we have a little more certainty on filling those holes where those holes being finite in nature. The Permian one, to Fernando's comment, that's in a basin where there's a substantial amount of noise. And we'll have to see how that develops, if looking at spot market our short-term work is the right answer, or potentially a short-term redeployment out of basin before coming back later this year or in 2019. That decision hasn't been -- made yet and that's probably where the uncertainty is in our minds.

[Taylor Zurcher:]

Got it. Thanks. I'll turn it back.

[Operator:]

Your next question comes from the line of Greg Colman with National Bank Financial. Please go ahead.

[Greg Colman:]

Hey gents, strong quarter. Well done.

[Fernando Aguilar:]

Thank you, Greg.

[Greg Colman:]

Just have a couple of real quick ones here, Fernando. Being cognizant of the various job sizes from basin-to-basin, can you give us an idea of how the EBITDA breakdown is by region in the U.S.? And how it would vary from the fleet breakdown? I mean when you think about your fleets, you've got about a quarter in Colorado, a quarter in North Dakota, a quarter in Pennsylvania, a quarter in Texas; maybe a little bit less in Pennsylvania, a little bit more in North Dakota. But is at roughly a quarter of EBITDA there in each region for the total U.S? Or because of differing intensities and differing in sizes and jobs, is it one area that's much different from what the fleet weighting would suggest?

[Scott Treadwell:]

No, Greg. We won't give you that level of granularity on the business. I mean I can tell you that our large spreads have roughly similar profitability. But the actual activity contribution, job size and dollars of EBITDA per region, we won't get into that.

[Greg Colman:]

Okay. That was worth a shot. Talking about the growth expectations, just two things. On spread 17, you moved it back to August deployment. Wondering if there's a risk of a further roll there, or is that's feeling fairly certain concerning we're only five or six days away? And then secondly, with a view to your last spread remaining 47,000 horsepower or spread 18, any thoughts on deployment of that? Or would that be something that is sort of not permanently, but on silence for now and maybe for revisiting in 2019 or whatnot?

[Fernando Aguilar:]

You know Greg, what we try to do -- and I think it's mentioned in our press release and also in our notes earlier this morning, it is related to generating a critical mass in the diverse market where we operate today. So, when you have one or two frac fleets in a specific area, your ability to generate and let's say, consume the overhead that you generate produce is a bit higher. So, what we try to do is just generate a critical mass with the number of frac fleets per basin, and the idea is to make sure that you -- we have that in the Eagle Ford, we have that in the Permian, we have that in Colorado, we have that in the Bakken and also in the Northeast. So that is the purpose of that additional fleets going into Texas as we speak. But as the market gets a little bit clearer, in the future, the idea is to have a solid number of frac fleets per area that would contribute -- will give better contribution to our margins.

[Greg Colman:]

That makes sense. And how about spread 18?

[Scott Treadwell:]

No, at this point, spread 18 is nothing more than an option. Whether that horsepower goes to backfill capacity, or to take a smaller spread and make it a larger spread, or to make its own spread, those options exist, but there's certainly been no decision at this point. And the potential exists that that horsepower could move back across the border. It can go anywhere between our North American franchise relatively quickly. So, we're going to continue to monitor the market. Obviously, if we have thought there was something compelling, we would have heard about it through our outlook. But because we haven’t, we just don't see there's a compelling reason to add more equipment to the basins.

[Fernando Aguilar:]

And as Scott normally tells you guys, the way the portfolio allocation happens in the company, it will come based on customer opportunities, good pricing and long-term potential for us.

[Greg Colman:]

Make sense. Just a last one for me, then moving over to the balance sheet. Mike, you mentioned -- reiterated I suppose, that you're comfortable with the two to two and a half times mid-cycle EBITDA for your leverage position, and you're focusing on you have your structure in place now for the debt there. You're looking at decreasing the overall size over time. Could you share with us what would you consider mid-cycle EBITDA based on your current company size?

[Michael Olinek:]

Well, I think again as I referenced in my call notes here, it's really where consensus is trending for 2018 and 2019. I think that's what we're guiding towards is our mid-cycle EBITDA estimate.

[Scott Treadwell:]

Greg, this is Scott. The way we structurally think about it is the mid-cycle in our business is all your equipment working and no punitive pricing, but no peak cycle kind of pricing. So, that feels like where we are today in the industry and relatively quickly will have all the equipment out contributing to EBITDA. Anything below while your equipment working, it feel like it's below the mid-cycle and when you get into the peak cycle real pricing power to pressure pumpers that feels like you're getting into the upper half cycle.

[Greg Colman:]

Perfect. That's it for me. Thanks so much.

[Fernando Aguilar:]

Thank you.

[Michael Olinek:]

Thanks Greg.

[Operator:]

Your next question comes from the line of Evan Templeton with Jefferies. Please go ahead.

[Evan Templeton:]

Thanks. Just a follow-up on the fleet activity. You mentioned that there's three fleets that are operating there about half the size of standard fleets. On what basins are those operating in? And what sort of work are they actually doing, given their size?

[Scott Treadwell:]

Yes, Evan, it's Scott. They're working in Grand Junction, which is the [Indiscernible] Basin and essentially, they are half the size. They're actually doing a very specific kind of fracturing sort of 12-hour days for private customers that I won't disclose. But it's essentially fracturing where you don't need to pump up and essentially just high-rate water and a little bit of chemicals. So, you don't need all the equipment that's out there. Really compelling returns, great customers, and we really like that work. Obviously, it's not enough to deploy 800,000 horsepower into it, but it's a nice piece of the business.

[Evan Templeton:]

Great. And then also just given the fleet you've got running today, what sort of contract visibility do you have on those?

[Scott Treadwell:]

It's a bit of a portfolio. So, we'll have pricing agreements that will expire almost every quarter. I mean there's obviously a bit of a natural progression to align it with producer budgets kind of on a calendar basis. But we're constantly discussing with our customers extensions of various length. And so over time, you're always having some discussion about some piece of your equipment renewing its agreement or looking for a new home or extending the agreement, those kinds of things.

[Evan Templeton:]

Okay, great And then last one just really housekeeping. Can you give us just a quick breakdown of where those 17 fleets are running just by region?

[Scott Treadwell:]

Sure. So, as of today, we're running three in Smithfield in the Marcellus. We're running five in Williston for the Bakken. We're running one in Platteville, which is just outside Denver, and then the three in Grand Junction and Colorado. And then we're running three in Artesia, New Mexico for the Permian. And we're running one going to two in San Antonio for the Eagle Ford.

[Evan Templeton:]

Okay, great. And assuming you do look to migrate the Permian spread out, would Eagle Ford be the kind of logical assumption there?

[Scott Treadwell:]

I'm sure lots of people would love to know that, but it will depend on, as Fernando said, who the customer is, what the terms look like. Obviously, it will depend on what the prospects are in Artesia and the Delaware and the Permian Basins that may form our decision of how far we move it or if we move it at all. So, there's a lot that goes into it.

[Evan Templeton:]

Perfect. Fair enough. Thank you.

[Fernando Aguilar:]

Thank you.

[Operator:]

And your next question comes from the line of John Watson with Simmons & Company. Please go ahead.

[John Watson:]

Good morning. Fernando, can you talk to us about your U.S. fleet? And how many are on a dedicated type of work versus spot? I'm trying to think through if there are more fleets that are on spot work beyond the three you mentioned that could experience lower utilization at some point this year.

[Fernando Aguilar:]

Yes, John. Good morning. We don't -- normally what we do is just try to build on our relations with customers and customers who are follow our -- not only our culture, but our technology and also the way we operate what we call our license-to-operate, and we're getting those longer term relationships. So, the amount of spot work that Calfrac has is very limited and I would say close to zero in a way. Sometimes we do work operational customers just to fill holes, but traditionally, the amount of work that we have in the U.S. is with a very strong customer base in a long-term sort of agreement.

[John Watson:]

Okay. So, beyond the three that you mentioned, you wouldn't expect other fleets to experience lower utilization at some point during 2018?

[Fernando Aguilar:]

Yes. We -- what is happening today is basically a little bit of a shuffling between our customers' budgets and what they see the constraint that we have in one or two areas where we operate today. And until that dust settles and they have the takeout capacity improving, some of these problems that they are going through, we will see that activity to come back to us. So, strong customer base, strong operations for them, very good performance, and that continuity is basically giving us the visibility that we have today. That doesn't mean that we will not go through that softness in the market as we expressed earlier. But these customer discussions are happening very positively going back to them as the market picks up again.

[John Watson:]

Okay, understood. And you spoke about quality crews in the U.S. being in short supply. Can you help us think about what constitutes a quality crew? And then maybe the size of that market as it is becoming bifurcated between quality and lesser quality?

[Fernando Aguilar:]

It's a combination of how you execute the work related to not only qualified workers and people who are very well dedicated to execute. So, the people piece is very critical and is very important. The other piece of this important as well as and is also related to the people is the maintenance programs. As the market has been increasing the volumes and the amount of work that is performed on a daily basis. You go from 14 to 18, you are basically pumping between four to six hours additional time. That is consuming more, let's say, more maintenance on the equipment and you have to be very, very good at keeping your preventive maintenance programs up to speed and making sure that the quality of that work and the quality of the repairs and the quality of your refurbishing of the equipment is up to the demand of amount of time that is happening in a daily basis. So, it's a combination of how you execute that. And then when you go to a quality piece of the work, Calfrac being one of the only companies that is fully API Q2, which is new standalone quality, all the standards are related to the way that we execute and on how we operate have to be followed very closely. Not all companies have done it or have access to that. And when you talk to customers and the way they want to execute, that basically translated in the calls, additional calls that we get to replace competitors that are basically failing to the same level of work at the quality that they demand.

[John Watson:]

Okay. And maybe just a follow-up to one of Taylor's questions. It sounds like topline growth in Q3 is expected. Do some of the competitive pressures that we've talked about, does that lead pricing lower and potentially EBITDA per fleet or EBITDA margins lower in Q3?

[Michael Olinek:]

Yes. So, are you referencing just the U.S. or consolidated?

[John Watson:]

Yes, excuse me, just U.S.

[Michael Olinek:]

Yes, I'm not sure we're going to see a ton of topline growth in Q3. I mean our activity is likely to be pretty static. It will be plus or minus a few percent, if it is, either way. In terms of pricing and margins, I -- we don't normally comment on pricing. But certainly if you're doing the same amount of work with one more spread, you're not going to get the same fixed costs absorptions. So, you're obviously going to pay a bit of a price there. Unless you're forecasting some net pricing gains to offset, it's unlikely that you'd be able to hold margins. So, we'll see how that plays out. It will depend on the frequency and how dynamic the schedule is for the U.S. that will sort of dictate where the margins trend. The nice thing is we shouldn’t have much in the way of reactivation costs in Q3, so that should be a bit of a tailwind for us. But certainly, not expecting massive improvement in profitability given where pricing is today and the schedule we're looking at.

[John Watson:]

Right. Thanks guys. I appreciate it.

[Fernando Aguilar:]

Thank you, John.

[Operator:]

Your next question comes from the line of Ian Gillies with GMP. Please go ahead.

[Ian Gillies:]

Good morning everyone.

[Fernando Aguilar:]

Good morning Ian.

[Ian Gillies:]

With respect to the U.S., have you seen much in the way of an influx of new equipment to new competitors, either in the Rockies or North Dakota, just given some of what it sounds like gaps in schedule or fly that's been occurring in the Permian?

[Scott Treadwell:]

I don't think we've seen anything massive sort of an exodus from the Permian to any of the other basins just yet. I think to the previous question, I think the Eagle Ford is the easier place or SCOOP/STACK for -- if there is overflow equipment in the Permian to go. And again I think as you go outside of Texas, our franchise is far more well-established. Our relationship with the clients are substantially deeper. And I think we've got -- I don't want to say you get first look at anything, but you certainly have much more intelligence on how the market is developing in some of those basins than you would in a place like the Permian where 2% of the market and we've been there less than a year. So, we're seeing as a bit of a newcomer there I think.

[Fernando Aguilar:]

Yes. And the additional thing of this comment is that maybe you have read in the past that Halliburton and other companies had been saying that additional horsepower coming to the market, 50% of that came for new fleets, and the other 50% came for additional equipment with the current fleets and also equipment replacement. So, that's why you don't see a massive influx of equipment into the operations.

[Ian Gillies:]

Okay, that's helpful. The other thing, in your conversations with customers in the U.S. right now, given the perceived slowdown, is there a notable difference in your conversations now than maybe two or three years ago that provides you with more confidence then? I know the oil price is different and so on and so forth, but I mean in your minds, what's a lot more different now than then?

[Fernando Aguilar:]

It's very different. Because when we were discussing with the customer four years ago, three years ago, there were -- the number of rigs was not there. The number of rigs' still the same. So, you have between five and eight rigs today lower than what we had a year ago, but you're still talking about in excess of 1,000 rigs right? So, 1,046 rigs today compared to the market that dropped a lot in the previous time. I think one of the most important reasons, as I -- and I think we explained earlier again, is related to how efficient the completion business had become. And they think the more number of hours that we are pumping, the higher volumes and the productivity of these wells and this business is the one that is generating this situation today. But very different to the market that will basically dropping rigs on a continuous basis to what is happening today.

[Ian Gillies:]

Okay. And I guess along those same lines, Fernando, with respect to efficiency, in Argentina, do you think you continue to grind out some additional margin there just on efficiency gains? Or do you need pricing at this point to help -- move profitability higher in that country?

[Fernando Aguilar:]

I believe so, and I hope that we will continue looking into that. We mentioned in the last couple of quarters, some of the issues that we were facing in the market due to different reasons. But I'm not basically trying to give excuses here, but you are basically filmed by the market like the Union negotiations happening from the government after their change of government. There were issues that were happening in the [Indiscernible] areas. So, there are many, many reasons why these things are happening. But we see today a market that is becoming more stable. Customers are understanding today the issues with logistics and the way that the efficiencies are basically built into the operation. The customers are busy and are basically providing more productivity, understanding the way of working with competitors. In the last -- one of the reasons where you see -- what you saw better performance in Argentina as well for Calfrac is related to the performance in the last couple of parts that we were operating for one of our customers down there. It's a good teamwork between the operator and the service company trying to get to a higher level of activity in terms of stages per day that is generating that momentum. So, we see that happening as we move into the second part of the year and into 2019. And as well with the government trying to get into more rig activity and also continuing the development of Vaca Muerta, that will provide more positive environment for whatever happens in front of our activity.

[Ian Gillies:]

Okay. And then Mike, with respect to the balance sheet, as you begin to add cash, is the preference or is -- to pay down the credit facility? Or will you look to use that prepayment option on the long-term debt?

[Michael Olinek:]

Well, the prepayment provision on the notes really relates to asset sales. So, certainly as free cash flow accelerates, we'll use that to bring down our revolving credit facility, for sure.

[Ian Gillies:]

Okay. And one last cleanup question for me. With respect to maintenance CapEx, it's kind of trending around 7.5% of revenue this year. Is that a reasonable run rate as we think about 2019 and go forward years, just given some of the changes in accounting policies?

[Michael Olinek:]

Yes. I would say that that's out of the gate, that's a pretty good run rate. Obviously there's some changes happening on the IFRS U.S. GAAP front that could make things capital [ph] to their expense. So that may blur that, but we'll know more as we exit the year.

[Ian Gillies:]

Okay.

[Michael Olinek:]

But certainly as a run rate, our maintenance capital, we see that as being fairly consistent for the back half of the year.

[Ian Gillies:]

Okay. Thanks very much everyone. I'll turn the call back over.

[Fernando Aguilar:]

Thank you, Ian.

[Michael Olinek:]

Thanks Ian.

[Operator:]

Your next question will come from the line of Jon Morrison with CIBC Capital Markets. please go ahead.

[Jon Morrison:]

Good morning all.

[Fernando Aguilar:]

Good morning Jon.

[Jon Morrison:]

Is the decision to call out the potential softness on a specific three crews that you did driven by specific changes in development plans for the customers that were using those fleets? Or was it more a broad review of all the fleets that are working with that those ones are perhaps giving you more heartburn than the other in terms of contract visibility?

[Scott Treadwell:]

No, I -- so I think that the reason we put it out was to paint the picture a little bit of Q3. I mean it's unusual to have visibility on the holes to the extent that we do today. So, normally, the holes appear on relatively short notice that tends not to align with our reporting or conference call schedule. And so we're at little bit of a loss at the corporate level to know where things are going to be on sort of four to six weeks out. We had the visibility and we thought it helped paint the picture for Q3. So, it was really just a confluence of coincident timing more than anything else.

[Jon Morrison:]

And were those crews fairly active in Q2? Or were those the ones that you referenced that there was some softness and obviously white spots in the frac in Q2 that you experienced?

[Fernando Aguilar:]

This is -- no Jon, this is what Scott mentioned earlier in one of the questions that was asked. The crews are moving. The crews are waiting for new contract and the new positioning. So, you have the same number of fracs days as it was reported earlier that are basically comparable to Q3. So, you have things that are basically happening. This is not a machine that operates 24 hours without interruption, right? So, that is reflected in those numbers in Q2 and also will happen in Q3.

[Jon Morrison:]

For sure. And just to follow-on John Watson's question. When you look at all the contracting that you do have in place and all of your customer conversations, you would say that it's a fairly low probability that the other 13 or 14 crews that are active today, that visibility on those would say that there shouldn't be any sort of a precipitous change in the next two quarters based on everything that's in front of you right now?

[Fernando Aguilar:]

We believe so, yes. We believe so. And -- but we -- I think you know the nature of our comments and they are very consistent with the way that we see the market and we never go out and try to claim that the market is not changing or the pricing is not change or whatever and we are very transparent in the way that we have always been reporting. You know very well that for the last few weeks, some of our competitors, especially in the U.S., were talking about nothing is going to happen to them. We've seen three reports in the last few hours about what happened in Q2, and is not reflecting what they were saying to the market earlier. That's not the case at Calfrac. So, we can tell you that if we are telling -- we are announcing today some softness in the market, it's because we believe [Indiscernible] today, but it's basically at that level and is not potentially affecting the rest of the fleets that we have in activity today.

[Jon Morrison:]

Thanks. That's very helpful. Can you give any more incremental outlook for Russia specific to Q3? Like is it fair to assume that margins in Q3 could eclipse what is traditionally already a strong quarter, given some of the rollover and delays that you experienced in Q2? Is that a fair assessment?

[Fernando Aguilar:]

Yes. Well, Russia we had a couple of situations in the first six months of the year that were not -- this is something that you cannot fight against it, and it's weather. And what happened in the first six months of the year related to weather was affecting -- it was very warm and very cold at the same time. So, you had a lot of disruptions because it was difficult to operate under those conditions, very soft grounds in one part and very, very cold days in the other one. But that was one piece of the performance that we didn’t achieve in the first six months of the year. But the other piece was -- that was happening with Gazprom and the local gas plays there that we are not very sure that this going to happen as we speak. But that affected the deployment of some of the additional fleets that we have in mind. So, are we looking into a more stable market in the second part of the year? We believe so and we believe that Q3 is going to go back to better operation as we were having before. So, those two affected our performance.

[Scott Treadwell:]

Yes, and Jon, for Q3, you're up against a finite 90-day window. It's our tier point, it's already the busy part of the year. So, there's not much incremental work you can do. So, the ability to move margins higher on fixed costs absorption is relatively limited in the third quarter.

[Jon Morrison:]

Okay. Last one just for me, in terms of Argentina, you mentioned the changes that you made in the cost structure. In order for you to expand margins from here, is really a function of continuing to grow activity levels more than anything else at this point.

[Fernando Aguilar:]

It's a combination of the two and I believe it's better management of activity. It's better discussions with suppliers for more continuous and, let's say, larger volume that we are experiencing today that is securing supply for 2019, as we speak. So, it's a combination of the two. It's better management and also understanding that the market is bringing bigger volumes for us in the future.

[Jon Morrison:]

Appreciate the color. I'll turn it back.

[Fernando Aguilar:]

Thank you, Jon.

[Operator:]

Your next question comes from the line of Howard Goldberg with Janney Montgomery. Please go ahead.

[Howard Goldberg:]

Yes, thanks very much. Just a couple of quick housekeeping items from me. Early on in your press release, you point out the C$8.3 million gain in Argentina related to settling receivables there. I wasn't sure if that was included or excluded in your definition of adjusted EBITDA, hoping you could settle that for me.

[Michael Olinek:]

Yes, the recorded realized FX gain was a part of the adjusted EBITDA calculation that we showed at Q2.

[Howard Goldberg:]

Okay. So, it was included?

[Michael Olinek:]

That's right.

[Howard Goldberg:]

Also while we're on the subject of Argentina, you mentioned that you purchased what I think is the remaining minority interest in the subsidiary. Do you now own 100% of it?? And can you describe in any way what you paid for that 20% stake?

[Michael Olinek:]

Yes, I can confirm that we have purchased the remaining 20% interest. So, as of Q3, we own 100% of that sub. But just given the materiality involved, we're not preparing to discuss any amounts at this time.

[Howard Goldberg:]

Okay. Thank you.

[Fernando Aguilar:]

Thank you, Howard.

[Michael Olinek:]

Thank you.

[Operator:]

And your final question today comes from the line of Greg Colman with National Bank Financial. Please go ahead.

[Greg Colman:]

Yes, gentlemen, sorry, just a quick follow-up there. Jon and Howard got a lot of follow-ups I had. But I just wanted to circle some of your recent litigation news -- news reports are picking up earlier in the week. Wondering if there's any update on your shareholder litigation? And if you can't comment on it, because it's active, just wondering from a timing perspective, what we could expect -- when we could expect to hear additional updates from you?

[Scott Treadwell:]

Yes, Greg, it's Scott. I mean in terms of summarizing what happened to-date, our news release and the statement of claim were by design, very comprehensive and sort of set forth our position on all of this subject. But because it remains before the courts, we really don't have any comment at this time, nor do we have any indication of when we might have comment and that's really all we can say.

[Greg Colman:]

No worries. Thanks then.

[Scott Treadwell:]

Okay.

[Fernando Aguilar:]

Thank you, Greg.

[Operator:]

And we have no further questions in the queue at this time. I'll turn it back to the presenters for closing remarks.

[Fernando Aguilar:]

Thank you very much Dan. And thank you everyone for joining our conference call today. And we at Calfrac wish you all a very good summer and a good holiday. Thank you. Good bye.

[Operator:]

Thank you to everyone for attending today. This will conclude today's call and you may now disconnect.