Calfrac Well Services Ltd.
Q3 2016 Earnings Call Transcript

Published: 28 Oct 2016

[Executives:]

Fernando Aguilar - President and Chief Executive Officer Michael Olinek - Vice President, Finance and Interim Chief Financial Officer

[Analysts:]

Sean Meakim - JP Morgan Brian Purdy - PI Financial Westley Nixon - National Bank Financial John Watson - Simmons & Company Ian Gillies - G.M.P Ben Owens - RBC Capital Markets Jeff Fetterly - Peters & Co Jon Morrison - CIBC World Markets

[Operator:]

Good afternoon, ladies and gentlemen. My name is Sally, and I’ll be your conference operator today. At this time, I’d like to welcome everyone to the Calfrac Wells Services Limited Third Quarter Results 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 will now turn the conference over to Mr. Fernando Aguilar, President and Chief Executive Officer of the Calfrac Wells Services Limited. Please go ahead.

[Fernando Aguilar:]

Thank you, Sally. Good morning and welcome to our discussion of Calfrac Wells Services third quarter results. Before we get started, I would like to outline how this conference call will be conducted. Mike Olinek, our VP Finance and Interim Chief Financial Officer will begin with an overview of our quarterly financial performance. I will then discuss our outlook for the fourth quarter of 2016 and 2017 after which, Mike, Ashley, and I will be available to answer your questions that you may have. I will now turn the call over to Mike.

[Michael Olinek:]

Thank you, Fernando, and thank you everyone for joining us for today’s call. Before I begin my discussion this morning, I will refer you to the forward looking statements disclaimer and our annul information forum which is available on our website and SEDAR. Have note unlike previous quarterly conference calls, I will take Calfrac’s third quarter press release which is also available on our website and SEDAR as read and will only discuss the key financial highlights this morning. Consolidated revenue in the third quarter decreased 39% year-over-year driven by a 36% reduction in fracturing job count in addition to reduced pricing in North America and to a lesser extent Argentina. A lower job count primarily related to a year-over-year decline in activity in Canada and the United States. Adjusted EBITDA for the third quarter of 2016 was negative of $11.1 million compared to positive $7.2 million in the comparable period in 2015 due to significantly lower utilization and pricing in North America combined with lower utilization and pricing in Argentina. The reduction in Adjusted EBITDA was partially offset by continued cost reduction initiatives that have been implemented since the end of the third quarter of 2015. Relative to the second quarter of 2016, Calfrac’s consolidated revenue increased by 16% primarily due to higher activity in Canada coming out of spring breakup and the completion of larger jobs in the United States. Adjusted EBITDA as a percentage of revenue improved by 310 basis points primarily due to a $4.6 million bad debt provision that was recorded in the second quarter in Mexico. Turning to Canada, revenue was down 51% from the third quarter of 2015 which resulted in an operating loss of $2 million compared to operating income of $10.6 million in the same period of 2015. This decrease in operating income is mainly due to a 42% decline in the number of completed fracturing jobs in addition to lower pricing. Wet weather across western Canada throughout most of the quarter contributed to the decrease in fracturing activity during the quarter. However, the continued trend towards greater service intensity partially offset this decrease in activity. Calfrac did experience pricing pressure at the onset of the third quarter with select competitors continuing to bid aggressively for work. However that behavior subsided as the quarter progress. On average, we believe pricing track second quarter levels gaining modest momentum towards the end of the third quarter. In the United States, revenue in the third quarter of 2016 was 43% lower than the same quarter in 2015. Calfrac experienced significantly lower fracturing activity across most of its operating regions with the exception of Pennsylvania at 32% pure fraction jobs were completed year-over-year. As discussed previously, the company temporarily suspended its operations in South Texas and all remaining cementing operations during the first quarter of 2016 which also contributed to this decrease in revenue. In the third quarter of 2016, we reactivated one fleet in North Dakota after temporarily shutting down operations during the second quarter of 2016 and added a second fraction fleet in Pennsylvania in anticipation of improved pricing and utilization. While the company did not experience full utilization of these fleets over the course of the third quarter, we were able to broaden our customer base and believe that we are making positive inroads with customers that are expected to be very active in 2017. Pricing in the United States was relatively flat on a sequential basis and we believe that it will remain challenging to realize any meaningful pricing increases until 2017. The operating loss of $6 million was fairly consistent with the comparative quarter end 2015. However these operating results were lower than expected primarily due to the startup costs associated with the deployment of the additional fracturing fleets in North Dakota and Pennsylvania as well as the impact of less than full utilization of these reactivated fleets. However, we believe that the reactivation of those fleets has left us better positioned to participate in a recovery in the U.S. market in 2017. Calfrac recorded a sales tax recovery of $2 million in Pennsylvania during the third quarter that offset a portion of the third quarter 2016 operating loss. In Russia, the company's revenue in our third quarter of 2016 decreased by 27% year-over-year to $26.3 million. The decline in revenue was due mainly to the loss of an annual fracturing contract with a significant customer to which the company also supply proppant and the 3% devaluation of the Russian rouble partially offset by higher callout activity an additional contracted activity with new customers. Operating income in Russia was $4.3 million during the third quarter of 2016 consistent with the corresponding period of 2015, but improved by 410 basis points as a percentage of revenue primarily due to the impact of not providing proppant to a major customer as well as the completion of more callout work. In Latin America, Calfrac generated total revenue of $36.4 million during the third quarter of 2016, which represented a 6% year-over-year decrease from 2015. Lower fracturing and cementing activity in Argentina resulting from a declining rig count combined with union strikes and lower overall pricing with primary drivers of this revenue decline. The majority of the strikes that impacted the company's operations in the third quarter were related to a decrease in oil focused activity in southern Argentina. In Mexico, revenue increased slightly primarily due to higher coiled tubing activity. Our operations in Latin America incurred an operating loss of $2.1 million during the third quarter of 2016 compared to operating income of $08 million in the third quarter of 2015. This decrease is mainly due to lower equipment utilization and pricing in Argentina. As a result of lower activity levels in Argentina, we implemented workforce reductions during the third quarter which resulted in $0.5 million of severance expenses being reported. Turing to the balance sheet, we had $106.6 million of cash including a $25 million fully funded equity care, as well as working capital of $269.1 million as of September 30, 2016. In addition, Calfrac had used only $1.9 million of its credit facilities for letters of credit and had no borrowings under its credit facilities leaving $298.1 million in available liquidity subject to borrowing base limitations at the end of the third quarter. With no net borrowings under our credit facilities given the significant cash balance, we were in full compliance with our financial covenants as of September 30, 206. Calfrac’s 2016 capital spending plan in unchanged at 40 million consisting of approximately 10 million in maintenance capital and approximately 30 million in carryover capital expenditure. While 2017 capital budget is yet to determined, we expect spending to remain at low levels next year. I would now like to the call back to Fernando for on outlook on our operations. Fernando Aguilar Thank you, Mike. With crude oil prices hovering around $50 per barrel and natural gas features its prices still around 3 per Mcf through the year, we expect North American completion activity to improve over the course of the fourth quarter and into 2017. Preliminary drilling and completion capital budgets for 2017 indicate that year-over-year spending both Canada and the United States will be higher than 2016. As a result, we anticipate pressure pumping demands to increase in North America which, in turn, is expected to lead to higher pricing for our services in 2017. In Canada, Calfrac experienced increased demand for its pressure pumping services during the latter part of the third quarter with the majority of activity focused in the Montney and Saskatchewan light oil plays. We expect completion activity to improve from third quarter levels and anticipate full utilization of our active fleets throughout the fourth quarter. However, we have experienced weather-related delays in Saskatchewan during October. While Calfrac has yet to realize any material increases in pricing, we expect the pricing environment to begin to improve in the fourth quarter given the current high levels of demand for our services and believe that this momentum will continue into the first quarter of 2017. Visibility for 2017 remains somewhat limited given the capital spending plans have yet to be confirmed, but initial customer indications coupled with recent improvement in commodity prices and strong activity expected through the end of 2016 lead us to believe that first quarter 2017 activity will be strong. Calfrac continues to believe that labor will be the most prominent constraint as activity continues to increase. In the United States, Calfrac reactivated equipment in North Dakota and Pennsylvania in the third quarter in anticipation of a market recovery and in order to align our sales with customers that are expected to meaningfully increase activity levels in 2017. For example, in the third quarter, Calfrac took part in the trial for large EMP company that is very active in the Marcellus. And after a successful execution of the job, Calfrac has continued to work with our customer with steady volumes and is currently in the process of discussing 2017 plans and the possibility of a dedicated fleet. We have additional trial scheduled in the coming month, I believe that they will result in a further broadening of Calfrac’s customer base and opportunities will increase activity levels next year. While we expect our financial performance in the United States to improve in a fourth quarter, some of the operational challenges experienced in the third quarter are anticipated to persist. Utilization is expected to be somewhat inconsistent over the coming months. However, we believe that completions activity in the United States will increase in early 2017. Calfrac’s active horsepower count at the end of the third quarter is at the appropriate level at this time to position the company for a market recovery and we do not expect to reactivate additional equipment until there is a meaningful improvement in pricing. Activity in Russia continues to be consistent with 2015 and we expect this trend to continue into the fourth quarter with the exception of the impact of normal winter weather operating conditions. We are currently in the early stages of the 2017 contract tender process with our customers and at this stage, we expect utilization and pricing to be comparable to 2016 levels. Moving to our Latin American operations, the current rig count in Argentina is approximately 30% below the end of last year which has resulted in a decrease in demand for Calfrac and other company’s services. In addition, pricing pressure has continued to increase across our operations with certain multinational competitors attempting to recover market share. While we do not anticipate further pricing adjustments to our existing contracts, we do expect lower pricing for new contract tenders. Overall, increased activity from certain gas-focused customers combined with the impact of cost reduction measures that were implemented during the third quarter are anticipated to drive improved financial results in the fourth quarter and continuing into 2017. However, we have experienced delays due to weather in Neuquén area in late October with heavy rainfall and flooding. I’m pleased to announce that Calfrac have been awarded a two year contract to provide completion services for Pan American Energy in the Vaca Muerta formation, utilizing and fracturing with multi-cycle fleets. Calfrac will rely on its extensive market leading expertise in hydraulic fracture in North America and Argentina to implement this technology for Pan American. Today, the company has been delivering another fraction with this technology highly successfully implement in with various operators in Argentina. In Mexico, activity across all regions remains low due to continued delays in Pemex’s budget process. While activity is expected to modestly increase in 2017, we’re expecting very minimal activity in the fourth quarter. Calfrac’s focus is to continue to proactively manage our cost structure to generate breakeven margins in Mexico. Overall, it appears that the global oil supply/demand balance is tightening, which is expected to have a positive impact on North American pressure pumping fundamentals. While the timing and magnitude of any recovery remains unclear, it is generally anticipated that pricing dynamics are poised to become more positive by year end. Calfrac continues to evaluate alternatives available for it to decrease its debt levels and improve its capital structure, and the Company’s cash position, fully funded equity cure and undrawn facility provide us with the flexibility to assess such measures with the benefits associated with any market recovery going forward. I would now turn the call back to the operator for questions. Thank you all very much for listening.

[Operator:]

[Operator Instructions] And your first question comes from the line of Sean Meakim with JP Morgan. Your line is open.

[Sean Meakim:]

Hi, good morning.

[Fernando Aguilar:]

Good morning, Sean.

[Sean Meakim:]

So I was hoping to start just talk about the U.S. a little bit. I’m curious if you guys I mean you run the map what kind of utilization do we think that we need in order to get back to the positive EBITDA, as we moving part with to respective pricing, utilization and cost reductions, but there was curious, what’s we could vote [ph] that we should be setting out there?

[Fernando Aguilar:]

Yes. So this is a good point. Sean, because it is the EBITDA problems are we facing the industry today are related to two things, one is activity and the other one is pricing. And this the situation is going to be fixed by only one of the two. So you will need more activity and you need better pricing for your operating margins to improve. So, and if you talk about our third quarter results, there was a combination of different things from weather number one trials with customers are basically didn’t have the productivity and efficiency in their pulse require to have that let’s say utilization level that you need. But if you think that with the fleet that we brought on board and the activity kept at high level continuous 24 hour operations and better pricing then the margins are going to start more in the right direction.

[Sean Meakim:]

Okay. Yes, that’s fair enough and then interesting here the comments about what’s happening in Argentina on the one hand sounds like you’re seeing some incremental opportunities, but felling more of the pressure there. As we think about 2017, can you help us to be quantified the better what that pressure looks like and then what steps do we need to see in the macro environment to improve the outlook there?

[Fernando Aguilar:]

Yes. So it is difficult when the oil industry has to rely on a government changes and the way that political decisions impact and industry like ours. So very well that less than a year ago or let’s say around a year ago, in December, there was a new government in place, and of course our government came from a completely different party and when that happens especially for national oil companies you have interruption in the management of all those entities. So what has happened in the first six months of the year, there were two effects. One is that they wanted to start fixing the economics of the country as a whole and we gain international confidence in how the country was going to emerge after many years so far other party that was not doing very well in the international arena, and was not very well respected by the financial institutions. So I think they have managed to go into other direction and they have done a very good job there. The second one is that there was a very, very dramatic change in the way that the National Oil Company was managed, because they replaced from the CEO, they creating in fact an additional position that they had before. So they have the president and CEO and then operations or like a CEO type of position in our word [ph]. So these new people are arriving, they are trying to understand exactly what is happening and while all these things were happening and the changes were taking place there was a shift from oil to gas because there was more interesting for them from the financial point of view. So we’ve seen change from oil into gas, change of management, change of government and of course at the same time the rig increases that our happening in 2014 and 2015, and the projected numbers that the industry was expecting for them to didn’t happen and in fact there was a reduction of 30% in doing activity. So all those things combined basically and if you want to add an additional problem which is basically from the summer and then getting into a new season and the rains is dramatic to see New Kansas city flooded, people are basically using coax to go from one house to other. You can you can basically see that activity has stopped in that area of the country for at least two weeks. If you going to get into 2017, I don’t think so, I think the government feels more comfortable today, in one of our recent trips to Toronto we had opportunity of listening to people from BP and Exane were discussing about Argentina, where they are very positive about the possibilities, of course, they want the government to be more let say more energetic and drastic and firm in the negotiations and discussions with labor to make sure that the industry opens in a more efficient way. So companies can become more proactive, more productive and also can be more, let say financially sound, because the labor cost in Argentina is one of the higher ones in the world. So as the government continues moving the right direction, we expect 2017 be a better year for the Argentina and industry, I just want to give you all those details so sorry for that long answer to your question.

[Sean Meakim:]

No, it’s very helpful. Fernando, thanks very much for the detail.

[Fernando Aguilar:]

Yes, thank a lot.

[Operator:]

The next question comes from Brian Purdy with PI Financial. Your line is open.

[Brian Purdy:]

Good morning, guys. I wanted to ask about some of the fleet reactivations and you obviously took the step to reactivate some of U.S., but I believe your comments said that you were looking for further pricing improvements to reactivate more. And I’m just wondering what your threshold is there, I mean do you need a 10% price increase and if you could contrast the U.S. and Canada for us that would be great to.

[Fernando Aguilar:]

So, Brian, when it 40%, is not 10%, is not 5%. If you go back and check, some of the charts that were presented in the last couple of months, the operating income, the media, the average of operating income for companies in the U.S, and I think you following up with the car companies are reporting is a 10% negative operating income as an average. So I don’t think 10% is going to be enough, because you’re still losing money as a whole for the company. You need and I don’t think you need the 40% and the industry has lost because the industry has become more efficient and because the costs from suppliers and personnel and all areas have basically been reduced. So I think you need to start moving in the right direction and prices go very fast down, but for them to start improving it takes longer. So as we start moving in, you need to make sure you have you align your resources and your activity to the areas where you believe the customers are going to require your services. And that’s exactly why we deal with those two geographies where we basically activated those two fleets. We had an indication from customers are they were willing to pay I would say between 5% and 15% because you have to take an average not tell you the 10% exactly. But that will help us are more in the right direction and negotiating with our customers. The fundamental sort of pricing where the pressure pumping industry has been hit so hard that is not enough with the 10%. But of course you understand the customers would also like to enjoy those lower costs coming from our lower prices coming from the pumping service industry until they recover from the commodity prices. As the tension that has been generated in the industry and which is very positive, it’s not it’s not nice because you have people fighting for pricing and then you still have some competitors I want to do it for a lower price, so they can position themselves. But at the end of the day what we feel today is a positive trend more activity and customers are basically going back to the situation where one EMP company was basically having two or three suppliers in their operation so the volumes are going to start looking more positive for our sector.

[Brian Purdy:]

Okay. Just maybe as a follow-up than, understand interest around your decision making here on reactivating the fleets. If you’re - if you’re not seeing that level of pricing increase yet, is this a bit of protecting a market you think is going to be growing and getting that level of pricing increase at some point in 2017?

[Fernando Aguilar:]

I believe so. I believe the combination of those two points correct.

[Brian Purdy:]

Okay, okay. Great, that’s all I had. Thanks very much.

[Fernando Aguilar:]

Thanks, Brian.

[Michael Olinek:]

Thanks, Brian

[Operator:]

Your next question comes from the line of Westley Nixon with National Bank Financial. Your line is open.

[Westley Nixon:]

Good morning, guys. This is a Westley Nixon tuning in, in the place of Greg Coleman.

[Fernando Aguilar:]

Morning Westley, how are you?

[Westley Nixon:]

Fernando, I was wondering if you could quantify the cost associated with activating the additional horsepower in the United States.

[Fernando Aguilar:]

So activating, well it depends where you are, because it depend how large the fleet is. So you have two different geography, geographical areas that where we activated fleets. One was North Dakota and other one was Pennsylvania where the basically I can say that in Pennsylvania is twice as large or a bit more than with the one you activating North Dakota so. You will all depend on the number of people you bring on board. So is the cost associated to people and then the cost associated to a preparing to fleet and also the working capital required to that so, I don’t know Mike, you want to be give a little more granularity to the to the answer.

[Michael Olinek:]

Yes, I mean I would say Westley that it’s going to various they said North Dakota being a smaller fleet size. It’s going to be in the $0.5 million range for probably in North Dakota just principally on the equipment side, and maybe around double that if we’re talking Pennsylvania, but we also have to be cognizant that a lot of their operating results were really due to the utilization levels that those fleets were able to generate in the quarter, not necessarily the cost of rent crude actually get them up and running. So it was really a combination of that and affecting our financial results for the third quarter.

[Westley Nixon:]

Okay. Appreciate the color, I guess the follow-up so that would be I was wondering if you guys needed any additional employees to reach your objective of realizing 100% utilization on the act of fleet in Canada, this coming quarter?

[Fernando Aguilar:]

Yes. So we are - I think we mentioned we have more activity in Saskatchewan, South America area and also in the Montney, and in fact what is happening today you heard that Mike was referring to some personnel reduction that took place in Argentina, but in the both the Canada and U.S. so let say North America, we are basically adding the range of 150 employees more or less between the two countries. So it is required to prepare the fleets on the people additional activity that we believe is happening and we continue happening into 2017.

[Westley Nixon:]

Okay. Well, appreciate the color and thanks for the detail.

[Fernando Aguilar:]

Thank you.

[Michael Olinek:]

Thank you.

[Operator:]

The next question comes from the line of John Watson with Simmons & Company. Your line is open.

[John Watson:]

Good morning.

[Fernando Aguilar:]

Good morning, John.

[Michael Olinek:]

Good morning, John.

[John Watson:]

On the labor side, can you talk about the differences between a labor situation in Canada and in the U.S., I saw that in the earnings release that shows that labor will be a concern in Canada, but I didn’t see a similar remark in the U.S. What are your views on the labor situation here in the States?

[Fernando Aguilar:]

So I think try to follow what everybody is saying about people. It gives you a little bit of a full picture of what is happening I believe three years ago you had precision drilling saying that they were hiring around a thousand people and then and then you see, okay so where is the number coming from is the North American number, yes, it was, but you see more U.S. and Canada of course it is because two more rigs increasing in the U.S. today. So you take this into consideration I think what we’re trying to do today is make sure in those markets we just go back to the people that we used to have that we that operated, were trained were experienced, and of course you have to bring a newer people, because as we mentioned earlier and you remember that John, not everybody not from the 200,000 people who have left the industry, not everyone wants to come back to industry after you know getting laid off. So I think it’s important to talk about different markets, I believe that the Canadian market today, because she is just starting to hire people, is basically following in the U.S. It is relatively normal to go back to the same source of personal that we had before they - but and the same thing is going to happen in the two countries. But as we continue going back to the activity levels that we believe are going to happen and as our competitors and also our service industries go on fight for the same pool is going to be gone more and more complicated as time goes by. So we believe that it is it is okay today in both countries. I don’t say that is easy because it’s never easy to our - to optimize and maximize the way that you hire people, because you really want to are to make sure that you reduce your attrition to the minimum level. So you don’t waste money in the process. The people you bring to a company you want them to stay, you want them to progress, you want them to make a career. So if you do it well, you want to make sure that this is the case and today, it is challenging, but it still manageable. I don’t think that we have an issue that is very complicated, and I can tell you in the in the two countries where we’re doing.

[John Watson:]

Okay that's helpful. And an unrelated follow-up, I saw that you're expecting inconsistent utilization in the U.S. in Q4, is that because of daylight work or is that related to holidays or weather, can you talk us through that outlook?

[Fernando Aguilar:]

Yes, so we would like the U.S. to be let’s say better work down while we told you in the conference notes, but you know that we have now a holidays for Thanksgiving in the next month and we also have holidays with the end of the year with Christmas and New Year, but we believe that the activities that is happening is going to compensate for some of those holiday breaks.

[John Watson:]

Okay great, and then one last one from me. Can you talk us through the increase in depreciation sequentially that's kind of surprised to see that?

[Fernando Aguilar:]

I would say that the increase in that would probably due to FX related on the U.S. side principally, because there’s been no structural changes to our PP&E.

[John Watson:]

Okay, great. I'll turn it back, thank you.

[Fernando Aguilar:]

Thank you, John.

[Operator:]

Your next question comes from the line of Ian Gillies with G.M.P. Your line is open.

[Ian Gillies:]

Good morning everyone.

[Fernando Aguilar:]

Morning Ian.

[Ian Gillies:]

As you think about putting through price increases in Canada, let's just if we pick a fictional number of 10%, what percent of that do you think actually falls into the operating income margin and what will get swallowed up by suppliers et cetera?

[Fernando Aguilar:]

You're always asking these questions, Ian. I think it's interesting the number that you’re picking, because we heard anecdotally that some competitors are writing letters to customers about it, but we believe that the pricing negotiation with or price increases that happen in our industry are for Calfrac always be in the one on one. And it depends on how the market can take those price increases, and how we position ourselves and in our strategy Calfrac has always been very careful with that relationship with customers for them to understand exactly where we are in the timeline for that. So let's say that you are taking a 10% increase today as you can see when the companies are basically in these negative operating margins that the industry has experienced for many quarters now. As I mentioned earlier the 10% is not enough, but it is the beginning of where you have to start moving to. So I believe that our suppliers and the way that we've been working with them we will require commodity pricing to be a stable, so customers will be able to spend more money and they will be able to as well to start generating more cash they can support the price increases that are going to happen from the service sector, and this is what is happening today. I believe at the discussion that we've been having with our customers in Canada specifically, because that's a question that you asked me is supported by them, I believe they understand that our industry has been really hammered with these low price environment, and they want to have an industry available for their activities in the future. They have to accept a price increases, and I think they've been positive, they've been very positive about that and they're reacting very well to it. So there is the environment is constructive not only from the activity point of view, but also from the price increase situation. And I and I believe that our suppliers understand that this is happening there will be some tension as well between the two areas and it's going to be translate in some cost inflation, but we hope that the industry is going to manage that properly, so we will be able to generate better margins for our shareholders.

[Ian Gillies:]

Okay, thanks, that's very helpful. And then in Canada where you currently have with reactivating equipment given that demand appears to be increasing if supply and demand are reasonably tight, I mean how close are you think you are at a rolling out equipment in that jurisdiction given that you've already done so in the U.S.?

[Fernando Aguilar:]

Canada is a very interesting place, because we have concentrated activity in the heart of the province of Alberta and so from that area you can control supervise and operate the south, the center, the north, the east and the west. So we don't - so we increase activity, if our active increases in Saskatchewan for example that will be from our operating out of let's say right here, you have more activity in the BC, northeast BC for example you will have fleets covering from the [indiscernible] area. So it is for the activity speaking up, but for us we see that happening in the two main basis without including the smaller satellite ones. But I have to tell you even though we go to our operations room and we see that our fleets are fully utilize and we have basically fully booked board in front of us for the next let’s say one or two quarters, their competitors that are not in the same situation, so that is going to hold pricing to move faster than what people expect. But I was saying before it is constructive activity speaking up and as activity picks up and the market saturates, we believe that we will be able to continue or being equipment completes into a Canadian market. We have to be very careful, because you have to understand and I think you know very well the break up is again around the corner. So you have to be careful that you don't over stuff you sell, and you end up in a situation that you know that you have more resources than the one that you need to go through that slow period of time as well.

[Ian Gillies:]

Okay that's helpful. Thanks very much. And I thought Russia was particularly strong in the quarter and it seems like there's been a bit of a change and how work is being sourced there given it seems like there’s bit more spot market work. So has there been a noticeable shift in customer behavior and how they want to source fractured services there or is it just a natural evolution I was hoping to get bit of additional detail there?

[Fernando Aguilar:]

I would say that, I would say no, as a general comment, I think Russia is a place where it is dominated by national oil companies, a conventional business because of the embargo that can give you opportunity or participating in on conventional. I have to say that for them to change and to move into a complete different model is not simple and normally the engineers in charge of operations in the Russian oil companies are not, let’s say risking their positions to the way. But I have to tell you that we've seen consistently in more horizontal work done more stages per week performed in some of these fields, and I think they're liking the fact that they can hire a fracturing company and go through let’s say other North American technology way where they can be more productive and more efficient with let’s say lower movement and rig moves and all of the issues that are generated around doing vertical wells and single well and single stage operations. So it is moving the right direction, but of course, it takes time for them to execute it in a very productive and effective way that is happens soon in North America.

[Ian Gillies:]

Okay, thanks very much. That's helpful. I’ll turn it back over.

[Fernando Aguilar:]

Thank you, Ian.

[Operator:]

Your next question comes from the line of Ben Owens with RBC Capital Markets. Your line is open.

[Ben Owens:]

Hi good morning.

[Fernando Aguilar:]

Good morning, Ben.

[Ben Owens:]

Wanted to follow-up on the labor question in Canada and just given the tightness in the market there for labor wanted to know how many spreads you could reactivate if you need to reactivate in the near term given the labor constraints is there a number of crews you could put back to work in the near term?

[Fernando Aguilar:]

I would like to go back to where we were maybe two years ago, two and half years ago, and as fast as I can, but it's not only related to - is not only related to labor, is related - is managing different variables. So you have to manage the activity coming from customers you have to manage how competition is stuck in the situation, you have to manage the price that is available and you have to bring all these things into the soup and see how you can get the best situation for the company. Ben the most important piece is to make sure that we build it properly and we keep our reputation our service, our technology, and our support to customers the way that we open doors for extended activity, and larger activity and I tell you this because it is not a matter of being Calfrac let’s say approach to business. We want to work for the best customers who are basically the ones that understand what Calfrac is about understand what Calfrac is about, understand the drivers of our strategy to make sure that our from quality, safety technology they get the support, and they and their operation to produce oil and gas in a more efficient way. So you have to bring all these things into consideration, but and going back to your original question you have to remember that when we were in 2014 into 2015, when things started to change and we the industry was talking about a shortage of a 100,000 employees in the oil and gas industry in Alberta, let’s say in Western Canada. So you go from there to a place where you release 200,000 employees in North America from services to oil companies to the whole thing. So that’s what is basically making people unhappy about if I go back to industry well is going to happen to me in the next two, three years I prefer to have a stable job somewhere else. So we have to be very careful with our speech and our discussions with in the new employees on how things are going to happen and how we’re going to be structuring them into the industry, for them to have the confidence of joining an industry is going to be not only viable, but is going to provide them with an income and the stability and the long term view that they need for them to come back. So that’s where you make in makes it tougher and more complicated today than what he was in the industry was let’s say in an upturn or in a or an explosion mode few years ago. So it is about understanding how we are going to be able to start to continue convincing people that this is a good industry to be and there is a future for them to join the oil and gas sector.

[Ben Owens:]

Okay. That’s helpful. Then on the fleet in Canada on the approximately 200,000 or so horsepower that stacked, I mean how much total incremental CapEx do you think to reactivate that equipment all or is there any portion of that that would require heavier spending refurbishment to become active?

[Fernando Aguilar:]

Yes, I believe so because I don’t think there is a single company in the pressure pumping business that be enough, let’s say that has to be the fleet 100% ready to operate. There are some repairs that are supposed to happen and in the past we’ve been saying that we needed to be between $25 and $30 million to bring the overall North American fleet to service. So part of it is the one required for Canada, and as we prepare these equipment, this money is not only required for repairs. Then it is also required for impairments of the equipment and licenses and new iron and a lot of different things that are parts of bringing the fleet again to operations. So I would say that that is the number that we have consider for North America varying between $25 million and $30 million.

[Ben Owens:]

Okay. Thanks Fernando, that’s help. I’ll turn it back.

[Fernando Aguilar:]

Thank you, Ben.

[Operator:]

[Operator Instructions] And your next question comes from the line of Jeff Fetterly with Peters & Co. Your line is open.

[Jeff Fetterly:]

Good morning, everyone.

[Fernando Aguilar:]

Good morning, Jeff.

[Michael Olinek:]

Good morning, Jeff.

[Jeff Fetterly:]

Couple questions around the margins. So in the U.S. side, I’m just trying to reconcile the sequential change in margin. So you were just under a $1 million operating loss in Q2 of 2016. If you back out the $2 million tax element in Q3 of 2016, it was about an $8 million operating loss. So you talked about 500,000 or so in North Dakota to get the capacity up and running about $1.5 million in the Marcellus. But can you help us reconcile the remainder of the quarter-over-quarter change, especially given that revenue was higher in Q3 that was in Q2?

[Michael Olinek:]

Yeah, Jeff, I help with that question. So I mean in addition to the hard cost as far as the equipment there was some labor costs associated with reactivating, which I didn’t get into. There’s some other factors that obviously I think had a fairly significant impact as well on the operating margins realized in the U.S. in the quarter. One was our, what we consider to be fairly spotty reutilization of some of those reactivated fleets. We also had a change in customer mix in Colorado, which impacted our cost structure a bit. As Fernando alluded too we have some inefficiencies working some of these new customers. And we had some higher RNM [ph] related to the replacement of some carbon fluid and as well, so all those factors sort of played into the realized operating loss for the quarter in the U.S.

[Jeff Fetterly:]

And so when you think of about Q4 relative to Q3, I know you’ve talked about financial performance improving. Is that predicated on revenue increasing in the fourth quarter versus the third quarter or how many of these cost elements do you think there isolated to Q3?

[Michael Olinek:]

Well, I think we believe that some of the cost elements are isolated specifically to that to the startup. But obviously we also discussed utilization being a little on even the holiday breaks as well. So what we do believe it’s going to be better the magnitude of that is obviously depend in an overall utilization of fleets.

[Jeff Fetterly:]

Okay. Similar question on the Latin American side, so if you look at Q2 excluding the bad debt provision you were essentially at breakeven from an operating income standpoint the revenue did increase in Q3 versus Q2. If you exclude the 500,000 severance you referenced earlier there’s still further material decremented margin change there. How do you think about that in Q3 and how should we think about that in Q4 and going forward?

[Michael Olinek:]

Yeah. Again, as I discussed in my in my notes here I think a lot of that has to do with the utilization that we were able to achieve in Southern Argentina given the shift in activity and the union strikes. So a lot of that has to play a role and how our operating income ended up for the quarter. When you’re also looking at utilization in the North, I think we expect that in Q4 to be a little bit less than we expected just based on these weather related problems that we’ve seen in October. So overall I think we believe that things are going to improve, but it all ultimately again depends on how we can get the utilization of our existing fleets. We believe it’s going to be better than it was in Q3, but obviously that will depend on how things evolve.

[Jeff Fetterly:]

How significant is the pricing delta between the contractor work in Argentina you described as being fairly stable and the incremental projects are the spot related stuff that you’re working on?

[Michael Olinek:]

No, we have to price decreases as far as contract renegotiations and as a result there was a magnitude increase of approximately around 10%.

[Fernando Aguilar:]

Jeff it is - when you see that you have a 30% activity decline. Let’s say number 30% less number of rigs that you have in Argentina, today. You have to remember that in Argentina, you have you have a lot of players - excuse me, in the sectors. So you have the conventional one [indiscernible] you have San Antonio, you have Calfrac. And then you have other good team as well, smaller player in the industry. You have seven players in one country and activity has dropped 30%. So what do you expect today normal competitors do as it happen in the U.S. and happen in Canada in long term people reduce the prices to let’s say preserve their share of the business that they have. And that’s exactly is only immune the situation to us in Argentina that is usually basically happen into rest of the people. So the price decreases that happen on in that market I related to that 30% activity decline.

[Jeff Fetterly:]

And the delta, if I heard correctly is about 10%.

[Fernando Aguilar:]

We believe so. Yeah.

[Jeff Fetterly:]

Okay. Last piece on the Canadian side the weather delays some of which in Q3, but specifically the references in October, it’s a Saskatchewan is that something that you expect will be caught up during the fourth quarter do you think that will carry forward into the first quarter beyond.

[Fernando Aguilar:]

It is not that we, let’s say lost the activity is basically activity has been pushed, because those programs are basically taking us into Q1 and Q2. But is basically activity that didn’t show up in month, and I give you an example of one of the customers that we were ready to operate I believe we spent three weeks basically standing by waiting for the government to give us permission to move our equipment and for the customer to be ready to operate and these are large customers that are basically pre active in that area. We moved that activity into the next month or quarter, but of course we don’t like that because that effected the results of the current month, right.

[Jeff Fetterly:]

So is that a Q4 dynamic, where you think the stuff will get caught up or is it going to be pushed beyond?

[Fernando Aguilar:]

Well it starts in Q4, because remember that we are in October and that is basically getting ready to operate again, in fact two days ago. As far as I recall now we went back to operating to other areas so let’s say in Q4 to Q1 correct.

[Jeff Fetterly:]

Okay, great. Thank you appreciate the color.

[Fernando Aguilar:]

Thank you, Jeff.

[Operator:]

And there are no further questions at this time. Mr. Aguilar, I’ll turn the call back over to you.

[Fernando Aguilar:]

Thank you, Sally. So thank you everybody for participating, sorry there is one more question was showing up on the screen, Sally.

[Operator:]

Certainly. Your next question comes from the line of Jon Morrison with CIBC World Markets. Your line is open.

[Jon Morrison:]

Good morning, all.

[Fernando Aguilar:]

Good morning, Jon.

[Jon Morrison:]

Just the follow-one just question about the U.S. margins, if you could have the quarter back again and you would have had a better line of sight with the actual equipment utilization would have been. What if you still reactivated those two crews or waited for some period of time?

[Fernando Aguilar:]

So it’s a combination, if there is never and yes or no answer to one of these questions Jon, because again you have to manage those different factors. If we don’t activate them and it takes time for us to activate those two fleets. Then we were not going to be ready for the quarter or the next quarter when we are basically getting the environment of better pricing, better pricing environment, sorry. So we were affected by that time and also because when you go and do these trials. You don’t get the best locations through them, so when you’re bidding, you’re trying to get let’s a six or five stages per day and then you’re going to a situation when you run three the economic don’t really make any sense, but that’s now you want to, because you want a position yourself with that necessity customer. So I would say that yes, we would still do it. But we have to be careful that that pricing an activity level is not going to affect dramatically your margins right. So you will be stronger in the middle for that Jon, is a very, very complicated situation to that and exactly when the right timing is. But we believe that this is positioning Calfrac in a very new way for those customers and those markets as activity continues improving.

[Jon Morrison:]

And Fernando in the past you’ve talked about having a base level of embedded field margin required before you putting start back to work which you didn’t achieve this quarter. Should we assume that that will be the case in future reactivations and that ultimately you’re going to try to position incremental in the field ahead of the ramp up or you ultimately from here on out can wait for those margins to be realized across your fleet and then you start activating. I’m just trying to figure out whether this is truly one time in nature or we could see this phenomenon carry in the next one, two, three, four quarters.

[Fernando Aguilar:]

Well, we hope that this is not the case, Jon. But I have to tell you that we can’t base our business in luck. But I have to tell you we were not lucky in this quarter, and why we were lucky because first of all we have some operations that efficiency that we were expecting, and second we have some weather issues as well in the northern part of the country that also affected. So there is combination of the pricing, the weather and also and the activation of those fleets. And the instructions to our operational groups and also to our managers to basically not to lose money, is the most important piece, but I don’t think you know we managed do that in the U.S. in the quarter. And that we don’t feel very happy about it. And I have to tell you that the only positive about this is that we see an environment that is constructive is not positive and the pricing is basically taking us to a better level that is going to start happening as we speak, because this is moving is an unique situation. And we will have those two fleets already in business, which is basically something that is going to help our positioning, but are we going to bring more fleets with the same situation I would say, no, if pricing doesn’t really get to the level where it has to be.

[Jon Morrison:]

Earlier in the call you talked about pricing expected to firm in Q4. I’m just wondering have you actually experienced any of that to date in the last call of 30 days or is it really you’re expecting a tenfold in the next two months and any color you can give on split in U.S. and how those markets should be different, would be helpful?

[Fernando Aguilar:]

I think you know you asked the question in a way, because the discussions have been happening that’s not something that happens overnight. And we see that pricing effect happing in a next couple of months. And I would say that can’t get faster in Canada than in the U.S. because of the nature of the business, and also we go so far the saturation of equipment. So you can saturate Canada faster you can saturate the U.S. and that’s the reason why we believe that the efficiencies that you bring to the market you can see them very fast in the U.S. but the pricing effect can be realized faster in Canada.

[Jon Morrison:]

Within Russia, you’ve talked about picking up some incremental spot market or color work in the quarter. Should we think about that being a one-time phenomenon back selling some of the contracts that if you previously had, what you believe that spot market work could translate into a affirming the longer term contract in the future?

[Fernando Aguilar:]

So you said in Russia.

[Jon Morrison:]

Yeah, specific just Russia, take up the spot market work I’m just trying to figure out whether that’s a one-time phenomenon in the quarter or you think that could carry forward?

[Fernando Aguilar:]

No. You have to remember that one of our competitors sold their activity to a national oil company and there was some uncertainty for our contract and it was like a year ago I believe. And the reason for that is because they were doing their own work and they were concentrating their activities, so we ended up with a couple of fleets that were near to go into the spot market. We’ve been let’s say successful positioning those activities. I think in general terms, 70% or 80% of the activity has been recovered and we have opportunities for 25% of that equipment that we have from those contracts to pick up our work or let’s say its spot market. But you have to remember that Siberia is Western Siberia is very large and sometimes you can make you very inefficient for you to grab work where even you spending a lot of time moving up and down instead of being front of the words. We prefer to be in areas where we can be more or less efficient to serve our customers rather than there’s been all the time transporting our equipment back and forth.

[Jon Morrison:]

Just as a point of clarification around Latin America, based on your current later said, do you believe that that business should turn back towards positive operating margins in the coming quarters based on everything including the incremental contract you got from Pan-American?

[Fernando Aguilar:]

We believe so, Jon. Yeah, we believe so on a I think the actions they were taking to measures that we are we size or management, operations and technical fracture to reduce activity are basically going to help due to arrive to those margins that we required to have in Argentina.

[Jon Morrison:]

So we should interpret the 500,000, severance cost quarter is one of the initiatives try to get you there and that’s not a sign that things are going to fall off from an activity level perspective from here forward?

[Fernando Aguilar:]

Yeah, we believe you, right. Yeah.

[Jon Morrison:]

Okay. Just in reference to the Marcellus dedicated crew that you talked about. Was that one more incremental crew above and beyond what you activated or you reactivated this one to hopefully have it is a dedicated crew for that customer?

[Fernando Aguilar:]

Yeah, is one more to come.

[Jon Morrison:]

Okay. Mike, just a quick question around working capital needs of the business go forward with the two more crew is going to be active in the U.S. and activity picking up. Given number that you’re thinking about possibly needing from a cash perspective to support the higher activity level we should be keeping in our mind.

[Michael Olinek:]

Yeah, I really from a working capital perspective incremental revenue about 25% of that translates into the working capital requirement on a go forward basis. That’s really what we realized on the way down through the downturn and we suspect it will be pretty similar on the way backup.

[Jon Morrison:]

So it’s sort of assumed that the cash balance of a little bit of north of $100 million in the balance sheet you believe that will easily handle your needs on a go forward basis?

[Michael Olinek:]

Well, it obviously depends on how go forward operating results transpire, but at this point you know towards the end of the year we feel confident we should be with positive cash and not really into our facilities at year end.

[Jon Morrison:]

Okay. Appreciate the color. I’ll turn it back.

[Michael Olinek:]

Thank you, Jon.

[Operator:]

And there are no further questions at this time, Mr. Aguilar, the call is yours.

[Fernando Aguilar:]

Thank you very much. So we’d like to thank everybody who were participating in our conference call and see you next quarter. Thank you. Goodbye.