Calfrac Well Services Ltd.
Q1 2015 Earnings Call Transcript

Published: 3 May 2015

[Executives:]

Fernando Aguilar - President and Chief Executive Officer Mick McNulty - Chief Financial Officer Ian Gillies - Investor Relations

[Analysts:]

Dan MacDonald - RBC Capital Markets Scott Treadwell - TD Securities Byron Pope - Tudor, Pickering Brian Purdy - PI Financial Dana Benner - AltaCorp Capital John Daniel - Simmons & Company Jon Morrison - CIBC World Markets Jeff Fetterly - Peters & Company

[Operator:]

Good morning. My name is Leanne and I will be your conference operator today. At this time, I would like to welcome everyone to the Calfrac Wells Services First 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. Fernando Aguilar, President and Chief Executive Officer, you may begin your conference.

[Fernando Aguilar:]

Thank you, Leanne. Good morning and welcome to our discussion of Calfrac Wells Services first quarter results. Before we get started, I would like to outline how this conference call will be conducted. Mick McNulty, our Chief Financial Officer, will begin with an overview of our quarterly financial performance. I will then discuss our outlook for the remainder of 2015. After which, Mick, and I will be available to answer questions that you may have. I will now turn the call over to Mick.

[Mick McNulty:]

Thank you, Fernando, and thank you everyone for joining us for today’s call. Before I begin my discussion this morning, I would like to note that this conference call will contain certain statements and expressions that are considered to be forward-looking statements under applicable securities legislation. Our assessment of future plans and operations is based on expectations that involve a number of business risks and uncertainties. These risks are set out in detail in our annual information form and include, but aren't limited to, commodity prices for oil and natural gas, equipment inventory levels, national and international economic conditions, political uncertainties and government regulation, the ability of our customers to access credit and capital markets, the concentration of our customer base, competition in the markets where we operate, product and supply availabilities, risks associated with our foreign operations, weather conditions, outcome of legal proceedings, currency exchange rates and labor shortages. These conditions could cause the company's actual results to differ materially from our current expectations. During the first quarter of 2015, Calfrac achieved the following financial results in comparison to the first quarter of 2014. Consolidated revenue was a record for the first quarter at $600.4 million, an increase of 10% from the prior year quarter. The increase was driven by higher activity in the United States and Latin America combined with a continued trend of greater service intensity and more stages completed per well in North America. Operating income was $27.8 million for the first quarter compared to $64.1 million for the same period last year. The decrease in operating income was mainly as a result of weaker pricing for the company's services in Canada and the United States, and the lower activity in Canada. We reported a net loss attributable to shareholders of $12.6 million or $0.13 per share diluted compared to net income of $8.9 million or $0.10 per share diluted in 2014. The results from Calfrac's operating segments are as follows. Calfrac's Canadian revenue during the first quarter of 2015 was $221.4 million versus $267.7 million in the same period of 2014. The decrease was primarily due to a mix of lower pricing and lower activity for its fracturing services. Revenue per fracturing job increased by 16% from the same period in the prior year as a result of larger job sizes. Total proppant per reported fracturing job increased by 30% over the prior year, while total proppant used declined by 7%. Operating income in Canada during the first quarter of 2015 was $20.5 million compared to $52.5 million in the same period of 2014. The decrease in operating income was a result of significantly lower pricing and utilization, cost reductions lagging changes in pricing, an earlier-than-expected breakup and an unplanned work stoppage in mid-March. The impact of a weaker Canadian dollar on the cost of proppant that is sourced from the United States also contributed to the reduction in operating income. Revenue from Calfrac's United States operations increased to $305.1 million during the first quarter from $211 million in the comparable quarter of 2014 due to higher fracturing activity and a stronger U.S. dollar despite pricing reductions that on average were down around about 12%. The growth in the number of fracturing jobs was primarily due to greater activity in South Texas, the Rockies and Pennsylvania. Revenue per job was higher year-over-year as the continued adoption of greater service intensity per job, job mix and a stronger U.S. dollar offset the significantly weaker pricing. Proppant per fracturing job increased by 15% over the same period in the prior year while total proppant used increased by 57%. With respect to proppant per fracturing job in the U.S., Calfrac experienced an increase in tons per fracturing job in South Texas, Pennsylvania and Colorado. In North Dakota, tons per fracturing job actually declined modestly, but stages per well increased 26% from the fourth quarter of 2014 and were up 27% from the first quarter of 2014. Lastly, a greater proportion of Calfrac's job count was in the Fayetteville area where our customer provides the sand and we do not. Operating income in the United States was $11.4 million for the first quarter of 2015, a decrease of 48% from the comparative period in 2014. The decline was primarily due to significantly lower pricing, higher product costs and increased subcontractor costs. Calfrac's cost structure in the first quarter of 2015 reflected very little impact from the cost reduction initiatives that were implemented due to the lag effect of these initiatives. SG&A expenses increased by 23% in the first quarter of 2015 over the same period in the prior year, half of which is exchange rate-related with the balance due to higher costs to support the company's expanded operations. Compared to Q4 2014 however, SG&A costs actually declined 32%. During the first quarter of 2015, revenue from Calfrac's Russian operations decreased by 22% to $30.5 million from $38.9 million. The decrease in revenue which is generated in rubles, was attributable to the 37% devaluation of the ruble in the first quarter of 2015 when compared to the first quarter of 2014. The decline in the ruble was partially offset by significantly higher fracturing activity in the Nefteugansk region. Revenue per fracturing job declined by 27% due to the currency devaluation, but was partially offset by an increase in average job size and a modest pricing increase. Operating income in Russia was $1.5 million during the first quarter of 2015 compared to $0.8 million in the corresponding period of 2014 due to fewer weather-related interruptions and improved operational leverage. Modest pricing increases also contributed to higher operating income during the quarter. SG&A expenses declined by 18% in the first quarter of 2015 due to a reduction in the ruble-denominated costs. Calfrac's Latin America operations generated total revenue of $43.4 million during the first quarter versus $30 million in the comparable three month period in 2014. The increase resulted from the significant growth in fracturing and coiled tubing activity in Argentina, which included the startup of a second unconventional crew in December 2014. The company also experienced revenue growth in Catriel and Las Heras, which are more focused on conventional activity. Activity in Mexico was muted during the first quarter of 2015. Operating income in Latin America for the three months ended March 31, 2015 was $4.4 million compared to $5.9 million in the comparative quarter in 2014. Operating income in the first quarter was lower due to the timing of foreign exchange rate fluctuations, a few one-time costs and modestly lower pricing in Argentina. In addition, Calfrac is also temporarily using subcontractors for services such as flowback and well testing more regularly than in the first quarter of 2014, which of course negatively impacts our margins. In Argentina, the operation is growing quickly and is a key part of the company's growth strategy. With the stepchange growth we are experiencing, we are also exposed to one-time expansion costs and we had a number of these items in the quarter that did impact margins to a certain extent. The company recorded an income tax recovery of $13.1 million during the first quarter compared to an expense of $2.6 million in the comparable period of 2014. The reversal to recovery was the result of the pretax losses incurred during the quarter. The effective tax recovery rate was 50% during the first quarter of 2015 compared to 22% in the comparable period in 2014. This was primarily due to a higher percentage of taxable losses in the United States, which has a higher average tax rate and the effect of certain deductions that do not fluctuate with earnings. Turning to the balance sheet, the company's working capital at quarter-end was approximately $414million, which included $51 million in cash. Long-term debt at quarter-end was $807 million, the vast majority of which is not due until 2020. As at December 31, 2014, the company had utilized $37 million of its credit facility for letters of credit and it borrowed $58 million against the facility leaving $305 million in available credit and of course the $51 million of cash. The company remains well within the debt covenants prescribed by its lenders. These ratios are expected to deteriorate as the year progresses due to reductions in profitability. However, significant working capital release will provide additional liquidity in 2015. Finally, in relation to the status of the dividend, I would like to clarify that a dividend was declared in March as stated in the MD&A and was paid in April. The Board reviews our dividend policy on a quarterly basis. Our second quarter dividend is typically declared in mid-June and is paid in mid-July. The Board will continue to monitor market conditions between now and then in order to determine whether a change to Calfrac's dividend policy is advisable. I would now like to turn the call back to Fernando for an outlook on the company's operations.

[Fernando Aguilar:]

Thank you, Mick. Crude oil prices appear to have stabilized in recent months, but at a price range significantly lower than in 2014. The oilfield services industry's equipment, utilization and pricing will continue to be adversely affected for at least the remainder of the year due to a decline in oil prices. Recent industry reports indicated that North American oil and gas capital spending will be down by 35% to 40% in 2015 from 2014. Furthermore, customers are taking a cautious approach in setting capital budgets, which is expected to create lower activity in the second half of 2015. Natural gas prices have declined modestly in recent months due to a stronger-than-expected supply growth and a return to storage levels around the five year average. Natural gas liquids pricing, which had been a key factor in natural gas development in Canada and the United States, has also declined significantly. The anticipated impact of these developments is a reduction in activity in key natural gas plays in North America in 2015. Calfrac believes that there will not be a meaningful recovery in commodity prices during 2015 and that future oil and natural gas prices will remain at levels significantly lower than those experienced in recent years. The company is working to restructure its business so it can be profitable in a lower commodity price environment. Calfrac has implemented its first phase of cost rationalization initiatives, which was outlined in detail in the press release issued this morning. The company anticipates the outcome of these challenges will allow it to become more profitable at a utilization level well below what was experienced in 2014. However, Calfrac does not expect these initiatives to be fully realized until the second half of 2015. The company has identified additional areas that could see cost reductions if activity moves naturally lower than what is currently expected. Calfrac remains committed to having a best-in-class cost structure while not sacrificing operational excellence or performance. Calfrac has a strategy in place for the idling of equipment in the U.S. and Canada. Calfrac has directed its operational teams to not use the idle equipment for spare parts because it will be a core piece of Calfrac's growth strategy when market conditions improve. Furthermore, the ability to react quickly and effectively to a rebound in activity is of paramount importance and this strategy will leave the company’s best position from an equipment standpoint. In Canada, horizontal well completion activity is expected to be lower in 2015 than 2014. Visibility after spring breakup is limited due to low commodity prices. Calfrac is anticipating that reduced activity experienced in the spring breakup will extend into the third quarter of 2015 and for activity to be at lowest levels experienced since 2009. Activity in the fourth quarter will depend on whether there is a recovery in oil and natural gas prices. In response, Calfrac plans to idle approximately 40% of its fracturing equipment until market conditions improve. In the United States, the company anticipate that activity in the second quarter of 2015 will be significantly lower than in the first quarter of the year. Visibility for activity beyond the second quarter remains limited given the ongoing changes in capital spending plans by the company's customers and competitive pricing dynamics. Calfrac intends to focus on reducing the impact of these weakened market conditions by executing its long-range strategic plan of generating economies of scale in each of the plays where we operate, aligning itself with large, stable customers and providing industry-leading service quality as measured by nonproductive time and safety standards. Sporadic activity and weak pricing is expected to lead the company's idling up to one-third of construction equipment during the second quarter of 2015 leading to margins that are not anticipated to meet the company's required financial returns. The company believes these are prudent steps in ensuring a high level of quality and safety from its fleet. There is a great deal of negativity surrounding the U.S. market today given the expected oilfield activity for the remainder of the year, while Calfrac recognizes that this is going to be a challenging year, there is likely going to be some positives to take from this downturn. We anticipate that there will be a significant amount of pressure pumping equipment retired and that consolidation will occur amongst the pressure pumpers. It is too early to speculate on how much equipment will be retired, or how consolidation will play out, but it should create a better supply and demand dynamic in upcoming years. Calfrac continues to believe in the long-term potential of Argentina's conventional and unconventional oil and gas development. The increasing customer demand for the company's services is providing the opportunity to deploy additional equipment into the country such as the newly constructed equipment totaling 40,000 horsepower, which is scheduled to be deployed in the later part of 2015. Calfrac believes that its service quality and technical expertise are developing its reputation as a service provider of choice in Argentina thereby providing the foundation for long-term growth. Calfrac's technical expertise was evident when we recently completed Argentina's first 12 stage ball drop completion using approximately 30 tons of sand per stage. The company believes it is an important event because it is another example of its ability to take North American knowledge, service, quality and safety and apply it in an international jurisdiction. This will be one of the key factors in Calfrac's ability to succeed in a market like Argentina. Calfrac expects its activity in Russia in 2015 to be similar to 2014 outside of normal weather-related variability, but a significant evaluation of the Russian ruble will decrease the reported 2015 financial results versus 2014. Calfrac’s participation in unconventional development will be delayed until sanctions applied by Canada, the United States and certain other jurisdictions are removed. The long-term prospects in Russia remain encouraging as unconventional development has become a pillar of that country's oil and natural gas growth plans. Oil and natural gas price headwinds are likely to make the remainder of 2015 challenging for the entire industry, but Calfrac believes it has a well-defined strategy to manage the near term challenges and remains optimistic about its future opportunities. The company and its experienced management team have been through a number of industry downturns leaving Calfrac well-positioned to navigate the current downturn. As well, the company has taken advantage of market opportunities in previous industry downturns to strengthen its operations and competitive position, which has had a positive effect on operations when industry activity has recovered. Over the long term, Calfrac believes that the pressure pumping services industry will remain a pivotal component of unconventional resource development and that the company's top tier safety logistics management, service quality and technology will serve to generate cost efficiencies for its customers. I will now turn the call back to the operator for questions. Thank you all very much for listening.

[Operator:]

[Operator Instructions] Our first question comes from the line of Dan MacDonald from RBC Capital Markets. Your line is open.

[Dan MacDonald:]

Hi, good morning.

[Fernando Aguilar:]

Good morning, Dan.

[Mick McNulty:]

Good morning, Dan.

[Dan MacDonald:]

Just wondering if you could start with your thoughts on the refrac market. It's been highly topical here as of late and have you done much of that work, how far along you think that technology ultimately is right now and what that opportunity might look like for Calfrac?

[Fernando Aguilar:]

There has been a lot of talk in the industry recently about refracturing all wells because of course the asset is already in place and it's a matter of us trying to go back to these old wells and make them productive or more productive again. There is a limitation and I think people have to realize, when you say refracturing, you have to understand that the completion design and the completion tubulars and packers and everything that is basically installed downhole sometimes is not going to give you opportunity of going back and refrac those wells. So when you talk to tool companies and you try to discuss about these refracturing, there will be very, let's say – there will be opportunities for restructuring, but the industry really wants to become serious about refracturing, that means that the new well design has to include the capability for these wells to – and sleeves and parts to be operated at a later date. So I believe this is not something that has been happening today. But then the other situation that happens to these opportunities is that if the customers are basically generating all those fracturing opportunities, why not to be fracturing them in the first run and leave those potentials on for the future. So this is [indiscernible] that people have to be careful with, but in today's environment when people talk about refracturing, I think we'll have to back and analyze the completion, design and the tools that are downhole to make sure that these wells are candidates for refracturing in the future.

[Dan MacDonald:]

Great. And then just on the service intensity side, and I know you noted you did see a continued increase in a lot of your U.S. basins, but can you maybe give us a bit of color on have you seen the rate of change start to decelerate in the U.S. or in Canada? Just kind of the rate at which it is growing at?

[Fernando Aguilar:]

No, this is a very, very adequate question to current environment because sometimes when activity goes on – so let's talk about growing activity when you see rigs going from 2000 to 800 like we have today and people try to tighten the screws related to how the industries investment in new wells happens and how much completion they will do, and how much money they will spend in completion, people will think that customers are basically reducing the volumes and the number of stages they pump. Our customer base – I have to qualify what I am saying – with our customer base, we haven’t seen any reduction in number of stages or volumes that we are pumping as we speak. And I believe these customers that I am referring to have been let's say going to a sweet spot, concentrating the more prolific areas in their fields and trying to complete those wells. So we haven’t seen any variation in the intensity that we experienced in Q4 compared to Q1 2015.

[Ian Gillies:]

Dan, its Ian here. The other thing I would note is, from Q4 to Q1, we did have a change in our job mix which is why the tonnage per job declined quarter-over-quarter. But largely from what we saw in each of the basins, we saw a pretty solid increase in South Texas to Marcellus and the Rockies. In North Dakota, what we ended up seeing actually was we are placing more tons per well, but we are doing significantly more stages, so there was just some variability there. So the rate of change is slowing a bit, but it is still moving higher.

[Dan MacDonald:]

Okay, that's great. Thanks a lot for the color, guys. I will turn it back over.

[Fernando Aguilar:]

Thanks, Dan.

[Operator:]

Our next question comes from the line of Scott Treadwell from TD Securities. Your line is open.

[Scott Treadwell:]

Thanks. Good morning guys. I really only had one question. I just wanted to get maybe a sense of your strategy to the extent you are comfortable disclosing it. You have idled a bunch of the fleet. Obviously you've got a sense of how much demand is out there. As you look forward, would the idling be to match that demand so you are expecting to be very high utilization on this reduced asset base, or are you giving yourself some slack and sort of being at the lower end of let's say a band of acceptable utilization in the short term with the expectation that, as demand picks up through the end of 2015, you don't have to hire new people and get – and put a bunch more cost back into the system?

[Fernando Aguilar:]

So this is, Scott, good morning. This is something that we are basically challenged every day and we have discussions with our management team to understand where the line is. And I believe Mick had a very good statement in his script about how the company tries to understand how the costs are basically had been moving in time because of the ability the company has to deploy and implement the cost savings and our – cost initiative is basically to happen. So this is going to that in mind and help us refining how many crews will basically stop from operating. So this is the first part. But when you go to activity level and you see Canada today at around 80 rigs and the U.S. in the 800s. We are not immune from the drilling rig activity decline. And when you have so many competitors, especially in the U.S. that are in a very, very aggressive pricing offering unsolicited most of the times to customers, use of running equipment until they destroy it and not maintain the equipment operating the quality and the safety they are supposed to be deployed, we don’t run and this is what you are referring to strategy. This is not Calfrac's strategy. We are not going to destroy our equipment, we are not going to offer our customers a lower service quality, because we don’t maintain our equipment and of course this is a decision that has to be taken at a time that it doesn’t make any financial sense for us to run our business. So 30%, 40% of the fleet part across the U.S. and Canada is something that we believe is going to happen unless activity picks up and then we see a better visibility in terms of drilling activity with our customers.

[Mick McNulty:]

And Scott, the other thing I would add is, with respect to R&M, there was an increase in 2014 just given how quickly we were working and we are hoping from pad-to-pad and when you are doing that, it’s perhaps not the most effective way to run R&M and in this sort of scenario, we can just run a more effective schedule and get those costs down a little bit.

[Scott Treadwell:]

Okay. So if you looked at your demand, does that mean that you might be running a little extra equipment simply to make that R&M a cheaper dollar value rather than maybe doing it in the field?

[Fernando Aguilar:]

No, our strategy as you remember Scott, we normally keep 20% of our fleet rotating for maintenance and we are not intending to change our maintenance programs because we operate and we need the equipment to operate in this market and in the next market and in the upturn when it happens. So if the equipment is not ready and fully operational, we won't be able to serve our customers and that’s why the 20% number is something that has been – we have got to that level because of experience, because that’s what we need in order to rotate our equipment to go through our preventive maintenance programs and when you are talking about a 24-hour operation are basically everything that we do in the U.S. today. If you don’t do that, they’re going to – you will start having a lot of failures. And I think this is something that our people are paying a lot of attention because, in a decline – in a very, very let's say the best pricing environment that we have today, as soon as customers start having issues with suppliers that are not performing, that's an opportunity for Calfrac to jump in and conquer those markets and those customers, and start asking for better pricing. I don’t think it’s going to be a lot because those customers are basically enjoying the low pricing environment today, but pricing is always – has always an opportunity to increase if your competitors are not providing the service that is expected to be provided.

[Scott Treadwell:]

Okay. And sort of follow-up on that same sort of vein. Obviously, the headcount reduction has been pretty material, but I am assuming that you guys would be comfortable that you’ve high-graded the bench from an operations point of view and that if the demand came back, you've got the bench strength to put equipment back to work without having to hire chokepoint guys in the field. You've got your supervisors and your key technical guys and it's more just a matter of adding – the guys turning wrenches and driving trucks, which is obviously difficult, but maybe not as challenging as the technical guys?

[Fernando Aguilar:]

I would agree with you. This is the way that we are trying to do it. We try to preserve our core personnel and people from operations, from technical services, from finance, from human resources are working very hard to understand and help us basically managing a business in a very complicated situation like the one we are facing, because when you hear bigger competitors like Schlumberger releasing 20,000 people and then Welford 11,000 and you have so many people releasing employees. And in a market in the U.S. is a little bit better than what people were expecting. Some of these employees will not come back to the industry and in all the downturns that we have been experiencing, there is always a group of people who don’t like being fired to a release from the industry and they don’t try to the industry anymore, so they don’t come back. So our ability to try to engage the employee that we have and make sure that through the way that we’ve been hiring these people and training them, have them standing by us as much as we can in order for them to come back and help us in as soon as activity picks up, is paramount importance for Calfrac. So we are very, very careful the way we do these things and we are in a constant communication with our troops, with our fleet, with our operators, with our supervisors to make sure that they understand what is happening in the industry and what is happening to our company.

[Scott Treadwell:]

Okay. great. As always, guys, appreciate the color. Thanks.

[Fernando Aguilar:]

Thank you very much.

[Operator:]

Our next question comes from the line of Byron Pope from Tudor, Pickering. Your line is open.

[Byron Pope:]

Good morning guys.

[Fernando Aguilar:]

Good morning, Byron.

[Mick McNulty:]

Good morning, Byron.

[Byron Pope:]

Fernando, I won't ask you to provide any quantitative stats, but could you help us think about some of the criteria and metrics that you guys will use internally when you make the decision whether to redeploy, whether and when, to redeploy some of the temporarily idle frac crews just to help us understand how you think about it?

[Fernando Aguilar:]

So you are talking about when – idle equipment when we go back.

[Byron Pope:]

So once the equipment has been temporarily idled, what are some of the criteria and metrics that you will use internally to make a decision as to when to redeploy frac crews into the field?

[Fernando Aguilar:]

So it is a relationship between customers activity. The opportunity we have in front of us for a business that is going to give us an amount of profit – revenue that we generate profit and then we can go back to operate. But I have to tell you and this is a very interesting question, Byron, because when we bring equipment and the park equipment, the equipment is parked is basically in a zone that like Mick mentioned earlier, we don’t remove pieces from that equipment. That equipment is basically run in a frequent basis to make sure the equipment is ready to go back to work. If we believe that the price of oil and the activity is going to start improving, let’s say, at the beginning of 2016, this equipment is almost ready to go back because the equipment is warm, if we can call. And then it will depend on our ability to understand the pricing and also type of margin that we can generate for that equipment to go back. So if today you think that the threshold was basically to be in a 15% range for field [ph] margin to operate, it is going to be interesting to see what happens because it is very simple to do it Byron. You presented and you know what the market is, and if the market is not where we want to be, we are not going to be basically to go back and bring it back to line, right.

[Byron Pope:]

Okay. And then just one additional question with regard to your U.S. operations. I think I heard you say that expect for maybe the magnitude of the top line decline in the second quarter to be more pronounced than it was in Q1, which held up nicely. And so I'm assuming that it will take some time to realize the cost savings. And so just realize you guys don't provide guidance, but it just seems as though the straight math would suggest that, in Q2 for your U.S. operations, that operating margins would almost have to be negative. But does it feel like once we get into Q3, the cost reductions take hold and such that maybe Q2 is your low point in terms of operating margins in the U.S.? Or is it still just too early to say?

[Mick McNulty:]

Byron, its Mick here. I think your analysis is probably pretty solid. We certainly don’t see Q2 being a very exciting quarter. It’s hard to see the visibility for Q3 and Q4 in them. But I think directionally we would see it happening the way you are suggesting.

[Byron Pope:]

Okay. Thanks, guys. Appreciate it.

[Fernando Aguilar:]

Thank you.

[Operator:]

Our next question comes from the line of Brian Purdy from PI Financial. Your line is open.

[Brian Purdy:]

Good morning guys.

[Fernando Aguilar:]

Good morning, Brian.

[Mick McNulty:]

Hi, Brian.

[Brian Purdy:]

I wanted to ask about the cost side of things. You have highlighted here some of your wage reductions. I am just wondering if – you have obviously put that plan in place, but is there a next step that is coming in terms of further wage reductions for the field staff, further cost reductions that you can get out of your suppliers?

[Mick McNulty:]

We approach this in phases and what we talked about earlier is Phase I. Obviously if things continue to be serious for us, then we have to go into potentially Phase II and a Phase III. Whether that sort of involves rolling back wages or not, I am not prepared to talk about on the call. But obviously we are doing a planning with a long-term view and depending on how long this last, then we will implement different phases of our planning.

[Fernando Aguilar:]

And of course when you take the situation that Mick was referring to, you take all the lines and you go from human resources to equipment, you go to training and the different areas, but it is important to observe here, Brian that there are programs that have to continue running because the company has to continue training and preparing the employees, it has to continue and maintaining the equipment, and of course there are discussions. And you know well from our previous discussions that, Calfrac has worked very well close with its suppliers to make sure that they help us going through these downturn, and that is a partnership between the two sides. And sometimes it is very difficult for both parties to engage in those type of discussions, but at the end of the day is with our customers and our employees that we managed to get a success story that we can basically bring and make the company more effective and more productive.

[Brian Purdy:]

Okay. Thank you for that. Just to press you a little further, is there some, I guess, threshold or benchmark that you would look at that might push you into that Phase II. Is it going to be another 10% price decline and are you seeing any further price declines as we head into Q2 here?

[Mick McNulty:]

I think it’s a combination of activity and price. I think pricing is probably is bottling out because I don’t think there is much further for people to go and so I think it’s more an activity related to threshold, Brian.

[Brian Purdy:]

Okay. And then I am assuming that you can mitigate some of that by idling more equipment if you needed to?

[Mick McNulty:]

Yes indeed, that is an option.

[Brian Purdy:]

Okay. Great. That's all I had. Thanks very much.

[Fernando Aguilar:]

Thank you, Brian.

[Operator:]

Our next question comes from the line of Dana Benner from AltaCorp Capital. Your line is open.

[Dana Benner:]

Good morning guys.

[Fernando Aguilar:]

Good morning, Dana.

[Dana Benner:]

I wanted to start with G&A. It came in I would almost say dramatically lower than I would've thought in Q1. I understand that you’ve been very aggressively trying to manage your costs, but typically when one sees that with companies you see severance charges and things like that that will blow that number out temporarily and then you see it arc down after that. So maybe you can help me understand why you were so successful. I know that you can't quite use that word when you're talking about cost because that's people, but how were you able to bring that down so quickly?

[Fernando Aguilar:]

So before Mick goes and answer the question with more technical information for you, Dana, I have to tell you that we run a very, very efficient organization, as you know. And we are very careful in every single step that we take that is related to cost and reductions and measures that we take in the company. So we evaluate all these different areas very carefully, but I have to tell you that when we consider the measures and actions that we take, a great level of detail and discussion happens with our management team.

[Mick McNulty:]

Yeah, I think the other point, Dana, is that this isn’t a very fat organization. But we do – we have structured the compensation levels very much with the variable compensation. And so in this type of situation, it works where you can eliminate the variable compensation fairly quickly. I wouldn’t say painlessly, but you can eliminate it so fairly easily and so that was put into effect immediately. In terms of severance costs, we did take a charge in Q4 last year to deal with what we anticipated would be the planned severance costs that we were expecting. So I think that we haven’t muddied the waters in Q1 if you like with new severance costs.

[Dana Benner:]

Okay, that's helpful. Secondly, with respect to the picture of idling of equipment in the U.S., you talk about up to a third. Can you give us a regional description of where we might expect that?

[Fernando Aguilar:]

I think it’s a little bit everywhere, Dana. When you see customers like Apache, for instance, that went from 19 rigs all over the country to around 15 or 16 today. And you see where they have basically parked the rigs, it’s everywhere right and the same thing happens in different areas. We might consider parking – like we mentioned earlier, 30%, or one third of our fleet and is going to come from all over because the activity is being reduced all over the country. So it is not an area or a region that is basically telling us you have to go aggressive and just to give an example, in the Bakken, it happens a little bit everywhere. So I wouldn't say that this is, there are regions that are not immune, as always. It is a nationwide problem right.

[Dana Benner:]

Great. I guess third question relates to the compensation, or I guess the cost model generally in fracking. Maybe because fracking wasn't the force it was back in the 1980s and 1990s, maybe the models evolved differently in drilling, but does a period like this argue for a rethink by the fracking industry on the compensation model in the business to allow better variable costing and what is the probability that you or the industry as a whole gets to a different place to allow you to better manage through these types of markets if the Saudis, for example, are not as willing to manage the price on a go-forward basis, it may argue that a different compensation model is required within fracking.

[Fernando Aguilar:]

Yeah, most probably, but I don’t think it is only related to compensation. It’s related to everything that we do. When people talk about what is the new commodity price, what is the new reality and then you try to think that the price of oil is not going to go to 120, kind of remain between 60 and 70, what activity levels companies can expect, you have to reformulate and think how you want to run your business. So if you remember few years ago when the industry went crazy in 2011 that there were fracturing initiatives like turbines, for instance, or gas track as you may recall at the time, and the operators and the customers used to pay for those technologies because there were not enough fracturing fleets and results available. But then after the big boom and everything that happened in last few years, the growth from many competitors, the industry basically over supplies sales and basically became to the level where we are today, and no more affected by the lack of activity. If what we are observing happens between the number of companies that are basically struggling because you can, the pricing that we have to date is not real. People cannot continue operating for the next, I don't know six months, nine months losing 20%, 30% because that’s not viable. You have to pay your people. You have to pay your technology development, your maintenance, your electricity bills and everything. So I don’t think it’s only related to compensation, it’s related to everything but these opportunities basically forces a service industry to become more efficient and more productive. And I believe that a compensation, it is not only related to how much we pay an individual but is basically challenging the number of people that we use on location, challenging the way that we rig up and prepare for the jobs. And if you take every single line that we have in front of us, you have projects that you can run. And it is not only about cost cutting, it’s about cost improvement and cost efficiencies and that’s what we try to run in a company. Calfrac runs in parallel with the two projects to make sure that we can come stronger from a downturn like this, but at the same time we are protecting our balance sheet and our financial situation. So you name it. Supplies, logistics, repairs and maintenance, compensation, everything. So you take all of that and you have to get improvements from all those lines so we can make this company a better company for the future and for our customers.

[Dana Benner:]

Great. And you've led me to my fourth and final question, which is, lower crew sizes. What is the likelihood that two years from now you could be running, or three years from now, pick your number, that you could be running materially lower crew sizes because of the rethink of the model in any way?

[Fernando Aguilar:]

I have to get there. We have to get there as an industry and I believe in a country like Canada this will help a lot because even though we are basically now experiencing a surplus of equipment and people because the industry is not active, when activity picks up again especially in Canada where we are short of people to operate for the oil sands, for the LNG projects, for everything. We are forced to reduce the crew sizes. So I can guarantee that as an industry and as a company, we will get there where you are basically telling us to go. This is where we have to be.

[Dana Benner:]

That's great. I will turn it back. Thank you.

[Fernando Aguilar:]

Thank you, Dana.

[Operator:]

[Operator Instructions] Our next question comes from the line of John Daniel from Simmons & Company. Your line is open.

[John Daniel:]

Thanks. Fernando, I don't know if you guys track this data, but I'll ask it anyway. Do you have any idea what your work today – what percent of your work today is zipper fracs and then just any guess where you think that number might be heading over the next year or so?

[Fernando Aguilar:]

John, we normally the line is not very good from your question, but you are referring to zipper frac, right?

[John Daniel:]

Yes, sir.

[Fernando Aguilar:]

We are tracking. Normally with the customers that we've been working, I can say that it’s between 10% and 15%, and is mostly in the U.S. and lately we haven’t had a lot of zipper fracs.

[John Daniel:]

In a normalized commodity price environment, let's say, do you get a sense that more of your customers are going to shift to that? Where could that percent go? Just trying to get a gauge for efficiency for the industry.

[Fernando Aguilar:]

I think it is complicated for the customers to go there because of the level of supervision and control that they have to have. So I would say that between 10% and 20% in a normalized market.

[John Daniel:]

Okay. Next is a housekeeping one from me. Ian, can you update us on how much horsepower has yet to be delivered and if that 40,000 that's going down to Argentina, is that new equipment or is that being moved from either Canada or the U.S.?

[Ian Gillies:]

Yes. Sure, John. So the 40,000 horsepower in going to Argentina, some of it has been delivered to date but it’s very, very small amount and you still don’t expect that to go to work too later in the year anyway. So we need [indiscernible] get there. And then the 100,000 horsepower coming in North America, once again, we don’t think that if there is demand, its likely will be operational till later this year.

[John Daniel:]

Okay.

[Fernando Aguilar:]

So John, just to complement that, you have to remember that one of the key points about equipment for Argentina is local manufacturing. So we are getting the major components, as we normally do from North America and they are assembled in the country as part of the regulations that are basically happening in Argentina for local equipment, promoting the local business and that’s the 40,000 that Ian was referring to. The 100,000 that we were discussing about North America, as you recall, we were talking about one crew for Canada and two for the U.S. And of course depending on how activity shifts from one place to the other, we will be deploying equipment. We expect that equipment to arrive between the end of the year and early next year, but it’s only three crews. So it’s not a big deal of equipment that is arriving and is going to position Calfrac based on once we have a chance or an opportunity to go back to the backlog that is available out there.

[John Daniel:]

Okay. Alright. And then just one final one from me and this might be a silly question, and if you clarified it earlier, I apologize. But I just want to understand the rotational versus idle horsepower commentary and I'll use the U.S. as the example, but if you've got 700,000 horsepower today and potentially one-third goes idle, let's call that 230,000 horsepower, if 20% is typically allocated as rotational capacity, does that mean that there is an additional 140,000 that is rotational, or is that coming out of the – as the one-third comment – does that include the rotational capacity?

[Fernando Aguilar:]

It is included in the 700,000 horsepower that we have allocated to the U.S. today.

[John Daniel:]

Okay.

[Ian Gillies:]

I think your question now is, is the third including the rotational. The answer to that is no. When we say we are idling it, that means it’s coming out of service and will be parked against the fence.

[John Daniel:]

Okay. So again, 230,000, which is a third of the 700,000 gets idled and – based off that comment – and then there's another 140,000 out there that is on any given day in maintenance and down on any given day, is that correct?

[Fernando Aguilar:]

No, I think your math is wrong there because it will be 20%..

[John Daniel:]

20% of the working. The delta between 700, 000 and 230,000. Okay, just clarifying. Thanks, guys.

[Fernando Aguilar:]

Okay.

[Operator:]

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

[Jon Morrison:]

Good morning, all.

[Fernando Aguilar:]

Good morning, Jon.

[Jon Morrison:]

I was surprised by the resilience of the U.S. operations, just the revenue they've put up in the quarter relative to Q4. Was that a function of your customer mix just being more active in the quarter or did you pick up marketshare or any individual customers in the quarter?

[Fernando Aguilar:]

You know, Jon, this is a question that people ask and this is very interesting and I basically enjoy that question because some people or some competitors and especially bigger ones are after marketshare. And when you in a market like the U.S. where Calfrac was basically at 4% market share or 5% market share is small and that’s where we believe the U.S. is a great opportunity for Calfrac to execute the way that we execute today. So the customers that we had basically kept busy during Q1 and that’s what [indiscernible] with a higher interest. Despite pricing was affected by pressure from our competitors as you are on a younger sign competitors come and offer lower prices, we have to give up and give concession right. But what happens is that as activity drops and number of rigs appear to the number of available frac jobs or frac buts where in front of us I can’t say that we had an increasing market share because our total market basically gave us the higher market, but it is not because we were looking for it. We were looking to serve our customers and continue running a very efficient operating with equipment that equal we have a cyclic industry.

[Jon Morrison:]

So, let’s fair to say that you didn’t go out purposely and try to pick up market share in the quarter.

[Fernando Aguilar:]

That is correct.

[Jon Morrison:]

Just in your comments about idling the third of the capacity, if you had roughly speaking 15 crews in the U.S., you ultimately part five of them, it kind of leaves two crews per major active basin that you are in. If you get below that level of two crews, can you run one crew in any individual play and make an economic return or is there a critical scale and size where you need two crews per play to really make a return --?

[Fernando Aguilar:]

That is a question that goes very close to the border line and this is – if we believe that this basically going to happen, because instead of the 800 rigs that we have today, we go to 500 in the U.S. then a lot of things are going to happen everywhere in the industry and the result will be maybe shutting down some of the districts that we have today, because there won’t be any business for – to justify the presence in a basin.

[Jon Morrison:]

Okay. Is it fair to say that the idling of one-third of capacity largely reconciles with the work in front of you right now?

[Fernando Aguilar:]

Most probably yes. I think can think…

[Mick McNulty:]

Yes. That’s what we’ve – that’s how we’ve assessed what we’ve got in front of us and where the pricing is right now, Jon and that could be work at to the lower prices, but we've just decided now we don’t want to take it.

[Jon Morrison:]

Okay. Mick, just a clarification on your comments in the preamble with the lag in the third-party costs and other supply and input costs coming down. You are not expecting any of those to really have an incremental impact until the back half and we shouldn't be factoring anything in for Q2, so to speak?

[Mick McNulty:]

There will be some in the U.S. obviously Canada is affected negatively by break-up, but we should see some impact in Q2 in the U.S. but I would agree with you that the major impact is going to be in the second half.

[Jon Morrison:]

Can you just give an update on the incremental crew that you put into Argentina and whether it has been operating on a steady-state basis? Even more broadly speaking, are you concerned that a slowdown is coming in that market and you just haven't seen it yet, or YPF seems pretty committed to their unconventional plans in country?

[Fernando Aguilar:]

I think we are committed – sorry YPF is committed to activity. They went to industry and asked the industry to help so just to make sure that the activity was going to remain. But remember, Jon, elections are going to hop-in in October this year and whatever happens in the country, the party that wins understands very well that the industry needs to be supported and this is what the parties are basically saying publicly today. So we believe that the activity in Argentina because of a national priority is going to push the industry to continue with the level they have today and if the party winning the election is basically in favor of the industry, you will see people that are going to be investing because we have a lot of companies, especially majors, that are sitting and watching what is happening for them to move quickly. So today you have people like Total and Exxon and others moving there, because the major customer today is YPF, but after the elections we believe that most support will come from companies like Petrobras, more support will come from companies like Exxon and others that are basically watching what happens there. And don't forget that they are all local operators like Pluspetrol and also people like Pan American that are very, very interested in Calfrac working for them and those are discussion that we are having as we speak.

[Jon Morrison:]

Of those one-time expansion costs that you said in Argentina was adding additional crew this quarter, was that just trying to build up and getting more steady-state work under that crew that you had fully employed, or were there other one-time expenditures that kind of dragged down profitability?

[Fernando Aguilar:]

I think – I mean I have to be careful how I say these because remember we continue building equipment for Argentina. It takes longer to manufacture equipment in the country. But I have to tell you something that, we are now very good at promoting the success stories. In the last quarter, the quarter we are reporting here, Calfrac basically broke a record of number of frac stages per day executing one day and that was for a Canadian company called Marilena. Marilena press released that and Calfrac was the service company fracturing. So that was very good for us to be part of that project. So we are still confident that Argentina is a very good place for us to continue our growth and expansion.

[Jon Morrison:]

Last one just for me. Mick, in your opening remarks, you talked about a muted Q1 in Mexico. Did you guys actually have active fracturing operations in the quarter?

[Mick McNulty:]

We had limited activity in the first quarter.

[Jon Morrison:]

Okay. Appreciate the color, guys.

[Mick McNulty:]

Thank you.

[Operator:]

And our last question comes from the line of Jeff Fetterly from Peters & Company. Your line is open.

[Jeff Fetterly:]

Good morning guys. A few random questions. On the cost side, you have highlighted the $25 million of SG&A annualized reductions. When you incorporate all of the other reductions in headcount, how much do you think you've brought your overall cost structure down?

[Mick McNulty:]

That is a random question. It's tough to answer, Jeff because obviously there is cost that come down in relation with activity as well. What we’ve tried to highlight there is those specific cut that we’ve implemented related purely to relate to people activities. So it’s tough to say exactly on an annualized basis because the whole activity related, but clearly significantly more than the $25 million.

[Jeff Fetterly:]

I guess put another way, do you think with all the changes to the cost structure and the reductions that you could handle activity that is 50% lower than where you were at the – in the second half of 2014, or do you have a sense of where that metric would lie?

[Mick McNulty:]

In terms of pricing being down 50%?

[Jeff Fetterly:]

No, I am talking about more from a volume standpoint combined with pricing.

[Mick McNulty:]

Yeah. I think at 50% levels, we can handle work, but it does depend upon the customer and their efficiency, and where the work is. So it’s difficult to answer that on a general basis because it is really very much customer specific and basin specific.

[Jeff Fetterly:]

Okay. The 100,000 horsepower of new capacity that is earmarked for North America, is it realistic to assume that will go to work once deployed, or is it most likely to go into the idle category?

[Fernando Aguilar:]

Well, it depends on when it happens, Jeff, because the equipment is going to be arriving and no complete fleets are frac crews from let’s say last quarter of this year to first quarter of next year. If the activity is picking up again, the equipment that we have currently in the company and whatever we product and these idle will go first to work. So as we deploy all the crews and we use all the equipment that we have today, we will start moving into the new equipment that goes to operations. This is what we will do. So it will depend how activity picks up and how we think 2016 is going to be.

[Jeff Fetterly:]

Okay. But at this point, do you have locations, potential customers earmarked for that new capacity or is still too early or too preliminary?

[Fernando Aguilar:]

Jeff, remember, everybody and I think all the people are basically have always parked equipment before we will, so of course, we don’t have an idea and the visibilities are limited today to understand where these frackers will be. We think we know where the equipment will go based on the let’s say activity level that we’ve experienced with some customers in some areas, but of course that will all depend how the drilling activity picks up or frac log activity picks up in those areas.

[Jeff Fetterly:]

Okay. You referenced 15% in terms of average decrease in pricing in the U.S. relative to Q4. Where would that fit today both relative to Q4 and relative to that Q1 average?

[Mick McNulty:]

So I think to the question, Jeff, because 15% is pretty much the average for the quarter and I think exiting the quarter we do have experience of pricing being down between 20% and 30%, particularly in the U.S. So significantly down, I mean we estimate we were down 12% versus Q1 and 15% versus Q4. It would be similar differential, so probably 25% down exiting the quarter versus Q4.

[Jeff Fetterly:]

Okay. And your comment earlier, Mick, in terms of thinking there's a bottoming and pricing here, do you expect that you are going to see much deterioration, or any further deterioration, or is this the threshold that the industry --?

[Mick McNulty:]

I have been wrong before because I thought we had bottomed we couldn’t possibly go as low as we have done, but no, I honestly think that we are at a point now where we are not going to work for negative cash and I think guys that do work for negative cash don’t do that for very long. And so I think that if you we are not there today, I think by the end of the second quarter we got to be there.

[Fernando Aguilar:]

I share what Mick is saying, Jeff. But the problem is as I mentioned earlier, how long can companies be basically working negative margins in a very asset intensive business. And when your pumping materials that cost money, chemicals, sand, all the transport, storage, facilities, people, these are big jobs. And I view in a big job we have to basically give up or give away a lot of money just to operate, you are not going to stay in business for too long.

[Jeff Fetterly:]

Okay. Okay. So for the U.S. business in the second half of the year, notwithstanding your commentary about weakness in Q2, and I am assuming what should be a negative margin as well, if pricing is down 25% from Q4 from the peak and you are idling a third of your fleet, do you think it is realistic that you could see margins improve from Q1 levels in the second half of the year? Has your cost reductions been significant enough to support that, or is it more realistic to think the second half of the year could be something along the lines of what Q1 margins look like?

[Fernando Aguilar:]

This is a very difficult question because the cost efficiencies are basically moving and I believe that we mentioned that we will see that the full deployment of these cost initiative is taking place in the full six months of the second part of the year, right. So margins could improve if the pricing remains where it is, but we have to sit down and calculate how these things are working based on the pricing level that we think is good for us to go out and work, because as we were saying before and Mick mentioned that earlier, we are now going to work if cash is not there. So I think these type of thing the cost efficiency measures that we took are going to help us in picking up that pricing. Maybe you are right, maybe that will happen but we will have to monitor and be close to that, right. Mick?

[Mick McNulty:]

Yeah. Again, I think it becomes very much customer specific. If you are able to work for efficient customers that have significant volumes of work to work consistently, then you might be at efficiency into the marketplace. Without that, it’s tough to say.

[Jeff Fetterly:]

Okay. Last question. With a significant portion of your North American fleet idle and a sizable capital program this year, is consolidation something that is even on your radar screen in terms of the U.S.? Your comments earlier in the call, Fernando, about obviously the industry needing that over the course of this year.

[Fernando Aguilar:]

I think it’s happening as we speak. When you see what is happening with 1.4 million, 1.6 million horsepower from Baker basically going to hybrids and then the neighbors equipped them more into CNJ and then before like – and there is a lease but I don’t really want to go through a lease of company that we monitor and track, but consolidation will happen and you have to remember that there are not many companies in the U.S. that are basically consolidated nationwide. They are very good at drilling other areas, so most probably the trend will be to have companies are going to play a role in the country rather than in the regions where they operate today. But that could be a challenge, because you remember when you consolidate and you bring companies together, there are different challenges from the culture, cultural fees, technology, equipment but we have to force the industry to go into consolidation, Jeff, because we cannot deal with 18 million horsepower in down market that is basically not going to be using as we speak today maybe within 10 and 12, right. So that’s what we have to make sure that the industry recognizes the importance of companies getting together and become more efficient, and deliver more productivity to our customer base.

[Jeff Fetterly:]

How does Calfrac figure into that?

[Fernando Aguilar:]

It depends on the opportunities, it depends on the companies that matches our strategy for the long term and that’s exactly what we – we normally have that discussion at management level and we also share with the Board. So we are open, we are open to these things. But as I was saying before, the match has to be according to our strategy.

[Jeff Fetterly:]

Okay, great. Thanks, guys. Appreciate it.

[Fernando Aguilar:]

Thank you.

[Fernando Aguilar:]

So I think that was the last question we had today. We exceeded our allocated time. I want to thank everybody for your participation in today’s Calfrac’s conference call.

[Operator:]

And this concludes today’s conference. You may now disconnect.