Calfrac Well Services' (CFWFF) CEO Fernando Aguilar on Q2 2014 Results - Earnings Call Transcript

| About: Calfrac Well (CFWFF)

Calfrac Well Services Ltd. (OTCPK:CFWFF) Q2 2014 Earnings Conference Call July 29, 2014 12:00 PM ET

Executives

Fernando Aguilar - Chief Executive Officer

Mick McNulty - Chief Financial Officer

Ian Gillies - Manager, Investor Relations

Mark Paslawski - Vice President, General Counsel

Analysts

Dana Benner - AltaCorp

John Daniel - Simmons & Company

Klayton Kovac - Tudor, Pickering, Holt

Scott Treadwell - TD Securities

Dan Macdonald - RBC Capital Markets

Jon Morrison - CIBC World Markets

Kevin Lo - FirstEnergy

Operator

Good morning. My name is Michelle and I will be your conference operator today. At this time, I would like to welcome everyone to the Calfrac Well Services Limited Second Quarter Results. 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)

I would now like to turn the call over to Mr. Fernando Aguilar, Chief Executive Officer. Please go ahead.

Fernando Aguilar - Chief Executive Officer

Thank you, Michelle. Good morning and welcome to our discussion of Calfrac Well Services second 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 2014, after which Mick, Ian Gillies, Mark Paslawski and I will be available to answer your questions that you may have.

I would also like to take a moment to congratulate all of our employees across all of our operating areas for helping Calfrac celebrate its 15th anniversary. The company has shown tremendous growth in a number of ways since it completed its first job in managing hard 15 years ago. It wouldn’t be possible without all of you working extremely hard in and day out, so thank you and congratulations for helping Calfrac what it is today.

I will now turn the call over to Mick.

Mick McNulty - Chief Financial Officer

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 are not 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.

Moving on during the second quarter of 2014, Calfrac achieved the following financial results in comparison to the second quarter of 2013. Consolidated revenue was $503 million, an increase of 74% from the second quarter of 2013. The increase was driven primarily by higher activity in the United States and Canada. The higher activity in the U.S. was a function of improved customer demand, the company’s entry into the Eagle Ford, a high percentage of 24-hour operations and increased service intensity per well. In Canada, the higher activity was due to increased service intensity per well and higher activity in the Duvernay.

Operating income, which is income generated after operating expenses and selling, G&A expenses, was $44.8 million for the second quarter of 2014, a 175% increase from the same period in the prior year. The increase in operating income was a result of significantly higher activity in the U.S. and Argentina. However, weaker year-over-year pricing in Canada and the U.S limited further growth. Calfrac incurred a net loss of $12.9 million or $0.14 per share diluted, which included a foreign exchange loss of $4.9 million compared to a net loss of $14.6 million or a loss of $0.16 per share diluted in the same period of 2013.

Depreciation expense was $34.4 million higher by 33% from the second quarter of 2013 due primarily to the purchase of Mission Well Services assets in the fourth quarter of 2013 and capital asset additions in North and South America. Calfrac’s interest expense increased by $5.2 million to $14.5 million due mainly to the issuance of an additional $150 million of senior unsecured notes to finance the acquisition of the machine assets, the depreciation of the Canadian dollar combined with higher debt levels in Canada and Argentina. In Canada revenue increased to $96.2 million in the second quarter ‘14 from $80.7 million for the same period of 2013. The increase in the revenue was a result of revenue per job increasing 28%, primarily due to higher service intensity and increased activity in the Duvernay liquids rich national gas play. This was somewhat offset by lower pricing compared to the same period last year.

An operating loss of $9.3 million was incurred in Canada during the second quarter compared to income of $2 million in the same period 2013. The reversal to an operating loss was primarily due to lower pricing and a reduction in multi-well pad work combined with increased subcontracted transportation costs and equipment repair expenses resulting from the very active first quarter. Subcontractor transportation costs were higher than expected due to larger product volumes and longer average travel distances to well sites in the unconventional oil and gas resource plays of Western Canada.

Furthermore, unlike in prior years our Canadian operations did not have clients completing significant amount of well pad works during this quarter. This type of work is extremely beneficial during the quarter because it is efficient and allows higher utilization rates. The result of not having this pad work was that the company was operating in a greater dispersion of locations which negatively impacted operating efficiencies and hence our margins. Further, impacted margins was the company’s plan to retain, hire and train more people than usual in the second quarter. This strategy though has positioned us to execute on new opportunities in the upcoming quarters.

For the United States total revenue was $316 million, 116% increase from the same quarter last year. The growth was primarily due to significantly higher activity across all the company’s operating regions and a greater level of 24 hour operations combined with the addition of Calfrac’s operating presence in the Eagle Ford which occurred during the fourth quarter 2013.

Operating income in the United States was $58.7 million for the second quarter of 2014, 133% increase from the comparative period in 2013. This increase was mainly due to the higher activity in the quarter. Operating income as a percentage of revenue increased to 19% from 17% year-over-year due to improved operating utilization. The gain in operating income was limited due to weaker pricing though combined with significantly higher subcontractor costs and equipment repair costs primarily resulting from the general increase in sand consumption assumption.

Revenue from Calfrac’s Russian operations during the second quarter increased by 37% to $51.2 million from $37.3 million in the corresponding quarter of 2013, the increase was mainly due to the completion of larger fracturing jobs particularly in (Lugansk) region. Additionally the company expanded its operations into Usinsk at the beginning of the year and also enjoyed improved coil tubing activity throughout the quarter. Operating income in Russia was $7.2 million compared to $3.4 million for the same – compared to the same periods of 2013. The increase was due to higher revenue base combined with a larger contribution from multistage fracturing jobs and lower SG&A expenses. Operating income as a percentage of revenue increased to 14% form 9% in the same period of the prior year due to high utilization and a reduction in the equipment repair costs.

Latin America which consists of Mexico, Argentina and Colombia generated revenue of $39.6 million in the second quarter of 2014 compared to $24.4 million for the same period last year. The increase was due mainly to the significant increase in fracturing, cementing and coil tubing activity mainly in Argentina. This was offset by significantly lower activity in Mexico resulting from budget constraints experienced by the company’s major customer in the region. Latin America generated operating income of $3.8 million versus a loss of $1 million in the comparative quarter last year. The improvement can be wholly attributed to the commencement of fracturing operations in Argentina during May 2013, offsetting the improvement were operating losses incurred in Calfrac’s Mexico and Colombian operations.

I would also like to point out the contracts Calfrac’s Latin America margins were negatively impacted by severe flooding at the start of the quarter in Argentina and by certain startup costs related to the second unconventional spread that has just arrived in that country. We also increased the support staff in our Argentina operations as we prepare to scale up for the new crew.

The company recorded income tax expense of $4 million during the second quarter compared to recovery of $4.1 million last year. The increase in total income tax expense was primarily due to increased profitability in the U.S. and Argentina combined with $2.3 million of income tax adjustments related to prior periods for Canada and Mexico. The effective tax rate this quarter looks a little weird because of the effect of this true up and the mix of earnings. We had losses in lower tax jurisdictions offset by strong earnings in higher tax rate jurisdictions.

Calfrac recently expanded its 2014 capital program to $360 million from $150 million. The additional $210 million will include $172 million of growth capital, two fleets in the U.S., one in Canada, and one in Argentina. Of note, Calfrac expects a $120 million of additional capital to be spent in 2015.

Turning to the balance sheet, the company’s working capital was approximately $334.3 million, which included $12.8 million in cash and long-term debt of $651.8 million. The vast majority of which is not due until 2020. As of June 30, 2014, the company had utilized $31.5 million of its credit facility for letters of credit and had borrowed $21.9 million leaving $246.6 million in available credit. The company continues to view the balance sheet positively given the trajectory of activity in the operating areas where Calfrac works.

Well count is one aspect of demand for the company’s services, but stages to well and service intensity for well also materially increased demand for pressure pumping. Furthermore, the adoption of multi-stage fracturing is increasing in the company’s international operating areas. Calfrac is focused on maintaining a strong balance sheet, which revised the financial flexibility to pursue further growth opportunities and maximize shareholder value.

I would now like to turn the call back to Fernando for an overview of the company’s operations.

Fernando Aguilar - Chief Executive Officer

Thank you, Mick. I will now discuss our prospects for the future in each of our business segments. I will begin with our operations in Canada. In Western Canada, horizontal completion activity is expected to be strong through the remainder of 2014 and into 2015. The company expects activity levels to be better in the second half of 2014 when compared to the second half of 2013. This is due to the stronger commodity prices, which have resulted in certain customers increasing 2014 capital progress.

Other developments that Calfrac believes will lead to an increased pace of completions activity include a weaker Canadian dollar, improved access to capital and LNG related development. To follow up on our first quarter conference call comments on Canadian pricing, we have increased our price book in Canada and have tightened our discounts. Pricing improvements will become effective throughout the second half of 2014 as we have discussions with our customers. It is important to note that not all of the pricing increases will flow through the operating margins due to increased use to subcontractors resulting from higher product usage from our customers.

Calfrac continues to have leadership position in the most important natural gas plays in Western Canada and expects to be a key participant in the long-term development of these areas. The company’s customers in the Montney, Deep Basin and Duvernay are expected to increase their activity in the second half of 2014. In particular, the company is committed to increasing the percentage of its fleet that is focused on 24-hour operations, which should be a catalyst for improved financial performance in the future. The increase in 24-hour operations not only increases our revenue per day, but also improves operating efficiencies. As a result, we are able to help bring our own production more quickly for our customers, which translate to improved cash flow for them.

Calfrac expects oil focused activity in Western Canada to be higher in the second half of 2014 when compared to the second half of 2013 due to increased demand in the Viking play while activity in the Cardium is expected to remain stable. The company continues to produce on increasing the percentage of its operations that are on 24-hour basis in the oil plays of Western Canada to improve equipment utilization.

In the United States, Calfrac expects activity to remain strong in upcoming quarters. The company continues to have a strong visibility across it’s U.S. operating areas, but believes delivering the efficiencies seen during the second quarter of 2014 will be challenging the size of well pads that were completed. Pricing in the U.S. largely remains customer and basin dependent. The pricing increases we have seen to-date have been related to commodity linked pricing agreements. We continue to have discussions with our customers about cost recovery mechanisms in our contracts, but these typically lack cost increases. Overall, we look forward to an improving pricing environment through the rest of 2014.

The company believes that if Marcellus operations will continue to achieve high utilization levels for the remainder of 2014 due to the placed low cost traction vicinity to natural gas consuming markets. Calfrac’s fifth Marcellus crew became operational in June 2014 and has seen a strong customer demand. As well, producers continue to develop the Utica, which could provide further opportunities for a company. The development plans being put in place by our customers in the Northeast U.S. are one of the primary reasons why we decided to increase our 2014 capital program. Our customers continue to trend towards more stages per well and increase proppant per well, which is positively impacting our performance.

In the Fayetteville, Calfrac is expecting activity to remain stable for the remainder of the year. The company temporarily deployed a third crew into this play during the second quarter of 2014 from Texas, but that too has since returned to original location, where it’s expected to experience strong utilization levels.

In the Eagle Ford, the company continues to optimize its operations and pricing is expected to remain steady. Calfrac continues to work on expanding its customer base in this region and is pleased with the progress that has been made in recent months. When the Eagle Ford assets were in the acquired, we thought integration would take 12 months from October 2013. The company is on track to meet these goals. The company’s Rockies operations and pricing are expected to be strong due to Niobrara activity. The company continues to be opportunistic about the Rockies region due to customer spending patterns and new producers entering the region.

Calfrac’s operations in North Dakota are expected to achieve strong utilization in the second half of 2014 due to improved customer demand and a reaction in competitor servicing in this play. As we execute the first quarter, it was challenging to determine the impact of weather on our performance, but it was significant and we have moved past all those weather-related issues.

We would like to speak about North America supply chain and logistics. Calfrac believes supply chain and logistics will continue to be an important piece of our business and how we differentiate ourselves from our competitors. With higher product volumes, we knew sort of fracturing across North America there has been an increase in the industry’s need for the use of third-party subcontractors. These subcontractors help facilitate the movement of proved volumes to their well sites when quantities are outside the scope of Calfrac’s current operations. The company continues to analyze and identify ways in which it can optimize the supply chain and logistics network in North America. A number of initiatives have been launched and it will continue in upcoming quarters to balance the need for subcontractor services and Calfrac’s own in-house capabilities.

Let us turn to Latin America. 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. Currently, an additional 32,000 horsepower is being deployed into Argentina and is expected to become active late in the third quarter of 2014. The new spread is expected to be used for conventional development in the Vaca Muerta shale play. Calfrac believes that its service quality and technical expertise are leading to a strong reputation as a service provider of choice in Argentina, which is providing the foundation for long-term growth.

In Mexico, Calfrac remains optimistic over activity in the longer term once the national reform of the energy industry is completed. Calfrac believes this will set the stage for increased spending levels by Pemex and create an avenue for new entrants to Mexico. In the near-term, the company will continue to prudently manage its cost structure in Mexico and closely monitor ongoing developments to remain prepared to take advantage of new opportunities.

In Russia, Calfrac expects activity to remain stable for the remainder of 2014. The company believes that the expanded use of multi-stage completion technologies in Western Siberia, such as horizontal drilling and multi-stage completions will continue. In particular, Calfrac believes that initial work in the (Vaca Muerta) shale play will begin as early as 2015, which would be the first unconventional development in Russia. The company expects the accelerating trend towards multi-stage completions will continue to drive demand for the service over the short and long-term as Russia’s producing sector gains confidence in this approach.

Calfrac has not seen any significant impact on its Russian operations associated with the ongoing turmoil between Russia and Ukraine. But the company continues to monitor the situation closely. The company has not experienced any issues as customers continue to pay their bills in a timely manner and work programs are progressing as expected. In summary, Calfrac’s confidence in its opportunities continues to increase due to customer indications of a greater pace of oil and natural gas development in a number of Calfrac’s operating areas.

Furthermore, the trends in North America towards pad drilling, 24-hour operations, more stages per well and greater tonnage per stage is having a positive impact on Calfrac’s equipment utilization. Internationally careful planning has helped develop a number of unconventional markets leading to additional opportunities for the company. The company’s people, service, quality, technology and HSE practices will make it a key partner in these developments.

The company considers itself well positioned to take advantage of these opportunities. Calfrac remains committed to this growth in its core operating areas. The company is continuing to assess the opportunities, but only as rates of return that makes sense to our shareholders.

I would now like to turn the call back to the operator to open the line for any questions we may have. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Dana Benner from AltaCorp. Your line is open.

Dana Benner - AltaCorp

Thanks. Good morning.

Mick McNulty

Good morning Dana.

Fernando Aguilar

Good morning Dana.

Dana Benner - AltaCorp

I wanted to start with your – I mean notwithstanding what you did, what you pulled off in the U.S. which was outstanding, I would like to start with Canada given the historical strength here for your company. And just looking at the margins and you mentioned a bunch of different effects lower pricing, different mix terms of multi-well pad programs, etcetera, transportation, logistics and all the rest. And I am wondering if you could us the sense of the relative contribution of those components and that might help us understand what the drag may or may not be as we move through the back of the year?

Fernando Aguilar

Thank you, Dana. We – so what we are experienced in the second quarter of this year was a combination of different things as you well put, but you have to remember that March was an all time record for the Canadian division before we entered breakup. And there were maintenance costs associated to the high utilization of our assets during that month that spill over Q2. That’s one piece of the story. The second one is that you know that Q2 is a quarter where companies – service companies operate at discount rates because the lack of work. And when you don’t have let’s say larger pad activity is not in a – in that environment, you go for smaller customers and smaller operations and that’s where we moved all over the country in different areas with smaller parts one or two wells for per operation. And that’s going to give the efficiency and productivity levels that you expect when you have 24-hour operations, larger pad activity. So that was the second reason of that situation. And the third one is of course it was related to pricing. So I would say that if you have take an average of each of these components they were equally balanced in the way that they affected the performance that we were expecting to have in the second quarter of the year. And that’s what happened in the country when you don’t – we don’t have the activity that you expect because of breakup.

Dana Benner - AltaCorp

Great. And maybe help us understand for the back half of this year which would be you have obviously you know the backlog of work, client mix, etcetera how much will these variance factors continue to impede margin recovery, etcetera?

Fernando Aguilar

Well, Q2 historically as you know is a question mark. Q2 traditionally can bring nicer prices when you are exposed to larger pads as I mentioned earlier. But how did we see the second half of the year as you remember when I was speaking earlier today, we were – we are predicting a strong activity. I think when you see what happened last year how much of the flags and delay in starting the activity for Q3 we saw that – we didn’t see that there is – we saw an earlier start up in Q3. So we tested Q3, Q4 as far as we see that today and the visibility that we have for our business and the amount of work and backlog that we have in front of us that we won’t be affected by those issues we had last year. Our customers are committing more capital to programs in the second part of the year. Now we are confident that that activity level is going to help us more actively throughout that part. So what we had – what affected our performance in Q2, I think the Canadian division are working on all those issues. We still talk about pricing and cost recovery with our customers especially understanding that the volumes have increased and we have to be careful how these costs are translating into our customers for them to – for us to recover from then. So we are positive Q3, Q4 and the activity levels that we have in front of us due to the backlog are quite important, so we already positive about it.

Dana Benner - AltaCorp

Just two more quick questions, I guess firstly you said before that its one thing to change discounts or change your price buckets, it’s an entirely different thing to see prices actually improved in the context of an improving market, which tends to be a more reliable driver of prices and so as we think about the second half of this year, do you think prices improved more so because it’s simply a tightening market and not so much that you are trying to push through a higher price book?

Fernando Aguilar

I think this is a philosophical discussion about pricing and pricing is not something that you can touch is always very fluid and it’s fluid because it is not a concept that applies all over the operation. It is customer related and competition related. Price book as you know is a reference and customers today are not asking for a price book in their tenders. They are asking for prices related to activity that they have. So price book is used as a reference when they want to use different services or they want to things that are not included in the quotations or price proposals that we submit to them. So then we go to what pricing is. In a market where you have competitors that are competing with us on a daily basis and submitting prices and trying to keep the fleet operating, it is very difficult to think that pricing it is going to be same for everybody.

You have customers where you have engaged the company into longer term arrangements and then those prices are basically going to remain at that level as Mick explained. But you have to understand that when the market starts getting busier and competitors cannot – lets’ say supply services to some of the companies that you are working for then there is an opportunity for prices to increase. And I think that is happening as we are speaking kind of. We – as you remember from February we have been talking to our customers for them to understand how important cost recovery was because for the last two years, the industry has been facing very low margins due to very first competition and lack of activity.

Once activity stabilizes and we get to a level of operations that can provide companies with a steady amount of work, prices can improve and the margin profits can recall, and that’s where we believe Q3 and Q4 will show us. We – as you know and we have been saying out for different quarters, we are cautious about that because of the amount of competition in the market, number one. Number two, customers are discussing with different companies on different price arrangements and I believe 50% of them understand that pricing has been an issue for the last few months and there other 50% are not very happy to see that prices increased. So in a way that’s daily battle that we have to fight, but the reality is that market is becoming busier and customers one way or the other are accepting that the prices that they have been experiencing from services companies for the last two years has to improve.

Dana Benner - AltaCorp

Alright. Okay, well that’s helpful. Three is good enough for me. I will turn it over to my peers. Thanks.

Fernando Aguilar

Thank you, Dana.

Operator

Your next question comes from John Daniel from Simmons & Company. Your line is open.

John Daniel - Simmons & Company

Yes, thank you for taking the call. I was hoping to get a little bit more color on the commodity price linked pricing agreement, specifically can you tell us how frequently the agreement resets and I presume it’s tied to nat gas?

Fernando Aguilar

Yes, that is correct, John. Some of our customers in our long-term arrangements have accepted the company to share the lows and also the highs in terms of how commodity pricing affects the business. And we had an opportunity in the second quarter of this year to experience better pricing from some of these customers, but you have to remember that as you will set that was related to natural gas, but I have to say that in today’s environment, Calfrac is not a gas-only company. And we try as you remember to keep a share between oil and gas in a 50:50 arrangement. And in the way that we contract our fleets, we try to be in a 60% to 70% contracted fleet and 30% to 40% in the spot market. So, as the way that we like to run our business to make sure that we protect ourselves from higher or lower commodity pricing and also contractual arrangements with customers.

John Daniel - Simmons & Company

Got it. So, when did that pricing agreement reset? How often?

Mark Paslawski

Actually, John, its Mark Paslawski. We have got several contracts which have that concept in them and no two are identical. So, it’s a little bit of a variable issue. You are looking kind of quarterly, but some look backward, some look forwards and it’s probably a little more granular than we are comfortable with getting into specifics on that mechanism, but despite to say that we have got more than one form and it is relatively short-term.

Fernando Aguilar

And the other thing that we should add to this is when Calfrac commits to its customers is related to long-term. We are a company that likes to get a contract for short-term with a customer and then shift. So, most of these arrangements are basically customers that have been traditionally loyal to Calfrac and Calfrac loyal to them and that helps the relationship build for future business.

John Daniel - Simmons & Company

Okay. I am just trying to understand given if gas prices soften here the potential impact to a headwind for you guys later this year? Okay. So you specifically noted in the release that delivering and speaking to U.S. now, the delivery efficiencies achieved in Q2 into Q3 will be challenging somewhat suggesting a cautionary outlook on Q3 revenue? At the same time, you got statistically into Marcellus that will have a full quarter benefit this quarter as well as the crew returning to I guess the Eagle Ford that will have better utilization as well as certain pricing improvements and certain basins. So, I am just trying to weigh the various comments, any colleague can have with respect to Q3 revenue would be helpful, if you have some thoughts there?

Fernando Aguilar

It’s relatively good, John. I think we don’t go to that level of detail as you know, but I have to say that our team in the U.S., are working very hard to make sure that they deliver what our promise is. And our promise is related to execute our jobs at a very, very high level of safety and quality. And it doesn’t connect automatically to the financial performance, but I can tell you that because of ACC and quality we are managing to get more work from our current customer base and also get more work from our customers that are curious to see why Calfrac is performing better than other companies. So, we will continue doing that. We will continue executing at very high level and that is opening the opportunity for us to increase our – not only pressings, but also our revenues and margins in the country.

John Daniel - Simmons & Company

Yes. Well, I hope you are successful. Last one for me, you referenced in the press release the 91% year-over-year increase in proppant, is that adjusted for the Mission assets, which is trying to do at the right apples-to-apples comparison?

Fernando Aguilar

Well, the increase in some utilization, I mean has been all over. I mean, I think what is happening and I believe that in the past we had opportunity of discussing how technology is affecting and impacting the unconventional shale revolution in the world. And I think what is happening today, customers are trying different technologies and mechanisms to understand how their wells can produce more.

John Daniel - Simmons & Company

Right.

Fernando Aguilar

We have experienced in the last six months a very, very high volume increase. But this is not only related to the U.S. And I think Texas is an area where customers are pushing for that, but I wouldn’t say Texas only, I would say all over.

John Daniel - Simmons & Company

I get that. What I’m asking is when you guys make the statement that it’s up 91%, obviously this quarter includes Mission, last year it didn’t, I just want to know if you do an adjustment to make investment for the Mission was, I am trying to get...?

Fernando Aguilar

John, though, we didn’t – it’s not adjusted for Mission.

John Daniel - Simmons & Company

Okay, that’s all I needed. Thank you very much.

Fernando Aguilar

Thanks.

Mick McNulty

Thank you, John.

Operator

Your next question comes from Klayton Kovac from Tudor, Pickering, Holt. Your line is open.

Klayton Kovac - Tudor, Pickering, Holt

Hi, good morning guys.

Fernando Aguilar

Good morning.

Klayton Kovac - Tudor, Pickering, Holt

So on the increased use of subcontractors in North America, to what extend is this impacting margins and what sort of initiatives is Calfrac launching to address this?

Fernando Aguilar

Yes, we – Klayton, we mentioned that in both recent mine interaction, it is affecting because as John was mentioning earlier there is an important amount of sand and chemicals are being increasingly used in the quarter, I mean, in the first six months of the year in fact. And so the mechanism that we are trying to use to record is talk to customers for those increased volumes. We are – we do with all the customers even the customers where we have contract arrangements, but the reality is that our – in some cases as Mick mentioned that doesn’t happen automatically in the first parts because there’s a time delay. But just to be more specific, storage has been increasing, the trend loads has been increasing and of course you have that as you need better planning, you need more facilities and you need to make sure that improved not only the relationship with your supply and also internal capabilities that you have in house. So, I have to say that you saw that in Q1 and we saw that again in Q2 for a more trucks transporting sand from transload facilities to the world size and the same thing happening, not only related to sand and chemicals, but it is also happening to nitrogen and (indiscernible) we use in a daily basis. So, that has been a very preventative.

Klayton Kovac - Tudor, Pickering, Holt

Okay, thanks and just as a follow-up. So, you mentioned in the press release that you’re focused on growing your 24-hour operations and – in the oil plays in Western Canada, what portion of your equipment in Canada is currently on 24-hour operations and what’s your target goal and then also on the U.S. side, is there any further opportunities to increase your 24-hour operations.

Fernando Aguilar

So you know – my goal is 100%. That’s why I want to see the company’s 24 hours operation happening. But unfortunately it’s not only related to us. It is related to the customer base. It is related to their ability to handle everything that is we require to keep an operation, non-stop in a continued basis. But it is not only the customers as well, used the service company that provide associated services to our business like the wirelines, like some of the transport, hauling water etcetera that make it more complicated to manage. And then you have to have the inventory of wells and stages ready for us to execute our services. So, you have a lot of moving pieces. For us in the U.S., the number that we use for the fleet that is available in 24 hours, it is related to around 80% and this is because we are very serious about our maintenance program. We have to make sure that we have keep rotation of our equipment to go back for preventative maintenance and equipment prepared for continuing an operation non-stop. So, very, very high utilization in the U.S. 25% 24-hour utilization in Canada, we will like that increase, but it’s not only related to us.

We provide service to our customers, some customers in which we try to help them getting organized for the 24-hours continuous operation, but as I mentioned earlier I would like that to increase and I think you tell me what do we think is going to happen from now till the end of next year. We should be heading into a 40% to 50% 24-hour operations because you have to remember that as the fleet increases in Canada the human resources available to our services or all services including the oil sands will be limited and also the ability for customers to get ready. So if I am in an let’s say optimistic way I would like to see 24-hour operations getting into a 50% at the end of 2015.

Klayton Kovac - Tudor, Pickering, Holt

Alright. Thank you. I will turn it back over.

Fernando Aguilar

Thank you, Klayton.

Operator

Next question comes from the Scott Treadwell from TD Securities. Your line is open.

Scott Treadwell - TD Securities

Thanks. Good morning guys. Maybe just a couple of housekeeping ones, the coil tubing results both in Canada and the U.S., nice improvement, I am just wondering if you can give me either a sense of run rate or if there is a lot of incremental growth from here, I know you sort of restructured coil tubing in Canada and now it looks like you have moved some units into the U.S., with that level of revenue or job count that you saw through Q2 certainly in the U.S. would you expect that to continue and would you expect maybe in Canada more return to maybe the levels you saw in 2012 before you began the restructuring?

Fernando Aguilar

Thank you, Scott. We as part of our strategy we are a high pressure pumping company and all services associated to help and improve our fracturing operation and associated services are critical. So that’s the reason why the company embarked into assets acquisition towards the end of 2013 in which we modernized our fleet. In the first six months of this year we have been modernize our equipment to make sure that our operators, engineers and supervisors have access to equipment that is modern, is up to the standards that the company wants to execute. And the execution part of this is basically working very well. We see increased activity in both countries. And of course I cannot say increased activity in the U.S. because we didn’t have that business line in the U.S., but we are deploying equipment in two of our operating areas in the U.S. And we are slowly trying to get not only the personnel associated to the business, but also making sure that we get access to a customer base that provides continuous activity. So we hope that that trend will continue and we can grow our 10% business in that area to maybe become 20% in the next two to three years according what our strategic plan tell us.

Scott Treadwell - TD Securities

Okay. Perfect. That’s good there. I am just wondering you mentioned some of the cost side on the U.S., do you have an idea of the magnitude of costs that you could take out of the Mission business, are we talking maybe a couple of million dollars annually or is it something maybe a bit more material than that?

Mick McNulty

Scott, it’s Mick here. I don’t really know what you mean by taking costs out of Mission. I mean we basically assets there and have been building the infrastructure around it Scott. So it wasn’t really an acquisition whereby we had to sort of eliminate any sort of synergies or anything. Now, we will obviously be able to get the benefit of purchasing power in Texas from the rest of the U.S. but I think the driver for us in the Eagle Ford is going to be getting that third crew working again which it is and getting the utilization up.

Scott Treadwell - TD Securities

Okay. So yes, I know one-time costs were largely dealt with almost immediately after the close, so it just sounds like it’s more like you said purchasing and Op costs that are – you are trying to optimize?

Mick McNulty

Yes.

Fernando Aguilar

Yes. But Scott there is something interesting about Texas and you remember that for three quarters now we have been talking about the impact of the acquisition of those assets in Texas. Remembering that we enter a market where we can have experience on the cost base. So for the last three quarters we have been learning about Texas. We have been expanding our customer base and let’s say marketing and showing the area where Calfrac can do and that is being nicely growing as we speak. And I think we have a better understanding and handling today. And I believe the 12 months that we wanted you guys to understand it was going to take Calfrac to understand that is going to happen as we mentioned to you. So, I believe by the end of the next quarter, when we start the full year of that activity going on, not only the customer base, but the performance is going to show good improvement and a good business decision for Calfrac to enter that market.

Scott Treadwell - TD Securities

Okay, good. Turning to the logistics side in this year’s CapEx, I think you have got $38 million assigned for the sort of infrastructure and support initiatives, can you give us an idea is that $38 million mostly in sort of rolling stock, are you just increasing capacity or is there some investment in facilities and maybe ERP software or some sort of connectivity that allows you to get more efficient on the process side. I am just wondering about how you improve from here? Is it just a matter of throwing more iron at the problem or do you need to be a bit more elegant in how you get from A to B?

Mick McNulty

We are always elegant, Scott. No, the majority of the equipment is operating equipment that’s going to help us optimize our fleet utilization. And filling in gaps where perhaps we need some additional storage like sand storage, for instance, there is some of that. There is no ERP in this year’s capital. We will probably look for that in the next couple of years.

Scott Treadwell - TD Securities

Okay, perfect. And my last one you and the peers that have reported so far a pretty meaningful turn in the U.S., but the theme has been very consistently in terms of scale and tonnage of sand and scale seems to be getting more and more important? I am just wondering if that’s caused yet, it maybe too early, any sort of change in the M&A landscape where some of the smaller guys who are obviously benefiting from increased activity look at the road ahead and see that they need to be 3 or 4 times as big as they are today and they see that the exit strategy might be a sale. Has there been any change in the M&A landscape at least as you guys view it?

Mick McNulty

Yes, I think there has been a change. I think price expectations have gone up to the point where it becomes very difficult I think for us to do tuck in operations at this point. As you know, Calfrac has a reputation of not overpaying for assets. And so we won’t move away from that discipline. And we have taken a look at a couple of them and the price expectations are too just high.

Scott Treadwell - TD Securities

Okay, great. That’s all I have got guys. Appreciate the color.

Mick McNulty

Okay.

Operator

And our next question comes from Dan Macdonald from RBC Capital Markets. Your line is open.

Dan Macdonald - RBC Capital Markets

Hi, good morning guys.

Fernando Aguilar

Good morning, Dan.

Dan Macdonald - RBC Capital Markets

Just wondering if you take a look at your horsepower fleet at the end of the quarter, it looks like you may have actually retired some pumping horsepower in North America, am I mistaken there? And I guess, if you did, is that kind of an attrition type run-rate that we might be able to look at or?

Ian Gillies

Dan, Ian speaking. So, part of what you are seeing is you are just seeing some transfers between geographic regionss. We did move some horsepower out of the U.S. down to Argentina during the quarter. So, if you take a look at the interim report, which is going to be posted shortly, you will see an update on horsepower by geography.

Dan Macdonald - RBC Capital Markets

Okay. So, you didn’t have any meaningful attrition than in the quarter?

Ian Gillies

No.

Dan Macdonald - RBC Capital Markets

If we had to look I guess your U.S. operations on a kind of more, slightly more basin specific level, where do you see I guess the most slack in your fleet now in terms of where the upside to utilization might be and is there much slack really left in your Marcellus or Eagle Ford operations at this point given the capacity in the ground?

Fernando Aguilar

Yes. Dan, I think what is very good about the U.S. is how diverse and different reasons are. And when you know each and one area where you have to concentrate and fix that issue and making sure that you keep dealer operating areas performing properly. And that’s basically what we have done in last two years. You remember from two years ago when we started it to be challenged by the activity and the operation, we were always consistent. And if there is a basin or an area that is not performing very well, we try to make sure that we concentrate on fixing it. And I cannot give you today the breakdown or let’s say a difference between all of them, because if we are operating all those basins is because we believe that it is important for our present and future business to be present in those areas that are – today, the most important shale development areas in the country. So, we had a couple of areas that we’re not performing very well in Q1 as you remember we discussed in Q1, it is improving in Q2 and the other places are behaving to why we expect it so, I can say that I would like to see all of our regions in the U.S. performing at the high level, but not all of them because of pricing, because of competition, because of activity. But in general, we see a trend in which we are and especially to Calfrac, our Calfrac operations in the U.S. are basically getting to high level of performance.

Dan Macdonald - RBC Capital Markets

Okay, thanks. And then just lastly on the 24-hour operation side, your goal to get that sort of 50% for the end of ’15 in Canada and you’re also obviously rolling out some incremental horsepower in Canada for 2015. How should we think about your ability to kind of grow from a labor availability standpoint beyond that we try and think of 2015, was that sort of – if you can get to the 50% 24-hour operations will that sort of max out, what your ability to get skilled labor is at this point or maybe you could still grow from horsepower side in Canada as well.

Fernando Aguilar

I think we can, it is a matter of two things, it’s a matter of planning, and it’s a matter of having visibility from customers. You need to make sure that you have especially very different customers you can engage in hiring people. And one thing that we hate at our company is waste, is people sitting do nothing and equipment parked against the fence. Those are the two things that we don’t like and try to manage that as the best because we are responsible to our shareholders and our employees to make sure that utilize our resources the best rate. So, if we have the customer visibility for the future, we understand and we understand exactly how we can plan for that. We can now accessed the people and that is not going to impede that Calfrac will be able to grow beyond 2015 according to the plan that we were discussing earlier.

Dan Macdonald - RBC Capital Markets

Great, thanks. That’s all I have.

Fernando Aguilar

Thank you very much.

Operator

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

Jon Morrison – CIBC World Markets

Good morning, all.

Fernando Aguilar

Good morning, Jon.

Jon Morrison – CIBC World Markets

Within the U.S., which of your basin showed the greatest improvement in profitability quarter-over-quarter. And was the impact of the commodity link pricing material in terms of driving profitability improvements or was it more broad utilization based?

Fernando Aguilar

Jon, you have been telling to the specific. We saw improvement almost everywhere in the U.S., I mean the U.S. I mean, it was not related only to commodity pricing but is also utilization. And you have to understand that the way customers operate in some instances or in some let’s say, months. They’re going to path – I just take an example they go to Pennsylvania and they have a path where you have 18 wells and you have 60 stages per well and you are pumping non-stop for two or three crews later and then that utilization on productivity will bring the levels that you expect any areas like Fayetteville that are continuously factory – gas factory, drilling, and production going very efficient and very well. So, we saw that in different areas we operate and if there is a – let’s say an improvement in couple of areas, I could think off, it could be Texas and North Dakota.

Mick McNulty

Yes, North Dakota was a biggest impact, Jon. Obviously, Q1 was a tough quarter for Williston and returned to much more buoyant levels in the second quarter.

Jon Morrison – CIBC World Markets

And that was just a weather-related. It wasn’t addition of any customers or anything in North Dakota.

Fernando Aguilar

It was a combination, Jon, we’ve seen weather-related issues and again competition as you remember in Q1 you see anybody and then they started leaving the place, three or four of the major competitors in the area left. And then pricing started recovering in a way. Because – when I don’t really know exactly, but we are talking to customers, we wanted to get more work because some of our competitors let they said – we want to give more work. The pricing has to change because people don’t want to work for a loss and that’s why you have three, four companies leaving the basin. And that’s exactly the approach that we’ve been having in those areas and make sure the customers understand that they want a quality operation they have to pay for that.

Jon Morrison – CIBC World Markets

The infrastructure investments that you guys are making this year broad-based kind of a cost in North American geographic platform or these are more targeted regions where you think that there is more opportunity to be seen?

Mick McNulty

It’s across the entire North America.

Jon Morrison - CIBC World Markets

Is there any of your U.S. capacity that isn’t as effectively you have spoken for at this point through the tail end of this year other than call it Christmas shutdown and other noise from the seasonal perspective?

Mick McNulty

No, I wouldn’t say so John, but obviously there is always some efficiency you can go in or out of any operation. But we are pretty pleased with the efficiency that we are seeing from our equipment.

Jon Morrison – CIBC World Markets

Within Colombia – in Colombia you guys referenced permitting issues, are those specific to your operations or are they broader industry based and that customers just have a tough time getting drilling permits in the country?

Fernando Aguilar

The situation in Colombia is more government-related and oil company-related. And I think I don’t know if you have been following what happened in the last round in Colombia which I think it was closed last week if I am correct. There were a lot of lows offered in on land and also offshore. And I think it was more attractive for companies to be the offshore. And land I believe there is only one company that was awarded an unconventional block and it was (indiscernible) if I am correct. So I think I believe people are still skeptical in Colombia to understand how this unconventional market will be developed because if unconventional activity there is a question mark related to permitting in unconventional that people don’t really understand yet they are more skeptical. So I think until they go through that situation, we will understand. But I think what’s happening in Colombia is that the new government which is continuing from the previous one to be the same President who was reelected, he has to understand that the revenues coming from the oil and gas industry will help his investment plans for the country. And we will see some sort of recovery towards beginning of 2015 when the new government gets in full power and starts operating again out of the election pre-period and all that. So is this going to change dramatically our performance in Colombia, no. I think in Colombia we will continue operating from the coil tubing, cementing – sorry cementing operations and looking for opportunities. But getting into fracturing for unconventional is going to take some time for that to happen.

Jon Morrison – CIBC World Markets

In Mexico has your outlook shifted at all over the past three months in reference to kind of 2015 and beyond or has your visibility improved or weakened relative to what you guys were thinking call it a quarter ago?

Fernando Aguilar

I believe yes – I believe there is an improvement. How material that improvement is going to be, I think there have been two rounds in front of congress and senate where the new rules and the frame for the contracting these international companies to operate in a country is progressing well, so that is moving forward. And I think ’15, ’16 will be the time our activity with Pemex and some of the companies in the area are giving us visibility, better visibility for the second part of the year. So while we want to do in Mexico is make sure that we protect our profitability and our presence in the country looking for the longer term opportunities.

Jon Morrison – CIBC World Markets

Last one just for me on the Canadian side, do you have a sense where industry pricing was spot market in Q2 relative to Q1 like was it down 5% or 10% just from a seasonal perspective and was your business anymore weighted towards spot or long-term contracts in Q2 relative to normal?

Mick McNulty

Yes. I would say pricing was down and exactly in that range 5% to 10%. And I think we probably had a lot more call out work in Q2 than the long-term contract work.

Jon Morrison – CIBC World Markets

I appreciate the color guys.

Fernando Aguilar

Thank you, Jon.

Mick McNulty

Thanks Jon.

Fernando Aguilar

Hello. Michelle?

Operator

Kevin Lo (FirstEnergy), your line is open.

Kevin Lo - FirstEnergy

Thanks. All of my questions has been answered. Thank you very much.

Fernando Aguilar

Thank you, Kevin.

Mick McNulty

Thank you, Kevin.

Operator

At this time I have no further questions. I will turn the call back over to presenters for closing remarks.

Fernando Aguilar - Chief Executive Officer

Thank you, Michelle. Thank you everybody for attending our second quarter conference call. And we will see you in three months for the next one. Thank you.

Operator

Thank you, everyone. This concludes today’s conference call. You may now disconnect.

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