Canyon Services Group, Inc. (OTC:CYSVF) Q2 2016 Earnings Conference Call August 5, 2016 2:00 PM ET
Barry O'Brien - CFO
Brad Fedora - President & CEO
Todd Thue - COO
Scott Treadwell - TD Securities
Ian Gillies - FirstEnergy
Brian Purdy - PI Financial
Jon Morrison - CIBC World Markets
Good afternoon. My name is Stefanie and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Canyon Services Group, Inc.'s Second Quarter Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions].
Thank you. I will now like to turn the call over to Mr. Barry O'Brien, CFO you may begin.
Thank you and good afternoon everyone, and welcome to Canyon's Second Quarter 2016 conference call. With me today is Brad Fedora, President and CEO and other members of Canyon's Executive Management team. I will address the key financial highlights in the current quarter and Brad will then address the outlook.
Before I start, I wish to refer you to the forward-looking statement disclaimer in our Investor Presentation on our website at www.canyontech.ca.
For the most part, I will take as read the condensed consolidated interim financial statements and MD&A for the quarter and six months ended June 30, 2016, which are now on SEDAR.
By way of background, declining activity levels combined with intense competition among service providers have now been in evidence across the oilfield services sector for the past several quarters. As a result, pricing levels for Pressure Pumping and Fluid Management Services have decreased to unprecedented levels, which is evident from the overall negative financial results experienced by the Pressure Pumping industry.
In Q2 2016, pricing declined sequentially by roughly 5% from the already low levels experienced in Q1 2016. This has resulted in current pricing levels in the Pressure Pumping business being approximately 40% to 45% lower than those prevailing at the beginning of 2015. Similarly, in the Fluid Management business prices have declined by approximately 35% from water transfer services and by up to 70% for containment services, when compared to peak 2014 pricing levels.
For the Pressure Pumping Services division is concerned, hydraulic fracturing jobs completed for the three and six months ended June 30, 2016, increased in particular for Q2 increased significantly over the comparable 2015 periods but this was mostly due to administrative changes requested by certain customers to invoice by integral or by stage rather than by day through the case last year. The number of stages fracked by Canyon in the second quarter is about 51% lower than in Q2 2015 which really tracks the decline in industry-wide activity levels. For the six months ended June 30, 2016 Canyon fracked about 33% fewer stages than in the first half of last year although wells drilled was down by about 44% from last year.
Cementing jobs completed for the three and six months ended June 30, 2016, increased dramatically for over the comparable 2015 periods primarily due to Canyon's focus on expanding its market share in Saskatchewan which has led to long-term contract-based work. This long-term contract based work has been in place for about a year now.
The pricing pressures and lower activity levels referred to above has resulted in Q2 2016 Pressure Pumping revenue declining by 37% to $23 million from $37 million in Q2 2015.
Since January 1, 2016 Canyon has had 75% of its consolidated workforce on a variable case structure. This is up from about 10% of the workforce in the first half of 2015. Recall that Canyon introduced this system commencing in August 2015 with additional staff transitions to variable pay in November and on January 1 of this year.
A variable pay structure benefits Canyon in periods of very low activities such as the second quarter, as it allows us to match labor costs which is our largest cash cost more closely to activity levels. In the second quarter of 2016, our variable pay structure resulted in savings of about $4.5 million.
Where input costs are concerned, Canyon continues to work with suppliers and customers to gain concessions on economies of scale. For example, Q2 2016 chemical costs have been reduced by about 17%, third-party hauling rates down by about 10% and proppants down by about 21% net of exchange rate fluctuations from Q2 of 2015 levels.
Industry conditions also impacted Fluid Management's results with Fraction contributing revenue of $2.6 million compared to revenues of $6.6 million in Q2 of 2015. Over the past 18 months, Fraction has also implemented significant cost cutting measures in response to lower activities or the lower activity levels on pricing.
In terms of the consolidated results, for the second quarter 2016, these include a one-time bad debt expense of $4.0 million as well as severance costs of $0.4 million. The bad debt expense of $4.0 million primarily relates to a private equity backed customer entering into insolvency proceedings during the quarter.
So far as the remaining receivables are concerned, Canyon is comfortable that these are collectible and at this time does not foresee having to make any additional material allowances for doubtful accounts.
Adjusting for this one-time $4.0 million bad debt expense, Canyon's Q2 2016 EBITDA loss would have been $10.3 million which approximates to Q2 2015 amount of negative $9.8 million. That's a negative $10.3 million for Q2 2016, even though industry conditions resulted in pricing driven revenue declines of 40% to $26 million of revenue from $43 million a year ago.
On the balance sheet, Canyon continues to maintain a strong financial position with net bank debt of $3.9 million at June 30, 2016. In addition, Canyon has $95 million available on those committed bank facility as well as a $50 million Accordion feature giving Canyon the ability to weather the current downturn as well as placing the company in a good position to meet an industry recovery.
I will now turn the presentation over to Brad, our President and Chief Executive Officer.
Okay. Thanks. I'm going to make some brief industry comments and then we will take questions at the end. So obviously Q2 was a difficult quarter, pricing was extremely competitive, and we basically chose to pass on most of the work just because the field margins or contribution margins were zero and negative in many cases and we're not, there is obviously no point in going to work on for negative field margin.
So we took your courage that we were not doing the work as our whole customers have, it was profitable to doing, and then passed on everything else, pricing continued to go down from Q1, I think we were down another sort of 5% to 10% depending on what part of the basin we're in and we're having luckily now pricing has stabilized but that's only because it just, it could possibly going lower.
In many cases we were losing jobs to our competitors that are getting us work at negative margins and certainly that does not even factor in the depreciation of the wear and tear, of the long-term ware and tear of pumping equipment.
The basin is still basically divided in two all of the activities Montney/Duvernay and Saskatchewan oil. Our focus over in the first half of the year has been fairly heavily in Duvernay focused with an expanding market share and so Saskatchewan which you know our goal there continues to go well, all of the work is essentially 24-hour work now. And we can have revenues split; it's probably half or 50% BC and then sort of 13% Alberta, 15% to 20% to Saskatchewan.
The one thing that have occurred, I think which is just the cost, the cost issue for our customers that the amount of Ottawa White sand where pumping is coming down in the last year probably 20% -- sort of 70% of the sand we pumped was Ottawa White from Northeast U.S. and we would get it a downturn of about 50% now.
I don't imagine that trend both in KU, if commodity prices increase. I think it's really just a cost issue but I could be wrong on that just due to amount of sand that's been into pumped into these wells now. Customers may have made permanent change which would be fine for us. Certainly any logistical issues that we incur on sand typically, we experienced with the U.S. based sand we're more than happy to pump more Canadian sand for customers to go that direction.
The amount of sand that we're pumping now, continues to grow and we're seeing what the U.S. customers as they continue to push the sand volumes up and they're telling us the study they've done is the more sand the better, the more sand you can get into the formation the higher production will be and so we expect sand volumes to continue to grow not just based on the number or not just an increase of stages but from an increase of sand on per stage basis and we were on a Duvernay have somewhere we pumped over 5,000 tons of sand in a slow wellbore and so the sand volumes have really grown.
Just, there is a billion rest of the year and so saying is pretty murky. We are actually having a fairly busy summer and but we're not making any predictions into Q4 as of yet, it was really raining in Western Canada and so we have a lot of interruptions in the field due to location access or road issues. So we are not sort of predictions as to when this will improve.
One thing I tend to say is when the oil gets $50, we experienced a significant increase in customer in barrel cost and certainly when the oil go back, lot of those conversations came to an end.
I would say, I just point though what is different from the winter or from Q4 of 2015 and Q1 of 2016 is that the conversations we're having with customers now are all buyers to the upside. It wasn't that long ago when we talked to customers and they would say things like we're going to do 10 well as an example but we may cut easier, may cut them down to five, now it's the reverse customers are asking, if we were to double our program or increase our program by 30%, would you still be able to provide us services. So this is the first sign that things are going to get better when commodity prices pretty back up here again.
We are -- one thing I do want to say as we will not protect market share. And we are taking a very select view of our customers and how we are getting these better programs from these prospect [ph]. Unlike some of the competitors, our competitors out there, we are not willing to work at negative margins or 0% field margins or the contribution margins for all your accountings, we will have to give up the market share I think we sold out in Q2. So we are not protecting top-line revenue at any cost.
We're taking huge takeaway through some of these programs and try to figure out how to make a little bit of money at the field level and it's a so you won't get awarded the best, as prices were moving, we're happy to let it go.
One thing I don't think the market really appreciates is just how quickly supply and demand are going to tighten up here. It used to be 11,000 wells with consumable frac here in Canada and that number has moved down to sort of 5,500 to 7,000 wells. And so I know Halliburton had made a comment about that in the U.S. and the sort of certainly the same as truly in Canada. There is approximately 2 million horsepower in Canada and may be slightly less than that. All of that horsepower would be consumed at 5,500 wells given today's fracking density and fracking density continues to grow which will that number will come down, if we went back to 9,000 or 10,000 wells in the Western Canadian Sedimentary Basin, we would need up to 3 million horsepower is how we're modeling that.
The amount of horsepower that's allocation now at some of these Duvernay wells has reached sort of unprecedented levels, we get 70,000 horsepower part allocation this summer for Duvernay pad and so that's almost a third of our company. And certainly if you factor that into supply and demand industry model, we are not, there is no way we can do anything more than sort of 6,000 or 7,000 wells in this basin.
And we have found that lot of people have left the industry, we've been trying to hire people over the summer and we're having a very difficult time. We try to hire over above 100 people staring over a month ago and we are not even halfway to our goal, so it does show that people have left the industry it's going to be difficult to get them back and so as to create tightness in this market, I think a lot more seeing particularly the people, a lot of people will realize.
Other trends in the industry it's just still an issue profitability can be won or lost depending on your ability to move sand through the basin and drill efficiently. On the Fluid Management side, we are still moving towards our price per tube market, we want to be able to integrate all of our services on the Fluid Management whether it's the program pipeline or trucking or storage and provide our customers with a fixed price per tube which they seem to be receptive and it gives them predictability on cost and so we are going to continue to work on that sales model.
Other changes in the company that we spoke about it on our previous calls; there is still efficiency and cost focus. One thing I would say is that we are not making any temporary changes or there is no stop gaps to get it soon as we're not wasting any time on any changes over efficiency improvements that we don't view as permanent and I think we did good job with that and certainly our fixed costs are showing the changes that we made. Barry spoke about our move to variable pay and it seems to me fairly broadly accepted in the industry now and we are certainly hoping that our competitors will maintain a variable pay structure as the labor market tightens, it's certainly is the only model that makes sense in this industry and we have every intention of sticking with that over the long-term.
On the cost side when it comes to inputs like sand, chemicals, diesel et cetera there hasn't been a lot of changes on those since our last call for Q1. One thing I would say is that cost have continued to creep down. But these are very temporary situation as soon as oil goes to $50 and above, our suppliers are going to start trying to push through price increases into our supply chains slightly with our customers and so I don't really think there is a lot more to talk about on the cost side of this equation.
From a capital programming perspective, we still have a very conservative capital program plan for 2016. I think we will make it up, we will provide an update this one fall on our attentions for the remainder of 2016 and 2017. But at this time it's just a bare minimum of capital that is required to continue equipment running and certainly nothing to report on any acquisitions we have been looking but there still an issue with what people are willing to sell forth and what you are willing to pay.
We are finding that the only companies that are really for sale are typically not the ones you want to buy and of course ones you want to buy are not for sale. So it's a very difficult time to find a right deal right now from a valuation and leverage perspective. So we will continue to look there is nothing to report on that obviously at this time.
I think I'm going to stop there and take questions.
Your first question comes from the line of Scott Treadwell with TD Securities. Your line is open.
Thanks. Afternoon guys. Wanted to may be start with your comments around labor and your challenges in staffing up and was there any consistent pushback whether the move to variable comp was it a lack of consistency on work or within a combination of things that’s been the hurdle trying to get pass the hiring guys?
I think it’s all of the above and then lot of the labors that we liked to hire obviously was experienced people. I think a lot of them were and sitting back make sure that there is going to be consistent work before they make a commitment to leave whatever they are doing over the summer.
Okay. So most of those guys are in another industry and it's hiring away from a steady paycheck.
Yes, I mean not all of them obviously but few people always find a place to land and those are the people we want to hire. So it's a big commitment to leave a job and to comeback to an industry that has let you down in the past so, we're still struggling with some of those issues and but I think once we see the work is consistent and we have oil settling at the $50 level I think we will get people back it's just going to take some work.
Okay. So do you see that potentially having to pay more in the short-term is the answer or as you said it's really just getting visibility on the work is going to be the big one?
I think this make visibility is probably more important than 10% pump and day rates or something like that.
Okay, perfect. And move on to a couple of capital questions first can you just give us an update on the pumps you guys are trailing, how that's work now and there has been any progression in terms of your view of commerciality timeframe?
There is not a lot to comment on probably I want to make some comments as well. But at this stage we were about a thousand hours into the test and it looks -- it looks encouraging and we haven't finalized all of the numbers yet from a group perspective and an operating cost perspective but it looks encouraging at this point and then, I think we'll more to say on that in a month or so but. Certainly given the pressures and ranges that some of the formations like the Duvernay require, we have to move to hydraulic pump design, there is no doubt about it. The wear and tear on Connor [ph] today is very significant.
I don't even -- I can't even imagine during this work with 2,250 or something like that we have -- generation pumps or the 2,500 horsepower pumps and even that doesn't seem like a math. So when we can probably move to the new pump design we will.
Okay. And a follow- up on the equipment side, you mentioned that going back to 6,500 sort of soft up all the equipment in the market, it's probably a little early to have this conservation yet but given how fabrication and capital equipment providers have ramped down as well. Is there any indication of what would build time be, if in fact you did any build some more horsepower or we still thought, would we be talking about 12 months just because the skew up would be a significant portion of that?
Great question. The initial orders will come in faster than that but you have like whole value change, needs to start pump again and inventories have been brought down and so sort of second round of capital additions will be, can very like take 12 months.
Okay, good and that's all I got guys. Really appreciate the color. I'll turn it back. Thanks.
Your next question comes from the line of Ian Gillies with FirstEnergy. Your line is open.
I just wanted to trying to get better understanding how was Canyon thinking about the amount of horsepower in Western Canada may not be able to come back to work as you try and stack up your competitors to try and help and assess the supply and demand dynamics.
Well, we -- so we estimate that first of all 1.2 million horsepower operating today and so that's sort of 700,000, to 800,000 horsepower part. I'm assuming it all need to work and when we sort of work through the math and what it's going to cost to bring our pumping equipment off the fence. It's somewhere between $100 million and $150 million required to get some of that equipment back to work and after the summer may be that was even higher, just given the wear and tear obsolesce some things like that pressure market in Duvernay that will ramp up, if they are required.
But it's going to take time to start it, it's going to take time to fix it, and it’s going to take money, and the money is going to be required at the same time as working capital is expanding. So it's going to put pressure on this industry and certainly that's one of the reasons why we keep a clean balance sheet. And so that we can expand when we want to but also so that we can do the [indiscernible] and absorb the working capital increases when things approved and I don't think all of our competitors can see they can do that.
Okay, that's helpful. Along the same lines, I know you guys will be able to put much you're coming back to work. But hypothetical situation what would be the decision tree I guess not bring a pump back to work, I mean how many pieces on it would not need to be working or what would not be need to be working for you guys not to bring it back.
Do you want to take that one Brad or --?
Yes, I’ll take; I’m going to comment and then Todd will follow-on. So it's all coming back. It's just a matter of when and when is going to be determined by the field margin that we're going need. In today's field margins we're not bringing this equipment back, and we need field margins in the 20% to 30% range to justify adding new equipment, yes, that's probably about right, and Todd may be add to that.
Yes I guess the only thing I really want to add would be that the equipment itself has made up of four major components. Anyway it would just be a matter of the replacing the component that would make sense for it versus buy a new. And in most cases it would be just to replace the major components. And I would like Brad said it was based on what sort of revenue you could generate with it.
Okay. And then last one from me guys, as activity ramps up from a utilization standpoint, do you think there's more you get more [indiscernible] Duvernay or the Montney?
It's published in the Montney.
Your next question comes from line of Brian Purdy with PI Financial. Your line is open.
Good afternoon guys. I was just, I wanted to ask about how things are going in Q3 here, you mentioned it's been rainy. With the little extra work coming out of spring break up is there any opportunity to regain some of the sequential pricing declines you saw in Q2?
We're getting a little back in Q2, but not significantly you still be incredibly shocked that some of the bids that are out there. And I don't know if its people not understanding their costs or sales teams that are running amok, I can't explain it. But it's very difficult to get pricing back when some of our people bidding on below cost at a field level. So that's before quarter costs. So it's not the customers, we can't blame this on the customers, they stopped asking for price discounts long ago. This is a self-induced industry track industry that we're hoping people will actually rise up and realize what it costs to do this work. So with oil goes back to tricky dollars, we're going to -- we'll see a price increase probably not a whole lot movement until that.
Okay. You've mentioned in your comments here at current pricing level is you expect to see I guess competitors in industry go under. Is that just a general comment or did you have specific competitors in mind?
No, that's a general comment on the fact at this pricing levels it's not sustainable. We don't have a business at these prices. And so certainly if you don't have a balance sheet to absorb this over the long-term, you'll see more casualties like we saw in the first half of this year.
Okay. And just follow-on the pricing theme obviously you've seen some bigger pricing declines in the fluid storage area. Do you expect as pricing comes back that that area will be the last one to recover or do think it all comes together?
I would say probably all comes together, it's modest, it's not an insignificant cost to our customers, but certainly they realize that the pricing has gone below sustainability upon that surplus line as well. And so I think when you see frac pricing increase you'll also see fluid natural price increase.
Your next question comes from the line Jon Morrison with CIBC World Markets. Your line is open.
Good afternoon all. Brad, when you say that we'd be shocked at the bids, does that imply that you're still seeing a number of bids on the market that would imply negative 10% to 20% margins at the field level at this stage?
And is that concentrated to like customers or was it universally?
No, probably it's universal and all parts of the basin and I would say that Montney is probably where we're seeing the most expensive below cost bidding were just the Saskatchewan light oil, I guess the smaller number of players are chasing that and that works fairly repetitive. And so I think people understand their cost better in that part of the basin. But we've got competitors both old and new that are still putting up below cost bids.
Okay. Todd I realize its fluid at this stage and customers change their mind in fairly short periods of time. But can you give any line of sight to what your tentative book of work looks like? Do you have visibility for the next four or six weeks it's shorter longer or there are still slots available?
We're fairly booked until mid September as long as our, as far as our visibility goes yes six weeks pretty booked up.
Okay, so if a customer wanted a multirole program to be done, it's probably October is if they really want to get going?
And this is temporary.
Okay. Given the changes that have taken place in the Canadian cementing market, are you seeing any better stability in pricing in that market to-date relative to fracturing?
No, not really that's always a very price competitive market even during the good times. And we're still seeing there is less players chasing work that we're pursuing but no it's undisciplined market as well.
Okay. You talked about trying to had 100 new hires recently, which I'm assuming it's just trying to prepare for what should be busier times but do you need to see a certain level of pricing increase to start reactivating equipment and taking it off the field and spending some of the CapEx that you mentioned at this point. Can you give any sense for what you believe that the margin needs to be for you to get certain amount to pull crew or equipment off the fence?
Yes, it's a toughest kind of moving target because we're not sure how our suppliers are going to react with price increases. But we would need pricing to go up sort of 15% to 20% before we're going to start activating equipment on the fence.
Okay. Last one just from me some of variable cost side you guys mentioned saving quite a bit in the quarter. Was there any signs that you lost employees who just ultimately didn't want to work under that model and decided to exit the industry temporarily in the quarter?
Yes absolutely, there is certain portion of our employee base especially in the ground area that don't want any part of a variable cost structure or variable pay structure and that's fine but we know we have to do what's best for the company over the long-term and we can do that, we would have turnover. And we did and we completely understand why they would make the choice to pursue other lines of work but we're not going to change back because we experienced a bit of turnover.
We always experienced turnover and for a variety of reasons, so this is something new, we built training centers because we expect to have a continuous base level of turnover in our staffs and we look to handle turnover that we've had and over the summer is somewhat difficult is we have been hiring this for a variety of reasons but I would say it's more of an industry issue than it is a variable pay issue.
As there are no further questions, I will turn the call back to Brad Fedora, President and CEO for closing remarks.
Okay, thanks everyone. Thanks for your time, if you need any more explanation you can certainly phone any of the management team here at Canyon and we will try to get back to you as soon as we can. Thanks very much.
This concludes today's conference call. You may now disconnect.
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