CE Franklin, Q2 2008 Earnings Call Transcript

| About: National Oilwell (NOV)

CE Franklin Ltd. (CFK) Q2 2008 Earnings Call July 25, 2008 11:00 AM ET

 

Executives

Michael West - President and Chief Executive Officer

Mark Schweitzer - Vice President and Chief financial Officer

Analysts

Sean Boyd - Westcliff Capital Management

Ward Grey - Private Investor

Doug Cooper - Paradigm Capital

Jackson Spears - Capstone Investments

Operator

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the CE Franklin second quarter 2008 results conference call. (Operator instructions) I'd like to remind everyone that this conference call is being recorded on Friday, July 25, 2008 at 11:00 a.m. Eastern Time. I'll now turn the conference over to Mr. Michael West, President and CEO. Please go ahead, sir.

Michael West

Thank you, Matt. Good morning, ladies and gentlemen and thank you for dialing in to CE Franklin's 2008 second quarter earnings call. I'm Michael West, the Company's Chief Executive Officer and joining me on the call today is Mark Schweitzer, the Company's Vice President and Chief Financial Officer.

I'd like to remind participants on the call that some statements or material discussed today may be forward-looking in nature within the meaning of securities legislation, and I would ask participants to review CE Franklin's 20-F filing available on our web site at www.cefranklin.com, which details the risk factors associated with the company and our industry.

On the call today I will review the market activity, update CE Franklin's strategic initiatives, discuss CE Franklin's Q2 and year-to-date results, and the Company's liquidity and capital resources.

Starting with market activity, oil and gas industry activity indicators in western Canada were mixed on a year-over-year basis for the second quarter ending June 30, 2008. The average rig count in western Canada increased 12% to 180 rigs operating for the quarter, compared to 161 the prior year.

Well completions decreased 15% for the quarter, gas well completions were down 21% and oil well completions were flat. The total number of wells completed in the second quarter were 2,607.

There are a number of factors contributing to the lower activity levels. Q2 is a quarter seasonally constrained by weather conditions referred to as "break-up" as the ground thaws and the moisture comes out of the ground it makes many areas inaccessible to heavy equipment and work is put on hold or deferred.

Although oil prices have remained high, gas prices have only recently shown signs of positive recovery. The higher gas prices have occurred after E&P companies had planned their 2008 capital expenditure budgets. Many E&P companies in the second quarter announced increases to their capital budgets which should increase activity levels in Q3 and Q4.

The Canadian dollar remains strong, trading at close to par with the U.S. dollar and has appreciated by over 15% in the last year.

Last fall, the Alberta government announced their intention to increase royalties charged to oil and gas companies. This reduces their economics and ultimately their capital spending. On April 10th, the Alberta government announced enhancements to the royalty rates, designed to improve the economics of production from deep wells drilled commencing in 2009. These revisions most likely will be seen positively by E&P companies.

Industry costs escalated significantly in 2005 and 2006 and did not subside in 2007 and we do continue to see cost pressures in 2008 in the industry.

Reduced oil and gas activity has led to increased competition within the services industry. And although the industry in Canada is still experiencing these significant headwind CE Franklin produced a positive second quarter results.

I'll update everyone on our strategies. Our oil field supply business have revenue of $88.1 million in Q2 2008, an increase of 15% over the prior year quarter. The acquisition of JEN Supply in December 2007 has strengthened our competitive position in east central Alberta. The integration of JEN Supply was completed by the end of the first quarter.

With the recent move to our new 153,000 square foot distribution centre and our established strength in north-eastern British Columbia and south-east Saskatchewan where activity is increasing, CE Franklin is positioned well for future increases in market activity.

Our oil sands strategy generated revenue in Q2 2008 of $3.7 million, comparable to the prior year quarter. We are making good progress on penetrating this business channel with a growing order book for the remainder of 2008. Many oil sands projects that our customers are working on are being delayed for reasons such as royalty review process, labor shortages, and other planning problems.

Forward-looking at more confidence in CE Franklin's ability to add value to our customers' oil sands projects and to gain market share by deploying our existing supply chair capabilities. We reported out last quarter we expected year-over-year oil sands revenue to be flat. We now anticipate the 2008 revenue will modestly outpace the 2007 results.

The production service diversification strategy was accelerated with the acquisition of Full Tilt Field Services in July of 2007. Overall production service revenue was 3.5 million in Q2, more than double the prior year quarter. We plan to differentiate our offering from other oil field equipment distributors by servicing more of our customers' product life cycle requirements.

Our international revenue was 1.1 million in Q2, comparable to the prior year and is comprised of capital project orders service from our Edmonton distribution centre. We established our Libyan joint venture operation in 2007, which is not yet material to our overall results.

Looking at sales and reviewing CE Franklin's second quarter results, sales for the second quarter were $96.4 million, this is an increase of 16% for the quarter compared to the prior year quarter. The increase in sales was positively impacted by the results of JEN Supply and the Full Tilt acquisitions.

Second quarter sales are seasonally low due to break-up, declining by 31% from Q1 sales an improvement from the 46% decline during the same period last year. Sales of product used in our customers' capital projects represented approximately 54% of overall CE Franklin sales in the second quarter at $52.2 million.

This increased by 17% from the same quarter last year, due in part to the increase in rig count. Sales of maintenance repair and operating products and services used in customer production activities were approximately 44.2 million in the second quarter, an increase of 15% from the prior year period.

Sales year-to-date are 237 million, comparable to the 2007 period. Capital projects year-to-date are 54% of revenue and MRO sales 46% of revenue. Sales year-to-date compared to the prior year increased by 26% in Saskatchewan and 8% in British Columbia, while declining 13% in Alberta, reflecting the oil and gas industry's response to the Alberta royalty announcement last fall.

CE Franklin's gross profit for the second quarter was 19 million. This is an increase of 13% over the prior year quarter. Gross profit margins as a percentage of sales were 19.7% for the quarter, compared to 20.3% from the previous year period.

Gross profit margins were almost a half percent higher than the first quarter profit margin of 19.3%. Gross profit year-to-date was 46 million, an increase of 7% compared to the prior year period. Gross profit margins as a percentage of sales were 19.4%, compared to year-to-date 2007 results of 18.2%.

Selling, general and administrative costs were 16.7 million in the second quarter, up 18% year-over-year, primarily due to the increase in people and facility costs associated with the acquisition of Full Tilt and JEN Supply, and higher facility costs at the new distribution centre.

SG&A costs were 17% of sales in the quarter, consistent with the prior year period. SG&A was down 200,000 from the first quarter. SG&A year-to-date was 33.6 million, up 15% year-over-year. The SG&A increases include increased lease costs, increased fuel costs, as well as the people costs associated with the acquisition of Full Tilt and JEN Supply.

Other expenses including amortization, interest and foreign exchange in the second quarter were 800,000, down about 900,000 from the prior year's second quarter. The decrease was due mainly to reduced debt levels in the second quarter of 2008, and a reduction of foreign exchange losses experienced in the second quarter of 2007.

The Company's effective tax rate for the quarter ended June 30, 2008 declined to 35.2% from 35.9% for the second quarter of 2007, due to a general reduction in corporate tax rates. Substantially all of the Company's tax provision is currently payable.

Net income for the quarter ended June 30, 2008 was 1 million, up 400,000 or 67% from the prior year period. Net income as a percentage of sales was 1%, up from the 7/10ths of a percent in the prior year period.

The weighted average number of shares outstanding during the second quarter was comparable to the prior year period. Net income per share was $0.05 in the second quarter of 2008, compared to $0.03 in the second quarter of 2007.

Net income year-to-date was 7.2 million, up 200,000 from the previous year's net income as at June 30, 2008. Net income per share was $0.39 for the first six months of the year, compared to $0.38 for the prior year period.

Looking at the liquidity and capital resources of CE Franklin, as at June 30, 2008 borrowings under the Company's bank operating loan were 18.4 million, a decrease of 25.9 million from December 31, 2007. Borrowing levels have decreased mainly due to the Company generating 9.1 million in cash flow from operating activities before net change in non-cash working capital balances and a 19.9 reduction in net working capital.

Net working capital was 114.9 million at June 30, 2008, a decrease of 19.8 million from December 31, 2007. Accounts receivable decreased by 5.2 million, or 6%, to 84.1 million at June 30, 2008, from December 31, 2007, due to the seasonal decrease in sales in the second quarter, offset by an 18% increase in days sales outstanding and accounts receivable, or DSO, in the second quarter of 2008, compared to the fourth quarter of 2007.

DSO was 73 days for the second quarter of 2008, compared to 62 days in the fourth quarter of 2007, and 63 days in the second quarter of 2007. The deterioration in DSO performance during the second quarter was due in part to temporary issues associated with the implementation of a new invoicing system that have now been rectified.

Inventory decreased by 3.5 million, or 4% at June 30, 2008, from December 31, 2007. Inventory turns for the second quarter of 2008 improved to 3.7 times, compared to 2.8 times in the second quarter of 2007, and 4.3 times in the fourth quarter of 2007. The Company will continue to address its investments in inventory in order to align with the anticipated activity levels in order to improve inventory turnover efficiency.

Accounts payable and accrued liabilities increased by 12.6 million, or 28% in the second quarter of 2008 from December 31, 2007, due to a seasonal increase in purchasing, combined with slower payment to suppliers.

The Company has a 364-day operating loan facility in the amount of 60 million arranged with a syndicate of three banks that matures in July of 2009. The Company's financial position is strong, with approximately 41 million of available undrawn bank lines at June 30th.

As at June 30, 2008, the Company's average debt to EBITDA ratio was 1.2 times for the last 12 months, and compared favorably to the debt to EBITDA borrowing covenant of 2.25times. As at June 30, 2008, the ration of the Company's debt to total capitalization was comprised 13% compared to 25% at June 30, 2007.

CE Franklin remains focused on growth and its strategies and will continue to work vigorously to improve its competitive position. The market environment in Canada is looking slightly more positive and CE Franklin is well positioned for incremental growth as the market activity improves.

Over the medium to longer term the Company is optimistic that its strong competitive position will enable it to take advantage of available market share, when natural gas prices recover to historic energy equivalent price relationships to oil, resulting in renewed conventional industrial industry activity and demand for the Company's products.

Effective execution of the Company's oil sands and service diversification strategy provide further opportunities to leverage supply chain infrastructure. Matt, I'll now turn the call back over to questions.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from Sean Boyd of Westcliff Capital Management. Please go ahead.

Sean Boyd - Westcliff Capital Management

Good morning. How are you doing Michael, Mark?

Michael West

Good, Sean, thank you.

Sean Boyd - Westcliff Capital Management

I guess I'd like to start off with the obvious here. There's two parts to this. Given what we've seen up until the last week or so, in terms of the better than net gas prices and increases in activity, especially down here in the States first and it seems to be coming up into Canada, the back half of the year. Can you just tell us where you're thinking you might see activity levels? So what you think you'd see on a year-of-year change in the rate count and then on completions.

Michael West

There's a lot of different opinions out there, Sean, everyone from Lehman's to CAODC to PSAC have given guidance and everyone of them has improved their outlook in the last half of the year. If you took a consensus averaging of what they're looking at, you'd say activity levels are probably up close to 10% year-over-year in the last half of the year.

When you break it down, in some of the companies that are reporting capital budget shifts, the larger companies, the ones that do over a billion dollars a year in CapEx are only shifting their budgets slightly, anywhere from 2 to 5%. The companies would spend somewhere between 300 million and a billion, more aggressively shifting their capital budget focus.

So that may be a long-winded answer to -- basically consensus is close to 10% on a year-over-year basis in activity level improvement, and I concur right now with that being the case. And there is a potential that it could do better than that as well.

 

Sean Boyd - Westcliff Capital Management

 

Got it, okay. And while it's extremely early I realize, and I'm not sure any of us has a real understanding as to what the sudden disinterest in natural gas is, has been driven by, but I have to ask is there -- has that changed anything?

Has that filtered through to you in any way in terms of maybe, I don't know, maybe some real smaller private operators decreasing orders or getting a little nervous due to the recent downturn in natural gas?

Michael West

Yes, nothing that's filtered through to us yet. Obviously, any time that the price comes off like it has in the last week, it causes people to step back and look and reflect. Some of the things that affected the downturn in Canada but didn't affect the rest of the world: the royalty review, the appreciation in the Canadian dollar, the royalty trust conversion to a direct tax model and some of those things.

That's all settled right now, and you know, even at the gas prices back in the $9.00 range, we should be economically competitive in Canada in order to compete globally, so I think the industry needs to continue to do a better job of improving its efficiency, its planning and its overall supply chain costs.

I think that's where we excel, and so you know, even with the retraction in gas prices, I would say that I would still be comfortable with the market activity guidance I just gave unless the price, you know, comes off a lot further than what it has.

Sean Boyd - Westcliff Capital Management

Got it. It's there. And so going back to that prospect of, you know, 10% year-over-year increases in activity, maybe a little better, walk us through how we should expect that to filter down into the two segments, capital projects and MRO.

Michael West

I think you'll see the capital projects increase a little more than the MRO. When they increased these CapEx budgets, it's to build new facilities or new exploration. MRO is a little more consistent. It's maintenance, repair and operating piece, so the increase that we're looking at, the majority of that will be in the capital project side of the business.

Sean Boyd - Westcliff Capital Management

Okay and obviously given your performance in the past where you guys have generally exceeded activity and actually in the last quarter by quite a bit, that would mean considerably higher growth than the 10% year-over-year overall activity.

Michael West

Our commitment remains the same. We need to -- and it's been consistent in the six years that I've been here -- we'll outperform the market activity on a year-on-year basis in topline growth. And with the investments we've made in our distribution center and expanding some of our branch operations network, being well-positioned in Northeast BC and in Southern Saskatchewan and being in the right size facilities now, we'll get the discipline and incremental flow-through that we've shown in the past as well.

Sean Boyd - Westcliff Capital Management

Very good. I appreciate that additional color.

Moving down below the revenue line, if we could, on the margins, we do have higher steel costs here, and I'm just wondering last year I think the company ran in the neighborhood of 18% margins. That was, of course, or that -- I guess we have the impact of the steel costs now. We also have the acquisitions running full bore. That will be probably a pretty minor impact, but can you help us on that?

Because you are -- at the same time you ran, you know, darn near 20% in the last quarter, 19%, a little over 19% in the first quarter. Can we think about 19% to 20% margins here or do we have to think about something more like that 18% from the back half of last year?

Michael West

On the product margin piece, you get a little bit of -- it gets interesting. The conventional business, the conventional oil and gas business and the service diversification has helped our margins grow.

Just commenting real quickly and I've even noticed there's a couple of our competitors dialed in to listen to the call. Some of the activities and actions going on in the marketplace are counterintuitive to where the pricing's going with steel, et cetera.

So we're still at a very competitive environment where folks are still liquidating inventories at a time when the replacement cost is going to go up exponentially. So I'm hoping the industry will get a little more discipline as we go forward.

The oil sands piece as we continue to grow that strategy, the oil sands product margins are traditionally at lower margins than our conventional oil and gas business, but the overall EBIT margins are very similar. So the product margins are lower, but a lot of the infrastructure costs we've already invested in, so we get the incremental flow-through on that.

So you might see, depending on how quickly the oil sands business mixes into that, you could see the margins drop back to 18% blended in certain quarters, depending on when the projects actually are billed. But they would -- if you saw the margin erosion like that, you wouldn't see EBIT erosion at the same time if that helps you at all.

Sean Boyd - Westcliff Capital Management

That does. That's interesting and that brings us to my oil sands question in that I want to make sure I've got some okay numbers on this. And specifically, I had that you did about $25 million in oil sands in '07 and maybe …

Michael West

Yes, $24.7 million or something. You can round it to $25 million, yes.

Sean Boyd - Westcliff Capital Management

Okay and that was about $19 million in '06?

Michael West

Yes, a little less than that but yes.

Sean Boyd - Westcliff Capital Management

Okay and so I thought it was interesting in your opening comments there saying that we now expected to modestly outpace '07, so just for an over or under, is that, you know, does that mean just a few percent better or this acceleration?

Because as I recall, this was a business that once we get through these long sales cycles, we should really see an inflection. Are we now thinking that inflection starts in '08 a little bit? Can you just give us a little more color in that improvement in your guidance?

Michael West

Yes, there's, you know, we've continued to be aggressive in our sales and marketing strategy in oil sands and our customer list continues to expand. And we've just been successful in a couple of projects where the work will be done in the lower half of this year, which gives us comfort moving that number up nominally. And then I have way more confidence that the $60 million number that we've guidance on next year will be delivered.

So it's just a case of winning a couple of projects in the $2 to $3 million range that gives us comfort that some of the revenue will fall into the third and fourth quarter this year.

Sean Boyd - Westcliff Capital Management

Got it. Okay, helpful. And if I could, just on the other -- on that breakdown, can you -- and if you've provided this in the past I apologize -- but can you just give us what the production services in international businesses were in '07 and '06, just annual revenues?

Michael West

 

International year-to-date in '07 was $2.7 million so pretty close to what it is this year, and in 2006 the international business was about $4.6 million by the end of the year on an annualized basis, and in '05 it was $5.4 million.

And the production services, I can only give you the annual numbers off the top of my head. The annual production revenue in 2006 was $6.9 million, and I think the year before that it was just under $6 million.

You can find that in our annual reports where it breaks down the Western Canada oil field, the oil sands, the production services and the international revenue for the last three years.

Sean Boyd - Westcliff Capital Management

Okay, easy enough. Last question is on the SG&A. We're running a bit higher. We obviously have the acquisitions integrated at this point. If I think about, you know, $17 to $17.5 million a quarter, is that a fair number into the back half or should we expect that to be up or down?

Michael West

You know, where the cost has gone up a bit, as we said, we've invested in some new facilities that will facilitate the growth as the activity cycle improves, so we're paying more for larger facilities. Then obviously as lease renewals come up in this environmental cost escalation, we've experienced some building lease increases.

The wage, the labor market remains competitive here, so we continue to have wage pressures. The cost of gas to run our fleet of 150 vehicles has gone up quite a bit as well. And then the natural gas cost to heat our facilities in the winter months goes up as well as the price in natural gas has gone up. So those are the factors that are driving it as well as the acquisitions. If you back out the acquisitions and just look at the organic business, our headcount is down year-over-year.

Going forward, our run rate in the second quarter looks good going forward other than there will be some incremental people costs as the revenue grows, but again, we'll get the incremental flow through the EBITDA at the 10% or greater going forward if that helps you in kind of modeling what the SG&A piece would be.

Sean Boyd - Westcliff Capital Management

Incremental flow-through on your EBITDA or EBIT?

Michael West

EBITDA.

Sean Boyd - Westcliff Capital Management

Right. Okay, that's it for me for now, Michael. Thank you.

Michael West

Thank you very much, Sean. Appreciate your interest.

Sean Boyd - Westcliff Capital Management

Absolutely.

Operator

 

Your next question comes from Ward Grey (ph), a private investor. Please go ahead, sir.

Ward Grey - Private Investor

Yes, good morning, gentlemen.

Michael West

Good morning, Ward.

Ward Grey - Private Investor

Couple of questions. First, in relation to the royalty review, is that now finished with the Alberta royalty review? And then following on from that, with your increased activity now in British Columbia and other areas, do you see that picking up and what is the sort of a potential area compared to what it's been in Alberta, which obviously, is the principal area.

Michael West

First, the royalty review process is over. The only outstanding issue to my recollection is that sin crude and the government are still negotiating. They, sin crude had signed an agreement with the government, I think, 15 years ago, so they're still working on what royalty changes had in the way of impact going forward.

Otherwise, the royalty structure is as is. The E&P companies are now adjusting to that, so as we said in April, they did do some slight modifications, which we think will be helpful on a go-forward basis.

And, you know, as I've said publically and at a couple of lesser conferences, it's the industries responsible to get into a competitive position where we can compete globally, so it's the service and the E&P companies' responsibilities to adjust to the tax structure and the economic reality and stay competitively positioned.

The work in BC is in Northeastern BC. There's large gas opportunities in that region. There's a lot of land sales that are going on right now, so we see increased land sales and directionally we've seen E&P companies start to talk about CapEx programs and drilling programs.

I don't know that we have enough information to know exactly what that increase is going to be, but you know, when I talked earlier in the script about what the revenue had increased year-over-year in that area, I think that will remain consistent or might even grow slightly more.

And then same with Southeastern Saskatchewan. That's more of an oil-driven piece, and as long as the oil prices remain high and the Saskatchewan tax structure is obviously a lot more attractive, you're going to see those areas grow as well.

I wouldn't be at all surprised to see when you talk about the 10% increase that it'll be 10% more in each of the regions as they just continue to grow. That may be consistent although there might be a slight expansion in Northeast BC and Saskatchewan and not quite as much acceleration in Alberta. It's hard to say right now.

Ward Grey - Private Investor

Okay and just coming back to the outlook for the second half in the tallying of sales and so forth, in the past you've made comments that when activity changes and you get a lot of sort of walk-in sales that your margin's actually higher than when you're bidding. Are you going to notice a benefit to margin in relation to those sort of transactions because obviously three or four months ago they weren't anticipated?

Michael West

Actually, the activity level is increasing on both ends, and what happens is that there's a lot more bidding activity, a lot more of the activity that's planned, and so that's been a competitive bid type situation and then as there's more work going on, the ancillary work that ties into that. So the more bid work and the more projects that get started, then the more ancillary and walk-in business to do add-ons or whatever else. So I think you'll see both go up at the same time.

And again, we're saying the capital business is going to grow more than the MRO business, and then from that capital business, the majority of it will be more budgeted bid type business or alliance customers that are doing the activity, but there is the -- it will bring the walk-in activity up as well but not at the same rate as the bid or planned work.

Ward Grey - Private Investor

Now tying in a comment in relation to inventory reduction, you're still well-placed with your inventories to cope with this extra work that's coming up?

Michael West

We are positioned, I think, well with our inventory investment. What we are seeing is cost escalations, so some of -- you're going to see our inventory start to increase in value a bit in the short term as we invest, and that's just because the per ton price for inventory is going up.

Our inventory turn performance still needs to improve, and we continue to work on that. And year-over-year it was a full turn better this year's quarter versus last year's, but I think we're well positioned.

There are material shortages globally. The mills are struggling to keep up. We feel that with our size that we're well positioned in the queue. We try to leverage our procurement with Wilson where possible and those relationships with the mills.

And you know, some of the inventory bulge that we saw 18 months ago where we did not cancel purchase orders with those mills will play well now in our position and the relationship we have with those mills going forward. So our inventory investment is adequate, and we'll continue to improve the efficiency, but we'll probably make investments in inventory as the activity level grows.

Ward Grey - Private Investor

Right. Now, from our own viewpoint, we were looking at timing of your sales compared to the movement in, say, well completion numbers or rig counts. What sort of -- from quarter to quarter is this a quarter late or six months late or what's the –

Michael West

Yes, for the first time actually, Ward, we're seeing a divergence in the rig count versus the well completions, and that happens from time to time. It usually lasts a quarter, but it's now been two quarters in a row where they've gone in opposite directions kind of thing. And so I think you'll see a bit of a catch-up in the well completion piece, which should help us, a little bit of catch up activity going forward, which should be helpful.

And so, you know, as the rigs work, the lag time's been a little longer than normal and some of that was I think some of the E&P companies stopped to reflect on the increases in pipe costs and oil country tubular goods, and so there was a little bit of pause in between them actually finishing off the completions, and so you'll see that catch-up. And the lifetime should be no different historically than it has been in the past.

Ward Grey - Private Investor

I noticed I think one of the last months there was a high degree of dry wells. Do you get any well completion work out of that or do they just plug that and just walk?

Michael West

No, that's -- dusters aren't good for us.

Ward Grey - Private Investor

Right. Yes because that could have affected the rig count.

Michael West

 

A little bit.

Ward Grey - Private Investor

Well completions, yes. And just a follow-on point. You made a comment in relation to the parity of oil and gas. What -- do you use the energy relationship of 6 to 1 or do you use -- other people talk about 11 to 1. What sort of parity would you say between the energy comparing of oil and gas?

Michael West

It used to be 6 to 1. Right now we'd be happy with 10 to 1.

Ward Grey - Private Investor

Yes but when you're using that, saying coming back to parity, you're talking about gas coming back or gas going up? Ideally, we'd want gas to go up.

 

Michael West

We were hoping the gas was going to go up a little more.

Ward Grey - Private Investor

Yes because I think PSAC said that anything over about, what, $6.00 or something, it justified the investments and so forth. So even at $10.00 or $9.00, it's still -- the activity levels should hold, shouldn't they?

Michael West

That's a number that's been used in the past, and companies are a little slow declaring what the push point is on a number now. With this new royalty structure, they've been a little close to the vest on what's economical and what isn't. And in some cases, it depends on whether it's deep gas or what it is you're drilling for what the price point is that makes it economical or not.

Ward Grey - Private Investor

Right.

Michael West

But at $9.00, $10.00, it should be economical. As I said, it's economical everywhere else in the world, so we need to be competitive.

Ward Grey - Private Investor

Well, very well. Thank you very much.

Michael West

Thank you.

Operator

Your next question comes from Doug Cooper of Paradigm Capital. Please go ahead.

Doug Cooper - Paradigm Capital

Hi, Mike. Just a quick question. You talked about Saskatchewan being up, I think, 26% year-over-year and I guess, I'm sorry, NBC being up 8%. What kind of base are those coming off? Do you have the actual sort of absolute dollar figures for those areas?

Michael West

Not off the top of my head I don't, no.

Doug Cooper - Paradigm Capital

 

Just ballpark as a percentage of your total sales, would Alberta still be, you know, 70% or…

Michael West

In there. In around 70%, 75%, yes.

Doug Cooper - Paradigm Capital

Okay, thanks, Mike. That's all I got.

Michael West

Thanks, Doug.

Operator

Your next question comes from Jackson Spears of Capstone. Please go ahead.

Jackson Spears - Capstone Investments

Hi. Congratulations. Those numbers were great, and I'm glad you're feeling better with your outlook. Much improved.

What about the cost pressures from suppliers? Are you able to pass most of that along or could that put some pressures on margins going forward?

Michael West

For the most part, we do pass the costs on, and that's structured into our agreements. Sometimes there's a timing or a notification period that plays into that, but for the most part, Jack, it is a flow-through, and it's never been material to the change in our margin performance, so we've never broke it out or reported out on it.

Jackson Spears - Capstone Investments

You mentioned the value of your inventory's going up. Could there be some inventory profit going forward in the third or fourth quarter?

Michael West

You know, intuitively I would say yes just on the material cost, the replacement cost increase, as you're selling product. But again, it's never been material where we've reported it out. It, you know, may be one tenth or two tenths of a percent for a quarter, but it's never been material.

Jackson Spears - Capstone Investments

You have an active acquisition strategy, and you're still looking. What areas are you focusing on and what kind of reaction are you getting from potential acquisition targets?

Michael West

We look at areas that will diversify the service offering that we currently provide, will expand the product scope or expertise that we currently have that we think would add value to our customers and make sense in the supply chain, and we'd also look at consolidation opportunities within the industry.

And again, they'd have to be accretive to shareholders in order to provide value, so we continue to look. And it has to be the right strategic fit and the right strategic price, and so yes, we would like to do more. Obviously, with our balance sheet and our cash position, we're well positioned should we find the right opportunity to execute the transaction.

Jackson Spears - Capstone Investments

You have a number of major customers. Is there any change in their relationship with you? Have some customers now gotten bigger than they were in the past like Petrol-Canada or Talisman?

Michael West

There's been some M&A activity, you know, Penn West and Canetic merged together to form a bigger company. We didn't have all of Penn West's business. We had portions of it and product mix. There's been, you know, Dura-Vent was acquired by Shell here very recently, nothing that would be material to a change in our results that we would report out.

Obviously, there will continue to be M&A activity in the E&P side, and there is a lag. In my own personal opinion, there's a lag in consolidation in the services sector in Canada, and the E&P guys are moving forward. I think there needs to be consolidation in the service section.

Jackson Spears - Capstone Investments

Your new distribution center opened in June. How is that going to affect your costs or your modus operandi, your operations?

Michael West

It actually opened in April, and so it was reflective in our costs in Q2 and was one of the reasons for the increase in the costs. The facility, the way I look at it, is it is more expensive to operate. It's 153,000 square feet. It's got a lot more capacity. It's got the ability to flow about 75% more capacity through it the way it's designed.

It is more expensive, but ultimately, as the market activity corrects itself and when it does return and as we continue to diversify our strategies and gain market share, the cost per revenue dollar should actually decrease over time. So it's reflective in our Q2 results and gives us a lot of capacity to execute our oil sands strategy as well as get the incremental flow-through.

Jackson Spears - Capstone Investments

Thanks, Mike.

Michael West

Thank you, Jack.

Operator

 

Mr. West, there are currently no further questions.

Michael West

Okay, Matt so I'd like to thank everybody for their participation on the call today and their interest in CE Franklin. We look forward to talking to you again at the end of the third quarter.

Operator

I'm sorry to interrupt, Mr. West. I do have one follow-up question from Sean Boyd.

Michael West

Okay.

Operator

Okay. It'll just take me one second please. Mr. Boyd, please go ahead.

Sean Boyd - Westcliff Capital Management

Thanks. One more if I could, Michael.

Michael West

Sure.

Sean Boyd - Westcliff Capital Management

Your comments there on the center have just got me thinking, and I'm sure you've mentioned it in the past, but revenue capacity at this point on absolute level would be what?

Michael West

Revenue capacity in what terms? What the capacity level of the company would be?

Sean Boyd - Westcliff Capital Management

Yes.

Michael West

I'm not sure that I know the exact number to be honest with you. We could certainly withstand a 20% to 30% revenue increase without hitting any kind of capacity constraints in the organization, and the facility itself has 75% more capability now.

So the distribution center itself, if it had 75% more capability, I could give you a little bit of guidance based on our current revenue stream, which looks like it's on course for about $500 million in that range. We obviously have the ability in our Edmonton distribution center to grow that by about 75%.

Sean Boyd - Westcliff Capital Management

Got it, okay. And on the oil sands, just two sides to this: You mentioned the potential margin pressure in the early days as you ramped that, but longer term, does that business have significantly different margins than the oil fields?

Michael West

 

Yes, it does. The project work, the capital project work has much lower product margins. There's a lot less infrastructure costs though as well to deliver those projects, so the product margin is lower, and that's on the capital project side where the majority of the spend is in the oil sands right now.

On a go-forward basis, we continue to work on our MRO strategy as those facilities are put in place. They do need maintenance, repair and operating equipment, and those will be at higher margins, so eventually you'll see the margins start to come back up.

Those projects on that large a scale, a lot of the work that we do, some of the material goes direct from the mill to the customer site, and obviously, we don't need as much of a margin, and we don't have as much cost structure. And then there are other parts of the project -- we're doing the marshalling at our facility, bagging and tagging to go to sites, et cetera, and that's why the margins are different. The work's different.

Sean Boyd - Westcliff Capital Management

Got it. But even all next year where we're talking about a $60 million business with an upturn in activity here, hopefully that -- while that is fantastic growth, it is still going to be a small enough component of the overall business. It's probably not -- we're not going to see that much of an impact I wouldn't think on the margins.

Michael West

On the overall margins, no. You know, like I said, it may reduce by about 1% on an overall gross product profit margin basis, and then on an EBITDA margin basis it will probably be positive actually in our incremental flow-through commitment.

Sean Boyd - Westcliff Capital Management

In your flow-through. Got it, got it. And just last thing on that, at $60 million or maybe at the idea of it being a $100 million a year business at some point is the breakout between capital projects and MRO similar to oil fields or different?

 

Michael West

Right now it's heavier skewed to capital projects versus MRO. Eventually that will close, but over the next two to three years, it will be heavily weighted towards capital versus MRO.

Sean Boyd - Westcliff Capital Management

Like 75%, 80% at least kind of a thing?

Michael West

Yes.

Sean Boyd - Westcliff Capital Management

Okay, thank you very much. Congrats on the quarter.

Michael West

Thank you.

Operator

 

Please continue, Mr. West.

Michael West

Okay, Matt. Again, I'd like to thank everyone for their interest in CE Franklin. Any employees who have dialed in, I'd like to thank them for their hard work and the results they delivered, and we're committed toward continuing to improve as we go forward. Thanks, everybody, for your interest. Enjoy your day.

Operator

Ladies and gentlemen, this concludes the conference call for today. Thanks for participating. Please disconnect your line.

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