Essential Energy Services' (EEYUF) CEO Garnet Amundson on Q3 2017 Results - Earnings Call Transcript

|
About: Essential Energy Services Ltd. (EEYUF)
by: SA Transcripts

Essential Energy Services Ltd. (OTCPK:EEYUF) Q3 2017 Earnings Conference Call November 9, 2017 12:00 PM ET

Executives

Karen Perasalo – Vice President-Investor Relations

Garnet Amundson – President and Chief Executive Officer

Allan Mowbray – Chief Financial Officer

Analysts

Reid Southwick – Calgary Herald

Jeff Fetterly – Peters & Company

Andrew Bradford – Raymond James

Operator

Good morning, ladies and gentlemen. Welcome to the Essential Energy Services Ltd. Third Quarter Results Conference Call and Webcast. I’d like to turn the meeting over to Ms. Karen Perasalo, VP, Investor Relations. Please go ahead, Ms. Perasalo.

Karen Perasalo

Thank you, John. Good morning, and thank you for joining our third quarter conference call. With me on the call are: Garnet Amundson, President and CEO; Jeff Newman, Senior VP, Business Development; and Allan Mowbray, CFO.

This morning, we will touch on the recent patent litigation decision, give you an overview of our third quarter results, speak to the outlook and then open the line for questions. In this conference call, we will be discussing financial measures, including certain non-IFRS financial measures such as EBITDA. Please see our November 8, 2017, third quarter news release for definitions of these terms.

Today’s call may include forward-looking statements. Such statements are given as of the date of this call and involve risks and uncertainties. A number of factors and assumptions were used to formulate such statements. Actual results could differ materially, and there can be no assurance of future performance or market impact. For additional information with respect to forward-looking statements, factors and assumptions, refer to our November 8, 2017, third quarter news release. In today’s call, we will refer to the Essential Coil Well Service operating division as ECWS.

I will now turn the call over to Garnet.

Garnet Amundson

Thank you, Karen. Good morning, everyone. First, I’ll say a few words about the patent litigation decision. We were thrilled with last week’s court decision that indicated the patent claims were not valid and that Essential did not infringe the patent. This confirms our view of the last 4 years that the case was without merit. This ruling was very positive and significant for our business, investors and employees.

The details of the court order are confidential for 30 days, allowing the plaintiff and defendants time to request redactions to protect confidentiality. As a result, we can’t share specifics behind the decisions today.

A few other things to note with regard to the possibility of appeal and recovery of costs. Packers Plus has up to 30 days from the date of the court decision to appeal the ruling. To be successful against Essential, both decisions, invalidity of – the invalidity and not infringed, would need to be overturned. And the court awarded Essential recovery of costs for both cases. Essential incurred significant defense costs on the litigation, but it is too early to estimate the amount and timing of the recovery.

Now a few comments about the overview of Q3 results. Yesterday, we reported strong results that were a significant financial and operational improvement compared to Q3 2016. Revenue of $49 million was 87% higher than the prior year quarter. EBITDAS of $8.5 million was much improved from $1.4 million in Q3 2016. ECWS and Tryton both performed well and benefited from a broader customer base and stronger industry activity as customer demand for well completions continued to improve. In addition, weather cooperated during this quarter. There was very little weather-related downtime. Essential’s debt at the end of December 2017 was $21 million and bank – debt to bank EBITDA was 0.8x. Debt increased from Q2 2017, which is natural as activity increases, and working capital increased due to higher accounts receivable.

Working capital of $57 million remains well in excess of debt. Allan Mowbray will now speak to our Q3 operating and financial results in more detail.

Allan Mowbray

Thank you, Garnet. Good morning. ECWS revenue was $28.6 million, a 106% increase from Q3 2016. The increase was due to stronger activity and higher revenue per hour. Our Gen III coil tubing rigs and higher pressure fluid pumpers continued to experience strong demand as customers completed long reach horizontal wells, particularly in the Montney region. We did not experience any sequential service pricing gains Q3 2017 compared to Q2 2017. Our revenue per hour increased due to the mix of work.

Compared to Q3 2016, revenue per hour was higher due to price increases implemented in Q1 2017. Gross margin as a percentage of revenue was 23%, a significant improvement from 12% in Q3 2016. This was driven by greater activity in the benefit of more – of our more efficient cost structure. Year-to-date results for ECWS reflect the resurgence in industry well completion activity since the beginning of 2017. ECWS revenue was almost 2x higher than the first 9 months of 2016. Gross margin was 19% compared to 6% for the 9 months ended September 2016.

Now over to Tryton. Tryton generated $20.1 million of revenue in Q3 2017, a 64% increase from the prior year quarter. Each Tryton service line reported higher revenue than the same period in 2016, but most notably, MSFS tool revenue experienced the greatest increase, and conventional tools revenue increased due to higher demand for maintenance work on producing wells. Tryton gross margin as a percentage of revenue was 27% in Q3 2017 compared to 18% in Q3 2016. On a year-to-date basis in 2017, gross margin was 25%, a substantial increase from 12% in the prior year period. The improvement was due to increased revenue and Tryton’s variable cost structure and fixed costs comprised a smaller proportion of revenue. Essential’s capital spending plans for 2017 of $23 million remain unchanged and on track.

I’ll now pass it back to Garnet to go over the [indiscernible]

Garnet Amundson

Thanks. Higher commodity prices in 2017 have supported E&P spending and resulted in greater demand for oil services – oilfield services in the WCSB, especially for completion related services. Essential has benefited from that. We expect fourth quarter activity to remain steady, with a possible slowdown later in the quarter as customers complete their 2017 capital programs and strive to maintain spending within cash flow.

We have seen some weather-related slowdown in early November as our ability to move heavy equipment on nonfrozen roads is impeded, but that is expected to be short-lived. The outlook for Q1 2018 is positive. Indicators suggest that first quarter industry well completion activity will continue to be strong, assuming commodity prices remain near current levels. Visibility for Q1 will become clearer as customers announce their 2018 capital budgets.

Essential does not expect meaningful pricing increases for its products and services in the near term with the exception of incremental pricing to partially offset rising labor costs in ECWS. Recently, we made the decision to increase ECWS hourly wages to preserve our competition, our competitive position in a battle to retain and attract skilled workers. We still need to see stronger activity for customers to support increased pricing for our services.

ECWS continues to recruit employees to reactivate more coil tubing and pumper packages for the first quarter of 2018. Approximately half of Essential’s 31 coil tubing rigs are considered active and ready for work. As activity increases and the employee base grows, Essential will activate more of its existing fleet.

In closing, with the largest coil tubing fleets in Canada, associated pumping services and an established downhole tools & rental operations, Essential is well positioned to succeed as the industry recovery continues. We have a well completion focus, a highly experienced and dedicated workforce, idle equipment that can be reactivated as activity increases, long-term customer relationships, a top-tier safety record and a strong balance sheet with low debt.

With the overhang of the patent litigation gone, we’re excited to direct our focus on a positive future, one of growth and improved profitability.

Karen Perasalo

John, at this time, we would like to open it up for questions.

Question-and-Answer Session

Operator

[Operator Instructions] First question is from Reid Southwick from Calgary Herald. Please go ahead.

Reid Southwick

Thanks for taking my question. I’m just wondering if you could provide a little bit more color on sort of the outlook, looking at – if you have any more numbers around how the – a key indicator of – sorry, I’m just referring to the news release here, where you’re looking at well completions. If you have any numbers around that? How it increased to 76% across the basin? And a little bit more color around what’s been happening there.

Garnet Amundson

Yes, good morning, Reid. We get a lot of our, I’ll say, our industry well completion information. Well we certainly look to industry groups like CAP, CAODC and PSAC, which basically recently updated, as you would have seen, their fourth quarter information. And then other than that, we’re now sort of in dialogue with our customers where in the area of well completions, equipment and availability of equipment has been a little tighter. So they have started engaging in those conversations with us. So it is really, I will call it, a bit of a leverage off. We look back to Q1 last year, see how we were doing, last year being Q1 2017 and then Q4 and then customer dialogue. So Allan, I don’t think there’s anything published yet from an official industry perspective on completion of data expectations for Q1 2018.

Allan Mowbray

There isn’t, no. No.

Garnet Amundson

So that’s really how we’re forming our view. And unlike I’ll say the good old days when customers might have been sort of contracting equipment or trying to get firm positions, right now it’s a bit of a mutual feeling out process where they’re assessing their own cash flow needs and their own production target needs and trying to, I’ll say have inquiring conversations about our equipment availability. So it’s a bit of a dance at this point, but I think that’s where our view of steady with hopeful, maybe even some uptick. That’s where we sit today.

Reid Southwick

Okay, and do you have any numbers around what the hard numbers are, with respect to those percentage increases like the 76% and 134%? And as well, do you have any – can you offer any kind of – do you feel like the strength is going to continue once we – I guess obviously, we don’t know what the producer budgets to a large degree are going to be. But do you think that kind of strength is going to continue?

Garnet Amundson

Well, I’ll answer the second part of the question first on the full year and an outlook. So we have used very much the language of steady, and I’ll say my own personal view, we’re still not done our 2018 budget. I would say that we can see reasons that, from a macro drilling industry point of view, I would be surprised to see 2018 being worse than 2017. But although we talk in the language of continued recovery, there’s lots of – there’s some industry analysts that cover us and write about the sector that would suggest that 2018 could be slightly below 2017.

We don’t see it that way. And then further, in the service lines that we’re in, in the completion space, combined with types of equipment that we have to offer, we’re actually hopeful that we can continue to make gains with our customers and see our own business expanding as we go into 2018, even if we have similar market conditions at an industry level. Your references to 76% was – that we put in 76% of well completions increasing. That was, I think we get that from JuneWarren-Nickel’s Energy Group. So that’s where the data, which is historic referring to the 9 months ended September 2017 compared to September 2016.

Reid Southwick

Okay. All right, fair enough. And just last question. Can you comment at all, a little bit further about any challenges you might be having in hiring – a labor crunch, a bit – is that continuing, that sort of thing?

Garnet Amundson

Yes, thanks. Great question to be asked. On the labor front, and I’ve chosen the script to use the word a battle for retaining and attracting people. We actually got some correspondence before when I talk along these lines because we know that Alberta and the Calgary area still has a significant unemployment rate, so it is troublesome for people to hear this. What we’ve been short on is actually people with the prior experience in the industry. We know that lots of our former employees left both Alberta, Western Canada, went home to the East. And they don’t want to come back to the industry because of the volatility, so we lost a portion of our labor pool.

The folks that we’re trying to bring in now, critical aspect for us is to make sure they’ve got Class 1 driver’s licenses. So we are seeing some indications where you can pick up Class 1 drivers but they don’t have any oilfield experience, and then oilfield workers without class 1 licenses. So basically, that puts us in a bit of a self-training mode, 30 to 60 days. Another unique factor is, you’ve seen the, some of the frackers in the industry, Tri-Chem, Calfrac, they are also – they’ve been having very successful quarters and they’re looking for exactly the same employee base as we are. So we’re all competing for a, I will say, a smaller pool of skilled labor, and I think there’s still some caution, too, where we’re trying to keep our, in our case, our costs under control and then not see cost inflation because our customers are not in a position to accept service pricing. So all in all, it’s quite a delicate dance.

Reid Southwick

Okay. Thank you.

Garnet Amundson

Thank you.

Operator

Thank you. The following question is from Jeff Fetterly from Peters & Company. Please go ahead.

Jeff Fetterly

Good morning all.

Garnet Amundson

Hey, Jeff.

Jeff Fetterly

On the coil tubing side, I know you mentioned that about 50% of the 31 units are running. Can you give us a breakdown of what is act over marketed today in terms of types of units?

Garnet Amundson

Sure. So we’ve got – on the Gen IV side, we’ve got – I’ll start with that. We’ve got a number of units, but we’ve been working one of them and, I’ll say sporadically in the last quarter. On the Gen III side, we’ve got a total available of 8, and we’ve got 6 available to work that we’ve been working. And 2 of the units that we acquired from Precision at the end of last year are still – haven’t been activated for no reason other than shortage of crews and literally, just haven’t made that time and attention focus.

They will be activated in the fourth quarter here, so we’ll then have 8 Gen IIIs available. In our Gen II fleet, we’ve got a total of 14, and we’ve had 8 of those active and working. And then we – the Gen Is, which are conventional trailer type units from a little smaller scale again, we’ve now adopted the language of Gen I, because that sort of where they fit in our history. And we’ve got 5 of those, with 2 of them available for working. So the math would add up there to 17 working rigs, of which – of total fleet of 31, so that’s where, about half is where the comment came from.

Jeff Fetterly

The 2 Gen IIIs being reactivated in Q4, what’s the line of sight for work on those?

Garnet Amundson

I think it’s pretty good. It’s – we commented before on our public materials, the Gen III equipment has been the, probably the highest in demand because of its ability to deal with a lot of the Montney, Duvernay light type wells. And again, we think we should be able to put all 8 of them to work in this marketplace, given where people are working. It was more of a, I’ll call it, just logistics and crew sizing, if I can say that, having enough guys available that we didn’t put our focus on getting the last 2 commissioned earlier.

Jeff Fetterly

But you do expect that they will be deployed in Q4?

Garnet Amundson

That is certainly our hope, yes.

Jeff Fetterly

Okay. The labor rate increase you mentioned earlier, do you expect that, that will be offset from a pricing standpoint so that can be pulled through fully?

Garnet Amundson

Probably the best way I could answer that question would be to say, I’m hopeful that we’ll have success with that dialogue. It is a very interesting marketplace out there. The right sequence of events is not to increase labor first and then go and try and ask for a price increase. But it appeared that some of our competitors got – we started having experiences and seeing lots of evidence where we were behind on labor rates. So we had to make that adjustment. That being said, we also know that it’s from a pricing discussion point of view, customers can be highly reasonable in terms of understanding if it’s offsetting our cost to keep the good people around. But at the same time, as I mentioned in the earlier call, those discussions, customers are also under a bit of a squeeze with their own margin issues. Perhaps with this recent little bump in oil price, it’ll make them in a better mood to accept price increases, but we’ll see.

Jeff Fetterly

Your comment earlier about, I guess, it was both coil tubing and Tryton that benefited from a broader customer base in Q3?

Garnet Amundson

Yes, I think my quote was in there. They both benefited from that, but I think related to the higher completions activity, was the context, but I would agree with that. I think broader customer base and greater completions.

Jeff Fetterly

And is that something that’s been a focus for you guys, especially on the coil tubing side? Or was that just of sort the nature of how customer activity has played out this year and – or specifically in Q3?

Garnet Amundson

I think it can be a bit of both. We’ve got a – like any oilfield service company, we’ve got a core group of, I’ll call it, favorite customers and the favorite word could probably apply both ways. They like us, we like them. And when you get a number of pieces of equipment on a regular basis out for a customer, when they’ve got a big ongoing budget, we tend to favor them in terms of making sure we can meet their needs. And at the same time, as industry activity has picked up, there’s been a broader list of names that have been needing coil. And in some cases, when they need coil and pumping, they’ve been a little more desperate and unable to get what they needed, and we’re really anxious to broaden our customer base given the available inactive equipment that we have.

So we’re making every effort to respond to that. Now the barrier has always been for us, since the downturn, we allow an awful lot of people go, as we were trying to control costs through 2015 and 2016. And now we’re trying to build up our workforce so we can broaden that customer base while still preserving critical things like safety. And so far, we’ve been successful. So it has been a conscious choice, and I think we’re heading down the right path. Because as we know, it’s always hard to predict what GMP is really going to take off and become tomorrow’s success story.

Jeff Fetterly

Last question. On the Tryton side, can you share how meaningful the U.S. contribution was in Q3? And how the year-over-year looked for the U.S. side of the business?

Garnet Amundson

Yes, we haven’t shown any specific quantification. And as we noted, it’s been cash flow positive for the – a few quarters. This is the best quarter that they’ve seen since probably 3 years. But it’s still in the more than hundreds of thousands of dollars more than the multimillion. So that’s why we haven’t sort of thrown a number to it. I think what we’re seeing there in the U.S. is, the demand is certainly there, they’re still suffering a little bit as well from, I’ll say, heavy competition factors. But what we’ve been doing now, it’s been 3 years that we’ve been working away in the U.S. We’ve really broadened our customer base there in the U.S. We really don’t do a lot of work without signing MSAs, so our team has been very busy signing up MSAs with a lot of customers. We’ve now got quite a broad roster actually of customers of some pretty well-known names. So I think as the U.S. industry stabilizes, as we get our rhythm back on, we hope to see that profitability continuing to grow.

Jeff Fetterly

On a relative basis, the Tryton business was up 64% year-over-year for revenue. Would the U.S. have grown faster then? Or recovered at a faster pace than that?

Garnet Amundson

I don’t have that right in front. The guys will look that up and see. My guess, off the top of my head is, is probably not. I would guess that the Canadian revenue growth probably exceeded the U.S., but we’ll see here if that pops up. Go ahead, Karen. You’ve got that data point in front of you?

Karen Perasalo

It did, but you’re dealing like on a percentage basis, that there’s a [indiscernible] there a bit more. But on a dollar basis, it’s a different story, right, because you’re starting with [indiscernible]

Operator

The following question is from Jim Monticello from Raymond James. Please go ahead.

Andrew Bradford

Hey, it’s Andrew, actually.

Garnet Amundson

Hello, Andrew.

Andrew Bradford

Hi. I wonder if you could just sort of describe the pricing dynamic. I know you touched on the labor rate flow through. But on the surface of it, some might say you’re – the dynamic should be fairly similar to what we’ve seen in other completions businesses where you have, still more equipment than you – than what you have in the field, so your utilization is not at 100%, but you’re constrained by labor. And in other completions segments that has caused a rising price environment. In your own words, why do you not see, or why have you not seen the same sort of pricing leverage in coil tubing?

Garnet Amundson

Thanks. Great question. In the deep coil space, which we’re referring to our – throughout our primary competitors, until capacity is absorbed, would be the frackers being Calfrac, Canyon and STEP, in sort of the public marketplace. And it’s hard to get as much clarity on what they’re doing with their pricing, but we can often be the, on location with them, a swing factor in terms of supply. And we’ve also got a – there’s a, some private players, maybe half a dozen out there that can compete in this deep coil market.

So I think as we look at the numbers and start to see the existing capacity used up, we have to get to that point to where the frackers obviously are today, when people are either nervous or unable to get the equipment that they need. And we’re not at that spot yet. We haven’t been in the coil market where, although it’s been tight at some points, people are still able to, if we can’t supply a job, they can go somewhere else. With the amount of capacity we’ve got, and now that we’ve released our quarter with our margins, which aren’t as strong as we’d like to see, but they’re certainly improved dramatically over last year, we’re not interested in, I’ll say it, annoying customers.

Further, to the earlier question, we would rather broaden our customer base and our market share and continue to focus on getting out there in the marketplace first and getting well established and then focus on price increases. But we can only rely on, I guess, the dialogue between our customers and our salespeople, and then watch our experiences to make that judgment call. But we’re well aware that getting higher prices is better for us and better for our shareholders.

Andrew Bradford

Okay. Thank you. And the other question I had was just really just around the Gen IV equipment. What is the – what do you think is the barrier between where we are today with one in the field working and getting higher utilization of the – of those higher spec pieces of equipment?

Garnet Amundson

Thanks. Yes, we – we’re actually working a way on that right now. I think as we’ve answered before, right now, this Gen III marketplace and the acquisition that we did at the end of 2016 was, I will say, well timed and very popular equipment, combined with our, I’ll say, our barrier to growth, which was people. So right now, we’ve been working a way as, well advertised on hiring new people and trying to grow our labor force so we actually didn’t have, when it comes to sort of commissioning, training and getting more Gen IVs ready. We didn’t have extra people capacity for that focus. The second thing is mobility and – of the Gen IVs and weight. And if you recall, they were originally all masted units. And in July of 2016, we actually pulled the masts out of a couple of them, which lightened the weight and give us greater flexibility on working with customers that have the taller wellhead assemblies, and where a mast maybe still wasn’t the right fit.

We are now working a way on again, trying as we look at bringing more of these units into place, we’re actually working a way on some other strategies to further lighten the units, take off some more weight and makes changes to things like our ability to more quickly do real swaps and to more easily crossover into what I’m going to call a, almost a hybrid into the high end of the Gen III market and give us a little bit more of the correct design I would say for the high-end conventional market. So that’s something that we expect to be introducing, probably in mid-2018 and we’ll have more information on that in our 2018 capital budget.

Andrew Bradford

And just to clarify, where is the 1 Gen IV working right now?

Garnet Amundson

It’s been pretty much all Grande Prairie Montney type work and a little bit of Duvernay.

Andrew Bradford

Okay. Thank you very much guys.

Garnet Amundson

Thanks.

Operator

Thank you. There are no further questions. I’ll turn the meeting back over to Ms. Perasalo.

Karen Perasalo

Thank you, John and thank you, everyone for joining us today.

Operator

Thank you. This concludes today’s conference call. Please disconnect your line at this time. We thank you for your participation.