Mr. Garnet Amundson reports
ESSENTIAL ENERGY SERVICES ANNOUNCES FIRST QUARTER RESULTS AND SUSPENDS THE QUARTERLY DIVIDEND
Essential Energy Services Ltd. has released first quarter results.
SELECTED INFORMATION
(in thousands of dollars except per-share, percentages and fleet data)
Three months ended March 31,
2016 2015
Revenue $ 30,915 $ 70,419
Gross margin 1,246 15,302
Gross margin % 4% 22%
EBITDAS (1) before severance costs (750) 12,544
EBITDAS % (1) before severance costs (2%) 18%
EBITDAS (1) (2,483) 10,859
EBITDAS % (1) (8%) 15%
Net (loss) income before impairment loss (8,459) 3,096
Per share -- basic and diluted (0.07) 0.02
Net (loss) income (53,918) 3,096
Per share -- basic and diluted (0.43) 0.02
Utilization
Masted coil-tubing rigs 39% 90%
Service rigs 18% 37%
Equipment fleet
Masted coil-tubing rigs 21 19
Service rigs 38 54
(1) A non-international financial reporting standard measure
Highlights
For the second consecutive year, first quarter oil and gas activity remained well below historical levels as exploration and production (E&P) companies sharply decreased capital spending to preserve cash flow and manage debt. Oil field service activity was hit hard, with drilling rig utilization reaching 30-year lows. Unseasonably warm weather also hindered activity with the onset of spring breakup conditions throughout the Western Canadian sedimentary basin (WCSB) in early March. Well completions and drilling activity in the WCSB declined 61 per cent and 43 per cent, respectively, during the first quarter of 2016, compared with the same period in 2015. To preserve cash until industry conditions improve, many E&P companies chose to drill to maintain landholdings and delay well completion work.
Similar to the industry, Essential's first quarter activity declined to levels that were unprecedented and unexpected. Essential reported first quarter 2016 revenue of $30.9-million, 56 per cent lower than the first quarter of 2015. Activity and price declines were experienced across all service lines. In a very challenging environment, Essential managed to maintain positive gross margins and continued to focus on cost management.
Revenue in each of Essential's operations was adversely affected by the significant drop in industry activity. Revenue in coil well service and downhole tools and rentals (DT&R) was approximately 50 per cent below first quarter 2015. Service rig revenue experienced a sharper decline with revenue 71 per cent lower than the prior-year period. Gross margin in each segment was significantly lower than the prior-year period, as activity declines were too significant to be offset by cost reductions implemented in 2015. Earnings before interest, taxes, depreciation and amortization, and stock-based
compensation before severance costs were negative $800,000 for the first quarter 2016 compared with $12.5-million before severance costs for the first quarter 2015.
With the poor start to 2016 and industry uncertainty for the rest of the year, rightsizing the business is key to long-term sustainability. In the first quarter 2016, management took pro-active steps for the second consecutive year to manage costs in an effort to support margins. Compensation and head count reductions were implemented across the organization. Severance costs totalling $1.7-million (2015: $1.7-million) were recorded in the first quarter of 2016 in the corporate and eliminations segment.
At March 31, 2016, Essential had $27.1-million of debt outstanding, an increase of $1.5-million from Dec. 31, 2015. At May 4, 2016, Essential had $28.2-million of debt outstanding and reported debt to EBITDAS of 2.7 times at the end of the first quarter 2016. The deterioration in the metric of debt to EBITDAS since Dec. 31, 2015, is due to the trailing 12-month calculation of EBITDAS. The stronger EBITDAS from the first quarter 2015 was replaced with the weaker EBITDAS from the first quarter 2016.
International financial reporting standards require the company to assess the carrying value of assets in cash-generating units (CGUs) when there are impairment indicators. The first quarter 2016 financial results were much lower than expected, and the industry outlook has deteriorated since Dec. 31, 2015, requiring Essential to complete an impairment assessment. The impairment assessment determined that the fair value of Essential's well-servicing segment was less than its carrying value. The company recognized an impairment charge in the first quarter of 2016 of $61.7-million: $28.5-million on coil well service equipment, $15.8-million on service rig equipment and $17.4-million on intangible assets.
Dividend suspension
Since the first quarter of 2012, Essential has maintained a policy of paying dividends on a quarterly basis. In August and November, 2015, the company reduced the dividend to better align the payment with operating conditions at that time. With further deterioration in industry fundamentals and the weak industry outlook, Essential's board of directors has suspended the corporation's dividend until further notice.
Results of operations
Segment results -- well servicing
Well completions, a key indicator of industry activity, declined 61 per cent as E&P companies limited capital spending amid low commodity prices. Coil well service first quarter revenue decreased 51 per cent compared with the same quarter in 2015 due to lower activity and pricing. Activity was particularly slow in March, 2016, as unseasonably warm weather resulted in early spring breakup conditions, limiting the ability to access customer well locations. Masted coil-tubing operating hours declined 52 per cent, and pumping operating hours declined 42 per cent. Essential continued to work for key customers, but at a slower pace compared with the prior-year period. Pumping activity experienced a smaller decline due to stand-alone work independent of masted coil-tubing operations. Revenue per hour was down from the first quarter 2015 by 5 per cent to 10 per cent and was consistent with the fourth quarter 2015. During the first quarter of 2016, a Generation IV rig completed a long-reach horizontal well in the Bakken.
Service rig revenue in the first quarter of 2016 declined 71 per cent compared with the first quarter 2015. Activity continued to deteriorate as a result of the industry downturn with operating hours 65 per cent lower than the first quarter 2015. Essential chose to decline work in the first quarter 2016 that was subeconomic, which had a negative impact on utilization. Similar to coil well service activity, service rig activity was negatively impacted by the early onset of spring breakup conditions. Revenue per hour was down approximately 15 per cent compared with the first quarter 2015, but remained consistent with the fourth quarter of 2015.
As revenue declines, fixed costs comprise a larger percentage of revenue, reducing gross margin. Cost containment initiatives implemented in 2015 were not sufficient to offset the significant decline in revenue in the first quarter 2016, and well-servicing gross margin was 8 per cent compared with 23 per cent for the same period in 2015. Given this sharp activity decline and industry uncertainty for the rest of 2016, additional cost reductions, including staff layoffs and wage rollbacks, were taken in March, 2016, to further reduce the company's cost structure.
Segment results -- downhole tools and rentals
DT&R revenue decreased 54 per cent from the first quarter in 2015 due to lower activity and a decline in pricing of approximately 20 per cent. Canadian MSFS revenue increased sequentially from the last quarter of 2015 and declined less than the 61-per-cent reduction in industry well completions compared with the first quarter 2015. Significant declines, compared with the first quarter 2015, were experienced in Canadian rentals revenue and U.S. downhole tools. Low industry drilling activity and restrained customer spending in the first quarter 2016 contributed to all revenue reductions.
Gross margin as a percentage of revenue in the first quarter 2016 decreased to 11 per cent compared with 29 per cent for the first quarter 2015. Due to the lower activity experienced in the first quarter 2016, fixed costs comprised a greater proportion of revenue, reducing gross margin as a percentage of revenue. DT&R gross margin was further reduced by significant U.S. operating losses and lower contribution from the higher-margin rentals business. Cost reductions in the Canadian operations implemented during 2015 and first quarter 2016 offset a portion of the impact of pricing reductions in the period. Cost reductions included staff layoffs and wage rollbacks in the Canadian operations. Cost reductions in the U.S. operations were implemented in the second quarter of 2016.
General and administrative
General and administrative expenses (G&A) comprised wages, severance costs, professional fees, office space, and other administrative costs incurred at the corporate and operational levels. G&A expenses for the first quarter 2016 decreased compared with the same period in 2015 due to cost reductions implemented in the prior year, including decreases in employee costs, professional fees and discretionary spending. For the first three months of 2016, $400,000 of severance costs was included in G&A (2015: $100,000), with the balance included in operating expenses. Due to lower revenue, G&A comprised a greater percentage of revenue in the first quarter 2016 than 2015.
With the sharp reduction in industry activity and uncertainty for the rest of 2016, additional cost reductions were implemented in the first quarter 2016, including head count and wage reductions. These are expected to reduce quarterly G&A to approximately $3-million per quarter.
Impairment loss
International financial reporting standards require the company to assess the carrying value of assets in the CGUs when there are impairment indicators. The first quarter 2016 financial results were much lower than expected, and the industry outlook has deteriorated since Dec. 31, 2015, requiring Essential to complete an impairment assessment. The impairment assessment determined that the fair value of Essential's well-servicing segment was less than its carrying value. The company recognized an impairment charge in the first quarter of 2016 of $61.7-million: $28.5-million on coil well service equipment, $15.8-million on service rig equipment and $17.4-million on intangible assets (2015: nil).
Income taxes
For the three months ended March 31, 2016, the current income tax recovery relates to incurring a loss before income tax in the quarter. For the first quarter 2016, Essential's deferred income tax recovery is due to the tax effect on the impairment loss.
Essential's 2016 capital budget of $9-million is composed of $6-million of growth capital and $3-million of maintenance capital. Growth capital will be used to complete the Generation IV masted coil-tubing rigs. At March 31, 2016, there was $3-million remaining to complete these rigs. One rig is expected to be in service in each of the second, third and fourth quarters of 2016.
Essential's long-term capital-build program increases the size and depth capacity of its masted coil-tubing fleet. As at May 4, 2016, the company added four Generation III and three Generation IV masted coil-tubing rigs. Upon completion of the $53-million spending program in 2016, Essential will have four Generation III and six Generation IV masted coil-tubing rigs. At March 31, 2016, Essential had spent approximately $50-million on this capital program. The Generation III and Generation IV rigs have the capability to work on long-reach horizontal wells and are well suited to work in deep, high-pressure basins, including the Montney, Bakken, Duvernay and Horn River. With a coil diameter of 2-3/8ths of an inch, the Generation III rigs can reach 6,300 metres, and the Generation IV rigs can reach 7,900 metres. While the Generation IV coil-tubing rigs are not in high demand in the current industry environment, management expects demand should increase once industry conditions improve.
Outlook
Recent increases in the price of oil and successful equity issuances by select E&P companies have created some positive sentiment toward the oil and gas industry. From an oil field service company perspective, Essential does not believe very much of the incremental customer cash flow will lead to increased oil field service spending. Instead, E&P companies are typically using available cash to reduce debt and strengthen balance sheets.
Unusually warm weather accelerated industry spring breakup conditions. Industry drilling rig utilization for the month of April was 6 per cent, below the same period in the prior year. In a normal year, this early breakup may lead to customers returning to work earlier in the second quarter. That is not expected to occur in this quarter as fewer E&P companies are engaging in oil field service spending as they strive to preserve cash flow in this difficult market. Essential anticipates that the remaining months of second quarter activity will continue to lag behind the prior-year period. Beyond that, the outlook remains unclear as customers assess their plans in a very uncertain macroeconomic environment.
After experiencing an unprecedentedly weak first quarter, combined with a relatively weak outlook for the rest of the year, managing Essential's margins and debt is a 2016 priority. Accordingly, Essential has implemented the following strategies:
- Implementation of further cost reductions; head count has been reduced by
an additional 40 per cent, which represents a reduction of 240 salaried and field
staff since the beginning of 2016; since the end of 2014, Essential's
head count has been reduced by 65 per cent; a second round of salary reductions
were implemented across the organization;
- Disposition of retired and redundant equipment;
- Suspension of the company's dividend.
Essential has been operating with a highly variable cost structure for a number of years, with the majority of field employees working on a variable compensation model. This helps support margins in periods of slow activity.
Essential's annual debt service costs and future capital commitments are low. Given the outlook for 2016, it may be difficult for Essential to significantly reduce its debt position during the year, but appropriate steps are being taken to mitigate the likelihood of an increase in long-term debt. With working capital of $50.4-million, working capital exceeded long-term debt by $23.3-million at March 31, 2016.
Management's discussion and analysis and financial statements are available on Essential's website and on SEDAR.
CONSOLIDATED INTERIM STATEMENTS OF NET (LOSS) INCOME AND COMPREHENSIVE
(LOSS) INCOME
(in thousands of dollars, except per-share amounts)
For the three months ended
March 31,
2016 2015
Revenue $ 30,915 $ 70,419
Operating expenses 29,669 55,117
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Gross margin 1,246 15,302
General and administrative expenses 3,729 4,443
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(2,483) 10,859
Depreciation and amortization 6,885 6,690
Share-based compensation 527 154
Impairment loss 61,652 -
Other expenses (income) 867 (716)
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Operating (loss) income (72,414) 4,731
Finance costs 287 472
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(Loss) income before income taxes (72,701) 4,259
Current income tax (recovery) expense (5,087) 442
Deferred income tax (recovery) expense (13,696) 721
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Income tax (recovery) expense (18,783) 1,163
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Net (loss) income $ (53,918) $ 3,096
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Unrealized foreign exchange (loss) gain (48) 248
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Comprehensive (loss) income $ (53,966) $ 3,344
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Net (loss) income per share
Basic and diluted $ (0.43) $ 0.02
Comprehensive (loss) income per share
Basic and diluted $ (0.43) $ 0.03
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First quarter 2016 financial results conference call and webcast
Essential has scheduled a conference call and webcast at 10 a.m. MT (12 p.m. ET) on May 5, 2016.
The conference call dial-in numbers are 416-340-2217 or 866-696-5910, passcode 7744496.
An archived recording of the conference call will be available approximately one hour after completion of the call until May 19, 2016, by dialling 905-694-9451 or 800-408-3053, passcode 7736666.
A live webcast of the conference call will be accessible on Essential's website by selecting investors and events and presentations. Shortly after the live webcast, an archived version will be available for approximately 30 days.
We seek Safe Harbor.
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