Mr. Garnet Amundson reports
ESSENTIAL ENERGY SERVICES ANNOUNCES THIRD QUARTER RESULTS
Essential Energy Services Ltd. has released third quarter results.
SELECTED INFORMATION
(in thousands of dollars except per-share, percentages and fleet data)
Three months ended Nine months ended
Sept. 30, Sept. 30,
2016 2015 2016 2015
Revenue $ 30,376 $ 47,824 $ 76,299 $ 142,233
Gross margin 4,030 11,927 3,681 27,809
Gross margin % 13% 25% 5% 20%
EBITDAS (1) 1,317 8,503 (5,635) 16,530
Net (loss) income (3,814) 2,996 (65,218) (4,403)
Per share -- basic and diluted (0.03) 0.02 (0.52) (0.03)
Utilization
Masted coil-tubing rigs 36% 70% 31% 62%
Service rigs 21% 24% 18% 26%
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(1) A non-international financial reporting standard measure.
Highlights
Despite oil and natural gas prices improving from the lows reached earlier in the year, exploration and production company spending continued to be well below historical levels throughout the third quarter 2016. This reduced spending limited oil field service activity and created an environment of excess equipment and aggressive competitor pricing. Wells drilled in the Western Canadian sedimentary basin (WCSB) during the third quarter 2016, a key indicator of industry activity, were 24 per cent lower than the third quarter 2015.
Essential's third quarter 2016 revenue was $30.4-million, 36 per cent lower than the same period of 2015 driven by low oil field service industry activity and pricing declines resulting from competitive pricing pressure. Key third quarter 2016 highlights include:
- Bank EBITDA (earnings before finance costs, income taxes, depreciation, amortization, transaction costs, losses or gains on disposal of equipment, writedown of assets, impairment loss, foreign exchange gains or losses, and share-based compensation, which includes both equity-settled and cash-settled transactions before severance cost) (1) of $1.3-million exceeded Essential's minimum bank
EBITDA (1) covenant of $1.0-million for the three months ended Sept.
30, 2016.
- Essential's Generation 3 and 4 masted coil-tubing rigs experienced
increased demand as customers used this equipment to complete complex,
long-reach horizontal wells in the Bakken, Montney and Duvernay regions
of the WCSB.
- Tryton MSFS revenue, while below the prior-year quarter, was the
strongest in the past three quarters due to drilling and completion
activity by a few key customers.
- On Oct. 12, 2016, Essential closed an equity issuance for gross
proceeds of $10.4-million. The proceeds were used to partially repay
outstanding indebtedness. The equity offering addresses near-term bank
covenant concerns as proceeds will be applied as an equity cure to the
company's financial covenants for the next four quarters, beginning with
the fourth quarter of 2016.
EBITDAS (earnings before finance costs, income taxes, depreciation, amortization, transaction costs, losses or gains on disposal of equipment, writedown of assets, impairment loss, foreign exchange gains or losses, and share-based compensation, which includes both equity-settled and cash-settled transactions) (1) was $1.3-million and negative $5.6-million for the three and nine months ended Sept. 30, 2016, respectively. Lower utilization due to reduced industry activity and competitive pricing pressure resulted in revenue and EBITDAS (1) declines from 2015. While third quarter 2016 revenue is comparable with the first quarter 2016, the cost-management strategies implemented earlier in the year resulted in improved EBITDAS (1).
Long-term debt outstanding at Sept. 30, 2016, was $31.8-million. With working capital (1) of $45.2-million, working capital exceeded debt by $13.4-million. On Nov. 9, 2016, there was $21.8-million of debt outstanding. The proceeds from the equity offering on Oct. 12, 2016, were applied to debt.
Results of operations
Segment results -- well servicing
Coil well service third quarter 2016 revenue declined 43 per cent compared with the third quarter 2015 due to lower activity and pricing. Lower E&P spending resulted in reduced operating hours for both masted coil-tubing and pumping operations. While there was a decrease in total masted coil-tubing operating hours, Essential's Generation 3 and Generation 4 masted coil-tubing rigs experienced increased demand as customers used this equipment to complete complex, long-reach horizontal wells in the Bakken, Montney and Duvernay regions of the WCSB. Coil well service revenue per hour declined by 5 per cent to 10 per cent compared with the third quarter 2015.
Third quarter 2016 service rig revenue decreased 43 per cent compared with the same period in 2015. Operating hours declined 31 per cent compared with third quarter 2015. Service rig revenue per hour was down approximately 20 per cent compared with the third quarter 2015. Limited industry activity continued to result in aggressive competition and pricing pressure.
Well-servicing gross margin as a percentage of revenue was 10 per cent in the third quarter of 2016, lower than the same period of 2015. Cost reductions implemented earlier in the year partially offset the impact of lower revenue.
On a year-to-date basis, well-servicing revenue decreased 50 per cent compared with the prior period. The year-over-year decline is due to lower activity and price declines as a result of the continued industry downturn. Essential maintained positive gross margin year to date despite the price and activity declines due to cost reductions implemented earlier in the year.
Segment results -- downhole tools and rentals
Downhole tools and rentals (DT&R) revenue decreased 23 per cent in the third quarter 2016 compared with the same period in 2015 due to lower Canadian and U.S. tools revenue as a result of decreased industry activity and pricing declines. Third quarter 2016 revenue from Tryton MSFS was the strongest in the last three quarters due to drilling and completion activity by a few key customers.
Gross margin was 18 per cent for the third quarter 2016, lower than the prior period, as pricing declines more than offset cost reductions implemented in the Canadian and U.S. operations earlier in the year. The 18-per-cent gross margin in the quarter was the highest achieved in the last three quarters.
On a year-to-date basis, DT&R revenue was below 2015 as all service lines were impacted by lower activity and price declines. Gross margin for the nine months ended Sept. 30, 2016, decreased compared with the same period in 2015 due to reduced revenue and fixed operating costs comprising a larger percentage of revenue. The gross margin decline was partially mitigated by cost reductions implemented earlier in the year.
Financial resources and liquidity
Credit facility
Essential's credit facility is composed of a $40-million revolving term loan facility with a $20-million accordion feature available on the lender's consent. The credit facility was renewed on June 15, 2016, and matures on May 31, 2019. It is renewable at the lender's consent and is secured by a general security agreement over the company's assets. To the extent the credit facility is not renewed, the balance becomes immediately due and payable on the maturity date. At Sept. 30, 2016, the maximum of $40-million under the credit facility was available to Essential.
The credit facility includes an equity cure provision, where proceeds from equity offerings may be applied to the calculation of bank EBITDA (1) in the covenant of financed debt (1) to bank EBITDA (1), the minimum cumulative bank EBITDA (1) covenant and the fixed-charge coverage (1) covenant. The equity cure provision can be exercised in the period that the proceeds are received or the prior period if the proceeds are received in advance of filing the quarterly compliance certificate with the banking syndicate. On Oct. 12, 2016, Essential received gross proceeds of $10.4-million for 16,019,883 shares issued at 65 cents per share from an equity offering. The company will apply the proceeds as an equity cure to its fourth quarter 2016 bank EBITDA (1) calculation under the credit facility. Due to the trailing 12-month nature of the covenants, the proceeds from the equity offering will increase bank EBITDA (1) for the first, second and third quarter 2017 covenants as well.
As at Sept. 30, 2016, all financial covenants were satisfied, and all banking requirements under the credit facility were up to date. Essential does not anticipate financial resource or liquidity issues to restrict its future operating, investing or financing activities. On Nov. 9, 2016, Essential had $21.8-million of debt outstanding.
Equipment expenditures and fleet additions
Near the end of the third quarter, the fabricator of Essential's Generation 4 masted coil-tubing rigs advised that it was unable to complete the two rigs under construction within the agreed delivery schedule and price. Given the fabricator's history of cost overruns, delivery delays and Essential's recent concerns with its ability to complete the project, Essential concluded that it would not provide further funds to the fabricator to complete the rigs. On Nov. 6, 2016, Essential executed a settlement agreement and terminated its contract with the fabricator. Pursuant to the terms of the settlement agreement, Essential has taken delivery of the partially completed rigs, and fabricated components, parts, technical information and certifications that were previously in the fabricator's possession. Essential is currently conducting a full evaluation of all equipment, parts and components received. The evaluation will include inventory verification, assessment of the percentage of completion, remaining costs and a timeline to bring the two Generation 4 masted coil-tubing rigs into service. Although Essential's decision to terminate this contract will delay the delivery of these two rigs, management anticipates that its existing fleet of Generation 3 and 4 masted coil-tubing rigs will meet near-term market demand.
In addition to the two rigs under construction, Essential had previously paid deposits of approximately $2-million to the fabricator for two additional rigs that had been deferred. Essential took delivery of the majority of parts and components associated with these deferred rigs. The balance of the parts is expected to be shipped directly to Essential from a third party fabricator by the end of the first quarter 2017.
Essential estimates that the cumulative value of assets that were in the fabricator's possession, including deposits, is $13-million.
Essential's 2016 capital budget has increased from $11-million to $12-million. It is composed of $9-million of growth capital and $3-million of maintenance capital. The $1-million increase in growth capital consists of additional deposits Essential expects to pay to a new third party fabricator for completion of the first of the remaining two Generation 4 masted coil-tubing rigs under construction and the purchase of incremental rental drill pipe for DT&R. The remaining cost to complete the rigs under construction will be included in Essential's 2017 capital budget.
Patent litigation update
Essential is in the final stages of preparing for trial in its defence against allegations that certain products and methods associated with the Tryton MSFS infringe on a patent issued to Packers Plus Energy Services Inc. The trial is scheduled to start on Feb. 6, 2017, and is expected to last four weeks. There are two parts to the trial:
- Validity: The validity portion of the trial will focus on whether or
not the patent is valid. Given the fact that Packers Plus has asserted
infringement of the same patent against Essential and three other groups
of defendants, Baker Hughes Canada Company, Weatherford Canada Ltd. and
Resource Well Completion Technologies Inc., and all of the defendants
have filed counterclaims seeking a declaration that the patent is
invalid, the federal court has directed that the counterclaims be
consolidated into a single trial. During
the joint validity trial, the four defendants will assert their common
position that the patent is invalid.
- Infringement: The infringement portion of the trial will focus on
whether or not Essential has infringed the Packers Plus patent, if the federal court holds that the patent is valid. The infringement portions
of the Baker Hughes Canada, Weatherford Canada and Resource
Well Completion Technologies trials will not be consolidated with
the infringement portion of the Essential case since each infringement
action, by its nature, deals with different tools and, additionally, the
other three actions were started more recently than the claim.
Essential continues to believe that the claim is without merit. The claim targets only the Tryton MSFS ball and seat system, which Essential commenced using in 2009. It does not target past or future operations of Essential's conventional tools, other Tryton MSFS tools or the rentals business. Proceedings of this nature can take years to resolve through the court process.
Outlook
Commodity prices have improved from earlier in the year resulting in a new level of cautious, but encouraging, optimism in the industry. Drilling rig utilization to date in the fourth quarter in the WCSB has been approximately 20 per cent, which is less than the same period in 2015 but is an improvement from the third quarter of 2016. Demand for oil field services has improved as stronger commodity prices support E&P investment. Visibility beyond the fourth quarter is limited but should become clearer as E&P companies announce their 2017 capital budgets.
For Essential, activity in the fourth quarter has improved from the third quarter. Customer interest and enquiries have increased. Due to staffing reductions in prior periods, Essential could become constrained in its ability to supply equipment in the short term if demand continues to increase. Essential has increased its labour pool by 30 per cent since the first quarter 2016 and is continuing to hire during the fourth quarter 2016 in anticipation of a busier winter season. Service pricing appears to have bottomed in the third quarter of 2016 and has remained stable, but with excess equipment in the industry, activity increases will need to be more pronounced before service pricing can increase in a meaningful way.
Essential completed an equity financing on Oct. 12, 2016, for gross proceeds of $10.4-million. This addresses near-term bank covenant concerns as proceeds will be applied as an equity cure to the company's financial covenants for the next four quarters, beginning with the fourth quarter of 2016.
Essential has among the lowest debt levels in the oil field services sector with debt on Nov. 9, 2016, of $21.8-million. Essential is well positioned to respond and grow as the industry begins to pull out of the prolonged downturn with the flexibility to meet anticipated operating needs and capital-spending requirements.
Management's discussion and analysis and financial statements are available on Essential's website and on SEDAR.
(1) A non-international financial reporting standard measure.
CONSOLIDATED INTERIM STATEMENTS OF NET (LOSS) INCOME AND COMPREHENSIVE
(LOSS) INCOME
(in thousands of dollars, except per-share amounts)
For the three months For the nine months
ended ended
Sept. 30, Sept. 30,
2016 2015 2016 2015
Revenue $ 30,376 $ 47,824 $ 76,299 $ 142,233
Operating expenses 26,346 35,897 72,618 114,424
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Gross margin 4,030 11,927 3,681 27,809
General and administrative expenses 2,713 3,424 9,316 11,279
Depreciation and amortization 4,313 6,280 15,736 19,434
Share-based compensation 805 34 1,520 648
Impairment loss - - 61,652 -
Other expenses (income) 780 (782) 2,164 (481)
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Operating (loss) income (4,581) 2,971 (86,707) (3,071)
Finance costs 272 325 940 1,129
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(Loss) income before income taxes (4,853) 2,646 (87,647) (4,200)
Current income tax (recovery)
expense (640) 1,805 (7,271) (1,757)
Deferred income tax (recovery)
expense (399) (2,155) (15,158) 1,960
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Income tax (recovery) expense (1,039) (350) (22,429) 203
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Net (loss) income $ (3,814) $ 2,996 $(65,218) $ (4,403)
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Unrealized foreign exchange (loss)
gain (20) 179 (72) 366
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Comprehensive (loss) income $ (3,834) $ 3,175 $(65,290) $ (4,037)
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Net (loss) income per share
Basic and diluted $ (0.03) $ 0.02 $ (0.52) $ (0.03)
Comprehensive (loss) income per
share
Basic $ (0.03) $ 0.03 $ (0.52) $ (0.03)
Diluted $ (0.03) $ 0.02 $ (0.52) $ (0.03)
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Third quarter 2016 results conference call and webcast
Essential has scheduled a conference call and webcast at 10 a.m. MT (12 p.m. ET) on Nov. 10, 2016.
The conference call dial-in numbers are 416-340-2217 or 866-696-5910, passcode 1561348.
An archived recording of the conference call will be available approximately one hour after completion of the call until Nov. 24, 2016, by dialling 905-694-9451 or 800-408-3053, passcode 4938292.
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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