Mr. Garnet Amundson reports
ESSENTIAL ENERGY SERVICES ANNOUNCES FIRST QUARTER FINANCIAL RESULTS AND REVISED CAPITAL SPENDING FORECAST
Essential Energy Services Ltd. has released strong first quarter results.
(in thousands of dollars except per-share amounts, Three months ended March 31,
percentages and hours) 2017 2016
Revenue $ 56,250 $ 26,556
Gross margin 14,394 1,318
Gross margin % 26% 5%
EBITDAS (1) from continuing operations 10,206 (2,202)
Net income (loss) from continuing operations (i) 3,480 (42,378)
Per share -- basic and diluted 0.02 (0.34)
Net income (loss) 3,150 (53,918)
Per share -- basic and diluted 0.02 (0.43)
Operating hours
Coil tubing rigs 16,420 9,677
Pumpers 18,653 10,218
(1) Non-IFRS measures.
(i) The three-month period ended March 31, 2016, includes an impairment loss of $45.8-million.
(in thousands of dollars, except fleet data) As at March 31,
2017 2016
Total assets (i) $227,646 $246,713
Long-term debt 18,169 27,053
Equipment fleet (ii)
Coil tubing rigs 31 32
Pumpers 32 30
(i) Total assets as at March 31, 2016, include the service rig business, which was sold in
December, 2016.
(ii) Fleet data represent the number of units at the end of the period.
The sale of Essential's service rig business in December, 2016, was reported as a discontinued operation, with the comparative figures for the three months ended March 31, 2016, restated to this same basis of accounting and disclosure.
Highlights
Essential's financial and operating results for the first quarter of 2017 reflect a resurgence of oil field service activity. Revenue and EBITDAS (earnings before finance costs, income taxes, depreciation, amortization, transaction costs, losses or gains on the 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) of $56.3-million and $10.2-million, respectively, exceeded management's expectations and are the highest reported since the fourth quarter of 2014, when the industry downturn began. Customer demand was strong for Essential Coil Well Service (ECWS) and Tryton, with both segments experiencing significant increases in revenue and gross margin compared with the first quarter of 2016.
Key first quarter highlights include:
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The Generation III coil tubing rigs were particularly busy, with operating hours three times higher than the first quarter of 2016. Customers used this equipment to complete complex, long-reach horizontal wells.
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Tryton MSFS revenue increased significantly compared with the first quarter of 2016 as key customers expanded their horizontal well completion programs.
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Higher revenue from increased activity resulted in significantly improved margins as fixed costs were absorbed by a larger revenue base.
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Essential continues to have a strong balance sheet, with debt outstanding at March 31, 2017, of $18.2-million and working capital (1) of $56-million. Low debt enables Essential to reinvest in people, equipment and working capital (1) as the industry recovers.
Industry overview
Oil field service activity improved in the first three months of 2017, with wells drilled in the Western Canadian sedimentary basin (WCSB), a key indicator of industry activity, 112 per cent higher than the same prior-year period. Oil and natural gas prices showed stability during the quarter, with an average price of $52 (U.S.) per barrel (West Texas Intermediate or WTI) and $3 (U.S.) per million British thermal units (Henry Hub), respectively.
Results of operations
Segment results -- ECWS
ECWS experienced strong customer demand for coil tubing and pumping in the first quarter of 2017, with revenue increasing $13-million or 82 per cent compared with the first quarter of 2016. The increase was primarily due to higher activity as customer demand for well completion work improved. Essential's coil tubing rigs and pumpers experienced their highest operating hours since the first quarter of 2015. Demand for ECWS equipment was particularly strong for long-reach horizontal well completions in the Montney, Duvernay and Bakken regions of the WCSB.
Essential's coil tubing fleet experienced a 70-per-cent increase in operating hours in the first quarter of 2017 compared with the same period in 2016. Customer demand for the Generation III coil tubing rigs was particularly strong, with operating hours three times higher than the first quarter of 2016. Generation III coil tubing rigs are well suited for complex, long-reach horizontal wells, where key customers were active.
Pumper operating hours increased 83 per cent in the first quarter of 2017 compared with the first quarter of 2016. Activity was weighted toward Essential's quintuplex and twin pumpers, rather than single pumpers, as the longer-reach horizontal wells require greater pumping capacity.
Crewing limitations resulted in ECWS prioritizing work with key customers and declining some spot market work in the first quarter of 2017. Essential's continuing recruitment and training activities are expected to increase its ability to crew more equipment in the second half of 2017.
Revenue per hour was consistent with the first quarter of 2016, but increased 5 per cent to 10 per cent compared with the fourth quarter of 2016. Increased activity and crew limitations led to select pricing increases in the first quarter of 2017. Revenue per hour was also higher due to the type of work quarter over quarter.
Gross margin as a percentage of revenue was 26 per cent for the first quarter of 2017, compared with 10 per cent for the first quarter of 2016. Higher activity, close proximity of well locations and pad work resulted in labour and travel efficiencies. Essential's continuing commitment to its maintenance program and the reliability of its equipment fleet throughout the first quarter of 2017 resulted in lower repairs and maintenance costs compared with the first quarter of 2016. Higher revenue compared with the first quarter of 2016 also contributed to improved margins as fixed costs represented a smaller portion of revenue.
Segment results -- Tryton
Tryton's first quarter 2017 revenue was the highest since the fourth quarter of 2014. Compared with the first quarter of 2016, revenue increased for each service line, with revenue from MSFS particularly strong as key customers expanded their horizontal drilling and completion programs. Tryton's rental revenue increased from drill pipe rental assets purchased in 2016 and early 2017. Labour shortages did not affect Tryton's business to the same extent as ECWS, as Tryton was able to attract and rehire a number of former employees released during the downturn. Pricing for Tryton's service lines was consistent with the fourth quarter of 2016, as the market remained competitive, making it difficult to implement price increases.
Gross margin as a percentage of revenue was 27 per cent for the first quarter of 2017, significantly higher than 11 per cent in the first quarter of 2016. Gross margin increased as fixed costs were absorbed by a larger revenue base.
Financial resources and liquidity
Credit facility
Essential's credit facility comprises a $40-million revolving term loan facility with a $20-million accordion feature available at 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 that the credit facility is not renewed, the balance becomes immediately due and payable on the maturity date. At March 31, 2017, 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 financed debt (1) to bank EBITDA (1) covenant, the minimum cumulative bank EBITDA (1) covenant and the fixed charge coverage (1) covenant. In October, 2016, Essential received gross proceeds of $10.4-million from an equity offering that the company applied 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 increase bank EBITDA (1) for the first, second and third quarter 2017 covenants as well.
As at March 31, 2017, all financial debt 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 May 9, 2017, Essential had $17.9-million of debt outstanding.
Capital spending forecast
Essential's 2017 capital forecast has increased from $11-million to $16-million. It comprises $6-million of growth capital and $10-million of maintenance capital. The $2-million increase in growth capital from the initial 2017 budget consists of additional costs to upgrade the coil tubing rigs and pumpers acquired in December, 2016, and the purchase of pumping support equipment.
Patent litigation
On Oct. 23, 2013, Packers Plus Energy Services Inc. filed a statement of claim in Canada's Federal Court against Essential, alleging that certain products and methods associated with the Tryton MSFS infringe on a patent issued to Packers Plus. Packers Plus subsequently limited its infringement allegations to just certain method claims in the patent.
Essential believes that the Packers Plus claim is without merit and filed a statement of defence and counterclaim on Nov. 22, 2013. The statement of defence denies infringement and pleads further that the patent is invalid because the methodology and equipment claimed in the patent were in use in the oil and natural gas industry prior to the patent's effective filing date of Nov. 19, 2001, or represent nothing more than obvious variations over what was already known in the industry at the time. This position is supported by the existence of similar products, articles and other patents prior to the effective filing date of the patent.
The trial was completed in March, 2017. There were two parts to the trial:
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Validity: The validity portion of the trial focused 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 defendants, Baker Hughes Canada Co., Weatherford Canada Ltd. and Resource Well Completion Technologies Inc., and all of the defendants filed counterclaims seeking a declaration that the patent is invalid, the Federal Court directed that the counterclaims be consolidated into a single trial. During this joint validity trial, the four defendants asserted their common position that the patent is invalid.
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Infringement: The infringement portion of the trial focused on whether or not Essential has infringed the Packers Plus patent. The infringement portions of the Baker Hughes Canada, Weatherford Canada and Resource Well Completion Technologies trials were not consolidated with the infringement portion of the Essential case since each infringement action, by its nature, deals with tools, designs and business activities specific to each company.
The court is expected to render its decision on both validity and infringement prior to October, 2017. The court must find that the Packers Plus patent is both valid and infringed. Given the appeal rights of the parties, and, if applicable, the process to quantify damages, final determination of the implications to Essential may not be known for up to two years.
The Packers Plus claim targets only the Tryton MSFS ball and seat system, which Essential started using in 2009. It does not target past or future operations of Essential's conventional tools, other Tryton MSFS tools or the rental service line.
Outlook
Improved commodity prices and industry optimism continue to support higher oil field service activity compared with 2016. April activity for the industry and for Essential was busier than the prior year, continuing the positive year-over-year trend that was experienced in the first quarter of 2017. For Essential, a number of completion projects, primarily pad work, were planned by customers for the second quarter. Given road restrictions at this time of year, Essential positioned equipment on customer locations for this work prior to spring breakup.
With increased activity, rebuilding a larger labour pool will continue to be a challenge for the oil field service industry. Essential continues to recruit qualified employees to meet expected customer demand following spring breakup. ECWS is targeting to recruit approximately 80 additional employees. This will allow ECWS to crew and operate approximately 18 coil tubing rigs and 20 pumpers by the fourth quarter of 2017.
ECWS labour constraints in the first quarter led to pricing discussions with customers and the commencement of pricing increases of 5 per cent to 10 per cent. Essential expects these price increase discussions to continue as activity increases in the third quarter. Higher pricing is required to achieve reasonable margins and offset increases in variable costs, including costs to retain, attract and train employees and increased repairs and maintenance costs to prepare Essential's fleet to meet customer expectations and demand.
Tryton's service lines also experienced higher activity in April compared with the prior year. While activity has increased year over year, pricing was relatively unchanged from fourth quarter of 2016. Labour, however, is less of an issue for Tryton as it has successfully rehired a number of former employees and the size of the Tryton labour pool is smaller than ECWS.
Essential's capital forecast increased to $16-million from $11-million, consisting of $6-million for growth capital and $10-million maintenance capital. The growth capital consists primarily of pumping support equipment, the cost to recertify and upgrade the coil tubing rigs and pumping equipment acquired in December, 2016, and the purchase of rental drill pipe assets.
As the industry recovers, Essential is financially well positioned to meet the anticipated incremental cash flow demands for operating and capital spending. Essential believes that it has a unique advantage with its low debt position on May 9, 2017, of $17.9-million.
The management's discussion and analysis and financial statements are available on Essential's website and on SEDAR.
CONSOLIDATED INTERIM STATEMENTS OF NET INCOME (LOSS) AND COMPREHENSIVE INCOME (LOSS)
(in thousands of dollars, except per-share amounts)
For the three months ended March 31,
2017 2016
Revenue $ 56,250 $ 26,556
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Operating expenses 41,856 25,238
Gross margin 14,394 1,318
General and administrative expense 4,188 3,520
Depreciation and amortization 4,001 5,936
Share-based compensation 1,544 527
Impairment loss - 45,838
Other (income) expense (25) 819
Operating income (loss) from continuing operations 4,686 (55,322)
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Finance costs 347 287
Income (loss) before income taxes from continuing operations 4,339 (55,609)
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Current income tax expense (recovery) 512 (4,192)
Deferred income tax expense (recovery) 347 (9,039)
Income tax expense (recovery) 859 (13,231)
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Net income (loss) from continuing operations 3,480 (42,378)
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(Loss) from discontinued operations, net of tax (330) (11,540)
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Net income (loss) 3,150 (53,918)
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Unrealized foreign exchange gain from continuing operations 10 15
Unrealized foreign exchange (loss) from discontinued operations - (63)
Other comprehensive income (loss) 10 (48)
Comprehensive income (loss) $ 3,160 $ (53,966)
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Net income (loss) per share from continuing operations
Basic and diluted $ 0.02 $ (0.34)
Net income (loss) per share
Basic and diluted $ 0.02 $ (0.43)
Comprehensive income (loss) per share
Basic and diluted $ 0.02 $ (0.43)
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2017 first quarter 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 10, 2017.
The conference call dial-in numbers are 416-340-2217 or 800-898-3989 and the passcode is 1833709.
An archived recording of the conference call will be available approximately one hour after the completion of the call until May 24, 2017, by dialling 905-694-9451 or 800-408-3053 and using passcode 6187672.
A live webcast of the conference call will be accessible on Essential's website. Shortly after the live webcast, an archived version will be available for approximately 30 days.
We seek Safe Harbor.
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