Mr. P. Scott MacFarlane reports
CATHEDRAL ENERGY SERVICES REPORTS RECORD Q4 AND ANNUAL REVENUES FOR 2014, REDUCTION IN CAPITAL SPENDING AND DIVIDEND
Cathedral Energy Services Ltd. has released its consolidated financial results for the three months and year ended Dec. 31, 2014, and 2013.
Fourth-quarter 2014 key takeaways:
- Total revenues up 12 per cent to a record $73,242,000 from the fourth quarter of 2013 of $65,238,000;
- Record fourth-quarter 2014 total revenues, including:
- Fourth-quarter record for U.S. directional drilling;
- Fourth-quarter record revenue for Canadian production testing;
- EBITDAS increased 16 per cent to $9,408,000 from the fourth quarter of 2013 of $8,124,000;
- 2014 EBITDAS was $38,487,000 ($1.06 per share diluted) representing a $5,672,000 or 17-per-cent increase from $32,815,000 (91 cents per share diluted) in 2013;
- Introduction of new proprietary technologies including:
- Upgrades to the company's proprietary EM-MWD platform to improve reliability and accuracy;
- Introduction of a real-time downhole drilling diagnostics system (HAWK) to optimize drilling performance by minimizing wasted energy, increasing bit life and minimizing equipment damage;
- Developing the company's own proprietary MWD gamma sensor design which has improved reliability and reduced system costs;
- Introduction of the Claw line to the company's nDurance drilling motors series which has generated regular inbound customer inquiries regarding interest in this motor's enhanced performance capabilities and also resulted in stand-alone rentals of these motors;
- The value of the company's MWD platform and nDurance drilling motors was further demonstrated in 2014 based on the company achieving a number of record drilling times for new and existing customers.
Outlook
Following a successful year for Cathedral in 2014 the company is now faced with the reality of a rapid decline in oil prices in 2015 with a lot of uncertainty around how long these low prices may last. Coupled with the recent oil price decline is soft natural gas pricing. Both these factors have resulted in the company's customers reducing their capital spending budgets in 2015 which has a direct impact on the company's business. Industry analysts are predicting 40-per-cent to 50-per-cent activity declines over 2014 which is similar or worse than what was experienced in the 2008/2009 downturn. Cathedral's strategy with dealing with this current reality is threefold:
- Adjust Cathedral's cost structure and financial obligations to reflect the decline in activity levels and protect the company's balance sheet;
- Preserve the company's key employee base so when industry conditions improve it is able to ramp up quickly;
- Continue to pursue operational improvements and execute on the company's strategic objectives to position Cathedral to be a stronger company in the future.
With respect to aligning Cathedral's cost structure with the current environment the company began to aggressively implement expense reductions in early January. Approximately 55 per cent of Cathedral's expenses are labour, much of which is variable depending on activity levels. Cathedral has undertaken a work force reduction primarily focusing on positions that will be directly impacted by lower activity in the field, shop and office. Cathedral has implemented wage rollbacks across the company, including its directors, ranging from 5 per cent to 20 per cent depending on the position and pay level. Employee benefit programs have also been reduced. Cathedral is reviewing all expense items looking for savings opportunities both short and long term. Cathedral's capital expenditure program in 2015 has also been reduced significantly from 2014 to target a capital spend in the $7-million range. Capital spending in 2015 will be largely offset by the sale and leaseback of Cathedral's Oklahoma City facility in the March time frame which the company anticipates will generate net proceeds of $4.8-million and proceeds from redundant asset disposals. Cathedral has also reduced its quarterly dividend to four cents per common share (previously 8.25 cents) to manage liquidity, maintain a strong balance sheet and better position the company to take advantage of opportunities which may present themselves.
As much as 2015 will be a challenging year for Cathedral the company also sees opportunities. The current energy company focus on costs is an opportunity for Cathedral to offer performance advantages that can impact an overall drilling program. For example, Cathedral's ability to assist Cathedral's customers in shortening drilling times has an impact on all the site services they require which can create significant cost savings over all. It is also an opportunity for Cathedral to demonstrate Cathedral's technology and service capabilities in new areas as both existing and potential customers are more receptive to gaining efficiencies. The slowdown also affords Cathedral the opportunity to implement a number of sales and operational performance improvements which will benefit the company in the long term. Cathedral is confident that it will come out of this current downturn in a very strong position to deliver increased value to Cathedral's customers and Cathedral's shareholders.
Dividends
It is the intent of the company to pay quarterly dividends to shareholders. The board of directors reviews the amount of dividends on a quarterly basis with due consideration to current performance, historical and future trends in the business, the expected sustainability of those trends and enacted tax legislation which will affect future taxes payable as well as required long-term debt repayments, maintenance capital expenditures required to sustain performance and future growth capital expenditures. The directors have approved a first-quarter 2015 dividend in the amount of four cents per share which will have a date of record March 31, 2015, and a payment date of April 15, 2015.
Annual and special meeting
Cathedral will be holding its annual and special meeting in the Plaza Room of the Metropolitan Centre, 333 4th Ave. SW, Calgary, at 3 p.m. (MT) on Monday, May 11, 2015. Business at the meeting will include the election of directors, appointment of auditors and consideration of approving unallocated entitlements under Cathedral's stock option plan. Dan O'Neil has indicated he will not be running for re-election at the meeting. On behalf of Cathedral, the company would like to thank Mr. O'Neil for his contributions to the company, his insights into the energy industry and wish him well in his future business endeavours.
2015 capital program
Cathedral's 2015 capital budget has been revised downward from the originally announced amount of $15-million to $7-million. The new capital budget includes $5.1-million of growth capital, $1.4-million of maintenance capital and $500,000 of infrastructure expenditures.
The directional drilling division is expected to invest $5.75-million of the 2015 capital budget including $3,915,000 for growth, $1,335,000 for maintenance and $500,000 for infrastructure. Growth capital expenditures will include the addition of nDurance motors and drill collars for the replacement of high rental expense items and certain MWD equipment. Maintenance capital expenditures are related to motors, trucks and EM/MWD equipment. The infrastructure investment of $500,000 relates to the remaining construction costs for an operations facility in Oklahoma City with full-service repair capabilities. Cathedral has entered into a purchase and sale agreement related to the facility being built in Oklahoma City and will enter into a lease for the facilities with the purchaser. The company expects this transaction to close approximately March 31, 2015, with net proceeds of approximately $4.8-million.
The production testing division anticipates investing a total of $1.25-million. Growth capital expenditures of $1,185,000 are related to storage tanks and additional equipment that would otherwise be rented. Maintenance expenditures of $65,000 are mainly related to purchase of ancillary equipment.
Cathedral intends to finance its 2015 capital budget from cash flow from operations, proceeds of the Oklahoma City facility sale and leaseback, proceeds from redundant asset sales, and if necessary, its existing credit facility.
2014 capital program
In 2014 the company invested an additional $30,763,000 (2013 -- $20,283,000) in property and equipment, excluding non-cash capital lease additions. The major additions for growth capital were $12,608,000 for additional directional drilling motors and related equipment for specific job requirements and $2,935,000 for additional ancillary production testing equipment which will reduce future rental costs. Infrastructure capital relates to progress payments on the construction of an operating facility in Oklahoma City which is expected to be operational in early 2015 and computer system upgrades. Maintenance capital included additional upgrades to existing production testing equipment and maintenance of downhole tools. The net property and equipment additions (additions net of proceeds on the regular disposal of property and equipment) to date in 2014 were $25,213,000 (2013 -- $20,996,000).
CAPITAL EXPENDITURES (CASH BASIS)
(in thousands of dollars)
Dec. 31, Dec. 31,
2014 2013
Growth capital $ 15,543 $ 12,897
Replacement capital 1,257 2,498
Infrastructure capital 4,324 1,330
Maintenance capital 9,639 11,558
Property and equipment expenditures 30,763 28,283
Less: proceeds on the regular disposal of property and equipment (5,550) (29,547)
Add back: non-recurring proceeds on disposal of property and equipment - 22,260
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Net property and equipment additions $ 25,213 $ 20,996
SUMMARY OF MAJOR EQUIPMENT OWNED BY THE COMPANY
Dec. 31, Dec. 31,
2014 2013
Directional drilling -- MWD systems 140 139
Production testing units 66 72
Results of operations -- three months ended Dec. 31
Revenue
Fourth-quarter 2014 revenues were $73,242,000 which represented an increase of $8,004,000 or 12 per cent from fourth-quarter 2013 revenues of $65,238,000. The increase was primarily attributed to the U.S. directional drilling and U.S. production testing divisions which both achieved record fourth-quarter revenue results.
Canadian directional drilling revenues increased to $22,582,000 in the fourth quarter of 2014 from $19.32-million in the fourth quarter of 2013, a 17-per-cent increase. This increase was the result of: i) a 13-per-cent increase in activity days to 1,896 in the fourth quarter of 2014 from 1,683 in the fourth quarter of 2013; and ii) a 4-per-cent increase in the average day rate to $11,910 in the fourth quarter of 2014 $11,480 in the fourth quarter of 2014. For Western Canada, the number of wells drilled declined in the fourth quarter of 2014 on a quarter-over-quarter basis from the fourth quarter of 2013 and the increase in Canadian activity days represents a market share gain.
U.S. directional drilling revenues increased to a record level of $32,408,000 in the fourth quarter of 2014 from $23,536,000 in the fourth quarter of 2013, a 38-per-cent increase. This increase was the result of: i) a 22-per-cent increase in activity days of 2,477 in the fourth quarter of 2014 from 2,027 in the fourth quarter of 2013; and ii) a 13-per-cent increase in the average day rate of $13,084 in the fourth quarter of 2014 from $11,611 in the fourth quarter of 2013 (when converted to Canadian dollars). The increase in U.S. activity days were due to the Texas and Oklahoma markets, with increased activity coming from both existing and new customers. The 13-per-cent increase in day rates is a combination of day rate increases in U.S. dollars (4 per cent) and in part due to strengthening of the U.S. dollar versus the Canadian dollar (9 per cent). The average day rate increase in U.S. dollars was due to performance-based pricing, this was partially offset by lower pricing in the Oklahoma region.
Canadian production testing revenues decreased to $7,656,000 in the fourth quarter of 2014 from $9,241,000 in the fourth quarter of 2013; a 17-per-cent decrease. The Canadian operating days were down 22 per cent based on work declines from specific existing customers mainly due to the clients expending their maximum capital budget. The fourth quarter of 2013 had one of the highest activity levels in Company history. The activity decline was partially offset by increased day rates achieved from customers using multipad well programs that require additional ancillary equipment and on-site staff.
U.S. production testing revenues increased to a record level of $10,596,000 in the fourth quarter of 2014 from $7.15-million in the fourth quarter of 2013; a 48-per-cent increase. Both activity levels and day rates increased as the division has replaced and then exceeded the lost work from a customer that shifted to a competitor in late 2013. The 38-per-cent increase in day rates is a combination of day rate increases in U.S. dollars (27 per cent) and in part due to strengthening of the U.S. dollar versus the Canadian dollar (11 per cent). The increase in U.S. dollar day rates related to benefit of revenue from additional equipment and staff due to a shift in the nature of work. The international resale and rental revenue was nil in the fourth quarter of 2014 as the company decided to terminate its pursuit of operations in Venezuela.
Gross margin and adjusted gross margin
Gross margin for the fourth quarter of 2014 was 13.5 per cent compared with 12.9 per cent in the fourth quarter of 2013. Adjusted gross margin for the fourth quarter of 2014 was $15,155,000 (20.7 per cent) compared with $13,474,000 (20.7 per cent) for the fourth quarter of 2013. The maintenance of the adjusted gross margin percentage was primarily due to declines in labour costs resulting from a continuing effort to maintain a cost-effective mix of staff and offset by increases in repair and rental costs resulting from overall increased activity.
Depreciation allocated to cost of sales increased to $5,231,000 in the fourth quarter of 2014 from $5,036,000 in the fourth quarter of 2013. As a percentage of revenue, depreciation included in cost of sales decreased to 7.1 per cent for the fourth quarter of 2014 from 7.7 per cent for the fourth quarter of 2013.
Selling, general and administrative expenses
SG&A expenses were $6,377,000 in the fourth quarter of 2014, a decrease of $342,000, compared with $6,719,000 in the fourth quarter of 2013. As a percentage of revenue, these costs were 9 per cent in the fourth quarter of 2014 and 10 per cent in the fourth quarter of 2013. Adjusted SG&A was $5,963,000 in the fourth quarter of 2014 compared with $4,973,000 in the fourth quarter of 2013, an increase of $990,000. Adjusted SG&A increased primarily due to wages, benefits and variable compensation. These increases related to increased sales commissions and additions to research and development personnel. In addition, adjusted SG&A was also higher due to higher insurance costs resulting from increases in activity.
Gain on disposal of property and equipment
During the fourth quarter of 2014 the company had a gain on disposal of property and equipment of $392,000 compared with $1,462,000 in the fourth quarter of 2013. The company's gains are mainly due to recoveries of lost-in-hole equipment costs including previously expensed depreciation on the related assets. The timing of lost-in-hole recoveries is not in the control of the company and therefore can fluctuate significantly from quarter to quarter. In the fourth quarter of 2013 there was an adjustment to gain on disposal of land and buildings resulting in a decrease in previously recognized gain of $460,000 (2014 -- nil).
Writedown/recovery of investment in associate and related assets
Cathedral decided to terminate its pursuit of operations in Venezuela. As a result in the fourth quarter of 2013, the company recorded a charge in the amount of $13.07-million related to the write-off of its investment in Vencana as well as certain assets located within Venezuela. During 2014 there was a minor recovery in the amount of $177,000. Cathedral will attempt to sell its interest in Vencana and any proceeds with respect to the sale of its joint venture interest will be recorded on a cash received basis as a recovery of this writedown.
Foreign exchange loss
The company had foreign exchange loss of $335,000 in the fourth quarter of 2014 compared with a loss of $372,000 in the fourth quarter of 2013 due to the fluctuations in the Canadian dollar compared with the U.S. dollar. The company's foreign operations are denominated in a currency other than the Canadian dollar and therefore, upon consolidation gains and losses due to fluctuations in the foreign currency exchange rates are recorded in other comprehensive income on the balance sheet as a component of equity. However, gains and losses in the Canadian entity on U.S.-denominated intercompany balances continue to be recognized in the statement of income. Included in the fourth-quarter 2014 foreign currency gain are unrealized losses of $452,000 (fourth quarter 2013 -- $336,000) related to intercompany balances.
Finance costs
Finance costs consist of interest expenses on operating loans, loans and borrowings and bank charges of $699,000 for the fourth quarter of 2014 versus $661,000 for the fourth quarter of 2013.
Income tax
For the fourth quarter of 2014, the company had an income tax expense of $1,287,000 compared with a recovery of $146,000 in the fourth quarter of 2013. The effective tax rate for the fourth quarter of 2014 was 42 per cent. Under international financial reporting standards, the quarterly tax provisions are based upon an estimated annual rate and the company did not utilize non-capital losses to the extent that was planned in the quarterly provision. As a result, fourth-quarter 2014 effective rate is higher than the annualized rate for 2014. Included in the fourth-quarter 2013 amount is an adjustment to prior year's deferred tax recovery of $313,000. Due to the write-off of investment in associate in the fourth quarter of 2013 the effective tax rate is not meaningful and is not presented.
Liquidity and capital resources
Overview
On an annualized basis the company's principal source of liquidity is cash generated from operations. In addition, the company has the ability to finance liquidity requirements through its credit facility and the issuance of debt and/or equity. For the year ended Dec. 31, 2014, the company had funds from continuing operations of $32,114,000 (2013 -- $25,359,000). The increase in funds from continuing operations is due to stronger earnings.
Working capital
At Dec. 31, 2014, the company had working capital of $38,135,000 (2013 -- $26,031,000) and a working capital ratio of 1.8 to 1 (2013 -- 1.7 to 1). During 2014 Cathedral's joint venture partner unexpectedly advanced Cathedral $6,782,000 (U.S.). In the context that the joint venture will be wound up or sold to the company's joint venture partner, the ultimate characterization of this payment is not determinable at this time and accordingly, the company has recorded the Canadian-dollar equivalent as a trade payable and this amount is included in the change in non-cash working capital.
Credit facility
On Aug. 8, 2014, the company entered into a three-year committed revolving credit facility in the amount of $85-million, which represents a $10-million increase from the prior credit facility. The credit facility includes a $25-million accordion feature which is subject to approval of the syndicate of lenders. The syndicate of lenders consists of Bank of Nova Scotia and National Bank of Canada.
The facility bears interest at the bank's prime rate plus 0.50 per cent to 2.00 per cent or bankers' acceptance rate plus 1.75 per cent to 3.25 per cent with interest payable monthly. Interest rate spreads for the credit facility depends on the level of financed debt to EBITDAS (earnings before interest on long-term debt, taxes, depreciation, amortization and non-cash compensation expense -- as defined in the credit agreement).
The credit facility is secured by a general security agreement over all present and future personal property and is subject to certain covenants regarding the payment of dividends. As at Dec. 31, 2014, the company is in compliance with all covenants under the credit facility.
CREDIT FACILITY COVENANTS
Ratio Dec. 31, 2014, value
Debt service ratio -- must be not less than 2.50:1 6.96:1
Funded debt to EBITDA (as defined in credit facility) --
must be not greater than 3.00:1 1.66:1
The new credit facility has a swing line (operating loan component) of $10-million compared with $20-million operating loan under the prior facility.
CURRENT CREDIT FACILITY
(in thousands of dollars)
Dec. 31, Dec. 31,
2014 2013
Total credit facility $85,000 $75,000
Drawings on credit facility
Operating loan 1,069 10,119
Revolving term loan 55,000 37,000
Letter of credit 700 700
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Total drawn facility 56,769 47,819
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Undrawn portion of credit facility $28,231 $27,181
Contractual obligations
In the normal course of business, the company incurs contractual obligations and those obligations are disclosed below. As at Dec. 31, 2014, the company had a commitment to purchase equipment of approximately $2,279,000, and the outstanding contractual obligation related to the building of a facility in Oklahoma was $450,000. Cathedral anticipates expending funds related to the purchase of equipment obligations in the first and second quarters of 2015 and the building obligation in the first quarter of 2015.
Contingencies
On Oct. 29, 2014, Cathedral received a letter from one of its U.S. clients alleging a downhole drilling incident which impacted two of its wells in December, 2013. The client has indicated potential damages of $3-million. Cathedral does not normally carry insurance for this type of incident. Cathedral is currently in the process of investigating the particulars related to this letter to understand its potential liability and the impact any liability may have on the company. Due to the uncertainty around what amount, if any, and the means of settlement, the company has made no provision in the financial statements for this incident.
The company's wholly owned subsidiary, Cathedral Energy Services Inc. (INC), has been named in a legal action in Houston, Tex., commenced by a former employee and was subsequently joined by one former employee alleging that they were improperly classified as exempt under the Fair labour Standards Act and therefore entitled to overtime that was not previously paid. Legal actions involving similar alleged violations have been filed in the United States against a number of other drilling companies. The claimants assert that they will seek to have the action certified as a collective action which may result in additional employees or former employees of INC joining the action. INC has filed a defence to the action and intends to vigorously defend the same, including, without limitation, any motion which may be brought for certification. Based upon a preliminary assessment of information available and certain assumptions the company believes to be reasonable at this time, Cathedral believes it has a number of defences to the claims asserted and the action is not currently believed to be material to the company.
Share capital
At March 3, 2015, the company had 36,295,380 common shares and 1,221,641 options outstanding with a weighted average exercise price of $6.94. The company's prior normal course issuer bid expired on July 7, 2014. There were no repurchases under the expiring NCIB. The company did not renew the NCIB.
CONDENSED CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(in thousands of dollars except per share amounts)
Three months ended Dec. 31, Year ended Dec. 31,
2014 2013 2014 2013
Revenues $ 73,242 $ 65,238 $ 275,435 $ 224,685
Cost of sales
Direct costs (58,087) (51,764) (215,865) (172,863)
Depreciation (5,231) (5,036) (19,373) (19,270)
Share-based compensation (19) (16) (112) (177)
----------- ----------- ---------- ----------
Total cost of sales (63,337) (56,816) (235,350) (192,310)
----------- ----------- ---------- ----------
Gross margin 9,905 8,422 40,085 32,375
Selling, general and administrative expenses
Direct costs (6,256) (6,776) (24,470) (23,777)
Depreciation (76) (70) (280) (557)
Share-based compensation (45) 127 (200) (335)
----------- ----------- ---------- ----------
Total selling, general and administrative expenses (6,377) (6,719) (24,950) (24,669)
----------- ----------- ---------- ----------
3,528 1,703 15,135 7,706
Gain on disposal of property and equipment 392 1,462 3,102 4,852
Gain (loss) on disposal of land and buildings - (460) - 4,894
(Writedown of) recovery on investment in associate
and related assets 177 (13,066) 177 (13,070)
----------- ----------- ---------- ----------
Earnings (loss) from operating activities 4,097 (10,361) 18,414 4,382
Foreign exchange (loss) (335) (372) (881) (752)
Finance costs (699) (661) (2,563) (2,516)
----------- ----------- ---------- ----------
Earnings (loss) before income taxes 3,063 (11,394) 14,970 1,114
Income tax recovery (expense)
Current (expense) (621) (262) (3,271) (2,604)
Deferred recovery (expense) (666) 408 (1,416) (52)
----------- ----------- ---------- ----------
Total income tax recovery (expense) (1,287) 146 (4,687) (2,656)
----------- ----------- ---------- ----------
Net earnings (loss) $ 1,776 $ (11,248) $ 10,283 $ (1,542)
=========== =========== ========== ==========
Other comprehensive income
Foreign currency translation differences for foreign
operations 1,609 2,364 2,611 3,918
----------- ----------- ---------- ----------
Total comprehensive income (loss) 3,385 (8,884) 12,894 2,376
Net earnings (loss) per share
Basic $ 0.05 $ (0.31) $ 0.28 $ (0.04)
Diluted 0.05 (0.31) 0.28 (0.04)
We seek Safe Harbor.
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