Mr. Tom Connors reports

CATHEDRAL ENERGY SERVICES LTD. REPORTS 2023 ANNUAL RESULTS

Cathedral Energy Services Ltd. has released its 2023 annual results.

2023 key highlights

The company achieved the following 2023 results and highlights:

• Revenues of $545.3-million in 2023 is the highest annual revenues in the company's history and represents an increase of 71 per cent, compared with $319.0-million in 2022.
• Adjusted EBITDAS (earnings before interest, taxes, depreciation and amortization, and stock-based compensation) of $90.9-million in 2023, also established a new corporate record, increasing 33 per cent, compared with $68.2-million in 2022.
• Higher United States and Canadian job count and operating days in 2023, compared with 2022, despite overall lower industry rig counts.
• An increase in the Canadian average revenue per operating day of 19 per cent in 2023, compared with 2022.
• An increase in the U.S. average revenue per operating day of 9 per cent in 2023 Q4, compared with 2023 Q3, owing to a greater mix of rotary steerable work.
• Net income of $10.6-million in 2023 was lower than the $18.3-million net income in 2022. The decrease was mainly related to increased acquisition-related depreciation and amortization costs which will normalize over time. In addition, the company recognized a non-cash provision of $5.4-million in 2023.
• Cash flow -- operating activities of $70.0-million in 2023, compared with $39.9-million in 2022.
• Free cash flow of $29.0-million in 2023, compared with $25.6-million in 2022.
• The company purchased 4,294,900 common shares of Cathedral under its normal course issuer bid (NCIB) for a total amount of $3.8-million at an average price of 82 cents per common share.
• The company acquired Rime Downhole Technologies LLC, a privately held, Texas-based, engineering business that specializes in building products for the downhole measurement-while-drilling (MWD) industry in exchange for approximately $41.0-million (U.S.).
• Subsequent to the acquisition of Rime in July, 2023, loans and borrowings less cash was $67.9-million as at Dec. 31, 2023, compared with $69.4-million as at Dec. 31, 2022. The company continues to focus on reducing its loans and borrowings and generating free cash flow in 2024.
• The company continues to see a significant opportunity for margin expansion in its U.S. directional business by using Rime-supplied MWD systems to reduce its third party rental costs.

President's message

Comments from president and chief executive officer Tom Connors:

"Cathedral achieved its highest revenue and adjusted EBITDAS for any year going back to its founding in 1998 despite the challenges of lower activity levels in the U.S. market combined with a much lower commodity price environment compared with that of 2022. Revenue was over $545-million while adjusted EBITDAS topped $90-million in 2023. To put the transformation in context, Cathedral generated less than $5-million of adjusted EBITDAS annually in 2019 and 2021, the two years that bracketed the severe activity pullback in 2020 from the COVID-19 global pandemic. The company set out several years ago to achieve size and scale in the North American directional drilling business and we are happy to report that the company is well on its way.

"In Canada, Cathedral ranks among the most active directional drillers in the country and outpaced the market with the highest levels of activity of any contractor at certain periods, while in the U.S. Cathedral is among the largest providers of directional services with a particular focus on the important Permian play and the Rockies. Cathedral has three operating divisions in the U.S. (Altitude Energy Partners, Discovery Downhole Services and Rime Downhole Technologies) and each weathered the commodity price volatility of 2023 quite well.

"Cathedral's U.S. directional drilling provider, Altitude Energy Partners, grew its job count in 2023 and this is best shown in 2023 Q4 results where operating days grew 13 per cent versus a U.S. land rig count that declined 21 per cent from Q4 2022 (source: Baker Hughes). Altitude relied on an excellent operating track record and strong client relationships to grow its presence in the U.S. during a period of slowing activity. With a continued focus on drilling performance, Altitude was also able to increase its average revenue per operating day slightly in 2023 Q4 due to a higher mix of rotary steerable as a portion of the overall job count. Altitude's strong presence in U.S. plays with better economics and with larger clients has helped it weather the rapidly changing conditions of 2023. Being the supplier to many of our competitors in a slower market, we did experience a decrease in utilization in our U.S. mud motor rental business but continue to keep pace with the market due to our focus on high performance mud motor technology.

"Cathedral's purchase of Rime in July, 2023, will allow the company to address one of the major value capture opportunities in its U.S. directional business -- the operating margin lost from renting third party MWD systems. At current activity levels, Cathedral estimates that it is spending $25-million (U.S.) to $30-million (U.S.) of margin annually to third parties for MWD technology to supply on its own work, which represents a substantial opportunity for margin expansion over the next 12 to 18 months for very reasonable levels of capital investment and very compelling rates of return. Rime has distinguished itself in the U.S. land drilling market by becoming one of the largest suppliers of components for MWD systems. Rime has already supplied 10 MWD systems for Altitude to help replace third party rental products and begin the process of margin expansion in 2024. In a year where forecasted activity levels are anticipated to be flat to slightly negative versus 2023 in North America, Cathedral can demonstrate meaningful continued growth driven by a reduction in expenses utilizing organically developed technology.

"In Canada, revenues grew 33 per cent in 2023 over the previous year due to an increase in both operating days and an average revenue per operating day driven by increasing demand for services and high performance technology from our customers. This compares to a 1-per-cent decline in the average Canadian rig count in 2023 versus 2022 (source: Rig Locator). More recently, Cathedral's 2023 Q4 operating days and average revenue per operating day were both roughly flat versus 2023 Q3 levels while the Canadian rig count declined 5.3 per cent (source: Rig Locator). Cathedral is a pre-eminent player in Western Canadian plays where wells have a high multilateral count, which helps the company weather volatility in oil prices and more recently the deep downturn in natural gas prices.

"In regard to our ongoing efforts to strengthen the balance sheet, Cathedral remains focused on paying down its loans and borrowings and generating free cash flow. The company continues to target the reduction of loans and borrowings to less than 0.5 times adjusted EBITDAS by year-end 2024, which should help it move closer to a broader shareholder return strategy. To date, Cathedral has been active under its NCIB program, which marks phase one of its pursuit to increase shareholder returns. Management believes that buying Cathedral shares at current share price levels represents good value and a sensible use of capital while also staying focused on paying down debt built up from the strategic acquisitions of Altitude and more recently Rime.

"Finally, I want to take this opportunity to thank both our employees for their dedication and our shareholders for their support as we continue to execute on our size and scale strategy and our vision to build Cathedral into a preeminent player in the North American directional technology market," concluded Mr. Connors.

Outlook

Global oil and North American natural gas prices weakened considerably in the fourth quarter of 2023, which caused an approximate 5 per cent decline in both the Western Canada and U.S. average active land rig counts when compared with their respective 2023 Q3 averages (sources: Baker Hughes and Rig Locator). Specifically, West Texas Intermediate (WTI) oil prices began 2023 Q4 at just under $90.00 (U.S.) per barrel and exited 2023 Q4 just over $70.00 (U.S.) per barrel, more than a 20-per-cent intraquarter move. U.S. NYMEX natural gas prices began the quarter just under $3.00 (U.S.) per-million cubic feet (mmbtu) and exited 2023 Q4 at close to $2.50 (U.S.) per mmbtu -- close to a 20-per-cent decline.

In the futures market, oil as traded on NYMEX remains in backwardation. With each successive future month price lower than the preceding month, there is no meaningful incentive for speculators to put oil into storage as is the case when the oil futures curve is in contango. This typically implies that the current oil supply-demand balance remains healthy. As such, Cathedral believes that the current WTI oil price of around $80.00 (U.S.) per barrel is likely considered a healthy price by most of Cathedral's exploration and production (E&P) clients to deploy planned oil-directed capital programs in North America for 2024.

The natural gas market outlook remains challenging in the short term with a 12-month strip price on the U.S. NYMEX futures curve of approximately $2.75 (U.S.) per mmbtu, which compares with the approximate $3.00 (U.S.) per mmbtu strip price when Cathedral released its 2023 Q3 results. A warm El Nino winter in many key consuming North American markets dampened gas demand considerably in latter Q4 and through early March, 2024, which has added to the excess natural gas being produced as a byproduct of strong U.S. crude oil production in areas, such as the Permian. The effect of both has been a severe weakening of near-term North American natural gas prices to levels last seen at the depth of the global COVID-19 pandemic or in some cases lower. This price compression is likely to have the effect of a further weakening of natural gas-targeted activity in U.S. areas such as the Haynesville, Marcellus and the Rockies as the year progresses. Cathedral's substantial presence in the oil-focused Permian and smaller presence in the Haynesville should act as a stabilizing influence amidst potential future E&P natural gas capital program cuts and potential declines in activity.

In Canada, the presence of natural gas liquids in the natural gas production stream gives an oil-like revenue stream to many E&P companies -- a revenue stream that is much less common in U.S. operating areas. As such, Cathedral's Canadian client base is affected to a lower degree and the company expects a fairly flat overall market in 2024. A survey of energy service analysts is consistent with the company's view that 2024 is likely to be reasonably flat to 2023 from an overall activity perspective with a bias to some potential strengthening in the market toward the latter half of the year on improving natural gas prices. Canada has some encouraging prospects for activity in the future given it was announced recently that the gas transmission pipeline (Coastal GasLink) for the LNG Canada project has now reached mechanical completion and with the looming start-up of the Trans Mountain oil pipeline expansion in months to come. Once both projects initiate operations they should support some degree of growth and stability in incremental drilling activity in the Canadian market for many years into the future.

Finally, looking at the first quarter of 2024, Cathedral is seeing more of the same trends evidenced in the fourth quarter of 2023. The company's 2024 Q1 U.S. job count remains generally consistent with 2023 Q4 levels. The first 10 Rime-supplied MWD kits have now been deployed into Altitude, which should also help increase divisional margins going forward as third party MWD systems are displaced. Cathedral anticipates introducing and deploying 40 Rime-supplied MWD kits throughout the remainder of 2024. In Canada, Cathedral was the most active directional drilling provider in 2024 Q1 with some of the highest job counts achieved in the company's history. Cathedral's clients have been particularly active in drilling wells with a high number of multilaterals, with the company's proven experience in those areas supporting a growth in job count over prior periods.

2023 acquisition

On July 11, 2023, Cathedral, through a wholly owned subsidiary, acquired Rime, a privately held, Texas-based, engineering business that specializes in building products for the downhole MWD industry in exchange for approximately $41.0-million (U.S.) (approximately $54.1-million) comprised: i) the payment of $21.0-million (U.S.) in cash (approximately $28.0-million); and ii) the issuance of principal amount of $20.0-million (U.S.) (approximately $26.4-million) of subordinated exchangeable promissory notes (EP notes) that are exchangeable into a maximum of 24.57 million common shares of Cathedral at an issue price of $1.10 per common share. In accordance with International Accounting Standards (IAS) 32 and IFRS 13, the EP notes were determined to be a compound instrument and, accordingly, recognized at the fair value of their respective debt component of $23.4-million and equity component of $1.2-million totalling $24.6-million.

The EP notes have a three-year term and accrue interest payable quarterly at a rate of 5 per cent per annum. Any time prior to expiry of the EP notes, if the 20-day volume weighted average trading price of the common shares of Cathedral equals or exceeds $1.10 per common share, Cathedral may cause the exchange of the EP notes for common shares. Cathedral and the holders of the EP notes may agree to an earlier exchange of the EP notes into common shares. In addition to the statutory hold periods applicable to the EP shares under Canadian and U.S. securities laws, the parties agreed to contractual restrictions on resale of any EP shares as follows: 33 per cent of the EP shares are restricted until July 11, 2024; a further 33 per cent of the EP shares are restricted until July 11, 2025; and a further 34 per cent of the EP shares are restricted until July 11, 2026, subject to certain exceptions contained in the terms governing the EP notes. In connection with the Rime acquisition, the company entered into a three-year term credit facility, replacing its existing credit facility with its syndicate of lenders led by ATB Financial (ATB).

The purchase price allocation was recognized under IFRS 3 Business combinations as shown in the attached table.

Reclassifications

The company has changed the presentation of certain figures in the comparative period related to equipment lost-in-hole reimbursements collected from customers and the corresponding derecognition of the property, plant and equipment (PP&E).

More specifically, the company reclassified its gain on disposal of PP&E in the comparative period as follows: a) reclassified the proceeds on disposal of PP&E, related to lost-in-hole equipment, to revenues and b) recognized a writeoff of PP&E for the net book value of the lost-in-hole equipment on the consolidated statement of comprehensive income. In addition, the lost-in-hole proceeds were reclassified from the company's cash flows -- investing activities to the cash flows -- operating activities on the consolidated statement of cash flows.

The company has changed its judgement regarding equipment lost-in-hole events that are contracted with its customers in that these events are now considered to be part of its ordinary business activities. The changes are reflected in the current and prior periods, as described herein.

These reclassifications recognized in the three months and year ended Dec. 31, 2022, are summarized in the attached tables.

Consolidated

The company recognized $145.4-million of revenues in the three months ended Dec. 31, 2023, an increase of $6.3-million or 5 per cent, compared with $139.1-million for the same period in 2022. The increase is due to a 3 per cent increase in operating days (2023 -- 7,014; 2022 -- 6,822) and a 2-per-cent increase in the average revenue per operating day (2023 -- $20,733; 2022 -- $20,397).

The company recognized $545.3-million of revenues in 2023, an increase of $226.3-million or 71 per cent, compared with $319.0-million in 2022. The increase in 2023 is mainly attributed to a full year of results from acquisitions completed in 2022. For 2023, there was a 53-per-cent increase in operating days (2023 -- 26,956; 2022 -- 17,662) and a 12-per-cent increase in the average revenue per operating day (2023 -- $20,229; 2022 -- $18,062).

The company recognized $115.6-million of cost of sales in the three months ended Dec. 31, 2023, an increase of $8.9-million or 8 per cent, compared with $106.7-million for the same period in 2022. The increase is mainly due to higher repairs, labour, and the inclusion of manufacturing costs related to Rime, which was acquired in July 2023.

The company recognized $440.0-million of cost of sales in 2023, an increase of $191.8-million or 77 per cent, compared with $248.2-million in 2022. The increase in 2023 is mainly attributed to a full year of results from acquisitions completed in 2022. In addition, the company continued to experience inflationary costs on the business in 2023, namely higher labour, repair and equipment rental costs.

The gross margin per cent decreased to 20 per cent and 19 per cent in the three months and year ended Dec. 31, 2023, compared with 23 per cent and 22 per cent for the same periods in 2022, respectively. The adjusted gross margin per cent decreased to 29 per cent and 27 per cent in the three months and year ended Dec. 31, 2023, compared with 31 per cent for the same periods in 2022, respectively. The decline in adjusted gross margins noted above were mainly related to increased labour, repairs and equipment rental costs.

Depreciation and amortization expense included in cost of sales increased to $11.2-million and $41.0-million in the three months and year ended Dec. 31, 2023, compared with $10.7-million and $28.7-million for the same periods in 2022, respectively, due to property, plant and equipment additions, including those related to the 2022 acquisitions.

Depreciation and amortization expense included in cost of sales as a percentage of revenue was 8 per cent in the three months and year ended Dec. 31, 2023, compared with 8 per cent and 9 per cent for the same periods in 2022, respectively.

The company recognized SG&A expenses of $18.1-million and $64.3-million in the three months and year ended Dec. 31, 2023, an increase of $6.6-million and $32.6-million, compared with $11.5-million and $31.7-million for the same periods in 2022, respectively. The increase is mainly due to acquisition activity and discretionary short-term incentive program payments, which were approved and recognized in 2023, compared with no discretionary incentive payments recognized in 2022. SG&A expenses as a percentage of revenues were 12 per cent in the three months and year ended Dec. 31, 2023, compared with 8 per cent and 10 per cent for the same periods in 2022, respectively.

Depreciation and amortization included in SG&A were $2.3-million and $7.6-million in the three months and year ended Dec. 31, 2023, compared with a recovery of $600,000 and $3.0-million for the same periods in 2022, respectively. The three months ended Dec. 31, 2022, was impacted by adjustments related to the intangible assets acquired from Altitude. The increase in the year ended Dec. 31, 2023, amount is mainly related to a full period of depreciation and amortization of Altitude assets in 2023 and amortization recognized in relation to the intangible assets acquired from Rime.

Stock-based compensation included in SG&A were $1.0-million and $4.2-million in the three months and year ended Dec. 31, 2023, compared with $400,000 and $800,000 for the same periods in 2022, respectively. The increase is related to stock options granted in the period, including those related to the Rime acquisition.

About Cathedral Energy Services Ltd.

Cathedral Energy Services, based in Calgary, Alta., is incorporated under the Business Corporations Act (Alberta) and operates in the United States under Discovery Downhole Services, a division of Cathedral Energy Services Inc., Altitude Energy Partners LLC and Rime Downhole Technologies LLC. Cathedral's common shares are publicly traded on the TSX under the symbol CET. Cathedral is a trusted partner to North American energy companies requiring high-performance directional drilling services. The company works in partnership with its customers to tailor its equipment and expertise to meet their specific geographical and technical needs. The company's experience, technologies and responsive personnel enable its customers to achieve higher efficiencies and lower project costs.

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