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Good morning, ladies and gentlemen. Welcome to the Essential Energy Services Limited Fourth Quarter Results Conference Call and Webcast.I would now like to turn the meeting over to Ms. Karen Perasalo, Vice President, Investor Relations. Please go ahead, Ms. Perasalo.
Thank you, Retta. Good morning, and thank you for joining our fourth quarter conference call. With me on the call today are Garnet Amundson, President and CEO; Jeff Newman, Senior VP, Business Development; and Allen Mowbray, CFO. This morning, we will give you an overview of our fourth quarter results, speak to the outlook and open the line for questions. In this conference call, we will be discussing financial measures, including certain non-IFRS financial measures, such as EBITDA. Please see our March 7, 2018, fourth quarter news release for definitions of these terms.Today's call may include forward-looking statements. Such statements are given as of the date of this call and involve risks and uncertainties. A number of factors and assumptions were used to formulate such statements. Actual results could differ materially, and there could be no assurance of future performance or market impacts. For additional information with respect to our forward-looking statements, factors and assumptions, please refer to our March 7, 2018, fourth quarter news release. In today's call, we will refer to the Essential Coil Well Service operating division as ECWS.I will now turn the call over to Garnet.
Thank you, Karen. Good morning. Yesterday, we reported Q4 '17 revenue of $43.3 million. Tryton and ECWS both improved compared to Q4 '16.Tryton also had a strong revenue quarter relative to the sequential prior quarter of Q3 '17. For ECWS, while revenue improved from the fourth year -- from the prior year fourth quarter, revenue was substantially less than the sequential third quarter 2017 and management's expectations.Given where we are in the industry reporting season, the ECWS revenue shortfall is likely not a surprise to those of you listening to this call. Other Canadian service companies have reported similar effects as customers slowed or ceased spending in the fourth quarter 2017.What was likely news was the incremental ECWS operating costs in the quarter. We discussed the reasons in our MD&A, and Allan will comment on it later in his call. ECWS combined with Tryton to generate fourth quarter 2017 EBITDAS of $1.2 million, much below our expectations and similar to the comparable 2016 quarter.For the full year, 2017 revenue was $175.9 million compared to $97.5 million in 2016, and EBITDAS was $18.6 million, an increase from negative EBITDAS in 2016. We have no news or developments regarding the Packers Plus litigation and appeal. We continue to believe that the appeal is without merit.Allan will now speak in more detail about Q4 '17 operating and financial results.
Thank you, Garnet. ECWS revenue was $22 million, a 25% increase from Q4 '16. Q4 activity slowed as the quarter progressed as customers completed their 2017 capital programs. Service pricing remains stable and relatively unchanged since we last increased prices in the first quarter 2017.In Q4, ECWS experienced higher costs related to reactivating equipment, recruiting and training crews and unanticipated equipment repairs. After the busy third quarter and with a plan to prepare for an anticipated busy first quarter 2018, decisions were made to continue to recruit and train crews and reactivate equipment. It takes 3 to 6 months to hire and train employees, so lead time is required. Our training approach often includes using an extra employee on many coil and fluid bumper crews. Unfortunately, demand for completions work slowed as the fourth quarter progressed.Higher costs in the quarter also included unanticipated equipment repairs, the result of a downtime, inefficient crew management and nonchargeable travel time. This also eroded margin. Gross margin for Q4 '17 was 4%, below the prior year period and the prior sequential quarter.Our Gen III coil tubing rigs and higher pressure fluid bumpers continued to experience strong demand as customers completed long-reach horizontal wells, particularly in the Montney region. For the full year, ECWS gross margin was 16%, a substantial increase from 7% in 2016.Tryton generated $21.3 million of revenue, a 36% increase from Q4 '16 and $4.2 million of gross margin. With its broad geographic base and varied product offering, Tryton successfully adapted to deteriorating industry activity in the fourth quarter 2017 and generated a solid revenue and gross margin. Tryton's cost control and cost structure varies mostly with revenue. This contributed to strong quarterly performance.Each Tryton service line reported higher revenue in the same period in 2016 with conventional tools revenue experiencing the greatest increase. Tryton's gross revenue as a percentage of revenue was 20% in Q4 '17 compared to 19% in Q4 '16. For the full year 2017, gross margin was 24%, a substantial increase from 15% in 2016. The improvement was due to increased revenue and Tryton's variable cost structure as fixed cost comprised a smaller proportion of revenue. Essential's 2018 capital spending budget remains unchanged at $13 million, comprised of $5 million growth capital and $8 million of maintenance capital. Essential's debt at the end of 2017 was $18 million, and debt to EBITDA was 0.96x. Debt at March 7, 2018, was $26.3 million. The increase from the year-end is largely due to funding working capital. Accounts receivable have grown with increased first quarter activity. That should start to decrease toward the end of March and end of the second quarter as customers pay their bills. Many take 70 to 90 days to pay.Garnet will now discuss the outlook.
So activity in the first quarter of 2018 so far has been strong for both ECWS and Tryton. So far, activity and revenue in January and February is progressing on a path very similar to Q1 '17. We're hoping for a full month of March activity like we experienced in 2017.Competitive pricing pressure remains a factor. Neither ECWS nor Tryton expect meaningful price increases for products and services in the near term. We need stronger industry activity and fewer competitors for customers to support increased pricing for our services. Many of our customers have benefited from higher oil prices, but that is not being passed through to Essential in the form of higher prices.Even though activity is similar to last year's first quarter, despite our best efforts, our cost structure has been somewhat increasing in ECWS, so we do not expect margins to equal the first quarter of 2017. Fourth quarter margin -- fourth quarter ECWS margins, however, are not an indication of ongoing margin expectations. Compared to last year, we're experiencing higher costs in labor, fuel, and repairs and maintenance. First quarter costs last year were unsustainably low as we pushed through the first solid signs of activity recovery.For ECWS, recruiting has been put on hold except to replace normal staff turnover. We now have sufficient trained crews and activated equipment to meet customer demand for this quarter.Tryton continues to perform well and appears to be on a similar path to last year's first quarter regarding cost control. Tryton has done a great job of adapting sales and products to the changing demands of our customers. We're excited about Tryton's new product offerings, including our composite bridge plugs and the Viking sleeve system. While these had a nominal impact on Q4 results, there have been some notable accomplishments so far in Q1 '18, including using its new composite bridge plug in conjunction with the Tryton ball & seat tools to complete two 90-stage MSFS, or multistage fracturing jobs, in the Montney. And secondly, using its Viking sleeve system, Tryton completed a 53-stage job in a single tool run in the Cardium formation.Beyond Q1, it is challenging to forecast activity. Many industry experts forecast 2018 to be similar to 2017. Our Canadian oil and gas industry faces significant headwinds due to the inability to access world markets and achieve higher commodity prices in addition to higher taxes and excessive regulation.The price of Western Canadian select and AECO are indicative of the challenges. We require stronger political and regulatory support from our governments to allow projects to proceed. The current uncertainty is not helpful or constructive to the Canadian oilfield services outlook.So in closing the formal comments from Essential's perspective, with the largest coil tubing fleet in Canada, associated pumping services and established downhole tools and rentals operation and our low debt, Essential is well positioned to exceed and succeed as the industry recovery continues.
Greta, at this time, we would like to open it up for questions.
[Operator Instructions] The first question is from Steve Kammermayer of Clarus Securities.
Just a question on the increasing costs in Q4. I was wondering if you could quantify the difference in how much the costs to reactivate equipment versus R&M versus increased labor in the quarter?
Yes. I can -- I mean, I don't know if I can get that granular, but I do think it's probably fair that I try to give a bit of color on things. Again, sort of applying some form of normal margin to where our revenue was, the fallout math would be something like $3 million, by our calculation, of, okay, nonrepeatable variable costs is what we're hoping for. And again, there's so many factors in there. That's a bit of a wild guess. And within that, we've sort of broken into a couple of big chunks of what we call the unanticipated equipment breakdowns. And it is not just the cost to do repairs -- all that into repairs and maintenance. There's just a whole bunch of associated costs with travel, fuel, subsistence and manpower costs related to how that happened. And then the other significant theme that Allan talked about is our efforts for hiring, recruiting and training personnel.
Okay. So the hiring, recruiting, and training would be in addition to that $3 million? So that $3 million...
No, that number actually out covers both of those areas. I would say the lesser one is the hiring, training and reactivating equipment. And I would say the bigger chunk of the cost is probably the equipment breakdowns.
Okay. So is the increase -- is the labor for the additional employees, excluding the hiring costs, recruiting costs, training costs, is that included in the $3 million? I'm trying to get to what portion of these costs will roll into Q1 as well.
Yes. And I think -- so to help you out with that, which I tried to put in the script comments, and we obviously don't give formal guidance on sort of go-forward, where we're at, but we obviously have looked closely at where our margins were in Q1 '16, and we don't see that as -- sorry, Q1 '17 relative to Q1 '18. We don't see us being able to repeat those margins that we had for ECWS in Q1 '17. And part of it is we've talked to -- just to -- it was a very competitive labor market, so we have had to give raises to our guys. We're just sort of doing what's going on in the space. But that number that I threw out, that rough number of $3 million is what I would call the nonrepeatable variable cost. So I think by the time you pull that out and do some math, somewhere between, we're not going to be as strong as last year, but Q4 has no indication of sort of a -- we'll call it a chronic ongoing problem within our margins.
Right. Okay. So I mean, just comparing the margins last year versus this year, operating margins were down close to 4%. Is that sort of a hit you're looking at in Q1 versus Q1 '17?
Yes, I'm going to have to, again -- probably getting too granular to be able to answer that one for you, Steve, but...
[Operator Instructions] Your next question is from Jeff Fetterly of Peters & Co.
A couple random questions. On the coil tubing side, for Q1 '18, how much higher would average pricing be compared to Q1 of last year?
I think Q1 last year, we'd seen our price increases, so we're up probably 5%, I think, Allan.
And is it safe to assume that your average costs have gone up more than 5% then?
I think that's probably safe to say.
And of that cost inflation side, what would be the largest elements?
I would put in probably in sequence -- and the largest one would be -- my guess would be labor. The next one, which is -- although it shows up as a variable cost, it's harder to trend and predict, but we've had some bad luck in this quarter, especially on R&M but also throwing in something on the R&M side, just for a little more information, part of the nature of the work that we're doing with these deeper long-reach, high-pressure horizontal wells, it's harder on equipment. And we've heard about that from, certainly, the frac-tors that have reported, things like fluid ends, power ends and injector damage, pumper wear and tear. So R&M has been trending up given the nature of the work. And the third category is fuel pricing has gone up.
And is the pricing traction or pricing dynamic any more favorable with the Gen III units versus Gen II or Gen IV, for example?
Right now, Gen III pricing, there is equipment out there that's competing on the Gen III that we have not been able to get pricing traction. That being said, this has been very exciting for us here in the first quarter, where we've often had demand for if we can have the crews and equipment ready for 7 or even all 8 of our Gen IIIs. the Gen IV has been working, I'll say, much more sporadically than we would like. And we're still trying to get the -- we'd like to see the utilization up higher. So in this market, we're basically pricing the Gen IV very similar to the Gen III. And our hope, when we get this retrofit done on our first Gen IV that we're making some changes to, we're hoping that the demand will be even higher for that unit, and then we will revisit pricing.
The investments you made in Q4 around hiring and training, was that principally for Q1 activity levels? Or is that to handle the incremental capacity that you're planning to add in 2018?
Good question, Jeff. It was actually both. And the -- if I -- sort of the time line of -- Allan made the comment, it takes sort of 3 to 6 months, depending on whether it's a totally green hand or a more experienced hand. So we really -- as we talked about in our August conference call, we made the decision to really get after a formal hiring program. And it was targeted at what we needed for Q1 busy season, for both new equipment deliveries and anticipated customer activity. We also suffered a little bit some of our equipment deliveries, the 2 -- those 2 new pumps. The 1,000- and 1,500-horsepower were supposed to be delivered by the end of calendar year 2017. And we actually just got our 1,000-horsepower pump here the other day. So we didn't have that work. We had some other equipment delivery delays. So we really targeted for Q1 '18 and anticipated that would allow us to carry that crew level, if I can say, through 2018 until we got a look at the back half. The big squeeze we got caught in, of course, is you can't stop that machine. And once you've got people trained up and onboard, there is a lot of -- and I'm going to say, voluntary shop time where these guys make their livings only when they're working. So they're purely hourly. That is one of the strengths of our highly variable compensation structure. They're paid purely hourly versus salary so we have to literally come up with ways to put money in their jeans, or these guys have to go somewhere else, and that's no way to build the business. So yes, we took a big hit, for sure, in Q4, but it was in the act of a strategic execution, but it just certainly doesn't look very good in Q4.
And in terms of activity so far in Q1, has it met the expectations you had coming into the quarter?
Yes, we're pretty much on track with what we expected on a revenue basis. I think we would have liked to see things busier than last year, but our -- the industry, certainly with what we saw with the following -- the falling dry natural gas price and some of the oil price shipment issues and customer behavior, we're basically on track, as I said, with Q1 '17 activity rates. And I would've liked to seen things be even busier, but when we can put out a comment like we did in the outlook of getting up to 15 coil units going out as a peak, that's a big stretch. That's -- because there's always -- we have to have crews ready for equipment that isn't working at the time, getting them ready for sort of the next customer and sort of, I'll say, downtime for transition between jobs and repairs. So it's been good, for sure, almost as good as we would have expected.
Sorry, let me frame it differently. Were you crewed up for activity to be higher in Q1 '18 than Q1 '17 coming into the quarter?
Yes, for sure. I made a comment as well, but I'll just say this explicitly. We have really -- when we went into the Q1 '17 period after Q4 '16, we basically were so thrilled and happy, both our workers and as a company, to be able to go to work that we had no problem finding people. And there's a rule within well field services on hours of service and how many hours people can work, and we were stretched right to the limits to accompany and accommodate the work that was available in Q1 '17. That's great from a cost point of view, but I'll tell you, you're running on the edge of exhaustion to work guys that hard. So we crewed up on a, I'll say, a heavier basis to give us some growth capacity. There was nothing left for -- if customers had arrived in Q1 '17 for incremental growth. We did have some capacity in Q1 '18. Here's another problem that happened to us. We actually recruited for 16 packages, which was our target by the end of Q4 '17. And with what you saw in the lack of work that hit us in November and December, we actually lost about 20 of those guys because they had to go elsewhere. So we ended up then dropping down to a capacity of about 14 packages on a steady basis, which is not ideal because we incurred the costs for training and getting those guys ready and then lost them due to lack of work. And that's something we have to work better with our customers to communicate those exercises because I think they feel that they can just -- the equipment and the people will be ready whenever they want it, and we're having a heck of a time running that balance. Is that answer better, Jeff?
Yes. With your comment about halting recruitments in ECWS, does that suggest -- or essentially, are you properly staffed to manage the reactivation of that Gen IV unit plus the additional fluid pumpers coming in?
Yes. We feel right now that we're probably staffed at this level. I think now as we're winding down in Q1, we don't have any more -- it would've been a bummer if we had left a lot of -- we actually run a report called a missed work opportunity report, and we haven't had a lot on that. And that means that I think at 14, we're probably staffed at the right level. Q1 '18 wasn't as robust as we had once hoped but still pretty darn solid. As we noted in the outlook comments, we're now going into breakup. So that's something -- one doesn't want to carry a bunch of extra people into breakup. And then we've got a lot of uncertainty on the second half outlook right now, but I don't see any situation where it's going to be dramatically different than sort of the pace that we experienced in, call it, Q3 '17. So we can accommodate that at our current crew levels.
Okay. Last clarification question. So if I back out the $3 million in your reference for nonrepeatable variable costs, it would imply Q4 margins for ECWS around 18%. Is that a decent reflection of both your activity level and, relative to the higher cost structure, what you think the profitability of that business could look like?
Well, I have to -- similar to my response to Steve, I'll have to be -- put a disclaimer out that I can't own that analysis because I'm not double-checking my numbers. And the second part is we don't actually give a public forecast on our quarter. But your math isn't crazy is probably the best thing I can say.
The next question is from [ Mike McBrayer ] of [ Seoul ].
I'm a shareholder. I've got 2 questions, comments. One's about your equipment utilization. It appears that there's not much growth there in terms of what the demand is in the Western Canadian Sedimentary Basin, and I'm wondering if it's possible to explore maybe selling some of that spare equipment or utilizing this in the U.S., maybe in other regions. And the other question is about shareholder value. I mean, the share price is pretty low relative to book. It's being hit this morning again. I'm looking at your numbers. It looks like you'll generate some free cash flow this year. Is there a possibility to initiate a share buyback or even entertain some potential sale of the company?
Thanks for the call, Mike. That's a lot of questions. I'll try to respond to each of them. The first one, as I recall, is the WCSB demand. And I think the -- similar to the answer I just gave to Jeff Fetterly, given what's going on in the Canadian oil patch relative to our neighbors to the South, I don't think it's easy for any of us to have a prediction for sort of what is going to be the demand in the Canadian oil patch. We look back through the downturn, and a number of people expected we'd be -- 2018 would be the big turnaround year. And now I think there's a lot of commentary in terms of basically saying maybe it's going to be 2019. We need a change in the tone and approach of our politicians, a little more comfort that we can get our product to market, otherwise, producers will continue to behave in an unpredictable manner. There hasn't been an appreciable reduction in the amount of competitive equipment in the services business. And there still are -- even as crazy as it's been, there's still private competitors adding to our space in this market. So there's still capital that is being injected into the space. So we do have surplus equipment. If I take a look at our coil and pumping fleet, I would say our pumping, when you look at the accounting -- the numeric counts, we always put a little footnote in our MD&A. We have been selling off some of the equipment that isn't in demand. For example, our single pumpers and our shallower coil. We do sell that equipment off regularly. We are using all of our Gen IIIs. And they're all busy. We think that's the right equipment. That was the most recent transaction we did in December to pick up more GEN III equipment. We have a surplus of Gen IV equipment, but some of that, that equipment was built for a market like the LNG gas development that has collapsed. So we're modifying that equipment to make it lighter and more mobile so it can share in the same marketplace demand as the GEN IIIs. So excited about that. Where we do have surplus now, which has just happened really in the last couple quarters, is in the Generation II market. Those units, the majority of them -- I'd say all of them came when we acquired Technicoil in 2011, and it's just a function of longer-reach horizontal wells and the fact that, that equipment now is sort of stretched to its max. On the good news front, you could say, what do we do with that equipment. We do think there is potential for that Generation II equipment to work in certain markets in the United States, so we will have those contemplations and conversations. We have been approached to sell Generation II equipment to competitors, but our experience has been that, that is not always a wise move unless we're going to be right out of that space. If we're still competing in the Generation II space, what we've seen is if you sell that to a private operator who is going to scrimp on safety and some of the features that we have to do in training as a high-integrity public company, they will then come along and undercut our price and steal market share right out from under us with our own equipment. So we don't consider that a good strategy. I'm going to stick in a plug just on that note. We operate, and always have, at a top-notch safety level. And the company actually had a record TRIF this year, record-low TRIF of just under 1, which is just an unbelievable and fantastic accomplishment considering all the new people we're hiring and the competitive market we're in. So that's how I see the selling companies -- their equipment. Your next point, I think, was around what would we do. We seem to be generating surplus cash. Right now, our idea, again, is to keep our capital at a modest level. The free cash flow looks like -- I agree with you, it will exceed our capital spending. And we'll continue to apply that against debt. We know that, especially on the producer side, there's been -- the producers have been introducing dividends and share buybacks. Companies like Tri-Chem have introduced a share buyback. But I think, given the uncertainty we're seeing until we're flush with cash, I think right now, we'll expect that 2018, if we have surplus cash, it will probably just go against debt. And as I mentioned, there's still lots of uncertainty on the back half of the year. Your last point, if I have not missed anything, was would we ever consider a sale of the company. And I think my view and the board's view as a public company is, by definition, we're always up for sale. We have a pretty broad shareholder base. We've got about 3 or 4 large shareholders that we talk to regularly. They know the market we're in. They see where we're valued. And they see where we're going from a strategy point of view. We've got a unique feature as well that people have talked about a lot over the years, this pending lawsuit appeal. We think it's without merit. But when you've got a significant lawsuit -- we got a great decision in the fall of 2017, we think that, that completely showed that the lawsuit is without merit. But now the appeal is out there again. And to sort of voluntarily enter into a transaction when you've got something like that on the books that is basically a recipe for valuation discount, I don't know if that's going to serve our shareholders' best interests. But I thank you for the idea, and I can assure you it's regularly discussed thoroughly by our board.
There are no further questions registered at this time. I would now like to return the meeting back over to Perasalo.
Great. Thank you, and thank you, everyone, for joining us today.
Thank you. The conference has now ended. Please disconnect your lines at this time. We thank you for your participation.