CES Energy Solutions Corp

TSX:CEU

Earnings Call Transcript 2023-Q1

[Operator]

Welcome to the CES Energy Solutions First Quarter 2023 Results Conference Call and Webcast. As a reminder, all participants are in listen-only mode and the conference is being recorded. After the presentation, there will be an opportunity to ask questions. [Operator Instructions]

I would now like to turn the conference over to Tony Aulicino, Chief Financial Officer. Please go ahead.

[Tony Aulicino, Chief Financial Officer]

Thank you, Operator. Good morning, everyone, and thank you for attending today's call. I'd like to note that in our commentary today, there will be forward-looking financial information and that our actual results may differ materially from the expected results due to various risk factors and assumptions, which are summarized in our first quarter MD&A and press release dated May 11th, 2023, and in our annual information form dated March 9th, 2023.

In addition, certain financial measures that we will refer to today are not recognized under current general accepted accounting policies and for a description and definition of these, please see our first quarter MD&A.

At this time, I'd like to turn the call over to Ken Zinger, our President and CEO.

[Ken Zinger, President and Chief Executive Officer]

Thank you, Tony. Welcome, everyone, and thank you for joining us for our Q1 2023 earnings call. On today's call, I will provide a brief summary on our strong financial results released yesterday, followed by our divisional updates for Canada and the US. I will then pass the call over to Tony to provide a detailed financial update. We will take questions and then we'll wrap up the call.

I actually want to begin the call today by acknowledging the impact of the forest fires in Central and Northwest regions of Alberta. Obviously, many people have been affected and some has placed by these fires. Our thoughts and prayers go out to anyone displaced from their homes, as well as to those who are working to fight the fires.

From a financial perspective, the effect on our business has been muted, largely due to the fact that most of the rigs are shut down in Alberta because of spring breakup. So far we have had three rigs shut down temporarily mid-well due to the proximity of the fires. None of our major facilities or equipment has been damaged or lost to-date.

In Q1 of 2023, our business continued to adapt to and overcome the ongoing challenges associated with supply chain and inflation. Our scientists, plant managers, field technicians, and procurement groups continued to provide solutions to complex problems for our customers in a timely manner. We continue to meet or exceed these challenges from industry through our culture of constant innovation responsiveness and of course service.

Some of the major financial accomplishments we were able to achieve through Q1 2023 included, near year record revenue of $558 million versus our old record set in the prior quarter of $563 million. Near-record EBITDA of $77.1 million versus our record level set in the prior quarter of $80.2 million. EBITDA margin of 13.8%, which was above our 2022 average of 13.4%, and within our targeted range of 13.5% to 14.5%. We reduced the debt to EBITDAC ratio to 1.78 times from 2.97 times one year ago and 2.17 times at year-end.

We realized cash flow from operations of $73.2 million. The draw on our credit facility, which peaked at $221 million at the end of Q3 2022 was reduced to $167 million at the end of Q1 2023 and has been further reduced to $130 million today.

Our working capital level moved slightly lower mark in the first quarter-over-quarter reduction in the last 10 quarters and we continued to reduce the cash conversion cycle days. Perhaps most importantly, as we announced a couple of weeks ago, we closed our amended and restated credit agreement, resulting in an increased credit facility size of $700 million. Tony will provide more details on this achievement during his portion of the call today.

Finally, due to all these achievements and due to the credit facility being finalized and put in place, we have elected to raise our quarterly dividend once again by 25% to $0.025 per share. This implies a roughly 4.2% annualized yield based on yesterday's share price. We view this level as attractive, affordable and sustainable. As predicted on prior calls, we are now clearly realizing the torque built into the business with our CapEx-light asset-light high surplus free cash flow business model.

Our outlook for industry in 2023 continues to predict a more stable environment and activity level. At CES, we continue to anticipate that oil prices will be likely somewhat range bound in the $70 to $90 levels throughout most of 2023, with prices likely hedging to the higher side of this estimate in the second half of the year.

We observed that producers continue to seek to improve drilling, completion and production performance and efficiency through any means possible, including chemical additions and advancements. We have the people, facilities and capabilities to help producers meet these challenges as we continue to grow and run a sustainable business so that we can provide long-term job security and prosperity for our employees as well as consistent returns to shareholders.

We continue to believe that the North American natural gas market will be a bumpy ride until the supply demand balance improves and there's more takeaway capacity. At CES, we remain well-positioned to take advantage of natural gas related activity as it evolves over the next few years.

However, our current focus remains on the oil and liquids producing basin throughout the countries, throughout both countries, as natural gas represents only about 15% of our total business. Our current rig count in North America is 176 rigs out of the 838 running or a 21% market share. This number compares to 19.4% from the same time last year.

We continue to overcome challenges throughout the business and industry. Shortages of certain chemistries and services, inflation, customer pricing fatigue and competitor pricing pressures all remain very present in the market. However, we have the right people, infrastructure and technology to effectively address them and grow our business.

I will now move on to summarize Q4 performance by division. The Canadian drilling fluids division continues to be the number one drilling fluid supplier to the Western Canadian Sedimentary Basin by market share. Today, we are providing service to 34 of the 90 jobs underway in Canada for a market share of 37.8%. We anticipate that activity during the last three quarters of 2023 will look a lot like the last three quarters of 2022.

PureChem, our Canadian production chemical business saw our highest revenue quarter ever in Q1. We have continued to see growing contributions from our frac chemical, stimulation and H2S scavenger groups as we further penetrate each of these end markets and gain market share, while utilizing only our current infrastructure and supply chain to support it. These sectors of the Canadian oilfield continued to be very active now and for the foreseeable future. And of course, our primary business production trading continues to grow and evolve as well.

In the United States, AES, our USA drilling fluids group is providing chemistries and service to 142 of the 748 rigs in the USA, for a 19% market share. This total is up from 119 rigs and 16.9% market share at this time last year. This includes a basin leading 108 rigs out of the 356 listed working there by baker or a 30.3% market share in the Permian Basin. Our second barite grinding facility which we are constructing in the Permian Basin continues to be on budget and is anticipated to be grinding and supplying or to our Permian operations early in Q3.

Finally, JACAM Catalyst continues to grow market share in the Permian. Our manufacturing facility in Kansas continues to operate at a very comfortable output level of approximately 65% of what we believe to be the current maximum capacity. Recently, we have been winning more business in the region and we believe our market share is continuing to grow in the Permian Basin in the Rockies.

As some of our competitors appear to be shifting focus to international markets and/or the Gulf of Mexico, it is creating opportunities for CES, which we are capitalizing on. I want to extend my appreciation to each and every one of our employees for their commitment to the business culture and success at CES. It is rewarding to note that due to the growth that we're experiencing, we have increased our total number of employees at CES from 2,122 on January 1st of 2023 to 2,155 today.

This is an increase of 33 employees so far this year or approximately 1%. Unlike last year, where we increased headcount in the company by 17% over the course of the year, we expect headcount to remain relatively flat going forward.

In conclusion, I would like to note that the results in Q1 were once again not due to any one division or area excelling. This was a very balanced effort across the company, in which every business unit contributed. It speaks once again to the quality of the people employed everywhere in every division here at CES Energy Solutions. As always, I want to sincerely thank all of our customers for their trust and commitment to CES in good times and in bad.

With that, I will turn the call over to Tony for the financial update.

[Tony Aulicino, Chief Financial Officer]

Thank you, Ken. CES's financial results for the first quarter demonstrated revenue adjusted EBITDAC and cash flow from operations near all-time high levels. These impressive results were realized amid industry stabilization and through a combination of growing market share, disciplined spending, effective pricing, and prudent supply chain management.

We have been talking about cash flow prioritization for the better part of two years and have tailored our capital structure, working capital management, and CapEx-light business model to achieve this goal. As Ken mentioned, we have now begun to realize that anticipated strong cash flow generation as our revenue has reached the $2.2 billion annualized range. I will provide more details on these important cash flow metrics in a moment.

In Q1, CES generated revenue of $558 million and adjusted EBITDAC of $77 million, representing a 13.8% margin. Q1 revenue represented an increase of 39% from $401 million a year ago and came in just below the all-time high of $563 million in Q4. Revenue generated in the US was $369 million or 66% of total revenue, which is relatively in line with $378 million in Q4 and up significantly from $249 million a year ago, reflective of stronger industry activity, higher production levels and improved market share year-over-year.

Revenue generated in Canada reached an all-time high of $189 million, up from $184 million in Q4 and $152 million a year ago. Canadian revenues benefited from increased drilling and completions activity, coupled with higher production volumes and stimulation-related chemical sales. Adjusted EBITDAC of $77.1 million in Q1 represented an 82% increase from $42.5 million generated a year ago and a sequential decrease of $3.1 million or 4% from our all-time high of $80.2 million in Q4. Adjusted EBITDAC margin for the quarter was 13.8%, compared to 14.3% recorded in Q4 and 10.6% reported in Q1 2022.

I am proud to report that during Q1, our cash flow from operations totaled $73.2 million, representing an increase of $34 million or 89% over Q4 and $86 million over Q1 2022. The improvement comes from near-record revenue and adjusted EBITDAC levels combined with the stabilization in activity levels and further working capital optimization.

This strong CFO level represents the cash flow generating capability of the company in this $2 billion plus revenue environment. It also represents the cash conversion quality of our earnings as measured by some of our peers and their respective analysts by calculating CFO less net CapEx divided by adjusted EBITDAC, resulting in a top tier 77% ratio for the quarter.

We continued our prudent capital spending through the quarter with net CapEx spend of $15 million, representing 3% of revenue. We will continue to adjust plans as required to support existing business and growth throughout our divisions and for 2023, we still expect cash CapEx to be approximately $55 million, split evenly between maintenance and expansion capital.

During Q1, we were active in our NCIB purchasing 1.6 million shares at an average price of $2.65 per share for a total of $4.2 million. Subsequent to the end of the quarter, we purchased an additional 1.6 million shares at an average price of $2.73 per share for a total of an incremental $4.4 million. We exited the quarter with a net draw on our senior facility of $167 million versus $209 million on December 31st. The decrease realized during the quarter was driven by strong cash flow generation enhanced by the reduction in working capital investment, partially offset by $4.2 million in share repurchases and $5.1 million in dividend payments.

We ended Q1 with $519 million in total debt net of cash, comprised primarily of $288 million in senior notes, which mature in October of 2024 and a net draw on the senior facility of $167 million. Our total debt to adjusted EBITDAC declined to 1.78 times at the end of Q1, down steadily as Ken mentioned from 2.2 times at Q4 and approximately three times a year ago, demonstrating our continued deleveraging trend.

I would also note that our working capital surplus of $679 million, exceeded total debt of $519 million by $160 million and demonstrated continued improvement in respective quarter-over-quarter metrics with cash conversion cycle improving to 119 days and working capital as a percentage of annualized revenue at the low end of our historical normal range of 30% to 35%, coming in at under 31%.

To better appreciate the quantum of surplus free cash flow in this environment for CES, I think the investors need to understand that from December 31st, 2022, to May 11th, 2023, our draw declined from $209 million to $130 million, representing surplus free cash flow of $78.5 million in 4.5 months. This very strong surplus free cash flow trend will be affected by occasional lumpy outflows, but it is indicative of the cash flow generating signature of this business model in this environment.

On April 25th, 2023, CES entered into an amended and restated credit agreement. This credit facility matures on April 25th, 2026, and effectively addresses CES's near-term foreseeable, sorry, near-term and foreseeable longer-term requirements. The total size of the increased facility is approximately 700 million, consisting of an aggregated revolving facility of approximately 450 million and a term loan facility of 250 million. The term loan is currently undrawn and will be used to repay and redeem our 6.38% senior unsecured notes scheduled to mature in October 2024.

The term loan provides us with very valuable flexibility with regards to our bond refinancing plans by avoiding a refinancing during unattractive market conditions and extending the refinancing window by two years to three years.

At this point, I believe it's important to step back and highlight the relative positioning of the company. CES's annualized revenue levels have now stabilized for two sequential quarters at the $2.2 million run rate level and is supported by generally constructive macro industry conditions. At these industry activity levels, we believe that CES's incremental working capital requirements will continue to decline and provide an era of strong surplus free cash flow generation fueled by record revenue and adjusted EBITDAC levels.

In accordance with that view, as Ken mentioned, the Board of Directors yesterday approved the 25% increase to the quarterly dividend from $0.020 per share to $0.025 per share. This currently represents a dividend yield of over 4% on an annualized basis and a very modest payout ratio of 12%.

Stepping back, it is important to highlight the specific developments that have contributed to CES's strong financial profile. Revenue and adjusted EBITDAC remain consistent at near-record levels, incremental working capital needs are muted in the stable revenue level environment, cash flow generation and quality of earnings are steady at near-record levels, our refinancing of two weeks ago effectively addresses our bond maturity, providing ample liquidity and supports financial flexibility for the next two years to three years.

This combination puts CES in a position of strength and flexibility, which is key to informing our capital allocation considerations, whereby we prioritize supporting existing and new business through investments in working capital as required and modest CapEx projects that deliver IRRs above our internal hurdle rates.

We remain very comfortable with our increased dividend, which represents a reasonable yield and is supported by a very prudent payout ratio. We will continue to buyback at least enough shares to offset equity compensation-related dilution and be prepared for opportunistic repurchases. And we will continue to use remaining surplus free cash flow to reduce debt and further strengthen our balance sheet and opportunities.

At this time, I'd like to turn the call back to Ken for comments on our outlook.

[Ken Zinger, President and Chief Executive Officer]

Thank you, Tony. As you and I both noted the near all-time record Q1 results kept us on a successful trajectory to return significant capital to shareholders. We are confident in our ability to grow the company within the stable industry environment, while providing attractive returns. Thank you to all of our employees for contributing to these spectacular results that Tony and I have had the privilege of presenting here today.

I'll now pass the call over to the operator for questions.

[Operator]

Thank you. We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Jonathan Goldman with Scotiabank. Please go ahead.

[Jonathan Goldman, Scotiabank]

Hey, good morning, guys.

[Ken Zinger, President and Chief Executive Officer]

Good morning.

[Tony Aulicino, Chief Financial Officer]

Good morning, Jonathan.

[Jonathan Goldman, Scotiabank]

Got a question on the operating environment. So as activity levels and commodity prices have stabilized, have you guys seen anything change in the competitive environment?

[Ken Zinger, President and Chief Executive Officer]

I wouldn't say so. No, I mean, everything has been on kind of the same trajectory. I think, no, we haven't yet. I mean, it's been pretty competitive all year on both sides of the border, so we've noted, I guess, we've noted a couple of places have done RFPs, where they have looked at low bid or gone low bid, but for the most part it has not. No.

[Jonathan Goldman, Scotiabank]

Okay. So I guess related to that, Ken, if we're thinking about the sustainability of the share gains over the past two years, do you see a situation or sort of any operating environment, where you have to make a trade-off between share and margin?

[Ken Zinger, President and Chief Executive Officer]

I mean, who knows what's in front of us. But based on what we're looking at right now, no, I mean, we're focused on margin. We have a set range that we ask all the divisions to meet when they're contributing to the overall earnings of the company and everybody is focused on that.

So, no, we're not anticipating doing that at all. I mean, we're always looking for new ways to build products especially in the production camp business, where we are building by field. So there's plenty of opportunities to reformulate and find more economic ways to provide the solutions the operators are looking for.

[Jonathan Goldman, Scotiabank]

Perfect That's good to hear. And then actually Ken wondering if you can elaborate on, I think, one of the comments in the prepared remarks about competitors maybe switching to International plays where there's more activity kind of exiting some of the plays in your markets and how that's impacting you? I just want to make sure I caught all the nuance there.

[Ken Zinger, President and Chief Executive Officer]

Yeah, I just spend a time with the guys at Jacam Catalyst, specifically. The major competitors in production chemicals in the US split their time between or their efforts between the land-based markets and then the Gulf of Mexico. And then a couple of those guys are big and they're focused on the international stuff.

We have noted that their margins in the past have been a little higher than ours, and we think it's because of the exposure to the Gulf of Mexico and the International stuff. And it just seems and feels to our people like they're taking their eye off the ball a little bit in some of the basins in the United States and it's creating an opening for us, which we've been able to walk through a couple of times here recently. So we see that trend continuing and we are very well positioned to take advantage of it.

[Jonathan Goldman, Scotiabank]

Perfect. That's good to hear. Thanks, guys. Those are my questions.

[Operator]

The next question comes from Endri Leno with National Bank Financial. Please go ahead.

[Endri Leno, National Bank Financial]

Yeah. Good morning, and thanks for taking my question. I joined a bit late, so apologies if I repeat something. But I just wanted to ask if you're seeing any impact from the wildfires. And then as a kind of follow-up to that, if you do -- do you have any business interruption insurance?

[Ken Zinger, President and Chief Executive Officer]

I'll let Tony get to the details of the insurance. But as far as interruption so far very muted. No, our facilities and equipment, major equipment is all fine. No, nothing lost there or currently threatened. And then as far as the business itself goes, three rigs that we have working in the region shut down temporarily. They shut in the wells and evacuated people due to the proximity of the fires. But all three are expected to be temporary shutdowns and back to work within a week, so we'll see how that closes out.

[Tony Aulicino, Chief Financial Officer]

Yeah. And on the insurance space to say, we have lots and lots of insurance and one of those lines is definitely business interruption. And we are well-informed on what we can use and when, if it does become an issue.

[Endri Leno, National Bank Financial]

Great. Thank you for that. My other question is, if you're both more a bit about capital allocation and in the process, but now, since you've got all your sort of DAX lined up, so to speak with stable environment, you got the debt facility in place, you're going to redeem the notes. So I was just wondering kind of how do you think about allocation in terms of further debt pay down or returning capital to our shareholders or even within the capital to shareholders between dividends and buying shares back?

[Tony Aulicino, Chief Financial Officer]

So I'll start. From a financial perspective, Endri, we do not have a formulaic approach the way like the midstream guys or the pipeline guys would have. What we do, though, is what you just saw, which is, we will continue to invest in the business, right.

Whenever we have high IRR CapEx related projects, or if we need working capital investment, that's where the money will go first. We're going to honor this current dividend level, which represents a conservative payout ratio of 12%. And we're going to continue to buy-back as many shares as required to offset stock-based comp dilution, which we've done already for the year.

And as I said, we will be opportunistic with the surplus free cash flow in that regard. And then the balance is going to be used to further bolster not only the balance sheet strength of the company, but also our flexibility. We believe that we can pick off the market in terms of buyback timing and specific price. But what we do know is, if we continue to improve our debt profile, as we're still paying a decent dividend and still buying back shares, it gives us an option value and being able to be more opportunistic on those first two items.

[Endri Leno, National Bank Financial]

That's great to hear. Thank you very much, guys. Appreciate it.

[Operator]

[Operator Instructions] The next question comes from Michael [indiscernible] with DLS Capital. Please go ahead.

[Unidentified Analyst]

Yes, good morning, and congratulations on excellent results. I've known your company, if I may just make a comment and then I'll ask the question. I've known your company for over a decade. And I don't know if you looked at this, but the last time you had a positive EVA spread was 2011. And you're now are back to positive EVA spread, which is the difference between the return on invested capital and the weighted average cost of capital. Congratulations. It's a fantastic position to be in. Understanding your operations and understanding the cyclicality of your business, and having the payout ratio of only 12%, can you share your thoughts about under what operating environment would you be willing could be much more aggressive? In terms of creating NAV per share, that's much, much higher than today.

[Ken Zinger, President and Chief Executive Officer]

Yeah. Hey, Michael, thank you for dialing in. Like you nailed it, the fact of the matter is that you're right. This is the first time we've done this in several, several quarters. So we need to get a few more quarters like this under our belt. We talked about it for the last two years. We started seeing it a little bit last quarter, and we're seeing it big time this quarter. We need at least a few more quarters under our belt to make sure that the machine operates the way we expect it to. And at that point, we come up for air to see if we want to get more aggressive on some of those other options.

[Unidentified Analyst]

Thank you. Congratulations. And we look forward to staying to being your shareholders for many years.

[Ken Zinger, President and Chief Executive Officer]

Thank you for the support, Michael.

[Tony Aulicino, Chief Financial Officer]

Thank you, Michael.

[Operator]

This concludes the question-and-answer session. I would like to turn the conference back over to Ken Zinger for any closing remarks.

[Ken Zinger, President and Chief Executive Officer]

With that, I'm going to wrap up the call by saying thank you to all of our customers, employees, and shareholders. We continue to be very optimistic about the future here at CES Energy Solutions and we look forward to speaking with you all again during our Q2 update in August. Thank you for your time today.

[Operator]

This concludes today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.