Major Drilling Group International Inc

TSX:MDI

Earnings Call Transcript 2018-Q4

[Operator]

Good morning, ladies and gentlemen. Welcome to the Q4 2018 Results Webcast and Conference Call. I would now like to turn the meeting over to Mr. Denis Larocque, President and CEO. Please go ahead, Mr. Larocque.

[Denis Larocque, President, CEO & Non]

Thank you. And good morning, everyone, and welcome to Major Drilling's Conference Call for the Fourth Quarter of Fiscal 2018. With me is David Balser, our CFO. You should all have received a copy of our results. If not, you can go to our website at www.majordrilling.com. Before we get started, I'd like to caution you as usual, that during this conference call, we'll make forward-looking statements about future events or the future performance of the company and these statements are forward-looking in nature, and actual events or results may differ materially. We finished the year on a good note, with our fourth quarter revenue being up 17% compared to the same period last year, this being our strongest quarterly revenue since July 2013. Given the headwinds we faced on currency conversion, activity levels were really up over 20% this quarter, and pricing has also started to improve in most of our regions. We continue to see a gradual increase in activity month-by-month, and this trend is continuing into our first quarter of fiscal 2019. As far as our fiscal year that just ended, yearly revenue was up for the first time since fiscal 2012, which indicates that the industry has started recovering from the prolonged downturn. The company's net cash position, net of debt, continues to be very healthy at $1.9 million. The decrease this quarter was due to a net working capital increase, mostly from higher receivables related to increased activity. As well, we spent $4.8 million on capital expenditures this quarter, adding 4 new rigs to our fleet while disposing of 19 older, inefficient and more costly rigs, bringing the fleet total to 628. David will take you through a summary of the quarterly results before I come back with the outlook.

[David D. Balser, Chief Financial Officer]

Thanks, Denis. Total revenue for the quarter was $95.4 million, up 17% from $81.5 million recorded in the same quarter last year. The unfavorable foreign exchange translation impact for the quarter, when comparing to the effective rate for the same period last year, is estimated at $3 million in revenue with negligible impact on net earnings. The overall gross margin percentage for the quarter was 24.3%, up from 24.1% for the same period last year. Improved market conditions and better production were offset slightly by increased wages and benefits and consumable expenses. General and administrative costs were up 4% at $12.2 million when compared to the same quarter last year. Staffing levels and salaries have increased as activity ramped up from low levels. As well, we continue to invest in recruitment and information technology as we continue to prepare for the upturn in the industry. Other expenses were $1.3 million compared to $2.6 million for the same quarter last year. This decrease is attributed to a decrease in bad debt expense compared to the same quarter last year and a true-up of $700,000 recorded in the same quarter last year on a contingent consideration due to better-than-expected results arising from the Taurus acquisition. Provision for income tax for the quarter was an expense of $2.5 million compared to an expense of $200,000 in the same quarter last year. Tax expense for the quarter was impacted by nontax-affected losses and nondeductible expenses. This combined for a net loss of $4.3 million or $0.05 per share for the quarter compared to a net loss of $8.2 million or $0.10 per share for the prior year quarter. In terms of financial position, we continue to have one of the most solid balance sheets in our industry. During the quarter, our net cash position, net of debt, decreased by $12.5 million for a total net cash position of $1.9 million. The bulk of this decrease relates to temporary working capital outflow from the quick ramp-up in revenue between Q3 and Q4. The company also spent $4.8 million of capital expenditures, adding 4 new rigs and support equipment to our fleet while disposing of 19 older, inefficient, more costly rigs. The total rig count is now 628 rigs. The breakdown for our fleet and utilization is as follows: 308 specialized rigs at 34% utilization, 148 conventional rigs at 30% utilization and 172 underground rigs at 43% utilization, for a total rig count of 628 rigs with an overall utilization of 36%. As mentioned before, specialized work in our definition is not necessarily conducted with specialized drills. Therefore, we'll also give you the breakdown of our revenue by type of work for the quarter: specialized work represented 57%; conventional work, 13%; and our underground work represented 30%. Also, seniors and intermediates represented 81% of our revenue for the fourth quarter, while juniors represented 19%. In terms of commodity, gold represented 59% of our revenue, while copper was at 22% this quarter. With that overview of our financial situation, I'll now turn the presentation back to Denis to discuss the outlook.

[Denis Larocque, President, CEO & Non]

Thanks, David. Global exploration spending continues to improve as most senior and intermediates have increased their exploration budgets for calendar 2018. This quarter, like David said, we saw an increase for copper exploration, rising to 22% of our revenue from 15% 3 months ago as the copper industry is facing a supply deficit and will be in the -- facing that for the next few years. Adding to this, on the demand side, EVs, electric vehicles, are gaining momentum and driving demand for a lot of metals like lithium and cobalt, with copper being the biggest need as an average EV contains 85 kilos of copper versus 25 kilos per a regular vehicle. That's 3.5x more copper. This does not include all the charging stations that will need a lot of copper as well. Recently, we have seen a resurgence in the price of nickel as well, which is up 75% over the last 12 months. In terms of drilling services, prices continue to improve, although these improvements are presently offset by an increase in labor, mobilization, training and repair costs, which is typical in a ramp-up environment. As utilization rates gradually improve, we should start to have considerable leverage to increase revenue and profits as we go forward. At the moment, we are seeing a lot of similarities with the up cycle of 2004 to 2012, which was briefly interrupted by the financial crisis in 2009 and '10. Indications support our belief that the industry is still early in the exploration cycle, with most industry watchers pointing to depleting mineral reserves for the foreseeable future as mining companies continue to search for significant discoveries. The number of large exploration projects is still very low compared to the cyclical peak in 2012, confirming this lack of significant discoveries. As mining companies begin to discover meaningful levels of resources, they will have to engage in their periods of enhanced infill drilling. With the easily accessible mineral reserves getting depleted around the world, attractive deposits will be in areas increasingly difficult to access and deeper underground, which will bring a resurgence in demand for specialized drilling. One of the challenges in drilling services right now and going forward is the shortage of experienced drill crews in the industry, a factor that will put some pressure on cost and productivity as we go forward. With safety and training in mind, we continue to deploy technology that will aid to -- in the continued development of safe, competent employees while, at the same time, in our quest for 0 harm, reduce the number of incidents involving new recruits as compared to previous cycles. These enhancements to our recruiting and training systems will produce continuous improvements over the next few years. As well, there are several innovation initiatives underway to help improve productivity going forward. An example of these initiatives is our mobile underground computerized rigs, which are now mounted with rod handlers, making them one of the only such rigs in the industry. We are very pleased with where the company is positioned at this point in time, still being the leader in specialized drilling. Coming out of one of the longest downturns in the industry with net cash on hand has allowed us to continue to improve our fleet to meet our customers' demands in terms of rigs, rod handling, mobile equipment and technology, which is key to our success to remain the leader in specialized drilling. Also, having the best equipment and financial resources allows us to attract the best people at a time when we are going into a labor crunch in our industry. Going into 2019, the company expects to spend approximately $30 million in capital expenditures to meet customers' demand, improve rig rate reliability, productivity and utilization as well as to invest in our continuous improvement initiatives. However, we will remain vigilant and flexible in order to react and adjust to unforeseen market conditions. That concludes our formal remarks, and we'll open the call for questions.

[Operator]

[Operator Instructions] Our first question is from Jacques Wortman with Eight Capital.

[Jacques P. Wortman, Research Analyst]

Q4 is seasonally your best quarter, yet gross margin was only slightly better than Q2 of this year and the same period last year. When do you guys think that the cost components that are weighing on gross margin: wages, benefits and consumable expenses, are going to be less of the constraint? Or do we simply need to wait for higher per-meter rates?

[Denis Larocque, President, CEO & Non]

Yes. Well, first of all, the Q4 is -- with now the mix where we operate and also mining companies have kind of changed, Q4 is not what it used to be. So I wouldn't think Q4 is our strongest quarter. But having said that, on the margins, the -- what we're seeing -- and this is, again, the correlation I made to the early -- to the previous cycle, we're seeing about the same thing happening is that as you ramp up, you have a lot of training, and you have repairs because your rigs have been -- you've got rigs that have been -- although we've done a lot, we still have rigs -- when you look at our utilization, it's still fairly low, and we haven't repaired all our rigs. So as we put a rig in the field, we bring a rig from the back. And the deeper you go in the back, the more -- a little bit more repairs is needed. But also, we are -- with the initiatives I mentioned on training, we are -- we have more people in the system, and that's basically to prepare for the growth coming up. So you end up with maybe some jobs having more helpers than usual because you're training more people in assistance because basically, the early part -- last year, we were picking up what we're calling experienced drillers or drillers that were in our system before. Now you're -- and that's the whole industry. We're all struggling to find experienced people, and we need to get back to the training, and we're already back to that. And that means -- and if you remember, in the last up cycle, we were doing some of that where we had extra people on rigs. And that's particularly the case in North America. And that's basically what -- although prices is up, we had extra costs to basically handle the growth. And again, when I bring you back to the early up cycle, revenue took off probably 12 months before we saw a pickup in margins. And so this is not dissimilar to the previous up cycle.

[Jacques P. Wortman, Research Analyst]

Okay. Two quick follow-up questions. If the usual seasonality that we had in the past sort of in order of 4, 2, 1, 3, is that -- is it more variable than that now? Or is there a progression of quarters? And the second question was, with 600-plus rigs in the fleet, you must have a significant number that don't need or have already had a lot of the maintenance completed. Isn't that correct? You do not -- you're not grabbing your worst rigs and doing a bunch of work on those to deplete those in the field, I imagine.

[Denis Larocque, President, CEO & Non]

Well, basically, the -- just on the rigs, what we're doing is we all -- as we've mentioned before, we've spent repairs in the last couple of years to put rigs on the shelf. Our goal is to keep that -- those number -- that shelf with enough rigs to respond to demand as they come. When you get a phone call and they want a rig for Monday morning, to be able to respond to that, you need to have rigs on the shelves ready to go. So our goal is to always have rigs on the shelf. But our approach in the downturn was not to go and repair hundreds of rigs to put on the shelves. It was to repair rigs to have enough on the shelf so that when you get the phone call, you're ready to go. So as you take a rig off the shelf and you send it to the field, and I mean, we had 20% growth versus last year here, as you do that, then you go back, and you get another rig in the shop, and you repair it, and you put it back on the shelf. That's what's going on right now. And until you get to a certain level of utilization where the bulk of your rigs are in the field turning and not -- then all you're doing is you're doing just the regular maintenance to keep them going. There's going to be a little bit of that that's going to weigh on the margins. And like I said, this is not dissimilar at all to what we saw in the previous cycle. And on the quarters, Jacques, basically, as we grow this, it's going to be -- I don't think it's going to be necessarily -- except for the third quarter, I don't think we're going to see necessarily a quarter that's going to be stronger than another one. We have seen, even at the last peak, we -- that kind of difference between the quarters had been muted.

[Operator]

Our next question is from Christoph Matern with HPS.

[Christoph Matern]

Can you break down the current trend -- the current growth trends a little bit between volume and price? And then specifically on the price outlook, can you give a bit of -- a bit more perspective of where you think pricing going to trend this year, whether this is going to be a bit of support? And then I have a follow-up question.

[Denis Larocque, President, CEO & Non]

Yes. I mean, it's still very early, and the bulk of the increase in revenue is really more rigs in the field. So a little bit of price, and I wouldn't say it's less than 5% of that 20%. It's probably between 0 to 5%, and then the other is -- between 15% to 20% is volume. I don't have like an exact number. But basically, we're just starting to see price move. And going forward, yes, pricing is going to move. It's dependent on the regions. Some regions were already pretty busy. So the next rig that goes out basically needs to go out at a higher price because -- it's like I tell our managers, it's more headaches, the next one going out, so there needs to be better pricing. There's other regions where maybe rig utilization is not necessarily at the peak, but the labor, for example, in regions like Canada and U.S. So again, it's a bit the same. The next rigs, you're going to lose on productivity. You're going to lose on -- you're going to have higher costs in terms of training because you need to -- it's -- there's a big turnover in terms of people we put in the system. So therefore, again, we need better prices. Just -- even just to hold the line on margin, we need better prices. But at the same time, we need to have -- we need to get better margins to get a return on our investment going forward.

[Christoph Matern]

That's great. That's helpful. And then the follow-up will be, how do you feel about the demand visibility overall with the projects in your discussions with your customers? Do you see like -- do you feel comfortable about that through the remainder of 2019? And then where do you feel your visibility breaks? So how do you think about that from your operational planning in general?

[Denis Larocque, President, CEO & Non]

Yes. We always say we only have 3 months visibility because things always move. We -- and we do -- internally, we do a 3-month forecast, and we don't forecast longer than that because it's always 20% wrong, and it could be 20% wrong up or 20% wrong down. So we just -- although we do have -- for the year, we do have a certain chunk of our business that's blocked, it's just the incremental part. There's a lot of stop and go during the year. But right now, things are looking -- I mean, looking forward, it's like I said, the -- we're seeing the continuing -- the trend that we've been on, we see that continuing in the -- that's why I just mentioned the first quarter. I didn't mention the whole year just because we don't have that visibility. And if gold jumps to $1,400, and then the junior adds -- you saw the junior still very low in our total revenue. It used to be 35%. Now it's 19% for the quarter. So if gold goes to $1,400, all of a sudden, boom like that, that number changes going forward because then the financing window opens up and then you have a lot of -- a lot more juniors. So to answer your question, next 3 months, looks like the trend is continuing. Further than that, we don't know but all the signs, though, are pointing in terms of lack of reserves, and everything is pointing to mining companies having to do a whole lot more exploration in the years to come.

[Operator]

Our next question is from Ahmad Shaath with Beacon Securities.

[Ahmad Shaath, Research Analyst]

I guess my question, on your views on the cycle, I mean, help us understand more the 12-month lag that you always spoke about between revenue improvement and margin improvement. I'm looking here, since revenue troughed on a quarterly basis in Q4 '16, I think you agree with me that we have been seeing, quarter-over-quarter if we exclude the seasonally weak quarter, we have been seeing revenue improvement. We have only seen the margin improvement in Q2 '18 and slightly, let's say, Q4 '18 on an EBITDA basis. So just looking at these 2 things, just help us understand why we still should expect another 12 months of revenue improvement before we see EBITDA margin improvement. Is that because of the -- because of drilling being part of the business that's kind of making things a little bit different compared to previous cycles? Or -- because I'm looking at the numbers now, and it seems that we should be starting to see some margin improvements going forward. Just help us wrap our heads around that part of the cycle.

[Denis Larocque, President, CEO & Non]

Yes. Well, I -- as I mentioned, I mean, the price is just starting to move. And it's not like the price moves, every contract gets repriced. So therefore, as price starts to move, it's the renewals that basically gets repriced. And then even on this repricing, you have -- like I say, in terms of ramp-up costs, you have those ramp-up costs that -- so that's why I'm referring -- when I refer back and maybe -- I think you took my -- when I say when revenue pick up and you went to when the revenue started to pick up. And really, we're just cross -- we've just crossed that threshold where pricing is starting to move. So price needs to move first, and we get these contracts renewed at better prices. And we have some, but I mean, there's still -- it's not every contract that has been renewed with new prices, but our costs are going up across the board, though, in terms of labor, in terms of consumables. And again, we're doing more training, so there's additional costs in training in there and with more -- basically just having more people in the field to -- and it's a little bit like an investment for the future. And that's what we did on the last -- if you go back in the last up cycle, we were saying we're putting double -- instead of one helper, we're putting 2 helpers because we end up growing the number of drillers that way. And that's where we're at. We need to train drillers so that we can take the growth that might be coming in the future. So we need to be prepared for that. So that's the investment. So the pricing has not jumped yet, so basically take all those costs and more.

[Ahmad Shaath, Research Analyst]

Okay. And I guess -- so that's very helpful. And from a geographical perspective, how should we think about your Canadian-U.S. business going forward? And Q4 came in a little bit weaker. How is the environment of the Canadian-U.S. business in terms of revenue activity, pricing and in terms of labor and mobilization costs?

[Denis Larocque, President, CEO & Non]

Yes. The -- well, the -- part of the -- we have slower start-ups this quarter, which impacted somewhat the revenue. But at the same time, we remain disciplined on the pricing. So we were not as aggressive on the pricing to go -- and that's basically related to the fact that labor is a challenge in North America right now. So therefore, going out there and putting -- trying to put rigs at any price is not a smart business decision in our view. So we've been more disciplined. So that is part of the reason why you don't see as much growth in North America on revenue. But then we have been investing the -- kind of the U.S. is the place where we've invested the most on the training, and that part where I talk about having more people in the system, which then has somewhat -- had somewhat of an impact on margins. So pricing has picked up in that region, but it's impacted by that -- those -- again, by those training costs.

[Operator]

[Operator Instructions] Our next question is from Daryl Young with TD Securities.

[Daryl Young, Mining Research Associate]

Just a quick question in terms of the percussive side and new contract wins and then maybe just an update on where you guys are at in that, because I know a large contract had rolled over recently.

[Denis Larocque, President, CEO & Non]

Well, yes, that contract ended at the end of basically -- or during the second quarter. So therefore, when you compare year-over-year, that contract was going full-blown in Q4 last year and was not here. But at the same time, we have picked up business to replace. So some of the rigs that came off have gone back to work. It's just we haven't replaced it all. And there's a -- what you need to understand on the percussive side, those contracts tend to be longer. So a lot of the time, they're 3-year contracts. And if 12 months a year, you're in the mine and you operate nonstop, so that gives you stability. But there's a bit longer -- there's a longer cycle to basically get a contract in that business. Whereas in the exploration, you get a phone call Monday morning and they'd like you to be there on Thursday, but then you'll drill for 2 months, and then they'll shut you down for 2 months. And then -- so it's a lot more volatile on the exploration, and -- but the cycle is much, much shorter. It's -- like I say, it could be a matter of days or a week where you're negotiating, get the rigs turning, whereas the other business is -- there's a lot longer cycle in picking a supplier and everything because it's a 3-year contract. So we -- like I said, we've done -- we've been able to replace already some of that business. And the more it goes, the more it's growing back. So...

[Daryl Young, Mining Research Associate]

Okay, excellent. And then in terms of the balance sheet, obviously, you guys have lots of liquidity. But just trying to get my head around the working capital investment over the next kind of 2 quarters, Q1, if activity levels continue to ramp up, just how much more need you guys will have there.

[Denis Larocque, President, CEO & Non]

Well, I'll tell you, my dream would be that cash drains by $50 million. Basically, that will mean that the -- our receivables are going to go through the roof. So it's just a factor of how much activity there is. That's what drives the working capital need. We are very -- we have tight control on our cash. And therefore, the -- we've seen the receivables jump as -- our revenue went from the $70 million in third quarter to this $95 million this quarter. So that's a big ramp-up. And typically, receivables are in the 45 to 60 days, so before that cash rolls in, and we have to pay all the employees. So going forward, now that the revenue will be a bit more stable because again, that -- it's not going to be that same ramp-up from Q3 to Q4, so it should stabilize. But if activity picks up and we need to buy inventory and -- or equipment for contracts, then we could see a drain. But if not, I think things are -- probably are going to stabilize going forward.

[Daryl Young, Mining Research Associate]

Okay, excellent. And then in terms of the -- I know you guys talked a little bit about the outlook and clarity, but are you seeing any new inbounds on the gold side? Or is it sort of the onetime 2018 budgets went higher, and you've had the negotiations with the companies, and now they're just executing? Or is there additional demand that you're seeing?

[Denis Larocque, President, CEO & Non]

Well, there's lots of talks. It's just how much is going to pan out. But it is -- that growth that we're seeing quarter-over-quarter is coming from both base metals and gold, whereas last year, it was mostly coming from gold. So gold participants are still adding rigs quarter-by-quarter. And basically, they know they need to do a whole lot more. So it's coming -- the nice thing right now is it's coming from both sides. Both base metal and gold, we're seeing a pickup in activity.

[Operator]

There are no further questions registered at this time. I would like to turn the meeting back over to Mr. Larocque.

[Denis Larocque, President, CEO & Non]

Well, thank you. And we'll be -- you -- we'll be coming out with our annual documents over the next few weeks, and there will be details about our AGM in there. And after that, we'll talk next quarter.

[Operator]

Thank you. The conference has now ended. Please disconnect your lines at this time, and we thank you for your participation.