Secure Energy Services Inc

TSX:SES

Earnings Call Transcript 2022-Q2

[Operator]

Good morning, ladies and gentlemen, and welcome to the Secure Energy Q2 2022 Results Conference Call. At this time, all lines are in listen-only mode. Following the presentation, we will conduct a question-and-answer session. [Operator Instructions] This call is being recorded on Wednesday, July 27, 2022.

I would now like to turn the conference over to Anil Aggarwala, VP of Investor Relations and Treasury. Please, go ahead.

[Anil Aggarwala, Vice President of Investor Relations & Treasury]

Thank you, Sergio. Welcome to Secure Energy's conference call for the second quarter of 2022. Joining me on the call today is Rene Amirault, our President and Chief Executive Officer; Allen Gransch, our Chief Operating Officer and Chad Magus, our Chief Financial Officer.

During the call today, we will make forward-looking statements related to future performance and we will refer to certain financial measures and ratios that do not have any standardized meaning prescribed by GAAP and may not be comparable to similar financial measures or ratios disclosed by other companies.

The forward-looking statements reflect the current views of Secure with respect to future events and are based on certain key expectations and assumptions considered reasonable by Secure. Since forward-looking information address future events and conditions, by their very nature, they involve inherent assumptions, risks and uncertainties and actual results could differ materially from those anticipated due to numerous factors and risks.

Please refer to our continuous disclosure documents available on SEDAR as they identify risk factors applicable to Secure, factors which may cause actual results to differ materially from any forward-looking statements and identify and define our non-GAAP measures.

I will now turn the call over to Rene for his opening remarks.

[Rene Amirault, President & Chief Executive Officer]

Thank you, Anil, and good afternoon, everyone. Today, we will review our financial and operational results for Q2, followed by our outlook for the remainder of the year. Strong momentum across our operations continued in the second quarter, where our team delivered yet another record setting quarter. We continue to be extremely pleased with the progress and the integration of the Tervita acquisition and we are realizing our target synergies ahead of our plan.

With the anniversary of the transaction behind us, our results today truly demonstrate the strength and scale of our expanded network and business model. With $67 million run rate synergies realized, we have now achieved 89% of the $75 million cost savings target in the first 12 months following completion of the transaction, as can be seen in our results.

Robust industry activity levels drove significant demand for our customer solutions and combined with synergies realized and our ongoing focus on managing costs resulted in another strong performance across our operations and a 310% year-on-year increase in our Q2 adjusted EBITDA to $127 million. This allowed us to reduce our leverage ratio to 2.5 debt to adjusted EBITDA, a full turn improvement in only nine months.

We also released our 2021 report on sustainability in May, demonstrating our commitment to ESG with tangible short-term goals. We are targeting a reduction in greenhouse gas emissions intensity by 15% by the end of 2024 and in freshwater usage by 5% in 2022.

With increased free cash flow generation capabilities and a strengthening balance sheet, we are well positioned to further reduce our leverage, expand our capital allocation priorities as we get closer to 2023. And at the same time, capitalize on growth at existing facilities and favorable industry trends.

Chad will now walk us through the key highlights of our Q2 results, then Alan will review our operational highlights and integration update, and I will conclude with our outlook for 2022.

[Chad Magus, Chief Financial Officer]

Thanks, Rene, and good morning to everyone on the call. Our second quarter results continue to demonstrate the strength of our combined business, our ongoing focus on managing costs and an overall improvement in the underlying markets.

We recorded net income of $54 million and $0.17 per share, an increase of $69 million and $0.26 per share for the second quarter of 2021. Funds flow from operations increased 344% to $80 million, driving a 136% increase on a per share basis to $0.26 per share. Our adjusted EBITDA of $127 million increased 310% and our, per basic share basis was $0.41, equating to a 116% increase from the prior year.

On a pro forma basis, our adjusted EBITDA was $50 million or 65% higher in the quarter than what was reported in the second quarter of 2021, as realized synergies and increased activity levels, led to higher processing and disposal volumes at our midstream infrastructure processing facilities and at our industrial landfills.

We also saw increased demand for services related to drilling and completion activity within the Environmental and Fluid Management segment. Relative to past years, our second quarter of 2022 with unseasonably warm in April, May, resulting in a shorter spring breakup that did not negatively impact activity levels as compared to previous years.

Our adjusted EBITDA margin of 36% increased from 26% in the second quarter of 2021, due to the positive impact from the cost savings and synergies and increased industry activity levels. The margin was higher than our first quarter of 2022 margin of 35%, as well, our G&A as a percentage of revenue, excluding oil purchase and resale fell to 8% compared to 11% in the second quarter of 2021.

Midstream infrastructure, our second quarter segment profit margin of 66% increased from 59% from the prior year, largely due to our expanded facility footprint, and synergies realized from the merger transaction, as well as higher crude oil pricing and more stable market dynamics, which led to increased drilling completion and production volumes.

Higher crude oil pricing in the second quarter also positively impacted our recovery oil revenue, and increased oil purchase and resale revenue by 336% to $1.7 billion. Environmental and fluid management, second quarter segment profit margin of 24% remained relatively consistent with 22% in the prior year.

The strong margin performance was largely due to the positive impact of the combined businesses, partially offset by higher midstream capacity costs in our industrial landfills from wet weather in late May and through June, and inflationary pressures most notably in our Fluids Management business.

Metals prices remained strong in the second quarter, as did demand for our environmental work. Our DD&A expense was reduced to $21 million in the second quarter compared to $56 million in Q1 of this year, driven mostly by a reduction in our asset retirement obligations and the corresponding asset values due to higher credit adjusted interest rates.

In periods with no changes to interest rates, we expect the DD&A to more closely track our Q1 expense. Our positive operating results and sustaining capital spending -- that was in line with our expectations to allow security to generate $66 million of discretionary free cash flow in the second quarter, an increase of 267% compared to the prior year or 91% on a per share basis, which was used mainly for debt repayment.

In 2022, our key capital allocation priority will continue to be on that repayment. With respect to our financial structure, our capital structure consists of no near-term maturities with the first fixed debt maturity in 2025.

We retained a strong liquidity position with approximately $287 million of availability on our credit facilities maturing in 2024.

In the second quarter, we saw lower prices which allowed us to repurchase $77 million or 26% of our 11% senior secured notes, which allow us to save a significant amount of future interest as we continue to optimize our capital structure.

As a result of our focus on debt repayment and the positive operational results, we continue to reduce our overall debt metrics. Our total debt-to-EBITDA ratio fell two and a half times, a considerable achievement considering we were at 3.5 times only nine months ago.

We're pleased with the balance sheet management since the merger and we'll continue to focus on debt reduction and capital structure optimization. As we move into 2023, we believe this focus and capital discipline will allow us to increase future shareholder returns.

Now, I'll pass to Allen to provide operational highlights.

[Allen Gransch, Chief Operating Officer]

Thanks Chad and good morning, everyone. Looking at our operational highlights, during the second quarter, we saw a robust activity levels continue from Q1 as producers move to pad drilling for their operations during spring break-up and road bans.

The second quarter also experienced less rainfall in April and May, which allowed activity levels to remain stronger. Midstream infrastructure segment saw higher volume throughput as a result of higher drilling and completion activities.

Water disposal volumes increased 116% from Q2 of 2021 with the total volume of water handled of 2.2 million cubic meters, which was only 3% lower than Q1 of 2022. In addition, we saw processing volumes increased 171% from Q2 2021, mainly as a result of the merger, improving production levels, and higher waste processing volumes.

Our terminalling and pipeline volumes also increased 10% from Q1 2022 and were up 68% from the prior quarter. Overall, a very strong quarter from the midstream processing facilities that they were experiencing increased utilization of higher drilling completion and production volumes from increased activity levels require more treating, processing, and disposal.

Our facility utilization continues to trend upward and at the end of the quarter is approximately 65%. We continue to have lots of capacity to handle additional increases in volume without needing to invest any significant additional capital.

In our environmental and fluid management segment, it also continued to benefit from higher commodity prices and increased activity levels. Landfill volumes were up 293% compared to Q2 of 2021 as a result of the merger and increased activity levels.

Our fluid management business also had another strong quarter. Our production chemical business continues to perform well as our customers look to optimize and enhance the production from their operating wells.

We are seeing strong demand for our customer solutions and continue to see inflation in both our businesses, but we have been able to pass along our cost increases and we have maintained a steady margin.

Metal recycling continues to benefit from a strong commodity pricing as spares prices remain high, which helped drive higher volumes. With regards to the projects business, we're also pleased with the progress made on increased abandonment, remediation, and reclamation activity work from the government stimulus package to help fund the closure and reclamation of orphaned and inactive wells.

We continue to expect increased abandonment, remediation, and reclamation activity to positively impact all of our Canadian operations over the term of the program. In terms of the federal program, the entire $1 billion allocated to Alberta has now been granted and must be spend by the first quarter of 2023.

Provincially, both the Alberta and Saskatchewan governments have introduced minimum spending programs, starting in 2023, with targeted spending levels that companies with retirement obligations and liabilities [indiscernible], secure is well positioned in the Environmental business segment as the projects team are positioned to bid on additional work and last bills will likely see more volumes as a result of this regulatory change.

We're extremely pleased with the progress made to date on the integration of the two businesses, and after 12 months, we have already realized $67 million or 89% on an annualized basis of our $75 million synergies target. Of the $67 million, approximately $38 million related to corporate overhead and G&A with the remainder, where operational efficiencies and facility rationalization.

With 89% achieved, we are confident on being able to reach a minimum of $75 million of synergies or more by the end of this year. This is despite secured recurring some facility rationalizations are recently forecasted for this year, but that we do put on hold due to activity levels that were higher than we originally forecasted. Additionally, savings through initiatives such as improving our capital structure, as well as minimizing sustaining capital by managing underutilized assets are expected to provide incremental discretionary free cash flow beyond our $75 million cost savings target.

ESG stewardship is the top priority of our company, as Rene mentioned, we released our 2021 sustainability report in May. In addition to the short and long-term targets we have set, we are continually evaluating opportunities to participate in carbon capture infrastructure, both in using our expertise in deep well operations and in filling theater pipelines, which could become a growth area for us and reduce overall emissions.

In Q2, we spent a total of $19 million of capital, which included $17 million of sustaining capital, primarily spent on well is facility maintenance, landfill cell expansion and asset integrity inspection programs. Drill capital of $2 million related largely to the expansion of the water disposal facility, which is backstopped by a commercial agreement with an existing customer at that facility.

In terms of our overall 2022 capital spending in our $45 million growth budget, we'll continue to focus on opportunities to connect producers to existing midstream infrastructure to further increase volumes and utilization on a long-term basis. With respect to sustaining capital, we will continue to expect to spend $55 million in 2022, including 3 landfill expansions. Our focus remains on customer-backed longer-life opportunities as we continue to prioritize deleveraging.

I will now turn it back to Rene to address our outlook for the second half of 2022.

[Rene Amirault, President & Chief Executive Officer]

Thanks, Chad. We are extremely pleased with the results in the second quarter year and the ongoing progress made with the Tervita merger, and we continue to see the benefits we expected from combining the companies. We are executing on our deleveraging plan, and we expect to continue to reduce our debt position this year. With our strong results to date, we're demonstrating that our enhanced scale, better positions us, to optimize existing assets and operations, so we can add more value to our customers and provide greater optionality in allocating capital through all market environments.

Turning to our outlook. We are reiterating what we've said over the past few quarters. Our near-term focus will be on continuing to strengthen our business, deleveraging our balance sheet, and we anticipate looking to increase returns to shareholders after this is completed. We expect to see continued industry improvement, which will support our strong momentum and drive higher year-over-year adjusted EBITDA and discretionary free cash flow in 2022.

During the second half of the year, we expect that the benchmark crude oil price will continue to fluctuate, supported by macroeconomic factors such as significant inflationary pressures, geopolitical risk premium due to the current warrant Ukraine as well as continued changes to the supply and demand out, notwithstanding the fluctuation in the price of benchmark through the economics producer cash flows remain robust and therefore, we expect strong energy industry activity in the second half of the year.

We also expect to benefit from the following; we expect to see contributions to our adjusted EBITDA for the realization of $75 million of annualized synergies by the end of 2022. We also anticipate increased utilization at midstream processing facilities and landfills as higher drilling, completion and production volumes from increased activity levels required treating, processing and disposal.

Also, higher abandonment remediation and reclamation activity from the government stimulus package to help fund the closure and reclamation of orphan and inactive wells. And then finally, high level of demand for both our drilling fluids and production chemical solutions as we expect oil industry activity to remain strong in the second half.

In closing, we have significantly strengthened our business and demonstrated the resilience and efficiencies achieved with our strategy to consolidate capacity in our markets, while managing our costs. We remain well positioned to generate strong discretionary free cash flow from our expanded network.

We are excited by the future of Secure using our technologies network and best-in-class team to form new partnerships, we remain focused on helping our customers develop the highest ESG standards and the lowest cost structure in the world, ensuring we create sustainable energy and environmental solutions for many decades.

With our efforts to-date and the continuing hard work for our employees, we believe we are well positioned to achieve our priorities for the rest of 2020. I want to thank all the secure employees that have continued to contribute to our success. I also want to thank our customers and stakeholders for their continued support and partnerships.

That concludes our prepared remarks. We would now be happy to take your questions.

[Operator]

[Operator Instructions]. Your first question comes from Keith Mackey from RBC. Please go ahead.

[Keith Mackey, RBC]

Hi. Good morning, everyone and thanks for taking my question.

[Chad Magus, Chief Financial Officer]

Good morning.

[Keith Mackey, RBC]

Just wanted to start off on the margins in midstream, quite strong in Q2, certainly. Given the factors you talked about with the fluctuating benchmark prices in the second half increased facility utilization and higher abandonment spending and so forth. How should those factors affect margins from Q2 levels throughout the second half of the year?

[Chad Magus, Chief Financial Officer]

Well, we certainly -- we're very happy with both our operating margins and EBITDA margin overall for the corporation. Going into the second half, there's still a lot of those synergies that weren't annualized last year that came in that are going to impact our ability to try to improve those margins. Obviously, we're trying to stay ahead of the inflation pressures and making sure that we're able to pass on cost to the customers.

So, I would say that our margins can improve a little. I wouldn't say a lot, but they might be able to – try to see the synergies and cost savings add up to give us an extra point or two, but we definitely have made the big move year-over-year, and it was very, very significant when you look at where we were a year ago. But I think -- there's always room for improvement. And I think the team is really finding as we get to know these assets better, the network better, they're just finding these little cost savings, and they all kind of add up. So it's not one big thing, Keith, but there's a lot of little things behind the scene that the team is doing to save costs.

[Keith Mackey, RBC]

Okay. Appreciate that color, Rene. And one unrelated follow-up for me, just on the Competition Bureau process. Can you give us a bit of an update on where that is? And when is the earliest and most likely time we could hear an update or a result from the process?

[Rene Amirault, President & Chief Executive Officer]

Yeah. Great question, Keith. The Tribunal now is finished the hearing, it's all wrapped up. And typically, if we look back in previous cases, they'll typically take six to nine months to come to a decision. So I think you can expect probably closer to the end of the year, Q1 of next year, we'll have a decision. But all we can tell you that there was no surprises in the hearing, and went quite well, and we look forward to their decision.

[Keith Mackey, RBC]

Okay. Appreciate the color. Thanks very much. I'll turn it back.

[Operator]

Thank you. Your next question comes from Aaron MacNeil from TD Securities. Please go ahead.

[Aaron MacNeil, TD Securities]

Hey, good morning, all. Rene, you mentioned in your prepared remarks that you may expand your capital allocation priorities into 2023. And obviously, you've already hit your debt reduction target a year early. So appreciating that debt reduction is still the priority for the balance of the year. Can you just give us a sense of -- or maybe some additional insights into your thinking on what 2023 capital allocation could look like and in terms of what you think is kind of the higher and lower priority capital allocation initiatives?

[Rene Amirault, President & Chief Executive Officer]

Yeah. If you go back, Aaron, if you go back 12 months ago, we certainly knew what we are inheriting, and we knew at 3.5x that was not going to be acceptable to us. So when we picked our target, it was to be 2.5 or less. And so really, I think what you're going to see from us is we would certainly like to continue to pay down debt -- you obviously saw us buying back bonds here in Q2. I mean those bonds are at 11% interest coupon rate. So we really -- we want to take that excess free cash flow and continue to get the debt lower. So that target wasn't the absolute so much as we just wanted to get the entire organization focused on getting less EBITDA ratio of less than 2.5x. So I think you'll see us continue to do that. What we would like to do is in the next quarter when we release and try to give you a better idea and all shareholders a better idea of what that debt position looks like plus our capital allocation and try to give you some color around that. So I'd say this next quarter is all about just continue to pay down the debt and trying to reduce our interest cost.

[Aaron MacNeil, TD Securities]

Understood. Just expanding on Keith's question on the Competition Bureau. You've had the opportunity to see closing arguments now. And I guess to maybe ask the question more specifically, like is there any scenario where the outcome may differ from your disclosure, where there won't be a material impact to either the asset base or the EBITDA generating potential as a pro forma company? What's your sense of that?

[Rene Amirault, President & Chief Executive Officer]

Nothing – nothing we're aware of. Like I said, no surprises kind of went according to plan. So that's why we've left it in our disclosure. It's -- there's nothing really new from our point of view.

[Aaron MacNeil, TD Securities]

Understood. Appreciate the color. Thank you.

[Operator]

Thank you. Your next question comes from Cole Pereira from Stifel. Please go ahead.

[Cole Pereira, Stifel]

Hi. Good morning, everyone. I'm just wondering if you can give any additional color on how customer conversations have been going in midstream. Are E&Ps looking for larger-scale solutions, or is it more so they're looking for additional tie-ins additional volumes, et cetera.

[Allen Gransch, Chief Operating Officer]

Hi, Cole, it's Allen here. Yes. With producers right now, they're managing their capital programs here for 2022. I think they're going to be very, very active here in Q3 and Q4. At the continuation from what they done here in Q2, which is making sure that they have access to that rig, access to that frac crew to be able to not only drill the well but complete the well and bring on that production. And I think, as they're looking bringing on some of this production, there is a lot of water and oil volumes to handle.

And so we are in discussions on some larger scale handling of water volumes. And that's very typical for our producers to look at their infrastructure and say, "Okay, I don't need to own all the disposal wells. I don't need to have all the infrastructure just on my side, if I'm not going to utilize it to 100%. And so the discussions are very much on, can we tie you in what does the economics look like and we're going through that as we speak. But I think the conversations are that they want to make sure that they have their – they have all their crews lined up and that they know they can deliver volume to us and have that capacity with us. So I would imagine it's going to be a fairly robust Q3 and Q4, and these discussions will continue on.

[Cole Pereira, Stifel]

Okay. Great. That's good color. Thanks. And you briefly mentioned feeder pipelines as an opportunity. I mean, I assume maybe you're in discussions with those as we speak. I mean, is there sort of anything near-term in that front? And I mean, obviously, it's quite a big time line. So, what if you were to pursue something like that, would it be one year, 1.5 years out before it's actually in service?

[Allen Gransch, Chief Operating Officer]

Yes. I think when we look at any of our pipelines, if it's a water pipeline or oil pipeline, they just take time to negotiate a contract and order your long lease, get your permits and get all the regulatory lined up for you to be able to – to go out and execute. And typically, that time line can be anywhere from six months to a year to 18 months. So it does take time.

I think looking at our capital program here for 2022, we publicly said, $45 million of the spend. Most of that spend will come here in the back half of this year. We'll likely provide a little bit more insight as to where that capital is being expanded at our Q3 meeting, because we are working on contracts right now. And we'll give you a little bit more clarity on where we're spending that capital and what type of contracts it relates to. So more to come in Q3 on that front.

[Cole Pereira, Stifel]

Okay. Perfect. And I guess just on that note as well, Rene, you briefly touched on it. So I mean, for Q3, should we be thinking about getting some details on the forward capital spending profile, but also how you're thinking about factoring in share buybacks, dividend increases and so on and so forth?

[Rene Amirault, President & Chief Executive Officer]

Yes. I mean, you start to do the simple math next year and you see a lot of free cash flow. So there's definitely a bunch of different levers that we can optimize as we go into 2023. So that's the kind of clarity color, we're going to try to at least give you when we report next quarter. And obviously, we'll work with our Board to come up with what makes sense for the corporation and our shareholders.

And again, we're -- we want to make sure that our debt is in the right position. We want to make sure that we continue to replace our high interest debt with the lower interest debt and make sure that we ultimately increase our free cash flow, which -- that sets up your return to shareholders. So that's really where we're at, but this next quarter is all about just continue to pay down debt.

[Cole Pereira, Stifel]

Okay. Got it. That's all for me. Thanks. I'll turn it back

[Operator]

Thank you. Your next question comes from Patrick Kenny from National Bank Financial. Please go ahead.

[Patrick Kenny, National Bank Financial]

Hi. Good morning, guys. Just on the marketing portion of your business with the heavy differential recently widening out here to more $20 a barrel. How should we be thinking about, I guess, incremental tailwinds through the back half of the year? And perhaps how might you be positioning your marketing business ahead of a further SPR release this fall.

[Allen Gransch, Chief Operating Officer]

Hi. Good morning, Pat, Allen here. Yes, on the marketing side, I mean, when we look at our budget and we look at our facilities that are pipeline connected, every year we're managing the spread between condensate, light sweet, light sour and the heavy dip. And there's typically one or two that provides advantageous opportunities to upgrade what we have coming into the facilities with our customers, and we typically partner up with them on that opportunity. And so you are correct. There's a bit of opportunity here in the heavy oil, but we do budget for that in our numbers that lease marketing arbitrage always happens every year. And I think when you look at our infrastructure in corroborating all through all the way up north, we have access to a lot of commodities, we're trading we're running through our system today over 120,000 barrels a day. So we manage a lot of commodity or a lot of the gifts with the commodity that's coming in. And I do think that, when you look at the infrastructure that we do have, we probably will have a bit more advantageous opportunities here in the next six months.

[Rene Amirault, President & Chief Executive Officer]

And just want to know -- I don't know if you saw the latest forecast for the SPR or the latest bid zone, and they're going back. It looks like about 80%, 85% sweet and the remainder sour barrels. So don't be surprised if that differential starts to narrow as we get a little later into Q3, Pat.

[Patrick Kenny, National Bank Financial]

Sounds great. Thanks for that color, guys. And then, maybe just a follow-up here on your ability to pass through some of the inflationary pressures out there today. And it looks like the operating costs are being managed quite well.

But I'm just curious, if you're expecting a similar pass-through of capital cost pressures on the potential growth projects that you're looking at today, whether its cost of steel or construction, labor costs, I guess, in a nutshell, are you seeing any compression on your projected IRRs from these potential projects, or is it a similar narrative to the operating cost pressures where you're able to manage the pass-throughs?

[Chad Magus, Chief Financial Officer]

Yes. I mean, we look at our capital program and we look at the opportunities where we're putting capital to work, we are factoring in, I think, on our capital costs, we've seen costs rise as much as 15% to 18%. On the operating side, it's more like 8%, 9%, 10%. And so, when we're reviewing the models, you have to anticipate that we've been in an inflationary environment, now pretty strong here since, call it, Q4 of last year, where we've seen that monthly.

So we anticipate, hey, look, it's going to cost us more for tubing. It's going to cost us more for pipe. And so we put that in our economic model. And when we're working with our partners to what is the right range, it's factored into those economics. So we don't -- we've got to bear that brunt of the new capital cost that we're seeing to make sure that the returns are appropriate. So it's already factored in, I guess, would be the answer to your question, Pat.

[Patrick Kenny, National Bank Financial]

Okay. That's great. I'll leave it there. Thanks, guys.

[Rene Amirault, President & Chief Executive Officer]

Thanks.

[Operator]

Thank you. [Operator Instructions]

[Rene Amirault, President & Chief Executive Officer]

Thank you for being on the conference call today. A taped broadcast of the call will be available on Secure's website. We look forward to providing you with updates on Secure's performance in November after the completion of our third quarter of 2022. Thanks again.

[Operator]

So there are no further questions at this time. Please, proceed.

[Rene Amirault, President & Chief Executive Officer]

Thank you for being on the conference call today. A taped broadcast of the call will be available on Secure's website. We look forward to providing you with updates on Secure's performance in November after the completion of our third quarter of 2022. Thanks again and bye, now.

[Operator]

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines. Thank you.