STEP Energy Services Ltd. (STEP) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen, and welcome to the STEP Energy Services First Quarter of 2023 Conference Call and Webcast. [Operator Instructions] This call is being recorded on Thursday, May 11, 2023. I would now like to turn the conference over to [ Dana Brenner ], Senior Advisor, Investor Relations.

Thanks, operator, and good morning, everyone. Welcome to STEP's First Quarter 2023 Conference Call and Webcast. I am pleased to introduce today's roster of speakers. Steve Glanville, our President and CEO, will give some opening remarks. Klaas Deemter, our CFO, will follow with an overview of the financial highlights before turning it back to Steve for some strategy and outlook focused commentary. We will then host a Q&A session to follow. Before I turn it over to Steve, I would like to remind everyone that this conference call may contain forward-looking statements and other information based on current expectations or results for the company. Certain material factors or assumptions that were applied in drawing conclusions or making projections are reflected in the forward-looking information section of our Q1 2023 MD&A. Several business risks and uncertainties could cause actual results to differ materially from these forward-looking statements and our financial outlook. Please refer to the Risk Factor and Risk Management section of our MD&A for the quarter ended March 31, 2023. For a more complete description of business risks and uncertainties facing STEP. This document is available both on our website and on SEDAR. During this call, we will also refer to several common industry terms and certain non-IFRS measures that are fully described in our MD&A, which again, is available on SEDAR and on our website. With that, I will pass the call over to Steve.

Thanks, [ Dana ], and good morning, everyone. Thank you for joining our first quarter 2023 conference call. As noted, my name is Steve Glanville, and I am the President and CEO of STEP Energy Services. We will be providing an overview of our Q1 results. By now, hopefully, you will have the opportunity to look at them, and you will also recall that we released the preliminary operations and financial update on April 10. As you see, our results fell comfortably within those projected ranges. The first quarter was a very good one for our company and have showed yet again the strength of our overall business model. This time, we had an excellent performance from our Canadian fracturing division as well as both Canadian and U.S. coiled tubing divisions. The combination of those 3 business units was about to propel STEP's consolidated revenue to the second highest level in its history and up 5% from the fourth quarter of 2022. We recall that in the fourth quarter call, my commentary was similar in that we had a terrific performance from 3 out of our 4 business units, but it was our U.S. fracturing that put up record revenue while E&P completion budgets in Canada wound down until the new year. This time, Canadian fracturing took the ball and ran with it. STEP's adjusted EBITDA for the quarter was $45.3 million, which is still very good in the context of last year's Q1 results. Overall, as I say frequently, it is difficult in our project focused business to have all groups performing at maximum capability all the time, which is why we believe in the strength of our diverse business offering. We continue to trend along as a company at a strong level overall and keep paying down debt as we go. In fact, since the middle of 2018, STEP has paid down approximately $180 million of net debt, and we are now sitting at 0.6x trailing 12-month adjusted EBITDA. For most of the last 25 years, that ratio would have been seen to be underlevered in relation to an efficient balance sheet. Thus, our financial position is strong, and we expect it to keep building on this strength. I am very proud of the continued efforts that our client partners and our STEP professionals give in making these results happen. Before I address our strategy and outlook, I want to turn the call over to Klaas, our CFO, for some financial highlights.

Thanks, Steve, and good morning, everybody. As noted, the first quarter once again showed the power of diversity in our business model with our Canadian segment as a whole, putting up its best revenue number ever and our U.S. coiled tubing business also setting a new top line record. The second quarter will open our group. As communicated in our April operational and financial update. However, our U.S. fracturing group had a slow start due to some client-driven delays that held us back somewhat in the U.S. as a whole. Now let's address our consolidated results first year. But before I start, I want to remind our listeners that all our numbers are in Canadian dollars, unless noted otherwise, when all surround or possible. Consolidated revenue in the quarter was $263 million, the second best in our history after the record set in Q3 of last year. Revenues in Q1 2023 were up roughly 5% from an already strong Q4 2022 level and up 20% year-over-year. On the midline, our consolidated adjusted EBITDA was $45.3 million, which was in the middle of our $43 million to $48 million guidance that we gave early in April. This number includes a $2.8 million expense for Canadian fluid ends. The $2.8 million includes a onetime $1 million expense to bring the useful lives of the existing fluid ends down to 12 months or less, with the remaining $1.8 million incurred to reflect the quarterly usage. Our previous practice was to capitalize fluid ends by the increasing intensity of our Canadian completion activity makes it reasonable to make this shift in treatment to expense in 2023. Our U.S. business has always expense fluid ends due to the different work scope that we see there. Our Q1 adjusted EBITDA compares to the approximately $37 million that we reported in Q1 2022 and $48.6 million that we reported in Q4 2022, neither of which recognized Canadian fluid ends on the maintenance expense. On the margin side, our Q1 '23 consolidated adjusted margin came in just over 17%, which is down from 19% in Q4 2022 but up from just under 17% a year ago. The delays experienced in our U.S. fracturing operations held look back to consolidated margin performance for would have otherwise been a much stronger level. I'm going to talk a minute here about the geographic regions. The full detail is in our MD&A. So I'm just going to hit a couple of highlights. We're extremely pleased with STEP's Canadian operations, the region on a robust first quarter in both fracturing and coiled tubing leading to its best ever quarterly revenue performance. Canadian revenue of $174 million was up 52% from Q4 and about 19% from last year in Q1. For context, the CAC reports that the Canadian drilling rig count in Q1 was 12% higher year-over-year. So we performed quite a bit better than this benchmark. Favorable weather conditions and client alignment resulted in a solid utilization in both service lines. STEP's 4 large fracturing crews operated primarily in the gas and condensate rich areas of the Montney, while our smaller low-pressure crew was active in the oil rich Cardium and Viking formations driving near record frac revenue for the quarter. The extended cold weather into late March provided a longer operating cycle for STEP's 9 coiled tubing units, with the service line recognizing its best top line performance since the third quarter of 2018. Note that we added a ninth coiled tubing unit in Canada in response to strong customer demand, and we had a full quarter's worth of contribution from these units in Q1. In line with the strong operating performance, the Canadian segment produced strong adjusted EBITDA of $44.8 million in the quarter, a margin of 25.7%, comparing to 20.5% in Q4 2022 and 21.7% a year ago. Stronger industry conditions and better pricing versus a year ago explain the margin growth. Note that revenues are roughly split 80% of fracturing and 20% coiled tubing in Canada, essentially unchanged year-over-year. Our U.S. operations saw mixed results in the first quarter. Coiled tubing had continued its trend of sequentially quarterly increases leading to record top line performance and the strong demand from leading public E&Ps across all basins for our industry-leading coil tubing capabilities. Revenues were $39.7 million in U.S. coiled tubing, up 2% sequentially and up 72% year-over-year. We activated a 12 unit mid-quarter, up from 11% in Q4 and 8 units a year ago. Our consolidation strategy in this sector is paying good dividends for us, and we believe we're the leading player overall in North America in this business line with a particular focus on the growing energy market. In U.S. fracturing, as we noted earlier, the service line was negatively impacted by a shift in client schedules related to drilling delays and commodity price pressures, which also resulted in lower levels of proppant pump. With these changes coming at the start of the year, we are unable to secure sufficient spot work for these crews, resulting in lower revenues relative to the fourth quarter. Our frac revenues of $49.3 million were roughly half the level we reported in our Q4 2022, but essentially flat on a year-over-year basis. U.S. fracturing contributed 55% of revenue, segment revenues in this quarter, down from 68% a year ago. On the margin side, additional sustaining capital and maintenance expense was deployed during the quarter to improve efficiencies and reliability of the fracturing equipment. However, the lower utilization negatively impacted the U.S. segment's adjusted EBITDA margins. On a percentage basis, U.S. adjusted EBITDA was 5.4% compared to 21% in Q4 up 13.5% a year ago. Turning to our balance sheet and cash flow, we have more good news to report. Our net debt was reduced to $133 million at the end of the quarter from roughly $142 million at the end of Q4 and then is down from $214 million a year ago, an improvement of over $80 million, measured against the trailing 12 months adjusted EBITDA. Net debt has fallen to 0.6x versus 0.7x from a quarter ago. For context, about 18 months ago, this ratio was over 3x. Going further back since 2018, the company has paid down roughly $180 million of debt, showing remarkable progress on our balance sheet. We generated free cash flow of $17 million in the quarter, while on a trailing 12 basis, free cash flow has been over $100 million. Notwithstanding these high free cash flow levels, we continue to invest in our fleet to keep it safe, modern and relevant to our clients. We remind investors that as of the year-end 2022, STEP had the best long-term track record among Canadian-based frac and coil tubing companies are spending at least as much in gross CapEx as is long-term depreciation of major assets. This matching is important to preserving long-term fleet quality and occurred despite some exceptionally lean years in 2016 to 2021. We also compare very favorably on this metric in the North American pressure public space. Our capital budget was adjusted to $98.9 million, down from the $103 million that we had previously approved to reflect the change in fluid end treatment. $51 million of this is allocated towards sustaining capital and $48 million is allocated towards optimization capital, which is generally spent on projects that are expected to bring incremental margin from improved reliability and efficiency. In terms of our current spend, we finished upgrading 8 of the 16 pumps on our Canadian Tier 4 dual fuel conversion, and we anticipate this being completed on schedule by the end of June. The first pumps are already in the field and are producing excellent results. Finally, EPS was $0.26 diluted compared to $0.23 in Q4 and $0.13 a year ago, building on a trend of 5 solid net income coatings. Our latest book value per share has increased to $4.55 from $4.27 at the year-end and versus $2.71 a year ago, giving full year accretion to equity holders of $140 million or $1.84 a share. With that, I'll turn it over to Steve for some remarks on our strategy and outlook.

Yes. Thanks, Klaas. With another solid quarter behind us, this is a good place to reiterate that we think the best business model in fracturing and coiled tubing is a North American-focused one. That is likely to be the most beneficial combination for equity investors going forward. Interestingly, the year 2023 is shaping up to be one where there's probably a bit more confidence in the Canadian energy market than of the U.S. Due to the onset of activity related to LNG Canada as well as the liquids content of a lot of Canadian natural gas production. Despite the heavy pullback in benchmark U.S. natural gas prices, many Canadian natural gas producers are still profitable with all the drilling and completion efficiencies gained in the past few years. Strong E&P balance sheets are common to both countries right now, but Canada looks a bit stronger to us industry-wide. However, when we look out to 2024 and beyond, we think the visibility is overwhelmingly tilted towards the U.S. relatively speaking. The rate at which the U.S. has established itself as a global LNG powerhouse is truly remarkable. Of course, this was an opportunity that Canada had as well, but we did not have the political leadership in the country to see the global benefits that come with producing Canadian natural gas that could otherwise displace the need for coal plants in developing countries such as China. This is also a staggering loss of wealth long term for this country and every Canadian should know that. However, we have adjusted the opportunity set around us and are carefully growing our exposure to the U.S. LNG buildout, which will take place principally along the Southern U.S. in gas plays such as the Haynesville and also the oil-focused Permian and Eagle Ford plays. It may be a surprise to some, but the relative portion of natural gas in the production stream for these areas is growing, and they will increasingly be known for their natural gas upside. We have an ultra-deep capacity coiled-tubing business with a Permian focus, so we check that box. We have a U.S. fraction business that is exclusively in the Permian, and we plan to make both business lines larger over time. And in short, we like our U.S. strategy. Another area where STEP differentiates itself in terms of strategy is our last mile logistics. We haul in an overwhelmingly large amount of our clients' profit needs, especially in Canada, which generates extra margin for us because we do it so proficiently. We have an outstanding team of individuals and a fleet of specialized assets that unburdens our clients for managing key logistics in their business. We will continue to invest in this differentiated business unit as trucking bottlenecks will continue to persist in our business. I want to finish with an update on our outlook. Starting in Canada, we have aligned ourselves with a Canadian client base that recognizes the advantages of operating in the second quarter, and we are seeing good utilization so far in our fracturing service line, particularly for the larger Montney, Duvernay size crews. So far, the wildfires in Northwestern Alberta have not impacted our operations, but we are monitoring the situation carefully and our hearts go out to all the people in the region affected as well as the firefighting crews and other emergency personnel who put their lives on the line to help everyone. STEP's smaller fracturing crew, our fifth one is more susceptible to road bands due to the typical spring breakup conditions in the area in which it operates, which will limit its activity until later in May. Coiled tubing is also more impacted by spring breakup conditions, which will result in a moderated of utilization in that service line until mid in the quarter. This is all very typical because of road restrictions for overweight vaults. Moving to the back of the year, visibility is solid with steady utilization anticipated across the company's core client group in both service lines. We have won some major projects already, which is filling up the calendar very nicely. Another way to look at it is by assessing the size of the current RFP or request for proposal season. This activity is larger than we are expecting, so the utilization looks solid for the back half of the year. I will reiterate that spending in the Montney is clearly on the rise and that LNG Canada project is the main reason for this increased activity. In the U.S., we are seeing considerably higher utilization within our fracturing service line in the second quarter. The strengthening of WTI oil prices into that $70 to $80 barrel range seems to provide support to activity, but the ongoing weakness in the natural gas price will remain a limiting factor. As a result, we have deferred our plan to add a fourth fracturing crew until the market conditions can support additional capacity. Coal tubing is expected to remain steady with some impact from spring breakup conditions expected in the northern areas of our business. We are running 12 units now, so that is great progress for us. Overall, I would say the utilization on STEP's fracturing and coating fleets is expected to remain steady through the second half of the year. It's not quite the heated market of 2022, but it is a busy market and the benefit to E&P companies is that some key material costs are starting to roll over, such as casing costs and other raw material prices. Before I turn the call back to the operator, I want to close by saying how proud I am of what we've accomplished together at STEP in the first quarter. It was yet another quarter where a complete team effort delivered strong results for our clients and shareholders. I am privileged to work with a team like this. Operator, we would be pleased to take any questions.

[Operator Instructions] Your first question comes from Cole Pereira with Stifel.

On the U.S. side, can you just talk about if you've made any changes there in terms of maybe some personnel aligned yourself with different customers, et cetera?

Cole, it's Steve here. Absolutely. We've -- it's funny as we went through kind of Q1, our client base that we had was mostly smaller private companies that we had worked with primarily in 2022. So their programs were quite robust when oil prices were, call about $100 to $110. As we saw in the quarter in Q1 with the decrease in WTI and of course, the decrease in gas prices, these private operators became a little bit more conservative on their CapEx. So hence, we've aligned ourselves with some larger clients in the Permian, and that's turned out favorably for our business.

Got it. And thinking about Q3 in Canada, you made a few comments, but can you maybe make some comparisons to how you see the quarter evolving, maybe specifically for the frac business compared to Q1 and compared to Q3 of last year?

Yes. I mean the last week, I guess, Cole with these wildfires, there's been -- as I mentioned, we haven't been effective a whole much as we're kind of in some gaps in our schedule due to break up. But I really think the operations will kind of get back to normal, call it, next week. And that could create a fairly tight situation for Q3. We -- obviously, we haven't lost any work. It's more -- it's kind of as operators want to complete these wells, it could create a little bit of a bottleneck going into Q3 and should really produce a very, very strong Q3 for the Canadian business unit.

Your next question comes from John Gibson with BMO Capital Markets.

First on the U.S. market, obviously, still challenging on the pressure pumping side. I'm just wondering how your competitors have been acting with some of the gas-related completion crews down. Are they moving fleet in the oil regions? Or have you seen signs of competitors' parking equipment?

John, we've -- I would say in Q1, we saw some fleets move from the Haynesville into the Permian and which, of course, created a bit of a kind of a pricing war for the quarter. Since then, a lot of fleets have been Well, some fleets have been parked. I know a lot of our larger competitors are not playing that price battle, which is beneficial for everyone. And so we see less fleets. I think the latest report was, call it, less than 290 fleets that are active in the U.S. And so I do believe that that's created a more stable market.

We think our intel shows that about 10 fleets have been laid down, John. And that's kind of -- those are active fleets as we see some of our competitors are consolidating a few fleets here and there. And then there's also the ones that potentially would have been incremental, ours would have been one of them. And as you see some of those new fleets that are coming out, they are being framed much more as replacement fleets versus new on versus incremental. There's no hedging any going on anymore there. It's just straight replacement.

Okay. Great. I'll ask sort of the same question for Canada. I mean, obviously, actuals are very robust. Have you seen any more signs of competitors moving equipment into Canada ahead of a busy second half?

Yes. We don't see that. Of course, there was -- we had made notion in Q4, there was an added fleet in the quarter and that created an oversupply situation. We saw that balanced out in Q1. But as we look into the kind of the back half of the year, we see it being more of a balanced market in Canada. And really, there's the economics to stand up another frac fleet for spot work does not make sense. And so we've been very disciplined with that, and we don't believe that there's room for another frac fleet in Canada. The large one that is.

Okay. Great. And last thing for me, do you think there's any ability to push pricing in Canada later in '23 or early '24, just based on where things are kind of trending right now?

I mean, we think that there's some opportunity perhaps in kind of the back half of the year. And I guess both Klaas and I get pretty excited about Q1 of 2024. We believe it's going to be an extremely tight market. As I mentioned earlier, is the LNG ramp-up of activity in the Blueberry River First Nations agreement that have been -- has been resolved. We're seeing a very, very large increase in well permits in BC. And so that will create some tightness and hopefully give us some ability to move prices.

Great. Actually, if you don’t mind, I'll ask one more. You talked about maybe growing certain business lines, particularly in the U.S. Could you maybe rank where you, priorities lay in terms of growing, whether it be adding more frac equipment in the U.S. via M&A, coiled tubing or even in Canada?

I'll just say all of the above, John. We get to look at every opportunity. And we -- as I highlighted, our balance sheet is in great strength, but we would only make that acquisition if it makes sense for us. We have a team that has shown the capabilities of running a great business. And I think there are some opportunities that we might see ourselves face to make some great decisions.

Your next question comes from Keith MacKey with RBC Capital Markets.

Good to see the Tier 4 equipment starting to make its way out into the field in Canada now. The pricing on that work, you mentioned in the release in September is linked to commodity prices and it includes inflation adjustment mechanisms. Commodity prices have kind of come down since that announcement. So like if the current commodity prices hold, what impact will this have on the profitability of that equipment relative to your initial expectations? You could even say relative to current margins, if that's an easier way to describe it.