AKITA Drilling Ltd. releases year-end results

CALGARY, March 3, 2017 /CNW/ - AKITA Drilling Ltd.'s net income for the year ended December 31, 2016 was $5,329,000 (net income of $0.30 per share (basic and diluted)) on revenue of $61,061,000 compared to a net loss of $33,965,000 or a $1.89 loss per share (basic and diluted) on revenue of $112,488,000 in 2015.  Results in 2016 included significant contract cancelation revenue of $28,250,000 ($20,609,000 after tax) while 2015 included an asset impairment expense of $41,968,000 (after tax effect of $30,748,000). The Company had a net loss from routine operations of $15,280,000 (net loss of $0.84 per share) in 2016 compared to a net loss from routine operations of $3,217,000 (net loss of $0.18 per share) in 2015.  Funds flow from operations for the current year was $34,500,000 compared to $38,510,000 in 2015, while net cash from operating activities for 2016 was $11,892,000 compared to $41,507,000 in 2015.

The Canadian drilling industry faced significant challenges in 2016. Average crude oil prices for the year declined 11% from 2015, after declining 48% from 2014 to 2015. This significant decline over the last two years has caused large reductions in the capital budgets of oil companies and therefore, significantly fewer opportunities for drilling companies. For AKITA, these market conditions resulted in the Company generating the fewest operating days in the Company's 24 year history. Furthermore, the Company's results were impacted by a significant reduction in day rates across the industry. 

During 2016, AKITA had two primary focuses; the management of discretionary spending and the retention of experienced field hands. Despite record low utilization and operating margins, the Company grew its cash balance through the year, ending the year with $14 million in cash, up from $9 million in 2015, and increased working capital from $16 million in 2015 to $35 million at the end of 2016. The Company upgraded four rigs in 2016, increasing depth capacities and move efficiencies on these rigs and also began construction of a new AC heavy pad double rig in the fourth quarter that is scheduled to be completed in July of 2017. The second focus of the Company in 2016, crew retention, was important to the Company in order to keep as many field employees working through the downturn as financially possible. This commitment to our employees has put AKITA in the enviable position of having enough experienced people to crew its rigs as demand picks up in 2017, as is expected to be the case.    

AKITA maintains a commitment to safety that permeates all levels of the organization.  Since inception, AKITA's annual safety performance has been among the best in the industry.  AKITA's 2016 total reportable accident frequency (often referred to as "TRIF") was the best in the Company's history, showing a 20% improvement over the Company's previous record.  To help achieve this, field employees complete extensive safety training and must meet current industry certification standards and managers, employees and subcontractors are all required to understand and accept their responsibility for maintaining a safe working environment.

On November 22, 2016, the Canadian Association of Oilwell Drilling Contractors ("CAODC") released its 2017 industry drilling forecast, estimating 23% average rig utilization compared to 17% actual average rig utilization in 2016, and 4,665 wells in 2017, up from 3,562 in 2016.  The 2017 forecast was based upon commodity price assumptions of US $53 per barrel for crude oil and CAD $3.00 per mcf for natural gas. This forecasted increase in the number of wells to be drilled in 2017 is positive; however, it is still 14% below 2015 figures and 58% below 2014. The Company anticipates that 2017 will be another challenging year, but is optimistic that this growth trend will continue based on recent positive news surrounding pipelines and Canada's ability to move crude oil to markets.

Selected information from AKITA Drilling Ltd.'s Management's Discussion and Analysis for the Annual Report is as follows:

Fleet and Utilization

The following table summarizes rig changes that occurred in 2016:

 

In 2016, the Company rebuilt and deployed two heavy single rigs that were constructed with a combination of spare parts and new components. These single rigs each have a 1,900 metre depth capacity and feature integrated top drives. Also during 2016, five rigs were decommissioned and moved into spare equipment. In the fourth quarter of 2016, the Company began construction of a new AC double pad rig.

During 2016, three of the Company's joint venture partners entered into an agreement with AKITA whereby they agreed to sell their ownership interest in two rigs to AKITA in exchange for settlement of outstanding payable balances on those and other joint venture operations. As a result of these sales to AKITA, the Company became the 100% owner of two former joint venture rigs. Weak market conditions were the contributing factors that necessitated this divestiture by the joint venture partners. AKITA remains committed to the health of its joint ventures and the success of its joint venture partners.  As a result of AKITA purchasing the partners' interest in these two rigs, the remaining four joint venture rigs with these partners are well positioned for future success and are financially stable.  

Utilization rates are a key statistic for the drilling industry since they measure revenue volume and influence pricing.  During 2016, AKITA achieved 1,583 operating days, which is the lowest in the Company's history and which corresponds to a utilization rate of 14%, compared to 2015 utilization of 31%, and 3% below the 2016 industry average of 17%.

The drilling industry is seasonal, with activity typically building in the fall and peaking during the winter months, at which time areas with muskeg conditions freeze sufficiently to allow the movement of rigs and other heavy equipment.  The peak drilling season ends with "spring break-up", at which time drilling operations are curtailed due to seasonal road bans (temporary prohibitions on road use) and restricted access to agricultural land. 

In addition to traditional seasonal impacts, the business of AKITA may be affected at various times in two important ways as a result of warmer than normal temperatures.  First, increases in overall temperatures would have the effect of shortening the winter drilling season.  A secondary impact on AKITA of warmer than normal temperatures is related to a reduced demand for natural gas for heating.  To the extent that warmer weather impacts the demand for natural gas including the resultant lower natural gas prices for many of AKITA's customers, those customers might reduce natural gas drilling programs, which in turn might reduce the demand for AKITA's services.

A significant shift in drilling has occurred in recent years with respect to the type of equipment preferred by AKITA's customers.  Specifically, there has been a shift away from conventional rigs, requiring trucks to relocate from well to well, towards the use of pad rigs with self-moving systems which allow the rig to move itself within a set of well locations, usually referred to as a "pad".  Moreover, pad rigs typically drill wells in "batches", whereby a series of surface holes are drilled, followed by one or more series of intermediate holes and a final series of main holes.  This style of drilling, as opposed to drilling each well from start to finish prior to moving, provides significant efficiency gains when used in appropriate applications.  Pad rigs are also less impacted by seasonal fluctuations as they can work throughout spring break-up provided they are in place before travel bans commence in the spring.

From time to time, the Company enters into drilling contracts for extended terms.  At December 31, 2016, AKITA had two rigs with multi-year contracts, one of which expires in 2017 and the other in 2018.

AKITA's competitive position is affected by the overall size of the Canadian drilling fleet and the level of customer demand.  At December 31, 2016, there were 668 drilling rigs registered with the CAODC (December 31, 2015 – 765).  AKITA's drilling fleet of 28 rigs represented 4.2% of the total Canadian drilling fleet at December 31, 2016 (December 31, 2015 – 4.1%).

Revenue and Operating & Maintenance Expenses

                       

Adjusted revenue of $49,781,000 in 2016 was 66% lower than the 2015 adjusted revenue of $144,951,000, primarily as a result of decreased rig activity coupled with reduced day rates. During 2016, the Company's revenue included a material contract cancellation fee. This fee has been excluded in the Company's adjusted revenue and adjusted operating margin, and adjusted operating margin per operating day analysis. The Company's pad triple rigs saw the largest decrease in operating days which were heavily affected by the suspension of oil sands operations due to both low crude oil prices and the Fort McMurray wildfires. Adjusted revenue was also lower on a per operating day basis, decreasing to $31,477 per operating day in 2016 from $36,102 per operating day in 2015, as a result of increased competition for limited opportunities in 2016. 

Adjusted operating and maintenance costs are tied to activity levels and amounted to $34,850,000 or $22,015 per operating day during 2016 compared to $94,834,000 or $23,620 per operating day for the prior year.  The reduction in operating and maintenance costs, when considered on a totals basis, is directly related to the lower level of activity in 2016 compared to 2015.  The decrease on a per day basis is a result of cost cutting measures that were started in 2015 and affected the full year in 2016.

The Company's adjusted operating margin for 2016 was $14,931,000 ($9,432 per operating day), compared to $50,117,000 ($12,482 per operating day) in 2015.  Lower drilling activity was the key factor behind the reduction in operating margin from 2015 to 2016. On a per day basis, reduced day rates in 2016 drove the operating margin per day lower than in 2015.

AKITA provided drilling services to 29 different customers in 2016 (2015 - 27 different customers), including three customers that each provided more than 10% of AKITA's adjusted revenue for the year (2015 – three customers).

Depreciation and Amortization Expense

 

Drilling rigs are generally depreciated using the unit of production method.  Depreciation is typically calculated for each rig's major components resulting in an average useful life of 3,600 operating days per rig, subject to annual minimum imputed activity levels.  In certain instances where rigs are inactive for extended periods, however, the Company's depreciation rate is accelerated.  Major rig upgrades are depreciated over the remaining useful life of the related component or to the date of the next major upgrade, whichever is sooner.  Major rig inspection and overhaul expenditures are depreciated on a straight-line basis over three years.

The decrease in depreciation and amortization expense to $23,959,000 during 2016 from $36,748,000 during 2015 was attributable to fewer operating days in 2016. On a per day basis, depreciation increased from $9,153 per day in 2015 to $15,135 per day in 2016 as a result of more inactive rigs incurring depreciation relating to minimum imputed activity levels in 2016. Drilling rig depreciation accounted for 96% of total depreciation and amortization expense in 2016 (2015 – 97%).

Selling and Administrative Expenses

 

Adjusted selling and administrative expenses decreased to $12,702,000 in 2016 from $15,524,000 in 2015.  The reduction in adjusted selling and administrative expenses (as well as selling and administrative expenses per the financial statements) is a direct result of cost cutting measures implemented by the Company impacting the full year of 2016 compared to 2015 when the cost cutting initiatives were started but did not impact the full year. Adjusted selling and administrative expenses equated to 25.5% of adjusted revenue in 2016, compared to 10.7% of adjusted revenue in 2015, as a result of decreased adjusted revenue and the fixed nature of selling and administrative expenses.

The single largest component of adjusted selling and administrative expenses was salaries and benefits which accounted for 55% of these expenses in 2016 (2015 – 57%). 

Asset Impairment

 

International Accounting Standard 36, "Impairment of Assets", requires an entity to consider both internal and external factors when assessing whether there are indications of asset impairment at each reporting period. At December 31, 2016, there were no internal indicators of impairment and an external indicator of impairment, namely the price of crude oil, still exists. Despite the positive trend in oil prices in the second half of 2016, crude oil prices remained low when compared to 2014. At December 31, 2016, significant market uncertainty still exists as to the extent and duration of the recovery of oil prices. This uncertainty impacts the earnings potential of the Company's cash generating units ("CGUs"), therefore an asset impairment test was performed at December 31, 2016.

The accuracy of asset impairment testing is affected by estimates and judgments in respect of the inputs and parameters that are used to determine recoverable amounts. In performing its asset impairment test at December 31, 2016, management determined value in use for each of its CGUs using estimated discounted cash flows ("DCFs"), which included estimates of future cash flows, expectations regarding cash flow variability, a determination of the discount rate and consideration of the recoverable amount and salvage value of each CGU. IFRS considers this approach to constitute a Level 3 hierarchy in its determination of value.

Upon completion of its asset impairment testing, the Company concluded that there was no impairment, nor reversal of previous impairment, required at December 31, 2016.

Equity Income from Joint Ventures

 

The Company provides the same drilling services and utilizes the same management, financial and reporting controls for its joint venture activities as it does for its wholly-owned operations.  The analyses of these activities are incorporated throughout the relevant sections of this MD&A.  Joint venture activities are often located in some of the most prospective regions in Canada.  Two thirds of AKITA's joint ventures utilize pad drilling rigs.

Other Income (Loss)

 

Interest income increased to $965,000 in 2016 from $130,000 in 2015 due primarily to interest accrued ($764,000) on the receivable portions of the contract cancellation revenue referenced earlier. The remainder relates to interest earned on cash balances.

During 2016, the Company recorded interest expense of $163,000 (2015 – $356,000) related to the future cost of the Company's unfunded defined benefit pension plan. Interest expense in 2015 also included interest on the Company's indebtedness which was fully repaid in 2015.

During 2016, the Company disposed of non-core assets resulting in a gain of $90,000.  AKITA disposed of several non-core assets in 2015, resulting in a $657,000 loss.

In 2016, amounts reported as "Net Other Gains" of $148,000 included miscellaneous income. In 2015, "Net Other Gains" of $462,000 included $267,000 of foreign exchange amounts related to forward exchange contracts settled in 2015 and miscellaneous income of $195,000.

Income Tax Expense (Recovery)

 

AKITA had an income tax expense of $2,206,000 in 2016 compared to a tax recovery of $10,579,000 in 2015. The change in current tax recovery resulted from a slightly lower loss for tax purposes in the year when comparing 2016 to 2015. The increase in deferred tax is due to an asset impairment expense recorded in 2015 that created a significant deferred tax recovery in 2015.

Net Income (Loss), Funds Flow and Net Cash from Operating Activities

 

During 2016, the Company recorded net income of $5,329,000 (net earnings of $0.30 per Class A Non-Voting and Class B Common Share (basic and diluted)) compared to a net loss of $33,965,000 (net loss of $1.89 per Class A Non-Voting and Class B Common Share (basic and diluted)) in 2015.  Funds flow from operations decreased to $34,500,000 in 2016 from $38,510,000 in 2015. 

During the first quarter of 2016, the Company recorded contract cancellation revenue of $28,250,000 ($20,609,000 net of tax) related to the cancellation of a multi-year contract. This contract cancellation revenue had a significant impact on the Company's financial performance, resulting in net income of $5,329,000. Excluding the contract cancellation revenue, the Company generated a net loss from routine operations of $15,280,000 compared to a net loss from routine operations of $3,217,000 in 2015 (net loss $33,965,000 plus $30,748,000 (tax effected asset impairment expense)). Weak market conditions were the primary factor for the significant decrease in results from routine operations. Funds flow from operations was affected by the contract cancellation revenue and weaker market conditions in 2016. Funds flow from operations was not affected by the asset impairment expense in 2015 as this is a non-cash item.

Liquidity and Capital Resources

At December 31, 2016, AKITA had $34,907,000 in working capital including $14,250,000 in cash and no bank indebtedness, compared to a working capital of $16,002,000, including $9,369,000 in cash at December 31, 2015. In 2016, AKITA generated $11,892,000 cash from operating activities.  Cash was also generated from joint venture distributions ($6,753,000), from reductions in cash balances restricted for loan guarantees ($3,009,000) and from proceeds on sales of assets ($202,000).  During the same period, cash was used for capital expenditures ($10,775,000)⁽¹⁾ and payment of dividends ($6,100,000)⁽¹⁾.

 

The Company chooses to maintain a conservative Statement of Financial Position due to the yclical nature of the industry.  In addition to its cash balances, the Company has an operating loan facility with its principal banker totalling $100,000,000 that is available until 2020.  The interest rate on the facility varies based upon the actual amounts borrowed and ranges from 0.45% to 1.45% over prime interest rates or 1.45% to 2.45% over guaranteed notes, depending on the preference of the Company.  The Company did not have any borrowings from this facility at December 31, 2016 or December 31, 2015.

As part of the loan facility agreement, the Company must adhere to the following financial covenants:

• Funded debt to EBITDA shall not be greater than 3.00 to 1;
• EBITDA to interest expense shall not be less than 3.00 to 1; and
• Tangible assets to funded debt shall not be less than 2.25 to 1.

Readers should be aware that each of funded debt, EBITDA, interest expense and tangible assets have specifically set out definitions in the loan facility agreement and are not necessarily defined by or consistent with either GAAP or determinations by other users for other purposes.

From time to time, the Company makes major purchases from non-Canadian suppliers in connection with its capital expenditures.  AKITA purchases forward currency contracts in order to minimize the risk of currency translation adjustments associated with these purchases.  At December 31, 2016 and 2015, the Company did not have any forward currency contracts.

The Company did not have an outstanding normal course issuer bid during 2016 or 2015.

The following table provides a summary of contractual obligations for the Company:

 

Property, Plant and Equipment

Capital expenditures totalled $13,193,000 in 2016 ($17,960,000 in 2015). Capital spending in 2016 was as follows; $4,723,000 for certifications and overhauls, $1,776,000 for drill pipe and drill collars, $3,206,000 for rig equipment and upgrades and $3,361,000 in loans and payables assumed by the Company upon the acquisition of three joint venture partners' percentage ownership of two joint venture rigs. The balance of capital expenditures was for other equipment. The costs incurred during 2015 for capital was $9,727,000 for completion of a rig construction project, $3,878,000 for certifications and overhauls, $2,544,000 in rig equipment for existing rigs, $1,490,000 for drill pipe and drill collars and $321,000 on other equipment. 

During 2016, the Company sold ancillary assets for $202,000 that resulted in a gain of $90,000.  During 2015, AKITA sold ancillary assets for $1,093,000 for a loss of $657,000.

Basis of Analysis in this MD&A, Non-GAAP and Additional GAAP Items

The Company reports its joint venture activities in the financial statements in accordance with IFRS 11 "Joint Arrangements".  In determining the classification of its Joint Arrangements, AKITA considers whether the Joint Arrangements are structured through separate vehicles, if the legal form of the separate vehicles confers upon the parties direct rights to assets and obligations for liabilities relating to the Joint Arrangements, whether the contractual terms between the parties confer upon them rights to assets and obligations for liabilities relating to the arrangements as well as if other facts and circumstances lead to rights for assets and obligations for liabilities being conferred upon the parties to the Joint Arrangement prior to concluding that AKITA's joint ventures are properly classified as joint ventures rather than joint operations.  Under IFRS 11, AKITA is required to report its joint venture assets, liabilities and financial activities using the equity method of accounting.  However, for purposes of analysis in this MD&A, the proportionate share of assets, liabilities and financial activities is included as non-GAAP financial measure ("Adjusted") where appropriate.  The Company provides the same drilling services and utilizes the same management, financial and reporting controls for its joint venture activities as are in place for its wholly-owned operations.  None of AKITA's joint ventures are individually material in size when considered in the context of AKITA's overall operations.

Adjusted operating margin, adjusted revenue per operating day, adjusted operating and maintenance expenses per operating day and adjusted operating margin per operating day are not recognized GAAP measures under IFRS.  Management and certain investors may find such operating margin data to be a useful measurement tool, as it provides an indication of the profitability of the business prior to the influence of depreciation, overhead expenses, financing costs and income taxes.  Management and certain investors may find "per operating day" measures for adjusted revenue and adjusted operating margin indicate pricing strength while adjusted operating and maintenance expenses per operating day demonstrates a degree of cost control and provides a proxy for specific inflation rates incurred by the Company.  Readers should be cautioned that in addition to the foregoing, other factors, including the mix of rigs that are utilized between conventional and pad and singles, doubles and triples can also influence these results.  Readers should also be aware that AKITA includes standby revenue in its determination of "per operating day" results.

Funds flow from operations is considered an additional GAAP item under IFRS.  AKITA's method of determining funds flow from operations may differ from methods used by other companies and includes cash flow from operating activities before working capital changes, equity income from joint ventures, and income tax amounts paid or recovered during the period.  Management and certain investors may find funds flow from operations to be a useful measurement to evaluate the Company's operating results at year-end and within each year, since the seasonal nature of the business affects the comparability of non-cash working capital changes both between and within periods.

Forward-Looking Statements

From time to time AKITA makes forward-looking statements.  These statements include but are not limited to comments with respect to AKITA's objectives and strategies, financial condition, results of operations, the outlook for industry and risk management discussions.

By their nature, these forward-looking statements involve numerous assumptions, inherent risks and uncertainties, both general and specific, and therefore carry the risk that the predictions and other forward-looking statements will not be realized.  Readers of this MD&A are cautioned not to place undue reliance on these statements as a number of important factors could cause actual future results to differ materially from the plans, objectives, estimates and intentions expressed in such forward-looking statements.

Forward-looking statements may be influenced by factors such as the level of exploration and development activity carried on by AKITA's customers; world crude oil prices and North American natural gas prices; global liquefied natural gas (LNG) demand; weather; access to capital markets; and government policies.  We caution that the foregoing list of factors is not exhaustive and that while relying on forward-looking statements to make decisions with respect to AKITA, investors and others should carefully consider the foregoing factors as well as other uncertainties and events prior to making a decision to invest in AKITA.  Except where required by law, the Company does not undertake to update any forward-looking statement, whether written or oral, that may be made from time to time by it or on its behalf.

Selected Financial Information for the Company is as follows:

 

 

 

 

 

SOURCE AKITA Drilling Ltd.