AKITA Drilling Ltd. releases year-end results

CALGARY, March 7, 2018 /CNW/ - AKITA Drilling Ltd.'s net loss for the year ended December 31, 2017 was $39,177,000 (net loss of $2.18 per share (basic and diluted)) on revenue of $71,198,000 compared to net income of $5,329,000 or $0.30 earnings per share (basic and diluted) on revenue of $61,061,000 in 2016.  Included in the 2017 net loss is an asset decommissioning and impairment expense of $29,123,000 (after tax effect of $15,320,000 or $0.85 per share). 2016 results included significant contract cancellation revenue of $28,250,000 ($20,609,000 after tax). Net loss from routine operations in 2017 totalled $23,857,000 (2016 - $15,280,000). Funds flow from operations for the current year was $6,607,000 compared to $34,500,000 ($13,891,000 net of contract cancellation revenue) in 2016, while net cash from operating activities for 2017 was $3,724,000 compared to $11,892,000 in 2016.

The Canadian drilling industry saw significant activity improvements in 2017 with utilization improving to an annual industry average of 30% from 17% in 2016. AKITA's utilization rose to 36% in 2017 from 14% in 2016. This improvement in activity was driven by higher prices for crude oil which steadily increased throughout 2017. The increase in activity was spread across several rig categories for the Company, with pad triples, pad doubles, conventional doubles and conventional singles all more than doubling their operating days in 2017 compared to 2016. Triple pad rigs were the most active category for the Company generating 65% of the Company's operating days. These rigs are primarily focussed in the SAGD/Heavy Oil segments of the Canadian market.

Despite the significant escalation in drilling activity in 2017 over 2016, there is still more supply than demand for rigs which is resulting in low pricing for drilling services. The Company's revenue per operating day decreased to $26,704 in 2017 from $31,447 in 2016. This 15% drop had a significant impact on the Company's earnings as well as funds flow from operations. The decrease in revenue per day for the Company was a result of a change in the mix of rigs that operated in the year. Without a significant shift in demand for rigs or a reduction in the Canadian rig fleet, AKITA does not anticipate any significant price increases in the near future.

On November 21, 2017, the Canadian Association of Oilwell Drilling Contractors ("CAODC") released its 2018 industry drilling forecast, estimating 32% average rig utilization up slightly from the 30% actual average rig utilization in 2017, and 6,138 wells in 2018, up from 6,031 in 2017. The 2018 forecast was based upon commodity price assumptions of US $52.50 per barrel for crude oil and CAD $2.35 per mcf for natural gas. Based on the CAODC forecast it would appear that 2018 will be very similar to 2017. Without improvements to the existing takeaway capacity in Canada, the Canadian market may see limited growth.

AKITA began looking for growth opportunities in other geographical markets in 2017 due to the low activity and low profit margins prevailing in the Canadian market. After evaluating several potential alternatives, the Company created a United States subsidiary to pursue opportunities in the most active basin in North America, the Permian Basin. In December of 2017 the Company moved a state of the art rig into Odessa Texas and began marketing the rig to operators in the area. This rig has subsequently been contracted to a major USA operator. AKITA's expansion into the USA presents an exciting opportunity for the Company, with significant growth potential.

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

Fleet and Utilization

Oil and gas contract drilling activity is cyclical and is affected by numerous factors, most importantly world crude oil prices and North American natural gas prices.  Overall demand for AKITA's drilling services improved in 2017 compared to 2016. 

Driving the increase in activity was the steady increase in oil prices through 2017, with the average West Texas Intermediate ("WTI") price increasing 18% in 2017 compared to 2016. Average Alberta natural gas prices also improved 6% in 2017 over 2016. Improved prices for both crude oil and natural gas led to increased capital spending by AKITA's customers, many of whom had scaled back their drilling programs in 2016.

At the same time both industry and AKITA utilization levels increased in 2017, the Western Canadian Sedimentary Basin ("WCSB") rig count continued to decline, dropping 6% in 2017 compared to 2016. The decrease in rig count contributed to the improvement in industry utilization; increased activity was the prime driver of the utilization increase. AKITA's drilling fleet of 27 rigs in Canada represented 4.5% of the total Canadian drilling fleet at December 31, 2017 (December 31, 2016 – 4.2%).

Utilization rates are a key statistic for the drilling industry since they directly affect total revenue and influence pricing.  During 2017, AKITA achieved 3,659 operating days, which corresponds to an annual utilization rate of 36%, compared to 2016 utilization of 14% (1,583 days), and a 2017 industry average of 30%. Historically AKITA's utilization has been above industry standard due to the higher than average number of pad rigs in AKITA's fleet. Pad rigs typically have higher utilization than conventional rigs as pad drilling is a more efficient way to drill multiple wells without needing trucks to move.

In 2017, the Company built and deployed an AC heavy double pad rig that commenced operations in the third quarter of 2017. AKITA also decommissioned one conventional triple rig during the year. 

 

Revenue per day

The decrease in revenue per day in 2017 was directly related to lower day rates in the industry. Despite the decrease in the WCSB rig count, there is still an oversupply of rigs compared to demand in Canada and therefore rates remain very low. In contrast, activity levels in the United States have reached a level where day rates are increasing. AKITA moved a high spec rig to the U.S. Permian Basin in the fourth quarter of 2017 to take advantage of high demand in that market.

Seasonality

The drilling industry in Canada 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. 

Revenue and Operating & Maintenance Expenses

 

Revenue of $71,198,000 in 2017 was 17% higher than 2016 revenue of $61,061,000, due to increased activity in 2017. Excluding the 2016 contract cancellation revenue of $28,250,000, revenue directly related to drilling activities increased 117% in 2017 compared to 2016 ($71,198,000 in 2017 from $32,811,000 in 2016). This increase in activity is also reflected in the 131% increase in operating days between the two years. Revenue per operating day including AKITA's share of revenue from its joint ventures was $26,704 per day in 2017, down 15% from $31,447 in 2016. The drop in revenue per day in 2017 corresponded to an increased number of lower margin rigs working in 2017 than in 2016 for AKITA. AKITA's share of revenue from its joint ventures was included in the per day amounts as AKITA provides the same drilling services through its joint venture rigs as it does its wholly-owned rigs.

Operating and maintenance costs are tied to activity levels and increased to $62,156,000 in 2017 from $24,169,000 in 2016. On a per day basis, when including AKITA's portion of joint venture expense operating costs per day in 2017 remained consistent with the prior year, increasing only 1% in 2017 over 2016. 

AKITA provided drilling services to 35 different customers in 2017 (2016 - 29 different customers), including two customers that each provided more than 10% of AKITA's revenue for the year (2016 – 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, 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 increase in depreciation and amortization expense to $27,126,000 during 2017 from $23,959,000 during 2016 was attributable to more operating days in 2017. On a per operating day basis, depreciation decreased to $7,414 per operating day in 2017 from $9,153 per operating day in 2016 as a result of fewer inactive rigs incurring depreciation relating to minimum imputed activity levels in 2017. Drilling rig depreciation accounted for 96% of total depreciation and amortization expense in 2017 (2016 – 96%).

Selling and Administrative Expenses

 

Selling and administrative expenses increased to $13,659,000 in 2017 from $12,502,000 in 2016.  The increase in 2017 is related to higher business development costs as well as higher personnel costs.

Selling and administrative expenses equated to 19% of revenue in 2017, compared to 20.5% of revenue in 2016, as a result of the increase in revenue and the fixed nature of the majority of selling and administrative expenses.

The single largest component of selling and administrative expenses was salaries and benefits which accounted for 51% of these expenses in 2017 (2016 – 55%). 

Asset Decommissioning and 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. While the Company did not determine any internal indicators of impairment at December 31, 2017, it did determine one external indicator of impairment at that date: the lack of an increase in market rates in the drilling industry despite both increases to both drilling activity and oil prices over the prior year. The resulting lower drilling rates for longer forecast prompted the Company to perform an impairment analysis on its CGUs which include the following:

• Hydraulic Singles;
• Heavy Singles;
• Tele-Doubles;
• Heavy Triples;
• A.C. Tele-Double Pad Rigs;
• A.C. Oil Sands Pad Rigs;
• D.C. Pad Rigs; and
• A.C. Deep Gas Pad Rigs.

As at December 31, 2017, the recoverable amounts of these CGUs were determined as the higher of fair value less cost of disposal and the value-in-use basis. Fair value less cost of disposal was determined through the use of appraisals prepared in December 2017 by independent third party valuation experts. Value-in-use was calculated using the discounted cash flow for each CGU using the Company's 2018 budget and business plan as well as internal forecasts as the bases of the calculation of discounted cash flows. These tests indicated that certain of the Company's CGUs carrying amounts exceeded their recoverable amounts, resulting in impairment losses in 2017 of $16,000,000 (2016 – nil). 

The amounts in excess of the recoverable amounts for each of the Company's CGUs that were impaired at December 31, 2017 were as follows: 

 

The assumptions used in the value-in-use impairment tests were based on the Company's board approved 2018 budget and business plan covering a three year period and applied an average growth rate ranging from 0% to 5% over a 10 year period depending on the CGU being analyzed. In forecasting its projected cash flows the Company assumed that current market conditions will persist into the future. The Company assumed a pre-tax discount rate of 13%, in order to calculate the present value of projected cash flows. Determination of this discount rate included analysis of the cost of debt and equity for the Company and the Canadian drilling industry incorporating a risk premium based on current market conditions. This valuation has a fair value hierarchy of Level 3.

Asset impairment testing is subject to numerous assumptions, inherent risks and uncertainties, both general and specific, and the risk that the predictions will not be realized.  As a result, the following sensitivity analysis has been performed to recognize that additional outcomes are possible:

• Reduced future revenue assumptions by 10%;
• Increased inflation for cash outflows to 5%; and
• Increased the pre-tax discount rate from 13% to 16%.

As rigs are long lived assets, no sensitivity adjustment was made for the projected forecast period.

The sensitivity tests resulted in reductions to the various rig CGUs' values in use ranging from $680,000 to $13,800,000.  As the base case test represented management's best estimates, these sensitivity reductions were not included in the asset impairment loss reported.

In the fourth quarter of 2017 the Company performed a detailed review of its property, plant and equipment in light of a forecasted lower for longer demand for drilling rigs in the WCSB. The review resulted in a non-cash asset decommissioning expense of $13,123,000 (2016 – nil) relating to older spare equipment with uncertain future value.

Equity Income from Joint Ventures

Equity income from joint ventures is comprised of the following.

 

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 relating to increased activity, revenue per day as well as operating expenses.

Other Income (Loss)

 

Interest income decreased to $439,000 in 2017 from $965,000 in 2016 due primarily to less interest accrued on the receivable related to the contract cancellation revenue as the Company continued to collect the outstanding receivable.

During 2017, the Company recorded interest expense of $168,000 (2016 – $163,000) related to the future cost of the Company's unfunded defined benefit pension plan. 

During 2017, the Company disposed of non-core assets resulting in a gain of $194,000 (2016 – gain of $90,000).  

In 2017, amounts reported as "Net Other Gains" of $232,000 included $119,000 in income from the sale of previously written off equipment. In 2016, "Net Other Gains" of $148,000 related to various miscellaneous income.

Income Tax Expense (Recovery)

 

AKITA had an income tax recovery of $14,053,000 in 2017 compared to a tax expense of $2,206,000 in 2016. The change in current tax recovery resulted from a slightly higher loss for tax purposes in the year when comparing 2017 to 2016. The decrease in deferred tax is result of the asset impairment and decommissioning expense recorded in 2017 that reduced the Company's future tax liability.

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

 

During 2017, the Company recorded a net loss of $39,177,000 (net loss of $2.18 per Class A Non-Voting and Class B Common Share (basic and diluted)) compared to net income of $5,329,000 (net income of $0.30 per Class A Non-Voting and Class B Common Share (basic and diluted)) in 2016. The material difference in net income from 2017 and 2016 is largely attributable to the asset decommissioning and impairment expense in 2017 of $29,123,000 and  $28,500,000 revenue from contract cancellation AKITA received in 2016. Funds flow from operations decreased to $6,607,000 in 2017 from $34,500,000 in 2016. 

Both net income and funds flow from operations were impacted by the low revenue per operating day in 2017. With revenue per day down 15% in 2017 from already reduced rates in 2016 and operating costs per day up 1% over the same time frame, the Company saw record low operating profits despite the activity for the year.

Liquidity and Capital Resources

At December 31, 2017, AKITA had $15,528,000 in working capital including $560,000 in cash and no bank indebtedness, compared to a working capital of $34,907,000, including $14,250,000 in cash at December 31, 2016. In 2017, AKITA generated $5,074,000 cash from operating activities.  Cash was also generated from joint venture distributions ($6,095,000), from reductions in cash balances restricted for loan guarantees ($1,444,000) and from proceeds on sales of assets ($221,000).  During the same period, cash was used for capital expenditures ($20,569,000)⁽¹⁾ and payment of dividends ($6,100,000)⁽¹⁾. Accounts payable at year end included $9,401,000 in accrued expenses, half of which related to routine operations while the other half related to one-time items such as the expense related to the changes in Saskatchewan PST as well as the cost to move a rig from Canada to the US.

 

The Company chooses to maintain a conservative Statement of Financial Position due to the cyclical nature of the industry.  In addition to its cash balances, the Company has an operating loan facility with its principal banker totaling $50,000,000 that is available until 2019.  The interest rate on the facility is 1.25% over prime interest rates or 2.50% over guaranteed notes, depending on the preference of the Company.  The Company had no borrowings from this facility at December 31, 2017.

The credit facility has the following financial covenant:

• EBITDA⁽¹⁾ to interest expense shall not be less than 2.00 to 1.

The borrowing base of the new facility is calculated on:

• 75% of good accounts receivable⁽¹⁾; plus
• 40% of the aggregate book value of the consolidated eligible fixed assets⁽¹⁾.

 

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, 2017 and 2016, the Company did not have any forward currency contracts.

The Company did not have an outstanding normal course issuer bid during 2017 or 2016.

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

 

Property, Plant and Equipment

Capital expenditures totaled $20,569,000 in 2017 ($13,193,000 in 2016). Capital spending in 2017 was as follows; $7,500,000 for the construction of a new pad double rig, $7,574,000 for certifications and overhauls, $2,671,000 for drill pipe and drill collars, $2,551,000 for rig equipment and upgrades and the balance of capital expenditures was for other equipment.  The costs incurred during 2016 for capital were $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.

During 2017, the Company sold ancillary assets for $221,000 (2016 - $202,000) that resulted in a gain of $194,000 (2016 – gain of $90,000).

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

AKITA and its Joint Ventures' revenue per operating day and AKITA and its Joint Ventures' operating and maintenance expenses per operating day are not recognized GAAP measures under IFRS.  Management and certain investors may find "per operating day" measures for AKITA and Joint Ventures' revenue indicate pricing strength while AKITA and Joint Ventures' 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 can also influence these 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.