News Release

HIGHLIGHTS

 

CEO MESSAGE

Fernando Aguilar, Calfrac's President & Chief Executive Officer commented "Despite volatility in commodity markets and activity levels, Calfrac once again delivered strong results including substantial debt reduction. Though 2018 is behind us, I would like to thank all our employees and their families for a successful year."

During the quarter, Calfrac:

• reported consolidated fourth-quarter revenue and operating income that were 3 percent and 38 percent higher than the comparative quarter in 2017;
• generated $109.5 million of discretionary cash flow, net of $39.2 million of interest paid and capital expenditures of $31.5 million, which was used to reduced borrowings on its credit facility by $75.0 million and increase cash on hand by $34.5 million; and
• announced a 2019 capital budget of $149.0 million which will be focused on supporting the Company's operations as well as the implementation of a new Enterprise Resource Planning (ERP) software system.

 

FOURTH QUARTER 2018 OVERVIEW

In the fourth quarter of 2018, the Company:

• generated revenue of $498.9 million, an increase of 3 percent from the fourth quarter in 2017, resulting primarily from higher activity in Canada and larger job sizes in the United States;
• recorded reactivation costs of $2.9 million compared to $7.4 million in the fourth quarter of 2017;
• reported adjusted EBITDA of $62.9 million versus $49.2 million in the fourth quarter of 2017;
• reported a net loss attributable to shareholders of Calfrac of $3.5 million or $0.02 per share diluted, compared to net income of $38.0 million or $0.26 per share diluted in 2017, which included a $76.3 million property, plant and equipment impairment reversal;
• reported period-end working capital of $329.9 million versus $327.0 million at December 31, 2017; and
• incurred capital expenditures of $31.5 million primarily to support the Company's United States fracturing operations.

 

CONSOLIDATED HIGHLIGHTS

 

Revenue in the fourth quarter of 2018 was $498.9 million, an increase of 3 percent from the same period in 2017. The Company's fracturing job count increased by 1 percent while consolidated revenue per fracturing job increased by only 2 percent. During the quarter, Calfrac pumped approximately 560,000 tons of sand in the United States and 290,000 tons in Canada, representing growth of 15 percent and 33 percent, respectively, from the prior year. However, the larger job sizes were offset by lower pricing and job mix. The number of cementing jobs decreased by 7 percent due to lower cementing activity in northern Argentina.

Pricing in the United States and, to a lesser extent, Canada decreased while pricing in Russia was consistent with the fourth quarter of 2017. In Argentina, the transition to more unconventional activity does not allow for a meaningful pricing comparison to the fourth quarter in 2017 as the type of job is significantly different than conventional activity. Net pricing in Canada was flat to slightly lower versus the comparable quarter as the pricing reductions given in the fourth quarter of 2018 offset all of the pricing gains made during the first three quarter of the year.

Adjusted EBITDA of $62.9 million for the fourth quarter of 2018 increased from $49.2 million in the comparable period in 2017 primarily due to lower total compensation awards being recorded in the fourth quarter of 2018 compared to 2017, combined with higher utilization in Argentina and a larger operating scale in the United States.

Net loss attributable to shareholders of Calfrac was $3.5 million or $0.02 per share diluted compared to income of $38.0 million or $0.26 per share diluted in the same period last year, which included a $76.3 million property, plant and equipment impairment reversal. The net loss in 2018 included a foreign exchange gain of $3.3 million while the fourth quarter of 2017 had a foreign exchange loss of $8.1 million.

 

Revenue in the fourth quarter of 2018 was $498.9 million, a decrease of 21 percent from the third quarter of 2018, primarily due to lower activity in North America and Argentina, and to a lesser extent, lower pricing in Canada. Revenue in the United States and Argentina was higher sequentially due to increased activity and job sizes. Revenue per fracturing job decreased by 4 percent primarily due to job mix in Canada. Average net pricing in Canada and the United States was down slightly on a sequential basis but did not have a significant impact on operating results in the fourth quarter.

In Canada, fourth-quarter revenue decreased by 21 percent from the third quarter to $145.1 million as several of the Company's major customers completed the majority of their 2018 capital programs during the early part of the fourth quarter. Operating income as a percentage of revenue was 11 percent versus 15 percent in the third quarter primarily due to lower equipment utilization.

In the United States, revenue in the fourth quarter of 2018 decreased by 22 percent from the third quarter to $279.3 million, mainly as a result of lower utilization of its active fleets in all of its operating areas. The U.S. division's operating income margin decreased to 18 percent in the fourth quarter from 25 percent in the third quarter of 2018. The weaker results were due to the sharp decline in crude oil prices that occurred during the fourth quarter of 2018 and the resulting decrease in customer completions activity.

In Russia, revenue of $24.9 million in the fourth quarter of 2018 was consistent with the third quarter with a slight increase in fracturing revenue, offset by lower coiled tubing revenue. The operating loss position in the fourth quarter was primarily due to higher operating costs as colder temperatures resulted in a switch to higher cost arctic fuel.

In Argentina, revenue in the fourth quarter of 2018 decreased by 19 percent from the third quarter to $49.6 million, while operating income declined to $4.4 million from $9.4 million in the third quarter. The decline was due to lower activity in Neuquén as the same level of operational efficiencies were not achieved in the fourth quarter due to a lower drilled and uncompleted well inventory.

BUSINESS UPDATE AND OUTLOOK

Calfrac's fourth-quarter results reflect the strength of Calfrac's global platform, impacted by seasonal and market-specific issues at year-end.

CANADA

In Canada, the fourth quarter began with very strong utilization and revenue due, in part, to weather-related delays during the third quarter that deferred activity into October. However, a significant widening of differentials for Canadian light oil and condensate was experienced during the fourth quarter which resulted in the deferral or cancellation of planned completion programs, and consequently, increased pricing pressure throughout the entire industry. In spite of these challenges, Calfrac's Canadian division delivered higher revenue and operating income as compared to the prior year.

At the beginning of 2019, Calfrac made the decision to suspend operations for one fleet in its Canadian division based on weaker demand for fracturing services. The Company expects acceptable utilization on its remaining seven fleets through the balance of the first quarter, but lower pricing relative to 2018 is anticipated to negatively impact operating income. The majority of this recently idled equipment has already been redeployed to support Calfrac's operations in the United States. Recent cold weather and schedule shifts have impacted utilization in February, however activity is projected to recover in March, and prospects for utilization during spring break-up appear to be improving. As always, weather and road bans will ultimately determine how much activity can be serviced in the weeks ahead.

Beyond the first quarter, Calfrac's client base is uncertain as to the scope and timing of their capital spending programs for the remainder of 2019. As such, Calfrac has unusually low visibility into its activity levels beyond spring break-up. The Company will continue to monitor the market and will remain mindful of retaining an industry-leading position in Canada while delivering acceptable financial returns for its stakeholders.

UNITED STATES

The fourth quarter saw a continuation of solid performance from Calfrac's operations in the United States. While budget exhaustion and lower crude oil prices impacted activity and pricing, the Company was able to deliver financial results that were slightly better than the same quarter in 2017. As expected, utilization was lower during the final weeks of the quarter due to normal seasonal patterns as well as budget exhaustion and lower commodity prices. Some pricing pressures were observed but they had limited impact on the reported fourth-quarter financial results.

Thus far in the first quarter, activity has been solid, although recent periods of cold weather have had an impact on operating cadence in North Dakota and Pennsylvania as programs have been paused.

Based on steady rig activity and a growing inventory of drilled but uncompleted wells, the Company's outlook in the United States remains strong as oil takeaway capacity additions in the Permian Basin are expected to increase completion activity in that basin during the second half of the year. Calfrac's strong presence throughout multiple basins in the United States and across several top-tier producers should lead to strong utilization over the short-run, and the Company will monitor producer plans for opportunities to further optimize its operational and financial performance in the United States.

RUSSIA

Calfrac's operations in Russia posted break-even results in the fourth quarter, as weather and client activity levels continued to impede the operation. However, after a successful tender season, the Company expects 2019 operating results to more closely resemble levels seen in 2017.

ARGENTINA

Calfrac's operations in Argentina again delivered strong year-on-year improvement in operating and financial results, due to higher activity and productivity across the operation.

Calfrac's outlook for Argentina in 2019 remains positive, as contracted work volumes are expected to be higher along with further improvements in cost management and productivity. The Company is in the process of transferring some previously idle cementing assets from the United States to further enhance Calfrac's service offering in Argentina.

CORPORATE

Calfrac demonstrated its ability to generate cash and reduce leverage during the fourth quarter, and will remain focused on cash generation in 2019. While uncertainty remains elevated, particularly in Canada, the Company's operating footprint and strategic approach is expected to generate cash in 2019 across a wide range of outcomes, with debt reduction continuing to be the Company's top priority. Calfrac will continue to focus on delivering safe and effective service in the field while bringing innovative ideas around products and logistics that, taken together, will be the catalyst for success for our clients, our employees and our investors.

As announced in December 2018, the Company's Board of Directors approved a 2019 capital budget of $149.0 million, consisting of $126.0 million of maintenance capital, $11.0 million in refurbishment capital and $12.0 million in corporate initiatives, consisting primarily of costs for the implementation of an ERP system in North America and Argentina. In addition, approximately $6.0 million of Calfrac's 2018 budget is forecast to be spent in 2019.

FINANCIAL OVERVIEW – THREE MONTHS ENDED DECEMBER 31, 2018 VERSUS 2017

CANADA

 

REVENUE

Revenue from Calfrac's Canadian operations during the fourth quarter of 2018 was $145.1 million versus $136.8 million in the same period of 2017 primarily due to higher activity, offset partially by lower pricing. In the fourth quarter of 2018, the number of fracturing jobs was 10 percent higher than the comparable period in 2017. In both 2018 and 2017, activity slowed towards the second half of the fourth quarter due to its customers exhausting their full-year capital budgets. In response, Calfrac offered pricing incentives in order to accelerate certain planned first-quarter 2019 projects into November and December, which resulted in slightly lower average pricing in the fourth quarter of 2018 versus the same period in 2017. The number of coiled tubing jobs increased by 7 percent from the fourth quarter in 2017 primarily due to a larger operating scale and a greater focus on the conventional coiled tubing market in western Canada.

OPERATING INCOME

Operating income in Canada during the fourth quarter of 2018 was $16.7 million compared to $14.7 million in the same period of 2017. The increase in operating income was due to lower proppant costs as pricing for sand trended lower towards the end of the third quarter in 2018 as supply improved, the benefit of which was realized during the back half of the fourth quarter. In addition, the $0.4 million decrease in SG&A expenses compared to the fourth quarter in 2017 was primarily due to a full-year bonus accrual being recorded in the fourth quarter of 2017, offset partially by severance costs of $0.3 million that were accrued during the fourth quarter in 2018.

UNITED STATES

 

REVENUE

Revenue from Calfrac's United States operations increased to $279.3 million during the fourth quarter of 2018 from $267.7 million in the comparable quarter of 2017 despite a 5 percent decrease in the number of fracturing jobs completed period-over-period. The sharp decline in crude oil prices that occurred during the fourth quarter in 2018 caused some customers to slow their completions activity during the quarter, with Colorado and Permian-based activity experiencing the largest activity declines. This was partially offset by increased activity in North Dakota and south Texas year-over-year. The decline in activity was more than offset by the 10 percent increase in revenue per job year-over-year due to the impact of job mix as the Company's operations in Texas and New Mexico resulted in the completion of larger overall job sizes. The 4 percent appreciation in the U.S. dollar versus the Canadian dollar also contributed to the increase in revenue.

OPERATING INCOME

The Company's United States operations generated operating income of $51.5 million during the fourth quarter of 2018 compared to $49.5 million in the same period in 2017. The improvement in operating results was primarily due to better utilization in North Dakota and Pennsylvania, offset partially by lower utilization in Artesia and Colorado. Operating results in the fourth quarter of 2018 included $2.9 million of fleet reactivation costs, while $6.0 million was incurred in the comparable quarter in 2017. SG&A expenses decreased by 14 percent in the fourth quarter of 2018 primarily due to a full year bonus accrual recorded in the fourth quarter in 2017.

RUSSIA

 

REVENUE

Revenue from Calfrac's Russian operations decreased by 29 percent during the fourth quarter of 2018 to $24.9 million from $35.0 million in the corresponding three-month period of 2017. The decrease in revenue was attributable to a decrease in fracturing activity in Noyabrsk and Usinsk, offset partially by higher activity in Khanty-Mansiysk. Revenue per fracturing job decreased by 11 percent primarily due to job mix as the Company did not perform any work in Usinsk which typically had significantly larger job sizes. Coiled tubing activity decreased by 33 percent, primarily due to lower utilization than expected with one of its customers. The 9 percent depreciation of the Russian rouble in the fourth quarter of 2018 versus the same period in 2017 also contributed to the decrease in reported revenue.

OPERATING (LOSS) INCOME

The Company's Russian division generated an operating loss of $0.3 million during the fourth quarter of 2018 versus income of $4.0 million in the comparable quarter in 2017. The decrease was primarily due to lower equipment utilization in Noyabrsk combined with the impact of the expiration of its contract in Usinsk at the end of the first quarter in 2018, as this region contributed positively to operating income in 2017. SG&A expenses were $0.4 million lower than the comparable quarter in 2017 due to a lower annual bonus provision.

ARGENTINA

 

REVENUE

Calfrac's Argentinean operations generated total revenue of $49.6 million during the fourth quarter of 2018 versus $46.0 million in the comparable three-month period in 2017. Revenue in Argentina was 8 percent higher than the comparable quarter primarily due to the completion of significantly larger jobs in Neuquén and in southern Argentina. The Company's revenue per job increased by 95 percent in the fourth quarter of 2018, primarily due to a greater proportion of activity in the Vaca Muerta, while job mix in the south also resulted in larger job sizes year-over-year. Coiled tubing revenue in Argentina decreased from the fourth quarter in 2017 as more of the Company's coiled tubing equipment was allocated to unconventional fracturing work. Cementing revenue was relatively consistent with the comparable period in 2017 as lower cementing activity in northern Argentina was offset by increased cementing activity in southern Argentina.

OPERATING INCOME (LOSS)

The Company's operations in Argentina generated operating income of $4.4 million during the fourth quarter of 2018 compared to a loss of $3.1 million during the fourth quarter in 2017. The Company achieved positive operating income through a combination of improved utilization and crew efficiencies during the quarter as it continued to transition to unconventional operations in Argentina. SG&A expenses were 13 percent lower during the fourth quarter in 2018 compared to the fourth quarter in 2017 primarily due to a $0.6 million adjustment to bad debt expense recorded in 2018, offset partially by higher personnel expenses in 2018.

CORPORATE

 

OPERATING LOSS

Corporate expenses for the fourth quarter of 2018 were $10.3 million compared to $20.3 million in the fourth quarter of 2017. Operating expenses were consistent with the comparable quarter in 2017. SG&A expenses decreased by $10.0 million primarily due to a lower share price at the end of 2018 which decreased stock-based compensation expense by $8.5 million versus the same period in 2017. In addition, the fourth quarter in 2017 included a full-year bonus provision resulting in a comparative decrease of $2.3 million in the fourth quarter in 2018.

DEPRECIATION

For the three months ended December 31, 2018, depreciation expense increased by $3.9 million to $40.4 million from $36.5 million in the corresponding quarter of 2017. The increase in depreciation was primarily due to the $76.3 million impairment reversal that was recorded during the fourth quarter of 2017, combined with capital expenditures related to the continued activation of fleets in North America during 2017 and 2018. In addition, the 4 percent appreciation in the U.S. dollar relative to the Canadian dollar resulted in higher reported depreciation during the fourth quarter in 2018. This was offset partially by the impact of fully depreciated assets in Canada which reduced depreciation expense during the quarter.

FOREIGN EXCHANGE GAINS AND LOSSES

The Company recorded a foreign exchange gain of $3.3 million during the fourth quarter of 2018 versus a loss of $8.1 million in the comparative three-month period of 2017. Foreign exchange gains and losses arise primarily from the translation of net monetary assets or liabilities that were held in U.S. dollars in Canada, net monetary assets or liabilities that were held in pesos in Argentina, and liabilities held in Canadian dollars in Russia. The Company's foreign exchange gain for the fourth quarter of 2018 was largely attributable to U.S. dollar-denominated assets held in Canada as the U.S. dollar appreciated against the Canadian dollar during the quarter.

IMPAIRMENT

A comparison of the recoverable amounts of each cash generating unit (CGU) with their respective carrying amounts resulted in no impairment against property, plant and equipment in the fourth quarter of 2018 while in 2017 the same comparison supported an impairment reversal of $76.3 million.

The Company reviews the carrying value of its inventory on an ongoing basis for obsolescence and to verify that the carrying value exceeds the net realizable amount. For the three months ended December 31, 2018, the Company recorded an impairment charge of $4.0 million to write-down inventory to its net realizable amount in Canada and the United States as well as write-off obsolete spare parts inventory in Mexico due to the closure of operations in that country.

INTEREST

The Company's net interest expense of $21.0 million for the fourth quarter of 2018 was consistent with the comparable period of 2017 despite a change in the debt mix. The higher interest rate on its US$650.0 million 8.50 percent senior notes during the fourth quarter compared to its US$600.0 million 7.50 percent senior notes that were repaid during the second quarter of 2018 resulted in an increase in reported interest expense. The stronger U.S. dollar during the fourth quarter in 2018 compared to the same period in 2017 also contributed to the higher reported interest expense related to its senior notes. This was offset by the impact of replacing a portion of its $200.0 million second lien term loan that carried an interest rate of 9.0% with lower interest rate credit facility borrowings.

INCOME TAXES

The Company recorded income tax recovery of $4.6 million during the fourth quarter of 2018 compared to an expense of $14.7 million in the comparable period of 2017. The recovery position was the result of pre-tax losses during the quarter in Canada, the United States and Argentina.

SUMMARY OF QUARTERLY RESULTS

 

SEASONALITY OF OPERATIONS

The Company's North American business is seasonal. The lowest activity is typically experienced during the second quarter of the year when road weight restrictions are in place due to spring break-up weather conditions and access to well sites in Canada and North Dakota is reduced.

FOREIGN EXCHANGE FLUCTUATIONS

The Company's consolidated financial statements are reported in Canadian dollars. Accordingly, the quarterly results are directly affected by fluctuations in the exchange rates for United States, Russian and Argentinean currency.

FINANCIAL OVERVIEW – YEARS ENDED DECEMBER 31, 2018 VERSUS 2017

CANADA

 

REVENUE

Revenue from Calfrac's Canadian operations in 2018 was $650.7 million versus $540.1 million in 2017. Completions activity in Canada improved during 2018  when compared to 2017 primarily due to a stronger first half of the year. The number of fracturing and coiled tubing jobs increased by 16 percent and 11 percent, respectively, due to a larger operating scale, combined with a more active and efficient customer base as compared to the same period in 2017. Revenue per fracturing job increased by 4 percent from the prior year while coiled tubing revenue per job was up 3 percent, primarily due to higher pricing during the first half of 2018 and the completion of larger jobs, which were offset partially by job mix.

OPERATING INCOME

The Company's Canadian division generated operating income of $87.2 million during 2018 compared to $84.7 million in 2017. The increase was due to improved utilization and better pricing during the first six months of 2018 compared to the same period in 2017, while second half utilization was lower year-over-year. The 13 percent operating income margin was negatively impacted by higher than expected third-party sand transportation costs during the first quarter, while higher costs for diesel fuel and products reduced operating income margins during the second quarter. Pricing for proppant trended lower towards the end of 2018 as supply improved, however, this lower pricing did not meaningfully impact profitability until the fourth quarter. Operating income in 2018 was negatively impacted by $1.4 million of provincial sales tax assessments in British Columbia and $0.3 million in severance costs. The $3.4 million increase in SG&A expenses compared to 2017 was primarily due to the reinstatement of compensation that was scaled back during 2016, combined with the Company allocating a greater proportion of its corporate SG&A costs that directly related to its operating divisions during 2018.

UNITED STATES

 

REVENUE

Revenue from Calfrac's United States operations increased to $1.3 billion in 2018 from $713.5 million in 2017 primarily due to significantly higher fracturing activity and improved pricing in 2018. Completions activity in the United States significantly improved year-over-year, which allowed the Company to reactivate equipment throughout 2017 and 2018, including the start-up of operations in Texas and New Mexico. The Company activated a 17^th fleet in the United States during the third quarter of 2018, representing the full reactivation of its entire operating fleet, although not all fleets were fully utilized during the fourth quarter. The result was a 35 percent increase in the number of fracturing jobs completed year-over-year. Activity was significantly higher in all operating areas with the exception of Colorado. Revenue per job increased 36 percent due to improved pricing combined with the impact of job mix as the Company's operations in Texas resulted in larger overall job sizes.

OPERATING INCOME

The Company's United States division generated operating income of $262.3 million in 2018 compared to $121.8 million in 2017. The significant increase was primarily the result of improved utilization and pricing in North Dakota and Pennsylvania as well as the addition of operations in Texas and New Mexico that did not commence until the third quarter of 2017. The operating income of 20 percent during 2018 was negatively impacted by market-driven logistical issues that resulted in higher than normal transportation and sand costs during the first three months of the year. These conditions abated during the second quarter; however, cost inflation continued, with products and fuel experiencing the largest increases. The third quarter saw a reversal of this trend with sand and transportation costs trending lower, however, most of these savings were passed through to customers and had little impact on profitability. Operating results included $12.9 million of reactivation costs in 2018 compared to $20.4 million in 2017. SG&A expenses increased by 43 percent in 2018 primarily due to higher personnel costs combined with growth in business scale and increased activity.

RUSSIA

 

REVENUE

Revenue from Calfrac's Russian operations in 2018 decreased by 14 percent to $106.8 million from $124.0 million in 2017. The decrease in revenue, which is generated in roubles, was partially related to lower fracturing activity, combined with the 7 percent depreciation of the Russian rouble in 2018 versus 2017. Revenue per fracturing job was consistent with the comparable period in 2017. The decrease in revenue was also due to a 12 percent reduction in coiled tubing activity.

OPERATING (LOSS) INCOME

The Company's Russia division incurred an operating loss of $0.4 million in 2018 compared to income of $13.4 million in the same period in 2017 primarily due to lower fracturing and coiled tubing crew utilization. Calfrac's operations in 2018 were impacted by weather-related delays and lower activity with one of its customers in Western Siberia. The Company shut down its operations in Usinsk following the expiry of its contract in that area at the end of the first quarter and reallocated equipment to Noyabrsk. Activity in Noyabrsk in 2018 was negatively impacted by production cuts resulting from Russia's cooperation with OPEC members during the year.

ARGENTINA

 

REVENUE

Calfrac's Argentinean operations generated total revenue of $202.2 million in 2018 versus $150.2 million in 2017. The 35 percent improvement in year-over-year revenue was primarily due to higher fracturing activity in the Vaca Muerta shale play. The increase in fracturing revenue was partially offset by lower cementing activity in northern Argentina combined with the impact of union strikes in southern Argentina that occurred during the first quarter of 2018. Coiled tubing revenue in Argentina increased year-over-year due to increased activity in unconventional resource plays in Neuquén, which also resulted in higher revenue per job.

OPERATING INCOME (LOSS)

The Company's operations in Argentina generated operating income of $12.8 million in 2018 compared to a loss of $3.1 million in 2017. The Company has continued to improve its operating margins throughout the transition to unconventional operations in Argentina mainly due to improved utilization. There were a number of one-time costs recorded in 2018, including $0.8 million in restructuring charges and a $0.4 million adjustment to bad debt expense. Similarly, the Company had $1.6 million in one-time costs in 2017 related to the retrofitting of equipment and $0.7 million of restructuring costs.

CORPORATE

 

OPERATING LOSS

Corporate expenses in 2018 were $50.1 million compared to $36.7 million in the comparable period in 2017. Operating expenses were $1.7 million higher primarily due to higher personnel costs during the year. SG&A expenses increased by $11.7 million primarily due to a $6.5 million increase in stock-based compensation expense. The remaining increase related to the reinstatement of compensation that was scaled back during 2016, offset partially by the higher allocation of costs that were directly attributed to the Company's operating divisions.

DEPRECIATION

Depreciation expense in 2018 increased by $29.5 million to $160.3 million from $130.8 million in 2017. The increase in depreciation was primarily due to the $76.3 million impairment reversal that was recorded during the fourth quarter of 2017, combined with capital expenditures related to the continued activation of fleets in North America during 2017 and 2018.

FOREIGN EXCHANGE LOSSES

The Company recorded a foreign exchange loss of $38.0 million in 2018 versus a loss of $34.3 million in 2017. Foreign exchange gains and losses arise primarily from the translation of net monetary assets or liabilities that were held in U.S. dollars in Canada and Argentina, net monetary assets or liabilities that were held in pesos in Argentina, and liabilities held in Canadian dollars in Russia. The Company's foreign exchange loss in 2018 was largely attributable to the translation of U.S. dollar-denominated liabilities held in Argentina during the first six months of 2018 as the peso devalued against the U.S. dollar during that time period. As disclosed in note 2 to the consolidated financial statements, the Company changed the functional currency of its Argentina subsidiary from Argentinean pesos to U.S. dollars effective July 1, 2018, which resulted in no further foreign exchange losses on its U.S. dollar-denominated liabilities held in Argentina in the last six months of the year. The consolidated foreign exchange loss was partially offset by a foreign exchange gain on U.S. dollar-denominated assets held in Canada.

IMPAIRMENT

A comparison of the recoverable amounts of each CGU with their respective carrying amounts resulted in no impairment against property, plant and equipment in 2018 while in 2017 the same comparison supported an impairment reversal of $76.3 million.

The Company reviews the carrying value of its inventory on an ongoing basis for obsolescence and to verify that the carrying value exceeds the net realizable amount. For the year ended December 31, 2018, the Company recorded an impairment charge of $7.2 million to write-down inventory to its net realizable amount in Canada, United States and Argentina as well as write-off obsolete spare parts inventory in Mexico due to the closure of operations in that country.

INTEREST

The Company's interest expense was $106.6 million in 2018 versus $85.5 million in 2017. The $21.1 million increase was partially due to the repayment of the Company's second lien term loan during the period which resulted in the write-off of the remaining deferred financing costs of $5.8 million. In addition, the Company closed a private offering of US$650.0 million aggregate principal amount of 8.50 percent senior notes during the second quarter, which were used to repay all of its outstanding 7.50 percent senior notes due 2020. The early repayment of these notes resulted in a make-whole interest payment of $10.4 million during the second quarter in 2018 and the write-off of the remaining $5.0 million unamortized deferred finance costs.

INCOME TAXES

The Company recorded an income tax recovery of $4.6 million in 2018 compared to a recovery of $7.7 million in 2017. The mix of earnings, combined with certain items that do not fluctuate with income, resulted in the recovery position.

 

LIQUIDITY AND CAPITAL RESOURCES

 

OPERATING ACTIVITIES

The Company's cash provided by operating activities for the year ended December 31, 2018 was $184.7 million versus cash used of $13.9 million during 2017. The significant increase in cash provided by operations was primarily due to improved operating results in the United States while working capital required $13.6 million of cash in 2018 compared to $117.2 million in 2017. At December 31, 2018, Calfrac's working capital was $329.9 million compared to $327.0 million at December 31, 2017.

FINANCING ACTIVITIES

Net cash used by financing activities for the year ended December 31, 2018 was $58.1 million compared to net cash provided by financing activities of $49.8 million in 2017. During the year ended December 31, 2018, the Company received net funds from the issuance of senior notes of $822.1 million, had net borrowings under its credit facilities of $90.0 million (net of $5.0 million of debt issuance costs), proceeds of $1.4 million from the issuance of common shares, repaid senior notes totalling $773.8 million and made principal payments under its term loan of $197.0 million.

On May 31, 2018, the Company repaid in full the remaining $196.5 million principal amount of its second lien senior secured term loan facility with Alberta Investment Management Corporation (AIMCo). The term loan, which had a maturity date of September 20, 2020 provided Calfrac the right to prepay the loan prior to June 10, 2018 with a nominal prepayment premium.

On May 30, 2018, Calfrac closed a private offering of US$650.0 million aggregate principal amount of its 8.50 percent senior notes due 2026. Fixed interest on the notes is payable on June 15 and December 15 of each year. The notes will mature on June 15, 2026. The Company used a portion of the net proceeds from the offering of the notes to repay all of its outstanding 7.50 percent senior notes due 2020.

On May 9, 2018, Calfrac amended its credit facilities to exercise $100.0 million of accordion capacity which increased its total facility capacity from $275.0 million to $375.0 million. The facilities consist of an operating facility of $27.5 million and a syndicated facility of $347.5 million. The Company's credit facilities mature on June 1, 2020 and can be extended by one or more years at the Company's request and lenders' acceptance. The Company also may prepay principal without penalty. The interest rates are based on the parameters of certain bank covenants. For prime-based loans and U.S. base-rate loans, the rate ranges from prime or U.S. base rate plus 0.50 percent to prime plus 2.50 percent. For LIBOR-based loans and bankers' acceptance-based loans, the margin thereon ranges from 1.50 percent to 3.50 percent above the respective base rates. The remaining accordion feature of the syndicated facility was reduced to $100.0 million, and is available to the Company during the term of the agreement. The Company incurs interest at the high end of the ranges outlined above if its net Total Debt to Adjusted EBITDA ratio is above 4.00:1.00. Additionally, in the event that the Company's net Total Debt to Adjusted EBITDA ratio is above 5.00:1.00, certain restrictions would apply including the following: (a) acquisitions will be subject to majority lender consent; (b) distributions will be restricted other than those relating to the Company's share unit plans, and no increase in the rate of dividends will be permitted; and (c) the Company will be prohibited from utilizing advances under the credit facilities to redeem or repay subordinated debt. As at December 31, 2018, the Company's net Total Debt to Adjusted EBITDA ratio was 2.92:1.00.

Advances under the credit facilities are limited by a borrowing base. The borrowing base is calculated based on the following:

 

As at December 31, 2018,  the Company had used $0.9 million of its credit facilities for letters of credit and had $120.0 million of borrowings under its credit facilities, leaving $254.1 million in available capacity under its credit facilities. As described above, the Company's credit facilities are subject to a monthly borrowing base, as determined using the previous month's results, which at December 31, 2018 was higher than the available capacity.

The Company's credit facilities contain certain financial covenants as shown below.

 

Proceeds from equity offerings may be applied, as an equity cure, in the calculation of Adjusted EBITDA towards the Funded Debt to Adjusted EBITDA covenant for any of the quarters ending prior to and including June 30, 2020, subject to certain conditions including:

 

The September 2017 amendments to the credit facilities provided that the Company can utilize two equity cures during the term of the credit facilities subject to the conditions described above. To utilize an equity cure, the Company must provide notice of any such election to the lending syndicate at any time prior to the filing of its quarterly financial statements for the applicable quarter on SEDAR. Amounts used as an equity cure prior to June 30, 2020 will increase Adjusted EBITDA over the relevant twelve-month rolling period and will also serve to reduce Funded Debt.

As shown in the table below, at December 31, 2018, the Company was in compliance with the financial covenants associated with its credit facilities.

 

The Company's credit facilities also require majority lender consent for dispositions of property or assets in Canada and the United States if the aggregate market value exceeds $20.0 million. There are no restrictions pertaining to dispositions of property or assets outside of Canada and the United States, except that to the extent that advances under the credit facilities exceed $50.0 million at the time of any such dispositions, Calfrac must use the resulting proceeds to reduce the advances to less than $50.0 million before using the balance for other purposes.

The indenture governing the senior unsecured notes, which is available on SEDAR, contains restrictions on the Company's ability to pay dividends, purchase and redeem shares of the Company and make certain restricted investments, that are not defined as Permitted Investments under the indenture, in circumstances where:

 

These limitations on restricted payments are tempered by the existence of a number of exceptions to the general prohibition, including a basket allowing for restricted payments in an aggregate amount of up to US$20.0 million. As at December 31, 2018 this basket was not utilized. The indenture also restricts the ability to incur additional indebtedness if the Fixed Charge Coverage Ratio determined on a pro forma basis for the most recently ended four fiscal quarter period for which internal financial statements are available is not at least 2:1. As is the case with restricted payments, there are a number of exceptions to this prohibition on the incurrence of additional indebtedness, including the incurrence of additional debt under credit facilities up to the greater of $375.0 million or 30 percent of the Company's consolidated tangible assets.

As at December 31, 2018, the Company's Fixed Charge Coverage Ratio of 3.86:1 was higher than the required 2:1 ratio so the aforementioned prohibitions will not be applicable as long as the Company remains above this ratio.

INVESTING ACTIVITIES

Calfrac's net cash used for investing activities was $149.8 million for the year ended December 31, 2018 versus $76.0 million in 2017. Cash outflows relating to capital expenditures were $157.2 million in 2018 compared to $86.4 million in 2017. Capital expenditures were primarily to support the Company's North American fracturing operations. The Company disposed of assets in 2018 for proceeds of $7.4 million compared to $10.5 million in 2017.

As announced in December 2018, Calfrac's Board of Directors have approved a capital budget of $149.0 million, which includes $126.0 million of maintenance capital, $11.0 million of refurbishment capital and $12.0 million related to corporate initiatives. In addition, approximately $6.0 million remaining from Calfrac's 2018 capital program is expected to be spent in 2019.

EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS

The effect of changes in foreign exchange rates on the Company's cash and cash equivalents during the year ended December 31, 2018 was a gain of $22.3 million versus a loss of $17.1 million in 2017. These gains and losses relate to movements of cash and cash equivalents held by the Company in a foreign currency during the period.

With its working capital position, available credit facilities and anticipated funds provided by operations, the Company expects to have adequate resources to fund its financial obligations and planned capital expenditures for 2019 and beyond.

At December 31, 2018, the Company had cash and cash equivalents of $51.9 million.

OUTSTANDING SHARE DATA

The Company is authorized to issue an unlimited number of common shares. Employees have been granted both performance share units as well as options to purchase common shares under the Company's shareholder-approved equity compensation plans. The number of shares reserved for issuance under the performance share unit plan and stock option plan is equal to 10 percent of the Company's issued and outstanding common shares. As at February 27, 2019, the Company had issued and outstanding 144,573,047 common shares, 209,851 equity-based performance share units and 10,667,545 options to purchase common shares.

ADVISORIES

FORWARD-LOOKING STATEMENTS

In order to provide Calfrac shareholders and potential investors with information regarding the Company and its subsidiaries, including management's assessment of Calfrac's plans and future operations, certain statements contained in this press release, including statements that contain words such as "seek", "anticipate", "plan", "continue", "estimate", "expect", "may", "will", "project", "predict", "potential", "targeting", "intend", "could", "might", "should", "believe", "forecast" or similar words suggesting future outcomes, are forward-looking statements.

In particular, forward-looking statements in this press release include, but are not limited to, statements with respect to expected operating strategies and targets, capital expenditure programs, future financial resources, anticipated equipment utilization levels, future oil and natural gas well activity in each of the Company's operating jurisdictions, results of acquisitions, the impact of environmental regulations and economic reforms and sanctions on the Company's business, future costs or potential liabilities, projections of market prices and costs, supply and demand for oilfield services, expectations regarding the Company's ability to maintain its competitive position, anticipated benefits of the Company's competitive position, expectations regarding the Company's financing activities and restrictions, including with regard to its credit agreement and the indenture pursuant to which its senior notes were issued, and its ability to raise capital, treatment under government regulatory regimes, commodity prices, anticipated outcomes of specific events (including exposure under existing legal proceedings), expectations regarding trends in, and the growth prospects of, the global oil and natural gas industry, the Company's growth strategy and prospects, and the impact of changes in accounting policies and standards on the Company and its financial statements. These statements are derived from certain assumptions and analyses made by the Company based on its experience and perception of historical trends, current conditions, expected future developments and other factors that it believes are appropriate in the circumstances, including, but not limited to, the economic and political environment in which the Company operates, the Company's expectations for its current and prospective customers' capital budgets and geographical areas of focus, the Company's existing contracts and the status of current negotiations with key customers and suppliers,  the effect unconventional gas projects have had on supply and demand fundamentals for natural gas and the likelihood that the current tax and regulatory regime will remain substantially unchanged.

Forward-looking statements are subject to a number of known and unknown risks and uncertainties that could cause actual results to differ materially from the Company's expectations. Such risk factors include: excess oilfield equipment levels; regional competition; the availability of capital on satisfactory terms; restrictions resulting from compliance with debt covenants and risk of acceleration of indebtedness; direct and indirect exposure to volatile credit markets, including credit rating risk; currency exchange rate risk; risks associated with foreign operations; operating restrictions and compliance costs associated with legislative and regulatory initiatives relating to hydraulic fracturing and the protection of workers and the environment; changes in legislation and the regulatory environment; dependence on, and concentration of, major customers; liabilities and risks, including environmental liabilities and risks, inherent in oil and natural gas operations; uncertainties in weather and temperature affecting the duration of the service periods and the activities that can be completed; liabilities and risks associated with prior operations; failure to maintain the Company's safety standards and record; failure to realize anticipated benefits of acquisitions and dispositions; the ability to integrate technological advances and match advances from competitors; intellectual property risks; sourcing, pricing and availability of raw materials, component parts, equipment, suppliers, facilities and skilled personnel; and the effect of accounting pronouncements issued periodically. Further information about these and other risks and uncertainties may be found under "Business Risks" below.

Consequently, all of the forward-looking statements made in this press release are qualified by these cautionary statements and there can be no assurance that actual results or developments anticipated by the Company will be realized, or that they will have the expected consequences or effects on the Company or its business or operations. These statements speak only as of the respective date of this press release or the document incorporated by reference herein. The Company assumes no obligation to update publicly any such forward-looking statements, whether as a result of new information, future events or otherwise, except as required pursuant to applicable securities laws.

BUSINESS RISKS

The business of Calfrac is subject to certain risks and uncertainties. Prior to making any investment decision regarding Calfrac, investors should carefully consider, among other things, the risk factors set forth in the Company's most recently filed Annual Information Form, which are specifically incorporated by reference herein. The Annual Information Form is available through the Internet on the Canadian System for Electronic Document Analysis and Retrieval (SEDAR), which can be accessed at www.sedar.com. Copies of the Annual Information Form may also be obtained on request without charge from Calfrac at 411 - 8th Avenue S.W., Calgary, Alberta, Canada, T2P 1E3, or at www.calfrac.com, or by facsimile at 403-266-7381.

NON-GAAP MEASURES

Certain supplementary measures presented in this press release do not have any standardized meaning under IFRS and, because IFRS have been incorporated as Canadian generally accepted accounting principles (GAAP), these supplementary measures are also non-GAAP measures. These measures have been described and presented in order to provide shareholders and potential investors with additional information regarding the Company's financial results, liquidity and ability to generate funds to finance its operations. These measures may not be comparable to similar measures presented by other entities, and are explained below.

Operating income (loss) is defined as net income (loss) before depreciation, foreign exchange gains or losses, gains or losses on disposal of property, plant and equipment, impairment of inventory, impairment of property, plant and equipment, interest, and income taxes. Management believes that operating income is a useful supplemental measure as it provides an indication of the financial results generated by Calfrac's business segments prior to consideration of how these segments are financed or taxed. In addition, management believes this measure allows investors to more accurately compare the Company's performance with its peers by providing an indication of its financial results prior to consideration of the age or size of its asset base, or the investment and accounting policies associated with its assets. Operating income (loss) for the period was calculated as follows:

 

Adjusted EBITDA is defined in the Company's credit facilities for covenant purposes as net income or loss for the period adjusted for interest, income taxes, depreciation and amortization, unrealized foreign exchange losses (gains), non-cash stock-based compensation, non-controlling interest, and gains and losses that are extraordinary or non-recurring. Adjusted EBITDA is presented because it is used in the calculation of the Company's bank covenants. Adjusted EBITDA for the period was calculated as follows:

 

 

ADDITIONAL INFORMATION

Further information regarding Calfrac Well Services Ltd., including the most recently filed Annual Information Form, can be accessed on the Company's website at www.calfrac.com or under the Company's public filings found at www.sedar.com.

FOURTH QUARTER CONFERENCE CALL

Calfrac will be conducting a conference call for interested analysts, brokers, investors and news media representatives to review its 2018 fourth-quarter results at 10:00 a.m. (Mountain Time) on Thursday, February 28, 2019. The conference call dial-in number is 1-888-231-8191 or 647-427-7450. The seven-day replay numbers are 1-855-859-2056 or 416-849-0833 (once connected, enter 9367823). A webcast of the conference call may be accessed via the Company's website at www.calfrac.com.

CONSOLIDATED BALANCE SHEETS

 

CONSOLIDATED STATEMENTS OF OPERATIONS 

 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME

 

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

As at and for the years ended December 31, 2018 and 2017

(Amounts in text and tables are in thousands of Canadian dollars, except share data and certain other exceptions as indicated)

1.  INVENTORIES

 

For the year ended December 31, 2018, the cost of inventories recognized as an expense and included in cost of sales was approximately $830,000 (year ended December 31, 2017 – $560,000).

The Company reviews the carrying value of its inventory on an ongoing basis for obsolescence and to verify that the carrying value exceeds the net realizable amount. For the year ended December 31, 2018, the Company recorded an impairment charge of $7,167 to write-down inventory to its net realizable amount in Canada, United States and Argentina as well as write-off obsolete spare parts inventory in Mexico due to the closure of operations in that country (year ended December 31, 2017 – $nil).

 

2.  PROPERTY, PLANT AND EQUIPMENT

 

 

 

 

 

 

 

Property, plant and equipment are tested for impairment in accordance with the Company's accounting policy. The Company reviews the carrying value of its property, plant and equipment at each reporting period for indicators of impairment. The decrease in crude oil prices during the fourth quarter of 2018 combined with the impact of significant oil and natural gas differentials in Canada which are expected to affect completion activity and pricing in Canada were an indicator of impairment and the Company estimated the recoverable amount of its property, plant and equipment.

The Company's CGUs are determined to be at the country level, consisting of Canada, the United States, Russia and Argentina.

The recoverable amount of property, plant and equipment was determined using the value in use method, based on multi-year discounted cash flows to be generated from the continuing operations of each CGU. Cash flow assumptions were based on a combination of historical and expected future results, using the following main key assumptions:

• Commodity price forecasts
• Expected revenue growth
• Expected operating income growth
• Discount rate

 

The main commodity price assumptions over the forecast periods were:

• WTI Crude Oil (US$/bbl) increased from $60 in 2019 to $73 in 2023
• Henry Hub Gas (US$/mmBtu) increased from $3.03 in 2019 to $3.68 in 2023
• AECO Gas (C$/mcf) increased from $1.85 in 2019 to $3.21 in 2023

 

Revenue and operating income growth rates for each CGU were based on a combination of commodity price assumptions, historical results and forecasted activity levels, which incorporated pricing, utilization and cost improvements over the period. The revenue and operating income cumulative annual growth rates (CAGR) over the forecast period from 2019 to 2023, by CGU, are outlined below:

 

The cash flows were prepared on a five-year basis, using a discount rate ranging from 13.1 percent to 21.2 percent depending on the CGU. Discount rates are derived from the Company's weighted average cost of capital, adjusted for risk factors specific to each CGU. Cash flows beyond that five-year period have been extrapolated using a steady 2.0 percent growth rate.

 

A comparison of the recoverable amounts of each cash-generating unit with their respective carrying amounts resulted in no impairment against property, plant and equipment for the year ended December 31, 2018 (year ended December 31, 2017 – reversal of impairment $76,296). The Company's 2017 year end impairment test supported the reversal of the impairment loss that was previously recorded in the United States CGU, after taking into account normal depreciation that would have been charged if no impairment had occurred.

A sensitivity analysis on the discount rate and expected future cash flows would have the following impact:

 

Assumptions that are valid at the time of preparing the impairment test at December 31, 2018 may change significantly when new information becomes available. The Company will continue to monitor and update its assumptions and estimates with respect to property, plant and equipment impairment on an ongoing basis.

3.  LONG-TERM DEBT

 

The fair value of the senior unsecured notes, as measured based on the closing quoted market price at December 31, 2018, was $661,492 (December 31, 2017 – $743,111). The carrying value of the revolving term loan facility approximates its fair value as the interest rate is not significantly different from current interest rates for similar loans.

On May 30, 2018, the Company closed a private offering of US$650,000 aggregate principal amount of its 8.50 percent senior notes due 2026. Fixed interest on the notes is payable on June 15 and December 15 of each year. The notes will mature on June 15, 2026, and provide the Company with the option to redeem up to 10% of the aggregate principal amount of the notes at a redemption price of 108.50% of the principal amount with the proceeds of asset sales at any time prior to December 15, 2019. The Company used a portion of the net proceeds from the offering of the notes to repay all of its outstanding 7.50 percent senior notes due 2020. The early repayment of these notes resulted in a make-whole interest payment of $10,403 and the write-off of the remaining $5,023 unamortized deferred finance costs.

On May 31, 2018, the Company repaid in full the remaining $196,500 principal amount of its second lien senior secured term loan facility. The term loan, which had a maturity date of September 30, 2020, provided the Company the right to prepay the loan prior to June 10, 2018 with a nominal prepayment premium. The repayment of the second lien senior secured term loan facility resulted in the write-off of the remaining unamortized deferred finance costs of $5,787.

On May 9, 2018, the Company amended its credit facilities to exercise $100,000 of accordion capacity, bringing the total facilities from $275,000 to $375,000. The facilities consist of an operating facility of $27,500 and a revolving term loan facility of $347,500. The Company's credit facilities mature on June 1, 2020 and can be extended by one or more years at the Company's request and lenders' acceptance. The Company also may prepay principal without penalty. The interest rates are based on the parameters of certain bank covenants. For prime-based loans and U.S. base-rate loans, the rate ranges from prime or U.S. base rate plus 0.50 percent to prime plus 2.50 percent. For LIBOR-based loans and bankers' acceptance-based loans, the margin thereon ranges from 1.50 percent to 3.50 percent above the respective base rates. The accordion feature of the revolving term loan facility was reduced to $100,000, and is available to the Company during the term of the agreement. The Company incurs interest at the high end of the ranges outlined above if its net Total Debt to Adjusted EBITDA ratio is above 4.00:1.00. Additionally, in the event that the Company's net Total Debt to Adjusted EBITDA ratio is above 5.00:1.00, certain restrictions would apply including the following: (a) acquisitions will be subject to majority lender consent; (b) distributions will be restricted other than those relating to the Company's share unit plans; and (c) the Company will be prohibited from utilizing advances under the credit facilities to redeem or repay subordinated debt. As at December 31, 2018, the Company's net Total Debt to Adjusted EBITDA ratio was 2.92:1.00.

Debt issuance costs related to this facility are amortized over its term.

Interest on long-term debt (including the amortization of debt issuance costs and debt discount) for the year ended December 31, 2018 was $106,940 (year ended December 31, 2017 – $85,520).

The following table sets out an analysis of long-term debt and the movements in long-term debt for the periods presented:

 

The aggregate scheduled principal repayments required in each of the next five years are as follows:

 

At December 31, 2018, the Company had utilized $887 of its loan facility for letters of credit and had $120,000 outstanding under its revolving term loan facility, leaving $254,113 in available credit, subject to a monthly borrowing base, as determined using the previous month's results, which at December 31, 2018 resulted in a liquidity amount that was higher than the available capacity.

See note 6 for further details on the covenants in respect of the Company's long-term debt.

4.  CAPITAL STOCK

Authorized capital stock consists of an unlimited number of common shares.

 

The weighted average number of common shares outstanding for the year ended December 31, 2018 was 144,041,910 basic and 146,828,943 diluted (year ended December 31, 2017 – 137,663,943 basic and 139,461,872 diluted). The difference between basic and diluted shares is attributable to the dilutive effect of stock options and warrants issued by the Company as disclosed in note 5, and the shares to be issued.

5.  SHARE-BASED PAYMENTS

(a)     Stock Options

 

The weighted average share price at the date of exercise for stock options exercised during 2018 was $7.01 (2017 – $4.76).

 

Stock options vest equally over three to four years and expire five years from the date of grant. When stock options are exercised, the proceeds together with the compensation expense previously recorded in contributed surplus, are added to capital stock.

The weighted average fair value of options granted during 2018, determined using the Black-Scholes valuation method, was $2.55 per option (year ended December 31, 2017 – $2.11 per option). The Company applied the following assumptions in determining the fair value of options on the date of grant:

 

Expected volatility is estimated by considering historical average share price volatility.

(b)     Share Units

 

 

Stock-based compensation expense is included in selling, general and administrative expenses.

The Company grants deferred share units to its outside directors. These units vest in November of the year of grant and are settled either in cash (equal to the market value of the underlying shares at the time of exercise) or in Company shares purchased on the open market. The fair value of the deferred share units is recognized equally over the vesting period, based on the current market price of the Company's shares. At December 31, 2018, the liability pertaining to deferred share units was $354 (December 31, 2017 – $867).

The Company grants performance share units to a senior officer. The amount of the grants earned is linked to corporate performance and the grants vest on the approval of the Board of Directors at the meeting held to approve the consolidated financial statements for the year in respect of which performance is being evaluated. As with the deferred share units, performance share units are settled either in cash or Company shares purchased on the open market. At December 31, 2018, the liability pertaining to performance share units was $761 (December 31, 2017 – $1,389).

In 2018, the Company expanded its performance share unit plan to its employees. These performance share units contain a cash-based component and an equity-based component. The cash-based component vests over three years based on corporate financial performance thresholds and are settled either in cash (equal to the market value of the underlying shares at the time of vesting) or in Company shares purchased on the open market. The equity-based component vests over three years without any further conditions and are settled in treasury shares issued by the Company. At December 31, 2018, the liability pertaining to the cash-based component of performance share units was $200 (December 31, 2017 – $nil).

Prior to 2018, the Company granted restricted share units to its employees. These units vest over three years and are settled either in cash (equal to the market value of the underlying shares at the time of exercise) or in Company shares purchased on the open market. The fair value of the restricted share units is recognized over the vesting period, based on the current market price of the Company's shares. At December 31, 2018, the liability pertaining to restricted share units was $3,158 (December 31, 2017 – $5,096).

Changes in the Company's obligations under the deferred, performance and restricted share unit plans, which arise from fluctuations in the market value of the Company's shares underlying these compensation programs, are recorded as the share value changes.

(c)     Warrants

In conjunction with the second lien senior secured term loan facility as disclosed in note 3, 6,934,776 warrants to purchase common shares of the Company were issued during 2016, entitling the holder to acquire up to 6,934,776 common shares at a price of $4.14 per common share. On November 6, 2017, all the warrants were exercised, for total proceeds of $28,709.

6.  CAPITAL STRUCTURE

The Company's capital structure is comprised of shareholders' equity and debt. The Company's objectives in managing capital are (i) to maintain flexibility so as to preserve its access to capital markets and its ability to meet its financial obligations, and (ii) to finance growth, including potential acquisitions.

The Company manages its capital structure and makes adjustments in light of changing market conditions and new opportunities, while remaining cognizant of the cyclical nature of the oilfield services sector. To maintain or adjust its capital structure, the Company may revise its capital spending, adjust dividends, if any, paid to shareholders, issue new shares or new debt or repay existing debt.

The Company monitors its capital structure and financing requirements using, amongst other parameters, the ratio of net debt to operating income. Operating income for this purpose is calculated on a 12-month trailing basis and is defined as follows:

 

Net debt for this purpose is calculated as follows:

 

The ratio of net debt to operating income does not have a standardized meaning under IFRS and may not be comparable to similar measures used by other companies.

At December 31, 2018, the net debt to operating income ratio was 3.01:1 (December 31, 2017 – 5.05:1) calculated on a 12-month trailing basis as follows:

 

The Company is subject to certain financial covenants relating to working capital, leverage and the generation of cash flow in respect of its operating and revolving credit facilities. These covenants are monitored on a monthly basis. At December 31, 2018 and December 31, 2017, the Company was in compliance with its covenants with respect to its credit facilities.

 

 

 

 

Adjusted EBITDA is defined in the Company's credit facilities for covenant purposes as net income or loss for the period adjusted for interest, income taxes, depreciation and amortization, unrealized foreign exchange losses (gains), non-cash stock-based compensation, non-controlling interest, and gains and losses that are extraordinary or non-recurring. Adjusted EBITDA is presented because it is used in the calculation of the Company's bank covenants. Adjusted EBITDA for the period was calculated as follows:

 

 

 

 

Advances under the credit facilities are limited by a borrowing base. The borrowing base is calculated based on the following:

 

The indenture governing the senior unsecured notes contains restrictions on the Company's ability to pay dividends, purchase and redeem shares of the Company, and make certain restricted investments in circumstances where

 

 

 

 

These limitations on restricted payments are tempered by the existence of a number of exceptions to the general prohibition, including a basket allowing for restricted payments in an aggregate amount of up to US$20,000. As at December 31, 2018, this basket was not utilized.

The indenture also restricts the incurrence of additional indebtedness if the Fixed Charge Coverage Ratio determined on a pro forma basis for the most recently ended four fiscal quarter period for which internal financial statements are available is not at least 2:1. As is the case with restricted payments, there are a number of exceptions to this prohibition on the incurrence of additional indebtedness, including the incurrence of additional debt under credit facilities up to the greater of $375,000 or 30 percent of the Company's consolidated tangible assets.

As at December 31, 2018, the Company's Fixed Charge Coverage Ratio of 3.86:1 was higher than the required 2:1 ratio and the aforementioned prohibitions will not be applicable as long as the Company remains above this ratio.

The Company has measures in place to ensure that it has sufficient liquidity to navigate the cyclical nature of the oilfield services sector and safeguard the Company's ability to continue as a going concern. The Company negotiated amendments to its credit facilities to provide increased financial flexibility. These amendments include an "Equity Cure" feature pursuant to which proceeds from equity offerings may be applied as both an adjustment in the calculation of Adjusted EBITDA and as a reduction of Funded Debt towards the Funded Debt to Adjusted EBITDA ratio covenant for any of the quarters ending prior to and including June 30, 2020, subject to certain conditions including:

 

In addition, to the extent that proceeds from an equity offering are used as part of the Equity Cure, such proceeds are included in the calculation of the Company's borrowing base.

On April 3, 2017, the Company elected to use the first of its two fully-funded $25,000 equity cures effective as of the quarter ending on June 30, 2017. On April 30, 2018, the remaining $25,000 was removed from the segregated account without being designated as an equity cure.

7.  CONTINGENCIES

GREEK LITIGATION

As a result of the acquisition and amalgamation with Denison in 2004, the Company assumed certain legal obligations relating to Denison's Greek operations.

In 1998, North Aegean Petroleum Company E.P.E. ("NAPC"), a Greek subsidiary of a consortium in which Denison participated (and which is now a majority-owned subsidiary of the Company), terminated employees in Greece as a result of the cessation of its oil and natural gas operations in that country. Several groups of former employees filed claims against NAPC and the consortium alleging that their termination was invalid and that their severance pay was improperly determined.

In 1999, the largest group of plaintiffs received a ruling from the Athens Court of First Instance that their termination was invalid and that salaries in arrears amounting to approximately $10,689 (6,846 euros) plus interest were due to the former employees. This decision was appealed to the Athens Court of Appeal, which allowed the appeal in 2001 and annulled the above-mentioned decision of the Athens Court of First Instance. The said group of former employees filed an appeal with the Supreme Court of Greece, which was heard on May 29, 2007. The Supreme Court of Greece allowed the appeal and sent the matter back to the Athens Court of Appeal for the consideration of the quantum of awardable salaries in arrears. On June 3, 2008, the Athens Court of Appeal rejected NAPC's appeal and reinstated the award of the Athens Court of First Instance, which decision was further appealed to the Supreme Court of Greece. The matter was heard on April 20, 2010 and a decision rejecting such appeal was rendered in June 2010. As a result of Denison's participation in the consortium that was named in the lawsuit, the Company has been served with three separate payment orders, one on March 24, 2015 and two others on December 29, 2015. The Company was also served with an enforcement order on November 23, 2015.  Oppositions have been filed on behalf of the Company in respect of each of these orders which oppose the orders on the basis that they were improperly issued and are barred from a statute of limitations perspective. The salaries in arrears sought to be recovered through these orders are part of the $10,689 (6,846 euros) cited above and the interest being sought in respect of these orders is part of the $28,365 (18,168 euros) cited below. Provisional orders granting a temporary suspension of any enforcement proceedings have been granted in respect of all of the orders that have been served. The order served on March 24, 2015 was heard on November 24, 2015 and a decision was issued on November 25, 2016 accepting the Company's opposition on the basis that no lawful service of Judgment No 4528/2008 had taken place until the filing of the opponents' petition and/or the issuance of the payment order. The plaintiffs have filed an appeal against the above decision which was heard on October 16, 2018 and a decision in respect of this appeal is currently pending. A hearing in respect of the order served on November 23, 2015 took place on October 31, 2018 and a decision in respect of such order is currently pending. A hearing in respect of the orders served in December of 2015 scheduled for September 20, 2016 was adjourned until November 21, 2016 and two decisions were issued on January 9, 2017 accepting the Company's oppositions on a statute of limitations basis. The plaintiffs filed appeals against the above decisions which were heard on October 16, 2018 and decisions in respect of such appeals are pending.

NAPC is also the subject of a claim for approximately $4,468 (2,862 euros) plus associated penalties and interest from the Greek social security agency for social security obligations associated with the salaries in arrears that are the subject of the above-mentioned decision.

The maximum aggregate interest and penalties payable under the claims noted above, as well as three other immaterial claims against NAPC totaling $902 (578 euros), amounted to $28,365 (18,168 euros) as at December 31, 2018.

Management is of the view that it is improbable there will be a material financial impact to the Company as a result of these claims. Consequently, no provision has been recorded in these consolidated financial statements.

8.  SEGMENTED INFORMATION

The Company's activities are conducted in four geographical segments: Canada, the United States, Russia and Argentina. All activities are related to hydraulic fracturing, coiled tubing, cementing and other well completion services for the oil and natural gas industry.

The business segments presented reflect the Company's management structure and the way its management reviews business performance. The Company evaluates the performance of its operating segments primarily based on operating income, as defined below.

 

 

 

 

 

 

 

 

Operating income does not have a standardized meaning under IFRS and may not be comparable to similar measures used by other companies.

 

SOURCE Calfrac Well Services Ltd.