Tom Simons - President, CEO Craig Nieboer - CFO

Jason Sawatzky - AltaCorp Capital Steve Kammermayer - Clarus Securities Bhakti Pavani - Euro Pacific Capital

Good morning, ladies and gentlemen. Welcome to the Canadian Energy Services and Technology Corporation Conference Call and Webcast with respect to the recently announced results for the first quarter ended March 31, 2015. Presenting for the company today will be Mr. Tom Simons, President and Chief Executive Officer and Mr. Craig Nieboer, Chief Financial Officer. Please be advised this call is being recorded. A question-and-answer session will follow at the end of the presentation. I would now like to turn the conference over to Mr. Craig Nieboer, Chief Financial Officer of Canadian Energy Services and Technology Corporation. Please go ahead Mr. Nieboer.

Thank you. Good morning everyone and thanks for attending the call. Before we start, I would like to note that in our commentary today, there will be forward-looking financial information and that our actual results may differ materially from the expected results due to various risk factors and assumptions. These risk factors and assumptions are summarized in our Q1 MD&A, our Q1 press release and our recently filed annual information form dated March 12, 2015. In addition, certain financial measures that we will refer to today are not recognized under current generally-accepted accounting policies and for a description and definition of these, please see our Q1 MD&A. At this time, I will turn it over to Tom Simons.

Good morning. Thank you, Craig. We would like to thank callers for calling in for our Q1 call. What we are going to do is provide an operations update, I will do that. We are going to talk a little bit about a little bit of additional capital expansion plans that we are going to pull the trigger on this year and why and we will give some financial information and then answer your questions. I'm going to start with the drilling side of our business. Down in the States today we are running about 85 jobs probably more importantly it looks like we are bottoming out there. We could see we believe as many rigs starting to hit the pending, or about to go back to work in the next couple of month's list as rigs that are expected to go down. So we think maybe we go as low as 75 maybe even 70 jobs, but we maybe able to keep it above 80 depending how customers react to oil pricing today. We remained very active in the Eagle Ford. We remained active in the Northeast U.S. And we remained active in the Permian. I would like to highlight that in the Permian, we have added some new customers over the last year because of some new technology we brought to the company a year-and-a-half ago through a royalty arrangement with an inventor for people that know us a bit, the mud terminology is MMH, it's a water-based fluid that we have had a lot of repeatable success working for one of the major drilling horizontals. It's allowed them to drop a string of intermediate casing in West Texas, which is ringing the bell for them because it makes the well cheaper to drill. Like to add that we are also drilling horizontal section of those wells with our clay free invert, so its polymer that we can degasify or thicken the oil base mud with the absence of the clay allows it to drill faster and we can achieve a little bit superior hydraulics or better hole cleaning. We see some room as people put rigs back to work in the areas where this has application. We see some room to take some work from our competitors with that technology. It's a good remainder to us that we constantly need to be bringing new ideas to customers to stay a step ahead of our competitors. On the Canadian side, we are sneaking up on 25 jobs today, Q2 has been very slow for us and I would imagine all service companies in Canada. We think that we are going to be able to retain our share of the Canadian market in Q3, Q4, which is roughly a third, might be a little better, might be a little bores depending on which customers go back to work. We can see our way too running as many as maybe 75 jobs in Q3 – things line up for us, but we understand that the drilling guys may think that we are coming up in management may not actually pull the trigger on that at our customers. To achieve those numbers, we need there to be decent activity in the Bakken and we need people to continue to drill the Montney and Duvernay and other west to five and six plays that you are hearing customers talk about. We don't think it will be spectacular. But, we do think it's going to allow us to make money. And maybe as importantly long-term it allows us to keep our team in tact, so that when there is a recovery, we got the experts in place that can help us win and retain the business that we want to be able to do. I will move over to the production specialty chemical side of the business. PureChem and JACAM continue to take market share. It's kind of a life saver for our business when we look back 2, 3 years as people know us and know our story 4 or 5 years ago coming out of 2008 and 2009. We recognized that we needed to get vertically integrated to defend this large retail mud business we had built in Canada over the previous decade. That's what led us to become a manufacturer and supplier of chemistry to our customers at the well-head. We are selling out to frac companies and happy to add increasingly selling the pipelines. And I will go into some detail on that. We see a lot of upside for PureChem and JACAM in the next couple of years, obviously, the more the production grows for North America, the better that macro environment is for us and people in our business. We see significant upside because of consolidation by Halliburton, Baker. We think that's going to create opportunity for us. We see new problems developing out of formations that are just starting to be multi-stage fracs that presents an opportunity to solve problems, user scientific capabilities, which is probably a bit segue to where we are going to spend some additional CapEx. We committed to ourselves and to shareholders that we are going to constrain CapEx unless we have got something. That's a clear line of sight to new business or something that's so strategic in nature and maybe only available when that we need to act. We think we got a line of sight to new business for PureChem and JACAM that is why we are going to create R&D lab capabilities in Calgary, in Houston and service lab capabilities in Midland. We could scare 10 million dollars Canadian putting those together. We think that helps us hold what we have. We think it helps between what's based out of Kansas today for R&D and what we think we can do with centers in Calgary and Houston where we think we can attract top talent. We think those three places together can continue to allow us to bring new products to market and importantly solve regional problems. In Calgary, we need to focus on shower production, we need to focus on corrosion; in Midland for service we need to focus on water and paraffin problems. In Houston, there will be of course a host of projects that we can work on, importantly we think that we can find the talent that can get us the outcome we need under JACAM and Dave Orton in Calgary sort of guidance and supervision. So that's something that we are going to start acting on. We have already got space leased in Calgary. In Houston, it can just be an expansion of our mud lab. And in Midland, we are going to place the lab on land that we already own and finished and kind of have put the brakes on upgrading as the stock point for mud. But, we are going to go ahead and finish putting a lab in there. So really it's the cost of the building and the equipment. We have the personnel inside the company that [no other duty things] [ph]. On an operation side, for JACAM, we are continuing as I said to grow market share discounting that we started a couple of months ago has helped us retain the clients that we have in JACAM, we haven't had any significant losses based on price or anything operational, so happy to report that we kept the clients that we built the business with. We have had some very nice new wins in West Texas on production chemicals. To remind people the stuff doesn't come on over night like a drilling rig where you mix $10,000 a day a product. The incumbent their products on location that product needs to be consumed and then we come in and we start applying our chemistry and our people start servicing the well-head. So in the coming months we will start to see growth both in sales and contribution of profit in West Texas for new business that has been awarded. We have also had some really wins just in the last week or two on pipelines. We have been able to problem solve for some midstream operators. These R&D E&P companies, they are big pipeline companies that were winning businesses from, starting about two years ago, we built a technical team to pursue the midstream market and that's now starting to pay us back with significant new business. And that is very recurring business, so it's a nice win. Also happy to report that frac sales are starting to come back, they are smaller than they were say through Q3, Q4, but certainly better than the zero that we had from the middle of February to the end of March. So we think that our frac customers probably depleted floor inventory we would call it, but they had on hand. And now that they are seeing some activity from their customer they are prepared to step-in inventory, but it makes sense to us that they wouldn't buy product from us when the talk amongst all the people in the financial world was nobody is completing anything they are drilling. So I think if you are a provider to that space you probably want to [skin down] [ph] inventory. So that is making a contribution, it's not as good as it was. But eventually all these wells will need to be completed and we think we will have a part in that. In Canada, most important thing to report about PureChem is the recruitment of some really good people. We have had significant new talent join us that is helping us grow our market share. We are winning business with the help of those folks. We have had a very nice win in this SAGD market just recently that's kind of a milestone for us last summer as people may know we acquired a small company specifically to get their technology that's allowed us to enter the H2S scavenging market there. We got business on a wider sort of spectrum of chemical treatments now in this SAGD market with this new customer. And we think that's going to be hopefully a sign of things to come for us. Just like in the U.S., we see a lot of upside with consolidation of our competitors. Baker has done a really nice job over the years of building a good culture in their chemical company. Not a lot of people left that group. We think there maybe some opportunity to find some people that don't have a place there through this consolidation or beside that they don't want to be there. So we like our chances to find people. We also think out of that consolidation there is going to be some customers looking for other options. The Canadian market to us looks like two really big guys owning the whole market with us chasing them down, we like that position that's part of why we are in – increase our lab capabilities in Calgary, and of course, for people that don't know we do have full service capabilities in Carlyle where we manufacture the products and can provide some service support out of Calgary where we have a mud lab today. On sort of update on the state of the industry for our business, we believe that our downsizing is complete. We may rationalize a few warehouses in the U.S. where we don't have enough activity out of a certain stock point. And we can just normalize some trucking save some money on overhead. But in general, we see more upside in activity even downside coming down the pipe at these oil prices. Of course, if prices go the other way, then we will be able to react and rationalize things that we need to. But, the message that we have given our people is, where we think we need to be, we are going to ask you to trust us. We are probably going to ask you to keep doing a little more for a little less. But, that's what it's going to take to retain this business. We think that when a recovery happens keeping our people is critical. These are experts we have invested a lot in building the team that we have. So for us the success of our business in the future isn't that we do this with a whole lot less people, it's that we do with a people we have and then continue to build a bigger team of scientists around it. And people that can either apply the chemical or sell it or invoice it or work in labs to refine new products. We think that we have significant organic opportunities in a recovery environment. We are certainly though looking at other ways to accelerate growth of the business. I will add for people's benefit that when we went through this in 2008, 2009, we were a small company just drilling fluids just Canadian-based. We were just trying to survive. We had PE firms trying to privatize us we sure had no PE firms shopping their investments to us. So I can't say that we knew this would be coming. But, what we are seeing is we are getting opportunities to look at ways that maybe we can expand sales channels for the company. We are very confident that we can grow this business materially in the next three to five years organically. So we would only act on something that we really like. We don't know if we will do that. But, it's nice to be in a position to be able to look at stuff, Craig is going to give everyone a financial update, but, I will take a little bit of your thunder Craig and let people know that we are totally out of our line right now. The drawdown in working capital really does happen for an inventory business. So we have a fabulous balance sheet, I think savvy owners of companies can see that maybe were a nice place to park something and then ride the price of oil back up with us. But, we are only going to act on things that we are very confident that one and one becomes three because we can get there on our own without issuing any more stock. So wanted to give people an update on that. And then I think I will turn it over to Craig.

Thanks Tom. I'm going to start off by – just highlighting that – as you saw in the press release we added new Director yesterday, a gentleman named Phil Scherman, a highly respected individual in the Calgary business community. He is on the Board currently of Mullen Group and Parallel Energy Trust as well. He is a chartered accountant with an illustrious 30-year career at KPMG, so we are very fortunate to add him to the Board. It's a reflection of the continued expansion in growth and the complexity of our business and we look forward to working with Phil over the years to come. So welcome Phil. As far as the quarter goes pretty reasonable quarter I think in light of the extreme industry conditions that we are under. Revenue was relatively flat year-over-year, Q1 to Q1 at $233.8 million versus $231.3 million from the previous year. It's detailed in the MD&A, but really it's a result of JACAM and PureChem continuing to grow in the market. AES drilling fluids was relatively flat quarter-to-quarter despite a slowdown in drilling activity and that's really based on some of the high grading of our – the work by our customers as the wells have been longer – deeper wells to work on, which were better revenue per day wells for us. Obviously, for AES Q2 saw a continued fall-off in rig count, so the ability to stay flat year-over-year for AES obviously is not possible in this declining rig count in Q2, but, very impressive results for them in Q1 in light of industry conditions. And then Canadian drilling fluids nowhere to hide, nowhere to run down it was with respect to the overall rig count. And as Tom mentioned, we should be long and deep break up. But, we are positioned to take advantage of things as that break up turns around just don't know exactly when that is. And then the other advantage to our earnings is our U.S. dollar-based revenue, obviously 2/3rds or almost 70% of our business is in the United States and when we get to translate those dollars at the favorable exchange, which also reminds people that our key obligations of interest and dividend are Canadian dollar denominated which is a natural hedge in these downturns as the Canadian dollar tends to weaken when oil prices weaken. As a result of all that, EBITDAC was slightly down year-over-year of $41 million versus $43.5 million, but once again, I think very reasonable results in light of very tough industry conditions. As Tom alluded to our balance sheet is in great shape and thanks to the combination of positive Q1 results and as Tom mentioned the other natural hedge in being a CapEx like absorbable chemical model being the return of working capital to the balance sheet. As Tom was talking about the draw on our operating line is positive, net positive today. We were $36 million drawn at March 31, we reported the MD&A $5 million drawn at April 30. We are now in positive territory. We will probably stay in that positive territory through most of Q2 and then as the ramp up hopefully of activity in the back half of the year takes place, we will probably enter the line again and to buy inventory and to sell and turn it into EBITDA obviously. Just to highlight as well, our obligations within analyst expectations, and I know we haven't given guidance so I will use the analyst expectations today on EBITDA ranging between $106 million and $130 million for 2015. We are fully funded on our dividend. Our dividend this year would be $72 million cash. Our cash interest cost or $25 million and our maintain CapEx is expected to be 6. So we have $103 million worth of obligations that are fully funded by the range of EBITDA expected by analyst this year. And we are very comfortable to say that the dividend is very dependable in this environment. Obviously, the commodity prices went – [for us sales] [ph] from here that may change but in the current commodity price environment activity level we are very confident that dividend is dependable and sustainable. As Tom mentioned the CapEx $35 million of expansion CapEx is committed to this year, Tom mentioned some of the projects that have been added. This essentially is funded them through a combination of EBITDA that we will generate this year. And the return of working capital which net-net during the year is going to be in the range of $60 million. I will also highlight due to our financial structuring, at the low-end of the analyst range is our cash taxes this year will be almost zero. At the high-end, they might approach $10 million, so once again, that obligation is covered by the earnings we think we are going to generate this year. At this time, I will turn it over to callers for questions.

[Operator Instructions] Your first question comes from the line of Jason Sawatzky with AltaCorp Capital. Your line is open.

Hey, good morning, guys.

Hi, Jason.

Tom, just to start off the pricing side, I guess, just wondering if you could maybe just quantify the pricing discounts that you experienced in Q1, maybe on both the drilling fluid side and on the production chemical side.

Well, we have stated this before, somewhere in the range of 5% to 7% on the actual consumable product. I think it's really important for people to understand that a typical drilling fluid invoice about 40%, 45% of it is the consumable about 40% or 45% is the refined oil that we turn into drilling fluids, so we change the viscosity, chemistry, density and then measure it 50 ways to Sunday while it's pumped down the drill pipe to clean the hole out. That stuff is just a pass through for us that base oil has come way off in price, the other sort of 10% of the invoice is service so that's people on location. By discounting that amount and then you add in the 25% or 30% drop maybe even a little more depending what oil you use, you shake that up, the customers invoice is down north of 10%, maybe even approaching 20% depending the ratios of each unit sold. The cost per drilling fluids for customers has come down in the range that they are reporting to the street services have come off. There just isn't that room to given on the consumable where cost plus business, I think it actually benefits us that we are public and it's transparent. But, that's the range. My call Jason on pricing is, I think that there will be a lag on commodity price recovery to sort of drilling completion activity. I think that could take 6 months and then I believe there will also be a lag on services getting pricing discounts off the books and back to sort of pre-collapsed pricing maybe as long as another 6 months. If I'm an operator, I'm going to hold this service guy down as long as I can. So we expect that to happen anything that's a little better than that is upside for us, but that would be my personal expectation on how this kind of plays out.

Okay, great. And then on the production chemical side, I think you still sort of in that 5% to 10% pricing reductions, is that fair to say?

In the States, in Canada all of our businesses sold new that it sort of priced in the context of the – call it spot price.

Okay.

So that hasn't really had a place in Canada like the SAGD business we just won that's brand new work. So pricing is today's pricing. But, in the States that's the range 10 might be a little high. But, we have certainly done with the customer needed, which was to give them a break and what's in it for us as we keep the work.

Yes. Okay. Okay. And then, you sort of touched on this, but now that you are seeing the fracing related chemical sales increase again here in Q2. The anticipated wave of sales demand here just given the backlog of uncompleted wells that we heard about in the U.S. as against 3,000 to 50,000 wells now that the oil price has come up a bit. Do you think you see a wave of sales?

No. I don't. I want to be clear that we are not back to sort of say Q4 levels in that side of our business, but from the middle of February to the end of March, it was virtually zero. So we are more than zero, but we are a lot less than what was going on. And I think you just look at the public reporting by some of the big independence. Guys are leaving 100s of wells uncompleted. I'm not as alarmed by this frac log as others all along to me there is a couple of well spread between the drilling rig and the frac spread. So if you cancel out 1800 rigs drilling in the States shouldn't there always be a couple of thousand uncompleted well bores just because of logistics. So the idea that this 4000 number is going to drive the price of oil back down, I could see a little wave of new production coming, but I think a lot of that is just the natural spread. But, we don't expect a tidal wave of frac product; if it comes we can make it. But, I don't think that's happening.

Okay, great. And then just finally in the U.S., was their rights still a bottleneck in the Permian with the reduced activity. And do you think, I know you are getting close to getting that facility in Corpus Christi done, will that – once that facility is done, in late Q3, do you expect to see any increase in activity?

I'm glad you asked that, I forgot to touch on [indiscernible] in our update. We are still on track to have that place finished by the end of summer. And there is no – we don't have a bottleneck any more, there is not enough rigs running for supply of that stuff to be sort of at risk. But, what will help us is our cost of goods will improve and it will improve the most in the Eagle Ford and Permian which is two of our three hot markets, if I – can a service guy say there is a hot market probably not. But, those are places that we are still busy. So that will be a nice help for those markets. And if the Permian's where things recover because people can get oil to markets because people have done enough work in the last couple of years to figure out where they want to drill, how they want to complete that will be a very nice tool, if the Permian is a market that goes back up.

Right, right. Okay, great. Thanks. That's it for me.

Your next question comes from the line of Steve Kammermayer with Clarus Securities. Your line is open.

Oh, thanks guys. You touched on this in your opening remarks about winning new customers in the U.S. with new technologies. I'm just wondering, customers are a little more reluctant now to try new fluid providers during this downturn. Typically speaking with what they know or are you seeing a willingness of them to try the new products to reduce their costs?

On the drilling side Steve, they don't have any work to give you to try new ideas. But, it's anecdotal, but in both markets Canada and the U.S., people are very open to hearing about ideas from service companies. I'm not sure they would risk the next drilling dollar to try something unproven. But, one example of our MMH system in West Texas, we have got six rigs running there 24/7. So as people go back to work in that sort of geographic pocket, they don't have to try something new and hope that we knew what we are talking about and it works out. So I like our chances to do that. To me, new stuff can be sold as long as there is some proven results for the customer. If all your results just didn't allow I think forget it. You got to wait until the customers got enough work going that they are prepared to risk something. So I don't think you will see unproven frac techniques or drilling techniques happen until prices are better. On the production side, people are all over problem solving, feel people in the customers operations, they are under instructions to not let wells go down under any circumstance and get operating cost down. So if you can bring something to the party that you can show the offsetting acreage owner is using the success, yes, you can win new business right now.

Okay. And then maybe just sticking with the production side, here so, you mentioned that in the press release anyway that you are looking to gain penetration there through the existing AES platform. You mentioned before you might look to acquisitions to sort of speed that growth. But, in your comments here it seems like that might be a little further off the table, is that a fair comment?

I guess, what I'm hoping to do is, sort of emphasize that we may not need to do anything. We have massive unused reporting Kansas to react chemistry. We have got the ability to finish it. So to blend it and turn it into a finished product in Canada. We have got that in West Texas as well. We can make what people need to buy our nitrile hydrogenation quaternization processes in Kansas continue to get moved ahead will be live but nitrile probably by the end of this quarter. We don't need to buy capabilities necessarily in manufacturing but we would look at sales channels. Most value to us will be treating production or treating pipelines and then the next thing sort of by order of value would be a way to accelerate selling to fracing. To me the value of that is kind of like a drilling business, you should expect that it's up and down. And it seems like maybe every few years you might have a bit of a bust because we all oversupply the market. So we want people to know we are looking. We want people who have stuff that maybe they want to put into something to know we are here to look at stuff. But, we don't need it, so we will only act, if we are really confident that what we get will go up later.

Great. Thanks. That's all I had guys.

[Operator Instructions] Your next question comes from the line of Bhakti Pavani with Euro Pacific Capital. Your line is open.

Good morning, guys.

Good morning.

Just kind of curious to know in your prepared remarks you did mention about opening up the lab facilities in Calgary, Houston and Midland. Was just kind of curious to know the lab that you are planning to open, what kind of opportunities are you seeing and how big of the opportunity is for you guys to open three labs and how soon do you think you can get returns on the investments?

Well, I don't know if I can give you a financial sort of return on investment analysis, but in the Canadian market third-party estimates are that the production specialty chemical market is something a touch over $1 billion a year. So for us, the upside for PureChem to take 5% or 10% of the market is massive. And in the U.S. that market is – orders higher, we need a lab in Midland to service the work that we either already have or in the process of being awarded. And in Houston, we don't necessarily – we have the capabilities to do the R&D in Kansas, but we think that we can attract more talent out of a bigger oil field center like Houston; we already have a very significant lab there for our drilling business. So what we are going to do is just expand the size of that lab and then add some more scientists and there would be equipment there that's more specific to production and drilling chemistry. But, the upside in it is massive and the spend on those three probably doesn't exceed $10 million.

Also, the problem solving that you mentioned, could you maybe elaborate on the problems that you are referring to?

Yes. We are finding economic ways for customers to deal with H2S. We are finding economic ways for customers to deal with corrosion, with paraffin problems, the new business we want in the oil sands is around solving emulsion problems. So it's things of that nature.

Okay. And also you did mention that you have one award in the pipeline business, was just kind of wondering, do you at this point given the current condition, what kind of opportunities are you seeing, and how do you think – you can maybe grab more market share or win more business in the pipeline or in the midstream market.

Two years ago, we built a technical team to pursue that market when we acquired JACAM one of our observations was that JACAM had corrosion control chemistry that we felt had been undersold, I think that's part of why JACAM wanted to put their business with our business. They saw that we had a bigger sort of [reach] into more customers across a bigger geographic market. And that's being sort of a plan that worked out for us. We brought in people that are experts, in pipelines we have trained them to our science and then we’ve continued to work on other products to consult problems. We had our new win around solving an H2S problem for someone in a pipeline. So it's – each account – each situation is unique which is why we think it's money well spent on these labs that's why a business like ours needs to invest in people that – ask guys out in the frontline bring the problem into the scientist and we solve it. The scientist doesn't work in isolation come up with a molecule and then hope that someone can sell it. It's the other way around. I hope that answers your question.

Yes. Just one more, if you have to quantify today in a percentage term, how big of the midstream market would account to your total sales?

We don't segregate those numbers. And we don't plan the start. I'm sorry.

No worries. Okay. That's it from my side. Thank you very much.

[Operator Instructions] There are no further questions at this time. I will turn the call back over to Mr. Tom Simons for closing remarks.

Well, we would like to thank people for calling. And then probably a little more importantly, we want to thank our customers for sticking with us through this we understand that you guys are getting pinched. We are going to be there as your partner, when it's down. And we hope that you take us along for the ride when it goes back up and to our employees, thanks for trusting us. We’ve had to make some tough choices, have to let some quality people go. We hope to be able to bring those people back. But, for the people that are here, we think that our plans are going to work. And we think we are going to act on opportunity and improve your opportunities as our employees. And with that, I will wrap up the call and say thank you.

This concludes today's conference call. You may now disconnect.