AKITA Drilling Ltd. Announces Year-to-Date Earnings and Cash Flow

CALGARY, July 27, 2018 /CNW/ - AKITA Drilling Ltd.'s net loss for the three months ended June 30, 2018, was $2,959,000 (net loss of $0.16 per share basic & diluted) on revenue of $17,293,000 compared to a net loss of $4,491,000 (net loss of $0.25 per share basic & diluted) on revenue of $17,986,000 for the corresponding period of 2017. Funds flow from operations decreased to $1,638,000 in the second quarter of 2018 from $3,254,000 in the corresponding period of 2017.

AKITA incurred a net loss of $4,870,000 for the six months ended June 30, 2018 ($0.27 per share basic & diluted) on revenue of $44,382,000 compared to a net loss of $9,466,000 ($0.53 per share basic & diluted) on revenue of $37,179,000 in the comparative period in 2017. Funds flow from operations for the January to June period of 2018 was $6,157,000 compared to $5,078,000 for the same period in 2017.

The second quarter of 2018 was less active for AKITA than the corresponding period of 2017 due to several of the Company's customers delaying rig reactivations as natural gas prices continue to fall and take away capacity for Canadian oil remains uncertain. In the United States, AKITA added a third rig to its US fleet at the end of the quarter, as demand in the US for quality equipment and operations continues to increase. AKITA's strong first quarter improved the year to date results in 2018 for both net income and funds flow when compared to the first half of 2017.

On June 4, 2018, AKITA and Xtreme Drilling Corp ("Xtreme") agreed to enter into a plan of arrangement to combine their respective businesses to create a leading intermediate North American land drilling contractor. Under the plan of arrangement, Xtreme shareholders will receive 0.3732394 of a Class A Non-Voting share of AKITA or $2.65 in cash for each Xtreme share. An Xtreme shareholder may elect to receive AKITA Non-Voting Class A shares, cash or a combination of AKITA Non-Voting Class A shares and cash such that the aggregate consideration to be paid by AKITA will not exceed $45,000,000 and will not exceed 22,235,458 Class A Non-Voting shares. The combined company will effectively double the market capitalization of each company on its own as well as double the drilling assets on a net book value basis. Both AKITA and Xtreme view this combination as highly complementary, the companies are like-sized, operate in different geographical segments for different customers and have a strong focus on safety and customer satisfaction. The transaction has received unanimous board approval from both companies and is subject to shareholder approval, as well as customary TSX, Court and regulatory approvals and other closing conditions, and is expected to be completed in the third quarter of 2018.

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

Introduction and General Overview

Activity levels in the contract drilling industry are highly correlated to the market prices of crude oil and natural gas. The average West Texas Intermediate crude oil prices for the second quarter of 2018 increased 41% compared to the same period in 2017. However, the impact of higher oil prices was offset by two factors. The first is that average natural gas prices for the second quarter of 2018, per Alberta Energy Company ("AECO") spot prices, have decreased by 58% compared to the second quarter of 2017. The second is the uncertainty around the takeaway capacity of oil in the Canadian market which is causing Canadian producers to delay capital spending or shift spending to other opportunities. This delay in capital spending resulted in decreased activity for AKITA in Canada when comparing the second quarter of 2018 to the second quarter of 2017.

The impact of lower activity levels for AKITA in Canada was offset somewhat by increased day rates in Canada, as well as higher utilization in the United States ("US") for AKITA's US rigs.

Historically, the first quarter of the calendar year is the most active in the Canadian drilling industry.  Lower activity levels that result from spring break-up and associated road bans on public roads typically characterize the second quarter. In the second quarter of 2018, breakup conditions persisted longer than average which also had an impact on activity levels.   

Fleet and Rig Utilization  

AKITA had 28 drilling rigs at June 30, 2018, including five that operated under joint ventures (26.75 net to AKITA), the same as at June 30, 2017. During the second quarter of 2018, a third rig was moved to the US leaving 25 rigs in Canada.

Generally, AKITA meets or exceeds industry average rig utilization rates as a result of positive customer relations, meaningful joint ventures with Aboriginal and First Nations partners, employee expertise, safety performance, drilling performance and because the majority of the Company's rig fleet are high-demand pad drilling rigs.

The decline in utilization in Canada for AKITA was mainly attributable to more rigs shutting down over break-up in the second quarter of 2018 compared to the same period in 2017. In the US, AKITA's third rig was moved late in the second quarter which negatively impacted utilization as the rig did not operate. Excluding the third rig that was moving, US utilization was 75%.

Revenue and Operating & Maintenance Expenses

Second Quarter Comparatives

During the second quarter of 2018, revenue decreased slightly to $17,293,000 from $17,986,000 due to fewer operating days worked by the Company's drilling rigs. The impact of this decrease in activity was offset by higher day rates which increased revenue per day to $30,722 from $27,142 in the second quarter of 2017. Day rates in the Canadian market are continuing a slow recovery which began in the fourth quarter of 2017. Also contributing to the increase in revenue per day is the US where day rates are typically higher than in Canada.

Operating and maintenance expenses are directly related to operating days and amounted to $12,087,000 ($22,224 per operating day for AKITA including joint ventures) during the second quarter of 2018, compared to $14,632,000 ($21,434 per operating day for AKITA including joint ventures) during the same period of the prior year.  The decrease in operating and maintenance expense is due to fewer operating days in the second quarter of 2018 compared to the second quarter of 2017.

Year-to-Date Comparatives

During the first six months of 2018, revenue increased to $44,382,000 from $37,179,000 during the first six months of 2017 as a result of higher revenue per day, which increased to $29,863 in the first half of 2018 from $26,748 in the same period of 2017. In addition, the increased revenue per operating day was impacted by the mix of rigs AKITA operated in the first quarter of 2018. Pad triple drilling rigs, which generally demand higher day rates than other conventional drilling rigs, achieved more operating days in the first quarter of 2018 compared to the same period of 2017. 

Operating and maintenance costs are tied to operating days and amounted to $32,477,000 ($21,986 per operating day) during the first six months of 2018 compared to $32,367,000 ($22,039 per operating day) in the same period of the prior year.  The decrease per operating day is a result of higher maintenance costs due to more rigs starting up in the first half of 2017 compared to the same period in 2018.

Depreciation and Amortization Expense                                                             

Depreciation and amortization expense decreased to $5,487,000 during the second quarter of 2018 from $7,735,000 during the corresponding period in 2017, primarily due to an asset write-down and asset impairment loss recorded in the fourth quarter of 2017, which reduced the Company's depreciable property by $29,123,000. This asset write-down and asset impairment loss also affected the depreciation and amortization expense for the first six months of 2018 which decreased to $11,413,000 compared to $14,471,000 for the corresponding period in 2017.

On January 1, 2018, AKITA changed its depreciation method to a straight-line calculation from a unit-of-production basis on drilling rig assets. The rationale for this change was to have rig depreciation more closely match the new lifecycle of rigs. Drilling technology is a critical component of modern drilling rigs and drilling rigs' useful lives are reduced as new technologies are utilized for modern drilling programs. As a result, the passage of time plays a more significant role than operating days in determining a drilling rig's life. Accordingly, the straight-line depreciation method matches the new lifecycle more accurately than the unit-of-production depreciation method.  The estimate effect of the change in depreciation method on the Company's interim financial statements for the first quarter of 2018 is not material.  In the first six months of 2018, drilling rig depreciation accounted for 97% of total depreciation expense (2017 - 97%). 

While AKITA conducts some of its drilling operations via joint ventures, the drilling rigs used to conduct those activities are owned jointly by AKITA and its joint venture partners, and not by the joint ventures themselves.  As the joint ventures do not hold any property, plant, or equipment assets directly, the Company's depreciation expense includes depreciation on assets involved in both wholly-owned and joint venture activities.

Selling and Administrative Expenses

Selling and administrative expenses increased to $8,561,000 for the first six months of 2018 from $7,387,000 for the same period of 2017 due to costs relating to AKITA's US operations as well as costs associated with the proposed business combination with Xtreme Drilling (see the future outlook section of this MD&A for detail on the Xtreme Drilling transaction). Selling and administrative expenses were 19% of revenue in the first six months of 2018 compared to 20% of revenue in the first six months of 2017. The single largest component of selling and administrative expenses is salaries and benefits, which accounted for 46% of these expenses (2017 - 47%). 

Equity Income from Joint Ventures

The Company provides the same drilling services and utilizes the same management, financial and reporting controls for its joint venture activities as are in place for its wholly-owned operations. The decrease in equity income from joint ventures in both the second quarter of 2018 and year to date 2018, when compared to the respective periods in 2017, is directly attributable to activity. In the second quarter of 2018 activity for AKITA's joint venture rigs dropped by 42% with 172 operating days in the second quarter of 2018, compared to 297 in the second quarter of 2017. The drop relates to a pause in capital spending by oilsands producers that are assessing their capital programs for the balance of the year and into 2019.

Other Income (Loss)

Total other income (loss) is the aggregate of interest income, interest expense, gain (loss) on sale of assets, and net other gains (losses) all of which are discussed below in detail.

Interest income decreased to $40,000 in the first half of 2018 from $231,000 in the same period of 2017. The decrease is related to the collection of the interest-bearing long-term receivable held related to contract cancellation revenue recorded in 2016. This long term receivable was collected over three years with the final payment received in the first quarter of 2018.

In the first half of 2018, the Company incurred interest expense of $85,000 on the Company's line of credit (2017 – nil), and $84,000 for the future cost of the Company's defined benefit pension plan (2017 - $84,000).

During the first half of 2018, the Company sold ancillary assets for proceeds of $23,000 resulting in a gain of $23,000 compared to the same period in 2017, when assets were sold for proceeds of $167,000 that resulted in a gain of $140,000.

During the first half of 2018, net other gains of $171,000 included $131,000 of proceeds on the sale of previously written-off assets. In the first half of 2017, $39,000 of net other gains was recorded made up of various balances.

Income Tax Expense

Income tax recovery decreased to $573,000 in the first six months of 2018 from $3,343,000 in the corresponding period in 2017 mainly due a smaller loss for tax purposes recorded in the first half of 2018 compared to 2017. There was no current tax recovery recorded in 2018 as all potential loss carryback amounts have been utilized.

Net Loss, Funds Flow and Net Cash From Operating Activities

During the three months ended June 30, 2018, the Company reported a net loss of $2,959,000 or $0.16 per Class A Non-Voting and Class B Common Share (basic and diluted) compared to a net loss of $4,491,000 or $0.25 per share (basic and diluted) in the comparative quarter of 2017. The reduction in the net loss between the second quarter of 2018 and the same second quarter of 2017 was caused by lower depreciation offset by lower equity income from joint ventures and lower income tax recovery.

Funds flow from operations decreased to $1,638,000 during the second quarter of 2018 from $3,254,000 in the corresponding quarter in 2017 due to decreased activity in 2018.

The Company incurred a net loss of $4,870,000 or $0.27 per Class A Non-Voting and Class B Common Share (basic and diluted) for the first six months of 2018 compared to a net loss of $9,466,000 or $0.53 per share (basic and diluted) in the corresponding period of 2017.  Funds flow from operations increased to $6,157,000 during the first six months of 2018 from $5,078,000 in the corresponding period in 2017.  The reduction in net loss and increase in funds flow from operations are both due to higher revenue in the first quarter of 2018 compared to the same period in 2017 which was the result of increased overall activity and higher day rates.

The following table reconciles funds flow and cash flow from operations:

Liquidity and Capital Resources  

Cash used for capital expenditures totalled $4,005,000 in the first six months of 2018 and related to routine capital spending. In the first six months of 2017 capital expenditures were $12,202,000 of which 42% was related to new build construction and the balance to routine items.

At June 30, 2018, AKITA's Statements of Financial Position included working capital (current assets minus current liabilities) of $16,219,000 compared to $24,557,000 at June 30, 2017, and $15,528,000 at December 31, 2017.  Readers should be aware of the seasonal nature of AKITA's Canadian operations and its effect on non-cash working capital balances.  Typically, non-cash working capital balances reach annual maximum levels at the end of the first quarter or during the second quarter as a result of spring break-up.  Non-cash working capital amounted to $9,117,000 at June 30, 2018, compared to non-cash working capital of $14,968,000 at December 31, 2017. Note that the non-cash working capital amount at December 31, 2017, included $10,641,000 in accounts receivable related to contract cancellation compared to nil at June 30, 2018.  Working capital at June 30, 2018 decreased compared to June 30, 2017, due to lower working capital balances at December 31, 2017($15,528,000) compared to December 31, 2016($34,907,000).

The Company chooses to maintain a conservative Statement of Financial Position due to the cyclical nature of the Canadian drilling industry.  In addition to its cash balances, the Company has an operating loan facility with its principal banker totalling $50,000,000 that is available until 2019 and which is currently undrawn.  The facility has been provided in order to finance general corporate needs, capital expenditures and acquisitions.

Management intends to increase its operating loan facility to $125,000,000 in order to fund the cash requirements of the Xtreme Drilling Corp. transaction. The interest rate on the current facility is 1.25% over prime interest rate or 2.5% over guaranteed notes, depending on the preference of the Company.  The Company drew on the facility in the first quarter of 2018 to fund working capital and repaid those borrowings in the second quarter of 2018. The Company did not have any borrowings from this facility at June 30, 2018, or at any time during 2017. 

The Company's objectives when managing capital are:

• to safeguard the Company's ability to continue as a going concern, so that it can continue to provide returns for shareholders and benefits for other stakeholders; and
• to augment existing resources in order to meet growth opportunities.

The Company manages its capital structure and makes adjustments in light of changes in economic conditions and the risk characteristics of the underlying assets.  In order to maintain or adjust the capital structure, the Company may adjust the amount of dividends paid to shareholders, repurchase or issue new shares, sell assets or take on long-term debt.  Since 1999, dividend rates have increased eight times with no decreases. 

During the 10 year period since 2008, AKITA has repurchased and cancelled 443,208 Class A Non-Voting shares through normal course issuer bids and has issued 122,200 Class A Non-Voting shares upon exercise of stock options.

The Company had two drilling rigs under multi-year contracts at June 30, 2018, one of which is due to expire in 2018 and one in 2020.

From time to time, the Company may provide guarantees for bank loans to joint venture partners in respect of sales of rig interests to joint venture partners.  At June 30, 2018, AKITA provided $787,000 in deposits with its bank for those purposes (June 30, 2017 - $2,253,000 and December 31, 2017 - $1,525,000).  AKITA's security from its partners for these guarantees includes interests in specific rig assets.  These balances have been classified as restricted cash on the Interim Statements of Financial Position. 

Future Outlook

The drilling industry is cyclical and certain key factors that have an effect on AKITA's results are beyond management's control. Like other drilling contractors, AKITA is exposed to the effects of fluctuating oil and gas prices and changes in the exploration and development budgets of its customers.

On June 4, 2018, Xtreme Drilling Corp ("Xtreme") and AKITA agreed to combine their respective businesses and entered into a plan of arrangement ("the Arrangement"), a copy of which is available at www.sedar.com. Under the Arrangement, Xtreme Shareholders will receive 0.3732394 of a Class A Non-Voting Share of AKITA or $2.65 in cash for each Xtreme Share. An Xtreme Shareholder may elect to receive AKITA Non-Voting Shares, cash or a combination of AKITA Non-Voting Shares and cash, in each case subject to proration such that the aggregate consideration to be paid by AKITA will not exceed $45,000,000 and will not exceed 22,235,458 Class A Non-Voting Shares of AKITA.

About Xtreme

Xtreme is a corporation existing under the laws of Alberta. Xtreme's primary business is to design, build and operate a fleet of high specification AC drilling rigs featuring leading-edge proprietary technology. Currently, Xtreme operates one service line - Drilling Services (XDR) under contracts with oil and natural gas exploration and production companies and integrated oilfield service providers in the United States.

Strategic Rationale 

The combination of AKITA and Xtreme:

• Combines two complementary companies, each with a focus on high-spec drilling rigs and disciplined operations that deliver leading performance for customers
• Provides AKITA with immediate scale in the US market, building upon its recent strategic expansion into the Permian, and the potential for premium day rates and margins
• Maintains a leading position in active Canadian markets, including oil sands maintenance drilling operations, with leverage to a longer-term recovery in Canadian drilling activity
• Expands operational and customer network across all major North American resource basins providing the flexibility to deploy high quality drilling rigs on both sides of the border to optimize utilization and returns
• Provides greater financial capacity to support potential new builds, including on Xtreme's 850XE premium spec platform or AKITA's high spec multi rig platform design which both have a proven premium value proposition for pad development
• Improves liquidity for all shareholders through increased scale and a larger public float
• Offers meaningful value creation opportunity from an estimated $8 million in annual recurring synergies and efficiencies
• Provides a differentiated opportunity to invest in a pure play drilling contractor with both Canadian and US exposure that has a strong balance sheet and liquidity

The transaction is pending and requires the following approvals:

Xtreme Shareholder Approval

A resolution approving the Arrangement must be approved by at least 66 2/3% of the votes cast by the shareholders of Xtreme present in person or represented by proxy at a meeting of Xtreme shareholders o be held August 13, 2018 (the "Xtreme Meeting"). If the resolution is not approved by Xtreme shareholders, the Arrangement cannot be completed as contemplated.

AKITA Shareholder Approval

A resolution approving the issuance of AKITA Class A Non-Voting Shares pursuant to the Arrangement must be approved by AKITA shareholders holding a majority of the AKITA Class B Common Shares. Pursuant to the requirements of the Toronto Stock Exchange, it is expected that the AKITA shareholder approval will be comprised of written evidence that holders of more than 50% of the AKITA Class B Common Shares are familiar with the terms of the transaction and are in favour of it. If such AKITA shareholder approval is not given, the Arrangement cannot be completed as contemplated.

Court Approval

On July 10, 2018, Xtreme obtained an interim court order providing for the calling and holding of the Xtreme Meeting and other procedural matters. If Xtreme and AKITA shareholder approvals are obtained, Xtreme will make an application to the court for the final order. The Arrangement is expected to be completed in the third quarter of 2018.

With demand in the Canadian market uncertain at this time due primarily to take away capacity, expansion in the US has been AKITA's focus year to date in 2018. The merger with Xtreme will add the scale AKITA's is seeking in the US with the infrastructure in place for successful operations. In Canada, AKITA's focus will remain on cost control and pursuing all potential opportunities.

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

AKITA and its joint ventures' revenue per operating day and AKITA and its joint ventures' operating and maintenance expenses per operating day are not recognized GAAP measures under International Financial Reporting Standards ("IFRS").  Management and certain investors may find "per operating day" measures for AKITA and joint ventures' revenue indicate pricing strength while AKITA and joint ventures' operating and maintenance expenses per operating day demonstrates a degree of cost control and provides a proxy for specific inflation rates incurred by the Company.  Readers should be cautioned that in addition to the foregoing, other factors, including the mix of drilling rigs that are utilized can also influence these results.

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

Forward-looking Statements

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

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

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

Selected Financial Information for the Company is as follows:

SOURCE AKITA Drilling Ltd.