AKITA Drilling Ltd. releases year-end results

CALGARY, March 4, 2015 /CNW/ - Net income for the year ended December 31, 2014 was $21,079,000 or $1.17 per share (basic and diluted) on revenue of $165,274,000.  Comparative figures for 2013 were net income of $26,515,000 or $1.48 per share - basic ($1.47 - diluted) on revenue of $168,111,000.  Funds flow from operations for the current year was $56,195,000 as compared to $57,619,000 in 2013, while net cash from operating activities for 2014 was $40,622,000 as compared to $39,554,000 in 2013.

The 2014 decline in net income compared to the previous year resulted from both lower operating margins and higher depreciation costs.  By contrast, the funds flow decline for 2014 occurred primarily as a result of lower operating margins and was much less significant than the reduction in net income.

For the fourth consecutive year, AKITA's rig utilization exceeded industry average.  AKITA relies on its key strengths to achieve this level of results – the operation of quality equipment by highly skilled employees, a commitment to customer satisfaction and significant emphasis on pad drilling.  The following table highlights AKITA's utilization rates for the past five years:

AKITA has focused significant resources in the development of its pad rig strategy over the past 14 years.  At December 31, 2014, AKITA's fleet included 20 pad drilling rigs (57% of the fleet), up from 18 pad rigs at the end of 2013 (47% of the fleet) and 3 pad rigs (8% of the fleet) one decade ago.  Additionally, pad rigs were responsible for generating 70% of the Company's 2014 adjusted revenue.

Capital expenditures during 2014 totalled $103,949,000 and were directed towards increasing the breadth and quality of AKITA's pad rig offerings.  This represented record spending for the Company resulting in the addition of two new pad rigs and upgrading two existing rigs to better serve the industry.  The Company also had an additional new pad rig under construction at December 31, 2014.  Each of these rigs was designed to meet market demand for anticipated liquified natural gas ("LNG") related drilling or to drill for heavy oil.  The four completed rigs have been actively drilling on their anticipated projects.

As a result of record capital expenditures in 2014, AKITA's December 31, 2014 Statement of Financial Position included $20,000,000 in bank indebtedness (representing 20% usage of a $100,000,000 lending facility), partially offset by $2,012,000 in cash.  This level of borrowing is manageable for the Company in the context of debt covenant coverage, anticipated repayment time and additional financial flexibility available to the Company.

AKITA is strongly committed to the safety of its employees as well as third parties at its worksites and continually achieves one of the safest working records in the Canadian drilling industry.  Of note, the 2014 total reportable accident frequency (often referred to as "TRIF") was the best in the history of the Company.  Management has taken measures to ensure that the Company's comprehensive safety plan is fully endorsed through specific actions and commitment at every worksite.

On January 22, 2015, the Canadian Association of Oilfield Drilling Contractors released its revised 2015 industry drilling forecast estimating 26% average rig utilization compared to 44.3% actual average rig utilization in 2014.  The 2015 forecast was based upon commodity price assumptions of US $55 per barrel for crude oil and CAD $3.00 per mcf for natural gas.  The revised industry forecast projecting a 41% decline in utilization is indicative of the anticipated impact on the industry from the significant drop in crude oil prices that began in the second half of 2014.  This forecast replaced a previous forecast issued two months earlier that predicted a 10% decline in industry activity.  While AKITA will not be immune to reduced activity, the Company is positioned for this downturn by having prudent financial management, skilled and experienced personnel throughout the organization and a high performance rig fleet that emphasizes pad drilling and participates in the two most significant resource developments in Western Canada – heavy oil and shale gas, including LNG focused plays.  AKITA has demonstrated its ability to compete effectively in weaker markets and expects to continue to do so.

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

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

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

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

Funds flow from operations is considered as an additional GAAP measure 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 as well as equity income from joint ventures adjusted for income tax amounts paid 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.

Revenue and Operating and Maintenance Expenses

Adjusted revenue of $229,364,000 in 2014 was 6% higher than the 2013 adjusted revenue of $216,952,000 largely as a result of achieving more operating days during 2014, especially for the Company's conventional triple and double sized rigs and to a lesser extent for AKITA's pad doubles.  This increase in demand for those specific rig categories was partially offset by weaker demand for the Company's conventional singles and pad triples during 2014.  During 2014, average adjusted revenue per operating day decreased to $35,179 per day compared to $35,724 in 2013 due to a shift in rig mix away from higher revenue generating pad triples as well as increased competition.  Pad rigs typically obtain higher day rates than conventional rigs.

Adjusted operating and maintenance costs are tied to activity levels and amounted to $152,891,000 or $23,450 per operating day during 2014 compared to $135,827,000 or $22,366 per operating day for the prior year.  Increased activity levels, higher costs for services and a change in rig mix resulted in higher operating and maintenance costs in 2014 compared to 2013 when considered on both an annual as well as a "per operating day" basis.

The Company's adjusted operating margin for 2014 was $76,473,000 ($11,729 per operating day), down from $81,125,000 ($13,358 per operating day) in 2013.  Despite AKITA's rigs being more active in 2014 compared to 2013, the change in rig mix, increased competition and higher costs for services all contributed to reduced operating margin results, both on a "total amount" as well as "per day" basis.

Revenue resulting from the supply of contracted services is recorded by the percentage of completion method.  Work in progress on day work contracts is measured based upon the passage of time in accordance with the terms of the contract.  All drilling revenue generated in 2014 and 2013 was generated under day work contracts.  No significant losses were anticipated at either of these year-end dates and accordingly no provision for material losses has been made.

From time to time, the Company requires customers to make pre-payments prior to the provision of drilling services.  In addition, from time to time, the Company records cost recoveries related to capital enhancements for specific customer related projects.  At December 31, 2014, deferred revenue related to these activities totalled $175,000 (December 31, 2013 - $334,000).

AKITA provided drilling services to 36 different customers in 2014 (2013 - 21 different customers).

Depreciation and Amortization Expense

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

The increase in depreciation and amortization expense to $30,200,000 during 2014 from $26,825,000 during 2013 was mostly attributable to the higher average cost base for drilling rigs combined with increased drilling activity.  Drilling rig depreciation accounted for 96% of total depreciation and amortization expense in 2014 (2013 – 96%).

Selling and Administrative Expense

Adjusted selling and administrative expenses increased to $18,929,000 in 2014 from $18,768,000 in 2013.  Adjusted selling and administrative expenses equated to 8.2% of total adjusted revenue in 2014, compared to 8.6% of total adjusted revenue in 2013, as a result of increased adjusted revenue.

The single largest component of adjusted selling and administrative expenses was salaries and benefits which accounted for 61% of these expenses in 2014 (60% in 2013).

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 analyses of these activities are incorporated throughout the relevant sections of this MD&A.  Joint venture activities are often located in some of the most prospective regions in Canada.  Two thirds of AKITA's joint ventures utilize pad drilling rigs.

Other Income

The Company invests any cash balances in excess of its ongoing operating requirements in bank guaranteed highly liquid investments.  Interest income decreased to $172,000 in 2014 from $345,000 in 2013 as a result of reduced cash and elimination of term deposit balances.  The Company has undertaken significant capital expenditures related to the construction of new rigs and the conversion of conventional rigs into pad rigs, utilizing term deposits and thereby reducing cash balances over time.

During 2014, interest expense of $262,000 (2013 – $108,000) related to the future cost of the Company's unfunded defined benefit pension plan as well as the cost of financing the Company's indebtedness during the fourth quarter.  

During 2014, the Company disposed of selected non-core assets resulting in a $536,000 gain.  AKITA disposed of several minor assets in 2013, resulting in a $106,000 gain.

In 2014, amounts reported as "Net Other Gains" of $331,000 include foreign exchange amounts related to forward exchange contracts purchased to provide a hedge for foreign rig equipment commitments related to rig construction (gain of $371,000), an unrealized cost related to loan guarantees that the Company has provided on behalf of certain joint venture partners (cost of $120,000) and other (gain of $80,000).

Other than the foreign currency hedge on major capital expenditures noted above, readers should be aware that in 2014 the Company conducted all of its operations in Canada, thereby reducing its exposure to foreign currency fluctuations.

Income Tax Expense

Income tax expense decreased to $7,042,000 in 2014 from $9,167,000 in 2013, due to lower pre-tax income as well as a decrease in the Canadian federal income tax rate as a result of a change in provincial allocations of revenue and expenses.  AKITA's proportion of income taxes that are deferred to future years has increased as a result of record capital expenditures in 2014.

Net Income, Funds Flow and Net Cash from Operating Activities

Net income attributable to shareholders decreased to $21,079,000 or $1.17 (basic and diluted) per Class A Non-Voting and Class B Common Share for 2014 from $26,515,000 or $1.48 per share (basic) ($1.47 - diluted) in 2013.  Funds flow from operations decreased to $56,195,000 in 2014 from $57,619,000 in 2013.

The net income decline in 2014 compared to 2013 was attributable to lower operating margins (as a result of a change in the classes of rigs worked, increased competition and higher service costs) combined with higher depreciation expense (due to a higher average cost base for drilling rigs as well as higher drilling activity).

While net income dropped 20% in 2014 compared to the previous year, funds flow from operations declined by 2% primarily as a result of lower operating margins.

Fleet and Rig Utilization

The following table summarizes rig changes that occurred in 2014:

Fleet Changes during 2014

Utilization rates are a key statistic for the drilling industry since they measure revenue volume and influence pricing.  During 2014, AKITA achieved 6,520 operating days, which corresponded to a utilization rate of 48.6% compared to an industry average utilization rate of 44.3% during the same period.  During the comparative year in 2013, AKITA achieved 6,073 operating days, representing 43.4% utilization.  It should be noted that AKITA calculates its utilization rates based only upon rigs actively operating.  Rigs that are moving or receiving standby revenue do not contribute to AKITA's utilization statistic.

During 2014, AKITA commissioned one new pad double rig and one new pad triple rig.  In addition, the Company converted a conventional double rig into a slant pad single rig.  During 2014, AKITA decommissioned two conventional single rigs as well as one conventional double rig and one conventional triple rig.  The Company also sold one pad triple rig into a market in which the Company does not compete.

Property, Plant and Equipment

Capital expenditures totalled $103,949,000 in 2014, a record level of capital spending for the Company.  The most significant expenditures related to the following projects:

• Completion of a new ultra-deep pad triple which commenced its multi-year contract during the fourth quarter of 2014;
• Completion of the conversion of a conventional double into the Company's first slant pad single (this rig commenced operations during the third quarter of 2014);
• Purchasing and refitting of a new pad double to enable it to operate in Canada (completion of the refit occurred in the fourth quarter of 2014 with the rig currently operating under a one-year initial contract);
• Upgrading of a pad triple to make it more suitable for drilling heavy oil targets in the Duvernay or Montney formations (this rig recommenced operations during the fourth quarter of 2014); and
• Commencing construction of a pad triple announced in the first quarter of 2014 (the rig is anticipated to meet demand for proposed liquified natural gas ("LNG") related drilling projects and is scheduled to be completed in the first half of 2015).

The cost incurred during 2014 for the five aforementioned rig construction projects was $81,667,000.  Additional capital expenditures related to certifications and overhauls having a life in excess of one year ($12,573,000), rig equipment for existing rigs ($5,846,000) drill pipe and drill collars ($3,459,000) and other equipment ($404,000).  Capital expenditures for 2013 totalled $35,113,000. 

During the third quarter of 2014, the Company disposed of one of its underutilized pad rigs.  Proceeds from sales of underutilized and non-core assets totalled $8,315,000 in 2014 (2013 - $443,000).

Asset Impairment Testing

International Accounting Standard 36 Impairment of Assets ("IAS 36") sets out requirements for reporting impairment which cover a range of assets (and groups of assets, termed "cash generating units" or CGUs).  The impairment test utilized by the Company compares each CGU's carrying amount with its recoverable amount.  The recoverable amounts are defined as the higher of the amounts calculated under the fair value less cost of disposal, and the value in use.

IAS 36 requires an entity to consider both internal and external factors when assessing whether there are indicators of impairment.  While the Company did not determine any internal indicators of impairment at December 31, 2014, it did recognize the significant decline in the price of crude oil as a potential external indicator of impairment.  Since year-end, this decline in commodity prices has affected drilling activity and expectations for ongoing drilling activity as discussed later in this MD&A under "Future Outlook and Strategy".  Further, the carrying amount of AKITA's net assets exceeded its market capitalization at December 31, 2014.  The Company did not note any additional events that occurred after December 31, 2014 that would provide additional indications of impairment as at December 31, 2014.

The accuracy of impairment testing is affected by the extent and subjectivity of estimates and judgments in respect of the inputs and parameters that are used to determine the recoverable amounts.  In performing its impairment tests at December 31, 2014 management determined value in use for its CGUs using estimated discounted cash flows ("DCFs"), which included estimates of future cash flows, expectations regarding cash flow variability, a determination of the discount rate and consideration of the inherent price of each CGU.  IFRS considers this approach to constitute a Level 3 hierarchy in its determination of value.

Management used its Budget and Business Plan, as approved on November 14, 2014 by its Board of Directors and subsequently adjusted for weaker market conditions, as its primary basis for its impairment testing at December 31, 2014.  Cash flows were determined for each of the Company's six operating CGUs: conventional singles, conventional doubles, conventional triples, pad singles, pad doubles and pad triples.  While these six operating CGUs encompass 98% of the Company's property, plant and equipment, consideration was also given to other corporate assets in the Company's impairment tests.

Additional significant assumptions used in AKITA's impairment tests at December 31, 2014 included potential annual revenue growth rates (taken as 0%), potential inflation for cash outflows necessary to generate cash inflows for CGUs (taken as 2%), the projected forecast period (taken as up to 10 years per CGU), the discount rate taken based on the Company's pre-tax determination of its weighted average cost of capital (calculated as 8%) and salvage value at the end of each CGU's useful life (determined as 20% of original cost).  The generation of cash flows was considered for the Company's CGUs based on the existing condition of each CGU at December 31, 2014.

The Company also performed the following sensitivity tests relative to its impairment testing:

• Decreased future cash flows from its approved budgets as subsequently adjusted for weaker market conditions by 10%;
• Changed annual revenue growth assumption from 0% to -2% per year;
• Increased inflation for cash outflows from 2% to 4% per year;
• Increased pre-tax discount rate from 8% to 10%; and
• Reduced salvage values from 20% to 15%.

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

The sensitivity tests resulted in reductions to the CGUs' values in use ranging between $9,710,000 and $28,666,000.  In all instances the adjusted CGU values in use exceeded the carrying values reported in the financial statements at December 31, 2014.  No adjustments to carrying amounts were made as a result of this asset impairment testing process.

Liquidity and Capital Resources

At December 31, 2014, AKITA had $5,028,000 in working capital deficiency, including $2,012,000 in cash and $20,000,000 of bank indebtedness, compared to $40,645,000 in working capital, including $13,998,000 in cash and no bank indebtedness, for the previous year.  In 2014, AKITA generated $40,622,000 from operating activities.  Cash was also generated from joint venture distributions ($26,874,000), from drawing on the Company's credit facility ($20,000,000), from proceeds on sales of assets ($8,316,000) and from redemptions of term deposits ($5,000,000).  During the same period, cash was used for capital expenditures ($102,862,000), payment of dividends ($6,015,000), increasing restricted cash balances used for loan guarantees ($3,431,000) repurchasing Class A Non-Voting Shares ($390,000), and payment of a loan commitment fee ($100,000).

The Company chooses to maintain a conservative Statement of Financial Position due to the cyclical nature of the industry.  In addition to its cash balances, the Company has an operating loan facility with its principal banker totalling $100,000,000 that is available until 2019.  Although the facility has been provided in order to finance general corporate needs, capital expenditures and acquisitions, management intends to access this facility primarily to enable the Company to fund new rig construction requirements related to drilling contracts that it might be awarded.  The interest rate on the facility varies based upon the actual amounts borrowed and ranges from 0.45% to 1.45% over guaranteed notes, depending on the preference of the Company.  The Company had borrowings of $20,000,000 from this facility at December 31, 2014.

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

• Funded debt to EBITDA shall not be greater than 3.00 to 1.  As at December 31, 2014 (the most recent measurement date), AKITA's actual rate was 0.34 to 1;
• EBITDA to interest expense shall not be less than 3.00 to 1.  As at December 31, 2014. AKITA's actual rate was 224 to 1; and
• Tangible assets to funded debt shall not be less than 2.25 to 1.  As at December 31, 2014, AKITA's actual rate was 16.05 to 1.

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

From time to time, the Company makes major purchases from non-Canadian suppliers in connection with its capital expenditures.  AKITA purchases forward currency contracts in order to minimize the risk of currency translation adjustments associated with these purchases.  At December 31, 2014, the Company had $1.3 Million in forward currency contracts related to capital expenditures which were executed in January, 2015.

Commitments

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 December 31, 2014, AKITA provided $9,381,000 in deposits with its bank for those purposes (December 31, 2013 - $5,950,000).  These funds have been classified as "restricted cash" on the Consolidated Statements of Financial Position.

From time to time, the Company enters into drilling contracts for extended terms.  At December 31, 2014, AKITA had four rigs with multi-year contracts that extend beyond one year.  Of these contracts, two are anticipated to expire in 2016, one in 2018 and one in 2019.

Forward-Looking Statements

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

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

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

Selected Financial Information for the Company is as follows:

SOURCE AKITA Drilling Ltd.