Q3 2023 CES Energy Solutions Corp Earnings Call
[music].
Thank you for standing by this is the conference operator, welcome to the CES Energy solutions third quarter 2023 results conference call and webcast.
As a reminder, all participants are in listen only mode and the conference is being recorded.
After the presentation there'll be an opportunity to ask questions.
And the question queue. You May Press Star then one on your telephone keypad should you need assistance during the conference call you May signal, an operator by pressing Star then zero.
I would now like to turn the conference over to Tony Allott Chino Chief Financial Officer. Please go ahead.
Thank you operator.
Good morning, everyone and thank you for attending today's call I'd 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.
Factors and assumptions are summarized in our third quarter MD&A and press release dated November 19, 2023, and in our annual information form dated March 2023. In addition, certain financial measures that we will refer to today or no.
Recognizing under current.
General accepted accounting policies.
For a description and definition of these please see our third quarter MD&A.
This time I would like to turn the call over to Xavier our president and CEO.
Thank you Jody and welcome everyone and thank you for joining us for our third quarter 2023 earnings call on today's call.
A brief summary of our strong financial results released yesterday, followed by an update on the capital allocation plan and then our divisional updates for Canada, and the U S as well as our outlook for 2024, I will then pass the call over to Tony to provide a detailed financial update we will take questions and then we'll wrap up the call I'll.
I'll start my comments today by highlighting some of the major financial accomplishments, we were able to achieve through Q3 2023.
This included record Q3 revenue of $536 $5 million versus our prior record levels in Q3 of last year of $524 7 million.
And this was our third highest revenue quarter ever.
Record Q3, EBITDA of $80 $2 million versus our prior record level set in Q3 last year of $73 3 million and effectively tightening our all time EBITDA record set in Q4 of 2022.
EBITDA margin of 15% versus 14% in Q3 of 2022 and 14, 3% in the prior quarter. This result was the highest EBITDA margin achieved by CES in over eight years.
Once again reduced total debt to TTM ratio. This time to 146 from two five to one year ago to one seven at year end, we realized free cash flow in the quarter of $75 6 million. This was our strongest free cash flow quarter ever other than when they harvested significant working capital.
The crisis of 2015 and 2020.
As promised on the Q2 earnings call. We have made significant progress on maximizing our <unk> purchases, having already bought almost 64% of the $18 7 million shares allowed under our current NCIC and just four months.
Our capital allocation strategy for the upcoming year. It remained consistent with what we announced last quarter. We will continue to support the business with the necessary investments required to provide acceptable growth and returns we intend to fully utilize our current NCI expiring in July of 2024 to repurchase the full 10% or $18 7 million.
Sharon it's allowable under the program.
We will continue to pay our dividend, 10% I'm, sorry, 10 cents per share per year or approximately $24 million per year, we may choose to adjust this level from time to time as cash flows and forecast allow you will use the balance of the remaining free cash flow to continue paying down debt towards the target of one times debt to TTM.
I will now move on to summarize the Q3 performance by Division currently our rig count in North America stands at 199 rigs out of the 821 running or 24, 2% of the market.
The Canadian drilling fluids division continues to lead the WCS and market share today, we are providing service of 67 of the 196 jobs listed is underway in Canada, or 34, 2% market share drilling activity in Canada throughout 2023 has been slightly lower year over year.
However, we are excited about the prospects for 2024 and anticipate it will be a stronger year due the next expected completion and startup of infrastructure projects and their associated takeaway capacity in Canada.
Sure Ken our Canadian production chemical business set new records for quarterly revenue and EBITDA. In Q3, we have continued to see growing contribution from our frac chemicals stimulation and HOS scavenger groups as we further penetrate each of these.
End markets and gain market share, while utilizing only our current infrastructure and supply chain to support them. Our primary business production treating also continues to take market share and grow we are very optimistic about the coming year and the current growth trends we are experiencing in this division.
In the United States, our U S drilling fluids group Aes is providing chemistries and service to 132 of the 625 rigs active in the USA for a 21, 1% market share. The number of rigs is down from 147 rigs at this time last year, but ahead of them on market share from the $19 one.
Percent reported at that time.
This includes a basin, leading 98 rigs out of the 318 listed working in the Permian equating to a 31, 1% market share versus the 29, 8% market share we had at this time last year.
Our second barite grinding facility located in the Permian Basin will allow us to self supply, 100% of our era needs going forward supporting increased market penetration and further margin improvement as well we have made a soft entry into the haynesville market and are looking at picking up a couple of more rigs there we believe our pico standing facility capability.
These will provide us with a niche to allow us to gain market share in the United States by participating in this market, which we had previously were not focusing on.
Finally, J Cam catalyst had its highest revenue quarter ever and second highest EBITDA quarter ever in Q3, our manufacturing facility in Canada. Just continues to operate at a very comfortable output level of approximately 65 to 70, 565% to 70% of what we believe to be the current maximum capacity.
We have continued the recent trend of winning more business in this region and internal analysis has allowed us to conclude that we are comfortably achieved the largest market share in the basin, even as we continue to grow.
Since this is the last earning call for us in 2023, I will now provide a view into our outlook for the future are short short term outlook for the industry activity in North American land market remains largely the same as discussed on the last couple of calls we continued to experience a more stable environment and activity levels at <unk>.
Our U S drilling fluids group, we have initiated operations and plans to grow aes within the Haynesville play in Texas, where.
Where we think we can add rigs into an area that we have not really participated in during the past handful of years. Once we achieve a meaningful run rate, we will fine tune supply chain to optimize earnings and efficiencies. Obviously this will lead to further improve market share overall when combined with the steady progress we are making throughout the U S. This.
This combined with ever increasing service intensity due to longer and more complicated horizontal sections of wellbore geometries that many operators have been speaking to has aes looking forward to 'twenty four 'twenty four being another very profitable growth year.
For our Canadian drilling fluids for CES.
We view the impending infrastructure completions in Canada is highly positive for the Canadian market and investments by E&ps as both <unk> and LNG, Canada gets closer to operation, we see activity in Canada continuing to accelerate.
Due to our position as a leader in the Canadian Energy services market, we stand to directly benefit from this inevitable uptick in activity service intensity is also a phenomenon being experienced in the Canadian market, which will lead to more meters being drilled by the same number of rigs.
And with the increase in meters comes an increase in chemical spend due to more complex issues. We see revenue growth in 2024 within Canada, and what we view is likely to be flat to slightly higher activity level.
As evidenced by our Q3 numbers <unk> catalysts and pure count are both growing at a rate that is almost fully offset the revenue reduction from the north American rig count dropping by 17% year over year.
The annual third party Kinder light production chemical supplier performance report highlighted and supported our view on how production chemicals divisions on both sides of the border have captured market share and outperformed our competitors. We believe the growth in these two divisions will continue to accelerate and that we have lots of room to take market share in <unk>.
<unk> revenue and earnings we have also continued to make progress in the long road to gaining traction in the lucrative Gulf of Mexico offshore market. After our acquisition of throw flow last year as we fine tune our support facilities and team locally.
All of these positive developments taken together have us very optimistic about the production chemical groups and their short and long term organic growth opportunities.
As a reference point for the growth prospects in front of us in production chemicals, we have consistently publicly noticed that our total corporate revenue consists of about 50 50 split between production chemical business in drilling fluids business Seres research.
<unk> reports on market size by geography and market space. Their most recent report estimates that the North American production chemical spend stands at approximately $6 75 billion Canadian in 2023 since 50% of our revenue in 2023 equals about 1 billion. This map shows that as a percentage of addressable.
In North America, we have achieved only around 15% of the total spend.
We believe we see a path to doubling that penetration by methodically continuing to execute our business plan in production chemicals in North America.
To summarize this outlook I want to emphasize the gross prospects directly in front of us and the markets that we're already participating in established in <unk>.
As a secondary focus we continue to look for opportunities to potentially enter strategic international markets in order to establish a foothold in these regions, which we currently have no exposure to.
As always I want to extend my appreciation to each and every one of our employees for their commitment to the business culture and successful Ges is rewarding to note that due to the growth that we're experiencing we have increased our total number of employees at CES from 2122 on January one of this year to 2000 and 235 to date. This is an increase.
Of 113 employees, so far this year or approximately 5%. Unlike last year, where we increased head count in the company by 17% over the course of the year, we expect head count growth to be relatively muted going forward.
In conclusion, I would like to note that the results in Q3 were once again not due to any one division or area selling this as a balanced effort across the company in which every business unit contributed and it speaks once again to the quality of people employed everywhere in every division here at CES.
As always I want to sincerely. Thank all of our customers for their trust and commitment to CES in good times and in bad and with that I will turn the call over to Tony for the financial update.
Okay.
<unk> financial results represented a third quarter record and demonstrated the continued continuation of strong revenue adjusted EBITDA and free cash flow levels. She has continued its trend of strong cash flow generation made a constructive supply demand environment increasing levels.
Service intensity, leading market share positions throughout its business in Q3, <unk> generated revenue of $537 million and adjusted EBITDA of $80 2 million, representing a 15% margin Q3 revenue of 537 million compared to $516 million in Q2.
It represented an increase of 2% from $525 million in Q3 2022.
Revenue generated in the U S was $361 million or 67% of total revenues for the company. This revenue number compared to $375 million in Q2, and 315 million a year ago, Although U S revenues for the quarter were impacted by decreased industry drilling activity. This was.
More than offset by higher production levels increased product intensity levels and market share gains year over year.
Revenue generated in Canada was $175 million in the quarter up from $140 million in Q2 as expected also seasonally lower activity levels and compared to $175 million in Q3 2022 sequentially Canadian revenue benefited from an increase in rig count.
And higher production volumes.
When compared to the previous year increases in production volumes offset declines to industry rig counts.
Adjusted EBITDA decreased $2 million in Q3 represented a 9% decrease from $73 $3 million generated in Q3, 2022, and the sequential increase of $6 3 million or 9% from $73 9 million generated in Q2.
<unk>.
Adjusted EBITDA margin in the quarter increased to 15% compared to 14, 3% recorded in Q2 and 14.0% in Q3 2022 and is reflective of a favorable product mix.
Active pricing and procurement practices and maintaining prudent SG&A levels.
I am proud to report that during Q3, our net cash provided by operating activities totaled $99 $3 million, representing an increase of $10 6 million.
Over Q2, and $116 2 million over Q3 2020.
The improvement came from strong revenue levels and attractive margins.
Improvements in working capital management.
During the quarter CES achieved strong free cash flow of $75 6 million compared to $66 7 million in Q2. This measure demonstrates the cash conversion quality.
All five of our earnings as measured by some of our peers in respective research analysts like calculating CFO.
Net capex and lease repayments divided by adjusted EBITDA, resulting in an industry, leading 94% ratio for the quarter.
<unk> continued to maintain a prudent approach to capital spending through the quarter with Capex net of disposal proceeds of $16 $1 million, representing 3% of revenue. We will continue to adjust plans as required to support existing business and go to other divisions and for 2008.
'twenty three we expect cash capex to be approximately $65 million weighted towards expansion capital to support higher levels of activity and business development opportunity.
Particularly in the production chemicals physicians as Ken mentioned.
During Q3, we were very active in our in CIB purchasing 12 million common shares at an average price of $3 34 per share for a total of $40 million.
Following Q3, we continued our aggressive buyback activity with an additional $2 9 million common shares.
Price of $3.66 per share for a total of $10 4 million.
We exited the quarter with a net foreigners senior facility at $92 $2 million compared to $120 2 million at June 30, and $208 5 million at December 31 2022.
The decrease was realized during the quarter.
Were driven by strong cash flow generation enhanced by a reduction in required working capital investments, partly offset by $40 million in share repurchases and $6 $3 million in dividend payments. We ended Q3 with $454 million in total debt.
Net of cash comprised primarily of $280 million in senior notes and the net flow in the senior facility of $92 2 million or total debt to adjusted EBITDA decline.
<unk> declined to a prudent 146 times at the end of Q3.
Steadily from 157 times at Q2, and 252 times, a year ago, demonstrating our continued deleveraging trends.
I would also note that our working capital surplus of $615 million exceeded total debt of 454 million by $161 million and demonstrated continued improvement in respective year over year metrics with cash conversion cycle, improving and working capital as a percentage.
Annualized quarterly revenue, achieving 20% versus historical loans of 30% to 35%.
Where each 1% improvement that piece revenue levels represents approximately $21 million on our balance sheet.
From December 31, 2022 to September 30 of 2023, our draw declined by $117 million from 290 million to $92 million driven by prioritization of surplus cash flow generation.
When you account for the $51 8 million spent on share repurchases and the 65 million on dividends.
Cash flow was actually $185 million through the first three quarters of 2023.
This very strong surplus free cash flow performance is indicative of the strong cash flow generating capability of CES in this environment at.
At this point I believe it's important to step back and highlight the relative positioning of the company over the past five quarters as we have now achieved a consistent and still increasing altitude a financial performance that we've been talking about for the last year and a house.
Annualized revenue levels have remained in two to $2 $2 billion run rate range EBIT back in the $75 million to $80 million range.
So in the general $60 million to $70 million range, which collectively underpins our thesis of strong cash flow generation.
These consistent near record levels has allowed <unk> to deliver on our commitment to returning capital to shareholders.
During the quarter, we returned $46 $3 million $340 million in share buybacks and $6 3 million in dividends, representing 46% of cash flow from operations and 61% of free cash flow.
At current levels of activity market share and service intensity CFS remains in a position of strength and flexibility supporting our capital allocation priorities as outlined by Ken none.
Number one we continue to prioritize capital allocation towards supporting existing and new business through investments in working capital as required and capex projects that deliver IRR above our internal hurdle rates.
Next we intend to repurchase up to the maximum common shares under the renewed in CIB over the coming year year to date, we have repurchased $19 3 million shares or just under 8% of outstanding shares at an average price of $3 22 per share and have exhausted.
11, 90 million of our $18 7 million in CIB program, which expires in July of 2024, we remain very comfortable with our dividend, which represents a yield of approximately two 8% and our current share price. It is supported by improving 13% payout ratio within there.
Target range of 10% to 20%, we will continue to use the remaining surplus free cash flow to reduce leverage toward the one time level.
To further strengthen our balance sheet overtime.
At this time I'd like to turn the call back to Ken for comments on our outlook.
Okay.
Thank you Tony.
Okay.
Well with that.
Alright, Thank you Tony you and I. Both noted the near all time record Q3 results combined with a 15% EBITDA margin allowed us to return significant capital to shareholders. We are confident in our ability to grow the company within a stable industry environment, while continuing to provide growing returns I'll now pass the call back to the operator for questions.
Thank you we will now begin the question and answer session Joanne.
To join the question queue you May Press Star then one on your telephone keypad.
Our atone acknowledging your request.
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Our first question is from Aaron Macneil with TD Cowen. Please go ahead.
Hey, good morning, and thanks for taking my questions Hi, Ken I know you referenced this in your prepared remarks, but as it relates to the <unk> entry into the Haynesville and the TECOS facility.
I'm wondering if we can all just taken a bit of a step back and compare.
Our haynesville footprint to say your Permian footprint.
And recognizing that the Permian is it much more established.
How that might impact your cost competitiveness and your ability to deliver a high quality service to your customers and then as a follow on if you are ultimately successful in the haynesville well require a bigger slug of capital in the future to build out that infrastructure.
Sure, Yes, I mean, I pointed it out because we've been thinking a lot about where we can grow within the markets. We're already in as well as where we can grow outside of the markets. We're currently in.
One of the things that we did back in 2015 as as energy and commodities kind of collapsed was was minimize our infrastructure across North America and the Haynesville warehouse was one of the ones that we shut down mothballed and actually sold so we don't actually have any infrastructure there right now so.
So with everything backing off a little bit over the last year here. We view this as a good time to come into that space as rigs start to pick back up hopefully I mean currently there's about 45, working there, which as you know seven or 8% of the total number of rigs in the U S. So it's a decent size, but the reason it's attractive to us is because it's primarily because of the <unk>.
Plus facility and the fact that.
That facility is going to allow US right now we have the corpus Christi barite grinding facility that gives us a big advantage in the Permian, but all of that burn rate is going to the Permian. So we didn't really have any extra is fair and we're actually buying in the open market right now we're so busy in the Permian as well to a small degree hence the P close facilities. So once we get.
People's online we can.
We can supply from their sorry, paperless, we can supply from there into the Permian and that'll give us some extra capacity in Houston.
Corpus Christi to supply the Haynesville market and the Haynesville market Barite market is supplied primarily by the grinders on the Gulf Coast. So we will be.
Online with what they have halliburton being the only one that we directly compete with that has full grinding capability.
Simba is the barite wholesaler in the United States. They supply most of our competitors in the independents. They are the ones supplying into that Haynesville play as well so that'll be the advantage we get in Haynesville as traditionally weighted it's gas it's pressure and so you have to house a lot of barite and that becomes a big part of what you're seeing.
Selling there and they had that you can bring so that combined with the fact that it's a little more technical allows for some better margins and now that we have the infrastructure in place we can actually support it.
Reliably, but we won't just run in there and buy land and even when we get going with the market that size, we're looking at leasing and renting we're not looking at buying and building.
That's very helpful. Thank you.
And then similar question on the.
Production chemicals side, I know, it's not disclose per se, but since you started laying out the growth potential of the U S production chemicals business I'm wondering if you can give us a sense of.
Total volumes in the U S production chemicals business has been trending I know you could treatment points, but it's not a great measure.
Like an annual CAGR, if you have that Andy and then how would you characterize the potential future growth trajectory over the next few years. If you are ultimately successful in achieving that market share capture strategy.
I'm trying not to get I mean, we're trying to be I'm trying to be promotional about where we're going and talk about the growth that we see.
But I don't want to give hard numbers on where we think we can go or where we are believe we're going to I don't have that number right now for the the volumes per se as it overall.
Push into the field just the treatment points.
Suffice it to say we are picking up for some reason we are picking up market share with customers that we know and then when you look at the kimberlite before and it gets a little more detail about who's working where and what they estimate and what customers are telling them. They are doing and we fared very well in that report, we've always fair very well, but on this most recent one.
It's pretty obvious that we were well ahead of everybody else and then we did some internal study as well on customers and in the region.
And what we have.
Believes that people beside us are doing for volumes and treatments compared to what we're doing again established us having a pretty significant lead in market share in the Permian basin and production chemicals.
We talked about internally a lot.
You guys covered a bit in your research.
We don't know if it's exactly the same trajectory, but we talk a lot about how aes doubled market share over the last five six years from the low double digits to 21 touching 22%. So we know exactly where Jay can catalyst in pure Kim are respected and leading that growth trajectory, but suffice it to.
Say that.
They are starting to get recognized by the biggest even more not that they weren't but all of the infrastructure that the teams have built the exposure that theyre getting into conferences technical pieces that they've been putting out.
In some cases working with that with producers on that is being recognized in and you can see good results in.
Our.
Our revenue and EBITDA levels, where they are on that growth trajectory. The real question is how long does that continue and housekeepers that curve right now we're right in the middle of it with market awareness and growth.
Okay makes sense.
I appreciate the answers I'll turn it back.
The next question is from Keith Mackey with RBC capital markets. Please go ahead.
Hi, Good morning, I'm. Just curious are there has been a fair bit of M&A announced amongst the customers or E&P base, rather than Canada, and the U S over the last several months.
Can you just maybe speak to how you see that activity playing out for CE, you and you know ultimately what your strategy is to to make the best of it you know either way as a as customers tend to tend to consolidate.
Yeah.
So it's a tough one to protect against Keith is going to be times. When you don't have that right and all those things, but you know, we just try and do that by being as broad basis make possibly Canada, which are important for everybody. We've made a real effort over the last 10 years to get more integrated but the bigger larger more likely to acquire companies that are to be the acquirer.
And you know year to date, we haven't had an acquisition.
It's hurt us and probably had a couple of what we definitely have a couple that have helped us. So so far we're waiting and that's all of it but there is opportunity and there's a couple of the big guys have adult workforce I'm one of them bought one of our good customers it could be it could be.
It could cost us a little bit of business.
We are doing everything we can and I almost every door and at least have a third or a piece of the work and all the all the majors as well as even the private companies trying to get in those stores. So like always it's a blanket approach, but like always there's no real way to defend against that.
As an industry people other other teams has talked about this trend.
Sort of like it like it a lot because you have these bigger stronger higher credit worthiness access to capital results oriented companies that are.
Probably developing.
<unk> resources that would not have been developed a at that pace and that extend N b.
These bigger guys are results oriented or are deploying their technology to get more out of what they got and let's not forget that a lot of this has been prompted by a deterioration between the inventory quality. So we like when these bigger more complicated results oriented guys are buying these other assets because what we're seeing in <unk>.
We are in Houston right now we had to report meetings here. This week listening today in Scandinavia, and and they're working with these bigger customers to employ more technically leading edge solutions, which falls right in time right down the middle of the fairway for us.
Got it and just one more question from me.
I appreciate the growth potential numbers on both the chems and the drilling fluids side.
Can you just talk generally and Directionally about how you would think about margins under under the potential growth trajectories that you can see like should margins materially improved from that 13, five to 14, 5% range if one business line.
Rose faster than the other or if you could just help us think through that a little bit would be helpful.
Sure I can start off just from a financial perspective.
You look at how we've been trending and we've been pretty candid about it we made a step change going from $1 billion run rate to two to $2 2 billion.
And if you look at the last few quarters that SG&A is sort of flattened and we are going to be spending a little bit in capex and that helps explain that $5 million increase that we showed but make no mistake about it we think that we can at least on the SG&A line.
Continuing to keep that flat or growing at a lesser rate than that revenue growth, which would mathematically lead to a bit of a margin expansion and then it's a question of the type of work.
Tony has talked to and we will elaborate probably on some of the other stuff that we look at it in the golf and some of these other really attractive opportunities.
I think it's hard.
To predict how high we could go with margin, but as Tony talked about there are some efficiency gains we're not entering any of these markets to get less margin. So.
First and foremost you know the third Canada have been working on it.
Stance and we've spent a lot of time in the last year really focusing on cash conversion cycle or at least follow up focusing on inventory levels. This will help with that and it will keep us focused on that but.
Our intent would be to get lift margins keep growing higher 15% was took a lot of things that come together to hit that this month.
Think necessarily that that's the new minimum we're going to continue to talk about the 13 to 14 and a half range. However, we'll see what the future quarters hold because everybody is working at a high level right now on conversion cycle, and that's having a big impact on overall.
Alright, I appreciate it I'll leave it there thanks.
The next question is from Ken Monticello with HEB capital market. Please go ahead.
Thanks for taking the question.
I'm just wondering if you can outline broadly.
Broadly what you think capital spending might look like one and 2020, where you've outlined a number of.
Promising growth trajectories.
And.
Based on that spending outlook, what you think you can yield or.
The growth in kind of a moderate <unk>.
Industry growth environment moderate to flat.
Sure.
Describe 24 as being sort of a catch up here, there's no major projects that we're doing but we've grown a lot over the last year and a half and we've been.
We've been running on something it takes supply.
Restrictions due to the storage volumes that you have in some of the facilities that.
And we put some pressure on the reactors and the blenders so its just updating equipment.
Updating its adding equipment that we probably shouldn't be I think it just takes time to get there, but things like our scavenge our plant in Michigan.
Double the volume of scavenger in the last two years and we haven't really done a lot with storage capacity. There. So we've been using railcars historic product because that's all we can get our hands on where we're going to update that a little bit and add some more storage. There. So we can stop paying for.
For the railcars to sit still and because the rail companies are telling us we can't help or anymore. So just some things like that you know reactors in Kansas.
So it is all over and more delivery trucks it at.
Jacob.
No one big item like in prior years with no barite my going in all big warehouses going in it's just all the other stuff that we're catching up.
So is should we expect capex to be lower area.
I think 25 potentially us can't say that yet if things stay relatively flat just it'll just come down to growth again, I mean, if if you what we're doing in 'twenty four well get us caught up and then I can see it dropping back down to that $50 million range. If we can if we stay completely slide 24 to 25.
However that is not our intention so hopefully we're spending more in 'twenty five.
Gotcha Okay.
And then.
I guess, we're pulling on a lot of levers around margin.
All up from the last one.
But.
When you think about the margin expansion that was one of the last two quarters, how much of that do you think.
Yes.
Structural in nature in terms of like.
Sustainable cost reductions.
At a product level and how much is kind.
Kind of just like operating aspiration.
And I.
I guess operating leverage.
I'd say it's.
About 55 seems like that's a high level answer and then if you look at that stage progression Q.
Q1 to Q3.
<unk> 843, 15 or has it been.
It is an anomaly we had one month of the three months, where was that where the stars aligned for she was our big areas of business.
But it's been a combination of those two.
We've been really smarter turns its ambitions have been really smart.
<unk>.
About having share price and with the customers and doing a bunch of work internally to bring those costs down either by leveraging procurement opportunities.
Or using our technical capabilities to reformulate and out and changed sources. So that's where you saw the Cogs.
<unk> contribution.
And then on the other it's like make no mistake about it everybody knows they're sort of not a guidepost in terms of margin expectations.
Theyre going after new business not just for new business. They are looking to reduce your margin business and that's what they're doing so it's been a combination of product mix and being smart about our balance.
Balancing the Cogs level with what's the pricing.
And then I guess a similar question.
Just.
On working capital.
Pretty staggering draw in the quarter.
Yeah, Mike staggering is a great way to describe it in general what are sort of scratching their heads we knew that the divisions were doing a great job.
Moving that.
Working capital optimizations down our working capital management.
Improving every single quarter.
We're looking at it like these numbers are phenomenal 110 days of cash conversion cycle in 2008, 7% working capital as a percentage of annualized revenue and we did a lot of work and there.
There is a there is one very large division that month after month quarter after quarter as shaped.
Probably about 15% of their.
Historical cash conversion cycle number so they so there is a structural improvement there and we look forward to that continuing.
Two of the other divisions sort of.
In line or slightly better than historical levels and then we have another division that is a bit higher than where they've been historically and we're seeing a significant improvement in those numbers. So I I'd like to say don't expect 100.
Turning next quarter don't expect 28, 7%.
Our normal level of cash conversion cycle.
In a flat market is typically in the mid one team. So if you're looking to model I would model that and we got mall hope to two to beat that estimate, but it is a little bit early on at this new very efficient level of working capital management.
Can you give us some tangible examples of the initiatives that you're implementing that are driving that type of efficiency that might be structural in nature.
Yeah, It's a really good question and just like we run the decentralized model from an operations.
H R.
Our perspective, and where we allow the divisional presidents to run their businesses.
Every division has a little bit different. So for example in one division had a massive customer that they do.
Worked very closely with to plug our ERP system directly into their payable system to shave a few days off of what is otherwise a very boring mundane process from the on the customers side, but that allows us in that case with a very good customer to shoot a few days off from DSL. Another.
For example.
It is where the division decided okay, well, we need more manpower and we need people and a very specific area geography.
Our customers are in and have them as collection folks. So they can develop relationships with the customers in a very constructive way.
Beyond them develop their relationships make sure that where.
We're tracking that so that.
They they're being measured appropriately and that division decided to hire a few extra people to do that.
Another division that historically has been very efficient working capital optimization, just like the entire company. There have been cases, where we have to buy a whole bunch of inventory there.
It's not readily available at a time, where the price was high and you have to step up and pay up and take down a big volume wherever they probably got a little bit more than we needed to and there is a division that is watching and working capital like a hawk, so a little bit of a spike and then just whittle that down so.
Those are the individual things that people don't like a corporate edict, we're incorporating some technology or software to do it it's cultural it's it's people.
People have been divisions talking about working capital and making presentations in some cases about working capital to everybody from the sales guys down to the warehouse people and getting them to understand what if you can make this little tweak in the amount of product that you're sending to the rig.
This is the amount that it saves and actually showing them all of the whether it's the road wear every day of cash conversion cycle that they are saving us $6 million to $8 million on the balance sheet and that resonates and it doesn't have to come from Canada or total knee on the divisional presidents all of them.
And it gives people in those influential operational positions are understanding it because they are really smart and they're getting people to realize the implications of what they're doing on a day to day. So I would tell you that the law will be a handful, but it's it's it's our DNA. These early results oriented people.
Got it and want to continue to help drive the shift in the same direction. This quarter was an example of that from a working capital perspective.
That's fantastic color I appreciate it.
Thanks for taking my questions.
The next question is from Jonathan Goldman with Scotia Bank. Please go ahead.
Hi, good morning, guys.
A lot of my questions have already been asked but I was wondering if you can provide some high level color on the relationship between rig counts and fluid intensity.
Obviously, you don't breakout with drilling fluids versus production chemicals, but revenues were up 2% year on year, and a lower rig count environment, obviously production's up in rig counts are down are we at a point where fluid intensity has fully offset.
Declining rig counts, one to one or maybe even more than once a month.
We've been doing a bunch of math I'm not ourselves Jonathan trying to understand exactly the impact of intensity. There is definitely an impact that we see it in our magic number that we use.
Cash flow per day per rig.
It's been steadily increasing over the last six years at a pretty good rate. So we'd have a ballpark idea, but to give you an exact I think you know part of the offset and we've seen in revenue year over year was due to that and part of it was.
Due to production chemical performance, we don't break the two out so that the ratio has changed a little bit on the percentage of work that we're doing on the production chemical side, but hopefully you can get more clarity and color for you guys going forward on what we see as intensity because it's a phenomenon that's happening and we're noticing it on both sides of the border.
Perfect that makes sense and then maybe just another one on the margins you guys great job talking about the structural improvements in the business but.
Dan You mentioned these are the highest margins I think you said eight years, maybe it's about 2017.
You know Youre doing 14, plus in the LTM you were <unk> 13 in 2018 2019.
Is there anything structurally different in the operating environment, that's causing the higher margins or is it mostly internal initiatives on your part.
There's a lot of internal initiatives and a lot of things like Tony is talking about everyone is very focused on conversion cycle like practically a year ago, everybody was talking about where are we going to get product and how much did I order because we should get what we can get because of so short everywhere and nowadays when you walk around everywhere you talk within the company everyone's talking about how to.
How to be more efficient and what is the right level to be at and how thin can we run things and that makes a difference overall to cost of goods as well as our capital structure and then as.
As far as why are the margins expanded on a on a practical level.
I think efficiencies come with everything when you get volume we've been pretty good at focusing on reservoirs at areas throughout the business.
That has a has a partner as we continue to be really busy in those areas. We get really good at it fine tuning costs in order to lower the cost side not the sell side.
Okay I'm sorry.
With all the answers the 13th and a half to 14 and a half target I talk about we.
Everybody has specific margin targets to aim for that generally arrive in there and this quarter. It actually arrived at all higher than there, which just means everybody is getting more efficient at.
And maybe that will equate to a little better margins that are at the bottom end of our range, but we'll see.
Don't want to make too big a promises yet it's one quarter, but it's a positive. It was a positive result, and we look forward to continuing to trying to achieve.
Well it seems to be working thanks for taking my questions.
Yeah.
Once again, if you have a question. Please press Star then one.
The next question is from Michael Bunion, there with <unk> capital. Please go ahead.
Hey, good morning, Michael Yes, yes. Good morning can you hear me okay.
Yeah Yeah.
Terrific.
First of all congratulations.
A truly remarkable performance.
There were a lot of questions on margins.
I just want to point out that the math on incremental margins.
Showing that for the nine months.
Incremental margins were 23% and for the quarter, there were 57% which is outstanding.
It would tell businessmen that youre entering an incredibly profitable.
<unk>.
Which will also translate into significant free cash flow.
So the question I have is that as you think about this.
Next four quarters six quarters eight quarters.
You are in a cyclical business.
You've touched on the priorities in terms of offshore.
Can you share.
Philosophically how much do you think you will be able to spend on growth.
And how much do you think may be leftover.
And if you're thinking of the offshore how significant.
Could that business become over the next three years.
Yeah look at it.
Very difficult to predict.
Suffice to say, we're doing a whole bunch of work that.
Got it.
That is assessing the market size.
Chemicals end markets.
With America land Gulf offshore and in Middle East North Africa.
And.
If somebody is expecting a.
A swing for the fences M&A deal to get US there. That's that's not the direction, we're going what we're doing is supporting each other supporting the business units you mentioned the Gulf of Mexico. So, let's talk about that one where under the leadership of <unk> catalyst found an opportunity with pro flow.
Small.
Low risk <unk>.
$10 million issued sooner sooner financials to merger this partner last year in terms of what we paid for it and.
And we're taking a year, we took a year to learn a lot.
And and and and gaining a footing there with our with our understanding of the technical requirements with our understanding of the capital requirements and they're not massive Michael we're looking at ones and twos and threes to bring in that specialized.
Quality control equipment, two to bolster the potential lab capabilities and our and what we're finding is it's allowing us to be the next guy being called for potential work after Baker and champion for offshore.
Drilling density in this group is seeing that right now and <unk> kind of catalyst and.
And we're going to continue to grow that reputation bring them more in the fold and just like we did with aes over the last five six years and <unk> catalyst is in the middle really grow with that trajectory. So we still and we typically provided during Q4.
M DNA publication, but as Ken mentioned non cash out of the bag or probably looking at about 65 again next year and and if we saw another 10 ish opportunity to further grow into a very large very very large market like that offshore market and Gulf of Mexico.
You could see us spending it but only if it was a competitive use of capital I E. You would have to we'd have to exceed our internal hurdle rate of 15% for production related Capex big Capex projects and 20% for more cyclical.
<unk> drilling fluids.
Okay.
Can can you share your philosophy because.
Any way you look at.
The performance of the company its outstanding and it has just started.
And because you have executed.
Our cultural change the way people before them.
Operating level is clearly.
Resulting in significant cash flow generation and this conversion cycle is a fly on the wheel, which only will mean that you will be generating more cash.
And again I mentioned last night I spoke your EMEA spread which is the difference between the return on invested capital.
Weighted average cost of capital continues to be positive and increasing.
Persons by the way in 2015 16, whether it was negative.
<unk> to 19%.
Youll return on equity is now over 20%. My point is is that you're going to have a lot of cash to reinvest in the market is missing it.
Scary, you'll philosophy and.
The way, we believe you will prioritize cash spending.
Yeah.
Obviously person operation, but youre not going to be able to spend at all.
What is your philosophy or thinking what is the boards.
Our philosophy with the cameras.
Sure.
I'd like to take a bunch of credit for how things have gone in the last couple of years, but really the market has cooperated with US a lot of what's happened in the company.
It's a more it's like it's been a cultural change in the last couple of years, where everybody is pretty focused on details.
As leaders and managers of divisions and bps and divisions everybody's looking at the details that everyone's trying to optimize and we give clear instruction on the points. We're looking at specifically cash conversion cycle inventory levels margin targets those types of things.
And it's just it's well received and we have a great culture at CES when everybody's focused on it. So the results show for themselves do that everybody's input.
As far as where we're going to go on what we're going to do with the capital we create.
The group I would say my philosophy is that for this year and for next year, we're going to just continue to see what it gives us we've been through a lot of cycles and that's over the last 25 years I don't want to get ahead of yourself, but where there's opportunity in wireless confidence will enter and we understand we need to continue to grow and hence the small step we're taking in the haynesville.
But sort of a little bit of floating that we're starting to get in the in the Gulf Coast I'd say, the Haynesville has the potential to come on more immediately or in a quicker way like inside of a year potentially we could have some some sort of a footprint Gulf coast it might happen, but that's a longer term.
Difficult place to enter same with the middle East and as Tony keeps pointing out you know we're not looking for a swing for the fences kind of a transaction to just suddenly enter one of those markets. If one fell on her of Aqua and the price was right and the culture of the business that they were looking at fit our culture. We may look at it but we're not looking for that we're going to try and figure out how to.
Strategically enter and then we'll do what we did with the primary business will look at vertically integrating to ensure our supply chain will get into the market will get to know the customers will get that other competitors will get to understand how the business is done in a small way and then we'll look for opportunities to grow and we will do that through infrastructure inputs kind of like we did in north.
Erica if he goes barite grinding facility that occurred in first class.
Candidates when we go out into production chemicals didn't take us long to realize that needed to be basic in the chemistry silhouette and finally found the Jacob.
Steps like that so I wont say, we have a five year plan on how we're going to spend the capital, but assuming the capital keeps coming we'll find a way to reinvest that to make money with it.
Thank you so much and congratulations on excellent results on paying down debt.
Thank you thank you Michael.
This concludes our question and answer session I would like to turn the conference back over to Ken Zinger for any closing remarks.
Well with that I'm going to wrap up the call by saying. Thank you to everyone who took the time to join US today and we continue to be very optimistic about the future as discussed here at CES energy solutions and we look forward to speaking with you all again during our Q4 update in February of next year. Thank you.
This concludes today's conference call you may disconnect. Your lines. Thank you for participating and have a pleasant day.
Okay.
Yeah.
Yes.