High Arctic Energy Services Inc. released its fourth quarter and year-end results today. The audited consolidated financial statements, management discussion & analysis (“MD&A”), and annual information form for the year ended December 31, 2022 will be available on SEDAR at www.sedar.com, and on High Arctic’s website at www.haes.ca. All amounts are denominated in Canadian dollars (“CAD”), unless otherwise indicated.
Mike Maguire, Chief Executive Officer commented:
“High Arctic enters 2023 well positioned to increase our service activity in Papua New Guinea in support of the significant LNG commitments made by our customers there. High Arctic has developed a strong position in PNG through top-tier equipment, local logistics expertise and a loyal and well-trained local workforce.
The divestment of underperforming businesses in Canada has provided funds to pursue opportunistic growth in both our PNG and Canadian businesses and return value to shareholders, while weathering any market turbulence due to high inflation or recession.“
Highlights
The following highlights the Corporations results for Q4-2022 and YTD-2022:
• Disposition of underperforming assets in Canada for $38.2 million.
• Executed a strategic consolidation of the snubbing industry in Canada by partnering with Team Snubbing, a large snubbing specialist.
• Retained profitable Rental and Nitrogen Services businesses and real estate in Canada.
• After a slowdown prolonged by the pandemic in PNG, rig operations recommenced in 2022.
• In April, reinstated a monthly dividend of $0.005 per share and returned $2.2 million to shareholders.
• Generated Adjusted EBITDA of $5.7 million YTD-2022 and a negative Adjusted EBITDA of $0.9 million in Q4-2022 while realizing a net loss of $36.6 million YTD-2022 and net loss of $9.1 million Q4-2022.
• The significant loss was due to non-cash impairment expense of $9.7 million and elimination of $7.7 million deferred tax asset both associated with the Canadian business sales, a $3.9 million PNG inventory adjustment and obsolescence provision in Q4-2022 in PNG, and $17.7 million in depreciation expense.
Strategy
High Arctic’s 2023 Strategic Objectives build on the platform we created in 2022, and include:
• Safety excellence and quality service delivery,
• Redeployment of idled assets in PNG,
• Scaling our Canadian business,
• Opportunities for growth and corporate transactions that enhance shareholder value, and
• Examination of the Corporation’s optimal capital structure and dividend policy.
In the following discussion, the three months ended December 31, 2022 may be referred to as the “Quarter” or “Q4-2022”, and similarly the year ended December 31, 2022 may be referred to as “YTD-2022”. The comparative three months ended December 31, 2021 may be referred to as “Q4-2021” and similarly the year ended December 31, 2021 may be referred to as “YTD-2021”. References to other quarters may be presented as “QX-20XX” with X being the quarter/year to which the commentary relates.
Papua New Guinea – Drilling and Ancillary Services
Drilling Services activities rose in 2022 with PNG seeing drilling rig activity following a long period of relative inactivity during the Covid-19 pandemic. Early in 2022, the Corporation utilized Rig 115 to complete the abandonment of a complex legacy well for a key customer while in Q3-2022 the Corporation executed a three-year renewal of the contract for the provision of drilling services with its principal customer using Rig 103. 2022 also saw the Corporation take steps to formalize the provision of personnel services to the PNG industry following the success of doing the same in 2021. Provision of personnel to both key PNG customers remained strong throughout the year. With higher industry activity, the Corporation increased utilization of its rental equipment including camps, matting, and mobile material handling equipment. The combination of these service activities led to High Arctic achieving revenues of $30.7 million in 2022 as compared to $10.7 million in 2021 in its Drilling Services segment.
In 2022, the Papua-LNG joint venture entered front-end-engineering-and-design (“FEED”) and commenced early works activity, foreshadowing a final investment decision (“FID”) in the second half of 2023. The operator of the PNG-LNG joint venture announced the signing of a gas agreement for the development of the P’nyang gas field in the Western Province of PNG, which is anticipated to result in the addition of further gas liquefaction capacity in the world class PNG-LNG export facility.
In preparation for year-end verification and active drilling in 2023, High Arctic conducted comprehensive substantive procedures to verify the current asset carrying value of inventory. This resulted in a $3.9 million inventory adjustment in the fourth quarter of 2022.
Canada – Production and Ancillary Services
On July 27, 2022, High Arctic executed two separate asset sales transactions resulting in the effective divestment of the Corporation’s Production Services segment (the “Sale Transactions”).
The Canadian well servicing business was sold for an aggregate purchase price of $38.2 million to be settled in cash consideration. The Well Servicing Transaction involved the sale of well servicing rigs, associated rental equipment, and real estate used in the support of these operations along with the transfer of field personnel and a large majority of the office support personnel. The sale price was $38.2 million, which resulted in impairment of $9.0 million recognized in 2022. The well servicing business was originally purchased by the Corporation in August 2016 for $42.8 million in cash with a non-cash $12.7 million gain on the acquisition booked to PP&E.
The Canadian snubbing business was sold to Team Snubbing for a consideration consisting of 42% equity ownership in the post-closing outstanding shares in Team Snubbing, valued at $7.7 million, and a convertible promissory note of $3.4 million. The note has a five-year term, with interest accruing at 4.5% from January 1, 2023, and principal repayments commencing July of 2024. High Arctic’s investment in the share capital of Team Snubbing allows for significant influence of key corporate, strategic and financial decisions and High Arctic has rights to the net assets of Team Snubbing. The sale resulted in a 2022 impairment loss of $0.7 million.
High Arctic retains its Ancillary Services Segment in Canada comprised of the Nitrogen Pumping business and a Rentals business focused on pressure control equipment.
As a result of the Sale Transactions, the Corporation has a significantly reduced Canadian business and has written down the deferred tax assets of $7.7 million while retaining $126.7 million of operating tax loss carry-forward in Canada. Additionally, the $37.0 million revolving bank loan credit facility was terminated effective July 28, 2022.
Three-month period ended December 31, 2022 Summary:
• High Arctic’s consolidated revenue for Q4-2022 reduced to $13,099 from $23,644 in Q4-2021, impacted largely by the Sale Transactions.
• Low margin reimbursable activity with customers combined with inventory adjustments relating to stock held in PNG reduced consolidated oilfield services operating margin as a percentage of revenue for Q4-2022 to (18.5)% from 19.9% in Q4-2021.
• Delay in the recommencement of Rig 103 in PNG contributed to a net loss of $9,103 in Q4-2022 versus a net loss of $4,608 in Q4-2021. Adjusted EBITDA for Q4-2022 was a loss of $892, compared to a profit of $1,836 in Q4-2021.
• Inventory count and obsolescence reviews conducted in PNG, led to an inventory adjustment of $4,450 and a reduction in the obsolescence provision of $579.
Year ended December 31, 2022 Summary:
• Higher drilling related activity in PNG more than offset the reduction in Canadian well servicing and snubbing revenue following the sale of these Canadian assets during Q2-2022 leading to consolidated revenue for 2022 of $80,020 as compared to $76,442 in 2021.
• Adjusted EBITDA delivered by the Corporation in 2022 was $5,664, compared to $4,918 in 2021.
• The Sale Transactions and costs associated with reactivation of drilling equipment in PNG contributed to a reduction in consolidated oilfield services operating margin as a percentage of revenue to 14.9% in 2022 from 19.9% in 2021.
• Non-cash impairment expense of $9,667 associated with the disposal of assets through the Sales Transactions, recognition of a non-cash deferred tax expenses on the elimination of a deferred tax assets of $7,743 associated with the Canadian operations, and PNG inventory adjustment and obsolescence provision of $3,871 contributed to the increase in net loss for 2022 to $36,583 compared with the net loss of $18,607 recorded in 2021.
Drilling Services Segment
The Bank of PNG continues to encourage the use of the local market currency, Kina or PGK. Due to High Arctic’s requirement to transact with international suppliers and customers, High Arctic has received approval from the Bank of PNG to maintain its USD account within the conditions of the Bank of PNG currency regulations. The Corporation continues to use PGK for local transactions when practical. Included in the Bank of PNG’s conditions is for PNG drilling contracts to be settled in PGK, unless otherwise approved by the Bank of PNG for the contracts to be settled in USD. The Corporation has historically received such approval for its contracts with its key customers in PNG. The Corporation will continue to seek Bank of PNG approval for future customer contracts to be settled in USD on a contract-by-contract basis, however, there is no assurance the Bank of PNG will continue to grant these approvals.
If such approvals are not received, the Corporation’s PNG drilling contracts will be settled in PGK which would expose the Corporation to exchange rate fluctuations related to the PGK. In addition, this may delay the Corporation’s ability to receive USD which may impact the Corporation’s ability to settle USD denominated liabilities and repatriate funds from PNG on a timely basis. The Corporation also requires the approval from the PNG Internal Revenue Commission (“IRC”) to repatriate funds from PNG and make payments to non-resident PNG suppliers and service providers. While delays can be experienced for the IRC approvals, all such approvals have eventually been received in the past.
Operating Activities
Q4-2022 cash flow from operating activities was $501 (Q4-2021: $3,472 cash flow used in operating activities), of which $8,540 are cash inflows from working capital changes (Q4-2021: $4,862 outflow) partially offset by $8,039 funds flow used in operations (Q4-2021: $1,390 fund flow from operations) mainly due to decrease in inventory and trade accounts receivable during the Quarter.
YTD-2022 cash flow from operating activities was $7,863 (YTD-2021: $1,797 cash flow used in operating activities), of which $10,843 are cash inflow from working capital changes (YTD-2021: $5,494 outflow) and $2,980 are funds flow used in operations (YTD-2021: $3,697).
Investing Activities
During Q4-2022, the Corporation’s cash used in investing activities was $61 (Q4-2021: $2,722). Capital expenditures were $97 (Q4-2021: $3,134), partially offset by proceeds on disposal of property and equipment of $36 (Q4-2021: $213). In Q4-2022, no working capital balance changes for capital items (Q4-2021: $199 inflow).
YTD-2022 the Corporation’s cash from investing activities was $6,652 (YTD-2021: $5,572 used). Proceeds on disposal of property and equipment mainly related to the Well Servicing Transaction was $11,401 (YTD-2021: $1,196), partially offset by capital expenditures of $4,073 (YTD-2021: $7,242), and $676 cash outflow relating to working capital balance changes for capital items (YTD-2021: $474 inflow).
Financing Activities
Q4-2022, the Corporation’s cash used in financing activities was $4,523 (Q4-2021: $2,088). During the quarter, the Corporation made mortgage principal repayments of $3,646, see “Mortgage Financing below”, dividend payments of $975 (Q4-2021: $9,747), and $98 inflow for adjustments to lease financing payment schedules post-Sale Transactions and other payments for share cancellations (Q4-2021: $416 outflow lease payments). The Corporation did not enter into any new debt financing arrangements in Q4-2022 (Q4-2021 - $8,075 proceeds mortgage financing.)
YTD-2022, the Corporation’s cash used in financing activities was $6,737 (YTD-2021: $13,389). During the period, the Corporation made principal payments on mortgage financing of $3,861, see “Mortgage Financing” below (YTD-2021: $10,000 loan payment on Credit Facility), dividend payments of $2,193 (YTD-2021: $9,747), lease payments of $866 (YTD 2021: $1,615), and share repurchases for cancellation of $60 (YTD-2021: $102). The Corporation did not enter into any new debt financing arrangements in 2022 (YTD-2021 - $8,075 proceeds mortgage financing).
Mortgage Financing
In December 2021, High Arctic entered into a mortgage arrangement with the Business Development Bank of Canada (BDC) for $8,100, secured by lands and buildings owned and occupied by High Arctic within Alberta. The mortgage financing provides the Corporation with long term liquidity and adds to existing cash balances. The mortgage has an initial term of 5 years with a fixed interest rate of 4.30% and an amortization period of 25 years with payments occurring monthly. In January 2023, High Arctic transferred title to certain owned real estate locations to the purchaser of the well servicing business, in preparation, the Corporation paid mortgage principal of $3,565 related to these properties during December, 2022.
The Corporation capitalized $25 in financing fees incurred to set up the loan in 2021 and applied this to the long-term debt liability. Financing fees will be amortized over the expected life of the mortgage financing.
Outlook
The Corporation begins 2023 with a strong balance sheet, access to substantial cash resources on hand and is well positioned. This enables High Arctic to pursue opportunistic growth in both our PNG and Canadian businesses return value to shareholders, and weather market turbulence due to high inflation or recession.
The fundamentals for sustained high LNG demand, particularly in Asia, positions PNG for substantive LNG export growth. The advancement of the TotalEnergies led Papua-LNG project’s FEED continues with early-works activity underway and an FID on the multi-train project expected in the 2nd half of 2023. This project is expected to be followed by the P’nyang gas field development in the Western Province of PNG, which is anticipated to result in the addition of further gas liquefaction capacity in the world class PNG-LNG export facility. These developments underpin our optimism of an expanding PNG energy sector and increasing future demand for our equipment, personnel and expertise.
To date, the recommencement of drilling activity has been slower than the Corporation anticipated. Currently, customer plans have deferred mobilisation of Rig 115, and both Rig 115 and Rig 116 remain preserved in condition ready to be deployed. The positive effect of the slower ramp up in activity is that the Corporation expects to be able to fund reactivation activities out of PNG cash flow. With the modification and upgrade works completed, Rig 103 commenced drilling operations last week. Given PNG market conditions and current customer plans, we expect Rig 103 to operate consistently through the term of its contract, which is up for renewal in 2025.
Notwithstanding the foregoing, High Arctic recently received advise from the PNG Central Bank instructing the Corporation to settle our contract for Rig 103 in PNG Kina. The Corporation observes that this follows similar well publicized instructions issued by the PNG Central Bank to other large PNG companies. High Arctic has engaged dialogue with the bank aimed at reinstating approval to settle the contract in USD, dialogue is ongoing. Meanwhile the Corporation has taken steps to minimise the impact of any currency conversion delays on its business.
High Arctic maintains a presence in the Canadian market, through its investments in Team Snubbing, HAES rentals and our nitrogen pumping operations. Canada is the world's fourth-largest producer of oil and gas, with vast reserves and additional export pathways coming onstream in the coming years. We continue to evaluate opportunities for investment as they arise in the Canadian market, while remaining attentive to opportunities to best realize a return on the investments in our existing Canadian service lines, and the inactive snubbing assets in the USA.
