HSE reports improved operating margins in Q1 2010 financial results
CALGARY, May 12 /CNW/ - HSE Integrated Ltd. ("HSE" or the "Company") today released its financial results for the first quarter of the current fiscal year, the three month period ended March 31, 2010.
Revenue declined by 6.7% from $22.4 million in Q1 2009 to $20.9 million in Q1 2010. This reduction in revenue was caused primarily by service pricing reductions in markets related to conventional and non-conventional oil and gas to assist clients in adjusting to reduced commodity prices, and a shift from safety-intensive sour natural gas drilling and completions towards sweet crude oil drilling.
Despite the reduced revenue, the Company's operating margin increased by 60% from $2.0 million (8.9%) in 2009 to $3.2 million (15.3%) in the current year. This is a result of HSE's cost mitigation and efficiency initiatives and a significant improvement in the performance of the Company's U.S. operations.
EBITDA was approximately seven times higher in quarter one 2010 than the comparative quarter in 2009, rising from ($0.2) million (-1.0%) in 2009 to $1.2 million (5.8%) in Q1 2010, a $1.4 million improvement. This was a combination of improved operating margin and a further reduction of SG&A expenses which declined a further $0.2 million year-over-year to $2.0 million.
Despite the improvement of the operating and EBITDA margins, the Company incurred a loss of $0.2 million or ($0.01) a share. This compares to a loss of ($1.8) million or ($0.05) per share in the first quarter of 2009.
HSE's balance sheet and working capital position remain strong. Working capital (not including current portion of long-term debt) increased to $14.9 million at March 31, 2010 compared to $14.1 million at December 31, 2009. Total long term debt obligations (term debt, operating debt and capital leases) declined by $0.1 million to $6.3 million during the same period.
At March 31, 2010 net tangible assets (cash, accounts receivable, inventory, property plant and equipment) totaled $46.0 million. This exceeded all tangible liabilities (accounts payable, income taxes payable, long term debt, capital leases) of $11.5 million by $34.5 million or $0.92 per basic and diluted common share.
During the first quarter, Industrial health and safety services revenue declined 1.8% from $12.1 million in 2009 to $11.9 million in 2010. This was due primarily to pricing reductions to major clients in non-conventional oil development which offset a general recovery in business in all other Industrial markets.
Oilfield health and safety revenues declined 12.4% from $10.3 million in the first quarter of 2009 to $9.0 million this year. The primary drivers were pricing reductions to major clients, intense competition caused by sectoral overcapacity, and a significant shift to sweet conventional oil drilling and development away from safety-intensive sour natural gas activities.
David Yager, Chairman and CEO of HSE, had the following comments about the Company's financial performance.
"While there was a general recovery in the economy and business climate and all markets in which HSE operates in the first quarter of 2010 compared to the previous year, business challenges remain. To help our clients adjust to reduced prices and because of intense competition due to overcapacity relative to demand, HSE has reduced pricing. The other major change in the marketplace which is discussed in detail in the MD&A is the shift away from the development of natural gas - particularly safety-intensive hydrogen sulphide gas - towards sweet conventional crude oil. These developments offset a recovery quarter in all other markets.
Regardless, HSE's cost control and operating efficiency initiatives helped the Company improve operating margin and EBITDA. During the quarter the Company had one-time expenses of about $0.2 million related to preparing to convert to the International Financial Reporting Standards next year. Without this expense, HSE would have broken even on a profit/loss basis for the quarter despite the lowest first quarter revenue since 2005.
Going forward, the Company is continuing to see improvement in demand for services in most markets. Recovered crude oil prices combined with the fiscal policy changes introduced by the Alberta government have renewed interest in drilling in this province, HSE's major market for Oilfield health and safety services. While not as safety-intensive as historical activity, this market is nevertheless improved compared to last year. Industrial markets in Ontario, Atlantic Canada and the United States continue to expand. The outlook for the remainder of 2010 and beyond is stable to improving which will result in improved financial performance compared to 2009. Depressed natural gas prices, however, will continue to constrain a full recovery in this sector.
The Company's balance sheet remains strong. During the quarter the negotiation of a new senior credit facility allowed the transfer of most of the Company's bank debt from current to long-term. This became effective in early May but is reported as at March 31, 2010 on the financial statements. The $14.9 million working capital position leaves HSE in a good position to continue to exploit economic recovery as it takes place in all markets.
HSE continues to build on its "brand" as the only national supplier of a comprehensive suite of integrated health and safety services. The most encouraging development is larger clients understanding the merits of national service agreements and preferred supplier arrangements. These arrangements are not available to HSE's competitors. The Company's focused marketing efforts on large, national clients is intended to yield future positive financial performance."
Conference Call Thursday May 13, 2010 9 AM MDT
On May 13, 2010 David Yager, CEO, and Lori McLeod-Hill, CFO, will be hosting a conference call to discuss the Q1 2010 financial results.
Conference Call Time and Date: Thursday May 13, 2010 11:00 AM ET (9:00 AM MT)
Dial-In Number: 1-647-427-7450 (Toronto area) or 1-888-231-8191
Conference Replay to June 10, 2010: 1-416-849-0833 or 1-800-642-1687 (Passcode: 73247007)
Webcast: http://www.newswire.ca/en/webcast/viewEvent.cgi?eventID=3070100
About HSE
HSE is an integrated, national supplier of industrial Health, Safety and Environmental services. From its head office in Calgary, Alberta, it serves its clients from field service locations in Alberta, British Columbia, Saskatchewan, Ontario, Nova Scotia, New Brunswick, Newfoundland and Labrador and Michigan. HSE also operates in Texas through a jointly owned company called Boots & Coots HSE Services LLC. HSE trades on the TSX under the symbol "HSL".
Forward Looking Statements
This news release contains forward-looking information and statements (collectively "forward-looking statements") within the meaning of applicable securities laws concerning, among other things, the Company's prospects, expected revenues, expenses, profits, financial position, strategic direction, and growth initiatives, all of which are subject to risks, uncertainties and assumptions. These forward-looking statements are identified by their use of terms and phrases such as expect, anticipate, estimate, believe, may, will, would, could, might, intend, plan, continue, ongoing, project, objective and other similar terms and phrases. These forward-looking statements are based on certain assumptions and analyses made by the Company based on its experience and assessment of current conditions, known trends, expected future developments and other factors it believes are appropriate under the circumstances. Such forward-looking statements are subject to inherent risks and uncertainties. There is significant risk that the forward-looking statements will not prove to be accurate. Readers are cautioned not to place undue reliance on forward-looking statements as a number of factors could cause actual future results and events to differ materially from that expressed in the forward-looking statements. Accordingly this news release is subject to the disclaimer and qualified by the assumptions and risk factors referred to in the Management Discussion and Analysis in the 2010 first quarter report, in the 2009 annual report, and in other filings with securities commissions in Canada as reported in the Company's profile at www.sedar.com. Any forward-looking statements in this news release speak only as of the date of this news release. Except as required by law, the Company disclaims any intention to update or revise any forward-looking statements to reflect new events or circumstances
Non-GAAP Measures
This report makes reference to EBITDA, a measure that is not recognized under generally accepted accounting principles ("GAAP"). Management believes that, in addition to net earnings, EBITDA is a useful supplementary measure. EBITDA provides investors with an indication of earnings before provisions for interest, taxes, amortization, gains or losses on the disposal of property and equipment, foreign exchange gains or losses, and the non-cash effect of stock-based compensation expense. Investors should be cautioned that EBITDA should not be construed as an alternative to net earnings determined by GAAP as an indication of the Company's performance. This method of calculating EBITDA may differ from that of other companies and accordingly may not be comparable to measures used by other companies.
HSE Integrated Ltd.
Management Discussion and Analysis ("MD&A")
For the three month periods ended March 31, 2010 and 2009
The following management discussion and analysis is dated May 12, 2010 and is a review of the financial results of HSE Integrated Ltd. ("HSE", "We", "Our", or the "Company") for the three month periods ended March 31, 2010 and 2009. This MD&A should be read in conjunction with HSE's other documents filed on SEDAR at www.sedar.com. Unless otherwise disclosed, the financial information presented in this discussion has been prepared in accordance with Canadian generally accepted accounting principles ("GAAP") and takes into consideration information available to management up to May 12, 2010. Unless otherwise stated, dollar figures presented are expressed in thousands of Canadian dollars and per-share figures in dollars per weighted-average common share. The following MD&A contains forward-looking information and statements. We refer you to the end of the MD&A for the disclaimer on forward-looking statements.
SELECTED FINANCIAL INFORMATION
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Quarter Quarter Year-
ended ended over-
March 31, March 31, year %
2010 2009 change
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Revenue $ 20,907 $ 22,401 (6.7)%
Operating and materials 17,726 20,410 (13.2)%
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Operating margin 3,181 1,991 59.8%
Operating margin % 15.2% 8.9%
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Selling, general and administrative 1,959 2,207 (11.2)%
Net earnings (loss) (208) (1,806) (88.5)%
Per-share basic (0.01) (0.05)
Per-share diluted (0.01) (0.05)
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EBITDA(1) $ 1,222 $ (216) (665.7)%
EBITDA % 5.8% (1.0)%
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Total assets $ 51,023 $ 64,554 (21.0)%
Total long-term liabilities $ 8,690 $ 17,189 (49.4)%
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(1) See Non-GAAP Measures
FINANCIAL REVIEW
Overview
HSE provides a suite of integrated asset, worker and community health and safety protection services to the private and public sector including: onsite safety supervision; gas detection; fixed and mobile air quality monitoring; breathing equipment rentals and services; fixed and mobile firefighting and fire protection services and equipment; well control and blowout recovery; worker shower (decontamination) services; onsite medical services; first aid; emergency medical response; worker safety training; industrial hygiene services; and safety management.
Total revenue for the quarter decreased 6.7% from $22.4 million in 2009 to $20.9 million in 2010. Operating margin (revenue less operating expenses) of $3.2 million was 15.2% of revenues, up from $2.0 million or 8.9% of revenues in 2009. Selling, general and administrative expense ("SG&A") decreased to $2.0 million from $2.2 million in the prior year. As a percentage of revenue, SG&A decreased from 9.8% of revenue in fiscal 2009 to 9.4% in 2010. HSE reported a loss of $0.2 million or ($0.01) per share compared to a loss of $1.8 million or ($0.05) per share in the prior year. EBITDA(1) was $1.2 million or 5.8% of revenue in 2010 up 665.7% from ($0.2) million or (1.0)% of revenue in 2009.
Revenue
In terms of reporting, the Company provides health and safety services to customers in two main business areas: Industrial and Oilfield. The differentiation takes place primarily because of the activity drivers that affect demand. Demand for Oilfield health and safety services is highly cyclical due to external factors such as commodity prices, currency exchange, capital markets, and changing government policy. Industrial health and safety services are provided to a vast array of clients with the commonality of being less influenced by the external factors that make the Oilfield sector cyclical.
Industrial services are provided to customers operating in a wide variety of industries and the public sector including; non-conventional upstream oil development and production (including oilsands extraction); oil and gas processing and refining; petrochemicals; pulp and paper; utilities; power generation; agriculture food and beverage; offshore operations; and diverse manufacturing industries. Industrial also includes worker safety training and safety management services.
Oilfield health and safety services are exclusively employed by oil and gas exploration, drilling and production companies that operate within the conventional upstream, or "wellhead", sector of the oil and gas industry. This includes oil and gas well exploration, drilling, completion and workover operations.
The Company tracks billings to customers by defined revenue groupings, but uses a common pool of equipment and manpower resources to provide these services. Management and administration services are provided from a common personnel pool.
The revenue for these business areas is shown below:
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Quarter Quarter Year- Quarter Year-
ended ended over- ended over-
March 31, March 31, year % March 31, year %
2010 2009 change 2008 change
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Industrial $ 11,924 $ 12,141 (1.8)% $ 11,608 4.6%
Oilfield 8,983 10,260 (12.4)% 15,961 (35.7)%
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Total Revenue $ 20,907 $ 22,401 (6.7)% $ 27,569 (18.7)%
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As a percentage of
revenue:
Industrial 57.0% 54.2% 42.1%
Oilfield 43.0% 45.8% 57.9%
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Total Revenue 100.0% 100.0% 100.0%
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Industrial
The Industrial health and safety services component of the Company's total revenue declined slightly in the first quarter of 2010. Although there was a general recovery in the industries and geographical markets in which HSE operates, services supplied to oil and gas non-conventional extraction operations and hydrocarbon processing facilities were subject to pricing pressure which included price reductions to key clients. This offset modest growth on a year-over-year basis in other markets and industries.
Industrial revenue decreased $0.2 million or 1.8% of revenue to $11.9 million from $12.1 million in the prior year. Industrial health and safety services comprised 57.0% of total revenues, up from 54.2% in 2009. Because of growth initiatives in numerous non-Oilfield markets and the continued low price of natural gas, Industrial revenues will continue to be greater than Oilfield revenues for the foreseeable future.
Compared to the first quarter of 2009, there was a general recovery in all markets and industries. This included northeast Alberta where HSE serves the heavy oil thermal recovery and bitumen mining industries; petroleum refining and petrochemicals in Alberta, Ontario and Nova Scotia; and expanded market share in various industries in southern Ontario, Atlantic Canada and the U.S. industrial Midwest.
Oilfield
Oilfield revenues in the first quarter decreased by 12.4% compared to 2009. The primary causes were a reduction in drilling and the shift from natural gas exploration and development to crude oil in the Western Canadian Sedimentary Basin ("WCSB"), and pricing pressure caused by clients seeking lower vendor costs and intense competition due to excess capacity among competitors relative to current levels of demand.
The Canadian Association of Oilwell Drilling Contractors ("CAODC") reports wells drilled by type for each month of the year. In the first quarter of the current year the industry drilled a total of 3,133 wells compared to 4,434 for the same period in 2009, a 29% decline. However, there was a significant shift in wells drilled from gas to oil compared to prior years. In Q1 2010, 1,355 wells or 43% of all drilling were classified as oil wells. This compares to only 950 wells or 21% of wells drilled in the same period in 2009. At the same time, gas drilling fell over 50% from 2,994 gas wells in the first quarter to 1,490 for the same period of 2010. As a percentage of wells drilled, gas drilling fell from 68% of all Q1 drilling in 2009 to 48% of all drilling in 2010. The impact of this shift in drilling will be discussed in more detail in the Outlook section that follows.
The other major factors that affected Oilfield health and safety revenues were competition and pricing pressure from clients. To offset the decline in commodity prices, oil and gas exploration and production, companies are seeking lower input costs from their vendors across the board. Therefore, since the first quarter of 2009, HSE has reduced its service prices to secure continued business with key clients. This contributed to the year-over-year revenue reduction. Further, pricing pressure from competitors continued because the capacity in this sector significantly exceeds current demand.
In the United States Boots & Coots HSE Services LLC ("BCHSE"), the Company's venture with Boots & Coots, Inc., contributed $0.2 million to revenue as BCHSE continues to gain customer acceptance as a capable provider of worker and asset protection services.
During the period ended March 31, 2010, the Company had one customer representing more than 10% of revenue (2009 - one). The Company had sales of $2.3 million to the customer during the quarter.
Operating and Materials Expense and Operating Margin
Operating and materials expense consists of costs directly attributable to the delivery of health and safety services to customers. These include; wages and benefits for field employees and contractors; equipment rentals and leases; field service center property costs; transportation; fuel; consumables; equipment repairs and maintenance; and field office administration including field sales.
Operating and materials expense for the quarter ended March 31, 2010 totaled $17.7 million or 84.8% of revenue, as compared to $20.4 million or 91.1% of revenue in 2009. Operating margin for the period increased from $2.0 million (8.9% of revenue) in 2009 to $3.2 million (15.2% of revenue) in 2010.
The increase in operating margin is due to a significant improvement in the profitability of the Company's U.S. operations, rigorous control over all expenses, and the quarter being subject to the full impact of the service technician remuneration restructuring which did not take effect until the second quarter of 2009. Partially offsetting the salary expense savings was the first reversal of the salaried employee pay reduction instituted in 2009 to offset a significant decline in revenue caused by the global recession.
The allowance for doubtful accounts receivable was $1.3 million or 6.5% of trade accounts receivable at the end of the quarter compared to $1.3 million or 7.2% of trade accounts receivable at December 31, 2009. The days sales outstanding ratio improved substantially from 95 days in the first quarter of 2009 to 78 days for the same quarter in the current year.
Selling, General and Administrative Expense
Selling, general and administrative ("SG&A") expense consists of costs not directly attributable to the delivery of services to customers. These include executive management; corporate head-office functions and support services; administrative personnel; corporate sales and marketing costs; liability insurance; professional fees; and investor-relations expenses.
SG&A for the quarter totaled $2.0 million (9.4% of revenue), down from $2.2 million (9.8% of revenue) in the prior year. The reduction in SG&A is due to continued control over expenses. Preparing the Company for the adoption of International Financial Reporting Standards ("IFRS") in 2011 resulted in expenditures of $0.2 million in the first quarter of 2010.
EBITDA and Net Loss
Despite a 6.7% decline in revenue, EBITDA (see "Non-GAAP Measures") in the first quarter of 2010 increased significantly from the same period in 2009, rising to $1.2 million from negative EBITDA of $0.2 million in the prior year. The EBITDA margin was 5.8% for the quarter, lower than historical performance but much improved over the negative EBITDA margin in the first quarter of 2009. This EBITDA increase was the result of cost reductions, improved financial performance in the United States, and the implementation of a new variable cost structure for delivery of health and safety services.
Total amortization for the quarter was $1.6 million, down from $1.7 million in the first quarter 2009. Property and equipment amortization decreased in the current quarter to $1.4 million compared to $1.6 million in the prior year. HSE continues to tightly control capital additions. Intangible assets amortization remained consistent quarter-over-quarter.
Stock-based compensation for the quarter was $0.04 million (2009 - $0.05 million). The year-over-year decline is due to a reduction in the number of outstanding unvested options.
Interest on long-term debt and other interest and bank charges decreased from $0.15 million in 2009 to $0.1 million in 2010. The Company had significantly lower levels of overall debt throughout the current quarter than it had in 2009. Capital lease obligations at March 31, 2010 decreased by $0.7 million compared to the same quarter from the prior year. Long-term debt was reduced by $5.6 million compared to same quarter from the prior year.
For the first quarter of 2010, the gain on the disposal of property and equipment was $0.4 million with proceeds on sale of $0.4 million. Included in the $0.4 million were proceeds of $0.1 million related to the disposal of assets impaired at December 31, 2009. Contributing to the gain is the amortization of a deferred gain on sale/leaseback of real estate assets as discussed in the 2008 annual MD&A.
Net loss for the quarter was $0.2 million or ($0.01) per share versus a net loss of $1.8 million or ($0.05) per share in the same quarter from the prior year. The year-over-year improvement was primarily due to cost containment and significantly increased EBITDA as described above.
Liquidity and Capital Resources
The Company's principal sources of capital are cash flows from operations, borrowings under an established credit facility with its senior lender and equity financing.
The Company, through the conduct of its operations, has undertaken certain contractual obligations as noted in the following table:
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Years ended December 31 2010 2011 2012 2013 2014 Total
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Capital lease
obligations $ 160 $ 105 $ 14 $ 3 $ - $ 282
Vehicle and equipment
operating leases 1,992 1,992 790 24 1 4,799
Rental facilities 2,198 2,599 2,235 1,856 1,475 10,363
Long-term debt 668 2,123 1,304 1,304 736 6,135
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Total contractual
obligations $ 5,018 $ 6,819 $ 4,343 $ 3,187 $ 2,212 $21,579
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Liquidity
On July 29, 2009, the Company amended its existing credit facilities with its current lender. The amended facility consists of a single $15 million revolving operating facility. This facility, which matures July 27, 2010, is margined to property and equipment and accounts receivable. The facility bears interest at the bank's prime rate (or U.S. base rate) plus a fixed margin or at bankers' acceptance rates with a fixed stamping fee. An additional standby fee is also required on any unused portion of the credit facility. The facility is subject to certain covenants including a covenant with respect to the ratio of total liabilities to net worth (as defined in the agreement), a current-ratio covenant, an interest-coverage covenant and other positive and negative covenants. The credit facility is collateralized under a general security agreement. The Company complied with all covenants required under the credit facility.
At the end of the first quarter, the Company had cash on hand of $0.1 million.
On April 27, 2010, the Company entered into a new $15.0 million credit facility with a regional financial institution. The facility consists of a $10.0 million operating revolving loan facility for general operating purposes and a $5.0 million non-revolving term loan facility. The two facilities were used to retire the $5.3 million in existing bank debt.
The $5.0 million non-revolving term facility is repayable in monthly payments of $109 starting July 1, 2010. The facility is payable in full 48 months after initial drawdown. The $10.0 million operating revolving loan facility is renewable annually and is margined to accounts receivable. Both facilities are subject to certain financial, positive and negative covenants. The credit facilities are collateralized under a general security agreement.
Cash used in Operations
Cash used in operations in the quarter was $0.3 million in 2010 compared to $0.6 million provided by operations in 2009. Days-sales-outstanding ("DSO") improved significantly to 78 days at March 31, 2010 compared to 95 days at March 31, 2009.
Cash used in Financing and Investing
Purchases of property and equipment for the year amounted to $0.5 million, the majority of which was revenue-generating health safety services rental equipment. Proceeds from the disposal of property and equipment were $0.4 million.
Working Capital
At March 31, 2010, the Company had working capital (not including current portions of long-term debt obligations) of $14.9 million. This compares to $14.1 million on December 31, 2009. The increase from March 31, 2009 is related primarily to an increase in accounts receivable compared to the prior year and offset by an increase in accounts payable and accrued liabilities.
Outlook
On a year-over-year basis, the overall business climate in which HSE operated in the first quarter of 2010 was improved over the same period in 2009. The 2009 fiscal year began with collapsed commodity prices, restricted equity capital markets, tight credit and lending availability, reduced capital expenditures, plant closures, delayed or postponed oilsands projects, postponed plant shutdown and turnaround programs, layoffs, and high degrees of economic uncertainty. The focus of the Company in early 2009 was to reduce internal spending in every way possible in order to offset a decline in revenue.
As HSE entered 2010, the operating environment was much more favorable. Commodity prices, particularly crude oil, recovered from 12-month lows. Equity capital markets were functioning for the right investments, and debt markets had improved. Several new oilsands projects were announced or scheduled to begin. The Company had emerged from a difficult year with lower debt levels and a strong working capital position. This is a sound foundation from which to resume growth.
But challenges remained. Customers became increasingly price-sensitive to input costs from vendors like HSE. Overcapacity ensured a competitive marketplace. Downward re-pricing of services for key customers to maintain business eroded some of the competitive advantages the Company created with its cost-reduction strategies in 2009.
The Company's financial performance in the first quarter reflected both the opportunities and the challenges. The slight decline in overall revenue demonstrated the new realities of the post-recession business environment - competitive pricing, reduced margins and intense competition. However, the increased operating and EBITDA margins demonstrated that HSE has responded appropriately to the new realities in the marketplace.
Industrial
Health and safety products and services delivered to the broad customer segment that HSE characterizes as Industrial remained relatively stable in the first quarter of 2010 compared to the prior year. The modest $0.2 million decline in revenue was largely attributable to pricing reduction with clients related to non-conventional oil development. This overshadowed a modest increase in revenues in all other markets.
The oilsands and non-conventional thermal recovery market of northeast Alberta remains a stable market with a combination of growth opportunities and competitive challenges.
On the growth side, HSE continues to introduce new products and services that fulfill the corporate mission of assisting clients to cost-effectively meet their obligation to protect workers, assets and the community. The Company secured a 24/7/365 fire protection contract for a major asset. The pro-active worker health facility pilot project continues to gain user acceptance. Both have growth potential in this and other markets. New major capital projects announced by HSE clients in the first quarter indicate that the opportunities for growth remain.
On the competitive side, the oilsands region remains one of the few areas of significant economic growth in North America. Combined with the downturn in the conventional oil and gas regions of western Canada, this is attracting more competitors to the area than HSE has had in prior years. While the growth opportunities in this market remain significant, HSE's historic rate of growth may not be sustainable as competitors gain a larger share of this market than in previous years.
Other markets, however, continue to look promising. Assisted by more aggressive marketing and economic recovery, the industrial heartlands of Ontario and the U.S. Midwest should remain growth areas for the foreseeable future. The recession has caused industrial operators to re-examine all their costs. The largest supplier of health and safety services to industry remains the asset owners themselves. Clients seem more willing to examine outsource health and safety opportunities than in prior years.
Atlantic Canada remains a strong area for the Company. Established locations in Saint John, NB and Dartmouth, NS remain steady with operations in both provinces gaining new clients. The new service location in Newfoundland and Labrador is now a year old and revenues are increasing. Being in the three major marine centers for this region is adding an offshore element to HSE's services package beyond oil and gas that has potential in other markets such as Vancouver.
The public sector is also a large market opportunity in which HSE does not yet have a major presence. The various elements include facilities such as hospitals, schools, universities and office buildings; utilities such as water and waste treatment plants and power generation and distribution; and services which include police forces and the military. HSE had no market presence or marketing efforts in this large market only a few years ago. Today the public sector is a growing client base as both the Company and the public sector learn more about each other.
A major key to continued growth is the growing credibility of the HSE brand. New to the world when the name was created on September 1, 2004, HSE now has over five years of successful experience offering Canada's most comprehensive health and safety services package and consistently delivering good service at fair prices. Continued marketing efforts and growing recognition of HSE's capabilities provide a solid foundation for greater market and client penetration.
Oilfield
The Oilfield health and safety component of HSE's business is the legacy foundation where the Company started and was its dominant business area for many years. HSE expanded its Oilfield delivery capability from 2004 to 2007 through acquisitions and upgraded its capital asset fleet through capital investments in 2006 and 2007.
However, the core Alberta market which has been the historical driver for HSE's Oilfield business has changed entirely in the past three years on three fronts; gas, oil and profitability. These are discussed in detail below.
The commercialization of non-conventional shale gas has permanently changed the North American natural gas market, collapsing gas prices and moving exploration and development activities from Alberta to northeast B.C., Quebec, New Brunswick, the northeast United States, Louisiana and Texas. Two of HSE's core services - H2S protection and frac fire protection - are oriented towards conventional natural gas. From 1992 to 2008, about 70% of all the wells drilled in western Canada had natural gas as the target.
However, because of poor economics for gas development, the type of wells being drilled is changing. In the month of August 2009, there were more oil wells drilled in the WCSB than gas wells for the first time in 17 years. In the first quarter of 2010 the shift towards oil as the development target was evident. More detail on the shift in drilling is contained in the Revenue section earlier in this document.
The result has been an underutilization of these two asset classes in the Oilfield sector. While the air trailers and breathing apparatus used for H2S protection can and are used in Industrial markets, the utilization of the fire truck fleet remains a challenge. The recent redeployment of one of these units on a 24/7/365 asset protection contract in another market could be one solution. Moving them to other markets is another.
The application of horizontal/multi-frac drilling technologies, used to commercialize shale gas reservoirs, on mature oilfields has been a very positive development, particularly in Alberta. Opening up much more of the reservoir to the wellbore using these processes has resulted in some attractive crude oil production rates from fields that yield only modest levels of production using conventional drilling and production techniques.
Of interest to HSE is that some of these oil reservoirs are water sensitive, meaning that they will produce better if fractured with hydrocarbon fluids instead of water. Although the cost of large hydrocarbon fracs is much higher than water fracs, reservoir sensitivity to water may offset the additional cost of hydrocarbons. Hydrocarbon fracs need fire trucks. The application of these new drilling technologies to Alberta's old oilfields is in its infancy. Therefore, its impact on the Company's major underutilized asset class has yet to be determined.
The last element in the major change in HSE's core Alberta Oilfield health and safety business is the Alberta government's New Royalty Framework ("NRF"). Announced in late 2007 and passed into law on January 1, 2009, the NRF has had a negative impact on investment in Alberta in the past 2.5 years. Cognizant of the need to attract and retain investment capital, on March 11, 2010 the Alberta government announced the results of a six-month long Competitiveness Review ("CR") of oil and gas investments in Alberta versus other jurisdictions.
The CR announced that Alberta would introduce a permanent 5% maximum royalty as a capital recovery mechanism for all new wells drilled in Alberta. The CR also said it would review the royalty rates levied on oil and gas wells with the final results to be announced by June 2010. At the time of writing, the exact fiscal regime under which Alberta's conventional oil and gas industry will operate in the future remains unknown.
In summary, in Alberta the Oilfield part of HSE's business is undergoing a major transformation. While some elements such as the sharp decline in gas drilling and the reduced profitability caused by higher Crown royalties have been negative, the application of new drilling techniques to old oilfields and the willingness of the Alberta government to improve investment economics are positive. While there has been a sharp decline in the total number of wells drilled, the wells that are drilled are more expensive and, in certain cases, more safety intensive.
HSE is studying these market changes very closely and will make asset and resource allocation decisions once the impact on Oilfield activity and the Company's future is better understood.
United States
HSE now reports segmented financial information for its U.S. operations which comprise - CRS Technologies Inc. ("CRU") which operates from Taylor, Michigan (a suburb of Detroit), and Boots & Coots HSE Services LLC ("BCHSE") which operates from a head office in Houston, Texas.
On a year-over-year basis, HSE's U.S. operations are significantly improved although still modest on a consolidated basis. Revenue for the first quarter more than doubled to $0.6 million and the operating income was slightly positive compared to a loss of $0.4 in the first quarter of 2009.
The Company anticipates this trend will continue in the remainder of 2010. In the Industrial markets served from Michigan, marketing efforts with new clients in new areas are providing encouraging results.
In Oilfield markets served from Texas, a modest capital program will give BCHSE sufficient equipment to maintain a positive operating margin at current utilization rates. This will be completed in the second quarter of 2010.
On April 12, 2010 Boots & Coots, Inc. announced that it had entered into an agreement under which all of its shares would be acquired by Halliburton. If approved by shareholders, this transaction is expected to close in the summer of 2010. The impact of this transaction on HSE and BCHSE is not known at the time of writing.
Quarterly Results
2010 2009
-------------------------------------------------------------------------
Q1 Q4 Q3 Q2 Q1
-------------------------------------------------------------------------
Industrial $ 11,924 $ 12,533 $ 14,375 $ 15,249 $ 12,141
Oilfield 8,983 6,557 6,169 4,317 10,260
-------------------------------------------------
Total Revenue $ 20,907 $ 19,090 $ 20,544 $ 19,566 $ 22,401
Net earnings (loss) (208) (2,178) (722) (1,928) (1,806)
EBITDA(1) 1,222 496 1,016 (451) (216)
-------------------------------------------------
Income (loss) per share
- basic and diluted $ (0.01) $ (0.06) $ (0.02) $ (0.05) $ (0.05)
-------------------------------------------------------------------------
-------------------------------------------------------------------------
2008
-----------------------------------------------------
Q4 Q3 Q2
-----------------------------------------------------
Industrial $ 15,308 $ 16,163 $ 19,420
Oilfield 14,597 12,039 8,667
-----------------------------
Total Revenue $ 29,905 $ 28,202 $ 28,087
Net earnings (loss) 431 396 (568)
EBITDA(1) 2,713 2,858 2,187
-----------------------------
Income (loss) per share
- basic and diluted $ 0.01 $ 0.01 $ (0.02)
-----------------------------------------------------
-----------------------------------------------------
(1) See Non-GAAP Measures
HSE's business has two offsetting seasonal components. Revenue for Oilfield health and safety services is historically highest in first and fourth quarters and lowest in the second quarter because this sector uses equipment that can only access well locations during certain times of the year, and because of the effects of weather on field activity. Industrial revenue includes a mix of year-round contracts and "turnarounds" - scheduled major maintenance projects and repair activities on client facilities. These turnarounds tend to be scheduled during the second and third quarters to avoid the possibility of adverse effects from freezing weather. As a result, Industrial revenue tends to be highest in the second and third quarters.
Related-Party Transactions
During the period, the Company had the following transactions with related parties all of which are measured at exchange amounts.
- In the first quarter of 2010, the Company paid rent of $0.1 million
(2009 - $0.1 million) for a regional office to a corporation related
to a Director of the Company.
- In the first quarter of 2010, the Company also paid rent of
$0.1 million (2009 - $0.1 million) for a regional office to a
corporation controlled by a Senior Manager of the Company.
Critical Accounting Policies and Estimates
HSE prepares its consolidated financial statements in accordance with Canadian generally accepted accounting principles. In doing so, management is required to make various estimates and judgments in determining the reported amounts of assets, liabilities, revenues and expenses, as well as the disclosure of commitments and contingencies. Management bases its estimates and judgments on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Estimates and assumptions are reviewed periodically, and actual results may differ from those estimates under different assumptions or conditions. Management must use its judgment related to uncertainties in order to make these estimates and assumptions.
The accounting policies and estimates believed to require the most difficult, subjective or complex judgments and which are material to the Company's financial reporting results include: allowance for doubtful accounts, impairment of long-lived assets, amortization of property and equipment, and future income tax liabilities. A full description of the methods for determining these accounting policies and estimates as well as the risks related to the possible effects of changes in these policies and estimates, can be found in HSE's 2009 annual report.
Accounting Standards Pending Adoption
Business Combinations, Consolidated Financial Statements and Non-controlling Interests
In January 2009, the Canadian Accounting Standards Board ("AcSB") issued three new recommendations regarding business combinations, consolidated financial statements and non-controlling interests. While these standards are effective for fiscal years beginning on or after January 1, 2011, early adoption is permitted if all three standards are adopted simultaneously. The new standards include:
- Section 1582, which will replace Section 1581, deals with accounting
for business combinations. The new standard harmonizes Canadian
accounting standards with IFRS 3 - Business Combinations. Section
1582 is applicable prospectively to business combinations entered
into after adoption.
- Sections 1601 and 1602 together will replace existing section 1600.
Section 1601 provides standards for the preparation of consolidated
financial statements, while section 1602 provides standards with
respect to accounting for non-controlling interests in subsidiaries.
The new standard harmonizes Canadian accounting standards with
proposed revisions to IAS 27 - Consolidated and Separate Financial
Statements. It makes changes to the circumstances under which the
Company must consolidate an entity, as well as to disclosure
requirements.
The impact of these standards on the Company's financial statements will depend upon the timing and nature of any future acquisitions.
International Financial Reporting Standards
On February 13, 2008, the Canadian Accounting Standards Board ("AcSB") confirmed the requirement for all publicly accountable enterprises to adopt International Financial Reporting Standards ("IFRS") for fiscal years beginning on or after January 1, 2011. Effective January 1, 2011 HSE will be required to report its interim and annual financial statements in accordance with IFRS including comparative information for the 2010 period.
HSE has commenced the process to transition from current Canadian GAAP to IFRS. A project team led by Finance has been established. Representatives from other areas of HSE participate as required. A Steering Committee comprised of HSE Executives monitors the IFRS project on a monthly basis. Regular reporting to the Audit Committee and the Board of Directors on the status of the IFRS project has also been implemented.
HSE has developed a project plan that consists of three major phases: initial assessment, detailed assessment and design, and implementation.
Initial assessment - this phase involved performing a high-level impact assessment to identify the areas that would be affected by the transition to IFRS. As a result of these procedures, the potentially impacted areas were identified as high, medium and low impact. The level of impact was determined based on the relative significance of the account balance and the nature of the differences between current HSE accounting policies and the accounting policies required by IFRS.
Detailed assessment and design - this phase involves the identification of changes required to existing accounting policies, information systems and business processes, together with an analysis of policy alternatives allowed under IFRS and the development of a template for IFRS financial statements and notes. HSE's efforts are currently focused on this phase of the project.
Implementation - this phase includes execution of changes to information systems and business processes, completing formal authorization processes to formally approve recommended accounting policy changes, completion of the opening balance sheet and training programs for the finance group and other areas of the company as required.
Progress-to-date
HSE has identified differences between accounting policies under Canadian GAAP and accounting policy choices under IFRS, both on an ongoing basis and with respect to certain choices available on conversion as allowed or required by IFRS 1. HSE undertook an analysis of all applicable standards to confirm the classification of the differences as high, medium and low impact. Differences in accounting policies related to property and equipment, leases, impairments, stock-based compensation and financial statement and note disclosures have been identified as high and medium impact.
HSE continues to identify major components of property and equipment and to review useful lives and residual values for all of its assets. The Company has also begun calculations to determine the amount of any adjustments required to the opening IFRS balance sheet related to property and equipment. HSE expects to complete the above work by the end of second quarter 2010.
HSE has completed a review of all leased properties, vehicles and equipment to identify operating and finance leases. The Company has begun calculations to determine the amount of any adjustment required for the transition balance sheet.
Changes to the general ledger will be straightforward. The most significant system changes relate to the fixed asset sub-system. The Company must track all assets as required under current Canadian GAAP until January 1, 2011 and then under IFRS effective January 1, 2011. Throughout 2010 the Company must also compile the fixed asset information under IFRS to prepare a comparative year of financial information. HSE is preparing a detailed system plan including a test plan to address all three requirements.
HSE has completed a review of all new disclosures required under IFRS to identify any system or business process changes required. HSE is preparing a draft template for IFRS financial statements and notes. This is expected to be completed by the end of second quarter 2010. After the completion of each 2010 Canadian GAAP quarter end, HSE will prepare a set of IFRS compliant financial statements for the same quarters. The purpose of this process is to build the 2010 comparatives required for 2011, identify where additional training of resources may be required, and to test the timelines required to meet 2011 interim and annual reporting deadlines.
As the review of accounting policies is completed, the policies are approved and differences are quantified, appropriate changes to ensure the integrity of internal control over financial reporting and disclosure controls and procedures will be made. The certifying officers plan to complete the design, and initially evaluate the effectiveness of new controls in the third and fourth quarter of 2010 to prepare for certification under IFRS in 2011. The Company will also ensure that its key stakeholders are informed about the anticipated effects of the IFRS transition.
The Company is required to meet various financial covenants included in its credit facility. There is a possibility that these covenants will be affected by required IFRS changes. A clause is included in the credit facility agreement allowing for a period of time to renegotiate affected covenants.
Work to be completed by the end of third quarter
- Formal approvals of recommended accounting policies and IFRS 1
elections by the Steering Committee and Board of Directors.
- Completion of draft template for IFRS financial statements and notes.
Initial reviews and approvals by the Steering Committee, Board of
Directors, and HSE's Auditors.
- Preparation of required transition disclosures and schedules.
- January 1, 2010 IFRS balance sheet prepared with quantification of
differences.
- Detailed system plan completed and testing underway.
Most adjustments required on transition to IFRS will be made, retrospectively, against retained earnings on the opening January 1, 2010 balance sheet. However, IFRS 1 First-Time Adoption of International Financial Reporting Standards provides entities adopting IFRS for the first time with a number of optional exemptions and mandatory exceptions, in certain areas, to the general requirement for full retrospective application of IFRS. The Company is analyzing the various accounting policy choices and will implement those determined to be the most appropriate in the circumstances. Significant exemptions available to HSE under consideration are:
- An exemption allowing business combinations to be accounted for under
IFRS standards starting at a date of the Company's choosing, rather
than requiring that all acquisitions be restated from inception as
they would have been under IFRS.
- An exemption allowing the Company to apply IFRS accounting for
stock-based compensation on a prospective basis for stock options
granted and unvested prior to transition.
- An exemption allowing an entity to value fixed asset components at
their fair value at the January 1, 2010 opening balance sheet, rather
than retrospectively restating amortization of components and
recording disposals and additions of components that were expensed as
required under Canadian GAAP.
Described below are the high priority areas where changes in accounting policies are expected to impact the Company's consolidated financial statements. The list below should not be regarded as a complete list of changes that will result from HSE's transition to IFRS. It is intended to highlight the areas that we consider most significant, however, an analysis of changes is still in progress and not all decisions have been made where choices of accounting policies are available. The differences described below are those existing based on Canadian GAAP and IFRS as of today.
Property, Plant and Equipment - IAS 16
IAS 16 defines property, plant and equipment as tangible items that are held for use in the production or supply of goods and services, for rental to others, or for administrative purposes, and are expected to be used during more than one year.
IFRS and Canadian GAAP contain the same basic principle for property, plant and equipment; however, there are some differences. IFRS requires that major components of an asset for which different depreciation methods or rates are appropriate to be depreciated separately and depreciation commences when the asset is available for use. IFRS also permits property, plant and equipment to be measured at fair value or at amortized cost.
As indicated above, IFRS 1 contains an elective exemption where the Company may elect to reset property and equipment, at its fair value on the date of transition, as its new cost basis.
Impairment of Assets - IAS 36
Canadian GAAP impairment testing compares the asset-carrying values with undiscounted future cash flows to determine whether impairment exists. If the carrying amount exceeds the recoverable amount, the carrying value is written down to estimated fair value.
IAS 36 uses a one-step approach for both testing for and measurement of impairment, with carrying values compared directly to the higher of fair value less costs to sell and value in use (calculated using discounted cash flows). This may result in more frequent impairments where carrying values of assets were previously supported under Canadian GAAP on an undiscounted cash-flow basis, but could not be supported under a discounted cash-flow basis.
IAS 36 also contains a requirement to reverse any previous impairment losses where circumstances have changed such that the impairments have reversed. Canadian GAAP prohibits the reversal of impairment losses.
Leases - IAS 17
IAS 17 classifies a lease as either a finance lease or an operating lease. In respect of lessors, there is a subcategory of finance lease for manufacturer or dealer leases.
Both Canadian GAAP and IFRS lease classification depend on whether substantially all the risks and rewards of ownership of a leased asset have been transferred from the lessor to the lessee, and are made at the inception of the lease. A number of indicators are used to assist in lease classification. However, under Canadian GAAP, in practice, the quantitative thresholds included in certain of the indicators are treated as "bright lines" and there are fewer indicators to be considered.
Immediate gain recognition from the sale and leaseback of an asset depends upon whether or not the sale takes place at fair value, and whether the leaseback is classified as an operating lease or finance lease.
Business Risks
The activities the Company undertakes involve a number of risks and uncertainties, some of which are: economic and market events including disruptions in international credit markets and reductions in macroeconomic activity; business cyclicality within the industries in which HSE's customers operate; competitive conditions including pricing pressures; risks of customer credit default; deterioration in the financial condition of financial institutions and insurance companies that HSE deals with; availability of financing at competitive rates; changes in foreign exchange rates and interest rates and litigation and contingencies. Additional risks and uncertainties that the Company may be unaware of, or that were determined to be immaterial may also become important factors that affect the Company. A discussion of the business risks faced by the Company is available in the Management Discussion and Analysis included in the Company's 2009 Annual Report.
Internal Control Over Financial Reporting
Changes in Internal Controls Over Financial Reporting During 2010
There have been no significant changes in the Company's internal control over financial reporting during the quarter ended March 31, 2010 that have materially affected, or are reasonably likely to materially affect, its internal control over financial reporting.
Common Shares Outstanding
At May 12, 2010 and December 31, 2009 there were 37,575,675 common shares outstanding. At March 31, 2010, the Company had options outstanding to issue 2,157,333 shares at a weighted-average exercise price of $1.55 per share. Of these options, 1,217,151 were exercisable. On April 5, 2010 an additional 715,000 stock options were granted at an exercise price of $0.49.
At May 12, 2010 there were 2,834,165 options outstanding at a weighted average price of $1.29 per share. Of these options, 1,397,965 were exercisable.
Non-GAAP Measures
This report makes reference to EBITDA, a measure that is not recognized under generally accepted accounting principles. Management believes that, in addition to net earnings, EBITDA is a useful supplementary measure. EBITDA provides investors with an indication of earnings before provisions for interest and bank charges, taxes, amortization, foreign exchange gains or losses, gains or losses on the disposal of property and equipment and the non-cash effect of stock-based compensation expense. Investors should be cautioned that EBITDA should not be construed as an alternative to net earnings determined by GAAP as an indication of the Company's performance. HSE's method of calculating EBITDA may differ from that of other companies and, accordingly, may not be comparable to measures used by other companies.
EBITDA Calculation
-------------------------------------------------------------------------
For the quarters ended March 31 2010 2009
-------------------------------------------------------------------------
Net earnings (loss) $ (208) $ (1,806)
Add (deduct):
Amortization 1,570 1,739
Stock-based compensation 41 50
Interest and bank charges 118 149
Foreign exchange loss (gain) (5) (1)
Gain (loss) on disposal of property and equipment (387) 93
Income tax 93 (440)
-------------------------------------------------------------------------
EBITDA $ 1,222 $ (216)
-------------------------------------------------------------------------
-------------------------------------------------------------------------
Quarterly EBITDA Calculation
-------------------------------------------------------------------------
2010 2009
-------------------------------------------------------------------------
Q1 Q4 Q3 Q2 Q1
-------------------------------------------------------------------------
Net earnings (loss) $ (208) $ (2,178) $ (722) $ (1,928) $ (1,806)
Add (deduct):
Amortization 1,570 1,618 1,650 1,692 1,739
Impairment of property
and equipment - 1,641 - - -
Impairment of goodwill
and intangible assets - - - - -
Stock-based compensation 41 43 101 99 50
Interest and bank
charges 118 135 140 120 149
Foreign exchange loss
(gain) (5) (8) (3) 12 (1)
Loss on disposal of
property and equipment (387) 57 35 126 93
Income taxes 93 (812) (185) (572) (440)
-------------------------------------------------------------------------
EBITDA $ 1,222 $ 496 $ 1,016 $ (451) $ (216)
-------------------------------------------------------------------------
-------------------------------------------------------------------------
-----------------------------------------------------
2008
-----------------------------------------------------
Q4 Q3 Q2
-----------------------------------------------------
Net earnings (loss) $ 431 $ 396 $ (568)
Add (deduct):
Amortization 1,399 1,821 1,920
Impairment of property
and equipment - - -
Impairment of goodwill
and intangible assets - - 100
Stock-based compensation 95 23 155
Interest and bank
charges 200 288 331
Foreign exchange loss
(gain) (35) 4 2
Loss on disposal of
property and equipment 193 129 326
Income taxes 430 197 (79)
-----------------------------------------------------
EBITDA $ 2,713 $ 2,858 $ 2,187
-----------------------------------------------------
-----------------------------------------------------
Forward-Looking Statements
Certain statements in this MD&A constitute forward-looking information and statements (collectively "forward-looking statements") within the meaning of applicable securities laws. These forward-looking statements concern, among other things, the Company's prospects, expected revenues, expenses, profits, financial position, strategic direction and growth initiatives, all of which involve known and unknown risks, uncertainties and other factors which may cause actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. When used in this MD&A, such forward-looking statements use such words as expect, anticipate, estimate, believe, may, will, would, could, might, intend, plan, continue, ongoing, project, objective, should and other similar terms and phrases. This forward-looking information reflects the Company's current expectations regarding future events and operating performance based on assumptions and analyses made by the Company based on its experience and an assessment of current conditions, known trends, expected future developments and other factors which management believe to be appropriate under the circumstances. These forward-looking statements include among others:
- The oilsands and non-conventional thermal recovery market of
northeast Alberta remains a stable market with a combination of
growth opportunities and competitive challenges.
- HSE continues to introduce new products and services that fulfill the
corporate mission of assisting in clients to cost-effectively fulfill
their obligation to protect workers, assets and the community.
- HSE's historic rate of growth (Oilsands) may not be sustainable as
competitors gain a larger share of this market than in previous
years.
- Clients seem more willing to examine outsourced health and safety
opportunities than in prior years.
- Being in the three major marine centers for this region is adding an
offshore element to HSE's services package beyond oil and gas that
has potential in other markets such as Vancouver.
- Today the public sector is a growing client base as both the Company
and the public sector learn more about each other.
- The core Alberta market which has been the historical driver for
HSE's Oilfield business has changed entirely in the past three years
on three fronts; gas, oil, and profitability.
- The application of horizontal/multi-frac drilling technologies to
Alberta's old oilfields is in its infancy. Therefore, its impact on
the Company's major underutilized asset class has yet to be
determined.
- At the time of writing, the exact fiscal regime under which Alberta's
conventional oil and gas industry will operate in the future remains
unknown.
- HSE is studying these market changes (Oilfield) very closely and will
make asset and resource allocation decisions once the impact on
Oilfield activity and the Company's future is better understood.
- In the Industrial markets served from Michigan, marketing efforts
with new clients in new areas are providing encouraging results. The
Company anticipates this trend will continue in the remainder of
2010.
- In Oilfield markets served from Texas, a modest capital program will
give BCHSE sufficient equipment to maintain a positive operating
margin at current utilization rates. This will be completed in the
second quarter of 2010.
- On April 12, 2010 Boots & Coots, Inc. announced that it had entered
into an agreement under which all of its shares would be acquired by
Halliburton. If approved by shareholders, this transaction is
expected to close in the summer of 2010. The impact of this
transaction on HSE and BCHSE is not known at the time of writing.
The forward-looking statements contained in this MD&A reflect several material factors, expectations and assumptions including, without limitation: economic conditions within Canada and the United States, both in general and within specific industries; demand for the Company's services by customers in various industries and geographic locations; pricing levels for the Company's services; commodity prices; foreign currency exchange rates; interest rates; access to financing; the Company's future operating results and financial condition; and competition within particular markets or for particular services.
Forward-looking statements involve significant risks and uncertainties and should not be read as a guarantee of future performance or results, and will not necessarily be an accurate indication of whether or not such results will be achieved. A number of factors could cause actual results to differ materially from the results discussed in the forward-looking statements including, but not limited to, the factors discussed above and other risk factors discussed herein and listed from time to time in the Company's reports and public disclosure documents including its annual report, annual information form and other filings with securities commissions in Canada as reported under the Company's profile at www.sedar.com.
The Company cautions that the foregoing list of assumptions, risks and uncertainties is not exhaustive. The forward-looking statements contained in this MD&A speak only as of the date of this MD&A, and the Company assumes no obligation to publicly update or revise them to reflect new events or circumstances, except as may be required pursuant to applicable laws.
Additional Information
Additional information relating to HSE is available under our profile on the SEDAR website at www.sedar.com and www.hseintegrated.com.
HSE Integrated Ltd.
-------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEETS
-------------------------------------------------------------------------
(stated in thousands of dollars) (unaudited)
-------------------------------------------------------------------------
March 31, December 31,
2010 2009
-------------------------------------------------------------------------
ASSETS
Current
Cash and cash equivalents $ 70 $ 460
Accounts receivable (note 3) 18,194 16,156
Inventory 214 199
Prepaid expenses and other assets 1,608 1,654
Income taxes recoverable 261 398
----------------------
20,347 18,867
Property and equipment 27,548 28,595
Intangible assets 3,128 3,260
----------------------
$ 51,023 $ 50,722
----------------------
----------------------
LIABILITIES
Current
Accounts payable and accrued liabilities $ 5,314 $ 4,667
Income taxes payable 106 72
Current portion of obligation under capital leases 200 233
Current portion of long-term debt (note 4) 1,808 5,222
Current portion of deferred gain 137 137
----------------------
7,565 10,331
Deferred gain 284 319
Obligations under capital leases 82 122
Long-term debt (note 4) 4,268 818
Future income taxes 4,056 4,170
----------------------
16,255 15,760
----------------------
SHAREHOLDERS' EQUITY
Share capital (note 5) 60,040 60,040
Contributed surplus 4,804 4,755
Deficit (29,978) (29,770)
Accumulated other comprehensive income (loss) (98) (63)
----------------------
34,768 34,962
----------------------
$ 51,023 $ 50,722
----------------------
----------------------
Contingencies (note 7)
Subsequent events (notes 4 and 5)
-------------------------------------------------------------------------
See accompanying notes to the consolidated financial statements.
CONSOLIDATED STATEMENTS OF LOSS
-------------------------------------------------------------------------
(stated in thousands of dollars, except per-share amounts)
(unaudited)
-------------------------------------------------------------------------
Three month periods ended March 31 2010 2009
-------------------------------------------------------------------------
REVENUE $ 20,907 $ 22,401
----------------------
COSTS
Operating and materials 17,726 20,410
Selling, general and administrative 1,959 2,207
Amortization of property and equipment 1,438 1,611
Amortization of intangible assets 132 128
Stock-based compensation 41 50
Interest on long-term debt 83 131
Other interest and bank charges 35 18
Foreign exchange gain (5) (1)
(Gain) loss on disposal of property and equipment (387) 93
----------------------
21,022 24,647
----------------------
LOSS BEFORE INCOME TAX (115) (2,246)
----------------------
Income taxes
Current provision 191 -
Future reduction (98) (440)
----------------------
93 (440)
----------------------
NET LOSS $ (208) $ (1,806)
----------------------
----------------------
Loss per share
Basic and diluted $ (0.01) $ (0.05)
----------------------
----------------------
Weighted average shares outstanding
Basic 37,576 37,576
Diluted 37,576 37,576
-------------------------------------------------------------------------
See accompanying notes to the consolidated financial statements.
CONSOLIDATED STATEMENTS OF OTHER COMPREHENSIVE LOSS
-------------------------------------------------------------------------
(stated in thousands of dollars) (unaudited)
-------------------------------------------------------------------------
Three month periods ended March 31 2010 2009
-------------------------------------------------------------------------
Net Loss $ (208) $ (1,806)
Other comprehensive income
Unrealized loss on translating financial
statements of self-sustaining foreign operations (35) (42)
----------------------
Other comprehensive loss $ (243) $ (1,848)
-------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF DEFICIT AND ACCUMULATED OTHER COMPREHENSIVE
INCOME (LOSS)
-------------------------------------------------------------------------
(stated in thousands of dollars) (unaudited)
-------------------------------------------------------------------------
Three month periods ended March 31 2010 2009
-------------------------------------------------------------------------
Deficit, beginning of period $(29,770) $(23,136)
Net loss (208) (1,806)
----------------------
Deficit, end of period $(29,978) $(24,942)
----------------------
----------------------
Accumulated other comprehensive income (loss),
beginning of period $ (63) $ 124
Unrealized loss on translating financial statements
of self-sustaining foreign operations (35) (42)
----------------------
Accumulated other comprehensive income (loss),
end of period $ (98) $ 82
-------------------------------------------------------------------------
See accompanying notes to the consolidated financial statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------------------------------------------
(stated in thousands of dollars) (unaudited)
-------------------------------------------------------------------------
Three month periods ended March 31 2010 2009
-------------------------------------------------------------------------
Cash provided by (used in)
Operations
Net loss $ (208) $ (1,806)
Charges to income not involving cash:
Amortization 1,570 1,739
Stock-based compensation 41 50
Future income tax reduction (98) (440)
(Gain) loss on disposal of property and
equipment (387) 93
Change in non-cash working capital (note 9) (1,187) 945
----------------------
Cash provided by (used in) operations (269) 581
----------------------
----------------------
Financing
Repayment of obligations under capital leases (73) (351)
Repayment of long-term debt (8) (37)
Amortization of deferred financing fees 44 -
----------------------
Cash used in financing activities (37) (388)
----------------------
----------------------
Investing
Purchase of property and equipment (517) (464)
Proceeds from disposal of property and equipment 442 209
----------------------
----------------------
Cash used in investing activities (75) (255)
Cash flow from operating, financing and investing
activities (381) (62)
Effect of exchange rate on foreign currency held (9) 9
----------------------
----------------------
Net change in cash and cash equivalents (390) (53)
Cash and cash equivalents, beginning of period 460 1,114
----------------------
Cash and cash equivalents, end of period $ 70 $ 1,061
----------------------
----------------------
-------------------------------------------------------------------------
See accompanying notes to the consolidated financial statements.
HSE Integrated Ltd.
Notes to the Consolidated Financial Statements
For the three month periods ended March 31, 2010 and 2009
(stated in thousands of dollars) (unaudited)
-------------------------------------------------------------------------
NOTE 1 - BASIS OF PRESENTATION
These unaudited interim consolidated financial statements of HSE
Integrated Ltd. ("HSE" or "the Company") have been prepared following the
same accounting policies and methods of computation as the audited annual
consolidated financial statements of the Company for the year ended
December 31, 2009. The disclosures provided below are incremental to
those included with the audited annual consolidated financial statements
and certain disclosures which are normally required to be included in the
notes to the annual consolidated financial statements have been condensed
or omitted. These unaudited interim consolidated financial statements
should be read in conjunction with the audited consolidated financial
statements and notes for the Company for the year ended December 31,
2009.
These unaudited interim consolidated financial statements include the
accounts of the Company and its subsidiaries which, with the exception of
Boots & Coots HSE Services LLC (note 8), are wholly owned. Unless
otherwise specified all amounts are stated in thousands of Canadian
dollars except for per-share amounts, which are stated in dollars per
weighted-average share.
These consolidated financial statements have been prepared in accordance
with Canadian generally accepted accounting principles ("GAAP"). In
preparing these consolidated financial statements, management is required
to make estimates and assumptions that affect reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities as at
the date of the financial statements and the reported amounts of revenue
and expenses during the reported period. Actual results could differ from
these estimates.
HSE's business has two offsetting seasonal components. Revenue for
Oilfield health and safety services is historically highest in the first
and fourth quarters and lowest in the second quarter because this sector
uses equipment that can only access well locations during certain times
of the year and because of the effects of weather on field activity.
Industrial revenue includes a mix of year-round contracts and
"turnarounds" - scheduled major maintenance projects and repair
activities on client facilities. These turnarounds tend to be scheduled
during the second and third quarters to avoid the possibility of adverse
effects from freezing weather. As a result, Industrial revenue tends to
be highest in the second and third quarters.
NOTE 2 - CHANGE IN ACCOUNTING POLICIES STANDARDS
Accounting Standards Pending Adoption
Business Combinations, Consolidated Financial Statements and
Non-controlling Interests
In January 2009, the AcSB issued three new recommendations regarding
business combinations, consolidated financial statements and
non-controlling interests. While these standards are effective for fiscal
years beginning on or after January 1, 2011, early adoption is permitted
if all three standards are adopted simultaneously. The new standards
include:
- Section 1582, which will replace Section 1581, deals with accounting
for business combinations. The new standard harmonizes Canadian
accounting standards with IFRS 3 - Business Combinations. Section
1582 is applicable prospectively to business combinations entered
into after adoption.
- Sections 1601 and 1602 together will replace existing section 1600.
Section 1601 provides standards for the preparation of consolidated
financial statements, while section 1602 provides standards with
respect to accounting for non-controlling interests in subsidiaries.
The new standard harmonizes Canadian accounting standards with
proposed revisions to IAS 27 - Consolidated and Separate Financial
Statements. It makes changes to the circumstances under which the
Company must consolidate an entity, as well as to disclosure
requirements.
The impact of these standards on the Company's financial statements will
depend upon the timing and nature of any future acquisitions.
NOTE 3 - FINANCIAL RISK MANAGEMENT
Overview
The Company is exposed to the following risks from its financial
instruments:
- credit risk
- liquidity risk
- market risk
The Board of Directors has overall responsibility for the establishment
and oversight of the Company's risk-management framework. The Company's
Audit Committee oversees how management monitors compliance with the
Company's risk-management practices and reviews the adequacy of the
risk-management framework in relation to the risks faced by the Company.
The Company's risk-management practices are established to identify and
analyze the risks faced by the Company, to set appropriate risk limits
and controls, and to monitor risks and adherence to limits.
Credit risk
Credit risk is the risk of financial loss to the Company if a customer or
counterparty to a financial instrument fails to meet its contractual
obligations, and arises principally from the Company's receivables from
customers.
The Company's accounts receivable are due from customers in a variety of
industries including a significant proportion with customers operating in
the energy and manufacturing industries. The ability of customers within
the energy industry to pay us is partially affected by fluctuations in
the price they receive for various hydrocarbon products. The maximum
credit exposure associated with trade accounts receivable is the carrying
value.
The Company follows a credit policy under which the Company reviews each
new customer individually for credit worthiness before the Company's
standard payment and delivery terms and conditions are offered. The
Company's review includes external ratings, where available, and trade
references. Customers that fail to meet the Company's credit worthiness
criteria may transact with the Company only on a prepayment basis. On an
ongoing basis, the Company also reviews the payment patterns of its
existing customers and the customers' continued credit worthiness.
Trade accounts receivable are recorded at the invoiced amount and do not
bear interest. The allowance for doubtful accounts is the Company's best
estimate of the amount of probable credit losses in the Company's
existing accounts receivable. The Company determines the allowance by
reviewing individual accounts past due for collectability, historical
write-off experience, and overall account aging. The Company reviews its
allowance for doubtful accounts on an ongoing basis, but at least
monthly.
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March 31, December 31,
2010 2009
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Trade accounts receivable $ 19,449 $ 17,416
Allowance for doubtful accounts (1,255) (1,260)
----------------------
Total trade accounts receivable $ 18,194 $ 16,156
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The aging of trade receivables from the invoice date is as follows:
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March 31, 2010 December 31, 2009
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Past due: Gross Allowance Gross Allowance
------------------------------------------------
0 - 30 days (current) $ 12,185 $ - $ 7,938 $ -
31 - 60 days 5,083 - 5,135 3
61 - 120 days 1,190 264 3,433 347
More than 120 days 991 991 910 910
------------------------------------------------
Total $ 19,449 $ 1,255 $ 17,416 $ 1,260
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The movement in the allowance for doubtful accounts receivables in
respect of trade receivables during the period is as follows:
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2010 2009
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Balance, January 1 $ 1,260 $ 1,405
Bad-debt provision 88 95
Write-offs net of recoveries (93) (10)
----------------------
Balance, March 31 $ 1,255 $ 1,490
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Liquidity risk
Liquidity risk is the risk that the Company will not be able to meet its
financial obligations as they fall due. The Company requires liquidity to
meet financial obligations as they come due and to fund our investing
activities.
The Company's contractual financial liabilities include interest
payments, trade and other payables, income taxes payable, secured
equipment loans, a revolving operating line of credit margined to
accounts receivable and property and equipment and capital leases for
equipment (note 4).
The Company's approach to managing liquidity is to ensure, to the extent
possible, that it will always have sufficient liquidity to meet its
liabilities when due, under both normal and distressed conditions,
without unacceptable losses or risking damage to the Company's
reputation. The Company generally relies on operating cash flow to
provide liquidity to meet its financial obligations. As well, the Company
had access to undrawn operating lines of credit of $9.7 million and cash
on hand of $70 at March 31, 2010.
On April 27, 2010, the Company entered into a new credit facility
(note 4).
Market risk
Market risk is the risk that changes in market prices, such as foreign
exchange rates, interest rates and equity prices will affect the
Company's income.
HSE is exposed to currency risk on U.S.-dollar denominated financial
assets and liabilities. The Company adjusts the reported amounts of
foreign-currency denominated financial assets and liabilities to their
Canadian-dollar equivalent at each balance sheet date. For amounts held
directly by the Company, any related foreign exchange gains and/or losses
are recognized in the consolidated statement of earnings. For amounts
held by the Company's self-sustaining foreign operations, the amount is
included in other comprehensive income. At March 31, 2010, the extent of
this exposure was not material.
HSE is exposed to interest rate risk on its prime-based revolving
operating facility. Based on amounts outstanding at March 31, 2010, a 1%
increase in the average prime interest rate for the year would cost the
Company $53 annually in additional interest expense.
NOTE 4 - OPERATING FACILITIES AND LONG-TERM DEBT
On July 29, 2009, the Company amended its existing credit facilities with
its current lender. The amended facility consists of a single
$15.0 million revolving operating facility which matures July 27, 2010.
The credit facility bears interest at the bank's prime rate (or U.S. base
rate) plus a fixed margin or at bankers' acceptance rates with a fixed
stamping fee. An additional standby fee is also required on any unused
portion of the credit facility. The amended facility is margined to
property and equipment and accounts receivable. It is subject to certain
covenants including a covenant regarding the ratio of total liabilities
to net worth (as defined in the agreement), a current-ratio covenant, an
interest-coverage covenant and other positive and negative covenants. The
credit facility continues to be collateralized under a general security
agreement. The Company has complied with all covenants required under the
amended credit facility to March 31, 2010. Deferred financing costs
associated with the credit facility have been shown as a reduction in the
carrying value of long-term debt and are being expensed over the term of
the debt using the effective-interest-rate method.
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March 31 December 31
2010 2009
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Equipment financing contracts bearing interest at
rates averaging 3.36% (2009 - 3.15%), payable in
blended monthly payments of $4 (2009 - $11)
secured by specific equipment $ 25 $ 33
Interest-only facility 5,300 5,300
----------------------
5,325 5,333
Accrued consideration on share-purchase acquisition 810 810
----------------------
6,135 6,143
Less unamortized debt-issue costs (59) (103)
Less current portion (1,808) (5,222)
----------------------
$ 4,268 $ 818
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Outstanding principal repayments are due as follows:
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Years ended March 31
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2011 $ 1,808
2012 1,309
2013 1,304
2014 1,304
2015 410
---------
6,135
Less: current portion and unamortized debt-issue costs (1,867)
---------
$ 4,268
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On April 27, 2010, the Company entered into a new $15.0 million credit
facility with a regional financial institution. The facility consists of
a $10.0 million operating revolving loan facility for general operating
purposes and a $5.0 million non-revolving term loan facility. The two
facilities were used to retire the $5.3 million in existing bank debt.
The $5.0 million non-revolving term facility is repayable in monthly
payments of $109 starting July 1, 2010. The facility is payable in full
48 months after initial drawdown. The $10.0 million operating revolving
loan facility is renewable annually and is margined to accounts
receivable. Both facilities are subject to certain financial, positive
and negative covenants. The credit facilities are collateralized under a
general security agreement.
NOTE 5 - SHARE CAPITAL AND STOCK-BASED COMPENSATION PLANS
At March 31, 2010 there were 37,575,675 common shares of the Company
outstanding (December 31, 2009 - 37,575,675).
At March 31, 2010, the Company had options outstanding to issue 2,157,333
shares (December 31, 2009 - 2,375,333) at a weighted average price of
$1.55 per share (December 31, 2009 - $1.56). Of these options, 1,217,151
were exercisable (December 31, 2009 - 1,360,315). On April 5, 2010 there
were 715,000 stock options granted.
Deferred Share Units
For the 2010 and 2009 years, the directors' retainers and meeting fees
are being paid with deferred share units (DSU's). The total DSU's
outstanding at March 31, 2010 were 195,443. On April 5, 2010 an
additional 103,263 DSU's were granted. The units are re-valued quarterly
and any change in value is included as an increase or decrease in stock
based compensation expense and accrued liabilities. The expense was
reduced by $8 for the quarter ended March 31, 2010 (quarter ended
March 31, 2009 - $3 expense)
NOTE 6 - RELATED-PARTY TRANSACTIONS
During the quarter, the Company had the following transactions with
related parties, all of which are measured at exchange amounts.
- In the first quarter, the Company paid rent of $60 (2009 - $57) for a
regional office to a corporation related to a Director of the
Company.
- In the first quarter, the Company also paid rent of $78 (2009 - $74)
for a regional office to a corporation controlled by a Senior Manager
of the Company.
NOTE 7 - CONTINGENCIES
In the ordinary course of business activities, the Company may be
contingently liable for litigation and claims with customers, suppliers,
former employees, and third parties. Management believes that adequate
provisions have been recorded in the accounts where applicable. Although
it may not be possible to estimate accurately the extent of potential
costs and losses, if any, management believes that the ultimate
resolution of such contingencies would not have a material effect on the
financial position of the Company.
NOTE 8 - SEGMENT INFORMATION
The Company operates in two main geographic areas: Canada and the United
States (U.S.). Each geographic area has a President responsible for the
operations and strategy of his area's business. Personnel working within
a particular region report to the President, and the President reports to
the Chief Executive Officer.
Within each geographic segment, the Company uses common resources to
provide services to a variety of customer industries. The Company groups
these customer industries into two categories. "Oilfield" services are
provided to customers in the conventional upstream, or "wellhead", sector
of the oil and gas industry. "Industrial" services are provided to
customers in a variety of other industries including: non-conventional
upstream oil development and production (including oilsands extraction);
oil and gas processing; petrochemicals; pulp and paper; utilities; power
generation; and manufacturing. It also includes worker safety training
and safety management services.
Corporate division expenses consist of salary expenses, stock
compensation, and office costs related to corporate employees, as well as
public company costs.
For the 3 months ended March 31, 2010, one customer provided more than
10% of the Company's revenue. Sales to this customer amounted to
$2.3 million during the quarter. For the period ended March 31, 2009, the
Company had one customer representing more than 10% of revenue. Sales to
this customer amounted to $2.3 million during the quarter.
On May 7, 2008, a new company called Boots & Coots HSE Services LLC
("BCHSE") was incorporated to pursue the expansion of Oilfield safety
services in the continental United States. The Company owns 100% of the
shares of HSE Integrated Inc. ("INC") a Delaware corporation that in turn
owns a 90% interest in BCHSE, a Delaware Limited Liability Company.
Boots & Coots Services, Inc. owns the remaining 10% interest. A
non-controlling interest has not been recorded as BCHSE has incurred
losses to date.
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March 31, 2010
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Canada U.S. Corporate Total
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Revenue
Oilfield $ 8,794 $ 189 $ - $ 8,983
Industrial 11,516 408 - 11,924
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Total revenue $ 20,310 $ 597 $ - $ 20,907
------------------------------------------------
Operating income
(loss)(1) $ 3,135 $ 46 $ (1,959) $ 1,222
Interest expense - - 118 118
Amortization of property
and equipment and
intangibles 1,547 23 - 1,570
Property and equipment 26,489 1,059 - 27,548
Intangibles 3,128 - - 3,128
Capital expenditures(2) 458 59 - 517
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(1) Operating income (loss) is defined as net income (loss) plus
amortization of property and equipment and intangibles, interest,
foreign exchange gains or losses, gains or losses on disposal of
capital assets, share-based compensation, and income taxes.
(2) Property and equipment for Corporate is included in Canada
-------------------------------------------------------------------------
March 31, 2009
-------------------------------------------------------------------------
Canada U.S. Corporate Total
------------------------------------------------
Revenue
Oilfield $ 10,242 $ 18 $ - $ 10,260
Industrial 11,867 274 - 12,141
------------------------------------------------
Total revenue $ 22,109 $ 292 $ - $ 22,401
------------------------------------------------
Operating income
(loss)(1) $ 2,417 $ (426) $ (2,207) $ (216)
Interest expense - - 149 149
Amortization of property
and equipment and
intangibles 1,718 21 - 1,739
Property and equipment 33,458 1,202 - 34,660
Intangibles 3,660 - - 3,660
Capital expenditures(2)(3) 213 251 - 464
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(1) Operating income (loss) is defined as net income (loss) plus
amortization of property and equipment and intangibles, interest,
foreign exchange gains or losses, gains or losses on disposal of
capital assets, share-based compensation, and income taxes.
(2) Property and equipment for Corporate is included in Canada
(3) $46 in property and equipment was transferred from Canada to the U.S.
in 2009
NOTE 9 - SUPLEMENTARY CASH FLOW INFORMATION
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Three month periods ended March 31 2010 2009
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Changes in non-cash working capital from operations:
Accounts receivable $ (2,048) $ 2,289
Inventory (14) (11)
Prepaid expenses and other assets 42 409
Accounts payable and accrued liabilities 660 (1,983)
Income tax payable (recoverable) 173 241
----------------------
Net change $ (1,187) $ 945
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%SEDAR: 00011733E
For further information: David Yager, Chairman & CEO, Telephone: (403) 266-1833, E-Mail: [email protected]; Lori McLeod-Hill, Chief Financial Officer, Telephone: (403) 266-1833, E-Mail: [email protected]
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