Cost Controls Conserve Capital As Revenue Declines 30% in Second Quarter Ended June 30, 2009
Wed Aug 12, 7:52 PMCALGARY, Aug. 12 /CNW/ - HSE Integrated Ltd. ("HSE", "Our", "We", or the "Company") today announced its financial results for the second quarter and first six months of the 2009 fiscal year ended June 30, 2009.
Total revenue for the quarter declined 30.3% to $19.6 million from $28.1 million for the same period in the 2008 fiscal year. For the six month period, revenue declined 24.6% from $55.7 million to $42.0 million. These significant contractions in HSE's business reflect the impact of both a severe recession in North America and a major downturn in conventional oil and gas well drilling and capital spending in western Canada compared to prior years.
These revenue declines had a very negative impact on operating margins. For the quarter, the operating margin declined 69.4% to $1.4 million (7.3% of revenue) from $4.6 million (16.5% of revenue) in the prior year. For the six month period, the operating margin contracted 64.7% to $3.4 million (8.1% of revenue) from $9.7 million (17.4% of revenue) in the 2008 fiscal year.
In response to the contraction in business, the Company has focused on cost control wherever possible. Sales, general and administrative expenses ("SG&A") for the quarter declined 23.9% to $1.9 million from $2.5 million in the prior year. For the first six months, SG&A declined 15.8% to $4.1 million from $4.8 million in fiscal 2008.
HSE reported a loss for the quarter of $1.9 million (a loss of $0.05 per share) compared to a loss of $0.6 million (a loss of $0.02 per share) in Q2 2008. For the six month period the loss was $3.7 million (a loss of $0.10 per share) compared to a loss of $0.6 million (a loss of $0.02 per share) for the prior year.
EBITDA for the quarter declined 120.6% from $2.2 million in Q2 2008 to ($0.5) million in Q2 2009. For the six month period ended June 30, EBITDA fell 113.8% from $4.8 million in 2008 to ($0.7) million in 2009.
The bulk of the revenue decline took place in the Oilfield portion of the Company's activities, the segment of the business related to health and safety services for conventional oil and gas exploration, drilling, completion and workover activities. Because of the collapse in crude oil and natural gas prices and the global credit crisis that took place in the latter half of 2008, HSE's client E&P companies drastically reduced capital and operating expenditures in the second quarter and first half of the current fiscal year. Oilfield revenues in Q2 fell 50.2% to $4.3 million from $8.7 million in 2008 and accounted for only 22.1% of total business. For the six month period, Oilfield revenue declined 40.8% from $24.6 million to $14.6 million. Oilfield represented only 34.7% of total business compared to 44.3% in 2008 and 55.6% for the same period in 2007. Due to the sharp decline in drilling and capital expenditures referenced above, all companies supporting this sector are experiencing similar business contractions in Canada and the United States.
Revenue generated from Industrial health and safety services also declined in the second quarter, primarily as a result of postponement of scheduled plant shutdown and maintenance services in western Canada as a cost-cutting measure and intense pricing pressure from competitors desperate to secure business. For the quarter, Industrial revenues declined 21.4% from $19.4 million to $15.2 million. This is the first time this portion of HSE's business has experienced a significant revenue decline. For the first six months, Industrial revenues declined 11.7% from $31.0 million to $27.4 million.
In the second quarter Industrial health and safety services accounted for 77.9% of total revenue, up from 69.1% in 2008 and 66.5% in 2007. For the first six months the same figures are 65.3%, 55.7% and 44.4% respectively. To highlight the Company's continued diversification of its client base compared to two years ago, the contracted Industrial revenues in Q2 were still 18.5% higher than in 2007. For the first six months of the current fiscal year, Industrial revenues were still 30.3% higher than for the same period two years ago.
The Company's balance sheet remained strong. At June 30, 2009, working capital (excluding current portions of debt repayments) was $18.4 million compared to $21.7 million at June 30, 2008 and $19.5 million at March 31, 2009. Bank debt remained unchanged from year end and March 31 at $10.8 million. HSE had $5.9 million in cash or cash equivalents on hand at June 30, 2009 compared to $0.2 million at June 30, 2008 and $1.1 million at March 31, 2009. Accounts receivables plus cash at June 30, 2009 exceeded all cash liabilities by $4.5 million.
The modest reduction in working capital at June 30, 2009 and increase in cash on hand compared to March 31, 2009 despite a 30.3% decline in revenue reflects HSE's determination to reduce costs and manage cashflow as effectively as possible without permanently impairing the Company's ability to return to historic levels of revenue and operating margin when the various sectors of the economy in which HSE operates recover.
At June 30, 2009 HSE had net tangible assets per share of $1.01. Tangible assets include cash, accounts receivable, inventory and book value of capital assets (property, plant and equipment). Tangible liabilities include accounts payable, income taxes payable, capital leases, bank debt and long-term equipment loans.
David Yager, Chairman and CEO, offered the following comments for HSE's second quarter 2009 financial results:
"Despite operating in an extremely difficult business environment, HSE is doing what it must to operate as efficiently as possible with the intention of conserving working capital and maintaining the Company's ability to exploit a recovery when it occurs. Based on communications with clients, the Company is now cautiously optimistic that contraction in demand for its products and services has stopped and the go-forward trend will be an increase in demand in most industries and markets. It appears the worst is behind us. However, it is unlikely the rate of revenue recovery will be as fast as revenue reduction experienced in the first half of the current year.
Regardless, the discipline tough economic times have forced upon our organization and labor markets makes us cautiously optimistic that HSE can earn a higher operating margin on the same revenue than in prior years. Part of this is internal, based on the way we pay our field service personnel, particularly in western Canada. Part of this is external where the end of the economic boom has tempered what were continually rising costs in every area, particularly labor and direct operating expenses.
The downturn in conventional oil and gas drilling in western Canada is unprecedented in modern times. The oilfield service sector has the capacity to drill in excess of 20,000 new wells annually. In 2009 drilling of new wells will likely be at 40% of that level. Fortunately for HSE, five years ago we began development of business opportunities in new industries and markets such as oilsands, refining, power generation, utilities, petrochemical, forestry, manufacturing, food and beverage, and the east coast offshore. While it is difficult to measure from total revenue, HSE continues to grow through new clients and markets. However, recession-based shrinkage in established markets obscures our success.
HSE's staff has done an outstanding job helping our Company through this difficult period. Management and the Board of Directors recognize the company-wide sacrifice. But considering the economy in which HSE is operating - and the devastation that the recession has inflicted on so many companies in so many markets and industries - our Company will emerge from this downturn as a stronger player in its field and remain a challenging, exciting and rewarding career opportunity."
For further information and analysis please see the attached Management Discussion and Analysis and Financial Statements.
CONFERENCE CALL
HSE will be hosting a conference call to discuss their results at 1:30 PM (Eastern Daylight Time), 11:30 AM (Mountain Daylight Time) on Thursday, August 13, 2009.
Dial-In Number: 1-866-250-4910 or 1- 416-644-3428
Conference Replay until September 13, 2009: 1-416-640-1917 or
1-877-289-8525 (Passcode: 21312984 followed by the pound sign)
Webcast: http://www.newswire.ca/en/webcast/viewEvent.cgi?eventID(equal
sign)2773540
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-Labrador and Michigan. HSE also operates in Midland, 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 2009 second quarter report, in the 2008 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 Quarter and Year to Date Ended June 30, 2009 and 2008
The following management discussion and analysis is dated August 12, 2009, and is a review of the financial results of HSE Integrated Ltd. ("HSE", "We", "Our", or the "Company") for the quarter and year to date ended June 30, 2009 and 2008. 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 August 12, 2009. 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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Three Three Six Six
Months Months Quarter Months Months Year
Ended Ended Over- Ended Ended Over
June 30, June 30, Quarter June 30, June 30, Year
2009 2008 % Change 2009 2008 % Change
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Revenue $ 19,566 $ 28,087 (30.3%) $ 41,967 $ 55,656 (24.6%)
Operating and
materials 18,145 23,440 (22.6%) 38,555 45,992 (16.2%)
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Operating
margin 1,421 4,647 (69.4%) 3,412 9,664 (64.7%)
Operating
margin % 7.3% 16.5% 8.1% 17.4%
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Selling,
general &
admini-
strative $ 1,872 $ 2,460 (23.9%) $ 4,079 $ 4,844 (15.8%)
Net loss (1,928) (568) (239.4%) (3,734) (579) (544.9%)
- per share
basic &
diluted (0.05) (0.02) (150.0%) (0.10) (0.02) (400.0%)
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EBITDA(1) ($451) $ 2,187 (120.6%) ($667) $ 4,820 (113.8%)
EBITDA % (2.3%) 7.8% (1.6%) 8.7%
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Total assets $ 60,745 $ 72,232
Total long-term
liabilities 16,462 20,474
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See Non-GAAP Measures for (1)
Financial Review
Overview
HSE operates in a single industry segment of industrial health and safety services provision. The Company provides a package of integrated asset, worker and community safety protection services including: on-site 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; worker shower (decontamination) services; on-site medical services; worker safety training; industrial hygiene services; and safety management and consulting services.
Total revenue for the quarter decreased 30.3% from $28,087 in 2008 to $19,566 in 2009. Operating margin of $1,421 was 7.3% of revenues, down from $4,647 or 16.5% in 2008. Selling, general and administrative expense ("SG&A") decreased to $1,872 from $2,460 in the prior year, but as a percentage of revenue SG&A increased from 8.8% of revenue in fiscal 2008 to 9.6% in 2009. HSE reported a loss of $1,928 or ($0.05) per share compared to a loss of $568 or ($0.02) per share in the prior year. EBITDA was $(451) or (2.3%) of revenue in 2009, down 120.6% from $2,187 or 7.8% of revenue in 2008.
Total revenue for the six month period declined 24.6% from $55,656 in 2008 to $41,967 in 2009. Operating margin of $3,412 was 8.1% of revenue compared to $9,664 or 17.4% of revenue in the prior year. SG&A was $4,079 for the period, a 15.8% decline from $4,844 in the prior year. However, as a percentage of revenue SG&A increased from 8.7% of revenue to 9.7%. The company reported a loss of $3,734 or ($0.10) per share compared to a loss of $579 or ($0.02) per share for the first six months of the 2008 fiscal year. EBITDA for the period was ($667) compared to $4,820 a year ago.
Included in expenses are one-time charges of $516 ($282 in the first quarter of the year and $234 in the second quarter) related to cost reduction initiatives undertaken by the Company. These initiatives are described below.
Revenue
The Company currently provides services to customers in two main business areas: Oilfield health and safety ("Oilfield") and Industrial health and safety services ("Industrial"). Oilfield services are provided to customers who 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. Industrial services are provided to customers operating in a wide variety of other industries, including: non-conventional upstream oil development and production (including oilsands extraction); oil and gas processing and refining; petrochemicals; pulp and paper; utilities; power generation; and diverse manufacturing industries. It also includes worker safety training and safety management and consulting services. The Company tracks billings to customers by defined revenue grouping, 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 revenue groups is shown below:
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Quarter Quarter Year Quarter Year
ended ended over ended over
June 30, June 30, year % June 30, year %
2009 2008 change 2007 change
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Oilfield $ 4,317 $ 8,667 (50.2)% $ 6,486 33.6%
Industrial 15,249 19,420 (21.4)% 12,866 50.9%
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Total Revenue $19,566 $28,087 (30.3)% $19,352 45.1%
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As a % of Revenue:
Oilfield 22.1% 30.9% 33.5%
Industrial 77.9% 69.1% 66.5%
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Total Revenue 100.0% 100.0% 100.0%
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Six Six Six
months months Year months Year
ended ended over ended over
June 30, June 30, year % June 30, year %
2009 2008 change 2007 change
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Oilfield $14,577 $24,628 (40.8)% $26,285 (6.3)%
Industrial 27,390 31,028 (11.7)% 21,015 47.6%
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Total Revenue $41,967 $55,656 24.6% $47,300 17.7%
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As a % of Revenue:
Oilfield 34.7% 44.3% 55.6%
Industrial 65.3% 55.7% 44.4%
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Total Revenue 100.0% 100.0% 100.0%
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Oilfield
--------
Oilfield revenues in the second quarter decreased by 50.2% in 2009 compared to 2008 from $8,667 to $4,317. For the first six months of the current fiscal year, Oilfield health and safety services revenue was $14,577, 40.8% lower than $24,628 generated in the same period in the 2008 fiscal year. Services delivered to this group of clients comprised only 34.7% of revenue compared to 44.3% in the prior year. This significant year-over-year decline is due to lower overall activity levels in Western Canada in the conventional upstream, or "wellhead", sector of the oil and gas industry: oil and natural gas well drilling, completion and workover (repair and maintenance) operations in the Western Canadian Sedimentary Basin. Compared to the same period in the prior year, this significant revenue decrease was caused by several negative external events including lower oil prices, lower natural gas prices, reduced access to debt and equity capital by Company clients, and the introduction of increased Crown royalties in Alberta, a major market for HSE.
Services provided in the Oilfield sector are primarily oriented towards supporting the development of natural gas with a higher level of health and safety protection required for the development of sour gas - reserves of natural gas containing hydrogen sulphide - and crude oil containing sour gas. Some oil reservoirs tend to go "sour" over time due to the injection of water for secondary recovery, thus increasing the requirement for safety services. The primary driver of revenue fluctuations in comparative reporting periods relates to a major decline in all forms of conventional oilfield activity in the markets served including drilling, new well completions, and well workover activities.
The overall depressed economic environment for the conventional oil and gas industry has also put pressure on the prices HSE can charge its clients for services provided. To compensate for vastly reduced commodity prices, clients are seeking pricing relief for input services including health and safety. Therefore, in many cases HSE has been forced to adjust its pricing downward in order to maintain clients and market share. To compensate for lower prices, HSE has undertaken a series of internal cost reduction measures to maintain acceptable operating margins. These initiatives are discussed in detail under the discussion of Operating Materials Expense and Selling General and Administrative Expense below.
In the second quarter of 2009, the Company's venture with Boots & Coots International Well Control, Inc. - Boots & Coots HSE Services LLC ("BCHSE") - generated increasing revenues as BCHSE gained customer acceptance as a capable provider of worker and asset production services. Assets employed included motorized combination fire/shower units, breathing air trailers, trailer-mounted decontamination units, breathing apparatus and electronic gas detection equipment. Working from locations in Odessa, Texas and Oklahoma City, Oklahoma, BCHSE increased its client base and revenues. While total revenue generated was modest, the Company is pleased with customer acceptance of the equipment, service and branding in light of the significant oilfield activity downturn that U.S. markets are also experiencing.
Industrial
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The Industrial health and safety services component of the Company's total revenue also declined in the second quarter of 2009 due to the negative effects of the global recession which include reduced commodity prices, plant shutdowns, project cancellations or delays, and the postponement of scheduled plant maintenance expenditures to some future date to save cash. This trend took place to some degree in virtually every industry and geographical sector in which HSE operates.
Industrial revenue decreased $4,171 (21.4%) to $15,249 from $19,420 in the same period in the prior year. Industrial health and safety services comprised 77.9% of total revenues, up from 69.1% in 2008. Without a significant recovery in Oilfield activity, Industrial revenues will continue to be greater than Oilfield revenues for the foreseeable future.
The year-over-year Industrial health and safety revenues generated varied widely depending upon the service location. Western Canadian plant shutdown and turnaround revenue declined for two reasons: facility operators postponed scheduled maintenance to conserve cash and the Company lost some bids on price as competitors slashed prices to sustain revenue and activity. As a group, revenue from locations in Ontario and Michigan increased because of one large plant shutdown. Locations in Atlantic Canada provided the most stable Industrial revenue stream on a year-over-year basis, however overall business declined in these markets as well. The new location in St. John's, Newfoundland & Labrador, generated revenue for the first time in the second quarter.
For the period ended June 30, 2009, the Company had one customer representing more than 10% of revenue (2008 - one). The Company had sales of approximately $2.4 million to the customer during the quarter.
For the six months ended June 30, 2009 HSE's Industrial revenue was $27,390, a decline of 11.7% from the same period in fiscal 2008. Revenues from these clients accounted for 65.3% of total revenue compared to 55.7% a year ago. The growth in Industrial health and safety revenue in the period as a percentage of total revenue was caused by the more significant decline in Oilfield health and safety revenue.
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 June 30, 2009 totaled $18,145 or 92.7% of revenue as compared to $23,440 or 83.5% of revenue in 2008. Operating margin for the quarter declined from $4,647 (16.5 % of revenue) in the second quarter of 2008 to $1,421 (7.3 % of revenue) in 2009.
For the first six months operating and materials totaled $38,555 or 91.9% of revenue compared to $45,992 or 82.6% of revenue for the period ended June 30, 2008. Operating margin for the first six months declined from $9,664 or 17.4% of revenue last year to $3,412 or 8.1% of revenue in 2009.
The decrease in operating margins is due to a number of factors. The Company's fixed field service location operating costs were spread over a significantly lower revenue base. Recognizing the impact of the economic downturn on the Company's operations, HSE undertook a series of cost reduction initiatives beginning in mid-January. During the first quarter of 2009, initiatives included layoffs of approximately 10% of full-time staff, salary reductions for all non-field employees in Western Canada of 5%, salary reductions from 10% to 20% for management and executives, a company-wide hiring freeze, and a series of operating costs reductions involving travel, advertising and entertainment expenses.
A new system of paying field service technicians came into effect June 1. Previously, most field service personnel in Western Canada were paid a base salary together with a job bonus. Effective June 1, this was changed to an hourly pay structure similar to that already in place for the Company's Eastern operations. For Western operations, this change directly links field service personnel expense to revenue for the first time.
One time charges of $516 ($282 in the first quarter and $234 in the second quarter) associated with the implementation of these cost reduction initiatives have been reflected in net income. Management remains confident that, based on its historical revenue mix, these cost reductions should reduce the average monthly revenue required to achieve break even EBITDA to approximately $6.0 to $6.5 million per month.
Included in operating expenses is an addition to the provision for doubtful accounts of $106 to reflect increased collection risks as a result of the deterioration in the general business environment. The allowance for doubtful accounts receivable was $1,210 (6.8% of trade accounts receivable) at the end of the quarter. During the quarter the Company wrote off $386 of previously allowed for receivables after all methods of recovery were exhausted. The largest portion of these was a receivable for $333 that had been allowed for in 2007.
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 costs generally associated with the following: corporate head-office functions and services; administrative personnel; corporate sales and marketing costs; liability insurance; professional fees; and investor relations expenses.
SG&A for the quarter totaled $1,872 (9.6% of revenue), down from $2,460 (8.8% of revenue) in the prior year. Personnel costs declined as staff numbers declined year-over-year and the impact of salary reductions on March 1, 2009 came into effect. Travel and advertising costs declined as part of a company-wide initiative to reduce all costs in response to reduced operating levels. Offsetting the SG&A cost reductions achieved by the foregoing was the inclusion of expenses related to BC HSE Services LLC for the first time in 2009.
For the first six months SG&A declined to $4,079 from $4,844 in the prior year. However, as a percentage of revenue SG&A increased to 9.7% from 8.7% in 2008.
EBITDA and Net Loss
EBITDA (see "Non-GAAP Measures") in the quarter decreased from $2,187 in the second quarter of 2008 to ($451) in the current quarter. The EBITDA decrease was primarily because of significant revenue declines on a year-over-year basis. For the first six months EBITDA was ($667) compared to $4,820 in the 2008 fiscal year.
Total amortization for the quarter was $1,692, down from $1,920 in 2008. Property and equipment amortization declined compared to the prior year at $1,554 (down from $1,722) as the Company controlled the pace of capital additions during 2008 and the first and second quarter of 2009. Intangible assets amortization declined to $138 from $198 in 2008 as certain amortization periods expired during 2008, particularly for non-competition provisions.
Stock-based compensation for the quarter was $99 (2008 - $155). The decrease is primarily due to a reduction in the number of outstanding unvested options offset in this quarter by a stock option grant in May 2009.
Interest on long term debt and other interest and bank charges decreased from $331 in 2008 to $120 in 2009. Interest on the Company's variable rate bank debt decreased as interest rates dropped. On average, the Company's average borrowing rate was approximately 2.6% lower in the second quarter of 2009 than in the equivalent quarter in 2008. This saved the company approximately $70 in interest charges. As well, the Company had significantly lower levels of overall debt throughout the current quarter than it had in the second quarter of 2008. Capital lease obligations at June 30, 2009 were $1,409 lower than at June 30, 2008. Long-term debt was reduced by $3,410 compared to June 30, 2008.
For the second quarter of 2009, the loss on disposal of property and equipment was $126 with proceeds on sale of $312. Partially offsetting the loss is the amortization of a deferred gain on sale / leaseback of assets as discussed in the 2008 annual MD&A. The remainder of asset divestitures consisted of retirement of vehicles replaced through the Company's fleet management program.
HSE had a $572 income tax recovery for the quarter versus an income tax recovery of $79 for 2008. The change can be attributed primarily to a decrease in taxable income in the year.
Net loss for the quarter was $1,928 or $(0.05) per share versus a loss of $568 or ($0.02) per share in 2008. The year-over-year decline was primarily due to the decrease in EBITDA as described above.
Current Quarter versus Q1 2009
Revenue for the second quarter decreased 12.7% to $19,566 from $22,401 in the first quarter. This was caused by significant reductions in revenues from Oilfield health and safety services. Industrial revenue increased $3,108 from $12,141 in the first quarter to $15,249 in the second quarter because most plant shutdown and turnaround activities take place in the non-winter months of the second and third quarters. Oilfield revenue decreased $5,943 from $10,260 to $4,317. This was caused by spring break-up and the general deterioration of the conventional upstream oil and gas industry in North America compared to 2008.
Operating expenses decreased by $2,265 from $20,410 (91.1% of revenue) to $18,145 million (92.7% of revenue). Operating cost decreases reflect one month of the field staff pay restructuring, total manpower reductions, and other cost containment activities.
SG&A declined from the first quarter by $335. The decrease reflected a full quarter of salary reductions, manpower reductions and restrictions on travel and other discretionary expenditures.
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, 2009 2010 2011 2012 2013 Total
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Capital lease
obligations $ 312 252 103 6 - $ 673
Vehicle operating leases 1,197 2,319 1,603 429 5 5,553
Property & other leases 1,483 2,610 1,786 1,236 815 7,930
Long-term debt 21 10,854 818 - - 11,693
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Total contractual
obligations $ 3,013 16,035 4,310 1,671 820 $25,849
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Liquidity
At the end of the second quarter, the draw against the revolving facility was $10,829, and there was no draw against the operating facility. At June 30 the Company had cash on hand of $5,923.
During the first and second quarter of 2009, the Company's credit facilities included a $25 million three-year interest-only revolving facility and a $7.5 million operating facility. The revolving facility had a maturity date of June 25, 2010, with an ability to extend the term at the lender's option. The operating facility was renewable annually on June 24 and was margined to accounts receivable. Both the operating facility and the revolving facility were subject to certain covenants including a covenant regarding the ratio of senior debt to cash flows (as defined in the agreement), a current ratio covenant, an interest coverage covenant and certain other positive and negative covenants that are typical for these types of facilities. The credit facilities were collateralized under a general security agreement.
In the first quarter of 2009, anticipating a continuation of the challenging business environment for Oilfield health and safety services for the remainder of 2009 and possibly 2010, management identified the need to amend its existing credit facilities. The Company approached its senior secured lender in March 2009 to discuss modifying the existing facilities. On July 29, 2009, the Company amended its existing credit facilities with its current lender. The amended facility replaces the facilities described above with a single $15 million operating facility. This amended facility, which matures July 27, 2010, is margined to property and equipment and accounts receivable. The amended 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 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 continues to be collateralized under a general security agreement. The Company complied with all covenants required under the amended credit facility.
Cash Provided by (Used in) Operations
Cash provided by operations in the quarter was $5,349 in 2009 compared to $4,244 for 2008. Reduced revenue levels in the quarter resulted in negative EBITDA and break-even operating cash flow excluding changes in working capital. However, collections of accounts receivable improved significantly when compared to 2008 as transition issues with the implementation of a new billing system effective January 1, 2008 delayed cash collections during 2008
Cash Provided by (Used in) Financing and Investing
During the quarter, the Company had no need to draw on its operating line. The Company also made scheduled debt reductions of $385 towards capital lease and other long term debt obligations.
Purchases of property and equipment for the second quarter amounted to $437, the majority of which was revenue generating health safety services rental equipment. Proceeds from disposal of property and equipment were $312.
Working Capital
At June 30, 2009, the Company had working capital (not including current portion of long-term debt obligations) of $18,368. This compares to $20,514 on December 31, 2008 and $21,717 at June 30, 2008. The change from December 31, 2008 relates to changes in non-cash working capital as collections of receivables during the quarter were partially offset by reductions in payables and accruals. The change from the balance at the end of the second quarter of 2008 related to improved cash position offset by reductions in non-cash working capital, particularly accounts receivable. The Company's cash position improved from $249 on June 30, 2008 to $5,923 at June 30, 2009.
Outlook
Due to a series of international and domestic economic events that took place in the last half of 2008, the business climate in the first six months of 2009 was the most challenging for HSE in its modern history. This began in 2004 with aggressive expansion that would eventually include 17 acquisitions. Although individual predecessor component companies of HSE may have endured business cycles and downturns, the current economic climate was our first major challenge as a combined group. But because of the experience of senior management, the relative strength of HSE's balance sheet, and a corporate business model that focused on a diversity of essential services provided to a diversity of clients in several regions, HSE has weathered the storm and is cautiously optimistic that the worst is behind in terms of prospects and opportunities.
Oilfield
In the first half of 2009, conventional oil and gas drilling, completion and workover activity in Canada declined sharply compared to all previous years in the 21st century. According to well completion figures compiled by the Canadian Association of Drilling Contractors ("CAODC"), the average number of wells drilled annually in Canada from 2001 to 2008 was 19,714. By contrast, in the six month period to June 30, 2009 only 5,938 wells had been drilled. On July 7, 2009 the CAODC revised its drilling forecast for the current year downward to 8,787 total new wells drilled, the lowest figure since 1992. Although by the end of June the price of oil had recovered substantially from a low of $34 in December of 2008, it still remained about half of what it sold for a year ago. The price of natural gas remains similarly depressed.
In response to the foregoing, HSE has undertaken a meaningful cost reduction strategy, while still maintaining the core technical staff and delivery capability required to remain in the business and service clients when activity improves.
Effective April 1, 2009, the government of Alberta introduced drilling activity royalty credits and a one-year reduced royalty period that expires March 31, 2010. The purpose was to spur drilling activity and employment. The two elements of the program significantly improve the economics of conventional oil and gas exploration and development drilling. This program was extended to March 31, 2011 in another announcement on June 25, 2009. Reduced drilling and service costs have also improved investment economics. However, because of continued tight equity and debt markets, the only companies that can take full advantage of the stimulus are companies with strong balance sheets and/or discretionary internal cash flow. Although debt and equity markets have improved somewhat in the past few months resulting in the ability of some of the Exploration and Production sector players to raise capital, the overall climate in which Canada's conventional upstream oil and gas industry operates remains severely challenged compared to prior year.
Saskatchewan and British Columbia have not been spared the effects of the downturn. Low natural prices are discouraging activity in northeast B.C. despite exciting new shale gas discoveries and an attractive fiscal regime. Lower oil prices and tightened equity and debt markets are having a similar impact on activity in Saskatchewan.
Natural gas prices continue to generate uncertainty. Current prices are low and analysts are starting to understand that unconventional shale gas exploitation in Canada and the United States may permanently change North American gas markets. Royalty incentive packages like those offered in Alberta are still not attractive enough to justify developing many gas deposits.
Nevertheless, the indication from HSE's clients for Oilfield health and safety services is that the worst is behind us. Activity will improve, but the pickup will not take place at the same rate as the decline. Oil prices have more than doubled from the multi-year lows experienced in late 2008. Although gas prices remain soft, this situation is regarded as temporary. A sharp decline in natural gas drilling across North America and slow but steady improvement in the economy has created a situation where supply and demand will come into balance.
The focus for the Oilfield side of HSE in Canada is cost control and the best possible service to ensure customer loyalty.
In the United States, the joint venture with Boots & Coots Services, Inc. operating as Boots & Coots HSE Services, LLC ("BCHSE") enjoyed revenue growth and customer acceptance in the second quarter. While this project does not yet generate positive cash flow, client interest in specific services and the need for a modern and more professionalized approach to Oilfield health and safety in general cause the Company to believe the long-term potential for BCHSE is meaningful.
Industrial
The outlook for the Company's Industrial health and safety services varies significantly because of the variety of markets and industries in which HSE operates. Although Industrial revenues in the second quarter were down on a year-over-year basis for the first time since HSE began expansion into new markets five years ago, the broad range of services, clients and regions ensures that this area of the Company will be the first to return to growth.
The oilsands region of northeast Alberta continues to look promising for several reasons. Production from new and existing extraction operations remain at full capacity, aided by higher prices that have ensured the vast majority of the oil produced sells for greater than development costs. The startup of Esso's Kearl Lake oilsands project was a positive development for the region. Because of tight economics, most customers are examining new ways of doing business that could yield efficiency gains and/or operating cost reductions. HSE has long believed that outsourcing certain health and safety functions to an expert service provider is a viable alternative to in-house methods. This means that HSE's opportunities can grow in this market whether or not the whole market grows.
Although other Industrial safety work in western Canada - primarily plant shutdown and turnaround services - has declined so far in 2009 so facility operators could conserve cash, the outlook for the remainder of the year has improved. This maintenance and repair work is essential for the ongoing operation of facilities. With the amount of work that was postponed in 2009, this segment of HSE's total business mix looks promising for 2010.
HSE's Ontario client base is diverse and is affected by the recession in different ways. Many of the facilities that were shuttered in the first half of 2009, such as steel mills and auto assembly plants, are re-opening which will increase HSE's business later this year. An agreement with the Laborers' Union to use unionized manpower on plant safety operations that was implemented in July of 2009 looks promising for this specific market where most of the client facilities are also unionized. A similar arrangement in New Brunswick has been highly satisfactory for HSE, the laborers' union and clients. Ontario and the industrial Midwest of the United States remain large markets with significant opportunity.
Despite a decline in revenues year-over-year, the Atlantic region of Canada remains a bright spot for HSE in 2009 and beyond. The Company's new service location in St. John's, Newfoundland-Labrador ("NL") will serve the offshore oil and gas industry and act as a regional base for large industrial projects in industries like hydro-electric construction projects, mining and mineral processing.
Marketing to new clients continues in all regions. HSE believes the ultimate potential for the Industrial health and safety revenues is many times greater than the Company has generated thus far.
Cost Control and Short-Term Outlook
Much of the attention of senior management in the first half of 2009 was on cost control in order to be able to work as efficiently as possible and maintain the strongest possible balance sheet and working capital position until the many segments of the economy in which HSE operates begin to recover.
While the general cost reduction plan was conceived in the first quarter, much of the execution took place in the second quarter. Of particular significance going forward is the change in field service technician pay structure from a base salary plus day bonus to an hourly wage. This has benefits for both management and field service staff. For management, the cost of supporting field personnel when they are not working on revenue producing jobs is greatly reduced; for field service personnel, it allows a worker the opportunity to earn more money than under the previous regime. This program was fully implemented on June 1, 2009. June's financial results indicated that this significant undertaking did indeed yield the desired outcome.
All other discretionary expenses, including items such as travel, advertising, entertainment and investor relations remain sharply curtailed until it is clear business has improved. Management believes it has taken all the prudent steps necessary to bring operating expenses in line with revenue for the remainder of 2009 while still maintaining the technical capability essential for quality service and sufficient capacity to be able to fill the known order book and client demand. HSE remains largely intact in the sense that no major business units or field service locations have been sold off or closed in order to survive the financial downturn.
The outlook for all of HSE's business units is marginally positive, particularly when compared to three consecutive quarters of contraction that took place in late 2008 and the first half of 2009. Credit markets are easing. Equity markets are functioning again. Some commodity prices like oil are up sharply while all others have at least quit declining. Clients are looking at their businesses with a view to expansion again instead of slashing all unnecessary costs to ensure survival. Although HSE has not yet lost any major competitors, several smaller ones have shut down. This may ease competitive pressures going forward.
Therefore, the Company reports with some confidence that the worst is over for HSE and the Company anticipates a return to revenue growth. However, returning to record levels of revenues enjoyed in 2008 will take longer than it did to decline from record to current levels.
Quarterly Results
-------------------------------------------------------------------------
2009 2008
-------------------------------------------------------------------------
Q2 Q1 Q4 Q3 Q2 Q1
-------------------------------------------------------------------------
Revenue 19,566 $22,401 $29,905 $28,202 $28,087 $27,569
Net earnings (loss) (1,928) (1,806) 431 396 (568) (11)
EBITDA(1) (451) (216) 2,713 2,858 2,187 2,633
-------------------------------------------------------------------------
Income (loss) per
share - basic
and diluted (0.05) (0.05) $0.01 $0.01 $(0.02) $0.00
-------------------------------------------------------------------------
-------------------------------------
2007
-------------------------------------
Q4 Q3
-------------------------------------
Revenue $26,464 $23,578
Net earnings (loss) (9,173) (15,920)
EBITDA(1) 2,601 1,376
--------------------------------------
Income (loss) per
share - basic
and diluted $(0.25) $(0.42)
--------------------------------------
--------------------------------------
See Non-GAAP Measures for (1)
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.
Revenue by quarter for the last eight quarters is as follows
-------------------------------------------------------------------------
2009 2008
-------------------------------------------------------------------------
Q2 Q1 Q4 Q3 Q2 Q1
-------------------------------------------------------------------------
Oilfield 4,317 $10,260 $14,597 $12,039 $8,667 $15,961
Industrial 15,249 12,141 15,308 16,163 19,420 11,608
-------------------------------------------------------------------------
Total revenue 19,566 $22,401 $29,905 $28,202 $28,087 $27,569
-------------------------------------------------------------------------
----------------------------------------------
2007
----------------------------------------------
Q4 Q3 Q2
----------------------------------------------
Oilfield $15,879 $11,722 $6,486
Industrial 10,585 11,856 12,866
----------------------------------------------
Total revenue $26,464 $23,578 $19,352
----------------------------------------------
----------------------------------------------
Related Party Transactions
During the quarter, the Company had the following transactions with
related parties all of which are measured at exchange amounts:
- During the second quarter of 2009, the Company paid rent and property
taxes for a regional office to a corporation related to a Director of
the Company in the amount of $103 (2008 - $105)
- During the second quarter of 2009, the Company also paid rent of $74
(2008 - $78) 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 2008 Annual Report.
Accounting Pronouncements
On January 1, 2009 the Company adopted the revised Canadian accounting standards regarding Goodwill and Intangible Assets. These standards provide guidance with respect to the recognition, measurement and disclosure of goodwill and intangible assets. The provisions of the new standards relating to the definition of intangible assets and their initial recognition have been changed to coincide with those in the equivalent International Financial Reporting Standard. This change had no effect on the Company's reported results.
Accounting Standards pending adoption
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 provided that all three standards are adopted simultaneously. The Company is currently in the process of evaluating the new standards. 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 - Business Combinations. It makes
changes to the circumstances under which the Company must consolidate
an entity, as well as to disclosure requirements.
International Financial Reporting Standards
The CICA's Accounting Standards Board has confirmed that IFRS will be adopted as Canadian GAAP for publicly accountable entities in Canada for interim and annual financial statements relating to fiscal years beginning on or after January 1, 2011. The Company expects the transition to IFRS to impact financial reporting, business processes and information technology requirements. As part of the conversion, the Company will be required to report its interim results for the quarter ended March 31, 2011, including comparatives for the quarter ended March 31, 2010, using IFRS. The Company will also be required to prepare an opening balance sheet at January 1, 2010 converting its balances as previously reported under Canadian GAAP to the amounts that would have been reported under IFRS.
The Company has started an IFRS conversion project and is currently evaluating the impact of the change to IFRS on the results of its operations, financial position and disclosures.
To date, the Company has identified the following accounting standards that apply to the Company where IFRS standards are different from those under existing Canadian GAAP:
- Financial instruments
- Property and equipment
- Intangible assets
- Impairment testing of long-lived assets
- Business combinations and non-controlling interests
- Income taxes
- Contingencies
- Leases
- Stock-based compensation
Of these areas, business combinations and property and equipment conversions are expected to have the most pervasive impact on the Company's processes and reported results.
Accounting for business combinations under IFRS differs from existing Canadian GAAP with respect to accounting for non-controlling interest, treatment of transaction costs incurred as part of the acquisition, valuation of share consideration given as part of an acquisition, treatment of contingent consideration given as part of an acquisition, accounting for future income taxes associated with an acquisition, and treatment of restructuring costs incurred as part of an acquisition.
Property and equipment accounting under IFRS requires that significant components that make up an asset be separately tracked within fixed assets, that the cost of each significant component be amortized over the estimated useful life of that component, and that any replacements of significant components be accounted for as disposals and acquisitions.
IFRS 1, First-Time Adoption of International Financial Reporting Standards, provides the framework for the initial conversion from Canadian GAAP to IFRS. The standard generally requires that the Company's results be retroactively restated at January 1, 2010 to the results that would have been reported if the Company had been operating under IFRS since incorporation, with the adjustments that arise as a result of this restatement being recognized in retained earnings. However, IFRS provides for certain optional exemptions upon conversion to IFRS. The significant exemptions available to the Company include:
- 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 as they would have
been under IFRS
- An exemption allowing an entity to value fixed asset components at
their fair value at the conversion date, rather than retroactively
restating amortization of components and recording disposals and
additions of components that were expensed as required under existing
Canadian GAAP
- The ability to apply IFRS accounting for stock-based compensation on
a prospective basis to stock options granted and vested prior to
transition.
- The ability to assess whether an arrangement constitutes a lease, and
accordingly falls under the IFRS standards for leases, as at the
conversion date rather than retroactively for all leases entered into
since incorporation.
The Company is currently evaluating which, if any, of these exemptions will be applied.
Financial and Other Instruments
The Company's financial instruments include cash and cash equivalents, accounts receivable, bank indebtedness, accounts payable and accrued liabilities, income taxes payable, obligations under capital leases and long-term debt. The carrying value of these instruments approximates their fair value either because of their short maturities or because the interest rates to which they are subject approximate market rates.
The Company is exposed to the following risks as a result of its use of financial instruments:
- credit risk
- liquidity risk
- market risk
These risks, and the Company's method of mitigating the risks, are described in the Management Discussion and Analysis included in the Company's 2008 Annual Report.
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; availability of qualified staff; 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 are included in the Management Discussion and Analysis included in the Company's 2008 Annual Report.
Internal Control Over Financial Reporting
There have been no changes in the Company's internal control over financial reporting during the quarter ended June 30, 2009 that have materially affected, or are reasonably likely to materially affect, its internal control over financial reporting.
Common Shares Outstanding
At August 12, 2009 and December 31, 2008 there were 37,575,675 common shares of HSE outstanding. At June 30, 2009, the Company had options outstanding to issue 2,712,166 shares at a weighted average exercise price of $1.55 per share. Of these options, 1,508,301 were exercisable. At August 12, 2009, there were 2,690,500 options outstanding at a weighted average exercise price of $1.54 per share. Of these options, 1,486,635 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 Six Months Ended June 30 2009 2008
-------------------------------------------------------------------------
Net loss $ (3,734) $ (579)
Add (deduct):
Amortization 3,431 4,145
Stock-based compensation 149 290
Interest and bank charges 269 628
Foreign exchange loss 11 -
Loss on disposal of property and equipment 219 326
Income tax (1,012) 10
-------------------------------------------------------------------------
EBITDA $ (667) $ 4,820
-------------------------------------------------------------------------
-------------------------------------------------------------------------
Quarterly EBITDA Calculation
2009 2008
-------------------------------------------------------------------------
Q2 Q1 Q4 Q3 Q2 Q1
-------------------------------------------------------------------------
Net earnings
(loss) $ (1,928) $ (1,806) $ 431 $ 396 $ (568) $ (11)
Add (deduct):
Amorti-
zation $ 1,692 1,739 1,399 1,821 1,920 2,125
Impairment
of goodwill
and
intangible
assets - - - - 100 -
Stock-based
compensation 99 50 95 23 155 135
Interest and
bank
charges 120 149 200 288 331 297
Foreign
exchange
loss (gain) 12 (1) (35) 4 2 (2)
Loss on
disposal of
property and
equipment 126 93 193 129 326 -
Income taxes (572) (440) 430 197 (79) 89
-------------------------------------------------------------------------
EBITDA $ (451) $ (216) $ 2,713 $ 2,858 $ 2,187 $ 2,633
-------------------------------------------------------------------------
-------------------------------------------------------------------------
2007
---------------------------------
Q4 Q3
---------------------------------
Net earnings
(loss) $ (9,173) $(15,920)
Add (deduct):
Amorti-
zation 2,243 2,004
Impairment
of goodwill
and
intangible
assets 10,505 15,000
Stock-based
compensation 255 186
Interest and
bank
charges 311 309
Foreign
exchange
loss (gain) 12 22
Loss on
disposal of
property and
equipment 103 99
Income taxes (1,655) (324)
---------------------------------
EBITDA $ 2,601 $ 1,376
---------------------------------
---------------------------------
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.
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 at www.hseintegrated.com.
HSE Integrated Ltd.
Consolidated Balance Sheets
June 30 December 31
(Stated in thousands), (unaudited) 2009 2008
-------------------------------------------------------------------------
ASSETS
Current
Cash and cash equivalents $ 5,923 $ 1,114
Accounts receivable (note 4) 16,662 25,740
Inventory 240 222
Prepaid expenses and other assets 1,356 1,897
-------------------------
24,181 28,973
Property and equipment 33,042 36,173
Intangible assets 3,522 3,788
-------------------------
$ 60,745 $ 68,934
-------------------------
-------------------------
LIABILITIES
Current
Accounts payable and accrued liabilities $ 5,206 $ 8,096
Income taxes payable 607 363
Current portion of obligations
under capital lease 426 922
Current portion of long-term debt (note 3) 35 98
Current portion of deferred gain 137 137
-------------------------
6,411 9,616
Deferred gain 387 455
Obligations under capital lease 197 370
Long-term debt (note 3) 11,600 11,628
Future income taxes 4,278 5,278
-------------------------
22,873 27,347
-------------------------
SHAREHOLDERS' EQUITY
Share capital 60,040 60,040
Contributed surplus 4,663 4,559
Deficit (26,870) (23,136)
Accumulated other comprehensive income 39 124
-------------------------
37,872 41,587
-------------------------
$ 60,745 $ 68,934
-------------------------
-------------------------
Contingencies (note 9)
Subsequent event (note 3)
See accompanying notes to the consolidated financial statements.
HSE Integrated Ltd.
Consolidated Statements of Loss
Three Months ended Six Months ended
June 30 June 30
-------------------------------------------------------------------------
(Stated in thousands),
(unaudited) 2009 2008 2009 2008
-------------------------------------------------------------------------
REVENUE $ 19,566 28,087 $ 41,967 55,656
----------------------------------------
COSTS
Operating and materials 18,145 23,440 38,555 45,992
Selling, general and
administrative 1,872 2,460 4,079 4,844
Amortization of
property and equipment 1,554 1,722 3,165 3,590
Amortization of
intangible assets 138 198 266 455
Stock-based compensation
(note 7) 99 155 149 290
Interest on long-term debt 103 271 234 538
Other interest and bank charges 17 60 35 90
Foreign exchange loss 12 2 11 -
Goodwill impairment - 100 - 100
Loss on disposal of property
and equipment 126 326 219 326
----------------------------------------
22,066 28,734 46,713 56,225
----------------------------------------
LOSS BEFORE INCOME TAXES (2,500) (647) (4,746) (569)
----------------------------------------
Income taxes
Current provision - 174 - 410
Future reduction (572) (253) (1,012) (400)
----------------------------------------
(572) (79) (1,012) 10
----------------------------------------
NET LOSS $ (1,928) (568) $ (3,734) (579)
----------------------------------------
----------------------------------------
Loss per share
Basic and diluted $ (0.05) (0.02) $ (0.10) (0.02)
----------------------------------------
----------------------------------------
Weighted average
shares outstanding
Basic 37,576 37,568 37,576 37,568
Diluted 37,576 37,568 37,576 37,568
----------------------------------------
----------------------------------------
See accompanying notes to the consolidated financial statements.
HSE Integrated Ltd.
Consolidated Statements of Other Comprehensive Loss
Three Months ended Six Months ended
June 30 June 30
-------------------------------------------------------------------------
(Stated in thousands),
(unaudited) 2009 2008 2009 2008
-------------------------------------------------------------------------
Net Loss $ (1,928) (568) $ (3,734) (579)
Other comprehensive loss
Foreign currency loss on
translating financial
statements of self-sustaining
foreign operations (43) - (85) -
----------------------------------------
Other comprehensive loss $ (1,971) (568) $ (3,819) (579)
----------------------------------------
----------------------------------------
Consolidated Statements of Deficit and Accumulated Other
Comprehensive Income
Three Months ended Six Months ended
June 30 June 30
-------------------------------------------------------------------------
(Stated in thousands),
(unaudited) 2009 2008 2009 2008
-------------------------------------------------------------------------
Deficit, beginning of period $(24,942) (23,395) $(23,136) (23,384)
Net Loss (1,928) (568) (3,734) (579)
----------------------------------------
Deficit, end of period $(26,870) (23,963) $(26,870) (23,963)
----------------------------------------
----------------------------------------
Accumulated other comprehensive
income, beginning of period $ 82 - $ 124 -
Foreign currency loss on
translating financial statements
of self-sustaining operations (43) - (85) -
----------------------------------------
Accumulated other comprehensive
income, end of period $ 39 - $ 39 -
----------------------------------------
----------------------------------------
See accompanying notes to the consolidated financial statements.
HSE Integrated Ltd
Consolidated Statements of Cash Flows
Three Months ended Six Months ended
June 30 June 30
-------------------------------------------------------------------------
(Stated in thousands),
(unaudited) 2009 2008 2009 2008
-------------------------------------------------------------------------
Cash provided by (used in)
Operations
Net loss $ (1,928) (568) $ (3,734) (579)
Charges to income not
involving cash:
Amortization 1,692 1,920 3,431 4,045
Stock-based compensation 99 155 149 290
Future income tax (572) (253) (1,012) (400)
Goodwill impairment - 100 - 100
Loss on disposal of
property and equipment 126 326 219 326
Changes in non-cash working
capital (note 8) 5,932 2,564 6,877 (2,159)
----------------------------------------
Cash provided by operations 5,349 4,244 5,930 1,623
----------------------------------------
Financing
Repayment of operating
line of credit - (3,711) - -
Repayment of bank indebtedness - (438) - (616)
Repayment of obligations
under capital lease (318) (422) (669) (749)
Repayment of long-term debt (67) (103) (104) (166)
Issuance of share capital,
net of costs - - - -
----------------------------------------
Cash used in financing (385) (4,674) (773) (1,531)
----------------------------------------
Investing
Purchase of property
and equipment (437) (1,139) (901) (1,661)
Acquisitions - (100) - (100)
Proceeds from disposal of
property and equipment 312 1,918 521 1,918
----------------------------------------
Cash provided by
(used in) investing (125) 679 (380) 157
----------------------------------------
Cash flow from operating,
financing and investing
activities 4,839 249 4,777 249
Effect of exchange rate
on cash and cash equivalents 23 - 32 -
----------------------------------------
----------------------------------------
Net change in cash
and cash equivalents 4,862 249 4,809 249
Cash and cash equivalents,
beginning of period 1,061 - 1,114 -
----------------------------------------
----------------------------------------
Cash and cash equivalents,
end of period $ 5,923 249 $ 5,923 249
----------------------------------------
----------------------------------------
See accompanying notes to the consolidated financial statements.
-------------------------------------------------------------------------
HSE Integrated Ltd.
Notes to the consolidated financial statements
For the three and six month periods ended June 30, 2009 and 2008
(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, 2008, except as outlined in note 2. 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, 2008.
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 (owned 90%), 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
On January 1, 2009 the Company adopted the revised Canadian accounting
standards regarding Goodwill and Intangible Assets. These standards
provide guidance with respect to the recognition, measurement and
disclosure of goodwill and intangible assets. The provisions of the new
standards relating to the definition of intangible assets and their
initial recognition have been changed to coincide with those in the
equivalent International Financial Reporting Standard. This change had no
effect on the Company's reported results.
Accounting Standards pending adoption
In February 2008, the Accounting Standards Board ("AcSB") confirmed the
changeover to International Financial Reporting Standards (IFRS) from
Canadian GAAP will be required for publicly accountable enterprises
effective for interim and annual financial statements relating to fiscal
years beginning on or after January 1, 2011. The AcSB issued an
"omnibus" exposure draft of IFRS with comments due by July 31, 2008,
wherein early adoption by Canadian entities is also permitted. The
Canadian Securities Administrators ("CSA") has also issued Concept Paper
52-402, which requested feedback on the early adoption of IFRS as well as
the continued use of US GAAP by domestic issuers. In March 2009, the AcSB
issued a second exposure draft regarding the adoption of IFRS. This
exposure draft clarified the definition of publicly accountable
enterprises, proposed to provide additional introductory material for the
CICA Handbook as part of the adoption of IFRS, and updated the IFRS
standards to be included in the CICA Handbook to include those standards
which had changed since the initial omnibus exposure draft was issued.
The eventual changeover to IFRS represents changes due to new accounting
standards. The transition from current Canadian GAAP to IFRS is a
significant undertaking that may materially affect the Company's reported
financial position and results of operations.
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
provided that all three standards are adopted simultaneously. The Company
is currently in the process of evaluating the new standards. 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 - Business
Combinations. It makes changes to the circumstances under which
the Company must consolidate an entity, as well as to disclosure
requirements.
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NOTE 3 - OPERATING FACILITIES and LONG-TERM DEBT
During the first and second quarter of 2009, the Company's credit
facilities included a $25 million three-year interest-only revolving
facility and a $7.5 million operating facility. The revolving facility
had a maturity date of June 25, 2010 with an ability to extend the term
at the lender's option. The operating facility was renewable annually on
June 24 and was margined to accounts receivable. Both the operating
facility and the revolving facility were subject to certain covenants
including a covenant regarding the ratio of senior debt to cash flows (as
defined in the agreement), a current ratio covenant, an interest coverage
covenant and certain other positive and negative covenants that are
typical for these types of facilities. The credit facilities were
collateralized under a general security agreement.
On July 29, 2009, the Company amended its existing credit facilities
with its current lender. The amended facility replaces the facilities
described above with a single $15 million operating facility. The amended
facility matures July 27, 2010. The amended 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
facilities. 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 complied with all covenants required under the amended credit
facility.
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.
-------------------------------------------------------------------------
June 30 December 31
2009 2008
-------------------------
Equipment financing contracts bearing interest
at rates averaging 4.2% (2008 - 2.93%), payable
in blended monthly payments of $5 (2008 - $12)
secured by specific equipment. $ 54 $ 131
Interest only credit facility 10,829 10,829
-------------------------
10,883 10,960
Accrued consideration on share purchase
acquisition 810 810
-------------------------
11,693 11,770
Less current portion (35) (98)
-------------------------
11,658 11,672
Less unamortized debt issue costs (58) (44)
-------------------------
$ 11,600 $ 11,628
-------------------------
Under the terms of the amended credit facility described above,
outstanding principal repayments are due as follows:
Calendar years:
2009 $ 21
2010 10,854
2011 818
-----------
11,693
Less: current portion (35)
-----------
Long-term portion before
unamortized debt issue
costs $ 11,658
-----------
-----------
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NOTE 4 - FINANCIAL RISK MANAGEMENT
Overview
The Company is exposed to the following risks from its use of 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. Customers in
both these industries may also face particular challenges in their
ability to secure debt and equity financing. 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
on going 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 a continuous basis as new information
becomes available and reviews past due amounts at least monthly.
June 30, 2009 December 31, 2008
---------------------------------------
Trade accounts receivable $ 17,872 27,145
Allowance for doubtful accounts (1,210) (1,405)
---------------------------------------
Total trade accounts receivable $ 16,662 25,740
---------------------------------------
---------------------------------------
The aging of trade receivables is as follows:
June 30, 2009 December 31, 2008
---------------------------------------
Gross Allowance Gross Allowance
Current (0 - 30 days from
invoice date) $ 10,086 13,465 -
Past due 1-30 days 3,249 45 6,633 -
Past due 31-90 days 3,296 215 5,949 481
More than 90 days 1,241 950 1,098 924
---------------------------------------
Total $ 17,872 1,210 27,145 1,405
---------------------------------------
---------------------------------------
The movement in the allowance for doubtful accounts receivables in
respect of trade receivables during the quarter is as follows:
2009 2008
---------------------------------------
Balance, April 1 $ 1,490 1,153
Bad debt provision 106 -
Write-offs net of
recoveries (386) (2)
---------------------------------------
Balance, June 30 $ 1,210 1,151
---------------------------------------
---------------------------------------
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NOTE 5 - RELATED PARTY TRANSACTIONS
During the quarter, the Company had the following transactions with
related parties, all of which are measured at exchange amounts:
- During the second quarter of 2009, the Company paid rent and property
taxes for a regional office to a corporation related to a Director of
the Company in the amount of $103 (2008 - $105)
- During the second quarter of 2009, the Company also paid rent of $74
(2008 - $78) for a regional office to a corporation controlled by a
Senior Manager of the Company.
NOTE 6 - SEGMENT INFORMATION
Management has determined that the Company operates in a single industry
segment, which involves the provision of industrial health, safety and
environmental monitoring services. Substantially all of the Company's
operations, assets, revenues, and employees are in Canada. For the
quarter ended June 30, 2009, the Company had one customer representing
more than 10% of revenue (June 30, 2008 - one). The Company had sales of
approximately $2.4 million to the customer during the quarter (June 30,
2008 - $3.3 million).
At June 30, 2009 US operations comprised less than 1% of revenues and
assets of the Company.
The Company provides services to two main groups of customer industries.
"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 oil sands extraction); oil and gas processing;
petrochemicals; pulp and paper; utilities; power generation; and
manufacturing. It also includes worker safety training and safety
management and consulting services. The Company tracks revenues provided
to each customer group as a method to predict future operating activity.
Revenue by customer group is as follows:
Three Months ended Six Months ended
June 30 June 30
2009 2008 2009 2008
---------------------------------------
Oilfield $ 4,317 8,667 $ 14,577 24,628
Industrial 15,249 19,420 27,390 31,028
---------------------------------------
Total Revenue $ 19,566 28,087 $ 41,967 55,656
---------------------------------------
As a % of Revenue:
Oilfield 22.1% 30.9% 34.7% 44.3%
Industrial 77.9% 69.1% 65.3% 55.7%
---------------------------------------
Total Revenue 100.0% 100.0% 100.0% 100.0%
-------------------------------------------------------------------------
NOTE 7 - STOCK-BASED COMPENSATION PLANS
Incentive stock option plan
The weighted average fair value of options granted for the quarter ended
June 30, 2009 was $0.26. The fair value of each option granted was
estimated on the date of grant using the Modified Black-Scholes option-
pricing model with the following assumptions:
June 30 December 31
2009 2008
----------------------------------------
Vesting period (years) 3 3
Risk-free interest rate 1.69% 2.11%
Expected life (years) 5 5
Price volatility 92.78% 89.70%
---------------------------------------
---------------------------------------
Pursuant to the stock option plan, a maximum of 10% of the issued and
outstanding common shares of the Company are reserved from time to time,
for issuance to eligible participants. Option prices and vesting terms
are determined by the directors at the time of granting at an exercise
price no less than market on the grant date. The term of options granted
does not exceed five years.
Information about outstanding stock options is as follows:
Quarter ended Year ended
June 30, December 31,
2009 2008
------------------- --------------------
Weighted Weighted
Average Average
Exercise Exercise
Options Price Options Price
------------------- --------------------
Outstanding, beginning of
period 2,533,499 $ 1.88 2,379,998 $ 2.15
Granted 650,000 0.36 735,000 0.99
Exercised - - (8,000) 0.50
Forfeited (471,333) 1.72 (573,499) 1.86
------------------- --------------------
Outstanding, end of period 2,712,166 $ 1.55 2,533,499 $ 1.88
------------------- --------------------
------------------- --------------------
Exercisable at end of period 1,508,301 $ 2.14 1,335,810 $ 2.16
------------------- --------------------
------------------- --------------------
The following table summarizes information about stock options
outstanding at June 30, 2009:
Weighted
Exercise average
Options prices remaining Number
outstanding $ life exercisable
-------------------------------------------------
1,165,000 0.25-1.19 4.38 178,330
853,500 1.20-2.14 2.00 668,647
318,666 2.15-3.09 1.69 286,324
375,000 3.10-4.04 1.78 375,000
-------------------------------------------------
2,712,166 1.55 2.95 1,508,301
-------------------------------------------------
-------------------------------------------------
Deferred share unit plan
On January 16, 2007, 15,000 deferred share units ("DSUs") were granted to
non-executive directors. An additional 15,000 DSUs were granted on May
15, 2008. On December 15, 2008 3,000 of the DSUs were settled for $1.
For the 2009 year, the directors' retainers and meeting fees are being
paid with DSU's. During the second quarter ended June 30, 2009, 130,970
DSU's were granted. The total DSU's outstanding at June 30, 2009 were
157,970.
The units are revalued quarterly and any change in value is included as
an increase or decrease in stock based compensation expense and accrued
liabilities. The expense recognized for the quarter ended June 30, 2009
was $43 (quarter ended June 30, 2008 - $16).
NOTE 8 - SUPPLEMENTARY CASH FLOW INFORMATION
Three Months ended Six Months ended
Increase (decrease) in non-cash June 30 June 30
working capital from operations 2009 2008 2009 2008
---------------------------------------
Accounts receivable $ 6,795 2,885 $ 9,084 (2,964)
Inventory (8) (2) (19) (5)
Prepaid expenses and other assets 143 (143) 552 10
Income tax recoverable/payable (3) 150 238 380
Accounts payable and accrued
liabilities (995) (326) (2,978) 420
---------------------------------------
Net change in non-cash working
capital $ 5,932 2,564 $ 6,877 (2,159)
---------------------------------------
---------------------------------------
NOTE 9 - 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.
ContactsHSE Integrated Ltd.
David Yager
Chairman & CEO
Telephone: (403) 266-1833
E-Mail: dyager@hseintegrated.com Lori McLeod-Hill
CFO
Telephone: (403) 266-1833
E-Mail: lmcleod-hill@hseintegrated.com
