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Edited Transcript of CEU.TO earnings conference call or presentation 15-Nov-19 4:00pm GMT

Q3 2019 CES Energy Solutions Corp Earnings Call

Calgary Nov 30, 2019 (Thomson StreetEvents) -- Edited Transcript of CES Energy Solutions Corp earnings conference call or presentation Friday, November 15, 2019 at 4:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Anthony Michael Aulicino

CES Energy Solutions Corp. - CFO

* Thomas J. Simons

CES Energy Solutions Corp. - President, CEO & Director

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Conference Call Participants

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* Aaron MacNeil

TD Securities Equity Research - Analyst

* Elias A. Foscolos

Industrial Alliance Securities Inc., Research Division - Equity Research Analyst

* Greg R. Colman

National Bank Financial, Inc., Research Division - MD and Energy Services & Special Situations Analyst

* Ian Brooks Gillies

GMP Securities L.P., Research Division - Director of Institutional Research and Research Analyst of Energy Services & Infrastructure

* Josef I. Schachter

Schachter Energy Research Services Inc. - Author & President

* Keith MacKey

RBC Capital Markets, Research Division - Analyst

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Presentation

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Operator [1]

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Thank you for standing by. This is the conference operator. Welcome to the CES Energy Solutions Third Quarter 2019 Results Conference Call and Webcast. (Operator Instructions) The conference is being recorded. (Operator Instructions)

I would now like to turn the conference over to Mr. Tony, our Chief Financial Officer. Please go ahead, sir.

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Anthony Michael Aulicino, CES Energy Solutions Corp. - CFO [2]

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Thank you, operator. Good morning, everyone, and thanks for attending today's call. I'd like to note that in our commentary today, there will be forward-looking financial information and that our actual results may differ materially from the expected results due to various risk factors and assumptions. These risk factors and assumptions are summarized in our third quarter MD&A and press release dated November 14, 2019, and in our annual information form dated March 12, 2019. In addition, certain financial measures that we will refer to today are not recognized under current general accepted accounting policies. And for a description and definition of these, please see our third quarter MD&A.

At this time, I'd like to turn the call over to Tom Simons, our President and CEO.

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Thomas J. Simons, CES Energy Solutions Corp. - President, CEO & Director [3]

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Well, good morning, and thank you for joining today's Q3 conference call for CES. On today's call, we'll talk about Q3 results. We'll share progress on our 80-20-16 capital allocation strategy. We will provide our customary detailed operations update and outlook for each of the business lines. We'll further share our outlook for industry, our company and our thinking around capital allocation, CapEx and growth prospects for the business. Tony will give a detailed financial update. We'll take questions, then we'll make closing remarks and conclude the call.

In the quarter, we generated CAD 315 million in revenue and $42.2 million of EBITDAC. The strong free cash flow that generated allowed us to further reduce our credit line from CAD 95 million to CAD 75 million. We easily funded our modest dividend and spent approximately $10 million cash CapEx. We further bought shares and canceled them to the modest tune of 0.75 million shares. We've since picked up the pace on share buying and have further bought almost that amount just since the quarter closed.

We plan to take advantage of potential tax loss selling of the stock. We increased working capital a little through the quarter because the port of Corpus Christi will close for 5 months this winter. So we need to build barite ore inventory in advance of that.

The company remains committed to 80-20-16 for the balance of the year. So 80% of free cash flow will be used to reduce the bank line. We want to further derisk the company. 20% of free cash flow will be allocated to buying back shares. $16 million funds the dividend. The $16 million remains a very low percentage of EBITDAC and free cash flow. We'll review the 80-20-16 allocation of free cash flow strategy in the New Year. Our priorities remain derisking the business, creating value for our equity holders, and preserving value for our bondholders. Our free cash flow capabilities make share repurchase a compelling option at these share price levels.

In our 13-year history as a public company, we've returned to shareholders approximately $325 million through dividends and distributions. Our business model supports returning capital to our shareholders, while being able to sustain and grow the business. However, pardon me, our business model supports that. However, we'll consider all options in the New Year in light of the share price.

CapEx remains around $10 million cash CapEx per quarter and $2 million to $5 million of lease CapEx per quarter. Because our manufacturing and logistics infrastructure are far below full capacity, CapEx is mostly rolling stock or trucks. We have added land in Midland to allow continued growth of Catalyst, our Permian production chemical business. For context, Catalyst operated on 7 acres 3.5 years ago, when we purchased the company. Now we operate on 30 acres.

I'll move on to operations and I'll also provide an outlook for each business line as we go through the update. U.S. drilling fluids made a great financial contribution in the quarter. We averaged 117 drilling fluid jobs through the quarter. Today, we're operating 102 jobs at AES. We see that as a likely activity level through Q4 and potentially right through 2020. We have capacity with our infrastructure and possible new customer wins that could create upside to that number, but we would need to take market share to expand that job count. We see drilling activity in the U.S. for industry around 800 rigs, with us on approximately 100. We continue to target results-based customers, hoping to win new business by providing better technology and execution, leading to lower overall drilling costs for our customers.

The biggest drop in activity for AES has occurred in Oklahoma. That's always been a very competitive market, so lower margins. Now it's also very slow for the industry. The Northeast is also off a couple of jobs for us. Texas and New Mexico continue to drive results for AES. At 100 jobs, AES can meet its targeted 15% EBITDA and generate nice amounts of free cash flow. Expansion on that job count would be very financially accretive. Just a shrinkage would reduce EBITDA percentage and free cash flow. The business relies on operating leverage.

I see our competitive advantage at AES in 2 lights. For our customers, we lower drilling days, saving them money. For investors, our previous investments in product manufacturing, infrastructure and building the best team in the U.S. mud business, all adds up to an upstream service line that generate substantial free cash flow. This business line pays its way within our portfolio of companies. It's not a loss leader for bundled offerings to big oil and gas companies. The North American operators don't want to buy any place. Baxter and his team continue to lead the U.S. drilling fluid industry in terms of innovation, and being a solid business.

U.S. production chemicals, Jacam Catalyst, saw a steady performance through the quarter. We continue to slowly expand with growth coming in the Permian and Rockies. We continue to see higher water cuts in the Rockies, which drives more chemical treatments. The Permian continues to expand for our customers, and we're growing in that growing market.

As the Permian's horizontals age, we expect water cuts to rise, driving increased treating. We also expect the overall production in the Permian to slowly rise, which will propel growth for us. Bern and his team are working hard to increase our profile within the market to firmly establish us as a Tier 1 chemical supplier. We need that to expand our business with the majors.

Our plan for U.S. production chemicals remains to service the customer with a sense of urgency of a small company with the science capabilities of a big company. That's really the magic formula for the entire company. We continue in the U.S. to push forward with StimWrx, our provider of novel stimulation chemistry. This is a very low capital niche business line that complements our operations, and financial model and goals.

I'll move on to Canada now. I'll start by expressing our dismay, with what we see as terrible public policy in Canada towards oil and gas. We applaud the Alberta and Saskatchewan governments for their leadership on this critical matter. We remain committed to Canada with our business, and we will be advocating as such. The path Ottawa has us on is wrong. And we're with our customers, our employees and our shareholders, and taking the fight to our opponents. Ottawa, Québec and Victoria are not putting Canadian oil and gas on blowdown mode.

Canadian drilling fluids managed to average 53 jobs in Q3. Today, we're at 58. At this level, we dipped below our targeted 15% EBITDA level. But because our infrastructure is built, we can still generate free cash flow at these levels. This is a low CapEx business. We see Q4 looking like Q3 with reduced activity over Christmas as is traditional in Canada. Q1 looks to be busier. But overall, industry likely only runs 125 to 140 drilling rigs on average in 2020. We need pipelines, so our customers can get real pricing for their production. LNG and oil pipelines will be powerful catalysts for Canadian drilling fluids. Like AES, Canadian drilling fluids relies on operating leverage.

I'll move on to PureChem, our Canadian production chemical business. Under new leadership, we continue to see solid top line results, but more importantly, better EBITDA margins and free cash flow generation. Morale is up, the pipeline to win new business is strong, and much improved processes around purchasing, manufacturing and pricing are all yielding solid results. Thank you to Ken and Dave Burroughs and the entire PureChem team for the great work and dedication to meeting the customers' needs, while also generating acceptable financial results in a tough market. We see substantial upside for PureChem as pipelines and LNG happens. We grow as well as age and as production expands.

StimWrx in Canada continues to help customers turn underperforming wells into cash flowing assets. As production is allowed to grow in Alberta, StimWrx will benefit. Sialco continues to perform very well. It's our reaction chemistry business based in Vancouver. We in-source to self-supply complex products through Sialco into all of our operating lines and also continue to expand the nonenergy sales Sialco generates. Clear is focused on new technologies to clean and recycle water. It's keeping its nose above water in a very tough Canadian market. We remain committed with Clear, but need increased activity or a technology breakthrough for Clear to be able to meaningfully financially contribute.

We're in a position to play the long game with Clear. We're convinced that money can be made around water and environmental matters. Our overall outlook remains positive because at current activity levels for industry, CES generates substantial free cash flow.

We see modest production growth likely in the Permian for industry, which we can benefit from. We see drilling and -- drilling fluid competition needing to knock off bad business practice and actually generate cash flow for themselves. We see that as a positive for CES. We see our biggest competition in production chemicals looking to spin-out of its parent company next year. That's possibly a positive for us. They won't be looking for either a low share multiple or declining financial results.

Our other major production chemical competition has twice saw price increases in the last 15 months. That's also a positive for CES. Most importantly, our customers now spend their own money on drilling and completions and maintaining their production. We believe this will mean that only best-in-class suppliers will survive and thrive in the long term.

I'll now turn it over to Tony.

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Anthony Michael Aulicino, CES Energy Solutions Corp. - CFO [4]

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Thanks, Tom. As Tom mentioned, Q3 represented another consecutive quarter of strong alignment with our financial areas of focus, including free cash flow generation, prudent CapEx, margin improvement, debt reduction, working capital optimization and improving returns. The company generated $316 million of revenue in the quarter and $42.2 million in adjusted EBITDAC, representing 13.4% of revenue and a third consecutive quarterly improvement in adjusted EBITDAC margin.

U.S. revenue increased slightly in comparison to Q3 2018, generating $227 million, or 72% of total revenue. U.S. results were underpinned by improving market share in our drilling fluids business, despite falling industry rig counts in the quarter and also benefited from increased activity levels across our production chemicals business, as the company was able to capitalize on its strategic investments completed in 2018 in key infrastructure and operations, in attractive markets, including the Permian and the Rockies.

Canadian revenue of $88 million or 28% of total revenue for the quarter represented a decrease of 21% year-over-year. This decrease is primarily attributable to the persistent industry challenges, which resulted in a decline in drilling activity as industry rig count decreased 31% and CES's operating days decreased 36%. However, year-to-date, the Canadian drilling fluids business has succeeded in maintaining very strong market share at 36%. PureChem's production chemical business model proved very resilient despite government-mandated production curtailments, as Canadian treatment points decreased by only 1% year-over-year. And perhaps more importantly, operational efficiencies in that division, which commenced in Q1 continue to be realized throughout the year into Q3.

During Q3, CapEx spend was $9.5 million, which represents a 64% reduction from the investments made in Q3 2018, primary expenditures in the quarter related to supporting increasing production chemical activity levels and associated headcount in the U.S. We continue to expect CapEx in 2019 to be at or below $50 million and include remaining key strategic investments, primarily in the Permian Basin. In the quarter, we also successfully completed an amendment and 2-year extension to our senior credit facility, providing us with additional availability on our U.S. facility, along with improved pricing on amounts drawn. As at September 30, we had a net draw of $75.3 million on our senior facility, compared to $161.5 million on December 31, 2018, and $94.8 million on June 30, 2019. This continued decrease was driven primarily by strong operational free cash flow generation in 2019, partially offset by opportunistic share repurchases through our NCIB program.

In Q3, we repurchased 764,000 shares at a weighted average price of $2.03 per share for a total amount for the quarter of $1.6 million. The company renewed its NCIB program effective July 17, 2019. Since inception of our NCIB programs, the company has repurchased a total of 9.4 million common shares at an average price of $3.21 per share for a total amount of $30.2 million, representing approximately 3.5% of outstanding common shares as of the initial July 17, 2018 inception date. Having completed significant CapEx programs in 2018, we continue to focus on increasing free cash flow generation and improving return metrics through execution in key markets, prudent CapEx, improved working capital efficiencies and opportunistic margin expansion. Throughout 2019, we continue to expect that EBITDAC will materially exceed the sum of cash expenditures on interest, taxes and CapEx, allowing for surplus free cash flow that may be allocated to reduce debt, pay our dividend and continue our share buyback program.

Operator, at this point, I'd like to turn it over to you to open up the line to potential questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question comes from Aaron MacNeil with TD Securities.

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Aaron MacNeil, TD Securities Equity Research - Analyst [2]

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Tom, in your prepared remarks, you mentioned your expectation for Permian water production volumes to show some growth in 2020. As water cuts increase over time and even if it's just anecdotally, how are you thinking about the change in contributions from Jacam Catalyst in 2020 versus 2019? And just in order to understand the order of magnitude, do you think that this growth can offset your expectations for a decline in AES?

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Thomas J. Simons, CES Energy Solutions Corp. - President, CEO & Director [3]

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I'm reluctant there to put too hard of a stake in the ground. But if I was a betting man, I'd say that 2020, probably is down 5% or 10% bottom line results for us over '19. Jacam Catalyst is growing. PureChem is starting to make appropriate returns against their revenue, but we probably need the rig count to be over 800 or we need some nice wins with some of the big customers we don't have rigs with today. So I think it's down a little just because industry is a little less active and any pickup closes that 5% or 10% delta pretty quick.

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Aaron MacNeil, TD Securities Equity Research - Analyst [4]

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Okay. And then, I guess, just moving over to U.S. drilling. You gave some guidance on expectations for the 800 average rig count. But in the context of your customer base today, without winning any additional customers, do you think that AES will outperform the broader market, perform in line or underperform based on the conversations you're having with customers today?

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Thomas J. Simons, CES Energy Solutions Corp. - President, CEO & Director [5]

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I think we'll outperform. We're making more money than our other mud customers because we've got a better cost of goods. We've got more efficient infrastructure. We're sized right for people, and we've got innovation or technology they don't have to offer that works. Are we going to go up 5% in market share? I don't think so, Aaron. We need to lead with price. But we're still hanging in there with high-70s in the Permian, and our new wins are happening in the Delaware as people look to push that north. Those wells potentially get harder to drill. And that's good for the mud company, and we've got infrastructure that could easily support 20 or 30 more jobs in that market and remain very efficient for the customer.

And about what we expect for Jacam and Catalyst, we bought more land in Midland because we expect to park more trucks. We're not in need of more analytical equipment, but we're going to build a 10,000 square-foot lab building basically in front of our office and lab complex in Midland, as part of our effort to showcase our capabilities to the majors because we do some work for them. We need to do a lot for them. And they're coming in late compared to the independents, obviously, on ramping up production, and we want to be in on that. So we need to project that we are a Tier 1, and then we just need to use the body of work we have as evidence that we're better than the competitor.

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Aaron MacNeil, TD Securities Equity Research - Analyst [6]

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Okay. And you had mentioned parking some more trucks. Given your expectations for some growth in Jacam Catalyst, do you expect to maintain your 2019 spending levels? Or do you think it will be higher or lower? Like any early glimpses of what 2020 CapEx could look like?

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Anthony Michael Aulicino, CES Energy Solutions Corp. - CFO [7]

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So Aaron, we continue to believe that we're going to track at or below the $50 million cash CapEx that we talked about this year. And we provided that in Q4 of 2018, and we'll do the same thing for next year during our Q4 MD&A and call. I think at this point, it's safe to say that, that $50 million is probably the higher end of what we think we're going to spend. But as Tom said, we need to continue to monitor the end markets in Q4 and early Q1, and at that point, give you a more reasonable estimate. But I think at this point, $50 million is the number to think about. And don't be surprised if we end up with a number that's below that for our expectation next year when we come out with that estimate at Q4.

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Aaron MacNeil, TD Securities Equity Research - Analyst [8]

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Okay. And then even with the 5% to 10% decrease in the bottom line performance, there's a good chance that you'll have paid off all or a whole bunch of the line by this time next year. And I know you had hinted at reevaluating the 80-20-16 plan in the New Year. But can you share any updated views on what you might look to prioritize even just conceptually? And is it as simple as just shifting to reducing the balance of the 2024 announce? Or do you have something else in the mind?

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Thomas J. Simons, CES Energy Solutions Corp. - President, CEO & Director [9]

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It's to derisk the business against the commodity shock. It's to derisk the business against losing a big customer. We only have 1 over 10%, but we owe it to the business to do that. We've made a huge step that way. We've dropped the line by over half. I think the next easiest way to create value for equity holders and security for bondholders is to buy shares. So we're going to look hard at that, Aaron.

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Anthony Michael Aulicino, CES Energy Solutions Corp. - CFO [10]

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And following up on some of the other elements, Aaron, we have a gift. We have a very strong free cash flow generating business. And we've continued to show that Q1, Q2, Q3, we're going to continue to focus on that. And that gives us the flexibility. And with regards to paying down debt, yes, we do talk about the bank line. But absolutely, if we had the opportunity to buy back some bonds that -- there is obviously higher cost debt. That's the way we look at deleveraging as part of the -- as one of the options that Tom referred to, and we would absolutely look at that option if it makes sense to us as well.

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Operator [11]

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The next question comes from Greg Colman with National Bank Financial.

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Greg R. Colman, National Bank Financial, Inc., Research Division - MD and Energy Services & Special Situations Analyst [12]

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Sorry, I'm still figuring out how phones work. I wanted to start by poking around our margins. It's great to see them tick up in the quarter. It was a little bit, but they did tick up. And I think we're back to close to 2-year highs now. Into year-end, we anticipate a normal seasonal roll for your EBITDA margins, given U.S. Thanksgiving, Christmas budget exhaustion. Is that consistent with what you're thinking? Or could we see either of something outside of that either them pulled in, which I think is unlikely or them more sort of roll than we've seen historically just given what's going on with the U.S., let's say, reluctant to spend outside of operating cash flow from a producer standpoint?

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Anthony Michael Aulicino, CES Energy Solutions Corp. - CFO [13]

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Yes, let me start off from a financials perspective, Greg. So obviously, with the rig count down to where it is, we're currently on 102 rigs in the U.S. with AES versus the 117 rig average in Q3 and 128 rig average in Q2. So obviously, you should expect a lower contribution in that business, which is a big part of our business. But however, it is a very strong business. And as I said and alluded to in terms of capital allocation considerations, we're going to do the same thing for the business and AES, in particular. It's a great business, with great people that run it, and that have always punched above its weight. We are not going to be looking at reducing costs that don't make sense in the mid to long term. So if we do have to realize a bit of a margin erosion in the quarter, as the company and AES figures out what the new environment looks like, we're going to keep those high quality people. And if it requires us to take it on the chin a little bit in margin in Q4 and even Q1, we'll do that. But I think your initial comment was bang on, quarter-over-quarter, absolutely, we should see a reduction. And frankly, that's already what we're starting to see that came out in initial reports from the research community.

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Thomas J. Simons, CES Energy Solutions Corp. - President, CEO & Director [14]

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Yes, Greg, I'll build on that. The reason to say, carry 20 people at AES through the winter is the success we're having with this new mud system in the Delaware. We're dropping costs and dropping days, and in the words of our VP of BD in the Permian, and he said, in 40 years, it's the first thing he's seen that somebody can't copy, and that it's real and measurable. So we're reducing incidences of lost circulation, drilling in the Delaware and intermediate section. We're reducing the need for diesel dilutions to keep the weight down to avoid the losses. And most importantly, we're able to break that system at the end and recycle the brine and the diesel. So we're going to keep people because we think that's a proposition that some of the big operators that we're on -- we're not on location with, they're going to give us a shot with that. And so we think we can put those people back to work.

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Greg R. Colman, National Bank Financial, Inc., Research Division - MD and Energy Services & Special Situations Analyst [15]

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Got it. No, that makes sense. Sticking with the margin commentary, looking at a little bit longer term. In the past, we've had some healthy discussions and debates about sort of critical EBITDA margin levels, 15 kind of being a bit of a magic number. I don't think anybody is anticipating that level in the short term, given the challenging macro environment. But Tom, do you have an idea, a challenging macro defining it as 800 rigs in the U.S., 125 to 140 in Canada, Tom, do you have an idea as to what we would need the macro to look like for sort of that 15% to be an achievable full year average in EBITDA? What kind of operating environment do you need to have for CES to get to those levels?

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Thomas J. Simons, CES Energy Solutions Corp. - President, CEO & Director [16]

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1,000 rigs in the U.S. and 200 in Canada, and maybe less if we continue to have success with this mud system in the Delaware. And if the pickup in the Canada is to support LNG, we're killing it on these deep plays, Greg, as you well know. So we don't even maybe need that much of a pickup in Canada. There's so much operating leverage in those businesses that an extra 20 jobs for both business units can really power charge the results. And then we're going to go back to that location after its fracked and treated. So production growth in the Permian and LNG in Canada, I don't think it takes a lot, but it does take a little or take some big market share gains for us.

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Greg R. Colman, National Bank Financial, Inc., Research Division - MD and Energy Services & Special Situations Analyst [17]

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No, I appreciate the frankness on those macro levels, we'll keep an eye on. Moving over a little bit to the balance sheet. On working capital, I think in prior quarters, you talked to net neutral working capital in the back half of 2019. Q3 is pretty close to 0. But the new factor you threw in there that, I guess, is new to me was the Corpus Christi port shutdown, so you want to stockpile some barite. Should we be looking for Q4 working capital to be around Q3, i.e., call it, not really plus/minus anything? Or should we look for a big harvester drop?

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Anthony Michael Aulicino, CES Energy Solutions Corp. - CFO [18]

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So we typically see an increase from Q3 to Q4 for a couple of reasons. Number one, what we're expecting in terms of the trend in quarter-over-quarter activity, and perhaps more importantly, our focus on working capital optimization, I think, this year versus others, you should expect flat quarter-over-quarter. And if we continue to do what we've been able to do over the last few quarters, you could see flat to potentially down quarter-over-quarter.

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Greg R. Colman, National Bank Financial, Inc., Research Division - MD and Energy Services & Special Situations Analyst [19]

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That's great to hear. Okay. And then lastly for me, just on the CapEx side, not to beat a dead horse here. I know, Aaron, touched on a lot of it, but just some clarity. You've got that $50 million bogey out there as 2019 $50 million spend or less. I think based on year-to-date, you're $34 million in. I think we're all kind of looking for less than that. But if we look at your CapEx net of dispositions, certainly net capital is only more like $20 million. So I just want to be clear that we're all talking about the same numbers here. When we talk about $50 million, that would be relative to $34 million year-to-date, i.e., up to a maximum of $15 million in Q4, not up to a maximum of something like $30 million in Q4, because your net number is more like $20 million?

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Anthony Michael Aulicino, CES Energy Solutions Corp. - CFO [20]

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That's correct.

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Greg R. Colman, National Bank Financial, Inc., Research Division - MD and Energy Services & Special Situations Analyst [21]

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Okay. Great. And then just on that, if we're looking into next year and thinking of up to $50 million or less, you have divested of about $15 million of assets year-to-date in 2019. Is there much left there to go? Are there non-core asset sales that could take your net number to materially below that? Or should we be thinking of that $50 million or a bit less?

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Anthony Michael Aulicino, CES Energy Solutions Corp. - CFO [22]

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So you should be still thinking of $50 million or a bit less until we give you the update. And again, as I told Aaron, don't be surprised if it is a bit less in terms of an estimate. We regularly dispose of assets, and that's typically us putting some of the rolling stock that we use to support our business, i.e., vehicles out for disposition or disposal, and it's a regular cadence. And that's actually part of our maintenance CapEx that we use to keep those vehicles on the road and when they're getting close to being mild out, we'll bring them in and we'll sell them. And that's where the majority comes from in terms of proceeds from disposal of assets. That number that you quoted for this year is a little bit higher than we typically see. So I wouldn't expect it to be that same size. But when you think about the amount of cash that we spend on CapEx, that number will be in that $40 million to $50 million in range, and we're thinking about where it's going to be for 2020, and we'll update you in Q4. But for now, use that number and that number does not include those disposals that you saw this year. And I would argue that, that number is a little bit higher this year than it will be next year.

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Thomas J. Simons, CES Energy Solutions Corp. - President, CEO & Director [23]

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Yes, we could be running a truck auction over here, Greg, if they were all in one place. You drive them, you depreciate them, you replace them and you sell them.

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Operator [24]

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(Operator Instructions) The next question is from Keith MacKey with RBC.

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Keith MacKey, RBC Capital Markets, Research Division - Analyst [25]

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Just one question for me. Tom, in your prepared remarks, you mentioned the competitive behavior of some of the larger mud companies. This is something that we think has been happening for quite some time. But have you noticed a change or intensification of that competitive behavior over the last quarter as the U.S. rig count has slid?

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Thomas J. Simons, CES Energy Solutions Corp. - President, CEO & Director [26]

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Well, we're watching the commentaries of the big integrated service companies to see how they talk about their business offerings, and then we compete with them every day on the street. What we're seeing is that there are new bids that they're putting in, they're raising their prices. And what we're hearing them say on their calls is they're not going to have loss leader business lines. They can't afford to subsidize the customer. And how they got into that position in the first place is they took a sales approach where they bundled everything for the big operator, and before it became a technical service, they allow drilling fluids to become a loss leader to help them get pumping equipment out or expensive downhole tools. And I think that they're getting the same pressure we're getting, make money or don't be in the business. So I don't think it's changing overnight, but we see the results of the guys that segment or have big businesses and those businesses are not making any cash flow. So we think we understand why they're behaving differently. And for the customers that think we do a better job, but the premium for the value adds too high, I think we can pick some of that work up when we cost the same as the other guy. We don't need to raise our prices to generate cash flow in these mud businesses, we just need enough volume.

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Keith MacKey, RBC Capital Markets, Research Division - Analyst [27]

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Got you. Okay. So just to be clear then, in what you're seeing in the competitive space, competitors have been actually raising prices and not slashing prices and, say, coming after some of your key clients?

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Thomas J. Simons, CES Energy Solutions Corp. - President, CEO & Director [28]

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We see mom-and-pops working for results that if they brought their accountant to their office once in a while, they quit doing. We don't think we can prevent that ever from changing. But the bigger corporate competitors need to do what we need to do, and that is turn some cash. So we're seeing the bigger competitors raise prices or even look at divestiture of the business because they've allowed the people that could maybe turn it around a leaf or they push them out.

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Keith MacKey, RBC Capital Markets, Research Division - Analyst [29]

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Got it. And just on the divestiture side then, would it potentially make sense or be viable to buy a competitor business as opposed to having to organically win competitors? Or how are you thinking about that currently?

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Thomas J. Simons, CES Energy Solutions Corp. - President, CEO & Director [30]

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I'm thinking that if they're selling it it's because it's not paying its way, and we're not issuing 1 share for anything that doesn't pay its way. And they're not selling it if it's higher-margin business. So I don't think we're interested. Maybe there's the odd asset that could drive cost of goods down or give us some infrastructure in a good place, but we're pretty built out everywhere and we don't need to add low-margin sales.

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Operator [31]

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The next question is from Ian Gillies with GMP.

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Ian Brooks Gillies, GMP Securities L.P., Research Division - Director of Institutional Research and Research Analyst of Energy Services & Infrastructure [32]

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With respect to some of the strategic initiatives in non-oil and gas, I guess, areas of focus, are you able to provide any goalpost of maybe coming even 2021, what percentage of your business you would like that to represent? Or I mean, where you'd like to be there?

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Thomas J. Simons, CES Energy Solutions Corp. - President, CEO & Director [33]

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If we could ever get it to 5%, it becomes interesting maybe you look at ways to expand that through M&A, but we're not at that point, Ian. It's a low volume, high-margin space, whether it's cosmetics or industrial or household goods. Probably the big volume areas would be agriculture, municipal water treating, and we continue to poke around at those markets. If we get a hit on a technology, we can make big volumes in Kansas, and we can make smaller volumes in Vancouver, where much of that stuff originates.

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Ian Brooks Gillies, GMP Securities L.P., Research Division - Director of Institutional Research and Research Analyst of Energy Services & Infrastructure [34]

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And you've kind of hit on the last set of questions and with mine. But I mean, historically, you've been pretty active and quite successful in the M&A market. Are you may be able to qualify what that market looks like right now relative to when you've been active previously and acknowledging that you have some room to grow at your Kansas facility in some of the prior comments you've made?

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Thomas J. Simons, CES Energy Solutions Corp. - President, CEO & Director [35]

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It's -- I mean, it's never say never, but it's not an area of focus. We think we can organically grow the business, we can organically shrink the share count and further derisk the business, and those are our priorities. We don't need infrastructure, Ian, anywhere that we need to be in. We need to work on adding relationships of trust and filling these plants because there's more margin in the second half, obviously, in the volume in the first half.

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Ian Brooks Gillies, GMP Securities L.P., Research Division - Director of Institutional Research and Research Analyst of Energy Services & Infrastructure [36]

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And with respect to adding customers in West Texas, I mean, what are some of the gating factors you've realized just trying to get in with these guys? And where are you, I guess, you think you need to improve to start winning some of these larger super major customers?

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Thomas J. Simons, CES Energy Solutions Corp. - President, CEO & Director [37]

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We need to work for their competitors that have better drilling or completion metrics than they do and play a hand in that, which we are and then we need to advocate for that. So we've got into a couple of the very big independents in the last 6 months in the Permian, specifically in the Delaware. And we're working hard on the super majors that look to be ramping up as the independents get a little slower. So we're going to get the work with technology and execution. And what they're looking for is to be as good as the best operators with their capital and have certainty of supply of high-quality products. Our mill in Corpus, our reaction plants in Kansas and Vancouver, our distribution in Midland, our mega mud plant in the Delaware, all of those things are the things that the super majors are evaluating when they consider you're ISO certified in manufacturing, working to have all of the labs be that way, we think we check the boxes for them. We give them what an independent gives them in service and sense of urgency, but the problem-solving capabilities of a big company.

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Ian Brooks Gillies, GMP Securities L.P., Research Division - Director of Institutional Research and Research Analyst of Energy Services & Infrastructure [38]

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Got it. Last one for me. Tony, I just want to reconfirm, but that $39 million of G&A in Q3, that's a reasonably good run rate moving forward?

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Anthony Michael Aulicino, CES Energy Solutions Corp. - CFO [39]

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Correct.

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Operator [40]

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The next question comes from Elias Foscolos with Industrial Alliance.

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Elias A. Foscolos, Industrial Alliance Securities Inc., Research Division - Equity Research Analyst [41]

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Just want to focus a bit on some of the things I've heard from some other service companies that they're seeing potentially a relatively hard stop in some sort of activity in the second half of Q4. There's a number of factors that play in here versus whether they're doing work for independents versus majors and whether they're drilling-related or completion related. I know it's a myopic question because it's short-term versus, I would agree, you're 800 rigs kind of long-term next year. But just to not be surprised, are you seeing anything along that line or not?

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Thomas J. Simons, CES Energy Solutions Corp. - President, CEO & Director [42]

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Traditionally, and that's not an uncommon event where people have exhaustion in their budgets. Traditionally, the hard stop is on completions. You want to drill the whole land, you want to drill to hold a high spec rig, and you're not going to shut production in at the end of the year to save the treating costs. So if you're hearing that, my guess is it's probably completions type work, which is a very small percentage of our business. We're kind of half upstream, half production, and the vast majority of the upstreams drilling. So we think there will be sort of a break in Canada at Christmas because we always observe it. The U.S. doesn't seem to shut the rigs down at Christmas. I think the 100 stays for the quarter in the U.S., plus or minus. And I think 50 to 60 in Canada and a little less for 10 days in December, and I think production ticks along. I think the hard stops are that people can leave a well to be completed after the New Year.

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Operator [43]

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The next question comes from Josef Schachter with Schachter Energy Research Services.

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Josef I. Schachter, Schachter Energy Research Services Inc. - Author & President [44]

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Congratulation on a decent quarter in a pretty tough business.

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Thomas J. Simons, CES Energy Solutions Corp. - President, CEO & Director [45]

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Josef, I am sorry, I missed your conference a month ago. I was stuck in the Toronto Airport for a day.

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Josef I. Schachter, Schachter Energy Research Services Inc. - Author & President [46]

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No, your partner did a great job, and we appreciate you being there and waving the flag and letting the story come through to the client base. The first question I've got is on the debt. You paid down $19 million in the quarter, $85 million year-to-date. Run rate on cash flow is [$130 million, $140 million]. What's the target in 2020, '21? You want again to get below 2:1? What's your comfort zone where you get off that 80-20 approach that you have right now in terms of NCIB, dividends and the 80% down? What is your target to get to $250 million? Is there a number? Or is there a percentage that you're looking at?

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Anthony Michael Aulicino, CES Energy Solutions Corp. - CFO [47]

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It's a good question. And they're -- as you can appreciate, a whole bunch of moving pieces. But the biggest moving piece was the one that we sort of have shown over the last 3 quarters, which is what level of free cash flow can this enterprise generate. So we have a really good feel for that. And obviously, so do you because you just rattled off some pretty good estimates. And then the next piece is, at what point do we get comfortable making a decision, if at all, to veer away from 80-20-16? On the one hand, we can wait until we get to a certain point in time. But much more realistically, we're going to regroup and take a look at what the free cash flow capability continues to be for the business, what we believe that will lead us to. And in terms of a metric, it's not really the debt amount, it's really the leverage level that we look at, that we feel gives us a point between those 2 guardrails that we feel comfortable making or tweaking the 80-20-16 if we choose to.

And very specifically, if I had to be put on the spot for a number, it would probably be around that 2x level that I think we'll get to over the next year or so. And on that, the thing that makes it tricky in a good way on the low extreme of the guardrails is the fact that, as you know, by the very nature of our business model when things are flat year-over-year or more importantly, when they soften year-over-year, we actually harvest a whole bunch of cash from working capital. So that gets us very comfortable allowing us the flexibility to tweak that ratio that Tom talked about, that will always be revisiting, but in terms of leverage level, it's probably around that 2x that we can see in the midterm that we're comfortable with. And then like I said, given the nature of our business, we have that additional cushion because if things are flat or down, we actually see an improvement on the debt side.

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Thomas J. Simons, CES Energy Solutions Corp. - President, CEO & Director [48]

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Josef, I'll jump in here and say, we're going to meet as management and Board in January. Once we see what our customers are going to do next year, what Aramco does with their IPO and OPEC does with supply, what happens with TMX and LNG in Canada. The variable for the change that could lead us to be a little more debt averse is that our customers have gone from spending 130% of cash flow for 20 years to spending about 80%. So we have a duty to make sure that the balance sheet for our business reflects that shift. I don't think we over-levered the business in the first place in the context of customers' outspending cash flow. But it seems like that change to cash flow-driven businesses that we work for is permanent or semi-permanent. And if that's the case, then we continue to pay down some debt and feel our way through our customers' expectations to spend money. We know that there's a lot of money to be made for long-term equity holders by buying and canceling stock, and we're keeping our eye on that.

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Josef I. Schachter, Schachter Energy Research Services Inc. - Author & President [49]

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Yes. No, I agree with you. And then also, if there is more caution in 2020, it just sets up a more powerful up-leg once people see the deliverability issues from the U.S. shales is not as high as expected. 2 more questions for me. One on the finance side. If this new mud system you've got for the Permian Delaware is giving you market share and your competitors don't really have a product for it, is this something that you can change to the Eagle Ford or to other basins and the Montney here in Canada, the Duvernay in Canada and create a higher-margin product for yourselves?

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Thomas J. Simons, CES Energy Solutions Corp. - President, CEO & Director [50]

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No. The great thing about the mud business as much as the industry says drilling is manufacturing, it's not. You're screwing a hole in the ground. And all you have to do is drive around North America to see that geography changes. And so that system, Josef, is as Schlumberger would call it basin-specific. It works in a certain type of geology and it's not required in other areas.

It's the fact that it's not -- if there was one size fits all, eventually, everyone would copy it, and then the customer would bid it down.

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Josef I. Schachter, Schachter Energy Research Services Inc. - Author & President [51]

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Yes, yes. I was just wondering if there was something that you were doing new here that you could use for a period of time until your competitors do create something, especially for the tougher basins, but I pick up what you're saying there. Lastly, with the announcement by Minister Savage of opening up conventional drilling, do you see that as a potential bounce to your Q1 revenue forecast or your business forecast for 2021 -- 2020, sorry?

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Thomas J. Simons, CES Energy Solutions Corp. - President, CEO & Director [52]

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Yes, we do. We've already seen products come in. We're seeing some well capitalized operators looking like they're going to put some money to work. So that move by the government looks to be helping services a bit in the near term.

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Josef I. Schachter, Schachter Energy Research Services Inc. - Author & President [53]

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Okay. And the last one for me is just popped in my head. With the TC decision, the interruptible, where hopefully, prices are firmer in the summer. Are you seeing anybody on the business side sort of talking to you about more activity given their hope that we're not looking at $0.20 gas but more like $1.50 gas in the summer and trying to put together a business plan for activity in the summer?

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Thomas J. Simons, CES Energy Solutions Corp. - President, CEO & Director [54]

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Too early to say. Our Canadian customers are getting very financially strong by being hamstrung on growing production. So I think the arb is growing. We just don't know when it opens up.

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Josef I. Schachter, Schachter Energy Research Services Inc. - Author & President [55]

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Congratulation, again, for a decent quarter, though tough business.

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Operator [56]

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This concludes the question-and-answer session. I would like to turn the conference back over to Tom Simons, President and CEO, for any closing remarks.

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Thomas J. Simons, CES Energy Solutions Corp. - President, CEO & Director [57]

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Well, in conclusion, the quarter allowed CES to further derisk by reducing the bank line by another CAD 20 million. It allowed us to buy 0.75 million shares, and it allowed us to comfortably fund our dividend out of cash flow. So we're not using debt or equity issuances, as our industry has long been known for to fund dividends or fund CapEx. We funded the $10 million cash CapEx out of cash flow as well. Going forward, we're going to remain conservative around our balance sheet. We'll buy and cancel shares and will fund our modest dividend out of cash flow. All of that is only possible because of our people running great business lines. We thank our customers for the business and look forward to creating value for equity holders, while preserving value in the bond. Thank you.

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Operator [58]

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Thank you. This concludes today's conference call, you may disconnect your lines. Thank you for participating, and have a pleasant day.