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Edited Transcript of STEP.TO earnings conference call or presentation 7-Nov-19 3:00pm GMT

Q3 2019 Step Energy Services Ltd Earnings Call

CALGARY Nov 13, 2019 (Thomson StreetEvents) -- Edited Transcript of STEP Energy Services Ltd earnings conference call or presentation Thursday, November 7, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Michael G. Kelly

STEP Energy Services Ltd. - CFO & Executive Vice President

* Regan Davis

STEP Energy Services Ltd. - CEO, President & Director

* Stephen Glanville

STEP Energy Services Ltd. - COO & VP of Operations

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Conference Call Participants

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* Aaron MacNeil

TD Securities 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

* Jon Morrison

CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research

* 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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Good morning, ladies and gentlemen, and welcome to the STEP Energy Services Third Quarter Results Conference Call. This conference call is being recorded today and will be webcast on STEP's website but may not be recorded or rebroadcasted without the expressed consent of STEP energy services.

All amounts discussed today are in Canadian dollars unless otherwise stated. The complete financial statement and management's discussion and analysis for the period ending September 30, 2019, were announced this morning and are available on STEP's website at www.stepenergyservices.com and on the SEDAR website.

During the call, management may make projections or other forward-looking statements regarding future events or future financial performance. Actual performance, events or results may differ materially.

Additional information or factors that could affect STEP's operational or financial results are included in STEP's most recent annual information form, which may be accessed through the company's website, through the SEDAR website or by contacting STEP Energy Services. Management also calls your attention to the forward-looking information and non-GAAP measures sections of the news release issued earlier today.

I would now like to turn the meeting over to Mr. Regan Davis, STEP's President and Chief Executive Officer. Please go ahead, Mr. Davis.

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Regan Davis, STEP Energy Services Ltd. - CEO, President & Director [2]

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Thank you, and good morning, everyone. Welcome to STEP's Third Quarter 2019 Results Conference call. With me this morning, I have Michael Kelly, our Executive VP and Chief Financial Officer; Steve Glanville, our VP of Operations and Chief Operating Officer; and Rob Kukla, our Director of Corporate Development.

In this challenging market, STEP remains focused on generating strong margin performance through our exceptional field execution, disciplined asset allocation, and rigorous cost management.

In Canada, we were able to achieve adjusted EBITDA margins of 24% in the third quarter, similar to last year and actually improved margins by 200 basis points in the first 9 months of this year compared to last year. We have focused on optimizing maintenance spend, and through numerous initiatives, to enhance equipment performance and extend asset life. As a result, we have been able to reduce our 2019 capital program by $20 million, bringing the total 2019 program down to $44 million.

Over the past several quarters, service companies have been idling equipment in anticipation of weaker activity. STEP is no exception. Since the third quarter of last year, we have reduced our manned fracturing capacity by 25% and manned coiled tubing capacity by 23% across both Canada and the U.S. As discussed on earlier updates, proactively managing our manned update in a changing market is a key driver of our margin performance.

Recently, we have seen public announcements of permanent equipment retirements and large asset impairments, removing a significant amount of horsepower from the U.S. market. This attrition and idling of equipment is very positive as it is a good start to alleviating oversupply and should help bring equilibrium back into the markets.

Michael will now provide a brief overview of our third quarter 2019 results. I will then provide an update on our North American operations and share STEP's go-forward business outlook. We'll then open the call up to any questions.

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Michael G. Kelly, STEP Energy Services Ltd. - CFO & Executive Vice President [3]

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Thanks, Regan. All financial comparisons I'm going to provide relate to third quarter 2019 compared to third quarter 2018, unless otherwise noted.

During the third quarter, STEP generated consolidated revenue of approximately $179 million, down 26% due to slower activity in both Canada and the United States. The Canadian segment third quarter revenue was $98 million, down $50 million or 34%, driven by decreased coiled tubing and fracturing activity, with 27% and 20% fewer operating days, respectively.

Increased levels of client-supplied sand from 16% a year ago to 63% this quarter also reduced revenue per day for fracturing services. As we previously discussed, late last year and early this year, we took measures to right-size our manned equipment levels in anticipation of this decline in an effort to maintain utilization and margin performance. These decisions are reflected in our current quarter and year-to-date performance. Canadian operations contributed adjusted EBITDA of $23 million, down $13 million or 36%, primarily related to decreased fracturing activity. However, adjusted EBITDA margin of 24% was flat from last year's third quarter. Despite lower pricing and activity, we were able to maintain margins through strong field execution, effective management of manned equipment and reductions in overhead and G&A spending that aligned with our reduced activity outlook.

When comparing year-to-date performance, we were able to improve adjusted EBITDA margins by 200 basis points to 20% over last year due to these optimization measures. The U.S. segment generated revenue of $81 million, down $12 million or 13% due to reduced fracturing activity and utilization, with 7% fewer operating days and increased pricing pressure in an oversupplied market. However, pumping efficiencies enabled STEP to pump 56,000 tonnes more proppant over 28% more stages compared to the third quarter of 2018.

Despite 34 more operating days and better utilization in coiled tubing, market pricing pressure continued to impact revenue, with coiled tubing day rates declining 18%. U.S. operations contributed adjusted EBITDA of $4 million or 5% margin compared to 10% -- $10 million or 10% margin previously. Adjusted EBITDA margin was impacted by a decline in the demand for our services and associated increased pricing pressure across all service lines.

Compared to the second quarter of 2019, revenue and adjusted EBITDA for U.S. operations decreased 27% and 76%, respectively. During the second quarter, STEP intermittently deployed a fourth fracturing spread, which is not utilized during the third quarter. The market has -- the market also experienced an earlier than expected slowdown as clients' capital spending programs near completion, which slowed activity and exacerbated the oversupply of equipment.

Expenses related to the corporate segment, including depreciation and share-based compensation were $4.2 million compared to $3.1 million. As expected, corporate expenses were flat from the second quarter of this year. As a result, consolidated adjusted EBITDA was $22.7 million or a 13% margin compared to $42.5 million or an 18% margin. Lower consolidated adjusted EBITDA was primarily due to decreased pricing activity associated with lower demand for our services. Strong execution and a continued focus on cost management helped offset some of the pricing compressions and preserve margins.

During the third quarter of 2019, STEP recorded $113.5 million noncash impairment charge with respect to goodwill and intangible assets in the U.S. fracturing business. Similar to 2019, the company anticipates sustained pressure on commodity prices and expects our clients will maintain a conservative focus on capital spending in 2020. These factors have a negative impact on our outlook for these operations and have resulted in an impairment to their carrying value.

Total capital expenditures in the quarter, excluding right-of-use assets, were $12.1 million. Most of which were maintained were related to maintenance CapEx programs. At the end of the quarter, the company had positive working capital of $96 million, an increase from $67 million at the end of 2018. Available financial resources were approximately $114 million, consisting of cash on hand and the remaining availability on our credit facilities. Excluding changes in noncash working capital, the company had positive cash flow from operations in the third quarter of $20 million and $54 million year-to-date. After subtracting capital expenditures from these amounts, the company produced free cash flow of $8 million in the quarter and $20 million for the year. At the end of the third quarter, net debt, consisting of loans, net of cash, was $236 million, down approximately $18 million from the end of 2018. The effective borrowing rate for the quarter was approximately 4.6%. At the end of the quarter, we were on side with all financial covenants.

I'll now turn the call back to Regan for the operations review and outlook.

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Regan Davis, STEP Energy Services Ltd. - CEO, President & Director [4]

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Thanks, Mike. STEP was able to generate strong margin performance while navigating through challenging market conditions. Cost control and efficiency initiatives are allowing the company to preserve margins while delivering strong field execution and exceptional service to our clients. For our Canadian operations, the third quarter performance was slightly better than our expectations heading into the quarter. We delivered solid adjusted EBITDA margins of 24%, which was on par with the third quarter of last year, despite lower levels of activity and pricing. Effective cost management and strong utilization levels in the field in both fracturing and coiled tubing drove the margin performance.

We stopped 9 coiled tubing units throughout the quarter. Coiled tubing utilization was strong, leading to increased operating days during the quarter. We continue to focus on disciplined asset deployment to optimize our utilization. We saw 6 fracturing spreads during the third quarter, benefiting from our strategy of aligning with clients that have active programs in Western Canada.

Higher pumping efficiencies reduced maintenance time, and a safe work environment drove strong performance. Our frac utilization was lower than anticipated, primarily due to weather and scheduling interruptions. However, increased pad work resulted in high pumping efficiencies, with 722 tonnes per day pumped compared to 488 tonnes per day pumped in the third quarter of 2018. This allowed STEP to set a new record for proppant pumped in the quarter at 255,000 tonnes. I'm pleased with the adoption and utilization of our STEP express unit, our clients are realizing the value of this partially electrified compact fracturing and coiled tubing spread, which comes with a smaller footprint and fewer operational professionals.

Now turning to our U.S. operations. As reflected by several peers this earnings season, the market experienced an earlier than expected seasonal slowdown as client capital spending programs mature. The market remains oversupplied, creating competitive pricing and a challenging asset utilization environment. However, as I discussed earlier in my opening comments, the retirement and idling of equipment in the U.S. market should help to reduce the oversupply and help bring some equilibrium back into the markets.

For fracturing operations, we maintained deployment of 3 spreads, but utilization was impacted by decreased activity and scheduling gaps. Our reputation for quality execution has allowed us to compete for and win work with clients that we have not worked for previously. This allowed us to fill some gaps in our schedule and helps position STEP for the 2020 RFP season.

Coiled tubing operations averaged 9 units during the quarter, and utilization is in line with our expectations. Towards the very end of the quarter, we idled one unit as demand tapered off, and we closed with 8 active units. We achieved increased coiled tubing operating days for -- versus the third quarter of last year and the second quarter of this year. However, strong utilization and more operating days could not overcome the market pressure on pricing from the increased competition.

Now I'll talk about our outlook for the remainder of the year and early thoughts on 2020. As we discussed during last quarter's call, we anticipated that drilling and completion activity would not improve in the back half of this year. And unfortunately, that came to fruition in both of our regional markets. Our clients remain conservative on their outlook and their capital spending plans. An expected seasonal slowdown in budget exhaustion came earlier than anticipated and impacted our third quarter. As we look to the remainder of the year, we expect this trend to continue and the pricing environment to remain challenging as we exit the year.

As we look to 2020 RFP season, it's underway, and most client's programs are underway, however, most client programs are still under review. In Canada, we are a bit ahead of the U.S. in this regard. We have been successful in securing the majority of work from our key clients for their 2020 programs. Additional opportunities will be finalized in the next month. We head into 2020, believing the first quarter will be an active quarter for our manned assets as we currently have commitments for 75% of our crews.

In the U.S. fracturing services, our goal for 2020 will continue -- will be to continue to align with clients with good visibility and steady work programs. We anticipate utilization will improve with this strategy.

We have a strong base of clients in coiled tubing in both Canada and the U.S. We saw coiled tubing pricing under pressure this year as new entrants came into the market, specifically in the U.S. However, we believe coiled tubing pricing has stabilized and should be steady in 2020. We will continue to differentiate ourselves in the coiled tubing markets with our suite of value added technologies. As we enter 2020, we anticipate operating similar manned capacity as we have throughout this year. For both our regional markets, we expect demand for our services to improve relative to the last quarter of 2019 as clients renew their capital programs.

Before turning the call over, I would like to thank all of our professionals for their unwavering commitment and delivery of exceptional service to our clients while remaining vigilant on safety. That concludes my comments, and I'll now turn over the conference to the operator, who will open the line for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions)

And your first question comes from the line of Aaron MacNeil of TD Securities.

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

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I thought I'd start with a couple of quick questions on U.S. frac. Obviously, it's a pretty challenging environment. I mean, we've all seen the same headlines and commentary from your competitors. But I guess, on the Q2 conference call, you set an expectation for continuation of the strength you saw in Q2 based on the conversations you're having with your customers. So I guess my question would be, what changed between then and now? And I guess, was it a change in customer plans? Was the work awarded elsewhere? I guess, any additional commentary there would be helpful.

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Regan Davis, STEP Energy Services Ltd. - CEO, President & Director [3]

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Yes, it's Regan here. I'll provide some thoughts on that. I think your 2 comments, change in plans and we did see some work slipped to other clients for pricing. So we saw that volatility. I don't think we're unique in our sort of outcome in the third quarter in the U.S.. It was a very dynamic quarter where we saw competitors looking to find utilization for assets. So work that we did have visibility, some of it slipped away. We -- as we noted, we were successful in working for some new clients. So we -- today, we find our focus on West Texas continues to prove constructive as we have visibility for a couple of crews out there, and we continue to see opportunities in South Texas and in Oklahoma.

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

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Okay, that's helpful. And then in terms of EBITDA contribution for the U.S. segment. I guess, if I looked at it quarter-over-quarter and without obviously getting into any specifics, but how much of a role did the coil tubing contributions play in the reduction in segment EBITDA quarter-over-quarter? And I'm just trying to understand the differences between -- you obviously had a higher job count, lower average revenue per job, but anything there would be helpful as well.

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Michael G. Kelly, STEP Energy Services Ltd. - CFO & Executive Vice President [5]

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Aaron, it's Michael. I'll provide some comments on that. I think most of the sequential performance degradation really arose out of fracturing. As Regan said, some of the work that we were planning, there were some customer interruption programs. We also witnessed some larger competitors coming in and offering unsolicited tenders on work. We've actually witnessed that behavior here in Canada as well recently with some of our competitors showing less discipline than they have in recent quarters. And so that certainly impacted the operating results. We were able to retain the work, but often, you have to reprice it to do so.

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

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Got it. Okay. And then on a go-forward basis, just given your concentration among your U.S. customers. Can you help us with some expectations for Q4 and then, I guess, the first half of the year?

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Regan Davis, STEP Energy Services Ltd. - CEO, President & Director [7]

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Yes. And again, as per my comments, our focus has been to align ourselves with clients that provide us some visibility to utilization. And we are having success with that. We are seeing, as I mentioned, a broadening of our client base. Certainly, Q4 is going to remain a tough quarter from a fracking point of view in the U.S. And as we look into Q1, we have a large funnel of opportunities to participate in, and we're working through those. They are a little behind where we are in Canada as far as sort of securing work programs for next year. I think that's just the nature of the budgeting down there. But I guess, we're executing on that strategy of aligning ourselves with clients that can keep our assets utilized, and we have a large funnel of those opportunities today as we look into 2020.

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

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Okay. And then switching gears and final question for me, to Canada. You'd mentioned in your prepared comments that you're successful in maturing and getting the majority of your work from your key clients. But could you give us any sense of what type of pricing you had to offer to secure that work? Even if it's just some goalpost, that would be helpful.

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Regan Davis, STEP Energy Services Ltd. - CEO, President & Director [9]

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Yes. Well, I guess I would start with acknowledging the cost structure of the business has declined, including the suppliers that we work with have continued to offer help on the cost side of the business. And I guess, what I would say is the market has been competitive, and we have had to react to those competitive pressures. But at this moment, I don't think we're in a position to talk to magnitude.

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Operator [10]

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Your next question comes from the line of Greg Colman from National Bank.

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Greg R. Colman, National Bank Financial, Inc., Research Division - MD and Energy Services & Special Situations Analyst [11]

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As we look out into Q4, you're guiding in your prepared commentary cautiously on both of your maturations relative to Q3. Is the rate of decline in the Q4 expected to be roughly the same in both areas? Or is one relatively steeper decline than the other? And I guess, to kind of put a specific point on it, should we be looking at last year's Q4 decline as a really good road map? Or is it not a good road map?

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Michael G. Kelly, STEP Energy Services Ltd. - CFO & Executive Vice President [12]

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So I think more broadly, the way we were looking at -- as we mentioned earlier in the year in our comments, the one area that we were really unclear on was how much work would manifest itself in Q4 because although clients may have the capability of spending more money due to higher cash flows than they budgeted, capital discipline and other factors may work against that. And so we've certainly seen that. As we think of Q4 in 2019. We think of it similarly to the way we looked at Q4 in 2018. I think we will see similar sort of activity. I think the pricing will be a little tighter than what we saw last year, but we largely see the quarters being similar.

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Greg R. Colman, National Bank Financial, Inc., Research Division - MD and Energy Services & Special Situations Analyst [13]

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And similar being sort of the rate of change from Q3 to Q4, not necessarily the absolute, I guess, EBITDA generated in Q4 of '18.

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Michael G. Kelly, STEP Energy Services Ltd. - CFO & Executive Vice President [14]

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I was thinking more along the lines of the output from the quarter. So EBITDA for the quarter, we'd see that being influenced by the same factors we saw by last year.

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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. On the asset side, as you guys mentioned, you've idled some equipment. But we haven't seen any retirements in your fleet. We have seen retirements from peers in both Canada and the U.S. Could you give us a little bit of color regarding that? What would be the potential for actual equipment or fleet retirements on your assets? Is this something that could happen in the near term? Is it a 2020 potential? And if not, can you just talk to sort of about age and quality of your equipment and when that sort of would come on the docket?

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Regan Davis, STEP Energy Services Ltd. - CEO, President & Director [16]

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Yes, Greg, I think I'd start with bringing you back to -- we do have a small portion of our asset base that does require some expenditures to sort of get it ready for the field. And we've never committed those expenditures because the market has not been in a position to absorb those assets. So we have some assets that we bought through '15 and '16 that we've yet to put in the field. Today, we look at all of our assets and consider them to be relevant for the current market conditions. It's just a matter of is there a return available to warrant putting additional assets in the field.

So I think it's important to note that we have not parked a piece of equipment because of maintenance reasons. All of our assets continue to be maintained and the ones that are operating are field-ready. And I think, like many of us, as we continue to invest in those assets we find the components that we're buying from our suppliers are, in fact, improving, becoming more reliable, and providing a lower cost of operations. So today, we don't anticipate any asset retirements.

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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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Got it. And Regan on that, because you raised a really good point about the equipment that you purchased, but sort of never put additional capital into get it out into the field. Can you give us a rough idea of how much of the $560 million in PP&E you've got on the balance sheet would be within that sort of "not yet ready for field" use pool? Is it 1%, 5%, 20%? Just a rough idea.

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Regan Davis, STEP Energy Services Ltd. - CEO, President & Director [18]

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I'm looking at Mike, hoping he knows the answer to that question.

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Michael G. Kelly, STEP Energy Services Ltd. - CFO & Executive Vice President [19]

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I think the better way to answer that is really from a horsepower perspective, Steve? Yes.

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Stephen Glanville, STEP Energy Services Ltd. - COO & VP of Operations [20]

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Yes, Greg, it's Steve here. We have, of course, a number of the legacy assets, as Regan mentioned, that we haven't put capital towards in getting to the field, and that would equate to between 40,000 and 50,000 horsepower.

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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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But I got to imagine that the book value of that is less than the book value of your active horsepower on a forward curve basis.

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Michael G. Kelly, STEP Energy Services Ltd. - CFO & Executive Vice President [22]

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That's correct. Just off the top of my head, if I have to range it, I would put about a 0.3 factor on it relative to the active horsepower.

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Greg R. Colman, National Bank Financial, Inc., Research Division - MD and Energy Services & Special Situations Analyst [23]

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Very useful. And then just finally for me, can you give us an idea of supply-demand in the U.S. as it compares to Canada? What's a more challenging area to operate in right now? I mean, obviously, we can see the margin in Q3. But as we sort of look out in your specific operating areas, where do you see the relatively better return on the capital that you've got out in the field right now? And does that inform what you're going to be doing sort of based in the basin and moving -- potentially moving equipment?

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Michael G. Kelly, STEP Energy Services Ltd. - CFO & Executive Vice President [24]

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As we look at that, we look at the rate of adjustment in the operating capacity. Certainly in Canada, while we've seen a really tightening of manned equipment, we've seen some of our major competitors adjust their fleets over the last 2 or 3 quarters or last 2 quarters, pardon me. Of course, we did it late last year. So I think from a supply-demand balance in Canada, we're probably in a pretty good position as we head into Q1.

We think there's going to likely be a few scheduling challenges here or there as customers try to get the work done, just because we think we've got that balance. And ourselves, and we expect our competitors aren't likely to be bringing equipment back without some sort of broader sight for sustained demand. So we think we have that balance relatively well struck for the Canadian market.

In the U.S., obviously, it's a much larger market and we're a much smaller player. And we think with respect to our position in South and West Texas, we're in the right areas, but we're seeing that rapid rescaling of available capacity that we've witnessed over the last 2 quarters in Canada really ongoing now. We don't think we're through that yet. I think we'll see some more of that equipment start to be idled. But we are seeing -- we do expect to see that we'll strike that equilibrium in a better sense over the next 1 to 2 quarters, which should help stabilize things as we're seeing in Canada.

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Greg R. Colman, National Bank Financial, Inc., Research Division - MD and Energy Services & Special Situations Analyst [25]

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So it sounds like Canada is the relatively better basin for your operations?

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Michael G. Kelly, STEP Energy Services Ltd. - CFO & Executive Vice President [26]

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I think that's going to -- as we look going into next year. Obviously, Q1 is always the more active segment of Canadian operations. We expect that will be true again this year. With our U.S. bases, obviously, you don't have the same sort of seasonal variability, but we're going through that competitive reset, and I think it might take one more quarter before we get there.

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Operator [27]

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Your next question comes from the line of Keith MacKey of RBC.

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Keith MacKey, RBC Capital Markets, Research Division - Analyst [28]

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Just a question from me on the comment about customers bringing an increased portion of their own sand, realize it's a lower margin offering. Can you give us an idea of how to quantify the go-forward impact of this trend, whether you expect that 63% to get to closer to 80% to 90%? Or should we expect it to stay roughly where it is? Just trying to get a sense of how we should calibrate that impact on revenue.

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Regan Davis, STEP Energy Services Ltd. - CEO, President & Director [29]

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Yes. I guess, a direct answer is, off the top of my head, I wouldn't expect it to increase dramatically for our Canadian business. In the U.S., we are seeing more customers explore that option. So we're seeing a little bit more of that in the U.S., but I think it's important to clarify that as we put pricing for work programs, sand-in or sand-out, our goal is to generate cash flow for the operating asset base. So if we're in a position where we supply sand and we get a bit of margin on that sand, that's great. If we're in a position where the client supplies sand, we endeavor to adjust pricing to reflect sort of cash flow -- sort of goals for our asset base. Overall, we're focused more on absolute EBITDA than we are in percentage because that drives the cash flow from the asset base.

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Keith MacKey, RBC Capital Markets, Research Division - Analyst [30]

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I see. And on that trend, is there anything that you'd consider doing to either protect your overall, I guess, position in sand marketing or proppant marketing? Or are you happy enough to let that piece of revenue go if, as you say, it's not generating a return on the asset?

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Regan Davis, STEP Energy Services Ltd. - CEO, President & Director [31]

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Yes, I think you can see that it's kind of a basin-wide phenomenon in Canada and many of these larger operators have gone just procuring their own sand directly. And again, our job is to adjust our pricing sand-in or sand-out to deliver cash returns. And I think the market as a whole is adopting that way.

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Keith MacKey, RBC Capital Markets, Research Division - Analyst [32]

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Right, right. And just shifting gears then, talked a little bit about asset positioning. Should we expect to likely see some of the assets shift from where they're working now to other -- some of the other basins you've mentioned? Or could we even potentially see a broader move of any of the assets, particularly in the U.S.?

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Regan Davis, STEP Energy Services Ltd. - CEO, President & Director [33]

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I wouldn't -- so I would start by saying we have moved some coil assets up into North Dakota. We see an opportunity there to put some -- couple of spreads into the field and get some decent utilization. So that's underway. On the frac side, I would say the areas we've spoken to as far as operations will remain our focus.

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Operator [34]

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Next question comes from the line of Josef Schachter.

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Josef I. Schachter, Schachter Energy Research Services Inc. - Author & President [35]

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Given the recovery in the price of natural gas, AECO and the TC-ed decision with access, are you seeing customer discussions recently that are a little more optimistic? And do you see a little more activity horizon than you did maybe a month or 2 ago?

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Regan Davis, STEP Energy Services Ltd. - CEO, President & Director [36]

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Yes, I would say, Josef, that's got some traction to it for sure. We see, with the improvement in AECO discussions around perhaps expanded drilling program. Certainly, you saw Peyto with that comment yesterday. So yes, I think there is a possibility for a bright spot in that equation as people look to take advantage of this pricing.

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Josef I. Schachter, Schachter Energy Research Services Inc. - Author & President [37]

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Okay. Second, on the increase in the length of time of the receivables going over 90 days, $16 million versus $4 million at year-end. Do you have any concern that there's going to be some erosion of the value? Or this is just, as you mentioned in your comments, the amalgamation in the States, and it's just taking longer for their accounting departments to come together and make the payments? Or do you expect that you'll have more continued delays, but no worry about collection?

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Michael G. Kelly, STEP Energy Services Ltd. - CFO & Executive Vice President [38]

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Josef, it's Mike. So the largest contributor to that in the fourth quarter -- or third quarter was that one customer we talked about is going through some system conversion, teething pains. They're working through it. We're working through it along with them. A lot of that has to do with reconfiguration of invoices and making sure you get things filed in a way that conforms with the new system. And so we think we're through a lot of that and will be through the fourth quarter. We have got an updated schedule from them as to when we expect to receive payment. And so as said, that factor will certainly be resolved this quarter, unless they have some unexpected impact of their system conversion, but we've been led to believe it's largely on track and in place and don't expect that to be a continuing factor.

More generally, certainly, in this environment where we see commodity prices erode, and we see some of our customers starting to feel the pinch associated with that credit worthiness. And our credit processes are something that we maintain quite a high degree of rigor on and visibility. We are watching what are days and credit limits with people and watching it carefully. And so I think that's a practice that we have in place through all cycles will become important as we go through some of this chop that we're seeing, particularly in the United States over the next couple of quarters.

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Josef I. Schachter, Schachter Energy Research Services Inc. - Author & President [39]

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Okay. So your allowance for doubtful accounts has gone up about $900,000, but as a percentage, it looks like it's about the same.

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Michael G. Kelly, STEP Energy Services Ltd. - CFO & Executive Vice President [40]

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We look at our allowance for doubtful accounts a couple of different ways under IFRS, you can look at the broad fraud provision, which is one way that we look at it. And on that basis, we think, relative to our peers, we're quite conservatively positioned. We also look at it on a specific case-by-case basis. Invariably, there's always a few accounts that you're looking at. And so we'll look at those and we'll test our assumptions on what the expected outcome will be and ensure that if there is going to be any sort of impairment in the value of those receivables, that it's covered by our allowance, and we completed that work in the third quarter.

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Josef I. Schachter, Schachter Energy Research Services Inc. - Author & President [41]

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Okay. In terms of 2020, your CapEx budgets going down to $44 million for this year. Should we put in some kind of a number like that for 2020, given the visibility is so poor into 2020 given the commodity deck?

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Michael G. Kelly, STEP Energy Services Ltd. - CFO & Executive Vice President [42]

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Yes. I think that as we look to 2020, as Regan indicated, we expect to be running a similar fleet as we did this year. We'll firm that up as we go through the balance of the fourth quarter and our capital spend will be largely driven, as it will be maintenance, it'll largely be driven by the amount of equipment we're operating. I would think this year would be a reasonable proxy. Steve and his team have done some great work in terms of optimizing that spend. We might be able to bring that down a little bit, but we have to go through those numbers. And we're doing that after we get a better line of sight on customer programs.

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Josef I. Schachter, Schachter Energy Research Services Inc. - Author & President [43]

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Okay. And the last question for me is on the loan and borrowings, 2 parts of it. One, was the write-down of goodwill impacted at all by those borrowing arrangements? And the second part of it is from looking at the required funding debt to adjusted bank EBITDA, we need to see a recovery by Q3, Q4 of next year for things to be in line.

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Michael G. Kelly, STEP Energy Services Ltd. - CFO & Executive Vice President [44]

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So firstly, talking about the write-down. That process is not at all impacted by any part of our syndicate or our borrowing arrangements. That's really driven by our outlook related to that business and the specific accounting rules. So as we look forward for the U.S. fracturing so -- maybe a step back. Under the accounting provisions, you're required to examine carrying value of your major cash-generating units, the assets associated with major cash generation units or you believe there may be an indication of impairment. Certainly looking at stock prices relative to enterprise values, that's one that would trigger a review, and we undertook that review in the quarter. Of 3 to 4 CGUs certainly had no challenge with our outlook. The fourth with being U.S. frac, and our outlook for U.S. frac was impacted by that review. And we determined that under that calculation was appropriate to write-off the remaining value or virtually all the remaining value of intangible assets and the goodwill.

With respect to the bank facility, we do believe that we are on side with our covenants at the end of Q3. We expect that we will be reviewing it, providing updates to our banks. Right now, we don't see ourselves with our outlook, which is subject to being reviewed. We see ourselves having an appropriate package. But if that should change, we do have good relationships with our banks. We have had ongoing discussions with them so they understand the business, the state we're in. And we believe that the support would continue to be there if it was needed.

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Josef I. Schachter, Schachter Energy Research Services Inc. - Author & President [45]

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Okay, super. And I'm more optimistic as we talked -- when I was with you. So hopefully, back half of 2020 does give us a better business and a better pricing environment.

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Operator [46]

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Next question comes from the line of Ian Gillies for 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 [47]

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In the event that U.S. activity actually doesn't recover in Q1, and if we were to use today's rig count as a run rate, call it for 2020, are you able to maybe outline some additional levers that you may still have to pull at this point to keep profitability up or perhaps above breakeven through 2020?

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Regan Davis, STEP Energy Services Ltd. - CEO, President & Director [48]

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Well, those levers are well understood here. We've spoken to them, Ian. And I think if you look at our U.S. operations, we have managed the costs down in that segment. We have positioned the assets into operating basis in new basins. And certainly, our strategy, in an environment where pricing is tough, is to drive utilization. So we have visibility being able to do that. And with that, with our focus on costs, our continual focus on our asset base and improving how it performs in the life and longevity of that asset base, which affects our maintenance capital, we're certainly of the view that we have the ability to generate positive cash flow out of that division next year.

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Ian Brooks Gillies, GMP Securities L.P., Research Division - Director of Institutional Research and Research Analyst of Energy Services & Infrastructure [49]

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Okay, that's useful. And Mike, I just wanted to make sure I was understanding correctly heading into 2020. It sounds like you think maintenance capital may be a bit lower year-over-year, reasonably similar. But if you look through the operational data and the document. I mean, very clearly, you're being more efficient with the equipment and it's working much better, but thereby probably working a bit harder. And so how do you reconcile that? Is it just cost savings on the supplier side like you alluded to earlier in the call?

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Michael G. Kelly, STEP Energy Services Ltd. - CFO & Executive Vice President [50]

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So I do think there's cost savings that has certainly impacted that view. I'm not sure I agree with the view that we're working our equipment harder. Actually, I think the guys have done a great job in terms of optimization to extend the life of the major components we have and are on top of it. So being able to reduce that or extend the life of some of those key component parts we're finding is really driving a lower maintenance CapEx estimate than what we entered the year with.

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Regan Davis, STEP Energy Services Ltd. - CEO, President & Director [51]

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And Ian, I would add to that, that we have been investing in digital technologies. We've really, really improved the sophistication of our maintenance information. We continue to see components from our supply chain that are lasting better. They're performing better. We're seeing those components available at lower costs. So it has been an incredible focus of the organization to understand that piece of our business better. And I can tell you that as we think about maintenance capital, we've got it down to hours of operation by play. So we can adjust our maintenance spend based on whether the asset base is running or not and how much hours are on it, and we can forecast and anticipate it that way. So it's been a real maturing of that part of our business, which helps us understand where those spends will be.

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Ian Brooks Gillies, GMP Securities L.P., Research Division - Director of Institutional Research and Research Analyst of Energy Services & Infrastructure [52]

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I mean, Regan, maybe just to follow-on very quickly on the comment you just made, like are you getting to a point now where some of the digitization has become predictive in nature, and you can kind of see things happening before they actually occur, making it a bit easier on yourself?

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Regan Davis, STEP Energy Services Ltd. - CEO, President & Director [53]

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I would say we're very, very early in that path. But that's certainly the goal, and we're moving towards that. Again, I think we've been focused on -- we call it a reliability system. So from the day we started the company, we've invested in certain maintenance systems for our asset base that we think extends the life of the assets. And so major overhaul intervals for big components have been extended because of those practices. And that does afford us a lower maintenance CapEx spend.

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Ian Brooks Gillies, GMP Securities L.P., Research Division - Director of Institutional Research and Research Analyst of Energy Services & Infrastructure [54]

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Okay. And maybe to rehash a theme from prior conference calls. The biofuel equipment that you guys have been using, I mean, you guys have been quite successful with, I think. But are you able to provide an update on customer conversations around using your biofuel equipment, the effectiveness there and how it's ultimately competing or showing up against refrac? I know there's another number of other variables that have changed since that time, but just curious what's happening there?

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Regan Davis, STEP Energy Services Ltd. - CEO, President & Director [55]

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Yes. So I mean, we've gone to the extent of putting a biofuel calculator available on our website, and we've put it out through social media. I mean, we've equipped our clients with the ability to be able to assess how they can save money with biofuel. And we believe with how we operate our biofuel fleets, we're achieving best-in-class conversion.

So we are clearly in a position where we can sit in front of a client and to a second decimal place, show them how they're going to save money with a biofuel fleet and how perhaps our biofuel fleet can perform better than others. So it does differentiate us in, certainly, in our client size. We see more and more interest in it. And I guess, we could go all the way to -- we're working with our clients to help them understand, from an ESG point of view, how we're reducing their carbon footprint.

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Operator [56]

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Next question comes from the line of Jon Morrison of CIBC Capital Markets.

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Jon Morrison, CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research [57]

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Regan, once we get visibility for 2020 CapEx programs in the U.S., whether that come in December or January or even February for some, would you expect multi-quarters of visibility from most of your customers? Or does it feel like it could be a scenario where it's more well-by-well or grouping of the well, which kind of translates to weeks and months, so to speak?

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Regan Davis, STEP Energy Services Ltd. - CEO, President & Director [58]

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Yes. Well, I guess to be really straight up with that, I would expect it'll be a blend of both. But certainly, as we've been commenting, we're working with clients that, first of all, value the execution we bring to the location. We're very, very proud of that, the work we're doing on location. We differentiate ourselves that way in many cases. And so with that, we're working with clients that have visibility to extended programs, and in some cases, you may have 1 frac spread that would work with 2 or 3 clients to drive utilization. So we're clear on what we want to achieve. I think we've got visibility to those opportunities. And that's the strategy for the U.S. asset base.

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Jon Morrison, CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research [59]

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So to Mike's earlier point about how you're seeing some unsolicited bids for your customers in the market. It's fair to assume that all of that, all of those things you just said would imply that, naturally, you have to respond to those pricing pressures in the market, but it's not as simple as "meet this or lose the work," or "low bid, get the job," kind of a bid?

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Regan Davis, STEP Energy Services Ltd. - CEO, President & Director [60]

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Yes, fair enough. I mean, we're not immune to that activity and there are situations where we do have to be dynamic in adjusting our pricing. So yes, we're not immune to that.

I guess, again, I think in the Canadian market, as Mike noted earlier, we have -- I think we have adjusted the available asset base to create the ability for better scheduling. And we're seeing that happening in the U.S. As Mike noted, it's probably a little behind how fast we've reacted in Canada. But certainly, the hope is that we get the asset -- demand asset base right sized so that there's a little more constructive behavior in the marketplace.

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Jon Morrison, CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research [61]

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Once we actually start seeing 2020 U.S. programs come out, would you expect visibility for coil to be meaningfully different than frac, just based on the different -- differences in competitive behavior and number of competitors? Or do you feel about the same right now?

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Regan Davis, STEP Energy Services Ltd. - CEO, President & Director [62]

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Yes. So we do have actually some contracted coil clients that have been loyal to us through an extended period of time, and we expect those to carry on. We do find that market can be pretty dynamic, where a client will try a new vendor for a pricing incentive. And then we clearly have established ourselves as a best-in-class operator in the coil side of the business, there and in Canada.

So while we see departures from clients who try new vendors, it's not uncommon for them to come back. And we are working hard to manage our pricing. We tend to -- I think we're pricing leaders in that market in the U.S. and in Canada. So oftentimes, they'll come back and are prepared to pay a little bit more for the reliability of our service. So I guess what I'm saying is perhaps what I didn't address is, we have some long-term relationships where we have predictable visibility to activity. And then we see a lot of call out activity in that business as needed. So it probably is a little bit different than the frac in that regard.

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Jon Morrison, CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research [63]

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Okay. Depending on how Q4 activity ultimately unfolds over the coming months, will it make you have to think about recalibrating staffing levels? Or to your earlier point, due to budget exhaustion and a bunch of other noise, it's going to be tough to take Q4 to kind of use that as barometer to calibrate broader activity levels, and you probably need to see Q1 to figure out whether you're running the right number of fleets at this point?

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Regan Davis, STEP Energy Services Ltd. - CEO, President & Director [64]

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Yes, again, we would say better clarity today on Canada, as I noted, about 3/4 of our frac assets have commitments to activity for Q1. And we have a number of opportunities still in the funnel that we certainly expect will put the rest of the remaining 2 fleets to work. In the U.S., I think it's going to take a bit more time. So we expect that the manned asset we have and asset base we have today will be active in the first quarter, and we intend to keep those assets manned and available through Q4 so that they can go to the field in Q1.

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Jon Morrison, CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research [65]

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Mike, you made some comments about some of the increased bidding activity or unsolicited bids in the U.S. starting to come to Canada. Are those comments very specific to U.S. competitors? Or does it include some of your domestically headquartered peers as well?

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Michael G. Kelly, STEP Energy Services Ltd. - CFO & Executive Vice President [66]

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I think early in the quarter, we would have seen that more from some of the larger U.S. competitors. More recently, I think we've seen that from some of our Canadian competitors as they've attempted to find a way into business relationships and find a way into work that had already been subject to tender and have been awarded.

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Jon Morrison, CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research [67]

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Perfect. Maybe just one last one for me. Just at a high level, are you guys surprised that there hasn't been more consolidation in the pumping market, albeit there's been a couple of larger transactions that gotten announced? Just given how challenging specific regions have been, are you surprised that there isn't more deals getting done? And do you think that, that would really tighten up the market or increase regional competition in the U.S. to the point that pricing no longer goes down?

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Regan Davis, STEP Energy Services Ltd. - CEO, President & Director [68]

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Yes. So surprised that we haven't seen more. I mean, at a spreadsheet basis, there should be consolidation. That's easy to get your head around. The social dynamics of creating these opportunities, making them happen are always where the challenges are encountered. I think we should expect to see consolidation in the business in North America. It makes a lot of sense.

I think the most encouraging thing we are seeing, though, is some of the larger players in the U.S. are recognizing they have assets that just don't work in this market. With a bit of work from reading other analyst reports and whatnot, it's well over 2 million horsepower that we expect to be garbage in the U.S. So I think that's probably the most encouraging news is that people are actually parking horsepower and making it go away.

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Operator [69]

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As there are no further questions at this time, Mr. Davis, you may continue.

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Regan Davis, STEP Energy Services Ltd. - CEO, President & Director [70]

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I would say thanks for joining the call. Appreciate the interest, and we'll hang up and end the call now.

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Operator [71]

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Thank you so much to our executives and to everyone who participated. This concludes today's conference call. You may now disconnect, and have a great weekend.