Total Energy Services Inc.

Daniel Halyk - President & CEO Yulia Gorbach - VP, Finance & CFO Scott Treadwell - TD Securities

Scott Treadwell - TD Securities Jon Morrison - CIBC World Markets

Thank you. Good afternoon and welcome to Total Energy Services Inc’s second quarter 2015 conference call.

Present with me this afternoon is Yulia Gorbach, Total's Vice President of Finance and Chief Financial Officer. We will briefly review with you Total’s financial and operating highlights for the three months ended June 30, 2015 and then provide an outlook for our business and open up the phone lines for any questions.

I will now turn the call over to Yulia Gorbach.

Thank you, Dan. During the course of this conference call, information may be provided containing forward-looking information concerning Total’s projected operating results, anticipated capital expenditure trends and projected drilling activity in the oil and gas industry.

Actual events or results may differ materially from those reflected in Total’s forward-looking statements due to a number of risks, uncertainties and other factors affecting Total’s business and the oil and gas service industry in general. These risks, uncertainties and other factors are described under the heading Risk Factors and elsewhere in Total’s most recently filed annual information form and other documents filed with Canadian Provincial Securities Authorities that are available to the public at www.sedar.com.

Our discussions during this conference call are qualified with reference to the notes to the financial highlights contained in the new releases issued earlier today. Unless otherwise indicated, all financial information in this conference call is presented in Canadian dollars.

Total's financial results for the three months ended June 30, 2015 reflects continuing difficulty industry conditions in a included in our second quarter results our $4.5 million of non-recurring expenses that reduced net-income from $0.17 to $0.03 per share on a diluted basis. These cost include onetime $0.08 million of income tax expense from the recently enacted 20% increased due to Alberta corporate tax rate and $0.7 million of accelerated non-cash accretion expense arising from the earlier redemption of the company's convertible debentures.

Consolidated revenues for the second quarter of 2015 were $71.9 million, a 14% decrease from the second quarter of 2014. Compression and Process Services contributed 78% for 2015 second quarter revenue based on transportation services 19% and contract drilling services 3% as compared to relative contributions of 67%, 24% and 9% in 2014.

Revenue [indiscernible] in Contract Drilling division drilling in the second quarter was $16,865, a 10.4% decrease from the $18,827 per day realized in 2014. Decreased spot market pricing was [indiscernible] for this reduction although the mix of equipment operating in 2015 as compared to 2014 mitigated price decrease.

The Rentals and Transportation Services Divisions, revenue per utilized piece of rental equipment during the second quarter of 2015 was relatively flat as compared to 2014, although pricing pressure was significant the mix of rental income operating as well as larger heavy truck fleet following in the acquisition of Wyoming Trucking company during the first quarter combine to hold this metric flat. Revenue within our compression and process services group was flat for the second quarter which was down in '15 compared to 2014.

Increased fabrication sales and sales of compressions rental equipment have set lower compression rental revenues due to a 19% decrease in compression for [indiscernible] at June 30, 2015 compared to June 30, 2014. Consolidated gross margin for the second quarter of 2015 was 24.4% of revenues as compared to 25.2% for the second quarter of 2014.

This reduction in our consolidated margin was due to the increased relative contribution of compression and process services due to consolidated revenues as this division usually generates lower gross margin than our other two divisions. Divisionally, our Contract Drilling and Rentals and Transportation Services actually experienced higher gross margins during the second quarter of 2015 as compared to 2014.

This was due not only to cost management but also to the fact that lower equipment utilization during the first half of 2015 particularly within our contract drilling division that’s resulted in significantly lower equipment shipment record [ph]. Second quarter gross margins in the compression and process service division decreased by a 280 basis points as compared to 2014 due primarily to a reduction in compression horsepower on rent on a year-over-year basis.

Consolidated cash flow before changes in non-cash working capital were $6.3 million for the second quarter of 2015 as compared to $19.9 million in 2014. The payment of $4.2 million of income taxes during the second quarter of this year as compared to $6.2 million income tax recovery during the second quarter of 2014 accounted for $10.4 million or 77% or $13.5 million decrease in cash flow.

The timing of the payment of income taxes is impacted in part by prior installment payment requirements. In 2014 Total was not required to make income tax installment payments which resulted in approximately $12.7 million of income taxes bill paid during the first half of 2015 that’s related to 2014 taxable income.

Total is required to make income taxes installment payments in 2015 and this is expected to minimize the monthly income taxes paid in 2016 that relates to 2015 taxable income. Consolidated EBITDA for the second quarter of 2015 was $13.3 million, a 17% decrease from 2014.

Substantial of lower equipment utilization and lower pricing in the contract drilling and rental and transportation services divisions were primarily the reasons for this decrease. Consolidated net income for the three months ended June 30, 2015 was $0.9 million, a 87% decrease from $7.2 million of the net income generated in 2014.

60% of the $6.3 million decreased in our second quarter net income was due to previously mentioned onetime income tax expense attributable to the recent 22% increase to Alberta corporate tax rate. Looking briefly at our balance sheet, during the second quarter 2015, we complete the redemption of 69 million of convertible debenture that redemption was financed with a $50 million of term bank debt and cash in hand.

These refinance [indiscernible] a material source of potential dilution of equity but it also reduces our interest and administrative cash cost by at least $200 million. In connection with the convertible debenture, we increased our operating line of credit to $65 million, this line is [indiscernible] standard margin requirement and is secured by cash, accounts receivable and inventory.

Our [indiscernible] remains undrawn and fully available to-date. At June 30, 2015 our total bank debt less cash on hand was 35.7 million while other bank covenants do not contain that through EBITDA financial ratio covenant, this equates to onetime the $35.2 million of EBITDA generated during the first six months of 2015 and 0.4 times the $89.1 million of EBITDA for the trailing 12 months to June 30, 2015.

Thank you, Yulia. The second quarter of 2015 was a tough quarter for the North American energy services industry.

However I'm pleased with how all of our business divisions have managed thus far through these difficult times regardless of all the headwinds our industry faces. Despite $4.5 million of onetime expenses during the quarter notably a $3.8 million income tax expenses incurred as a result of the Alberta government's recent decision to increase the corporate tax rate by 20%.

Our company remained profitable on an after tax basis. I'm particularly pleased of this accomplishment given that we did not separate as onetime cost, the cost that we incurred during the second quarter to right size our operations to the reality of current market conditions.

Unfortunately such costs are regular or current given the cyclical nature of the energy services industry which is why we choose not to segregate them. We fully expect that our industry will face a challenging environment for the foreseeable future as such we have taken the necessary steps to right size our operations and response to reduced customer demand.

Steps have also been taken to refocus sales efforts and to relocate assets to jurisdictions based on current and future expected activity levels. We will take additional measures to rationalize the company’s operating cost structure and relocate operating assets and personnel as future industry conditions or customer demand may warrant.

In our news release earlier today we announced the appointment of William Kosich as Vice President, Drilling Services effective immediately. As I mentioned on previous occasions Total Energy had undertaken a search for new Vice President to provide leadership guidance and support to our contract drilling group, I was very pleased with the caliber of candidates that expressed interest in the position and we very much welcome Mr.

Kosich to the Total Energy team. Bill will be instrumental in developing and executing our strategic plan as we look to continue to build our contract drilling services business.

Our balance has never been stronger and will serve us well during these difficult times. We believe that our industry needs to continue to look for ways to see operating efficiencies in order to lower cost.

This does not simply mean lower prices but rather seeking to do things faster and more efficiently. As well as the North American energy services industry has excess capacity to virtually every major business line.

The need for increased operating efficiencies in service industry overcapacity, [indiscernible] for industry consolidation and we’re very working hard to identify and evaluate opportunities in that regard. However we will remain focused and disciplined in our execution as the difficult industry outlook held us to be.

I would now like to open up the phone lines for any questions.

I wanted to start on compression and process equipment side, obviously a little drop in the backlog there but revenue held up relatively well I'm wondering without giving maybe too much competitive information away at what point was the backlog start to really drop off? Is it sort of eventually weighted through the next four quarters or is it more weighted to '15 or '16?

Just kind of getting a sense of what the shape of that curve looks like without maybe getting too granular?

Well first of all the industry generally is a tougher place, in terms of the backlog this is committed orders that will be built out over the next while. We have been working with customers to manage deliveries to accommodate their schedules but this tends to be a fairly front end loaded number and that said how that backlog plays out we’re not I would say there is not a whole bunch of difference relative to prior down-turns and you know there continues to be new awards but definitely things are slower but again we’re coincidentally the revenue number was pretty much identical year-over-year, the underlying mix changes but we are pretty happy with how that group performed and again we will wait and see how things play but there is we’re seeing a shift in terms of the customer base certainly infrastructure play tend to get a little more attention now and we’re all well aware of the take away issues in North West Alberta and [indiscernible] and there is infrastructure demand that comes out of that.

So again we will see how things playout but there is nothing there that would be out of line with prior slower periods.

Second one on compression, a drop in the utilization of the rental fleet, could you characterize that as some seasonal, some structural or was that entirely industry driven slowdown?

I think there is a bit of both, we commented a bit on our last call in terms of the NOMADs, the flip side is you see both beneath those numbers a lot of movement on an individual unit by unit basis. I think there is obviously there was some takeaway issues so why compress if you can't put it in the pipeline.

That surely is part of it. Certainly we’re in a slower period, to flipside if you look at the rig activity it tends to be today focused on more gas areas.

So I would suggest without any specific data that anecdotally it's a combination of both factor, Scott.

And the last one for me, just I wanted to turn to rentals for a second, the revenue per piece obviously down but maybe overall revenue wasn’t down as much as the headline numbers like rig count and completions when you added that sort of revenue per piece might indicate, were there some strengthening in the mix there just given the more valuable pieces were going to work and then maybe less of the [indiscernible] that are a bit more commoditized?

I think first of all our revenue per utilized piece which is what we look at so simply we take the opening rental equipment fleet plus the closing divided by two and if you divide that number into divisional revenues that was reasonably flat year-over-year for the second quarter. Now as Yulia commented there is two reasons for that, pricing pressure is brutal, again as we commented during the last call on certain lines particularly on iron we’re seeing prices I’ve never seen before and we’re falling out of that because that’s just not sustainable.

That said, a lot of the projects we’re involved would tend to be large complex where a malfunction of a $20 a day simple dumb piece of iron is going to cost to operate a 100s of 1000s dollar having a bunch of dirty tanks, or leaking tanks show up because someone is not replacing $19,000 bells [ph] that’s not worth the risk to prudent operators that have back spreads sitting in their way to [indiscernible]. So we’re seeing differentiation there, obviously we have added product lines we don’t talk about but they tend to be higher day rates, they are high capital cost, and the other factor is obviously we have trucks without revenue mix, we don’t break that out and won't but our truck fleet is larger today than it was Q2 of last year relative to our rental fleet we did that acquisition Q1 of the trucking company in Wyoming so that obviously would skew a bit too.

Okay, and maybe just a follow-up to your point about quality of fleet. Have you seen an increasing tendency operational upsets because people have been investing in maybe some of those dumb iron type fleet or is that something that’s yet to come?

Absolutely. It's starting, I would say, I guess ahead of the curve in the U.S.

relative to Canada, we expect more.

Okay, and that’s probably due to the seasonality that there wasn’t a lot going on?

It could be, I think it's also due to I'm not going to comment who the secured parties but I suspect some of the secured parties down south have less tolerance, I know because we’re trucking third party equipment to auction sales and been paid by receivers.

I want to start with contract drilling I would imagine you’ve taken the same strategy in Q2 and perhaps you will be doing the same thing in the second half of this year that you did in the first quarter which is due to frustration on pricing just choiring not to market it bunch of that equipment for fear of just banging it up so without adequately characterized Q2 for you?

We lower our cost as best we can and if we’re bidding and lose work on price we’re okay with that in the sense, you know no one is okay with losing work but if you can't make a bit of money and cover your cost we’re not going to work. So you’re quite right and that will continue, that said the gain you look at the Q2 margins ironically this year versus last year in our rig division were up, and why is that?

Because in Q1 we ran our rig fleet at 18%, we did incur the typical big flurry of repair cost that normally come running at 65%, 75% utilization in Q1 and again keep in mind our utilization numbers are spud the rate release so they exclude move up and [indiscernible] which you will need ask 2 to 3 percentage point start utilization to equate with the CODC reported. That said you’re bang on, we’re going to do that and the put side is anyone who does and doesn’t cover the cost will be financing the repairs from some source other than income from the rigs and we don’t control or worry about other people, we control and worry about what we do and what we won't do is subsidized drilling programs by working at a loss.

It comes to the point where at some point you say park [ph]. But again we continually strive to get our cost down and be competitive but I'm very comfortable that our costs are as low as anyone out there.

At the end of the day it comes down to whether the industry is going to subsidize drilling or not.

While I guess companies are never really done restructuring which is why you don’t do the cargo like many do. Is it safe to say that for now you feel the organization is right sized to the environment we’re in?

I think we’re watching things carefully particularly in Alberta and I think at this point we’re pretty comfortable with our operations. We were pleased with our Q2, you know our management within all our divisions did what they needed to do and we don’t take pleasure in that but you got to do what you need to do and we’re going to continue to monitor particularly Alberta and my sense is it will be more relocation of assets and personnel's as opposed to cuts.

But you know time will tell. We’re generally try and protect our corp volume [ph] we can been pretty creative in doing that.

And I guess ultimately that’s the next question which is you’ve already shown an increased willingness to move assets and I guess operations outside of Alberta and should we be as we think about you with a very good balance sheet, lots of dry powder, should we be expecting maybe a greater focus either down south or I guess at least in other provinces for the foreseeable future?

Yes.

Okay, and I guess moving to compression and processing here, your compression group, any more color that you can give us on any changing mix between compression and processing, are you seeing one part of the market holding there unduly or is it pre-balanced?

I'm not going to comment on that. It's competitive and we are not inclined to share where the strengths and weaknesses are.

Okay, and just one final comment on M&As, is there a one area with the [indiscernible] that you’re maybe a little more intrigued on value and opportunity right now or not necessarily?

Yes. The area that’s going to provide us the greatest return on capital.

We’re looking across the Board and we’re seeing opportunity in all fronts. I don’t mean to be flipping there but it comes down to that.

As between the three divisions they are like children, we love them all, they are all different, at the end of the day you’re going to put money into one that presents the greatest opportunity.

Dan, within [indiscernible] do you’ve a sense for how many rigs you expect to run at the peak in the back half of the year or said in other ways, do you expect to add more rigs than you’ve in the field right based on conversations?

I'm not going to forecast, we never have. I believe we are up to five today but it's well by well market right now so those are extremely tough to forecast.

I'm not going to try and forecast. What I will say though is first all we don’t roll-over and dive, we have got sales and marketing and we have added a new senior person that is a long standing industry veteran and it's a good time to hire good people and we compete and that’s not going to stop and the one thing I can assure our customer is that we’re going to be here to support and stand behind our products and services and that may not be the case in every case, so we’re seeing a little bit of a high grade there, you know generally the rig business is not fractured as the rental transportation but at the end of the day we’re here to stand behind work and our customers can know that we will be here, we’re not going to have a receiver showing up pulling our stuff out like we’re doing for others and that’s we’re something to credible operators.

It also means we invest in the repair and maintenance of our equipment but we also expect when we work we generate a return that will cover those costs, so you’re not going to get a piece of junk showing up that’s going to blow up half way drilling the well. But again you rig expenses repairs are big and if you’re not covering your cost there it's a no win situation and it ultimately it's going to impact your operation.

Or you end up subsidizing it.

Within Rentals and Transportation, can you comment on whether average pricing has seen a material change over Q2 versus where it exited at Q1?

I think it's bouncing along bottom right now, I think on the U.S. side we’re seeing the call [indiscernible] it's bit ahead of Canada but we’re going to see more on the Canadian side as these things roll out here.

I'm trying to reconcile margins within the rentals business and I think I guess I'm trying to reconcile the comment you made on the last call with it being one of the most challenging markets you’ve seen in the past, call it 2 or 3 decades versus fairly resilient margins in the quarter with mix that big of a driver or did you save your cost structured that way?

We saved our cost structured pretty hard. And the other things we’re now down to our 18, so when you’re 18 whether it's your rigs, you know our safety statistics have never been better.

They are unbelievably good but whether it's our rigs, our trucks, our rental maintenance people or people operating rental operations we got the A Team out there, when you’ve the A Team your bumps and bruises are less and bumps and bruises cost you money. Again as I mentioned earlier if we screw up we will take care of the customer, we’re not going to make the customer pay for our screw up we’re not going to pay for someone to screw up or someone else choice to cut corners but if we screw up we stand behind it and again when you’re running the C-Team you’re going to get more screws up and hence cost.

So I think the combination of really tightening up having the A Team how we put is everyone is going to make difference in these market conditions and if they don’t they are probably not going to working for us. And difference of beating the odds is different.

I'm proud of our people, they have been through this before and they are doing what we need to do so there is no magic behind it, it's simply rolling up the sleeves and watch every cent and doing a good job, not banging stuff up and ultimately I also -- we commented a few quarters, we last year given up market share, we’re now getting that back we bought our pricing down to where it needs to be and definitely the first half of this year compared to '14 we have gained market share it's hard to know exactly what it is but anecdotally I know we have gained market share.

Have you structurally reduced pay within that division as well or is just simple function of more efficient operations? Because I'm just trying to understand open ended pricing and activity.

On the salaried side we have never had a salary roll back with the exception corporate in '09 we voluntarily took [indiscernible] for a small group. On their hourly wages where we don’t control you know like the COC and things like that where the market chases them up, they come off with the market but primarily our base salary compensation is built for the cycle just like our dividend is and it's built to survive the bottom-half of the cycle so it's not a whipsaw, you’re not putting your employees through that whipsaw, we have cut no employee benefits, we have reduced no employee benefits.

As crass as it sounds our only reductions on salary are 100% but we will take care of good employees that take care of us and these are times where hopefully our employee base are the ones that will do a good job, appreciate this stability we bring where we’re not eliminating their savings plans. We’re not cutting their health plans, we’re not rolling their base salaries down.

Now listen, your extra compensation that comes with strong market times that’s obviously going away but they can count on their base pay check just like shareholders can count on their dividend.

Within compression and process, in terms of the backlog change quarter-over-quarter, was that all converted into sales or did you’ve have any contract cancellations in the quarter?

We have had one reported contract cancellation that we’re working on but it's not something that we’re broken out yet. So we’re in discussions but our contracts are extensive taker pace and so there is either two things, one it gets built or two there is a termination payment, so we’re discussing that but for the most part our backlogs were all along just great.

Okay so you don’t view the backlog that’s booked today to have any material risk in the next.

There is always risk but if it was material we would be disclosing it.

Thank you. If there is no further questions, we thank you all for participating in our conference call and look forward to speaking with you after our third quarter.

Thanks and have a good afternoon.