Total Energy Services Inc.

Daniel Halyk - President & CEO Yuliya Gorbach - Vice-President Finance and CFO

John Bereznicki - Canaccord Genuity Jon Morrison - CIBC World Markets Ian Gillies - FirstEnergy

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

Present with me is Yulia Gorbach, Total's Vice President of Finance and CFO. We will review with you Total’s financial and operating highlights for the three months ended December 31, 2015, we will then provide an outlook for our business and open up the phone lines for questions.

Yulia, please proceed.

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 businesses 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 the 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 December 31, 2015 reflects a very challenging operating environment. Consolidated revenues for the fourth quarter of 2015 were $52.1 million, a 57% decrease from the fourth quarter of 2014.

Compression and process services contributed 70% of 2015 fourth quarter revenues. Rentals and transportation services 22% and contract drilling services 8% as compared to relative contributions of 57%, 30% and 13% in 2014.

Revenue per spud to release operating day in our contract drilling division during the fourth quarter was $16,405, a 24% decrease from $21,503 per day, realized during 2014. Decreased day-rate pricing was primarily the reason for the decrease.

Divisional EBITDA was $1 million or 26% of revenue for the fourth quarter of 2015, compared to $5.5 million or 34% of revenue for Q4 of 2014. Within the rental and transportation services division, severe price competition resulted in significant declines in equipment utilization divisional revenue.

Fourth quarter rental equipment utilization decreased 61% to 17% in 2015 compared to 44% in 2014. Divisional revenue per utilized piece of rental equipment for the fourth quarter of 2015 decreased 17% compared to the same period in 2014.

The mix of rental equipment operating as well as relatively larger heavy truck fleet offset somewhat the impact of the severe pricing pressure. Divisional EBITDA for the fourth quarter of 2015 was $9.2 million or 10% of revenue compared to $12.6 million or 35% of revenue in 2015.

Unlike our contract drilling division, this division has relatively high fixed cost structure that pressures margin during the periods of lower activity but also provides significant earnings leverage when activity levels improve. Fourth quarter revenue within our compression and process services division decreased 47% in the fourth quarter of 2015 compared to 2014.

This division generated $5.3 million of EBITDA in the fourth quarter of 2015 compared to $12.3 million in 2014. EBITDA margins declined by 336 basis points on a year-over-year basis due to competitive pricing and 65% decrease in the quarter in compression horsepower on rent.

The 29,200 horsepower decrease in compression on rent during 2015 was due primarily to purchase options being exercised during the year in respect of approximately 25,700 horsepower of rental compression. Consolidated gross margins for the fourth quarter of 2015 was 24.5% of revenue compared to 31.5% for 2014.

This decline was due to inability to offset pricing declines with immediate cost savings, particularly within our rentals and transportation services division given its relatively high fixed cost structure and the time required to realize cost savings. As well, our compression and process services division contributed 70% of consolidated fourth quarter revenues in 2015 compared to 57% in 2014, as this division historically realizes lower gross margins than our contract drilling Services and rentals and transportation services divisions that increased contribution lowered our consolidated gross margin.

Consolidated cash flow before changes in non-cash working capital item was $5.9 million for the fourth quarter of 2015, as compared to $30.3 million in 2014. The decrease in cash flow was due primarily to decreased operating earnings which in turn was adversely impacted by costs incurred to right-size whole divisions for current activity level.

Consolidated EBITDA for the fourth quarter of 2015 was $6.6 million, a 78% decrease from 2014. Lower activity levels and the huge EBITDA margins in all divisions contributed this decrease.

Consolidated net loss for the three months ended December 31, 2015 was $3 million after recording $2.7 million unrealized loss on holdings of marketable securities during the quarter. Excluding this unrealized loss, but including the impact of restructuring and severance costs incurred to right-size operations, the fourth quarter net loss amounted to $0.7 million or $0.02 per share.

Total Energy’s financial condition remains very strong, with $90.3 million of positive working capital at year end. Included in year end working capital is $14.6 million or $0.47 per share of cash and marketable securities.

At December 31, 2015, the company has no net debt. Total bank debt at December 31 2015 consists of $40.8 million of term loan that is secured by approximately two-thirds of our own real estate.

This debt as amortized over 20 years bears interest at a fixed annual rate of 3.06% and requires monthly principal and interest payment of $278,800. At the end of five year term in May of 2020 approximately $40.2 million of principal will be outstanding.

With the exceptional real estate that secures this term loan, all of Total’s capital assets are available to support future borrowings as might be required. Total’s $65 million operating line of credit was undrawn at the year end and that remains still today.

Such operating line is secured by company’s working capital. Total’s bank covenants consist of debt to equity ratio of no greater than 2.5 to 1, current ratio at least 1.3 to 1.

At December 31, 2015 Total’s debt to equity ratio was 0.12 to 1 and its current ratio was 3.74 to 1.

Thank you, Yulia. Current industry conditions are as difficult as any faced by Total Energy since we commenced operations in 1997.

Price competition has been fierce with some competitors literally offering certain of their equipment and service for free in order to secure what little work there is. We cannot and will not compete with free.

Rather, our strategy is to continue to offer quality equipment and service but to decline unprofitable business opportunities. Further we have remained diligent in the management of counterparty credit risks.

Our refusal to pursue unprofitable work and recklessly extend trade credit has undoubtedly had a negative impact on near term equipment utilization and revenue. On the other hand, our bad debt expense has been minimal and our equipment fleet is and will be in a good state of repair and ready to resume normal and profitable operations in short order with relatively little start up costs.

Having struggled through several downturns in our corporate history, we appreciate and respect the cyclical nature of the oil and gas service industry. As such, we have sought to strengthen our financial position during busier times.

While this approach has negatively impacted our short term return on invested capital during such busy times, particularly given the poor return on cash in recent years, the short term impairment on return on capital is well worth the cost when the cycle turns negative as we are able to use our balance sheet when others are fixing theirs. Like most in our industry, we have taken significant measures to adjust our capacity and thereby lower our operating cost structure.

We have to make difficult decisions, including difficult personnel decisions that have seen our workforce decrease by approximately 40% over the course of 2015. However unlike many in our industry, we do not segregate so-called non-recurring or one-time expenses that relate to right sizing our operations, nor are we motivated by our bank covenants to do so.

Rather we strive to operate as efficiently as possible so as to remain as competitive but profitable regardless of what part of the cycle we find ourselves in. That said, if we exclude the unrealized loss suffered on our holdings of marketable securities which is truly unrelated to operations, as well as so-called non-recurring restructuring and severance costs incurred during the fourth quarter, we would have been profitable for the fourth quarter.

As Total Energy enters its 20th year of operations, the challenges facing our industry are straight as any we have experienced. Management remains focused on the efficient and prudent operation of our business and the preservation of the company's financial strength and flexibility.

Despite the difficult environment, Total Energy is still very much in business and we have and will continue to make targeted investments to serve our customers’ needs. In January, we announced a preliminary 2016 capital budget of $12.1 million which included $3.9 million for the purchase of the operating assets of the United States oil field equipment rental company effective January 1.

Management continues to work hard to identify and evaluate investment opportunities that will add sustainable shareholder value. Having regard to the impact of recent changes in the Canadian political environment have had or are expected to have both on the regulation and taxation of the energy industry, and the likelihood of major Canadian energy infrastructure projects moving forward on a timely basis, our focus is necessarily shifting towards expanding our international presence.

In that regard, I am pleased to report that we just recently received significant compression order from Australia. We also see good opportunities to grow our presence in the United States.

However while numerous international investment opportunities have been identified, we will remain focused and disciplined in our pursuit of such growth. Similar to our investment approach, Total Energy's dividend policy remained grounded on a pragmatic view of the nature of the energy services industry during better times.

As such, while our Board of Directors reviews our dividend on a quarterly basis as a matter of course, radical change is not expected nor required. Finally, I would like to encourage all of our shareholders and other stakeholders to attend our annual meeting of shareholders on Thursday May 19 at the Calgary Petroleum Club.

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

Dan, I know you're not going to tell us what the severance and restructuring amounted to in Q4, but can you give us a sense of how it might have been distributed between the business lines?

Certainly the brunt of it would have been borne by rental and transportation group, just given the -- certainly your rigs, a lot of your labor tends to be variable.

And then maybe just looking at the compression business, obviously some rationalization there. Give us a sense of what, the lease cost savings might work out to now as a result of those initiatives?

So we're pulling back our footprint or capacity of approximately 20%. We've vacated two leased premises and we're putting those up on the market.

The good news the lease terms aren’t super long on them which in turn makes sub-leasing a little more tricky. The flip side is, regardless of whether we sub-let or not just the efficiency and reduced costs associated with consolidating will be realized.

We'll see that play out over the next quarter or two. Obviously, to be frank we actually turned down one sub-lease opportunity, the counterparty risk associated with the sub-tenant wasn't worth the savings that we would have realized.

So there's an example of not just doing a deal simply to do a deal, you end up a year later having to chase someone for rent and fix all the damages to the building.

One last one if I may. In terms of the compression segment, obviously revenue went one way and margins went the other way.

Is that just a shift in mix away from fabrication towards rental in the quarter?

Well, first of all, say all divisions, we're very pleased with the fact that they've made tough decisions. We're in a market now that six months ago your decisions were a little easier.

So all of our management teams have been having to make some pretty tough decisions – pragmatic decisions and they've also been managing their cost structure very well. Any improvement in margins, there’s going to be some revenue mix certainly on the compression process side, the significant decline in horsepower on rent.

Yuliya commented on how much of that is attributed to the sale of compression last year. So that was a big factor which is why we've suggested to analysts it's probably not appropriate to back out gain on sale of assets, because that's -- you can either sell or lease it at the upfront.

Or you can sell it during the course of a lease, that’s normal business. We had a significant amount of lease buyouts last year.

So on a go forward basis you're not getting that rental income. The flip side is our balance sheet’s never been stronger.

We brought a lot of cash in, as that asset base was reduced. Definitely the remaining business fabrication, listen it's a competitive market, parts and service and rental.

Any improvement in margin is based on cost savings and efficiencies. We'll see that hopefully continue to play out as we go out and also listen, bad debt, I can't understate the impact that will have on our industry.

And again we've turned down work where we've not been willing to accept the credit risk. And so I've seen a few situations where people are adding back bad debt.

You shouldn’t have had it in your income statement in the first place, to add bad debt back to normalize EBITDA or earnings makes no sense to me because it was in the EBITDA to begin with. And the only thing worst, John, in not getting a job is getting it and not getting paid.

Dan, out of the $8.1 million order cancellation that you referenced taking some legal action against in the quarter. Was there any other material customer backlog cancellations in the quarter?

No. There were none during the year and none today.

So there has nothing been follow-on cancel since quarter end at this point.

Nothing. We've got a strong book.

We have taken legal action on that and we expect to be successful. The terms and conditions are pretty clear.

In terms of the significant compression order that you referenced, that of Oz [ph], was that embedded in the Q4 numbers or is it going come subsequent to?

Just recent. It's not in Q4.

When you look at the –

[cross-talk] to you is simply give you a little bit of flavor. We are definitely competing in the international market.

Australia has been an interesting market. I think generally it's taken a lot longer to come to fruition for a number of Canadian service companies.

But we're in the market and we're happy to get an order. And hopefully we'll get more because lower Canadian dollar doesn't hurt these days either.

And even with the shipping you would expect moving product into Oz to be as profitable as North America?

Shipping, we don't bear the cost of that. You'd have to ask the customer.

But the reality is compression going to Oz generally comes from Calgary and Houston.

When you look at the composition of your backlog within compression and process, are the embedded margins materially different than you've had in the past, just seeing the fall off that we've had in pricing for a lot of services?

I'm not going to comment on business lines within the compression and process group. What I will say is I'm extremely pleased with the efficiency gains that our groups have got and it's not just beating on suppliers.

We're achieving some purchasing savings but it's more importantly process improvements and obviously in a market like this you've got the A team working. And so your labor efficiencies are strong and like I said it's not sexy, it’s bottom line cost control and very efficient operations.

And so it's -- any margin maintenance is being borne internally in the sense of cost savings and productivity improvements.

Let me ask it this way then, has your economic return expectation materially shift in the last six to twelve months just given the market expectations for any fabrication work you’re doing?

My expectation is we get a return on our invested capital over time. And my other expectation is that we remain profitable.

We're not going to pursue work that we can't make a reasonable margin on. And again we've lost business, we've lost bids, because we refused to drop our price where perhaps someone else has, and maybe they're way more efficient than we are, I don't know.

But our expectations in that business have not changed. [Indiscernible] in any of our divisions.

The reality is you're working in -- you're working harder for less money. But there comes a point where you say park up.

And that's the point where we're at, we're saying we'll park up.

You make specific reference in the release to not making a decision to not cannibalize your fleet to lower your R&M and keep working. Is that something that you’re really ever contemplating, or is that more of a shot at some of your competitors on what you're seeing in the industry right now?

Well, let me give you an example. We're seeing it in the industry.

You're seeing the rig count, the marketed fleet dropped dramatically over the last year, Jon. But I'll give you a good example of what this means.

We went and drilled one hole for a customer this winter. It was a cold break having worked for so many months.

And so cold break, one hole. We came in the 18.5% under their AFE both time wise and obviously that translates into dollars and we've got a very nice note from that customer saying they couldn't believe that we came in 18.5% under their AFE, which presumably their expectations on days were set by the other rigs that we're working in the area for them.

That was a cold start. But why we can do that is we put our equipment down, we spent the time and money necessary to preserve it.

And so we can start up cold and compete with warm rigs and beat them. Now if I am stealing pumps and stealing this and that and shakers and all that, and then I've got to put a rig to work, there's going to be a big cost.

And what I can say is we started that rig up with minimal cost and went and beat the curve by 18.5%. And so that's what I want to do and all of our divisions are under those instructions, that when we put things down we spend the time and money to put them down, preserve them.

Because this will change and when it does we'll be ready to go to work and our clients won’t be facing downtime. And all of our rigs are available to work today.

Do you find that customers are actually asking for more concessions on price at this point or do you believe it's competition from competitors that’s pushing it further at this point?

I think, I noticed our rig guys handed me a slide from one of our competitors on the rig side, they happen to have rental company and – rental equipment, and I will quote from the presentation, “Idle rental fleet assets being provided at no cost to maintain day rates and margins”. We don't do that.

If we go back over the last couple of calls you’d talked about having a moratorium on buying Alberta businesses given all the uncertainty that we had in the provincial government changes and royalty review we're going through. Does that hold today?

If we can't move it out of this province, we're not interested in buying it.

Last one just from me. You talked about turning down work because of counterparty risk and maybe the lack of ability to get paid.

Was that in terms of customers that you were already working for or that you stopped working for? Is that new customers that you just didn’t want to engage in business with?

I think a bit of both. We have very strict credit controls, I will get phone calls 10 at night on Saturday night as to whether or not we can work for someone.

And we will do due diligence, I will do due diligence at 10 at night. Usually someone phoning 10 at night on a Saturday, meeting at for six in the morning the next morning.

That's a big flag. But definitely we're requiring deposits in some cases.

We flat out refuse to work unless payment upfront.

Just curious as to whether seller expectations have come more in line over, call it, the last sixty to eight weeks given the further collapse in commodity prices, because I know for a lot of 2015 the expectations – it was just too wide.

Definitely. I've had a lot of vendors come back.

In some cases we have made offers. In two specific cases recently we've declined to reengage.

Quality of the asset base was one problem. Also the quality of the personnel has been an issue, the equipment's one thing.

In certain instances particularly where we're looking to expand our geographic footprint we're more interested in the people. And the discussions we have in that regard are we will partner with good operators.

They can reduce our financial risk and become part of -- we're almost a mutual fund for some of these people. And so what we're not interested is being the stupid public company runs around and over pays and then has write-downs two years later.

By the way, Ian, we've never had a write-down in our history in 19 years of goodwill or capital assets, and that remains the case today. The flip side is they've got to diversify their risk.

And going forward when the industry recovers we both make money. We also buy distressed assets where the people don't matter.

That’s fine but we have had a number of vendors come back wishing to reengage. And generally we reject those unless it's a situation where the assets are such that we are happy owning them and we don't need the people.

But I hope, the acquisition we did in January, we kept the people. That’s a wonderful example of a partnership and there's many more of those that I hope we can do.

And as you look across your business lines that you have today and when you couple that with what's available for purchase, I mean is there one area that is particularly attractive to you at this point, or are you agnostic as long as it delivers an adequate return on capital?

We’re agnostic. Definitely just by nature of the industry the rental transportation side has obviously got the most opportunities but we're seeing opportunities in all three divisions.

And then I guess a couple questions on the operations side. I mean, first off, you guys noted fixed costs associated with the rentals business.

Is there any merit in rationalizing your operating bases given views going forward on where the activity is going to take place in Western Canada, where people anticipate it's going to take place?

So first of all, in 19 years we've never closed any of our rental transportation branches and we're not going to now. We've had situations in the past where there's been good discussions with divisional management about shutting the branch down, three years later became our number one branch literally.

When we make a commitment to a community, first of all, we don't open them lightly but once we open them we commit to that community. Now listen, we'll bring our cost structure down as much as we can.

But we stick, we're not quitters. The easy thing to do is quit and we don't quit.

That said, and listen we bring our cost structure down and then we hunker down and – but that’s intangible assets that's not on our balance sheet that when activity levels recover and you've supported a small community during a pretty rough time they remember who paid their property taxes during the rough times. They remember who supported the community employed the locals.

And I can tell you number one, the community defends you. And number two, it’s pretty easy to find people to work for you relatively speaking.

And so we take that commitment very serious. And we've never shut a branch down and we’ve hunkered down and gone through some pretty tough times.

And we're proud of that. And again there's no doubt we could have some short term savings by doing that.

But it’s a little bit like not having suffered any asset impairments over the years. That’s something that defines our culture, we're proud of it and we don't need to do it either.

The short term savings, frankly don't, -- are far outweighed by the long term benefits and we're a long term thinking company. That said, do you want to buy a bunch of assets you can’t move out of a jurisdiction that you think is going to be relatively sold, or you’re going to go where you think the work is going to be.

But there will always be something going on in the jurisdictions we’re in. We’re just hoping most of our competitors go broke before we do it.

And then last one from me, with respect to NOMAD utilization, have you seen a noticeable change this quarter from last quarter given the declining gas prices?

No but the leverage we have to any movement to start moving more gas molecules with our rental fleet is significant. And again it’s bought and paid for and we owe nothing on it.

End of Q&A

Thank you. If there's no further questions I thank everyone for participating in our conference call and look forward to speaking with you after our first quarter.

Have a good day.