Total Energy Services Inc.

Daniel Halyk - President & CEO Yuliya Gorbach - VP, Finance & CFO

Ian Gillies - FirstEnergy John Gibson - CIBC World Markets

Thank you. Good morning, everyone and welcome to our second quarter conference call.

Present with me this afternoon is Yuliya Gorbach, Total's Vice President, Finance and Chief Financial Officer. We will review with you Total's financial and operating highlights for the three and six months ended June 30, 2016.

We will then provide an outlook for our business and open up the phone lines for any questions. Yuliya, please proceed.

Thank you, Dan. During the course of this conference call information may be provided containing forward looking information containing Total's projected operating results, anticipated capital expenditure trends and projected 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 in 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 news release 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, 2016 reflects difficult industry conditions compounded with breakup. Consolidated revenues for the second quarter of 2016 were $43.9 million, a 39% decrease from second quarter of 2016.

Compression and process services contributed 84% of 2016 second quarter revenues. Rental and transportation services 14% and contract drilling services 2% as compared to relative contributions of 78%, 19% and 3% in 2015.

Revenue per spud to release operating day in our contract drilling division during the second quarter was $12,981, a 23% decrease from the $16,865 per day realized during 2015. This decrease was due primarily to lower spud market pricing as the company has no drilling rigs under term 6 price contracts during this period.

Segmental EBITDA was negative $0.3 million for the second quarter of 2016, compared to $0.5 million or 21% of revenue for Q2 of 2015. Within the rental and transportation services segment, severe price competition resulted in significant declines in equipment utilization and segmental revenue.

Second quarter rental equipment utilization decreased 47% to 10% in 2016 compared to 19% in 2015. Segmental revenue per utilized piece of rental equipment for the second quarter of 2016 decreased 15% compared to the same period in 2015.

Segmental EBITDA for the second quarter of 2016 was negative $0.9 million compared to $2.9 million or 21% of revenue in 2015. This decline resulted from low equipment utilization and pricing as compared to 2015 and the fact that cost did not decline in proportion to the decline in segment revenue.

This segment has relatively high fixed cost structure as compared to company's either business segment. Our fixed cost structure includes cost associated with significant operating branch infrastructure such as utilities, insurance, property taxes and grant as well as depreciation expense of the equipment that is recorded on a straight line basis and is not co-related to levels of activities.

Second quarter revenue within our compression and process services segment decreased 34% in the second quarter of 2016 compared to 2015. This segment generated $2.9 million EBITDA in the second quarter of 2016 compared to $11.6 million in 2015.

Segmental second quarter EBITDA margin declined by 663 basis points as compared to 2015 15% decrease in the quarter end compression horsepower on rent, as well as competitive pricing. This segment exited the second quarter of 2016 with $35.9 million backlog of fabrication sales orders, as compared to $68 million at June 30, 2015 and $48.9 million at December 31, 2015.

The timelines for conversion of such failed backlog to revenue varies from order to order and often changes due to factors outside of company's control. Included in the December 31, 2015 and June 30, 2016 backlog is $8.1 million order purported to be cancelled without payment or the prescribed cancellation fee.

Legal action has been taken to enforce such contracts and no revenue has or will be recorded in respect of such order until resolution. As of June 30, 2016 the total of horsepower of compressive in rent was approximately 12,000 as compared to approximately 28,900 as of June 30, 2015.

The compression rental fleet experienced an average utilization of 30% and 33% based on sweet horsepower respectively during the three and six months ended June 30, 2016 as compared to 69% and 73% for the same period in 2015. Consolidated gross margins as a percentage of revenue for the second quarter was 15% of revenue as compared to 24% for the same period in 2015.

The lower gross margin realized in 2016, compared to 2015 is a result of the CDS and RTS segments contributing a lower portion of consolidated revenue in 2016, as compared to 2015, as these segments historically generate a higher gross margin percentage than CPS segment. Lower pricing in all three segments during 2016 as compared to 2015 also contributed to lower realized gross margin.

Consolidated cash flow before changes in non-cash working capital item was $1.8 million for the second quarter of 2016, as compared to $6.5 million in 2015. The decrease in cash flow was due primarily to decreased operating earnings, which was partially offset by reduced income tax payment.

Consolidated EBITDA for the second quarter of 2016 was $1.4 million, a 90% decrease from 2015 comparable quarter. Lower activity levels and result in lower EBITDA margins in all segments contributed to this decrease.

Consolidated net loss for the second quarter ended June 30, 2016 was $4.2 million. This move from operating income to an operating loss was a result of decreased business activity and lower price in those three segments that was not fully offset by proportionate cost reduction.

Total Energy's financial condition remains very strong with $79.4 million of positive working capital at June 30, 2016 is compared to $90.3 million over working capital at December 31, 2015. Shareholders' equity decreased by $9.3 million during the first half of 2016 due to the realization of a net loss and continuous payment of dividend.

Total's bank debt at June 30, 2016 consists of a $47.8 million of term loan that is secured by approximately 60% of our owned real estate. This debt is 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 exception of the 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 June 30, 2016 and that remains the case today. Such operating line is secured by company's working capital.

Total's bank covenants consist of debt to equity ratio of not greater than 2.5 to 1, and the current ratio at least 1.3 to 1. At June 30, 2016 Total's debt to equity ratio was 0.11 to 1 and its current ratio was 4.33 to 1.

Thank you, Yuliya. Difficult industry conditions continue through the second quarter and were compounded by spring break up in Canada.

Activity levels in our contract drilling services and rental and transportation segments were at historic lows in part due to our determination not to pursue unprofitable work. During the second quarter we completed two different acquisitions at a total cost of $5.1 million to bolster our rental and transportation services segments presence in North Dakota.

Included in these acquisitions was an operating facility located in Watford city where our North Dakota operations are being consolidated. Our compression and process services segments after, over the past several years, to develop a meaningful presence have begun to bear fruit.

Earlier this year we received a $7.3 million order for gas compression equipment from an intermediate Australian Natural Gas producer and in late July we received a $21.3 million compression order from a large Australian producer. We are optimistic that further business opportunities will emanate from this region.

While the improvement in commodity prices in the second quarter led to an improvement in industry sentiment, oil prices remain volatile and significant industry uncertainty exists. As such Total Energy continues to focus on improving the efficiency of existing operations, pursuing sensible business opportunities and declining unprofitable business.

Protecting our financial strength, and liquidity, and evaluating opportunities to grow our company, navigating through these difficult times we continue to take steps to align ourselves to stable and reputable business partners so as to mitigate the negative consequences of counter party defaults and to better position our company for the eventual recovery. While difficult times call for difficult measures, I am proud of the fact that our people have not compromised on the quality or the safety of our operations or the integrity in which we do business.

Total Energy is ready if willing enable to ramp up operations when our industry is ready to go back to work. I would now like to open up the phone lines for any questions.

Thanks, good morning. Just wondering, what you are seeing in the rental market in terms of attrition as far as some of the smaller private competitors out there?

I am curious if that has maybe intensified to the second quarter?

I would say that we are definitely seeing the acceleration of attrition on both sides of the border in the rental and transportation side and I expect that to continue to accelerate over the next several months.

Great. And I know in the last few quarters you have been more biased to US acquisitions on that front, is that still the case in your mind?

Yes.

Okay. And then just wondering if you could give us a little more color on the latest Australian order in the compression business?

So as you know we have been over in Australia for, I was over there personally for about three and a half years ago and that market has taken longer to open up for us and maybe everyone hopes but we have had a steady stable cost effective presence there and it's starting to bear some fruit and we are very pleased obviously as I mentioned earlier in the call John, earlier in the year we received a $7.3 million order, that's currently being completed for an intermediate Australian producer. This $21.3 million order post June 30 is from a very large producer and you know if we do a good job, obviously we are showing that we can compete in that market and I am very optimistic or people are doing an excellent job and demonstrate that we should hopefully get some more work over there.

Great color, thanks Dan and is there any nomad equipment in those orders?

I am not going to comment specifically what's in the order but there's a fairly wide range of equipment, some very big stuff and pretty hesitant to comment on specifics given that there is ongoing competitive bid situations in that marketplace.

Fair enough. Thanks again, that's it for me.

Thanks John.

Good morning, everyone.

Good morning Ian.

I just wanted to follow on John's question on Australia quickly. Are you able to provide any detail around when you expect to recognize the revenue from that contract order?

I mean it's large and probably going to be lumpy so is it going to be mostly in Q1 2017 or is it going to be evenly spread through the next few quarters? How should we think about that?

What I would say is, we currently expect it to be completed by Q1 and so under our percentage completion which we adopted Yuliya about 2010?

2010.

So about 4 years ago, historically we would recognize revenue upon completion which made it really lumpy, now we recognize it as percentage of completion so you will see that roll out over the next three quarters basically of which it rotates with all of our orders. The revenue is recognized as the units are completed on percentage completion and like I said current schedules for completion by Q1 again we would expect that to stick but you never know these things but currently that's the expectation.

And we're not going to update every order if there's delays, if there's modifications or something, but what we're trying to do is give you a sense of -- we have a very substantive presence outside of Canada.

Okay, that's actually very helpful. Thanks very much.

With respect to acquisitions, I mean, I think across the whole space, they've been slower to develop than most people have expected and under the scenario that no meaningful acquisitions appear or the valuation gap doesn't come in, how do you think about deploying organic capital moving forward to perhaps try and ouster some of these smaller competitors or capture market share?

Well, I think what we're seeing in the rigs and the rental business are many operators offering their products and services at astonishing prices. And this isn't just small operators; this is very large ones as well.

And so our expectation is the equipment fleet in the industry will be in severe state of disrepair and perhaps a lot of it will not be able to return to work when things wrap up. And so, you know, we're declining certain acquisition opportunities based on the quality nature of the asset base.

The pricing is actually not the issue, it's our view -- we're looking ahead a year from now and going do we want to put money into that and so we're going to balance doing acquisitions, again, our focus is always on the asset base, and it comes down to is that an asset base we'd rather own or compete with? And again, given the -- we're seeing ridiculous pricing in rigs where we are knowingly giving up work because the pricing is simply beyond what we can live with.

And so we've given up market share there, we've definitely given it up in the rental space. The flip side is you get what you pay for.

And these fleets that people are working at where they're not covering their costs, that catches up with you. And those are fleets that we're not interested in owning.

So we'll let them wear it out and when there's a reasonable margin to be had, we'll come back to work. And in the meantime, we'll acquire good assets and we're not afraid to pull the trigger for good quality assets.

Okay. And with that prior comment in mind and on prior conference calls, you've noted that you may try and capture some additional market share back in the rentals division.

Has that strategy more or less been put on hold, given continued deterioration of pricing?

You know, it's selective. I think it depends on the nature of the equipment, the customer, and the -- who the competitors are.

And so we are -- first of all, we are not interested in working for people that can't pay their bills. So we're not going to aggressively go after that work.

Secondly, things with moving parts tend to have a shorter shelf life and you're seeing pricing that -- our view is let that play over a few quarters and then the competitive landscape will be materially different. And thirdly, we are focusing our effort on players that we believe are good partners.

And this is both on customers and suppliers; we're shortening our supplier base. Just anecdotally, yesterday we got a letter from one of the provincial governments where a supplier of ours has been garnished by them.

And so we're very sensitive to our supply chain, just like we expect our customers are and the last thing we want to do is deal with counterparties where creditors come in and seize their assets. So we're monitoring not just customer risk but supplier risk and smart customers of ours are doing the same.

And we see that in all divisions and particularly larger projects and larger customers are a little more focused on that.

Okay. Thanks very much, I appreciate that.

I'll turn the call back over.

Thanks, Ian.

Good morning. I know you touched a little bit on it but I'm just wondering if you could talk about your bad debt provisions and do you see any more coming in the quarter?

I know they're small, but just if you give some color going forward here.

So we're -- obviously in this market, John, credit management is a very strong focus of ours. It always has been, but we're in a heightened risk environment.

It starts with who do you work for. We have some very rigorous credit processes and so the only thing worse than not getting the work is getting it and not getting paid.

So it goes to the comment I made where we have given up market share where we have assessed credit risk and determined that we require some or all of the expected costs up front. And in some cases, the customers appreciate that and will work and in some cases they don't or can't pay, and we're -- it's a business call you make.

So a lot of it is avoiding extending credit to -- excessive credit situations. And then certainly, timely invoicing, account management and follow up are critical and on a corporate level, we've been very involved over the past several quarters in assisting all our divisions with the credit management and collections piece.

And so we monitor that literally daily. And we're continuing to work hard to minimize that expense.

That said, across all of our divisions, we would have 500 to 600 customers and you're bound to get some things wrong here and there. And so when we have reasonable evidence that suggests it's not collectable, we provision for it.

I appreciate that.

I'm not going to comment on future periods other than to say that we continue to be very diligent on that front.

Perfect. I know we talked about rentals a bit, but do you see a trough in pricing or is it still too early to tell?

I know it's a little of that here in Q2 and --

Certainly, we're troughed. You know, the reality is, we're going to have a very different competitive landscape a year from now and what's going on in that market is astonishing and, again, I think as the next several quarters play out, people like you as well as our customer base will realize the impact of what's going on currently will have on the medium- to long-term supply chain.

And it's not -- it'll be positive for players like us that get through it, but there's a lot of cannibalization…just basically the fleet is going downhill and as you work it harder and don't put money back in because you don't make any money, it just simply accelerates and again, when you're running 30 rigs during Q2, you're not going to see it. But as we ramp up, our expectation is the quality of the asset base will start to really differentiate between operators, and I'm very confident that the quality of our asset base will command a premium price when we get into a busier environment.

Okay, great. I guess just touching on last month, have you seen any pickup on the -- any activity on the drilling side or --

Yes, we have. It's still very competitive.

We have given up work based on price and we know that 100%. What I would say is there's various groups that claim to have Tier I equipment that are operating for Tier 5 pricing, and the only reason we lost the work is 100% on price.

And we know that.

Okay, that's great. Just -- could you talk a little bit about your compression margins?

They seem to be fairly resilient and is it just a factor of your cost structure largely changing in lock step with reduced pricing or --

You know, we're -- in all our divisions, I'm very happy with the way divisional management has been proactive on cost management. And that includes our compression process.

So it's been a grind, it's just old-fashioned line-by-line cost management. And our divisional management and employee base have been very proactive and diligent in managing our costs structure.

So certainly, our compression process, that group's no exception and we continue to look at ways to be more efficient and get our costs down. And our customers benefit from that.

Moving back to Australia, do you see any work on the service side or are these contracts more just an export opportunity?

When I was down there 3½ years ago, I met with a bunch of different onshore producers and I'm hoping to go down as kind of rolled some of our big orders out here. We've had that discussion and basically, my message to these producers was once we have sufficient horsepower on the ground, we will look to provide appropriate parts and service support, but what we're not going to do is spend a bunch of time and money building an infrastructure to do nothing.

In the meantime, we're quite happy to let competitors service our equipment in the short run. You know, we go and start it all up so we have people go over and start up and all that on major overhauls, but as we build our horsepower fleet there very similar to what we've done in Canada and the U.S., to a certain extent is parts and service will follow horsepower.

And the customers are happy with that.

Okay, last one just from me. Did you see any cancellations in your fabrication backlog?

I'm not sure if I misheard, but I thought I heard Yuliya talk about an $8.1 million cancellation --

Well, that's the one we've been referring to the last several quarters. So that's still in our backlog because we have a valid contract.

We're not going to repeat that verbiage in every press release. What I will say is, as Yuliya mentioned, there has been zero revenue recorded on that contract and we're not going to record any revenue, I mean, until it's resolved.

We've taken legal action and we're not going to provide an update until that's resolved. So we're pressing aggressively to move that forward to resolution.

We're very confident in our position and it's a U.S. midstream company that has -- they're a growing concern and we'll let the judge decide.

Like I said, we're very -- these contracts are pretty black and so, ultimately, once we have resolution there, we will provide an update to the marketplace. We have recorded zero revenue on that and that's important to know.

Okay, great. Again, I appreciate the color.

I'll turn it back.

Thank you. We appreciate your interest and participation in our conference call and look forward to speaking with you after our third quarter results.

Have a good day.