Total Energy Services Inc.

Daniel Halyk – President and Chief Executive Officer Yuliya Gorbach – Vice President, Finance and Chief Financial Officer

John Bereznicki – Canaccord Aaron MacNeil – TD Securities Ian Gillies – GMP Daine Biluk – CIBC Capital Markets

Thank you. Good morning, and welcome to Total Energy Services Second Quarter 2018 Conference Call.

Present with me this morning is Yuliya Gorbach, Total’s VP Finance and CFO. We will review with you total’s financial and operating highlights for the three months ended June 30, 2018, and then provide an outlook for our business, and open up the phone lines for questions.

Yuliya, 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 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 forms and other documents filed with Canadian provincial securities authorities that are available to the public at www.cedar.com.

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

Total Energy’s financial results for the three months ended June 30, 2018, improved significantly compared to the second quarter of 2017. Recovering industry conditions in the United States and Australia as well as rationalization and meaningful cost savings from the integration of Savanna Energy Services and increase in production levels at our Weirton, West Virginia compression facility contributed to such improved results.

Consolidated revenues for the second quarter of 2018 were $193.8 million as compared to $154.9 million in the second quarter of 2017. Geographically, 46% of second quarter revenue was generated in Canada, 32% in the United States and 22% in Australia as compared to 58% in Canada, 23% in the United States and 19% in Australia during the second quarter of 2017.

By business segment, Compression and Process Services contributed 54% of 2018 second quarter consolidated revenues, Contract Drilling Services 20%, Well Servicing 18% and Rentals and Transportation Services 89%. Second quarter revenues for the Contract Drilling Services segment was $38.3 million or $24,019 per spud to release operating day.

Excluding Canadian subsistent revenues that essentially flow through to increase and on which no margin is earned. Revenue per spud to release day for the second quarter was $23,411, a 15% increase from Q2 2017.

Segment EBITDA was $4.8 million or 13% of revenue in the second quarter of 2018 as compared to negative EBITDA of $3.1 million in the second quarter of 2017. Contract Drilling Services segment recorded 1,593 operating days or 15% utilization during the second quarter of 2018.

Drilling activity during the second quarter of 2018 was lower as compared to the second quarter of 2017, due to lower North American drilling activity. In Canada, our strategy to decline on profitable work, combined with a decrease in natural gas drilling result, resulted in the low operating days.

In the United States, second quarter operating days were negatively impacted by the fact that three drilling rigs, that were activity during the second quarter of 2017 in Pennsylvania, were released subsequent to the quarter end. Two of these rigs were relocated to Texas and Colorado and both rigs commenced operations in June.

Partially offsetting reduced operating days in North America was 121% year-over-year increase in second quarter operating days in Australia. The revenue reported from our Rentals and Transportation segment increased 11% to $14.9 million for the second quarter of 2018 as compared to $13.4 million for the same period in 2017.

The revenue increase was primarily due to a 6% increase in revenue per utilized piece and marginally increased equipment utilization, offset by disposition of 700 rental pieces since June of 2017. Second quarter rental equipment utilization increased to 19% in 2018 as compared to 18% in the second quarter of 2018.

Segment EBITDA for the second quarter of 2018 was $1.7 million or 12% of revenue as compared to EBITDA of $1.3 million or 10% of revenue in the second quarter of 2017. Contributing to increased segment EBITDA was an increase in both in the size and utilization of our United States equipment fleet.

More specifically, compared to the second quarter of 2017, utilization in the United States increased 31% and revenue per utilized piece increased by 111%. Additionally, the rental fleet increased by 100 pieces or 20% to 600 pieces at June 30, 2018 compared to June 30, 2017, with the relocation of underutilized equipment from Canada and targeted new equipment additions.

The utilization of rental equipment in Canada during the second quarter of 2018 was consistent with the second quarter of 2017, albeit in the rental fleet that decreased by 800 pieces or 7%. Revenue per utilized piece of equipment in Canada increased 2% as compared to second quarter of 2017.

This was primarily due to the change in mix equipment operating during the quarter. Within our Compression and Processes Services segment, second quarter revenue for 2018 increased 61% compared to the same period in 2017.

Such increase was due primarily to higher sales activity, particularly within United States and other international markets. This segment exited the second quarter of 2018 with a record fabrication sales backlog of $216.1 million as compared to $149.2 million at June 30, 2017 and $207 million at March 31, 2018.

Utilization of the compression of rental fleet continue to recover during the second quarter with approximately 24,845 horsepower on rent at June 30, 2018. This compares to 19,000 horsepower on rent at June 30, 2017 and 18,500-horsepower on rent at March 31, 2018.

Segment EBITDA increased 110% to $12.9 million for the second quarter of 2018 as compared to $16.2 million in Q2 of 2017, with quarterly EBITDA margins increasing 219 basis points on the year-over-year basis. Compared to the first quarter of 2018, segment EBITDA margins increased 280 basis points as efficiencies began to be realized with a steadily increase in production from our Weirton, West Virginia compression fabrication facility.

Second quarter revenues for our Well Servicing segment was $35.5 million and EBITDA was $8.7 million or 24% of revenue as compared to revenue of $35.9 million and EBITDA of $7.5 million or 21% of revenue during the second quarter of 2017. Total service hours for the second quarter were 36,472, of which 50% were in Australia, 36% in Canada and 14% in the United States.

This compares to 34,935 service hours during the second quarter of 2017, of which 46% were in Australia, 37% in Canada and 17% in the United States. Consolidated gross margin for the second quarter of 2018 was $37.5 million or 19% of revenue as compared to $25.4 million or 14% of revenue in the second quarter of 2017.

The increase in margin amount and percentage was in line with increased margins in all business segments as a result of improved industry conditions in the United States and Australia and the realization of substantial cost savings from the integration and rationalization of Savanna. Consolidated cash flow, before changes in noncash working capital items, was $22.5 million for the second quarter of 2018 as compared to $10.9 million in the second quarter of 2017.

This increase was due primarily to increased activity levels in both Compression and Process Service segment and Savanna Australia’s operations as well as improved EBITDA margins in all business segments. Consolidated EBITDA for the second quarter was $22.2 million, a 253% increase as compared to the second quarter of 2017.

Total Energy achieved profitability for the consecutive quarter, generating second quarter net income attributable to shareholders of $3.8 million or $0.08 per share on a diluted basis. Total Energy’s financial position remains solid with $103.1 million of positive working capital, including $24.1 million of cash and marketable securities at June 30, 2018.

After paying $5.5 million of dividends to shareholders during the first half of this year, since the end of 2017, our shareholder’s equity increased by $5 million as a result of company’s returned – return to sustained profitability. Total debt was $297.9 million at June 30, 2018, a $29.8 million reduction from December 31, 2017.

In addition to regular monthly principal payments on $59.9 million of mortgage debt, during the first six months of 2018, Total Energy repaired $27.5 million of debt assumed with acquisition of Savanna. At June 30, 2018, $236 million was drawn on $295 million of available revolving bank credit facility.

Our bank covenants consist of maximum senior debt to trailing 12 months bank-defined EBITDA of four times and the minimum bank-defined EBITDA to interest expense of 2.5 times. At June 30, 2018 the company’s senior bank debt to bank EBITDA ratio was 2.2 times and the bank interest coverage ratio was 7.63 times.

Thank you, Yuliya. We are pleased with our second quarter results as they began to demonstrate our ability to generate improved financial results from the combination of Total and Savannah and to execute on our international growth strategy.

As Yuliya mentioned, underpinning our second quarter results for strong international demand for compression equipment and the continued recovery in industry conditions in the United States and Australia. While industry conditions in Canada remained relatively challenging, particularly during spring break-up, operating efficiencies and cost synergies arising from integration of Savanna, coupled with modestly improved pricing, also contributed to our improved year-over-year financial results.

As we have discussed in previous quarterly calls, during the integration of Savanna, we took substantial action and incurred significant nonrecurring expenses to restructure and improve the operational and financial performance of our North American drilling, Rental and Well Servicing business. Declining unprofitable work, extracting cost savings and working to improve the quality and efficiency of our operations have allowed us to work our equipment less, yet achieve better financial results.

For example, despite a 50% year-over-year reduction in North American spud to release days, second quarter EBITDA for our Contract Drilling Services segment increased by $7.9 million compared to the second quarter of 2017. Our integration efforts have also given rise to substantial cost savings, which we now estimate will be at least $17 million on an annualized basis.

As such, we would expect our financial performance to continue to improve in the near to medium term, everything else being equal. However, despite relatively stable industry conditions, uncertainty exists within the global energy market, particularly, in Canada.

In such environment, we continue to focus on pursuing investment opportunities that are expected to provide appropriate risk-adjusted returns, and we will remain disciplined in our pursuit of such opportunities. While there is further work to do to improve the efficiency of our operations and further cost savings are expected with the expiry of unoccupied property leases and the disposition of surplus real estate and other assets, the integration of Savanna is substantially complete.

I would like to thank our many employees, who have worked hard during the integration process. Your efforts have meaningfully contributed to the improvement in our operating and financial performance and positioned Total Energy well going forward.

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

Hi, good morning everyone.

Good morning John

Good morning John

Just looking at Australia, utilization was up sequentially, looks like across-the-board. Just wondering if you can give us a sense what you’re seeing there right now in terms of the activity and pricing dynamic through the balance of the year?

So as we mentioned in our previous quarter, we expected Australia to continue to improve, that’s the case. We’re currently – Savannah is currently as active as they’ve ever been in the history of their Australian business in terms of equipment working.

What we have seen on the pricing front is a bit of moderation in the sense that there were some legacy contracts that expired. That said, I think a combination of some cost improvements combined with continued reasonably strong spot market pricing conditions have led to continued good bottom line performance there.

So while the legacy contracts, the pricing was better, I think, we’ve more than dealt with any price declines through improved cost management.

Great. Shifting gears to CPS.

Obviously, margin’s up nicely on a sequential basis. Trying to understand is it fixed-cost absorption?

Is it reduction in start-up cost or more rental revenue? Just wondering if you could maybe give us a little more color on that

I’ll take all three, John. Obviously, as our production levels go up, your absorption is better on overhead.

In terms of the start-up costs of Weirton, that’s an ongoing process. But as you continue to ramp-up production and train and improve your – train employees, improve your production processes, your cost go down on a per unit basis.

And definitely, we’ve also seen a nice uptick in our compression rental fleet utilization. Interestingly, in our previous – I believe it was in March, we increased our capital budget by $15 million to allow the compression group to continue to grow its U.S.

Rental business. They’ve been pretty successful in deploying existing unutilized pieces as opposed to, necessarily, I think a whole bunch more.

But certainly, we have the flexibility to add new units to the fleet if circumstances warrant. But definitely, a nice uptick in utilization of the existing fleet.

Got it. Thanks.

And then just lastly, looks like you’ve moved another rig out of Canada into U.S. in Q2.

Thoughts on further relocation here in the back half of the year.

We’re monitoring the situation pretty closely. We’re committed to Canada.

And our view is – there’s been a fair amount of equipment migration out of Canada. We do require fairly, how would you say, firm commitments before we will move.

The flip side is, we’re not going to abandon our Canadian clientele. And so we’re sensitive to that, but at the end of the day, we’ve got a big asset base we’ve got to put to work, and we’ll make a call on a rig-by-rig, client-by-client basis.

So I don’t want to speculate on any further movement of the equipment.

Okay, terrific. That’s it from me, appreciate the color.

Thanks.

Thanks, John.

Good morning guys.

Good morning, Aaron.

On the Compression and Process side, I guess, I’d note that may be your outlook in Canada is a bit more guarded than one of your peers. But would you be willing to comment on what you’re seeing either from a booking backlog, order inquiry activity, subsequent to quarter end in Canada, the U.S.

and maybe in other regions?

I would just generally say, we’re very pleased with how our business is competing in Canada. We have a significant share of the market.

It’s hard to determine exactly what, but we’re a very, very material player in the Canadian market. And we’ve been more than holding our own in terms of participating in business in Canada.

So that said, on a year-over-year basis, what’s driving a material increase in the backlog is certainly the international piece. But that doesn’t diminish from the importance of Canada to our business.

Is it fair to assume that Canadian performance could be up meaningfully next year over or this year?

I think, what you have is a fairly significant Western Canadian infrastructure deficit. You’re seeing the midstream infrastructure being built out a bit.

Obviously, everyone knows about our pipeline constraints. It’s frustrating to watch what’s happening south of the border relative to north on major pipeline construction.

That said, as that plays out, there is significant upside for us in Canada. And also, our exposure to LNG is very significant and probably not appreciated, but we’re not going to speculate on what a particular project may or may not mean.

Other than to say that, if you have one or more Canadian West Coast LNG projects go forward, we would expect that, that would be very beneficial for, not only our Compression business but some of our other segments as well.

Assuming that an LNG project goes ahead, what do you think the timing might be where you actually see revenue from that project?

Depends what segment. Obviously, you’re going to have.

On the compression – I’m Sorry.

Yes, it depends on the build schedule so I don’t want to speculate on a particular project. I think there’s some – obviously, you have the main plant itself, and then you’ve got all the gathering systems going into that plant.

And what I do know is when a proponent of a previous project that since has been canceled was moving forward. We participated very significantly in the field compression component of that project and that was a few years back.

So again, I’m not going to take anything for granted, but I would expect that we would have a reasonably good chance to compete for incremental business.

Okay. And then maybe switching gears to Well Servicing and drilling, maybe, in Australia, in general, I guess, piggybacking on John’s question.

Can you comment on what your contract position or outlook looks like on both our drilling and service rig side makes.

So we generally don’t comment on individual customers. It’s never been our practice to do that.

I’m not going to do that. What I would say, generally, it’s a much more concentrated marketplace.

I would also say, relative to last year our customer base is more diversified, which is a positive thing. And typically, you tend to have term commitments there as opposed to spot market.

And – so I feel quite good about where we stand today and how we’re positioned. Ultimately, you’ve got to do a good job.

If you don’t, piece of paper – I’m not going to rely on a piece of paper to keep us with the customer, I’m going to rely on doing a good job. So we’re not going to put a lot of – we’re not going to hide that stuff, I guess, Aaron.

What I would say is we’re in a good place in terms of customer diversification, contractual backing and performance. One thing we’re very proud about in Australia is our safety record.

It’s incredible. They do a very good job there.

And that’s a function of having good steady work with customers that are equally committed to the safe operation and protection of our people. And so I would say, we’re second to none in both Drilling and Well Servicing safety performance in Australia.

And we’re working with very large customers that appreciate and are willing to pay for that service.

I guess, maybe throwing that question on the window and asking it a bit differently. You’ve mentioned in your remarks that you had some contracts roll off and then you had spot market pricing that was okay.

But do you think that run rate – or Q2 is an appropriate run rate for both of their drilling and service rig side in Australia?

Yes. I think we’re running things at a pretty high level.

I don’t see anything causing that to change to the negative. And like I said, offsetting some price decreases on contract renewals is – our group has done a very good job at improving cost structure.

And again, I think part of that is – we’ve implemented compensation schemes there that directly align segment management with bottom line performance, which has not been the case with Savanna, historically.

And then maybe just as a final question and a point of clarification. The three rigs that you moved from the Marsalis, did I hear it correctly that two are currently operating in Texas?

And then our operating today? Is that correct?

No. So we moved two rigs from Marcellus, one is working in Texas, one in Colorado.

Those commenced operations in late Q2. We moved a rig from Canada to Texas towards the end of Q1.

It started operating in Q2 as well. So three rigs moved, two from the Eastern U.S., one from Canada.

And all three are moving. We still have one idle rig in Pennsylvania.

We’ll give you an update next quarter on that one, hopefully.

Thanks Daniel.

Hopefully.

Would you be willing to share where the compression backlog is today or maybe even just whether it’s up or down from, I guess, what was disclosed at 2Q? And just given the strong revenue performance in second quarter and so on and so forth, would just be interested to hear how bid activity is as well?

We’re not going to give a number, Ian, never have, never will. We’ll give it next quarter end.

But like I said, I’m very pleased with how our Compression and Process group is competing, both in Canada and internationally. So we’ll give an update after Q3 but we’re not going to start doing that.

How about some color around how bid activity is relative to maybe what you’ve seen over the last six or 9 months.

Its busy.

Busier.

You’ll find out September 30th. We’re busy.

Okay. With respect to the Permian, have you seen any impact yet on your operations or in your conversations with customers, is there anything that lead you to believe that there may be a slowdown?

Not yet.

With respect.

Let me put it this way, we’ve actually, deliberately slowed down on some of the lighter rigs as contracts expired. We’ve declined future work because the pricing wasn’t there.

And so you’ve got some cost inflation in the Permian given it’s very, very active. And as we have legacy contracts expire, we either get better pricing or we shut the rig down.

And so the absolute number of rigs working in the U.S. has been relatively stable.

I can tell you there has been movement below the service – the surface there. And generally as rigs are coming off, we’re either better pricing or we’re shutting them down.

And that explains in part, the 50% year-over-year decrease in spud to release days in North America, yet a material improvement in the bottom line and we expect that to continue. We’re going to, frankly, not work for nothing and that’s going to stop.

And if and when rigs can go back to work for a reasonable rate they will, where ever in the world they are.

There seems to be some notional amount of positivity around day rates in the back half of the year in Canada. Do you think – or have you seen them or are they moving enough yet or you think you may be able to start capturing some market share back in Q3 perhaps relative to what it was in Q1?

So I think Q1 would appear with the benefit of hindsight today to be the low for us on market share. I think where we see some good strength, and again, we commented on this after our Q1 results is on the shallower end light oil.

That’s a market where we are a very significant player. We’re also seeing the double market picking up a bit.

Interestingly, in the second quarter, we drilled the deepest, longest well that Savanna or Chinooks ever drilled. It was close to 6,700 meter with a mechanical, double, no top drive.

And so – and we did it in a material shorter period than what the well was feed for. And so, I think, as you see the exodus of high spec, or whatever you want to call them, I would call them as – you see an exodus of overcapacity rigs, including triples, but also high-capacity AC doubles out of the marketplace.

You’re going to get a migration back to rigs that are more than capable of doing the work. And ultimately, that will help the deeper end.

But to date, where we’ve seen our market share starting to recover is more on the lighter end. And I’m hopeful that as our customers continue to – they need to start making money and many of them are and as they continue to recover financially.

And there’s a tighter market on the deeper because of equipment leaving the country that you’ll start to get some normalization of the deeper end of the market, but time will tell. But we definitely gave up market share and we’ve been open about that.

But we’re also working less and making more.

And with respect to working capital, I mean, there’s been some pretty solid effects there. You guys made some previous changes on tightening up working capital since the Savannah acquisition.

Do you think it can get better from here? Have you kind of right sized that piece as well?

Well, what we saw, and this is interesting as literally, we went from about four rigs working through break-up to north of 20 in about three, four weeks. So that’s a pretty good working capital pool in June.

And so I would think that, as we go forward, we will actually do better on working capital. You know as well we’ve had a pretty good ramp-up in our Compression process.

It’s been quarter-over-quarter. The other group that’s – we’re quite pleased with the improvement in both activity and bottom line has been our Well Servicing, including in Canada.

I think, again, we’ve taken a real effort to get out of the unprofitable work, the gypsy work. But there’s been a pretty good pick up there, and we’ve also just sat down and told our customers that we can’t work for these rates and we’ve declined a lot of work.

And – but fortunately, in a lot of cases the customer see that and they work with us. So all in all, I think, we’ve had a fairly good ramp-up in June, which has put some working capital pressures.

And as things level out and steady, I suspect our working capital performance will improve.

Okay, thanks that’s helpful, turn a call back over.

Good morning, Halyk. Was there anything that drove service rig pricing in Canada and the U.S.

higher outside of straight rate increases? Was geographic mix a function of moving rates higher at all?

No, rate increases.

Pure rate increases, okay.

Yes.

Can you give us a sense that what sort of capacity that Weirton facility was operating at in the quarter? Just trying to get a better sense of what the business ramp to, especially given the higher backlog?

There’s much more to go there. What we find, and I’m hesitant to give numbers publicly is when we think we’re at 100 in Canada, we find ways to get another 50% out of it.

We have a lot of room to – run room in Weirton. But it’s ramping up.

And our focus really, at this point, is on training and securing additional labor, not worrying about physical capacity of the plant. So our primary focus is to continue to expand our workforce there and train them and improve the efficiency of our labor force.

Okay. That’s a good colour.

Listen, we’re hiring in Weirton, and we’re having some pretty good success.

On the Compression backlog added in the quarter, can you provide any further color on the geographies and contract size of that?

I would say a nice balance. Definitely year-over-year an increase in international.

And we did – I think, it’s public knowledge in the marketplace that we did receive during the period a very, very large order out of Australia, which was one of our biggest single orders ever. And so we continue to compete very well in that marketplace.

All right. Okay.

And then just the last question from me. Dan, can you talk about how happy you are from a broad-integration perspective with having had Savanna for over a year now?

And is the integration officially behind you? Or is there still more to do at this stage?

So I would say it’s been a lot of work. I was a busy guy during the actual takeover.

I’m very pleased with the job that our senior management team, both at a corporate and divisional level has done to take the ball and run with it within each of the segments. I’m very pleased with the cultural alignment over the past year.

I think, realistically at first, there was probably some skepticism about some of the discipline that we sought to bring in on pricing in that. But I think as our management team see the outcome, they’ve completely bought in, particularly, as we’ve implemented bottom line based compensation, which, in some cases, has already contributed to meaningful compensation increases.

And for those segments that are still in recovery mode will contribute to meaningful compensation increases and so that, obviously, brings the natural alignment. In terms of the kind of the rationalization, I think, from a people perspective, that’s done.

We are always going to have tweaks, but really, the focus now is on liquidating access real estate, other assets. We’re still not done the call and decommissioning process.

But we’re steadily making progress. We’re not going to sell things at the bottom of the market.

We’re going to be smart about it. But we’ve also taken steps to reduce the carrying cost of certain assets.

We’ve also – like I said, we see at least $17 million a year now in annualized cost savings. Q2 was really the first quarter that those cost savings kicked in when we didn’t have a bunch of corresponding onetime costs, severances and the ERP system, for example, we’ve pretty much got that cleaned up.

That was a real mess when we locked in here and there was a source of distraction and a lot of work for everyone. And that’s been wrestled to the ground and is functioning reasonably well now, in large part because we simplified it.

But there was a lot of money spent on that pretty us, what, $7 million, Yuliya? $10 million, all in by $7 million we rolled off ballpark and $10 million in total that was expensed and that’s behind us.

So all in all, I’m very happy. I think, these things take time.

And we’re not just going to just start firing people or shutting things down. We want to understand the business, want to understand the people and that just takes time.

But we’re done. And now our focus is to continue to improve our operations.

And with that, improvement, will come bottom line performance that gets better.

That’s a great color, thank you. Congrats on the good quarter, now turn a back.

Thanks Daine.

Thank you. Thanks for calling in, and appreciate your questions, and we look forward to speaking with you after our third quarter in the fall.

Have a good weekend.