Total Energy Services Inc.

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

Daine Biluk - CIBC World Markets John Bereznicki - Canaccord Genuity

Thank you. Good morning, and welcome to Total Energy Services' third 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 September 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 September 30, 2018 continued to improve significantly compared to 2017. Recovering industry conditions in the United States and Australia as well as the realization of meaningful cost savings from the integration of Savanna Energy Services, increase in production levels at our Weirton, West Virginia compression facility and declining unprofitable work contributed to such improved results.

Consolidated revenues for the third quarter of 2018 were $232.9 million as compared to $185.2 million in the third quarter of 2017. Geographically, 54% of third quarter revenue was generated in Canada, 30% in the United States and 17% in Australia as compared to 50% in Canada, 32% in the United States and 19% in Australia during the third quarter of 2017.

By business segment, Compression Process Services contributed 49% of 2018 third quarter consolidated revenues, Contract Drilling Services 25%, Well Servicing 18% and Rentals and Transportation Services 8%. Third quarter revenue for the Contract Drilling Services segment was $57.7 million or $20,341 per spud to release operating day.

Excluding Canadian subsistence revenues that essentially flow through to increase on which no margin is earned, revenue per spud to release day for the third quarter was $18,941, a 2% increase from Q3 2017. Segment EBITDA was $10.9 million or 19% of revenue in the third quarter of 2018 as compared to EBITDA of $7.6 million or 13% of revenue in the third quarter of 2017.

Contract Drilling Services segment recorded 2,836 operating days or 27% utilization during the third quarter of 2018, as compared to 3,153 days or 29% utilization in the third quarter of 2017. Despite lower activity, the Contract Drilling segment generated $2 million of operating income in Q3 2018, compared to $3.3 million operating loss in Q3 2017.

This improvement was a result of realized operating synergies arising from successful integration of Savanna, improved discipline in decline non-profitable work and ongoing cost management. Drilling activity during the third quarter of 2018 was lowest compared to third quarter of 2017, due to lower North American drilling activity as a result of our strategy to decline unprofitable work.

Partially offsetting reduced operating days in North America was 58% year-over-year increase in third quarter operating days in Australia. The revenue and utilization reported from our Rentals and Transportation segment for the third quarter of 2018 was consistent with revenue and utilization for the comparable period in 2017.

Segment EBITDA for the third quarter of 2018 was $3.5 million or 18% of revenue as compared to EBITDA of $5.7 million or 29% of revenue in the third quarter of 2017. Contributing to decreased segment EBITDA were segment Canadian industry conditions that prevented price increases necessary to offset increased operating cost arising directly from regulatory changes in Alberta, particularly the cost of labor, fuel and utilities.

Also negatively impacting Q3 segment EBITDA compared to 2017 was approximately $0.2 million of cost associated with the disposal of excess equipment. Offsetting decreases in Canada was an increase both in size and utilization of our United States equivalent fleet.

More specifically, compared to the third quarter of 2017, utilization in the United States increased 42% and revenue per utilized, this increased by 10%. Additionally, the rental fleet increased by 100 pieces or 20% to 600 pieces by September 30, 2018 compared to September 30, 2017 with the realization of underutilized equipment from Canada and targeted new equipment addition.

The utilization of rental equipment in Canada during the third quarter of 2018 was 4% lower as compared with the third quarter of 2017. On the rental fleet, that decreased by 800 pieces or 7%.

Revenue per utilized piece of equipment in Canada increased 2% as compared to third quarter of 2017. This was primarily due to change in the mix of equipment operating during the quarter.

Within our Compression and Processes Services segment, third quarter revenue for 2018 increased 70% compared to the same period in 2017. Such increase was due primarily to higher sales activity in all markets particularly the United States.

This segment exited the third quarter of 2018 with a record-fabrication sales backlog of $236.7 million as compared to $160.7 million at September 30, 2017 and $216.9 million at June 30, 2018. Utilization of compression rental fleet continues to recover during the third quarter with approximately 31,500 horsepower on rent at September 30, 2018.

This compares to 20,200 horsepower on rent at September 30, 2017 and 24,800 horsepower on rent at June 30, 2018. Segment EBITDA increased 53% to $13.5 million or 12% of revenue for the third quarter of 2018, compared to $8.9 million or 13% of revenue in Q3 2017, negatively impacting EBITDA margins in the year-over-year basis with costs associated which continue to ramp up all production at our Weirton, West Virginia plant and cost associated with securing additional fabrication space in Canada, from which there was no production activity in Q3 2018.

Third quarter revenue for our Well Servicing segment was $41 million and EBITDA was $11.6 million or 28% of revenue as compared to revenue of $39.3 million and EBITDA of $8.8 million or 23% of revenue during the third quarter of 2017. Total service hours for the third quarter were 44,447, of which 47% were in Canada, 43% in Australia and 10% in the United States.

This compares to 41,256 service hours during the third quarter of 2017, of which 44% were in Canada, 41% in Australia and 15% in the United States. Consolidated gross margin for the third quarter of 2018 was $48.2 million or 21% of revenue as compared to $40.8 million or 22% of revenue in the third quarter of 2017.

The marginal decrease in margin percentage was due primarily to higher relative contributions of CPS segment to consolidated revenue. Consolidated cash flow, before changes in non-cash working capital items, was $34.8 million for the third quarter of 2018 as compared to $30 million in the third quarter of 2017.

This increase was primarily due to increased activity levels, involve the Compression and Process Services segment and Savanna Australia operations as well as improved EBITDA margins in Contract Drilling and Well Servicing segment. Consolidated EBITDA for the third quarter of 2018 was $34.6 million, a 27% increase compared to third quarter of 2017.

Total Energy achieved profitability for the fifth consecutive quarter, generating third quarter net income attributable to shareholders of $8.9 million or $0.19 per share on a diluted basis. Total Energy's financial condition remains strong with $117.6 million of positive working capital, including $27.9 million of cash and marketable securities at September 30, 2018.

After paying $8.2 million of dividends and repurchasing $2.7 million of common shares during the first nine months of this year, since the end of 2017, shareholder's equity is increased by $2.7 million as a result of our return to sustained profitability. Total debt was $295.6 million at September 30, 2018, a $32.1 million reduction from December 31, 2017.

In addition to regular monthly principal repayments in $59.3 million of mortgage debt, during the first nine months of 2018, Total Energy repaid $20.7 million of debt assumed with acquisition of Savanna. At September 30, 2018, $236 million was drawn on $295 million of available revolving bank credit facilities.

Our bank covenants consist of maximum senior debt to trailing 12 months bank-defined EBITDA of three times and the minimum bank-defined EBITDA to interest expense of 3x. At September 30, 2018 the Company's senior bank debt to bank EBITDA ratio was 2.02x and the bank interest coverage ratio was 8.08x.

Thank you, Yuliya. We are pleased with our third quarter results as they continue to illustrate our ability to generate improved financial results from the Savanna asset base and the steady and profitable growth of our international business operations.

Providing a tailwind for our third quarter results were continued industry recovery in the United States and Australia and strong domestic and international demand for compression and process equipment. Cost synergies and economies of scale arising from the successful integration of Savanna, as well as improved discipline in declining unprofitable work offset continued challenging industry conditions in Canada.

While the recent decision of LNG Canada to proceed with construction of a liquified natural gas terminal on Canada's West Coast was a positive development for the Canadian energy industry, it is not expected to have an immediate impact on Canadian natural gas prices. As such, Canadian oil and gas producers continue to suffer substantial price discounts relative to global bench mark prices due to a lack of energy transportation infrastructure.

The current regulatory environment in Canada makes the advancement of energy infrastructure projects challenging in the anticipated federal passage of Bill C-69 is widely expected to further exacerbate the challenges facing proponents of such projects. Compounding the challenges based in the Canadian energy industry, particularly in Alberta are recent regulatory and tax changes that have contributed to higher labor, fuel utilities and other operating cost at a time when market conditions prevent service providers from increasing prices to the extent necessary to recover such increased cost.

Given the poor energy investment climate in Canada, substantially all of our $30 million of growth capital expenditures for 2018 have been directed to expanding our international presence, particularly in the United States. Further, it has become necessary to adjust the rental and transportation segments' fixed cost structure to the reality of current industry conditions in Canada and to achieve additional efficiencies falling the acquisition and integration of Savanna's oil field rental operations.

Specifically, we have determined to close five RTS branch locations in Canada by the end of 2018. We will also continue to relocate equipment to the United States for opportunities to immediately put such equipment to work exist.

Finally, we are pursuing opportunities to dispose of surplus idle equipment and thereby rightsize our rental and trucking fleet for expected future activity levels. As such, while this rationalization will reduce our geographic footprint in Canada, particularly in Northern Alberta, it is not expected to have a negative impact on segment revenue, but will have a meaningful impact on reducing fixed costs.

We are working hard to achieve profitability in all business segments and in all geographies and I believe this is a very achievable goal should industry conditions remain relatively stable. I would now like to open up the phone lines for any questions.

In Canada, are you fairly agnostic when it comes to drilling market share in order to pursue economic rates of return?

Yes.

Was there a base level of activity that you'd be looking to keep and maintain cruise for merits [ph] and whatnot?

Yes. I think we're pretty comfortable with our current position in the market.

I look at our results in the context of the industry and believe that we can compete with anyone out there in terms of price, but as we've done consistently in a difficult market, we're not going to work when it doesn't make sense. I believe the current industry conditions will allow us to maintain a reasonable market share and thereby keep sufficient activity, keep cruising that busy.

We continue to work to get our cost structure down, but again, our Canadian drilling segment is profitable pretax and after tax, but I'm not sure there's many that can save that and such were prepared to compete in whatever market conditions.

Understood. Can you share where regions you would like it to close the RTS branches?

And with the bulk of that equipment be moving to the U.S. or would a good portion of that be staying in the WCSB?

First of all, I'm not going to get into exact specifics there. We did a pretty detailed analysis following the acquisition of Savanna.

We did pick up some branches with Savanna, so part of this was driven by our assessment over the past year of what we can do to get more efficient. But a large part of it is based on our assessment of where activities are going to be in the next five years in Western Canada.

As such I'm not going to share particulars for obvious reasons, but we'll continue to service all areas of the basin. It will just be from a smaller footprint and unfortunately to the extent that it's in areas where we have closed operations.

The trucking bill will be higher if someone wants to move assets. But we've spent a lot of time very closely analyzing historical and budgeted activity levels from our customer base and others.

So these were very targeted closures. And in terms of equipment, we are looking to continue and embed it within our cost and we don't break results specifically.

We did comment on $200,000 of cost largely on disposal equipment, but we're incurring expenses daily to relocate equipment that's all embedded in our cost structure. We're not carving that out.

That's going to the U.S., that will continue, likely accelerate given what we're seeing in the United States and we're also going to look to dispose of rational and controlled manner, surplus equipment where there's opportunities to do so at fair prices. Typically we're seeing that equipment leave the country and being applied in other industries.

All in all, we've held on for four years. I think the trigger for us was the Trans Mountain decision and that followed on that.

So we're taking some pretty significant steps. Again, the equipment that's going to lead Canada and leave our Canadian fleet will either go to the U.S.

and generate revenue or be disposed of. So we don't see any impact on revenues here.

I guess currently on the same line of thought, for the incremental compression of horsepower you added to your rental fleets so far this year, has most of that been in the U.S. and are you at a point where you'd look to move some of your Canadian horsepower to the U.S.

as well?

Definitely both sides of the border have been strong. We have been relocating compression horsepower into the U.S., but Canada, we've seen a fairly good pick up too.

I think this is part of -- I would call it the infrastructure bill that's happening on a regional basis. We're seeing that benefit our compression process services both on the fabrication of the rental side.

Okay. And then just last one for me.

When thinking about share buybacks versus incremental dividend increases, how are you weighing the two options? And do you have a preference for one or the other at the stage?

I think you've seen us step up our buybacks and given where we're at relative to -- it's a game -- we look at buybacks like we do any capital expenditure, but they're looking more and more attractive everyday. So I would think that's probably an area that we'll continue to focus in capital.

I appreciate the color. I'll turn it back.

Thank you.

Just in thinking about the fabrication expansion in Canada, how much of that is being driven by what you're seeing internationally dn how much of that is maybe a precursor to what may come here on the LNG front in Canada?

Both and it's not just the LNG. There's a current infrastructure bill in Canada that's probably not fully appreciated, but this expansion is necessary to address current activity levels both in Canada and internationally.

Got it. If you look at what the capacity will look like I guess in a few quarters from now versus your U.S.

capacity, how would the two compare in terms of cost structure when you're bidding on international work?

Depending on where you're shipping from. What we're seeing is generally the cost to operate is slower in the U.S.

It's just a whole different ball game there. The flip side is we've got extremely highly skilled in efficient work force in Western Canada and also currency as Canadian dollar continues to weaken.

There's obviously some currency advantages there to certain extent. But it's a good balance portfolio here.

Certainly I guess one of the benefits of all the negativity in Canada in our sectors fabrication space on a subtly space is fairly attractive. So we can add some pretty significant incremental production here at very efficient cost.

We weighted and make the call to expand our footprint in Canada based on a number of variables. But current Canadian activity is also contributing to that need.

Got it. Good color.

I guess shifting back to RTS, it's really striking looking at your numbers, where you're generating a profit on the U.S. on much smaller business.

Can you envision a day when RTS is bigger in the U.S. than it is in Canada right now?

The way I look at it, John, is our RTS segment, we built over the course of 22 years and really it was built to service 650 rigs going into winter and we haven't had that for four years. Like I said, kind of a catalyst for a major review as both obviously Savanna acquisition, we've picked up some branches, as well as the keystone decision which we see is impacting differentials here forbid on heavier oil.

So we did a very detailed analysis and these are very targeted closures. The other thing that is somewhat frustrating is the cost increases being pushed on business particularly on Alberta that you have no control over and you can't pass.

It's things like vacation entitlement, staff holiday pay. Again on businesses where you have a piece of equipment specifically tied to approach at, it's a lot easier to pass that on, but when you're running the equipment we are in this segment, if there's a staff holiday and you got to pay everyone, it's not tied to a specific customer project, you just can't recover that.

Your heating bills are more, fuel is a big cost in this division and carbon and fuel taxes has been going up, and up, and up and it just got to a point where you can't sustain it. We're going to rightsize it.

We don't see 650 rigs working in Western Canada anytime soon probably in that 350 range. So our infrastructure is too large for what's going on and we're going to rightsize it and as well we're going to rationalize the equipment base.

You'll see that play out over the next few quarters. We'll update our fleet size, but at the end of the day we're going to get it lean and mean here.

Really, we don't have a revenue problem there, we've got a fixed cost problem. We're going to address that.

Great. It makes sense.

In terms of drilling, obviously the U.S. really closed the gap from last year in terms of minimizing the operating loss.

I know it's a goal of yours to get that in the plus side. Any sense on when you might be able to do that given what you're seeing out there?

I think the color we gave Q2 as we're now going into the next stem, a few quarters here where it's like you see, contracts are rolling off and we're rolling into a better price environment. We've also really been focused on turning down unprofitable work.

I was just down in Texas last week. It's busy down there.

Interestingly, one of our heavy doubles displays to triple. What we're hearing down there is the price of triples of which we have three -- one of ours, we're doing a level 4 research -- and then it's going back into better pricing.

But what we're hearing and I've heard this directly from one of our good customers down there is the triple prices are going up to the point where they're not going to use bazookas to shoot mice anymore, but we're literally with one of our doubles drilling 18,000-20,000 foot. We're drilling these entire wells that triples have been drilling, doing it and saving significant money for our customers both on move time and day rate although our day rates are going up.

And interestingly, I asked specifically about trip times and they're not identifying that as a concern. And again, this specific rig that's doing it, we relocated from Canada and there's appetite for more.

Great. Good to hear.

And then just one last one for me and I'll turn it over. Just generally speaking, what are you seeing in Australia right now?

Good steady market. I think supply demand is pretty balance, but we've never been more busy in terms of equipment of work and we expect that to continue.

Again, they came out of a downturn just like North America. It's recovering and it's a very healthy balance market right now.

I think you're going to continue to see good steady performance there. We're going to look at opportunities to continue to grow.

But like I said, everything but one service rig and one flush by unit going there right now which they've never had that level of activity. Our goal is to get it all off the bench, but do it in prices that makes sense and then look to continue to support that business to logically grow without creating market imbalance, I guess you would say.

Got it. Okay that's great color.

That's all for me. Thank you.

Thanks, John.

Thanks, everyone for participating in our call and look forward to speaking to you when we release our year-end results. Have a pleasant weekend.