Total Energy Services Inc.

Thank you. Good morning and welcome to Total Energy Services’ fourth quarter 2019 conference call.

Present with me 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 December 31, 2019, 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 concerning Total’s projected operating results, anticipated capital expenditure trends, and projected drilling activity in the oil and gas industry.

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

Our discussions during this conference call are qualified with reference to the notes to the financial highlights contained in the 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 three months ended December 31, 2019 reflect continuing difficult industry conditions in Canada that were exacerbated by poor field conditions due to wet weather and reduced production activity in our Compression and Process Services segment. Offsetting these challenges were relatively stable business activity levels in the United States and Australia and the receipt of USD13.5 million contract termination payment in the Contract Drilling Services segment.

By business segment, contract drilling services contributed 39% of 2019 fourth quarter consolidated revenues. Compression and Process Services 27%, Well servicing 24% and Rentals and Transportation Services 10%.

For 2019, CPS segment contributed 48% of consolidated revenue, contract drilling 25% well servicing 18% and rental and transportation is 9%. Geographically, 48% of fourth quarter revenue was generated in Canada, 31% in the United States and 21% in Australia.

For 2019, 41% of revenues came from Canada, 38% from the United States and 20% from Australia and 1% from other parts of the world. Within our Contract Drilling Services segment, an approximate 28% year-over-year decline in Canadian drilling activity as measured by industry operating days resulted in lower fourth quarter revenue excluding early contract termination payment as compared to Q4 of 2018.

Offsetting activity declines was US$13.5 million revenue or approximately CAD17.6 million of early contract termination payments received and recorded in the fourth quarter of 2019. Excluding early contract termination - revenue CDS generated CAD0.2 million operating income in Q4 2019 as compared to CAD1.5 million operating loss in Q4 of 2018.

Despite a 12% decline in the fourth quarter operating days compared to 2018 and excluding contract termination revenue an 8% increase in revenue per operating day an increased operating efficiencies resulted in continued bottom line improvement in our U.S. drilling operations.

Sequentially from Q3, 2019 the operating loss within our U.S. drilling business excluding contract termination revenue improved by 86% as the result of cost management and completion of our equipment optimization projects the cost of which was expensed over several prior quarters.

While utilization in Australia was 8 percentage points higher than in Q4, 2018 revenue per operating day in Australia was lower in Q4, 2019 as compared to Q4, 2018 due to lower camp and other ancillary revenue. Operating income for the fourth quarter in Australian drilling business was 23% higher than prior year comparable quarter due to high utilization and decreased lower margin revenue.

For 2019, 39% of contract drilling revenue came from United States, 33% from Canada and 28% from Australia. Substantial year-over-year decline in Canadian industry activity also contributed to 45% decline in the fourth quarter Canadian revenue for our Rentals and Transportation Services segment.

This decline was somewhat offset by 48% increase in the United States revenue as we continue to reallocate underutilized Canadian equipment to that market and made targeted investments in new equipment. On an unconsolidated basis, fourth quarter RTS segment revenue decreased 20% as compared to prior comparable period.

Fourth quarter revenue per utilized rental piece in RTS increased 68% from 2018 due to the mix of equipment operating as well as higher realized pricing on equipment reallocated from Canada to the United States. In 2019, 41% of RTS segments revenue was generated in the U.S.

compared to 21% in 2018. RTS segment incurred $1 million of reallocation expenses during the fourth quarter as we continued to move underutilized equipment from Canada to the United States.

Excluding the reallocation expenses an additional CAD1 million of recurring depreciation expense following the change in depreciation estimates in Q3 2019. The operating loss was CAD2.5 million for the fourth quarter of 2019 as compared to a loss of CAD0.9 million in the same quarter of 2019.

Within our Compression and Process Services segment, fourth quarter revenue for 2019 was CAD40.7 million, a 65% decrease compared to the fourth quarter of 2018. This segment exited the fourth quarter 2019 with fabrication sales backlog of CAD48.6 million an CAD8.8 million increase from September 30, 2019.

The decrease in revenue was a result of lower fabrication sales, although it is encouraging that for the first time since the third quarter of 2019 the quarter-end fabrication sales backlog increased from the previous quarter-end. Fourth quarter revenue for our Well Servicing segment was CAD35.2 million a 5% decrease from Q4, 2018.

This was due primarily to modestly lower prices in North America, lower camp and other ancillary revenue in Australia and weakening of Australian dollar relative to Canadian dollar over past year. Total service hours for the fourth quarter were 42,175 of which 45% were in Australia, 44% in Canada and 11% in the United States.

This compares to 42,382 service hours during the fourth quarter of 2018 of which 46% were in Canada, 45% in Australia and 9% in the United States. Consolidated gross margin for the fourth quarter of 2019 was CAD49.3 million or 33% of revenue as compared to CAD41.2 million or 19% of revenue in the fourth quarter of 2018.

Positively contributing to the gross margin were the receipt of CAD17.6 million early termination contract payment in CDS segment. Consolidated cash flow before changes in non-cash working capital items, was CAD36.9 million for the fourth quarter of 2019 as compared to CAD23.1 million of cash flow generated in the fourth quarter of 2018.

During the quarter, we invested significant capital into raw materials inventory in our CPS segment. This investment related primarily to major components that were previously ordered when factory deliveries at times exceeded 60 weeks.

Our commitment to purchase inventory in CPS segment peaked last year and will be significantly lower going forward until such time as we see the meaningful pickup in fabrication orders. As such, at current production levels, we would expect to generate up to CAD40 million of additional cash flow during 2020 with the monetization of this inventory.

Consolidated EBITDA for the fourth quarter of 2019 was CAD35.8 million as compared to CAD29.2 million of EBITDA realized in Q4 of 2018. Excluding non-recurring expenses and unrealized foreign exchange losses on transaction of each company working capital balances, fourth quarter EBITDA for 2019 was CAD39.3 million.

During the fourth quarter of 2019, Total Energy generated income attributable to shareholders of CAD8.5 million or CAD0.19 per share as compared to CAD8.6 million or CAD0.19 per share in Q4 of 2018. Total Energy financial conditions remain strong with CAD103.2 million of - positive working capital - after reclassifying CAD40.9 million of mortgage debt as current at December 31, 2019.

We expect to renew such mortgage debt when it matures in the second quarter for another five-year term. During 2019 Total Energy returned CAD16.3 million to shareholders through dividends and share buybacks.

Total bank and mortgage debt were CAD277.9 million at December 31, 2019. Our debt net of working capital was CAD145.2 million at year end, a 10% decrease from December 31, 2019.

Our bank covenants consist of maximum senior debt to trailing 12 months bank-defined EBITDA of 3 times and minimum bank-defined EBITDA to interest expense of 3 times. At December 31, 2019 company’s senior bank debt to bank EBITDA ratio was 2.06 and bank’s interest coverage ratio was 9.49 times.

Thank you, Yuliya. Extraordinary times call for extraordinary action.

The global coronavirus pandemic and an oil price war have given rise to social turmoil, economic uncertainty and severe market volatility. And navigating through these times, Total is focused on protecting our financial strength and liquidity and positioning ourselves to capitalize on historic opportunities that arise during times of crisis.

Given the macro environment, we took the decision to suspend our dividend and substantially reduce capital spending until such time as market conditions stabilize and visibility improves. Combined these two actions will increase 2020 free cash flow by CAD23.8 million.

As Yuliya mentioned earlier, monetization of working capital as our investment in inventory naturally decreases with lower production levels in our CPS segment will also contribute substantially to 2020 cash flow. For the past year, we have been working to align our various businesses to reflect the realities facing the Canadian energy industry.

For example by this spring the number of RTS branches in Canada will be half of what it was a couple of years ago. Equipment has been relocated to the United States and leased properties have been vacated as leases come up.

Several owned facilities have been leased to third-parties, operations and all business segments have been relocated to own facilities where possible including own facilities vacated by another business segment, where activity levels did not warrant continued operations. In many cases, we have consolidated multiple business segments within the same owned facility.

The head office lease that we assumed with the takeovers of Savannah expires in Q2 of 2021. And when it does, we expect to reduce our annual head office lease expense by at least $2.5 million bringing total cost synergies from the integration of Savannah to well over $20 million.

Expenses related to this rationalization and restructuring effort are largely behind us. The benefits lie ahead.

Our continued investment in maintaining our equipment fleet and the fact that we expense equipment repairs not capitalized them means, that we're able to operate our fleet at current utilization rates and the rates that we've been operating at for the past few years with minimal capital expenditures. This past winter, we started up several drilling rigs that have not worked for several years at minimal expense and with minimal operating issues.

The fact that we have consistently realized gains on the sale of old underutilized equipment confirms that the book value of our assets is solid even in these challenging times. The estimated market value of our inventory in real estate is roughly equivalent to the entire amount of our bank debt including mortgage debt.

There are very few energy service companies that can eliminate their debt simply by liquidating inventory and doing a sale leaseback on their own real estate. As such, our liquidity position is very strong and we have many options available to us to ensure that remains the case.

Our decision to suspend the dividend and reduce CapEx to minimal requirements only strengthens our flexibility and resilience. The energy industry was already facing significant made in Canada challenges before the coronavirus and oil price crash including the reluctance of authorities to enforce the rule of law and federal government actions that stimulate project cancellations not investment and job creation.

Recent events have simply put more pressure on the industry and will force industry rationalization through bankruptcy and consolidation. Years of mal-investment in the energy services industry not only in Canada, but globally, has been and will be punished severely.

There will be winners and losers, but when this cleansing process is complete. Our industry will once again be positioned to deliver appropriate risk adjusted returns to our stakeholders.

I can assure you that Total will be one of the winners. I would now like to open up the phone lines for any questions.

So I guess maybe just starting off on the dividend cut and the CapEx reduction. Could you maybe just walk through your thoughts on allocating - those proceeds to debt repayments and/or share buybacks, is one or the other seeing a hang parity in the current environment?

I think consistent with our 23 year history, we're flexible and we will do what's best. We don't chase things and we always do the what-if and like I said, I don't want to give any particular guidance on that.

But those - the decisions increased our free cash flow by almost CAD24 million for this year so definitely we have CAD24 million extra dollars to do both.

Right, that's fair and that make sense. And I guess maybe just as a follow-on is it fair to say that despite the softer activity picture today, 19.08.

You feel comfortable that you could have still funded the dividend and the cut is just one of seeing more attractive uses of capital in the debt repayment and share buybacks?

Absolutely, we could have maintained this dividend. I think there’s several things.

When you're literally getting a 40% premium at the auction sale for your used equipment and the equity markets is paying what CAD0.30 on the dollar for the same equipment that in itself is a historic opportunity. And the other thing is listen we have to make tough decisions, particularly in Canada.

Given the current environment, I expect there is going to be continued prudence and tough environment and when you’re laying people off and closing branches down, you’re not sending a very good message to your employees or your customers to maintain a dividend in these circumstances. So it's not just the monetary element it's the - you lead by example.

We're asking everyone within our company to batten down the hatches and that includes - our owners are going to have to do the same thing. And I'm the largest individual shareholder in the company so, I don't cut these things lightly and our Board doesn't cut it lightly.

But what we want to do is take advantage and position ourselves to the best we can in a very historical time right now and this will pass. And when things normalize and our industry is back on a better footing we're going to continue to reward our shareholders with the dividend.

And, but our Board reviews it quarterly and it's not just a rubberstamp reviews, looking forward and what environment are we in - and like I said when you literally have the NHL shutting down. You know things are a little bit different and it's probably time to hunker down and make sure that you've got all available levers available to you to get through some tough times.

Right, that makes sense. It was good color and couldn't agree more.

I guess obviously considering kind of - this is sort of unique times and there's going to be some fairly distressed assets that are coming up for sale in the coming year. I mean, do you have high end focused on M&A in the current environment or are you just kind of happy with the current platform?

Absolutely, I mentioned in my comments, Daine. There’s going to be a major restructuring and perhaps it took the coronavirus and oil price war and frankly dysfunctional energy policy in Canada to get us there.

There will be consolidation rationalization it's already happening you know we're focused on transactions that make this company better not worse, that's both from a equipment perspective and a financial perspective. And so I expect you're going to see banks, large shareholders, but more so the creditors and not just in Canada, United States and elsewhere and look to fix problems and you know we've had a history of being able to fix problems.

I'd look at what we've extracted on the Savanna integration and I look at the success we've had operating that asset base a pretty low utilization such that you know we firebreaks up this winter that hadn't worked for five years at minimal expense, minimal disruption. And so we take a long-term view.

We're not going to overpay, we're not going to do transactions that put our company at risk we're going to do transactions that make our company better and offer the target the opportunity to share in the spoils when things get better. But we're not going to fix.

We're not paying to fix people's problems. We'll get paid to.

Like I said that's part of the dividend cut is to give us additional firepower to do good transactions that arise during times of crisis.

All right, it makes perfect sense. Yes, good color.

Okay I think just one more from again this is probably early days, but any indications from your Australian customers. Are they looking to dial back activity on the back of this COVID related softness at all?

So far Australian operations have been stable. And we had no impacts with fires and you know it’s a stable.

It’s a kind of a nicer in island I guess.

Right.

But no, Australia has been stable market.

I don’t know if you could shed a little light on the - modest uptick and the fabrication backlog within the Compression business?

Well, I never like to call bottoms, but last year was a strange year in that business. We had a lot of quoting activity.

I think that was a consistent message from our competitors. People were hesitant to pull the trigger.

We saw that loosen up a little bit in Q4. We don't, we’ll provide another update end of Q1 here, but that industry as well there's been overinvestment more so in the U.S.

in capacity we're seeing major players start to vacate or substantially reduce their capacity. Like I said, it's a commodity business and low cost is going to win.

And we're coming or came into this bit of a downturn with over CAD90 million of good inventory that's bought and paid for. And even in the continued lower production environment that business will do well for us.

One of the positives in Canada has been gas prices have held in relatively well. And ironically it seems like gas might be the place to be for the next couple of months.

But like I said our group there runs a very good business, we’re becoming increasingly international. The U.S.

is a big part of our business now including keeping our Canadian facilities busy. There’s massive infrastructure builds underway and still pending.

And we're going to get our fair share of that tough business. And so that set our - we’re doing what we need to do to right-size our cost structure for - what's in front of us and they've done a good job doing that and - we'll get our fair share, John.

So, we have to adjust there like everywhere else, but that business much more variable cost structure than fixed certainly been a lot easier adjustment process in terms of the mechanics. Certainly people lost jobs in that, but trying to adjust the fixed cost structure within our rental transportation group it's been a lot more work just because of the physical nature of the infrastructure.

But as I mentioned - we've done a lot there in the past year and all of this has been expensed and we've not carved out in any of our quarters any of our restructuring costs. We don't use that as an excuse and that's behind us.

And we're going to realize the financial consequences of that on a go forward basis.

I appreciate the color there. And just sticking within compression on the rental side it looks like pretty steady activity quarter-on-quarter, any comment and kind of what you're seeing there vis-à-vis sales versus rental?

Yes, rental demand is still solid and steady and frankly a good chunk of the CAD10 million budget we have is earmarked for new additions of rental fleet. On that again, and I can’t overemphasize this enough.

We expensed things that most companies capitalize. And like I said all the start-up of these rigs we did this winter are all expensed.

We don't capitalize that stuff. And so, when you're looking at our capital budget, it's not an apples-to-apples with other companies.

But it also gives you comfort that the margins we’re generating over the past several years in a tough environment are real margins. They're not playing around with expensing versus capitalizing.

And so that's why we can run this business on a bare minimum CapEx and the CAD10 million capital budget we have does include growth capital for compression rentals. Given the environment and particularly our focus on credit quality, we're basically I need to approve every rental - new rental commitment in this environment largely because we want to make sure the credit is good.

Right, got it.

That's our biggest concern is credit on new rental assets. And so, we're watching credit like a hawk, knock on wood.

We've had a pretty good run so far, but that requires a lot of effort both upfront and sometimes after the fact and that could bring a lot of smaller companies down.

Right, and then just lastly on housekeeping front as you monetize your inventory - within compression given your current backlog. Any sense of how long a period that might take tends to happen?

I'm not going to give a forecast on that. I think we've been consistent since our Q3 call that we’re kind of telling the market, and telling you that at current production levels you’re going to be in that CAD40 million of unwind…

Got it, got it.

This year, so we’re not going to give any forecast on production levels or that sort of thing. But assuming kind of a steady state if it gets busier, that'll go up.

Dan - given that these circumstances pretty good quarter and pretty good year. But I have two areas rather to ask about.

We're now seeing almost every day companies announcing major cutbacks cancellation of rigs. What happens when you do see that do you get any partial payments, is it just gone - is it do, you have an agreement where there’s a deferral would you get the business later?

And where do you see the first cracks in terms of the business both in Canada and the United States?

Josef so far I would say the announcements have been forward-looking not backward looking. We're going into breakup right now anyways.

And so, honestly, it's probably not a bad time to have a pandemic if you ever going to have a pandemic. It's our typical slowdown in Canada.

So - but we're being cautious here. And so we're communicating with our customers.

It's going to be the survival of the fittest. And again it's going to come down to your balance sheet strength, the quality of your asset base.

Your ability to fund working capital requirements when things do pickup and who you’re working for, and so we’ve been extremely diligent on all those points for the last five years not just starting yesterday. We took the historic step of eliminating or suspending our dividend for now, because we recognize these are crazy times and we don't know exactly what the future is going to look like.

We don't know how long this is going to go on. We don't know when the flames are going to beat the oilers in the playoffs.

Those are things that we've got to maintain maximum flexibility. But I can tell you this company is extremely well positioned.

The quality of our asset base is second to no one. You're going to get a gravitation towards equipment that's most efficient, not - you don’t need bazookas to kill a mouse.

And so all this mal-investment and super ultra-heavy, super-duper triple rigs, we had a rig drill a well in Q1. It was a record well for the company a longstanding customer of ours and a record well for us.

One of our AC doubles was over 7,000 meters of hole and we tidied in 20 days. I’ll put that up against any triple.

And I can tell you the fuel consumption and the rig mover materially lower than bringing on £1 million hook load rig. And so, you can gravitate towards - back towards I would say economic-driven selection of suppliers, not energy service subsidized capital programs.

The energy service sector has been subsidizing E&P budgets for a well over - for probably a decade. We’re drilling faster.

We’re drilling more efficiently safer and our day rates are going down. That’s going to end with this final perch.

And like I said, we’ve tried to be disciplined over the years. We didn’t get caught up in the fads.

We didn’t throw our shareholders money building stuff that didn’t make economic sense to us and that's all going to get purged here. And it's kind of be - it will be like golf courses, it'll probably go through a couple owners by the time it ends up in the right hands, the cost base will be such that you can’t get a return going forward.

And so, I'm very confident that we will be able to make some historic investment moves here not the least of which is buying our shares back.

Yes, did you do any share buybacks in 2019?

Yes very much so. We spent time, what’s the exact number?

5.3 million.

Just over CAD5.3 million on share buybacks we are early, but again we don't try and time the markets. We don't try and fight them on the way up or fight them on the way down we go with them.

And we've been blacked out here since mid-January, which is probably been a good thing. But we're in this for the long haul and ultimately when I was at a conference that you were at there, Josef, we had a few people asking us, how do you feel about the earnings power of this asset base?

And I went back to 2014 and I looked at what Savannah did standalone I used EBITDA because we have different depreciation estimates, so I didn’t for apples-to-apples. And Savannah was I think around CAD153 million of EBITDA in 2014, Total was CAD105 or so.

So I took those two numbers added them together, put on the CAD18 million of synergies that we've realized to-date and divided that by our current share count and that was north of CAD6 a share of EBITDA.

Yes.

It's totaled at CAD3 and something in 2014. So you can see the accretive power of the transaction we did.

We've been steadily paying down debt for 2.5 years, but also investing. Last year we spent net CAD40 million on CapEx, a lot of that was equipment upgrades and additions to the rental fleet both in gas compression and in our U.S.

rental business which is performing well. So, we feel good about where we stand.

I don't feel good about this market, but we don't control the market. So, we're controlling what we can and doing what we think is necessary to not only survive, but prosper when this thing is over.

So if we have - the rig count in the states were 793 last week, 682 oil, 109 gas if we had a third to half the fleet being removed because of the pricing. How bad do you think that that would impact you by the time we get into the late summer?

Well interestingly, Josef where we see the weakness in our U.S. drilling it’s on the triples.

Today, we have I believe five rigs going. They’re all doubles and singles.

And so, again similar to Canada, I expect what you're going to see when you get into crazy times is operator’s going to bread and butter, low cost development drilling postholes in the Viking. And there is postholes in the Permian.

3,000 meter laterals with 75 stage fracs are probably not what - what's going to drive things when you get into crazy times and we're seeing that in our business. And again our rig fleet particularly in Canada is extremely well suited to service that market.

And again, I think you're going to see - like I said the triples right now are our weakest part of our U.S. drilling business.

And so, we'll see the spot market, we’ll take time outs. We parked equipment we refused to work when pricing gets due.

But we have done that we'll continue to do that including with triples. And so what we don't want to do is work our equipment base into the ground.

On the rental side, what we've seen is basically continued market share gains in a decreasing market. We're literally being asked today to replace old equipment on rigs.

The equipment we're moving from Canada relative to the equipment we're displacing is far superior in quality and that's the tragedy of all this as the Canadian sector is not you know when things do recover there's going to be shortages. And we already experienced shortages in certain lines of equipment in Canada this year, this winter.

Yes during the quarter one.

We've had to say no we just don't have it. We're not going to move it back either we're getting paid in real dollars down there and we're getting better utilization.

Yes.

And so there will be equipment shortages in Canada. The equipment or the - market prices today do not warrant purchasing more unless it's in a distressed situation and the asset quality is - it warrants taking that over so.

The market works - as brutal as this is the market works. And you're going to have continued separation between winners and losers.

And I think finally we've had a couple external shocks that will hopefully bring this to a - more of a conclusion here this year.

One last one from or me if I may. Health issues for your staff they're in close quarters they're working together - in a very small space.

What have you got contingencies in place related because the virus on a rig in any field operation that you’ve got and - have there been any incidents so far. And what are you doing to make - to protect everyone if there was such an incident in the field?

For sure so good question, so we have a - our VP Operations also is in charge of our health safety and environmental groups within all divisions. They convened a meeting yesterday and we're rolling out - just reinforcing policies and procedures that do exist.

They were fairly theoretical until a few weeks ago. So we're taking steps to ensure that our employees are aware of what the symptoms are.

Know what to do if they exhibit the symptoms. Certainly when I came in the office this morning we have hand sanitization stations.

We're restricting travel - unnecessary travel is restricted. I guess the good thing is most agencies and organizations are doing the same thing.

So I think everyone is kind of going a bit into lockdown. We do have - the rig part is probably safer than a manufacturing plant.

You got pretty open space there. But again, we're reinforcing and ensuring our policies are understood, procedures are understood, we're making available of personal sanitation and ensuring that employees know what to do if you exhibit signs and staying home.

And so far we had no identified cases of coronavirus in any of our operations globally.

Thanks all for participating in our call and we look forward to speaking with you when we issue our first quarter results. Have a good weekend.