Total Energy Services Inc.

Thank you, operator. Good morning and welcome to Total Energy Services first quarter 2020 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 March 31, 2020 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 businesses and the oil and gas service industry in general. These risks, uncertainties and other factors are described under heading Risk Factors and also in Total's most recently filed Annual Information Form and other documents filed with Canadian Provincial Securities Authorities and 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 the three months ended March 31, 2020 reflect a relatively strong track to the year as compared to 2019. They were short-lived when oil prices collapsed as a result of the COVID-19 pandemic and the Saudi Russian battle for share in the global oil market.

The impact of the decline in oil prices was felt in all of Total Energy's businesses segment. North American drilling and completion activity began to decline materially in March and revenue in the Compression and Process Services segment decreased materially on a year-over-year basis with a lower production activity.

Driven in service rig activity remains stable in Australia during the first quarter alone, although increased wet weather conditions resulted in the greater rig standby time. Revenues for the quarter were CAD134.3 million, which was 40% lower than prior year comparable quarter.

By business segment, Contract Drilling Services contributed 32% of 2020 first quarter consolidated revenues, Compression and Process Services 30%, Well Servicing 25% and Rentals and Transportation Services 13%. This compares to 55% in CPS segment, 21% in CDS segment, 17% in Well Servicing and 8% in RTS segment in the first quarter of 2019.

Geographically, 52% of first quarter reported revenue was generated in Canada, 23% in the United States and 25% in Australia. In the first quarter of 2019, 43% of revenues came from Canada, 34% from the United States and 23% from Australia.

Within our studio segment, 57% of first quarter revenue came from Canada, 27% from Australia and 16% from the United States. While operating days for the first quarter of 2020 were 7% higher than 2019, segment revenue for the quarter declined 6% on a year-over-year basis.

This decrease alone arose from 12% decline in revenue per spud to release, which was due primarily to the mix of equipment operating. Despite lower revenue, efficiency gains and cost management give rise to CAD2.9 million improvement in quarterly segment operating income.

The most significant year-over-year financial improvement within our CDS segment came from our US drilling operation. Despite 37% year-over-year decline in operating days and 16% decline in revenue per spud to release days during the first quarter of 2020, the operating loss within our US drilling business decreased by 45%, following efforts over the past several quarters to consolidate operations and improve efficiencies.

Underlying year-over-year decrease in the first quarter revenue for our US drilling operations was a substantial reduction in operating days for our three triple rigs as the market for bigger rigs began to soften. While first quarter utilization in our Australian drilling operations was one percentage point lower and revenue per day was CAD1970 lower than 2019, operating income was 45% higher in Q1 2020 as compared to Q1 2019.

This was due to a reduction in lower margin camp and other ancillary revenue, as well as strong cost management, while rigs were on the paid standby due to prolonged wet weather conditions. Continued competitive industry conditions in Canada was a primary driver for 9% year-over-year decline in first quarter segment revenue within our Rentals and Transportation Services segment, somewhat offsetting a 17% year-over-year decline in revenue in Canada with a 6% increase in the first quarter revenue from our US RTS operation.

41% of first quarter RTS segment revenue was generated in the US as compared to 35% during Q1 of 2019. The RTS segment incurred an operating loss of CAD2.4 million for the first quarter of 2020, as compared to CAD1.6 million loss in Q1 2019.

The primary reason for this CAD0.8 million increase in quarterly operating loss was a CAD1.6 million year-over-year increase in depreciation expense, following the change in accounting estimates that was the effective July 1, 2019. Within our Compression and Process Services segment, first quarter revenue for 2020 was CAD40.7 million, a 66% decrease compared to the first quarter 2019.

Substantially lower year-over-year fabrication sales was the primary driver of reduced segment revenues. Despite cost management efforts, first quarter operating income decreased 76% from Q1 2019 to CAD2.8 million as lower production activity resulted in lower fixed cost absorption.

Compression horsepower on rent at March 31, 2020 increased by 11% compared to March 31, 2019. The CPS segment exited the first quarter of 2020 with the fabrication sales backlog of CAD44.5 million, a CAD4.1 million decrease from December 31, 2019.

First quarter revenue for our Well Servicing segment was CAD33.7 million, a 9% decrease from Q1 2019. This was due primarily to modestly lower pricing in North America, lower camp and not until revenue in Australia and the weakening in Australian dollar relative to the Canadian dollar over the past year.

Total Service hours for the first quarter was 41,530, of which 47% were in Australia, 40% in Canada and 13% in United States. This compares to 42,649 service hours during the first quarter of 2019, of which 49% were in Canada, 42% in Australia and 9% in United States.

Despite lower quarterly segment revenue compared to 2019, operating income for the Well Servicing segment increased 6% on a year-over-year basis, primarily as a result of improved performance in our Australian operation. Consolidated gross margin for the first quarter of 2020 was CAD33.6 million or 25% of revenue, as compared to CAD42 million or 19% of revenue in the first quarter of 2019.

Increase in gross margin was due primarily to proportional increase in contribution from higher margin segments to Total's consolidated revenue for Q1 2020 compared to Q1 2019. Consolidated cash flow before changes in non-cash working capital items was CAD29.9 million for the first quarter of 2020, as compared to CAD28.5 million of cash flow generated in the first quarter of 2019.

During the quarter, our investment in inventory grew by CAD7.4 million as we continue to take delivery of long lead-time major components previously on order within our CPS segment. Remaining purchase obligations at March 31, 2020 were approximately CAD7.9 million, a CAD6.3 million reduction from December 31, 2019.

We estimate our investment in inventory at March 31, 2020 is near peak levels and this going forward, we would expect such investment to decline as existing inventories are consumed. Consolidated EBITDA for the first quarter of 2020 was CAD30.9 million, as compared to CAD29.4 million of EBITDA realized in Q1 2019.

Excluding CAD7.9 million of unrealized foreign exchange gains and CAD0.4 million provision for doubtful accounts, first quarter 2020 EBITDA was CAD23.4 million. During the first quarter of 2020, Total Energy generated income attributable to shareholders of CAD4.7 million or CAD0.10 per share, which was consistent with Q1 2019 net income and earnings per share.

Total Energy's financial conditions remain strong with CAD124 million of positive working capital after reclassifying CAD40.4 million of mortgage debt as current at March 31, 2020. On April 29th, 2020 the Company renewed this loan in the principal amount of CAD50 million for a five-year term, at a fixed annual rate of interest of 3.1% per annum.

Total bank and mortgage debt was CAD282.2 million at March 31, 2020. Our bank debt net working capital was CAD117.1 million at the quarter end, a 12% decrease from December 31, 2019.

Our bank covenants consist of maximum senior debt to trailing 12 months bank-defined EBITDA of three times and a minimum bank-defined EBITDA to interest expense of three times. At March 31, 2020, the company's senior bank debt to bank EBITDA ratio was 2.18 and the bank interest coverage ratio was 8.66 times.

Thank you, Yuliya. 2020 began on a relatively positive note compared to 2019.

However, as everyone knows, things rapidly changed with the outbreak of COVID-19, particularly after March 11th when the World Health Organization declared COVID-19 to be a global pandemic. Measures taken in response to the pandemic gave rise to a sudden and substantial decline in economic activity and, consequently, global oil consumption.

At the same time, Saudi Arabia and Russia engaged in a battle for market share in global oil markets with devastating consequences for near-term oil prices. The Canadian energy industry was particularly vulnerable to the dual shocks of the COVID-19 pandemic and oil price war, given structural price discounts due to the lack of oil pipeline capacity necessary for Canadian oil to reach Eastern, Canadian and global markets.

COVID-19 is arguably resulted in the most challenging operating environment ever experienced by Total Energy. North American drilling and completion activity has decreased significantly since March, while Australian activity has not yet been materially impacted.

We are monitoring industry conditions there closely. As we navigate through unchartered waters, our top priority is the health and safety of our employees, other stakeholders and the public at large.

We were quick to implement protocols throughout our global operations to mitigate the spread of the virus. Now, I'm pleased to advise that we have had no reported cases of COVID-19 infection in any of our operations to-date.

As summarized in our first quarter news release, Total Energy has made unprecedented adjustments to its North American cost structure in order to protect our balance sheet and financial liquidity. These adjustments, which will take full effect during the second quarter, will substantially lower our cost structure and preserve our equipment fleet until such time in the industry conditions begin to recover.

We recently announced the refinancing of a CAD40.2 million term loan that matured at the end of April, with the new CAD50 million 5-year term loan bearing interest of 3.1%. Such loan is secured by approximately 45% of Total's real estate based on net book values at the end of 2019 and illustrates not only the confidence our banks have in total, but also our ability to leverage our significant real estate portfolio to enhance our liquidity and lower our cost of capital.

Given the severity of the current downturn, we expect a substantial increase in bankruptcies and insolvencies in the energy service industry, as such industry goes through what we believe will be a historic process of rationalization and consolidation. The basic economic laws of supply and demand are driving this process and, while it will be brutal and negatively impact many stakeholders.

It is also necessary to ensure the future sustainability and the economic viability of the industry. Total would not be successful without the efforts and support of our employees, owners and other stakeholders.

While we regret the job losses and the suspension of our dividend, we are grateful to our remaining employees who are working harder for less pay and without complaint. The understanding and support of our owners and bankers has allowed management to remain focused on running our business and the established relationships we have with our many customers and suppliers are critical, as we work together to get through these challenging times for our industry.

Total Energy has demonstrated over its 24-year history its ability to successfully navigate through industry downturns. The current downturn has once again put our company to the test.

Our discipline during better times, together with the focused measures we have taken thus far to adjust our cost structure, our geographic and business diversification and the strength of our relationships with key stakeholders gives us confidence that Total will not only pass its latest test, but emerge as a stronger and more significant player in the global energy services industry. I would now like to open up the phone lines for any questions.

Hey, good morning everybody.

Good morning, Mr.Bereznicki.

Hey, just looking at CPS, it looked like sequentially revenue was pretty flat, but the margins were up, was that a function of revenue mix or cost containment or maybe a bit of both?

Definitely revenue mix. I think you had increases in rental revenue obviously evidenced by the increase in horsepower on rent, which tends to be higher margin.

An element of cost control, but as I mentioned, a lot of our cost control impact will be felt in Q2. There were some within Q1 for sure, though, but revenue mix with some cost control.

Got it. And still within the CPS, looking at your overall inventory at the end of the quarter, CAD113 million, is the majority of that's still within CPS and do you think you can convert some of that into cash here in the coming quarters?

Yes. As Yuliya mentioned, we believe that Q1 March 31 inventories will be added near peak and we expect that to begin unwinding beginning Q2 over the balance of the year.

Got it. And then, lastly on the Orphan Well fund, I think there was some mention of it in the MD&A, can you give us a little more color on how you think it could touch your businesses here going forward?

So there's two kind of components to abandonment. There is the Orphan Well Association, the OWA, which our well servicing group has done a lot of work for historically.

They're receiving CAD200 million from the federal government as part of that CAD1.7 billion abandonment program, plus the Alberta government had announced about a month or two earlier an extra CAD100 million. So that's separate from the CAD1 billion that has been given to the provincial government by the Fed's for abandonment activity which will be non-OWA work.

And then, there's CAD400 million to the Saskatchewan government and CAD120 million to the BC government. We expect that to be a pretty significant driver of well service rig activity over the next several quarters and, being a fairly large well service company in Western Canada, we expect to benefit from that.

We also are seeing good opportunity for our rental and transportation services group to participate in those activities as well. So tough to give forecast, but I would simply say we have no reason to believe that we wouldn't get our fair share of activity there.

And really I think the limitation for use of those funds will be more service provider capacity then demand from operators to complete abandonment work.

Got it, that's great color, Dan. Thank you.

That's it for me. Thanks.

Thanks, John.

Good morning, everyone.

Good morning, Tim.

John touched on some of my questions here in the CPS segment, but I was just wondering if you could give a little bit more color around the standby revenue you received in Australia, around drilling segment or in the well servicing segment and if you expect to see any of that in the four quarters?

So Q1 is typically their wet season in Australia. It's the breakup or a little bit like breakup in Canada although not having the same consequences.

They saw a wetter Q1 than normal. Our standard arrangements with the customers are -- were paid standby and rigs are not able to operate due to wet weather.

I think the big difference this year was our group, our managers and employees there did a much better job on the cost control side, perhaps in prior years. Certainly, it was a wetter year than last year, but the biggest difference wasn't any change contractually, it was cost management.

Okay. So moving to quantum, do you have a range of what those standby fees may have been in the first quarter?

We do, but we don't disclose that.

Okay.

I think really -- it's really irrelevant. I think at the end of the day, conceptually standby is intended to compensate you for the costs of having to be on standby and so to the extent you can better manage.

It's like any business, if you do a better math or do better on cost management, you can get better math margins. And so, really theoretically it's irrelevant, whether rigs actively drilling or on standby.

In fact, sometimes you can do worse with standby because you get complacent and don't manage your costs.

Okay, got you. And then, I guess just more ideologically or just from a macro standpoint, the Australian market.

Do you expect to see that market come off from where it is today; obviously it's been relatively flat year-to-date? I don't know, if that has to do with off-take through the LNG or for some of the collective methane in the region or is that more stable through the cycle or do you see that that's just sort of a later thing to fall?

Well, our exposure is to the gas side. Certainly there is oil activity in Australia and while we don't have any direct exposure, certainly we're hearing anecdotally, the oil sides being hit just like it is elsewhere.

Obviously, we're watching the market carefully. Domestically, there's gas shortages in Australia, so I think there is an underlying relatively healthy gas market there.

Obviously, the LNG markets globally are another variable. Again, I think it comes down to company-specific, producer-specific circumstances, what are their take or pay, obligations, all that sort of thing and then again, I wouldn't comment on third party's businesses there.

We do know that Tom, we're going to have a couple of drilling rigs come off for level 4 certification this year. We've been running that pretty smart, so we will have natural decline.

That's not Yuliya, so I'm not sure. It's interesting, so we've got a couple of rate.

It's interesting with the home office thing, we've heard a lot of noises over the last couple of months, it's entertaining but haven't heard any screaming kids yet, so that's a good sign. Anyways back to Australia, we do know we're going to have a couple of drilling rigs come up for level 4.

So those will be out of service but that's ordinary course.

Okay. So those will come down through what, maybe a month or so, or does it take longer?

Yes. We'll give updates when we know, timing, TBD and that.

But that's just normal course business. But so far we haven't had any disruption there.

And like I said, the big thing is ensuring our workplace is infection free and that's been a big part of our ability to keep operating, in fact we've demonstrated, we can protect our workers.

Okay. Another one, just on the cost rationalization, it appears, I mean the margins are pretty strong in the first quarter, how much more cost do you think you're -- you can expect to take out maybe on a fixed cost basis or any color you can provide on cost of that?

Well, we gave a pretty general, high-level summary in our news release of things we've done. That will generally hit in Q2.

So I'm not going to give forecast, but what I would say generally, our objective is to come through this downturn, our goal, living within existing bank covenants which our bank covenants are some of the tightest out there. When we first took Savannah over we had up to five times bank defined EBITDA to debt.

That came down to three. And our goal is to work within that.

Now obviously, I'm not going to give forecast, but we're working hard to get through this without having to adjust.

Okay, that's helpful there. Yes, I'll turn it back.

Thanks a lot.

Thank you.

Morning, everyone. Historically Total has been acquisitive, counter cyclically through these bottoms, can you may be provide some thoughts around your desire to add more capital on the fleet given the underutilized assets and perhaps how you're thinking about available capacity in the context of your bank debt and whether share prices and perhaps whether -- acknowledging you want to stay within covenants or perhaps you look for some sort of a lead include any sort of pro forma acquisitions?

Sure. Good question.

I think there's a lot of variables at play there. First of all, for whatever reasons Total does not have a cost of cap or cost of equity advantage in the current market.

We've been hit like everyone else and our cost of equity is extremely high. I think the refinancing of our mortgage debt illustrates the marginal cost of our debt remains quite attractive.

So practically the cost of equity is going to force us to be creative in how we are able to accomplish any transactions, we're pretty actively looking. I would say a few things, first of all, we've never had historically issues financing acquisitions.

And I wouldn't expect that to be the case this go-around. How we do it would be tailored to the uncertainty and the uniqueness of this current downturn but I've got lots of different ideas as do our Board and Yuli and her group.

So, capital generally won't be the constraint. We've seen a lot of bankruptcies and insolvencies in the last month that are accelerating particularly within the rental and transportation segment and the well servicing segment.

We are seeing a lot of assets that are not physically in good condition and we declined to bid on a number of situations strictly based on asset quality. That will be the key determination in our minds as to whether we're willing to do a transaction or not will be underlying asset quality.

That said, there is also a lot of financial partners within these groups that have capital stock and so I think really at the end of the day, those capital providers; whether they're banks, private equity firms or others are going to be looking really to consolidate assets under strong managers and the financing is really already in place and I would just conclude by saying, any deal that we do will benefit our owners going forward, it will not put our company at risk and we're not going to -- no one will be getting a windfall on the way out. They'll -- to the extent there are windfalls, it will be following our ability to complete, digest, integrate and realize profits from the acquired assets.

Okay, that's helpful. And then, perhaps on the US outlook, I mean, there appears to be a bit of a divergence in performance between the rentals business and the drilling business.

As you think about that, is there any way you can perhaps leverage some of that rentals business into the drilling business or is there any steps you can take perhaps move them more closely in line, acknowledging how challenging the current operating environment is?

First of all, I think there is a bigger question here. And in Canada what we saw, which was similar to the US ironically, the stronger market in Q1 was on the shallower rigs in both countries.

Now over the last 10 years, you think about the North American drilling industry where is all the capital gone, it's been building triples. Really Savannah was the last major rig company to engage in a significant singles built and they spend a lot of money doing that, there was, before we acquired them, two write downs and effectively a write down when we acquired them.

Same thing on the double side and there is also reason why over 24 years Total could never justify building a new triple. We've been running economics on triples for 22 years, and they never made sense to us even in the best of times.

I think what we're going to see during the current downturn is, what happened to the singles and doubles over the last 10 years happened to the triples and it's one thing to generate cash flow, it's another to generate a return on invested capital, and I don't believe our triples historically have provided economic returns to their owners. So, I expect the part that's going to get hit the hardest in this downturn will be the heavier end of the market.

So looking at our US drilling, what we did see and we have a competitive cost basis on our triples, but we saw what we've seen on the singles and doubles over the last five years start to happen with the triples and we decided to stand on the side-lines and not wear our equipment out when the spot market was declining rapidly. And so, the rest of the industry is take-or-pay contracts expire or operators are not able to fulfill the terms, you're going to see that if this downturn continues, like the time really hit the deeper end of the market and we will probably see the market adjustments to carrying values happen that already have happened in this shallower end of the drilling rig fleet.

So there is nothing -- there is nothing idiosyncratic to Total on the drilling side. To the contrary, I think the heavier ended the fleet, it's going to take some write-downs and the question then becomes, whether the market conditions are there for groups like Total or others to consolidate triples at prices that make sense on a go-forward basis.

So stay tuned. I see, from our own side, a lot more downside to our deeper end of the rigs and I do on the shallow end of the rigs.

The other thing we saw in the US beginning in Q4, accelerating into Q1, was shrewd operators understanding that you don't need a shotgun to kill a gopher and so we saw increased demand for our shallower rigs relative to our deeper rigs and typically, these were private companies that didn't care about IP rates, that cared about return on capital. I've spoken to certain of them, and these are shrewd operators that were running singles in West Texas, drilling vertical wells, and the only reason they're down right now is because there is nowhere to put their oil.

But I can tell you, their cost per barrel is materially lower than groups that are drilling three mile laterals. t's not sexy but when you get a pay-out on your well at CAD40 oil in less than a month, you're going to be drilling those all day long and, I'm told by some of them, the only reason they're down is there's nowhere to put their oil.

So it will be interesting to see operator behavior going forward as well.

That's useful context. And the last one for me, I mean, with rightsizing of the rentals basis, are you seeing much of an opportunity for real estate sales in any of these areas?

Just given -- I mean, the realized value could be higher than book value and perhaps it's a funding avenue, is there anything we should be thinking about and do you want to hold on to that stuff in case there are brighter days ahead?

Well listen, everything's for sale for the right price, but what we've done, first of all, we're leasing some of our real estate out to third parties. We're also displacing leased with owned, particularly relocating our gas compression operations from lease to owned and so there is an underlying shift that doesn't really -- it's not apparent.

The other thing is we're utilizing it to-- I call it kind of our permanent debt on the balance sheet, between the CAD50 million now that we've got on the renewed mortgage and then when we acquired Savannah there was a roughly CAD16 million mortgage, which is now CAD14 million in change. To me, that's permanent debt and certainly you can always do a sale leaseback if you wanted to.

But there is an operating cost advantage for us to owning that and, like I said, we're utilizing this real estate right now through all divisions, and so something that may have been our RTS branch six months ago is now between our Contract Drilling and CPS segments being used. We did note that we're temporarily idling a significant portion of our North American heavy truck fleet.

We have good secured storage for that, that on a cash basis costs us nothing. I can tell you, theft and vandalism is a huge issue and you can minimize that by having good secured storage which we do and it doesn't cost us anything on a cash basis.

So we have sold some real estate over the past couple of years, we'll continue to do that when it makes sense, but we're also-- it's a valuable asset for us that we're currently using, and it's serving us well and our cost base on this is very low, a lot of it was acquired decades ago.

Okay, thank you very much. I'll turn the call back over.

Thanks.

Good morning, guys. I just had one and I apologize if you've already touched on it, but I'm just wondering about bidding activity in compression, just wondering if customers hit the panic here early on the COVID-19, and I think stabilized somewhat, or any sort of color you can give on that would be appreciated.

Thanks.

Bidding activity actually has remained relatively strong now, how much of that is based on people trying to justify their existence, I guess we'll see. But we're reasonably constructive on gas; I think we've seen stabilization in the backlog here over the past couple of quarters.

I think as the economy opens up, that's certainly a positive. The bid activity has been steady, certainly you're seeing a migration to better credit, more midstream infrastructure players but also there's still producer activity particularly in key areas that are deficit positions on infrastructure.

So we're not going to give a forecast, but it's healthy to see stabilization, it's healthy to see some strength in the gas markets, and I guess we'll see what the remainder of the year looks like. But we're also seeing a lot of stress, particularly on the US side with major competitors.

And again, we saw that in Canada over a decade ago where we went from number seven in Canada quickly to number two just through attrition and consolidation of bankruptcies. And I think there is the potential for that to happen in the US, where we continue to gain some significant market presence smart through attrition.

Okay, great, thank you for the color. I'll turn it back.

Low cost always wins in a commodity business.

Well, thank you everyone for calling in. I hope everyone is doing well and your families are safe and healthy, and thank you for participating.

We'll look forward to speaking with you after our second quarter. Have a good day.