Total Energy Services Inc.

Thank you, good morning and welcome to Total Energy Services second quarter 2020 conference call. Present with me is Yuliya Gorbach, Total's Vice President, Finance and CFO.

We will review with you Total's financial and operating highlights for the three and six months ended June 30, 2020. We will 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 the 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 ending June 30, 2020, reflect a historic collapse in economic and industry activity as a result of the COVID-19 pandemic and the implementation of quarantines and other restrictions in economic activities intended to contain the virus. North American drilling and completion activity began to decline in March of 2020, with the decline accelerated in April.

Drilling and completion activity in Canada came to a virtual hold during the second quarter with rigs current reaching all-time lows. U.S.

drilling activity continued to grind lower during the quarter with rig counts also reaching historical lows. Revenue in Compression and Process Services segment decreased materially year-over-year with a lower production activity.

Industry activity in Australia began to moderate but did not have material impact on the company's second quarter results. Our strategy to diversify geographically and operationally paid-off during a tremendously challenging period.

Productions in North American revenues were somewhat offset by relatively stable revenues from Australia during the second quarter of 2020. Geographically, revenue generated in Australia during the second quarter of 2020 relative to 2019 increased by 28 percentage points to 44% of consolidated revenue, while North American contribution to consolidated revenue declined to 56%.

By business segments Compression and Process Services contributed 43% of 2020 second quarter consolidated revenues, Well Servicing 31%, Contract Drilling Services, 20%, and Rentals and Transportation Services 7%. This compares to the second quarter of 2019 when CPS contributed 62% of consolidated revenue, Contract Drilling Services 16%, Well Servicing 14%, and RTS segment 7%.

When the COVID-19 outbreak was declared as a pandemic in March of 2020, Total Energy took immediate and decisive action to protect its financial strength and liquidity. This included cost reductions and fiscal strategy changes including the suspension of the dividend and the reduction in the capital budget.

As a result, despite a 67% year-over-year decline in quarterly revenue, consolidated EBITDA only declined 27%. The receipt of $4.5 million of Canadian Emergency Subsidy, Wage Subsidy, or CEWS during the second quarter reduced cost of services by $2.6 million and SG&A by $0.9 million.

Consolidated gross margin percentage for the second quarter of 2020 was 26% as compared to 15% during the second quarter of 2019. Excluding CEWS, gross margin percentage was 21%, which represent a 40% increase as compared to the second quarter of 2019.

This improvement was primarily due to a relatively greater contribution of high margin percentage service lines due to overall revenues and extensive cost savings measures implemented during the quarter. Selling, general and administration expenses for the second quarter of 2020 decreased by $6.5 million or 53% compared to Q2 of 2019.

Excluding CEWS, second quarter's SG&A declined by 46% on a year-over-year basis. Within our CDS segment, spud to release drilling days decreased by 67%, during the second quarter of 2020, while revenues decreased by 58%, the EBITDA decreased only by 7%.

The smaller proportionate decrease in EBITDA compared to revenue was primarily due to North American cost control measures, combined with increased relative revenue contribution from Australia as well as receipt of CEWS. For the first half of 2020, CDS EBITDA increased 32% as a result of the completion of various North American equivalent rationalization projects during 2019, increased relative contributions from Australia, and then growing cost control measures in all jurisdictions.

Effective April 1, 2020, CDS segments revised its depreciation estimates for drilling equipment. As a result, the segments recorded $26.3 million of non-recurring depreciation expense related to now fully depreciated assets and additional incremental depreciation expense of $4.2 million.

This perspective change in depreciation estimate had no impact on EBITDA or cash flow. During the second quarter of 2020, RTS segment experienced a 62% decrease in rental utilization and a 20% decrease in revenue per utilized piece as compared to the same quarter of 2019.

The decrease in revenue per utilized piece was primarily the result of the mix of equipment operating. This resulted in a 69% year-over-year decline in revenues and 67% decrease in EBITDA.

Total Energy continues to identify and pursue opportunities to rationalize operations in this segment to reflect the reality of current industry conditions. For example, during the second quarter of 2020, a substantial portion of heavy truck fleet was taken out of service to reduce operating cost and equipment wear, until such time, as North American industry conditions weren't place in such units back into service.

While the Compression and Process Services segment continued to experience reduced demand for new product orders, the fabrication sales backlog stabilized after several quarters of declines. At June 30, 2020, this segment had a $43.8 million sales backlog, which was consistent with a $44.5 million backlog at March 31, 2020, but lower than the $77.2 million backlog at June 30, 2019.

While quoting activity remains active, project awards have been delayed as customers await more visibility. Despite a 77% year-over-year decline in CPS, second quarter revenue, segment EBITDA for the quarter declined only by 44%.

The lower rate of EBITDA decline was primarily due to a lower proportion of revenues being derived from lower margin fabrication sales as well as cost management, as well as receipt of CEWS. Second quarter service hours and revenue in our Well Servicing segment was 31% and 29% lower respectively, while segment EBITDA decreased by 10% as compared to the same period of 2019.

Offsetting the 67% year-over-year decline in Canadian second quarter utilization and a similar 71% decline in the United States, was relatively stable utilization in Australia of 64%. While industry activity in drilling began to moderate in Australia, such decline did not materially impact our Australian operations during the second quarter.

While substantial government funding has been announced to accelerate well abandonment activity in Western Canada, to-date no significant incremental service rig activity has resulted from such announcements, although current expectations are that such activity will commence in the near future and we expect that our Well Servicing segment to begin from such -- to benefit from such activity. During the second quarter of 2020, Total Energy has generated $13.8 million of cash flow and $36.2 million of cash from operating activities as compared to $22.4 million and $4.1 million respectively in the second quarter of 2019.

Contributing to the increase in cash generated from operating activities was $6.7 million of inventory unwind during the quarter as well as $3.3 million increase in deferred revenue, as deposits were received during the quarter for new fabrication sales orders and gas compression rental contracts. Following the refinancing of $40.2 million term debt that matured in April 2020 with a $50 million five-year term loan bearing interest at a fixed annual rate of 3.1%, our net working capital position increased from the end of 2019 by 27% to $131 million.

Net debt decreased 14% to $124.6 million from December 31, 2019, with a repayment of $28.5 million of long-term debt including $27 million of voluntary repayments of amount outstanding on Total Energy's $295 million of revolving credit facilities. At June 30, 2020, our weighted average interest rate on outstanding long-term debt was 2.96% as compared to 4.34% at June 30, 2019.

This lower interest rate, combined with lower outstanding long-term debt balances contributed to a $0.8 million year-over-year reduction in quarterly interest costs. Total Energy's 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 June 30, 2020, the company's senior bank EBITDA to -- bank EBITDA ratio -- bank debt to bank EBITDA ratio was 1.95 and the bank interest coverage ratio was 9.5 times.

Thank you, Yuliya. The second quarter of 2020 was unlike any period in our 24-year history.

In the face of the COVID-19 pandemic and a substantial decline in the price of oil, the North American energy industry experienced historic activity declines and the industry activity levels began to moderate in Australia. The benefit of Total Energy's diversified revenue base combined with the immediate and substantial actions taken in response to these exceptional market conditions are reflected in the company's ability to generate significant free cash flow, even during the most difficult of times.

We're pleased to be able to support our customers by maintaining continuous operations in all jurisdictions, while at the same time ensuring the health and safety of our employees and other stakeholders and preserving the company's financial strength and liquidity. During the second quarter of 2020, as Yuliya mentioned, our financial position continued to strengthen after $6.3 million of net capital expenditures, and $2.5 million of interest expense, the company generated $5 million of free cash flow before changes in non-cash working capital items.

With the monetization of working capital, cash provided by operating activities during the second quarter of 2020 was $36.2 million, which was utilized to reduce long-term debt by $32.9 million or approximately 12% during the quarter. Additionally, with the refinancing of $40.2 million of term debt that matured in April of 2020, our working capital position increased to $131 million, which included $21.1 million of cash at June 30.

Net debt totaled $124.6 million at June 30, 2020, the lowest amount since Total Energy completed the acquisition of Savanna Energy Services in June 2017. In the three years since completing the Savanna acquisition, despite lackluster industry conditions for much of that time, Total Energy has reduced its net debt position by $110.4 million or 47%.

During the same period, the company has invested $100.3 million in net capital expenditures, and returned $42.5 million to shareholders through dividends and share buybacks. Having suspended the dividend and reduced our 2020 capital expenditure budget by 57% to $10 million earlier this year, Total Energy is now squarely focused on further debt reduction and the pursuit of exceptional investment opportunities.

I'm extremely proud of how our employees across all business segments have stepped up to ensure that Total Energy will not only survive the most challenging environment we have ever faced, but also emerge in a stronger and more competitive position. On behalf of our Board of Directors and shareholders, thank you.

To our employees that are waiting to go back to work, we thank you for your perseverance and understanding and look forward to welcoming you back as soon as possible. I would now like to open up the phone lines for any questions.

So, I guess starting-off on the two Australian rigs that you had taken out of the field for upgrades and recertifications, I guess two part question. One being how active are those rigs over the first half of the year?

And secondly, any incremental color you can share on the nature of the upgrades as well as lead customer commitment?

So, first of all, we have telegraphed in Q1, we had anticipated these rigs would be coming down for research. And the -- our current $10 million 2020 capital budget contemplates the recertification of those rigs.

The fact that they're going down for research and upgrades doesn't mean they won't work during the period. What we're doing is doing some, how would you say component upgrades/replacements that may allow the rigs to do shorter-term projects until such times we have to pull them in and basically retrofit the main components.

So, that's a pretty dynamic process. I can't get into all the details, nor do I know all the details at this time.

But sufficed to say, we expect both rigs will be retrofit upgrades and research will be done so that they're back operational in Q2. We do have the one rig committed, I'm not going to comment on contract terms, but the commitment includes us doing some -- some modifications basically to increase the capacity of the rigs.

And so we're pretty comfortable with what's happening there. So again, I think you'll see utilization over the next three quarters and that'll reflect two of these rigs being in a bit of a funny place undergoing research and upgrades but also somewhat being available for one-off wells.

Understood, that's good color. Thanks.

Yes, we can put them out for a program right now because we would -- the Derricks would be maxed out on days.

Right. Right.

Okay, that makes sense. I guess shifting gears to Compression and Processing margins, obviously was very strong in Q2, but that had been aided by anything unique to the quarter or was that more of a function of mix given the lower fabrication activity?

Certainly mix was important obviously fabrication sales dropped-off considerably year-over-year that also happens to be your lowest margin part of the business. The highest margin part of the business is -- is rentals.

And you can see our quarterly utilization and then horsepower in the fleet. So that contributed, cost management.

All of our divisions we're quite pleased with how management employees button down and really manage their costs and then obviously an element in all divisions is CEWS within Canada.

That makes sense, understood. I guess maybe just last one for me acquisitions is something we've been talking about for a bed now.

You've highlighted that as a good opportunity in this environment, can you maybe just discuss what would be an ideal target for you in this environment and whether that's something where you're looking for material synergies? Or perhaps taking out a bloated platform where you could really add value by cutting costs?

Like, what make an ideal target right now?

So first of all, we have to benchmark any external acquisition with a pretty compelling opportunity we see, which is the repurchase of our shares. That said, everything else being equal, we're partial to growth over contraction.

But we benchmarked any external acquisition against them, our own reducing our share count. With that in mind, we're definitely focused on continuing our strategy of gaining critical mass in all our key markets in our four business lines.

Target acquisitions would be entities where we see the significant opportunity to extract cost savings and synergies. And obviously, asset quality is of critical importance, we're not just going to buy something to add iron.

So really what will drive us is assuming quality assets, our ability in our minds to take that entity and extract some significant synergies and I think there's a lot of that out there. The key is doing it at a price that allows us to get a return on capital over the life of the investment.

And so I think the market conditions are increasingly becoming favorable to that. But ultimately, it's going to be the providers of capital whether equity or debt that are going to push those opportunities along.

So stay tuned, I guess.

Fair enough. Fair enough.

Well, appreciate the color. That's all for me.

Congrats on the good quarter. I'll turn it back.

Thank you.

Hi, Dan. How are you?

I'm well, Orin.

Can you hear me?

Yes. We must be near bottom if you're falling.

I hope so, that led me to --

In a while.

My question you mentioned share repurchases is a compelling investment opportunity. Have you begun a share repurchase program or what's your thinking on that?

This is my first question. Second question is any further color on your compression backlog going forward?

So on the first question; we do currently have a normal course issuer bid in place. We suspended purchases in late Q1 with kind of the whole pandemic thing and -- and wanting to get a better understanding of what that meant for our cash flows.

The one thing we're sensitive, we did receive some paycheck protection payment money in the U.S., we have not recorded that as income and won't until it's forgiven. And so we're pretty sensitive to -- we want to make sure that we get through all of this and -- and don't do things that compromise our ability to take advantage of programs to help get us through this.

So but that said, we're pretty interested in our -- in reducing our share count right now. I think one indication as we continue to sell old equipment.

During the quarter, we sold or retired literally for scrap metal, some old equipment. Some of it was through private sale, other through auction.

And we're consistently getting significant premiums to net book value from Ritchie Bros and other disposal sites, whereas, we're trading at what $0.20 on the dollar in the public equity markets. So there's in our minds a pretty significant disconnect between in our public valuation and what cash buyers are willing to pay.

So the second question on -- sorry, that was --

Backlog?

On the backlog. So I guess encouragingly, Orin, we saw stabilization.

It was a -- as everyone knows, I don't need to belabor this but it was a really, really tough strange, weird quarter. Communication itself was pretty limited with people quarantining and offices closed.

And so, I got to say, I'm pretty happy with our group to basically kind of preserve their backlog. And we'll see where it goes; we're encouraged with North American natural gas prices.

I think we're seeing some strength in Europe which bodes well for -- for gas prices. The Asian economies continue to grind out of the downturn.

And so we'll see but we've been waiting for gas prices for a decade. So we're not going to -- we're not going to get too extreme, I think, Orin, really on what's going to help us in all of our business lines is contraction of supply.

We're seeing a dramatic decrease in competitors in North America in all business lines. And that's going to catch-up with the industry as activity levels recover.

My first question is just on the compression, the CPS revenue in the quarter, it seems like the composition of backlog slowed a little bit in the second quarter. Was that due to just timing on original project builds and deliveries or was there any delays in what customers were looking for delivery schedules?

No. I think it was a pretty normal quarter.

I don't know Yuliya anything from your --

There's nothing unusual, it's just the normal course of execution replaced by a couple of new orders, a little.

Obviously, we've reduced our throughput capacity largely on the manpower side, you don't want to be, you can't pay people to sit around and so you throttle back on your throughput, but other than that, pretty normal quarter.

Okay. Do you think that's the run rate or the throughput level in the second quarter is reflective of what we should see for the back half of the year?

As we increase orders and increase the backlog, we can throttle, upper throttle, down. In my mind pretty amazingly quickly.

It's a tough thing somewhat you're dealing with human beings that you want to treat with respect and fairly, but you're also dealing with a business that's low margin, and you've got to keep your costs under control. But like I said, I'm -- I'm quite pleased with how that segment managed their workforce and kept core capacity intact and was able to adjust to a pretty, pretty significant decline in activity, although this has been ongoing now for several quarters.

So, but they've been very methodical and proactive in adjusting throughput and again depending on your forecast, we can adjust up as quickly as we can adjust down.

Okay, great. Second question just around those asset disposals that you were talking about.

Was that primarily in the Rental division, when those asset disposals were taking place and do you have a slate of equipment that you expect to be able to sell back half of the year?

It was right across all segments. In our Rental business, we get calls from time to time from groups completely outside of our industry for older equipment and most of it was old stuff that was underutilized.

And like I said, we've been booking consistent gains on that, which gives us pretty good comfort on our good stuff. On the rig side, we did decommission seven rigs during the quarter and literally salvage some major components but cut those rigs out for scrap.

Steel on the proceeds we got exceeded book value before our change in estimate on depreciation; really our change in estimate didn't affect those rigs. Those were rigs that we had allocated purchase price three years ago at the Savanna acquisition that reflected the fact that we didn't put a lot of value on them.

So our change in estimates did not impact. And on our change in estimates within our drilling rig business, really what precipitated us to review that was the fact for the first time that we've ever seen in 24 years, we've had good rigs sitting for extended periods of time.

And our view is that, there's going to be depreciation with that. We've also put rigs that have sat for several years back to work with minimal startup costs and minimal physical issues.

And so we've got a significant amount of comfort in the quality of our asset base. But we also recognize that particularly given our strategy of not working rigs at uneconomic prices that these rigs are going to sit for a bit.

And so our new estimates are very much in line with the industry, it's straight line. That's the major change and what it does will increase our depreciation expenses and floor periods, busier periods, it may decrease it.

But the fact is we wanted to get to zero quicker given the fact that we're facing industry conditions that see rigs sit for many years. But physically it -- there's no change to our view of our asset base and we're going to continue to make decisions to rationalize dispose and repair and upgrade that makes sense on a go-forward basis.

Okay. Do you think your -- the majority of the rigs that you would scrap or maybe all of them that you're considering scrapping happened in the second quarter?

Do you expect more of that to continue?

We took a good hard look, so seven mechanical doubles in the U.S. and two singles in Canada.

And again, that's a constant process, but we've got pretty much the real old stuff. We did around last year, some of the old triples in the U.S.

and a few others. So, it's not going to be a big issue going forward.

We feel pretty good about our fleet. And in terms of depreciation estimates, again last year we focused on our rental business, this year on our rigs.

And I don't see at this point, any major areas of that need review going forward.

Okay. And then just wanted to dig into the comments that you had around M&A and potentially focusing on getting to critical mass in your core businesses.

On a geographical basis, has your view changed on which markets you find the most attractive, there's a lot of talk about the U.S. market, never getting back to, or at least not in the near-term getting back to levels that we even saw in 2019 in terms of rig activity.

So how do you view the markets I guess on a range basis between Canada, U.S. and Australia in terms of M&A?

Well, every market is different. I think the U.S.

is obviously by far the largest market. And I think the same, analysts that say we'll never get back to 2019, we're also in probably 2017, saying we're growing much, much higher.

So I think depending on where you're at in the cycle, you're going to get different views. Our view is we've got a long, long way to go in the U.S.

to achieve critical mass. So that's obvious area of interest for us, but we don't do things just to grow.

And so we've turned down many opportunities to grow where the math didn't work for us, including some pretty prominent drilling rig consolidations that have happened in the last couple of years here. That said we're seeing a lot of potential deal opportunity there.

But we're also open to organic but again, it comes down to math, and where do we see the best returns for an incremental dollar of investment. So there's a lot of change underway in the U.S.

We're seeing a much, much higher rate of insolvencies and bankruptcies, both on the E&P and the service side, and that's going to change the industry a lot. And we feel quite comfortable with how we're going to end-up coming through this.

And so we're seeing a lot of deal flow, and we're going to remain disciplined and make sure that any deal that we do, do works for our shareholders. And we look at the Savanna acquisition that we completed three years ago.

Certainly we wouldn't have expected the mediocre conditions that we've seen over the last three years. But again, I talked a bit about of our cash flow and ability to pay down debt.

And when we modeled that, we model to say, what if it continued to be tough. And I'm pretty happy we did that because it has been tough.

But we've also made in my mind quite impressive steps to pay-off the debt that we assumed, not work our asset base super hard at ridiculously low prices. And we're going to come out of this with a good quality asset base; it's ready to go to work with minimal capital requirements.

And so that's how we're going to view any acquisition. Australia is a pretty small market; we're a well-regarded participant in that market.

The reality is it's a very high cost jurisdiction to do business. And I know Savannah historically learned a lot when they entered that and frankly it was before we owned it.

And we're trying to learn from their experiences and we have learned, as have they. And so you've got kind of 35 to 45 rigs drilling in all onshore Australia at the peak times, that's a market that it's not the same as the U.S.

Canada right now, the reality is we see that as the most difficult market largely just given the political environment here and the inability to get infrastructure built. And so what it does mean is our risk adjusted perspective requires a heck of a deal.

We just -- our risk -- our risk perspective is highest in Canada. Now, that could change with one election.

Yes, absolutely. U.S.

dynamics might change as well due to election.

So you always want to do the what if.

Great, that's -- that's really helpful color. I appreciate that.

And then I guess one more question for me. And that's just around, the federal government's abandonment aid package.

I'm wondering if you've seen any contract awards from that as yet. And if you have any idea of what that could look like in terms of, I guess Well Servicing activity and in rental activities in the back half of the year?

So we're very active in all three provinces. What we've seen is the deployment of funds not flow as quickly as one would have hoped.

I expect that will accelerate here over the next couple of months. But for whatever reasons, there's been a slow deployment of funds coming out of those programs.

So the reality is in Q2 out of that federal $1.7 billion or whatever, there was no activity for us. Going forward, we expect that to change.

But again, I can't control government departments. So I'm not going to give any forecasts but our sense is, it's going to be reasonably soon here.

Okay. So you haven't -- you don’t have anything concrete and --

These two had no benefits for our businesses.

Great. And just to clarify, thus far into Q3, has there been any --?

I don't comment on -- I'm not going to comment on that. I think we're very active in that mix and I'm not going to comment on specifics.

Okay, fair enough. I appreciate all the details you provided.

Thanks, Dan.

I expect Q3 will be better than Q2 for us, for proceeds from those programs. I'll give you that forecast, Tim.

Directional guidance is better than no guidance. Thanks.

Yes, you're welcome.

Thank you for joining us this morning in our conference call and we hope everyone has a safe and happy summer and we look forward to speaking with you after our third quarter results. Have a good day.