Total Energy Services Inc. (TOT) Earnings Call Transcript & Summary

Thank you for standing by. This is the conference operator. Welcome to the Total Energy Services Second Quarter Results Conference Call. [Operator Instructions] The conference is being recorded. [Operator Instructions] I would now like to turn the conference over to Daniel Halyk, President and CEO. Please go ahead.

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 3 and 6 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 services 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 the 3 months ended June 30, 2020, reflect the historic collapse in economic and industry activity as a result of the COVID-19 pandemic and the implementation of quarantines and other restrictions on economic activities intended to contain the virus. North American drilling and completion activity began to decline in March of 2020, which decline accelerated in April. Drilling and completion activity in Canada came to a virtual hold during the second quarter, with rig counts reaching all-time lows. U.S. drilling activity continued to grind lower during the quarter, with rig counts also reaching historical lows. Revenue in the Compression and Process Services segment decreased materially year-over-year, with a low production activity. Industry activity in Australia began to moderate, but did not have a material impact on the company's second quarter results. Our strategy to diversify geographically and operationally paid off during a tremendously challenging period. Reductions 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 segment, 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 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 $3.6 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 represents 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 to the overall revenues and the 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 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 57 -- 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 the increased relative revenue contribution from Australia as well as receive of CEWS. For the first half of 2020, CDS EBITDA increased 32% as a result of the completion of various North American equipment rationalization project during 2019, increased relative contribution from Australia and ongoing cost control measures in all jurisdictions. Effective April 1, 2020, CDS segment revised its depreciation estimate for drilling equipment. As a result, this segment recorded $26.3 million of nonrecurring depreciation expense related to the fully depreciated assets and additional incremental depreciation expense of $4.2 million. This prospective 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 fees as compared to the same quarter of 2019. The decrease in revenue per utilized piece was primarily as a result of the mix of equipment operating. This resulted in a 69% year-over-year decline in revenue 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 placing 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 decline. At June 30, 2020, this segment had a $43.8 million sales backlog, which was consistent with the $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 are being 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 were 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 finding was been -- 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 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 5-year term loan bearing interest that affects 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 amounts 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 3x and the minimum bank-defined EBITDA to interest expense of 3x. 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 9.5x.

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 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 are 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 noncash 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 3 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 15 -- 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.

[Operator Instructions] Our first question comes from Daine Biluk of CIBC.

So I guess starting off on the 2 Australian rigs that you had taken out of the field for upgrades and recertifications. I guess 2-part question. One being, how active were those rigs over the first half of the year? And secondly, any incremental color you can share on the nature of the upgrade as well as the customer commitment?

So first of all, we had 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 are 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 upgrade/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 suffice it to say, we expect both rigs will be the 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 modifications, basically to increase the capacity of the rig. And so we're pretty comfortable with what's happening there. So again, I think you'll see utilization over the next 3 quarters. And that will reflect 2 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...

Yes. We couldn't 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. Would that have 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 rentals. And you can see our quarterly utilization and 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. And you've highlighted that as a good opportunity in this environment. Could you maybe just discuss what would be an ideal target for you in this environment? Whether that's something where you're looking for material synergies? Or perhaps taking up a bloated platform where you could really add value by cutting costs? Like what would 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 our own -- reducing our share count. With that in mind, we are definitely focused on continuing our strategy of gaining critical mass in all our key markets in our 4 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.

Congrats on the good quarter.

[Operator Instructions] Our next question comes from Orin McCluskey of Lincolnshire Management.

Can you hear me?

Yes. We must me near bottom if you're calling.

I hope so, that lead me to my question. You mentioned share repurchases as a compelling investment opportunity. Have you begun a share repurchase program or what's your thinking on that? 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 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 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 per 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 market. So there's a -- in our minds, a pretty significant disconnect between 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 a 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 have preserved 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 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 get too extreme. I think really, Orin, what's going to help us in all of our business lines is contraction of supply. We are 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.

Our next question comes from Tim Monachello of ATB Capital Markets.

My first question is just on compression, the CPS revenue in the quarter. It seems like the composition of the 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, for delivery schedules?

No. I think it was a pretty normal quarter. I don't know, Yuliya, anything from your...

There was nothing unusual. It's just a normal course and execution and 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 you should see for the back half of the year?

As we increase orders and increase the backlog, we can throttle up or 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 quite pleased with how that segment managed their workforce and kept core capacity intact and was able to adjust to a 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 rentals division where those asset disposals were taking place? And do you have a slate of equipment that you expect to be able to sell for the 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 7 rigs during the quarter and literally salvaged some major components but cut those rigs up for scrap. Steel and 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 have allocated purchase price 3 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 start-up 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 in slower periods. In busier periods, it may decrease it. But the fact is we wanted to get to 0 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 7 mechanical doubles in the U.S. and 2 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 I just wanted to dig into the comment 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 ranked 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, were also in probably 2017 saying we're going 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 an 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. And 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 works for our shareholders. And we look at the Savanna acquisition that we completed 3 years ago. Certainly, we wouldn't have expected the mediocre conditions that we've seen over the last 3 years. But again, I talked a bit about of our cash flow and ability to pay down debt. And when we modeled that, we modeled 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 that'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 Savanna historically learned a lot when they entered that. And thankfully, 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 perspective is highest in Canada. Now that could change with one election.

Yes, yes, absolutely. U.S. dynamics might change as well with the election.

Exactly. So you always want to do the what if.

Great. 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 rental activity for the back half of the year?

So we're very active in all 3 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 forecast, but our sense is it's going to be reasonably soon here.

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

Q2 had to do have no benefit for our businesses.

Right. And just to clarify, thus far into Q3, there hasn't 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. I expect Q3 will be better in Q2 for us, for proceeds from those programs. I'll give you that forecast, Tim.

Hey, directional guidance is better than no guidance.

[Operator Instructions] This concludes the question-and-answer session. I would like to turn the conference back over to Mr. Halyk for any closing remarks.

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.

This concludes today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.