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Good morning, ladies and gentlemen. Welcome to the Total Energy Services Inc. Fourth Quarter and Year-end Results Conference Call. [Operator Instructions] I would now like to turn the conference meeting over to Mr. Daniel Halyk. Please go ahead, Mr. Halyk.
Thank you. Good morning, and welcome to Total Energy Services Fourth Quarter 2019 Conference Call. Present with me is Yulia Gorbach, Total's VP Finance and CFO. We will review with you Total's financial and operating highlights for the 3 months ended December 31, 2019. We will then provide an outlook for our business and open up the phone lines for questions. Yulia, 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 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 a -- 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 3 months ended December 31, 2019 reflect continued 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 United States dollars, USD 13.5 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 Rentals 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. Australian activity declines was USD 13.5 million revenue or approximately CAD 17.6 million of early contract termination payments received and recorded in the fourth quarter of 2019. Excluding early contract termination, revenue in CDS generated $0.2 million operating income in Q4 2019 as compared to $1.5 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 and increased operating efficiencies resulted in continuing 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 a result of cost management and completion of 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 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 the prior year comparable quarter due to higher utilization and decrease 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 a 45% decline in the fourth quarter Canadian revenue for our Rentals and Transportation Services segment. This decline was somewhat offset by a 48% increase in the United States revenue as we continue to relocate unutilized Canadian equipment to that market and make targeted investments in new equipment. On a consolidated basis, fourth quarter RTS segment revenue decreased 20% as compared to prior year comparable period. Fourth quarter revenue per utilized rental fees in RTS increased 68% from 2018 due to the mix of equipment operating as well as higher realized pricing on equipment relocated from Canada to the United States. In 2019, 41% of RTS segment's revenue was generated in the U.S. compared to 21% in 2018. RTS segment incurred $1 million of relocation expenses during the fourth quarter as we continue to move underutilized equipment from Canada to the United States. Excluding the relocation expenses, an additional $1 million of recurring depreciation expense following the change in depreciation estimates in Q3 2019, the operating loss was $2.5 million for the fourth quarter of 2019 as compared to a loss of $0.9 million in the same quarter of 2018. Within our Compression and Process Services segment, fourth quarter revenue for 2019 was $40.7 million, a 65% decrease compared to the fourth quarter of 2018. This segment exited the fourth quarter of 2019 with fabrication sales backlog of $48.6 million and an $8.8 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 $35.2 million, a 5% decrease from Q4 2018. This was due primarily to a modestly lower prices in North America, lower camp and other ancillary revenue in Australia and weakening of Australian dollar relative to Canadian dollar over the 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 $49.3 million or 33% of revenue as compared to $41.2 million or 19% of revenue in the fourth quarter of 2018. Positively contributing to the gross margin was the receipt of $17.6 million early termination contract payment in CDS segment. Consolidated cash flow before changes in noncash working capital items was $36.9 million for the fourth quarter of 2019 as compared to $23.1 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 is 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've seen a meaningful pickup in fabrication orders. As such, at current production levels, we would expect to generate up to $40 million of additional cash flow during 2020 with monetization of this inventory. Consolidated EBITDA for the fourth quarter of 2019 was $35.8 million as compared to $29.2 million of EBITDA realized in Q4 2018. Excluding nonrecurring expenses and unrealized foreign exchange losses on transaction in each company working capital balances, fourth quarter EBITDA for 2019 was $39.3 million. During the fourth quarter of 2019, Total Energy generated income attributable to shareholders of $8.5 million or $0.19 per share as compared to $8.6 million or $0.19 per share in Q4 of 2018. Total Energy financial condition remains strong, with $103.2 million of putting -- positive working capital, after reclassifying $40.9 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 5-year term. During 2019, Total Energy returned $16.3 million to shareholders through dividends and share buybacks. Total bank and mortgage debt were $277.9 million at December 31, 2019. Our debt net of working capital was $145.2 million at the year-end, a 10% decrease from December 31, 2018. Our bank covenants consist of maximum senior debt to trailing 12 months bank-defined EBITDA of 3x and minimum bank-defined EBITDA to interest expense of 3x. At December 31, 2019, company's senior bank debt to bank EBITDA ratio was 2.06 and bank interest coverage ratio was 9.49x.
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. In 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 decisions to suspend our dividend and substantially reduce capital spending until such time as market conditions stabilize and visibility improves. Combined, these 2 actions, we'll increase 2020 free cash flow by $23.8 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 lease properties have been vacated as leases come up. Several owned facilities have been leased to third parties, operations in all business segments have been relocated to owned facilities where possible, including owned 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 Savanna 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 Savanna 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 expensed equipment repairs, not capitalize 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 and real estate is roughly equivalent to the entire amount of our bank debt, including mortgage debt. There are very few energy service companies that could eliminate their debt simply by liquidating inventory and doing a sale leaseback on their owned 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 a 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 to bankruptcy and consolidation. Years of malinvestment 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.
[Operator Instructions] Our first question comes from Daine Biluk with CIBC Capital Markets.
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 sales proceeds to debt repayments and/or share buybacks? Is one or the other seeing a high priority 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 ifs. And like I said, I don't want to give any particular guidance on that. But those -- the 2 decisions increase our free cash flow by almost $24 million for this year. So definitely, we have $24 million extra to do both.
Right. That's fair enough. Makes sense. And I guess maybe just as a follow-on, is it fair to say that despite the softer activity picture today, 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 market is paying, what, $0.30 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's 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 slightly, 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 rubber stamp review, it's looking forward and what environment are we in. And like I said, when you literally have the NHL shutting down, 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. Right. That makes sense. That's good color and couldn't agree more. I guess, obviously, considering kind of the -- 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 a heightened focus on M&A in the current environment? Or are you just kind of happy with your current platform?
Absolutely. I mentioned in my comments, Daine, there's going to be a major restructuring and perhaps it took the coronavirus and the oil price war and frankly, dysfunctional energy policy in Canada, to get us there. There will be consolidation rationalization. It's already happening. 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 we've had a history of being able to fix problems. I look at what we've extracted on the Savannah integration, and I look at the success we've had operating that asset base, a pretty low utilization, such that we fire rigs up this winter that haven't worked for 5 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.
Right. Right. That makes perfect sense. Yes, good color. Okay. I think just one more for me. 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 that we had no impacts with the fires, and it's a stable -- it's kind of nice there in Ireland, I guess. But no, Australia has been a stable market.
Our next question comes from John Bereznicki with Canaccord Genuity.
Yes. I was wondering if you could shed a little light on the modest uptick in 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 is well. There's been over investment, 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 $90 million of good inventory that's bought and paid for. And even in a 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 business. And so that said, our -- we're doing what we need to do to rightsize our cost structure for the -- 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 have lost jobs in that, but trying to adjust the fixed cost structure within our rental transportation group has 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.
Got it. Got it. Appreciate the color there. And just sticking within compression, on the rental side, looks like pretty steady activity quarter-on-quarter. Any comment on 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 $10 million budget we have is earmarked for new additions to the rental fleet. On that again, and I can't overemphasize this enough, we expense things that most companies capitalize. And like I said, all the start-up of these rigs we did this winter, 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 bare minimum CapEx. And the $10 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.
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's could bring a lot of smaller companies down.
Right. And then just lastly on the housekeeping front, as you monetize your inventory within compression, given your current backlog, any sense of how long a period that might take 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 $40 million of unwind this year. So -- but we're not going to give any forecast on production levels or that sort of thing. But assuming kind of steady state. If it gets busier, that will go up.
Our next question comes from Josef Schachter with Schachter Energy Research.
Dan and Yuliya, given these circumstance, a pretty good quarter and a pretty good year. But I have 2 areas to ask about. We're now seeing, almost every day, companies announcing major cutbacks, cancellation of rigs, what happens when you do receive that? Do you get any partial payments? Is it just gone? Is it -- do you have an agreement where there is a deferral that 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 or 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're 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 pick up, and who you're working for. And so we've been extremely diligent on all those points for the last 5 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 some equipment that's most efficient, not -- you don't need bazookas to kill a mouse. And so all this malinvestment 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 long-standing customer of ours, and a record well for us. One of our AC doubles was over 7,000 meters of hole, and we TD'd in 20 days, I'll put that up against any triple. And I can tell you that fuel consumption and the rig move are materially lower than bringing on 1 million pound hookload rig. And so you're going to 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 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 purge. And like I said, we've tried to be disciplined over the years. We didn't get caught up in the fabs. 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 -- it'll be like golf courses. It will probably go through a couple of owners. By the time it ends up in the right hands, the cost base will be such that you can 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 -- what's the exact number?
$5.3 million.
. $5.3 million, just over $5.3 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. We've been blacked out here since mid-January, which has 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 out 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 Savanna did stand-alone, I used the EBITDA because we have different depreciation estimates. So I didn't -- for apples-to-apples. And Savanna was, I think, around $153 million of EBITDA in '14. Total was $105 million or so. So I took those 2 numbers, added them together, put on the $18 million of synergies that we've realized to date and divided that by our current share count. And that was north of $6 a share of EBITDA. It totaled at $3 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 $40 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 was 793 last week, 682 oil, 109 gas, if we had 1/3 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 is on the triples. Today, we have, I believe, 5 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 as operators going to bread and butter, low-cost development. Drilling post holes in the Viking and there's post holes in the Permian. 3,000 meter laterals with 75 stage fracs are probably not 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 out. We parked equipment, we've refused to work when pricing gets stupid, 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 is the Canadian sector is not -- 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. We have -- 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. 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 qualities, it warrants taking that over. So the market works is -- as brutal as this as, the market works, and you're going to have continued separation between winners and losers. And I think, finally, we've had a couple of external shocks that will hopefully bring this to more of a conclusion here this year.
One last one for 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 to 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 into the office this morning, we have hand sanitization stations. We're restricting travel, unnecessary travels restricted. I guess the good thing is most agencies and organizations are doing the same thing. So I think everyone's kind of going a bit into lockdown. We do have -- the rig part is probably safer than manufacturing plant. You've got the open space there. But again, we're reinforcing and ensuring our policies are understood. Procedures are understood, we're making available personal sanitation and ensuring that employees know what to do if you exhibit signs and stay home. And so far, we've had no identified cases of coronavirus in any of our operations globally.
[Operator Instructions] This concludes the question-and-answer session. I would like to turn the conference back over to Daniel Halyk for any closing remarks.
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.
This concludes today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.