Total Energy Services Inc

TSX:TOT

Earnings Call Transcript

[Operator]

Thank you for standing by. This is the conference operator. Welcome to the Total Energy Services Fourth 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, for opening remarks. Please go ahead.

[Daniel Kim Halyk, President, CEO & Director]

Thank you, and good morning. Welcome to Total Energy Services Fourth Quarter 2020 Conference Call. Present with me this morning is Yuliya Gorbach, Total's VP Finance and CFO. We will review with you Total's financial and operating highlights for the 3 and 12 months ended December 31, 2020, and then provide an outlook for our business and open up the phone lines for questions.Yuliya, please proceed.

[Yuliya Gorbach, VP of Finance & CFO]

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 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 December 31, 2020, reflect continued difficult industry conditions in North America and the moderation of activity levels in Australia. Despite the challenging industry environment, Total's financial performance for the fourth quarter of 2020 improved from the third quarter of 2020, with quarterly revenue increasing 7%, EBITDA increasing 9% and a quarterly net loss decreasing by 67%.A modest increase in industry activity levels underpinned by the continued recovery in the commodity prices, changes in competitive landscape and ongoing efforts to manage costs contributed to this sequential quarterly improvement in the financial performance.The ability of Total Energy's geographic and business diversification to provide a measure of fiscal stability was demonstrated in the fourth quarter. Geographically, as activity levels in Australia moderated during the second half of 2020, in part due to removal from service of 2 drilling rigs for recertification, activity in North America continued to improve from the historic lows experienced during the second quarter. This is evidenced by the fact that North America contributed 79% of consolidated revenue in the fourth quarter of 2020 as compared to 68% in the third quarter and 56% in the second quarter of 2020.Within North America, Canada continued to recover more quickly compared to the United States, with the relative contribution from Canada to consolidated fourth quarter revenue increasing 8 percentage points compared to Q4 2019. Fourth quarter revenue contribution from the United States decreased by 8 percentage points on a year-over-year basis, with Australia's fourth quarter revenue contribution remaining relatively consistent with 2019.By business segment, Compression and Process Services was the largest contributor to the consolidated revenue, generating 39% of 2020 fourth quarter consolidated revenues, followed by the Contract Drilling Services at 28%, Well Servicing at 24% and Rentals and Transportation Services contributing 8%. This compares to Q4 2019 when CPS contributed 27% of consolidated revenue, Contract Drilling Services 39%, Well Servicing 27% and RTS segment 10%. And in Q4 2019, the CDS segment received a $17.6 million contract termination payment that materially increased that segment's revenue contribution.While fourth quarter consolidated revenue declined 45% on a year-over-year basis, consolidated EBITDA increased by 12% after adjusting for $0.8 million unrealized foreign exchange loss on intercompany working capital balances in Q4 of 2020 and excluding nonrecurring $17.6 million termination payment received in 2019.This is a result of the measures taken in all business segments at the onset of COVID-19 pandemic to manage costs and receipt of government assistance in Canada, in the United States and Australia. The $9.1 million received on various COVID-19 relief programs during the fourth quarter of 2020 reduced cost of services by $8.1 million and SG&A by $1 million.Excluding $17.6 million termination payment received in 2019, consolidated gross margin percentage for the fourth quarter of 2020 was 29% as compared to 24% in Q4 of 2019. Excluding both COVID-19 funds received in Q4 2020 and the termination payment, the gross margin percentage for Q4 2020 was 20% as compared to 24% for Q4 2019. This decrease was due to lower activity levels in normal jurisdiction and competitive pricing, particularly in North America as well as the year-over-year change in the segmental revenue mix.Selling, general and administration expenses for the fourth quarter of 2020 decreased by $6.5 million or 55% compared to Q4 of 2019. Excluding COVID-19 relief funds, fourth quarter's G&A declined by 47% on a year-over-year basis.Within our CDS segment, despite a substantial year-over-year decline in activity, excluding the $17.6 million termination payment received in 2019, this segment's EBITDA margin increased by 35% or 680 basis points. The increase in EBITDA margin was primarily due to increased relative contribution from Australia combined with North American cost control measures and the receipt of COVID-19 relief funds.Fourth quarter operating days in Australia were negatively impacted by 2 rigs having been removed from service in the third quarter of 2020 for recertifications and upgrades. Both rigs have been contracted, with one rig scheduled to return to service next month and the second in July of this year.While our fourth quarter United States rig utilization was down on a year-over-year basis, utilization increased by 118% or 13 percentage points from 11% in Q3 2020 to 24% in Q4 2020 compared to approximately 29% increase in the U.S. land rig count during Q4 2020.Similarly, while fourth quarter Canadian drilling activity was lower on a year-over-year basis, our Canadian rig reutilization doubled in the fourth quarter of 2020 compared to Q3 of 2020. Effective April 1, 2020, the CDS segment revised its depreciation estimate for the drilling equipment to reflect change in economic and industrial conditions. As a result, additional incremental expense of $3.2 million was recorded during the fourth quarter. This prospective change in depreciation estimate had no impact on EBITDA or cash flow.The RTS segment similarly experienced a substantial year-over-year decline in the fourth quarter rental utilization. While this resulted in a 56% year-over-year decline in revenue, fourth quarter segment EBITDA increased by 9% and EBITDA margin increased by 148% as compared to 2019. Excluding the receipt of COVID-19 relief funds, the RTS segment saw fourth quarter EBITDA decline at almost half the rate at which revenue declined relative to 2019. And the quarterly operating loss in this segment decreased by 20% on a year-over-year basis as a result of significant cost rationalization actions undertaken over the past 2 years.Significant increase in equipment utilization in the United States as well as change in the mix of equipment operating contributed to 17% increase in RTS' segment revenue for the fourth quarter of 2020 compared to Q3 of 2020.While new equipment demand remained sluggish in the fourth quarter of 2020, our Compression and Process Services segment saw a modest increase in its fabrication sales backlog during the quarter, as improving global natural gas fundamentals began to stimulate capital investment. The recovery in North America natural gas prices during the latter part of 2020 also contributed to support for CPS' parts and service and retrofit business lines, which has continued into 2021.Utilization for the compression rental fleet equipment decreased during the fourth quarter due primarily to the return of 6,500-horsepower compression rental units following the bankruptcy of a U.S. customer. These units are in the process of being redeployed with the new customers.Despite a 19% year-over-year decline in CPS fourth quarter revenue, segment EBITDA for the quarter increased by 22% and EBITDA margin increased by 52% as a result of cost management and the receipt of COVID assistance.Fourth quarter service hours and revenue in our Well Servicing segment were both 42% lower as compared to Q4 2019, while segment EBITDA decreased by 15% as compared to the same period of 2019. Despite lower activity levels in all jurisdictions, the fourth quarter EBITDA margin in this segment increased to 35% compared to a 23% EBITDA margin in Q4 2019 as a result of cost management efforts and the receipt of COVID-19 relief funds.While our Canadian Well Servicing segment began to receive some federal government funded well abandonment work during the fourth quarter of 2020, such activity did not have a material impact on this segment's financial performance in 2020.Total Energy's financial and liquidity position continued to strengthen during the fourth quarter of 2020. At December 31, 2020, the weighted average interest rate on outstanding bank debt was 2.72% as compared to 4.09% at December 31, 2019.This lower interest rate, combined with lower outstanding debt balances, contributed to a $2.6 million or 20% year-over-year decrease in annual finance cost. Total net debt position at December 31, 2020, is the lowest since we completed the acquisition of Savanna in June of 2017. Subsequent to the year-end, in addition to regular mortgage payments, further $10 million of bank debt has been repaid.Total Energy's bank covenants consist of maximum senior debt to trailing 12-month bank EBITDA of 3x and minimum bank-defined EBITDA to interest expense of 3x. At December 31, 2020, the company's senior bank debt to bank EBITDA ratio was 2.35, and the bank interest coverage ratio was 8.67%.

[Daniel Kim Halyk, President, CEO & Director]

Thank you, Yuliya. 2020 was a year that most would like to forget. At the same time, 2020 brought out the best in many people, including the employees of Total Energy, whose perseverance and hard work saw us successfully navigate through the most challenging industry downturn that I have ever experienced.Despite the increased health and safety risks presented by COVID-19, not only was Total able to support our customers' essential operations by providing continuous service in all jurisdictions in which we operate, but we also achieved the lowest annual consolidated total recordable injury frequency in our 24-year corporate history.This is an achievement that I'm very proud of, given the difficult circumstances faced by our employees over the past year. 2020 also demonstrated the strength and resiliency of Total Energy's business model and the benefits arising from our commitment to managing our operations and investing our owners' capital in a disciplined and prudent manner.While 2020 revenue fell by over 50% compared to 2019, Total continued to generate substantial free cash flow that was used to reduce bank debt by $44.8 million and further strengthen the company's liquidity position.While oil and natural gas prices have recovered significantly over the past few months and we have seen activity levels rebound from the lows experience following the outbreak of COVID-19 last March, energy producers remain cautious and industry conditions remain uncertain. As such, we remain focused on the efficient operation of our business and the preservation of our liquidity and balance sheet strength.While debt repayment remains a priority, Total will also pursue investments that make economic sense, as evidenced by our Board's decision to increase our 2020 capital budget by $4.5 million.Total Energy's track record of disciplined capital spending and prudent operational management positioned our company to get through some very difficult times. Our shareholders and other stakeholders can rest assured that we remain committed to our core value of capital stewardship. And as such, capital deployment will continue to be disciplined and focused on investment opportunities that generate economic profit as we begin our 25th year in business with a sense of cautious but increasing optimism.I would now like to open up the phone lines for any questions.

[Operator]

[Operator Instructions] The first question comes from Patrick Tang with ATB Capital Markets.

[Patrick Tang, Associate of Institutional Equity Research]

So just wondering if you could give us some details here. Regarding the 6,500 horsepower in rental compression that was returned in the quarter, based on current market conditions, do you expect that to go back to work anytime soon? Or is this something that might take some time to find a home in the field? And also was there any associated write-off of receivables related to that particular customer?

[Daniel Kim Halyk, President, CEO & Director]

So in answer to the first question, about 1/3 of that has already been contracted. So it's proceeding quite well. There's good demand for that style of equipment. And secondly, there was no write-off in relation to any payables in regards to that situation.

[Patrick Tang, Associate of Institutional Equity Research]

Okay. All right. So a 2-parter here. With Australia, the drilling days were a bit more robust than we had originally thought with the rigs leaving the field for upgrades. Do you expect a bigger hit on activity through the first half of '21? Or can we expect fairly flat levels from Q4?And second, Well Servicing hours were also really down in Australia. Just wondering if there's anything nonrecurring in that or if we should be looking at a lower level going forward?

[Daniel Kim Halyk, President, CEO & Director]

So I think Australia generally lagged North America in terms of, I would call it, the COVID impact. But as things -- as society tightened up, their lockdowns tightened up, we definitely saw moderation in the back half of 2020. Going forward, obviously, we've telegraphed for 2 quarters now or 3 quarters the scheduled removal of the 2 drilling rigs. We're happy to say both have been contracted with a very good client. And the one will be starting here in a few weeks and the second in July. So we expect our rig days to go up over the course of this year.And the Well Servicing side, again, Q1 is typically your slow quarter in Australia, given it's the rainy season, it's essentially the breakup. But what I think we're seeing in Australia, similar to North America, is good recovery in prices, particularly in Australia, the Asian LNG gas market was very strong this past winter. And so I'm not going to make any predictions or give forecast, but we're generally fairly positive on Australia for the balance of the year.

[Patrick Tang, Associate of Institutional Equity Research]

Okay. So just changing gears a little bit here. Through the company's Compression and Process Services business, have you found any opportunities to participate in any energy transition or sustainability project? Anything along the lines of carbon capture and storage, hydrogen, renewable natural gas, et cetera?

[Daniel Kim Halyk, President, CEO & Director]

Very much. So I would refer you and other listeners to our website. During the -- in the past few months, we've actually rebranded Spectrum to OPSCO. If people recall, back in 2013, we acquired the business OPSCO manufacturing, which has been around for a long time, 40 years or so. But they had previously had some good experience in things like carbon capture. We have some very good current experience and some unique projects tied to different things like portable LNG, and I would invite people to have a look at our website.But certainly, we're -- we have exposure to hydrogen, biogas, carbon capture, all of that stuff. In essence, gas is gas. I know there's certain gas that seem to be the flavor of the day. But we manufacture, design and engineer equipment that's used to handle solids, liquids and gas of all forms of nature. So we have good exposure. On the drilling front, we'd be the, by far, #1 driller for helium in Canada. I think we're pretty much the only driller for helium. So again, those are kind of unique niche areas that we have some good experience in.

[Patrick Tang, Associate of Institutional Equity Research]

Okay. Last one here and a little bit of clean up. It seems like activity levels are looking a little bit more bullish through the year across your footprint. But that said, do you anticipate requiring a meaningful investment in working capital through the year?

[Daniel Kim Halyk, President, CEO & Director]

I think as things pick up, obviously, you're going to have your normal working capital pickups. The flip side is we're sitting on some very good inventory within our compression and process group, which will be unwind as things pick up. So I think we're in a bit of a unique position where our unwind of the inventory will be a significant offset to any normal working capital increases. So again, as the compression process business picks up, that will be very helpful in helping us unwind our investment in inventory. And we saw that to a certain extent in Q4, about $10 million reduction over the course of the year there. So we hope that, that will continue here in 2021.

[Operator]

The next question comes from John Bereznicki with Canaccord.

[John Mark Bereznicki, Analyst of Oil and Gas]

So I think you've already addressed my questions on Australia. But just on compression, you've obviously built some backlog in the fourth quarter. You're throwing a little extra capital at the rental fleet. Just wondering if you could kind of characterize the dynamic with your clients right now on sales versus rentals and capital allocation and kind of what you're seeing out in the field in that regard.

[Daniel Kim Halyk, President, CEO & Director]

I think everyone -- last Q2, the world just stopped. I think everyone was trying to figure out what this meant. And I think everyone was trying to protect their balance sheet and liquidity. And as we come out of this layer on the Saudi, Russian oil price war, it was a pretty crazy time. I think everyone is figuring out where things are at and where they're going. And obviously, we've had some pretty good commodity price recovery. And our customers have to make some money, and we're starting to see them make some money. And that's the first step towards them having confidence to make investment decisions.So I'm not a person to try and predict commodity prices. But if we have some stability at these levels, I'm willing to bet we'll have a better year than we did last year. And I think we started to see that in Q4, and we need to see our customers have confidence and continue to invest and they're starting to do that. So I don't want to speak for them, but I think the sense of optimism clearly is improving from a few months ago.

[John Mark Bereznicki, Analyst of Oil and Gas]

Got it. And then just geographically, broad brush, can you give us a sense of kind of what you're seeing in compression right now in terms of customer sentiment?

[Daniel Kim Halyk, President, CEO & Director]

I think, certainly, we're seeing good demand on our parts and service business, and that's a function of some pretty good spot gas prices here in North America. There's also been a lot of, I would say, industry contraction on the supply side in all divisions. We're also seeing a pickup again in some international business opportunities. So that's encouraging as well.I think the Asian LNG price uptick has certainly stimulated some investment. And again, as we see the West Coast LNG project in Canada continue, that should be helpful as well for not only new products but for our parts and service business as well.On the U.S. side, interestingly, today, I believe we're running 6 rigs down in Texas, and I expect that number to go up here in the next few weeks. So I think we're -- I'd have to check, but we're pretty close, if not higher, than where we were this time last year. So that's interesting as well.

[John Mark Bereznicki, Analyst of Oil and Gas]

Yes, great color. And you kind of transitioned to my next question. Obviously, Q4 seems like a bit of an inflection point in your U.S. drilling businesses. Has anything changed structurally for you in that market? Or is it just a matter of taking advantage of higher industry rig counts?

[Daniel Kim Halyk, President, CEO & Director]

I think what we've done there is we've revealed our management team over the last couple of years, and they're doing a fantastic job of running a very safe, efficient operation. And we're demonstrating the value of having good competent crews with good, well-maintained iron. And frankly, until the last couple of days, all of our utilization was -- did not involve triples. We've got a triple starting up as we speak. But we're competing very well by bringing in lighter, more efficient rigs that are doing the job in some cases that triples used to do.

[Operator]

[Operator Instructions] The next question comes from Josef Schachter with Schachter Energy Research.

[Josef I. Schachter, Author & President]

Going first to the business. Are you seeing much improvement in Q1 versus Q4? And in the orders and discussions that you're having with people for the post breakup in Canada and as we said, you're looking to bring a triple on in the U.S., how do you feel the sentiment? How do you feel the activity rate? And what do you see in terms of pricing? Do you see having the ability to charge for things that you used to give for free? Are you seeing now that you can get some payment for that?

[Daniel Kim Halyk, President, CEO & Director]

Well, first of all, I think you can see what the drilling numbers were in Western Canada this winter in Q1, Josef, and they were off year-over-year. Again, I think as I mentioned earlier, it takes a while for producers to heal their balance sheets and have confidence. What I would say, though, is sentiment today is quite a bit stronger than it was even a month ago. And we're in a position where we're probably -- and this -- I'll speak to all divisions generically here, where we're oversold on some classes of equipment and that sets the table for price discussion.

[Josef I. Schachter, Author & President]

Okay. Now as part of the price discussion, the pressure from labor costs and hiring people and training them because of a lot of people having left the industry?

[Daniel Kim Halyk, President, CEO & Director]

Definitely, labor will be a challenge if things pick up materially. We ran in Western Canada. I don't think we cracked 200 rigs, so we didn't push it. From our perspective, we didn't experience any significant labor challenges. But I think as an industry, that's going to be a big issue here as we look to come to anything close to what historically was operated.So how do you attract labor back? You have to, first of all, offer them steady work and a fair and reasonable competitive wage. And I think the biggest thing is going to be the prospect of steady work, because a lot of -- I believe a lot of people have left the industry for lower paying per-hour jobs, but they're steady.

[Josef I. Schachter, Author & President]

Yes. That's going to be a challenge.

[Daniel Kim Halyk, President, CEO & Director]

And so we need as an industry to have some steady work if we want to have a reliable, consistent workforce. So I think step 1 is going to be to get some stability, particularly in Canada, where it's been a rough industry for 5, 6 years now, less so in the U.S. But it was a rough year last year. You had rig count in North America go to places we've never seen before.

[Josef I. Schachter, Author & President]

Now on the rig count, with the rig upgrades in Australia, are they moving towards bi-fuels, pad-walking units? What are you doing on the upgrades there? And what's the difference on upgrades there versus maybe upgrades in Canada and the States?

[Daniel Kim Halyk, President, CEO & Director]

So we have bi-fuel. We have walking systems. We have all that everywhere. That's pretty off the shelf. In fact, we had a rig in Northeast B.C. It's got to be well over 10 years ago. We were told at the time it was drilling for Encana that -- we were told it was the first rig in the world to drill with bi-fuel but also drill under balance of natural gas. We just -- we don't make a big deal out of that, but we have all of that. And so we're operating rigs today that are fueled by natural gas, have walking systems, all of that stuff. Our partnership with Pason, we're delivering automation and data collection and analytics, just like any other leading drilling contractor.The upgrades in Australia, we're pretty tight hole on that. I understand we're displacing another contractor in at least one of the cases. So -- but there are things that we're comfortable with. We have to recertify both rigs anyways. And in the process of marketing, we ended up signing a contract for a multiyear project that required some -- primarily hook load upgrades.

[Josef I. Schachter, Author & President]

Okay. The next one from me would be the -- we've seen a lot of M&A in the E&P sector. We haven't seen much M&A in the service sector. Is it, people feel they're worth more? Or is it just -- it's a question of equipment and management styles, operating styles? Any reason, your thought process as to why we haven't seen more activity there?

[Daniel Kim Halyk, President, CEO & Director]

I think part of the problem is, is debt levels with some of the potential targets. The relative debt levels to the cash flow those asset base can generate are a real problem. And so for us to pay par value for debt when there's some serious questions as to whether that asset base can even service that, let alone getting into having a discussion on equity value, that's a problem.The other thing is, is the quality of the asset base. I think we saw it more in the U.S. so far, where older assets are just going the way of the scrapyard. And I think you're going to increasingly see that in Canada, where a lot of that's happened already. You look at the Canadian rig fleet, it was north of 900 rigs not so long ago, and we were sub-500. And realistically, if 300 could work, I'd be surprised.But I just -- I think if you're trying to evaluate that, look at the ability of various companies to generate cash flow relative to their interest payments. And that will -- that's a big barrier. So I think unless until debt holders mark-to-market their debt, that's going to be a barrier to consolidation. But I believe consolidation has to happen. It needs to happen. We've seen with our acquisition of Savanna very significant benefits. We've been able to get through a very tough time and pay down debt pretty aggressively at very low utilization rates. We're going to continue to see good synergies in 2021 here.We're -- the lease that we acquired on Savanna's head office premises expires here at the end of June. And on a go-forward basis for the next 6, 7 years, we're going to be saving about $3 million a year in lease costs, which -- that's in addition to the over $20 million of synergies that we've extracted so far. So consolidation allows you to take costs out. We're big fans of it, and we're working hard to try and do more. But we're also not going to put our balance sheet at risk and put our shareholders at risk.

[Josef I. Schachter, Author & President]

Okay. Last one from me. The last investor presentation was changed in September of 2020. Do you have any idea or game plan to upgrade that? Or is that the latest one from point of view of information to integrate into a report?

[Daniel Kim Halyk, President, CEO & Director]

Well, we're hoping more people would be interested in our industry. It seems just turning a bit. We'll upgrade typically around presenting at a conference or if there's a material change. But we'll likely upgrade for Q4 here in that. So -- but we're pretty focused on running our business, Josef. And I've always been a believer that you've got to put the numbers up, and those are the best things to promote your stock. It's just put up good numbers and ultimately, hopefully, your shareholders are rewarded.But definitely, we're trying a bit more here to illustrate our exposure, for example, to some of these emerging potential opportunities, hydrogen, all that. I remember when we first started Total, hydrogen was a big thing back then and kind of flopped. It's back again. We'll see if there's any significant opportunities there. But we'll build whatever, we'll drill for whatever. And we're going to do it in an industry-leading, responsible way.

[Josef I. Schachter, Author & President]

Okay, super. It's not that we shouldn't be unhappy. Stock has tripled from the March low, but definitely got a way to go to get back to the lofty years of 2016, 2018 period.

[Daniel Kim Halyk, President, CEO & Director]

I think our -- you look at our share count, Josef, it's a low share count. You look at our EBITDA that we were able to generate in a very, very difficult year and at low equipment utilization. Again, we made some difficult choices not to go completely into the tank on pricing, and that resulted in some market share loss last year. But I think you start to see in Q4, as the pricing starts to become a little more reasonable, we're regaining lost market share. And we're also going to see whose equipment is ready to go to work without major capital. And I can tell you ours is.And there's going to be a lot of companies that work their equipment into the ground, don't have the ability to fund working capital upticks, because they worked too cheap for a long time and didn't maintain their equipment or put it down in bad shape.And I think the industry in North America, particularly, will be in for a bit of a rude awakening if we try and get that rig count up in the next quarter or 2. And it's not just rigs, it's all the support equipment. We're already seeing it in some parts where our rigs are sitting waiting for some vendors or other service providers, it's just there's a shortage of them. Rig moves in Texas right now, a lot of rig movement, companies went broke.

[Operator]

This concludes the question-and-answer session. I would like to turn the conference back over to Daniel Halyk for any closing remarks.

[Daniel Kim Halyk, President, CEO & Director]

Thanks, everyone, for participating. I hope you have a good weekend, and we look forward to speaking with you after our first quarter results. Have a good day.

[Operator]

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