Total Energy Services, Inc. (OTC:TOTZF) Q2 2019 Earnings Conference Call August 9, 2019 11:00 AM ET
Daniel Halyk - President, CEO & Director
Yuliya Gorbach - VP, Finance & CFO
Conference Call Participants
John Bereznicki - Canaccord Genuity Corp.
Patrick Tang - AltaCorp Capital Inc.
Jon Morrison - CIBC Capital Markets
Good morning, ladies and gentlemen. Welcome to the Total Energy Services Inc. Second Quarter 2019 Results Conference Call. [Operator Instructions].
I would now like to turn the meeting over to Mr. Daniel Halyk. Please go ahead, Mr. Halyk.
Thank you. Good morning, and welcome to our second quarter conference call. Present with me is Yuliya Gorbach, Total's VP Finance and CFO. We will review with you Total's financial and operating highlights for the three months ended June 30, 2019, then provide an outlook for our business and open up the phone lines for any questions.
Yuliya, please proceed.
Thank you, Dan. June 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 affecting -- factors affecting Total's business 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 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 three months ended June 30, 2019, reflect continued challenging industry conditions in Canada. Prolonged wet weather conditions throughout much of Western Canada extended the usual seasonal decline in activity during spring breakup, which was partially offset by relatively stable industry conditions in United States and Australia.
By business segment, Compression and Process Services contributed 62% of 2019 second quarter consolidated revenues, Contract Drilling Services, 16%, Well Servicing, 14%, and Rentals and Transportation services, 7%. Year-to-date, CPS segment contributed 58% of consolidated revenues; Contract Drilling, 18%, Well Servicing, 16% and RTS, 8%. Geographically, 51% of second quarter revenue was generated in United States, 33% in Canada and 16% in Australia. Year-to-date, 42% of revenues came from the United States, 38% from Canada and 20% from Australia.
Within our Contract Drilling segment, a significant year-over-year decline in Canadian drilling activity resulted in lower second quarter revenues and increased operating loss compared to Q2 of 2018. Despite a 29% decline in the second quarter operating days in the United States compared to 2019, improve day rates have increased operating efficiencies resulted in continued bottom line improvement for our U.S. drilling operations. While utilization of Australia remained stable, revenue per operating day was lower in Q2 2019 as compared to Q2 2018 due to a combination of lower average day rates and lower camp and other ancillary revenue. This combined with a weakening of the Australian dollar relative to the Canadian dollar over the past year contributed to a decline in revenue and operating earnings compared to Q2 2019.
For the first half of 2019, 35% of Contract Drilling revenue came from Canada, 33% from Australia and 32% from the United States. The substantial year-over-year decline in Canadian industry activity also contributed to a 13% decline in second quarter Canadian revenue for our Rentals and Transportation Services segment. This decline was more than offset by a 65% increase in U.S. RTS revenue as we continued to relocate equipment to that market. As such, second quarter segment revenue increased 5% compared to the prior year comparable period. Revenue per utilized rental piece in RTS increased 57% from Q2 2018 due to the mix of equipment operating as well as higher realized pricing on equipment relocated from Canada to the United States.
Year-to-date, 37% of RTS segments revenue was generated in the United States compared to 19% for the first half of 2019. Improved pricing in the U.S. with a larger U.S. fleet, together with cost management efforts in Canada, resulted in improved quality, quarterly bottom line performance for the RTS segment compared to the prior year even after incurring $0.4 million of equipment relocation expenses in the second quarter of 2019. Within our Compression and Process Services segment, second quarter revenue for 2019 was $132.9 million, a 26% increase compared to the second quarter of 2019. Despite higher revenue, segment operating earnings decreased due to higher year-over-year overhead costs following the expression of fabrication capacity in late of 2018 as well as the completion of lower-margin fabrication projects during the quarter. This segment exited the second quarter of 2019 with a fabrication sales backlog of $77.2 million, an $82.6 million decrease from March 31, 2019.
During the second quarter, the CPS segment received an Alberta Court of premium's bench judgment for $11.5 million in respect of an order canceled in 2015 without payment of contractual termination fees. While the judgment has been appealed, the end process of registration that in the United States in order to proceed with collection. Revenue arising from this judgment will be recorded when received. Second quarter revenue for our Well Servicing segment was $30.5 million, a 14% decrease from Q2 2018. A 28% year-over-year decrease in Canadian service dollars due in part to extended bad weather conditions was the primary factor contributed to revenue decrease.
Total service hours for the second quarter were 31,109 of which 54% were in Australia, 30% in Canada and 16% in the United States. This compares to 36,472 service hours during the second quarter of 2019 of which 50% were in Australia, 36% in Canada and 14% in United States. Consolidated gross margin for the second quarter of 2019 was $31.8 million or 15% of revenue as compared to $35.8 million or 18.5% of revenue in the second quarter of 2018. Consolidated cash flow before changes in noncash working capital items was $22.4 million for the second quarter of 2019, consistent with a $22.5 million of cash flow generated in the second quarter of 2018. Cash provided by operating activities for the first half of 2019 after changes in working capital items was $54.3 million.
Consolidated EBITDA for the first quarter of 2019 was $17.5 million, a $5.7 million decrease from the $23.2 million of EBITDA realized in Q2 2018. $3.4 million of such decrease arises from the translation of foreign currency intercompany working capital balances that are noncash in nature. The appreciation of Canadian dollar relative to the U.S. dollar over the past year gave rise to this unrealized loss on currency translation. Total Energy remained profitable during the second quarter with the net income attributable to shareholders of $3.4 million or $0.07 per share on a diluted basis as compared to $3.8 million or $0.08 per share on a diluted basis in the second quarter of 2018.
Total Energy's financial condition remains strong with $74.3 million of positive working capital, including $33.9 million of cash at June 30, 2019. $41.9 million of mortgage debt was reclassified as current during the second quarter. We expect to renew such mortgage debt when it matures in April of 2020. During the second quarter of 2019, Total Energy paid $2.7 million of dividends and repurchased $2.5 million of common shares. Total bank debt net of cash was $235.4 million at June 30, 2019, a $19.7 million reduction from December 31, 2018. In addition to the regular monthly principal payment on $57.2 million of mortgage debt, during the first half of 2019, Total Energy voluntarily repaid $15 million of bank debt assumed with acquisition of Savanna. At June 30, 2019, $212 million was drawn on $295 million of available revolving bank credit facilities. Our 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, 2019, company's senior bank defined EBITDA ratio was 1.79, and the bank interest coverage ratio was 6.91x.
Thank you, Yuliya. With challenging and uncertain industry conditions, we remain focused on the efficient and sustainable operation of our various business segments, preservation of our balance sheet strength and prudent stewardship of our owners' capital. While we continue to strategically invest in the growth and maintenance of our equipment fleet, we are able to generate significant free cash flow, even when operating at historically low utilization rates. This is evidenced by our net capital investment in property plant and equipment relative to cash flow generated.
The success of our strategy to geographically diversify our revenue base was evident during the second quarter with 2/3 of our revenue coming from outside of Canada, including 51% from the United States. Compare this to 2015 when only 3.4% of our annual revenue was derived from outside of Canada. We are encouraged with the steady progress being made in our U.S. drilling business. Following the acquisition of Savanna at mid-2017, we set out to renegotiate or terminate unprofitable legacy contracts as they came due, consolidate operations geographically and improve the efficiency of our operations. This strategy has seen our U.S. drilling business reduce its operating loss by almost 50% from the second quarter of 2017 to the second quarter of 2019, despite a 44% decline in spud to release days and a corresponding 43% decline in quarterly revenue.
With most legacy contracts behind us and with our operations now functioning much more efficiently, we are optimistic as to the future prospects for this business, despite the recent pullback in U.S. drilling activity. We are also pleased with the steady progress being made by our U.S. Rentals and Transportation business. We are experiencing strong demand for quality equipment and service as we continue to gain market share in a relatively flat market.
Historical demand for our Compression and Process equipment has generally followed the North American onshore drilling rig count, an exception has been strong demand arising from the North American energy infrastructure build, particularly in the United States, which has insulated the CPS segment from a falling rig count over the past few quarters. With a significant decline in oil prices in late 2018, during the first quarter of 2019, we began to see a decline in the conversion of quotes in the firm orders relative to historical experience. This continued in the second quarter.
Australian and other international orders for compression tend to be lumpier than North America. While there are significant North American and international energy infrastructure projects in front of us and quoting activity remains strong, we are closely monitoring industry conditions to ensure our fabrication capacity and resulting cost structure and overhead absorption are in line with anticipated industry conditions. That said, I would note that the $82.6 million decline in the CPS fabrication sales backlog from Q1 to Q2 represents 62% of the $132.9 million of revenue generated in the second quarter. In other words, the diversity of our revenue streams within the CPS segment saw almost 40% of our second quarter revenue being generated by other activities such as parts and service and compression rentals that did not drag down our fabrication sales backlog.
Market conditions in the energy industry have been uncertain and volatile for some time now, particularly in Canada where our industry has faced unique and significant political and regulatory barriers to putting people and equipment back to work. While we are encouraged by recent regulatory and policy changes in Alberta, the implementation of Bill C-48 and C-69 by the federal government is very disappointing. These loss are deeply discriminatory towards domestic oil producers relative to foreign imported oil and will continue to discourage investment in Canadian resource development.
A definite consequence of these laws will be less jobs and less tax and royalty revenues across Canada as investment continues to flow to other energy-producing nations that, in most cases, do not operate the same operational, environmental and social standards that the Canadian industry operates at and that is expected by Canadians. I am grateful to our employees and their families for their continued perseverance and commitment to operating at the highest standards, despite the headwinds that our industry has faced over the past few years. Like them, I am proud of our industry and of how we have managed to navigate through these challenging times.
I am confident that we will emerge as a stronger company and that our owners will be rewarded for their patience and support.
I would now like to open the phone lines up for any questions.
[Operator Instructions]. The first question comes from John Bereznicki with Canaccord Genuity.
Just in terms of the compression backlog, just wondering if you would be willing to give us an indication of where that backlog might fit today relative to the end of second quarter?
We are not, John, just like we've never done in 22 years. I think, like I said, it's -- your international projects tend to be lumpy, and domestically, you're seeing a pretty consistent North American experience with producers sitting on their wallets a little bit. That said, overall, gas volumes in North America continue to rise, particularly in the U.S. We're seeing a build out of oil pipelines in U.S. that will help release some bottlenecks, particularly in jurisdictions that have some pretty high collateral gas production. And we're also looking, hopefully, at some LNG development in Canada and North America. So these things are lumpy. Definitely, we've seen a pullback in conversion from quotes to orders. I think that's pretty consistent across the board. But as I noted, John, almost 40% of quarterly revenue didn't grind the backlog. So there is a base of ongoing recurring revenue within that business. But we're watching it very, very closely. And we'll stick candle through this and adjust our cost structure as best we can to reflect what we think our productive capacity needs to be going forward.
Got it. Okay. And then just related to that, and I think you touched on it. It looks like your active rental fleet did tick up nicely in Compression, sequentially in Q2? Is that kind of a trend you're seeing maybe concurrent with the fabrication backlog coming down? And maybe a little color there would be helpful.
Well, certainly, it's logical to expect that particularly producers will look to utilize someone else's balance sheet. And we're happy to do that, provided the risk reward is satisfactory. But we have definitely seen a pretty steady uptick in our current -- our Compression rental fleet. And that's been a fairly steady move over the past couple of years. And again, capital is pretty scarce in the energy business, and we're happy to put our balance sheet towards going forward if it makes sense.
Got it. And then just shifting gears to RTS, obviously, a nice margin improvement there in Q2. Is the nature of your fleet in the U.S. a little different than in Canada? I'm just kind of curious how the business makes difference now that you're moving equipment elsewhere?
No. It's pretty much the same fleet. The only difference is we get paid a lot more, and there's more work.
The next question comes from Patrick Tang with AltaCorp Capital.
Just want to start by asking, while you see that CPS margins took a bit of a step back in the quarter, do you expect this to normalize over the near term? Or was the margin compression mostly a function of lower-margin more commoditized were completed during Q2? Or were there other factors that contributed?
I think there's a mix of the projects that were completed through the quarter as well. Obviously, you have work overhead absorption issues as you're throttling back a little bit. We did expand in Q4. We basically displaced a smaller leased facility with a larger. The absolute rent was actually lower on the building, it's a sub-rent situation. But obviously, bigger space, so you've got more utilities and that sort of thing as well as people. So we're going to adjust our productive capacity as required within reason, and ultimately, bring your overheads as best you can in line with your throughput on the fabrication side. But definitely, overhead absorption becomes an issue when you're running at lower levels of utilization.
Just one more question for me. Could you give us an update on what your bookings look like for each of the geographical segments? Like, is the bid pipeline pretty strong in terms of value and quality? In other words, are there a number of projects that you guys think you can win a bid for? And are these projects have higher-type margin width that would imply stronger returns?
So first of all, I'm not going to give any color on specific geographies for competitive reasons, obviously. But we've demonstrated over the past two years as we've ramped up our U.S. presence, and certainly, have been very competitive in the Australian market that we can compete in all those markets, and we expect to get our fair share of activity in those markets. So we're right in the middle of everything there. And I would say that nothing that we see within our existing pipeline or what we see our competitor is getting is much of a surprise. It's really -- it's a fairly small industry. We're pretty aware of what's going on.
[Operator Instructions]. The next question comes from Jon Morrison with CIBC Capital Markets.
Dan, Australia continues to be a really good market for you guys. As you look to what demand should be in the coming period, do you believe that there is going to be any need for you to actually add assets at this point to the market?
I would expect that will be a jurisdiction where we do deploy additional capital, John.
Within that market, obviously, the strength that you're seeing across your business can be extended across a lot of other ancillary service lines, of which a decent amount would be owned by smaller contractors. Given that backdrop, do you have any interest in entering other service lines and expanding your service offering? And I just asked that from the perspective that, obviously, you're a leader in that market, you've got a well-established platform, and you've a long history of improving the profitability of smaller companies that you require. So is that a market where consolidation opportunities would make more sense than organic CapEx at this point?
So within the existing operations what we saw year-over-year, we actually had a fairly significant geographic movement with some of our rigs that displaced the need for camps. And so you're seeing a little bit of a revenue per operating day reduction on the drilling site. The flip side is you don't have the cost associated with that. We were pretty successful in, I would say, monetizing our assets that were required to support that business. The flip side is, we are seeing opportunities to displace third-party equipment utilized in our drilling and Well Servicing processes with our own equipment. We'll always take a pragmatic view that we can't be everything to everyone. And if we're going to do something, we want to do it well operationally as well as ensure that it gets appropriate returns. But there is definitely opportunities in that front to be a little more turnkey. As well, I think the opportunity to grow our business there is just pretty good. As you noted, we're operating at a pretty high utilization levels.
We see the market as being relatively stable, we're also -- frankly, we've got a very good reputation over there. I would see new builds probably being a little more compelling than acquisitions, just given the general quality of the asset base over there. And the other thing is, you're working in pretty remote areas where you don't have the support that you would -- we take for granted North America even in some of our remote northern locations. And so when you're 600 miles from your nearest major center, you need to have a pretty robust modern fleet that is not going to require a lot of servicing from far away. So we're biased towards some new builds, but they're -- from time to time, we have looked at acquisition opportunities, but asset quality will be a key consideration in that regard.
And just when you say new builds, are you specifically referring to rigs, whether it be drilling or work over? Or what about some of the ancillary stuff that would surround a rig that is not core today?
Okay. Switching gears...
But it's also pretty expensive to build. You're pretty much -- most of your major equipment, your rigs -- service rigs are brought from North America.
Yes. Given those fabrication capabilities, it's still cheaper to build it here, ship over and then just make sure that you meet specifications in that market.
Yes. It's both cost and excess to capable fabricators in the engineering.
And the price dislocation and equity values for a large number of your peers is obviously immense, even despite the fact that we all know that we're in a very challenging market. As such, can you just give a high-level thought on how you think about consolidation opportunities right now, given that you tend to be very countercyclical in nature and this is a market where you would tend to deploy more capital?
We've been very busy on that front. We -- for every one we do, we probably look at 50, some bigger, some smaller. I think a couple of points, John, on that. We've seen the benefits of consolidation directly with the Savannah acquisition. That's been a good deal, I believe, for both sides. Certainly, we've been operating in a pretty tough environment for the drilling site since that acquisition, but we've, for the most part, extracted pretty good bottom line performance at a very low utilization. And another point that I made in our call was our ability to generate free cash flow relative to the capital we're investing in the maintenance and growth of the fleet, and it's I will encourage our owners and analysts to look at our capital relative to our cash flow. And that's half the game. If you're spending 2x your cash flow on maintaining and growing your cash flow, that's a bit of a treadmill. We were the exact opposite of that, I think, in Q2 it was less than 20% on maintenance and growth. And obviously, the growth part will benefit us going forward. So again, back to your question.
We're very active in looking at consolidation. I believe this industry needs to consolidate more, and we're going to be part of that, where it makes senses for our owners. And obviously, our cost to equity is a lot higher than it was a couple of years ago, which -- the message that sends to us is we've got to be remained disciplined. And so we will do that, but if it makes sense, we can do that. We do have the support of our bankers; we've got the digestion of Savanna behind us. I feel very good about it, and again, you're seeing in the U.S. drilling where we've been focused lately, and finally, all the legacy contracts are coming off. We're going to really show what we can do with the smaller shell of our fleet there. And like I said, we need more mass down there. In Canada, it's about -- it's all about stripping costs, and in some cases, relocating assets outside of Canada. But there'll be more consolidation, and we hope to be part of it.
Just as a follow-on to that. You have a long history of being prudent with your equity. But in this type of environment, do you view everything to be relative in that if a seller solely wants equity and there is an accretive deal to be done, you would ultimately possibly issue stock for them? Despite the fact that it doesn't feel good to do it below book value or where you'd traditionally issue it in the past?
It's all relative, how do you carve the pile? So -- in fact, now is a great time to do acquisitions. But it's got to make sense to us. Savanna, we did issue -- it was the largest equity issue we ever did. It was certainly at a lower port in the cycle, but I think it's worked for both sides, and again, if we could do a similar transaction going forward that made sense, we would certainly be open to it. But again, the market is telling us clearly that we need to be diligent, and it's got to work for us. Otherwise, we wouldn't do it. But we're not going to do anything crazy, John, but we're very open and flexible, and it's got to work for both sides as well. We get that.
Just a last one for me. Given some of the slowing in bookings that you're seeing and obviously your peers have been reporting over Q2, do you believe that we get into an environment where pricing becomes much more competitive than it has been in the last 12 months? Or it just leads to perhaps lower throughput but pricing remains fairly stable?
The sector has never really had excess of returns for the past while. And how do I know that, you look at the competitive landscape, it hasn't really changed. In fact, you've seen consolidation within the smaller private site, particularly in Canada. And you've seen in the U.S. on the master limited partnership side quite a few financial distress situations there. Situations where risk was being underpriced. So when you don't have excess returns, you don't get excess of overcapitalization. And so I think the market is reasonably balanced, and that allows you to adapt and adjust a lot more in. And also, there's still a lot of projects in front of us, North American and globally. And so all it takes is one order to change your backlog pretty quickly. So I think you're probably going to see a pretty disciplined and stable industry there unlike the rigs in the rentals, where you've had massive overcapitalization, and it's been truly a pretty brutal rightsizing. But it's ongoing, and ultimately, we'll come out of that in a situation where, hopefully, we do realize excess returns for a month or two.
This concludes the question-and-answer session. I would like to turn the conference back over to Mr. Daniel Halyk for any closing remarks.
Thank you. We appreciate your participation in our conference call and look forward to speaking with you after we've released our third quarter. Thanks, and have a good weekend.
This concludes today's conference call. You may disconnect your lines. Thank you for participating, and have a pleasant day.