Total Energy Services Inc. (TOT) Q4 2021 Earnings Call Transcript

Total Energy Services Inc. ( ?????? : TOT) Q4 2021 earnings call dated Mar. 11, 2022

Corporate Participants:

Daniel Halyk — President & Chief Executive Officer

Yuliya Gorbach — Vice President, Finance and Chief Financial Officer

Analysts:

Ernest Wong — Baskin Wealth — Analyst

Patrick Tang — ATB Capital Markets — Analyst

Presentation:

Operator

Thank you for standing by. This is the conference operator. Welcome to the Total Energy’s Fourth Quarter and Year-end 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 of Total Energy Services, Inc. Please go ahead.

Daniel Halyk — President & Chief Executive Officer

Thank you. Good morning, and welcome to Total Energy Services Fourth Quarter 2021 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 December 31, 2021, and then provide an outlook for our business. We will then open up the phone lines for any questions. Yuliya, please proceed.

Yuliya Gorbach — Vice President, Finance and Chief Financial Officer

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 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 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 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 December 31, 2021, reflect improving industry conditions, primarily in North America as compared to the fourth quarter of 2020. Higher North American activity and the reactivation of 2 drilling rigs in Australia contributed to a significant year-over-year improvement in Total’s fourth quarter financial results and the return to profitability with fourth quarter net income of CAD1 million as compared to a net loss of CAD1.7 million in 2020.

Fourth quarter consolidated EBITDA increased 15% from CAD19.5 million in Q4 2020 to CAD22.6 million in the fourth quarter of 2021. Excluding COVID-19 relief funds, fourth quarter EBITDA increased 103% on a year-over-year basis.

Total geographical diversification continued to be a stabilizing factor for our financial performance. Geographically, a significant increase in North American industry activity from the historic lows experienced during the second quarter of 2020 resulted in North America contributing 81% of consolidated revenue in 2021 as compared to 72% in 2020.

By business segment, Compression and Process Services generated 37% of 2021 fourth quarter consolidated revenue, followed by contract drilling services at 36%, well servicing at 19% and rental and transportation services contributing 8%. This compares to Q4 of 2020 when the CPS segment contributed 39% of consolidated revenue; Contract Drilling Services, 28%; well servicing, 24%; and the RTS segment, 8%.

While fourth quarter 2021 consolidated revenue increased 61% as compared to Q4 2020, EBITDA increased by 91% after adjusting to exclude COVID-19 relief funds and unrealized foreign exchange losses on translation of intercompany working capital balances, resulting in an adjusted quarterly EBITDA margin of 16% as compared to 14% in the fourth quarter of 2020.

The CAD1.4 million of COVID-19 relief funds recorded in the fourth quarter of 2021, reduced cost of services by CAD1.3 million and SG&A by CAD0.1 million. This compares to CAD9.1 million of COVID-19 relief funds in Q4 of 2020, which reduced cost of services by CAD8 million and SG&A by CAD1.1 million.

Consolidated fourth quarter gross margin, excluding COVID-19 funds was 2 percentage points higher as compared to 2020. This was primarily to modest price increases in North America, necessary to offset rising labor and material costs. Excluding COVID-19 relief fund, gross margin as a percentage of revenue improved to 22% for the fourth quarter of 2021 as compared to 20% in Q4 of 2020.

Selling, general and administration expenses for the fourth quarter of 2021 increased by CAD3.1 million or 59% compared to Q4 of 2020 as employee compensation was reinstated to pre-Covid levels and the contribution of COVID-19 funds decreased by CAD1 million or 91% as compared to prior year comparable quarter.

The improvement in North American drilling activity and the reactivation of two drilling rigs contributed to a 93% increase in Total operating drilling days in Total’s CDS segment, which resulted in a 108% increase in consolidated drilling utilization during the fourth quarter of 2021 as compared to the prior year, an 8% increase in revenue per operating day.

Changes in geographic revenue mix and high activities resulted in a 109% year-over-year increase in the fourth quarter CDS segment revenue. Fourth quarter CDS segment EBITDA increased 102% compared to 2020 as a result of high activities and changes in the mix of equipment operating in North America.

An increase in Canadian drilling activity resulted in an 80% increase in the fourth quarter operating days in Canada compared to 2020 and 116% increase in CDS’ Canadian revenue. Improving industry conditions and market share gains contributed to 132% year-over-year increase in fourth quarter United States operating days, which in turn drove a 173% year-over-year increase in the fourth quarter U.S. drilling revenue.

Fourth quarter operating days in Australia increased by 89% compared to 2020 as two rigs returned to service following the completion over certifications and upgrades. One Australian rig was removed from operations during the third quarter of 2021 for certification and upgrade and returned to service in the first quarter of 2022.

Improving North American industry conditions contributed to a 100% increase in the fourth quarter equipment utilization within the RTS segment as compared to 2020. Fourth quarter RTS revenue increased by 56% on a year-over-year basis, which in turn drove a 23% increase in segment EBITDA. EBITDA increased at a lower pace than revenue due to the mix of equipment operating, cost inflation not being fully offset by price increases and lower year-over-year COVID relief funds being received.

Fourth quarter revenue in total CPS segment increased by 50% compared to 2020. This segment saw a fifth consecutive quarterly increase to its fabrication sales backlog, which was 236% higher on a year-over-year basis. Higher natural gas prices also provided support for CPS segments’ parts and service business and utilization of the compression and rental equipment fleet increasing 11% from December 31, 2020.

Operating income for the fourth quarter of 2021 decreased 50% on a year-over-year basis as additional expenses were incurred to prepare for a substantially increased production activity in 2022 as well as general cost inflation and reduced COVID-19 relief funds received during the quarter.

Operating income margin are expected to improve over the course of 2022 with higher production levels and improved pricing. Fourth quarter revenue increased 26% in our well servicing segment compared to 2020. While service hours increased 25% during the fourth quarter, revenue per service remain comparable to prior year relevant quarter as an increase in revenue per service hour in Canada and United States was offset by decrease in Australia.

Continued strength of oil prices and increased well abandonment activity in Canada contributed to an increase in activity in all geographical regions. This segment’s EBITDA margin decreased 9 percentage points in the fourth quarter of 2021 as compared to the same quarter last year due primarily to cost inflation in North America that was not fully recovered through price increases and lower COVID-19 relief funds receipt.

Total Energy’s financial and liquidity position remains very strong. At December 31, 2021, the weighted average interest rate on outstanding bank debt was 2.68% as compared to 2.72% at December 31, 2020. This lower interest rate, combined with lower outstanding debt balances contributed to a 31% year-over-year decrease in fourth quarter finance costs.

Total net debt position at December 31, 2021, is the lowest since we completed the acquisition of Savanna in June of 2017 as we remain focused on a continued repayment of debt. In January of 2022, Total extended the maturity of our primary bank credits facility to November 10, 2024. As part of this extension, we requested a CAD30 million reduction in available credit, such that we now have CAD225 million of revolver bank credit facility capacity.

Following a CAD20 million of voluntary principal repayments thus far in 2022, CAD115 million of credit is currently available to Total. Total energy bank covenants consist of maximum senior debt to trailing 12 months bank defined EBITDA of 3 times and a minimum bank-defined EBITDA to interest expense of 3 times. At December 31, 2021, the company’s senior bank debt to bank EBITDA ratio was 1.40, and the bank interest coverage ratio was 17.35 times.

Daniel Halyk — President & Chief Executive Officer

Thank you, Yuliya. What a difference a year makes? Entering 2021, the energy service industry continued to face extremely challenging business conditions following the historic collapse in energy industry investment as a result of the outbreak of COVID-19 in March of 2020. At the same time, the seeds of recovery have been planted.

While 2021 industry activity levels remain below pre-COVID levels in all geographic regions where Total operates, improving industry conditions in the second half of the year and our continued efforts to operate in a safe and efficient manner were effective in restoring corporate profitability. We are also very proud that despite the additional challenges associated with COVID-19 and ramping up field activity after a prolonged downturn, Total achieved the lowest annual consolidated total recordable injury frequency rate last year since we began tracking this measure in 2008.

Total’s diversified business model has once again demonstrated our ability to generate significant free cash flow even during the most difficult of times. From January 1, 2020 to December 31, 2021, we have reduced bank debt net of cash by CAD100.8 million or 39%. And as Yuliya mentioned, our bank debt has been further reduced by CAD20 million thus far in 2022. At the same time, we continue to maintain a strong cash position that has funded share buybacks under our normal course issuer bid and expenditures under our 2022 capital expenditure plan. Notwithstanding continued strength in commodity prices, many oil and gas producers have been hesitant to substantially increase capital budgets. At current commodity prices, total energy expects that oil and natural gas drilling, completion and production activity will continue to improve. Demand for equipment and services provided by our CPS segment has also continued to strengthen in 2022 as investment in global energy infrastructure recovers from the pandemic collapse.

Total Energy’s track record of disciplined capital spending and prudent operational management has enabled our company to get through some very challenging times. As we celebrate Total’s 25th anniversary in business this year, our owners can be assured that we remain committed to our core values of focus, discipline and growth that have served us well over the past quarter century.

As we look forward to better times for our business, I would like to thank all of our employees for their perseverance and dedication over the past 2 years. Together, we work to get through a severe industry downturn and a global health pandemic and came out a stronger and more innovative organization.

I would now like to open up the phone lines for any questions.

Questions and Answers:

Operator

[Operator Instructions] Our first question comes from Ernest Wong of Baskin Wealth. Please go ahead.

Ernest Wong — Baskin Wealth — Analyst

Hey, guys. How are you all doing?

Daniel Halyk — President & Chief Executive Officer

Well, thanks, Ernest. How are you?

Ernest Wong — Baskin Wealth — Analyst

Doing well. I just wanted to — first of all, maybe you can talk a little bit about how you think about capital allocation, given that you’ve been repaying debt and with modest buybacks at current prices. So how are you guys thinking about maybe a dividend?

Daniel Halyk — President & Chief Executive Officer

We’ve been fairly aggressive on the buybacks. The reality is we’re restricted with a daily limit. That’s based on our liquidity, which is quite low. So that makes it a bit challenging. But we’ve been quite active so far.

In terms of capital allocation generally, we annually calculate our WACC. We have it calculated by a third-party group. And that drives our investment decisions and investment can mean new equipment acquisitions, share buybacks. And ultimately, if there’s no opportunities to reinvest our capital, including through share buybacks, that makes sense, you return it to dividend or to shareholders through a dividend.

Right now, we see some pretty compelling opportunities on the share buyback front. We have a capital budget that we announced earlier this year that we’re going to fund through cash and cash flow, if necessary. I expect reinstatement of our dividend will likely be on the Board agenda this year, and I defer to our Board on that. But ultimately, returning capital to our shareholders that we can’t reinvest and have returns that generate economic profit is — that’s just the way we’ve run this business over the years. So we expect that will continue and primarily through share buybacks and ultimately, restoration of the dividend.

Ernest Wong — Baskin Wealth — Analyst

Got it. And maybe just on a larger picture, like your management team has now gone through, I guess, two pretty severe downturns over the last even six, seven years. So how does that change how you guys think about how you manage the business going forward?

Daniel Halyk — President & Chief Executive Officer

I think it reinforces our core principles, Ernest, that focus, discipline and growth. And so we try and come out of every downturn stronger than we went into it, and that’s taking advantage of opportunities that arise when everyone is fleeing the sector. And this last downturn, we worked pretty hard on different acquisition opportunities. That said, we remain focused and disciplined. So we didn’t pursue ones that didn’t make sense for our existing shareholders, but we also bought back a significant portion of our shares in the open market. And we brought our share count from, I think, it was north of CAD46 million when we completed to Savannah down to CAD42 million and change. So we’ve shrunk our share count. We paid back a lot of debt. To me, that’s straight to the shareholders. And we continue to work to try and take advantage of opportunities that will come.

So really, this last downturn was probably the most severe just given the unique nature of the lockdowns. But we’ve been through quite a few over the last 25 years. And really what it does is just reinforce our core principles of being prudent, not getting too excited when times are good and putting some money away and not jumping off a bridge when times are a little bit rough.

Ernest Wong — Baskin Wealth — Analyst

Thanks a lot. Good luck.

Daniel Halyk — President & Chief Executive Officer

Thank you.

Operator

[Operator Instructions] Our next question comes from Patrick Tang of ATB Capital Markets. Please go ahead.

Patrick Tang — ATB Capital Markets — Analyst

Wondering if you could provide some commentary regarding leading-edge pricing across Total business segments. Specifically, are you seeing any net pricing gains after considering cost inflation? And are these increases, if any, likely to drive margins higher in the coming quarters?

Daniel Halyk — President & Chief Executive Officer

So I would say yes and yes. You saw in Q4, I would call it a bit of a transition period. Every business is a little bit different. Our drilling rig, service rigs tend to be in the middle. Rentals tends to be the most exposed to spot, although probably service rigs and drilling rigs pretty close to that. Compression process, obviously, work that we secured earlier in 2021 hit the floor in Q4, so you have a bit of a lag. Generally, across the board, we are increasing prices, and that’s absolutely essential. You can see the cost creep. And my simple perspective and message to all of our businesses if we can expand margins in a CAD100 oil environment, there’s something wrong.

Patrick Tang — ATB Capital Markets — Analyst

Okay. Thank you. So just looking at margins in the CPS business, you alluded to this a little bit. I mean they were down a little quarter-over-quarter. So 2-parter here. Can you provide some reason why this margin compression took place in Q4? Was it just largely on the mix of projects that was booked earlier in the year? Or was Total working through some other lower margin orders in the quarter?

Then is the margin implied in the current backlog at these lower levels? Or should we begin to see gross margins normalize pretty quickly here.

So definitely, the work that hit the floor in Q4 was work that was secured earlier in the year in a more competitive market. The other thing, as we noted in the press release, is we were expanding our productive capacity in Q4. As you can see by the backlog, we’ve had a tremendous increase in customer orders. And so obviously, last year, things were pretty quiet, but we have to gear up for much higher production activity in 2022, and there’s a cost to doing that, including we’ve just completed a move from a one lease shop to another here, a bit more efficient shop. So those are some costs baked in.

Cost inflation for sure, hit. But I would expect to gain, as Yuliya mentioned in her comments that you’ll see margins in that business improve over the course of 2022, both through improved pricing as well as when you have more production activity, you tend to have more efficiencies and cost overhead absorption. So we would expect margins to trend higher this year. Awesome. That’s all I had. I’ll turn it back. Thank you.

Daniel Halyk — President & Chief Executive Officer

Thank you.

Operator

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

Daniel Halyk — President & Chief Executive Officer

Thank you all for participating in our conference call, and we look forward to speaking with you after our first quarter results. Have a pleasant weekend.

Operator

[Operator Closing Remarks]