Total Energy Services Inc. (OTCPK:TOTZF) Q2 2022 Earnings Conference Call August 9, 2022 11:00 AM ET
Company Participants
Daniel Halyk – President and Chief Executive Officer
Yuliya Gorbach – Vice President, Finance and Chief Financial Officer
Conference Call Participants
Cole Pereira – Stifel
John Gibson – BMO Capital Markets
Tim Monachello – ATB Capital Markets
Operator
Thank you for standing by. This is the conference operator. Welcome to the Total Energy’s Second Quarter Conference Call and Webcast. As a reminder, all participants are in a listen-only mode and 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
Thank you. Good morning, and welcome to Total Energy Services second quarter 2022 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 three months ended June 30, 2022, and then provide an outlook for our business and open up the phone lines for any questions. Yuliya, please proceed.
Yuliya Gorbach
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 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 security 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, 2022, reflect the continuous recovery of global energy industry, particularly North America. Higher North American activity and the reactivation in late 2021 of two Australian drilling rigs that were out of service during Q2 2021. [indiscernible] recertifications and upgrades contributed to significant year-over-year improvement in Total’s second quarter financial results.
Net income of $6.1 million, represents Total’s fourth consecutive profitable quarter and a substantial improvement from the $2.1 million net loss incurred in Q2 of 2021. Second quarter consolidated EBITDA increased 46% from $19.7 million in Q2 2021 to $28.8 million in the second quarter of 2022. Excluding $8.1 million of COVID-19 relief funds received in 2021, second quarter EBITDA increased 148% on a year-over-year basis.
By business segment, compression and process servicing generated 52% of 2022 second quarter consolidated revenue, followed by contract drilling services at 28%, Well Servicing at 13%, and Rentals and Transportation Services at seven 7%. In comparison for the second quarter of 2021, The CPS segment contributed 40% of consolidated revenue, Contract Drilling Services 30%, Well Servicing 23%, and the RTS segment contributed 7%.
While reported second quarter consolidated EBITDA increased 46% in 2022, as compared to 2021, EBITDA increased by 170% after adjusting to exclude COVID-19 relief funds and unrealized foreign exchange gains on translation of intercompany working capital balances, resulting in adjusted quarterly EBITDA margin of 16% as compared to 12% in the second quarter of 2021.
Consolidated second quarter gross margin, excluding COVID-19 funds was 4 percentage points lower as compared to Q2 2021. This was primarily due to increased CPS contribution to consolidated revenue, which historically had lower margin percentages. Excluding COVID-19 relief funds, gross margin as a percentage of revenue improved to 21% for the second quarter of 2022, as compared to 17% in Q2 of 2021.
Selling, general and administration expenses for the second quarter of 2022 increased by $4 million or 67%, compared to Q2 of 2021 as increased compensation was reinstated to pre-COVID levels. Higher profit based employee compensation was recognized in certain segments and no COVID-19 funds were recorded during the quarter, compared to 0.8 million of COVID-19 relief funds received in Q2 of 2021.
The improvement in North American drilling activity and the reactivation of two Australian drilling rigs contributed to a 70% year-over-year increase in the second quarter, Total operating drilling days in CGS segment. This combined with a 13% increase in revenue per operating day, resulted in a 92% year-over-year increase in second quarter CDS segment revenue. This increase in revenue was partially offset by cost inflation and the lack of COVID-19 relief funds in 2022, resulting in second quarter CDF segment EBITDA increasing by 87% as compared to 2021.
Increased industry activity and market share gains contributed to a 79% increase in second quarter Canadian operating days. Price increases and the mix of equipment operating contributed to a 36% year-over-year increase in second quarter Canadian drilling revenue per day, which underpinned a 144% year-over-year increase in CDS’ second quarter Canadian revenue.
Improving industry conditions and market share gains in the United States contributed to a 49% year-over-year increase in second quarter operating days and 25% increase in drilling revenue per day, which in turn drove 86% year-over-year increase in second quarter U.S. drilling revenue.
Second quarter operating business really increased by 95% compared to 2021 as two rigs returned to service following completion of recertifications and upgrades. This contributed to a 41% increase in Australian second quarter drilling revenue, although revenue per day decreased due to extended wet weather conditions in 2022, that resulted in lower standby rates being received on several [revenues] [ph]. 7:45 **
Improving North American industry conditions contributed to 75% increase in second quarter equipment utilization and a 122% increase in second quarter revenue in RTS segment. Segment EBITDA increased at a lower rate than revenue due to equipment reactivation costs and operating cost inflation. The absence of COVID-19 relief funds in 2022 also contributed to a lower year-over-year second quarter EBITDA margin in the RTS segment.
Second quarter revenue in total CPS segment increased by 176% as compared to 2021. This segment saw a seventh consecutive quarterly increase to its fabrication sales backlog, which was 216 high on a year-over-year basis and marginally higher on a sequential and quarterly basis.
Strong natural gas prices provided tailwinds for the CPS’ segments, parts and service and rental business lines. With second quarter utilization of the compression of rental equipment fleet increasing by 15% as compared to 2021. CPS segment EBITDA for the second quarter of 2022 increased by 95% on a year-over-year basis. With high production levels and improved pricing with a substantial completion in prior quarters of legacy orders received when industry conditions will be favorable, CPS segment operating income margins improved significantly in the second quarter of 2022.
However, the absence of COVID relief funds in 2022 resulted in a year-over-year decrease in second quarter CPS’ segments EBITDA margin. Second quarter revenue increased by 21% in our Well Servicing segment as compared to 2021, underpinned by a 17% increase in service hours and a 3% increase in revenue per service hour.
The increases in revenue per service hour in Canada and the United States were offset by decrease in Australia as extended weather conditions resulted in a lower standby rates being received for several rigs. Second quarter EBITDA and EBITDA margin decreased in Well Servicing segment, as compared to 2022 as price increases were offset by cost inflation and the absence of COVID-19 relief funds in 2022.
Total Energy’s financial and liquidity position remains very strong. During the second quarter of 2022, Total repaid $10.7 million or 6% of bank debt and repurchased [indiscernible] common shares under company’s normal course issuer bid at a total cost of $2.4 million. Total net debt position at June 30, 2022 was $43.7 million and is the lowest since we completed the acquisition of Savanna in June of 2017.
Total currently has 125 million of credit available under its 225 million of available credit facilities. Total Energy’s bank covenants consist of a maximum senior debt to trailing 12-month bank defined EBITDA of 3x and the minimum bank defined EBITDA to interest expense of 3x. At June 30, 2022, company’s senior bank debt to bank EBITDA ratio was 0.72, and the bank interest coverage ratio was 22.74x.
Daniel Halyk
Thank you, Yuliya. We are pleased with our second quarter results, while economic uncertainty and commodity price volatility contributed to negative equity market conditions in the latter part of the second quarter, energy industry fundamentals remain strong and underpinned our fourth consecutive profitable quarter.
Despite significant supply chain challenges, cost pressures, and the absence of COVID relief, our financial results for the second quarter of 2022 improved both on a sequential quarterly and year-over-year basis. Oil and natural gas prices remain relatively strong. Notwithstanding continued global economic and political uncertainty, following several years of industry under investment, the near-term outlook for activity levels is positive.
While many producers remain constrained in their activity relative to prior periods of similarly high commodity prices, capacity attrition within the global energy service industry has contributed to improving market fundamentals in all of Total’s business segments.
In this environment, Total’s Board has approved a $14.1 million increase to the company’s 2022 capital expenditure budget, which now stands at $56.2 million. $10 million of this increase will be directed towards continued equipment upgrades and new equipment purchases in the CDS, RTS, and Well Servicing segments.
The remaining $4.1 million relates to capital lease obligations for light duty vehicles for deployment in all business segments. After funding the remainder of our capital budget, given current market conditions, continued debt repayment and share buybacks remain attractive opportunities to direct a significant cash flow we expect to generate for the remainder of 2022.
We also continued to evaluate targeted capital investments, as well as industry consolidation opportunities and will pursue any that meet our investment criteria. As we look forward to a busy second half of the year, I would like to thank all of our employees for their continued focus and commitment to conducting our operations in a safe and responsible manner.
I would also like to acknowledge our General Counsel, Cam Danyluk, who will be leaving Total to pursue a new career opportunity with an oil and gas producer. On behalf of the Board of Directors and employees of Total Energy, I’d like to thank Cam for his excellent service over the last 11.5 years and look forward to working with him in the future as a customer.
I would now like to open up the phone lines for any questions.
Question-and-Answer Session
Operator
Thank you. [Operator Instructions] Our first question comes from Cole Pereira of Stifel. Please go ahead.
Cole Pereira
Hi, good morning, everyone. So, the CPS segment obviously looked very strong. So, there is that 7 million of contract cancellation revenue, but was there anything else one-time or lumpy in there or absent the cancellation fee, is Q2, sort of a reasonable run rate for that business going forward?
Daniel Halyk
Yes. And the cancellation revenue is simply the realization of a contract, so to back that out is not – that would be not reflecting the normal operations. It was simply a contract that – or contracts that were not completed, but the payments reflected the terms of the contract, as well as there’s costs associated with those contracts.
Cole Pereira
Okay. Got it.
Daniel Halyk
It reflects a normal improving market compression and process equipment.
Cole Pereira
Okay, got it. And then you kind of touched a little bit on it, but so was the cancellation just driven by a change in customer terms or if you could give any color there that would be helpful. We’re not inclined to discuss specific contracts in any detail. The bottom line is, we noted it simply, I guess, because we have to, but the reality is, you know the payment simply reflected amount sowing under contracts that were terminated prior to completion and delivery of the final goods. There’s nothing special about it.
Yuliya Gorbach
Very much normal, Cole.
Cole Pereira
Okay, got it. Thanks. And so, it sounds like pricing is moving up across all business lines. I mean, is there anyone in particular that might be moving up ahead of the others?
Daniel Halyk
Again, it’s a pretty active spot market. And so, I’d be hesitant to say much in particular as we’re currently in all divisions working to get our margins up. And so, what I would say generally is the supply demand dynamics in all four business segments have been steadily improving and supporting price increases and we’re, as you’re well aware, Cole, the last few years have not been sustainable pricing and we’re finally starting to see some material traction in restoring sustainable pricing to our business.
Cole Pereira
Okay, got it. Thanks. And on the M&A front, I mean, any meaningful changes from your prior view that might make transaction more likely? I mean, have you seen valuation expectations narrow or anything of that nature?
Daniel Halyk
Yes. The biggest challenge right now for us on the M&A front is our cost of equity. And we judge investment opportunities relative to our cost of capital, which when your cost of equity is very high, that makes it challenging. It’s all relative to a certain extent. So, we’ve been quite active in receiving and evaluating opportunities. Several have not proceeded due to non-financial considerations, but I would say high level, Cole, we’re big believers in the industry consolidation and we’ll continue to try and do that on a basis that works for our owners.
Cole Pereira
Okay, great. That’s all from me. Thanks. I’ll turn it back.
Daniel Halyk
Thanks, Cole. Our next question comes from John Gibson of BMO Capital Markets. Please go ahead.
John Gibson
Good morning all and congrats on the strong quarter here. I just wanted to, kind of lead off with Cole’s questions on the CPS segment. Nice to see the big jump in margins. I’m just wondering if it’s a good run rate to think about going forward or will the one-time item, sort of impact things going forward a little bit as well?
Daniel Halyk
Yes. Again, we’re hesitant to give forecasts. I would say generally, but I thought we did a pretty good job in Q1 telegraphing that you shouldn’t read too much negative into those as we’re wrapping up pretty competitively bid projects that we would start to see margins improve. And Q2 definitely started to see that and we’re going to continue to work hard to be competitive, but also get our margins up.
So, I think you’re going to continue to see barring any material industry downturns progress on all fronts to restoring sustainable pricing.
John Gibson
Got it. Thanks. Moving to the drilling side, can you give any sense of rig additions in the back half of the year and into 2023, particularly I think North America just given the increase to your capital program?
Daniel Halyk
So, we’ve been steadily upgrading rigs, particularly in Canada. We also obviously did some in Australia here that went back. We’re currently running more rigs in Canada than we did at any time in Q1. We expect that to continue to trend up as we go into the fall winter season. The higher capacity rigs are effectively sold out. We’ve been steadily doing select upgrades to increase our, I’d call it deeper capacity, higher pressure rig fleet and that’s part of our CapEx increase.
On the U.S. side, we’re closing in on becoming fully sold out of marketable rigs. And so, at some point, there’ll be not much to do there other than perhaps look at relocating equipment, but given the strength in the Canadian market, I’m not sure we’re too inclined to do that. So, bottom line is, we’re definitely starting to see equipment shortages. Even on the single side, we’re, I think on our [TDS3000] [ph] side pretty close to sold out there. So, it’s becoming a tighter market for quality equipment for sure.
John Gibson
Thanks. I appreciate that color. And then last one for me. Just can you maybe touch on the labor market, any areas of strength or weakness across each of your business lines?
Daniel Halyk
Labor has been a challenge as we’ve ramped up, but we actually see things easing a little bit surprisingly. I think part of it is a function of, you know this industry has been very, very difficult, particularly in Canada for a long time, but we’ve had good steady work for several quarters now.
And I think just guessing that there’s a sense within the workforce, particularly experienced workers that left for other opportunities that we’re going to have a good run here and it seems to be attracting people back. So, again, it’s always our number one challenge, but we’re having reasonably good success attracting people and so we hope to continue to do that.
John Gibson
Okay, great. Again, I appreciate the color. I’ll turn it back.
Daniel Halyk
Thanks, John.
Operator
[Operator Instructions] Our next question comes from Tim Monachello of ATB Capital Markets. Please go ahead.
Tim Monachello
Hey, good morning, everyone.
Daniel Halyk
Good morning, Tim.
Tim Monachello
Most of my questions were answered, but I’m wondering if you can provide a little bit more detail or help quantify impact of the weather disruptions in Australia in the quarter?
Daniel Halyk
It was material. Our standby days were up materially and standby without crews, due to wet weather, which typically Q1 is your wet season in Australia. That extended well into Q2 and really substantively delayed a lot of drilling programs and production and completion program. So, it had a material impact on active drilling and active Well Servicing days. We’re seeing that abate a bit here, but I can’t predict the weather, but it had a material impact on the second quarter for sure.
Tim Monachello
So, Q3 is still somewhat impacted? What’s the right way to think of it?
Daniel Halyk
It seems to be abating. Again, all it takes is one good rain there to delay things, but it’s definitely abating thus far in July, August, but it did carry on a bit in July, but it seems to be abating here. So, knock on wood.
Tim Monachello
So, the base rates in Australia. Obviously, there’s a mix component there with standby revenues, but is it the right interpretation to think that the base rates are largely unchanged?
Daniel Halyk
For the most part, yes. We’re going into contract discussions and with cost inflation and that, but that’s go forward situation. The difference I think in Q2 versus Q1 even was more standby without cruise as opposed to standby with cruise, just simply was so wet that the operators just sent everyone home as opposed to waiting trying to move rigs.
Tim Monachello
Okay. And then my next one just on the CapEx increase. You must be getting a little bit more visibility in terms of outlook for activity, was the CapEx increase based on a view to the second half activity or more to 2023? And if you could just maybe provide an update to how your visibility has progressed?
Daniel Halyk
These are near term opportunities that are in direct response to specific opportunities that we will see commence in this year. And so, the last thing we want to do is start doing upgrades or acquiring equipment that shows up in the middle of February right in time for spring breakup. So, I’d call them rifle shot investments that are geared up towards better positioning us for what we see is a pretty busy winter coming up.
Tim Monachello
Okay, got it. And then last one for me. Can you just, I guess, update your capital allocation strategy as you go through the year? And I guess where return to shareholders fits into that in terms of increasing the dividend over the next 12 months or so?
Daniel Halyk
Sure. So, you know as I mentioned, we have a strong understanding and appreciation of our weighted average cost to capital and any investment we make has to achieve economic profit. That’s a substantial portion of the senior executive teams annual incentive compensation, which we have known that for a few years now, but hoping to get back.
So that’s the bottom line. And I think we’ve always been seen as being stewards of capital and we respect the fact it’s our owners capital not our capital. And so, if we can’t get economic profit with any degree of certainty, we were inclined to give that back to owners and not overcapitalize the business.
So, now we have both the dividend and share buybacks, given our current equity cost of equity share buybacks are certainly a pretty compelling opportunity for us to continue to deploy capital. And it also is sustainable in the sense that it’s discretionary. And so, we cannot put the company in a bad position by committing to things that we can’t fulfill in the medium-term to long-term.
Tim Monachello
In terms of that, I guess then, are leading edge opportunities meeting your threshold for returns?
Daniel Halyk
Yes.
Tim Monachello
Okay. That’s great. I appreciate it. I’ll turn it back.
Daniel Halyk
Thanks Tim.
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
Thank you everyone for participating in our call and we hope you have a good summer and look forward to speaking with you after our third quarter. Have a good week.
Operator
This concludes today’s conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.
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