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Operator
Welcome to the Total Energy's third quarter conference call and webcast. As a reminder, all participants are in listen-only mode and the conference is being recorded. After the presentation, there'll be an opportunity to ask questions. To join the question queue, you may press star then 1 on your telephone keypad. Should you need assistance during the conference call, you may signal an operator by pressing star and 0. I would now like to turn the conference over to Daniel Halleck, President and CEO of Total Energy Services, Inc. Please go ahead.
Daniel Halleck
Thank you. Good morning and welcome to Total Energy Services' third quarter 2022 conference call. Present with me is Yulia Gorbache, Total's VP Finance and CFO. We will review with you Total's financial and operating highlights for the three months ended September 30th, 2022. and then provide an outlook for our business and open up the phone lines for questions. Yulia, please proceed.
Yulia Gorbache
Thank you, Dan. During the course of this conference call, information may be provided containing forward-looking information concerning total 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 forward-looking statements due to a number of risks, uncertainties, and other factors affecting total businesses and the oil and gas service industry in general. These risks, uncertainties, and other factors are described under heading risk factors and elsewhere in total most recently filed annual information form and other documents filed with Canadian Provincial Securities Authorities that are available to the public at www.cedar.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 September 30, 2022, reflect the continued recovery of the global energy industry particularly in North America, Total Energy's third quarter results saw all business segments in all geographic areas return to profitability, which in turn contributed to record quarterly consolidated EBITDA, cash flow, and net income being achieved. Third quarter net income of $17.2 million represents Total's fifth consecutive profitable quarter, and a substantial improvement compared to $4.3 million net income in the third quarter of 2021. While reported 2022 third quarter consolidated EBITDA increased 57% as compared to 2021, EBITDA increased by 90% after adjusting to exclude $4.5 million of COVID relief funds received in 2021 and unrealized foreign exchange gains on translation of intercompany working capital balances, resulting in an adjusted quarterly EBITDA margin of 20% as compared to 19% in third quarter of 2021. By business segment, compression and process servicing generated 42% of 2022 third quarter consolidated revenue, followed by contract drilling services at 36%, while servicing at 14%, and grand trials and transportation services at 9%. In comparison, for the third quarter of 2021, the CPS segment contributed 32% of consolidated revenue, contract drilling services 36%, well servicing 21%, and RDS segment contributed 10%. Consolidated third quarter gross margin was four percentage points lower as compared to Q3 of 2021. This was primarily due to the increased CPS contribution to consolidated revenue, which historically has lowered gross margin percentages and no COVID-19 relief funds received in Q3 of 2022. Excluding COVID-19 relief funds, gross margin as a percentage of revenue was 24% for the third quarter of 2022. as compared to 25% in Q3 of 2021. Selling general and administration expenses for the third quarter of 2022 increased by $2.4 million, or 34%, compared to Q3 of 2021, as employee 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 third quarter of 2022, compared to 0.5 million of COVID-19 relief funds being received in Q3 of 2021. The improvement in North American drilling activity and pricing contributed to 39% year-over-year increase in third quarter total operating drilling days in the CDS segment. This, combined with 22% increase in revenue per operating day, resulted in a 71% year-over-year increase in third quarter CDS segment revenue. The increase in revenue per operating day in North America was somewhat upset by decrease in revenue per operating day in Australia as a result of lower standby rates being received during extended wet weather conditions. The year-over-year increase in operating days and revenue per operating day was somewhat offset the set cost inflation, and despite the lack of COVID-19 relief funds, resulted in the third quarter of CDS segment EBITDA increasing by 91% as compared to 2021. Increased industry activity, rig upgrades, and market share gains contributed to a 55% year-over-year increase in third-quarter Canadian operating days. Price increases and the mix of equipment operating contributed to a 40% year-over-year increase in third-quarter Canadian drilling revenue per day, which underpinned a 117% year-over-year increase in CDSS third-quarter Canadian revenue. Modestly improving industry conditions and market share gains in the United States contributed to 6% year-over-year increase in third quarter operating days and 37% increase in drilling revenue per day, which in turn drove a 45% year-over-year increase in third quarter drilling revenue. Third quarter operating days in Australia increased by 39% as compared to 2021 as two drilling rigs returned to service following the completion of recertification and upgrades. This contributed to a 4% increase in Australian third quarter drilling revenue, although revenue per operating day decreased year over year due to continued wet weather conditions that resulted in lower standby rates being received on several rigs. The RTS segment also benefited from improving North American industry conditions. A 31% year-over-year improvement in third quarter equipment utilization combined with a 19% increase in the revenue per utilized piece of equipment drove a 47% increase in third quarter revenue in RTS segment. This segment's leverage to high activity levels, given its relatively high fixed cost structure, was demonstrated by a 75% year-over-year increase in segment EBITDA and a 7 percentage point increase in EBITDA margin despite significant inflationary cost pressures and the absence of COVID-19 relief funds in 2022. Third quarter revenue in total CPS segment increased by 127% as compared to 2021. This segment saw an eight consecutive quarterly increase to its fabrication sales backlog, which was 107% higher on a year-over-year basis and 9% higher on a sequential quarterly basis. Strong natural gas prices provided tailwinds for CPS segment parts and service and rental business lines, with the third quarter utilization of the compression rental equipment fleet increasing by 19% as compared to 2021. CPS segment EBITDA for the third quarter of 2022 increased by 36% on a year-over-year basis. The absence of COVID-19 relief assistance and general operating cost inflation contributed to a 40% year-over-year decrease in the CPS segment's third-quarter EBITDA margin. Third-quarter revenue increased by 16% in our wealth servicing segment. as compared to 2021, underpinned by a 3% increase in service hours and a 12% increase in revenue per service hour. Increased activity in pricing contributed to a 6% year-over-year increase in third quarter segment EBITDA. Increases in activity and revenue per service hour in North America were partially offset by decreases in Australia as extended wet weather conditions negatively impacted utilization and resulted in lower standby rates being received for several rigs. Third quarter EBITDA margin decreased slightly in the well servicing segment on a year-over-year basis as price increases were offset by cost inflation and the absence of COVID-19 relief in 2022. Total Energy's financial position remains very strong. During the third quarter of 2022, Total repaid $10.7 million, or 7% of bank debt, and repurchased 304,652 common shares under the company's normal course, issued a bid at total cost of $2.2 million. Total net debt position at September 30, 2022 was $26.1 million and is the lowest since we completed the acquisition of Savannah in June of 2017. Total net debt decreased further in October when we used $13.3 million of cash on hand to voluntarily repay mortgage loan taken out by Savannah early 2017. Total currently has $135 million of credit available under its $225 million of available credit facilities. Total Energy's bank governance consists of maximum senior debt to trailing 12 months bank-defined EBITDA three times and a minimum bank-defined EBITDA to interest expense At September 30, 2022, the company's senior bank debt to bank EBITDA ratio was 0.61 and the bank interest coverage ratio was 24.82 times. Thank you, Yuliya.
Daniel Halleck
We are pleased with our third quarter results. Despite broader market uncertainty and continued commodity price volatility, Energy industry fundamentals remain strong and contributed to record quarterly results for total energy. Our ability to achieve record quarterly EBITDA, cash flow and net income during a quarter that is not typically the seasonally strongest quarter in Canada, and despite oil and natural gas producers remaining constrained in their capital programs relative to prior periods of similarly high commodity prices, is due to several factors. These include our increased international footprint, the significant contraction in energy service industry capacity over the past few years, and our leverage to improving North American industry conditions following the acquisition of Savannah in mid-2017 and subsequent realized annual synergies of approximately $23 million. This latter point reinforces our belief that further industry consolidation is both necessary and desirable. Of significance is the fact that for the first time in our 26-year history, and after returning over $260 million to our owners through dividends and share buybacks, on September 30, 2022, Total's retained earnings exceeded its paid-up share capital. This reflects our long-term track record of achieving industry-leading returns on invested capital and the fact that we have never recorded any capital asset impairments, including in respect of goodwill and the over 40 acquisitions that we have completed since 1997. Oil and natural gas prices remain relatively strong, and current indications are that North American industry activity levels will continue to moderately increase in the near to medium term. While Australian industry conditions have also improved, prolonged wet weather conditions have hampered field activity. In response to immediate opportunities to upgrade and redeploy equipment, Total has increased its 2022 capital expenditure budget by $7 million to $63.2 million, which includes $4.1 million of light-duty vehicle leases. Excluding capital leases, approximately $17.1 million of 2022 capital commitments remained outstanding at September 30th, which will be funded by cash on hand and cash flow. The pre-cash flow that we expect to generate over the remainder of 2022 and into 2023 will continue to be directed towards debt repayment, share purchases, and dividends. I would like to take this opportunity to welcome Jeremy Bush Howell to our senior leadership team. Jeremy was appointed Total's Vice President Legal and General Counsel in early October and joins us from a private oil and gas midstream company. Prior to entering the oil and gas industry, Jeremy practiced corporate and securities law with a large Canadian firm for eight and a half years and brings a wealth of legal and industry experience to our team. I would now like to open up the phone lines for any questions.
Operator
Thank you. We will now begin the question and answer session. To join the question queue, you may press star, then one on your telephone keypad. You will hear a tone acknowledging your request. If you are using a speakerphone, please pick up your handset before pressing any keys. To withdraw your question, please press star, then 2. We will pause for a moment as callers join the queue. Our first question comes from Cole Pereira of Stiefel. Please go ahead.
Cole Pereira
Morning all. On the M&A front, have things improved at all or are valuation expectations still a bit of a hurdle?
Daniel Halleck
I would say the biggest hurdle is the relative cost of capital, our relative cost of equity relative to private company expectations, if you know what I mean. It's tough for us to, you know, we measure everything against our cost of capital as well as, you know, the repurchase of shares. And right now the repurchase of shares ranks quite high.
Cole Pereira
Got it. That makes sense. How do you think about the dividend going forward? Obviously, free cash flow continues to improve. Do you review it annually? Do you review it on a more ad hoc basis? How do you think about that?
Daniel Halleck
Our board formally reviews it quarterly, so I won't speak for the board. Again, I think in the context of current market conditions, given the And it's not just a total issue, it's an industry issue. The equity valuations certainly put share buybacks quite high in our focus list. Also, we continued to aggressively pay down bank debt. We took out a variable rate mortgage that Savannah had taken out just months before we acquired them. With rising interest rates, the rate was... And so we wanted to minimize the prepayment penalty, which is typical in term debt like that. So we took that out in October. And the only debt that Total had prior to Savannah was the mortgage debt, which is fixed until 2022. at 3.1%, so we're not too worried about that. And then obviously our revolving credit facilities, our variable rates, those have been coming up but still are quite attractive on an after-tax basis, but we continue to pay it down. So again, our board reviews dividends quarterly and You know, I think our track record of returning capital, the shareholder speaks for itself. We've distributed, I think we're closing in on $6 a share in dividends. That includes trust distributions over our history. So that'll continue to be an important part of the mix.
Cole Pereira
Got it. And some of your competitors have talked about how high spec rigs in Canada are fully booked through the winter drilling season. Obviously, you know, with those booked, that should put more demand into the double category, which you have a lot of. Can you just talk about the pricing and activity outlook for those rigs in your fleet in the next year?
Daniel Halleck
Yeah, so obviously, you know, we've been targeting some rig upgrades, reactivations here. Also, you know, equipment and other business lines are rental and transportation and well servicing. You'll see the full impact of our 2022 capital budget in Q1 of 23. You know, we have done a lot of work to enhance the capability of our double fleet. And, you know, if you wanted a high spec double today, good luck. We continue to have rigs that will roll out into Q1 and as well as other equipment. And, you know, we expect... that you'll see some decent returns on the incremental capital that we put to work there. Pricing is definitely going in the right direction. It's not at new build economics yet, but we're not spending anything close to new build to upgrade and reactivate certain equipment.
Cole Pereira
Okay, perfect. And just quickly on the compression business, can you talk about how we should be thinking about margins in that business over the next few quarters?
Daniel Halleck
you know, gas prices hold, they'll go up.
Cole Pereira
Perfect. That's all for me. Thanks. So I'll turn it back. Thanks. Cool.
Operator
Our next question comes from Tim Monticello of ATB Capital Markets. Please go ahead.
Daniel Halleck
Morning, Tim. You're on mute.
Tim
I am on mute. Sorry. I've been talking for a while. Cool. Asked most of my questions, but I guess just to follow up, given just the breadth of your operations in North America, I'd be really interested to hear your perspective on industry activity into 2023, where you think you can see, you know, I guess where you're most optimistic across your business lines and where you think it might be some challenges.
Daniel Halleck
I'm bullish on North America. I just think the underinvestment on the supply side is rapidly catching up. I've been saying this for three years. It's finally starting to manifest itself, but the devastation to the service side is also manifesting itself. We're seeing a lot of different markets, different equipment lines in short supply. And I'm not going to comment specifically for competitive reasons, but it's going to be a very interesting winter. And I think the fact that we were able to generate record quarterly numbers where industry activity is not even close to what it was in 2013, 2014, I think really reflects the the reality of the current market. It's a different market.
Tim
What are customers saying about their activity levels next year?
Daniel Halleck
Generally, they'll be higher. I think customers are being disciplined. We like discipline. We're trying to be disciplined, and for the most part, capital is much, much more disciplined, and that's resulting in a more balanced environment. As soon as you say things are different this time, you're probably cursing it, but I think there's a whole host of reasons I won't get into that suggest that you're not going to see the overcapitalization of the service sector to the same extent you have in previous cycles. And, you know, in certain areas, we're still working through that overcapitalization. But what I'm seeing this time that is fundamentally different than the last several cycles on the upswing is there are so many companies want to sell. They're tired. They don't want to put more capital at risk. And I also look at kind of the leadership within major players, and we're not getting any younger. You know, so it's a different time, and I think, you know, the next few years will benefit disciplined companies.
Tim
Okay. That's helpful. When you look at the rental segment, like margins are, you know, very strong this quarter. You know, at levels you haven't seen in a very long time, if ever. And obviously there's some operating leverage in that business. Is there, was there anything else that maybe was one time in the quarter or has the industry just hit a point where supply isn't leading demand and you're getting pricing power in that business for the first time in a long time? I'm just curious to understand the dynamic at play that pushed the margin so high in 18-3.
Daniel Halleck
So first of all, I'd say finally. You know, we've been working for many years, particularly on the Canadian side, to get reduce the fixed cost structure in that business. And historically, and I've, you know, over the years have said, historically, we've needed 20 to 25% utilization in that business to break even pre-tax. We've lowered that substantially, as you can see in our Q3 numbers, and that's all cost. The other thing I would say is historically, full utilization in that division is around 60%. that's just the nature of the equipment. You know, you're constantly turning things around and cleaning, fixing, you know, so our break even now is probably in that, um, 15% range or bit less and full on is 60. Now there'll be certain lines of equipment. We'll never hit full utilization, you know, in the next while, but there's also lines that were short. And so I think our, our team there has done a good job, um, relocating equipment within North America to enhance utilization and also ensuring that equipment that's in short supply drives utilization of equipment that's more plentiful. In other words, you want this unit, you've got to take that unit and not get it for $2 a day less from someone else. And so, you know, our footprint's big, but we've done a good job of reducing the fixed overhead structure and the leverage to higher activity, as Yulia mentioned, is most significant in that business. So as we see continued increasing activity, you can expect to see improving bottom line results.
Tim
Great to hear. The capital program focused on some upgrades. I think I saw that – I don't have the press list in front of me, but, you know, rental is involved in the upgrade program. I guess just broadly speaking, can you speak about, you know, the amount of upgrades or, I guess, high return growth opportunities you have across your segments? And I guess a preliminary view on how your go-forward upgrade program could look compared to what you're dealing with in 2022. Yeah.
Daniel Halleck
So first of all, I would say you will see the full impact and benefit of our 2022 capital program in Q1 of 23. And the beauty of our capital program, including the $7 million increase we just announced, it's similar to our business diversification. It's very broad. It's across primarily, you know, drilling, rentals and well servicing and encompasses many jurisdictions. These are rifle shot investments in equipment that will go to work immediately upon completion. Like I said, our owners will see the full impact of that in Q1. In regards to 23 capital budgets, we have a board meeting just prior to your conference in Toronto, so that'll be out. You know, we truly started zero on CapEx, and so we'll have a zero-based budgeting process, and, you know, we'll invest in appropriate opportunities, and so stay tuned on that. But our focus right now is executing, completing on our 2022 program and ensuring we reap the benefits of that opportunity
Tim
I'm sorry to dig into this, but I'm just not wrapping my head necessarily around what an upgrade in the rental space would look like, and is that on a speculative basis, or do you have customers coming up to you saying, no, I need one piece of rental equipment, but it's not hitting the specifications I need?
Daniel Halleck
A typical upgrade in the rental situation would be refurbishing a well site trailer, for example. Something that someone has to live in. There's lots of different things. You've got a generator that needs a new engine. Yeah, and expand higher margin lines of equipment. But stuff like that, again, very broad, rifle shot, Basically, as soon as the equipment's ready, it goes to work. And what we're seeing is just a lack of certain lines of equipment. Again, particularly equipment with moving parts or engines. You know, we pulled a lot of our heavy trucks off the fence here in the last bit. There will be a trucking shortage this winter. I can almost guarantee you that. And the returns are not there for us to reinvest in buying new trucks. But that industry is going to be very challenged this winter. You're already seeing them try and get a rig moved in West Texas. There's lots of delay.
Tim
So when you think about the industry and given your breadth of exposures, Where do you see the biggest constraints in service supply?
Daniel Halleck
I can't comment for competitive reasons. Okay. But we're definitely – our capital program is targeting those areas.
Tim
Okay. And the last one for me – I was just trying to push this button again. Nicole kind of asked it, but – it seems that you've got a lot of capacity to increase the dividend. You've been working on the share purchase program. Is there a level or a guidepost you're looking at for when a valuation stock is, or your capital priorities change from, you know, share purchase to dividends on the increment?
Daniel Halleck
Yeah. So I, you know, I don't speak for the board. There's six of us, you know, my own perspective is anytime you can buy assets for pennies on the dollar, good assets that you know intimately I'm all in on that and you know where we're trading at a pretty small percentage of our book equity and where we've consistently over many many years including through some pretty challenging times here recently of book gains on disposal of older equipment to me those are historical opportunities and so You know, at current valuations, share buybacks are pretty compelling. You know, as your cost of equity is reduced, you know, that will help shift things to acquisitions, to dividend increases. But we've always been, you know, strong supporters of dividends. You know, at the end of the day, it's our owner's money. And if we can't put the capital to work, you know, into opportunities that will generate a return above our cost of capital over the medium to long term, give the money back. We firmly believe that. You know, in conversation with some of our larger shareholders, they're very much of the view that share buybacks are pretty compelling in this environment, which would be consistent with my personal view. Got it.
Tim
All right. Appreciate all the details, though.
Daniel Halleck
But dividends are nice, too, and so... you know, it's a major shareholder. I appreciate that as well.
Operator
Once again, if you have a question, please press star, then one. Our next question comes from Prem Kumar, private investor. Please go ahead.
Prem Kumar
Good morning, Dan and Yulia. Congratulations on your quarter. And I just wanted to thank you for your capital discipline throughout the cycle. I'm glad to be a investor in the company and a part owner. I have two questions. Thank you for your confidence in us. Thank you. And I have two questions. You've touched base on both of them slightly, but I'd still like to ask them. First one is the utilization in CDS and RTS segments, particularly in Canada is still quite low. Can you give your thoughts on this and also plans to increase the utilization? I definitely appreciate that. I know you've brought the cost of the segments down to, as you mentioned in RTS, below 15% utilization, but just wanted to hear your thoughts on plans to increase the utilization itself.
Daniel Halleck
Sure. So good question. I think, Prem, I'll start with the drilling segment. So when we acquired Savannah, they had 101 drilling rigs, and we had 18, so 119 in total. We're down to, what, 95? Yeah. So we've decommissioned and basically scrapped a lot of rigs that we believe would never go back to work. The remaining fleet are rigs that could go back to work, but, for example, in Canada, there would be 15... rigs that are CT1500s. So they're coil units that were built, first of all, to drill coal bed methane. And they were very active. When we had a rig count of 650 and a well count triple of what we've got now, those rigs were working in southern Alberta drilling coal bed. That hasn't happened for several years now with gas prices. Those rigs ended up going coring in the oil sands. That is rapidly, that is significantly dropped as well. And so, you know, just backing out those 15 rigs, you look at our utilization, it's materially higher. Now, we could pull those out of the CODC registration. You know, my view is they're out there, they're available to go to work. The reality is... The markets that they're playing in are quieter right now, but we're also looking at opportunities to deploy them outside of Canada. Our philosophy is you don't quit. You don't hide stuff if it's capable of working. There probably will be over the next while determinations to decommission more rigs, but we're also not going to cut the price just to put them to work. And so you can't force those things. You've got to let the market come. Interestingly, we will have one of those rigs go to work this winter for coal bed methane. So you're starting to see some of those markets reopen. And again, if you try and force it, you end up losing a lot of money and incinerating owner's capital. And so we're not going to force it. We'll let the market come. And we'll also look at opportunities to redeploy We also have upgraded a bunch of rigs to basically increase their marketability and capacity, but we'll only do that if it makes sense. So I'm quite comfortable with how our drilling group is managed. And like I said, our focus is on return on capital, not utilization. It always has been. I'd rather make more money working less than work really hard and make no money. And so that's kind of the rig side. On the rental side, again, kind of a similar story. You know, with the well count way down, you just have less equipment needed. Now, within that, and for competitive reasons, I won't break it down, there's certain lines of equipment that we're out of. There's also certain lines of equipment that are, we'll never have to build another one. You know, we have enough forever. And so those will be pieces of equipment as they wear out. Their net book values are zero. We'll sell them for scrap metal and make a gain. And over time, your utilization will go up by attrition. But again, our carrying values right now are pretty low on that stuff. And the beauty is we leave them in a condition that they can go to work when needed. And we're not going to put more money refurbishing equipment that we have lots of. And so that'll naturally over time just take care of itself. But also, you know, the reality is full utilization, our rental business, like the best years we've ever had, you know, we would have barely cracked 60% utilization. That's just the reality of that business. You're constantly moving, fixing, repairing, cleaning. I can tell you if we get half the way there, that division will perform exceptionally well. Okay, perfect. Did that answer your question?
Prem Kumar
It did. Thank you. Thank you, Prem. The second question that I had is on cost of equity, and you touched on this a bit today. So clearly the cost of equity is quite high considering how low low the market cap is compared to the free cash flow generation capacity of the company. I understand that you have a 5% NCIB going, but what are your thoughts on doing more aggressive buybacks, going beyond that 5% maybe even?
Daniel Halleck
Again, that's a board discussion, but certainly one factor that would weigh in favor of that is the intention of the federal government to tax buybacks. You know, again, you know, our preference is to grow, not shrink. But the reality is in 26 years, I've never seen a market valuation like we've seen here. And, you know, so you have to adjust your thinking and your perspective to reflect the reality of what you're facing, not what you hope or wish. And so, like I said, that's a board decision. But, you know, share buybacks are certainly – quite high on our list of good opportunities to spend your money.
Prem Kumar
I agree with that. Thank you.
Daniel Halleck
Thank you.
Operator
This concludes the question and answer session. I would like to turn the conference back over to Mr. Halleck for any closing remarks.
Daniel Halleck
Thank you for participating in our discussion. Third quarter conference call, and we look forward to speaking with you after our year end. Have a great day.
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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