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Edited Transcript of TOT.TO earnings conference call or presentation 8-Nov-19 4:00pm GMT

Q3 2019 Total Energy Services Inc Earnings Call

CALGARY Nov 9, 2019 (Thomson StreetEvents) -- Edited Transcript of Total Energy Services Inc earnings conference call or presentation Friday, November 8, 2019 at 4:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Daniel Kim Halyk

Total Energy Services Inc. - President, CEO & Director

* Yuliya Gorbach

Total Energy Services Inc. - VP of Finance & CFO

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Conference Call Participants

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* Aaron MacNeil

TD Securities Equity Research - Analyst

* Daine Biluk

CIBC Capital Markets, Research Division - Associate

* David P. Vanderwood

Burgundy Asset Management Ltd. - SVP, Portfolio Manager and Director

* John Mark Bereznicki

Canaccord Genuity Corp., Research Division - Analyst of Oil and Gas

* Josef I. Schachter

Schachter Energy Research Services Inc. - Author & President

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen. Welcome to the Total Energy Services Inc., Third Quarter Results Conference Call. (Operator Instructions)

I would now like to turn the meeting over to Mr. Daniel Halyk. Please go ahead, Mr. Halyk.

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Daniel Kim Halyk, Total Energy Services Inc. - President, CEO & Director [2]

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Thank you, operator. Good morning, and welcome to Total Energy Services Third Quarter 2019 Conference Call. Present with me this morning is Yuliya Gorbach, Total's Vice President, Finance and Chief Financial Officer. We will review with you Total's financial and operating highlights for the 3 months ended September 30, and then provide an outlook for our business and open up the phone lines for any questions.

Yuliya, please proceed.

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Yuliya Gorbach, Total Energy Services Inc. - VP of Finance & CFO [3]

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Thank you, Dan. During the course of this conference call, information may be provided containing forward-looking information concerning Total's projected operating results, anticipated capital expenditure trends and projected drilling activity in the oil and gas industry. Actual events or results may differ materially from those reflected in Total's forward-looking statements due to a number of risks, uncertainties and other factors, affecting Total's 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 securities authorities that are available to the public at www.sedar.com.

Our discussions during this conference call are qualified with reference to the financial highlights contained in the news release issued yesterday. Unless otherwise indicated, all financial information in this conference call is presented in Canadian dollars.

Total Energy's financial results for the 3 months ended September 30, 2019, reflect continued difficult industry conditions in Canada and reduced production activity in our Compression and Process Services segment, offset by relatively stable industry conditions in the United States and Australia.

By business segment, Compression and Process Services contributed 42% of 2019 third quarter consolidated revenues; Contract Drilling Services, 28%, Well Servicing 21%; and Rentals and Transportation Services 9%. Year-to-date, the CPS segment contributed 64% of consolidated revenues; Contract Drilling, 21%; Well Servicing, 17%; and RTS, 8%.

Geographically, 42% of third quarter revenue was generated in Canada, 34% in the United States, 20% in Australia and 4% from the rest of the world. Year-to-date, 40% of revenues came from the United States, 39% from Canada, 20% from Australia and 1% from the rest of the world.

Within our Contract Drilling Services segment, an approximate 33% year-over-year decline in Canadian drilling activity, as measured by industry's operating days, resulted in lower third quarter revenues and operating loss as compared to operating income in Q3 of 2018. Despite a 14% decline in third quarter operating days compared to 2018, improved day rates and increased operating efficiencies resulted in continued bottom line improvement in our U.S. drilling operations.

Sequentially, from Q2 2019, the operating loss within our U.S. drilling business decreased by 60% as a result of cost management and completion of government optimization projects, the cost of which were primarily expensed in prior quarters.

In October, our U.S. drilling subsidiary received $17.6 million as a compensation for the early termination of certain rig contracts in 2017. This payment will be recorded as revenue in the fourth quarter of 2019. While utilization in Australia was 4 percentage points lower than in Q3 2019, revenue per operating day in Australia was higher in Q3 of 2019 as compared to Q3 of 2018, due to marginally higher rates, that were partially offset by lower camp and other ancillary revenue. Operating income for the third quarter in our Australian drilling business was $0.3 million lower than prior year comparable quarter, due primarily to weakening Australian dollar relative to the Canadian dollar over past year.

For the first 9 months of 2019, 36% of Contract Drilling revenue came from Canada; 33% from the United States; and 31% from Australia. The substantial year-over-year decline in Canadian industry activity also contributed to a 44% decline in third quarter revenue in Canada for our Rentals and Transportation Services segment. This decline was offset by a 71% increase in United States revenue as we continue to relocate underutilized equipment from Canada to the U.S. market and made targeted investments in new equipment.

On a consolidated basis, third quarter RTS segment revenue decreased 20% compared to prior year comparable period. Third quarter revenue per utilized rental piece in RTS increased 10% from 2018 due to the mix of equipment operating as well as high realized pricing on equipment relocated from Canada to the United States. Year-to-date, 38% of RTS segment's revenue was generated in the United States as compared to 20% for the first 9 months of 2018.

During the third quarter, management conducted a review of depreciation estimates within the RTS segment, most of which were made over 20 years ago when we commenced operation. Generally speaking, we determined that our previous estimates as to the useful life of rental equipment were too short, but their estimated salvage values were too high. There were no changes to our depreciation estimates related to heavy trucks and trailers. Accordingly, effective July 1, 2019, we changed our depreciation estimates within RTS segment, and as a result, the RTS segment recorded onetime depreciation expense of $7.9 million in respect of now fully depreciated assets as well as $1 million of incremental recurring depreciation expense.

The RTS segment also incurred $0.5 million of relocation expenses during the third quarter as we continued to move underutilized equipment from Canada to the United States. Excluding the relocation expenses and the onetime depreciation expense, the operating loss was $3.9 million for the third quarter of 2019 as compared to a loss of $0.6 million in the same quarter of 2018. If one considers the additional $1 million of recurring depreciation expense in Q3 of 2019 resulting from our estimate change, on an apples-to-apples basis, the year-over-year increase in operating loss was $2.3 million. During the third quarter, RTS segment acquired certain oilfield transportation assets operating in the United States for $2.3 million.

Within our Compression and Process Services segment, third quarter revenue for 2019 was $72.1 million, a 37% decrease compared to the third quarter of 2018. This segment exited the third quarter of 2019 with a fabrication sales backlog of $39.8 million, a $37.4 million decrease from June 30, 2019. The decrease in revenue and the sales backlog are a result of lower customer orders. While quoting activity remains high during the quarter, customers continue to be hesitant to make orders.

Third quarter revenue for our Well Servicing segment was $35.8 million, a 13% decrease from Q3 of 2018 and 11% year-over-year decrease in Canadian service dollars due in part to extended weather conditions and 14% year-over-year decrease in revenue for service dollar in Australia due to modestly lower pricing, lower camp and ancillary revenue and the weakening Australian dollar relative to the Canadian dollar over the past year were the primary factors contributing to the revenue decrease.

Total service hours for the third quarter were 42,210, of which 46% were in Australia, 43% in Canada and 11% in the United States. This compares to 44,447 service hours during the third quarter of 2018, of which 47% were in Canada, 43% in Australia and 10% in the United States.

Consolidated gross margin for the third quarter of 2019 was $36.9 million or 22% of revenue as compared to $48.6 million or 21% of revenue in the third quarter of 2018. Consolidated cash flow before changes in noncash working capital items was $24 million for the third quarter of 2019 as compared to $34.8 million of cash flow generated in the third quarter of 2018.

During the quarter, we invested significant capital into raw materials inventory in our CPS segment. This investment related primarily to major components that were previously ordered when factory deliveries at times exceeded 60 weeks. Our commitment to purchase inventory in CPS segment has peaked and will be significantly lower going forward until such time as we see meaningful pickup in orders. As such, at current production levels, we would expect to generate at least $40 million of additional cash flow during 2020, with the monetization of this inventory.

Consolidated EBITDA for the third quarter of 2019 was $24.9 million as compared to $34.6 million of EBITDA realized in Q3 of 2018. Excluding nonrecurring expenses, third quarter EBITDA for 2019 was $25.4 million.

During the quarter, Total Energy incurred a loss attributable to shareholders of $6.2 million or $0.14 per share as compared to $8.9 million of net income or $0.19 per share in Q3 of 2018. Excluding the $8.4 million of nonrecurring expenses incurred in the third quarter, net income attributable to shareholders was $0.3 million.

Total Energy financial conditions remain strong with $85.8 million of positive working capital after reclassifying $41.4 million of mortgage debt as current at September 30, 2019. We expect to renew such mortgage debt when it matures in April 2020 for a minimum of 5-year term.

During the third quarter of 2019, Total Energy returned $3.7 million to shareholders by the way of $2.7 million of dividends and $1 million of share repurchases under its normal course issuer bid. Total bank debt was $281.6 million at September 30, 2019, and our debt net of working capital was $165.9 million.

In addition to the regular monthly principal payments on $56.5 million of mortgage debt, year-to-date, we voluntarily repaid another $5 million of bank debt assumed with the acquisition of Savanna. Our bank covenants consist of a maximum senior debt to trailing 12 months bank-defined EBITDA of 3x, and a minimum bank-defined EBITDA to interest expense of 3x. At September 30, 2019, the company's senior bank debt to bank EBITDA ratio was [2.53], and the bank interest coverage ratio was 6.66x.

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Daniel Kim Halyk, Total Energy Services Inc. - President, CEO & Director [4]

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Thank you, Yuliya. Global economic uncertainty and resulting commodity and capital markets volatility continue to weigh on the capital expenditure budgets of North American oil and natural gas producers, particularly in Canada, where industry activity remained significantly below prior year levels. That said, the resilience of our business model continues to be demonstrated with the generation of free cash flow despite low activity and continued investment in equipment and inventory to support our various businesses.

As the current industry downturn enters its sixth year in Canada, the energy industry has been forced to become more efficient through downsizing, consolidation and the adoption of new technologies and methods of doing business. The challenges facing the Canadian energy industry, as evidenced by the tens of volumes of dollars of canceled investments, the exit of the some multinationals and the recent decision of a major Canadian producer to relocate to the United States, have been exacerbated by harmful government policies such as Bill C-48 and C-69. The outcome of the recent federal election suggests that these political and regulatory headwinds may continue until at least the next election. As such, we necessarily remain focused on the continued rationalization of Canadian operations and growing our business in the United States, Australia and elsewhere.

Never in our almost 24-year history has the majority of Total Energy's annual revenue been generated from outside of Canada. That could change in 2019 with approximately 61% of our revenue for the first 9 months of this year having been generated from outside of Canada. Of significance is the fact that the United States has now surpassed Canada as our largest market as measured by revenue, having accounted for 40% of year-to-date revenues. This is a considerable change from a mere 4 years ago when in 2015, less than 4% of our revenue came from outside of Canada. We expect this trend will continue until a change in Canadian federal energy policy occurs.

As difficult as this downturn has been, particularly for the dozens of companies that have not been able to weather the storm and the tens of thousands of Canadians who have lost their jobs, global demand for oil and natural gas is not going down, but continues to grow and is expected to do so until at least 2050. As such, demand for Canadian oil and natural gas, which has produced at the highest environmental and social standards, will only increase. The only question is whether Canada will continue to leave billions of dollars a year on the table as a result of its inability to access global oil and natural gas markets.

Well, there's plenty of doom and gloom, there are also reasons for cautious optimism in Canada. The fundamentals of the Canadian natural gas markets that have given rise to recent price increases and progress on increasing [egress] transportation capacity may provide much needed relief for the beleaguered Canadian industry in the not-so-distant future.

Total Energy Services is proud to be part of the energy industry as evidenced by our name. We remain committed to supporting our customers in all our markets by providing quality equipment, services and technologies that are essential to satisfying the world's insatiable demand for responsibly produced energy.

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

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question comes from John Bereznicki with Canaccord Genuity.

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John Mark Bereznicki, Canaccord Genuity Corp., Research Division - Analyst of Oil and Gas [2]

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So Dan, I'm not going to ask where your fabrication backlog sits today, but I was wondering if you could give us a sense of what you see right now in the compression market, both geographically and maybe between sales, rental and service?

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Daniel Kim Halyk, Total Energy Services Inc. - President, CEO & Director [3]

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What I would say, John, is the core activity remains very active. For competitive reasons, I'm not going to comment too much on geographies, but we've been working on many different bids, large and small. And I would expect -- I don't want to -- I'm not going to call bottoms, but definitely we're right in the mix. And there's a lot of projects going on around the world that we're right in the middle of, and so obviously, the bigger the project, the more time required to finalize and win a bid. But there's lots going on, so time will tell, but I would expect the world isn't ending.

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John Mark Bereznicki, Canaccord Genuity Corp., Research Division - Analyst of Oil and Gas [4]

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Got it. And in the third quarter, it looks like, obviously, you -- a decline in sales revenue, but the rental side was up. Is that just a function of capital constrained producers looking to rent a bit more either in Canada or U.S.? Or how would you see that?

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Daniel Kim Halyk, Total Energy Services Inc. - President, CEO & Director [5]

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Yes. We've definitely seen demand for rental equipment, I think, perhaps tighter capital markets explains part of it. Also we're continually expanding our footprint in North America beyond Canada, and we're seeing some pretty interesting opportunities even outside of the conventional oil and gas business. But also what we're seeing with particularly currently with kind of the resurgence of (inaudible) is some -- definitely some interest in shorter term gas production and consequential demand for rentals and parts and service support.

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John Mark Bereznicki, Canaccord Genuity Corp., Research Division - Analyst of Oil and Gas [6]

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Got it. And then just to shift gears here to Australia, I mean, it looks like that market's performing really nicely for you. And just further your previous comments of maybe growing outside of Canada, are there some levers there in Australia you can pull either in terms of expanding your current business lines or looking at something else there to grow in that market?

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Daniel Kim Halyk, Total Energy Services Inc. - President, CEO & Director [7]

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Yes. We see Australia as a very balanced market right now. I would say relative to 2 years ago, the supply demand dynamics have probably improved for natural gas. And so going forward, we would see that as an area that we'd like to grow our presence. We have a good strong presence in that market, not only in drilling and well servicing, but also gas compression, and we'd like to grow at least proportionately to the growth of the market and hopefully disproportionately.

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John Mark Bereznicki, Canaccord Genuity Corp., Research Division - Analyst of Oil and Gas [8]

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Got it. And then just one last housekeeping question. It looks like in the third quarter, your payables and deferred revenue declined sequentially and certainly declined from your historic trend. What was driving that? And where do you see that going, going forward here?

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Daniel Kim Halyk, Total Energy Services Inc. - President, CEO & Director [9]

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So Yuliya commented on it, John. About a year ago, lead times on major components within the CPS segment were 60 weeks plus. And so we were literally ordering major components over a year in advance of when we would receive them. Obviously, with the decrease in production here over the past several quarters, you've got these components coming in that are not immediately being packaged and sold. And so that, I would say, as Yuliya mentioned, our commitment to purchase inventory has peaked. It's going down significantly. You can see that in our MD&A under the commitments notes. The flip side is we've got a bunch of paid-for inventories sitting on our balance sheet that at current production levels is going to give rise to a very significant increase in our cash flow in 2020 as we just monetize that through building units and selling them at current production levels. So you're going to see quite a significant reversal, everything else being equal, in 2020, and we expect incremental of kind of your normal cash flows at least $40 million of excess cash flow at current production levels.

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John Mark Bereznicki, Canaccord Genuity Corp., Research Division - Analyst of Oil and Gas [10]

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Got it. So expect a pretty meaningful working capital harvest here in the coming quarters?

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Daniel Kim Halyk, Total Energy Services Inc. - President, CEO & Director [11]

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Absolutely, yes.

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John Mark Bereznicki, Canaccord Genuity Corp., Research Division - Analyst of Oil and Gas [12]

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Got it. Got it. And Yuliya was saying, sorry, I missed that.

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Daniel Kim Halyk, Total Energy Services Inc. - President, CEO & Director [13]

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And that's part of -- I was going to say that's part of our ability to -- when we were making these commitments well over a year ago, that gave us the ability to write up the demand wave because we were -- but we put our balance sheet to work, and now we're not obviously going to be ordering stuff, we don't need until we need it again. But having the balance sheet did allowed us to catch that wave and it's also going to allow us here to sit on a significant amount of the inventory -- good inventory, this is all engines, coolers, things that are in high demand. And -- but if you're a smaller group that doesn't have access to capital, it's a challenge.

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Operator [14]

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(Operator Instructions) The next question comes from Daine Biluk with CIBC Capital Markets.

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Daine Biluk, CIBC Capital Markets, Research Division - Associate [15]

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So despite the lower throughput on the compression business, margins held up fairly well in the quarter, how much of that was cost-cutting initiatives versus higher embedded margin work?

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Daniel Kim Halyk, Total Energy Services Inc. - President, CEO & Director [16]

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I think there's a few variables. Definitely, that division was very proactive, you can tell what's your production schedule looks like and so they manage their cost structure accordingly. And they've done a very good job of that. Also, the revenue mix, you're seeing the compression horsepower on rent go up. That's obviously a higher margin albeit higher capital business. So I think as that rental horsepower on rent keeps going up against lower fabrication sales, that's going to pull your margins up, but definitely the division's done a pretty good job of proactively managing their cost structure to reflect current production levels.

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Daine Biluk, CIBC Capital Markets, Research Division - Associate [17]

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Got you. Okay. That's good color. And sticking with compression still, one of your competitors highlighted that they're looking at a strategic alternative for their North American fabrication business. If that was to come to market, would it be something you'd be interested in acquiring? Or alternatively, if that business was scaled back, what would it mean from the opportunity/market share perspective?

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Daniel Kim Halyk, Total Energy Services Inc. - President, CEO & Director [18]

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Well, first of all, this is not the first competitor that's looking at strategic alternative, so I'm not going to comment specifically, but there's another fairly large one that recently made the same thing. I'm not going to comment or speculate on specific opportunities. What I would say, Dan, is this is illustrative of the fact that in this business, low cost wins. And despite us being quite a bit smaller than some of the big U.S. packagers, I would say, we're able to compete very effectively in the North American market, as I would say, we are one of the low-cost producers.

And so at the end of the day, we saw the rationalization of the compression industry occur in Canada a decade plus ago, and it's remained reasonably balanced since that time. I think you're going to -- it appears we're going to see that happen in the U.S. market and that will ultimately bring balance and more sustainable returns for the industry on a go-forward basis. So who does what exactly, time will tell.

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Daine Biluk, CIBC Capital Markets, Research Division - Associate [19]

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Right. Actually, that's good context. That's helpful. U.S. drilling was pretty strong in the quarter, and it looks like you put a couple incremental rigs to work sequentially. Any details you can share around those? Whether new customer wins? And fair to assume that those were all West Texas based?

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Daniel Kim Halyk, Total Energy Services Inc. - President, CEO & Director [20]

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Well, first of all, I've seen some commentary suggesting that we're kind of a niche player there, and we've been pretty open -- a number of our heavy double rigs have in fact displaced triples in West Texas and are drilling 20,000, 21,000-foot wells and doing those extremely competitively, both in terms of drill and tripping time, but equally importantly, move time, rig uptime. We're moving in a day and drilling versus 3, 4 days for a triple. We're also -- these are all walking rigs. And so the sense that somehow we're a niche player that's not competing in the heart of the Permian is just not correct. We also service the shallower end, and we've got some very good projects there that have been ongoing.

What you saw in the third quarter was the first kind of, I'd say, cleaner quarter where we didn't have any baggage from legacy contracts. We also -- when we took over Savanna, did a lot of work to restructure the, I would say, operational focus of the division, be proactive on rate maintenance as opposed to reactive, fixing in the shop is better than the field and that took time and money. But I'm very happy with the progress that's been made by our U.S. drilling group, and we expect that to continue going forward. Again, low cost wins, and at the end of the day, West Texas drillers operators are starting to realize that the biggest rig is not necessarily the most cost effective rig, and that's going to play very well into our fleet. And I expect that'll migrate up north here as well.

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Daine Biluk, CIBC Capital Markets, Research Division - Associate [21]

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Understood. Okay. That's helpful. Switching gears one more time, when you think about the supply-demand balance for rentals in Canada, obviously, that's not going to be balanced by higher demand at this point in time. But maybe thinking about the other side of the equation, are you seeing any signs that we could be in for an accelerated period of tightening supply from bankruptcies, equipment retirements, relocations and whatnot?

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Daniel Kim Halyk, Total Energy Services Inc. - President, CEO & Director [22]

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It's going to be very interesting. I think the Canadian industry would be extremely challenged to put 300 drilling rigs to work, both in terms of the rigs and the people and the surrounding equipment, and that used to be a regular summer 5 years ago.

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Daine Biluk, CIBC Capital Markets, Research Division - Associate [23]

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Right, yes.

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Daniel Kim Halyk, Total Energy Services Inc. - President, CEO & Director [24]

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You'll never -- we won't appreciate the damage that's been done to the Canadian service industry until we get to 250 to 300 rigs, and then I think that damage is going to be extremely apparent.

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Daine Biluk, CIBC Capital Markets, Research Division - Associate [25]

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Right. Okay. That's helpful. Last one for me. Any desire to enter new basins in the U.S. with some of the Rentals and Transportation equipment you're moving from Canada?

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Daniel Kim Halyk, Total Energy Services Inc. - President, CEO & Director [26]

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So we've -- what we're seeing is we're gaining market share there in a tightening market and that continues today. Our philosophy has always been steady, methodical, sustainable growth, and so we've been asked to move into other basins. We're pretty focused on establishing critical mass and scale within our core. We have in the past few months, opened a branch in West Texas, so that's new to us. But we're pretty focused on North Dakota down through the Rockies into West Texas. We do have opportunities we've been asked by customers to move elsewhere. Again, our focus right now, we don't have the equipment to do that. And so we'd have to make some major, I would just say, expenditures to move equipment again from Canada into some new areas. Our preference is to continue to support the growth and scale within our existing footprint, and we did supplement that with an acquisition in Q3 of a trucking company that was quite a nice fit. There were some circumstances there that made it quite appropriate for us to do that and again it reinforced our presence in a market that we're quite established in. And so I think that's -- our continuation would be building solid core before we start adding overhead.

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Operator [27]

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The next question comes from Josef Schachter with Schachter Energy Research.

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Josef I. Schachter, Schachter Energy Research Services Inc. - Author & President [28]

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On your balance sheet, you mentioned in the commentary, Yuliya, that you're going to renew the mortgage debt in April. How do you see the balance sheet in terms of your -- will you be picking up some money from the Savanna transaction, $17.6 million, do you see trying to strengthen the balance sheet? Are you looking at noncore asset sales, land, et cetera? And then the whole focus on it is having a stronger balance sheet or using some of that cash for your NCIB as you bought stock at $8.66 and now you're more like $6. How do you see the makeup going forward? Do you want to go balance sheet? Or do you want do a mix of them? How do you see the progress as we head at the year-end?

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Daniel Kim Halyk, Total Energy Services Inc. - President, CEO & Director [29]

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I think a bit of both, Josef. First of all, you can do the math, but the $17.6 million payment we received here in Q4 is going to be pretty significant, both from an EBITDA and the balance sheet perspective. So that's something that we have been working on for a while, and we didn't accrue. That's our -- tendency is not to accrue things until we collect them when they're unusual in nature, and so that will be gravy. The working capital inventory unwind that Yuliya and I discussed earlier is going to be a very significant event in 2020. And again not all depths equal. Our mortgage debt, Total Energy Services is sitting on a very, very large real estate portfolio. The book value is materially below market value. We had an appraisal done on our real estate back in 2015, that was substantially higher than the book value at that time. Since then we've added a bunch of real estate through the acquisition of Savanna and some other private transactions along the way.

We see that real estate as an asset that allows us to do 2 things. Number one, our historical costs on it is quite low, which gives us a competitive advantage operationally, but it's also an asset that we can use to secure what we see as kind of our permanent debt within our capital structure. So we did a mortgage of $50 million in 2015, it expires in 2020. We're not going to prepay it for 2 reasons: one is why would you pay a penalty to early retire 3.06% debt; and number 2, we've had discussions with our bank and very comfortable that, that will roll. The only question is what amount do we put on it? And so that would be our kind of permanent portion of debt. That was the only debt we had pre to Savanna acquisition. We see the debt that we acquired with Savanna is something that we will look to reduce over time.

We also balance that against the opportunities we have to reinvest in the business as well as the opportunity to return money to our shareholders, both through dividends and share buybacks. And so we've always taken a balanced approach. On a normal course, we don't get too excited at any point in time. It's pretty methodical. We're also because of our tight float, pretty restricted in how much we can buy on a daily basis, and so that's a natural, I guess, restraint. But we've been well served over the decades, Josef, by taking a balanced approach. And as Warren Buffett said, if you like cheeseburgers, you really like them at half price. And so right now, the Canadian energy sector is cheeseburgers on sales. So we definitely see our normal course is something that probably makes sense. But again, we're also interested in bringing our debt down, but also using our balance sheet when we need to, to make good investments.

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Josef I. Schachter, Schachter Energy Research Services Inc. - Author & President [30]

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One more for me. How do you see the fourth quarter going? We've got, of course, you mentioned on the commentary that natural gas prices echoes [$280, $290] now. Have you seen in your discussions more bookings in -- I know towards Christmas it's going to be slower, but have you seen discussions for the rest of the winter, i.e., Q1, where you're going to be more active than you were in 2018, 2019, Q4, Q1?

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Daniel Kim Halyk, Total Energy Services Inc. - President, CEO & Director [31]

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It's an interesting question. I think definitely, we've seen on the rig side, groups that haven't been particularly active pick rigs up here and looking to pick rigs up to do a few wells here and there. I think publicly, you've seen groups like (inaudible) comment on that. We've seen it directly. In fact, we've had a bit of a pickup this weak even, and so -- is it going to result in a massive run on rigs, probably not. But I think there's some incremental activity coming out of that, where I also think it's going to be quite positive. This is within our field service group, within our CPS segment. It will be an interesting Q1, Josef, you know better than I, but looking at where we're coming into the winter, a normal to colder winter in Western Canada could result in some fairly robust Western Canadian gas prices.

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Josef I. Schachter, Schachter Energy Research Services Inc. - Author & President [32]

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Yes. And with the tight supplies as well $4 or $5 of -- we had that last year for a little while, hopefully, it's longer this time.

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Daniel Kim Halyk, Total Energy Services Inc. - President, CEO & Director [33]

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Well, I've got to side that with one of my VPs, that spot (inaudible) (51.49) go over [7.50]. So it will take lunch at -- steak lunch at Caesars. So I'm hoping it goes over 7.50 .

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Operator [34]

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The next question comes from David Vanderwood with Burgundy Asset Management.

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David P. Vanderwood, Burgundy Asset Management Ltd. - SVP, Portfolio Manager and Director [35]

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Dan, how are you thinking about capital allocation as you look out to next year?

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Daniel Kim Halyk, Total Energy Services Inc. - President, CEO & Director [36]

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Well, we're going to go into -- we have a strategic planning session with our Board later this month that kind of is the pretax to our budgeting meetings that will happen in early 2020, I guess, now. And so what we like to do is we tend to set our capital budget after we get some flavor from the customer base as to what their capital budgets are looking like. We also literally started 0. And so what I would say is we have a lot of flexibility. We're coming in within kind of what we predicted at the start of last year for 2019 capital.

I would say there's been quite a bit of movement below the surface in terms of the detail of where exactly that capital's gone. Very, very targeted on the growth side, but we're going to start at 0. And if the current environment continues, where you've got negativity and reduced rig counts, everything else being equal, David, our CapEx would be materially lower next year than this year.

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David P. Vanderwood, Burgundy Asset Management Ltd. - SVP, Portfolio Manager and Director [37]

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Great. And just turning to Weirton, I know, obviously, we're at a cyclical low here in activity. How are you feeling about labor productivity there, the quality of people that you're finding there? And just how are you feeling about that operation now that you've been into it for a little while?

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Daniel Kim Halyk, Total Energy Services Inc. - President, CEO & Director [38]

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So very good question. We've been open the challenges of setting up there where you didn't have a lot of experienced traits in the compression industry. Part of the reason we had a better third quarter margin-wise was some pretty significant gains within our Weirton operations on productivity, and we're literally working with the state to setup and define apprenticeship standards within a number of trades critical to our business there. In fact, there's -- I understand there's going to be a fairly significant events in the next while where I believe the governor of the state is coming to visit. But literally, we're getting some recognition of the systems from the state to help the technical school some set standards and criteria for certifications.

So to me, that's the goodwill. You could have got in and bought something, put goodwill on your business -- on your balance sheet, pardon me, or you take the time and effort necessary to train a local workforce. That's the goodwill. And the good news is, David, it's all been expensed, none of that's sitting on our balance sheet.

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Operator [39]

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The next question comes from Aaron MacNeil with TD Securities.

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Aaron MacNeil, TD Securities Equity Research - Analyst [40]

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Maybe just to add on to Daine's question on U.S. drilling, can you give us a bit of an update on the outlook for the business, just given some of the downward pressure on the rig count? And maybe what you're seeing for asset categories in your fleet that might not get as much attention and public commentary. And I guess, I'm wondering a couple things, even if it's in broad strokes, but what is bid activity like? Is pricing at a level you'd be willing to put additional rigs to work or where you can generate an appropriate return? And does your outlook defer by some of the various sub regions?

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Daniel Kim Halyk, Total Energy Services Inc. - President, CEO & Director [41]

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Well, I think the biggest pressure is on the big rigs. The price ran up on those, Aaron. The price didn't run up on your medium to shallower rigs. I would say, Savanna has the best shallow to medium fleet in West Texas. Part of that was the investment we've made over the past 2 years in getting that equipment up to our specs and getting the standards and expectations of the workforce to our specs. And so we're quite pleased with what happened. We have doubles displacing triples. We had doubles go up, triple go down in Q3.

Coding activity is very strong. I think what we're seeing is we're gaining a reputation for being a very efficient safe productive driller, and we're saving customers a lot of money, and that's going to play out here. We've been gaining operating days when the industry has been declining, and barring some catastrophic event, we expect that to continue. At the end of the day, it's simple. You got to drill safely, efficiently at a cost-effective price, and we're doing that. And so this obsession with big rigs, they have their place, but the price ran up down there and now it's coming down, and we haven't been exposed to that.

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Aaron MacNeil, TD Securities Equity Research - Analyst [42]

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So based on your commentary, it's fair to assume that you think you can continue to kind of buck the trend on the rig count, is that fair?

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Daniel Kim Halyk, Total Energy Services Inc. - President, CEO & Director [43]

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Yes. There's pressure, obviously, but our simple message is, we didn't run the rates up, and so we're not going to run down. Listen, we're not profitable yet there either. We're getting close. We're not happy until we're pretax profitable. And frankly, we're not happy in the long run until we're getting return on invested capital that beats our WACC, and so we've got a ways to go there yet. But I am pleased with the progress that's been made to significantly improve our operating margins, gross margins and to get closer to pretax profitability. Ultimately, whether we're going to invest in new equipment or additional equipment is going to be driven by, can we get a return of that investment that reflects our weighted average cost of capital. And right now, our WACC is high. Our cost to equity right now is through the roof.

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Operator [44]

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

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Daniel Kim Halyk, Total Energy Services Inc. - President, CEO & Director [45]

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Well, thank you for participating this morning, and we look forward to speaking with you when we do our year-end conference call next year. Have a wonderful weekend.

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Operator [46]

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