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Basic Energy Services (NYSE:BAS)

Q1 2008 Earnings Call

May 6, 2008 10:00 am ET

Executives

Sheila Stuewe – DRG&E

Ken Huseman, President and Chief Executive Officer

Alan Krenek – Chief Financial Officer

Analysts

James Rollyson – Raymond James

Victor Marchon – RBC Capital Markets

[Matt Beebe] – Morgan Keegan

Operator

Good morning ladies & gentlemen. Thank you for standing by. Welcome to Basic Energy Services First Quarter Earnings Conference Call. During today’s presentation, all parties will be in a listen only mode. Following the presentation the conference will be opened for questions. If you have a question, please press the * followed by 1 on your touchtone phone. If you would like to withdraw your question, please press the * followed by 2. If you are using speaker equipment today, please lift the handset before making your selection. This conference call is being recorded today, Tuesday, May 6th of 2008. I would now like to turn the conference over to Sheila Stuewe with DRG&E. Please go ahead madam.

Sheila Stuewe – DRG&E

Thank you, Mary. Good morning and welcome to the Basic Energy Services 2008 First Quarter Earning Conference Call. We appreciate you joining us today. Before I turn the call over to management I have a few items to go over. If you would like to be on our email distribution list to receive future news releases or if you experience a technical problem and didn’t get one last night, please call us at 713-529-6600. If you would to like to listen to a replay of today’s call, it will be available via webcast by going to the investor relations section of the company’s website at www.basicenergyservices.com or via recorded instant replay until May 21st 2008. This information was also provided in yesterday’s earning release. Information reported on this call speaks only as of today, May 6th 2008, and therefore you are advised that time sensitive information may no longer be accurate as of the time of any replays.

Before we begin let me remind you that certain statements made by management during this call and on the transcript of this conference call includes forward-looking statements and projections made in reliance of the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995. Basic Energy Services has made every reasonable effort to ensure that the information and assumptions on which these statements and projections are based are current, reasonable, and complete. However, a variety of factors could cause actual results to differ materially from the projections, anticipated results, or other expectations expressed in this release, including (i) Basic Energy’s ability to successfully execute, manage, and integrate acquisitions including the merger with Grey Wolf, (ii) changes in demand for services and any related material impact on our pricing and utilization rates, and (iii) changes in our expenses including labor or fuel costs. Additional important risk factors that could cause actual results to differ materially from expectations are disclosed in item 1A of Basic Energy Services Form 10-K for the year ended December 31, 2007, and subsequent Form 10-Qs filed with the SEC. While Basic Energy Services made these statements and projections in good faith, neither Basic Energy Services nor its management can guarantee that the transactions will be consummated or that anticipated future results will be achieved. Basic Energy Services assumes no obligation to publicly update or revise any forward-looking statements made herein or any other forward-looking statements made by Basic Energy Services, whether as a result of new information, future events, or otherwise.

In connection with the proposed merger, a registration statement by Horsepower Holdings Inc. will include proxy statements by Basic Energy Services and Grey Wolf and other materials will be filed with the Securities and Exchange Commission. Investors and security holders are urged to carefully read the registration statement and the proxy statement/prospectus and other materials regarding the proposed transaction when they become available because they will contain important information about basic energy services, Grey Wolf, Holdings, and the proposed transaction. Investors and security holders may obtain a free copy of the registration statement and the proxy statement/prospectus when they are available and other documents containing information about Basic Energy Services and Grey Wolf without charge at the SEC's website at www.sec.gov. Basic Energy Services’ website at www.basicenergyservices.com, and Grey Wolf's website at www.gwdrilling.com. Copies of the registration statement and the proxy statement/prospectus and the SEC filings that will be incorporated by reference therein may also be obtained for free by directing a request to either Investor Relations, Basic Energy Services Inc., 432-620-5510 or to Investor Relations, Grey Wolf Inc., 713-435-6100.

Basic Energy Services and Grey Wolf and their prospective directors, officers, and certain other members of management may be deemed to be participants in the solicitation of proxies from their respective stockholders in respect to the mergers. Information about these persons can be found in Grey Wolf's proxy statement relating to its 2008 annual meetings of stockholders as filed with the SEC on April 8, 2008. Information concerning the beneficial ownership of Basic Energy Services stock by its directors and certain of its executive officers is included in its Form 10-K/A filed on April 29, 2008, and subsequent statements of changes in beneficial ownership on file with the SEC. Additional information about the interests in such persons in the solicitation of proxies in respect to the mergers will be included in the registration statement and the joint proxy statement/prospectus to be filed with the SEC in connection with the proposed transaction. At this point, I’ll turn the call over to Ken Huseman, President and CEO of Basic Energy Services.

Kenneth V. Huseman

Thanks Sheila, and welcome to those joining us on the call. With me on the call today is Alan Krenek, our Chief Financial Officer. As stated in the press release, we are generally pleased with our results for the first quarter. More importantly, our optimism regarding the balance of the year is supported by April activity which we reported in the press release issued earlier this morning. And of course we are looking forward to the merger with Grey Wolf Drilling that we announced a couple of weeks ago. We will discuss each of those topics in a bit more detail to try to reserve most of the time on the call for questions. Our earnings release discusses the first quarter results compared to the first quarter of 2007. But this year is starting off to be completely different from last year. New equipment delivered into every segment of the industry over the last two years along with lower levels of activity and many gas related markets has resulted in the supply of equipment matching demand over the last several quarters. As a result our utilization has been lower than last year, and we have had to be less aggressive on pricing. Despite those fundamentally different market conditions we began the year with solid results. Revenue for the quarter of $230 million established a new record for the company reflecting our ability to grow the business throughout the cycle. Our EBITDA margin is almost 29%, was down only slightly compared to the 30% margin in the year ago quarter. Fully diluted earnings per share of 47 cents compared to 56 cents last year due to higher depreciation and interest expense related to the investments we made in acquisitions and equipment. The press release provides a detailed year-over-year first quarter comparison by segment; so I won’t spend more time on that here. I think it’s more relevant to discuss our sequential performance.

Total revenue increased by $4 million or $1.8 million from the fourth quarter of 2007. That revenue included increases of $4 million in our completion and remedial services segment, $3 million in our fluid services segment, but was partially offset by approximately $1.5 million revenue declines in both our well servicing and contract drilling segments. The EBITDA margin for the quarter of 28.7% was up slightly from the fourth quarter supported by firm pricing and good cost control. The $1.6 million increase in EBITDA over the fourth quarter implies a 40% incremental margin indicating the impact additional revenue could have on our profitability. Fully diluted earnings per share of 47 cents matched our earnings reported in the forth quarter.

Segment results were mixed compared to the fourth quarter. Our well servicing revenue declined by $1.5 million, but the direct margin of 39.8% was a full percentage point higher than the previous quarter. Utilization of 72.2 % was down by about half a percentage point from the prior quarter, and hourly rates were 2.7% lower. The decline in the average rate per hour was more related to the change in the waiting of activity to lower rate well servicing markets rather than any deterioration in pricing. Somewhat better labor absorption without the holiday costs accounted for the margin improvement during the quarter. Beginning of this quarter, our fluid services segment now includes our small well site construction services business that we used to report separately. We operate those two services under the same field management and from the same facilities; so this change allowed us to streamline our reporting. Fluid services revenue for the quarter increased by $3 million driven in part by higher fuel surcharges. Fast rising fuel costs and continued competition for labor however caused the segment margin to slip by 7/10 of a percent compared to the fourth quarter. Improving activity levels should allow a higher level of recovery of fuel costs and further fleet and labor efficiencies as the year progresses. Approximately half of the $4 million revenue increase in the completion and remedial services segment resulted from the Xterra acquisition completed in January while the remainder reflects stronger activity later in the quarter. The segment margin increased by 1.5 percentage points reflecting better labor and fixed cost absorption.

Our contract drilling segment is being reported separately from our well servicing operations for the first time this quarter. Revenue in this segment declined by $1.4 million as demand weakened at year end and didn’t strengthen until late in the first quarter. We worked 9 rigs at a utilization rate of 79 % compared to 10 rigs at 82% during the fourth quarter. One carrier mounted rig was converted to heavy work overload in anticipation of a higher level of the reentry activity in the Permian Basin market. As expected in this type of drilling market, margins declined due to the higher level of fixed costs associated with retaining experienced personnel. We actually saw a slight increase in day rates of about $130 per day as several rigs were placed on footage contracts. Despite a bit of a drop in utilization in April, we expect to see strong utilization in this segment as the year progresses. At this point, I’ll turn the call over to Alan to take you through the remainder of the income statement and the balance sheet.

Alan Krenek

Thanks Ken, and good morning to all of you. This morning I would like to review our income statement in more detail and then discuss our liquidity and capital resources. Our G&A expense for the first quarter of 2008 was $25.9 million or 11% of revenue compared to $22.6 million or 11% percent of revenue during first quarter of year 2007, and was up approximately $500,000 sequentially. The majority of the increase from the first quarter of 2007 reflects the growth of the company during that time particularly from the JetStar and Sledge acquisitions. It should be noted that since the second quarter of 2007, G&A expense has been consistent at the level we reported in the first quarter of 2008. For 2008, we expect the G&A expense as a percent of revenue will average 11%. Depreciation and amortization expense in the first quarter at 2008 was $28 million compared to $19 million in the same period of 2007. This increase reflects a substantial capital expenditure program we’ve had in place as well as the acquisitions that we have closed since March 2007, particularly the JetStar acquisition that closed in March 2007 and the Sledge acquisition that closed in April 2007. For 2008, based on our current capital expenditure program, we estimate that depreciation and amortization expense will be between $118 to $120 million. This estimate also includes $2 million of amortization of intangibles recorded from the Sledge and JetStar acquisitions at year end. Net interest expense in the first quarter of 2008 was $6.6 million, up from $5.1 million in the first quarter of 2007, but essentially flat with the fourth quarter of 2007. The year-over-year increase is due mainly to the interest expense from the utilization of $150 million of our credit revolver for the cash portion of the Jetstar and Sledge Drilling, and Wild Horse acquisitions that closed in 2007.

The effective tax rate in the first quarter of 2008 was 37.4%, flat with last year. We expect our tax rate will be approximately 38% for the full year in 2008. As Ken mentioned earlier we had net income of $19.7 million or 47 cents per diluted share for the quarter, weighted average diluted share count for the quarter was approximately $41.5 million. We do not expect our weighted average diluted share count in 2008 to differ that much from the count in the fourth quarter. Our balance sheet remains solid and we continue to generate good cash flows. In March we were very pleased to get it up right from S&P to doubly minus on both our corporate credit and $225 million senior notes [inaudible]. Our cash balance at March 31, 2008, increased approximately $100 million from $92 million at year end even with approximate $23 million used in late January 2008 for the Xterra and Lackey acquisitions. We maintain liquidity of $159 million at March 31st, and our revolver had $150 million of borrowings unchanged since year end. Our debt-to-EBITDA ratio was 1.6 times while total debt capitalization was 44%. We remain in good financial position to act quickly on acquisition opportunities as they may arise. During the first quarter 2008, we had cash flow from operations of approximately $56 million or 24% of revenues compared to $38 million or 19% of revenue for the same period in 2007. Cash capital expenditures during the first quarter of 2008 were $18 million, $5 million less than in 2007. We also entered into $10 million of capital leases for additional equipment during the fourth quarter of 2008. We plan for cash capital expenditures for 2008 to be approximately $115 million which includes 24 new build rigs, 20 of which will be replacing older less efficient rigs. In addition, we plan on $33 million of capital leases for additional equipment.

As a final note, this week we will be filing the historical segment information by quarter for the past three years reflecting our current business segments. At this point, I’ll turn it back over to Ken Huseman.

Kenneth V. Huseman

We have a few more comments. As stated at the outset, we are optimistic in our outlook for the remainder of the year; our April activity summary supports that view. Well servicing utilization moved up to 78 % reflecting improving activity levels throughout our markets. We are seeing capital spending projects being kicked off in oil markets to optimize fuel performance with major workovers and reentry projects, enhanced recovery project, and infield drilling programs. Many of those are long lead time projects requiring substantial engineering and legal work that are now being put into action. In addition, drilling activity is increasing in the resource place and conventional gas markets pretty much throughout the country. People shortages remain a factor throughout the industry, however, and the capital spending programs of many of our customers are likely being restricted by lack of personnel and field technical and professional positions. As we’ve stated in our prior calls, labor continues to be our biggest expense and management challenge as well. The industry has a chronic shortage of experienced people. While wage pressure moderated along with the slower growth in the drilling count in 2007, we are seeing the need to increase wages as drilling rig count increases. Labor shortages are particularly acute in certain markets and for the more specialized positions. We are addressing the labor shortage with programs aimed at recruiting people from inside and outside the industry and retaining those we have with competitive wages and benefits. We are taking additional steps to expand our workforce, including a program to provide housing assistance for people moving into the rural areas where we provide our services. More recently fuel prices are adding pressure on margins directly and indirectly by driving the cost of most of our inputs higher. We expect inflation to become a more significant factor as the year progresses and the cost of fuel creeps into the general economy. Despite those concerns we are confident that we can protect our margins by moving rates up to match those cost increases. We don’t however want to project margins retuning to the historical high levels experienced in 2006.

Regarding acquisitions, we believe the opportunities in the current environment are excellent and will likely increase through the year. We had previously reported closing two acquisitions in the first quarter and recently closed the third. On April 30th, we acquired [BNS Disposal], a [Barnett Shale] based company with 17 fluid trucks, 2 disposal wells, and 3 workover rigs. Those acquisitions were all closed at prices well within the full [inaudible] of EBITDA we have stated as a critical part of our investment criteria. The three deals for aggregate consideration of about $30 million are great examples of how we can use relatively small acquisitions along with organic expansion to fill in our footprint and generate meaningful growth for the company. We expect to continue to find and close acquisitions of that type throughout our segments and geographic markets.

Now I’ll speak briefly about the merger with Grey Wolf Drilling. As you will appreciate at this stage of the process, there is not a lot we can say in addition to the publically available information. I will however reiterate why we believe this merger is a great fit with Basic Energy Services. We have stated for several years that we intend to continue developing avenues for growth for the company. We have always believed that growing the company’s asset and revenue base in a disciplined manner is the best way to build value for the shareholders of Basic Energy Services. This merger addresses that objective by providing a platform for substantial additional growth in the US. The combination also provides a size to address opportunities in other parts of the world, which we cannot do without the size the combination brings. We also believe that re-capitalization is a great way to return capital to our shareholders without restricting the combined company’s ability to finance the opportunities that we see available. While we are still in the documentation stage, our management team is enthusiastic about the prospects for the combined company and look forward to getting the deal completed early in the third quarter. At this point, let’s turn the call back to the operator for questions.

Question-and-Answer Session

Operator

Thank you, Sir. Ladies and gentlemen, at this time we will begin the question-and-answer session. [Operator instructions]. And our first question comes from the line of Jim Rollyson with Raymond James. Please go ahead.

James Rollyson – Raymond James

Good morning guys.

Kenneth V. Huseman

Hey Jim.

Alan Krenek

Hello Jim.

James Rollyson – Raymond James

Ken, you talked about cost coming up – labor and fuel and what not – and you’re hoping to offset that a little bit with rising pricing. Are you starting to be able to push through pricing just yet or is that something you are expecting as you move throughout the year?

Kenneth V. Huseman

It depends on the service line in fluid services. We’ve added fuel surcharges in most cases already. We pushed up rates in some of the other services. We have not moved our rig rates in our well servicing business yet, but we expect those increases to be available probably at the beginning of the next quarter.

James Rollyson – Raymond James

Okay. I guess [just 30,000 foot – do you] question based on the commentary you had and your prior guidance for the steady first half ’08 and slight expectations or slight increases in pricing as you get into the second half. Do you think your bottomline looks steady to maybe slightly up as you go through the year?

Kenneth V. Huseman

Yeah. I think so. The utilization – a lot of our cost structure right now is fairly fixed in the short term – so any utilization increase or each dollar revenue has a pretty high incremental margin. So we are pretty comfortable that the guidance we provided is something we can live with.

James Rollyson – Raymond James

Great. Excellent job guys. Thanks.

Kenneth V. Huseman

Thank you.

Operator

Thank you. Your next question comes from the line of Victor Marchon with RBC Capital Markets. Please go ahead.

Victor Marchon – RBC Capital Markets

Thank you. Good morning.

Kenneth V. Huseman

Hello Victor.

Victor Marchon – RBC Capital Markets

The first question I have is just on the well servicing side, the mix that you guys had talked about as it relates to revenue [prow] in the first quarter. I just wanted to see if you can just delve into that a little bit more, specifically how that looks going forward – is the shift becoming more favorable as what you guys see in your backlog?

Kenneth V. Huseman

As the activity in the higher rate areas, workover areas, like Lackey, South Texas, adding another workover rig, etc., as we add those or as that proportion grows, you will see our rates being pulled up without an actual rate scheduled increase. So, we will see the reverse of what we saw occur in the first quarter we think in subsequent quarters.

Victor Marchon – RBC Capital Markets

And that should – at least as it relates to [Lackey], I would imagine that you see some of that impact or positive impact in the second quarter end?

Kenneth V. Huseman

Yes, that’s correct, and that’s where some of our utilization improvement is coming from as longer hours and weather factors improve.

Victor Marchon – RBC Capital Markets

The second one I have is on contract drilling; how many rigs right now are on footage versus day work.

Kenneth V. Huseman

I think about half.

Victor Marchon – RBC Capital Markets

As you look at the operating costs, as utilization ramps, what’s a good target to use – once you guys are in the 85% utilization level – as it relates to operating costs – are you back below $10,000 a day on operating costs or somewhere still north of that given what’s happening on the fuel cost side?

Kenneth V. Huseman

I think we will see rates move up above the $15,000 range as we progress; the cost will be about flat with where we are now.

Victor Marchon – RBC Capital Markets

Great. I appreciate it. That’s all I have.

Operator

Thank you. Our next question comes from the line of [Matt Beebe] with Morgan Keegan. Please go ahead.

[Matt Beebe] – Morgan Keegan

Good morning everybody.

Kenneth V. Huseman

Good morning Matt.

Alan Krenek

Good morning Matt.

[Matt Beebe] – Morgan Keegan

I was just curious if you guys could provide a little more detail on the $150 million tax for the year – I guess outline the cost related to the 24 rigs and maybe talk about any pressure pumping capacity you might have added.

Kenneth V. Huseman

I will let Alan give you the big picture, but on the pressure pumping side, we have a few pump trucks scheduled for delivery. In fact, I think they’ve been built and have been delivered, but not in the fleet. They are not significant to the total. We’re not adding huge fleets like most of the competitors in the business are, and Alan if you want to go over the….

Alan Krenek

Sure. What it basically breaks down as far as expansion and replacement and sustaining and then other, we have close to about $50 million that relates to expansion of which probably the majority of that versus last year most of the expansion related to well servicing, this year majority of it relates to our fishing and rental business as well as the pressure pumping part of our business, and then we are also expanding our number of our salt water disposal wells which add probably another $12 million to that. So that’s taken up the lion share of the expansion for this year, and then close to about $70 million of the $150 million total relates to sustaining and replacement of our existing fleet, continual upgrading, etc.

[Matt Beebe] – Morgan Keegan

Okay. Thank you. That’s helpful. I guess, also maybe a different way to ask if you exited the first quarter with 120,000 in hydraulic horsepower. Do you guys see – I guess where do you guys see the end of the year – what level do you guys see yourself at the end of the year

Kenneth V. Huseman

Between 125,000 and 130,000.

[Matt Beebe] – Morgan Keegan

Okay. And then you said the recent acquisition that you did – the total cost was $30 million….

Kenneth V. Huseman

No. That’s the aggregate for all three we’ve done since the first of the year. The last one was about $6.5 million.

[Matt Beebe] – Morgan Keegan

Okay. That’s very helpful. That’s all I have. Thanks.

Operator

Thank you. [Operator instructions]. One moment please. And I am showing that there are no further questions. I will turn the call over to Mr. Huseman for closing comments. Please go ahead, sir.

Kenneth V. Huseman

Okay. We thank you all for joining us today and we look forward to talking with you on future calls

Operator

Thank you. Ladies and gentlemen, that will conclude today’s teleconference. If you would like to listen to a replay of today’s conference, please dial in to 303-590-3000 and enter the access code 11112877 followed by the $ sign. Once again, that number is 303-590-3000, and the access code is 11112877 followed by the $ sign. We thank you for your participation in today’s conference, and at this time you may disconnect.

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