KLX Energy Services Holdings, Inc. (NASDAQ:KLXE) Q1 2020 Earnings Conference Call June 4, 2020 9:00 AM ET
Ryan Tyler - VP, Corporate Development, Financial Planning and Analysis
Thomas P. McCaffrey - President, CEO, and CFO
Conference Call Participants
Unidentified Analyst -
Simon Wong - Gabelli & Company
Ladies and gentlemen, thank you for standing by and welcome to the KLX Energy Services First Quarter 2020 Earnings Conference Call. At this time, all participant are in a listen-only mode. After the speakers presentation there will be a question-and-answer session. [Operator Instructions]. Please be advised that today's conference is being recorded. [Operator Instructions]. It is now my pleasure to introduce VP of Corporate Development, Ryan Tyler.
Thank you, Andrew. Good morning and thank you for joining us. Today, we are here to discuss KLX Energy Services financial results for the first quarter ended April 30, 2020. For comparative purposes, we have presented our financial results adjusted to exclude costs associated with asset impairment charges, the company's major downsizing program, and costs associated with the pending merger. These costs are collectively referred to as costs as defined. The company's earnings news release, which was issued earlier this morning, presents our results. If you haven't received it, you'll find a copy on our website. We will begin with remarks from Tom McCaffrey, President, Chief Executive Officer, and Chief Financial Officer of KLX Energy Services.
For today's call, we have prepared a few slides to help you follow our discussion. You can find our presentation on the Investor Relations page of the KLX Energy Services website at klxenergy.com. In addition, copies of the slides are posted on our website for you to refer to. Before we begin, we have some additional information to cover. Any forward-looking statements that we make are subject to risks and uncertainties and as always in our prepared remarks and our responses to your questions we will rely on the Safe Harbor exemptions under the various securities acts and our Safe Harbor statements and the company's filings with the Securities and Exchange Commission. We will address questions following our prepared remarks, at that time the operator will provide Q&A instructions. Now, I will turn the call over to Tom McCaffrey.
Thomas P. McCaffrey
Thank you Ryan and good morning everyone. Thank you for joining us today to discuss our first quarter financial results and the pending merger with Quintana Energy Services or QES. The oilfield services industry experienced an abrupt deterioration in demand during the second half of 2019 which is continuing into 2020 and was further exacerbated by the unprecedented demand destruction caused by the COVID-19 pandemic. The combination of the Saudi Arabia/Russia oil market share dispute and the demand destruction caused by the COVID-19 pandemic has driven the price of oil to unprecedented levels resulting in an abrupt and steep decrease in demand for oilfield services. The company responded with contemporaneous cost reductions in all aspects of the company’s business, resulting in business rationalization costs, and initial costs related to the pending merger with QES, totaling $14 million. In addition, the company recorded an approximately $209 million non-cash asset impairment charge, as required by GAAP, due to the sudden decline in demand for oilfield services. All of these costs aggregated approximately $223 million.
As we previously discussed we initiated an ongoing comprehensive business review and cost rationalization program targeted at aligning our cost structure with customer demand. Specifically we implemented referral program and approximately 15% reduction in base pay, we realigned our field compensation structure, we set expectations for no-cash bonuses in the current environment, and we trimmed our selling, general, and administrative costs in various areas to allow the company to align our organizational structure with expected demand. All of these actions are expected to reduce our cost structure by approximately $100 million per year compared to our cost structure at the end of the second quarter of 2019. Our workforce, which stood at approximately 1650 employees at the end of the second quarter 2019, was reduced to approximately 790 employees at May 31, 2020, that's a reduction of about 52%. By way of comparison, our revenues for the first quarter as we reported today, were $83 million, a decline of approximately 49.7% as compared with the second quarter of 2019. We warm stacked assets, we aggressively cut costs in every area of the business and we will continue to monitor our staffing and cost structure going forward. While painful, these actions were necessary to protect our liquidity in a period of uncertainty while continuing to provide best in class service to our customers.
We realized a substantial benefit from our cost rationalization actions in the first quarter just ended, as evidenced by a 420 basis point increase in adjusted gross margin on the 16% decline in sequential quarterly revenues.
The incremental cost reduction benefit realized during the first quarter was approximately $8 million. During the first quarter, the company generated $7 million of cash flows from operations and approximately $2.2 million of free cash flow ended -- and ended the quarter with approximately $127 million in cash and no borrowings under our $100 million credit facility. We believe the company’s continued tight cost controls and focus on return on invested capital and free cash flow generation should enhance our position as a proven value added partner to our customers with a strong liquidity profile and a history of providing value added services while maintaining superior health, safety, and environmental standards.
We're pleased to share with you that to date, we've not had one KLX employee test positive for COVID-19 and no customer has discontinued using KLXE as a result of employee illness or lack of proper tools or controls to prevent COVID-19 on the job. We are very proud of our talented HSC team, the discipline that they've instilled in our employees. We are equally proud of all the employees in the field for complying with new processes during the pandemic. Results like this do not happen without extensive training and reinforcement of the importance of following established processes and procedures. We know our customers appreciate all your efforts to maintain a safe work environment and our various stakeholders should be equally grateful and proud of the safety culture we live every day at KLXE.
The U.S. land market continued to be under unprecedented price pressure during the first quarter as the impact of the pandemic and the Saudi Arabia/Russian market share dispute and the resulting supply demand imbalance led to an unprecedented deterioration in industry conditions. As we all know, essentially all new activity that was planned has been delayed or canceled while completion activities that were underway were completed but no new wells were started. For more than two months or more economic activity globally was at a near standstill. Energy consumption dropped and storage for production evaporated, resulting in severe declines in the price of oil. Our oil production has decreased and energy consumption has begun to increase. The outlook for the demand for oil and gas production for us and for our services remains murky at best.
Let's turn to Slide 3 and review our first quarter 2020 consolidated results. For the first quarter ended April 30, 2020 revenues were $83 million, a decrease of $15.8 million or 16% as compared with the fourth quarter of 2019. The decrease in revenues reflects the impact of the COVID pandemic, the impact of the Saudi/Russia market share dispute, and the resulting supply demand imbalance which led to unprecedented deterioration in industry conditions. Gross profit and gross margin, adjusted to exclude costs as defined and depreciation expense, were $15.37 million and 18.9% respectively. Adjusted gross margin expanded by 420 basis points as compared to the prior quarter, despite the 16% decline in sequential revenues. This improvement in adjusted gross margin reflects a substantial benefit from the company's cost reduction initiatives. Adjusted operating loss was $12.9 million and adjusted EBITDA was approximately $2.6 million. Adjusted net loss was $20.1 million or negative $0.87 per share for the first quarter. Before we review our first quarter 2020 segment results we like to remind everyone that the company allocates all of our corporate costs to our three segments. The costs allocated to our three segments during the first quarter were approximately $11 million. Cost allocated to each segment for the three month period ended April 30th were as follows; Rocky Mountain segment $4.5 million, Northeast/Mid-Con segment $3.3 million, and Southwest segment $3.3 million.
Let's now turn to Slide 4 and review our first quarter Rocky Mountains financial results which include the $4.5 million allocation of corporate costs that were allocated to them. During the first quarter Rocky Mountain segment revenues of $33.8 million decreased by $12.9 million or 27.6%, as compared with the fourth quarter of 2019. Adjusted operating loss for the fourth quarter was negative $3.6 million as compared with adjusted operating loss of $1.1 million in the fourth quarter of 2019. Adjusted EBITDA was $1.7 million or 5% of revenues, as compared to the fourth quarter adjusted EBITDA of $6.3 million or 13.5% of revenues. Let's turn to Slide 5 and review our first quarter Northeast/Mid-Con segment performance. First quarter ended April 30, 2019 Mid-Con revenues were $24.8 million, increased by 800,000 or 3.3%. Adjusted operating loss was $5 million and adjusted EBITDA and adjusted EBITDA margin were $400,000 and 1.6% respectively. Let's turn to Slide 6 to review our first quarter Southwest segment performance. First quarter ended April 30, 2020 Southwest segment revenues were $24.4 million and decreased $3.7 million or 13.2% as compared with the first quarter of 2019. Adjusted operating loss was $4.3 million, compared to a fourth quarter adjusted operating loss of $8.5 million. And adjusted EBITDA was $500,000 compared to fourth quarter adjusted EBITDA of a negative $2 million.
Before we review our financial position, let's briefly discuss the pending merger with QES. On May 3, 2020 the company entered into an all stock merger agreement with QES. The combined company will have an industry leading asset light product and service offering present in every major U.S. onshore and oil and gas basin with more than a billion dollars of Pro Forma fiscal year 2019 revenues and approximately 106 million in fiscal year 2019 adjusted EBITDA, excluding an estimated $40 million of annualized cost synergies and a strong liquidity profile with approximately $118 million of cash and $100 million revolving line of credit. Over the past five weeks managements of both companies have been engaged in preliminary integration planning activities. The merger proxy was filed with the SEC on June 2, 2020 and the company believes the merger will be completed during the second half of this year.
This merger clearly expands the breadth of the services offered throughout the lifecycle of the well and provides significant opportunities to generate incremental revenues for the legacy businesses that may not otherwise have been available. QES will add directional drilling, snubbing, and well control services to KLXE’s already broad range of product and service lines. Together we will be rationalizing two of the largest fleets of coiled tubing and wire line assets dramatically reducing future capital spending requirements. We expect the merger to facilitate the pull through of the combined companies asset light products and services and in addition this merger facilitates QES’s decision to reap the benefits from repurposing the vast majority of its recently idled pressure pumping equipment to support the foremost fleet of large diameter coiled tubing assets in North America and support one of the largest wire line in U.S. KLXE has successfully demonstrated that the provision of coiled tubing services, along with our broad range of asset light products and services results in the addition of new customers and facilitates a capture of a greater share of customer spend.
Fundamentally, this transaction allows the combined company to pursue what we know to be a successful returns focused strategy, so focused on return on invested capital while positioning the company to weather the current storm and ultimately to grow on a significantly reduced capital expenditure budget. Chris Baker, QES’s CEO and his team have clearly embraced this philosophy throughout our negotiations and leading up to the merger and throughout our preliminary integration planning discussions. Both companies are looking forward to completing the merger which is expected to facilitate more than $40 million in expected annual cost savings and beginning to implement our jointly developed integration plan as we address new market opportunities arising from the combination.
Now let's take a moment and review our financial position on Slide 7. As of April 30, 2020 cash on hand was approximately $126 million, an increase of $2.1 million on a sequential quarterly basis. Total long-term debt of $250 million less cash resulted in net debt of approximately $124 million. The company's net leverage ratio was approximately 2.3 times. There were no borrowings outstanding under the company's $100 million credit facility and there are no debt maturities until November 2025. For the three months ended, April 30, 2020 cash flow provided by operations was $7 million and cash flow was 2.2 -- free cash flow was $2.2 million. Capital expenditures were approximately $5 million, most of which was spent prior to the oil price collapse. We continue to expect total CAPEX for this fiscal year of about $8 million.
We will remain focused on serving the needs of our customers in both winning new customers and gaining share of customer spend by providing a broad portfolio of product service lines and equipment across all major basins, while maintaining a high level of -- healthy level of liquidity and prudently managing our capital expenditures. In an operating environment where our financial strength is a key differentiator, we believe that our ongoing cost reduction efforts and driving cost synergies from the pending merger with QES will set KLXE apart from the other oilfield service providers and allow the combined company to further pursue strategic combinations as we participate in the industry consolidation. So we remain committed to maintaining a healthy and liquid balance sheet as the industry conditions change. We will begin to deploy capital where we believe it will generate the highest potential return to our shareholders and evaluate our share or debt repurchases or capital investments in our product service lines through the same lines. With that, I'll turn the call back over to Ryan.
Thank you, Tom. I will now turn the call over to the operator for the Q&A portion of today's call. The operator will provide instructions on how to ask a question. Andrew.
Thank you. [Operator Instructions]. So our first question comes from the line of Jamie Perez with Lassidy [ph].
Good morning everybody. Thanks for taking my call. Yeah, it was a solid quarter. This was a tough market, but it was a solid quarter, almost double the EBITDA. But we've been hearing some of the Permian producers are going back and restarting wells, limited -- although a limited amount and some haven't trimmed down their completion activity since the trough of May. I mean, could you tell us -- give us some color, where do you think the market is heading towards in the next couple of months, given the fact that some producers are actually going in and restarting wells?
Thomas P. McCaffrey
Jamie, I think that it's awfully early for us to talk about providing additional color on the initial activity of a few folks which are initiating completion activity. What we do believe is beginning to occur and will occur first is the most logical thing is to a number of the wells that have been shut in are actually now beginning to -- the E&Ps are going back and having those wells re-stimulated and put them back in production. If you think about it, the fastest way to generate revenues and profits is to go to a producing well.
And that's an area where we're very well suited with our strong intervention business. But I think we have one of the largest fishing tool inventories and our industry expertise in each of the regions is pretty well known. So, we think that's going to be an area where we'll see an uptick first. And if you think about it, the natural progression from deployment of capital from an E&P perspective would seem to be first put back into production what previously had not, which you had capped off. And it's the cheapest and best way to get revenues and cash flow going for an E&P. And then the second would be to look at, the over 8000 ducts drilled and uncompleted wells, which are scattered throughout the U.S. and the inventories of the E&Ps that they look there to complete their wells before initiating new drilling activities. And so some of the completions we may be referring to very well could be some of the ducts in the Permian. But right now, there's not enough information to really provide anything more anecdotal on that topic. I hope that's helpful.
Yeah, that was helpful. Also, some of the producers mentioned that another basins open up the PRB is attractive, is that something you will consider going into the future, do you have any assets that could be redeployed in the PRB area?
Thomas P. McCaffrey
We are -- we have a presence in each of the major basins and so wide proportion of our Rocky’s business. So it really is, its -- as we look at the opportunities which are being presented to us, we are hearing that some people are going to reactivate as soon as July or August, we will have to see what that is and what the pricing is going to be. As we have been in the past, we're not going to work for free and just run our assets down. So I think that we will be smart about how we deploy our assets and bring people back on, because it has to be done with a view towards generating profits and not just running our assets into the ground for cash flow purposes. We have a healthy balance sheet and we want to keep it that way.
Yes, that's the primary thing and it is more keeping a solid balance sheet, which you guys have done an excellent job for it you should be commended for, especially in this tough environment. That's all the questions I have for now. I'll pass it along. Thank you.
Thank you. [Operator Instructions]. Our next question comes from the line of Simon Wong with G Research.
Good morning, Tom and Ryan. How are you?
Thomas P. McCaffrey
Good, how are you Simon?
Good, just a quick question on the cost saving, looks like you did a good job remaining at detrimental [ph] in the first quarter you've got $8 million of cost savings, how do you see the cost saving ramping up for the rest of the year?
Thomas P. McCaffrey
Well, it's the cost from our business and by the way we normally don't break out gross profit excluding depreciation, but we thought it was helpful in this situation just to show with the cash benefit otherwise it gets lost a little bit in the non-cash charge. I think that you'll begin to see further benefit as we go through each of the quarters that the costs that we've taken out in the first quarter, we'll begin to realize the exact order. And as we talk through it, it always seems that most of the reductions for whatever reason are always at the end of a period. So they tend to be back end loaded and maybe a little bit of that has just has to do with the timing of jobs and also human nature. But you should see the benefits begin to improve. I think that as we look at activity being when it does begin to improve we should see an additive benefit associated with that is really bringing demand increases to the point where we need to bring people back. Our cost structure will change again and will actually add some people in. But that'll be a positive thing because we won't add them in unless we're generating profits.
–That does help. Can you quantify how much of the cost savings, the $100 million in cost saving is structural versus variable?
Thomas P. McCaffrey
It's almost all variable. I mean, to the extent you think about it it's labor, it is all on a fully loaded basis. It's the trucks that people drive. It's the health and benefit costs, it's subsistence with people are in man camps offsite. It's -- there's a lot of costs that go into each to maintain each individual. It's the training that's required to bring people and onboard them. All of those costs drop off when you don't -- when the employees aren't there and going through an incurring costs on a regular basis. Gas, fuel, I mean, it just literally it sort of stair steps down with the drop off in activity.
Okay, just a final question. You talked about the $100 million in revolving credit facility is undrawn. But you only have about $42 million available. Is that because it's an asset backed facility that's where the availability is lower than what -- $42 million is lower than $100 million?
Thomas P. McCaffrey
Yes, it is. Yes, it is. So it's -- well, I think it shows we've done a very good job in managing our receivables and our receivable exposure. If you are going through receivables, you can't pledge them if they're not there. So I think it's simple as that as the business begins to grow there's working capital, we have the availability. Candidly, we've never drawn on our revolver with sort of just in case money, sort of the way that we look at that. And I don’t think that we ever drew our loan before we did the spin off at KLX. So we tend to run an overly conservative balance sheet but I think in a highly cyclical industry, that's really important both to our shareholders, the equity holders, and the bondholders is to know that we are -- we just don't intend to take the risk and put the company in harm's way. And I don’t think we are going to change our stripes. I know that Chris Baker and Keefer Lehner over at QES share that same view. And so you should not expect any change post-merger.
Alright. Okay, great. That's all I have.
Okay, thanks Simon. Be safe.
Thank you. I'll now turn the call back over to Ryan Tyler for closing remarks.
Yes. Thank you to everyone for participating on this morning's call. We look forward to speaking to you again next quarter. Thanks and have a great day.
Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect.