KLX Energy Services Holdings Inc. (NASDAQ: KLXE) Q2 2020 earnings call Sep. 03, 2020
Corporate Participants:
Ken Dennard — IR
Christopher J. Baker — President & CEO
Keefer M. Lehner — EVP & CFO
Analysts:
John Daniel — Simmons — Analyst
Jaime Perez — RF Lafferty & Co — Analyst
Presentation:
Operator
Greetings, and welcome to the KLX Energy Services Fiscal 2020 Second Quarter Earnings Conference Call. [Operator Instructions]
It is now my pleasure to introduce your host, Ken Dennard with Dennard Lascar. Thank you, Mr. Dennard, you may begin.
Ken Dennard — IR
Thank you, operator, and good morning everyone. We appreciate you joining us for the KLX Energy Services conference call and webcast to review fiscal second quarter 2020 results.
With me today are Chris Baker, KLX’s President and Chief Executive Officer; and Keefer Lehner, Chief Financial Officer and Executive Vice President. Following my remarks, Management will provide a commentary on the recent completion of the KLXE-Quintana merger, the financial details of the second quarter and their integration and operational plans and outlook before opening the call to Q&A. There will be a replay of today’s call and it will be available by webcast on the Company’s website at klxenergy.com. There will also be a recorded replay available until September 10, 2020 more information on how to access that replay feature was included in yesterday’s earnings release.
Please note that information reported on this call speaks only as of today, September 3rd, 2020 and therefore you are advised that time sensitive information may no longer be accurate as of the time of any replay listening or transcript reading. In addition, Management’s comments may contain forward-looking statements within the meaning of the United States Federal Securities laws. These forward-looking statements reflect the current views of KLX’s management. However various risks, uncertainties and contingencies could cause actual results, performance or achievements to differ materially from those expressed in the statements made by Management. The listener is encouraged to read the report — Annual Report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K to understand certain of those risks, uncertainties and contingencies.
The comments today may also include certain non-GAAP financial measures. Additional details and reconciliation to the most directly comparable GAAP financial measures are included in the quarterly press release, which can be found on the KLX Energy website.
And now, finally, I’d like to turn the call over to KLX Energy Services, President and CEO, Mr. Chris Baker. Chris?
Christopher J. Baker — President & CEO
Thank you, Ken, and good morning everyone. Thank you for joining us today for KLX Energy Services fiscal second quarter 2020 conference call. This is an exciting time for all of us, as it represents the inaugural post merger call for the new KLX, which brings together the outstanding personnel, comprehensive asset and customer bases and extensive industry expertise of two leading oilfield services companies, KLZ Energy Services and Quintana Energy Services.
Since the closing of this merger, on July 28, I have formally taken on the role of President and Chief Executive Officer of KLX. And Keefer Lehner, has likewise assumed the role of Executive Vice President and Chief Financial Officer of the Company. Together, with the rest of our leadership team, we see the tremendous potential of this merger and look forward to the successful integration and bright future of the Company with an eye on additional consolidation opportunities.
With that in mind, I would like to begin by talking about the merger and highlighting the many strategic merits of the deal. I will then turn the call over to Keefer, to review our fiscal second quarter financial performance, before returning for some final comments on our strategy for the business going forward, including integration, synergy capture and the generation of new opportunities in the marketplace.
Now, let me begin by discussing the closing of our recent merger. On July 24, KLX and QES shareholders approved the merger of the two companies at their respective special meetings. Our shareholders also approved a reverse stock split, which resulted in our Board, ultimately authorizing a one-for-five split ratio for a final post split exchange ratio of 0.0969, both the reverse split and the merger closing were completed on July 28.
Given all the hard work and countless hours put in by both teams to see this deal through to a successful conclusion is extremely gratifying to complete what was an accelerated process in a very challenging market. And I’m thankful for all the contributions and tireless efforts by all involved. Their sacrifices and dedication have resulted in a Company that is a much more robust organization, that is better-positioned to weather the current industry turmoil and to deliver growth via significantly reduced cost structure, benefiting both our customers and our stockholders. The successful completion of the merger creates an industry-leading provider of drilling completion production and intervention solutions across all major US basins.
KLX’s broad suite of asset-light products and services spans a full well lifecycle and includes vision and rental thru-tubing, pressure control, fluid pumping, downhole completion tools, drilling motors, flow back and testing services and well control, and is supported by a growing portfolio of proprietary technologies which greatly enhances margin and efficiencies and reduces the need for additional capital spending. The combined asset base also includes the largest fleet of large diameter coiled tubing units in the United States, one of the largest wireline fleets in the United States and QES’ contributed leading directional drilling franchise.
There are also a number of complementary strength across our key product service lines, which generates a greater potential for incremental cross-selling and pull-through opportunities, resulting in both new customers and greater share of customer spend.
Finally, the deal will be accretive to shareholders based on free cash flow per share within 12 months. It has significant and immediate cost synergies, as well as additional upside for potential revenue synergies. With the transaction now successfully consummated and our two companies combined into one, we have fully turned our attention to integrating and rationalizing our cost structure and operations, so that we can best position KLX in a very challenging market.
I’d note that prior to the merger, both companies had already done a substantial amount of work on a standalone basis to reduce their fixed cost structure. And as we stated previously, we expect to capture annualized run rate cost synergies of at least $40 million and we plan to implement those annualized run rate cost synergies by the end of the first fiscal quarter of 2021.
As of today we have captured approximately $18 million of run rate cost savings. The synergy opportunity is what I would largely categorized as low-hanging fruit, which will enable us to realize the cost savings more quickly and opens the door to identify additional improvement to the cost structure, as we work through integration.
As a premier provider of drilling completion production and intervention solutions, KLX will continue to focus on operational excellence across its diverse product and service portfolio. With the Company now offering a significantly expanded suite of product service lines, the challenge is to leverage these, as well as our combined proprietary technologies into a more cohesive fully-integrated and symbiotic enterprise that will enable us to deliver more value to our customers at a lower cost. This PSL strategy will be a critical factor in driving our long-term efficiency and competitiveness in the marketplace. I’ll discuss this effort, as well as our go-forward strategy in more detail and comment on our outlook in my closing remarks.
With that, I’ll now turn the call over to Keefer, who will review our 2Q financial results. Keefer?
Keefer M. Lehner — EVP & CFO
Thank you, Chris. Good morning, everyone. Before we review our second quarter 2020 segment results, I’d like to highlight a few noteworthy items.
First, please keep in mind that since the merger was completed on July 28, our combined second quarter results include only three days of results from legacy QES business. And they are, therefore, largely representative of KLX’s premerger structure. Additionally, there’s little to no synergy benefit reflected in our Q2 results. Second, we will maintain a January 31st fiscal year-end that follows KLX Energy’s legacy financial reporting and our segment results will be reported on a geographic basis consistent with KLX’s past practice. The three geo markets will remain the Southwest, the Rockies and the Northeast and Mid-Con.
Third, after completing our initial draft of the purchase price allocation for the merger, the transaction was determined to be a bargain purchase due to the fair market value of acquired assets exceeding the purchase price. This is a function of the depressed market environment driving low prevailing market caps and the transaction being structured on a relative basis with the consideration primarily being KLX shares. As a result, our incomes statement reflects a total bargain purchase gain of approximately $41 million. Fourth, in addition to the bargain purchase gain, there were a handful of extraordinary costs impacting our results for the quarter. We had $5.5 million of deal costs, $7.5 million of severance, and $15.1 million of non-cash equity compensation tied to accelerated vesting.
With that said, I’ll now dig into our second quarter 2020 consolidated results. For the second quarter ended July 31, 2020, revenues were $36.2 million, a decrease of $46.8 million, or 56% as compared to the first quarter of 2020. The decrease in revenues reflects the impact of the COVID-19 pandemic, the impact of the Saudi and Russia market share dispute, and the resulting supply and demand imbalance that led to unprecedented deterioration in US industry drilling, completion and production activity.
Adjusted EBITDA loss and adjusted EBITDA margin adjusted to exclude costs as defined and depreciation expenses were $10.6 million and negative 29%, respectively. Adjusted operating loss was $23.1 million for the quarter.
Before I review our second quarter 2020 segment results, please keep in mind that the Company allocates all of our corporate costs, excluding the bargain purchase gain into our three geographic segments I mentioned earlier. Total costs allocated to the three segments during the second quarter were approximately $39.6 million.
Costs allocated to each segment for the three-month period ended July 31 were as follows: $20.9 million allocated to the Rocky Mountain segment, $13.7 million allocated to the Northeast and Mid-Con segment, and $5 million allocated to the Southwest segment.
I’ll begin the segment review with ours second quarter Southwest results. The Southwest segment generated revenues of $4.2 million, a decrease of $20.2 million, or 83% as compared to the first quarter of 2020. Adjusted operating loss was $6.4 million compared to first quarter adjusted loss of $4.3 million and adjusted EBITDA loss was $1.9 million compared to first quarter adjusted EBITDA income of $0.5 million.
Moving to the Rockies. The Rocky segment second quarter revenue of $18 million decreased by $15.8 million, or 47% as compared with the first quarter of 2020. Adjusted operating loss for the second quarter was $8.3 million, as compared with adjusted operating loss of $3.6 million in the first quarter of 2020. Adjusted EBITDA loss was $3.7 million, as compared to the first quarter adjusted EBITDA income of $1.7 million.
Lastly, the Northeast and Mid-Con segment second quarter revenues were $14 million, a decrease of $10.8 million, or 44% from the first quarter. Adjusted operating loss for the second quarter was $8.4 million, as compared with adjusted operating loss of $5 million in the first quarter of 2020. Adjusted EBITDA loss was $5 million, as compared to the first quarter adjusted EBITDA income of $400,000.
Now, let me take a moment to review our financial position. KLX has afforded one of the strongest liquidity positions in the small to mid-cap oil service space. As of July 31, 2020, cash on hand was approximately $99 million and decreased $27 million on a sequential quarterly basis. The sequential decline in cash was largely driven by $5.5 million of transaction costs associated with the QES merger, $7.5 million in severance tied to the QES merger and exiting the KLX legacy headquarters in Florida and $10.6 million of adjusted EBITDA loss.
Total long-term debt of $243 million less cash, resulted in net debt of approximately $145 million. The Company’s net leverage ratio was approximately 0.93 times on a pro forma combined basis for 2019 when including synergies. There were no borrowings outstanding under the Company’s $100 million credit facility, with $15 million of availability, excluding the QES current asset collateral base, and there are no near-term debt maturities with our bonds not maturing until November of 2025.
Preserving our cash and liquidity is our number one priority in the current market environment, and we’re executing on the realization of the $40 million of cost synergies as quickly as possible. For the three months ended July 31, 2020, cash flow used in operations was $22.5 million and free cash flow for the quarter was negative $26 million. Capital expenditures were approximately $3.7 million, most of which was spent early in the quarter and tied solely to maintenance spending. We continue to expect total CapEx for the fiscal year of about $15 million to $20 million.
With that, I’ll turn the call back over to Chris.
Christopher J. Baker — President & CEO
Thanks, Keefer. As we look ahead, our efforts will be squarely focused on integrating and streamlining our operations and support functions, while fully capturing the $40 million of cost synergies that we have identified.
Our anticipated synergy opportunities fall into three general categories. The first is the elimination of KLX’s legacy corporate headquarters in Wellington, Florida and rationalizing associated corporate functions to Houston. This will result in immediate cost benefits through the reduction of duplicative public Company costs, including director and auditor fees and insurance economies of scale, as well as other administrative and support staff expenses, such as accounting, legal, IR and supplementary functions and the elimination of other legacy KLX corporate cost. We have made excellent progress in realizing these savings, as our corporate functions are being transitioned to Houston and we have either retained or hired new leaders for each of these areas. We currently anticipating closing the Florida office by the end of October at the latest.
The second synergy category is the combination and rationalization of redundant Houston facilities and teams, which accounts for a smaller portion of the overall savings. This represents an additional reduction in duplicative management and associated costs, sales and marketing expenses, economies of scale related to benefits cost, as well as incremental savings in HR, IT and system savings, as well as the consolidation of the Houston corporate office space.
The third category is made up of operational synergies in the area of personnel, facilities and rolling stock. These represent the consolidation of over 20 overlapping facilities, reductions in redundant management, sales, HS&E and other field level support staff within certain geographic basins, where we overlap with legacy QES operations, as well as procurement savings and economies of scale benefits across our operations.
Beyond these three categories, we believe there to be additional sources of upside synergies that we will identify while working through the integration. These include such items as cross-selling opportunities across the organization, leveraging in-house manufacturing and downhole tool expertise from the directional product line to the completion side of the business and the repurposing of legacy horsepower to lower wear, wireline and coiled tubing operations and support.
Beyond these, there’s also the opportunity to enhance vertical integration by leveraging QES’ trucking and machining capabilities to reduce KLX’s transportation and tool cost. In short, there are significant value creation opportunities in the near-term that can be initiated to better position the organization for the future.
From a macro view, conditions in the market remain very tenuous. Although there are some signs of an improvement amid the weakness. As Keefer stated, it was an extremely challenging second quarter. Rig count declined approximately 40% from the end of our first quarter and frac spread activity bottomed somewhere around 40 to 50 spreads according to industry estimates.
Similar to Q1, market demand for our services remains challenge due to the COVID-19 pandemic and macro supply concerns. We begin to see an uptick in activity at the end of the quarter and early into the third quarter, particularly on the completion side of the business, but the ultimate extent of the duration of the impact of COVID-19 on the global economy is unknown. So far, completions activity is leading the way in the recovery, but we have recently seen rig count increase 10 rigs off the bottom. And we believe our diverse product and service offering uniquely positions KLX to respond to a rapidly evolving marketplace, where we can provide a comprehensive suite of engineered solutions for our customers with one tall [Phonetic] and one MSA.
In response to the current market conditions, we’ve reduced our capital spending by approximately 60% in the first-half relative to our budget, and are on track to cutting capital spending by more than 50% year-over-year. With North American operators reducing or suspending activity and CapEx being cut in response to unfavorable commodity prices and pandemic-related demand destruction, there has been far too much uncertainty to predict the timing of a recovery. However, we are seeing that the completion services have been the first to reflect an improvement in the market activity, as operators have focused on completing their backlog of DUC wells from earlier in the year.
In terms of our own visibility on activity, we’ve seen an uptick in July, and the August and September months have shown a notable increase in scheduled work, particularly for completions-related projects as the completion of DUC wells will drive demand for coiled tubing, technical services, as well as rentals. However, I would reemphasize that this may merely be a transitory uptick as the outlook for the fourth quarter remains opaque at best, and there remains a good deal of overhanging concern from our clients regarding 2020 budget exhaustion. With that said, we’re working to realize synergies and reduce our cost structure and hope to exit the year on at least a $30 million synergy run rate.
Finally, let me emphasize that we remain committed to growing the business, while maintaining a conservative balance sheet and a returns-focused mentality. And we continue to believe that industry consolidation is an ideal means to achieve this goal. As such, we will continue to remain active in pursuing consolidation opportunities and we’ll prioritize those that have a strong strategic fit and/or offer meaningful technological differentiation, maintain or improve the strength of our balance sheet and offer additional cost savings or synergies.
In closing, let me once again say that I’m very grateful for the support of our shareholders, who have entrusted us to see the Company through these trying times and I’m also extremely thankful for our dedicated employees, who have made many sacrifices in adapting to these extraordinary conditions to deliver the superior product and service quality that our customers are accustomed to receiving.
With that, we will now take your questions. Operator?
Questions and Answers:
Operator
[Operator Instructions] Our first question comes from the line of John Daniel with Simmons. Please proceed with your questions.
John Daniel — Simmons — Analyst
Hey, guys, thanks for putting me in. Just for the transcripts, no longer with Simmons with Daniel Energy Partners. But Chris, you alluded to consolidation opportunities still something that you wish to pursue. Obviously, you’re probably pretty busy with the integration now. But can you speak to a consolidation strategy? Would you — does it make more sense to target the smaller tuck-in deals? Or do you go for the gusto again with another larger transaction?
Christopher J. Baker — President & CEO
Yes. Good morning, John, and a good catch. We saw that up on the screen, the Simmons note. So congrats on your new role and appreciate you dialing in and your interest in KLX. Look, as you know, we’re huge proponents of industry consolidation. We saw consolidation in the market earlier this week, and we congratulate both of those teams. I’m sure you’re well aware. We’ve also started to see some consolidation in some of the larger privates over the last month, same month. And so we congratulate all of those parties. I’m just starting to move the needle.
First and foremost, we’re going to focus on integration and synergy realization period in the story, that’s our number one goal, along with bringing the Company back to break-even EBITDA. And so that’s what we’re focused on. But I think we’ve discussed mergers, ad nauseam on prior calls. We view this as step one. We’re still looking to gain scale in certain service lines. And we’ll continue to look to add complementary technology, all while trying to preserve the strength of the balance sheet.
And so, as we look at the outlook in front of us, KLX is afforded with a diverse mix of product service lines and an impressive technology portfolio and a strong balance sheet and liquidity position. So, we think we can use our position of relative strength to our advantage, and we’re going to continue to look for ways to grow the business. And I think, between myself and Keefer and our Board, we all have relationships, to your point, on the larger side of the business, as well as the private and we’re going to be opportunistic there. But we’re not going to let a transaction get in the way of integration.
John Daniel — Simmons — Analyst
Fair enough. Would you envision, as a consolidation strategy does unfold sort of sticking with existing core competencies? Or do you see yourself wanting to branch out to expand product line? And that’s all for me.
Christopher J. Baker — President & CEO
Yes. No, look, I think, to my earlier point, we’re pretty diverse at this point in time. And so we’re going to try to continue to gain scale and stick with our knitting, right? I’m not going to say that we wouldn’t look to bring the Company into more production service lines in the OpEx side of the business. But it would be something that tucked in well and was synergistic to our existing technology platform, where we could cross-sell some of those technologies and tools.
John Daniel — Simmons — Analyst
Okay, great. Thanks for putting me in, guys.
Christopher J. Baker — President & CEO
Yes. No, I appreciate it, John. Thank you.
Operator
Our next question comes from the line of Jaime Perez with RF Lafferty & Co. Please proceed with your questions. Jaime Perez, your line is live.
Jaime Perez — RF Lafferty & Co — Analyst
Good morning, everybody. How are you doing? Thanks for headed on mute. Thanks for taking my question and congratulations on the merger. I have a question on utilization for the quarter. Can you give us some color or details on utilization? And what would be the break-even utilization for gross margins? I mean, we have a — gross margin is pretty weak. I’m just wondering what volume of work that you need to have to achieve break-even gross margins? And I have further questions beyond that.
Christopher J. Baker — President & CEO
Yes. Jaime, I appreciate the question. Look, what I would say is, across all product lines and all regions, revenue was down differing levels, right, and differing levels of utilization. And so we haven’t historically closed utilization by product line. But overall, 2Q is a very difficult market. I mean, rig count bottomed at basically 231 on a horizontal and directional basis. It’s now up plus 10. We talked about how frac spreads and completion activity, which includes flowback and all the related tools and drill outs were down in the 40 range, and we now see those back up into the low-100 range. And so that’s going to drive utilization across a whole host of our service lines.
We’re also starting to see some of the shut-in wells be brought back online, and that will also drive intervention services and some of the tools to go back to work. And so, we’re seeing a ramp in utilization today. Pricing is still soft across the Board. And so, from a break-even perspective, it’s going to be highly dependent on the revenue mix coming out of the product lines, the revenue mix, whether it’s driven by incremental utilization or incremental pricing, we have seen a pricing uptick in certain business lines. And then lastly, the timing of realization of synergies within a given quarter. So I don’t think we’re prepared to provide guidance on required break-even revenue. But I think that gives you the building blocks and components.
Jaime Perez — RF Lafferty & Co — Analyst
Yes. That’s helpful. Also, as far as the integration, I mean, how far — I know the merger completed was closed on late July. But as far as the integration of all the –of the Company and especially the field and operations, how far have we gotten? And if an operator wanted service, how fast could you provide it?
Christopher J. Baker — President & CEO
Yes. Look, I mean, what I would say is, we talked about it in the prepared remarks. We think we’ve realized about $18 million of synergies thus far. Step one was absolutely the consolidation of the corporate functions, right? And so we’re working on that. We’re working on the consolidation of the Houston functions as well. There’s only certain geographies where we truly had overlap, and that would have been the Southwest geo market and then the Mid-Con. And so we hit the ground running basically week one, day one with regards to consolidating those opportunity sets. And I think we’ve done an excellent job. And part of that consolidation and integration is what’s driving some of the uptick in activity that we’re seeing today. And so, from a customer response standpoint, we’re ready to go at a moment’s notice, as soon as they call us. So I don’t think we’ve had any issues with regards to the responsiveness to customers.
Jaime Perez — RF Lafferty & Co — Analyst
Very good. Yes. My next question, you have about $99 million of cash on the balance sheet. What’s the plan to use for the cash? Are you going to use it to buy more equipment? Is it pay down some debt? I mean, you do have large amounts of debt servicing throughout. It was about $7.6 million this quarter. And if you analyze that, it’s almost $30 million. What’s management’s thought about paying off some debt?
Christopher J. Baker — President & CEO
Yes. I think with regards to — I’ll just hit the first part of that question with regards to CapEx. We alluded to the fact that we basically suspended all growth CapEx and we have scrubbed maintenance CapEx to absolutely require the unnecessary items. And so we will cut that number 50% year-over-year and don’t anticipate, in this market, increasing capital spending anytime soon. Keefer, you want to jump in on kind of the debt in the balance sheet?
Keefer M. Lehner — EVP & CFO
Sure. So I appreciate the question and good morning. So you’re spot on. We ended the quarter with about $99 million in cash. We had about $15 million of availability on our ABL facility. But as we noted in the prepared remarks, that doesn’t include the borrowing base impact associated with the current assets from the legacy QES side, which were not wrapped into our borrowing base as of July 31. But that will be complete prior to reporting our Q3 results. I think to get to where you’re going with your question, it seemed to be more on the liability management side. And I think what I’d say is, the Company is evaluating all opportunities in front of us, whether it’s to grow through consolidation or to improve the balance sheet. So in addition to consolidation, liability management is certainly a hot topic within the industry today. But as we stated in the prepared remarks, cash and liquidity preservation in the current environment are king. And so, as we approach or evaluate liability management option, we’ll do so in the same manner with which we evaluate all investment opportunities for the Company, which is really to focus on the risk-adjusted returns there, understanding that the key in this type of market environment is cash preservation and liquidity preservation.
Operator
This concludes our question-and-answer session. I’d like to hand the call back to Mr. Baker for closing remarks.
Christopher J. Baker — President & CEO
Thank you once again for joining us on this call and for your interest in KLX Energy Services. We look forward to talking to you again next quarter.
Operator
[Operator Closing Remarks]