KLX Energy Services Holdings, Inc. Q2 FY2022 Earnings Call

Greetings and welcome to the KLX Energy Services Second Quarter Earnings Conference Call. As a reminder, this conference is being recorded. It’s now my pleasure to introduce your host, Ken Dennard, Investor Relations. Thank you, Ken. You may now begin.

Thank you, operator and good morning everyone. We appreciate you joining us for KLX Energy Services conference call and webcast to review second quarter 2022 results. With me today are Chris Baker, KLX Energy’s President and Chief Executive Officer; and Keefer Lehner, Executive Vice President and Chief Financial Officer. Following my remarks, management will provide high-level commentary on the financial details of the second quarter and outlook before opening the call for your questions. There will be a replay of today’s call available by webcast on the company’s website at klxenergy.com, and also a telephonic recorded replay available until August 26, 2022. More information on how to access these replay features was included in yesterday’s earnings release. Please note that information reported on this call speaks only as of today, August 12, 2022. Thus, you are advised that time-sensitive information may not be accurate as of the time of any replay listening or transcript reading. Additionally, comments on this call may contain forward-looking statements within the meaning of United States federal securities laws. These forward-looking statements reflect the current views of KLX 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 or reader is encouraged to read the 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 reconciliations to the most directly comparable GAAP financial measures are included in the quarterly press release, which can be found on KLX Energy’s website. And now with that behind me, I’d like to turn the call over to KLX Energy Services President and CEO, Mr. Chris Baker. Chris?

Thank you, Ken and good morning everyone. Thank you for joining us today. We are very excited to discuss our Q2 results, which exceeded the top end of our prior guidance for both revenue and, more importantly, adjusted EBITDA margin, as well as our go-forward outlook. The broader macro backdrop for KLX’s services continued to experience strong demand despite somewhat volatile commodity prices. Average U.S. rig count was up approximately 13% during the quarter. Frac spread count was up 4% sequentially. Crude prices averaged over $108 per barrel and natural gas averaged $7.50 per MMBtu. Additionally, supply chain and qualified personnel constraints continue to support improved pricing. The fundamental industry backdrop remains strong, and it certainly feels like we are at the very beginning of a multiyear OFS up-cycle. During the second quarter, KLX generated $184.4 million in revenue, up 21% sequentially from $152.3 million in Q1, which was above the top end of our prior guidance. Likewise, we generated Q2 adjusted EBITDA of $17.4 million, increasing $12.5 million sequentially or 255%. Adjusted EBITDA margin increased to 9.4% from 3.2% sequentially or approximately 3 times higher than Q1, which was also above the top end of our prior guidance. We continue to benefit from significant operating leverage, driven by the 2020 merger with QES and the associated synergies, but we also experienced higher utilization and, more importantly, significantly improved pricing across all product and service lines in the second quarter. In fact, I am proud to say that both revenue and margin increased in every single product line quarter-over-quarter, except for one. We continue to experience extremely high utilization across our drilling, completion, production, and intervention businesses due to strong demand for our equipment and services. Directional drilling charge days were up 15% versus a rig count increase of approximately 13%. Fishing activity was up 15%. Accommodations rental days were up 9%. And I would add that we remain largely sold out in that business line. Wireline revenue days were up 25%. Plugs sold were up 55%. Pressure pumping stages were up 32%. BOP rental days were up 19%, and tubing rental days were up 29%. The depth of our product service offering supports our ability to cross-sell and leverage revenue synergy opportunities. Meanwhile, we continue to have additional asset capacity across several service lines, including coiled tubing, frac rentals, and wireline to support expanded customer activity and new customers. Reduced white space, along with improved pricing, drove materially improved Q2 results. Given the supply and demand fundamentals in the OFS industry and demand for KLX’s highly qualified personnel and execution in the field, we are in a fortunate position to be able to leverage the value of the KLX brand across the board. The labor market remains tight, and the reality of the market is that increased pricing is required to generate sufficient margins to support the equipment demands required to deliver the efficiencies that U.S. shale operators have come to expect. Q2 pricing improved meaningfully across all product service lines when compared to Q1, increasing from the high single to low double-digit percentages sequentially. While margins are above 2019 levels in some product lines, we have not yet returned to historical 2019 levels in aggregate. We continue to accelerate the pace of pricing improvements during Q2 and expect another leg up across our service portfolio during Q3. I will provide additional outlook later in my prepared remarks. However, as we telegraphed on our last call, the prior monthly revenue record did not last long, and we continue to see meaningful monthly improvements exiting the second quarter on an upper $700 million revenue run rate with adjusted EBITDA margins trending towards the low double digits. With that, I will now turn the call over to Keefer, who will review our financial results and I will return later in the call to discuss our outlook in greater detail. Keefer?

Thank you, Chris. Good morning, everyone. I will begin this morning by discussing our second quarter 2022 consolidated results, where we experienced broad-based improvement in our revenue and margins across all geographic segments and product service lines. For the second quarter, revenues were $184.4 million, an increase of $32.1 million or 21% compared to the first quarter. Revenue growth was driven by broad increases in our drilling, completion, production, and intervention activity and pricing across the majority of our core geographic markets. On a product line basis, drilling, completion, production, and intervention products and services contributed approximately 28%, 50%, 12%, and 10% to revenue respectively for the second quarter of 2022. These relative contributions are largely unchanged from Q1, and we saw our largest sequential revenue increases in pressure pumping, coiled tubing, directional drilling, wireline, rentals, and accommodations. Adjusted operating income for the second quarter was $2.6 million. This is the first positive quarterly result on the adjusted operating income line since Q2 of 2019. Adjusted EBITDA and adjusted EBITDA margin were $17.4 million and 9.4%, respectively. Adjusted operating income and adjusted EBITDA improved sequentially by $12.1 million and $12.5 million, or 127% and 255%, respectively. We generated a very strong 39% incremental margin from Q1 to Q2. Note, we continue to be burdened by $2.1 million of quarterly lease expense related to leased coiled tubing packages. We do not add this cost back, but it does impact comparability to our peer results. Total SG&A expense for Q2 was approximately $18 million, which equates to roughly 9.8% of Q2 revenue. If you back out nonrecurring G&A expense, we were really at 8.6% of revenue. As we’ve discussed on prior calls, following the QES merger integration, KLX now has one of the most efficient fixed cost structures in the OFS industry and we believe we can continue to scale from current levels with minimal fixed cost G&A additions. Turning now to a review of our segment results. Let me begin with the Rockies. The Rockies segment second quarter revenue of $53.1 million increased by $9.8 million, or 23%, compared with the first quarter. The sequential increase in revenue was primarily driven by an increase in activity and pricing throughout the DJ Basin, Wyoming, and Bakken, primarily across our coiled tubing, directional drilling, rentals, fishing, and wireline offerings. Adjusted operating margin for the second quarter was $4.1 million compared with an adjusted operating loss of $700,000 for the first quarter. Adjusted EBITDA was $9.3 million as compared to first quarter adjusted EBITDA of $4.7 million. The increase in profitability was driven by the previously mentioned increase in activity and pricing across most of our product service lines with rentals, downhole products, and directional drilling leading the way. Moving now to our Southwest segment. The segment increased its revenue by 16% sequentially compared to the first quarter, generating revenue of $60 million in Q2. The increase in revenue was primarily driven by increased activity and pricing across the majority of our product service lines, with directional drilling, coiled tubing, and wireline experiencing the largest increases. Q2 adjusted operating income for the segment was $1.8 million compared to a first quarter adjusted operating loss of $300,000, and adjusted EBITDA was $6.4 million for the second quarter compared to first quarter adjusted EBITDA of $4.2 million. The increase in profitability was driven by previously mentioned increases in activity and pricing across our various product service lines but led by strong margin expansion across directional drilling, coiled tubing, wireline, and frac rentals. Now to wrap up the segment discussion with the Northeast and Mid-Con. Q2 revenue was up $14.2 million sequentially to $71.3 million. The increase in revenue was primarily driven by sequential improvement in activity and pricing across pressure pumping, rentals, coiled tubing, and accommodations across the region. Adjusted operating income for the second quarter was $7.4 million compared with an adjusted operating loss of $700,000 in the first quarter. Adjusted EBITDA was $11.1 million in the second quarter compared to first quarter adjusted EBITDA of $2.7 million. The increase in profitability was driven by the previously mentioned increase in activity and pricing led by meaningful margin expansion across those same product service lines. I’ll now turn to our balance sheet and cash flow. Our Q2 cash balance increased by $12.1 million to $31.5 million when compared to Q1. The increase in cash was largely driven by $20 million of additional borrowings on our ABL facility, $5.3 million in share sales under our ATM program, and continued monetization of $3.9 million in obsolete assets and non-core real property, offset by $14.4 million of semiannual interest paid in early May. We continue to proactively manage working capital and convert cash flow as quickly as possible. Net working capital was $51.3 million in Q2, up 12% compared to Q1 net working capital of $45.9 million. This increase in net working capital was largely driven by the 21% increase in revenue, but we were able to negate some of the investment by reducing DSO by 4% to approximately 60 days as of Q2, while modestly increasing our days payable outstanding. Capital expenditures for the second quarter were approximately $7.8 million, and we're primarily focused on maintenance spending across our segments. Going forward, we continue to expect total CapEx for 2022 to be in the range of $25 million to $30 million and to be approximately 80% focused on maintenance spending. With that said, supply chain issues have slowed deliveries of CapEx items so far in the first half of 2022, but we hope this trend will improve as we navigate through the remainder of 2022. As of June 30, we had $6.3 million of assets held for sale related primarily to the sale of real property in the Rockies and Southwest segments. We are continuing to work through options to monetize those facilities in the near-term, and based on the current status, we expect to close $1.5 million in Q3 and $2.4 million of sales in Q4. Total liquidity as of June 30 was $70.7 million, and our available liquidity was $56.6 million, comprised of $31.5 million in cash and $25.1 million in borrowing availability on the June 30 borrowing base certificate net of a $14.1 million fixed charge coverage ratio holdback. Debt outstanding as of Q2 was $250 million in 2025 maturity senior secured notes and $50 million drawn on our $100 million ABL facility that matures in the fall of ‘23. Given expectations around cash generation in the second half, we believe we may be able to reduce our borrowings under the ABL facility as we navigate the remainder of 2022. Given that our ABL facility matures in the fall of 2023, we are in advanced discussions with lenders around various refinance options, including an amend and extend. As we have emphasized on prior calls, continued management and preservation of liquidity while supporting the ongoing rebound in our underlying business remains a top priority. We remain focused on positioning the company to generate positive levered free cash flow and believe we are close to achieving this goal as we look out to the second half of 2022. Based on current calendars and pricing trends, we are excited about our outlook for the back half of the year and into 2023. I’ll now turn the call back to Chris, who will provide some additional color on our outlook.

Thanks, Keefer. Before we wrap up, I’d like to share some more detail on our outlook and expectations for Q3 and the remainder of 2022. With operating efficiencies in mind, customers are choosing to work with the most experienced and reliable crews and equipment for their drilling, completion, and production programs. The tight labor market continues to be a net benefit for KLX as it remains the primary catalyst for further improved pricing. Additionally, KLX is able to attract employees and crews, given our strong reputation, the latest generation equipment and technology, and long-standing relationships with top operators. Our pricing strategy and higher utilization should further reduce whitespace through the remainder of 2022. We continue to evaluate opportunities and have seen success in cross-selling and pulling through multiple KLX product lines across the vast number of wells that we touch. We will continue to review opportunities from both a pricing and returns perspective by prioritizing the deployment of assets to customers and basins that maximize free cash flow generation. By deploying our assets in the most profitable manner, we can leverage our operational expertise with improving market dynamics amid a volatile commodity backdrop. Looking ahead, we are extremely bullish about Q3 and the second half of 2022. We exited June on a strong run rate and expect to benefit from a favorable macro backdrop with net pricing improvements. We are very confident that we will continue to grow our top line and drive margin expansion in Q3 and into 2023. We expect sequential third quarter revenue growth between 9% and 13%, and Q3 adjusted EBITDA margins to be in the range of 10% to 12%. We are also increasing our full year revenue guidance to a range of $730 million to $750 million. Based on the current trajectory and expected results, we believe we may return to positive free cash flow by year-end. In closing, we are very excited about the future for KLX. Most importantly, I want to thank our team for delivering superior operational performance in the second quarter. Eliminating white space and maximizing utilization to drive financial results doesn’t come without personal sacrifice and tremendous coordination and planning to maximize revenue and margin opportunities by every single KLX team member. The KLX team executed exceptionally well in the second quarter. We believe we are well on our way back to pre-pandemic activity and margin levels, and KLX is uniquely positioned to benefit from the current upcycle and deliver improved results in the second half of 2022 and beyond. With that, we will now take your questions.

Thank you. And our first question is from the line of John Daniel with Daniel Energy Partners. Please proceed with your question.

Hi, good morning, guys.

Good morning.

Yes. Hi, good morning.

Chris, in your prepared remarks, you talked about some of the segments with idle capacity that could still be deployed. Could you go through that again? I missed that. And then just elaborate a little bit on what’s out there?

Yes, sure. Look, we did not give unit counts on that capacity. But I think we’re trying to provide the market with more transparency on our product lines that are really driving the results. I think we did a good job at that, talking about where assets and day count was up. As we think about incremental unit capacity, it’s really, as you well know, the coiled tubing space, the wireline space. On our frac valve rental business, we have assets that are either undergoing refurbishment or prepared to be deployed if the market warrants in certain basins and if customers have demand. We’re seeing incremental utilization and we definitely saw materially improved results in Q2 for all of those businesses, but we’re evaluating the market before we deploy additional assets.

Okay, fair enough. Because I was doing the monthly calculations, looking at the revenue guidance and what you’ve got year-to-date, and I did this in my head. So I could be wrong here because I was driving, but I had similar to Q4, the implied revenue in that $240 millionish range just by doing the math. I think I’m not mistaken. Therefore, that would be up quarter-over-quarter. Normally, there is some seasonality that has exposure to weather-prone areas. It just feels really good. Any color there and how you get there from Q4 versus Q3, if my math is right and the way of driving?

Yes, so look, we did not guide on Q4 yet. We’re still evaluating seasonality. We brought up last quarter. There is always the potential for fourth-quarter budget exhaustion. We are not seeing or hearing that from our clients. In fact, we’re actually seeing the opposite. We’re seeing a lot of RFQs, especially on the smaller operator side, for incremental fourth quarter activity. So the revenue guide effectively shows 9% to 13% up quarter-over-quarter for Q3; if you’re extrapolating further into Q4, potentially you get there. I think if seasonality hits, that’s still to be determined at this point in time.

Okay, all right. I guess the last one is, most companies have reported, particularly on the drilling side, talked about the inquiries for 2023, incremental equipment from customers. Can you just speak big picture to what customers are asking you as you prep for ‘23? Any color would be appreciated.

Yes, look, we’ve heard about that, particularly on the drilling and completion side, specifically within frac where you typically see contracted service lines. We are in the initial stages of talking to customers on RFQs for wireline and other completion-type services, the frac rental business, etc. We are definitely having conversations with customers where they are starting to talk about programs that kick off at the end of this year and are going to run flat out through next year. It’s well before budget season for our E&P clients. So they are all initial conversations.

Okay, well, that’s all I had. Thank you for taking my questions.

Appreciate it, John.

Thanks John. Chris, Keefer, we have received a number of email questions from people that weren’t going to be on the call or typically don’t ask questions out loud on the call. The first one was related to M&A, and it says, looks like OFS consolidation has picked back up with recent transactions in coiled tubing and directional drilling. How are you thinking about the M&A landscape for services? And how does KLX fit into the equation?

Yes. Appreciate it, Ken. I will jump in here. We saw a few deals get done in Q2 and early Q3 in both coiled and directional drilling. Candidly, it’s nice to see non-distressed deals getting done as consolidation, as we talked about previously, is desperately needed in the OFS space. Our customers have done a fantastic job of consolidating the industry, especially in the Rockies and the Marcellus. But the service sector has not kept pace. We think the consolidation is needed. Candidly, we think it improves our marketplace, whether we are a participant in that consolidation, similar to the recent deals or not. It’s not just going to improve the marketplace for the target or the acquirer. We think KLX is well positioned to continue to participate in consolidation, and we think our improved financial results and long history of successfully integrating acquisitions and growing through consolidation proves out that strategy.

Thanks. The next question came regarding ESG. I wanted to know what steps are KLX taking to address ESG and climate change in the field and strategically?

Yes. Appreciate it, Ken. We have evaluated a number of opportunities on the ESG front throughout our history, including carbon sequestration, methane containment, and how our assets might participate in some of those markets, as well as looking at drilling geothermal wells. Our primary focus on the ESG front today is really the continuation of electrifying various components of our fleet where that makes sense via conversions or otherwise. We have talked about in the past that at this time, we have got two electric hybrid wireline units. We are currently undergoing conversions for two additional units. We have actually converted one of our coiled tubing units and one of our snubbing units to electric hybrid units, and we are adding electric trucks to our fleet as available and where appropriate. We have had conversations with specific customers in one basin that we would like to have a fully electric KLX spread on the footprint in the very near future. Additionally, we just commercialized our Gen 3 dissolvable plug and have numerous other initiatives in R&D that will assist with our ESG goals along the way. From a regulatory and compliance standpoint, we are working to stay ahead of all regulatory bodies to ensure we collect and analyze all the required data for KLX and our customers. We expect to know more on formal reporting requirements later this year or early next year.

Thank you. Keefer, this question is probably coming to you. The next question here about credit is, given the significant improvement in EBITDA, how are you thinking through options with the balance sheet for both the ABL and the notes?

Yes. Thanks, Ken. If you look at the June 30th balance sheet and borrowing base certificate, we exited Q2 with gross availability of about $71 million. If you back out the structural holdback related to our fixed charge coverage ratio, that’s a springing covenant in the ABL dock. That holdback was $14 million, giving about $57 million of available liquidity as of the end of the second quarter. Regarding that ABL facility, it does mature in the fall of next year. We continue to advance options with lenders in order to address that maturity prior to the facility going current, including an amend and extend option. On the note side of your question, the notes don’t mature until the fall of 2025. Based on our Q2 run rate results, we are now below a 4x net leverage ratio. We didn’t explicitly guide on Q3 adjusted EBITDA guidance, but we forecast sequential revenue growth as well as an uptick in margins to be 10% to 12% in the third quarter, which would imply that on a run rate basis, our net leverage ratio should continue to improve. So, I think with that said, we are rapidly approaching a more normalized credit profile, certainly on a run rate basis today. In addition to continued improvement in our underlying business and financial results, we continue to have optionality and opportunities to augment our credit profile, liquidity position, and, from a strategic positioning perspective as well, utilizing both our ATM program and planned asset sales that Chris mentioned during our prepared remarks.

Thanks. Speaking of margins, the next question says it appears you experienced very strong sequential margin from Q1 to Q2. How do you think about operating leverage and margins going forward?

Yes. So, Ken, I will jump in. This is Chris. Keefer can add as necessary. To put things in perspective, rig count averaged 74 rigs during Q2. We generated an annualized adjusted EBITDA of about $70 million at a 9%-plus margin. The last time rig count was at this level for a quarter was Q1 of 2020. At that point, we were generating annualized EBITDA of approximately $16 million at a 3% margin for that period. I think the benefit of fixed cost reductions we have seen associated with the merger are permanent. They are real. It should be readily apparent when comparing our current performance to historical numbers. The delay in realizing some of that candidly has been similar to many of our peers as you unstack assets off the fence line, etc. R&M expenses increased, and some of that takes a little while to normalize until reaching a certain revenue scale and consistent utilization. We saw some of that normalize in Q2. So, we have a tremendous amount of operating leverage in the business. We continue to push pricing and redeploy existing assets as the market warrants from a return on invested capital perspective. Revenue was up about 21%. However, headcount was up in the low-single digits. We are a very labor-intensive business. As you think about effective crew utilization and how we push pricing significantly over the same time, that’s the driver of margin. We have been laser-focused on crew utilization rather than on asset utilization, and we focus on allocating assets to customers where they will maintain utilization for 24 days a month. A small change in crew utilization has a very material impact on margin. Lastly, if you consider 2019 pro forma EBITDA—including the synergies from the QES deal—that would have been in excess of $150 million. There is still significant room to move back to 2019 levels, and we are clearly a much leaner and efficient organization, as Keefer pointed out regarding SG&A. If we were operating in that 2019 market today, we would likely outperform the legacy KLX business.

Thanks, Chris.

Thank you. We have a follow-up question coming from the line of John Daniel with Daniel Energy Partners. Please proceed with your question.

Hey guys. Thanks for putting me back in. I apologize for my math, but I caught my earlier calculation. Chris, a question for you on some of the smaller basins that we never really hear about anymore, but given where commodity prices are. Places like the Barnett, San Juan Basin, Utah, anything that you are seeing that would lead you to believe there might be a step change in activity into next year? Just one question is, repositioning assets there, if you are not there.

Yes. Look, I guess two things. One, no problem on the math. Like I said before, we haven’t given Q4 guidance; therefore, I assume you were doing some extrapolation and mathematical calculations. Well, not a problem. Look, I think we are a very diversified completion and drilling, completion, production, and intervention company. As we mentioned last call, we are redeploying assets, and it has taken a little while through the integration process. In several business lines like flowback and frac rentals, we really try to gain scale within certain basins. For other business lines like rentals, fishing, wireline, P&A, etc., we are active in every basin you mentioned. What’s beyond Henry Hub has really supported the incremental activity. I don’t want to project what happens to natural gas next year. As we've seen NATI hold in north of $5, let alone where it’s been sitting in the last couple of weeks in the $7 to $8 range. Those operators in the smaller basins have definitely become active, and we are trying to take advantage of deploying assets into those spaces.

Okay. Great. Thank you very much.

Yes. I appreciate it, John.

Thank you, John. It looks like we are coming to the end of the call. I just wanted to let the listener or reader know that management will be at Barclays and at H.C. Wainwright in September. So, sign up and see them in person at those conferences. For final comments and closing of the call, Chris, take it away.

Yes, thank you, Ken. Thank you once again for joining us on our call today and your interest in KLX Energy Services. We look forward to speaking with you again next quarter.

Thank you, ladies and gentlemen. Thank you for your participation. This does conclude today’s teleconference. You may disconnect your lines at this time and have a wonderful day.