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Edited Transcript of KEG.N earnings conference call or presentation 7-Nov-18 4:00pm GMT

Q3 2018 Key Energy Services Inc Earnings Call

HOUSTON Nov 13, 2018 (Thomson StreetEvents) -- Edited Transcript of Key Energy Services Inc earnings conference call or presentation Wednesday, November 7, 2018 at 4:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* J. Marshall Dodson

Key Energy Services, Inc. - Senior VP, CFO & Treasurer

* Katherine I. Hargis

Key Energy Services, Inc. - Senior VP, General Counsel & Corporate Secretary

* Robert J. Saltiel

Key Energy Services, Inc. - President, CEO & Director

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Presentation

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Operator [1]

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Good morning. My name is Holly, and I'll be your conference operator today. At this time, we'd like to welcome everyone to the Key Energy Services Quarter 3 2018 Earnings Conference Call. (Operator Instructions) I'll now turn today's conference over to Katherine Hargis, Senior Vice President and General Counsel. Please go ahead, ma'am.

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Katherine I. Hargis, Key Energy Services, Inc. - Senior VP, General Counsel & Corporate Secretary [2]

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Thank you, Holly. And thank you all for joining Key Energy Services for our third quarter 2018 financial results conference call.

This call includes forward-looking statements. A number of factors could cause actual results to differ materially from the expectations expressed in this call, including risk factors discussed in our 2017 Form 10-K, our first quarter 2018 10-Q and other reports most recently filed with the SEC, which are available on our website at www.keyenergy.com.

This call may also include references to non-GAAP financial measures. Please refer to our previously posted earnings release, which can be found on our website, for a reconciliation of any non-GAAP financial measures provided in this call to the comparable GAAP financial measures.

For reference, our general investor presentation is available on Key's website at keyenergy.com under the Investor Relations tab.

On the call this morning is Rob Saltiel, Chief President and CEO; and Marshall Dodson, Chief CFO. I'm now going to turn the call over to Rob.

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Robert J. Saltiel, Key Energy Services, Inc. - President, CEO & Director [3]

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Thank you, Katherine, and good morning to everyone joining today's call.

During my first 3 months in Key, I've spent a lot of time in the field, visiting our facilities, meeting our clients and getting to know our people. I've been very impressed with the Key employees I've met. Despite our company's challenges over the past few years, we have retained a very capable and dedicated base that will lead us into better times. I've also been impressed with the scale and quality of our equipment, the rigor of our training programs and our strong safety culture. Each of these elements differentiates us from our competitors, and I've heard our clients site these advantages as reasons why they select Key for their well services. With our distinctive capabilities and supported market fundamentals, I'm excited about the opportunities ahead for our company.

Turning now to our financials. Our revenues for the third quarter were $134.7 million or $9.7 million lower than the second quarter. This decline is largely attributable to the loss of market share in our California Rig Services business and lower utilization of our large diameter coiled tubing units. This lower activity drove a decline in our adjusted EBITDA, which came in at $5.6 million for the quarter.

I will now address the performance of each of our 4 business segments. In our Rig Services segment, our quarterly revenue came in at $77.2 million, down about 4% from second quarter as the lost business in California was not offset with growth elsewhere. Despite the quarterly dip, Rig Services revenue for the company is up more than 24% from year ago levels. We expect this general upward trend to continue into 2019 for both productions-related and completions-related work in our other basins. Quarter-on-quarter, our completion rig hours increased 15%, led by activity in the Permian and the Bakken, as we averaged around 17 rigs due in 24-hour work, the bulk of which was for completions. We also had over 30 rigs participate in the 24-hour completion market last quarter, and we continue to field requests today from our clients for additional rigs.

Looking forward to 2019 for our Rig Services segment, we expect to see higher onshore CapEx budgets from the E&P operators bullied by strong oil prices and improving netbacks in the Permian Basin as additional pipeline takeaway capacity comes online. This should spur clients to increase work-over and well maintenance activities to maintain their growing inventory of horizontal wells and to take advantage of high-return, short-cycle investments. In addition, the number of drilled, uncompleted wells, or DUCs, continues to rise, especially in the Permian. And this should increase completions work using service rigs in 2019.

One of our industry's principal challenges will be to meet the growing demand with sufficient numbers of qualified and well-trained crews. We have multiple initiatives at Key underway to ensure that we can attract, train and deploy new people to our rigs. However, skilled labor will continue to be tight, so higher prices will be required to allocate demand for our services.

Our Fishing & Rental segment consists of services and equipment rentals, the company well completions and work-over services. These services may be complementary to Key's own well service rig offerings or be combined with rigs provided by our competitors. Segment revenues increased to $17.5 million for Fishing & Rental, a 6% increase over the second quarter, and we saw a continued improvement in our EBITDA margins. The revenue and margin gains were driven by higher production related well work-over and maintenance activity as well as deployment of rental assets into completions.

Today, our Fishing & Rental segment is renting, on average, 35 well service rig completion packages daily on Key or competitors' rigs, which is close to 80% of our workable fleet. These completions-oriented assets have seen very high utilization, and we expect to see further growth of our capability by approximately 25% by midyear 2019.

Our Fluids Management Services segment revenues came in at $21.9 million and were impacted by slowing completions activity in the Permian and a general shortage of qualified drivers. Truck hours were down 8% versus the second quarter, accounting for the majority of the revenue decline. Lower margins resulted from labor costs that were not fully passed through in our rates and from lower volumes at our saltwater disposal, or SWD, wells due to maintenance and improvement activities made at some of our Permian facilities. We expect to see increases in our trucking prices to accommodate the rises in labor costs and that this will be a catch-up quarter on margins. As overall completions activity improves, we expect -- as we expected well in 2019, our ability to increase both activity and prices for Fluid Management Services should be enhanced.

Turning finally to our Coiled Tubing Services segment. As we move into the third quarter, we began to see disruptions in our schedules due to delayed fracking programs and/or change-outs of pressure pumping service providers by our clients. This lowered the utilization of our large diameter units, and we averaged about 5 units working in the third quarter as compared to approximately 6 units working in the second quarter. The wet Texas weather in September also negatively impacted our utilization. With the activities slowing in the Permian across the third quarter, we have also seen some of our competitors move their coiled tubing equipment out of the Permian Basin and into other parts of Texas and Oklahoma. The additional competition of softened prices in those markets has increased the challenge of providing skilled crews to operate the units. However, we believe that as completions activity picks back up in the Permian Basin, this will tighten markets across the U.S., allowing us to increase the pricing and utilization of our large diameter units.

I'll return with some closing comments after Marshall updates us on more details on the financials. Marshall?

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J. Marshall Dodson, Key Energy Services, Inc. - Senior VP, CFO & Treasurer [4]

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Thanks, Rob.

In our Rig Services segment, revenues fell $3.3 million or 4% as the lost business in California was only partially offset by growth in other markets. While we do expect demand in California to improve enough to redeploy assets with other customers in 2019, we do not expect our revenues in that market to be fully recovered until around mid next year. Our average rigs worked was 193 in the third quarter, down from 205 in the second quarter of 2018. Our gross margin in this segment fell to 20% in the third quarter, and adjusted EBITDA margin fell to 15%, both down about 450 basis points from the prior quarter, largely on the lost activity and costs in California. About 100 basis points of the decline was due to costs associated with the vehicle accident in the quarter. We also had some labor inflation that cost us about 60 basis points of margin. Price increases, averaging low single digits, we implemented late in the quarter should offset this in the fourth quarter. And we expect margins to be fairly flat next quarter on activity seasonally down 5% to 7%.

The revenue and margin improvement in our Fishing & Rental Services segment in the third quarter of 2018 as compared to the second quarter of 2018 was due to higher fishing and completion rental activity. We expect seasonality over the fourth quarter dropping revenues 3% to 5%, with margin somewhat negatively impacted 100 to 200 basis points on the lower Q4 activity.

In our Coiled Tubing Services segment, it was impacted by the factors Rob described, with revenues of $18.2 million in the third quarter, down $5.7 million from the second quarter. We expect to average around 3 large diameter units working in Q4, with that average moving up again towards the end of the first quarter of 2019. This low activity, coupled with a seasonal slowdown in maintenance work and pricing down 5% to 10% on average, will impact margins over the next several months, keeping margins flat to down 100 basis points in the fourth quarter and until activity picks back up towards the end of the first quarter.

Our Fluids Management Services revenues declined 7% in the third quarter of 2018 from the second quarter of 2018 on an 8% drop in activity, with a 1% increase in revenue per truck hour due to price increases. Labor costs caused 400 basis points to the margin decline quarter-on-quarter. We also had higher expenses associated with disposal wells. The cost is 300 basis points of margin. We don't expect that cost to repeat again next quarter. We expect the seasonal activity decline of 3% to 5% in truck hours in the fourth quarter, with increases in non-truck revenues and low single-digit price increases, offsetting about half of this decline.

Our G&A for the third quarter of 2018 was $23.9 million as compared to $22.9 million in the second quarter of 2018. Included in G&A for the third quarter was $1.6 million of equity-based compensation as compared to $0.3 million in the second quarter due to a gain upon the resignation of our former CEO. Also included in the third quarter 2018 G&A were $1.2 million of costs, largely severance, associated with the executive changes we made in the quarter. Excluding these items, G&A was $21.1 million in the third quarter of 2018 as compared to $22.6 million in the second quarter of 2018. We expect G&A next quarter to be down around $1 million from Q3.

In the third quarter of 2018, depreciation expenses was $21.8 million, and interest expense was $8.7 million. We expect both of these costs to be consistent over the remainder of the year.

Cash flow from operations was $0.2 million in the third quarter, and operating use of cash over the first 9 months of 2018 was $15 million. Our capital expenditures were $11.3 million for the third quarter of 2018 and $28.5 million over the first 9 months of 2018.

We also have had around $12 million in proceeds from asset or other sales over the first 9 months of 2018, resulting in a net spend of $16.5 million. We expect total CapEx spend for 2018 to be around $40 million. So $12 million to come in the fourth quarter, along with another $5 million of asset, sale or other non-operating proceeds in the quarter.

Turning to our balance sheet. Cash stood at $43.3 million at the end of the third quarter of 2018, and we had $29.5 million available under our ABL credit facility, which is undrawn. This combines for a total liquidity of $72.8 million at the end of the third quarter of 2018. With a lower cash from operations over the back half of the year, we now expect our total liquidity to be around $65 million at the end of the fourth quarter. Looking out into Q1 of next year, with payments of annual costs such as property taxes, we expect to see our liquidity low point in February with those payments, then expect liquidity to increase from there on improving business fundamentals.

The asset coverage ratio under our term loan stood at 1.88x at the end of the third quarter as compared to the minimum required of 1.35x.

I'll now turn the call back over to Rob. Rob?

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Robert J. Saltiel, Key Energy Services, Inc. - President, CEO & Director [5]

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Yes. Thanks, Marshall.

Just a few points to wrap-up before we take questions.

While the third quarter had its challenges, we think that the organizational changes we are undergoing, coupled with current service pricing increases that we are implementing, will -- that these will help counter the seasonal weakness of the fourth quarter and produce a similar EBITDA result in the third quarter. Looking to 2019, higher service rates and activity levels should position Key for a very solid financial year.

We are currently undertaking a review of our corporate and field organizations to ensure that we are well positioned to deliver higher earnings in 2019. We have eliminated management layers in our field organizations, which is lower cost, and improved the communications and connectivity with our corporate center. We have streamlined our G&A organization to rightsize with near-term activity levels while allowing for scale up with expected activity growth. We are also consolidating some facilities that are geographically close into single locations, closing unprofitable yards and optimizing our repair and maintenance spend.

Some of these moves have only recently been implemented and will only see a full realization in the first quarter of 2019. We estimate that we have reduced our expenses by approximately $10 million on an annual run rate basis.

Let me close by saying a few words about consolidation in our industry. The well services industry is a traditionally low to medium margin business across an entire cycle, with reasonably high fixed costs. Our industry is currently characterized by a high degree of fragmentation as we have a very large number of small players, and we've seen sizable new entrants join as well. We believe that Key can be a much more efficient entity by growing our revenue base while preserving the similar fixed costs structure. The most straightforward way to do this is through business combinations. We are confident that these transactions would be good for all shareholders due to the significant cost synergies that can be realized. We also believe they would be good for our clients as we would be better able to allocate investments into our equipment and into the training and development of our people across the entire cycle. As a result, we will continue to pursue inorganic growth opportunities that can bring strong value for our shareholders.

Operator, this concludes our prepared remarks, and we'll now open up the call for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions)

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Katherine I. Hargis, Key Energy Services, Inc. - Senior VP, General Counsel & Corporate Secretary [2]

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Thank you, Holly. This concludes our call.

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Operator [3]

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I apologize, it appears we have no questions. I'll turn the call back over to you, Katherine.

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Katherine I. Hargis, Key Energy Services, Inc. - Senior VP, General Counsel & Corporate Secretary [4]

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Thank you, Holly. This concludes our call. A replay of this call can be accessed on our website at keyenergy.com under the Investor Relations tab. Also under the Investor Relations tab, we have posted a schedule of our quarterly rig and truck hours. Thank you for joining us today.

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Operator [5]

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Once again, we'd like to thank you for participating on today's conference call. You may now disconnect.