UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

Quarterly Report Pursuant to Section 13 or 15(d)

of the Securities Exchange Act of 1934

 

 

For The Quarterly Period Ended October 31, 2018

 

 

Commission File No. 001-38609

 

 

KLX ENERGY SERVICES HOLDINGS, INC.

 

(Exact name of registrant as specified in its charter)

 

 

 

 

1300 Corporate Center Way

Wellington, Florida 33414

(Address of principal executive offices)

 

(561) 383-5100

(Registrant's telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] (as to part 1) NO [X] (as to part 2)

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). YES [X] NO [  ]

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act: Large accelerated filer [  ] Accelerated filer [X] Non-accelerated filer [  ] Smaller reporting company [  ] Emerging growth company [X]

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [  ]

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES [  ] NO [X]

 

The registrant has one class of common stock, $0.01 par value, of which 22,362,241 shares were outstanding as of December 3, 2018.

 

 

KLX ENERGY SERVICES HOLDINGS, INC.

 

Form 10-Q for the Quarter Ended October 31, 2018

 

Table of Contents

 

 

 

 

PART 1 – FINANCIAL INFORMATION

ITEM 1. CONDENSED FINANCIAL STATEMENTS

 

KLX ENERGY SERVICES HOLDINGS, INC.

CONDENSED BALANCE SHEETS (UNAUDITED)

(In millions other than per share amounts)

 

 

See accompanying notes to condensed financial statements.

KLX ENERGY SERVICES HOLDINGS, INC.

CONDENSED STATEMENTS OF (LOSS) EARNINGS (UNAUDITED)

(In millions other than per share amounts)

 

 

See accompanying notes to condensed financial statements.

 

 

KLX ENERGY SERVICES HOLDINGS, INC.

CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED)

(In millions)

 

 

See accompanying notes to condensed financial statements.

 

 

KLX ENERGY SERVICES HOLDINGS, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

(Unaudited – In millions)

 

Note 1.Description of Business and Basis of Presentation

 

Description of Business

 

On September 14, 2018, KLX Inc. (the “Former Parent” or “KLX”) created an independent, publicly-traded company through a spin-off of its Energy Services Group business to Former Parent’s stockholders (“Spin-Off”).  As a result of the Spin-Off, KLX Energy Services Holdings, Inc. (the “Company” or “KLX Energy Services”) now operates as an independent, publicly-traded company. Basic and diluted earnings per common share and the average number of common shares outstanding were calculated using the number of KLX Energy Services common shares outstanding immediately following the Spin-Off.

 

The Company is a provider of completion, intervention and production services and products to the major onshore oil and gas producing regions of the United States.

 

Basis of Presentation

 

Prior to the Spin-Off on September 14, 2018, the Company’s unaudited condensed financial statements were derived from the Former Parent’s condensed consolidated financial statements and accounting records as if it was operated on a stand-alone basis and were prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). All intercompany transactions and account balances within the Company have been eliminated.

 

The condensed statements of (loss) earnings reflect allocations of general corporate expenses from the Former Parent, including, but not limited to, executive management, finance, legal, information technology, human resources, employee benefits administration, treasury, risk management, procurement and other shared services. The allocations were made on a direct usage basis when identifiable, with the remainder allocated on the basis of revenues generated, costs incurred, headcount or other measures. Management of the Company considers these allocations to be a reasonable reflection of the utilization of services by, or the benefits provided to, the Company. The allocations may not, however, reflect the expense the Company would have incurred as a stand-alone company for the periods presented. Actual costs that may have been incurred if the Company had been a stand-alone company would depend on a number of factors, including the chosen organizational structure, what functions were outsourced or performed by employees and strategic decisions made in areas such as information technology and infrastructure.

 

Former Parent Company Investment – Former Parent company investment in the condensed balance sheet as of January 31, 2018 represents Former Parent’s historical investment in the Company, the net effect of cost allocations from transactions with Former Parent and net transfers of cash and assets from Former Parent. See Note 4 for a further description of the transactions between the Company and Former Parent.

 

Financial Statement Preparation – The accompanying unaudited condensed financial statements have been prepared in accordance with GAAP for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. All adjustments which, in the opinion of the Company’s management, are considered necessary for a fair presentation of the results of operations for the periods shown are of a normal recurring nature and have been reflected in the condensed financial statements. The results of operations for the periods presented are not necessarily indicative of the results expected for the full fiscal year or for any future period.

 

Note 2.Recent Accounting Pronouncements

 

In May 2017, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2017-09, Compensation—Stock Compensation (Topic 718). This ASU was issued to provide clarity and reduce diversity in practice regarding the application of guidance on the modification of equity awards. The ASU states that an entity should account for the effects of a modification unless all of the following are met: the fair value, vesting conditions and the classification of the instrument as equity or liability of the modified award is the same as that of the original award immediately before such award is modified. The guidance became effective for annual reporting periods beginning after December 15, 2017, and interim periods within those annual reporting periods. The adoption of ASU 2017-09 did not have a material impact on the Company’s condensed financial statements as the Company historically has accounted for all modifications in accordance with Topic 718 and has not been subject to the exception described under this ASU.

 

In January 2017, the FASB issued ASU 2017-01, Business Combinations. This update clarifies the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. This ASU is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The adoption of ASU 2017-01 is not expected to have a material impact on the Company’s condensed financial statements.

 

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments related to how certain cash receipts and payments are presented and classified in the statement of cash flows. These cash flow issues include debt prepayment or extinguishment costs, settlement of zero-coupon debt, contingent consideration payments made after a business combination, proceeds from the settlement of insurance claims, proceeds from the settlement of corporate-owned life insurance policies, distributions received from equity method investees, beneficial interests in securitization transactions, and separately identifiable cash flows. This ASU is effective for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2019, with early adoption permitted, and should be applied retrospectively. The Company does not expect a material impact upon adoption of this ASU to its condensed financial statements as the Company’s condensed statements of cash flows are not impacted by the eight issues listed above.

 

In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting, which amends ASC Topic 718, Compensation—Stock Compensation. The ASU includes multiple provisions intended to simplify various aspects of the accounting for share-based payments, including that excess tax benefits and shortfalls be recorded as income tax benefit or expense in the statement of earnings, rather than equity, and requires excess tax benefits from stock-based compensation to be classified in cash flows from operations. The guidance is effective for annual periods beginning after December 15, 2017, and interim periods within annual periods beginning after December 15, 2018. Early adoption is permitted in any interim or annual period. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. An entity that elects early adoption must adopt all of the amendments in the same period. The Company does not expect a material impact upon adoption of this ASU to its condensed financial statements.

 

In February 2016, the FASB issued ASU 2016-02, Leases, which supersedes ASC Topic 840, Leases, and creates a new topic, ASC Topic 842, Leases. This update is effective for fiscal years beginning after December 15, 2019 and interim periods within fiscal years beginning after December 15, 2020. Earlier adoption is permitted. ASU 2016-02 requires lessees to recognize a lease liability and a lease asset for all leases, including operating leases, with a term greater than 12 months on its balance sheet. The update also expands the required quantitative and qualitative disclosures surrounding leases. ASU 2016-02 will be applied using a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The Company is currently evaluating the effect of this update on its condensed financial statements.

In May 2014, FASB issued ASU 2014-09, Revenue from Contracts with Customers, which updated the guidance in ASC Topic 606, Revenue Recognition. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve that core principle, an entity should identify the contract(s) with a customer, identify the performance obligations in the contract, determine the transaction price, allocate the transaction price to the performance obligations in the contract and recognize revenue when (or as) the entity satisfies a performance obligation. In August 2015, the FASB deferred the effective date for implementation of ASU 2014-09 by one year and during 2016, the FASB issued various related accounting standard updates, which clarified revenue accounting principles and provided supplemental adoption guidance. The guidance under ASU 2014-09 is effective for fiscal years beginning after December 15, 2018, and interim periods within annual reporting periods beginning after December 15, 2019. To assess the impact of this guidance, the Company has established a cross functional implementation project team, inventoried its revenue streams and contracts with customers and applied the principles of the guidance against a selection of contracts to assist in the determination of potential revenue accounting differences. Based on its preliminary assessment, the Company may be required to provide additional disclosures to comply with the ASU but does not expect significant changes to its balance sheet or prior period statements of (loss) earnings.

 

Note 3.Property and Equipment, Net

 

Property and equipment consist of the following:

 

 

Depreciation expense was $10.0 and $8.1 for the three months ended October 31, 2018 and 2017, respectively, and $28.1 and $24.9 for the nine months ended October 31, 2018 and 2017, respectively.

 

Note 4.Related Party Transactions

 

The condensed statements of (loss) earnings for the three and nine months ended October 31, 2018 and 2017 include an allocation of general corporate expenses from KLX. These costs were allocated to the Company on a systematic and reasonable basis utilizing a direct usage basis when identifiable, with the remainder allocated on the basis of revenue generated, costs incurred, headcount or other measures.

 

Allocations for general corporate expenses, including management costs and corporate support services provided to the Company, totaled $3.2 and $4.8 for the three months ended October 31, 2018 up through the date of the Spin-Off and October 31, 2017, respectively, and $16.6 and $13.4 for the nine months ended October 31, 2018 up through the date of the Spin-Off and 2017, respectively, and were reported in the Company’s selling, general and administrative expenses on its condensed statements of (loss) earnings. These amounts include costs for allocations related to Former Parent’s strategic alternatives review process in the first quarter of 2018, the Company’s Spin-Off process in the second and third quarters of 2018 as well as for functions including executive management, finance, legal, information technology, human resources, employee benefits administration, treasury, risk management, procurement and other shared services.

 

In connection with the consummation of the Spin-Off, KLX Energy Services entered into a number of agreements with KLX, including a transition services agreement, distribution agreement, an employee matters agreement and an IP matters agreement. These agreements govern the relationship between us and KLX and provide for the allocation between us and KLX of various assets, liabilities and obligations (including

employee benefits, information technology and insurance). All services under the transition services agreement with Former Parent were terminated prior to October 31, 2018, and amounts under such agreement were not material for the three and nine months ended October 31, 2018.

 

Note 5.Accrued Liabilities

 

Accrued liabilities consist of the following:

 

 

 

Note 6.Long-Term Debt

 

As of October 31, 2018, long-term debt consisted of $250.0 principal amount of 11.5% senior secured notes due 2025 (the “Notes”) offered pursuant to Rule 144A under the Securities Act and to certain non-U.S. persons outside the United States in compliance with Regulation S under the Securities Act. On a net basis, after taking into consideration the debt issue costs for the Notes, total debt was $243.0.

 

As of October 31, 2018, the Company also had a $100.0 asset-based revolving credit facility pursuant to a senior secured credit agreement dated August 10, 2018 (the “ABL Facility”). The ABL Facility became effective on September 14, 2018, the date of the Spin-Off, and matures in September 2023. On October 22, 2018, we amended the ABL Facility primarily to permit the Company to issue the Notes and acquire Motley Services, LLC (“Motley”) and also amended the required ratio (as defined in the ABL Facility).

 

Borrowings under the ABL Facility bear interest at a rate equal to the London interbank offered rate (as defined in the ABL Facility) plus the applicable margin (as defined). No amounts were outstanding under the ABL Facility as of October 31, 2018.

 

The ABL Facility is tied to a borrowing base formula and has no maintenance financial covenants. The ABL Facility is secured by, among other things, a first priority lien on our accounts receivable and inventory and contains customary conditions precedent to borrowing and affirmative and negative covenants, all of which were met as of October 31, 2018.

 

Letters of credit issued under the ABL Facility aggregated $0.8 at October 31, 2018.

 

Note 7.Fair Value Information

 

All financial instruments are carried at amounts that approximate estimated fair value. The fair value is the price at which an asset could be exchanged in a current transaction between knowledgeable, willing parties. Assets measured at fair value are categorized based upon the lowest level of significant input to the valuations.

 

Level 1 – quoted prices in active markets for identical assets and liabilities.

 

Level 2 – quoted prices for identical assets and liabilities in markets that are not active or observable inputs other than quoted prices in active markets for identical assets and liabilities.

 

Level 3 – unobservable inputs in which there is little or no market data available, which require the reporting entity to develop its own assumptions.

The carrying amounts of cash and cash equivalents, accounts receivable-trade and accounts payable represent their respective fair values due to their short-term nature. There was no debt outstanding under the ABL Facility as of October 31, 2018. The fair value of the Company’s Notes, based on market prices for publicly-traded debt (which the Company classifies as Level 2 inputs), was $251.9 as of October 31, 2018.

 

Note 8.Commitments, Contingencies and Off-Balance-Sheet Arrangements

 

Lease Commitments – The Company finances its use of certain facilities and equipment under committed lease arrangements provided by various institutions. Since the terms of these arrangements meet the accounting definition of operating lease arrangements, the aggregate sum of future minimum lease payments is not reflected on the condensed balance sheets. At October 31, 2018, future minimum lease payments under these arrangements approximated $50.7, of which $23.8 is related to long-term real estate leases.

 

Litigation – The Company is a defendant in various legal actions arising in the normal course of business, the outcomes of which, in the opinion of management, neither individually nor in the aggregate are likely to result in a material adverse effect on the Company’s condensed financial statements.

 

Indemnities, Commitments and Guarantees – During its normal course of business, the Company has made certain indemnities, commitments and guarantees under which it may be required to make payments in relation to certain transactions. These indemnities include indemnities to various lessors in connection with facility leases for certain claims arising from such facility or lease and indemnities to other parties to certain acquisition agreements. The duration of these indemnities, commitments and guarantees varies, and in certain cases, is indefinite. Many of these indemnities, commitments and guarantees provide for limitations on the maximum potential future payments the Company could be obligated to make. However, the Company is unable to estimate the maximum amount of liability related to its indemnities, commitments and guarantees because such liabilities are contingent upon the occurrence of events that are not reasonably determinable. Management believes that any liability for these indemnities, commitments and guarantees would not be material to the accompanying condensed financial statements. Accordingly, no significant amounts have been accrued for indemnities, commitments and guarantees.

 

The Company has employment agreements with certain key members of management expiring on various dates. The Company’s employment agreements generally provide for certain protections in the event of a change of control. These protections generally include the payment of severance and related benefits under certain circumstances in the event of a change of control.

 

Pursuant to the distribution agreement, the Company will indemnify KLX to the extent that KLX determines that it has recognized any gain on the distribution, as calculated in the manner described in the distribution agreement. Management does not expect to be required to indemnify KLX as preliminary calculations, which will be finalized at January 31, 2019, resulting in no gain being recognized.

 

Note 9.Accounting for Stock-Based Compensation

 

The Company has a Long-Term Incentive Plan (“LTIP”) under which its Compensation Committee has the authority to grant stock options, stock appreciation rights, restricted stock, restricted stock units or other forms of equity based or equity related awards.

 

Compensation cost is generally recorded on a straight-line basis over the vesting term of the shares based on the grant date value using the closing trading price.

 

Compensation cost recognized during the three and nine months ended October 31, 2018 and 2017 primarily related to grants of restricted stock and restricted stock units granted or approved by our Former Parent. The vesting of all unvested shares of restricted stock was accelerated upon the sale of our Former Parent to the Boeing Company on October 9, 2018, resulting in approximately $10.7 of share based compensation expense during the three months ended October 31, 2018. As a result, share based

compensation was $14.1 and $2.8 for the three months ended October 31, 2018 and 2017, respectively, and $19.2 and $8.6 for the nine months ended October 31, 2018 and 2017, respectively. Unrecognized compensation cost related to restricted stock awards made during the current quarter to three key executives and the Company’s Board of Directors in lieu of cash compensation was $61.9 at October 31, 2018.

 

The Company has established a qualified Employee Stock Purchase Plan, the terms of which allow for qualified employees (as defined in the Plan) to participate in the purchase of designated shares of the Company’s common stock at a price equal to 85% of the closing price on the last business day of each semi-annual stock purchase period. The fair value of the employee purchase rights represents the difference between the closing price of the Company’s shares on the date of purchase and the purchase price of the shares. Compensation cost relates to the Former Parent’s employee stock purchase plan as the Company has not yet opened its first option period. Compensation cost was not material for the three months ended October 31, 2017, and was $0.1 and $0.1 for the nine months ended October 31, 2018 and 2017, respectively. Former Parent’s final option period ended on June 30, 2018; as a result, there was no compensation cost for the three months ended October 31, 2018.

 

Note 10.Income Taxes

 

The Company had no provision for income tax in the current period due to a pre-tax loss. For the nine month period ended October 31, 2018 and 2017, the provision for income taxes was reduced by a reduction in the valuation allowance established for its net deferred tax asset. The effective income tax rate varies from the federal statutory rate of 21% in 2018 (35% in 2017) primarily due to the fact that the Company has established a full valuation allowance against its net deferred tax asset. The 2018 federal statutory rate is lower than the rate in the prior year as a result of recently enacted tax legislation.

 

Note 11.Segment Reporting

 

The Company is organized on a geographic basis. The Company’s reportable segments, which are also its operating segments, are comprised of the Southwest (the Permian Basin and Eagle Ford Shale), the Rocky Mountains (the Bakken formation, Williston, DJ, Uinta and Piceance Basins and Niobrara Shale) and the Northeast (the Marcellus and Utica Shales as well as the Mid-Continent STACK and SCOOP and Haynesville). The segments regularly report their results of operations and make requests for capital expenditures and acquisition funding to the Company’s chief operational decision-making group (“CODM”). This group is comprised of the Chairman and Chief Executive Officer and the Senior Vice President and Chief Financial Officer. As a result, the CODM has determined the Company has three reportable segments.

 

The following table presents revenues and operating (losses) earnings by reportable segment:

 

 

The following table presents revenues by service offering by reportable segment:

 

 

 

 

The following table presents capital expenditures by reportable segment:

 

Capital expenditures for the administrative office and functions have been allocated to the above segments based on each segment’s percentage of total capital expenditures.

 

The following table presents total assets by reportable segment:

 

Assets for the administrative office and functions have been allocated to the above segments based on each segment’s percentage of total assets.

 

 

 

Note 12.Net Earnings Per Common Share

 

Basic net (loss) earnings per common share is computed using the weighted average common shares outstanding during the period. Diluted net (loss) earnings per common share is computed by using the weighted average common shares outstanding including the dilutive effect of restricted shares based on an average share price during the period. For the three months ended October 31, 2018 and 2017, 0.1 and no shares of the Company’s common stock, respectively, and no shares for the nine months ended October 31, 2018 and 2017 were excluded from the determination of diluted net (loss) earnings per common share because their effect would have been anti-dilutive. The computations of basic and diluted net (loss) earnings per share for the three and nine months ended October 31, 2018 and 2017 are as follows:

 

 

 

 

 

 

 

Note 13.Subsequent Events

 

On November 5, 2018, the Company acquired Motley, a premier provider of well completion and intervention services for complex, long lateral, horizontal wells for $139.2 in cash, subject to certain purchase price adjustments, and $9.0 of shares of the Company’s common stock payable to certain employees of Motley. The valuation of the acquired assets and liabilities is not yet complete, and as such the Company has not yet finalized its allocation of the purchase price for the acquisition.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

($ In millions)

 

The following discussion and analysis addresses the results of our operations for the three and nine months ended October 31, 2018 as compared to our results of operations for the three and nine months ended October 31, 2017. In addition, the discussion and analysis addresses our liquidity, financial condition and other matters for these periods.

 

Company Overview

 

We are a leading provider of completion, intervention and production services and products (our “product service lines” or “PSLs”) to the major onshore oil and gas producing regions of the United States. We offer a range of differentiated, complementary technical services and related tools and equipment in challenging environments that provide “mission critical” solutions for our customers throughout the life cycle of the well.

 

We serve many of the leading companies engaged in the exploration and development of North American onshore conventional and unconventional oil and natural gas reserves. Our customers include independent and major oil and gas companies. We actively support these customer operations from 36 service facilities located in the key major shale basins. We manage our business in these basins on a geographic basis, including the Southwest Region (the Permian Basin and Eagle Ford Shale), the Rocky Mountains Region (the Bakken formation, Williston, DJ, Uinta, Powder River and Piceance Basins and Niobrara Shale) and the Northeast Region (the Marcellus and Utica Shales as well as the Mid-Continent STACK and SCOOP and Haynesville). Our revenues, operating profits and identifiable assets are primarily attributable to these three reportable geographic segments. However, while we manage our business based upon these regional groupings, our assets and our technical personnel are deployed on a dynamic basis across all of our service facilities, to optimize utilization.

 

We work with well operators to provide engineered solutions across the entire lifecycle of the well, by streamlining operations, reducing non-productive time and developing cost effective and often customized solutions and customized tools for our customers’ most challenging service needs, which include technically complex unconventional wells requiring extended reach horizontal laterals and greater completion intensity per well. We believe our growing reputation for delivering differential service outcomes has resulted in the number of our customer agreements growing by over 140%, from over 400 as of January 31, 2016 to over 1,000 as of January 31, 2018. These agreements enable us to work for many of the major and independent exploration and production (“E&P”) companies in North America.

 

We offer a variety of targeted services that are differentiated by the technical competence and experience of our field service engineers and their deployment of a broad portfolio of specialized tools and equipment. Our innovative and adaptive approach to proprietary tool design has been employed by our in-house research and development (“R&D”) organization and, in selected instances, by our technology partners, to develop tools covered by 12 patents and 26 U.S. and foreign pending patent applications as well as 20 additional proprietary tools. Our technology partners include manufacturing and engineering companies that produce tools, which we design and utilize in our service offerings.

 

We utilize outside, dedicated manufacturers to produce our products, which, in many cases, our engineers have developed from input and requests from our customers and customer-facing managers, thereby maintaining the integrity of our intellectual property while avoiding manufacturing startup and maintenance costs. We have found that doing so leverages our technical strengths as well as those of our technology partners. The PSLs that we offer are modest in cost to the customer relative to other well construction expenditures but have a high cost of failure and are, therefore, “mission critical” to our customers’ outcomes. We believe our customers have come to depend on our decades of combined field experience to execute on some of the most challenging problems they face. We believe we are well

positioned as a company for continued growth, as the oil and gas industry continues to drill and complete thousands of increasingly complex wells each year and as thousands of older legacy wells require remediation.

 

KLX Energy Services was formed from the combination and integration of seven private oilfield service companies acquired over the 2013 through 2014 time period. Each of the acquired businesses was regional in nature and brought one or two specific service capabilities to KLX Energy Services. Once the acquisitions were completed, we undertook a comprehensive integration of these businesses, to align our services, our people and our assets across all the geographic regions where we maintain a presence. We established a matrix management organizational structure, where each regional manager has the resources to provide a complete suite of services, supported by technical experts in our primary service categories. We have endeavored to create a “next generation” oilfield services company in terms of management controls, processes and operating metrics and have driven these processes down through the operating management structure in every region, which we believe differentiates us from many of our competitors. This allows us to offer our customers in all of our geographic regions discrete, comprehensive and differentiated services that leverage both the technical expertise of our skilled engineers and our in-house R&D team.

 

We invest in innovative technology and equipment designed for modern production techniques that increase efficiencies and production for our customers. North American unconventional onshore wells are increasingly characterized by extended lateral lengths, tighter spacing between hydraulic fracturing stages, increased cluster density and heightened proppant loads. Drilling and completion activities for wells in unconventional resource plays are extremely complex, and downhole challenges and operating costs increase as the complexity and lateral length of these wells increase. For these reasons, E&P companies with complex wells increasingly prefer service providers with the scale and resources to deliver best-in-class solutions that evolve in real time with the technology used for extraction. We believe we offer best-in-class service execution at the wellsite and innovative downhole technologies, positioning us to benefit from our ability to service the most technical, complex wells where the potential for increased operating leverage is high due to the large number of stages per well in addition to customer focus on execution rather than price. We have been awarded 12 U.S. patents, have 26 U.S. and foreign pending patent applications and utilize 20 additional proprietary tools, some of which have been developed in conjunction with our technology partners, which we believe differentiates us from our regional competition and also allows us to deliver more focused service and better outcomes in our specialized services than larger national competitors who do not discretely dedicate their resources to the services we provide.

 

We are focused on generating attractive returns on capital for our stockholders through the superior margins achieved by our differentiated services and the prudent application of our cash flow to targeted growth opportunities, which is intended to deliver high returns and short payback periods. Our services generally require less expensive equipment, which is also less expensive to maintain, and fewer people than many other oilfield service activities. In addition to the superior margins our differentiated services generate, we believe the rising level of completion intensity in our core operating areas contributes to improved margins and returns. This provides us significant operational leverage, and we believe positions us well to continue to generate attractive returns on capital as industry activity increases and the market for oilfield services improves. As part of our returns-focused approach to capital spending, we are focused on maintaining a capital efficient program with respect to the development of new products. We support our existing asset base with targeted investments in R&D, which we believe allows us to maintain a technical advantage over our competitors providing similar services using standard equipment.

 

We operate in three segments determined on a geographic basis: the Southwest Region (the Permian Basin and the Eagle Ford Shale), the Rocky Mountains Region (the Bakken formation, Williston, DJ, Uinta and Piceance Basins and Niobrara Shale) and the Northeast Region (the Marcellus and Utica Shale as well as the Mid-Continent STACK and SCOOP and Haynesville). As noted above, our revenues, operating profits and identifiable assets are primarily attributable to these three reportable geographic segments.

 

Demand for services in the oil and natural gas industry is cyclical. For example, the domestic E&P industry in the United States underwent a substantial downturn in 2015 and much of 2016, placing unprecedented pressure on both our customers and competitors. However, we believe our company is well positioned to operate successfully as a standalone company as a result of the numerous initiatives we undertook during the integration of the seven businesses acquired while we were part of KLX Inc. (the “Former Parent” or “KLX”). We believe our operating cost structure is now materially lower than during the historical financial reporting periods and that there is greater flexibility to respond to changing industry conditions. We improved our cost structure by centralizing a number of common functions, as evidenced by our higher level of cash provided by operating activities. The implementation of integrated, company-wide management information systems and processes provide more transparency to current operating performance and trends within each market where we compete and help us more acutely scale our cost structure and pricing strategies on a market-by-market basis. Profitability levels are dependent more directly on pricing for our services rather than utilization rates; as such, our ability to differentiate ourselves on the basis of quality contributes to revenue growth and profitability even in a stable or declining market environment through market share gains and growing business with existing customers.

 

We believe we have strong management systems in place, which will allow us to manage our operating resources and associated expenses relative to market conditions. We believe our services often generate margins superior to our competitors based upon the differential quality of our performance, and that these margins also support strong free cash flow generation. The required investment in our business includes both working capital (principally for account receivables growth tied to increasing revenues) and capital expenditures for both maintenance of existing assets and growth. Our required maintenance capital expenditures tend to be lower than other oilfield service providers due to the generally asset-lite nature of our services, the average age of our assets of less than three years and our ability to charge back a portion of asset maintenance to customers for a number of our assets. In addition to these internal expenditures, we may also pursue selected acquisition opportunities. We believe industry conditions are likely to continue to support existing activity levels of oilfield service providers, but that the pace of industry consolidation will pick up, as weakened private company competitors look to take advantage of the market activity to exit.

 

The Spin-Off

 

On September 14, 2018, we completed our Spin-Off from KLX and became an independent, publicly-traded company. In connection with the consummation of the Spin-Off, KLX Energy Services entered into a number of agreements with KLX, including a distribution agreement, an employee matters agreement and an IP matters agreement. These agreements govern the relationship between us and KLX and provide for the allocation between us and KLX of various assets, liabilities and obligations (including employee benefits, information technology and insurance). All services under the transition services agreement with Former Parent were terminated prior to October 31, 2018, and amounts under such agreement were not material for the three and nine months ended October 31, 2018.  In addition, our undrawn $100.0 asset-based revolving credit facility (“ABL Facility”) is available for borrowing for working capital and other general corporate purposes. The approximately $69.0 availability under the ABL Facility is tied to the aggregate amount of our accounts receivable and inventory that satisfy specified criteria. We issued $250.0 principal amount of 11.5% senior secured notes due 2025 (“Notes”) and, depending on market conditions, we may incur other indebtedness in the future to make additional acquisitions and/or provide for additional cash on the balance sheet, which could be used for future acquisitions.

 

Factors Affecting the Comparability of our Results of Operations

 

Our results of operations may not be comparable to our historical results of operations for the periods presented, primarily for the reasons described below:

 

 

 

 

 

Key Financial Performance Indicators

We recognize the highly cyclical nature of our business and the need for metrics to 1) best measure the trends in our operations and 2) provide baselines and targets to assess the performance of our managers, which is intended to help us grow stockholder value. The metrics we regularly monitor within each of our geographic reporting regions include:

 

 

 

The measures we believe most effective to monitor and consider when rewarding management performance include:

 

 

 

 

 

 

RESULTS OF OPERATIONS

 

THREE MONTHS ENDED OCTOBER 31, 2018

COMPARED TO THREE MONTHS ENDED OCTOBER 31, 2017

($ in Millions)

 

The following is a summary of revenues by segment:

 

Third quarter 2018 revenues of $123.2 increased $34.0, or 38.1%, as compared with the prior year period. Our revenue growth was driven by a 22.4% increase in Southwest revenues, a 34.4% increase in Rocky Mountains revenues and a 66.2% increase in Northeast revenues reflecting a higher level of activity throughout each operating region. On a product line basis, as compared to the same period in the prior year, completion revenues grew 52.2%, production revenues grew 42.8% and intervention services revenues grew 10.9%.

 

Third quarter 2018 cost of sales was $90.2, or 73.2% of sales, as compared to the prior year period cost of sales of $72.8, or 81.6% of sales. Cost of sales as a percentage of revenues improved by approximately 840 basis points, due to substantially improved results at all three segments of our business resulting from improved market conditions, increased sales of higher margin PSL’s and operating leverage.

 

SG&A expense during the third quarter of 2018 was $42.3, or 34.3% of revenues, including $23.0 of costs related to the completion of the merger of the Aerospace Solutions business of KLX Inc. with The Boeing Company, the Spin-Off of the energy services business into an independent public company, including $10.7 of non-cash compensation expense related to the acceleration of unvested shares held by the Company’s employees, the amendment of the $100.0 asset based lending facility, the issuance of $250.0 of Notes and the acquisition of Motley Services, LLC completed on November 5, 2018 (“Motley”) (collectively, “Costs as Defined”). SG&A in the prior year period was $17.4, or 19.5%, of revenues. Excluding the $23.0 of Costs as Defined (none in the prior year period), SG&A in the third quarter of 2018 was $19.3, or 15.7% of revenues, and as a percentage of revenues, improved by approximately 380 basis points in the third quarter of 2018 as compared with the prior year period primarily due to increased operating leverage as the 38.1% increase in revenues significantly outpaced the 10.9% increase in SG&A. Third quarter 2018 research and development costs were $0.6 as compared to the prior year period of $0.8, reflecting our continued focus on in-house research and development to deploy new specialized and proprietary tools and equipment.

 

Operating loss was $(9.9), including the $23.0 of Costs as Defined discussed above, as compared to a loss of $(1.8) in the prior year period. Exclusive of Costs as Defined, current period operating earnings were $13.1 and increased by $14.9 reflecting a higher level of activity by our customers throughout our geographic regions and incremental operating leverage. The continued recovery in the major oil and gas producing basins of the onshore U.S. market has resulted in increased demand for our products and services. Additionally, we believe incremental growth has been driven by differentiation in our products and services due to successful R&D initiatives and the quality and depth of our personnel.

 

There was no income tax expense for the three months ended October 31, 2018 and 2017 due to pre-tax losses in both periods for the reasons set forth above. The federal statutory rate in the current period was 21% (35% in the prior year period). The 2018 federal statutory rate is lower than the rate in the prior year as a result of recently enacted tax legislation.

Net loss for the three months ended October 31, 2018 was $(9.9) as compared to a net loss of $(1.8) in the prior year period. Net loss in the third quarter of 2018 was impacted by the $23.0 of aforementioned Costs as Defined.

 

Segment Results

 

The following is a summary of operating (loss) earnings by segment:

 

 

The three month quarter to date 22.4% increase in Southwest segment revenues was driven by an increase in production, completion and intervention of 37.8%, 26.3% and 7.6%, respectively. Southwest segment operating loss of $(6.0) increased by $4.8 primarily due to $7.0 of Costs as Defined. Although Southwest segment revenues increased 22.4% year-over-year, the segment’s revenues were impacted by the Texas fllods. Seventeen consecutive days of rain and the attendant floods, road and highway closures and impassable mud negatively impacted revenues.

 

The three month quarter to date 34.4% increase in Rocky Mountains segment revenues was driven primarily by a higher level of completion activity. Rocky Mountains segment operating earnings declined $4.5 to $(3.2) primarily due to $9.3 of Costs as Defined.

 

The three month quarter to date 66.2% increase in Northeast segment revenues was driven by an increase in intervention, production and completion revenues of 68.5%, 67.8% and 64.2%, respectively. Northeast segment operating loss of $(0.7) decreased $1.2 despite the $6.7 of Costs as Defined offset by increased operating leverage and solid demand for higher margin PSLs.

NINE MONTHS ENDED OCTOBER 31, 2018

COMPARED TO NINE MONTHS ENDED OCTOBER 31, 2017

 

The following is a summary of revenues by segment:

 

For the nine months ended October 31, 2018, revenues were $351.4, an increase of $125.2, or 55.3%, as compared to the same period of the prior year. Revenue growth was driven by a 53.8% increase in Southwest revenues, a 50.2% increase in Rocky Mountains revenues and a 65.3% increase in Northeast revenues, reflecting the higher level of activity by our customers throughout the regions we serve. On a product line basis, revenue growth for completion, production and intervention services was 77.9%, 51.2% and 25.1%, respectively.

 

Cost of sales for the period was $257.9, or 73.4% of sales, as compared to the prior year period of $192.4, or 85.1% of sales. Cost of sales as a percentage of revenues improved by approximately 1,170 basis points, due to substantially improved results at all three segments of our business resulting from improved market conditions, increased sales of higher margin PSLs and operating leverage.

 

SG&A expense during the nine months ended October 31, 2018 was $82.0, or 23.3% of revenues. SG&A in the prior year period was $52.2, or 23.1% of revenues. SG&A, as a percentage of revenues, increased by approximately 20 basis points as compared with the prior year period primarily due to Costs as Defined of $28.7. Excluding the $28.7 of Costs as Defined (none in the prior year period), SG&A was $53.3, or 15.2% of revenues, and as a percentage of revenues, improved approximately 790 basis points for the nine months ended October 31, 2018 as compared with the same period in the prior year primarily due to increased operating leverage as the 55.3% increase in revenues significantly outpaced the 2.1% increase in SG&A. Research and development costs for the period were $1.9 as compared to $1.6 in the prior year, reflecting our continued focus on in-house research and development to deploy new specialized and proprietary tools.

 

Operating earnings were $9.6, including the $28.7 of Costs as Defined discussed above, as compared to a loss of $(20.0) in the prior year period. Exclusive of Costs as Defined, current period operating earnings were $38.3 and increased by $58.3 reflecting a higher level of activity by our customers throughout our geographic regions and incremental operating leverage. The continued recovery in the major oil and gas producing basins of the onshore U.S. market has resulted in increased demand for our products and services. Additionally, we believe incremental growth has been driven by differentiation in our products and services due to successful R&D initiatives and the quality and depth of our personnel.

 

Income tax expense for the nine months ended October 31, 2018 and 2017 was $0.1, primarily due to the full valuation allowance against the net deferred tax asset. The 2018 federal statutory rate is lower than the rate in the prior year as a result of recently enacted tax legislation.

 

For the nine months ended October 31, 2018, net earnings was $9.5 as compared to a net loss of $(20.1) in the prior year period. Net earnings were favorably impacted by the improvements in pricing and activity driven by the overall improvement in the oil and gas sector partially offset by the $28.7 of aforementioned Costs as Defined.

Segment Results

 

The following is a summary of operating earnings (loss) by segment:

 

 

 

The nine month year to date 53.8% increase in Southwest segment revenues was driven by increases in production, completion and intervention activity of approximately 64.7%, 57.8% and 40.8%, respectively. Southwest segment operating loss of $0.8 improved by $9.6, including the negative impact of $9.0 of Costs as Defined, reflecting the increased demand for our products and services and operating leverage inherent in our cost and operating structure. As mentioned earlier, Southwest segment revenues increased 53.8% year-over-year, the segment’s revenues were impacted by the Texas fllods. Seventeen consecutive days of rain and the attendant floods, road and highway closures and impassable mud negatively impacted revenues.

 

The nine month year to date 50.2% increase in Rocky Mountains segment revenues was driven by increases in completion and production activity of approximately 103.5% and 41.9%, respectively. Rocky Mountains segment operating earnings of $3.3 improved by $3.8, including the negative impact of $11.5 of Costs as Defined, reflecting the increased demand for our products and services and operating leverage inherent in our cost and operating structure.

 

The nine month year to date 65.3% increase in Northeast segment revenues was driven by an increase in completion, intervention and production activity of approximately 77.0%, 55.3% and 55.4%, respectively. Northeast segment operating earnings of $7.1 improved by $16.2, including the negative impact of $8.2 of Costs as Defined, reflecting the increased demand for our products and services and operating leverage inherent in our cost and operating structure.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Current Financial Condition

 

At October 31, 2018, we had $313.2 of cash and cash equivalents, or approximately $174.0 adjusted for the acquisition of Motley on November 5, 2018. Cash on hand at October 31, 2018 increased by $313.2 as compared with no cash on hand at January 31, 2018 due to the centralized cash management by our former parent as well as a result of cash flows from operating activities of $51.6, proceeds from long term debt of $250.0, offset by $8.3 of debt offering costs, capital contribution by our former parent prior to the Spin-Off of $50.0 and prior net funding from our former parent of $24.9 offset by $55.0 of capital expenditures. Our liquidity requirements consist of working capital needs and ongoing capital expenditure requirements. Our primary requirements for working capital are directly related to the level of our operations. Our sources of liquidity were historically from advances from KLX and cash flow from operations.

 

Working capital as of October 31, 2018 was $354.7, an increase of $316.6 as compared with working capital at January 31, 2018. As of October 31, 2018, total current assets increased by $337.1 and total current liabilities increased by $20.5. The increase in current assets was primarily related to an increase in

cash of $313.2. The increase in total current liabilities was primarily due to an $11.9 increase in accrued liabilities.

 

Cash Flows

 

As of October 31, 2018, our cash and cash equivalents were $313.2 as compared to $0 at January 31, 2018. Net cash flows provided by operating activities was $51.6 for the nine months ended October 31, 2018 as compared to net cash used in operating activities of $13.2 in the prior year, reflecting a $29.6 increase in net earnings, $13.4 increase in accounts receivable ($37.7 increase in the prior year) and a $19.3 increase in accounts payable and accrued liabilities in the current period ($18.1 increase in the prior year). Cash used in investing activities consists of capital expenditures of $55.0 and $33.7 for the nine months ended October 31, 2018 and 2017, respectively, and reflects the higher demand levels for our services and equipment. Cash flows from financing activities of $316.6 and $46.9, respectively, for the nine months ended October 31, 2018 and 2017 reflect $250.0 of proceeds from long-term debt, offset by $8.3 of debt offering costs, and $74.9 of aggregate pre-Spin-Off net funding from our former parent in the current period ($46.9 in the prior year).

 

Capital Spending

 

Our capital expenditures were $55.0 and $33.7 during the nine months ended October 31, 2018 and 2017, respectively. We expect to incur approximately $90.0 in capital expenditures for the year ending January 31, 2019, principally related to our growth and maintenance capital expenditures as well as investments related to the large diameter coiled tubing PSL as a result of the acquisition of Motley on November 5, 2018. The nature of our capital expenditures is comprised of a base level of investment required to support our current operations and amounts related to growth and company initiatives. Capital expenditures for growth and company initiatives are discretionary. We continually evaluate our capital expenditures, and the amount we ultimately spend will depend on a number of factors, including expected industry activity levels and company initiatives. We expect to fund future capital expenditures from cash on hand, cash flow from operations and from funds available from our secured $100.0 ABL Facility, none of which was drawn at October 31, 2018.

 

New Financing Arrangements

 

In connection with the Spin-Off, we entered into a $100.0 ABL Facility on August 10, 2018. The ABL Facility became effective on September 14, 2018, the date of the Spin-Off, and is scheduled to mature in September 2023. Borrowings under the ABL Facility bear interest at a rate equal to the London interbank offered rate (“LIBOR”) (as defined in the ABL Facility) plus the applicable margin (as defined). Availability under the ABL Facility is tied to a borrowing base formula and the ABL Facility has no maintenance financial covenants. The ABL Facility is secured by, among other things, a first priority lien on our accounts receivable and inventory and contains customary conditions precedent to borrowing and affirmative and negative covenants, all of which were met as of October 31, 2018. No amounts were outstanding under the ABL Facility as of October 31, 2018. The effective interest rate under the ABL Facility would have been approximately 4.8% on October 31, 2018. 

 

In conjunction with the acquisition of Motley, we issued $250.0 of Notes due 2025 offered pursuant to Rule 144A under the Securities Act and to certain non-U.S. persons outside the United States in compliance with Regulation S under the Securities Act. On a net basis, after taking into consideration the debt issue costs for the Notes, total net proceeds were $243.0, which a portion was used to acquire Motley, and the balance will be used for general corporate purposes including potential acquisitions for at least the next 12 months.

 

We believe the $50.0 capital contribution from our former parent, the trend in improved market conditions and cash from operating activities and our financial plans for 2018, the approximately $69.0 of availability under our $100 undrawn ABL Facility as well as the additional cash on hand from a portion of the proceeds from the Notes, provide us with the ability to fund our operations, make planned capital expenditures, meet our debt service obligations and provide funding for potential future acquisitions.