Nine Energy Service, Inc. (NYSE:NINE) Q3 2020 Earnings Conference Call November 5, 2020 10:00 AM ET
Heather Schmidt – Vice President of Investor Relations
Ann Fox – President and Chief Executive Officer
Guy Sirkes – Chief Financial Officer
Conference Call Participants
Taylor Zurcher – Tudor, Pickering, Holt
JB Lowe – Citi
Waqar Syed – AltaCorp
Thank you, and good morning, everyone. Welcome to Nine Energy Service Earnings Conference Call to discuss our Results for the Third Quarter of 2020. At this time, all participants will be in listen mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.
At this time, I’ll turn the conference over to Heather Schmidt, Vice President of Investor Relations. Please go ahead, Heather.
Thank you. Good morning, everyone, and welcome to the Nine Energy Service earnings conference call to discuss our results for the third quarter of 2020. On the call with me today are Ann Fox, President and Chief Executive Officer; and Guy Sirkes, Chief Financial Officer. We appreciate your participation. Some of our comments today may include forward-looking statements reflecting Nine’s views about future events. Forward-looking statements are subject to a number of risks and uncertainties, many of which are beyond our control.
These risks and uncertainties can cause actual results to differ materially from our current expectations. We advise listeners to review our earnings release and the risk factors discussed in our filings with the SEC. We undertake no obligation to revise or update publicly any forward-looking statements for any reason. Our comments today also include non-GAAP financial measures. Additional details and a reconciliation to the most directly comparable GAAP financial measures are also included in our third quarter press release and can be found in the Investor Relations section of our website.
I will now turn the call over to Ann Fox.
Thank you, Heather. Good morning, everyone, and thank you for joining us today to discuss our third quarter results for 2020. As we all navigate through these unprecedented times, I hope you and your families are safe and healthy. Our top priority at Nine continues to be the health and safety of our employees, customers, vendors and community at large. We are working closely with our partners to ensure our operations in the field and offices are within CDC federal and state guidelines. I want to thank our employees for their leadership and diligence. The U.S. market remained very challenged in Q3, with total U.S. completions and new wells drilled once again down quarter-over-quarter.
That said, we believe that we have passed through the trough during the May-June time frame, and we have seen sequential activity and revenue increases month-over-month throughout the course of Q3. But activity and revenue did not reach April level. Although the percentage basis increases appear very robust, the absolute activity levels remain weak with increases coming off a very low base. We do expect Q4 to be better sequentially than Q3 from an activity and revenue perspective. As activity returns, however, many competitors are trying to buy market share, driving down prices and offsetting much of the revenue increases. Today, we estimate there are approximately 115 to 130 active frac crews in the U.S., with approximately half of those operating in the Permian.
For some benchmarking, we estimate that in 2018, peak active frac crews were over 400 in the U.S. and averaged over 300 in 2019. According to the EIA, total U.S. completions were down again approximately 29% quarter-over-quarter and new U.S. wells drilled were down approximately 41%. I will just remind everyone that April was still a relatively good month for activity and August and September completions in the Permian were approximately 50% lower than April levels. In fact, total U.S. completions in the Permian for this quarter were less than total completions in just the month of February.
We do not believe current OFS pricing is sustainable and similar to 2016, when activity recovers, we expect operators will revert back to higher quality versus low-cost providers as service execution at the well site and operational efficiencies diminish. Additionally, as activity increases, much of the OFS equipment will require significant maintenance capital, helping to further remediate the oversaturated competitive landscape.
We are being very mindful with where we are pricing tools and services, and balancing remaining competitive in the bidding process without setting pricing precedents that are unrecoverable and/or negative gross margin. Activity in the gas-levered basins remain steady, and the outlook is relatively positive with supportive natural gas prices.
The EIA is currently forecasting natural gas prices above $3 for 2021. We have seen a slight uptick in RFQs in both the Haynesville and Northeast, which could materialize into activity growth in the late Q4 or Q1 time frame. Unlike the Permian, both of these basins are less saturated with competitors and should provide potential opportunities for growth in 2021.
Our total stages completed in wireline and completion tools was relatively flat quarter-over-quarter despite total stages completed and completed wells declining over the same time period. While cementing activity was down quarter-over-quarter, we continue to outperform the market and doubled our market share in the Eagle Ford.
Our operational team demonstrated their ability to gain market share, growing our percentage of stages completed from approximately 16% in Q3 2019 to approximately 22% in Q3 of 2020. Company revenue for the quarter was $49.5 million. Net loss was negative $18.5 million and adjusted EBITDA was negative $11.1 million. Basic EPS was negative $0.62. Adjusted net loss for the quarter was negative $33.8 million or negative $1.13 per share.
Our Q3 adjusted EBITDA includes $3.5 million of unusual costs and expenses, of which $3.2 million are noncash. Guy will provide additional detail on these. During this downturn, our team capitalized on opportunities that better position the company from a financial and operational perspective. We once again saw an opportunity to purchase additional bonds on the open market at a significant discount, lowering our annual cash interest expense, while reducing our overall debt outstanding.
During and subsequent to Q3, the company repurchased $23.6 million par value of bonds for $7.2 million of cash. To date, Nine has repurchased approximately $53.3 million of bonds for $14.6 million. On average, representing 27% of par value and leaving $346.7 million par value bonds outstanding and an undrawn ABL. We have been very purposeful in balancing near and medium-term liquidity needs with the refinancing of our debt, and our top priority continues to be the preservation of cash.
Today, we remain undrawn on our ABL with approximately $80.3 million of cash on the balance sheet. On the operational side, we organically expanded our cementing service line into the Haynesville. Operations and management identified the Haynesville as a relatively active basin with a near and long-term profitability outlook, while adding size and scale to our cementing service line. Our cementing team will be able to leverage their expertise in high-pressure, high-temperature environments similar to the Eagle Ford, highly consolidated competitive landscape to win market share and drive revenue growth. The cementing team was able to execute this expansion with very minimal capital outlay and Nine’s previous CapEx guidance of $10 million to $15 million remains unchanged. We will be utilizing current and newly delivered cementing spreads, along with components from our current operations to facilitate the majority of the expansion.
We are leveraging our existing relationships with our coil and completion tool customers in the Haynesville and anticipate we will begin generating minimal revenue in 2020 with more significant contribution starting in Q1 of 2021. On the technology side, I remain extremely happy with the performance of our dissolvable plugs and the customer’s appetite for dissolvable option. We are currently running a plug with some of the largest acreage holders, with over 80% of the tools deployed run by public operators across multiple basins. We also continue to penetrate the cold temperature market, running approximately 35% of the low-temp Stinger products in the Permian and approximately 46% in the Northeast. We are confident that once we see a real recovery in activity, the dissolvable tools will begin generating growth. The extremely low coil prices do create a temporary headwind for dissolvable plug adoption, but we believe this will alleviate itself once coil prices increase and operational failures with coil lead to more downtime and delayed completions.
As a reminder, we never forecast tool prices increasing. So as service pricing increases, our tool pricing will remain the same. We also continue to see many of our large public operators focus on ESG and are looking for actionable and scalable ways to reduce emissions, which the dissolvable plug provides. As I mentioned on our last call, our high temp dissolvable plug is complete, and we have run a minimal number of plugs due to low activity levels in applicable basins like the Eagle Ford, Bakken, and Mid-Con. We continue to work on the commercialization of our new composite plug, which has been delayed due to supply chain issues related to the COVID pandemic, causing delays in the manufacturing of our slips.
I would now like to turn the call over to Guy to walk through financial information for the quarter before I provide an outlook for the remainder of the year.
Thank you, Ann. I want to start with an update on our debt and liquidity profile. As Anne mentioned, we once again saw an opportunity to purchase additional bonds on the open market. During and subsequent to Q3, we repurchased $23.6 million par value of bonds for $7.2 million of cash. To date, Nine has repurchased approximately $53.3 million of bonds for $14.6 million of cash, leaving $346.7 million of bonds outstanding. To date, the average purchase price on our bonds is approximately 27% of par, and we have reduced our annual interest expense by approximately $4.7 million.
We purchased the notes using cash on the balance sheet, and our ABL remains undrawn. We will continue to monitor the market for attractive M&A or bond repurchase opportunities but the preservation of cash remains our top priority as we balance near-term liquidity with long-term refinancing.
As of September 30, 2020, Nine’s cash and cash equivalents were $80.3 million, with $39.5 million of availability under the revolving ABL credit facility resulting in a total liquidity position of $119.8 million as of September 30, 2020. Availability under the ABL is based on accounts receivable and inventory balances, so as we unwind or build working capital, the ABL availability will fluctuate.
As of September 30, 2020, we had $34.8 million in accounts receivable. We also had $52.7 million in inventory. We continue to be focused on our inventory monetization, particularly in completion tools and believe that we will be able to slowly work down the inventory balance over the course of the year and into 2021. In Q3, we generated approximately $9.2 million in cash from the monetization of accounts receivable and inventory. For Q4, the main cash outflows will be related to our approximately $15 million interest expense for our senior notes and the remainder of our CapEx.
Our CapEx guidance remains unchanged at $10 million to $15 million, of which 58% is already spent using the midpoint of the range. In the first nine months of 2020, Nine has been successful in largely offsetting our capital expenditures with equipment sales. In the first nine months of 2020, we have spent $7.2 million in CapEx compared to $6.5 million in proceeds from sales of PP&E and PP&E insurance proceeds. In the first nine months of the year, we have generated $4.6 million cash flow from operations and negative $600,000 cash flow from investing, which is the net of the CapEx and PP&E proceeds. Our negative change in cash for the year is largely driven by the $14.4 million cash spent on bond repurchases, which are discretionary.
During the third quarter, revenue totaled $49.5 million with adjusted gross loss of negative $3 million. Nine’s negative $3 million adjusted gross loss includes $3.2 million of unusual items, the vast majority of which, sorry, $3.5 million of unusual items. The vast majority of which affects cost of sales, of which $3.2 million are noncash. We incurred a noncash $1.2 million lease adjustment, $1.4 million noncash inventory reserve, $700,000 bad debt reserve and a $300,000 contract settlement.
During the third quarter, we completed 378 cementing jobs, a decrease of approximately 15% versus the second quarter. The average blended revenue per job decreased by approximately 12%. Cementing revenue for the quarter was $15.3 million, a decrease of approximately 25% quarter-over-quarter. During the quarter, we received two incremental cementing units and continued to stack 12 of our 40 cementing spreads. We have now received all of our growth capital cementing units related to 2019 CapEx. During the third quarter, we completed 3,081 wireline stages, an increase of approximately 38% versus the second quarter.
The average blended revenue per stage decreased by approximately 2%. The wireline revenue for the quarter was $13 million, an increase of approximately 35%. We did not receive any incremental wireline units during the quarter, and have stacked 26 of our 47 units. In completion tools, we completed 8,943 stages, a decrease of approximately 10% versus the second quarter. Completion tool revenue was $13.9 million, a decrease of approximately 8%. During the third quarter, our coiled tubing base works decreased by approximately 5%. And the average blended day rate for Q3 increased by approximately 1%. Coiled tubing utilization was 19%, with revenue of $7.3 million, a decrease of approximately 4%. We did not receive any incremental coiled tubing units during the quarter and stacked seven of our 14 units.
The company reported general and administrative expense of $10.7 million compared to $11.3 million for the second quarter. Depreciation and amortization expense in the third quarter was $11.9 million compared to $12.6 million in the second quarter. The company’s tax benefit for the three and nine months ended September 30, 2020, was less than $0.1 million and $2.3 million, respectively.
The company’s year-to-date tax benefit was primarily a result of the discrete tax benefit recorded in the first quarter of 2020 and related to the Coronavirus Aid, Relief and Economic Security Act, as well as the release of valuation allowance due to the goodwill impairment, which was also recorded in the first quarter of 2020.
During the third quarter, the company reported net cash provided by operating activities of $2.3 million. The average DSO for the third quarter was approximately 64.7 days compared to 67.9 days in Q2. Total capital expenditures for Q3 were $2.2 million, bringing the total spend this year as of September 30 to $7.2 million.
I will now turn it back to Ann.
Thank you, Guy. As we look into Q4, we anticipate the market will remain challenged, but expect revenue and activity increases driven from added frac crews in the Permian and potentially Northeast in Haynesville. There is still uncertainty around timing of frac crew additions, holiday shutdowns, and potential weather impacts.
Operators do not want to outspend capital budgets and the commodity price remains depressed, which could delay completions into 2021 as budgets reset and there’s more visibility on commodity prices and other macro variables. Historically, we have seen holiday and weather shutdowns in the Northeast begin after Thanksgiving. But with support of natural gas prices, we could see customers in this region continue to operate through the end of the year.
In the Permian, we expect minimal activity uptick in October and November, with potential holiday shutdowns starting later in the quarter. We are unsure how customers will behave, and if they will push completions into Q1 of ’21, but we do believe Q4 activity and revenue will be better than Q3. All of our service lines have begun the bidding process for 2021 and early indications from the public companies flat production year-over-year. Most of our customers are still evaluating multiple scenarios based on potential. The published today are indicating they will likely as capital spend.
Private operator activity levels [indiscernible] significant in overall health activity levels of. Customer activity and CapEx spend will be determined by commodity prices and there are still many unknowns, including [indiscernible] vaccine, global demand growth, and non-U.S. behavior that will impact commodity pricing and CapEx spend throughout 2021. The majority of cost-cutting measures for Nine were implemented throughout Q2.
We will and can continue to reduce costs if we see a change in our current activity expectations, but believe we have right-sized the organization to meet the current market environment without impeding the quality of the business and our ability to capitalize on potential activity increases throughout 2021.
Today, we are focused on continuing to gain market share across service lines with quality customers at positive gross margins. As volume and activity increases, we will be able to cover fixed costs and return to positive EBITDA results. We are experiencing strong incremental margins as our revenue recovers and as we leverage our fixed cost base and existing labor pool.
The Permian, Northeast, and Haynesville will drive the vast majority of revenue generation for the company in the near term. While the market is extremely difficult, we have proven our ability to gain market share throughout downturns. Due to the evolving drilling and completion plans of our customers, we will not be providing guidance for Q4. We are an asset-light company that can flex with the market and grow quickly with minimal capital requirements. We will continue to be cautious and maintain liquidity but also be opportunistic to better position the company for the long term.
We will now open the call to Q&A.
Thank you. At this time we’ll be conducting a question-and-answer session. [Operator Instructions] Thank you. Our first question is from the line of Taylor Zurcher with Tudor, Pickering, Holt. Please proceed with your question.
Hey, thank you and good morning. Ann, you talked about some of your competitors buying share or starting to buy shares as we progress out of this downturn, and that’s created even more of a headwind on pricing. I was wondering if you could help us think about if that pricing is more acute in certain parts of your portfolio versus others? And then as we think about Q4, I suspect there’s going to be a net negative pricing impact versus Q3. And just hoping you could help us think about that for Q4.
Sure. It’s a great question. There will not be — we do not anticipate there will be a net negative. We just caution that the level of activity increases that we’re seeing, which really are material. Like when we look at October, which obviously I’m not going to give you right now, it’s up very significantly from September. So we are seeing a lot of green shoots. Obviously, gas prices are extremely supportive right now and we expect those to continue.
So I don’t want to give the impression that those revenue gains are washed out by pricing. I am just cautioning the market that this is still a very fragmented competitive landscape. It is still hypercompetitive and there still are small players that are driving down pricing. So I just — I want to caution on incremental margin assumptions to factor in pricing is really the way I would qualify Q4.
But again, we are very encouraged by what we’re seeing. And we also, as I earlier mentioned, we don’t expect the level of shutdowns that we’ve seen in the past over the holidays. So again, I think once again, our challenge will be hiring. We have hired already a good chunk of folks back. So I certainly would not be doing that if we didn’t anticipate some good activity increases. I’m not sure if that answers your question.
Yeah, it did. It did, thank you. And kind of a similar question for Q4. If I jotted down the numbers correctly, it looked like wireline was really the only service line that saw some growth in Q3. And I realize you probably don’t want to put a number on how much you think your revenues can grow in Q4. But between your service portfolio lines today, is there any one particular service line you expect to kind of lead the way higher in Q4? Or do you expect all of them to kind of grow uniformly into Q4.
And into 2021?
Sure. It’s another great question. We expect to see significant growth in wireline, very significant growth in coil, and also good growth in tools. I think the one service line that will be up but flatter than the inclines of the other service lines will be cement just because, again, remember, 35% to 37% of our top line is really driven by that drill bit. So it’s not completions related. And so that’s really going to follow the rig count.
So again, we expect very good sequential growth in all three of those completions-related service lines. And when you think about our Q3 kind of relative to completions, just do keep in mind that you had a very, very significant completions drop from Q1 to Q2. You also had a drop in new wells drilled, but you had another 41% drop in new wells drilled from two to three. So when you think about that chunk of revenue related to drilling, we did see that show up in our financials. But again, to answer your question specifically, all three completions lines will experience at this point in time with what we know, significant inclines in activity.
Okay, thanks. I’ll sneak one more in. The organic expansion into the Haynesville and cementing, it seems like a nice strategic move for you guys. You talked about minimal revenue contribution in 2020 and more meaningful in 2021. Can you talk a little bit about what sort of scale you hope or expect to generate in that service line in the Haynesville over the course of 2021?
Yes. I won’t be specific on scale. Again, obviously, we’re very hopeful and really pleased with both the current natural gas pricing we’re seeing as well as what we look to in the future. We expect that to be a very good basin. And we really think we have the best cementing team in the U.S. with some of the slurries that are on the forward leaning of the curve. Operational execution has proven over years to be exceptional. So we expect to take share there. And I would also add there, just for the broader, for the folks on the call that really think about OFS as one of the most saturated and toughest competitive landscapes there is, the cementing service line is one of the more consolidated, least saturated competitive spaces. And that market, in particular, is very consolidated, and I expect our team to do quite well there.
[Operator Instructions] The next question is from JB Lowe with Citi. Please resume your question.
I was just wondering if you could give us an update on the delays you’ve had with some of your new products and the time line for commercialization as you see it today for those new products?
Yes, sure. Another great question. Again, we’ve launched the low temp and the high temp on time in line with the expectations that we put forward to the market. So the product that has lagged has been the new composite plug. And let me just back up and talk a little bit strategically as to why that’s important for us. Today, whether it’s 85% or 90% of the stages in the U.S. are completed with composite plugs. We have an excellent composite plug offering that is growing in market share. But we are looking forward and trying to drive down the cost to manufacture on that composite plug so that we can take a lot more share.
So to be clear, we are still driving good revenue and good earnings from our composite plug offering. We just want to do better, and that’s the product that’s delayed. And it’s specifically delayed because as we’re tweaking the design on the slip, we will test that product at surface. We then tweak the slip to more and we go back and we need another set of slip, and that process is taking longer as a result of the pandemic.
And when I say as a result of the pandemic, I mean because people have obviously cut staff very lean. And you’re seeing across the supply chain choke points. It hasn’t, as you’re all aware, been the nicest market out there, not just for energy, but broadly. So again, this is causing some delays but we are a team that will put a good product out, and I would argue that the tools that we have put out are top three in every category. I expect to be the same with this composite plug. So I’m not sure if I answered your question.
No, that was great. The other one for me was within completion tools, could you give a breakdown of dissolvable versus composite revenue?
We don’t give that breakdown. But again, the preponderance of the U.S. market is still a composite market, and we did talk about the headwinds of coil pricing. So before the pandemic hit you could be AFE neutral on your dissolvable plugs and your wellbore. I would say with the drill out and the clean out pricing put in there. I would say now the degradation in that coal pricing has been very severe. And so for that completion engineer, that may not be an AFE neutral choice at the moment.
So I think it’s a very tough market when you’re sub-300 rigs to extrapolate medium-term data as far as what that plug looks like. I think what’s been encouraging is given that pandemic when we were sitting here in March, I really thought, wow, who is going to take a risk on a product that was launched in Q1. And so the adoption rate far surpassed our expectations.
So if I have to think about an anecdote or a way to extrapolate what that could look like in a regular way market, I get very hopeful. And on top of that, the performance and the dissolution has been absolutely excellent. So I think we just couldn’t be more pleased with the predictability of the dissolution.
And I think that’s really going to separate us going forward. But as you know, it’s a market that’s hyper-focused on every dollar as our customers should be. But again, so I think it’s a little bit dangerous in this market to think about percentages of share just because it’s such a depressed situation at the moment.
Yes, that’s fair. Just to kind of follow-up on that.
But, I would say, though, JB, one point to note is that the percentage of dissolvable plugs that we have sold as it relates to the total plugs is up quarter-over-quarter. I’m just not breaking it down for you.
No that’s fine. What was I going to ask? So do you think, I mean in terms of the AFE neutral for dissolvables being hindered somewhat by coil tubing pricing, do we need to see a significant increase in coil pricing for you guys to get the kind of revenue growth that you’re hoping to see in dissolvables? Or do you think you can still grow that business if it’s something more than AFE neutral?
Yes. I think we can. I think we need to see a low double-digit increase in coil pricing to answer that on specifically. But I think what we’re also seeing some very large operators do now is look, they’re so excited, and they trust the results of the dissolution so much, they’re ignoring even checking on the bottom stages of their well to see if it’s gone.
Now, that starts to save time for these operators. So I think to answer your question, the more that these operators see in dissolution and the more efficiencies they can build into that completion cycle, the more we can grow the product line. So I think it is a headwind, but irrespective of that, as we gain traction with the tool and the operators understand where they can just cut out pieces of their process, yes, in fact, we will start to grow it. And of course, it depends what happens with the E of ESG and how far do we keep going with that? And how green do these guys want to get, right? Do they want coil units sitting there, throwing lot of diesel fumes off into the air drilling out those plugs or not. I mean, time will tell, right?
Fantastic. All right, thanks Ann.
[Operator Instructions] The next question is from the line of Waqar Syed with AltaCorp. Please proceed with your question
Hi. Good morning.
So my first question relates to the restructuring the two of the big three service companies are going through in North America. And what opportunities and challenges that presents for Nine as these big players restructure their — how they do business in the U.S.
So it’s a great question and it’s one we started to look at a couple of years ago. We just think it amplifies the vacuum for legitimate companies that can complete wells that are getting more complicated with lateral lengths that are pushing out, right? So Baker is obviously taking a turn. Schlumberger is taking a turn. That leaves whitespace — We love whitespace. The Halliburton Baker transaction — potential transaction that they tried to consummate during the last downturn, that provided whitespace. We took it. So this is something we’re excited about.
Is this primarily on the completion tools side that you’re benefiting or in cementing? Or how would you characterize the opportunity in which business lines?
Yeah. I would say for one of those folks, we benefit across the spectrum of service lines. And for one of the other large players, they are going to keep their feet here in cementing at least for now. So we’ll see. But if that were to take a turn, as you know, that cementing space is just very consolidated, and you don’t just pop into it. So just to remind the market, this is the one service line where you can lose the asset for the customer.
So if you cement the wellbore, it’s done. And so it’s very high risk. Operators audit your operations very heavily and so you can’t — once you lose a potential competitor in that space, you don’t just birth a new one. Takes a heck of a lot of time. It takes capital, and you’re going to be on surface work for quite some time before you get the opportunity or privilege to do a production string for a large operator. And so I think as acreage consolidates, that really works in our favor for that service line. So let us just see what one of those other big guys does on the cementing line. But to answer your question, all of that helps us, Waqar. We believe.
Absolutely. Now, as we look into the first quarter, any early read? You mentioned that there’s a pretty significant change in RFQs, RFPs, sorry. Could you quantify the magnitude of change that you think activity could be for the industry first quarter versus fourth quarter?
I can’t quantify that, Waqar. What I can say is that right now, we’re anticipating that ’21 is a better year than ’20 based on what we’re seeing and what’s being asked.
Year-over-year or second half versus second half 2020 when you compare that with 2021?
Second half is what I’m talking about compared to 2021.
Okay, fair enough. And then just a question for Guy. I missed some of the data that you provided about the cementing business and wireline in the third quarter. Could you kindly repeat that, please?
Sure. So during the third quarter, we completed 378 cementing jobs, and the average blended revenue per job increased by 12%. And then for wireline, we completed 3,081 wireline stages, and the average blended revenue per stage decreased by approximately 2%.
Thank you. At this time, we’ve reached the end of our question-and-answer session. I’ll turn the call back to Ann Fox for closing remarks.
Thank you for your participation in the call today. I hope you and your families stay safe and healthy during these very difficult times.
Thank you. Everyone this will conclude today’s conference. You may disconnect your lines at this time. Thank you for your participation.