Nine Energy Service, Inc.
Q4 2020 Earnings Call Transcript

Published: 8 Mar 2021

[Operator:]

Greetings and welcome to the Nine Energy Services Fourth Quarter and Full Year 2020 Earnings Conference. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Ms. Heather Schmidt, Vice President of Strategic Development and Investor Relations. Thank you. Please go ahead.

[Heather Schmidt:]

Thank you. Good morning, everyone and welcome to the Nine Energy Service earnings conference call to discuss our results for the fourth quarter and full year of 2020. 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 reconciliation to the most directly comparable GAAP financial measures are also included in our fourth quarter and full year press release and can be found in the Investor Relations section of our website.

[Ann Fox:]

Thank you, Heather. Good morning, everyone. Thank you for joining us today to discuss our fourth quarter and full year results for 2020. It clearly goes without saying that 2020 was unprecedented. COVID has taken a major toll on so many from both the health and financial perspective and I want to commend and thank our employees at Nine for their leadership, empathy and professionalism throughout the year. I was reminded again this year how important the team you have around you is, especially when navigating through unthinkable circumstances. The market saw unparalleled uncertainty and heightened volatility throughout the year and the COVID pandemic caused an extreme decline in global demand, estimated to be close to approximately 17 million barrels per day from peak Q4 2019 levels to the trough in Q2 of 2020. WTI was negative during the second quarter and our customers responded accordingly, reducing our completely suspending activity across U.S. lands. We estimate that the average U.S. active frac count declined from approximately 330 in 2019 to as low as 73 in May of 2020 and then increasing to approximately 160 active U.S. frac crews at year end. The EIA reported U.S. completed wells declined approximately 49% year-over-year and new U.S. drilled wells declined approximately 56%. The choices we made throughout 2020 were critical in positioning ourselves for future success and I would categorize this year as a balancing act, constantly assessing and managing the short, medium and long-term needs of the company. This included making significant cost reductions to preserve liquidity for the near term, but also maintaining key people, assets and our footprint, so as not to impede the future earnings of the company for the medium and long-term. Our operational and corporate teams were facing extraordinary market conditions, while also integrating new processes and procedures in the field and a new virtual world of selling and communicating. Despite this, our team was able to remain opportunistic and continue to execute on our strategy of being an asset-light business, providing the best technology and service for our customers. Although profitability was down year-over-year in conjunction with the market, we were able to demonstrate our ability to flex quickly cutting costs and preserving liquidity. By the end of Q2, we reduced our headcount and payroll expense by over 50% and our 2020 CapEx was $10.2 million, an approximate 84% reduction year-over-year and at the low end of our guidance of $10 million to $15 million. We were able to preserve cash and liquidity through good working capital management, generating approximately $66.5 million in cash from the monetization of accounts receivable and inventory. During 2020, the company repurchased $53.3 million par value of bonds for $14.6 million of cash, on average, representing 27% of par value and leaving $346.7 million par value of bonds outstanding and an undrawn ABL.

[Guy Sirkes:]

Thank you, Ann. I want to start with an update on our debt and liquidity profile. As of December 31, 2020, Nine’s cash and cash equivalents were $68.9 million, with $37.9 million of availability under the revolving ABL credit facility, resulting in a total liquidity position of $106.8 million as of December 31, 2020. We did not repurchase any additional bonds during Q4 and as Ann mentioned, during 2020, the company repurchased $53.3 million par value of bonds for $14.6 million of cash, on average, representing 27% of par value and leaving $346.7 million par value of bonds outstanding and an undrawn ABL. For Q4, the main cash outflows were related to our approximately $15 million of interest expense for our senior notes and the remainder of our CapEx. Our total CapEx for the year was $10.2 million, a reduction of approximately 84% year-over-year and at the low end of our original guidance of $10 million to $15 million. During the year, we have been successful in largely offsetting our capital expenditures with equipment sales. For the full year 2020, we spent $9.4 million in cash CapEx compared to $7.6 million in proceeds from sales of PP&E and PP&E insurance proceeds. During the fourth quarter, revenue totaled $62 million, with adjusted gross loss of negative $5 million and adjusted EBITDA of negative $13.9 million. During the fourth quarter, we had $9.8 million of unusual net costs with substantially all of them increasing cost of sales and negatively impacting adjusted gross profit and adjusted EBITDA. The largest of these unusual cost items was the $10 million negative inventory adjustment that we recorded as a result of the rationalization of our completion tools portfolio. In Q4, we evaluated our completion tools portfolio to streamline our product offering, resulting in a discontinuation of certain legacy products. This rationalization of our product offering allows us to transition customers to our newest technologies like the Stinger dissolvable frac plugs. Our other unusual items are relatively small in nature and offset each other such that the net impact is not material. During the fourth quarter, we completed 509 cementing jobs, an increase of approximately 35% versus the third quarter. The average blended revenue per job decreased by approximately 12%. Cementing revenue for the quarter was $18.2 million, an increase of approximately 19%. We ended the year with 40 cementing units, of which 10 were stacked during Q4.

[Ann Fox:]

Thank you, Guy. While we have certainly seen improvement in the market and have passed through the trough, we are still anticipating a very challenging environment in 2021. It will take time for stability to reach the market and we will need significantly more increases in rig and frac crew counts to reach healthy levels for OFS companies coming off all-time activity and pricing lows in 2020.

[Operator:]

Thank you. Our first question is coming from Sean Meakim of JPMorgan. Please go ahead.

[Sean Meakim:]

Thank you. Good morning.

[Ann Fox:]

Good morning, Sean.

[Sean Meakim:]

So Ann to start, can we maybe talk about the path to positive EBITDA as we move through ‘21? I think your comments on anemic volume improvements and the pricing headwinds I think those are well noted, but what type of incremental margins can you expect to generate as activity is ramping in the first half of the year? What does that look like if we are just growing volumes versus what you think you could generate if you were able to capture some incremental pricing maybe later in the year?

[Ann Fox:]

Yes. Well, it’s a great question, Sean. We are not guiding. So I won’t give you a guide on incremental margins. I would say that largely you can capture this as both a pricing and volume problem. So as volumes increase, clearly, that’s going to help flow through to the margin. And I think generally speaking, the team has better visibility on volumes than we view on pricing. Clearly, one typically lags the other, but again, with recent commodity prices, we do think that’s helpful. We do think the percentage of the private rig count will be helpful. So we are up around the 40% mark of the U.S. rig count is private. Obviously, as you well know, they are not subject to investors’ concerns as it relates to cash. So I think that will all be very helpful on the volume that will certainly drive better incremental margins. And then the question mark is, what is the activity point at which OFS starts to gain leverage against the operators as it relates to price? I do think there is a growing concern amongst operators that what we have at the moment in the sector is just not sustainable. And I think there is a willingness to recognize that. And I would say we have seen that at private and larger public. So, I do think we get pricing amelioration. I do think we see much better incremental margins. And I will really stress, highlight and underscore that Q1 will be our worst quarter. We had a lot more white space in January than we thought. So, we had a lot of our specific customers coming out of the gate much slower. And as you know with small numbers, that white space is very challenging. And then clearly, the winter storm was probably the largest number of consecutive days down we have seen in our history at Nine. So, I think again those things will be helped. We also have just internal organic margin expansion efforts going on with our tools, which we think by year end we will be able to ameliorate those margins up over the double-digit level. So, the speed of those price declines is just faster than what we could take the cost out of the tool, but that’s forthcoming and we have a lot of confidence in that. And frankly, we have done that before with our Scorpion Composite plug offering, where we have been able to hold the margin despite 25, 30 points of price decline over time. So, it’s been done and there is going to be a little bit of a lag there, but we are very hopeful about incrementals coming into the back half of the year.

[Sean Meakim:]

Got it. Thank you for all that detail. I think the natural next question then is the path to positive free cash flow. Your CapEx is going to stay fairly tight. Working capital will be a consumer of cash as you are growing the top line it sounds like. Interest expense is still a pretty decent hurdle in the current environment. So, can we get back to positive free cash on a quarterly basis at some point in ‘21? How do you see those building blocks?

[Ann Fox:]

Yes. I think again if you look at the company for 2020, what’s really remarkable to me just to go back to this for a minute is, you spent about $7 million outside – you burned about $7 million outside of those bond buybacks, which obviously were all discretionary. And so to cover down your CapEx and to take a 63% loss on your top line and only rip through $7 million was pretty darn good. I think this year our challenge will be to manage that working capital build and the pace of that. And our receipt of that, I think is really going to be, I think there is a lot of pencils cracking on budgets right now, again, inside our private operators and maybe even inside of some of our public. And so how fast is activity come on or not is really going to dictate the pace and speed of that cash flow. As you know, also, obviously, our ability to leverage price and start to get some price will be very important as it relates to generating that cash. So I think we will be very prudent with CapEx. We’ll be very careful. We’ve clearly shown our ability to put up major fences around the cash and shelter it. And we’ll do that this year, too. Again, the real challenge here will be managing net working capital build, should the activities spike the way some are projecting.

[Sean Meakim:]

Understood. Thanks a lot.

[Ann Fox:]

Thank you, Sean.

[Operator:]

Thank you. Our next question is coming from George O’Leary of Tudor, Pickering, Holt. Please go ahead.

[George O’Leary:]

Good morning, guys.

[Ann Fox:]

Good morning.

[Guy Sirkes:]

Good morning.

[George O’Leary:]

On the commentary around private operators, we’ve noticed that phenomenon to certainly in the – on the rig count side of the equation where we kind of drill down on who is adding. I wondered if you could frame how much of revenue or job mix for Nine comes from those private operators as we sit here today?

[Ann Fox:]

So what I’ll frame for you is that 70% – roughly 70% of this company’s revenue comes out of the Permian. So that’s just an important fact. When you think about like the Haynesville, of course, we’ve got a lot more private operators there that we work for. The point is, is I think the private operators could be a great driver for incremental revenue for us. We have a good diversification between large independents and super majors all the way down through private. So to answer your question, we will get a kick, a big kick if the privates decide to speed it up. But I don’t want to be overly bullish. And I do think there is a lot of third degree burns out there. And I think people are going to be careful about risking capital. And I think there is going to be more of a pause than we’ve seen in previous – in our past history in the oil patch. So again, obviously, as we all know, OPEC+ is making this market for us right now. And I think last year, March 7, none of us were anticipating Russia and Saudi opening this tickets. So when you have something looming over your head that can change within 24 hours, I think it just causes pause and so really important to keep that in mind. And I think that goes for a lot of private operators as well.

[George O’Leary:]

Great. That’s helpful. And then the margin expansion with respect to tools that you spoke about in one of Sean’s questions. Just curious the driver there, is that more manufacturing process driven, lowering the cost to input materials? Kind of what are you guys doing specifically to reduce the costs and up the margins on the completion tools side?

[Ann Fox:]

Sure. So yes. So just to reflect on that a minute, of course, we took a waiving $10 million hit there on inventory in Q4. So it really completes the margins and the profitability of the corporation. As we always do, we first want proof of product. We want to get that product down whole, both on the composite side as well as on the dissolvable side. We want to make sure anything that we’re doing that’s new is working first. And then we start engineering down the costs. And that can be through minor design changes, it can be through vendors. And so those discounts are showing up in all of those ways. We’ve codified that internally. We have great confidence in it, and it’s, again, a material change in margin that I’m very confident will be reached by the year-end. So that’s forthcoming. We’re also transitioning our customer base to some of our newer technologies, which is margin enhancement from some of the legacy products also some of those that were "streamlined" inside of that inventory write-down. So you’ve got a lot of moving parts there. Some of that, George, would have happened more quickly if we didn’t have the market that we were faced with in 2020. So this is – it’s a little bit slower than we would like. But again, lots of margin enhancement coming through the switch of new products, engineering down the cost and working with vendors. So, we are very pleased with what we see when we put pen to paper on those products by year end.

[George O’Leary:]

Great. I’ll sneak in one more, if I could. You guys touched so many different parts of the wellbore from construction to completion. Just curious if you’re seeing any notable changes in well design as we look at kind of the runway for 2021 year-over-year versus maybe a more normal year in 2019? Anything you guys are seeing that’s interesting would be much appreciated?

[Ann Fox:]

Sure. I think we’re not seeing much in the way – I would say not material changes in well design. We are seeing, of course, operators continue, I would say, to push out the lateral length and want to play around with 3-mile laterals. From an efficiency perspective, you’re seeing folks play with simul fracs. But other than that, George, we’re not seeing any new kind of start-ups sprinkled across here. So I think it’s getting back to normal and figuring out what the spend should be for our customers, but we’re not seeing material changes to completion designs.

[George O’Leary:]

Thank you, Ann.

[Ann Fox:]

Thank you.

[Operator:]

Thank you. Our next question is coming from Chris Voie of Wells Fargo. Please go ahead.

[Chris Voie:]

Thanks. Good morning.

[Ann Fox:]

Thank you.

[Chris Voie:]

Just maybe another question on completion tools obviously, it’s a big driver of your margins. Just curious if you think after this kind of pricing decline, if you could get to maybe prior cycle margins, which I think were 30% plus, maybe 40%, is that achievable? Or do you need really strong growth in activity going forward for that to be possible?

[Ann Fox:]

I think it’s achievable. I think it’s going to depend on volumes as well. So again, in completion tools, there is a bunch of different aspects here. But obviously, as volumes increase, you get more leverage through your supply chain. So that’s one aspect of it. I think the margin is something we’ll see if we can get those margins back to where they need to be as far as pre-pandemic levels. So that’s something that we are also wondering about. It’s a very good question. As you well know, we never anticipate the price coming back. So our history over the past 8 years or so with completion tools has been that the price comes down, it doesn’t reset higher. So then, therefore, you’re going to have to get it through margin enhancement on the product and/or volumes and leverage through the supply chain.

[Chris Voie:]

Okay, thanks. That’s helpful. And then curious, you mentioned simul frac. That’s obviously an interesting area now that potentially could grow. Does that, in your mind, kind of dovetail with the increased use of dissolvables? Just curious what you think your participation is on those kind of jobs and if that’s an opportunity or kind of not really impactful?

[Ann Fox:]

I think dissolvables, where that just fits into is just the broader theme of U.S. operators striving for greater and greater efficiencies. And what it just reminds me of is that every time folks question whether they can get more efficient, they come up with – or service and E&P come up with ways to get this land more efficient. So I think dissolvables play into the efficiencies, certainly, we believe that, especially with the cost of dissolvables coming down, and our incredible science behind our dissolution. So the predictability of the dissolution is so darn good now. That – now that price point is coming down in some ways, you could ask why would people not use the dissolvable because the time efficiencies created are huge and of course, the green nature of dissolvables and the lack of safety risk without human beings sitting up there, drilling out plugs under pressure is huge. So I think all of this points in the direction of increased dissolvable adoption. And as painful and hideous and wicked as 2020 was, the one thing it will force this company to do is live within a very cheap dissolvable price and drive a margin. And that, therefore, we think, in the medium term, drives adoption of the dissolvables. Because remember, the hurdle, there was always price. But so it doesn’t directly – there is not like a direct correlation between simul fracs and dissolvables, but I think generally, a point to these operators searching for efficiency.

[Chris Voie:]

Okay. That’s helpful. And maybe I’ll squeeze in one more here, but I wonder if you could comment on the M&A landscape, but just the tenor that you’re seeing in Nine’s appetite for any kind of combination?

[Ann Fox:]

Yes. I mean I think we – certainly, our history has been through organic and M&A growth. This team is always eyes wide open to new technologies. And again, we did a really key acquisition of the Scorpion Plug product in August of 2015 when nothing seem doable and the next few quarters look as dark as they actually ended up being. So it’s not impossible. It’s something we’re always pursuing. And I think, generally, of course, the oilfield service sector knows that we’ve got to get some power and some margin enhancement, and there is a lot of us out there. So I would say we’re all considering a bunch of different options for going forward.

[Chris Voie:]

Thank you very much.

[Operator:]

Thank you. Our next question is coming from Waqar Syed of ATB Capital Markets. Please go ahead.

[Waqar Syed:]

Thank you for taking my question. Good morning, Ann, Guy and Heather.

[Ann Fox:]

Good morning.

[Waqar Syed:]

Ann, could you comment on international markets, what’s the outlook there and are you having any further market penetration there in Latin America or Middle East?

[Ann Fox:]

Well, thank you for asking that question. We are, in fact. So, if you had asked me when we purchased Magnum, if we would be selling dissolvables into the Middle East? I would have said, wow, that’s ambitious, but we are. And so yes, we are getting market penetration there. And we are also working on some other tool strings, which I won’t be specific about specifically for the Middle East. So that’s an area of great focus for us. We do sell-through to Argentina. And so that’s something that we’re also excited about. So I do expect that, that grows for us.

[Waqar Syed:]

Okay. And then in terms of correlating U.S. E&P budgets versus your own revenue projections. If we look at your quarterly run rate for last year, it comes out to be about $78 million. And it looks like that if you have another 25% type revenue growth, first quarter could look like that quarterly run rate for last year. So your revenues should potentially be higher year-over-year, even though U.S. E&P budgets could be lower, is that reasonable?

[Ann Fox:]

We’re not guiding forward at this point in time. So I’ll just – I’ll leave that question to the side. I will just remind you, too, of course, as I said, that Q1 had a couple of different factors with the slow start in January as well as the winter weather storm. But again, we’ll leave the forward guys to decide for a minute there, Waqar.

[Waqar Syed:]

No. But when you said that the pace in the first quarter would be higher, did you mean that if you grew at 25% in the fourth quarter, the growth rate is going to be higher sequentially in the first quarter? Am I misunderstanding that?

[Guy Sirkes:]

Waqar, it’s Guy here. I think what we’re saying is just that the – we’re seeing the rig count improve and basically, activity levels are increasing. And so putting aside weather issues in a January slow start, things are starting to pick up. And so the rate of activity is higher than it was before. Sorry if that was unclear and unclearly worded.

[Waqar Syed:]

So what you’re saying is the absolute level of activity is higher versus the fourth quarter, but the sequential rate of change may not be? Am I putting it correctly?

[Guy Sirkes:]

The absolute level of activity is higher now. And yes, I mean we’re not guiding whether our revenue will be tracking or not tracking the activity increases proportionately. So we’re not guiding Q1 in any way, yes.

[Waqar Syed:]

Okay. And then you mentioned there is a small amount of growth CapEx in our CapEx budgets, could you maybe break that down, what that is? What the growth CapEx is?

[Ann Fox:]

Sure. I’m not going to be very specific here, Waqar, but what I’m going to tell you is it’s some new plug-in electric technology we’re working on.

[Waqar Syed:]

Okay. Okay. And when do you – when should we be expecting to hear more about that?

[Ann Fox:]

Yes.

[Waqar Syed:]

Okay. Thank you and appreciate that.

[Ann Fox:]

Thank you, Waqar.

[Operator:]

Thank you. Our next question is coming from John Daniel of Daniel Energy Partners. Please go ahead.

[John Daniel:]

Hi, good morning.

[Ann Fox:]

Good morning, John.

[John Daniel:]

No modeling questions or questions for me. Ann, can you just qualitatively or just discuss the near-term outlook, if you will, between coil, wireline, cementing? Just really where you’ve got better relative visibility? And is it basin-specific, customer-specific, just some of the trends there, please?

[Ann Fox:]

Sure, sure. Yes. So I mean, it’s not going to be a surprise to you, John. You know these basins so well. But as far as basins go, the trends certainly in the Permian are looking quite nice. And I would say, we’ve got all our service lines represented there. So that’s really across service lines from an activity perspective. I think when you think about pricing going forward, which one is moving faster, we are seeing our depreciation-based service lines moving more quickly in price. And I think that’s – of course, you’ve got a market that’s really constrained by liquidity. So when you think about our medium and long-term strategy of being asset-light, at the moment, that works against you because the asset-light business lines you can come in and out of, and you don’t impede your liquidity or you’re not trying to find a dollar of cash to do that. Whereas those coil in those cement spreads are expensive, they are expensive to maintain, their expenses keep working. And so you’re seeing more pricing traction in the depreciation-based service lines. So I’m not sure if that answers your question. Pricing across the board, as you’ve talked about, and you know so well. It’s just not where it needs to be for the service sector, hasn’t been for some time. But I would say if I had to call which horses are leading the pack right now? It’s cement and coil. Did that answer your question?

[John Daniel:]

That’s good enough for me. Thank you.

[Ann Fox:]

Okay.

[John Daniel:]

The last one just comes back to ESG. And I don’t know if you can do this or not, but do you have a – can you hazard a guess, like how many of your customers today are using some sort of ESG score as they procure their services? And just how do you see that playing out a year from today and do the private even care? I think I know the answer a lot, but just I will let you…

[Ann Fox:]

Yes. Okay, sure. So I think most of the private, I’ll be careful not to say that they don’t care, but they don’t care. And the publics, yes, most of them have scorecards. We think that pressure increases. And I think they know that allocation of capital to them will be really hampered if they can’t demonstrate that they are first movers in being greener. And so I think that becomes more and more pronounced. And I don’t see that tailing back. So that’s something we’re very focused on. And once it goes to compensation for our customers, which for many of them, it has, as we know money talks. And people will drive toward those compensation metrics. So we expect that continues.

[John Daniel:]

Okay, got it. So that’s it for me. I will – couple offline when you have some time. Thank you very much.

[Ann Fox:]

Thank you, John.

[Operator:]

Thank you. At this time, I’d like to turn the floor back over to Ms. Ann Fox for closing comments.

[Ann Fox:]

Thank you. I want to end by thanking you for your continued support. Additionally, I want to thank our incredible employees who are executing in the field and innovating every day so that we can partner with the best operators in the industry. I hope you and your families are safe and healthy.

[Operator:]

Ladies and gentlemen, thank you for your participation in today’s conference and your interest in Nine Energy Services. You may disconnect your lines at this time and have a wonderful day.