NINE - NYSE

Greetings and welcome to Nine Energy Service Q1 2022 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Heather Schmidt, Vice President, Strategic Development and Investor Relations. Please go ahead, ma’am.

Thank you. Good morning, everyone and welcome to the Nine Energy Service earnings conference call to discuss our results for the first quarter of 2022. 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 first quarter press release and can be found in the Investor Relations section of our website. I will now turn the call over to Ann.

Thank you, Heather. Good morning, everyone. Thank you for joining us today to discuss our first quarter results for 2022. We had a very strong growth quarter, with revenue of $116.9 million, which fell above our original guidance of $108 million to $116 million and reflects an 11% increase quarter-over-quarter. We generated adjusted EBITDA of $12.2 million, reflecting a 168% increase quarter-over-quarter and an adjusted EBITDA margin of 10%. Incremental adjusted EBITDA margins were approximately 65%. Overall, market activity did improve quarter-over-quarter, with the average frac crew count increasing approximately 6% to 8% over Q4, equating to 14 to 16 additional frac crews. According to the EIA, U.S. completions increased approximately 3% and new wells drilled increased by approximately 15%. These increases are far from extraordinary, but as anticipated, any added incremental activity on a damaged OFS industry has caused labor, equipment and material shortages, enabling us to implement price increases across most of our service lines and drive strong incremental margins. The majority of our service lines experienced activity or pricing increases this quarter. Cementing had an exceptionally strong quarter, with revenue increasing approximately 31% quarter-over-quarter versus the average rig count, which increased approximately 13%. Along with activity increases, we have been able to implement double-digit price increases and have had the most pricing leverage in this service line thus far in the recovery. We anticipate it will continue to be a very strong service line for the remainder of the year. We operate in the most active basins in the U.S., including the Permian, Haynesville and Eagle Ford, and continue to gain profitable market share through superior technology and service. Our market share in the Haynesville has already grown to approximately 33% after just entering the market at the end of 2020. As a reminder, on our last call, we provided an update on the overall U.S. dissolvable plug market and estimated that approximately 20% to 25% of the U.S. stages completed at the end of 2021 used dissolvable plugs versus 10% to 15% at the end of 2018. We project these percentages will increase to over 35% by the end of 2023. ESG initiatives, specifically the proposed climate rules recently announced by the SEC, should help propel the adoption of dissolvables as operators look for cost-effective and scalable technology to help reduce emissions. Along with dissolvables, we continue to believe we have one of the top-performing completion tool portfolios in the U.S. Wireline activity is steadily increasing. Our team in the Northeast have done an excellent job maintaining a strong market share position in that region, and we have recently won market share in the Permian Basin, which is reflected in the 7% activity increase quarter-over-quarter. With the exception of tools, a service line we rarely forecast price increases, wireline has been the most challenging service line to implement net price increases due to the extensive competitive landscape, but we are beginning to gain traction as labor scarcity continues. Coiled tubing revenue increased by approximately 11% driven mostly by price increases of approximately 18% quarter-over-quarter. While we have gained traction on pricing, cost inflation, especially on wages, continues to be a challenge. For example, the hourly rate for one of our entry-level driving positions, which does require a CDL, has increased approximately 40% over the last 8 to 12 months. While this is not the case across the organization, it illustrates the magnitude of these increases. Wage increases flow up the organization. And while we work with the customer as quickly as possible to pass through these increases, there is typically a lag which can affect margins. Company revenue for the quarter was $116.9 million, net loss was negative $6.9 million and adjusted EBITDA was $12.2 million. Basic earnings per share, was negative $0.23. ROIC for the quarter was 2.1%. I would now like to turn the call over to Guy to walk through our detailed financial information.

Thank you, Ann. As of March 31, 2022, Nine’s cash and cash equivalents were $19.9 million with $54.7 million of availability under the revolving ABL credit facility, resulting in a total liquidity position of $74.6 million as of March 31, 2022. On March 31, 2022, the company had $20 million of borrowings under the ABL credit facility and has subsequently borrowed an additional $7 million. During the first quarter, revenue totaled $116.9 million with adjusted gross profit of $22.6 million, an increase of approximately 52% quarter-over-quarter. During the first quarter, we completed 1,006 cementing jobs, an increase of approximately 14% versus the fourth quarter. The average blended revenue per job increased by approximately 16%. Cementing revenue for the quarter was $45.2 million, an increase of approximately 31%. During the first quarter, we completed 4,924 wireline stages, an increase of approximately 7%. The average blended revenue per stage decreased by approximately 8%. Wireline revenue for the quarter was $21.4 million, a decrease of approximately 2%. For completion tools, we completed 23,729 stages, a decrease of approximately 8%. Completion tool revenue was $28.7 million, a decrease of approximately 2%. During the first quarter, our coiled tubing days worked decreased by approximately 6%, with the average blended day rate increasing by approximately 18%. Coiled tubing utilization during the quarter was 42%. Coiled tubing revenue for the quarter was $21.6 million, an increase of approximately 11%. During the first quarter, the company reported general and administrative expense of $11.8 million, which was flat quarter-over-quarter. Depreciation and amortization expense in the first quarter was $10.4 million compared to $10.7 million in the fourth quarter. The company recognized income tax expense of approximately $0.1 million for the quarter, resulting in an effective tax rate of negative 1.7% for the 3 months ended March 31, 2022. The tax expense for 2022 is primarily the result of our tax position in state and foreign tax jurisdictions. The company reported net cash used in operating activities of negative $6.5 million. The average DSO for Q1 was 62.7 days. CapEx spend for Q1 2022 was $2.4 million. As a reminder, we guided $20 million to $30 million of CapEx for the full year. The cadence of that CapEx will depend on delivery of equipment. In Q1 2022, we largely offset our CapEx with asset sales, though we do not forecast this to continue for the balance of the year. For Q2, our largest cash outflows will be our senior note interest payments of approximately $14 million, CapEx and changes in net working capital, which will closely mirror revenue changes. I will now turn it back to Ann.

Thank you, Guy. We remain optimistic looking into the rest of 2022 and into 2023. Although WTI prices have been extremely supportive, we have not seen significant increases in activity above pre-announced 2022 plans, especially with the recent release from the U.S. reserves, coupled with cost inflation for operators as price increases are implemented across OFS. As I mentioned previously, cementing has led on both activity and pricing in Nine’s service lines due to the strong inflection in drilling activity at the end of Q4 and into Q1. We anticipate this service line will continue to grow but not at the same rate as the pace of drilling activity increases normalize. We do expect completion activity to increase throughout the rest of the year, which should be a catalyst for further price increases in coiled tubing and wireline. Labor challenges continue as well as finding reliable, well-maintained equipment. While we have begun to see positive traction in pricing, we still have a long way to go to return to sustainable profitability. And I believe we will continue to see OFS pricing increase throughout the rest of the year. This may serve as a headwind for operators to add incremental rigs in the near term, but additional activity will be needed to maintain and/or grow production in the medium to long-term. OFS is also facing wage and material inflation. As I mentioned before, we are bullish on the outlook for the dissolvable plug market and its continued growth, and I remain very happy with both the performance and adoption of the technology. We expect revenue for all of our service lines to increase in Q2, and we should continue to see net price increases in the majority of our service lines. Looking into the next quarter, we expect Q2 to be up sequentially versus Q1 with projected revenue of $130 million to $140 million. We also anticipate adjusted EBITDA will increase in Q2 versus Q1. Due to both wage and material inflation, incremental adjusted EBITDA margins will be lower and more normalized for Q2 versus this past quarter. We continue to prove our ability to capture a growing market, more than doubling our adjusted EBITDA in only one quarter. Our team is prepared and well positioned to generate growth with diversified service lines and geographic footprint. We will now open up the call for Q&A.

Thank you. [Operator Instructions] Our first question is from the line of John Daniel with Daniel Energy Partners. Please go ahead.

Ann, I guess first question is – it’s going to be a hard one to answer, I acknowledge, before I can even ask. But let’s assume the dissolvable market achieved the estimated market share of just call it, 35%ish. I think that’s the number you mentioned in the prepared remarks. What would that mean to your financial results?

So think about these two ways. One, obviously, we feel we’re a market leader, and very few folks have the position that we have in the dissolvable market. So the competitive landscape there is just not saturated when you talk about scaling the technology. So when you talk about dependability on execution, when you talk about material dissolution and predictability of that material dissolution, I would put us at number one. So when we work with operators, we can, in a very accurate way, tell them when that material will be gone. And then, of course, we have to, obviously, isolate the wellbore properly. So I think we do both in a fabulous way. So if that market share grows, obviously, it will impact our revenue line significantly. But as you well know, part of our strategy when we became public was to be relatively asset-light inside of the OFS space. So that’s a huge generator of cash. And as you also know, we’re very, very light on R&D expense. We have a few incredible engineers, so we just don’t overengineer this particular division. So the cash drop down is huge. Think about the free cash flow conversion on $1 of EBITDA, it’s almost 100%. It’s not quite there. But again, I’ll remind the market, CapEx in that business line is a pickup truck and a tin roof. So that part is pretty exciting. And I’m not sure if you’ve looked at the proposed SEC regulations, but they are – onerous is a kind word. I mean it’s a kind word. So I think our operators have been looking first at frac but, frankly, they are going to need to look at every single thing if they are going to punch down these emissions.

And I have not read the SEC rules, it would put me to sleep, but I’m curious, as you’re talking to the customers, I mean, clearly, this is going to be an issue for them. At what point do they have the epiphany and say, you know what, we should pivot more. Does that make sense?

Yes. I think some time in the next 6 to 12 months because these large accelerated filers, they are going to get hit with this very quickly. And so I think you’ll see your large publics will turn quickly. Obviously, John, you’re privates, they don’t care. So it’s kind of like how fast do they get gobbled up by the large publics. But it’s going to be a very fast and furious focus. And I think the timing to implement this stuff for the SEC, if it’s adopted, is pretty quick.

Okay. And then the last one for me, it’s sort of a monkey math question here. I know [indiscernible] long-term, but I’ll ask nonetheless. It seems to me, I mean, you guys could potentially be sort of on a run rate of $20 million adjusted EBITDA by Q3, in that range. Does that pass the smell test?

It’s not. It does pass the smell test.

Thank you very much.

Thank you, John.

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

Thank you for taking my question. Congrats on a great quarter.

Thank you.

In the wireline and completion tools business, revenues kind of declined a little bit. Could you maybe provide some guidance on why there is a revenue decline?

Sure. So if you do remember, obviously, we said the EIA has told us that the completions activity went up about 3% quarter-over-quarter. But just remember, in a lot of the basins that we work, we had very significant weather delays on top of some massive sand shortages. So we saw some pullback there. We do not anticipate that in Q2. So we’re very excited about that, and you shouldn’t see that again.

Okay. And then could you give us the numbers for your active units for cementing, wireline and coil tubing in Q1?

Yes. And we’re happy to do that all, Waqar, maybe post this call would be best. But I would tell you that, if you think about utilization broadly, we are really maxed out on cementing. The one service line where you could see spare capacity on the fence line, in a chunky way, is wireline. The challenge for the service sector broadly is there is no crews. So to just give you an idea of the magnitude of this problem, I’ve been trying to hire 12 individuals for a large region in the Marcellus Utica for over 60 days, and we cannot get them. Now that doesn’t mean we don’t bring young folks in and then they tap out in 2 days, I’m talking about retaining 12 qualified individuals. That is how tight this labor market is. So regardless of stacked equipment, it’s going to be a crew and labor problem, which we can’t accurately predict when that pressure eases. But it’s very significant. So that’s going to be a real continued challenge for OFS.

And so there was also a comment made that some of the CapEx for the year is for additional equipment. Would you be ordering that equipment given some of the labor tightness that you talked about, number one? And in what areas are you thinking of adding capacity? And what’s kind of the lead time on new equipment orders?

So this is the CapEx budget that we put to the market earlier. I think the point we really wanted to make to the market is that the net CapEx of almost zero in Q1 is not going to continue because we do expect to take delivery of those units that we put on order sometime this year. The challenges you mentioned is that the labor market, I just painted a picture of that, the equipment market is even worse. So OFS is going to really struggle to get equipment delivered in a timely manner. So I think when the U.S. operators go to increase their activity next year, which they’ll have to do even if they want to maintain production, they will be doing that largely on the same equipment set they have today because deliveries are already backed up sometime to March and June of 2023. So this is where we’re going to really see the supply chain struggle which, of course, we don’t dislike because it means that our opportunity to raise price goes up. So again, I think you can think about lead times. If you’re going to place an order today, you’re going to get that equipment sometime in June of ‘23.

Okay. And then in terms of Q2 incremental margins, you mentioned more kind of normalized. So what do you consider normalized margins?

Well, definitely not a 65% incremental, and I’ll flip it to Guy, but far less than that. And again, I think you could see some stronger incrementals in the back half because Q3 is typically a very strong quarter for the service sector. But I’m going to flip it over to Guy.

Waqar, we’re not guiding on margins quite yet. I think it’s tough to guide incremental margins just because there is so many moving pieces; pricing is changing; labor costs, material costs are all changing; we’re activating crews. And all these things contribute to choppiness there. I do expect there to be positive incremental margins. So EBITDA should continue to increase. But we haven’t guided to a specific level. I mean historically, people think about incremental margins for this sector in the 20% to 40% context. And I know that’s a broad range, but it could be somewhere in there or outside of that. I mean it’s difficult to say right now.

Alright. Makes sense. Thank you very much. That’s very helpful.

Thank you so much, Waqar.

Thank you. Ladies and gentlemen, there are no further questions at this time. And now I would like to turn the call back to Ann Fox for closing remarks.

Thank you for your participation in the call today. I want to thank our employees, our E&P partners and investors. Thank you.