Greetings, ladies and gentlemen, and welcome to Nine Energy's Second Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions]. It is now my pleasure to introduce your host, Ms. Heather Schmidt. Thank you. You may begin..

Thank you. Good morning, everyone, and welcome to the Nine Energy Service Earnings Conference Call to discuss the results for the same quarter 2021. On the call with me today are Ann Fox, President and Chief Executive Officer; and Guy Sirkes, Chief Financial Officer. We appreciate you're here today.

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 participants 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. 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 second quarter press release may is filed 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 second quarter results for 2021. The quarter was in line with what we anticipated with Q2 revenue of $84.8 million coming towards the top of management's original guidance of $78 million to $86 million, and representing an increase of 27% over Q1 2021.

During the quarter, we wrote down $2.4 million of tools inventory as we replace legacy tools and transition our customers to our newest technology, which did negatively impact our operating results, including adjusted EBITDA. Market activity improved throughout the quarter, with June activity slightly stronger than anticipated.

While somewhat skewed due to weather-related shutdowns during Q1, the EIA reported completed well increasing approximately 19% quarter-on-quarter, driven mostly by Permian completions, which increased by approximately 26% quarter-over-quarter. U.S. new wells drilled increased by approximately 24% over that same time period.

At quarter end, there was estimated to be approximately 205 active frac crews in the U.S., with approximately half of those operating in the Permian. The average active frac crews increased approximately 13% quarter-over-quarter, equating to 23 total new frac crews added.

Activity in the gassy regions, specifically the Haynesville and Northeast remained steady but the vast majority of activity growth for the industry and for Nine has come out of the Permian. Despite completions increasing 19% quarter-over-quarter, Nine's revenue increased by approximately 27% driven by activity improvements across service lines.

Our pricing remains depressed, so we have begun implementing net price increases in our cementing service line in the 10% to 20% range as well as minimal price increases in our coiled tubing service line in the 8% to 12% range.

We have been navigating through materials and labor inflation, some of which we are able to pass through to our customers, mostly within cementing and coiled tubing. We remain focused on strategically implementing incremental price increases where applicable without sacrificing crucial market share with key customers.

The largest challenge today is labor. It is extremely difficult to find and retain qualified field personnel, causing many of our service lines to miss revenue because of an inability to man equipment. Additionally, OFS is fighting for the same labor pool as other industries causing wage inflation that is in some cases, superceding price increases.

While the labor shortage may potentially be a catalyst for implementing price increases within our service lines moving forward, the magnitude of potential price increases will depend a great deal on the timing and pace of further rig and frac crew additions throughout the second half of the year.

We do anticipate some wage inflation to continue for the remainder of the year as OFS increases its capacity. All that said, as OFS recovers, our strategy of being an asset and labor-light company is coming to fruition. From Q1 to Q2, Nine's revenue increased by approximately 27% versus our headcount, which only increased by 6%.

And our seat is completed per employee increased from 16.8% to 19.7%. This will be an advantage for Nine as OFS continues to battle wage inflation and finding qualified labor in order to meet revenue goals. In Cementing revenue increased by approximately 19%, driven by both activity and price increases.

This service lines performed very well because of Nine service quality and technical offerings. We continue to see cement shortages across the industry, which has helped create pricing leverage as well.

Additionally, we continue to gain market share in the Haynesville basin and have already begun work for multiple large operators in this region and estimate our market share is already 15% to 20%. Coiled tubing revenue increased by approximately 32% quarter-over-quarter.

This is driven by a mix of price and activity increases in both the Permian and Haynesville. Wireline revenue increased by 46% in Q2. We have not yet implemented net price increases in the service line that have seen market share gains, specifically in the Permian, driving the majority of the quarterly growth.

Our dissolvable plug continues to perform very well. This quarter, we increased the net total number of dissolvable stinger sold by over 40%. The efficiency and ESG benefits of dissolvable plugs continue to be better understood by our customers, helping to drive adoption. During 2020, we saw significant pricing declines in the dissolvable plug market.

While we continue to bring our manufacturing cost down, the decrease in price is also helping to increase adoption as coiled tubing and other ancillary service costs increase and service quality diminishes, we believe more operators will transition from composite to dissolvable plugs as well as hybrid to full wellbore and dissolvables.

We have also seen significant increases in our composite plug sales. From Q1 to Q2, we increased the total number of composite plugs sold by approximately 42%. I am confident we have one of the best-performing downhole completion tools portfolios in the U.S. We continue to battle competitors offering very low prices for products.

We do believe quality and performance will win out, and we are holding price steady. Our R&D team is working to lower our cost of manufacturing. Company revenue for the quarter was $84.8 million. Net loss was negative $24.5 million and adjusted EBITDA was negative $0.4 million. Basic earnings per share was negative $0.81.

I would now like to turn the call over to Guy to walk through financial information for the quarter..

Thank you, Ann. As of June 30, 2021, Nine's cash and cash equivalents were $33.1 million with $52.3 million of availability under the revolving ABL credit facility, resulting in a total liquidity position of $85.4 million as of June 30, 2021.

Availability under the ABL is based on accounts receivable and inventory balances, so as we build working capital in concert with licensing revenue, the ABL borrowing base should increase. This quarter, we did not repurchase any of our bonds.

During the second quarter, revenue totaled $84.8 million with adjusted gross profit of $8.2 million, an increase of approximately 89% quarter-over-quarter. During Q2, we wrote down $2.4 million of tools inventory as we replace legacy tools and transition customers to our newest technology, and this did negatively impact adjusted EBITDA.

During the second quarter, we completed 641 cementing jobs, an increase of approximately 3% versus the first quarter. The average landed revenue per job increased by approximately 15%. Cementing revenue for the quarter was $27.3 million, an increase of approximately 19% quarter-over-quarter.

During the second quarter, we completed 4,639 wireline savings, an increase of approximately 35% versus the first quarter. The average blended revenue per stage increased by approximately 9%. Wireline revenue for the quarter was $18.6 million, an increase of approximately 46%.

In completion tools, we completed 21,826 stages, an increase of approximately 26% versus the first quarter. Completion tool revenue was $24.4 million, an increase of approximately 22%. During the second quarter, our coiled tubing days worked increased by approximately 25%. The average blended day rate for Q2 increased by approximately 5%.

Coiled tubing utilization was 36% with revenue of $14.5 million, an increase of approximately 32%. The company reported general and administrative expense of $12.2 million compared to $10.2 million in the first quarter. This increase was largely due to a legal accrual.

Depreciation and amortization expense in the first quarter was $11.5 million compared to $11.9 million in the first quarter. The company's tax provision for the second quarter of 2021 was approximately $0.1 million and $0.1 million year-to-date. The provision for the year is primarily attributable to state and non-U.S. income taxes.

During the second quarter, the company reported net cash used in operating activities of negative $19.6 million. The average DSO for the second quarter was approximately 64.3 days compared to 65 days in Q1. Total capital expenditures for Q2 were $900,000, bringing the total CapEx spend through Q2 2021 to $2.8 million.

Our 2021 full year CapEx guidance of $15 million to $20 million remains unchanged. But there is a possibility that a portion of this is deferred into 2022 and 2021 CapEx comes in below or at the bottom end of the range. For Q2, our largest cash outflows were our senior note interest payments of approximately $14 million.

CapEx and changes in net working capital. Looking forward, working capital will most likely continue to be a use of cash as revenue increases. I will now turn it back to Ann..

Thank you, Guy. Throughout the quarter, we saw moderate activity increases each month, with June being one of our strongest months from a revenue perspective since Q1 2020. As we mentioned on our last call, we do anticipate Q3 will be better than Q2 from an activity and revenue perspective.

Additionally, we will have price increases in place for some customers within our cementing and coiled tubing lines. That said, our public customers remain committed to capital discipline despite very supportive oil prices. Because of this, we anticipate only moderate activity increases for the remainder of 2021.

Activity remains very low when compared to historical levels, where we are facing an unprecedented labor shortage, which will be the main catalyst for potential price increases in our labor heavy service lines, including cementing, coil and wireline.

Similar to other downturns, as OFS begins to ramp up hiring and unstaffed equipment, we also begin to see a deterioration in service quality and safety, causing many customers to shift their focus from cost to performance, which should provide a very good opportunity for Nine from a market share and pricing perspective.

Our pricing in our tools business is steady, as is always the case for tools, we do not anticipate any price increases for this business in the near term, but are instead increasing volume while also working internally to lower manufacturing costs and increase the margin.

As part of 2021 growth CapEx, we are converting 2 of our existing wireline units to electric wireline. These units are powered by lithium-ion battery packs and can significantly reduce carbon emissions. We expect to receive these new units mid-Q3. We are very excited to pilot this new technology and provide leaner completions for our customers.

Looking into next quarter, we expect Q3 to be better sequentially than Q2, with projected revenue of $95 million to $103 million, driven mostly by activity increases as well as price increases. Today, we remain focused on continuing to gain market share across service lines with quality customers at positive gross margins.

It is very important that we are managing growth within the business as to not sacrifice service and product quality as well as safety. We believe we are well positioned to capitalize on the recovery with our asset and lever like business model. We will now open up the call to Q&A..

[Operator Instructions]. Our first question comes from the line of J.B. Lowe with Citi..

My question is just on incrementals going into 3Q. It looks like you've been about 35% incrementals on the gross margin front in 2Q.

Should we expect something similar for 3Q given the moving pieces between pricing increases and cost inflation?.

I think it's not unreasonable. Again, I imagine you're normalizing for the inventory write-down. So we're clearly not guiding it, but I don't think it's an unreasonable thought..

Okay. So I guess the corollary of that is how much of the pricing that you're pushing through, do you think it is going to be net? Is it all gross? Are you not pushing through all the pricing, all the costs of....

This is our conversation 6, 7 times a day, and the data is moving so significantly on the cost side, both for labor as well as materials. So for 2 days you think you understand what that's going to be.

And then all of a sudden, you'll get news that there's been inflation on some certain component or a piece of material that you're using and/or wages have moved where you didn't think they were going to. So my answer to you is we just -- we don't know yet.

We can suppose based on what the company has done historically and inflation we faced in the past. But this is a very, very dynamic market, and I'll tell you of the ups and downs and the contractions we've dealt with before and the expansion. This has been the toughest one from a forecasting perspective.

It's just -- it's literally like a movement in something you didn't expect every 3 days..

Got you..

The other thing I want to say is we also -- the whole country obviously is experiencing the Delta variant. So you're going to have some costs that come through from that as well. We've already got short labor in the market. We're already missing revenues prior to Delta for labor shortages.

And this is, generally speaking, an oil patch that's not jumping up for joy over the vaccine. So just factor that in as well, and it's something that should be top of mind for everybody, customers included..

Yes. Got you. Okay. My other was just on -- Guy this one might be for you. What are you guys expecting for free cash flow or cash use in the back half? And when do you think free cash flow positive is possible..

Yes. So as we discussed, working capital is going to continue to be a use of cash. So as revenue rises, you'll see accounts receivable and to a lesser degree, potentially inventories build as well. So that's going to be a drain on cash. Our CapEx, you would've seen, we spent very little CapEx in the first half of the year.

So our CapEx budget is necessarily going to be back-weighted. And we've also got a coupon payment for the bonds here in the back half of the year as well..

Our next question comes from the line of John Daniel with Daniel Energy..

Ann, I was hoping you'd elaborate a bit more on the -- just the ESG benefits of the dissolvables? And have you had a chance to measure relative emissions from that product versus the traditional drill outs. Just any color would be helpful..

Sure. Yes. So we actually did -- we conducted an independent environmental study when we took on the dissolvable plug. And what that means is it's a conversation, frankly, we're seeing infrequently in the country. But what we did is called cradle-to-grave environmental assessment.

So that means from source all the way through manufacturer, all the way through disposals, looking at the entire life cycle of the conventional plug versus the dissolvable plug. And so I'll give you the round numbers. But it's about -- if you did a conventional cleanout and you had 70 plugs, John. It's about 75,000 kilograms of carbon equivalent.

If you use that 70-plus dissolvable offering that we have, it's about 7,000 kilograms of carbon equivalent. Now if you look at a 6-well pad, you're talking about a pretty extreme difference there. So you're talking about 404 metric tons of carbon or 84 cars coming off the road.

And I think when you think about our customers, it's darn hard to get to some of their goals. And I think they're going to have to look at everything. Combustion is obviously a big concern and combustion is the service base. So wherever we can, we're trying to take the emissions from combustion out of the picture.

What really happens is the dissolvable -- you're not using the gallons of diesel on a drill out. So when you're sitting there drilling out either with your workover rig or your coiled tubing unit, all those gallons of diesel are significant. We're taking that right off the pad. We're also working on other dissolvable components.

And I won't get into details, but we're seeing not only much less use in water pumping down but frankly, tons of diesel savings. So what we're starting to do as a company is really focused on that diesel. It's measurable, it's quantifiable.

And so we're trying to set this up where we can offer our customers the choice, frankly, between some of the greener, cleaner completions or more conventional. And obviously, if you can imagine our public, customers are going to be very focused on this. Some of our privates won't.

So we've got to have offerings that reflect those various pressures on each constituent that we serve. So we're really excited about it. When we acquired Magnum in October, this is a part of our thesis and part of the industrial logic, it's just at the time nobody cared, and now people do.

So I think we're going to start to see this push the dissolvable offering. And on top of that, you know the core state so well. That pricing is going to move very considerably because it is one of the most labor-intensive and capital-intensive service lines.

So when you think about the inflationary pressures on both of those lines, we suspect -- and you think about the absolute cash constraints of this sector across the board. That service line is going to become quite expensive.

And so we think that, coupled with the pricing degradation we had in the dissolvable plug market last year is really going to further push the dissolvable offering. So we're pretty excited about that. We're also seeing our operators have a tremendous amount of trouble drilling out their plugs in low-pressure environment, out in the Permian.

And I'll just remind the market, we just introduced the dissolvable technology for the Permian in Q1 of 2020. So it's hardly had a minute to get up and run. So we're pretty excited about this 40% quarter-over-quarter pop in the dissolvable sale..

Okay. I just want to follow up on ESG, if I may. I know it's impossible to measure rate of change in terms of customer sentiment, but the ESG thing is clearly developing and ramping.

I mean can you just elaborate on in customer interest in dissolvables willing to taking the meetings versus what might have been tested in Q4, Q1? Just how fast is this uptake in interest?.

The uptake has been unbelievable. So I would say over the past 60 to 90 days, this went from something -- if you talk to my guys out in the field selling, there was never even the word emissions in the conversation, not even present. And now it seems to be part of the conversation constantly.

I was on a location up in the Northeast, everyone in the frac van is talking about it. I mean it's just -- it suddenly has appeared. And the rate of change has been, I can't quantify it for you, but it's been unbelievable.

And also, John, I'm going to tell you another thing is, I think, similar with our safety stat in the service sector, if you drop back before the service sector cared about safety, the customer started caring about it, and when we couldn't get on the well pad unless you were safe.

We see the same thing emerging with ESG metrics is that the service sector will come under pressure to demonstrate KPIs in ESG. And that will of course help Nine..

Our next question comes from the line of Waqar Syed with ATB Capital Markets..

Ann, could you provide some measure of what the mix is in terms of your sales between composite plugs and dissolvables right now?.

Well no, we actually don't give the exact mix. We certainly had strong growth quarter-over-quarter for dissolvables as well as composites. But the stinger technology is a huge piece of our dissolvable offering we've launched, as you know, a bunch of new technology last year. We're seeing a lot of great adoption.

So again, I can't quantify it for you, but I can tell you the percentage increase is very significant, especially relative to the completion that we're seeing in the market. And I would also give you a little color, Waqar, where we're seeing more customers now go to full wellbores. So we haven't seen that previously, and that's been a market change..

Ann, we're hearing about supply chain issues with -- on the cementing side, quite a bit of availability of wellsite cement. What's Nine doing with regards to securing and making sure that you've got ample supplies of cement? [Technical Difficulty].

Sorry, I think we had a technical issue there.

Can you hear us?.

Yes, we can..

Sorry, Waqar, I'm not sure where I left off. I was rambling for a while there until we realize the line was cut..

No, we were just talking about the cementing supply chain..

Yes. So I was just saying that there is -- I went all around about it, but the long -- the short answer is there's no great way to shelter the service sector from the cement shortages. The fortunate thing for us is our market share is so significant that we've got really good relationships.

I was also saying that quality of cement is really bad right now. So I was saying that some of our folks are literally qualifying it as bottom of the barrel, which means it's still with lots of little rocks and things that shouldn't be in there.

And so to me -- if I'm a customer, that makes me even more concerned about getting a cement company with excellent process and execution and QA/QC. Because as you're well aware, even a rock or 2 can throw off everything when you're trying to execute long strings. So I think it's a very real problem. I think we'll see it persist.

And I think we'll see it exacerbated in Q1 as our operators potentially put up more rigs. So I think this is a big deal. And if I'm a customer, I'm worried about it. And again, we're -- we just haven't seen it at this level before ever..

Are your suppliers trying to rectify this issue? Do you think that it gets rectified? Or is that just so focused on providing -- building cement that they don't really care about the oil and gas sector?.

Yes. I don't think they're trying to rectify it. I think they don't care. Historically, we thought about the service industry as about 5% to 7% of kind of the classes of cement globally. So we've always been a very small piece of the pie for these guys, and now we're just much smaller. Assuming, of course, during the pandemic, construction was great.

fairly the long gas industry was not. And so we're now an even smaller piece far less relevant for them. So I don't think there's really any reason for them to turn their wheels considerably right now. So again, we're watching this very, very closely. And I think we're well positioned relative to competition to handle it.

But it's -- I think the bigger concern is for the folks that are not locked in with long-term relationships this could be a very significant problem. And of course, when you have the United States operating on razor thin maintenance production, very tight guides quarterly for their production, this could become very interesting..

So Ann, we're seeing it in pumping and other segments as well, this customer focus on low emissions fleet.

Are you seeing any trends towards changing or upgrading cementing fleets towards low emissions as well?.

I mean I think the customers are very focused on having fleets that are electrified even having products and materials that are seen as possible. I think the challenge is the customer base largely doesn't recognize the cash constraints on the service side, which is, as you well know, a diesel-based service industry. So it's not that it can't be done.

It's that there is no funding to do it. So I think that's wherein lies the challenge. But I do think there's I think 2021 is probably qualified as electric is more kind of the right to play and hold market share, but that could quickly turn to electric becomes a way in which you garner incremental price just through scarcity..

Yes. And because of labor shortages, I know last cycle as well that you were refusing jobs because you were worried about service quality.

And are you close to that? And if so, what do you think the revenue impact is for growing jobs because of labor or labor not meeting your standards of quality?.

Yes, it's a great question, Waqar. We haven't quantified it for the market, but I suspect it gets worse, not better. So again, we're getting labor that, obviously, if we get it, it's very new to the market.

And so you've also, of course, most service companies have cut back all support functions, to your ability to take that labor and properly train them both from an operational execution perspective as well as the safety perspective is limited. And then you layer Delta variant on top of that very complex situation here.

So I think that it's more challenging, not less challenging. And I think this is going to be very similar to what we saw as the market ramped up in H1 '17, where our customers had been ridiculously focused on price only, and suddenly had such massive service quality issues and safety issues. They've started to revert back to quality.

So we suspect there will be a similar trend, most especially as we come into 2022 and activity picks up even incrementally. So again, I think this it's going to be an interesting time and we'll see. And hopefully, our customers start requiring back cards to get on the well site or it's going to be very challenging for service..

Yes. Just one final question, Guy.

Could you confirm that the coupon payments are due in Q4?.

Yes. There's the coupon payment that's due in Q4, yes, $14 million..

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

Thank you for your participation in the call today. We appreciate your continued support of Nine. Thank you..