Greetings, and welcome to the Nine Energy Service Third Quarter 2021 Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Heather Schmidt.

Thank you. Heather, you may begin..

Thank you. Good morning, everyone, and welcome to the Nine Energy Service earnings conference call to discuss our results for the third quarter of 2021. 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 2021.

The quarter was slightly lower than what we anticipated with Q3 revenue of $92.9 million, coming below management's original guidance of $95 million to $103 million but still representing an increase of 9% over Q2 2021, which outpaced both frac crew additions and U.S. completed wells, which increased between 5% and 6% quarter-over-quarter.

Q3 revenue was less than anticipated due in large part to labor constraints in the Permian Basin specifically related to our wireline operations. We have spoken at great length about the labor scarcity and turnover in the oil field especially in the most active basins like the Permian.

We continue to compete with our peers for the same labor pool, driving up wages as little to no new labor is coming into the industry. Because of this, we were unable to field anticipated wireline jobs in this region starting in August and continuing through September.

By the end of the quarter, we were able to fulfill the majority of our labor needs for the Permian wireline division but anticipate labor shortages will continue to be a significant challenge for Nine across business lines and for the OFS industry more broadly. We saw nominal market activity increases throughout the quarter.

The EIA reported completed wells increasing approximately 6% quarter-over-quarter and U.S. new wells drilled increasing by approximately 14% over that same time period. At quarter end, there was estimated to be approximately 209 active frac crews in the U.S., which was down approximately 2% from the August average of 213.

The average active frac crews increased approximately 5% quarter-over-quarter, equating to approximately 11 total new frac crews added. Even with very supportive gas prices, activity in both the Haynesville and Northeast remained steady. U.S.

completions in the Northeast and Haynesville increased approximately 2% and 5%, respectively, quarter-over-quarter. We are waiting to get more visibility into how natural gas prices will impact CapEx and activity in these regions for 2022 but expect areas like the Haynesville will see supportive activity increases for next year. Despite U.S.

completions only increasing 6% quarter-over-quarter, Nine's revenue increased by approximately 9% driven by a very strong quarter in our completion tool business. Pricing across service lines remains low.

That said, we are continuing to implement incremental price increases of approximately 5% to 10% in both cementing and coiled tubing, which will go into effect in Q4. Within wireline, price increases remain very challenging mostly due to the large competitive landscape within this service line.

We anticipate completion tool pricing will remain steady into Q4 2021. The majority of current price increases are being offset by rising labor and material costs. As I mentioned at the beginning of the call, retaining, recruiting and onboarding qualified labor remains very challenging.

The industry is not attracting labor sources outside of the energy industry, which is creating a very competitive labor market and driving up wages. On top of that, our operational team is navigating COVID. Many crews are having to quarantine unexpectedly and immediately, and we are not able to fill in with excess labor.

Not only do we lose revenue but we are taking on the cost of paying wages during the quarantine period and any associated medical expenses.

All that said, if activity picks up, the labor market is so tight, we would anticipate price increases in 2022, but we do not anticipate any major activity spikes for the remainder of 2021 despite very supportive oil and natural gas prices.

Our operational team continues to execute in the field with revenue increase across service lines between 3% and 18%. In cementing, revenue increased by approximately 8% driven by activity increases of approximately 18%. The average revenue per job was down this quarter due to job and geographic mix.

But overall, we continue to increase prices in this service line. Coiled tubing revenue increased by approximately 18% quarter-over-quarter. This was driven by a mix of price and activity increases in both the Permian and Haynesville. Wireline revenue increased by approximately 3% in Q3.

As I mentioned, Northeast activity remained steady, and we were not able to field previously anticipated work in the Permian due to labor shortages. Our dissolvable plug continues to perform very well. This quarter, we increased the total number of dissolvable stingers sold by 18%, significantly outperforming U.S. completions.

Nine is uniquely positioned in having an extensive completion tool offering, which will require little to no capital commitment or additional labor to grow with the recovery. Additionally, the dissolvable plugs will provide a more environmentally friendly completion option that eliminates or reduces the need for drill-out services.

We anticipate pricing for drill-out services will continue to rise and potentially be unavailable as activity levels increase into 2022. We still expect that dissolvable plugs will become a larger percentage of overall plugs run in the U.S.

and abroad especially as our dissolvable plug continues to perform very well downhole, overall market activity increases and the labor and equipment market becomes less available and reliable. I would now like to turn the call over to Guy to walk through financial information for the quarter..

Thank you, Ann. As of September 30, 2021, Nine's cash and cash equivalents were $30 million with $55.4 million of availability under the revolving ABL credit facility, resulting in a total liquidity position of $85.4 million as of September 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 third quarter, revenue totaled $92.9 million with adjusted gross profit of $14 million, an increase of approximately 71% quarter-over-quarter.

During Q3, we did have approximately $2.4 million of one-off adjustments that positively affected adjusted EBITDA, including a sales tax refund of approximately $0.9 million as well as a workers' compensation insurance refund of approximately $1.5 million.

During the third quarter, we completed 758 cementing jobs, an increase of approximately 18% versus the second quarter. The average blended revenue per job decreased by approximately 8%. Cementing revenue for the quarter was $29.5 million, an increase of approximately 8% quarter-over-quarter.

During the third quarter, we completed 4,793 wireline stages, an increase of approximately 3% versus the second quarter. The average blended revenue per stage was flat. Wireline revenue for the quarter was $19.2 million, an increase of approximately 3%. In completion tools, we completed 21,815 stages, which was relatively flat quarter-over-quarter.

Completion tool revenue was $26.9 million, an increase of approximately 10% due mostly to a larger mix of dissolvable plugs and higher-priced tools sold this quarter. During the third quarter, our coiled tubing days worked increased by approximately 12%. The average blended day rate for Q3 increased by approximately 6%.

Coiled tubing utilization was 40% with revenue of $17.1 million, an increase of approximately 18%. The Company reported general and administrative expense of $11.1 million compared to $12.2 million for the second quarter. Depreciation and amortization expense in the third quarter was $11 million compared to $11.5 million in the second quarter.

The Company's tax provision for the third quarter of 2021 was approximately zero and $0.2 million year-to-date. The provision for the year is primarily attributable to state and non-U.S. income taxes. During the third quarter, the Company reported net cash used in operating activities of negative $1.8 million.

The average DSO for the third quarter was approximately 58 days compared to 64.3 days in Q2 and 65.4 days year-to-date through September 30. Total capital expenditures for Q3 were $2.1 million, bringing the total CapEx spent through Q3 2021 to $4.9 million.

CapEx guidance remains unchanged at $15 million to $20 million but could come in below or at the bottom of the range if we are unable to take delivery of equipment this year, which we are unable to predict.

Looking ahead to Q4, our largest outflows of cash will include our senior notes interest payment of approximately $14 million, our remaining 2021 CapEx and any changes in net working capital. At the end of Q3, the ABL was undrawn. Subsequent to September 30, we have drawn approximately $10 million on our ABL credit facility.

As a reminder, as revenue increases, so too will our accounts receivable and inventory, which will increase availability of the ABL. I will now turn it back to Ann..

Thank you, Guy. During Q3, we saw only moderate activity increases and do not anticipate significant activity increases going into Q4. Operators are still focused on coming within or below their original 2021 CapEx budget, which means we will have some typical Q4 seasonality.

However, we do not anticipate it will be as severe as we have seen in prior years. As I mentioned, we have implemented minor price increases during the quarter in cementing and coiled tubing, but wages and material costs are arising simultaneously, which is leading to little or no net price increases for the remainder of 2021.

We are all very focused on 2022 and have begun bidding on work across all of our service lines. We are waiting for our customers to provide formalized plans to get a better understanding of activity levels. But with what we know today, we do anticipate North American CapEx increasing meaningfully year-over-year.

But it is too early to provide formalized guidance on where we see the market going. We do believe supply chain constraints, especially labor, will become more severe, not lessened, into 2022. Like our peers, we have conserved cash and delayed CapEx when possible, and capital will be needed to get equipment back to work.

Additionally, I do not see any near-term solution for the labor shortages we are facing. Putting more activity on a very fragile OFS industry will lead to an inability to hire and find crews as well as underperformance at the well site.

This will likely provide pricing leverage back to the service providers, which could allow the industry to drive net price increases. Commodity prices are extremely supportive today and look to remain supportive into next year as OPEC and U.S. operators remain disciplined.

Basins like the Permian and Haynesville will continue to be significant growth drivers for the industry and Nine. Looking into next quarter, we expect Q4 to be flat to slightly up sequentially versus Q3 with projected revenue of $92 million to $100 million. We remain optimistic looking into 2022.

At Nine, we remain focused on continuing to gain market share and net price increase across service lines through our technology and well site execution. Our completion tool business will be critical as labor and equipment continue to be a bottleneck.

We are well positioned with balanced exposure across basins and commodities, which will allow us to capitalize on activity increases across North America and abroad. We will now open up the call to Q&A..

[Operator Instructions] Our first question comes from Waqar Syed with ATB Capital Markets..

Guy, the severance costs of around $375,000, how were they allocated between G&A and OpEx in the quarter?.

Waqar, it would be mostly in OpEx, but I can come back to you off-line with a better breakdown of that..

No, that's okay as long as it's mostly from the OpEx line. That's good to know. Okay. And then -- and in terms of revenues, you mentioned that it could be flat to up.

Is the same true for EBITDA as well for Q4?.

Yes. Waqar, we're not guiding adjusted EBITDA. We did provide a range of $92 million to $100 million. And I'd also remind you, we had about $2.4 million of what we view as nonrecurring items that affected adjusted EBITDA.

So as you think about incrementals, I mean you can make your assumptions there, consider adjusting those one-off items and just reflect the revenue guidance or whatever revenue forecast you have..

I would also add to that, Waqar, that we are moving entry-level labor costs, so that moves kind of what I'll call up the stack. So this poaching that's going on in the oil field is creating real traction in wage increases.

And we are not seeing corresponding levels of price increase to get -- again, to get net price that would ultimately impact our margin to the positive. That doesn't mean we don't think we get that in 2022. But as it relates specifically to Q4, I do think that will impact the margin..

Sure.

And typically, what kind of delay do you see in passing on costs to the customers? Is it like a quarter delay typically or in months? Or how do you -- how would you quantify that?.

No, it's not a quarter. It shouldn't be a quarter, but it could be 30 to 45 days. So when the field folks sense an issue or a problem with wage rates in the field, as you know, they're going to move instantly. So that would be a day one activity. And by the time they can push net price through, that could be a 30- to 45-day lag.

So again, these are going to be drags on OFS margin as we all move to retain our labor force that we have into 2022 because as you know, Q1 will be very important, obviously as well the remaining quarters of 2022. So again, it's a very dynamic environment.

If you had asked me eight weeks ago if I saw this type of inflation on the wage line in this manner, I would say no. So it's a -- I would say that there's so many variables that the leaders of these businesses are trying to anticipate but absolutely cannot predict accurately.

And I would say at the moment, for 2021, without the increased CapEx spending, without the increased rig count, that is going to put downward pressure on OFS margins for 2021..

Yes. Okay. And then -- and so there's still some time, but like 2023 is -- people are focused on that, and you've got some debt payments coming due.

What's the -- have you started having discussions with the lenders? And what's going to be the strategy over the next maybe six to eight months?.

Yes. Well, I'm going to let Guy take the back half of this conversation. I would say that right now, we see a very supportive outlook for '22, perhaps an even more supportive outlook for '23. So this is truly a nice tide turn.

And I would also just remind the market that this is a business that did somewhere around $10 million of the EBITDA in '16, somewhere around $140 million in 2018. So the operating leverage and the ability to spring is proven. It's not a guess. And we are certainly a far better business today than when we became public.

So you've got close to over 30% of your top line driven by completion tools. It wasn't near that in '17. It might have been 3%. So very differently positioned business, far more capital-light, far more labor-light and obviously far greener because we don't have the standard capital intensity. So I think we're very excited about the macro backdrop.

We've clearly moved our stage count and market share from that pre-IPO time of maybe 5% to 7% of the stages in the U.S. market to up over 20% of the U.S. market. That's a very significant market share. You can't see it in our financials right now because OFS pricing is so depressed.

But if we do see an inflection point in that OFS pricing, it will be significant for our financials. So I think I personally am more optimistic for the outlook of the business than I have been in over two years and for New England where it's tough to be optimistic. So -- but with that, I'll pass on to Guy..

Yes. Thanks, Ann. I think, Waqar, just to add to that, we've got a healthy amount of liquidity. We do have interest payments semiannually, as you know. But we think the Company continues to operate as a going concern, and we don't have any concerns in that respect. So we'll continue to run the business. There's a lot to look forward to in 2022.

And obviously, to the extent that capital markets are supportive, then -- and there's something to be done, then we'll certainly look to refinance our capital structure. That's something we're focused on. We just need to see where this -- what the market has in store for us in 2020, but we're very focused on maximizing our earnings potential there..

Yes. I would also just add one other driver here, Waqar. We've been talking about dissolvable plugs for a long time. When we transacted with Magnum in October '18, we forecasted for the market that we saw that North American land stages would be 35% to 50% dissolvable stages in three to five years.

And if you look at 2023, I don't think we're going to be far off that forecast as it relates to percentage of dissolvables. So we're feeling extremely encouraged about that. Clearly, this ESG initiative is a major, major push.

If we do see a price for carbon per metric ton, we've also obviously proven that we reduce the metric tons on each well significantly with the dissolvable plugs. So again, we've, on top of that, we have close to 60% stage efficiency per employee since 2018. So again, much more labor-light, not just capital-light.

So again, very, very encouraged if the macro backdrop is there..

And you make an important point in terms of when you compare to history, you said the completion tools business is going to be a bigger piece of the business now than before.

Could you maybe highlight for everybody, just remind us again, why is that important? Is it because you think the margins in completion tools are significantly better than some of the other businesses? So why do you highlight that as a key point?.

Yes. So I highlight that as a key point because in the OFS industry, when you hit a recovery point and if we hit a recovery point in '22, you typically find businesses constrained because they have to put so much CapEx, so much capital in to drive the revenue and to drive the EBITDA.

So when we became public, one of our strategies was to be more capital-light. And in completion tools, your CapEx is pickup trucks, right, and a tin roof line. The expense is the R&D.

We have a very, very nimble and flexible and low-cost R&D program here, and we're still able to be on the leading edge, not only in frac plugs but also other tools that we're working on in niche markets both in the U.S., Argentina and the Middle East.

So again, I think you're looking at less than -- the labor is less than half, well less than half on a percentage basis of the revenue. So it's a critically important service line, very cash generative. When you look at $100 of EBITDA in the completion tool business, the great majority of that flows right down to your net cash increase.

So you just don't have the deductions coming out of that, that you have for your other capital-intensive businesses. The other thing is, again, just that you think about the crews for frac, for cementing, for wireline, for coil, that's tough. That's a really tough piece of the business. So we're extremely excited.

We've got a product line we launched in the teeth of COVID that has, frankly, taken off, which is a real tribute not just to the R&D team but also to the sales and operational team. And I think, honestly, we've got one of the best operational teams for completion tools.

So sometimes you see people trying to throw products -- just be a product company and throw a product at the customer. These wells are still very unique, very bespoke wells. And they really do need tailored applications, and that's what this team does. So I really believe we're top three completion tools in the market.

Again, we've just gone through an epic downturn, so you don't see that in our financials. And the market share gains this company has made is just tremendous. And that will show up if the stage count and rig count goes up..

Our next question comes from John Daniel with Daniel Energy Partners..

Ann, first of all, congratulations on the Semper Fidelis Award. Very cool..

Oh, thank you, John..

Question, first, just kind of big picture because I'm not that smart. When you look at the traction you're getting on the dissolvable plugs, right now, is it leaning more towards sort of large-cap folks versus smaller players? I'm just curious who tends to be the early adopters..

Well, I actually think the beauty here is that we're seeing adopters from both super majors all the way down to small privates. And what we're really starting to see now, John, is increased share inside the wellbore.

So for instance, where we really started seeing these used at the toe to really derisk the toe and the drill out in the toe of these long laterals, we're starting to see those dissolvables really come up the well.

And as crushing and as punishing as COVID was, it forced our teams to reduce the price of that dissolvable, narrowing the gap between a dissolvable and a composite. And what that did is it gives the completion engineer a chance to have an equal AFE and yet they have much less emissions and a much smoother go of it.

And I think some of these operators, as you well know, they've got very tight production guidance, right? They're spending very little capital, and they've got to answer to The Street each quarter on their production.

So if for some reason, coil can't show up because the capital is not there or the labor is not there and you can't get those wells online, I mean that's catastrophic, most especially considering this commodity price environment. So those operators that are choosing to use dissolvables really derisk that next year..

And once someone tests the technology and sees it at work -- and this is going to be a stupid question, you guys are going to laugh off-line.

But like what's the time line and the process and then the likelihood that someone just starts saying, "We are absolutely standardizing on this," and then you see a step change in your business?.

I'm just -- my folks would have a much better answer, but if I had to give you an average, I would say somewhere between three to six months..

Okay. Got it. Turning to the labor market....

I mean -- and that, John, is over a period of, again, terrible degradation in rig count and completion activity.

So what does that look like in a hot market? Obviously, the time line gets compressed significantly, right?.

Okay. It just seems logical to me, like if it works, you just standardize on it, but again, I'm a simpleton. Labor markets, you touched on the Permian being awful.

What degree of awful are the other markets for you right now?.

I mean the Bakken is terrible, right? So I think operators up there really -- they're going to struggle a lot. And we saw this, remember, in 2012 when the rig count was out of control in the Bakken. Folks couldn't even get their wells fracked.

So they went to sliding sleeves not because it yielded better production or better well results but because they couldn't get their wells fracked. So they did the ball drop [sleeve shifting], right? And that's actually why we knew it wasn't going be extrapolated across the U.S. because it didn't yield better production.

So the Bakken is just a nightmare. And that's just because people don't live there. So you're having to import labor into that state, and no one is doing that. The Permian is just a poaching nightmare. It's just going to keep going. So I would say we hire -- and I think I've said this before, but we're hiring three employees for one. So that's not fun.

And if some of this infrastructure bill gets passed, that's the same call on labor that the oil field service industry needs. So that's going to cook this even more..

Okay. Sounds like fun. The last one for me kind of....

Yes. I mean I think also every leader is just -- I mean we're going to be tremendously worried about safety out there because we've all stretched our teams so hard, right? Where we should have four, we have three. And we and the operators will start to see that show up in their safety records..

That's right. Okay. Sorry, one more here. Sorry to hog on the phone. You recently announced the success of running the electric wireline unit up in the Northeast. I'm curious, what's the -- we always hear about electric frac and emission-friendly equipment there.

Just what's the call on interest from customers on the wireline technology? And that's it for me..

Yes. I would say when we first placed the capital, we took it in and out of the budget many times. Do we need this? Is it relevant. By the time the units were delivered and we had them, we knew we had to have them. So I would say that's been extremely dynamic where the call is strong for electric.

And if you can green the whole pad, people are very keen on that. So again, as you well know, combustion might make up 30% of an operator's emissions. And the only way to reduce that carbon is for us to actually take that diesel out. And we're collecting data on this, John.

But like our wireline trucks that we've refurbed, we might use 10% of the diesel that we typically use. So again, that's still a data collection. But regardless, it looks to me it's going to be significantly less. So our approach to ESG is just beginning at Nine, but it will absolutely be practical.

And when I say that, I mean it's got to be profitable for us and better for the environment. And where we can find those solutions like electric wireline that are both profitable for us and cleaner, we'll do that all day long..

All right, that's all I have. Thank you for taking the question..

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

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation..