NCS Multistage Holdings Inc (NCSM) 2020 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the NCS Multistage Second Quarter 2020 Earnings Conference Call. (Operator Instructions) Please be advised that today's conference is being recorded. (Operator Instructions)

I would now like to hand the conference to your speaker today, Ryan Hummer, CFO. Please go ahead, sir.

Thank you, Victor, and thank you for joining NCS Multistage's Second Quarter 2020 Conference Call. Our call today will be led by our CEO, Robert Nipper, and I will also provide comments.

Before we begin today's call, we would like to caution listeners that some of the statements that will be made on this call could be forward-looking. And to the extent that our remarks today contain information other than historical information, please note that we are relying on the safe harbor protections afforded by federal law. Such forward-looking statements may include comments regarding our future expectations for financial results and business operations and are subject to known and unknown risks and uncertainties, including with respect to the COVID-19 pandemic and its impact on the global economy, oil demand and our company. I'd like to refer you to our press release issued last night, along with other public filings made from time to time with the SEC, that outline those risks.

I also want to point out that in today's conference call, we refer to adjusted EBITDA, free cash flow and net working capital, which are non-GAAP financial measures. We use these measures because they allow us to compare performance consistently over various periods without regards to the costs associated with our capital structure and in a manner that we believe better reflects our operating performance. Our press release and the updated investor presentation posted yesterday, which are both available on our website, ncsmultistage.com, provide reconciliations of these non-GAAP financial measures to the nearest GAAP financial measure.

I'll now turn the call over to Robert.

Thank you, Ryan, and welcome to our investors, analysts and employees joining our second quarter 2020 earnings conference call. Hope that everyone listening today is healthy and safe in these challenging times.

The second quarter was by far the most challenging one that we faced. The pace and magnitude of the decline in industry activity in response to the reduction in oil demand and pricing related to the global COVID-19 pandemic was extraordinary. During the second quarter, rig counts in the U.S. and Canada reached multi-decade lows, and U.S. completions activity fell even more swiftly than the U.S. rig count. This contributed to a reduction in revenue for NCS of 84% as compared to the first quarter, which included declines of 78% and 95% for our U.S. and Canadian operations, respectively. Our performance in the U.S. in the second quarter was impacted by the waiting that we have, the activity in the Permian Basin through repeat precision, where many of our customers quickly laid down completion crews and suspended completion operations for much of the quarter. Our U.S. performance was also impacted by a reduction in our tracer diagnostics services business, especially during the periods when oil prices were at their lowest given the more discretionary nature of the service.

While starting from a low base, I'm encouraged by the rebound in completion activity from the trough experience in the middle of the second quarter. And so far, in the third quarter, we've seen an increase in demand in the U.S. for our frac plug product line as well as our tracer diagnostic services. The increase in tracer diagnostics work is also partially attributable to a new service we are offering, which provides a lower price point to our customers and reduces cost of service on our end. NCS continues to be known for this type of adaptation and innovation to drive solutions that benefit us and our customers.

In Canada, the weakness in the second quarter was far greater than the typical seasonality we experienced as a result of spring breakup. The rig count began to fall in mid-March and reached a multi-decade low of only 12 rigs in late June. Normally, we would have expected the rig count to start picking up in early June as weather conditions permit. As with the U.S., Canadian activity has increased from the trough in the second quarter, but the rebound has been muted, with 47 active rigs as of last Friday as compared to approximately 135 rigs this time last year.

International activity was a relative bright spot for us in the second quarter, with international revenue representing 30% of our total revenue, even with shutdowns in Argentina and travel restrictions in other markets negatively impacting our business. We remained active supporting our largest customer in the North Sea, and we're also able to participate in tracer diagnostics projects in Latin America and the Middle East. We made progress during the quarter in qualifying more of our products and services with customers in the Middle East, paving the way for future opportunities in those markets, consistent with our objective to continue to increase the share of our revenue generated from outside of North America. In response to the prevailing environment in our industry, we have taken swift and decisive action to lower our cost structure to align with the current and expected level of industry activity. Our earnings release from last night details these actions, though I will touch on a few.

Since late March, we made the difficult decision to reduce our workforce by over 45% in the U.S. and Canada, representing a reduction of over 190 employees. In doing so, we have better aligned our field service capability with current market activity levels and significantly reduced our SG&A expense, including changes that we believe to be structural in nature that will enhance our efficiency as industry activity recovers. We have reduced our assembly and filled facility footprint, and we'll continue to look for additional opportunities to do so. And we are continuing to reduce our third-party spending across departments, including performing additional work more cost effectively in-house. With the actions outlined above as well as other initiatives that we have executed on already, we expect that we will reduce our reported SG&A expense in 2020 by over $25 million as compared to 2019 and over $30 million if you were to exclude the approximately $6 million in severance expense that we expect to incur this year. This represents a $5 million increase to the cost reduction expectation that we provided on the last quarter's call.

We have also taken actions to further enhance our liquidity. We've reduced our CapEx budget for the year to $2.5 million at the midpoint and expect to generate additional cash through vehicle sales to further reduce our net capital expenditures. We are filing for tax refunds that we expect to receive in the second half of the year. And most importantly, we were able to amend our revolving credit facility to a borrowing base structure that we believe will provide us with enhanced financial flexibility.

We generated free cash flow of over $16 million in the quarter and over $19 million through the first 6 months of the year. This is in large part due to the impressive collections performance, especially during the second corner -- quarter. While we expect that working capital will reverse from a benefit through a use of cash in the second half of the year, we continue to expect that we'll be free cash flow positive for the full year 2020. The next several quarters will likely continue to be challenging for our industry and our company, though we believe that the second quarter represented the trough in the industry activity and that the benefits from the actions we've taken will be demonstrated as activity recovers from the trough levels.

Now I'll ask Brian to discuss our financial results in more detail.

Thank you, Robert. As reported in yesterday's earnings release, our second quarter revenues were $8.7 million, 78% lower than the prior year second quarter. On a sequential basis, revenue in the second quarter was 84% lower than revenue in the first quarter, reflecting the steep decline in completions activity in the U.S. and historically low rig count and activity level in Canada. Gross profit, defined as total revenue less total cost of sales, excluding depreciation and amortization expense, was $2.3 million in the second quarter or 27% of revenue. This compares to $16.7 million or 42% of revenue in the prior year second quarter. For a sequential comparison, our gross profit was $23.9 million or 44% of revenue in the first quarter. Our gross margin percentage was lower during the second quarter of 2020 primarily due to the sharp decrease in revenue, which led to the under absorption of fixed costs, partially offset by our cost reduction actions that we've taken throughout the year.

Selling, general and administrative costs were $15.5 million in the second quarter, and this was $7.4 million or 32% lower as compared to the $22.9 million of SG&A we had in the prior year second quarter and it's also over $5 million lower than the first quarter's level of $20.8 million. Our reported SG&A includes share-based compensation and certain nonrecurring expenses, including certain litigation costs and severance expenses. During the second quarter, our nonrecurring severance expenses totaled $3.5 million, while litigation expenses were a benefit of $0.4 million due to a $1.1 million in proceeds that we received from our D&O insurance reimbursing us for certain legal defense costs.

Our adjusted EBITDA for the second quarter was negative $7.9 million as compared to negative $1 million in the prior year second quarter. Our depreciation and amortization expense for the quarter totaled $1.1 million. And we had a net loss attributable to noncontrolling interest of $0.1 million, reflecting a modest loss at our joint venture Repeat Precision. Our average basic and diluted share counts for the quarter were both $47.3 million -- or 47.3 million shares.

Turning now to cash flow items and the balance sheet. Cash flow from operations for the second quarter was $16.5 million, and our net CapEx for the second quarter was $0.2 million, resulting in free cash flow for the quarter of $16.4 million and $19.5 million through the first 6 months of the year. At June 30, 2020, we had $31.3 million in cash and total debt of $21.4 million, which included $15 million that was drawn under our revolving credit facility. $10 million of which was in the U.S. and $5 million was drawn in Canada. On August 6, we entered into an agreement to amend our existing cash flow-based revolving credit facility into one that's governed by a borrowing base formula tied to our accounts receivable. In doing so, we eliminated certain financial covenants, including our maximum leverage and minimum interest coverage tests. The amendment also reduced the total facility size, from $75 million to $25 million, and added a new minimum liquidity covenant. In connection with the amendment, we repaid the full $15 million that we had outstanding under the facility at June 30. Following the repayment, we had approximately $12 million in consolidated cash and a borrowing base of approximately $3 million under the amended credit facility. In addition, NCS had net working capital of $48.6 million at June 30, and Repeat Precision also has access to over $9 million in borrowing capacity that is separate from our revolver. Further details with respect to the amendment are available in the 8-K that we filed yesterday.

As Robert mentioned, we expect that the second quarter represented a trough for us for revenue, and we expect third quarter total revenue to increase by at least 75% as compared to the second quarter. With increases in completions activity, especially in the Permian Basin, we expect our U.S. revenue to increase by at least 35% sequentially in the third quarter. We expect our international revenue in the third quarter to be roughly in line with the second quarter, with the remainder of the revenue increase related to our Canadian operations as activity increases from the second quarter's historically low levels. The increase in activity and the impact of additional cost reduction initiatives completed in July is expected to improve our gross margin in the third quarter relative to the second quarter, with incremental margins expected to be in excess of 40% during the third quarter. We expect our reported SG&A, inclusive of share-based compensation, nonrecurring items and severance, to be between $12.5 million and $13.5 million for the third quarter. This includes approximately $1.6 million in share-based compensation, $1 million on severance expense and approximately $0.5 million in litigation expenses. We expect our third quarter depreciation and amortization expense to be approximately $1.3 million, and our net interest expense to be approximately $0.3 million.

Our expected gross capital expenditures for the full year 2020 have been revised to $2 million to $3 million, a further reduction from our guidance in May, and at the midpoint, over 60% below our gross capital expenditures of $6.4 million in 2019.

I'll hand it over to Robert for closing remarks.

Thank you, Ryan. Before we open up the call for Q&A, I'll close with a couple of brief comments. We continue to face an uncertain environment, and we are focused on the aspects of our business that we can control. We've taken actions to structurally reduce our cost structure while preserving our ability to provide exceptional customer service and drive further innovation and value for our customers. We are being very judicious with our capital, but continue to make targeted investments to advance and enhance near and long-term opportunities for our business. We've taken steps to enhance our liquidity and preserve our strong balance sheet. Our revolver is undrawn, and we have demonstrated our ability to generate free cash flow. We are positioned to weather the currently industry downturn and to benefit from a rebound in industry activity.

With that, we'd be happy to take questions.

(Operator Instructions) And our first question will come from the line now of George O'Leary from TPH & Co.

The gross margin -- the decremental margins in the second quarter were pretty impressive given the magnitude of the revenue decline quarter-on-quarter. You guys put out that list of cost reductions that you made in the press release, which is very helpful. I wondered if you could walk through some of the primary kind of structural cost reductions on the cog side of the business? So excluding the SG&A adjustments, things like relocating the U.S. assembly operations, I assume, would be a part of that. But any color on structural cost reductions would be super helpful.

And then it seems some of those costs may come back a little bit in the third quarter. Is that part of the driver of the more-muted-than-usual incremental margins? Or is that more pricing headwinds and things like that?

Yes. So we've made a number of moves that we talked about in the press release. And you asked specifically about manufacturing. What we've done with manufacturing is we've lowered our cost because we were under-absorbed in the manufacturing facility that we had. We have a vendor that's been manufacturing components for assemblies for us for a number of years, and they were under-absorbed as well. And so we've instructed a deal with that particular vendor, where now they've taken on the assembly with some of our employees in-house there to oversee that. So we still have full control over the assembly, but -- however, what we've done is now between both of the companies, we're fully absorbed in the manufacturing facility. That move has also reduced our cost -- our internal cost because of the underabsorption. So we don't expect that to change for the next 12 to 18 months. As we look out into the future, we believe that we may start seeing some recovery to something later next year, but a full recovery may be 150 frac spreads and 4 -- mid-400s in rig count. And so what we've done is we've assumed that that's the environment that we're going to live in. And we've made these cost reductions, assuming that, that's where we're going to be.

And so as far as the costs coming back, we don't really expect that a lot of these costs will come back. We were -- in the quarter, because a lot of our fixed costs are in cost of sales, we did have these decremental margins. But because of some of the moves that we made, we were able to control that decrement.

Yes. And maybe I'll just follow-up a bit there, George. Our cost structure for the Canadian business has always been highly variable. We do have in-house field hands, but we also use a contractor model in Canada. Given the big swings on a seasonal basis, it's always been a market where we've utilized contractors, which has helped to soften the blow in the second quarter from a decremental margin perspective. But we did take additional actions in the U.S. certainly. In addition to what Robert mentioned, we have closed a couple of our field districts: 1 in Oklahoma City and 1 in Corpus Christi. So we're really consolidating our U.S. footprint as much as possible. And then we've also been working with both our vendors on the -- call it, the steel goods side as well as the contractors to make sure that our rates that we're paying are aligned with market conditions, which has also helped to preserve margins.

As far as turning forward into the commentary around incrementals, there are a couple of things there. Certainly, there has been some pricing pressure throughout the year. However, I think, that's, by and large, behind us. But I will say is that we're very focused on using our inventory as a source of cash. So we're really moving some of the goods that we have. And you may see some sales through inventory, which are slightly lower margins versus what we had seen historically as we work to harvest that source of capital and source of cash on our balance sheet.

Okay. Great. That's very helpful. And then the revenue increase on a sequential basis, and I fully appreciate that we're coming off a low base. But given the activity rebound, seasonal activity rebound in Canada, it was late to kick in. It's still an eye-popping percentage. I wonder if focusing on the U.S. in particular -- is the completions rebound you guys are seeing on the plug and the tracer side fairly balanced? Or is this more of a Permian-specific phenomenon at this point?

It's fairly balanced, but the Permian is weighted more in terms of activity. As we look forward -- well, looking back. So for repeat precision specifically, the customer mix that had declines in activity hit us especially hard in the quarter. Some of those customers are bringing -- and there customers that we had large market shares with. So some of those customers are bringing activity back on, adding additional frac spreads. So we're already seeing the benefit from that. For the tracer business, we've seen -- we went down pretty hard in the first quarter, toward the end of the quarter. But then in the second quarter, we started seeing activity increases as well. Another thing that drives those 2 products for us are those areas for us between tracers and composite plugs is the DUC activity. So we're seeing more DUC completions now, and that's helping to drive activity increases as well.

Got it. And then just one more, if I could. On the free cash flow side. You guys have done an impressive job thus far, generating free cash flow. And the guidance for full year 2020 to be free cash flow positive is helpful. I realize working capital is probably a headwind in the second half, but there will be some tax benefits employed that you guys will get in the second half, as you alluded to on the call. How do you think that -- are you targeting like a free cash flow-neutral program so that $19 million is kind of what you get for the year? Or is there a chance that you're free cash flow positive in the back half as well?

Yes. So George, I think working capital, as you said, is likely to be a little bit of a headwind, certainly in the third quarter. And we're still working our way back from the profitability level in the second quarter towards something approaching EBITDA breakeven as we get towards the latter part of the year. So I'd expect a little bit of a negative free cash flow quarter in Q3, getting back to more or less breakeven on a quarterly basis as we approach the fourth quarter. So full year will be a little bit lower than the $19 million that we're at right now.

(Operator Instructions) And our next question will come from the line of Kurt Hallead from RBC.

The questions I have, at least initially here, was you mentioned you're $21 million of debt exiting the second quarter at June 30. Given the changes in the revolver, given the change in your cash balance, can we assume that's a reduction of your cash balance is predominantly related to debt reduction?

Yes. You can assume that with the $15 million reduction to the revolver associated with the amendment that the cash balance went down one-for-one associated with that, if that's the question.

Yes. That was it. Appreciate that. The other thing that -- and Robert, you gave a good kind of overview on what's driving the revenue dynamics in the U.S. But I'm still sitting here scratching my head, not specifically with NCS, but from a number of other companies where you're looking at average rig count, average frac activity being down sequentially in third quarter relative to the second quarter, yet prospect for revenues to be improving on a quarter-on-quarter basis. Usually, if activity is going to be down on average and the exit rate on activity was lower than the entry rate, just -- I guess I'm just looking for a little bit more as to really what's driving that sequential revenue increase given the fact that average activity and exit rates are going to kind of be lower as we get into third quarter. So any additional color around that would be really helpful.

Yes. For -- just to address Canada, we haven't talked about that yet. So in Canada, we had the weather was pretty bad. Coming out of spring breakup, we had rain. We got delayed about 3 weeks -- 3 to 4 weeks in activity increases there. The rig count went down to the single digits. It was really, really tough. Now it has rebound low numbers, but it's 4x higher than it was -- 4 to 5x higher than it was at the low. And so we -- the rigs that are coming back on are rigs that we've had higher market share with. The customers that we have higher market share with.

And the same kind of dynamic in the U.S. If you look at where we've gone in frac spreads from the mid-40s to up around in the 70s, the frac spreads that came off on the way down, those were frac spreads that we had higher market shares with customers. And in both fixture diagnostics and with -- in composite plugs. And so as frac spreads are coming back on, it's customers that we have higher market share with. Just as an example, our market share for composite plugs went from the low teens, down to about 5% as we -- as activity went down. But now as those frac spreads are coming back on, the market share is actually increasing above where it was before. So it's all about the customer mix and the activity increases. So our revenue is going up at a disproportionate rate because of that.

Yes. For us, on the completion side, we really -- we saw the activity really start to move meaningfully lower in early April. So we didn't have that slope down that you might have seen when you're talking about completion spreads, we're very heavily weighted to people that went on frac holiday early, and we're talking even about production curtailments within Texas, and we're being quite vocal about it.

Got it. That's great color. Appreciate that. Maybe one follow-up here. Can you -- is on Ryan on your front? What is the liquidity covenant on the new revolver?

We need to maintain $7.5 million of liquidity. And liquidity is defined as cash on hand and the controlled accounts related to the facility as well as the unused portion of the borrowing base. The combination of the two.

Okay. Great.

And then, Kurt, one more thing I'd like to add. So another dynamic that we have for this year, we've talked about litigation expense over the last year. We've had a lot of litigation expense, and it's been on a number of different fronts. We've got intellectual property, we've -- most of the technologies that we're using today are technologies that we've developed in-house. They've been novel, and we have high market shares with them. And so there are another -- a number of companies that we believe may be offsides on our IP. So we've we made the decision to spend the money to defend our intellectual property. So we have a number of lawsuits ongoing around IP, and we've just entered into a license agreement with one of the companies that -- so we were able to settle the lawsuit there, and we're in discussions with a number of other companies. So we believe that ultimately, we end up with a revenue stream from royalties that will offset some of the market share gain -- losses that we've had over the last couple of years from some of these other companies. So we intend to continue to defend our intellectual property and defend it stringently.

(Operator Instructions) And our next question will come from the line of Chris Voie from Wells Fargo.

First, I was wondering if you can an update on the product mix in North America. If we think about frac plugs, AirLock, sleeves, Spectrum tracer. Could you give maybe some kind of percentages or a ranking of the size of those? And what you expect going forward?

Chris, that's information that we really just give out on an annual basis. That's -- obviously, given the seasonality in Canada, it tends to move a lot quarter-to-quarter.

Sure. That's fair. And then maybe thinking about the CapEx budget down $2 million to $3 million, could you help us think about how sustainable that is? Specifically, if you think about frac plus, which I think is a decent share of the mix now. That business tends to have a lot of innovation and new products on market all the time. Is that enough to keep your product lines competitive and enough innovation in the product line going forward? Or is that CapEx budget going to have to come up a little bit next year?

Well, that number is sustainable, Chris. So when we think about CapEx -- I mean, we really don't have a lot of CapEx. The majority of that CapEx is machines that we're buying for a new product line that we're starting. So that's -- ex that, we'd be spending $0.5 million kind of thing. I mean, we were buying vehicles. That was -- that's been a big part of our CapEx budget in the past. We're not buying vehicles now. In fact, we've got about 30 or 40 that we're selling right now. So it is somewhat sustainable.

Yes. Chris, I mean, we've maintained a capital-light business model intentionally really since the inception of NCS. So you can think of maintenance CapEx being $1 million or less, quite honestly. But there's obviously a distinction as far as product development between what's required for CapEx and the spending that we're doing on R&D. And we're certainly continuing to put forward very significant effort in research and development, both with our in-house engineering team as well as the relationships that we have with respect to third parties for testing that all goes into the develop -- continuous development of new products. So the spending for both sustaining engineering as well as new product development, you really see in our operating expense line and not in the capital expenditures line.

Okay. That's helpful. Maybe to squeeze one more in. You mentioned maybe the 200 frac crew or less environment going forward, potentially in Lower 48. Obviously, that's causing cost absorption issues for a lot of companies. Just curious if you can give an update on what you're seeing in Lower 48 in terms of consolidation conversations? And whether you guys would potentially be open to a merger of equals type situation, anything like that? Just an update.

Well, my belief is that there are too many service companies out there today, and I think there's a lot of people that believe that as well. There doesn't seem to be much of an appetite today to action things unless a company has a gun to their head. But it's going to have to happen. There's too many management teams, there's too many service companies, but there's a lot of service companies, I believe, that are sitting on a lot of inventory. And as they burn through that inventory, profitability is going to matter. And I think it's going to take getting that excess inventory out into the market. And once that happens, and people have to get to profitability again, I think there's a lot of companies that are going to have that proverbial gun to their head. So I think we'll see it. We just won't see it any time soon, I don't believe. But it will have to happen over time.

As far as our view on consolidation, I -- we're open to anything that makes sense. We have liquidity that will get us through the environment that -- I earlier mentioned that I thought we were going to be in for the next 12 to 18 months. We've got liquidity enough to be able to get through that kind of environment. We've got technology. We've got a growing business internationally. And so we have the wherewithal to stay. We've got a new product pipeline that's still working, albeit it's a little bit more muted pace than it has been in the past, but we do have new products that will be coming out over the next few months. So we intend to weather the storm. If there is a situation that makes sense, we're open to it, but we're not going to do something silly.

(Operator Instructions) All right. I'm not showing any questions at this time. I'd like to turn the call back over to Robert Nipper for any closing remarks.

Thank you, Victor. On behalf of our management team and the Board, we'd like to thank everyone on the call today, including our shareholders and the research analysts who cover NCS, but especially our employees and our former employees. I'm very proud of our team at NCS, which has reacted swiftly to the changing industry environment. We have made significant adjustments to our headcount and cost structure to match the current market activity level. We continue to operate safely, with 0 recordable incidents so far this year. We're providing excellent service and continue to innovate in order to add value to our customers. A large part of our organization is working remotely and has taken on additional responsibility as a result of the workforce reductions. The team has done a tremendous job in managing the myriad of challenges that come with double whammy of COVID-19 on life in general as well as the direct impact on our industry in NCS. We're only as good as our people, and I believe we have the best team in the industry. We appreciate everyone's interest in NCS Multistage, and we look forward to talking again on our next quarterly earnings call in November. Thank you.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.