Nine Energy Service Inc (NINE) 2019 Q3 法說會逐字稿

Greetings.

Welcome to Nine Energy Service 2019 Third Quarter Earnings Call.

(Operator Instructions) Please note, this conference is being recorded.

At this time, I will turn the conference over to Heather Schmidt, Vice President of Investor Relations.

Ms. Schmidt, you may now 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 2019.

With me today are Ann Fox, President and Chief Executive Officer; and Clinton Roeder, 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 a special thank you to all of the veterans for their service to the country.

Thank you for joining us today to discuss our third quarter results for 2019.

This quarter, revenue fell below management's original guidance, and adjusted EBITDA fell within the range of management's original guidance.

The revenue was below guidance due primarily to the sale of our well services division in which we lost a month of contribution and the closing down of our wireline operations in Canada, which I will speak to more later in the call.

Despite market conditions weakening throughout the quarter, we increased cash flow from operations by over 6x quarter-over-quarter, and our cash position is up significantly to $93.3 million as of September 30.

We expect our cash generation to remain strong through the remainder of the year and into 2020.

We also anticipate total CapEx to be down by over 60% in 2020.

Company revenue for the quarter was $202.3 million.

Net loss was $20.6 million, which included a loss on the sale of our Production Solutions segment of approximately $15.8 million, and adjusted EBITDA was $24.2 million.

Basic earnings per share was negative $0.70.

Adjusted net loss for the quarter was $4.7 million, or negative $0.16 per share.

ROIC for the third quarter was 4%.

The market was challenged in Q3 and worsened throughout the quarter.

Our customers remain extremely focused on staying within capital budgets, prompting many operators to scale back or slow down activities in the second half of the year to ensure they meet or come in under their budgets.

With that, many of our competitors are acting irrationally from a pricing perspective to gain market share.

This behavior, coupled with activity declines throughout every region, has led to increased pricing pressure from which no service line is immune.

The hardest-hit region remains the Northeast, where we estimate frac activities already down over 25% versus the end of Q1, which has caused increased pricing pressure and our total revenue in this region to decrease by approximately 26% from Q2 to Q3, slightly more than the 20% decline we anticipated.

As a reminder, we said on our last call that we estimated frac crews to drop from as high as approximately 55 to 60 crews at the end of Q1 to as low as 35 to 40 and potentially more following Thanksgiving.

We believe these declines are still accurate.

Our operations and sales team have done an incredible job winning new market share and managing costs to keep that region viable, and we believe the staff we have in place is rightsized to address the current operational needs of the business for the remainder of the year and into 2020.

The Northeast accounts for approximately 20% of Nine total revenue and includes both wireline and completion tools.

As we anticipated and discussed during our last call, composite plugs continue to receive pricing pressure across all regions.

Activity declines have caused revenue in total stages completed to decrease quarter-over-quarter.

Since the second quarter, we have lost approximately 20 to 25 frac crews followed across our composite plug business, the majority out of the Northeast.

For some context, you can think about every frac crew completing approximately 2.5 wells per month with each well having approximately 75 plugs.

Assuming 22 crews, this equates to approximately 4,100 plugs per month or approximately 12,300 plugs per quarter.

The bulk of these losses came from dropped frac crews by operators curtailing activity, while a few others were lost due to our unwillingness to chase price to the bottom.

While we've reduced price on our composite plugs to maintain existing market share to aid and accel the introduction of our new tools in 2020, we have made a strategic decision to not meet unreasonable pricing by some of our competitors.

Cementing remains steady with both activity and price relatively flat quarter-over-quarter despite rig count dropping by approximately 11% over that same time period.

Cementing remains one of our most defensible businesses, and we continue to innovate with new slurry designs and execute with unparalleled ontime rates of over 95% on the service execution side.

In the Permian, we were able to increase market share for the third quarter in a row.

Coiled tubing sought to meet declines in pricing pressures during the third quarter.

Increased pricing pressure comes from a combination of overall activity decline, new units coming to market and competitors looking to buy market share.

While these competitors do not often win the work, it does allow operators to put additional pressure on us to reduce price.

Additionally, we estimate that its overall activity has declined throughout 2019.

Approximately 30 to 35 new large-diameter units have come on or are coming to market, bringing a rough total of U.S. large-diameter units at year-end to 240 to 250 units.

We are not there yet, but because coil is a more highly capital-incentive business, we are watching pricing closely, and we'll stack units before we destroy capital and generate negative full cycle returns.

U.S. wireline has been hit the hardest to-date on pricing.

However, our team has done a great job maintaining overall market share in a declining activity environment.

We are working with our best and most efficient customers to increase stage volume, enabling us to better work with them on pricing.

Because of the increased efficiencies in this business and the low capital nature, there is very minimal maintenance Capex.

We do have more flexibility on pricing and are still generating positive EBITDA margin for every active region in the service line.

While the back half of the year has been challenging, we have been focused on executing our 2019 strategic initiatives, including evaluation of existing service lines and geographies that are not accretive to ROIC, adjusted EBITDA margins and cash generation as well as the development of our new dissolvable and composite plug technologies.

I will start by addressing service lines and geographies and then provide an update on our tool progression.

As part of this evaluation process, we identified 2 areas within the portfolio we wanted to address, well services in Canada.

On August 30, we completed the sale of our well services division, Brigade Energy Services, for approximately $17.4 million in cash, subject to working capital and other postclosing adjustments.

This transaction made Nine a pure-play completions company that is more asset-light while also reducing our employee base by approximately 24%.

With 107 workover rigs, some of which were over 30-plus years old, we identified a material capital commitment coming in 2020 and beyond, and we were not willing to destroy capital moving forward.

The divestiture also allows us to focus solely on our core service offerings and the successful development and commercialization of our new technology.

Simultaneously, during the third quarter, we began the process of shutting down our wireline operations in Canada.

We will maintain a completion tool footprint in this region, including a small number of employees and an office.

Over the last several years, the Canadian market has been extremely difficult with depressed activity, challenged infrastructure and an oversupply of service companies and equipment.

Despite having a great team in place at Nine, this geography was not contributing to the overall earnings and returns of the business.

Additionally, like well services, the wireline equipment was aging and would have required a significant infusion of capital to maintain current operations.

In the beginning of September, we halted all wireline operations in Canada and received a minimal revenue and EBITDA contribution for the month.

We reduced headcount from approximately 90 people to 10, and there were approximately $1.4 million of severance costs associated with the layoff, which comprises part of the restructuring charges in Q3.

None of the 14 wireline trucks in the region will be generating revenue for the company moving forward.

1 to 2 trucks could potentially be utilized for backup units or EMEA work in U.S., but the vast majority will be sold.

Today, we are working on selling these units along with the remaining ancillary equipment and inventory.

Year-to-date, Canada has generated approximately $18 million in revenue and generated $30.5 million in revenue in 2018, the majority of which has been from the wireline business.

Total net PPE for Canada as of September 30, 2019, was approximately $3.8 million, and there is approximately $1.7 million of inventory we are in the process of selling or sending to the U.S. Our restructuring the Canadian operations to be solely focused on completion tools, we have lowered the fixed cost significantly, eliminated future capital expenditures, and we'll be more resilient in the face of continued challenging market conditions.

We believe our new dissolvable and composite plugs will be marketable in Canada and can take market share, driving profitability in 2020 and beyond.

Before I turn the call over to Clinton, I will provide an update on our technology trials, which remained one of Nine's highest priority.

The first technology we will be bringing to market is the low-temperature dissolvable plug, which will address the Permian, Northeast and portions of other basins as the DJ-Niobrara with lower bottom-hole temperatures.

Originally, we anticipated field trials will be completed by mid-Q4.

Because of current market conditions and significant activity drop during Q3, especially in September, we are extending trials to ensure we have met our internal threshold of successful trials.

We are, however, still very confident that our Q1 2020 time line for commercialization remains on track.

Throughout the quarter, we have won many trials across several basins from multiple customers with unique wellbores.

The success rate of the tool has been above 90% to-date.

With any of the trials we did not deem having 100% success, we were able to very quickly identify the issue with the operator, remediate the problem and apply the changes to the next trial.

Through the trials, we have seen the foundational elements of the tool are intact, including the integrity of the new IP design and its ability to hold pressure without slipping as well as the performance of our new materials that have dissolved within the time frame required in temperatures as low as 137 degrees.

We continue to receive very positive feedback from the customers we are partnering with, and there is a strong appetite from other operators to trial the tool as we continue to produce and share positive results from our completed trials.

The second technology we will be introducing is a high-temperature dissolvable plug to address U.S. markets, like the Eagle Ford, Haynesville and the Bakken as well as international markets, including Argentina and Saudi Arabia.

This plug will utilize some of our existing high-temp materials, which are proven and have consistently performed flawlessly.

Trials for this plug will begin during the fourth quarter of this year, and we still anticipate field trials will be completed in Q1 with commercialization in Q2 of 2020.

We remain very confident in the continued performance of the materials that we've been running successfully for over 4 years in high-temperature environments and have many strong relationships with customers willing to trial the new tools.

These operators' belief in dissolvables is already very resolute due to historic run rates and our new shorter and lower-cost plug should only proliferate adoption across these regions.

Lastly, we will be introducing a new, shorter, all-composite plug that will address the entire composite plug market.

There is still a large addressable market for composite plugs that we can continue to access and gain market share.

We will be utilizing similar materials from our current Scorpion design and anticipate continued high-level performance from this product.

Field trials for the composite plug will begin in early 2020 with commercialization before the end of Q2 2020.

As we have progressed with the trials, we have grown more confident, not only in the dissolvable thesis but in the tool design and materials.

Despite reducing the size of the tool by over 70%, our team has been able to hold the highest downward pressures across the United States and provide a consistent and predictable dissolution result in some of the coldest temperatures.

As a reminder, all 3 tools will be utilizing the same IP design, which is approximately 70% shorter than our current plugs, with fewer component parts, which will streamline assembly and supply chain.

Most importantly, it will reduce our manufacturing costs, ultimately allowing us to lower the overall cost to complete for our customers.

Our customers are still finalizing budget for 2020, but today, we do anticipate overall North American E&P CapEx spend to be flat to down up to 15%.

We will not be providing any formal guidance for 2020 numbers at this time but have tried to be as specific as we can for commercialization time lines.

As we think about technology adoption and what we have seen from introducing new products in the past, we believe strongly the largest risk to the tools is not in the future adoption of dissolvables or their successful performance of our tools but rather the timing for market penetration and revenue ramp.

It is extremely difficult to pinpoint the exact time frame of large volume adoption, but we believe this will happen in 2020.

We will start to commercialize the low-temp dissolvable plug in Q1 but do not anticipate a significant revenue increase to occur in Q1 but more likely in late Q2 or Q3.

That said, I want to reiterate our strong confidence in our tool design and materials as well as the overall dissolvable thesis and the growth potential this brings to Nine.

We feel confident we've reduced manufacturing costs to a point that enables us to lower the upfront AFE for our customers to be less or net neutral to current plug and drill-out prices, while increasing returns for the operator by significantly reducing cycle times.

Ultimately, these new products will provide a significant step-change in the way our operators complete their wells, increasing their IRR through significant time savings, reducing their overall AFE and cost to complete with our lower-priced offering and the elimination of drill-out days, lowering their carbon footprints with less diesel-powered equipment at surface for the drill-out and reducing overall risk at the wellsite.

I would now like to turn the call over to Clinton to walk through segment and other detailed financial information for the quarter.

Thank you, Ann.

In our Completion Solutions segment, third quarter revenue totaled $186.3 million with adjusted gross profit of $33.6 million.

During the third quarter, we completed 1,116 cementing jobs, a decrease of approximately 3% versus the second quarter.

The average blended revenue per job increased by approximately 2%.

Cementing revenue for the quarter was $55.8 million, a decrease of approximately 2% quarter-over-quarter.

During the quarter, we received one incremental cementing unit related to our 2018 CapEx.

At this time, we anticipate receiving 5 of the 8 cementing units related to 2019 CapEx before the end of the year, which will likely begin generating revenue in 2020.

We hope to receive the remaining 3 units during H1 of 2020.

During the third quarter, we completed 11,781 wireline stages, an increase of approximately 2% versus the second quarter.

U.S. wireline stages were down quarter-over-quarter or were slightly offset by an uptick in Canadian wireline coming out of spring breakup despite little contribution during the month of September.

The average blended revenue per stage decreased by approximately 10%.

Wireline revenue for the quarter was $59.2 million, a decrease of approximately 8%.

In completion tools, we completed 20,414 stages, a decrease of approximately 38% versus the second quarter.

The majority of this decline came from our composite plug business.

Completion tool revenue was $40.2 million, a decrease of approximately 28%.

During the third quarter, our coiled tubing days worked decreased by approximately 16%.

The average blended day rate for Q3 decreased by approximately 5%.

Coiled tubing utilization during the third quarter was 49%, which does include 2 small-diameter units we have parked for the entire quarter.

Coiled tubing revenue was $31.1 million, a decrease of approximately 20%.

In our Production Solutions segment, second (sic) [third] quarter revenue totaled $16.1 million with adjusted gross profit for the third quarter of $1.9 million.

During the third quarter, well services had utilization of 66%, which increased approximately 9% quarter-over-quarter.

Total rig hours for the quarter was 34,325, and the average revenue per rig hour was $470.

As a reminder, financial and operational metrics for the Production Solutions segment are for the time period of July 1 through August 30 and do not include any contribution from September.

The company reported selling, general and administrative expense of $19.2 million compared to $21.8 million for the second quarter.

This decrease was largely due to a reduction in stock-based comp and a reduction in the retention bonus related to the Magnum acquisition.

Depreciation and amortization expense in the third quarter was $16.8 million compared to $18.5 million in the second quarter.

The company recognized income tax expense of approximately $700,000 in the third quarter of 2019 and overall income tax benefit year-to-date of approximately $1.5 million.

The discrete impact from the Production Solutions divestiture and the current year impact of valuation allowance positions, along with the state and non-U.

S. income taxes, are the primary components of our 2019 tax position.

During the third quarter, the company reported net cash provided by operating activities of $69.4 million, an increase of approximately 6x quarter-over-quarter.

The average DSO for the third quarter was approximately 57.8 days compared to 64 days in Q2.

Total capital expenditures were $10 million, of which approximately 47% was maintenance CapEx.

Full year CapEx guidance of $60 million to $70 million remains unchanged with approximately 73% spent year-to-date using the midpoint of the provided range.

As of September 30, 2019, noncash and cash equivalents were $93.3 million with $118 million of availability under the revolving ABL credit facility, resulting in a total liquidity position of $211.3 million as of September 30, 2019.

Our ABL is undrawn, but availability decreased quarter-over-quarter due to the sale of our Production Solutions business and a reduction in accounts receivable.

During Q4, we will have scheduled cash payments of approximately $39 million, which includes an interest payment of approximately $17 million, CapEx between $16 million and $17 million, and payout of Magnum's retention bonus of approximately $5 million.

We do anticipate working capital will be a source of cash during Q4.

I will now turn it back to Ann to discuss our Q4 outlook.

Thank you, Clinton.

During Q3, we began to see activity softness across all regions with the largest declines in the Northeast.

We do anticipate this continuing for the remainder of 2019, and that budget exhaustion will be exacerbated this year versus prior years due to E&P capital discipline, coupled with typical slowdowns related to weather and holidays.

With further activity declines, we will also see realizations of full quarter impact of additional pricing concessions made in Q3 across all service lines.

With what we know today through discussions with our customers, we do not anticipate further pricing declines in Q4 and into Q1 of 2020 from the September decline.

At these current prices, across service lines, we are still able to generate positive EBITDA margin, but we'll watch pricing closely to ensure we are not impeding ROIC, and we'll park units when warranted.

With the current market, we are managing costs very tightly and working closely with our operational teams to ensure we are shielding margin wherever possible without fundamentally impeding our earnings potential moving forward.

This includes headcount reductions where applicable, and since Q2, including the sales of Production Solutions and closure in Canada, our headcount is down approximately 32%.

Additionally, we are working with our vendors to reduce pricing on materials such as coil rails, gun bodies and other large-volume items.

As we gain more visibility into 2020 from our customers, we will adjust accordingly but, today, feel very confident we have rightsized the business from a headcount perspective to meet our current activity levels while maintaining the highest-quality service execution.

For Q4, we expect total revenue between $150 million and $160 million and consolidated adjusted EBITDA between $11 million and $15 million.

The revenue associated with the Production Solutions segment and the closure of our Canadian wireline business for the full quarter would have ranged from $20 million and $25 million, and the remainder of the decline comes from the full quarter impact of September pricing pressure and exacerbated activity decline due to customer budget exhaustion.

On our Q1 call, we talked about Q1 of 2019 as a good quarterly run rate forecast in 2019 and expected a flat year overall from activity and earnings perspective.

We used this assumption as the basis for our annual guidance numbers as well as the foundation for our outlook on leverage metrics into Q4 2020.

At that time, we miscalculated the inclusion of the gas market and the effects that have on our back-half numbers as well as the added activity softness and pricing pressure has taken place across North American land in the back half of this year.

Because of this, we have updated some of our previous guidance.

On the annual metric side, we anticipate cash flow from operations per share will now be between $3.25 and $3.75 for 2019 versus the original $4 to $5 per share, and we expect ROIC will be between 5% and 6% versus 7%, which does not include the loss of the Production Solutions sales.

With the acquisition of Magnum, we restructured our capital structure to have more flexibility and issued a $400 million bond and putting new ABL in place, which is currently undrawn.

Our target leverage is 1x net debt to EBITDA.

Originally, we thought we would reach to it in Q4 of 2020 using flat H1 2019 run rate as our baseline with the addition of our new technology and our lower CapEx in 2020.

Since that time, we have seen the market shift in H2 of 2019 and do anticipate North American activity will be down year-over-year in 2020.

While we still expect growth in our tools business and a significantly lower CapEx number in 2020, with the market conditions, we have had to push the 1x net debt/EBITDA time frame into 2021.

Delevering the company will remain one of our top priorities, but I do want to be very clear that we feel very good about the liquidity of the company.

We have shown, even in a down market, that we are capable of generating significant cash flow, and this will only become stronger as we shift more of our top line to completion tools.

We are already in discussions with our customers regarding our plans into 2020.

We do anticipate North American activity will be down year-over-year with the largest declines coming in the Northeast but are gaining good visibility into H1 2020.

Budgets will be set in Q1, and we do not think Q4 is a good run rate for 2020.

Our team has proven their ability to gain market share in an anemic environment, and our discussions with customers to-date show activity picking up at the beginning of the year.

Regardless of the market forces, Nine has a unique opportunity to generate EBITDA margin expansion and strong cash flow with the introduction of the new tools.

Whether the inflection point of volume for tools comes in Q2 or Q3 of 2020, we're excited about the commercialization of our new tools and the potential upside it brings to the company as well as the value it brings our customers.

Our capital-light strategic plan is playing out.

We feel very good about our liquidity position, which we expect to improve as we shift more of our EBITDA mix to completion tools while simultaneously reducing CapEx.

The biggest strategic challenge for the '19 continues to be the creation of a strong ROIC business with the ability to generate good profitability through cycle.

We will now open the call to Q&A.

(Operator Instructions) Our first question today is coming from the line of Sean Meakim with JPMorgan.

So I understand that giving 2020 guidance is difficult at this time, but let me talk about how you would flex the numbers with respect to generating cash.

I think selling well services would be helpful in terms of shedding some G&A burden, given the heavy labor content.

It sounds like there may be close to maintenance spending on CapEx.

And how confident are you in terms of free cash generation next year?

And just how do you think about the levers across the mix shift towards tools, capital spending, working capital management, (inaudible) as you walk through that a little for us.

Sure, absolutely.

So if you think about our strategic acquisition of Magnum, that was all done with a push towards making business more capital-light.

So typically, if you thought about reducing that CapEx spend by 60% or potentially more than that, you'd say, "Hey, you're spending under your annual depreciation expense.

You're really impeding the sustainability of the business going forward.

And what we would tell you is we're actually shifting the generation of those earnings.

So you should continue to see that capital spend be light in the next -- in the near term.

So that's kind of just one aspect to realize is that not that we're temporarily pulling back CapEx, but they were actually just fundamentally shifting the nature of the driver behind the earnings, which is a lot more capital-light.

So that's one thing I would say.

When you think about 2020, obviously, as we said, we expect this to be a flat to down year.

Certain E&P customers have come out with their budgets.

Others have not.

So we're saying right now, it's flat to down 15%.

That could change significantly as we come into Q1, meaning it could be a little bit better than the down to 15% -- down 15%.

So you should expect that as you think about qualifying the overall numbers, and again, you should expect to see revenue and EBITDA contribution from the tools continue to make a push over time.

If you think about the margin trajectory, Sean, think about us as starting this year with a 17% adjusted EBITDA margin.

And if you look at the midpoint of Q4, that's an 8% margin.

So when you walk that 9 points down, it's my intent to get this company to walk that 9-point stack up in 2020 by the end of the year.

So you'll see us continue to expand that EBITDA margin, which also, obviously, helps us generate good solid free cash flow.

So I would expect margin expansion and free cash flow as the story for 2020.

And then beyond that, we can start to layer in that really nice top line growth.

But again, as we said, we wouldn't anticipate the trajectory of tools to really start to impact this company until H2 2020, but that's something that we're very excited about.

We think it's a unique opportunity for this company outside of market forces.

And if I didn't answer your question, I'm happy to provide additional color.

Obviously, we'll also be providing cash flow per share metrics for 2020 when we get to that Q4 call so that you guys can build that cash flow statement, but I'm happy to take incremental questions.

Ann, I think you answered that quite well.

So definitely a good segue to talk about the dissolvable commercialization.

So 1Q '20 is still on track.

I'm just trying to think through when do you think you'll be able to provide a firmer runway for the adoption rate?

And I think your point is well taken in terms of getting to an exact point of high adoption or high-volume adoption, but maybe you could just walk through the fundamental building blocks beyond early commercialization in 2020.

Yes.

I mean I think right now in this market, it's a tense market.

The tone is tough.

It's a zero-defect mentality across any service line.

And so what really matters probably more in this market, I must say, if it was a $75 WTI market.

Its customers really want to see what's working for other customers.

And so I think there'll be -- spot market penetration will be a little more conservative, at least, what we've priced in as far as the Q2 or Q3 ramp just because of the tone in the market and customers wanting to say, hey, let me see how this guy does with a full wellbore or partial wellbore before they commit to it.

So I think that's what we've priced in as far as thinking about when that inflection point happens.

And that's a bit of a nuance given just the market right now.

And I would say, again, it's the commodity price environment and the activity and the budgets that we're seeing come out.

Those are certainly headwinds for any service line and even tools that makes it a little bit slower.

So it's again, very difficult for us to project exactly when this ramp will occur, and that's why we're asking folks on the phone to risk that somewhere between Q2 in the back half of 2020 because it's just -- it's very difficult for us to pinpoint it exactly, but our experience with tools is it's a little bit more like runners taking them -- their mark, and that can be a slow process, but the minute that gun fires, it just goes.

And that's really based on dependability and performance of those tools, and that's what we have a whole lot of confidence about our foreseeing the field trials.

Our next question is from the line of George O'Leary with Tudor, Pickering, Holt.

A piggyback on Sean's initial question, which, I agree, you answered well, but just kind of peeling back the onion on the cost side of the equation.

Maybe you talked about 900 bps of EBITDA margin that you'd like to get back next year.

I'm just curious, as you think about the primary drivers there, whether that be cost or revenues?

One, could you, kind of, frame that for us, whether it's cost or revenues that really get you back?

And then two, taking a lot of cost out of this system already with the closure of Canada, removal of 24% of your workforce with the production business, what buckets are left for you guys to do a little away out on the cost side?

And where's your -- where's the management team kind of focused at this point on the cost side of the equation?

Yes.

I mean certainly, your big meter is obviously headcount, right.

So prior to the Production Solutions sale, if you looked at our labor as a percentage of the top line, on any given quarter, you can see that fluctuates between 30% to 35%, right?

So on a run-rate basis, we probably dropped 10 points off of that, and that was obviously by design.

It's not just shedding capital-incentive businesses but shedding labor-intensive businesses.

So that's also a part of the strategy.

But to your point, 2020, the margin expansion is not driven by cutting costs inside of those financial statements.

The primary driver for margin expansion and regaining those points of margin throughout the year is the introduction of tools with a very high-margin profile.

So again, obviously, you're always tweaking costs here and there, but the primary driver is going to be from introduction of those tools.

And also, remember George, we have purposely slammed that margin on these tools right now to hold those wellbores.

So that was part of our initiative that we talked about in Q2 of holding wellbores and holding market share so that we can fill those wellbores with costs that are lower, with products that are lower cost to our customers with much nicer margin profile for the company.

So again, primary driver is from tools on the margin expansion side.

Okay.

Great.

That's helpful.

And then just -- I know you're not giving guidance for 2020, but I want to make sure I get out over my skis.

If I think of the CapEx budget for 2020, assuming the down 60-ish percent year-over-year, I mean, that $35-ish million ballpark -- $30 million, $35 million, am I thinking about that correctly?

You're too high.

It's going to be lower than that.

Our next question comes from the line of J.B. Lowe with Citi.

That's quite the CapEx cut.

That's -- it's good to hear.

I had a question on the field trials for the new low-temp plugs.

I know you guys said 90%-plus success rate, I guess is that -- I mean is that good?

What kind of success rate is needed for these tools?

This is kind of -- I know you're working with customers that have already used these things before, but did you -- do they need to see success rates above 95% getting to the high 90s?

And I guess, as you did some tweaks after the first run, what did you get that success rate up to on -- kind of the second go around?

Yes.

It's a very good question, and I'm glad you asked it.

So when you think about some of the failures we've had, it's really important to think about what type of failures those are.

So if those had been, for instance, plug slipping or showing us that the design was flawed.

Then even though the percentage of the failures may be low, we would be concerned.

In some cases, these were, frankly, operational issues that surfaced, and there were issues that literally indicated to us that it had nothing to do with the design or the materials.

It was more just a collection of human error, frankly, sometimes on our part.

So I think if you'd stripped out and normalized, you would find that we are -- we have not so far been concerned with any of those failures, but we did want to be clear that we have had them, and they've just been literally due to take human error or, for instance, sometimes not choosing the right charges, simple and, frankly, stupid things that we should have been more conscious of before running those downhole.

But what you're really looking for in these dissolvable plugs when you make a tool that short, it's very, very hard to hold the differential pressures that we see in U.S. And so these tools are rated to 10,000 PSI, and for a very short tool to be able to hold high differential pressure is really challenging.

And so we've been very pleased with seeing that and the tools' ability to hold pressure.

And then secondly, when you think about materials, we don't want the customer finding anything on the drill-out, and that can be any piece or part of that plug.

And so we've been enormously pleased with the fact that our customers are not finding anything when they go in -- go back into that well.

So those are kind of the 2 categories of issues that we're really looking at.

And the other failures are just -- frankly, just not a concern for us.

So I'm not sure if that answers your question, but of course, customers want to see 100% success all the time.

And right now, in U.S. land market, they are very focused on that.

And you have a bunch of really nervous completions engineers out there.

And so you can be very, very conscious of their context, and we certainly are.

Great.

Yes, I can imagine.

Follow-up question just on the 2 other new technology additions.

I guess, the difference between the kind of the old generation and the new generation, is it mostly just on the length of the tool.

It's not so much materials that's going into the composition?

That's right.

That's exactly the right way to think about both the high temp and the composite so that it allows us to come back into that wellbore, offer a lower price to our customer and offer much amelioration on our margins.

Okay.

So the materials have been proven.

It's just a different price point.

Got you.

Okay.

Exactly.

Then on the pricing concession that you gave in 3Q.

Can you kind of bucket those?

And I mean, either an absolute number of percentage decrease or which product lines got hit more because -- I mean, your cementing revenue held in for the quarter, was there pricing concessions on the cementing side as well?

Or did that kind of avoid it on that?

No, it was -- yes, but it was pretty flat.

So when you think about -- or at least, when I think about Q4 as it relates to Q3, 50% of that revenue guide, give or take, is due to divestitures or closing down wireline, right?

And then the remaining 50% is related to price and activity, and we actually split that out and ran those numbers.

And it's almost half-and-half.

So where the activity declines are most pronounced will be in the tools business and the coil business.

And where the pricing has been really hit hardest as of late is in the coil business.

And so that's kind of how you should think about.

I mean, I think we're really at a bottom now for wireline pricing.

The other thing, I think, is important for folks on the phone to remember is we're always also looking back at 2015 and '16 and 2014 with pricing and looking at this current-day pricing and thinking about how it relates to those years.

So if you look at current-day pricing relative to 2016 in cementing, wireline and coil, you're still well over 50% in all of their service lines than where you were in 2016.

So that's just important to remember.

'14, you're still down in most of them.

And the only reason our cement business looks like it's up in price over '14 is because we fundamentally shifted the percentage of production stream jobs that we were doing.

So we're always watching those.

So as difficult and challenging is this market itself, I have never once felt it is remotely close to where we were in 2016.

It's just anemic.

But there is activity rebound that we already know about in Q1, and we still think this business has a great ability by the end of the year to generate very nice margins, given the context of the environment as well as excellent free cash flow and fundamentally reduced percentage of CapEx as it relates to the top line.

So not a great market, but again, we can grow well positions to navigate it.

Our next question is from the line of Chase Mulvehill with Bank of America.

I guess, I wanted to come back to the 900 bps margin expansion that you expect in 2020.

And you kind of highlighted the completion tool business as the main driver there.

So maybe could you talk about kind of where margins are to-date for this business?

And kind of where they were 12 to 18 months ago and just to kind of help us frame the margin...

Sure.

Yes.

So I mean, I think we're not giving specifics, but I'll just tell you generally, when you think about completion tools, you're generally thinking about a business that's a 30% margin business, and we've taken significant points off that margin.

Significant points.

And so we're going to put those points back on, and that's -- without getting too specific, Chase, that's where we're going to see the driver of the expansion.

And again, I'll just remind you, we've slammed those margins because of composite plugs, but then incremental to that, we're also holding high-temp wellbores with dissolvables at much lower margins than we typically would have had until we can get these new products out to market.

So we're getting hit on both sides on the completion tools front.

And then obviously, you layer on the activity.

So you have a reduced ability to cover that fixed cost absorption that you need in a product line business like this.

So it's very significant degradation in the margin there that we've assumed for these tools.

It's significant.

Okay.

And if we think about the composite exposure that you have out of the total, some of these laterals, what kind of revenue exposure do you think you have out there that would be cannibalized by dissolvable plugs?

That's a great question.

I think the cannibalization, it will begin a bit in the back half, but where you'll see it be more pronounced is in kind of that next 2- to 3-year period as the adoption rate for dissolvables increases.

So next year, as we think about 2020, the primary story for us won't be the cannibalization because, remember, we'll be introducing a new composite plug, which we actually think will gain incremental share above where we are now.

And so that will complete the picture, we believe, if we do our job right.

So what we're hoping to do is claw into incremental market share in the composite plug market while we continue to claw share from other composite plug providers with dissolvables.

But again, we don't split out the revenue between composites and dissolvables that we have.

We said many times, the primary driver of the revenue right now for completion tools is certainly composite plugs.

Okay.

And if I can squeeze in one more real quick.

You have a unique perspective on lateral lengths.

So I'd be curious to kind of get your view on how much further you think that the industry can push lateral lengths?

That's a very good question.

And I think we're seeing some wellbores that are extending beyond even the longest ones that we've done.

But I think the industry is kind of finding its footing in lateral lengths.

And that's probably somewhere around the 10,000-foot mark.

And again, you'll see Northeast operators pushing beyond that.

I think sometimes we see in West Texas operators are constrained by acreage.

And so if they don't have the contiguous acreage, they're unable to push beyond those points.

But I would say it's really, for us, if you think about it as kind of a 10,000- to 12,000-, 13,000-foot lateral lengths.

And what I always remind myself is when we started building this company in 2010, a 5,000-foot lateral was like so long in the Bakken and not one of us at the table ever thought we will get to the lateral lengths we're at now.

So I just remind myself that we make these assumptions and we try to kind of cap things, but anything can change.

And as you all know, the drilling efficiencies are just unbelievable and seem to keep growing.

So I think a lot of operators are seeing a real plus to their IRRs when they go out that couple thousand extra feet.

And if the completion services industry can actually make the completion of those extra few thousand feet easy and decrease their risk popping their IRR, then you may see them go longer.

But right now, it becomes very risky, depending what the total measured depth is to get out really beyond that, and I think that is constrained a bit of the increase in lateral lengths.

The next question is from the line of Praveen Narra with Raymond James.

I guess I wanted to ask one follow-up on the trials, just quick one.

What percentage of your customer base has trialed the low temp at this point?

I think it makes just sense about the cadence, but I was just curious on how many you've seen it?

We're not giving out that percentage, but what I'll say is that we've been really pleased with the number of different customers that hold very different perspectives that have been willing to trial this tool, but we're not giving out the actual number.

And just as a reminder, our top-10 customers make up about 24% of our revenue.

Great.

I guess I was curious on the comment that we don't expect any further pricing declines in Q4 or 2020, assuming I heard that correctly.

I guess is that -- is it fair to assume then that we've seen the competitive behavior become more rational?

Or I guess, is it E&P customers that are willing to, at these prices, take on the premium service provider?

It's a good question.

What I meant specifically by that is we saw a lot of pricing degradation coming into the back half of Q3, specifically into September, but we will see that impact on a full quarter basis in Q4, but we do not anticipate further declines from that level.

And I think you even saw in EOG's call, they came out and talked about the Saturday field service pricing is not going to move anymore in order to keep sustainable OFS businesses.

And I think we're certainly seeing that, that decline has stopped, and people are no longer willing to go lower.

So we just don't anticipate further degradation here from price, but where you do see that in our margin, like I said, is you see the full quarter impact of the pricing declines that we did take.

But our teams, even in the Northeast, feel confident that we have reached the bottom here on pricing.

And that's a feeling you get when your competitors stop moving again.

And fortunately or not for the industry, I think we've found that for us, if that's helpful.

Yes.

That's very helpful.

If I can just ask one more.

I guess, you mentioned that basically Q4, you guys expect this to be the bottom.

In Q1, we see a bit of recovery.

I assume that means you guys are willing to hold onto a little bit of excess, and so this is why Q4 is not a good base, right?

Can you kind of help us quantify how much excess capacity, whether it's in personnel or just unabsorbed cost in Q4, that we should recover just when activity comes back?

I think it's -- I think, again, we'll be a lot more specific about this in 2020 numbers.

But if you looked at the midpoint of our margin at 8%, when I think about cost and what I think about we're hanging on to you, it's probably a couple hundred basis points.

(Operator Instructions) And our next question is from the line of Waqar Syed with AltaCorp.

My question, Ann, first, is on the competitive landscape for the low-temp plugs.

Are you aware of any of your competitors coming out with a similar product?

Do they have anything on field trials or anything already being marketed or sold?

That's a very good question, and no, we are not aware of anything, Waqar.

But we've often said to our investor community and the folks on the phone that we would expect the large caps to play in the space and continue to innovate.

And they are competitors who are used to having and we plan to have.

But no, there's nothing that we see in trial right now that's addressing the market the way in which we're addressing it.

Okay.

Great.

And then could you -- I may have missed this, do you have any DD&A guidance for the fourth quarter?

We've not laid that out specifically for the fourth quarter.

We haven't, but I think the way you can think about is excluding obviously the production, the changes, about $16 million for the full quarter.

Right.

And then in terms of the number of cementing units, I know you added one.

What's the total number of units as of today?

32.

32.

And so by the end of the year, you'll be at 37 and then sometimes next year on 40.

Is that -- am I thinking it correctly?

That's correct.

Okay.

Great.

Is it possible for you to provide us with the magnitude of pricing changes that you've seen over last 3 or 4 months in the different service lines?

We're not going service line by service line, Waqar, for Q4, but we can walk through some of the magnitude of the pricing that we saw from Q2 to Q3, if that would be helpful.

So the cementing was somewhat flat.

It said it was up 2%, but that was really the mix of jobs.

For wireline, you saw the average revenue per stage go down about 10%.

And for coiled tubing, we talked about the day rate down about 5%.

And again, that saw kind of that pricing pressure during the quarter, so you'll see the full impact of that in Q4.

At this time, I'll turn the floor back to Ann Fox for closing remarks.

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

Thank you.

This will conclude today's conference.

You may disconnect your lines at this time.

Thank you for your participation.