Nine Energy Service, Inc. (NINEQ) Earnings Call Transcript & Summary

Hi. I'm Sean Meakim, the oil field services and equipment analyst at JPMorgan. Thanks for joining us for our fifth annual JPMorgan energy conference, first one in a digital world. So with me, I have Ann Fox, CEO of Nine Energy services. Ann, welcome.

Thank you, Sean.

Nine is primarily exposed to completions activity in U.S. shale but through services that are characterized by lower capital intensity, particularly compared to pressure pumping. The company was originally formed in 2013 as a portfolio company for private equity firm SCF Partners and subsequently grew as an M&A roll-up before IPO-ing 2 years ago. Ann has served as CEO since 2015 and served as CFO prior to that since the inception of Nine. Ann, as always, great to see you. I'll turn it over to you, and then I'll come back on for some questions a bit later.

Okay. It's very nice to see you too, Sean. So this is obviously a bit of a different environment. Good afternoon, everyone. I'm still really pleased to be here speaking to you, although I would certainly prefer it be in person. I'm going to start today on Slide 4, and I will try to remember to call out the slides as some of you are moving through the presentation on your own computers. So again, starting on Slide 4, just a bit of a company overview. A lot of you are familiar with Nine, but for those of you that aren't, we're a primarily North American land business. We are almost 100% in the completion phase of the well. And we started -- and I'll talk more about the strategy that we pivoted to in 2018, but we are really focused on trying to build a full-cycle ROIC business. I recognize in this environment right now it's really tough to talk about returns on anything, but as Sean mentioned, we would like to be relatively more asset light and actually more OpEx light. So CapEx light, people light and trying to build service lines that have stronger barriers to entry is our goal. You can see on the bottom right-hand side the diversification in service lines. So if you look at completion tools, that's typically a service line where you're going to find patents, lots of moats, lots of barriers to entry and almost no CapEx. So the cash conversion there on an EBITDA basis is almost dollar for dollar. So high-margin business and very high-quality EBITDA dollar. On the cementing side, it is relatively more capital intensive, but we love the technical barriers to entry of the laboratory facilities. We feel like we compete with the biggest and most formidable service companies, and we are probably in a group of 5 to maximum 10 companies that really own the production string cementing business in the United States. If you move around that sphere, you'll see the coiled tubing business. If you look at this business in the future and the team gets to where we want to be, you'll see a greater percentage of this pie will be completion tools, and a smaller percentage will be coiled tubing. We have not deployed growth capital in this area, as you have seen. And one of the reasons why is because we believe so heavily in dissolvable plugs, which I'll talk about in great detail later in the presentation. So again, we feel coiled tubing is capital intensive. And those technical barriers to entry around it are in the deep-reach lateral when you're milling out plugs at 10,000 feet of depth. Wireline is a business that doesn't have strong technical barriers to entry but is very capital light, not much maintenance CapEx at all required to keep this business going. And you're really competing in wireline on service execution. So quite difficult, but we love that because though all -- very saturated with wireline trucks in the U.S., it does feel to us that there aren't many wireline companies that can execute consistently. And that allows us to select into the larger and -- operators that are doing really complex wellbores. On the left-hand side, just for your reference, we have our 2018 numbers in there as well as 2019 actuals. You can see the margin degradation from '18 to '19, as the oil field service industry started to take pricing degradation in H2 '19. So obviously a very different world, and I often remind myself that nobody predicted COVID-19 nor Saudi's behavior. And so again it's just a reminder of how volatile the industry is and one of the reasons why we're trying to build a service company that has more sustainability and better mitigates risk. So I'm now moving on to Slide 5. We have cut down the company very significantly. We have a very high variable costs business, but one of the things that we are hoping not to cut is our footprint. We did not do it in the last downturn. We don't anticipate doing it here. We love to be spread out across these basins, both because different basins have, at times, different regulatory hurdles or infrastructure hurdles that other basins don't. We also have really nice cut in our diversity as it relates to both gas and oil, and we like that as well. I'll just remind you all, if I was speaking to you in January, talking about being hopeful about green shoots in the gas market, you would have thought I was crazy. And now of course, we're looking to the Marcellus and Utica as areas of good exposure for the company. So again a reminder that, in a 90-day period, the perspectives and views can change drastically, which is one of the reasons we love this diversity. So again, this lends to sustainability. It also really helps us distribute tools. We learn a lot from deploying tools across multiple different formations. They behave differently in different rocks. Operators have teams that are also have very different perspectives in different areas, so this really helps inform our R&D process for that very important service line of completion tools. Moving on to Slide 6. This really demonstrates the asset-light model that Sean was referencing relative to pressure pumping. So depicted here on the slide, in the blue circle, is our wireline truck. And then the red is a frac spread on completing a well. So again, when you think about the capital requirements, forget about the OpEx requirements and the labor needed, but when you think about the capital requirements, they're significantly different. We are sitting at surface with that wireline truck, and we're levered to the stage count and the lateral length underneath the earth there with our tools. So I'll also remind you that completion tools are stage count-driven to their volume-based product, and they, too, do not require CapEx. So again, in 2018, we did 2 technology acquisitions, 1 out of Norway and 1 out of the U.S., really looking to expand our completion tool portfolio and go after the dissolvable plug market, which I'll talk about in a little bit. But this is again a demonstration of our pivot to be more asset light and people light. The other thing that this does is it helps the management team have to make less long-term capital allocation choices. And I don't think it matters where you went to school or how many numbers you can calculate. The world is a very murky place. We have all been proven wrong so many times. So the less amount of times you have to allocate capital in this business, the better. And that's part of the strategy as well. I'm moving on to Slide 7. So if you look at the top bar graph here. In 2016, you will see 8%. That reflects 8% of the North American stage count that Nine wireline or tools completed at the time. If you fast forward to our latest reported numbers in Q1 of 2020, we touched 18% of the stages in North America. So if you think about kind of a 10-point gain, you often hear people say, don't waste a good downturn. I think this company has really proven not only that it can survive these things, but it can also come out and really thrive. So we certainly would hope to gain market share coming out of this downturn as competition really takes a knee. We also hope to see some consolidation on the E&P side so that we can continue to see larger acreage holders because they're doing more complex wells. They've got balance sheets that support a good, continued piece of completions activity. And they're really also usually very innovative in thinking about how to do things better and cheaper and faster. On the bottom of this graph, you can see our cementing business based on percentage of rigs followed. And you can see, at the end of Q1 2020, we had about 16% of share in West Texas as well as in South Texas. And so again, really nice pickup in West Texas since 2014. So I'm going to move on to talk about dissolvable plugs and really what we call the Plug Revolution, and I'm going to move to Slide 9. On the left-hand side, we start in kind of the year 2000 and we bring you kind of across a couple of decades, up to the present time. And if you look back at the time, we were really using what we called cast iron slips plugs. Those were some of the first plugs in the market. And if you look at that far left-hand side of the page, you can see that, that plug was about 28 inches in length. And this is, of course, not covering every plug on the market. It's just to give you an idea of what has changed. And those slips are really the bands that you see there, and they're iron because we didn't -- at that time we didn't have another material we felt could actually bite into the casing and hold the pressure of the frac. So imagine this as kind of like a cork in a wellbore. And when the frackers come, they're pushing fluid against it, and its job is to hold back that fluid and not allow any bypass. So it's a bit of a trick to not have it move down the wellbore and to properly isolate that frac. And at the time, again, we used cast iron. It was very effective in isolating. It did a really good job. The challenge was, when you went to drill out cast iron, it's extremely challenging to do so. And it takes a long time to do that. So on average, you were looking at 15 to 25 minutes per plug to drill that out. And when you're dealing with wellbores of over 100 stages, that's quite a bit of time. And not only that, the risk of getting caught or stuck while drilling out those cast iron plugs is significant. So then you started to move into the composite plug revolution. When the technology was first introduced in the oil field service industry, we had a lot of plugs slipping. We had a lot of composite slips that just wouldn't hold the pressure against the frac. So we acquired our plug -- our composite plug technology in August of 2015. The reason I bring that up is just because I expect the '19 to play offense and defense. We are certainly, I think, good at both. And that's an example of smack in the middle of a downturn, finding a really unique technology that made a very big difference for us. We estimate that about 90% of the stage count today in the United States is still composite plugs, so they still play a very large role. They're much lighter and they drill up much more easily. So again, you move from kind of 15 to 25 minutes on a drill out to 10 to 15 minutes, depending on which plug you are using. We then started to see dissolvables enter the market. They first went into formations with what I'll call hot rocks because things naturally like to dissolve at high temperatures. And they also got shorter, so they started to look more like a 12-inch plug. And this plug here is the Magnum Vanishing Plug, which is the company that we acquired -- one of the companies we acquired in October of 2018, that really launched us into the dissolvable market. So as much as we love the composite plug and it still plays a big role, we could see the market moving. And we knew that we needed to be into the dissolvable plug market because we could see our operators. We're constantly trying to take whole pieces out of the completion process so it can become more predictable and faster and cheaper. Then you see us move into what we call the all-temp dissolvable world. So Nine does not believe that we had a dissolvable plug that was appropriate for cold rocks prior to this year; and our introduction of our low-temperature dissolvable plug, which is really well suited in the U.S. for the Permian basin in the Northeast markets. You can see here it's only 5.5 inches long. And really when you see this plug in person, it's remarkable because it's really not even much bigger than a hand and, when it's set, even smaller. So if you think that, that can hold 10,000 pounds of pressure per square inch is really remarkable. And that's really the engineering feat, is when you make a tool smaller, it's much, much harder to get it to hold pressure. Then you add the material science of dissolving material; and not only is it expected to deal with erosion from sand and pressure, but it also then has to dissolve to the needs and desires of the customer. So what makes our plugs so great is that we're seeing excellent isolation, ability to hold back a frac and incredible dissolution results, some of which I'll show you in just a minute. The last point I want to make on this slide, which is really important, is the size of the plug matters significantly on 2 fronts. It changes the drill-out time, which means the operator can complete and bring their well on faster. But for the service company, it fundamentally reduces the costs to manufacture. When we reduce our costs to manufacture, we can begin to offer a dissolvable plug at a much lower price, much closer to a composite plug, and therein lies a game changer as far as getting adoption because, the closer you can be to the alternative, the harder it is to justify not using dissolvable plugs. So now I'm going to just quickly go over Slide 10. Because of that size change, we now feel like we can be neutral on the upfront AFE or the actual costs of the ticket, or in some cases we can reduce the costs of the ticket because we're taking out that coil drill-out on the back end. The IRR should go up just because of the time savings on the wellbore, which I'll go over in just a minute. I'll also walk you through the emissions reductions as a result of using dissolvables, and that's really primarily due to not using so much diesel on the drill-out. Increased safety is a big deal. So prior to COVID-19, we would think about that literally as just well site injury. Now that we've seen the unbelievable and good and rigorous process that our customers are taking to keep our employees safe, less of them consolidated together at surface is a really good thing. And so that's another real benefit of dissolvables. Moving to Page 11. We've just depicted what a regular completion life cycle can look like, and this can obviously vary. So you'll see some variation on the days, but if you start at the top, you can see that drilling and cementing of the wellbore 7 to 14 days. Then your wireline and frac are on there, another 7 to 14 days. And then when you come in with that coiled tubing or stick pipe to drill those plugs out, and I'm talking about legacy composite plugs, you're sitting there anywhere from 4 to 10 days. Obviously, that doesn't account for problems if you got stuck. And so you can see, on average, with traditional composite plugs, you're anywhere from 18 to 38 days on that wellbore. If you move to the bottom of the page. Your whole life cycle is anywhere from 14 to 31 days. So kind of at the worst, a 20% time efficiency; and at the best, a little over 60%. So really, really significant time savings. And again, that just helps lend to predictability of completion time as well because you're just not risking getting stuck down hole with coiled tubing or stick pipe. So let's move to Slide 12 and look at the United States and Canada. We've colored the areas, orange, that are high temp. And as I said earlier, the high temp market was addressed previously with dissolvables. The challenge with it is the dissolvables were expensive. So you didn't see the uptake in those markets that you would have because there was such a premium to put a dissolvable down hole versus a composite. We've now changed that. The low-temp area is highlighted in blue. And you can see those are also the areas where we would expect, hopefully, significant growth in the future in the U.S. So we're very excited about the results we have seen from our low-temp tool, both on the dissolution as well as the ability to hold and isolate the frac. So that gives you an idea of where these dissolvables go. If you look at Slide 13, you can see internationally really the Vaca Muerta in Argentina. And as well, Saudi Arabia is a nice, really hot formation as well. So again, 2 international markets that are very interesting for dissolvables. And it's been really interesting to see Saudi Aramco play around with these dissolvables. So on Slide 14, again just a quick review of the new Stinger dissolvable. Just as a reminder again, 70% decrease in size. So that big barrier to entry for dissolvables, which was priced a price tag, we've really eliminated that for the operator. We have really good, predictable dissolution. That was the other barrier; is previously in the market you had operators buying these plugs, paying a premium, and they weren't dissolving. We really think we've eliminated that issue. So again, a reminder that one stage equals one plug. So it's a volume tool, stage count driven. And also a reminder that there's really very minimal CapEx that comes out of the EBITDA generated from this service line and very well protected of patents and IP. So on Slide 15, this is just a quick look. I'm going to show you 2 slides, 1 that case -- that shows a little case study in the Permian, the other in the Northeast. Again, this was a case where we ran 123 of these dissolvable plugs in 3 full wellbores. All of them achieved great zonal isolation. They all degraded, so the operator came back in and concluded that this is -- these products were some of the best results they've experienced yet with dissolvable plugs. And these were still very low temperatures between 100 to 150 degrees. So this was an excellent result for us, and this is going to be a great customer for us. On Slide 16. This is just really remarkable to me because this is at room temperature. So 75 degrees. That's really tough to get things to dissolve at 75 degrees. And this is where the material science at Nine comes in, where we've really mixed and matched lots of different materials. And we've really gained a lot of insight into their interaction as well as what is their interaction with the various fluids that our customers are using, whether it's freshwater, chlorides or produced water. So again, this was a really great opportunity for us to see this in a very challenging low-temp environment. We ran 10 of these. And the picture on the right is amazing because I have a dime picture there, and that little picture on the bottom, that was the combination of all 10 of those plugs. That's what came back to surface. So again you can really see for the operator that, once the price point is right, it -- you just kind of scratch your head and say, "Why wouldn't you run dissolvables?" Which is I think why we're gaining traction even in this really black market that we're in right now. On the next slide, 17, here's another benefit of these plugs. On a 6-well pad, we can take -- on an annual basis, we can take 84 cars off the road. So that's just really significant, especially as our industry comes under pressure to get rid of carbon equivalents, CO2 equivalents. So this is just another benefit of using less diesel. And on the next slide, Slide 18, it just shows that the carbon footprint goes down by about 91% if you run dissolvables without a cleanout run. And the next slide is Slide 19. If you do, do a cleanout run, where you're kind of jetting out that hard-packed sand afterwards, you could still reduce that carbon footprint by 18%. So again really nice, positive environmental impact of using the dissolvable plugs. So I'm just going to quickly move through these financial slides so we can have some time for questions. I'm moving on to Slide 21. I'm not sure folks care much about what we did on an actual basis in Q1, but I would really highlight on this slide that very sizable cash balance of a hair over $90 million, which was really a significant amount of cash for us to have. And we feel very comfortable with our liquidity profile. So again, I'll let you ponder through the rest of this on your own, but that's the one point I would really like to highlight, as I think we're in a pretty decent liquidity position, which on Slide 22, you can see our total net debt there is $288.9 million. I will also remind you that in total, we've publicly announced that we've bought back roughly $30 million of our debt at $0.25. So we're always managing what is the liquidity profile we want. Where do we want to deploy our cash? What are good opportunities for us? So both again offense, defense at play here. So -- and our total liquidity profile as of March 31 was $183.6 million. So Sean, that really concludes my remarks. And again, I'm trying to move through quickly so we can leave time for questions.

Great. Well, I appreciate the rundown, Ann.

So to start. I mean the dissolvable plugs have become such a central part of the story and for obvious reasons. So if we're at a point now where we think we have the costs in line with composite. We've improved the predictability. It sounds like, from -- even from our last discussion, even maybe say like a month or 2 ago, that your confidence in the efficacy of the technology is only growing in terms of its ultimate commerciality. So that all sounds directionally quite constructive. Can you maybe just give us a sense of are you -- so are you getting more traction with certain types of customers? Does the ESG angle drive some of this? Just curious. Like across different types of customers, you're seeing those conversations evolve. And to what extent, just the last piece, is like kind of, the top-down from the CEO suite down to in the field, how is that kind of dual sales force -- sales initiative taking hold?

Yes. So I would say for our large operators, either super majors and/or super independents, the ESG conversation permeates all the way through to even kind of the lower-level completions engineers. That's present in our mind. It's part of the conversation, and it's very additive to the sales process. For your small or private E&Ps, maybe not so much. What is really relevant there is the speed and predictability of the completion, so I would also say that we're seeing an appetite for these plugs across all sorts of different customer base. And so what's important to us is that we have all those benefits. Some of our customers want the plug for certain reasons, but it's certainly nice to have all of that. And again I would also say the traction that we've gotten and the appetite that we see, even in this depressed market, really makes us think, if activity resumes, we could see a really significant uptake in these plugs. And I think a lot of folks on my team would say now they feel comfortable this is technically one of the best plugs on the market.

Well, yes, that's obviously very encouraging. You mentioned earlier that, in the near term, the competition takes a knee. And I'm curious. To what extent -- given the bounce back we've seen in the oil price, sort of seeing some production come back online already, to what extent do you worry about -- in the near term, it's very challenging to -- just to survive in an environment like this. At the same time, the quicker things get better -- or the competition can come back without having a chance to really see the type of attrition that you were perhaps hoping to see in a downturn. Just curious how you think about that obvious kind of a push and pull, if you will, with the different dynamics.

Sure. I mean it's obviously a concern. I think, though, I'm may be less concerned about it because I do not believe that this balance maybe is as strong as others do. I think it's just -- it's perception. So when there's absolutely nothing and then something, onesies, twosies, come back or you have operators that were going to start end of August and now they're pulling forward those operations to July, that's great to hear, but we're not remotely excited about kind of the recent uptick because it really doesn't make an industry. We still see it as a very depressed completions market out there, still incredibly challenging. So I would say our view right now is that this thing into kind of Q4 is just not pretty. And I think most OFS companies are going to be fighting to figure out how to go out to work and not have a negative gross margin. So I think there's plenty of time for people to die. I don't see any of this as propping any competition up anytime soon. In fact, if they're dumb enough to go out and do work at negative gross margins, it might kill them faster.

Right. Well, fair enough. So then coming back to Nine in terms of free cash flow generating capability. Maybe you can just talk about confidence in the near term. And then if we look out to 2021, I'm not asking for a number for '21 itself but just thinking about in a low level of activity environment, your ability to just generate cash in that type of environment would be certainly a point of note for investors.

I think, in '21, if the strip colds and '21 has some anemic recovery, then yes, on an annual basis, we'll be able to generate cash. Of course, we'll have a use of cash as that activity comes back. And then what all OFS companies are experiencing right now is it feels good to see that cash come off your balance sheet, but it's actually from a really dangerous place, right? So that will get used right back up as activity pops. And then depending on your cash conversion cycle, by the end of the year, you should be -- we should be able to generate, at least be neutral to generate cash -- good cash flow, depending on how fast that ramps and how fast we can turn that back into cash. So I'm moderately hopeful for '21, but I think it takes a while to put this demand back in place. And I'm -- suspects that it all comes rolling back. It feels exuberant to me right now.

Yes. Yes, well, same here. So then in the meantime, we've got to manage the balance sheet as well. So opportunistically buying back some of the debt to try and keep as much cash on the balance sheet otherwise. Maybe can you just elaborate, to some extent that you can, around capital allocation decisions as you go through the year?

Sure, yes. Well, the good thing for us is we have put significant growth CapEx into the business previously. So what we're really always thinking about is do we go and buy that debt. Do we not? And we're watching the pricing obviously very carefully. I can't give you benchmarks as to when we would or not, but when we think the market has really mispriced it and we're comfortable with our liquidity, then we will. We're also conscious that if this thing turns back hard and fast, that we do need that working capital, and we will need that liquidity. So it's funny because, as fast as it dries up on the downside, it can dry up as activity goes up too. So we've experienced both of that. So I think you'll see us be very conservative. And if we get something wrong, I'd love to look back and say, "Darn it, could have back -- could have bought back all that debt." I'd love that to be the mistake. I would not want it to hit a liquidity wall sooner than that, though.

Right. No, that's very fair. So it looks like we're about out of time here. So Ann, I just want to, again, thank you, again, from all of us at JPMorgan, for joining us today. It's really great to get an update...

Yes. Thank you, guys. Bye. Please stay safe -- yes.

Yes, all right. Thanks, everyone.

Okay. Thank you.