NCS Multistage Holdings, Inc. Q1 FY2020 Earnings Call

Ladies and gentlemen, thank you for standing by. And welcome to the Q1 2020 NCS Multistage Earnings Conference Call. At this time, all participant lines are in a listen-only mode. As a reminder, this conference is being recorded. I would now like to hand today's conference over to your speaker for today, Ryan Hummer. Please go ahead.

Thank you, Stephanie. And thank you for joining NCS Multistage's first 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 need to point out that in our earnings release and in today's conference call, we refer to adjusted EBITDA, adjusted EBITDA margin, adjusted EBITDA less share-based compensation, free cash flow and net working capital, which are all non-GAAP measures of operating performance. We use these measures of operating performance because they allow us to compare performance consistently over various periods without regards to the costs associated with our current 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, provide reconciliations of these non-GAAP financial measures to the nearest GAAP financial measure. With that said, I'll turn the call over to Robert.

Thank you, Ryan. And welcome to our investors, analysts, and employees joining our first quarter 2020 earnings conference call. Today, I'll review our accomplishments in the first quarter, how the COVID-19 pandemic has impacted our business, and the initiatives NCS has taken to reduce costs and improve liquidity. I'll also briefly discuss our outlook for each of U.S., Canada, and international markets. After that, I'll turn the call over to Ryan to discuss the quarterly results and our liquidity position in more detail, after which, I'll provide some closing remarks. Before discussing our results, I'd like to express our hope that everyone listening, as well as your families, are safe in these challenging times. I'll start by briefly touching on our results from operations in the first quarter. We increased our Q1 revenue by 3% on a year-over-year basis and 5% sequentially. We saw the continuation of two positive trends for NCS in the quarter. First, our momentum in Canada was maintained with a 17% year-over-year increase in the first quarter, compared to a 7% increase in rig count. This momentum reflects market share gains in fracturing systems and continued pull-through of our other product and service offerings. Second, we continue to grow our international business; our international revenue in the first quarter increased by 68% as compared to the prior year. We believe we lost some revenue because of the COVID-19 pandemic in mid-to-late March, which drove our revenue and gross profit margin below our original guidance for the quarter, which we originally provided in early March but later withdrew in early April. Despite this, our adjusted EBITDA for the quarter was $9.2 million or 17% of revenue, an improvement from $7.4 million in the first quarter of 2019 and from $8.3 million in the fourth quarter of 2019. We generated free cash flow of $3.2 million during the first quarter, which compared favorably to a negative $5.8 million in free cash flow in the first quarter of last year, a reflection of better working capital management and a significantly reduced capital spending plan. The COVID-19 pandemic and the associated response by governments across the world is truly unprecedented in its impact on the global economy and oil demand. For NCS, the health and safety of our employees is our highest priority. We have implemented our response plan in accordance with guidelines from the CDC, WHO, and state and local governments. We've had a small number of employees test positive for COVID-19. Fortunately, the employees have only had mild symptoms and we have taken measures to ensure that we have a safe and healthy workplace; employees have access to appropriate protective gear and social distancing measures are being enforced. Impacts to our supply chain have been modest to date, with some delays in chemical shipments from China for our tracer diagnostics business and stay-at-home measures in Mexico impacting our machine shop operations. In both of those cases, we have adequate supply and inventory to meet our customers' needs for the foreseeable future. Certain R&D projects have experienced delays resulting from supplier operations as well. By far, the biggest impact NCS has been the secondary impact driven by a reduction in oil demand of over 20 million barrels of oil per day in the second quarter. This reduction in demand paired with delayed responses by our producers in reducing supply has led to massive overcapacity in global storage builds. This oil glut has resulted in a collapse in the price of oil in the front months and a meaningful reduction across the futures curve. Our customers have responded by dramatically reducing their capital budgets and activity levels for the remainder of the year. North American E&P capital budgets for 2020 have been reduced by over 30% from initial levels. The current operated U.S. frac spread account is reported to be below 90, and the U.S. horizontal rig count has fallen by over 300 in the last six weeks alone. The current land rig count in Canada is in the mid-20s, the lowest level ever reported in the Baker Hughes rig count. Many North American E&Ps have instituted what some are calling frac holidays for several months and are shutting in high-cost production. As a result, we expect that industry completion activity in North America could be lower by 75% to 85% sequentially in the second quarter and remain at low levels through at least the end of 2020. In addition, we believe that drilling and completion activity in Canada will remain at historically low levels through the second quarter, with only a muted recovery in the second half as we exit spring breakup. We believe activity in the international markets we participate in will be reduced as well, with overall activity for 2020 expected to decline compared to our prior expectation for modest growth. To date, the international regions experiencing the greatest disruption for NCS have been China and Argentina, with activity in other areas ongoing but subject to quarantine measures for our personnel. We cannot reasonably estimate the duration of the disruption to the economic activity and oil demand related to COVID-19 pandemic and elevated global crude oil storage levels. As a result, NCS management has undertaken multiple initiatives to make structural changes to our cost base, limit our capital expenditures, and enhance our liquidity. These measures are listed in detail in our earnings release issued yesterday evening, and I'll highlight a few of the most impactful measures we've taken. Over the course of the last 40 days, we have reduced over one-third of our workforce in the U.S. and Canada, representing a reduction of over 130 employees. All remaining employees are working under decreased hours through furloughs or have had their salaries reduced, including reductions in executive salaries averaging 20%. In doing so, we have better aligned our field service capability with current market activity levels and significantly reduced our SG&A expense. We've reduced our bonus accruals and eliminated the employer match for our retirement plans. We are benefiting from government initiatives in the U.S. and Canada and expect to receive a U.S. income tax refund of over $1 million in the second half of 2020. We borrowed $5 million under our credit facility at the end of the quarter to fund severance obligations related to the reduction in workforce. We increased the borrowing capacity at Repeat Precision, which is part of a separate credit group from our credit facility, and we have reduced our planned capital expenditures for the year. With the actions outlined above, as well as other initiatives that we have executed on, we expect that we will reduce our reported SG&A expense in 2020 by over $20 million compared to 2019. We've been successful in converting our net working capital, which was in excess of $70 million at March 31st, into cash, with a consolidated cash balance in excess of $25 million at the end of April. On last quarter's call, we highlighted the value that we bring to our customers through our product and service offering; bringing differentiated technology to our customers that saves them time and cost is important today, more important than it has been before. We remain committed to leveraging our technology to continue to improve our market share across the U.S., Canada, and international markets. We also remain highly focused on free cash flow, benefiting from our capital-light model and on our liquidity, as Ryan will speak to in a moment. While the next several quarters will be challenging for our industry and our company, we're committed to taking decisive action so that we will be well-positioned to participate in the increase in activity that inevitably follows the downturn. Before I hand the call back over to Ryan, I'd like to speak to an ongoing litigation matter that we have brought up before. As a technology company, it is important for us to defend our intellectual property, including any intellectual property that we have licensed from others. In early April, the U.S. District Court for the Western District of Texas issued a final judgment in connection with the litigation with Diamondback Industries Incorporated, awarding Repeat Precision approximately $40 million plus attorney's fees in connection with our claims for Diamondback's breach of the exclusive license, patent infringement, and torturous interference. In its ruling, the District Court validated the terms of Repeat Precision's exclusive license with respect to the setting tool technology and enjoyed Diamondback from selling its infringing line of setting tools. On April 21st, Diamondback filed for Chapter 11 bankruptcy and filed its notice of appeal related to the judgment. While the judgment remains subject to appeal and any monetary award is subject to collection, we intend to vigorously challenge the appeal and try to enforce our rights. I'll now ask Ryan to discuss our financial results in more detail.

Thank you, Robert. As reported in yesterday's earnings release, our first quarter revenues were $54.6 million, 3% higher than the prior year's first quarter. On a sequential basis, revenue in the first quarter was 5% higher than revenue in the fourth quarter, with a seasonally driven increase in Canada, offset by declines in the U.S. and in international markets. Gross profit, defined as total revenue less total cost of sales, excluding depreciation and amortization expense, was $23.9 million in the first quarter, or 44% of revenue. This compares to $26.1 million, or 49% of revenue in the prior year's first quarter. For sequential comparison, our gross profit was $26.1 million, or 50% of revenue in the fourth quarter of 2019. Selling, general and administrative costs, or SG&A expense, was $20.8 million in the first quarter, as compared to $23 million in the prior year's first quarter and it was also lower than fourth quarter 2019's level of $22.2 million. Our reported SG&A includes share-based compensation and certain non-recurring expenses, including certain litigation costs and severance expenses. In the first quarter, our non-recurring litigation expenses totaled $1.4 million, and our severance expense totaled $1.3 million. Adjusted EBITDA for the first quarter was $9.2 million as compared to $7.4 million in the prior year's first quarter. Our adjusted EBITDA in the first quarter as a percentage of our total revenue was 17%. We recorded non-cash impairment charges totaling $50.2 million during the quarter, which included approximately $9.7 million related to property and equipment and $40.5 million related to intangible assets. Our depreciation and amortization expense for the quarter totaled $2.6 million and will be reduced going forward due to the impairments I just mentioned. We had net income attributable to non-controlling interest of $2.6 million during the quarter, which reflects positive net income at Repeat Precision. Our average basic and diluted share counts for the quarter were both 47 million. Turning now to cash flow items and the balance sheet, cash flow from operations for the first quarter was $3.6 million and our net capital expenditures for the first quarter were $0.4 million, resulting in free cash flow for the quarter of $3.2 million. At March 31, 2020, we had $15.5 million in cash and total debt of $17.7 million, which included $15 million drawn under our revolving credit facility with $10 million drawn in the U.S. and $5 million drawn in Canada. We will not be providing revenue or gross margin guidance for the second quarter, but do have the following points of guidance: We expect our reported SG&A, inclusive of share-based compensation, non-recurring items, and severance to be between $17 million and $18.5 million. This includes approximately $1.8 million in share-based compensation, $3.6 million in severance expense, and approximately $0.5 million in litigation expenses. We expect our second quarter depreciation and amortization expense to be approximately $1.5 million and we expect our net interest expense to be approximately $0.4 million for the quarter. Our expected gross capital expenditures for the full year 2020 have been revised to a range of $2.5 million to $4 million, a further reduction from our guidance in early March, and at the midpoint, nearly 50% below our gross capital expenditures of $6.4 million in 2019. I'll take the next few minutes to discuss NCS's liquidity position and our revolving credit facility. NCS ended March with $15.5 million in cash and $17.7 million in total debt for net debt of $2.2 million. The debt is comprised of the $15 million drawn under our senior secured revolving credit facility, with the remainder being short- and long-term capital leases. We were in compliance with our credit facility's financial covenants at March 31, 2020. We view the most restrictive covenant under this facility to be a maximum total debt to trailing 12-month EBITDA covenant of 2.5 times. If current depressed market conditions continue or worsen, it will have a material negative effect on the company's financial performance, which would be expected to result in a breach of the covenants and a default under the credit agreement, which could occur as early as the third quarter of 2020 in a depressed market environment. In the event of a default, the lenders may elect to declare all outstanding borrowings under the facility immediately due and payable. To address this, the company is currently engaged in preliminary discussions with its lenders regarding a possible amendment to the credit agreement. We are in the process of determining whether our cash on hand and cash flows from operations will be sufficient to fund our capital expenditures and liquidity requirements for the next 12 months, including the potential acceleration of amounts outstanding under the credit facility. This analysis includes the actions that the company has taken as described by Robert earlier to reduce costs and enhance liquidity. We expect to finalize this analysis in connection with the filing of our Form 10-Q. With this, it's important to note that NCS had net working capital of $70.4 million at March 31, 2020, which is well in excess of the current borrowings under the revolver. With strong collections performance since the end of the quarter, as Robert mentioned earlier, NCS had over $25 million in cash on hand at the end of April, but no change to the revolver balance at March 31. 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. Our industry is facing unprecedented challenges, especially in North America, as our customers are rapidly reducing activity in the face of storage limitations and an uneconomic oil price environment. NCS delivers a focused portfolio of technologies that help our customers operate more efficiently and optimize the value of their assets, the right technologies for this market. Our international footprint, while we're still relatively small, provides us with exposure to markets exhibiting greater strength than North America. We're focused on adjusting our cost structure and capital spending for the current environment. We've reduced our U.S. and Canadian headcount by over one-third and are targeting $20 million in reduction in SG&A compared to 2019. We've maintained a capital-light business model, which facilitates free cash flow generation. I want to thank our employees. We've been through two very difficult reductions in recent weeks. We have a world-class workforce and every employee at NCS is currently making a sacrifice on behalf of their coworkers and stakeholders associated with NCS. Your hard work, dedication, and ingenuity are key to our company's success and to the credible outcomes we deliver for our customers now and in the future. With that, we'd be happy to take your questions.

Thank you. Your first question is from Ian MacPherson of Simmons. Ian, your line is open.

Hi. Can you guys hear me now?

Good morning, Ian.

Hey, Robert, sorry, I was not on mute; it was another glitch. But thanks for the comments. I hear you loud and clear, you're not in the hope camp for activity rebounding this year, perfectly reasonable. If we did have a different price signal from the commodity, would you wager your bet as to which market might be a little bit more sensitive to a recovery between your Canadian business and your U.S. business?

Yeah. If we're speculating here, I would say, probably, the U.S. market. The Canadian market will rebound, obviously; I mean, right now we're break up, rig counts at a low that we've never seen before; I mean, almost 20 rigs, give me a break. But, no, I think the U.S. market could rebound if we got something that was completely unexpected.

Yeah. On the litigation collection, what's your legal team advising with regard to the timeframe of resolving that and any sort of risk-adjusted assessments that you're getting in terms of collectability?

Yeah. So, I'm not going to handicap the collectability part of the deal. As I mentioned before, Diamondback has filed for bankruptcy. Our legal team believes that, that is exactly the place that we need to be at this point for maximum advantage in collectability based on all the facts that are in place today. So as far as handicapping when there's going to be a collection and how much it's going to be actually, I can't comment on that.

Okay. Well, good luck with it. It's obviously a hugely material piece now relative to the capitalization and the liquidity endpoints that we're contemplating. So I'll stay tuned for the Q and the resolution on the credit facility and I’ll pass it over for any other questions. Thanks.

Thanks, Ian.

Thank you, Ian.

Our next question is from the line of Taylor Zurcher with Tudor Pickering Holt.

Good morning. I wanted to follow up on Ian's question regarding the changes in the business mix at NCS since the last downturn. As you face this current downturn, are there any products or services in your portfolio that you believe may perform better than others in North America? I understand everything may be affected, but considering the different product mix you have now compared to the previous downturn, is there anything that stands out as potentially more resilient?

Yeah. Well, it's a really good point. In the last downturn, we were primarily a slotting sleeve company in the U.S. and now wellbore construction is a big part of our business, as well as tracer diagnostics and frac plugs. So the products that we offer today versus what we had back then, they're products that are being used every day on wells that are being completed. And so the difference is that we were trying to push technology into a market that wasn't very receptive to it in a lot of different places with some of the sliding sleeve products that we had and today, these products are already accepted. It's just a matter of getting more market share. And we believe that our cost structure is such that we can compete; price is not that much of an issue for us. We have, in anticipation of closings from the COVID virus, increased manufacturing capacity and started building inventory. And so we're in a good spot to be able to take advantage of whatever activity that there is, we think.

Okay. That's helpful. I have a follow-up regarding working capital. It seems that at least until April, collections have improved, and you've managed to generate more cash from working capital. I understand these predictions can be difficult, but do you have any goals or benchmarks in mind for potential cash generation from working capital throughout 2020, or is it still a bit too early to determine that?

I think it's still too early to say. Typically, what we will see from seasonal patterns in the business would actually be some modest negative free cash flow in the first quarter; we outperformed that a bit. Typically, we generate free cash flow in the second quarter and fourth quarter. And with the resumption of activity in Canada coming out of breakup and revenue picking up, we built receivables and built working capital, therefore, working capital being a use of cash typically in the third quarter. So I'd say this year, we see the second quarter being probably stronger than normal with respect to free cash flow generation and working capital release, probably still a bit too early to determine the magnitude of any working capital outflows in Q3 and inflows in Q4, just depending on how activity shapes up in the back half of the year.

Okay. Understood. Thanks guys.

Yeah.

Your next question is from the line of JB Lowe with Citi.

Hey. Good morning guys.

Good morning.

Good morning.

I was just curious, Ryan, could you run through the actual covenants again on your debt?

Sure. There are two financial covenants. The first is maximum debt to trailing 12 months EBITDA on the facility, a maximum of 2.5 times, and then there's an interest coverage covenant with a minimum of 2.75 times. And of those really the one that we view as being the most operative, if you will, would be the total debt-to-EBITDA covenant.

I appreciate that. I'm curious about the recent conversations with customers, as there seems to be some uncertainty. Do you have any way to evaluate the pricing discussions you've had regarding the activities that you've engaged in?

I'm sorry, the pricing conversations on activity or…

Yeah. Like how much pricing concessions are guys asking for in this environment?

They're asking for a lot. We've had…

Yeah.

The pricing discussion began about a month ago, with several customers reaching out via letters and calls, requesting reductions of 25% to 30%. We have noticed this demand tapering off. The industry seems to have reached a limit on discounts, and there isn’t much more to offer. While there has been some decline in prices, it hasn’t been nearly as significant as what customers were requesting. We’ve observed that some companies with excess inventory are offering heavily discounted products to free up cash. Overall, prices are stabilizing where they currently are. However, I do anticipate some price declines in the future, though not to the extent we’ve seen previously.

And I'd add to that, that any conversation that we have with our customers around pricing will also involve bundling of more of our products and services into the mix.

Okay. That makes sense. One last question from me, can you discuss your exposure to the gassier basins that may experience more stable activity?

Yes. Our main focus is in the U.S. First, regarding our U.S. operations, we're involved in the oil plays in the Permian and some in the Mid-Con area. We also have a presence in the Rockies, which has gas exposure. In the Northeast, our work is actually increasing. While we're not currently operating in the Haynesville Shale, it is another area we are considering. The products and services we offer allow us to be flexible and operate almost anywhere in the U.S. In Canada, we are active across the board. We hope that gas demand grows, as that could certainly assist our efforts.

All right, guys. Appreciate the answers. Good luck and stay safe out there.

Thanks. Same to you.

Thanks.

Thanks, JB.

At this time, there are no further questions. I'll hand the call back to Robert Nipper for closing remarks.

Thank you, Stephanie. On behalf of our management team and our 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. I extend my appreciation to our more than 250 employees around the globe, as well as the team at Repeat Precision. I continue to believe that we have the best team in the industry and our performance backs that up. It is through the talents, effort, and dedication of this team that NCS is able to provide exemplary customer service and drive the innovations that we bring to the industry. We appreciate everyone's interest in NCS Multistage, and we look forward to talking again on our next quarterly earnings call in August. Thank you very much.

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