Nine Energy Service, Inc. — Q3 2018 Form 10-Q
Business context and period. Unaudited results cover the quarter and nine months ended September 30, 2018, compared with the same periods in 2017. Nine provides completion and production services to North American onshore oil and gas customers through Completion Solutions and Production Solutions. The company completed its IPO in January 2018. The Magnum acquisition and related financing closed after quarter-end, on October 25, 2018, and are not included in the September 30 results.
Financial performance and position
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $218.4m | $148.2m | $597.7m | $389.4m |
| Gross profit, GAAP | $37.3m | $13.1m | $85.1m | $20.2m |
| Operating income (loss) | $16.4m | ($0.2m) | $32.5m | ($23.1m) |
| Net income (loss) | $13.7m | ($5.1m) | $24.4m | ($37.9m) |
| Diluted EPS | $0.56 | ($0.34) | $1.03 | ($2.61) |
| Adjusted EBITDA (non-GAAP) | $38.4m | $18.1m | $93.1m | $39.8m |
| Adjusted gross profit, excluding D&A (non-GAAP) | $52.5m | $28.3m | $130.0m | $66.5m |
Q3 GAAP gross margin was approximately 17.1%, versus 8.9%; adjusted gross margin was approximately 24.1%, versus 19.1%. Nine-month GAAP gross margin was approximately 14.2%, versus 5.2%; adjusted gross margin was approximately 21.8%, versus 17.1%. Margins are calculated from reported figures.
- Segment revenue: Completion Solutions revenue rose 53% to $196.6m in Q3 and 62% to $536.4m for nine months. Production Solutions revenue rose 12% to $21.8m in Q3 and 5% to $61.4m for nine months.
- Segment adjusted gross profit: Completion Solutions increased to $49.4m in Q3 and $121.8m for nine months. Production Solutions was $3.1m in Q3 and $8.3m for nine months; nine-month profit declined $2.9m year over year.
- Cash flow and investment: Nine-month operating cash flow was $50.8m, versus $3.8m; capital expenditures were $29.5m. Investing cash outflow was $26.0m and financing cash inflow was $44.6m. Accounts receivable increased $62.7m in the cash-flow reconciliation, a substantial use of operating cash.
- September 30 liquidity and debt: Cash was $86.5m; reported availability on the revolving facility was $49.5m, for total liquidity of $136.0m. Debt was $114.0m net of deferred financing costs ($115.3m principal); the company reported compliance with debt covenants.
- Balance sheet: Total assets were $706.5m and stockholders’ equity $490.6m at September 30, 2018. The company reported no off-balance-sheet arrangements.
Material changes, outlook and risks
- Revenue growth reflected stronger North American completion activity and improved pricing. Management attributed Q3 Completion Solutions growth to higher activity and pricing; wireline stages increased 34%, while completion tools stages increased 102% but revenue per stage fell 17% as the sales mix shifted toward plugs from sleeves. Production Solutions rig hours declined 1% in Q3 and 4% year to date, partly offset by pricing and non-rig work.
- Management said improved commodity prices and operating efficiencies supported activity and expected further service demand if prices held or improved. It anticipated potential pricing gains as activity and job complexity increased. No quantified financial guidance was provided.
- On October 25, Nine acquired Magnum for approximately $334.5m cash, subject to customary adjustments, plus 5.0m common shares. Additional contingent cash payments may include up to 60% of specified E-Set business net income for 2019–2025 and up to $25m tied to 2019 dissolvable-plug sales. Purchase accounting was not complete at filing.
- To finance the transaction, Nine issued $400m of 8.750% senior notes due 2023 and borrowed approximately $35m under a new ABL facility; it repaid and terminated its prior credit agreement. Management reported approximately $435m of debt immediately after the acquisition. The ABL facility permits up to $200m subject to its borrowing base, initially $146.5m. Management expects Magnum to add free cash flow, improve margins and reduce capital intensity, but flagged higher interest costs and integration demands.
- Risks include dependence on oil and gas activity and commodity prices, competition and pricing pressure, acquisition integration and unknown liabilities, supplier concentration in some acquired product lines, and higher leverage. A wrongful-death lawsuit related to a 2017 worksite accident was ongoing; plaintiffs sought damages including punitive damages, discovery was underway and trial was scheduled for mid-2019. Nine tendered the matter to its insurer but could not assure coverage would fully protect it.
- Management concluded disclosure controls and procedures were ineffective as of September 30, 2018 because of material weaknesses previously reported in the 2017 Form 10-K. The filing also notes potential goodwill impairment sensitivity in the Production Solutions segment, whose estimated fair value had only an 11% cushion over carrying value at year-end 2017.
Important facts for investors to verify
- Post-acquisition debt, borrowing-base availability, interest expense and compliance with the new financing agreements.
- Magnum integration progress, purchase-price allocation, realized synergies and any contingent payments.
- Whether growth and pricing gains persist, particularly given falling completion-tools revenue per stage and weaker Production Solutions year-to-date adjusted gross profit.
- Cash conversion and receivables collection as revenue expands, alongside required capital spending.
- Remediation of the disclosed control weaknesses, the outcome and insurance coverage of the wrongful-death litigation, and any goodwill impairment indicators.