Nine Energy Service, Inc. quarterly report, Q2 FY2018

Nine Energy Service, Inc. — Q2 2018 Form 10-Q

Business context and reporting period. Nine provides completion, production enhancement and well-workover services to onshore oil and gas customers, primarily in the U.S. and Canada. This unaudited quarterly report covers the three and six months ended June 30, 2018, compared with the same periods in 2017. Amounts below are in U.S. dollars; financial statement amounts are in millions unless stated otherwise.

Financial performance

Metric	Q2 2018	Q2 2017	Six months 2018	Six months 2017
Revenue	$205.5	$135.9	$379.3	$241.2
Operating income (loss)	$11.5	($8.1)	$16.2	($22.9)
Net income (loss)	$9.0	($12.1)	$10.7	($32.8)
Diluted EPS	$0.37	($0.83)	$0.46	($2.31)
Adjusted EBITDA, non-GAAP	$30.6	$15.7	$54.7	$21.8

Revenue grew 51% in Q2 and 57% for the first half. Completion Solutions drove the increase: segment revenue rose 61% in Q2 and 68% year to date. Production Solutions revenue declined 2% in Q2 and rose 2% for the first half.
Adjusted gross profit, excluding depreciation and amortization, was $41.9 million in Q2 versus $24.3 million, and $77.5 million for the first half versus $38.2 million. Corresponding margins were approximately 20.4% versus 17.9% in Q2 and 20.4% versus 15.8% year to date. These are non-GAAP measures.
Production Solutions adjusted gross profit fell to $2.8 million in Q2 from $5.5 million, and to $5.2 million for the first half from $8.4 million, despite modest first-half revenue growth.
General and administrative expense increased to $16.1 million in Q2 and $31.5 million for the first half, partly reflecting greater activity, IPO and public-company costs, and revaluation of Scorpion contingent consideration. G&A was 8% of revenue in both 2018 periods, compared with 9% in Q2 2017 and 10% in the first half of 2017.
Interest expense declined to $1.8 million in Q2 and $4.7 million for the first half, from $3.9 million and $7.7 million, respectively, following debt reduction and refinancing.

Cash flow, debt and liquidity

First-half operating cash flow was $25.2 million, versus cash use of $21.0 million a year earlier. Investing cash use was $15.0 million, including $18.1 million of property and equipment purchases. Operating cash flow less those purchases was approximately $7.1 million.
Cash and cash equivalents were $70.9 million at June 30, 2018, up from $17.5 million at year-end 2017. Management reported total liquidity of $120.2 million, including $49.3 million of available revolver capacity.
Debt before deferred financing costs was $115.3 million ($113.9 million net of those costs), compared with $242.2 million before costs at year-end. The new facility includes a $125 million term loan, subject to mandatory amortization, and a $50 million revolver; both mature in July 2020. The company reported compliance with debt covenants at quarter-end.
The January IPO raised approximately $168.3 million net. Proceeds and new term borrowing were used to repay legacy facilities; the company also made a required $9.7 million term-loan prepayment.

Changes, outlook and risks

Management attributed improved results to higher North American completion activity and pricing as oil and gas prices and customer spending improved. Completion Solutions benefited from more wireline stages, completion-tool stages, cementing jobs and coiled-tubing jobs. Management said sustained or improving market conditions could support further demand and pricing; the filing gives no quantitative earnings or revenue guidance.
Higher activity also increased materials, labor and other operating costs. Completion Solutions’ adjusted gross profit improved substantially, while Production Solutions’ profitability weakened, in part as rig hours declined.
Completion tools revenue per stage fell 22% in Q2 and 23% year to date, reflecting a shift toward plugs from sleeves. The filing also notes that one customer represented at least 10% of revenue in both the three- and six-month 2018 periods; it does not identify that customer in the supplied text.
A Scorpion acquisition contingent-consideration liability was revalued upward by $1.67 million in the first half and stood at $3.4 million at June 30; payment was expected by December 31, 2018.
The company disclosed a wrongful-death lawsuit arising from a 2017 worksite accident. Plaintiffs seek damages, including punitive damages; the company tendered the matter to its insurer but cautioned that insurance may not cover all costs. The company also self-insures some medical claims, with an estimated $1.3 million liability.
Disclosure controls and procedures were deemed ineffective at June 30 because of material weaknesses in internal control over financial reporting previously described in the 2017 annual report. Management reported no material change in internal control during the quarter.
Key business risks include oil and gas prices, customer capital spending and completion activity, ability to retain skilled personnel and maintain or increase pricing, operating and safety incidents, seasonality and weather, and environmental or other regulatory changes. The filing reported no material change to the risk factors in the 2017 annual report.

Investor verification priorities

Verify the durability of the activity and pricing recovery, especially whether Completion Solutions growth and margins can be sustained as customer spending and commodity prices change.
Assess Production Solutions’ declining adjusted gross profit and rig-hour trends, and the completion-tool revenue-per-stage decline.
Review cash conversion, receivables growth (to $141.0 million from $99.6 million at year-end), capital spending and the company’s ability to fund operations and debt obligations.
Confirm debt amortization, maturity and covenant terms, as well as actual revolver availability and future financing needs.
Examine customer concentration, the Scorpion contingent payment, the wrongful-death litigation and insurance coverage, and progress remediating the disclosed internal-control material weaknesses.
Distinguish GAAP results from management’s non-GAAP adjusted gross profit and Adjusted EBITDA measures when comparing performance.