Nine Energy Service, Inc. — Q2 2019 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2019. The unaudited filing covers an oilfield-services provider focused on unconventional-well completion and production services in North America and elsewhere. Amounts below are in millions unless stated otherwise.
Financial performance
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Revenue | $237.5 | $205.5 | $467.2 | $379.3 |
| Adjusted gross profit | $53.0 | $41.9 | $104.1 | $77.5 |
| Operating income | $14.0 | $11.5 | $40.9 | $16.2 |
| Net income | $6.1 | $9.0 | $23.4 | $10.7 |
| Adjusted EBITDA | $38.0 | $30.6 | $77.2 | $54.7 |
| Operating cash flow | Not separately presented | Not separately presented | $17.4 | $25.2 |
| Capital expenditures | Not separately presented | Not separately presented | $37.3 | $18.1 |
Q2 revenue rose 16%; six-month revenue rose 23%. Adjusted gross margin was approximately 22.3% in Q2 versus 20.4% a year earlier. GAAP gross margin was approximately 14.6% versus 13.1%. Q2 net income and diluted EPS fell to $6.1 million and $0.21 from $9.0 million and $0.37, despite higher revenue and operating income, mainly as interest expense increased to $10.6 million from $1.8 million. For the first half, diluted EPS was $0.80 versus $0.46.
Six-month cash flow from operations declined $7.8 million, primarily because working-capital needs used more cash. Investing used $27.1 million and financing used $37.2 million; cash fell $46.7 million to $16.9 million. Operating cash flow less capital expenditures was approximately negative $20.0 million.
Balance sheet and liquidity at June 30, 2019
- Cash: $16.9 million; accounts receivable: $169.5 million; inventories: $87.9 million.
- Total assets: $1.098 billion; total liabilities: $473.4 million; stockholders’ equity: $624.3 million.
- Debt was $400 million principal under 8.75% Senior Notes due 2023, shown net of financing costs at $391.0 million. No ABL revolver borrowings were outstanding; approximately $161.1 million of availability remained, net of a $0.5 million letter of credit. Reported total liquidity was $178.0 million.
- Cash interest paid in the first half was $19.4 million. The company reported compliance with Senior Notes and ABL covenants at quarter-end.
Material changes and unusual items
- Growth primarily reflected the October 2018 Magnum acquisition, which was included in 2019 results but not the 2018 comparison. Completion Solutions revenue rose 17% in Q2 and 25% for the first half; Production Solutions revenue rose 6% and 7%, respectively.
- Completion tools revenue rose 118% in Q2 and 147% in the first half, largely due to Magnum. Coiled tubing revenue declined 18% in Q2 and 14% in the first half, with lower job counts.
- Six-month operating income included a $14.9 million noncash gain from revaluing acquisition-related contingent liabilities, mainly reflecting reduced estimated 2019 sales of certain dissolvable plugs. The gain materially affects year-over-year comparisons and adjusted EBITDA excludes it.
- Acquisition-related debt increased interest expense; acquisition-related amortization and integration costs also increased. General and administrative expense rose to $21.8 million in Q2 from $15.5 million.
- The Magnum transaction included potential earnout payments, including up to $25 million tied to certain dissolvable-plug sales in 2019 and payments tied to E-Set results through 2026. Recorded contingent liabilities totaled $10.5 million at June 30.
Outlook, risks and controls
The filing gives no specific revenue or earnings guidance. Management said 2019 customer budgets were more limited following the late-2018 oil-price decline and that E&P investment was expected to average below 2018 levels; even higher commodity prices might not materially lift activity because operators were expected to remain within existing capital plans. Management cited demand for technically complex, high-efficiency completions as a potential support for its services and expected Magnum to contribute free cash flow, improve margins and diversify basin exposure.
Key risks include commodity-price volatility and customer capital spending, competition and pricing pressure, demand forecasting, staffing, weather, operational accidents and equipment failures, regulation, and successful acquisition integration. The company stated disclosure controls and procedures were not effective at June 30 because of the material weakness previously reported in its 2018 Form 10-K; no material change in internal control over financial reporting was reported this quarter. A fatal 2017 worksite-accident lawsuit was settled in May 2019, with settlement fully funded by insurance. The company said other pending or threatened claims were not expected to have a material adverse effect.
Important facts for investors to verify
- Whether operating cash flow and working-capital trends can support elevated capital spending and debt service.
- Whether revenue growth and margins persist after separating Magnum’s contribution from underlying activity and pricing.
- The sensitivity of earnings and liquidity to 8.75% note interest, commodity prices, customer budgets and ABL borrowing-base availability.
- How contingent earnouts, including the Magnum plug-sales and E-Set arrangements, are ultimately measured and paid.
- Management’s remediation of the material weakness and progress toward effective disclosure controls.