NCS Multistage Holdings, Inc.

The conference will begin shortly. Good day, and thank you for standing by.

Welcome to the NCS Multi-Stage Third Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1-1 on your telephone. You will then hear an automated message advising your hand is raised. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Ryan Hummer, Chief Financial Officer. Please go ahead.

Thank you, Hope, and thank you for joining the NCS Multistage third quarter 2022 conference call. I will leave the call today, and Robert Knipper, our founder and retiring CEO, will also provide comments. We are also joined for the first time by Mike Morrison, who will soon take over for me as CFO. I want to remind listeners that some of today's comments include forward-looking statements such as comments regarding our future expectations for financial results and business operations. These statements, including our financial guidance, are subject to many risks and uncertainties that could cause our actual results to differ materially from any expectation expressed herein, including the impacts of the COVID-19 pandemic, inflation, central bank actions to combat inflation, and Russia's ongoing invasion of Ukraine, all on the global economy, oil demand, and our company. Please refer to our most recent annual report on Form 10-K and our latest SEC filing for risk factors and cautions regarding forward-looking statements. Our comments today also include non-GAAP financial measures, including adjusted EBITDA, free cash flow, and networking capital. The underlying details and reconciliations of non-GAAP to the most comparable GAAP financial measures are included in our third quarter earnings release, which can be found on our website, ncsmultistage.com. With that said, I'd like to welcome our investors, analysts, employees, and other attendees to our third quarter 2022 earnings conference call. We significantly exceeded the consolidated revenue guidance for the third quarter of 2022 that we provided in early August. enabling us to generate over $8 million in adjusted EBITDA during the quarter. I'll start by briefly discussing our results and outlook for each of Canada, the US, and our international markets. Starting with Canada, our Canadian revenue of nearly $35 million in the third quarter exceeded the high end of our guidance range of $23 to $24.5 million. These results reflect several factors, including favorable weather conditions during the quarter, which allowed for higher customer activity levels than we had anticipated. In addition, we added new customers for our fracturing systems product line, which contributed to incremental sales. This is the result of our highly focused efforts by our sales team, leveraging our strong performance in the field where we drive operating efficiencies for our customers. As an example, we recently participated in a unique SimulFrac project in Canada on a multi-well pad. with two wells being simultaneously fractured utilizing NCS sliding sleeves and shift frac closed operations from a single frac spread. Through that process, we helped to enable greater operational efficiencies for our customer and look to repeat that in the future. Our Canadian team continues to execute on opportunities to drive market share in other product lines as well. For instance, we set an ambitious goal to triple the number of liner hangers that we installed for our customers in 2022 as compared to the prior year, and we are on track to achieve this goal. Our growth in this technically demanding operation demonstrates the quality of our people and technology and provides us with additional opportunities to supply a full wellbore of NCS products to our customers, including toe sleeves and float equipment, centralizers, sliding sleeves, and the liner hanger. We are also continuing to add to the Canadian customer base for our purple seal frac plugs and are delivering tangible value to our customers through the insights provided through our NCS tracer diagnostic service. Activity in Canada has remained robust early in the fourth quarter, though we believe that the favorable operating conditions experienced over the last several months have accelerated the timing of customer activity, which is currently expected to lead to budget exhaustion for certain customers and lower activity as we head into the last two months of the year. Turning to the U.S. Our revenue of $11.5 million for the third quarter fell just below our guidance of $12 to $13.5 million. Further sequential improvements in fracturing systems, tracer diagnostics, and frac plug sales were offset by declines in well construction volumes and also lower volumes of perforating gun sales at repeat precision. We're especially pleased with the performance of the tracer diagnostics business for the quarter, as we participated in many high intensity projects for our customers. helping them to advance their understanding of completion performance and also well-to-well interaction. The knowledge gained from these tracer diagnostics projects helps our customers to further optimize their completion strategies and to adjust field development planning to maximize hydrocarbon recovery and to optimize the financial returns on their assets. Our U.S. tracer diagnostics revenue is 46% higher through the first nine months of 2022 as compared to the first nine months of 2021, with high activity continuing into the fourth quarter as our tracer field service crews are operating at nearly maximum capacity. At repeat precision, we intentionally reduced our perforating gun sales activity starting in the second half of the third quarter as we implemented upgrades to components within the system. We believe that these upgrades will further enhance the operating performance of our Purple Fire modular perforating gun system. and the benefit of these upgrades has recently been demonstrated in the field. During the quarter, we also had successful trials of our Purple Fire system with several additional wireline customers, which we anticipate will diversify our customer base for this new product line, setting the stage for further growth. Our international activity approved again sequentially in the third quarter, with revenue of $2.6 million, which was slightly below our expectations of $3 to $4 million. The sequential revenue improvement during the quarter was led by an increase in tracer diagnostics activity, primarily in Argentina, where we completed several projects. Service activity in the North Sea continues to be steady, and we have received additional sleeve orders from our second North Sea customer, which we expect to deliver during the fourth quarter. On a consolidated basis, we began to benefit more fully in the third quarter from pricing increases that we implemented earlier this year. Our gross margin percentage for the third quarter of 2022 was 42%, the highest of any quarter this year. We continue to be impacted by rising costs across our supply chain, especially for the tubulars that we utilize to build our fracturing systems and well construction products, so the pace of the cost increases is beginning to moderate. To offset these cost increases, we expect to initiate further pricing increases to recover our costs and to improve our gross margins. ensuring that we are adequately compensated for the value that we bring to our customers. I'll now discuss certain financial results in more detail. As reported in yesterday's earnings release, our third quarter revenues were $48.9 million, 51% higher than the prior year's third quarter, with increases of 57%, 43%, and 14% in Canada, the US, and international markets respectively. On a sequential basis, our revenue in the third quarter was 78% higher than our revenue in the second quarter of 2022, with an increase of 171% in Canada, due in part to normal seasonality, and a 5% increase in international markets, offset by a 5% decline in the US. Gross profit, which we define as total revenue, less total cost of sales, excluding depreciation and amortization expense, was $20.5 million in the third quarter, or 42% of revenue. This was in line with our guided range of 40 to 44% for the quarter and compared to $14.8 million or 46% of revenue in the prior year's third quarter. The prior year's third quarter benefited from the employee retention credit in the U.S. and was also less impacted by cost increases in our supply chain. For a sequential comparison, our gross profit in the second quarter of 2022 was $8.9 million or 33% of revenue. The increase in gross margin percentage in the third quarter of 2022 as compared to the second quarter of 2022 was due primarily to the benefits resulting from price increases achieved with our customers and also the increase in revenue. Our selling, general, and administrative expenses, or SG&A, were $15.4 million in the third quarter of 2022 and were within our guided range of $14.5 to $15.5 million. despite higher incentive accruals related to an improvement to our expected financial results for the year. Our SG&A expense was $4.4 million higher than the third quarter of last year, primarily due to increased headcount and higher salary expense. Our SG&A in the third quarter of 2021 also benefited from the employee retention credits, which did not recur in 2022. Our reported SG&A expense includes share-based compensation and certain non-recurring expenses, including litigation costs. In the third quarter, our non-cash share-based compensation expense totaled $0.9 million, and our non-recurring litigation expenses totaled $1.7 million, which was an increase from the prior year, primarily due to a patent infringement trial, which I'll discuss further in a moment. Our adjusted EBITDA for the third quarter of 2022 is $8.4 million, as compared to $4.2 million in the prior year's third quarter. This year-over-year increase of $4.3 million reflects an incremental margin of 26% on an increase in revenue of $16.5 million for the same period. Our adjusted EBITDA for the trailing 12 months ending September 30, 2022 is $15.2 million, a 10% margin on our trailing 12-month revenue of $152 million. During the third quarter of 2022, our depreciation and amortization expense was $1.1 million and there was minimal income attributable to a non-controlling interest in repeat precision. Turning now to cash flow items and the balance sheet. Our cash flow from operations for the third quarter of 2022 was negative $3.8 million, and our net capital expenditures for the third quarter were $0.1 million, resulting in free cash flow for the quarter of negative $4 million. The negative free cash flow was primarily related to a seasonal increase in net working capital of $7.3 million during the quarter. Our net capital expenditures have totaled $0.4 million through the first nine months of 2022, highlighting both the capital-like nature of our business and our continued financial discipline. On September 30th, 2022, we had $9.9 million in cash and total debt of $7.8 million for net cash of over $2 million. We also had a borrowing base of $23.8 million on our undrawn ABL. Finally, NCS had net working capital of $56.9 million on September 30, 2022, an increase from $48 million at the end of 2021. We believe that the third quarter of 2022 marks the seasonal trough for our cash balance, with strong collections activity occurring in the beginning of the fourth quarter. By the end of October, our cash balance had already increased from $10 million to approximately $14 million. Turning now to a few points of guidance for the fourth quarter and the full year for 2022. We currently expect fourth quarter total revenue of $42 to $46 million, an increase as compared to the fourth quarter of 2021, but a decline from our robust third quarter. We expect our U.S. revenue to be between $13 and $14.5 million. We expect international revenue of $2 to $3 million, and we expect our Canadian revenue to be between $27 and $28.5 million, impacted by an expected seasonal slowdown in December due in part to customer budget exhaustion, as well as the weakening of the Canadian dollar relative to the US dollar, which accelerated in late September. We expect our gross margin percentage in the fourth quarter to be between 39% and 43%, reflecting the seasonal reduction in revenue sequential reduction in revenue, cost pressures, and FX impacts. We expect our reported SG&A expense to be between $13.5 and $14.5 million in the fourth quarter. This includes approximately $0.2 million of non-cash share-based compensation and approximately $0.9 million in litigation. We expect our fourth quarter depreciation and amortization expense to be approximately $1.1 million. As a result, our full year guidance for 2022 is as follows. We currently expect full year revenue of $157 to $161 million and full year adjusted EBITDA of $15 to $17 million. As compared to the guidance provided in August, the midpoint of our revenue range has increased by $6.5 million and the midpoint of our adjusted EBITDA range has increased by $1.5 million. We expect our gross capital expenditures for 2022 to be between $1 and $1.5 million, which is a decrease of over $1 million from our initial expectations for the year. We expect to generate positive free cash flow during the fourth quarter, but continue to expect modestly negative free cash flow for the whole year. Before we open the call up to Q&A, I'd like to make a few additional comments. First, I want to touch briefly on NCS's long-term strategy. Our leadership team has recently communicated our long-term strategy to employees across the company. We have three core strategies that we will follow over the next three to five years to drive growth and profitability in our business. The first core strategy is to build upon our leading market positions. One example of this is the success that we are having in Canada and growing our liner hanger business. By leveraging the core strengths and leading market share that we have in fracturing systems in Canada, we are able to deliver additional value to our customers by providing the full suite of equipment that they need for well construction and completions operations. The second core strategy is to capitalize on our growing set of international and offshore opportunities. Examples of how we are advancing this strategy include growing our customer base in the North Sea and expanding the suite of products that we have qualified and available to be used by Saudi Aramco in Saudi Arabia, including tracer diagnostics, our airlock casing buoyancy systems, and a unique composite centralizer product that reduces friction if casing is being run. The third core strategy is to commercialize innovative solutions to complex customer problems. For example, we are working with an international oil company to develop a completion system for deepwater offshore applications. Our solution is expected to enable this customer and likely others to enhance the economics of their deepwater wells by accessing additional deeper pay zones. They require an efficient system to hydraulically isolate and fracture multiple zones in highly deviated and horizontal wellbores. These core strategies are supported by our guiding principles of upholding the NCS promise, which embodies our values and which outlines the commitments we make to our key stakeholders. and to our other guiding principle of maximizing financial flexibility, which is supported by our Capital Light business model. We are working diligently to implement our strategy and to align our corporate, regional, and product line goals for 2023 with our long-term objectives. You'll hear more about our strategy and our progress in coming quarters. Next, we are pleased that a jury in a recent trial affirmed the validity of our patent utilized in our airlock casings buoyancy system, and concluded that the patent had been infringed upon. This is the second case we have won this year related to our casing buoyancy intellectual property, with total past damages awarded in those cases of approximately $2.4 million and the potential for future royalties with over 10 years remaining on the patent, though the awards remain subject to appeal. We make meaningful investments in research and development and in securing and maintaining our intellectual property and we will continue to defend our intellectual property if we believe that our competitors may be infringing upon it. I'd also like to touch briefly on industry consolidation. We've been consistent in expressing our belief that our industry needs to consolidate. We see significant value in our organic growth strategy and opportunities, but we are very well positioned to drive industry consolidation as well, leveraging our presence in multiple product lines and geographies, our strong balance sheet, and the infrastructure that we have in place as a public company. So to conclude, we continue to execute on our strategy and our growth initiatives. Achieving the midpoint of our annual revenue guidance would result in revenue growth of approximately 34% in 2022 as compared to 2021. We have the infrastructure in place to support revenue growth with leverage to grow future earnings as demonstrated by the 26% year-over-year incremental adjusted EBITDA margin achieved in the third quarter of 2022. Achieving the midpoint of our annual adjusted EBITDA guidance would result in adjusted EBITDA growth of approximately 75% in 2022 as compared to 2021, more than twice the rate of revenue growth, demonstrating the operating leverage in our business. We continue to successfully introduce new technologies that meet the needs of our customers, adding to our product and service portfolio and expanding our addressable market. We are diligently managing through the supply chain challenges that we and others in our industry are facing, and we are benefiting from price increases that we achieved earlier this year. The work is not done, however. We will continue to strive to be compensated for the value that we deliver to our customers. Our team at NCS continues to do a tremendous job operationally, with outstanding field execution and an excellent safety record. We maintain a very strong balance sheet and liquidity position, providing us with strategic flexibility. And finally, we believe that we are in a favorable multi-year cycle for our industry, with strong fundamental supply-demand dynamics paired with a measured and disciplined approach to growth. I'm excited by how NCS is positioned to participate in that growth and to deliver benefits to our employees, our customers, our shareholders, and our other stakeholders. With that, we would welcome any questions.