Q2 2019 Earnings Call
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I would now like to turn the conference over to your host Mr. Ryan Thomas. Please go ahead.
Our call today will be led by Robert Knepper, Our Chief Executive Officer, and I will also provide comments.
Before we begin our call today, we would like to caution listeners that some of the statements that will be made on this call could be forward looking statements and to the extent that our remarks today contain information other than historical information. Please note that we're relying on the safe harbor protections afforded by federal law.
Such forward looking statements may include comments regarding future financial results and are subject to several known and unknown risks.
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 Securities and Exchange Commission that outline those risks.
They also need to point out that in our earnings release and in today's conference call.
We have discussion will refer to adjusted EBITDA adjusted EBITDA margin adjusted EBITDA less share based compensation adjusted net income adjusted net earnings per diluted share and free cash flow all of which are non-GAAP measures of operating performance. We use these measures of operating performance because they allow us to compare performance consistently over periods without regard to costs associated with our current capital structure and in a manner that we believe better reflects our operating performance.
Our press release from yesterday, which is posted on our web site and see US multistage Dotcom provides reconciliations of these non-GAAP financial measures to the nearest GAAP financial measures with that said I'll turn the call over to our CEO Robert never.
Thank you Ryan and welcome to our investors analysts and employees, joining our second quarter 2019 earnings conference call.
Today, I'll review high level second quarter results and we'll discuss what we're seeing in our Canadian U.S. and international operations I'll also walk through the items that resulted in our gross margin being lower for the quarter and the work being done to improve it.
I'll also provide details on the cost reduction reduction initiatives that were mentioned in yesterday's earnings release.
After that I will turn it over to Ryan to discuss the quarterly results in more detail I will then provide some closing remarks, highlighting some of our recent accomplishments.
Total revenue in the second quarter was $39.8 million, 8% below the year ago period, and a 25% decrease sequentially and in line with the high end of the guidance we provided in last quarter's call.
Adjusted EBITDA in the second quarter minus $1 million reflected an adjusted EBITDA margin of minus 3%.
Starting with our Canadian operations, our revenue of $11.5 million for the second quarter was 17% lower than the second quarter of 2018, and 54% lower sequentially coming in slightly better than the high end of the guidance range provided in last quarter's call.
I'm very proud of what our team in Canada has been able to accomplish this year in the face of a very challenging market environment.
The group is truly firing on all cylinders right now executing on the business strategies, we have in place in that market.
We have a team that is working extremely well together and delivering excellent execution in the field, resulting in winning new business and gaining market share.
Our 17% year over year decline in revenue in the second quarter was achieved in the face of a 24% reduction in rig count.
And also in spite of pricing adjustments, we made in Canada last year, demonstrating significant improvements in market share.
We sold only 1% fewer sliding sleeves in the second quarter than we did in last year's second quarter and completed more wells with our customers.
Our business development and operations teams have effectively highlighted the value that we bring to our customers by leveraging publicly available data to demonstrate NCS is operational efficiency relative to other completion techniques and our direct competitors.
The work is directly translating into additional business, we're growing our presence with certain key customers, increasing our scope of work across our operating areas.
We're also leveraging our market position in fracturing systems to grow our sales of well construction products and tracer diagnostic services, allowing our customers to streamline their vendor relationships and providing us with incremental revenue opportunities.
While we continue to perform well in Canada. The overall market environment remains challenging based on conversations with our customers. We continue to believe that the capital budgets for 2019 will be more heavily weighted to the second half of the year than in prior years. However, the rig count thus far in the third quarter is 41% lower than last year, indicating that activity remains muted.
While current oil and condensate prices differentials and exchange rates as well as historically low service costs have positioned our customers to benefit from higher cash flows than expected in their initial budgets without additional pipeline capacity that remains little incentive for our customers to grow production.
As a result, we believe that the primary application of our customers excess cash flows will continue to be to reduce debt or return capital to shareholders until additional pipelines are completed potentially in 2021 or beyond.
Now turning to the U.S., our revenue for the second quarter of $26.7 million was 3% lower than the year ago period, but were 6% higher sequentially.
We delivered sequential growth in product revenues for the seventh consecutive quarter with 8% growth in the second quarter.
The product sales growth was primarily driven by repeat precision.
Revenue from our well construction products fell slightly during the quarter, reflecting a modest decline in volume as well as more competitive pricing environment.
Our fracturing services product sales were slightly higher in the second quarter as compared to the first quarter. We expect further growth in our fracturing systems business in the us in the second half of the year based on specific customer drilling and completions programs as our customers continue to value the combination of controlled fracture networks and the elimination of post completion intervention offered by our pinpoint completion technology.
U.S. services revenues declined by 2% sequentially with a slight increase in activity and tracer diagnostics offset by slight decline in services revenue related to fracturing systems.
Tracer diagnostics activity continues to improve modestly and we expect further growth in the third quarter.
The pricing pressure for our treasure diagnostic services business in the U.S. has largely stabilized and we continue to expect that we will be able to retain a premium to discounted competitive offerings based upon our ability to offer particular tracers and the quality of our field service and laboratory operations.
I'd like to highlight the success of our repeat precision business, our purple Sill Frac block has been first fully commercial for just over 18 months now.
And we are approaching 60000 cumulative plug sold we believe we are currently a top five supplier frac plugs in the U.S., an amazing achievement for an organic development.
Since commercializing the purple so frac plug we've continued to expand our product offering having introduced the purple Sill Express system, which combines our frac plug with a single use disposable setting tool. This integrated easy to use and factory assembled system now accounts for well over 25% of our plug sold and we believe the percentage will continue to move higher.
As we discussed on the last call Justice customer see the efficiency and field safety benefits of integrated perf gun and charged systems for per part of plug and perf operations, our purple Sill Express system bring similar efficiency and adjusted the benefits to the plug side of the equation.
We have also recently begun selling our RP 10, and RP 20 single use disposable setting tools on a standalone basis and have also introduced our purple sill bridge plugs responding to customer demand.
With these product introductions, we continue to expand the addressable market, we serve and provide flexibility to our growing customer base.
Our international revenue for the second.
Of $1.5 million was below the low end of our guidance. However, as we discussed during last quarter's call. We continue to expect our international revenue to be more heavily weighted to the second half of the year.
Our international activity has picked up significantly during the third quarter and we are either currently working in or expect to work in Argentina, China. The UK, the North Sea, Russia, Oman, and Saudi Arabia during the third quarter.
I'll now review, our gross margin performance for the quarter and the steps, we're taking to improve it.
Our gross margin for the second quarter was 42% down from 49% in the first quarter and below the midpoint of our guidance range. We had several factors that contributed to the results some of which we believe are temporary.
The first item is pricing, we're in a very competitive industry and one in which activity levels for our customers is declining in North America. This is apparently us rig count as well as completion counts and activity in Canada has been at depressed levels for over a year now.
There is overcapacity across all product and service lines right now and significant price competition across any moderately differentiated or commoditized product or service and we expect this to continue.
For NCS, we saw increased pricing pressure during the second quarter, and our well construction product line and to a lesser extent in fracturing systems treasure diagnostics and repeat precision.
We are focused on demonstrating the value that we bring to our customers to combat pricing pressure and are also exploring opportunities to produce savings through our supply chain to support our margins.
We have also experienced the impact of under utilization of our field service personnel in the us during the second quarter as we had lower volumes of fracturing systems and treasure diagnostics jobs than we anticipated.
Activity in both fracturing systems and trace or diagnostics has improved in the third quarter to date, which is helping to more fully absorb the fixed costs, we carry to support the business.
I mentioned earlier the growth that we had had repeat precision a result of increasing penetration of the purple still express within our product mix and the fact that we recently began selling our RP 10, and RP 20 single use disposable setting tools.
To accommodate this growth we opened the second manufacturing facility in Mexico in late 2018, we made the decision to move machining capacity that supports NCS sliding sleeve components to the new facility. So that we can integrate the full scope of our purple sill and setting tool operations and the original facility.
We plan to move of the sleep manufacturing equipment during spring break up when volumes are typically lower for our Canadian business.
As we have commission work at the new facility in Mexico, we have been slower to ramp up ramp up our prior volumes than we had anticipated.
We also had very successful sales efforts in Canada during spring break up which resulted in a rapid increase in sleep demand in June and into the third quarter as activity increase. These volumes also included additional work for larger.
A large existing customer and new operating areas.
The combination of a high volume of demand for sliding sleeves in Canada with relatively short lead times and delays in ramping up volumes at our new facility in Mexico required us to increase our utilization of third party machine shops to build sleeve components and assemble sleeves, primarily in support of our Canadian operations. The impact on NCS is twofold as pricing from outside machine shops is higher than our internal costs and because we don't benefit from our share of the profit generated with precision what an outside machine shop reduces sleeve components.
We believe that these issues will be fully resolved by the end of year, although an impact will continue to be felt in the coming quarters.
We are methodically, increasing our capabilities with the new facility in Mexico and have also renegotiated pricing with certain third party machine shops that we are using for an overflow capacity, which will partially mitigate future cost variances.
We are also working to staff a second shift in our Houston Assembly facility, which allows us to increase our assembly capacity without requiring any additional capital.
We are focused on both short term and long term initiatives to support our gross margin in the near term, we will work to increase the output from our new Mexican facility and continue the path to commercialization of our shorter lower cost sliding sleeve for high pressure applications.
We will also continue to gain efficiencies and cost reductions from other areas within our supply chain.
With these initiatives as well as the seasonal and market share driven growth that we expect in the third quarter, we estimate our gross margin to be between 42 and 46% in the third quarter.
Longer term margins can only be supported through continued innovation, bringing solutions to market that allow our customers to operate more efficiently efficiently reduce costs and improve profitability. We have R&D projects underway in each of our product and service lines to support innovation.
We also believe that our margins will also be supported through our growth in international markets, which are growing both onshore and offshore where our technology brings clear benefits to our customers and where the competitive environment is more disciplined than onshore North America.
Turning now to the cost reduction initiatives that were mentioned in yesterday's release as I've mentioned throughout this call. It's clear that we're operating in a challenging market environment with declining customer activity in North America, and excess capacity amongst our peers and competitors.
NCS has built and structured for growth both in North America and internationally and we continue to believe that we can grow our business in this environment.
Our management made the difficult decision to implement a reduction in force that impacted approximately 6% of our friends and co workers. We've also reduced salaries were certain executives as part of our cost reduction efforts. This was a very difficult decision. Since we believed that we were already lean and streamline with annual revenue per employee of approximately $500000, which is above many of our competitors.
We believe that the reduction in force and executive salary reductions will result in immediate pre tax annualized expense reduction of approximately $5 million, which will be primarily reflected an SDMA.
Beyond these measures we continue to evaluate other opportunities to further reduce expenses, which we expect to implement over the coming quarters.
We anticipate that we will incur onetime severance expenses related to the reduction in force of less than $1 million in the third quarter.
With the head count reductions, we also implemented changes to flatten our reporting structure and changes, which we believe will allow us to be more responsive to changes in the market environment accelerate new product development and support our international growth objectives.
We believe these cost objective or cost reduction initiatives will support our ability to generate free cash flow and will facilitate improved return on invested capital over time.
We continue to believe that the investments that we've made in the past several years organically through repeat precision and the spectrum acquisition provide us with multiple long term opportunities for capital efficient growth in each of the markets we operate.
We continue to balance the investments required to innovate and drive revenue growth with a capital light business model that can produce free cash flow.
We've taken steps to right size, our operations for the current market environment and are making progress on near term challenges that have impacted our gross margin.
Through disciplined growth and free cash flow generation, we plan to continue to improve our return on invested capital and create value for our shareholders.
Ill now turn the call over to Ryan to discuss our financial results in more detail.
Thank you Robert.
As reported in yesterday's earnings release, our second quarter revenues were $39.8 million, 8% lower than the prior year second quarter and in line with the high end of the guidance, we provided on last quarter's earnings call.
On a sequential basis overall revenue in the second quarter was 25% lower than revenue in the first quarter with a 6% sequential increase in us revenue more than offset by normal seasonal decline in Canadian revenue and lower international revenue.
Gross profit defined as total revenue less total cost of sales, excluding depreciation and amortization expense was $16.7 million in the second quarter or 42% of revenue. This compares to $23.5 million or 54% of revenue in the prior year second quarter with lower margins on both product sales and services revenue.
This gross margin percentage was below the midpoint of the guidance we provided for the quarter based on the factors Robert mentioned earlier.
First sequential comparison gross profit was $26.1 million or 49% of revenue in the first quarter.
Selling general and administrative costs or SGN today increased to $22.9 million in the second quarter from $22.1 million in the prior year second quarter, but decreased slightly from the first quarters level of $23 million. As a reminder, our reported SGN today include share based compensation as well as certain nonrecurring expenses, including ongoing litigation.
The year over year increase was primarily driven by higher head count increased litigation expenses support services related to our new ERP system higher share based compensation expense as well as higher bad debt expense, partially offset by reductions in accrued bonuses and other professional services.
Adjusted EBITDA for the second quarter was negative $1 million as compared to a positive $5.3 million in the prior year second quarter.
Adjusted EBITDA as a percentage of total revenue was negative 3% in the second quarter 2019.
Our second quarter, 2019, depreciation and amortization expense totaled $2.6 million.
During the second quarter, we recorded an impairment charge of $7.9 million to goodwill related to our tracer diagnostics reporting unit.
This impairment together with the deferred tax asset valuation allowance, we recorded in the first quarter resulted in an income tax expense of $2 million in the second quarter, Despite a pretax loss of $17.5 million.
We had net income attributable to non controlling interest of $2.7 million in the quarter, reflecting positive net income at repeat precision.
Our average basic share count for the quarter was 46.8 million and our current basic share count remains $46.8 million.
Our adjusted loss per diluted share for the second quarter was 11 cents compared to an adjusted loss per diluted share of nine cents in the prior year second quarter.
Turning now to cash flow items in the balance sheet.
Cash flow from operations in the second quarter was $9.1 million and was $6.1 million for the first six months of the year.
Our net capital expenditures for the second quarter were $1.3 million and were $4.1 million for the first six months of the year.
As a result, our free cash flow for the quarter was $7.8 million and was $1.9 million for the first six months of the year.
At June Thirtyth 2019, we had $12.2 million in cash and total debt of $19.5 million, which included $16 million drawn under our us revolving credit facility.
We reduced our debt balance by $6.5 million during the quarter.
We also have up to $59 million in total potential availability under our revolving credit facilities, bringing our total potential liquidity at June thirtyth, two approximately $71 million.
I'll close with a few points of guidance for the third quarter.
For the third quarter. We currently expect total revenue to be $59 million to $65 million.
With U.S. revenue higher by 8% to 18% on a sequential basis, driven by repeat precision fracturing systems and tracer diagnostics activity.
In Canada, we expect a seasonal sequential increase in revenue of 115% to 135% from the second quarter, reflecting improvements in our market share with new and existing customers.
We expect international revenue of approximately five and a half to six and a half million dollars as we benefit from the work we have across the multiple geographies that Robert mentioned earlier.
Approaching the higher end of the revenue range will depend primarily on continued seasonal increases in the rig count in Canada, which have been slower to materialize than in prior years.
We expect our gross margin to be between 42, and 46%, reflecting a modest increase relative to the second quarter, reflecting better fixed cost absorption and supply chain initiatives, we have underway.
We expect our reported EPS DNA inclusive of share based compensation and nonrecurring items to be between 21.5 and $22.5 million.
This includes approximately $3 million in share based compensation expense.
0.6 to zero point $7 million in severance expense related to our reduction in force and ongoing litigation expenses.
The decrease compared to the second quarter will primarily be driven by the cost reduction initiatives Robert outlined earlier.
We expect our third quarter depreciation and amortization expense to be between 2.6 in $2.8 million. We expect our net interest expense to be between 0.4 and zero point $6 million in the third quarter and we expect our book effective tax rate for the remaining quarters of 2019 to be a benefit of 15% to 20%.
We have again reduced our expected capital expenditures for 2019, with a new full year range of $7 million to $10 million.
At the midpoint of this range our capital expenditures for 2019 would be approximately 45% below 2018, and our $2.5 million below our initial guidance range for the year.
I'll hand, it over to Robert for closing remarks.
Thank you Ryan.
Before we open up the call for questions I'd like to highlight a couple of our accomplishments through early August .
In Canada, we continue to execute on our strategy to increase our market share and cross sell our products and services in order to fully capitalize on our strong market presence as I mentioned earlier, we sold just 1% fewer sliding sleeves and completed more wells in Canada in the second quarter as compared to the second quarter last year. This coming in the face of a 24% year over year reduction in rig count.
In the US we have posted our seventh consecutive quarter of increased product sales driven in large part by market share growth for our purple sill, Frac plugs and a continued expansion of repeat precision product offering in response to customer demand.
We expect continued growth in the us in the third quarter, despite a declining rig count and flat completions market with improving activity across fracturing systems treasure diagnostics and repeat precision.
Internationally, we successfully shifted sleeves that had been installed in the customers well in China for over four years, which speaks to the quality and durable products.
We have also booked follow up orders for products that were trials in Saudi Arabia and have secured a trowel for work in Oman.
We continue to grow our presence in international markets, which we believe will have a more stable near and medium term outlook than North America.
I'll close with just a couple of brief comments, we continue to execute on the strategies that we've had in place for the past several years, we have leadership positions in the product lines and services in which we compete.
We have tactically expanded our product and service offering over time and have invested in our sales force and international infrastructure to allow us to capitalize on our revenue opportunities across the globe.
We are not immune however to the challenges that are we're facing as a company and our industry in North America. We are focused on addressing the company specific challenges that we faced in the second quarter as we rapidly increased our activity in response to customer demand, which we believe will lead to a recovery in our gross margin in the second half of the year.
In addition, we recognize that our customers are reducing activity levels in North America limiting growth opportunities and increasing competition. Among service companies. We have made the difficult choice to implement cost reduction initiatives that included a 6% workforce reduction in order to better align our operations with the opportunities in the market.
We have already achieved run rate savings approximately $5 million from these actions and are actively evaluating and implementing strategies to further reduce our expenses.
As a technology driven company, we continue to innovate to bring new products and services to market that are highly valued by our customers improving efficiency, reducing costs enhancing recoveries and improving their financial returns.
As a result, we believe we are well positioned to deliver capital efficient long term organic growth through increased adoption of our innovative completion equipment and services.
Our capital light business model provides us with the ability to generate free cash flow, while maintaining a very strong balance sheet.
This in turn provides us with optionality to allocate capital to high return investments and evaluate options for the return of capital to shareholders over time.
And with that we'd be happy to take your questions.
Ladies and gentlemen, if you have a question at this time. Please press. The Star then the number one key on your Touchtone telephone. If your question has been answered or you wish to remove yourself from queue. Please press the pound key.
And our first question comes from the line of our Sean Atkins with Raymond James. Please go ahead.
Good morning, guys.
It seems like your Canadian share and sliding sleeves continues to be a stand out on the positive side, it's all got to.
Start with good given the increasing concerns apparent child in the US where do you stand on penetration of that market in the us and.
And.
Give us some color on.
Why the Canadian market share continues to grow.
And us guys seem to be.
I guess, a little slower to to buy into the sliding sleeve same.
Yeah, Good morning Marshall.
Yes, so as I said earlier I am really proud of the effort that that our teams put in place in Canada to grow market share there that market share is not coming from the existing basins that in which we're working it's coming from the new areas. So the montney the do Vinay.
With existing customers, but also with new customers for NCS as we look to the us and our efforts with sliding sleeves here as I've mentioned on the last three or four calls.
We recognize the fact that we havent grown the market share in the US the way that we had hoped that we would and Theres a number of factors. We believe that that are related to that one. It's just been very very difficult with the technology. That's been entrenched for 30 years in the industry the infrastructure around plug and perf is is built out and it's very difficult to get customers to change, but one of the big big issues is that plug and perf has become much more efficient in terms of costs over the last three to five years.
Where when we first came into the U.S., we were slightly cheaper than than plug and perf in terms of the cost for the customer and now plug and perf is in some cases less expensive than than pinpoint is so the value proposition to a customer would be you have the potential to get better production.
But there is no way to prove that up front. So the customer we're faced with a more expensive completion technique.
Chooses not to not to change over however, what we have seen in the US is that if we if we break the our dissect the market down and to all the different opportunities out there there are certain areas in certain applications, where we and our customers believe pinpoint is superior either from a cost standpoint or from an efficiency standpoint.
Some of those opportunities are.
Were you just mentioned the child parent relationship the impact of Frac hits on offset wells. That's one application where our customers are are using us for value and the cost is about the same or little bit more for the customers, but what they're seeing is they are better able to control the issue of impacting their offset wells during the frac jobs.
Another opportunity that we've seen where we continue to get repeat businesses in basins, where there is lower pressure in the formation, which causes drill out issues when you're drilling out composite plugs.
On the drill outs can be quite long the risk is higher because there is a risk of actually getting the bundles simply stuck and so to remediate those types of issues is very expensive. So when you look at the cost for pinpoint compared to plug and perf and those applications and you amortize it over a project it is less expensive and customers recognize that so as we as I said earlier, we expect fracturing systems to to grow sequentially in the us in the third quarter over the second quarter.
We continue to focus on that product line, we have product line manager over that product line. We continue to improve the products. We have we continue to take cost out of the system. So that it is more competitive with plug and perf.
But again, we realize that it's just not going to grow as fast as we hoped it would originally.
Okay, you mentioned that I guess in your earlier comments you are having.
A lot of competitive pricing issues I, just assume maybe as competitors sliding sleeves, but it sounds like it's more competition and plug and perf is that on the cost side or pricing side that reading that right.
You are you are in the us the the the real competitor is plug and perf and the cost pressure is on the cost of plug and perf versus sliding sleeves.
One of the one of the other things I didn't mention.
That does seem to be changing in the market a bit which is a tailwind for us is that when we do a cost analysis for a customer on what it costs to do pinpoint versus plug and perf.
There's there's puts and takes there theres theres coal tubing unit on location longer doing pinpoint.
That's a that's a cost add but you don't have to pay for the wireline or for the for the composite plug, but one of the big offsets the cost is that doing pinpoint.
Theres not as much horsepower, Florida location, so instead of a 50000 horsepower, Brad we only need 35000 horsepower.
And so there is a cost benefit for the customer there that offset a significant amount of the of the savings that plug and perf has.
We've had difficulty in being able to to have our customers be able to take advantage of that in the past because most customers are contracted in their contracted for frac spreads and those frac spreads are 50 60000, whatever the whatever the size is and it's been very difficult for the customers to get their service providers to change the contracts. So that they can get 35000 horsepower or whatever the requirements are for that operation and get the cost reduction associated with that but in the environment that we find ourselves in today, what we're seeing is that the customers are having.
More success in being able to get those pricing contracts changed so that they are only paying for the horsepower. They need. So we believe that's a tailwind that we haven't really factored into.
The activity growth that we see in fracturing systems, but it certainly it certainly could give us an additional boost.
Yeah that makes a little more sense since there's a few extra horsepower on the fence right now.
Shifting gears to the tracer and international guidance, which for the for this upcoming quarter looks.
A lot better.
I guess as a positive surprise for me.
You have the rig count going down the us trace revenues going up so give me some color on that and likewise, the international business. It looks like a substantial quarter to quarter improvement expected. There is that just normal lumpiness. We should expect to continue going forward or is there something else.
That you can help us.
The thought process there.
Yes first on tracer diagnostics.
In the last call, we talked about the pricing pressure that that we were seeing in the marketplace is twofold one the third.
Deduction and activity in the us market.
As well as on new competitors coming into the marketplace with treasure diagnostics and there was a lot of pricing pressure and we were holding prices a little more from then.
Than than what our competitors were and so it did cause a revenue reduction in in the first quarter and as well as the the the fourth quarter from the previous year. So that has somewhat mitigated itself.
We've we've made some adjustments.
And pricing, but we've also been able to.
Go back to our customers and where they have had an opportunity to try new entrants into the market seen what the quality was that they were they were actually getting we've been able to win back some of that work. So in fact recently, we have been a number of times, we've been completely sold out in terms of personnel being able to go location. So we've seen seem that that changing in the market and some of the lower pricing. We know that we believe was not sustainable we're starting to see it wasnt sustainable and those prices have slightly come up so all those things together have combined in helping us to.
To have a more clear view that tracer diagnostics is increasing in the us.
Looking at the international business on the last call I mentioned that that.
We were going to be down in revenue in the second quarter.
But that we expected that we would have a pretty big big jump in the in the second half of the year and Thats exactly what what we're seeing now and it is lumpiness in the international markets, but its not unpredictable lumpiness. If you will so what this was was a result, I mean, a big part of that increase.
Is from the Aker BP contract that we've got in the North Sea that project had stalled for a bit.
With the intention of kicking back off in the third quarter, which we were actually seeing now we've already have shipped orders.
Into into Norway, now to support that project and we continue to see that that business growing as we thought that it would.
But we've also been successful in getting some trial wells in the Mideast, which as I'm sure. You know is pretty big it can be a long protracted process to be able to even get those field trials, we've been successful in being able to make it less.
Unless long process and Weve had success in the field trial. So now we're starting to see the benefits of that and so there's been a lot of things that we've been doing over the last few quarters internationally and it just takes time to build up over time, but I think we will see that the international business will continue to be lumpy.
But we will see it.
The line will be moving up to the right.
Yes, and you'll have visibility ahead of time. Thank you all very much.
Thanks Marshall commercial.
And your next question comes from the line of Sean Meakim with Jpmorgan. Please go ahead.
Thanks, Hey, good morning.
Well Sean.
Maybe to follow up on the comments on pricing pressure core talked about the discretionary nature of spend on tracers on their call.
Which is what how they described the impact they saw in the second quarter, reducing their revenue doesn't sound like you had the same experience in the second quarter, but you did to some degree in the first quarter.
And you see some pricing pressure in the other product lines going well construction that you called out. So can you maybe just give us some more detail on pricing pressure in terms of the fundamental drivers for each of the major product lines I kind of think of.
Tools as generally always experiencing declining pricing for any product just due to the natural obsolescence cycle. So you always need to deliver new iterations of products to support your pricing in your gross margins. So how much of what you're seeing is natural pressure on pricing versus more aggressive behavior by competitors and even your customers is there they are feeling the squeeze.
To reduce their costs as well.
Yes, so it's a mix of all that I mean I appreciate the comments.
That you mentioned the core had around discretionary spending and certainly we saw some we see some of that because there are projects, where that's one of the things that gets cut earliest in a budget.
But it hasn't been that significant for us.
In the tracer product line. The most significant pricing pressure that we saw was from a new entrant into the market and really how are you going to get market share when you come in with the new service offering and its cut price and typically if there is if its not a better widget. So that's what we saw in Q4 in the first quarter this year and into the second quarter. This year, but as I mentioned earlier you know that's that's starting to alleviate a bit.
Looking at fracturing systems, the pricing pressure, there is really against plug and perf and not necessarily direct competitors in the us.
However, in Canada, there is direct competitive pressure, which we just deal with and as you say you have to come out with new products and services to.
Continue to obsolete. So that you can continue to stop pricing pressure in that and that's what we've done.
We continue to add to bring out the what we call. The HP threes that we've been talking about it's the lower cost sliding sleeve.
That we expect to see some benefit in margin from coming into the third quarter and into the fourth quarter of this year.
But yes, I mean with fracturing systems, we probably see less pricing pressure.
From a pure competitive standpoint, the U.S. than than any other product line.
Looking at repeat precision our composite plug product line. So we've we've chosen not to be the low cost provider. We believe that we have a differentiated technology, they're not just with the purple Sill Express, but also inherent into the plug itself. A few of the features and benefits there that are bringing value to customers and so we've been able to hold pricing fairly steady there, but we still I mean, there's there's 30 competitors with with composite plugs out there and there there's.
At some point will be a fight to the bottom, but right now we're not seeing what we're seeing prices somewhat stable in that but that could change over time as you say before you know if if if it's a highly commoditized product offering pricing does tend to disintegrate pretty quickly, but right now we've been able to hold our pricing and repeat precision product line. So thats.
Finally, the the other products that we have.
Product line is wellbore construction, so primary airlock, which the airlock if you recall as a as a product that we developed a few years ago introduced into the market Wasnt unique.
There was another company that had a version of a case of buoyancy system, but it was very expensive in terms of rig time as well as the cost of the customer to buy it.
But what we did as we were able to design something that was a fraction of the cost of the customer.
And was intervention lists and so.
Where a market where there was probably 1% of the of the wells total that were using case Morenci now we believe that that's that's climbed above 15% and still climbing higher and with any type of successful new product coming into the market. There is going to be competition and so we've seen a number of other companies that have come into the marketplace with similar type offerings and so that it drives pricing pressure, but again as you mentioned earlier, we have to continue to innovate and we have nine new improved offerings on the on the what we call. The airlock system that are coming out, but we have to continue to innovate that and that's one of the reasons that we continue to have a strong as DNA spend because we do invest in technology development.
Right. Thank you Thats really helpful feedback and its a good segue.
I was hoping to get more feedback on your cost structure going forward. So you noted your revenue per employee is fairly high versus peers at 500000, each and no doubt and then making these kind of cost reductions decisions are difficult.
So after cost reductions your DNA is still running at 40% to 45% of sales on a trailing 12 month basis. So if activity does not recover above two Q1 9 levels lets say through the end of next year.
And it seems like there is an increasing portion of the probability distribution that says that could be the case.
What levers are available to you to improve profitability.
So international growth is one piece you highlighted just more opportunities growing there.
What else is available to you in that scenario or do you just hold tight for optionality for market share growth in the us.
Well.
We are going to control the things that we can control and the market share growth for sliding sleeves or fracturing services in the US is something that we expect to continue to grow over time, but it's not going to be the big driver that we had hoped it was at one time. So we're not going to just sit and wait for something to happen or not happen.
So as we have done in the past over the last three years, we'll continue to add ways that we can.
To take advantage of the infrastructure that we built as a company at NCS.
Both in our ability to introduce new products into the market as well as the channels that we've already developed into markets as you've seen our international business is growing.
As a result of effort that we put in and infrastructure that we put in place over the last couple of years and so we're starting to see that pay off and so we'll continue to drive other products and services out internationally, that's a big opportunity for us because right now and a lot of the places that we work internationally, it's a single product service.
And we're just starting to drive additional products into some of the markets. As an example in Argentina started there with with.
Fracturing services and now tracers is becoming a pretty big part of that business has and will continue to drive wellbore construction products and our rubber precision products into those markets. So we have a lot of opportunities internationally.
We still have a lot of a lot of room to run in the us with with our repeat precision products. So as I mentioned earlier only about 25% of the plugs that we sell today are people still express. So that's that's something that's growing very fast for us.
We're still in one of the top five providers of composite plugs in the U.S. So there's still opportunity for us to continue to gain market share as we've done over the past. So we'll continue to pull all the levers that we can to to continue to add products. We look at our engineering effort I talked on the last call about our enhanced oil recovery systems that were being developed and that were filled trawling today, that's not up 20.
2020.
Big revenue producer, but in 2021, it could be a really big revenue producer, but we'll continue to invest in those and when we make decisions today, Sean on on how to allocate the capital and how to allocate our SGN, a spin which is where our our research and development spend is and.
If we see a market that we can't grow in.
Are we can't grow to the extent that we think is appropriate.
And we'll have to make some decisions on how we allocate that spend do we continue to invest in and our longer term projects or do we just invest in shorter term projects. As you pointed out as gene is still a big percentage of of our revenue and as we believe its appropriate today, but if market conditions change we have the ability to adjust that just as we've made some made some tough decisions previously.
But we're also not finished with our cost cutting measures.
We've we've made the head count adjustments that we think are appropriate for now but there are still other other line items and SGN a other than head count that we're focused on.
Making reductions in and doing things that we believe are more appropriate environment that we're in today. So there will be more cost cutting measures that you'll see the benefit of over the next quarters I mentioned earlier.
But this is the start.
It is definitely not easy decision that I appreciate all the feedback there. Thank you Robert.
Thanks, Sean.
And your next question comes from the line of Ian Macpherson with Simmons. Please go ahead.
Hi, Thanks, good morning.
Hey in rubber given how.
You've described the.
Technological innovations and plug and perf have really improved the the cost competitiveness.
In the us.
I imagine you're.
Even though your total US revenue mix continues to do better than the market your revenue growth that is.
Your mix must be less weighted towards leads than you had envisioned a couple of years ago and I just wonder how you think about deployment of R&D capital for the us market going forward, if you think that.
You need to continue to emphasize your brand.
Pinpoint brand in the us or endpoint is really just under a much broader umbrella.
In terms of new product development going forward, and really becoming more of a hybrid that embraces plug and perf for the us market over the next two or three or four years.
Yes, I think thats, probably the right way to think about it.
It's another service offering and product and service offering that we have in the us it's not going to be what we had hoped it would be three years ago.
But it's still something that we can continue to grow in the us and we can make money off of it.
Traditionally the R&D spend has been highly weighted to pinpoint.
Because that was the primary business. It was the only business line for years ago. So as we as we've changed over time, we've also changed our philosophy on how we how we allocate those R&D dollars.
It was still a very high spend in research and development in 2018, but thats coming down now.
As of last quarter, we are sorry as of the beginning of the third quarter.
We had.
R&D product projects for each of our product lines and engineering for the first time ever. So we are allocating additional spend for repeat precision.
For Wellbore construction.
There's there's still different places are different ways that we can add products and some of the current year.
Product groups. If you will that we offer today that we're focused on and I mentioned the art again I mean, that's that's something that it's a longer term project, but it has the potential to be to be a really big project.
One of the things that we've been fortunate to be able to do is instead of having to to fund 100% of that development internally at NCS. We we were just.
Chosen to participate in a department of Energy program, where we do have a grant for funds and we're working specifically with a with another operator.
Well with the S&P operator and.
The Neo our project, where our cumulative.
Product line is going to be develop so we'll we'll be able to continue to fund the development of that project, but we will have to do it organically.
That's interesting thanks Robert.
Unless I missed it it sounded like you can find your second half guidance to the third quarter.
I believe that was the case, but.
I was impressed by.
Outlook for US total revenues in the third quarter given how.
How challenging the market is double digit topline growth would be certainly differentiated do you have any visibility beyond the third quarter to the U.S. could could remain similar or even stronger in the fourth quarter or is that just.
Okay. At this point I think we would expect the seasonality lower in the fourth quarter for Canada, but just curious about the U.S. side and then.
Following that maybe any anything you could tell us about the margin progression.
Q3 into Q4 as well as possible.
Yes, as far as Q4, I could guess if you want but that's that's all it would be.
We don't really have clear visibility on the I think there is a possibility in the fourth quarter that that we could see budget exhaustion. The customers that were talking that we're working for today and talking to.
They are not given us real clear guidance on what the fourth quarter looks like so we we don't have anything better than any of the other 14 calls that you've heard over the last couple of weeks.
I'm sorry, what was the other part of that question Marty Marty.
Margin progression right.
Yes, what I'll say on the margin.
What I'll say on the margins is what was what was said earlier is that the 42% that we posted for Q2, that's that's the bottom we believe.
And there's a number of ways that I discussed earlier that that were going to move that margin back up I mean, the way I look at the margin is that that was an investment that we made.
And future revenue.
The the biggest piece of the margin decline that we had was around our cost structure. So pricing certainly was part of it but the biggest part was.
We got a contract for a customer one of our large customers in Canada.
That we weren't expecting to get that had incremental business in it and our supply chain wasnt set up to be able to fill those orders, but we also we also.
Sorry, there's something a little high and we also got.
There were two major customers in.
And the deep basin plays in Canada that we got awarded work for that is continuing work and so we weren't expecting that so the cost to be able to support those projects because we didnt, we werent ramped up forward.
That was the biggest driver and hurting our gross margins, but as I mentioned earlier, we're we were putting things in place to get that back aligned and we'll see that move out over the next two quarters.
So you would say that the sequential decline from Q1 to Q2. When your margins went from 49 to 42 that third party machining costs was the biggest individual component of that that pressure in the second quarter.
That was the biggest individual if you put.
That with the pricing pressure.
Primarily in Wellbore construction.
That was probably 75% of it both of those combined.
Got it thanks, a lot Robert pass it over.
Thank you.
And your next question comes from the line of George O'leary with Tudor Pickering. Please go ahead.
Good morning, guys.
Hey, George.
Thank you guys mentioned that disposable setting tools is seeing some some tailwind and also kind of sales and then.
Independently I Wonder if you could provide more color on what.
Exactly that means and how that's a change from how you've been selling it historically does that mean, you're kind of de bundling. It from wells Frac plug in certain instances anymore color there would be would be appreciated.
Sure as when we started this project with the with the disposable setting tools.
We chose to focus on what we call Purple Sill Express, which is where we deliver a complete unit to location that includes the the bridge plug and the setting tool.
As we've been able to ramp our capacity and our ability to build these tools.
We have started to expand that and what that allowed us to and what that means is that we're not just selling the setting tools on a bridge plug we're going to wireline companies now and selling the the setting tools directly to the wireline companies and they can put it on whoever setting tool or whoever's plug that they want to put it on so it's a it's a really big market that we didn't take advantage of early on because we didnt have the capacity to do it but now that we've been able to build out the capacity, we're starting to expand into that other market and that is very well most likely will be a higher number of setting tools get sold through that channel versus on the on the bridge plug itself, but the bridge plugs the purple Sill Express the bridge plug in the in the setting tool together. It is highly differentiated right now and we're the only ones in the market that are doing it.
Great Thats helpful color and then just also curious on the intervention Lis system you guys have been working on for some time now so any update there.
On progress seems likes is we go out in the field and talked to some folks it's still love to see.
More sleep products, where you don't have to use coil tubing.
Alongside them and is that seems like a nice market opportunity for you guys. Just curious what you're seeing there how dialogue with customers is on that front as well.
Yeah. We're hearing the same thing, but cost is whats driving everything and so the system that we will that we're working on that we have the the interventional system.
And I talked about the improvements in the cost structure for plug and perf over the last couple of years well those those.
Efficiencies have been significant enough that an interventional system has to be cost competitive with it and the interventional system that we were working on.
That we began working on was what we found in this new environment, it's not going to cost competitive with plug and perf. So we've actually change the.
The engineering specs on that and we're still working on an interventional assist them, but it's probably going to be more for tow type applications and it is going to be for full wellbore, just because plug and perf has become so much more efficient from a cost standpoint.
But yes the market the market is looking for something interventional as it just has to be cost competitive as well.
Thanks, guys.
Thank you.
And your next question comes from the line of Kurt Hallead with RBC capital. Please go ahead.
Hey, good morning, guys I know it.
Hey, Kurt Kurt.
The.
Appreciate all the color you provided so far.
I guess the focal point for me at this juncture would just be.
Just getting a read on on the pathway to free cash flow as you kind of get through the second half of <unk>.
Of 19, maybe maybe we'll get started Darren and maybe focus on the working capital dynamics, because you've already provided.
Our guidance on Capex.
Sure occurred as.
As we've said in the call. We still believe we can deliver free cash flow in 2019.
Where were modestly free cash flow positive through the first six months of the year and I would point out that we have many adjustments there in the cash flow from operations were also counting $3 million that we paid to repeat precision as part of that earn out.
We would expect the second quarter from a working capital perspective to create a little bit of a draw.
So.
Maybe about free cash flow neutral through the first nine months and then generate additional free cash flow in the fourth quarter to keep us positive on here.
Okay, and then and then that positive won't swing factor will come from working capital Okay.
Earnings and working capital.
Okay, all right I appreciate that now.
Yeah again, you guys have gone through great pains to.
Explain.
What you see happening with respect to your business in particular and I would echo one of the earlier questions about the one thing that definitely caught my attention was your expectation for us revenue growth.
In the third quarter, given everything that we've heard from the industry about activity being down.
Both in terms of rig count and completion activity in the.
In the third.
So pretty clear you talked about purple seal express.
And gaining share and those types of dynamics, but I was hoping maybe you could flesh it out.
Just maybe a little bit more and what is driving that conviction or that expectation I would say.
For for your revenue growth to more than bucked the trend on total activity in U.S.
Its all market share the market is definitely down, but we're fortunate enough that our market shares are low and fracturing services. Some of these less than 1% of the market. So we're not dependent on 100% of the market Margo Tailwinds will be fantastic because there are certain areas that we've traditionally work worked in with fracturing systems, where customers aren't working right now just because economics, so we'd love to have those tailwinds, but having said that.
With Purple Sill express with the with fracturing systems with our treasure diagnostics business, we can still grow.
Growth through market share and we it's not that we hope to get the market share its market share that we've already gained and that we have and that we see orders for so we feel fairly comp confident in.
Putting out there what we can do in the third quarter.
Matt Hi, printing, it's faring very impressive in the context of the Canadian dynamic right you referenced again overall activity there being down 40% on a year on year basis, and however that activity level progresses.
Yeah, so to to what extent do you think you could outperform that it should we use kind of the proxy so far.
Through the first half of the year and kind of looking at your Canadian revenue relative to activity and kind of extrapolate that.
Through the full second half of the year.
Would that be a fair way to kind of assess your Canadian market position.
Yes, I think what I'd say is we've certainly increased our market share with the within fracturing systems in the Canadian market over the course of the last six nine months.
We've also been successful in bundling together, well construction and tracer diagnostic products, taking advantage of the platform we have there.
If you're looking for some calibration as far as how as to think about Canada going forward I look more at the combination of the first nine months, including our guidance for this quarter as opposed to just the first six months.
Okay.
All right Thats helpful. Now over the last couple of years.
There has been a seasonal dynamic in the fourth quarter were your revenues have come down.
I then Robert I know you answered the question earlier it'd be a pure guess on your part and I think we're all guessing at this stage as to what May transpire in the fourth quarter, but let's just assume that 19 kind of replicate 17, and 18, you get a seasonal downtick in revenue given the cost.
Reduction measures that you have in place and and so on is there an outside chance that your margins could gross margins could potentially hold firm, even if revenues declined in the fourth quarter that would be.
Happy too much to ask what's your sense.
Well it just depends on the magnitude of it Curt, but you know we we.
We do believe that were hit the bottom for the gross margins anyway.
Okay, all right I appreciate that thanks, guys.
All right. Thanks.
And your final question comes from the line of Chris Lee with Wells Fargo. Please go ahead.
Good morning.
Good morning, Chris.
Most of my questions have been answered, but I guess, just one to get a little color around the us and Canada can you give a sense of the portion of revenue that came from.
Leaves frac plugs and other products like airlock, respectively, or maybe rank at least in those markets.
We don't we don't break down revenues like that we just break it down by service and sales.
Okay.
That's all I had thanks.
All right. Thanks.
And Im showing no further questions at this time I would now like to turn the call back for closing remarks.
On behalf of the entire management team and our board, we'd like to thank everyone that joined us on the call today, including our shareholders employees and research analysts who cover NCS.
I'd like to personally thank our nearly 400 employees around the globe, which I continue to believe is the best team in the industry.
It's through the talents effort and dedication of this team that NCS is able to grow our customer base provide exemplary customer service and drive the innovations that we bring to the industry. We appreciate everyone's interest in NCS multi stage and we look forward to talking again on our next quarterly earnings call in November .
Thank you operator.
Ladies and gentlemen. This concludes today's conference. Thank you for your participation and have a wonderful day you may all disconnect.
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