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MarketScreener Homepage  >  Equities  >  Nyse  >  Nine Energy Service, Inc.    NINE

NINE ENERGY SERVICE, INC.

(NINE)
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NINE ENERGY SERVICE : MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (form 10-Q)

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05/08/2020 | 06:08am EDT
The following discussion and analysis of our financial condition and results of
operations should be read in conjunction with the accompanying unaudited
condensed consolidated financial statements for the three months ended March 31,
2020, included in Item 1 of Part I of this Quarterly Report on Form 10-Q and the
consolidated financial statements and "Management's Discussion and Analysis of
Financial Condition and Results of Operations", including "Critical Accounting
Policies", included in our Annual Report on Form 10-K for the year ended
December 31, 2019.
This section contains forward-looking statements based on our current
expectations, estimates, and projections about our operations and the industry
in which we operate. Our actual results may differ materially from those
discussed in any forward-looking statement because of various risks and
uncertainties, including those described in the sections titled "Cautionary Note
Regarding Forward-Looking Statements" and "Risk Factors" in this Quarterly
Report on Form 10-Q and "Risk Factors" in Item 1A of Part I of our Annual Report
on Form 10-K for the year ended December 31, 2019.
OVERVIEW
Company Description
Nine Energy Service, Inc. (either individually or together with its
subsidiaries, as the context requires, the "Company," "Nine" "we," "us," and
"our") is a leading North American onshore completion services provider that
targets unconventional oil and gas resource development. We partner with our
exploration and production ("E&P") customers across all major onshore basins in
both the U.S. and Canada as well as abroad to design and deploy downhole
solutions and technology to prepare horizontal, multistage wells for production.
We focus on providing our customers with cost-effective and comprehensive
completion solutions designed to maximize their production levels and operating
efficiencies. We believe our success is a product of our culture, which is
driven by our intense focus on performance and wellsite execution as well as our
commitment to forward-leaning technologies that aid us in the development of
smarter, customized applications that drive efficiencies.
Business Segments
The Completion Solutions segment provides services integral to the completion of
unconventional wells through a full range of tools and methodologies. Through
the Completion Solutions segment, we provide (i) cementing services, which
consist of blending high-grade cement and water with various solid and liquid
additives to create a cement slurry that is pumped between the casing and the
wellbore of the well, (ii) an innovative portfolio of completion tools,
including those that provide pinpoint frac sleeve system technologies as well as
a portfolio of completion technologies used for completing the toe stage of a
horizontal well and fully-composite, dissolvable, and extended range frac plugs
to isolate stages during plug and perf operations, (iii) wireline services, the
majority of which consist of plug-and-perf completions, which is a multistage
well completion technique for cased-hole wells that consists of deploying
perforating guns to a specified depth, and (iv) coiled tubing services, which
perform wellbore intervention operations utilizing a continuous steel pipe that
is transported to the wellsite wound on a large spool in lengths of up to 30,000
feet and which provides a cost-effective solution for well work due to the
ability to deploy efficiently and safely into a live well.
On August 30, 2019, we entered into a Membership Interest Purchase Agreement
("Production Solutions Purchase Agreement") with Brigade Energy Services LLC
("Brigade"). Pursuant to the Production Solutions Purchase Agreement, on such
date, through the sale of all of the limited liability interests of our wholly
owned subsidiary, Beckman Holding Production Services, LLC, we sold our
Production Solutions segment to Brigade. For additional information on this
divestiture, see Note 1 - Company and Organization included in Item 1 of Part I
of this Quarterly Report on Form 10-Q. Prior to August 30, 2019, we reported our
results in two segments, the Completions Solutions segment and the Production
Solutions segment.
The Production Solutions segment provided a range of production enhancement and
well workover services that were performed with a well servicing rig and
ancillary equipment. Our well servicing business encompassed a full range of
services performed with a mobile well servicing rig (or workover rig) and
ancillary equipment throughout a well's life cycle from completion to ultimate
plug and abandonment. Our rigs and personnel installed and removed downhole
equipment and eliminated obstructions in the well to facilitate the flow of oil
and natural gas.
How We Generate Revenue and the Costs of Conducting Our Business
We generate our revenues by providing completion services to E&P customers
across all major onshore basins in both the U.S. and Canada as well as abroad.
We primarily earn our revenues pursuant to work orders entered into with our
customers on a job-by-job basis. We typically will enter into a Master Service
Agreement ("MSA") with each customer that provides a

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framework of general terms and conditions of our services that will govern any
future transactions or jobs awarded to us. Each specific job is obtained through
competitive bidding or as a result of negotiations with customers. The rate we
charge is determined by location, complexity of the job, operating conditions,
duration of the contract, and market conditions. In addition to MSAs, we have
entered into a select number of longer-term contracts with certain customers
relating to our wireline and cementing services, and we may enter into similar
contracts from time to time to the extent beneficial to the operation of our
business. These longer-term contracts address pricing and other details
concerning our services, but each job is performed on a standalone basis.
The principal expenses involved in conducting our business include labor costs,
materials and freight, the costs of maintaining our equipment, and fuel costs.
Our direct labor costs vary with the amount of equipment deployed and the
utilization of that equipment. Another key component of labor costs relates to
the ongoing training of our field service employees, which improves safety rates
and reduces employee attrition.
How We Evaluate Our Operations
We evaluate our performance based on a number of financial and non-financial
measures, including the following:
•            Revenue: We compare actual revenue achieved each month to the most
             recent projection for that month and to the annual plan for the
             month established at the beginning of the year. We monitor our
             revenue to analyze trends in the performance of our operations
             compared to historical revenue drivers or market metrics. We are
             particularly interested in identifying positive or negative trends
             and investigating to understand the root causes.


•            Adjusted Gross Profit (Excluding Depreciation and Amortization):
             Adjusted gross profit (excluding depreciation and amortization) is a
             key metric that we use to evaluate operating performance. We define
             adjusted gross profit (excluding depreciation and amortization) as
             revenues less direct and indirect costs of revenues (excluding
             depreciation and amortization). Costs of revenues include direct and
             indirect labor costs, costs of materials, maintenance of equipment,
             fuel and transportation freight costs, contract services, crew cost,
             and other miscellaneous expenses. For additional information, see
             "Non-GAAP Financial Measures" below.


•            Adjusted EBITDA: We define Adjusted EBITDA as net income (loss)
             before interest, taxes, and depreciation and amortization, further
             adjusted for (i) property and equipment, goodwill, and/or intangible
             asset impairment charges, (ii) transaction and integration costs
             related to acquisitions, (iii) loss or gain on revaluation of
             contingent liabilities, (iv) gain on extinguishment of debt, (v)
             loss or gain on the sale of subsidiaries, (vi) restructuring
             charges, (vii) stock-based compensation expense, (viii) loss or gain
             on sale of property and equipment, (ix) other expenses or charges to
             exclude certain items which we believe are not reflective of ongoing
             performance of our business, such as legal expenses and settlement
             costs related to litigation outside the ordinary course of business.
             For additional information, see "Non-GAAP Financial Measures" below.


•            Return on Invested Capital ("ROIC"): We define ROIC as after-tax net
             operating profit (loss), divided by average total capital. We define
             after-tax net operating profit (loss) as net income (loss) plus (i)
             property and equipment, goodwill, and/or intangible asset impairment
             charges, (ii) transaction and integration costs related to
             acquisitions, (iii) interest expense (income), (iv) restructuring
             charges, (v) loss or gain on the sale of subsidiaries, (vi) gain on
             extinguishment of debt, and (vii) the provision or benefit for
             deferred income taxes. We define total capital as book value of
             equity plus the book value of debt less balance sheet cash and cash
             equivalents. We compute the average of the current and prior
             year-end total capital for use in this analysis. For additional
             information, see "Non-GAAP Financial Measures" below.


•            Safety: We measure safety by tracking the total recordable incident
             rate ("TRIR"), which is reviewed on a monthly basis. TRIR is a
             measure of the rate of recordable workplace injuries, defined below,
             normalized and stated on the basis of 100 workers for an annual
             period. The factor is derived by multiplying the number of
             recordable injuries in a calendar year by 200,000 (i.e., the total
             hours for 100 employees working 2,000 hours per year) and dividing
             this value by the total hours actually worked in the year. A
             recordable injury includes occupational death, nonfatal occupational
             illness, and other occupational injuries that involve loss of
             consciousness, restriction of work or motion, transfer to another
             job, or medical treatment other than first aid.



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Factors Affecting the Comparability of Our Results of Operations Our future results of operations may not be comparable to our historical results of operations for the periods presented, and our historical results of operations among the periods presented may not be comparable to each other, primarily due to our divestiture of the Production Solutions segment.

In addition, the historical results of operations for the three months ended March 31, 2020 included in this Quarterly Report on Form 10-Q do not include activity related to the Production Solutions segment whereas the historical results of operations for the three months ended March 31, 2019 do include activity related to the Production Solutions segment for the entire period. Furthermore, future results of operations after August 30, 2019 will not include activity related to the Production Solutions segment. For additional information on the divestiture of the Production Solutions segment, see Note 1 - Company and Organization included in Item 1 of Part I of this Quarterly Report on Form 10-Q. Industry Trends and Outlook Our business depends, to a significant extent, on the level of unconventional resource development activity and corresponding capital spending of oil and natural gas companies. These activity and spending levels are strongly influenced by the current and expected oil and natural gas prices. The worldwide coronavirus outbreak in early 2020, which was declared a pandemic by the World Health Organization in March 2020, the uncertainty regarding its impact, and various governmental actions taken to mitigate its impact have resulted in an unprecedented decline in demand for oil. In the midst of the ongoing pandemic, the Organization of Petroleum Exporting Countries and other oil producing nations, including Russia ("OPEC+"), were initially unable to reach an agreement on production levels for crude oil, at which point Saudi Arabia and Russia initiated efforts to aggressively increase production. The convergence of these events created the unprecedented dual impact of a massive decline in the demand for oil coupled with the risk of a substantial increase in supply. While OPEC+ agreed in April 2020 to cut production, downward pressure on commodity prices has remained and could continue for the foreseeable future. Accordingly, while we have experienced impact in the first quarter, we expect a significant decline in activity coupled with downward pricing pressure and corresponding reductions in revenue and profitability for the remainder of 2020. See "Risk Factors" in Item 1A of Part II of this Quarterly Report on Form 10-Q for more information regarding risks relating to the coronavirus outbreak and actions of OPEC+. Significant factors that are likely to affect 2020 commodity prices include the extent to which members of OPEC+ and other oil exporting nations continue to reduce oil export prices and increase production; the longevity and severity of the coronavirus pandemic; the effect of U.S. energy, monetary, and trade policies; the pace of economic growth in the U.S. and throughout the world, including the potential for macro weakness; geopolitical and economic developments in the U.S. and globally; the outcome of the United States presidential election and subsequent energy and Environmental Protection Agency policies; and overall North American oil and natural gas supply and demand fundamentals, including the pace at which export capacity grows. Demand for our products and services will continue to decline as our customers revise their capital budgets for 2020 downwards and adjust their operations in response to lower oil prices, which has and will continue to adversely affect our business. The posted price for West Texas Intermediate ("WTI") oil during the first quarter decreased from a high of $63 per barrel in early January 2020 to a low of $14 per barrel in late March 2020, a level which had not been experienced since March 1999, with physical markets showing signs of distress as spot prices have been negatively impacted by the lack of available storage capacity. In April 2020, the posted price for WTI oil traded at negative levels for a brief period and ranged from $28 per barrel to $(37) per barrel. Even with price improvements in oil and natural gas, operator activity may not materially increase, as operators remain focused on operating within their capital plans, and uncertainty remains around supply and demand fundamentals. We cannot predict the length of time that the market disruptions resulting from the coronavirus pandemic and efforts to mitigate its effects will continue, the ultimate impact on our business, or the pace or extent of any subsequent recovery. Nevertheless, we will maintain our commitment to safety and service quality for our customers and continue to focus on generating returns and cash flow. Operators have continued to improve operational efficiencies in completions design, increasing the complexity and difficulty, making oilfield service selection more important. This increase in high-intensity, high-efficiency completions of oil and gas wells further enhances the demand for our services. We compete for the most complex and technically demanding wells in which we specialize, which are characterized by extended laterals, increased stage spacing, multi-well pads, cluster spacing, and high proppant loads. These well characteristics lead to increased operating leverage and returns for us, as we are able to complete more jobs and stages with the same number of units and crews. Service providers for these projects are selected based on their technical expertise and ability to execute safely and efficiently, rather than only price.


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Results of Operations
Results for the Three Months Ended March 31, 2020 Compared to the Three Months
Ended March 31, 2019
                                                    Three Months Ended March 31,
                                                        2020               2019           Change
                                                                   (in thousands)
Revenues
Completion Solutions                             $       146,624$   209,132$  (62,508 )
   Production Solutions (1)                                    -            20,573        (20,573 )
                                                 $       146,624$   229,705$  (83,081 )
Cost of revenues (exclusive of depreciation and
amortization shown separately below)
Completion Solutions                             $       126,008$   161,439$  (35,431 )
   Production Solutions (1)                                    -            17,151        (17,151 )
                                                 $       126,008$   178,590$  (52,582 )
Adjusted gross profit
Completion Solutions                             $        20,616$    47,693$  (27,077 )
   Production Solutions (1)                                    -             3,422         (3,422 )
                                                 $        20,616$    51,115$  (30,499 )

General and administrative expenses              $        16,395$    19,939$   (3,544 )
Depreciation                                               8,541            13,530         (4,989 )
Amortization of intangibles                                4,169             4,688           (519 )
Impairment of goodwill                                   296,196                 -        296,196
Gain on revaluation of contingent liabilities               (426 )         (13,955 )       13,529
Gain on sale of property and equipment                      (575 )             (23 )         (552 )
Income (loss) from operations                           (303,684 )          26,936       (330,620 )
Non-operating (income) expenses                             (659 )           9,166         (9,825 )
Income (loss) before income taxes                       (303,025 )          17,770       (320,795 )
Provision (benefit) for income taxes                      (2,125 )             460         (2,585 )
Net income (loss)                                $      (300,900 )$    17,310$ (318,210 )

(1)We sold the Production Solutions segment to Brigade on August 30, 2019. For additional information on the Production Solutions divestiture, see Note 1 - Company and Organization.


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Revenues

Revenues decreased $83.1 million, or 36%, to $146.6 million for the first
quarter of 2020 which is primarily related to reduced activity and pricing
pressure caused by rapidly deteriorating market conditions late in the first
quarter of 2020, driven by an economic recession associated with the coronavirus
pandemic, as well as international pricing and production disputes. We depend,
to a significant extent, on the level of unconventional resource development
activity and corresponding capital spending of oil and natural gas companies
onshore in North America. In turn, activity and capital spending are strongly
influenced by current and expected oil and natural gas prices. During the first
quarter of 2020, the average closing price of oil was $45.34 per barrel, and the
average closing price of natural gas was $1.91 per MMBtu. During the first
quarter of 2019, the average closing price per barrel of oil was $54.82, and the
average closing price of natural gas was $2.92 per MMBtu.
Additional information with respect to revenues by historical reportable segment
is discussed below.
Completion Solutions: Revenue decreased $62.5 million, or 30%, to $146.6 million
for the first quarter of 2020. The decrease was prevalent across all lines of
service and was a direct reflection of pricing pressures caused by reasons
described above. More specifically, our tools revenue decreased $21.5 million,
or 40%, as completion tools stages decreased by 19%, and completion tools
revenue by stage decreased by 27% in comparison to the first quarter of 2019.
Wireline revenue decreased $18.5 million, or 29%, as total completed wireline
stages decreased by 18%. in comparison to the first quarter of 2019. Coiled
tubing revenue decreased by $17.9 million, or 46%, as total days worked
decreased by 35% in comparison to the first quarter 2019 and cementing revenue
(including pump downs) decreased by $4.6 million, or 9% as our total cement job
count decreased 8% in comparison to 2019.
Production Solutions: Revenue decreased $20.6 million, or 100% for the first
quarter of 2020 as the Production Solutions segment was sold on August 30, 2019.
Cost of Revenues (Exclusive of Depreciation and Amortization)
Cost of revenues decreased $52.6 million, or 29%, to $126.0 million for the
first quarter of 2020. which is primarily related to rapidly deteriorating
market conditions late in the first quarter of 2020, driven by an economic
recession associated with the coronavirus pandemic, as well as international
pricing and production disputes.
Additional information with respect to cost of revenues by historical reportable
segment is discussed below.
Completion Solutions: Cost of revenues decreased $35.4 million, or 22%, to
$126.0 million for the first quarter of 2020. The decrease in comparison to the
first quarter of 2019 was prevalent across all lines of service and was a direct
reflection of reasons described above. More specifically, the decrease was
primarily related to a $20.3 million decrease in materials installed and
consumed while performing services, a $9.2 million decrease in employee costs, a
$4.5 million decrease in other costs such as repair and maintenance, travel,
meals and entertainment, and vehicle expenses and a $2.4 million decrease in
transaction and integration costs associated with the Magnum Acquisition. The
overall decrease in cost of revenues was partially offset by an increase in
severance and other cost of revenue type restructuring costs of $1.0 million
mainly associated with headcount reductions and cost cutting measures in
response to the challenging market conditions across the industry.
Production Solutions: Cost of revenues decreased $17.2 million, or 100% for the
first quarter of 2020 as the Production Solutions segment was sold on August 30,
2019.
Adjusted Gross Profit
Completion Solutions: Adjusted gross profit (excluding depreciation and
amortization) decreased $27.1 million to $20.6 million for the first quarter of
2020 due to the factors described above under "Revenues" and "Cost of Revenues."
Production Solutions: Adjusted gross profit (excluding depreciation and
amortization) decreased $3.4 million to $0.0 million for the first quarter of
2020 as a result of the factors described above under "Revenues" and "Cost of
Revenues."
General and Administrative Expenses
General and administrative expenses decreased $3.5 million to $16.4 million for
the first quarter of 2020. The decrease in comparison to the first quarter of
2019 was primarily related to a $2.2 million decrease in transaction and
integration costs associated with the Magnum Acquisition, a $1.7 million
decrease in other costs such as marketing, office, travel, meals and
entertainment and facility expenses and a $0.9 million decrease in employee
costs mainly associated with the recently sold Production Solutions segment. The
overall decrease in general and administrative expenses was partially offset by
an increase

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in severance and other general and administrative type restructuring costs of
$1.3 million mainly associated with headcount reductions and cost cutting
measures in response to the challenging market conditions across the industry.
General and administrative expenses as a percentage of revenue was 11.2% for the
first quarter of 2019, compared to 8.7% for the first quarter of 2019.
Depreciation
Depreciation expense decreased $5.0 million to $8.5 million for the first
quarter of 2020. The decrease in comparison to the first quarter of 2019 was
primarily related to a reduction in depreciation expense associated with our
coiled tubing business mainly due to the property and equipment charge recorded
in the fourth quarter of 2019. The decrease was also partly attributed to the
reduction in depreciation expense in the Production Solutions segment, which was
sold on August 30, 2019.
Amortization of Intangibles
Amortization of intangibles decreased $0.5 million to $4.2 million for the first
quarter of 2020, primarily due to a $0.3 million decrease in amortization
associated with certain non-compete agreements that were fully amortized in
2019, coupled with a $0.2 million decrease in intangible assets associated with
our coiled tubing business mainly due to the intangible asset impairment charge
recorded in the fourth quarter of 2019.
Impairment of Goodwill
We recorded goodwill impairment charges of $296.2 million for the first quarter
of 2020 in our tools, cementing, and wireline reporting units due to sharp
declines in global crude oil demand and an economic recession associated with
the coronavirus pandemic, as well as, sharp declines in oil and natural gas
prices associated with international pricing and production disputes. No
goodwill impairment charges were recorded for the first quarter of 2019.
(Gain) Loss on Revaluation of Contingent Liabilities
Gain on the revaluation of contingent liabilities decreased $13.5 million to a
gain of $0.4 million for the first quarter of 2020. The reduction was primarily
related to a $14.1 million gain recorded in the first quarter of 2019 in
connection with the estimated sales of certain dissolvable plugs associated in
with the Magnum Acquisition that did not recur in the first quarter of 2020. The
reduction was partially offset by an increased gain attributed to the earnout
associated with our acquisition of Frac Technology AS.
Non-Operating (Income) Expenses
We recorded $0.7 million in non-operating income for the first quarter of 2020
compared to $9.2 million in non-operating expenses for the first quarter of
2019. The decrease in non-operating expenses was primarily related to a $10.1
million gain on the extinguishment of debt related to the repurchase of Senior
Notes (as defined in "Liquidity and Capital Resources") in the first quarter of
2020 that did not recur in the first quarter of 2019.
Provision (Benefit) for Income Taxes
We recorded an income tax benefit of $2.1 million for the first quarter of 2020
compared to an income tax provision of $0.5 million for the first quarter of
2019. The $2.6 million decrease in the income tax provision was primarily a
result of the discrete tax impact from the net operating loss provisions of the
Coronavirus Aid, Relief, and Economic Security Act and the goodwill impairment
recorded during the quarter, coupled with changes in pre-tax income between
periods.
Adjusted EBITDA
Adjusted EBITDA decreased $28.9 million to $10.3 million for the first quarter
of 2020. The Adjusted EBITDA decrease is primarily due to the changes in
revenues and expenses discussed above. See "Non-GAAP Financial Measures" below
for further explanation.
Non-GAAP Financial Measures
EBITDA and Adjusted EBITDA
EBITDA and Adjusted EBITDA are supplemental non-GAAP financial measures that are
used by management and external users of our financial statements, such as
industry analysts, investors, lenders, and rating agencies.
We define EBITDA as net income (loss) before interest, depreciation,
amortization of intangibles, and provision

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(benefit) for income taxes.
We define Adjusted EBITDA as EBITDA further adjusted for (i) property and
equipment, goodwill, and/or intangible asset impairment charges,
(ii) transaction and integration costs related to acquisitions, (iii) loss or
gain on revaluation of contingent liabilities, (iv) gain on extinguishment of
debt, (v) loss or gain on the sale of subsidiaries, (vi) restructuring charges,
(vii) stock-based compensation expense, (viii) loss or gain on sale of property
and equipment, and (ix) other expenses or charges to exclude certain items which
we believe are not reflective of ongoing performance of our business, such as
legal expenses and settlement costs related to litigation outside the ordinary
course of business.
Management believes EBITDA and Adjusted EBITDA are useful because they allow us
to more effectively evaluate our operating performance and compare the results
of our operations from period to period without regard to our financing methods
or capital structure. We exclude the items listed above from net income in
arriving at these measures because these amounts can vary substantially from
company to company within our industry depending upon accounting methods and
book values of assets, capital structures, and the method by which the assets
were acquired. These measures should not be considered as an alternative to, or
more meaningful than, net income as determined in accordance with accounting
principles generally accepted in the United States of America ("GAAP") or as an
indicator of our operating performance. Certain items excluded from these
measures are significant components in understanding and assessing a company's
financial performance, such as a company's cost of capital and tax structure, as
well as the historic costs of depreciable assets, none of which are components
of these measures. Our computations of these measures may not be comparable to
other similarly titled measures of other companies. We believe that these are
widely followed measures of operating performance.
The following table presents a reconciliation of the non-GAAP financial measures
of EBITDA and Adjusted EBITDA to the GAAP financial measure of net income (loss)
for the three months ended March 31, 2020 and 2019:
                                                      Three Months Ended March 31,
                                                         2020                2019
                                                             (in thousands)
EBITDA reconciliation:
Net income (loss)                                 $      (300,900 )$     17,310
Interest expense                                            9,828              9,326
Interest income                                              (371 )             (160 )
Depreciation                                                8,541             13,530
Amortization of intangibles                                 4,169              4,688
Provision (benefit) for income taxes                       (2,125 )              460
EBITDA                                            $      (280,858 )$     45,154

Adjusted EBITDA reconciliation:
EBITDA                                            $      (280,858 )$     45,154
Impairment of goodwill                                    296,196                  -
Transaction and integration costs                             146              4,762
Gain on revaluation of contingent liabilities (1)            (426 )          (13,955 )
Gain on extinguishment of debt                            (10,116 )                -
Restructuring charges                                       2,329                  -
Stock-based compensation expense                            3,592              3,153
Gain on sale of property and equipment                       (575 )              (23 )
Legal fees and settlements (2)                                  4                 68
Adjusted EBITDA                                   $        10,292$     39,159

(1)Amounts relate to the revaluation of contingent liabilities associated with our 2018 acquisitions. The impact is included in our Condensed Consolidated Statements of Income and Comprehensive Income (Loss). For additional information on contingent liabilities, see Note 10 - Commitments and Contingencies included in Item 1 of Part I of this Quarterly Report on Form 10-Q. (2)Amounts represent fees and legal settlements associated with legal proceedings brought pursuant to the Fair Labor Standards Act and/or similar state laws.


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Return on Invested Capital
ROIC is a supplemental non-GAAP financial measure. We define ROIC as after-tax
net operating profit (loss), divided by average total capital. We define
after-tax net operating profit (loss) as net income (loss) plus (i) property and
equipment, goodwill, and/or intangible asset impairment charges, (ii)
transaction and integration costs related to acquisitions, (iii) interest
expense (income), (iv) restructuring charges, (v) loss or gain on the sale of
subsidiaries, (vi) gain on extinguishment of debt, and (vii) the provision or
benefit for deferred income taxes. We define total capital as book value of
equity plus the book value of debt less balance sheet cash and cash equivalents.
We then take the average of the current period-end and prior year-end total
capital for use in this analysis.
Management believes ROIC is a meaningful measure because it quantifies how well
we generate operating income relative to the capital we have invested in our
business and illustrates the profitability of a business or project taking into
account the capital invested. Management uses ROIC to assist them in capital
resource allocation decisions and in evaluating business performance. Although
ROIC is commonly used as a measure of capital efficiency, definitions of ROIC
differ, and our computation of ROIC may not be comparable to other similarly
titled measures of other companies.
The following table provides an explanation of our calculation of ROIC for the
three months ended March 31, 2020 and 2019:
                                         Three Months Ended March 31,
                                             2020               2019
                                                (in thousands)
Net income (loss)                     $      (300,900 )$   17,310
Add back:
Impairment of goodwill                        296,196                -
Transaction and integration costs                 146            4,762
Interest expense                                9,828            9,326
Interest income                                  (371 )           (160 )
Restructuring charges                           2,329                -
Gain on extinguishment of debt                (10,116 )              -
Benefit for deferred income taxes              (1,588 )           (478 )

After-tax net operating profit (loss) $ (4,476 )$ 30,760 Total capital as of prior year-end: Total stockholders' equity

            $       389,877$  594,823
Total debt                                    400,000          435,000
Less cash and cash equivalents                (92,989 )        (63,615 )

Total capital as of prior year-end $ 696,888$ 966,208 Total capital as of period-end: Total stockholders' equity

            $        91,851$  615,467
Total debt                                    386,171          415,000
Less cash and cash equivalents                (90,116 )        (31,157 )
Total capital as of period-end        $       387,906$  999,310
Average total capital                 $       542,397$  982,759
ROIC                                        (3.3)%             12.5%


Adjusted Gross Profit (Excluding Depreciation and Amortization) GAAP defines gross profit as revenues less cost of revenues and includes depreciation and amortization in costs of revenues. We define adjusted gross profit (excluding depreciation and amortization) as revenues less direct and indirect costs of revenues (excluding depreciation and amortization). This measure differs from the GAAP definition of gross profit because we do not include the impact of depreciation and amortization, which represent non-cash expenses. Management uses adjusted gross profit (excluding depreciation and amortization) to evaluate operating performance. We prepare adjusted gross profit (excluding depreciation and amortization) to eliminate the impact of depreciation and amortization because we do not consider depreciation and amortization indicative of our core operating performance. Adjusted gross profit (excluding depreciation and amortization) should not be considered as an alternative to gross profit (loss), operating income (loss), or any other measure of financial performance calculated and presented in accordance with GAAP.


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Adjusted gross profit (excluding depreciation and amortization) may not be comparable to similarly titled measures of other companies because other companies may not calculate adjusted gross profit (excluding depreciation and amortization) or similarly titled measures in the same manner as we do. The following table presents a reconciliation of adjusted gross profit (excluding depreciation and amortization) to GAAP gross profit (loss) for the three months ended March 31, 2020 and 2019:

                                                              Three Months Ended March 31,
                                                                  2020              2019
                                                                     (in thousands)
Calculation of gross profit
Revenues                                                    $       146,624$  229,705
Cost of revenues (exclusive of depreciation and
amortization shown separately below)                                126,008        178,590
Depreciation (related to cost of revenues)                            7,943         13,306
Amortization of intangibles                                           4,169          4,688
Gross profit                                                $         8,504     $   33,121
Adjusted gross profit (excluding depreciation and
amortization) reconciliation:
Gross profit                                                $         8,504     $   33,121
Depreciation (related to cost of revenues)                            7,943         13,306
Amortization of intangibles                                           4,169          4,688
Adjusted gross profit (excluding depreciation and
amortization)                                               $        20,616$   51,115


Liquidity and Capital Resources
Sources and Uses of Liquidity
Historically, we have met our liquidity needs principally from cash on hand,
cash flows from operating activities and, if needed, external borrowings. Our
principal uses of cash are to fund capital expenditures and acquisitions, to
service our outstanding debt, and to fund our working capital requirements. In
2018, we issued $400.0 million principal amount of 8.750% Senior Notes due 2023
(the "Senior Notes") to, together with cash on hand and borrowings under the
2018 ABL Credit Facility (as defined and described below), fund the Magnum
Acquisition as well as fully repay and terminate the term loan borrowings and
the outstanding revolving credit commitments under our prior credit facility.
For additional information regarding the Senior Notes, see "Liquidity and
Capital Resources - Senior Notes" below. In the third quarter of 2019, we
divested the Production Solutions segment for approximately $17.1 million in
cash. We plan to use such proceeds to fund a portion of our 2020 capital
expenditures and support working capital requirements.
We continually monitor potential capital sources, including equity and debt
financing, to meet our investment and target liquidity requirements. Our future
success and growth will be highly dependent on our ability to continue to access
outside sources of capital. In addition, our ability to satisfy our liquidity
requirements depends on our future operating performance, which is affected by
prevailing economic conditions, the level of drilling, completion and production
activity for North American onshore oil and natural gas resources, and financial
and business and other factors, many of which are beyond our control.
Although we do not budget for acquisitions, pursuing growth through acquisitions
may continue to be a significant part of our business strategy. Our ability to
make significant additional acquisitions for cash will require us to obtain
additional equity or debt financing, which we may not be able to obtain on terms
acceptable to us or at all.
We may also, from time to time, make open market debt repurchases (including our
Senior Notes) when it is opportunistic to do to manage our debt maturity
profile. In the first quarter of 2020, we repurchased approximately $13.8
million of the Senior Notes for a repurchase price of approximately $3.5 million
in cash. As a result, we recorded a $10.1 million gain on extinguishment of debt
which was calculated as the difference between the repurchase price and the
carrying amount of the Senior Notes partially offset by $0.2 million in deferred
financing costs. The gain on extinguishment of debt is included as a separate
line item in our Condensed Consolidated Statements of Income and Comprehensive
Income (Loss) for the three months ended March 31, 2020.
Subsequent to March 31, 2020, we repurchased an additional $15.9 million of the
Senior Notes for a repurchase price of approximately $3.9 million in cash.

                                       24

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At March 31, 2020, we had $90.1 million of cash and cash equivalents and $93.5
million of availability under the 2018 ABL Credit Facility (as defined below),
which resulted in a total liquidity position of $183.6 million. In response to
rapidly deteriorating market conditions driven in large part by the coronavirus
pandemic and international pricing and production disputes, we have implemented
certain cost-cutting measures across the organization to continue to maintain
our current liquidity position. Based on our current forecasts, we believe that,
cash on hand, together with cash flow from operations, and borrowings under the
2018 ABL Credit Facility, should be sufficient to fund our capital requirements
for at least the next twelve months from the issuance date of our condensed
consolidated financial statements. However, we can make no assurance regarding
our ability to achieve our forecasts. Furthermore, depending on our financial
performance and the ever-changing market, we may implement additional
cost-cutting measures, as necessary, to continue to meet our liquidity and
capital resource needs for at least the next twelve months from the issuance
date of our condensed consolidated financial statements. We can make no
assurance regarding our ability to successfully implement such measures, or
whether such measures would be sufficient to mitigate a decline in our financial
performance.
Senior Notes
On October 25, 2018, we issued the Senior Notes under an indenture, dated as of
October 25, 2018 (the "Indenture"), by and among us, including certain of our
subsidiaries, and Wells Fargo, National Association, as Trustee. The Senior
Notes bear interest at an annual rate of 8.750% payable on May 1 and November 1
of each year, and the first interest payment was due on May 1, 2019. The Senior
Notes are senior unsecured obligations and are fully and unconditionally
guaranteed on a senior unsecured basis by each of our current domestic
subsidiaries and by certain future subsidiaries.
The Indenture contains covenants that limit our ability and the ability of our
restricted subsidiaries to engage in certain activities. We were in compliance
with the provisions of the Indenture at March 31, 2020.
Upon an event of default, the trustee or the holders of at least 25% in
aggregate principal amount of then outstanding Senior Notes may declare the
Senior Notes immediately due and payable, except that a default resulting from
certain events of bankruptcy or insolvency with respect to us, any of our
restricted subsidiaries that are a significant subsidiary or any group of
restricted subsidiaries that, taken together, would constitute a significant
subsidiary, will automatically cause all outstanding Senior Notes to become due
and payable.
Unamortized deferred financing costs associated with the Senior Notes were $7.2
million and $7.9 million at March 31, 2020 and December 31, 2019, respectively.
These costs are direct deductions from the carrying amount of the Senior Notes
and are being amortized through interest expense through the maturity date of
the Senior Notes using the effective interest method.
2018 ABL Credit Facility
On October 25, 2018, we entered into a credit agreement dated as of October 25,
2018 (the "2018 ABL Credit Agreement"), by and among us, Nine Energy Canada,
Inc., JP Morgan Chase Bank, N.A. as administrative agent and as an issuing
lender, and certain other financial institutions party thereto as lenders and
issuing lenders. The 2018 ABL Credit Agreement permits aggregate borrowings of
up to $200.0 million, subject to a borrowing base, including a Canadian tranche
with a sub-limit of up to $25.0 million and a sub-limit of $50.0 million for
letters of credit (the "2018 ABL Credit Facility"). The 2018 ABL Credit Facility
will mature on October 25, 2023 or, if earlier, on the date that is 180 days
before the scheduled maturity date of the Senior Notes if they have not been
redeemed or repurchased by such date.
Loans to us and our domestic related subsidiaries (the "U.S. Credit Parties")
under the 2018 ABL Credit Facility may be base rate loans or London Interbank
Offered Rate ("LIBOR") loans; and loans to Nine Energy Canada Inc., a
corporation organized under the laws of Alberta, Canada, and its restricted
subsidiaries (the "Canadian Credit Parties") under the Canadian tranche may be
Canadian Dollar Offered Rate ("CDOR") loans or Canadian prime rate loans. The
applicable margin for base rate loans and Canadian prime rate loans vary from
0.75% to 1.25%, and the applicable margin for LIBOR loans or CDOR loans vary
from 1.75% to 2.25%, in each case depending on our leverage ratio. In addition,
a commitment fee of 0.50% per annum will be charged on the average daily unused
portion of the revolving commitments.
The 2018 ABL Credit Agreement contains various affirmative and negative
covenants, including financial reporting requirements and limitations on
indebtedness, liens, mergers, consolidations, liquidations and dissolutions,
sales of assets, dividends and other restricted payments, investments (including
acquisitions) and transactions with affiliates. In addition, the 2018 ABL Credit
Agreement contains a minimum fixed charge ratio covenant of 1.00 to 1.00 that is
tested quarterly when the availability under the 2018 ABL Credit Facility drops
below $18.75 million or a default has occurred until the availability exceeds
such threshold for 30 consecutive days and such default is no longer
outstanding. We were in compliance with all covenants under the 2018 ABL Credit
Agreement at March 31, 2020.

                                       25

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All of the obligations under the 2018 ABL Credit Facility are secured by first
priority perfected security interests (subject to permitted liens) in
substantially all of the personal property of U.S. Credit Parties, excluding
certain assets. The obligations under the Canadian tranche are further secured
by first priority perfected security interests (subject to permitted liens) in
substantially all of the personal property of Canadian Credit Parties excluding
certain assets. The 2018 ABL Credit Facility is guaranteed by the U.S. Credit
Parties, and the Canadian tranche is further guaranteed by the Canadian Credit
Parties and the U.S. Credit Parties.
At March 31, 2020, our availability under the 2018 ABL Credit Facility was
approximately $93.5 million, net of an outstanding letter of credit of $0.2
million.
Cash Flows
Cash flows provided by (used in) operations by type of activity were as follows
for the three months ended March 31, 2020 and 2019:
                                            Three Months Ended March 31,
                                              2020                2019
                                                   (in thousands)
Operating activities                    $         745       $        5,888
Investing activities                              535              (18,139 )
Financing activities                           (3,908 )            (20,279 )
Impact of foreign exchange rate on cash          (245 )                 72

Net change in cash and cash equivalents $ (2,873 )$ (32,458 )



 Operating Activities
Net cash provided by operating activities was $0.7 million in the first quarter
of 2020 compared to $5.9 million in net cash provided by operating activities in
the first quarter of 2019. The $5.2 million decrease in net cash provided by
operating activities was primarily a result of a $26.7 million decrease in cash
flow provided by continuing operations, adjusted for any non-cash items,
primarily due to a decrease in revenue in the first quarter of 2020 compared to
the first quarter of 2019. The overall decrease in net cash provided by
operating activities was partially offset by an increase of $21.5 million in
cash collections and other changes in working capital which provided an
increased source of cash flow in the first quarter of 2020 in comparison to the
first quarter of 2019.
Investing Activities
Net cash provided by investing activities was $0.5 million in the first quarter
of 2020 compared to $18.1 million in net cash used in investing activities in
the first quarter of 2019. The $18.6 million decrease in net cash used in
investing activities was primarily related to a decrease of $19.6 million in
cash purchases of property and equipment in the first quarter of 2020 in
comparison to the first quarter of 2019. The overall decrease in net cash used
in investing activities was partially offset by $0.5 million in proceeds from
notes receivable payments which were received in the first quarter of 2019 but
did not recur in the first quarter of 2020. The overall decrease was also
partially offset by a reduction in proceeds from sales of property and equipment
(including insurance) of $0.4 million in the first quarter of 2020 compared to
the first quarter of 2019.
Financing Activities
Net cash used in financing activities was $3.9 million in the first quarter of
2020 compared to $20.3 million in net cash flow used in financing activities in
the first quarter of 2019. The $16.4 million decrease in net cash used in
financing activities was primarily related to $20.0 million in payments on the
2018 ABL Credit Facility in the first quarter of 2019 that did not recur in the
first quarter of 2020. The overall decrease in net cash used in financing
activities was partially offset by $3.5 million of payments on the Senior Notes
in the first quarter of 2020 that did not occur in the first quarter of 2019.
Contractual Obligations
Our contractual obligations at March 31, 2020 did not change materially, outside
the normal course of business, from those disclosed under "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Contractual Obligations" in Item 7 of Part II of our Annual Report on Form 10-K
for the year ended December 31, 2019.

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Off-Balance Sheet Arrangements
At March 31, 2020, we had a letter of credit of $0.2 million, which represented
an off-balance sheet arrangement as defined in Item 303(a)(4)(ii) of Regulation
S-K. As of March 31, 2020, no liability has been recognized in our Condensed
Consolidated Balance Sheets for the letter of credit.
Recent Accounting Pronouncements
See Note 3 - New Accounting Standards included in Item 1 of Part I of this
Quarterly Report on Form 10-Q for a summary of recently issued accounting
pronouncements.

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