Ladies and gentlemen, thank you for standing by, and welcome to the NCS Multistage Earnings Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions] I would now like to hand the conference over to Mr. Ryan Hummer, Chief Financial Officer, NCS Multistage. Please go ahead, sir.

Thank you, Yolanda, and thank you for joining NCS Multistage's Third Quarter 2020 Conference Call. Our call today will be led by our CEO, Robert Nipper, and I will also provide comments. Before we begin today's call, we would like to caution listeners that some of the statements that will be made on this call could be forward-looking and to the extent that our remarks today contain information other than historical information, please note that we are relying on the safe harbor protections afforded by federal law. Such forward-looking statements may include comments regarding our future expectations for financial results and business operations, and are subject to known and unknown risks and uncertainties, including with respect to the COVID-19 pandemic and its impact on the global economy, oil demand and our company. 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 SEC that outline those risks. I also want to point out that in today's conference call, we refer to adjusted EBITDA, free cash flow and net working capital, which are non-GAAP financial measures. We use these measures because they allow us to compare performance consistently over various 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 and the updated investor presentation posted yesterday, both of which are available on our website, ncsmultistage.com, provide reconciliations of these non-GAAP financial measures to the nearest GAAP financial measure. I'll now turn the call over to our CEO, Robert Nipper.

Thank you, Ryan, and welcome to our investors, analysts and employees joining our third quarter 2020 earnings conference call. I hope that everyone listening today is healthy and safe. NCS' performance in the third quarter demonstrates the resilience of our team, the strength of our business model and technology, and the effectiveness of cost reduction and liquidity enhancement measures we've enacted over the last several months. During the third quarter, we saw a trough in U.S. rig counts with a gradual increase over the last several weeks. In addition, there was a strong recovery in the number of frac spreads working in the U.S. in August and September. The Canadian rig count rebounded from multi-decade lows, but the seasonal recovery in the third quarter was much more muted than in prior years. Activity in international markets declined slightly with meaningful variations across markets. As we benefited from market recovery, NCS was able to deliver sequential revenue growth of 87% in the third quarter as compared to the second quarter, with sequential growth of 103%, 146% and 25% in the U.S., Canada and international markets, respectively. The improvement in U.S. revenue was primarily driven by our completion-oriented offerings at Repeat Precision and in our Tracer Diagnostics service line. We believe that we are continuing to gain share in the competitive composite plug market through Repeat Precision, where our plugs provide excellent performance that our customers value, with fast running speeds, reliable isolation, and quick and consistent drill-outs. We've seen continued uptake of our new value-oriented Tracer Diagnostics offering that removes personnel from the location and reduces the overall cost of wellbore clearance diagnostics. We are cautiously optimistic about activity in the U.S. in the fourth quarter. While completion activity has continued to increase thus far in the fourth quarter, we believe…

Thank you, Robert. As reported in yesterday's earnings release, our third quarter revenue was $16.3 million, 73% lower than the prior year's third quarter. However, on a sequential basis, revenue in the third quarter was 87% higher than in the second quarter, reflecting the recovery in completions activity in the U.S. and the seasonal improvement from the historically low rig count and activity level in Canada in the second quarter. As Robert mentioned, we delivered sequential revenue increases of 103% in the U.S., 146% in Canada and 25% internationally. Gross profit, defined as total revenue less total cost of sales, excluding depreciation and amortization expense, was $6.1 million in the third quarter or 37% of revenue. This compared to $28.6 million or 47% of revenue in the prior year's third quarter. For a sequential comparison, gross profit was $2.3 million or 27% of revenue in the second quarter. Our gross margin percentage increased primarily due to the sharp increase in revenue, which led to better absorption of fixed costs and also benefited from the actions we've taken to rationalize our field service footprint and to improve our manufacturing efficiencies. SG&A costs were $12.5 million in the third quarter, which was $8 million or 39% lower as compared to the $20.4 million in SG&A expense in the prior year's third quarter. It was also $3 million lower than the $15.5 million in SG&A we incurred in the second quarter. Our reported SG&A includes share-based compensation and certain nonrecurring expenses, including certain litigation costs and severance expenses. In the third quarter, nonrecurring severance expenses totaled $0.8 million while litigation expenses were $1.2 million. Our adjusted EBITDA for the third quarter was negative $2.1 million as compared to $13.6 million in the prior year's third quarter. This represented an improvement of $5.8 million…

Thank you, Ryan. Before we open up the call for Q&A, I'll close with a couple of brief comments. While we believe we are past trough market activity levels, we continue to face an uncertain environment, and we are focused on the aspects of our business that we can control. We have taken actions to structurally reduce our cost structure while preserving our ability to provide exceptional customer service and drive further innovation and value for our customers. We continue to make disciplined and targeted investments to advance near and long-term opportunities for our business, which will expand our addressable market over time. We have taken steps to enhance our liquidity and preserve our strong balance sheet. Our revolver is undrawn, and we have demonstrated our ability to generate free cash flow over the years. We are positioned to weather the current industry downturn and to benefit from an eventual recovery in the industry activity. In bringing innovations to our customers, we have made substantial investments to develop our intellectual property, and we continue to work to enforce and defend our IP to ensure we make a proper return on those investments. And with that, we'd be happy to take your questions.

[Operator Instructions] And your first question comes from the line of George O'Leary with TPH & Company.

The guidance call you guys provided was very helpful. I guess, the incremental margins were strong, 50% incremental margins in the third quarter, if I remember correctly. You guided to 40% plus. I guess, what are the puts and takes that could pull that back up closer to third quarter incrementals? Any color there would be super helpful.

Yes, George, this is Ryan. Look, I think in last quarter's call, we guided to incrementals being 40% plus, and we ended up coming in a bit ahead of that. And part of that has to do with the mix of revenue in the third quarter. So we were a little bit stronger in the U.S., particularly in Tracer Diagnostics and in Repeat, which have a pretty strong incremental margin profile. The Canadian business didn't pick up quite as strongly during the third quarter as we had anticipated. And international also was a bigger percentage of the overall revenue during the third quarter. So those were the drivers that allowed us to come in at that close to 50% level in the third quarter. As we look forward to the fourth quarter, as you can kind of parse through the guidance, a large percentage of the revenue growth is coming from Canada. And while there's certainly some benefit in being able to amortize that revenue and better absorb fixed costs in Canada and then also to realize a full quarter's worth of our manufacturing efficiencies, the incremental margins on product sales in Canada aren't quite as strong in some of the other areas. So that's really what's moderating, I think, the guidance with respect to incremental margins there. And I think we feel pretty good about where we've guided. Certainly, we hope there is potential for some upside there, but we're comfortable with that 40% plus on the fourth quarter incrementals.

All right. Very helpful, Ryan. And then, Robert, I think you mentioned the composite plug market share early in the prepared remarks. Wondering if you could frame where you guys think you sit from a market share perspective? Or if you don't want to give the number, just frame how much you think that market share has improved year-to-date over the last few years. Just any way to help us think about market share for you all in that composite plug business would be helpful.

Yes. So if you recall, our first quarter of -- our first full quarter of commercialization with our composite plug product line was in the first quarter of 2018. And so we've been able to successfully grow market share over time on a quarter-by-quarter basis. When we came into the downturn earlier this year, because of our customer mix, we saw what appeared to be a decline in market share, and it was a fairly significant decline. But as those operators came back to work and our customer mix got back closer to normal, we saw our market share increase to beyond where it was before that downturn. So we believe that we're in the top 5 in terms of market share for composite plugs in the U.S. and continuing to grow market share.

Great. Very helpful. And I'll sneak in one more, if I could. The $53 million in working capital that you guys have, can that still be a source of cash, even as revenue starts to grow? Or how should we think about free cash flow moving forward with working capital, CapEx and kind of some moving pieces as we head into 2021?

Yes. So George, I think we'll have some offsetting impacts there. So as our revenue grows, I think you'd expect to see our receivables tick up a little bit along with that. However, inventory continues to be a source of opportunity for us. We've been able to reduce our inventory by, I think it's $3 million, over the last 2 quarters, and expect to be able to continue to bring that down as we continue to utilize existing sleeves, existing tracers in our operations and are very judicious about what we bring back into the company. So working capital will help to offset, but might not fully offset -- or sorry, inventory will work to offset, but maybe not fully offset accounts receivable. And then the other piece to that, the big piece within working capital would be payables. And as the business picks up, we'd expect payables to increase a little bit as well, which would also offset some of the receivables growth.

[Operator Instructions] And your next question comes from the line of Kurt Hallead with RBC.

I appreciate all the color, commentary as always. So just wanted to come back around to the reference you made into the patent lawsuit settlement. So you expect to get a $15 million upfront cash payment. Do you have general sense as to when you could reasonably expect that to come across?

Yes, Kurt. Just keep in mind that, that is a lawsuit between Repeat Precision and Diamondback Industries and Derrek Drury. So it is Repeat and not an NCS lawsuit. So where we are currently is there's a bankruptcy confirmation hearing next week. Assuming that, that -- the plan that the company has put forward to emerge from bankruptcy is approved by the court, then we would expect, within 2 to 4 weeks, to be able to get -- start getting those payments.

Okay. Got it. So as you go -- as you guys go into the first quarter, Ryan, you kind of talked through your incremental margins here in the fourth quarter. I know that there's an extreme seasonality that could occur as you roll through second quarter next year on your Canadian business. But should we think about that 40% plus kind of incrementals as kind of -- think about that for 2021 as something that's reasonable?

I think when you're looking at a full year, incrementals that are something better than 40% is fair. However, as you alluded to, there's a pretty significant seasonality in our business, which will drive variation quarter-to-quarter as we would progress through 2021.

Got it. And then just kind of curious, on the Canadian front, very strong revenue growth expected here in the fourth quarter. By most accounts, the overall activity is not going to double fourth quarter versus third quarter. So where do you see yourselves picking up that differential in revenue?

Yes. Well, as we mentioned earlier, we've had a pretty slow start for activity in the third quarter coming out of breakup. And that's not common for the industry. So we believe that the activity increase will come in from the rig count standpoint. One of the things that has a little uncertainty around it is what are -- what's going to be the availability of frac crews in Canada, how many frac spreads are actually going to be on the market? And can the current frac spreads handle the amount of activity that we see coming into the fourth quarter. So that's kind of a wildcard for us, is are there going to be enough frac spreads? We think that there will be, but our customer mix is -- we feel very good about the guidance that we gave for revenue in the fourth quarter.

Operator, if there are no further questions, I think we will -- Robert, would like to provide some closing remarks.

On behalf of our management team and our Board, we'd like to thank everyone on the call today, including our shareholders and the research analysts who cover NCS, but especially our employees. I truly appreciate the enormous effort that our people are putting in and the sacrifices that have been made by everyone at NCS to support the company and each other through this very challenging market environment. We continue to operate safely with 0 recordable incidents this year. Our team continues to provide excellent service to our customers and is developing new products and services that will enable our customers to be more successful in the current market environment. Our people have done a tremendous job in managing the many challenges that come with the impacts of COVID-19 on life in general as well as our industry and our company. We're only as good as our people, and I believe that we have the best team in the industry. We appreciate everyone's interest in NCS Multistage, and we look forward to talking again on our next quarterly earnings call next year, and that will conclude our call, operator.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.