National Energy Services Reunited Corp

Welcome to NESR's second quarter 2020 earnings call. With me today is Sherif Foda, Chairman and Chief Executive Officer of NESR. On today's call, we will comment on our second quarter results and overall performance. After our prepared remarks, we will open up the call to questions. Before we begin, I'd like to remind our participants that some of the statements we'll be making today are forward-looking. These matters involve risks and uncertainties that could cause our results to differ materially from those projected in these statements. I therefore refer you to our latest earnings release filed earlier today and other SEC filings. Our comments today may also include non-GAAP financial measures. Additional details on reconciliations to the most directly comparable GAAP financial measures can be found in our press release, which is on our website. Finally, feel free to contact us after the call with any additional questions you may have. Our investor relations contact information is available on our website. Now, I'll hand the call over to Sherif.

Thanks Chris. Ladies and gentlemen, thank you for participating in this conference call. We are very excited to report on our continuous outstanding performance this quarter. This is the first time we have surpassed the 200 million mark in revenue. We grew 27% year over year and 2% sequentially, despite all the turmoil around the globe, especially in the energy sector that is the most affected. This achievement speaks about the strength of our field personnel on the ground, their resilience, dedication, commitment and the top operational management team. At the time of crisis, you can determine the real differentiator when the results defy the norm. We are basically swimming against the current and still outperforming the entire OFS industry. Our best-in-class, talented employees know how to score the top position in everything they do. We have been essentially six months into the pandemic, yet we maintained 100% capacity. We have seen the situation change and evolve continuously. We are always ready, agile, and adapt real-time on the spot to the condition of each country. The Middle East has seen strict and stringent action to control the spread of COVID-19. This has included curfews, severe travel restrictions on both land and air, quarantines, testing and tracking protocols. The strictness varied from country to country. and consequently we developed a detailed country-specific strategy early in the cycle. In addition, we have developed our protocols which are required to be followed by all employees. All this has essentially increased the complexity as well as the cost of hours and our customer operation. They greatly value the company that supports them and keep the operations intact. It is a credit to our operating teams that in an environment of increased cost, we have managed to maintain our operating margins. We are not releasing anybody or taking any charges and have produced those numbers on a very clean quarter. Since the start of the pandemic back in February, when we set up our CMT Crisis Management Team, We did not turn down a single job. The CMC, led by my direct reports, continued to meet daily and review the entire operation of each country, including spares, chemicals, personnel readiness, customer needs and their feedback, all type of details you can imagine. This is the key to our success. and ensuring we are never surprised by any regulation, lack of spare parts, any sudden change of customer program that we are not well prepared for. On a human level, we are doing everything to ensure that our personnel are taken care of and every possible protection protocol is diligently followed. Working cycles for field personnel have changed, some mandated by the customer and some essentially due to the driver restrictions. I'm very thankful and blessed to have such a talented pool of individuals who take pride in not only what they are doing for NET, but also in serving the communities and their countries in which they are working. One of the advantages of having a large national workforce is that you get all these factors helping you in managing the situation. It is a great source of national pride for each of them. to hear that they, as national, are delivering and coping with this once-in-a-lifetime event in a much better manner than almost everyone else. Meanwhile, we ensure to continue to follow with the rotational expat community who are stuck in the country of operation that their family back home is well taken care of. This is part of our DNA and commitment not only to the employee but all their extended families in such a difficult time. Now let me say a few words about the macro and how do we see things with the global pandemic effects. On the short term, it goes without saying that MENA will remain clearly the most resilient for oil and gas activities. The core GCC market overall have held very well and have seen a drop in the 10 to 15% on average, while the non-GCC MENA market have a steeper drop due to mainly security, pandemic effect, and more importantly, the different client mix. As an example, North Iraq, which has a large count of small independents, have seen similar level of drop in activity to North America, and is primarily related to the economics of the production agreement that is very sensitive to oil prices. National oil companies remain focused on the long-term. Being the most reliable provider of energy to the world, they do not change their long-term plans and remain vigilant for the health and safety of their economy, their people, and their well-being. This is not to say there was no effect on activities in the different countries. They did release drilling rigs, mainly the poor performing, and they did delay some of the earlier plans so-called nights to have or more of exploratory in nature or frontier project. Going forward, they will keep adjusting the short-term rig assignment between oil and gas depending on the worldwide demand. However, we do not see the main activities In addition, the rigorous work will adjust accordingly. Internal consumption for the gas and energy transition remains solid. ESG commitment is very high on the agenda of all our clients. They will continue in their pursuit to ensure the lowest carbon footprint for their energy demand, and will indeed develop their massive gas resources. For NETS, do not get tired of doing a good job. We believe we will maintain the course and ensure we are serving all our different customers professionally, ensuring our current activities will not get affected. Last quarter, I talked about how we initiated and started executing our unconventional fleet operation in the Jafura Basin in Saudi Arabia, which has been a successful project for NETS as well as for our customers. In addition, we spoke about sending a second fleet and working before year-end. I'm glad to announce we did send our second fleet from our partner next year. We did manage to ship and clear customs during the pandemic. Most importantly, that fleet hit the floor running. Not only we were assigned work, but we managed to start the fleet without expats. This was done in close coordination with our trusted customer. We have actually performed a par or better than other existing established fleets in the region. In addition to this, our American team, who have been in the country for more than three months, had to go back home to see their families towards the end of May. Everyone thought we would have to stop or delay the work. On the contrary, we managed to put the Saudi team who have been trained in both the Permian and the region to completely take control and manage the operation professionally since then. This is the best testimonial of the talent and ingenuity of the Saudi nationals. They took control, managed the fleet, operated the entire setup without any issues. Despite the elevated temperature during the summer months, and with all the pandemic restrictions. It is the culture and the proof when you provide the proper training, proper exposures, proper tools, people will excel in everything they do. We are really proud of being national and our professional crews who compete at the same level and standard with the best, not only in the region, but the entire industry. Again, this could have never been achieved Thank you for watching. Logging operations started very small when we put this company together and we are progressing in the last three quarter and with the addition of Sopesco we have good one line operation in four countries which will be an important avenue of high quality revenue growth in the future. We also did our first testing operation for a major client in Iraq. This was done with a full national crew. In Kuwait We gained market share with a new record of cementing number of jobs a month. Subsequently, our clients assigned a higher number of rigs to us as we continued to replace the competition. Similarly, we had an increase in the assigned TRS rigs. Today, we have solid three contracts in Kuwait and we are looking forward to enhance our presence in this very important market. In Oman, we won several key drilling and production contracts, further solidifying our position. We ran a dual casing section mill, successfully milling 30 meters with controlled ROP for our client. The technology saved three and a half days with time versus conventional tools that would do the job in seven to eight days. The technology is a new worldwide application. The third tool globally and the first to make this 30 meter in one run. We continue to engage at all levels in our core country where we have the highest level of humanization among the service industry. In Abu Dhabi, we extended our cementing contract for a further period of two years. We have maintained all our operation for coal tubing with minimum interruption to the field despite the restrictions. In Libya, we continued to perform our operation in the east of the country. We have maintained our 100% Libyan nationals who are capable to serve the limited number of rigs available to the client. We maintained our presence and ready for future expansion should the NOC decide to add rigs. In summary, and as you see in our results, our momentum and direction has not changed. and we have shown resiliency across the board on our results and activities. NetToday has an appreciable drilling portfolio and our endeavor recently has been ways to high grade the portfolio by adding technology offering and we have been working towards creating this technology for our customers. In Q2, we have finalized two of these investments which are long cycle investments and we shall be introducing them to our customers shortly in the region. This is the continuation of our new technology strategy where we team up with the best and invest with the innovative minds in North America. Lastly, as you know, we announced that effective the 1st of June we are in charge of running SAPESCO and we are accordingly reporting it as such. SAPESCO has a lot of talent and brings next accretive contracts and business lines. Beyond the ongoing integration activities, we are already working on opportunities to expand the business lines where we do not have an offering in the countries where they don't offer the same. Industrial service is the focus area and we are working on several opportunities in the GCC area. We already won a TCP contract for a client in Egypt and we are expanding our footprint in Libya with their logging and slickline business. This month, we already moved their operation in Saudi and Libya to our basis. This shows you the commitment and the level of eagerness of both organizations to work together. Despite the drop of activities in Egypt, we remain very focused on the long-term business and potential in the area. And on that note, I will pass the call over to Chris to talk about the financial and details. Thank you.

Thank you, Sherif. As Sherif mentioned, we reported our highest quarterly revenue ever, with second quarter revenues of $203 million. This represents an increase of 27% over the prior year quarter and 2% over the first quarter. The sequential and year-over-year growth was driven primarily by the new unconventional product line in Saudi Arabia and our new contracts in Kuwait and Abu Dhabi. that offset market declines in Iraq and North Africa. The second quarter also received the benefit of one month of Cepesco revenue. We also achieved another record in the second quarter as adjusted EBITDA was also the highest quarterly amount we've ever reported. Adjusted EBITDA was $52 million or 26% of revenue, increasing 13% over the prior year quarter and up $1 million over the prior quarter. EBITDA adjustments of $1.8 million for the quarter are primarily for transaction and integration costs associated with the acquisition of Sipesco in Egypt. Despite the market conditions, we are pleased that our adjusted EBITDA margins remain flat over the first quarter. We have experienced increased recurring costs related to COVID-19, such as employee testing, rotation costs, field lodging, catering, and sanitization. We consider these costs as normal operations and have made no adjustments to EBITDA for them. To mitigate the impact of these incremental costs and reduce activity in some markets, we have been successful in finding opportunities to reduce other costs. For example, we have been aggressively negotiating and receiving discounts in our supply chain. especially in product costs, equipment rentals, transportation, and field facilities. Moving to our segments, our production segment revenue for the second quarter was $139 million, another quarterly record, growing 46% over the same period last year and 4% over Q1 2020. The sequential and year-over-year growth is primarily related to unconventional completion activity in Saudi Arabia and new contracts in Kuwait and Abu Dhabi. This was partially offset by lower activity in Iraq and North Africa. Adjusted EBITDA margins for the production group of 29% were down sequentially from 31%. Margins were impacted by the startup costs for the new conventional frac fleet, but as a note, these costs were not adjusted out of our results. Also, lower margin pass-through revenue associated with unconventional activity grew as a percentage of total production revenue. Separately, our drilling and evaluation segment revenue for the second quarter is $64 million, flat compared to the same quarter last year and down 3% sequentially. The sequential decline is primarily related to reduced well testing due to lower drilling activity. However, adjusted EBITDA margins improved to 25% in the second quarter, the highest in several quarters, from 22% in the prior quarter. This was from a more favorable mix of revenue from logging and through tubing services. Depreciation and amortization increased to $30.4 million in the second quarter compared to $29.2 million in the prior quarter. Most of this increase was due to one month of incremental DNA from the SOPESCO transaction. We expect DNA to increase by approximately $2 million in the third quarter compared to the second quarter run rate from new CapEx and a full quarter of SOPESCO. Interest expense in the second quarter was $4.2 million, down slightly from $4.5 million in the prior quarter. The benefit of lower interest rates on LIBOR were partially offset by one month of incremental interest from SOPESCO. Our effective tax rate continues to track well below the rates seen in 2019 as we continue to optimize our tax structure. The effective tax rate for the first half of 2020 was 19.7%, compared to 23.2% in the first half of last year and the full year 2019 rate of 24.9%. Based on current full year projections, we expect the effective tax rate to stay at or below 20%. This resulted in reported net income of $10.5 million or $0.12 per diluted share and adjusted net income of $12.3 million or $0.14 per diluted share. We were also very pleased with the sequential improvement in operating and free cash flow. Cash flow from operations for the second quarter was $42.7 million, our second highest quarterly rate ever, up from $9.9 million in the first quarter. Gross collections increased approximately 13% sequentially on a revenue increase of just 2%. While invoice processing delays significantly improved from the onset of COVID, we are still experiencing a longer collection cycle than normal. We continue to align our supplier payment timing with our customer collections to mitigate this impact. Capital expenditures in the second quarter were $27.1 million. Most of this cash spend was for payments of CapEx received or approved in 2019. In the first half of 2020, we have only authorized approximately $25 million in new commitments, which is about 25% of the original plan for 2020. This improvement in operating cash flow generated positive free cash flow of $16 million in the second quarter compared to negative $14 million in the first quarter. We expect even higher average quarterly free cash flow in the second half of 2020 over the second quarter rate. This will be achieved through improved collections and lower CapEx. We expect DSO by year end to return to or improve over the level seen at year end 2019. The expected retention payment of approximately $20 million was collected in July and we could possibly receive an additional smaller retention release in the second half. We also expect additional DSO improvement in several markets that have been experiencing processing delays due to COVID. Capital spending levels in the second half should be lower than the first half run rate as we significantly reduced our originally planned 2020 CapEx commitments at the outset of the COVID crisis. Cash CapEx for the second half is expected to be in the range of $30 to $35 million, down from $51 million in the first half. Net debt increased to $342 million at June 30, 2020, compared to $336 million at the end of the first quarter. Net debt increased sequentially as our net cash generation was offset by the addition of net debt of $22 million from Sipesco. We drew an additional $15 million from the revolver to fund a portion of the upcoming regulatory closing of Sipesco. As of June 30, 2020, our net debt to adjusted EBITDA ratio was 1.7, flat from last quarter, and should reduce to our target level of approximately 1.5 in future quarters. Also, we remained in full compliance with our credit facility financial covenants in Q2 2020. Finally, in response to changing market conditions, we were able to successfully renegotiate the timing of certain closing cash and debt payments for the Cepesco transaction. The initial agreement called for cash and debt repayments of approximately $50 million at closing. Now, only $22 million of cash and debt payments need to be funded when the final post-closing regulatory actions are completed in Q3. Additional cash payments of $6 million will be paid monthly over the third quarter. We also negotiated additional earnouts for cash payments of up to $7 million only if certain milestones are met in the fourth quarter. Finally, Sepetco's primary lender agreed to extend the remaining long-term debt repayment of $10 million until the third quarter of 2021. Moving to ESG, during the second quarter, NESR issued its second full proxy statement that details our compensation philosophy. Our executive compensation is highly targeted to achieving performance targets. Our base salaries are generally below market, with the majority of our compensation linked to achieving short-term and long-term goals that focus on growth, cash generation, and stock price performance. Many may not realize that Sherif has waived his equity grants for the last three years so that more operational employees can participate in the equity program. The purpose is not only to align a broader group of employees with our shareholders, but also ensure that these employees share this potential compensation and not just the senior executive. At NESR, ESG is not just about achieving a certain rating but also how we manage the company every day for the sake of all of our stakeholders. In conclusion, NESR continues to outperform the market in revenue growth and margins through our regional focus and strong operational execution. We also strive to outperform the market Thanks, Chris. In conclusion, I would like to leave you with four key takeaways. Number one, we have managed the COVID-19 situation and our readiness is better than anyone in the industry, maintaining 100% capacity at all times.