National Energy Services Reunited Corp

Good day and welcome to NESRR's third quarter 2020 earnings call. With me today is Sharif Foda, Chairman and Chief Executive Officer of NESR. On today's call, we will comment on our third 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 Sharif.

Thanks, Chris. Ladies and gentlemen, thank you for participating in this conference call. We are very pleased with another outstanding record performance this quarter. We grew 35% year over year and 7% sequentially, which is a phenomenal achievement given this growth has been delivered against the backdrop of continued industry surplus supply, compounded by pandemic-related effects on the global demand. I believe we are an outlier in the OFS space for delivering such results when the rest of the industry is contracting with these headwinds. As I have previously stated, we have achieved this due to the stellar effort of our teams on the ground. We not only have managed to hold the line but have learned to thrive in this very tough environment. I cannot speak highly enough of our management and operation team in each of the countries. I am blessed to have such talented individuals who run their operations with an unmatched passion and dedication. Most of our leadership in the country are nationals of the country, and not only they have an acute understanding of all the nuances of what needs to be done for the business, but they also have stepped up to the roles as leaders in the community. Just to give you an idea on how well we have managed the operations, we have increased our operating hours this quarter, and we have added headcount to manage our growing operations while the rest of the industry is laying off people. All this while being acknowledged as the best service quality provider this quarter by one of our main customers measured by non-productive time or MPT during operation. One of our main differentiators is our execution ability during the COVID-19 and maintaining 100% capacity at all times. We have been very clear that we will handle this crisis by fundamentally modifying and strengthening our processes. Essentially, a big emphasis on planning short and long cycles. We managed the recent curfews reinstated in some of the countries. The continuation of some borders shut down. Difficulties include changes or importing spirits or chemicals on time. Our crisis management team is still in full action and so are the emergency response teams in each of the countries. And yes, in this new normal, there is an extra layer of cost you have to bear for COVID preparedness and handling. I just visited the Middle East and was with our customers in different countries. By the time I finished my trip, I had taken four COVID tests and had quarantined in a couple of hotels for a few days. I was very pleased to see my deal clients and friends. I'm very thankful to our customers to give us their trust and the opportunity to serve them. All this cost does add up, even though we have a large local content in our company. You also have to carry additional backup functionalities in the field in terms of personnel, larger inventories, some of which our suppliers carry, and some we have to. Meanwhile, you have to plan for any eventuality of a second wave and the need to keep all these costs in place to ensure we are not taken by surprise, ensuring the safety of our employees and readiness to our customers. Coming to the macro, which has evolved in some areas since our commentary last quarter. I won't spend a lot of time on the demand and supply debate, but as we know, Global economy is seeing a contraction due to the pandemic, and certain sectors, like air travel, have been affected severely with longer recovery ahead of them, while others, like shipping, have recovered much faster. Our view is that the demand will rebound sharply, and the market underestimates how fast the demand will come back once we have a handle on the price. The airports are not going to be always empty, and people are eager to get back to normal life, although this won't stabilize before we see a vaccine and more clarity on the potential second wave. However, the fact is, our industry continues to drastically underinvest for six years now. Therefore, most of the rebound and energy needs will come from the Middle East. As you saw in April and May, the main players in the region have the capacity to turn it on and meet the demand as the most reliable supplier. And we believe that would be the case when the time comes again. This could be sooner than many expect. Meanwhile, as I mentioned last quarter, we continue to see the same pattern in the MENA region. The core GCC markets have been measured and deliberate in their approach. We see more weeks released lately, but overall, they run their business for the long term and the health of their countries and populations. Others, the drop has been significant, as expected, as it is characterized by smaller independent or larger IOC with significant budget cuts, security concerns, pandemic fears, with cash constraints and others. We are seeing anywhere from 40% to even 80% cut in some of the activities. Given our size and scale and also our geographical exposure, we are able to manage these activity reductions by essentially gaining market share in either the same country or moving assets to other countries where we have gained recent work or replacing competition who can't deliver on their work scope. Best example, we managed to mobilize for our recently awarded coal tubing and pumping contract in Abu Dhabi by marshaling most of the resources internally. This also helps our overall utilization, which we have to balance with the need for adequate safety margin during this pandemic. Last week, we announced that we extended our five main contracts in PDO for a period of up to nine years. and we landed an additional contract in Deling, which gives us an option to further expand in that space. These contracts, which are worth over $1 billion, form the backbone of our operation in Oman and our drilling segment. It is a tremendous achievement for our Omani team, working very closely with our customers to achieve a mutually beneficial outcome. I would like to thank the Ministry and PDO for their trust in our abilities and for their guidance throughout the process. This cement our foundations and ensure we can amplify our investment to achieve our goals to maintain and secure the highest level of Omanization and in-country value. We have big plans to export Omani talent to meet the needs of human capital in the region. Today, we already have Omani National working in several countries. We will be hiring and training more to ensure we are ready for the future. As an example, today, all our through-tubing business across Nesr is headquartered in Oman and they support all our operations across the GCC and the larger MENA. We proved the model works and now... we can do even more as we expand on our offerings and contract duration. As you have seen, we are heavily invested in the social aspect of our business and engagement in the region. And this is ESG in action with a direct consequence on the sustainability of our business. Another example of NESF ESG commitment is how we have taken our fracturing operation to the next level. As you know, we continue to break all operation records in terms of stage efficiency and was delivered. Meanwhile, we looked with our customer how to continuously improve on the environmental impact. From smaller projects like solar lights for our camps and sites to our latest endeavor where we have worked with our customer to optimize the frag design with cutting-edge technologies, to effectively reduce the slick water fluid volumes by one-third. This means we are now transporting and pumping one-third less water, which is more than half a million barrels a month. This has a material effect in a water-stressed area like the MENA region. In addition, such fluid systems supported the reduction of the FRAC fleet carbon footprint by 30% as the FRAC jobs are consequently shorter. We are working on more initiative with our clients and our partners to implement different technical solutions to the challenges we face. Just keeping to the water example, we are working very closely to come up with a solution to use high sulfate water for frag jobs, which will completely eliminate the usage of over half a million barrels of fresh water for these jobs. In the same spirit of optimizing and make fractures better, we have recently invested in a technology company called Deep Imaging, which we are going to shortly introduce to the region. This technology allows us to monitor fracs as they happen down hole in real time and uses electromagnetic arrays on surface to measure the changes in reservoir as the fracs are happening. This will allow us to control the fracs in real time, which is the holy grail of frac optimization. It is estimated from public studies that only 60% of the frac stages produce as expected. And this measurement technology will allow us to further improve the existing processes. Another tech company which we are partnering with is developing technology to deploy downhole pressure, temperature, and flow rate sensors during the frac jobs, allowing us to measure both the frac and flow back performance. To marry all this and to give the maximum value to our customers, we have also partnered with Bill Van Garten and Bill Van Garten Laboratories who are the premier reservoir consultants and have a state-of-the-art laboratory in the unconventional reservoir space. We are already working with them in the Middle East for one of the NOCs who are in their planning stage, and we will continue to develop this across the region. So as you see, we are on the leading edge of taking the FRAC technology into the digital age, which will help reduce both the FRAC footprint and contribute positively towards the larger ESG goals. In drilling, KBOS investment is bearing fruit, and this shear-anything technology is now sold in Gulf of Mexico. As you may recall, KBOS is making shear-anything ramps, which will enable operators to shut in the wells if everything else fails in the case of blowouts. This innovation uses technology used in space programs and military application and applies to a problem in the oil field environment which has the potential to take a terrible human, economic, and environmental toll whenever things don't work as planned. As in our norm, we invested in this company and now are in advanced stages to take it to the region where the customer wants to apply this technology to use it as a barrier in H2S environment, which when it leaks, is known as the silent killer. We have several other technology investment and partnership in the works, which we shall announce in the near future. They all have the same purpose, how to solve our customer problems using the most innovative technologies which will help our clients to either produce more from the same reservoir or produce at a lower cost while reducing the overall carbon footprint of the operation. Lastly, I wanted to give you a quick update on SAPESCO, where we have now fully closed the transaction. The integration is ongoing, and we are already seeing the benefit of this outside of the main operation in Egypt. our customers in Egypt and outside have received the transaction quite well. And we have leveraged that position to either win some awards or bid for some tenders which previously Ness would not qualify for. So a great start, and we have big plans to expand that industrial service portfolio outside Egypt. And on that note, I will pass the call over to Chris to talk about the financial details.

Thank you, Sharif. As Sharif mentioned, we reported another record quarterly revenue record with third quarter revenues of $218 million. This represents an increase of 35% over the prior year quarter and 7% over the second quarter. The sequential and year-over-year growth was driven primarily by the new FRAC product line in Saudi Arabia, a full quarter's contribution from Sipesco, and our new contracts in Kuwait and Abu Dhabi. that offset market declines in Iraq and North Africa. We also achieved another record quarterly level of adjusted EBITDA in the third quarter of 56 million, or 26% of revenue. This represents an increase of 17% over the prior year quarter and 8% over the prior quarter. EBITDA adjustments of 2.5 million for the quarter are mainly 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 remained flat over first half 2020 levels. We have continued to experience increased recurring costs related to COVID-19, just 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 reduced activity in some markets, we have been successful in finding opportunities to reduce costs in areas such as equipment rentals, transportation, and field facilities. These supply chain efforts continued in the third quarter with improved pricing realized on certain production-related product costs. Moving to our segment, our production segment revenue for the third quarter was $148 million, another quarterly record, growing 53% over the same period last year and 7% over the prior quarter. The sequential and year-over-year growth is primarily related to frack activity in Saudi Arabia and the 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 were 29% in the third quarter. While margins were flat sequentially, lower margin pass-through revenue associated with frack activity grew as a percentage of total production revenue in the third quarter. This impact was mitigated by less contract startup costs for the conventional fleet and other cost reduction efforts. Separately, our drilling and evaluation segment revenue of $70 million in Q3 was also a quarterly record, up 9% compared to the same quarter last year and sequentially. The increase over Q2 is primarily related to a full quarter benefit from SOPESCO and higher well testing activity in Saudi Arabia. Adjusted EBITDA margins of 24% in the third quarter were down slightly from 25% in the prior quarter, mainly from a less favorable revenue mix. Depreciation and amortization increased to $32.2 million in the third quarter compared to $34.4 million in the second quarter. Most of this increase was due to a full quarter impact of DNA from Sipesco. We expect DNA to increase by approximately $1 million in the fourth quarter compared to the third quarter run rate. primarily from new CapEx additions. Interest expense in the third quarter was $3.8 million, down slightly from $4.2 million in the prior quarter, primarily from the benefit of lower interest rates on life. Our effective tax rate needs to track well below the rate seen in 2019 as we continue to optimize our tax structure. The reported effective tax rate for the first nine months of 2020 was 21%. compared to 23.4% in the first nine months of last year and the full year 2019 rate of 24.9%. The increase over the first half rate was primarily due to an unfavorable mixed shift of income earned in higher tax jurisdictions. Based on current full year projections, we expect the full year 2020 effective tax rate to be similar to the year to date. This resulted in reported net income of $11.7 million, or $0.13 per diluted share, and adjusted net income of $14.2 million, or $0.16 per diluted share. Turning to cash, I will initially review the impact on Q3 of the closing of the SOPESCO transaction. First, we paid $11 million for the closing cash obligation. Second, we made $4 million of post-closing installment payments. Third, we paid off $11 million of $21 million assumed bank debt. These were funded by available cash operations. In the fourth quarter, we expect $4 million in additional post-closing installment payments, plus possible other earn-out payments. The remaining $10 million of assumed bank debt will be paid in the third quarter of 2021. The issuance of the closing shares will occur in the fourth quarter of this year, but are already included in our share count for EPS. Switching to operating and free cash flow, both were down sequentially, but we were pleased to generate positive free cash flow of $9 million while still investing in our sequential revenue growth and our capital spending program. Also, since the onset of the pandemic, our cash balances and net debt have remained relatively flat, even with our revenue growth and the funding of the Sobesco transaction. During the third quarter, we added approximately $12 million in net working capital, mainly through additional receivables to support the 15 million sequential increase in revenue and higher VAT receivables in Saudi Arabia as the VAT rate increased from 5% to 15%. This was partially offset by a corresponding increase in accounts payable. Included in the working capital addition with certain inventory purchases to both support our activity, but also to ensure we have sufficient supply of production chemicals and spares in case of any disruptions from a second global COVID wave. Capital expenditures in the third quarter were $24.8 million. The majority of this cash spend was for payments of CapEx received or ordered in 2019. In the first nine months of 2020, we've only authorized approximately $30 million in new commitments. which is about one-third of the original plan for 2020. We expect free cash flow to increase sequentially as the fourth quarter is typically the highest collection quarter of the year. Additionally, our customers' payment processes continue to improve as inefficiencies from COVID are mitigated or resolved. Net debt increased slightly to $349 million at September 30th, compared to $342 million at the end of the second quarter. Net debt increased sequentially primarily to fund these working capital investments. As of September 30th, 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 covenant in the third quarter. Moving to ESG, during the third quarter, we added significant new ESG disclosures to the NETSER website. These disclosures will help our investors and the rating agencies better understand how NSER does business and its commitment to ESG. As we look into next year, NSER will expand its executive compensation disclosures by voluntarily adding a CEO pay ratio, which we believe will show we have one of the lower sector ratios, and adding a stay-on-pay vote to our proxy. As we have highlighted before, our executive compensation is highly focused on achieving performance targets with participation in short and long-term incentive plans carried down into the organization and not just with the executive team. At Nessar, ESG is not just about achieving certain ratings, but also how we manage the company every day for the sake of all of our stakeholders. In conclusion, Nessar can strongly outperform the market in revenue growth and margins through our regional focus, strong operational execution, while still generating positive recast. With this, I'd like to pass back to Sharif for his final comments.