National Energy Services Reunited Corp. Q1 FY2020 Earnings Call

Greetings, and welcome to the National Energy Services Reunited First Quarter Earnings Call. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Chris Boone, Chief Financial Officer. Thank you, sir, you may begin.

Good day, and welcome to NESR's First 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 first 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 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 outstanding results this quarter. It is the largest quarter ever in the history of the company. We grew 31% year-over-year and 8% sequentially. This is in contrast to a usual seasonal decline from Q4 to Q1, and it was achieved under the shadow of both a worldwide pandemic crisis and a once-in-a-generation oil price collapse. I will touch on, in detail, both the challenges and our actions related to COVID-19 as well as the reality of the new oil price environment. But before that, I want to acknowledge the exceptional efforts all our employees have put in to support our customers and differentiate ourselves in these challenging times. The resilience, hard work, and extended stays in the different countries and at the work sites are the reasons we are considered the trusted partners by our customers. It's an outstanding team effort, and I'm very thankful to be blessed with such an enterprising group of individuals in our company across all levels. I have spent a fair bit of my career in the field. And in normal days, things are challenging enough. But to do that under the limitations of this pandemic adds a layer of complexity which only the best can handle. Our teams on the ground have come out with flying colors, and the results are there to speak for themselves. So how did we enable our organization to gain market share, deliver growth, and exceed our customer expectations in such circumstances? I will take a few minutes to explain our approach. We prepared early and appointed a Crisis Management Team, or CMT, which comprised of all my direct reports and key operation personnel. Below it, each country had its Emergency Response Team, or ERT, activated. This CMT has been meeting daily and reviewing the status of our readiness across all aspects of our operation as well as addressing any upcoming or potential issues we could face in due course. So we are not only focused on what is happening today, but also simultaneously planning for things 2 weeks, 1 month, 2 months down the road, and for any eventualities, including if the borders between the countries are completely shut down. This covers everything from logistics, supplier sustainability and how they are handling their own operations, customer engagement, minimum inventory for spares and chemicals, liaising with our customer and local authority for their elevated and continuously evolving processes, navigating through each country’s regulation on handling quarantine procedures while ensuring the health, safety, and well-being of our employees and everything else which could and would get affected. Lastly, we always need to ensure that we go the extra mile to confirm our people on the ground are well taken care of. The CMT set out a series of initiatives to not only take care of our employees at their work sites, but also for their families. One of these initiatives was to offer financial help in the form of prepayment of salaries to the families of employees who are either out of their home countries or at the well site for an extended period of time and send money to their country of origin. In these difficult times, we strongly believe it is our duty to support all our employees and their families. They are making the difference for our customers and maintaining our business continuity intact. Our customers recognize these efforts and have, in turn, depended on us more and more to cover for any disruptions of their activity on account of some of our competitors' inability to manage through the challenges. In summary, not only are we coping with our existing normal work scope, but we are actually taking on more work in this period because we have been able to plan better than others and manage our equipment, supplies, and inventories as well as our staff. It is a testament to the culture of performance and customer-first that we have built. All of this reflects the 8% growth sequentially when overall customer activity has been flattish, and I will expand on an example later in my comments. Now let me dig into what is happening on the macro front. I won't belabor the dynamics of OPEC, Russia, and U.S. land, as everybody knows or has an opinion on it. But the key point of relevance to oilfield services that I want to make is that international low-cost per barrel markets are always more resilient in the downturns. This especially applies to the Middle East and Russia. From Day 1, the reason we formed NESR was to focus in the Middle East and our clients, and that is the exact reason we opted not to change our mantra. There is inherent stability in the region, and our main clients are national companies who have larger objectives than to respond to short-term oil price gyrations. They focus on their country's well-being, maximizing the result of the country as a whole, employment, and social effects of the industry. Yes, as priorities change, they will move between oil and gas as per the long-term direction, and yes, they also have to work within the parameters of the oil price environment reality. But this also provides us an opportunity to innovate in our delivery and the solutions we provide both commercially and technically. The GCC as a whole remains active and had no slowdown in Q1. Things will change, obviously, with the OPEC cut in May, but I see it both as a challenge and an opportunity to strengthen the business. In my opinion, going forward, most of the delays will come from new projects: seismic, exploration cancellation, offshore new frontier, and additional downstream mega development. We pride ourselves on being close to our customers. We understand them and have the pulse of the region, and the way we will execute our strategy is by being agile to react and adapt. Our relatively small size also helps us readjust to any changes. Outside of the GCC, North Africa and Iraq are both affected by these oil prices as they are driven by several international and local independent operators. This is further compounded by the effect of the coronavirus in an already security and structurally challenged environment. Drilling new wells will be the most affected, especially the large LSTK projects, but the production activities won't be affected on the same scale. On a marginal basis, they still have a very low-cost of production per barrel, so these fields are going to continue to produce and maintain production and workover activities rather than drilling new wells. Outside of the larger MENA region, Africa has seen a significant drop in project cancellations. West Africa will be heavily affected, and I don't see any new deepwater or offshore projects being sanctioned in the near future. Our limited exposure is to Chad only, where most clients declared force majeure, but in the overall scheme of things, it's insignificant to list. As in any downturn, pricing is going to be a topic of issue, if not already with our customers, and we have to ensure that we adjust to the market realities in the most optimal way. Similarly, we are working to get the appropriate savings from our supply chain and align our partners and suppliers with the new reality. All this is happening in parallel, but overall, our endeavor is to reduce the total cost of operation and share those savings with our customers. Last quarter, I talked about how we initiated and started executing our unconventional fleet operation in the Jafurah Basin in Saudi Arabia. We broke all records and did all this in a very short period of time, all with a very innovative CapEx-light business model with our main partner NexTier. I'm very pleased to report that we have further consolidated our position, and we have been assigned the primary work scope for unconventional fracturing in Jafurah. We have consistently outperformed our competition and brought significant innovation, making it similar to U.S. land efficiency to this very complex operation in the Middle East. To compare on like-for-like conditions, our customer conducted 2 separate frac-offs where we went head-to-head with our competition. I can tell you that each time we arrived later at the pad and finished before and left the pad while the competition was still fracking. It is a clear testament to our execution capabilities and ability to project-manage one of the largest oilfield services projects. Our customers are very wise and truly believe in leveraging the best of the world and the open-source methodology to create differential outcomes for themselves. If a local company does it, even though it may not have the same pedigree or history as its larger counterpart, even better and more commendable as that ties into their improving in-country capability objectives. I would like to remind everybody that we did all this with a truly innovative business model and not just by a fleet, and hence this project has been accretive from Day 1. We did this by capitalizing on merging our knowledge, experience, and expertise with our partners, mainly NexTier, for which the structure is also accretive. If you look at the structure in light of today's environment, it makes even more sense than it already did. I am very pleased with how this has panned out for us and our partners, and most importantly, our customers. To further build on this, we have already shipped a second fleet from NexTier to the region, with plans to deploy before year-end. We have been in active discussions with our customers to put the framework in place to repeat the same performance in other fields. As we mentioned in previous quarters, we made significant investment in our new countries of operation, like Kuwait and to a smaller extent, Bahrain, where we have delivered stellar performance. In Kuwait, we are conducting our cementing contract at full tilt, and our activity is more than 3x our exit rig assignment in Q4 of 2019. In Iraq, we have started operations on our large integrated service contract with a super major, which is a commendable effort on the part of the team, given the logistical challenge in the current environment. In Indonesia, we have expanded our offerings by conducting our first cementing and wireline operation outside of geothermal wells. We also conducted a small prop frac operation for one of our clients. Another great milestone, very close to my heart, was the groundbreaking of our technology R&D center in Saudi, with the presence of the President of the University KFUPM and all Aramco senior management. The center, called NORI, which in Arabic means My Light, is set up with our technology partners to lead the way to develop and deploy custom-fit solutions for our customers. Today, we have more than 15 technology agreements in place, and NORI is going to be the anchor of our innovation strategy once we inaugurate it in early 2021. As most of you have seen, we announced the signing of the agreement to acquire SAPESCO, one of the largest service companies in Egypt and the oldest oilfield service in the region. I spoke about it in detail in the last quarterly conference call. As an update, we are working through the modalities of closing the transaction, given several regulatory delays. With this acquisition, NESR will have a large footprint in Egypt, and operations in Saudi Arabia, UAE, and Kuwait are directly accretive with no or minimal overlap. This transaction is also accretive from a cost perspective as we will leverage the human capital and back-office capability that SAPESCO invested heavily in. Chris will delve into the details about the numbers. But briefly before I pass this to Chris, I want to speak about our approach to CapEx in this brave new world. Typically, because of how our growth mobilization has worked out, we have front-loaded our CapEx to ensure readiness of these projects. But going forward, we have cut the second wave of CapEx as we believe that our better utilization, as well as the drop in activity in U.S. land, will present us with opportunities to arrange with partners or procure the required assets at significant discounts, with which we can cover the growth. We are already working on four such deals. Consequently, we have cut 30% of our CapEx for the year. On that note, I will pass the call over to Chris to talk about the financial details.

Thank you, Sherif. First quarter revenues were $199 million, an increase of 31% over the prior year quarter and 8% over the fourth quarter. The sequential growth was driven primarily by the new unconventional product line in Saudi Arabia. This, coupled with most of our other new contracts now being active, puts NESR in a strong position going into the second quarter. Adjusted EBITDA was $51 million for the first quarter of 2020, increasing 25% over the prior year quarter. EBITDA adjustments of $1.7 million for the quarter are primarily for transaction and integration planning costs associated with our pending acquisition of SAPESCO in Egypt. Despite increased costs related to COVID-19, we considered all these costs as normal operations and made no adjustments to EBITDA for them. Moving to our segments. Our Production segment revenue for the first quarter was $133 million, growing 45% over the same period last year and 10% over Q4 2019. The sequential growth is primarily related to unconventional completion activity in Saudi Arabia. This was partially offset by lower activity in Iraq and North Africa from the initial impact of the global oil price environment, as well as shutdowns and security challenges. Adjusted EBITDA margins for the production group of 31% were down sequentially from 33%. Margins were impacted by the higher proportion of pass-through revenue associated with unconventional activity and the impacted markets. The company has taken actions to reduce costs in these impacted markets to align operating costs with current business levels. Separately, our Drilling and Evaluation segment revenue for the first quarter was $66 million, growing 11% over the same quarter last year and 3% sequentially. The sequential growth is primarily related to drilling services in Oman and Kuwait, as well as wireline and well testing activities in Saudi Arabia. Adjusted EBITDA margins improved to 22% in the first quarter compared to 21% in the prior quarter due to a more favorable mix of revenue. Depreciation and amortization increased to $29.2 million in the first quarter compared to $28.4 million in the prior quarter. The majority of this increase was due to additions from capital spending. We expect D&A to increase by approximately $2 million in Q2 2020 and an additional $1 million in Q3 from equipment additions. These estimates do not include any additional depreciation and amortization related to the SAPESCO transaction. Interest expense in the first quarter was $4.5 million, up slightly from $4.3 million in the prior quarter. The effective tax rate for the first quarter of 2020 was 18.2%, a decrease from the fourth quarter 2019 rate of 37%. Based on current full year projections, we expect the effective tax rate to stay at or below 20% due to the benefit of certain legal entity restructuring and other tax efficiency initiatives. This results in reported net income of $11.4 million or $0.13 per diluted share and adjusted net income of $13 million or $0.15 per diluted share. Turning to cash flows. Cash flows from operations for the first quarter were $9.9 million. Operating cash flow decreased from the fourth quarter, primarily due to an increase in total receivables, which include unbilled revenue and retention of $34 million. Absent the short-term increase in receivables, free cash flow would have been $20 million in the quarter. Approximately half this increase in receivables was due to the sequential increase in revenue. However, we did experience some slowing of collections in March from COVID-19 restrictions in the region, which were earlier and more stringent than in the U.S. This impacted field ticket approval, invoice processing, and customer approvals. In addition, the processing of the retention release payment of approximately $20 million was delayed but should be paid in the second quarter. DSO, however, only increased sequentially by approximately 7 days to 114 days. While the collection cycle will continue to be impacted in Q2, there was an improvement in invoice processing in April in most areas. It is also important to remember that most of our customers are NOCs and large IOCs that have always paid even if the process is a bit slower today. In the second quarter, we expect to see strong free cash flow as collections mostly normalize and put us back on our cash generation plans. CapEx for the 3 months ended March 31, 2020, was $24 million. In the wake of COVID-19 and its impact on oil prices and energy demand, we have reduced our original 2020 cash CapEx budget of $100 million by approximately 30%. Net debt increased to $336 million at March 31, 2020, compared to $310 million as of December 31, 2019. Net debt increased quarter-over-quarter to fund accounts receivable growth and capital expenditures. Overall debt balances remained relatively flat sequentially. As of March 31, 2020, our net debt to adjusted EBITDA ratio was 1.7x, down from 1.8x last quarter and should reduce to our target level of approximately 1.5x in future quarters. Also, we remain in full compliance with our credit facility financial covenants in Q1 2020. The SAPESCO transaction is still expected to close during the second quarter. Currently, we have finalized the audit of the financials and are awaiting final regulatory clearances, which have been delayed due to ongoing COVID-19 restrictions. We believe we have sufficient liquidity to fund the transaction with existing cash and credit facilities, and the transaction will be overall accretive to that. Finally, in response to current market conditions, we have been taking steps to maintain our financial strength and margin profile. For smaller markets that have experienced activity declines, we are rightsizing our organization as well as redeploying assets to our growth markets, which will improve our asset efficiency metrics. In all markets, we are aggressively negotiating and receiving discounts with both global and local suppliers on CapEx, products such as chemicals, spare parts, and services such as equipment rentals. Also, as part of our working capital management, we are aligning supplier payment terms with our customer payment cycle. We have also recently implemented new ERP tools to enhance the visibility of available spare parts across all countries to help reduce inventory levels and enhance cash flow. In conclusion, we are pleased with the investments we've made in CapEx, new product lines, and new country entries that will allow NESR the opportunity to grow and gain market share in a difficult global market. With this, I'd like to pass back to Sherif for his final comments.

Thanks, Chris. So to conclude, going forward, we plan to navigate and be ahead of the curve to ensure we continue to capture the growth, mainly market share gains by demonstrating readiness with our customers and executing flawlessly when others are struggling or trying to keep their head above water. We are an execution machine, and we strongly believe we can continue on our growth path with appropriate adjustments. I go back to our original thesis: the Middle East is going to be the last man standing when it comes to oilfield services, and we are in a great position to leverage our execution capabilities, in-country knowledge, and deep customer relationships to capture the opportunities the market presents to us. On that note, I would like to pass it on to the operator for your questions. Donna?

Our first question is from David Anderson of Barclays.

Sherif, Jafurah Basin, I think it might be the only unconventional basin in the world that's actually adding frac crews right now. I was just wondering if you could talk a little bit about the success you've had there. You talked about a second frac-off in which you've won that again. I think you originally had a long-term contract and now you have what you call the primary scope for Jafurah, so I don't know if there's a difference in that. But maybe you could just talk about what the differences are here? And why you're able to win those frac-offs so convincingly? I mean I think most of us, as we've been looking at unconventional plays, particularly pressure pumping, find it hard to differentiate from one player to the other. So how do you differentiate in that part of the world, and how are you able to succeed there?

Thank you, David. To summarize, the Jafurah Basin is currently developing a significant project valued at $110 billion with a capacity of 200 Tcf, which was announced by the Kingdom. The strategy has always been to have two frac fleets operational for the foreseeable future, with plans to increase capacity once drilling rigs are set up for the second phase, anticipated in 2024 and 2025. Right now, we had a second frac-off, where we were on one pad and our competitor on another, competing to see who could deliver stages more effectively and safely. We succeeded in both rounds, which led to us being designated as the primary contractor responsible for completing the wells. If there are additional wells, they will call upon the second fleet. There are no plans to add more fleets to the Jafurah Basin; in fact, there may be a slowdown. However, this would not impact us since we are the primary contractor. Any reduction in drilling activity or withdrawal of a frac fleet will affect our competitor, not us. Their shifts between oil and gas, and between conventional and unconventional gas, reflect their business model. With OPEC's production cuts, it’s expected that some projects may face delays. The important part for us is to maintain our primary position; any potential delays or cancellations will not originate from us. We attribute our success to our innovative business model, which includes selecting the best crew from NexTier. I worked closely with Robert Drummond to ensure we brought in top-notch equipment and innovative technology previously unseen in the Middle East. We invested appropriately and currently have a team of 12 from NexTier and about 100 from our organization, effectively combining U.S. efficiency with local expertise in Saudi Arabia. This approach has impressed our clients, including visits from high-ranking officials and teams, who were very pleased with our designation as the primary contractor for such a complicated project.

Okay. So when you think about how Jafurah gets developed over the years, you said there's a timeline out to '24, '25 right now; what's limiting it right now? I know there's processing that they're building there, which has nothing to do with you. But you have a lot of wells that have to be in front of you to have an efficient field. So is it part drilling? Is it part processing? I don't know if you can share with us kind of how that.

There are no delays. I would say there are no delays at all. They have the plan as is. You have the natural delays, right? What I mean is these natural delays happen because of what took place. The Middle East was one of the first to completely shut down borders and flights. So a lot of this is just going to get 6-month natural delays. On top of that, it's compounded by the oil price and what's happening. Obviously, Saudi was producing 12.3 million barrels in March and April. So there was a lot of associated gas that came with this production. They did not need to have the conventional projects, but the plan is as is. Now are you going to add more rigs at the same pace in the current environment? That's yet to be seen. They will decide on that. That's why it was important for us to be the primary contractor because if there are any delays, those delays will come from the current rig count affecting how many pads can be completed. They have the same rig count on those in Jafurah Basin, but will they add more rigs in the current environment? That's yet to be seen, and obviously, I am sure some of the downstream projects will also see delays due to what's happening.

Look, Sherif, that was my final question. I just want to ask you a more general take on Aramco. We saw a couple of months back, Aramco comes out and talks about lowering their overall CapEx budget by 25-30%. What's changed in the field from your standpoint? Is that just a shift from kind of gas to more rigorous work on oil? Is it more of a downstream mix? Can you just kind of help us understand a little bit without getting into details? I don't want to put you in a bad spot, but just from a general standpoint, what are the changes that are going on in Aramco? And where do we see that budget cut?

I think one of the big, I would say, misunderstandings is that people always take the budget cut from what they were planning to, not from the previous year. Yes, obviously, if you go to $35 million or further down to $40 billion, people see a huge cut. But if you take it from year to year, to be able to come back to your question about activities, what was the spend in 2019? And what will be the spend in 2020? You get a much more modest cut. It's not as drastic as people say because that's from the budget. So if you go from $29 billion to $25 billion, or even $20 billion, you're talking about a 15% to 20% reduction. The cuts you see today relate to 4 months of natural delays because of COVID-19. A lot of this will come from mega projects. You have all these gas processing projects, which are $5 billion, $6 billion, $7 billion, that have been delayed by 4-5 months. Some of it will be postponed as well. The upstream budget today will not drop as people think. Remember, Saudi will always maintain their production capacity, and they always prove to the whole world that they can produce 10 million barrels; they produced 12.3 million barrels. They will maintain activity for that.

Our next question is coming from Sean Meakim of JPMorgan.

I appreciate all those details. There's a lot to show on there, especially in Saudi. So with the 30% cut to CapEx, it doesn't necessarily sound like you're dialing back your growth plans. If anything, maybe you're being opportunistic in terms of how you pay for the equipment or how you get it. Can you maybe just give us a consolidated view of the top-line opportunity set for NESR in terms of 2020 on a medium-term basis? Are there any risks to the 20% CAGR?

No, I think so far, I would say, obviously, there are always risks. Would you get a second wave of coronavirus? Will you get another shutdown? But for our plans, we are moving ahead, as I explained. You can see that we spent already our $24 million CapEx in Q1, front-loaded. We added all our CapEx. What we see today is that we have many opportunities with our partners to procure equipment for the second half of the year at significantly larger discounts or different business models, as we did with the frac. Therefore, we are going to get the same amount of equipment but will spend 30% less. Today, our target, if we spent $107 million in 2019, we will not spend more than $75 million in 2020, but we're going to get the same amount of equipment. We have the same growth plans.

Got it. Well, I think that capital efficiency should certainly resonate even in this environment. Could you maybe just talk about which markets seem most prone to delays or slow-playing activity versus those that should be more resilient? Just any risks of certain markets which you can see volumes decline in '20 or '21?

In 2020, I would say, as I said in previous calls, North Africa and Iraq will definitely see an impact. We see it already, right? We saw it in Q1. I think it's going to get worse for sure in Q2. In Iraq, you have to separate it between two regions: Kurdistan and Basrah. Kurdistan will go to zero because this is an independent operator; they need cash flow. At this oil price, they won't trade and will wait for the next wave. The IOCs that have big contracts will drill new wells. Today, if you are a big supermajor, you will not drill new wells; you would just stop, and that’s exactly what they're doing. The biggest drop will be in drilling new wells—and that's why the effect on us is much less. I'm not saying we are much better; it's just that we are not into these projects. We are lucky—we are not an LSTK. We are not drilling new wells in Iraq because those are all lump sum contracts. Those projects are going to be slashed by 70% at least. How do they make their money? They make money because they have producing fields. The contracts they have in Iraq are fee-per-barrel. If you are in Rumaila, you charge per barrel, and it produces 1.4 million barrels. The government might tell you to cut your quota by 100,000 or 150,000 barrels; you keep the rest so you maintain your workover and production activity intact, and that's where we get involved. If we look at North Africa, you have Algeria and Libya, where Tunisia and Morocco are insignificant. Libya had a shutdown due to ongoing conflict before the virus, and they are not producing or exporting anything. The situation is compounded by the virus. Algeria has announced a 50% budget cut. You have the national oil company (NOC) and international players. The international players will do minimal work, while the NOC will maintain the budget and cancel all new projects. Today, all exploration in Algeria is zero. So the activity has shrunk significantly, but the effect on us is much less than on others because we are not engaged in new projects or anything deemed as nice-to-have or exploration.

Our next question is coming from George O'Leary of Tudor Pickering Holt.

I wanted to expand on your last question and a comment you made earlier in the prepared remarks. You talked about the opportunity to strengthen the business in a downturn, and my read on that is playing a little bit of offense while a lot of other folks are just kind of in defense mode, which screams both intriguing and smart in this type of environment. You talked about it a little bit with respect to maybe opportunistically adding some equipment at cheaper than previously anticipated costs. But I realize you have a big transaction that's still ongoing. But could you describe the M&A landscape and just broadly the opportunity to go on offense while everybody else is going on defense? Is there anything in the M&A landscape that has cropped up as a part of that?

Sure. There are three main aspects to the answer. The first is organically continuing to secure market share because we are ready and others are not. They are struggling; we are not. Our approach leads to a great line of differentiation. Customers trust us, and we are getting more work. That's why you see this growth from Q4 to Q1, and we expect to keep doing the same. What this does is gain market share and trust and leads to more complicated projects, compensating for the countries that are going down significantly. The second part is similar—in today’s climate, I have a strong agreement, for example, on the frac with my partners. Why don’t we elaborate more on this agreement to make it with other equipment? We have a framework in place to repeat the same success in other fields. The third part of growth is, as mentioned, M&A. A lot of people are reaching out saying they need to join us; they have amazing offerings. To be frank, we have had little interest in acquiring anything in the U.S. except equipment at a steep discount. The MENA landscape—if there’s an accretive and solid company like SAPESCO, the numbers they’re quoting now, which were in the 9-10x EBITDA multiple, are now coming down because they see that the market is not as rosy as before. This results in a significant opportunity for us. This naturally takes time, but it’s another part of our growth strategy.

That was very helpful color, Sherif. And then secondarily, as you talk about market share opportunities and organic growth, it feels like there's a lot of myopia going around now. Everyone is focused on the very near term. But thinking about the next 18, 24, 36 months, in a longer-term timeframe, which geo markets do you think offer you the greatest organic growth opportunities over that time frame?

It will be the same: the GCC. The GCC will definitely be the biggest. And I believe you’re going to see a significant uptick coming. I strongly believe that the destruction of all the deepwater projects in West Africa, et cetera, and the return of oil demand to normal means the Middle East will be the biggest provider of that additional oil. Definitely, Saudi will be the clear winner. They have the capacity and will see many projects going. Our goal is to strengthen our core to a certain degree and gain flagship trusted partners. By handling projects like Jafurah, replacing an international service company, we can demonstrate that we can execute better, which gives us credibility and earns trust to capture bigger projects.

Our next question is coming from Greg Colman of National Bank Financial.

I wanted to dive into sort of normal – this is not a normal year, and I want to talk about normal Middle Eastern seasonality. In past years and following some of your competitors in the region, we tend to see escalation over the course of the year as spending and the move through the budget rises from Q1 to Q2 through into Q3 and Q4. However, this is not a normal year. We have borders closing, we have commodity issues. Should we expect the normal seasonality to trump any of the near-term hiccups? Or are pricing discussions and logistical issues going to flatten the activity for NESR over the course of the year, so we should be cautious about quarter-over-quarter growth rates going into subsequent quarters?

Yes, you are absolutely correct, Greg. This is not a normal year. I think in Q2, you will see the activity start dropping. So far, we are in good shape. But definitely, people will start dropping because they have to cut due to OPEC restrictions. A lot of these countries, if not for employment reasons, could cut 70% of rig counts and produce to the OPEC quotient without needing any drilling. They can produce optimally without additional drilling. Therefore, you will not see the typical seasonality of Q1 to Q4. Instead, we will see a more moderate trajectory from Q1 to Q4. The extent to this depends on what happens in Q3 and Q4 in terms of demand. If demand picks up, some of the drop we expect may not occur, leading to strong performance in Q3 and Q4. Overall, I agree with you: it will be more of a flattening effect due to growth in market share potentially competing with necessary price concessions and additional budget cuts from other countries operationally and among the super majors working in the Middle East.

That makes sense. That's pretty consistent with what we were looking for. And I had some technical issues earlier, so apologies if you already addressed this. But you were talking about border closings and the challenges with moving people and logistics. Can you talk to us about the percentage of your capacity which has fallen off as a result of these challenges? If pre-COVID, if, call it, whatever, Q4 or early Q1 was 100% capacity, what have you pulled back to now? And what are you going to be maintaining as we go through this period of more challenged border control and logistics?

I will answer you, but the whole idea of the CMT and what we did is to maintain 100% capacity. And we have maintained that. It’s surprising for some people, but the way to do it is to negotiate with everyone. We have a lot of local workforce, right? And that is the strength of the company. We then told the rotation workers one by one: if you want to go now, for example, to the field, you might stay 4 months. If you stay 4 months, the people replacing you cannot come. We subsequently managed rotation schedules. We took care of their families, sent money, etc. Many didn't complain because they wouldn't be able to go home anyway with the flight bans. Our capacity is now at 95-100%. We’ve captured all the market share, which is reflective of our 8% growth Q-over-Q. If this lasts for another 6 months, yes, we will have a problem because the workers cannot last forever. However, we already have ongoing discussions with our clients in a couple of countries about the need for crew changes. People who haven’t been home for 3 months will be expected back, and they want to come back afterward for another 3 months.

Our next question is coming from Andres Menocal of Evercore ISI.

So just two questions from me today. The first one is, as we think about the opportunity set that's expanding for you guys in the region, and I would say even outside of the region, is you're going to be one of the clearly surviving and thriving players through this downturn. My question is, thinking outside of the cash you have on the balance sheet and liquidity, if you need to get some kind of large form of deal done, can you kind of talk through what kind of strategic financing levers that you'd be able to pull? And what's at your disposal if you want to ramp things up to take advantage of an opportunity?

Look, I don’t see anything when you say large. We are not doing anything large, honestly. It will always be bolt-on. We will always be able to finance with cash because all the arrangements will be cash and shares, as we are doing with SAPESCO, or will be similar. If something is on a different scale, which there isn't much really in the region, then yes, we can look at different avenues. We have many of our core investors wanting to get on board in a bigger way into the story, especially at these price points. So there are many avenues for us to capitalize on. We want to keep our leverage; we don't want to exceed it. Many banks are offering us to raise more debt, but we won't do that. We want to maintain our covenant and our leverage, which we always mention is between 1.5 and 2. Our cost of capital is very small; we want to maintain that. We certainly reduced cash flow in this quarter. We had some retention issues with clients, which we know; this is with our deep-rooted clientele. We know that the logistical issue made it hard for them to attend the offices and release necessary payments. We can be flexible in Q2 to release the retention payments. If we hadn’t had that, we would have nearly $20 million of free cash flow.

So yes, it's a high-class problem to have. Second question and the last for me, and this was alluded to earlier, but can you try to describe the process and philosophy as to how you arrived at the newly revised CapEx number? What was the thinking behind that? Obviously, a lot of that is due to the decline in oil and gas activity. And I don't want to put you in a bad spot, but just curious to see how much of that is due to lower activity versus what you think is going to be a new changing landscape for how you decide to spend in order to generate revenues?

This is Chris. When you look at cash CapEx, some of our payments pertain to CapEx we've already purchased. But moving forward, as Sherif already mentioned, the whole point now is to take a quick break in CapEx and understand the overall market, especially where we can take advantage in the future by acquiring CapEx differently than we might have a month or two ago. We are exploring whether we can create partnerships with U.S. operators to utilize their underutilized equipment or find it at reduced prices. We would look at how we can leverage our equipment more effectively, which we are currently doing, before buying anything else. We will reassess quarter two to get a clearer picture and possibly reactivate some of our plans.

Our next question is coming from Blake Gendron of Wolfe Research.

I appreciate the helpful color on all the volume puts and takes here. I wanted to focus on pricing a little bit. It sounds like your 15% to 20% growth target is still intact. You're offsetting some pricing pressure with share gains, so on volume. For modeling purposes, we build your top line based on legacy activity, SAPESCO, and then thirdly the unconventional contract. Focusing on legacy work, I'm wondering if you've gotten the pricing call yet broadly. I know it's not homogenous across the region. Could you help quantify the magnitude of pricing and the net impact on margin?(...)

Pricing is an issue that is going to arise. Obviously, I am not going to instigate it. The smart thing to do is be the last man asked. So far, as long as you deliver well, they will ask you last, and that’s our plan. Do I feel what will be the impact? In my history, usually, the impact is around 10%. This is the Middle East. They may ask for 50%, and you end up at 20%, but then you have some lines that you discount, some that you do not. Some items can be passed through with your partners and suppliers; some cannot. So overall, you arrive at around 10% effects. Regarding your question about cost-plus, the Jafurah Basin or the frac is not a cost-plus scenario; it’s a clear per stage, very robust business setup. The thing we have in this contract is a lot of cost-plus. We provide the camp and related logistics, which comes at a high cost and dilutes your margin.

On the third piece of the model here, the SAPESCO deal, it sounds like it's going to close on schedule. I’m wondering what your outlook is for the Egyptian market specifically. Should we adjust our assumptions for top-line growth as a result of that contribution?

The Egyptian market gets affected like North Africa. It is characterized by many small independents. They also have IOCs and NOCs, and it gets impacted by the oil price. People will delay drilling, and it will see a decline year-on-year. This is part of the negotiation because the earn-outs are linked to activity levels—we cannot pay earn-out while the activity is down. We are in discussions regarding that. Their business outside will be with us, and so far it is intact. The Saudi, UAE, Kuwait operations are intact. Their business in Libya, as I mentioned earlier, will be affected like ours, but the Egyptian market probably won’t see the same. Thus, we will experience a decline year-over-year.

That's helpful. One more if I can sneak in here. I know we're past the hour. In the D&E segment, typically in 1Q, I would have anticipated seasonally weak margins, but it appears in a clean quarter you drove margin improvement. Was it a mix tailwind in the first quarter for D&E? Or are you starting to see some cost leverage potentially on the portfolio pull through the endeavoring?

It's a mix, Blake. No, it’s purely due to the mix. We delivered more in evaluation this quarter, like last quarter. The segment performed phenomenally, successfully replacing several competitors. Despite our cost increase to maintain crews, we still drove strong performance, resulting in the observed margins. The opposite applies in drilling; people in North America say they will drill wells without production, whereas, in the Middle East, they typically cease most drilling while focusing on production. This approach fits us well, as we do not have directional drilling or other such complexities.

Our next question is coming from Igor Levi of BTIG.

You talked about gaining share by being the primary contractor on frac work based on performance. You also mentioned gaining additional jobs as competitors had significant disruptions due to COVID-19-related logistical issues. Could you elaborate on the second point? What were the circumstances where you overcame these logistical issues? And what happens when they return to work? Do they get that work back, or do you keep that market share?

It's a mix, I would say. To simplify, many market share gains are achieved through solid planning. A client calls me, like with testing—some competitors are not prepared because they didn't plan adequately for personnel. Several faced cases of COVID, causing customer shutdowns. We prepared by stockpiling 6 months of chemicals and spares before the shutdowns. We have that buffer now while other smaller competitors do not. Will they return to their previous share when ready? Yes, to an extent. They will reclaim work, but not indefinitely. The market share gain that we’ve earned can be permanent if we prove effective execution has more sustained results.

Our next question is coming from Jeff Fetterly of Peters & Company.

A couple of quick follow-up questions. On the frac side, the second crew you're bringing into Saudi, you mentioned that crew will be working in Saudi?

Yes.

What sort of visibility or contract structure do you have to support that crew coming in?

We are in very strong discussions with our customer. I know the customer pretty well, and I trust them, so I am confident we will be able to use this crew effectively. We sent the equipment without people because there are currently no personnel able to travel. The fleet consists purely of frac equipment, supported by our NESR team in Saudi. While there are no workers reintegrating from the U.S. to Saudi, we are prepared to utilize our local personnel now.

Your earlier comment about broadening the scope of some of the partnerships that you have or are considering—will you also have additional services, whether it's coiled tubing, wireline, or others?

Yes. That is always the plan to expand our scope of services.

Is that equipment coming from the U.S. as part of the NexTier partnership? Or is that equipment you have in-country or building yourself?

I have in-country equipment and will manage better utilization across the group now. Since we merged our companies, we are moving towards better utilization metrics with a nearly 12-point increase since we started.

If you spend $70 million or $75 million in 2020, do you expect the revenue capacity of the business to be similar to what you previously expected when you budgeted $100 million?

Yes.

Is there a concern regarding your sustainability or contingency plans? Could you maintain your 100% capacity through the second quarter? If these restrictions are still in place through the second quarter, would you start seeing some deterioration in productive capacity?

I can sustain it through the second quarter. We have agreements with everyone and an expectation that the borders do not open up, and we will maintain our capacity intact for the second quarter.

So you expect to see some improvement in accessibility or logistics in the third quarter?

Correct. My expectation is that after Ramadan, we will start to see some easing in the opening up of borders for spare parts and some flights for personnel.

This brings us to the end of our question-and-answer session. I would like to turn the floor back over to management for closing comments.

Thank you very much. I know that we took more of our time. So I really appreciate your time, and we are very, very excited about the quarter and looking forward to further success in Q2 until the end of the year. Thank you very much.

Ladies and gentlemen, thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.