National Energy Services Reunited Corp. Q3 FY2021 Earnings Call

Greetings. Welcome to the NESR Q3 Earnings Call. At this time, all participants are in a listen-only mode. Please note this conference is being recorded. I will now turn the conference over to your host, Chris Boone, Chief Financial Officer. Thank you. You may begin.

Thanks, Alex. Good day, and welcome to NESR's third quarter twenty twenty one earnings call. With me today is Sherif 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 Sherif.

Thanks, Chris. Ladies and gentlemen, good morning, and thank you for participating in this conference call. The global commodity outlook is stronger than it has been in nearly two decades. On the whole side, as predicted more than a year ago, all the under investments and the supply gap, along with North America capital discipline will lead to significant supply deficits which will consequently cause activity increases starting later in twenty twenty one. And this is what we are seeing now. As we have been very vocal about it, the MENA region will carry most of the load, primarily because our customers always have taken the long view and have invested in spare capacity, as well as they understand that nobody but them will be able to fulfill this demand, especially in the short term and they can sustain it longer than anybody else. This will put pressure on the talent and equipment from service providers to deliver on these needs, which, as you know, is a function of the health of the service industry. As I have been doing since the beginning of the pandemic, I always wanted to be physically with our customers. I listen carefully to their plans and needs and feel the pulse of the evolving energy dynamics. This quarter is no different. I spent a lot of time in the field in the different countries like Saudi, UAE, Oman, Egypt, and Libya. Additionally, we started to have face-to-face industry forums and I'm glad that I was able to attend and present in most of them. I can tell you that everyone, without exception, is extremely bullish on the activities. They want to secure the adequate resources to ensure the deliverability of their objectives and are also very focused on meeting their ESG goals and commitments. They are reviewing and discussing the service industry strength and weaknesses and running proper sensitivity analyses on the different scenarios. This again reminds me of the two thousand and five super cycle. I also led a massive leadership visit to Libya to see all the customers in the entire country. We spent a solid week with the NOC and all the operators and visited the remote field locations. We wanted to ensure we are with them at the highest level, and we understand what is needed to restore the production to previous country highs. We are discussing together multiple approaches and a new business model given the nature of the activities and the fastest way to revive the production from shut-in wells. Additionally, we are reviewing how to have a paradigm shift in using the existing resources, enhancing them, capitalizing on the fact we have a one hundred percent nationally trained workforce that understands the subsurface and the facility constraints. We have placed a multi-disciplined team to look at the entire value chain and propose solutions to our customers. Meanwhile, we are looking into water scarcity, using flare gas, and how we can produce in the different fields in a sustainable manner. Overall, we are completely aligned with our customers in the region for fast activity increases in the coming quarters. And this feedback from recent customer meetings gives me confidence that the outlook is very strong as we have predicted previously. Now it is on us to demonstrate our industry-leading localization and execution as the National Champion of MENA. Since we front-loaded our CapEx, as I have said before, NESR remains ready and nimble to meet the demand of our customers, who will look to put activity on production capacity to new heights in the coming year. We continue to invest in human capital and equipment as we are convinced that this cycle will last for several years and the talent gap will surely be felt very soon in the industry. Next, I want to turn to the ongoing COP26 climate summit, and how the industry can be a total game changer in pushing humanity forward in the energy transition. Clearly, governments around the world are elevating the important issue of climate change, which will most likely result in laws and regulations that further incentivize green spending, particularly in Europe and North America. What the market may not appreciate is how our forward-thinking customers in the MENA region are also taking leadership roles in the energy transition. We have all seen the Saudi Green Initiative, demonstrating its commitment to its people and to the world. I was impressed with the level of details they laid out in their plans. Aramco again, as a world leader, explained how committed they are to achieve net zero and how they walked the talk and put credible targets and how they will achieve them. Additionally, you also saw the recent announcement from the kingdom on their plans for using the gas from Jafurah for generating Blue hydrogen. And as you know, NEOM already has aimed to build the largest Green hydrogen facility in the world. The key now is to remain pragmatic on how best we use our resources to achieve what is best for humanity. We do not want just to pass the emissions from one area to another. What we want is to lower the overall carbon footprint while looking at all other angles from eliminating waste and elevating the lives of people under the poverty line. As I mentioned in my hydrogen panel during the Future Investment Initiative in Riyadh last week, OFS can play a major role in actualizing this vision by taking the produced water and using the electricity generated from heat from the producing gases and facilities along the gas feedstock to provide the essential ingredients for this endeavor. Our thesis is that the industry can leverage existing infrastructure and production streams to support the production of new energies like hydrogen. We have invested in technologies to deliver part of this workflow. And I personally see a great opportunity by leveraging all this new tech measured with our existing footprint, technical know-how, and more importantly, project execution capabilities. This is where NESR's ESG IMPACT comes in. After we launched this new segment in January of this year, NESR has partnerships and investments in several technologies. In particular, in the water space, where I strongly believe our industry plays a vital role, especially in a water-starved region like the Middle East. I believe once we improve the economics in several projects, this segment will be as big or even bigger than our other two segments. Our esteemed customers play an enormous role in their existing economies and they are all and will be at the forefront of development and adoption of green technologies, which would enable the transition with the aim of not only the largest oil and gas companies but also the largest full-spectrum energy companies in the world. On the water side, following the previously announced and ongoing water pilots in Iraq and Saudi, we have been in continuous dialogue with customer inquiries and proposals for additional projects in the region. A key feature of this water market is that we are bringing new technologies in front of oil and gas producers. So, it's a market that we are essentially creating alongside our tech partner that today don’t exist. In emission detection, we recently finalized an MOU with another IP partner, which we should announce shortly, to bring GHD and H2S detection capability to the region that is moving quickly to both quantify and reduce component two emissions. Similarly, we are also moving quickly in the name of flare management and elimination. I believe that there are fantastic bundling opportunities with both emission detection and flaring. Progress across all ESG impact subsegments is being driven both bottoms up by NESR and continuously canvassing and evaluating the new energy technology landscape and also top down from forward-thinking customer partners. NESR's flexibility and nimbleness is key in having these discussions and in bringing new ideas to the table. Our open technology platform, much like it has enhanced our oilfield feed service portfolio is also the key element in bringing new innovations to the ESG impact discussion. Now, I want to turn to another key theme that is driving both our strategy and our positivity for the future, which is the progress we have made in our drilling and evaluation segment with a number of key technology investments, breakthroughs, and partnerships that will completely transform our capability in this segment. So far in twenty twenty one, we have announced marquee key technology alliances in the direction drilling tools with Phoenix Energy service, a company that continues to break records in NAM, and Ulterra, the U.S. Leader in drill bit technology. Over the last couple of years, we decided to invest ourselves with some of the most innovative minds in the industry to come up with new state-of-the-art downhole technologies. One of these investments is around rotary steerable technologies. Historically, the typical development cycle has been in the range of several years, five to seven, normally. Our aim was to do that in less than three years. I'm glad that we have recently tested our innovative RSS tool with one of our customers. We managed to deliver the well ahead of time with superior performance. We continue to test the tool with other customers, and we believe we will have a commercially viable leading-edge RSS in the very near future. The tool is designed to have minimal maintenance cycles and greater dog leg than existing tools in the market. This will complete our portfolio of drilling technologies and enable the company to enter that space. Recent D&E contract awards highlight this strategic focus of ours. During the third quarter, we announced more than one hundred and fifty million dollars in D&E awards across Slickline, Tubular Running Services, and Testing with several key NOC partners. In terms of innovative breakthroughs, we decided to increase our investment in kinetic pressure control. They had successfully commercialized a deployment in deepwater and are receiving multiple orders from several clients. We have implemented successfully multiple trials in Saudi for the fit-for-purpose device for Coiled Tubing operation. This technology today is relevant in all basins globally, as this is essentially a true environmental ESG technology to take the probability of blowout to zero. We see ample opportunity to pull this technology through in areas with high H2S and those proximate to local communities given the clear safety and reliability features of this technology. For some of our customers, this is transformational as it now allows them to access reservoirs that were off-limits before. Another solid investment we have made is ICE Thermal Harvesting, where we are a significant shareholder and will form an integral part of our offerings around hydrogen opportunities. This has now progressed with patents being granted and is generating significant interest from not only oil and gas, but the industrial and power generation spaces. In one study, by utilizing the heat generated by a power plant, this technology was able to deliver an additional ten to fifteen percent power versus what was previously being generated. To summarize, our industry fuels the growth of the world and is the most reliable energy source. Alongside oil production, we also generate associated gas and with each barrel of oil, we produce reservoir water that is not used all the time, and we generate a lot of heat from the well all the way along the supply chain to bring this product to market. We are everywhere in this chain, and we can take these raw materials to help our customers deliver their plans while properly reducing the carbon footprint. Carbon capture and storage is essential. Furthermore, the industry has the infrastructure; it just needs economical technologies and a regulatory framework to put all these together and deliver on the ground. On that note, I will pass the call back to Chris to talk about the financials.

Thank you, Sherif. Turning to our results, we reported quarterly revenue of two hundred eighteen million. This is flat over the prior year quarter and seven percent over the second quarter. The sequential decline was primarily driven by lower unconventional frac activity, partially offset by higher activity in Kuwait. Adjusted EBITDA in the third quarter was forty-nine million or twenty-two percent of revenue. This represents a decrease from twenty-six percent in the prior year quarter and twenty-three percent in the prior quarter. The sequential decline was primarily driven by the leverage impact of lower production revenue. EBITDA adjustments of five million for the quarter were mainly for headcount restructuring costs, non-capitalizable project startup costs, and certain integration costs associated with our recent Kuwait acquisition, non-capitalizable SAP implementation costs, and certain non-cash FX charges due to currency weakness in Libya and Algeria. Moving to our segments, our production segment revenue for the third quarter was one hundred thirty-eight million, declining seven percent over the same period last year and ten percent over the prior quarter. The sequential decrease was primarily driven by lower frac activity. Adjusted EBITDA margins for the production group were twenty-six percent in the third quarter, down from twenty-seven percent in the prior quarter as we maintain our current manpower structure in anticipation of improved markets and upcoming quarters as clearly highlighted by Sherif. Separately, our drilling and evaluation segment revenue of eighty million dollars in the third quarter was up thirteen percent compared to the same quarter last year, but down three percent sequentially. Adjusted EBITDA margins of twenty-one percent in the third quarter were flat sequentially. Depreciation and amortization increased to thirty-six point seven million in the third quarter compared to thirty-five point one million in the second quarter of this year. The sequential increase was primarily related to additional D&A from the recent Kuwait acquisition, as well as the impact of additional employee equity grants. We expect D&A to be in the thirty-eight million range next quarter. Interest expense in the third quarter was three point seven million, up from three point two million in the prior quarter due to higher debt levels. The reported tax rate for the first nine months of twenty twenty-one was nineteen point seven percent. Excluding the net benefit of adjustments of reserves from prior year taxes, our reported tax rate would have been twenty-two point nine percent. The sequential increase in our tax rate is due to an unfavorable shift in income across tax jurisdictions. We expect to improve upon this rate going forward as the income mix shifts more favorably and through the benefit of certain tax planning initiatives. Adjusted net income and EPS, which includes the impact of the noted EBITDA adjustments, were seven million and zero point zero eight dollars per diluted share. Switching to free cash flow, we are pleased with another quarter of positive free cash flow generation of seventeen million dollars. This brings the year-to-date cash generation to sixty-four million, compared to eleven million in the first nine months of last year. While we continue to improve in our invoicing and collections, DSO increased by nine days over the prior quarter level, still bringing the year-to-date DSO down eighteen days, a strong accomplishment by the whole NESR organization. This sequential increase was primarily driven by the impact of summer holiday processing delays. We expect to see the DSO levels improve in the fourth quarter. Capital expenditures in the third quarter were eighteen million, down slightly from twenty-one million in the second quarter. In the fourth quarter, capital expenditures should increase to approximately forty-five million, in line with our full year estimate of capital expenditures near one hundred million. We continue to expect free cash flow in twenty twenty-one to significantly increase over twenty twenty levels due to flat planned CapEx, continuous improvement on fleet utilization, and improved DSO. Net debt decreased to three hundred twenty-six million at the end of the third quarter, compared to three hundred thirty-five million at the end of the second quarter. The sequential decrease is primarily from higher net cash balances from the free cash flow generated in the quarter. As of September thirty, twenty twenty-one, our net debt to adjusted EBITDA ratio was one point six, flat from one point six last quarter. Also, we remained in full compliance with our primary credit facilities' financial covenants in the third quarter. As was noted in the press release, we are extremely pleased with the refinancing that was recently completed this quarter. We are proud to have entered into a green loan facility as part of the broader refinancing, which is based on certain sustainability key performance indicators, encompassing environmental, social and governance metrics. With the addition of two additional banks to the syndicate and increased commitments from our existing lenders, we have expanded the term loan capacity by one hundred seventy-five million dollars, revolving credit facility or RCF by fifteen million, and the working capital facility by one hundred forty million dollars. We will utilize the additional term loan funds to repay the current sixty-five million RCF balance, ten million of term debt acquired through the SAPESCO transaction, and thirty-six million of short-term debt, leaving approximately sixty-four million of additional cash, plus the full eighty million RCF to fund additional growth opportunities in twenty twenty-two or pay down additional short-term debt. We will not be required to make any term loan amortization payments until the first quarter of twenty twenty-three, and the term loan repayment period has been extended by two years. The increased working capital facility will provide us more capacity to issue LC’s for contract bids and awards. Also, we are pleased with the progress we have made in our SAP projects. We have implemented the system in countries representing approximately eighty percent of our revenue. We expect all of our operations to be using the new system for twenty twenty-two transactions. This will provide us a common and enhanced platform that will facilitate SOX compliance in twenty twenty-two and provide opportunities to enhance financial reporting and analysis. In addition, it will be able to improve our back office efficiency by centralizing certain functions that were impractical when on multiple ERP systems. Lastly, as you've already heard from most reporting companies, the activity bottlenecks from supply chain impacting our short-term growth are transitory, and we believe that burgeoning capacity tightness will give way to service pricing improvements in twenty twenty-two and beyond, if the OFS industry as a whole stays disciplined. In the interim, as we have shown with our margin performance, we will remain vigilant on cost control and equipment deployment will be prioritized to margin accretive opportunities. Also, we will continue to strategically invest in our D&E segment as part of our long-term growth and portfolio strategy. We believe strongly that the next six months will be an inflection period, and conversations after this period will be dramatically different than what we have had in the last two years for the industry. NESR has strongly grown through the tough times for the industry, and we firmly believe that the next leg will come from how well we deliver on our core as well as new endeavors. We are squarely focused on this. In conclusion, we are very pleased with even stronger finances and the health of our balance sheet and the financial markets' appreciation for our strategy and outlook. I will now turn the call back to Sherif for his closing remarks.

Thanks, Chris. To conclude, the MENA region will be an even more prominent engine for oil and gas, particularly given detailed and favorable feedback from my most recent visit to the GCC in North Africa. Secondly, as we have heard and seen from COP26, FII, and the Saudi Green Initiative, transition is here. Although oil and gas will be an integral part of the global energy picture, the industry as a whole has to view this as an opportunity to evolve, and our customers are wholeheartedly embracing this, leading the change within our industry. For NESR, with steady progress in our ESG impact segment, we can clearly see how we can leverage existing energy infrastructure and expertise to not just pass emissions from one spot to another, but to totally reduce the carbon footprint of the industry for the benefit of the world and humanity. Third and finally, I'm extremely excited about the progress and results of our investment in the drilling and evaluation portfolio, especially our RSS, given this was delivered in record time. Meanwhile, our investment with our partners has been well timed for the coming super cycle. And now, I would like to pass the call to the operator for your questions. Alex?

Thank you. Our first question comes from the line of James West with Evercore. Please proceed with your question.

Hey, good morning, guys.

Good morning.

Sherif, you know we’ve heard from some of the larger service companies about their outlooks for twenty twenty-two. You are clearly in the – your business grew in the focal point of where the growth will be. I'd love to hear your thoughts on both spending growth in the MENA region in twenty-two and what that means for equipment tightness and then of course, like I said leverage on the pricing?

Thanks, James. Absolutely, the region is going to go as I said. As they spend on their spare capacity, and as they are looking forward in twenty-two, twenty-three, you're going to see a very sharp increase. In my view and my visit and my talks, I'm talking about significant double-digit growth. I mean, it might go in some countries above thirty-five percent. It depends where you start. For example, the bigger ones will have a less percentage and the smaller ones will have a much higher percentage and the ones that had problems will have a significant increase. For example, in a country like Libya, I wouldn't be surprised if there was more than one hundred percent growth year on year because you're talking about revising the shut-in wells, adding rigs, and trying to get the budget approved. And with this oil price, these guys make some serious money, right? So, it's going to be seen. As for the service industry, you wouldn't see the same growth pattern unfortunately because of pricing. So, the pricing discipline is not there yet. And what you are going to see is pricing happening after the equipment tightness, and that's why I predicted last quarter; it usually takes six months for the equipment and talents to dry up and catch up with the activity increase. Then you would see pricing capturing. All the large tenders today have seen price deterioration sometimes in the twenty-five to thirty percent range.

Okay, understood. And then perhaps somewhat unrelated follow-up, but you touched on Saudi and the Blue hydrogen initiative, and I know that you're all over this and how you guys can leverage your skill set to help some of these companies and countries move forward with their hydrogen plans. Could you maybe elaborate a bit more? I think this is a huge theme and something that's underappreciated by the market, the oil service companies' role in the burgeoning hydrogen economy?

You're absolutely right. I was very fortunate to have been in a panel during the FII, the Saudi Future Investment Initiative, and I was with the CTO of Aramco. During that panel, we discussed how the whole infrastructure of having the gas infrastructure that today exists, for example, in Saudi, and how you're going to take this, either if you go to the Blue hydrogen with the feedstock and then separate it and how you do the carbon capture. All this comes to understanding the subsurface, how to inject the CO2, and how to put this into a lot of activities. If you look at the Green, I'm advocating that a region starved of water, there is no way I'm going to use a RO plant and use electricity to get water to be able to make Green hydrogen. I mean, that's basically, again, we are passing the emissions from one spot to another. What you need is to scan the energy sector itself, use that water, and utilize the heat from all the facilities to harness it and make something out of it, besides obviously the renewable. It's not to replace this, but we can use the infrastructure. I think the service company will play a big role in that. That's why we are advocating and discussing, and definitely, as I said, Saudi really has very big leadership in that.

Great. Thanks, Sherif.

Thank you. Our next question comes from the line of David Anderson with Barclays. Please proceed with your question.

Thanks. Good morning, Sherif. So, it’s been an unconventional gas development kind of one of the more prolific elements of your growth story in the Middle East. Even talking about kind of adding fleets in Saudi and now Oman, a couple of weeks ago Schlumberger talked about they had won a large unconventional tender in Saudi and another one in Oman. The question in a lot of people's minds is kind of what this means for your growth strategy? Can you just kind of talk about that and kind of just address that issue head on, please? Thank you.

Sure. As I explained earlier in calls, what we have on what the market is having in the Middle East is exponential growth in the unconventional and the Fracturing business. I mean, even in your conference, I think I explained that this is going to go five to ten times, right? So, if today, what did we do for ourselves as NESR? I said we are going to have three to four fleets before the end of the year, and that's what we have. Today, I have four fleets running. We have two fleets in Saudi, and the third fleet is going to start in the next week. We have a fleet in Oman working for a client, and we are awarded a contract in Oman, and we are actually fracking as we speak. So today, we have four fleets in the region, three in Saudi and one in Oman, as we predicted. The difference here what people misunderstand or underappreciate is the size and the scale. The big fleet is definitely the Jafurah, and this is where it is very equivalent to the North America type of fleet, which is obviously what we have accomplished with our client with Aramco over the last couple of years. Together, we managed to get to ten to twelve stage a day that is unheard of in the previous life of the company. Aramco leads that in a big way. What's happening, and obviously, I'm not commenting on others' comments or awards, but I can tell you what happens is the Saudis have decided that this is going to be a huge contract and multiple awards as they did in the last bid have to be awarded.

Okay. So, the pie is getting bigger in unconventional; it's not that you're not getting shut out by any stretch, you're just – the scope is getting bigger and in other words I would imagine your slice of that pie is going to get bigger as well?

Yes. Basically, the whole contract is much bigger. This contract, people have to understand as well, what we have been doing over the last couple of years was a multiple award as well. It was not only us. It's just because of the performance, we managed to be the sole provider and the scope was available for, if you like, for one provider. Now, the scope is much bigger, and they managed to slice it to several. The issue becomes the scale; the difference of who gets a bigger pie usually sometimes is the cheapest one. And the clients are very smart, so they managed to get a very solid price concession to be able to, because of the scale.

That's not surprising. Thank you very much for clarifying that. A little bit more specific, though, on Saudi rig count, I was wondering if you can just kind of provide a little bit of insight. We don't have a ton of, you know, the numbers that I really trust on the Saudi rig count numbers that we see. Can you just kind of tell us what's going on the ground? I think we're expecting kind of, some rigs to come into September and maybe kind of as a slug or more come on by year-end. Can you just kind of bring up to speed on kind of what you're seeing on the ground in Saudi in terms of the pace of that ramp up? And is it kind of what you were expecting? Is it a little slower? Just any kind of insight that you're comfortable sharing would be really appreciated? Thank you.

Obviously, I mean, I would comment always, David, that our target is a public company and they would definitely announce whatever they would like to announce. What I will tell you is the activity is very evident. The plans as they always do are very long-term, and they know exactly which increment and where to put the rigs, the facility, etc. They do this in a very coordinated manner, and I would say they are world-class in that. So, what we are preparing for is the increase in activity to ensure that we have the equipment on the ground. I ordered a lot of this equipment at the beginning of this year. As you have seen from our CapEx number, despite the fact that you don't see it because of the delay in the supply chain that happened and the way the accounting works, we're going to take the CapEx only when it arrives. Everything I ordered was ordered in January, February, and March. So, we will take delivery of all this equipment in the fourth quarter and the first quarter of next year, which basically means I am ready for their short increase in activity. So, whether this gets delayed a bit because of COVID or whether there is some shifting here and there, but at least I know I'm ready because I know activity is going to increase.

So, it sounds like you think we're sort of on the verge of this, just a little bit of a timing issue, but it's pretty clear to you that this is coming?

Absolutely.

Our next question comes from the line of Arun Jayaram with J.P. Morgan. Please proceed with your question.

Yes, Sherif. Good morning. I want to maybe start clearly NESR is engaged on the new energy opportunities set in MENA, and so I was wondering if you can maybe help us frame the near term versus the longer-term top line opportunity set for you over the next couple of two, three years.

Thanks, Arun. I think the immediate on the new segment what you will see because obviously this project, as you know, takes time. If you look, for example, at the hydrogen, people are talking about twenty-six twenty-seven until you really materialize and see those projects into motion. What I think from a service company from us, I would see that you would see the top line very evident on the water project because that's I think, in my opinion, a no-brainer. The industry has to do this immediately. You'll see this in the flaring, you will see this in the emission measuring, and we are very excited about geothermal as well. The latest patent that we got with ICE is impressive. So, I see that happening and I would say in twenty twenty-two. More in twenty-three, twenty-four, you would see more of the carbon storage and all other activity that comes to the value chain of the new energy. And again, I’m repeating, I’m here talking about that a lot of it has to come that the existing oil and gas needs to be greener, and there is so much to be done for that. I mean, you just saw the COP26 with the missing thirty percent. How are you going to do that? You need to stop all this pop of valves and flaring and some of the operation time, eighty percent of that comes during that period. If we have the tools to stop that and monitor it, immediately you have a quick win, right? That is I think where we are very focused, and that's why we have so many partnerships and we invested a lot of money for the last two years, and I see this going to happen from next year. The two pilot projects will be paid in Iraq and Saudi, so that will be already revenue from twenty twenty-two.

Great. And just my follow-up is, I know, Sherif you and your team had some boots on the ground in MENA. And so, I'm just trying to, as we think about our modeling over the next six to eight quarters, trying to think about some of the near-term pressures you face on COVID and just general inflation and then your point about the business hitting an inflection point at some point in twenty twenty-two, any sense of how the margin progression could trend and maybe about the timing when would you expect to hit that inflection point?

Okay. So definitely, COVID is an issue, right? In the sense of moving, in the sense of extra costs. A couple of quarters, we still carry that. It didn't go away, and we are still carrying the testing. A lot of it as well used to be paid by the government; now it is all paid by the companies. There is no more subsidy on that. We still have the hotels. We still have, for some of the times, you have to test the people every week when they are on rig site, etc. So, all this cost, I think…

Please standby. Ladies and gentlemen, we apologize for the technical difficulties. Hello, Sherif and Chris, you may proceed.

Should I go ahead? Arun?

Yes. Our line is live. Arun, you may continue. I apologize for the inconvenience.

Yeah, Sherif. This is Arun again, hopefully you can hear me. I was just wanting to get your thoughts on …

I heard your question. I was answering; I don't know if you heard my answer.

You got cut off just maybe midway between in the second question. So…

Okay. What I was saying just to try to, I was saying that yes, the COVID cost is there, and yes, the supply chain bottlenecks are severe. You see a three hundred percent cost increase for the containers from China, for example, on a lot of our suppliers. The NOVs and the rest of the world. The pipe cost is ridiculous; the cost inflation due to transportation and raw material is a very significant increase. Obviously, we manage it. We talk to the long-term partners to manage this properly. But the key again is, let's not be, no secrets here. The key for all this inflation and all this increase in cost is to align the pricing. You have to understand that the industry has been dropping prices since twenty fourteen. There are seven years of dropping prices. Now, when there is a big tender that is an LSTK type contract, and you know that your cost is increasing, but then the leader of the industry goes and drops the price by thirty percent, don't expect there will be any margin improvement, right? The key difference would be that the industry itself has to be able to recoup some of this cost inflation because you cannot push your suppliers and your providers anymore, right? Honestly speaking, some of the shipping companies today tell you very clearly to take it or leave it. This is the new price. If you don't like it, we have so many other industries that require shipping, so just wait at the bottom of the line. That’s I think what is key. For us, we are going to be as we said very selective, maintaining discipline to ensure that we can keep growing without eroding our margins.

Great. Thanks a lot.

Our next question from the line of Taylor Zurcher with Tudor, Pickering, Holt. Please proceed with your question.

Hey, good morning. Sherif and Chris, thanks for taking my question. First one is on the technology partnership strategy that you continue to make a lot of progress on. In recent months you've announced a couple with Cactus and Ulterra. I'm curious where we sit in this sort of strategy moving forward; you've got a number of them under the fold now, and moving forward, should we expect you to continue to explore additional avenues with respect to incremental technology partnerships to round out the portfolio, or are we kind of in the latter innings when it comes to these sorts of arrangements?

Thanks. No, you are spot on. We are very, very focused in our strategy since the beginning of the company. The established, well-run companies in North America that have solid credible execution and solid credible technology, we will partner with them to go to the MENA region and propose those fit-for-purpose technologies to our customers. I always repeat that. We are not an agent; we are not a promoter. We're a technical company looking at this technology and what fits with the Middle East, and we want to ensure it is executed properly. So Phoenix has been doing a great job in North America, and I think they are almost leadership in the U.S. plant. Ulterra is the same with drilling bits. We are there now offering this to our customer. We took Cactus, and again they have a leadership position and we're working with them in Saudi. Again, that type of partnership and we keep exploring this all the time. We are discussing with some companies regarding new energy and other stuff, and obviously, we don't announce until we sign everything. An agreement has to be credible for both of us transparently, very equally. For example, let's look at our partnership; next year we decided to have the new arrangement where we can share the fleet financially. We don’t want to reinvent the wheel. Everything that is necessary, whatever the latest technology comes, we work together. Our RSS is going to be something truly new, and I don't want to oversell it, but once we have a track record of commercial run, we will have a viable RSS tool to the industry, which is key. So, partnerships with solid people and innovation, along with establishing the portfolio to offer longstanding technologies.

Good to hear, and that's a good segue into my follow-up, which is on rotary steerables. The rotary steerable market, I imagine, is largely dominated by the OFS big boys in the Middle East. It's not like you're new to competing with those guys, but for RSS, certainly, at the higher end of the technology spectrum. So, just curious if you could frame for us what sort of features with your tool might be a little bit different than what's currently out on the market? I tend to think of RSS as requiring some element of ongoing R&D investment just to stay competitive sort of on the leading edge technology curve. I'm just curious if you would agree there and how you're thinking about potential incremental R&D investment for RSS moving forward?

So, obviously, without giving all the secret sauce, we put that investment two years ago and with partners. The way it works is we have a set-up where one hundred percent we continuously invest and improve the tool. Our innovative R&D setup is based in North America, and we have the partners; we are a small, I would say, part of equity holder of the company itself, and we have the tools to use it in the Middle East, and they can sell, and they can run the tool in North America and others. What features will this tool have? Obviously, it’s no secret. What is problematic today differs from type of steering mechanism and how to stay within a couple of feeds, how you get a very solid and homogeneous hole to be able to have a good LWD and good running after that and then the dog-leg. So, our tool will have a superior feature in any and every single aspect once we commercialize. My expectation is that in six months we should have the tool commercialized and launched as a commercial tool. This will allow us to go after that market in the Middle East, which is a couple of billion dollars.

Got it. Good to hear. Thanks for the answers.

Our next question comes from Igor Levi with BTIG. Please proceed with your question.

Good morning. To start, could you provide a little bit of additional color on how the two water contracts, both the pilot contract in Saudi and the brine contract in Iraq are progressing? And as far as the revenue ramp up from that into next year?

So, the pilot in Saudi is rigged up as we speak, and we are going to run the pilot. As soon as it proves scalability, we will see which part that we should start with on the scalable setup, right? I would say the revenue would come from January, but it’s started as a very small number. Until you get the scalable plant, the brine contract in Iraq, with one of the super majors, is today being constructed. The revenue will come maybe in Q1 when it starts being fully functional. This is very innovative in the sense that it's real ESG in action. We are going to replace what used to be done for years and years with something so innovative, removing the need to track all this wasted energy, taking the produced water and making brine and sending it to the different fields. This is, I think, going to get so much bigger because of the increase of activity in different fields in Iraq. Now with the oil price, it’s a no-brainer that you will see significant increase of activity in Iraq going forward.

Great. And you also mentioned that ESG could be bigger than the two other segments, what is your roadmap to get there? What has to happen? And do you think you'll be there by twenty thirty where fifty percent or less of your sales are driven by the ESG segment?

Yes. I mean, if you're talking about all what you heard in the last couple of days in COP26, with all the infrastructure that the energy sector has to do to leverage and capitalize on what they have existing. If I look at the amount of carbon captured and stored, the amount of emission control, again, nobody talks about that, but I'm still very, my personal opinion, this is the low-hanging fruit is the water projects. My personal opinion is that this is going to be bigger than the other two segments by twenty thirty.

Great. Thank you. I'll turn it back.

Thank you. Ladies and gentlemen, we have reached the end of the question and answer session. I will now turn the call over to Sherif Foda for closing remarks.

Thank you. Thanks, Alex. Thanks everyone. We are again extremely excited. Remember this is a super cycle; whoever was around in two thousand and five, this is going to repeat itself. So, good time to be in this industry. Thank you very much.

This concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation and have a wonderful day.