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Edited Transcript of NESR.OQ earnings conference call or presentation 7-Aug-19 1:00pm GMT

Q2 2019 National Energy Services Reunited Corp Earnings Call

Aug 10, 2019 (Thomson StreetEvents) -- Edited Transcript of National Energy Services Reunited Corp earnings conference call or presentation Wednesday, August 7, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Christopher L. Boone

National Energy Services Reunited Corp. - CFO

* Sherif Foda

National Energy Services Reunited Corp. - Executive Chairman & CEO

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Conference Call Participants

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* Blake Geelhoed Gendron

Wolfe Research, LLC - SVP of Equity Research

* Byron Keith Pope

Tudor, Pickering, Holt & Co. Securities, Inc., Research Division - MD of Oil Service Research

* Greg R. Colman

National Bank Financial, Inc., Research Division - MD and Energy Services & Special Situations Analyst

* Igor Levi

BTIG, LLC, Research Division - Director and Energy & Shipping Analyst

* Jeffrey Eric Fetterly

Peters & Co. Limited, Research Division - Principal and Oilfield Services Analyst

* Sean Christopher Meakim

JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst

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Presentation

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Operator [1]

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Greetings and welcome to National Energy Services Reunited Corporation Second Quarter 2019 Financial Results Conference Call. (Operator Instructions) Please note this conference is being recorded. I would now like to turn the conference over to your host, Mr. Chris Boone, CFO. Thank you. You may begin.

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Christopher L. Boone, National Energy Services Reunited Corp. - CFO [2]

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Good day and welcome to the National Corp's Second Quarter 2019 Earnings Call. With me today is Sherif Foda, Chairman and Chief Executive Officer and we are hosting this call from London where we just concluded our second quarter Board Meeting. On today's call, we will comment on our second quarter results and overall performance. After our prepared remarks, we will open 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, some of you may be calling today for the first time, so please feel free to contact us after the call with any additional questions you may have. Our Investor Relations contact information is available at www.nesr.com.

Now I'll hand the call over to Sherif Foda. Sherif?

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Sherif Foda, National Energy Services Reunited Corp. - Executive Chairman & CEO [3]

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Thank you, Chris. And welcome to another call. Ladies and gentlemen, thank you for participating in this conference call. We are excited to report on another quarter of tremendous result and continuous progress. We grew our revenue 22% year-over-year, which is more than double the industry average operating in the MENA region.

This remarkable growth is due to continuous and sustained spending of our customers, while NESR continues to properly execute and take more shares on our investment contracts. We are expanding our footprint as well as introducing new business lines in our operating countries. I would also like to highlight our stellar financial performance this quarter which Chris is going to discuss in detail later.

Adjusted EBITDA of $46 million is 12% higher sequentially, and 33% higher year-over-year. Adjusted net income of $16 million grew approximately 13% sequentially. We saw strong performance in both our Production as well as Drilling & Evaluation segment with Production growing revenue by 10% year-over-year and D&E growing by 45% for the same period. (inaudible) activity strengthen as we go further into the second half, same as the previous years.

Now I'd like to talk about the detail of the new activities and our plans going forward. As you also have heard many times, and this is something I've been very vocal about, the market overall is underestimating the magnitude of activity growth in the MENA region. All the estimates out there were in the mid-single-digit range for '19 versus '18. We have been consistently saying that the actual growth rate is at the high end of that range to lower double-digits.

As you have may noticed, this narrative is now being validated by the recent commentaries we are hearing by the other players in these markets. We are very close to our customer. We understand their long-term [hopes] and how they want to achieve them and what is happening on the ground. Continued activity growth in the MENA region is here to stay. As I mentioned in the previous quarter, we grew 20% in '18 versus '17. In the first half of this year, we grew more than 25% over the same period last year and we aim to have a higher rate from the year-end.

We also have done an excellent job at capturing share over and above the activity growth to produce these results and we have continued to execute and win more contracts in this quarter. We continue to bid for new work and our customers want to have new players and ensure the bid is given to the most reliable and responsible supply. They always look at the prices. Our focus is on in-country value, service quality and proper setup.

Most of you saw our recent announcement for the awards in Saudi Arabia. These awards are key to us as they are the foundational contract in the kingdom. Notably, the expanded scope take a term of up to 7 years for this contract; gives us the (inaudible) to invest locally; further build our capabilities. With the increased scope and revenue, the clients want to entrust you with managing a larger pool of services taking a bigger role in the value-chain executing on those contracts.

We also announced multiple awards for well intervention services in Bahrain which will allow us to enter another growing market in the region. Today we do not operate in Bahrain and with these awards across multiple product line we will have the foothold to start expanding. With the discovery of the Khalij Al-Bahrain Basin, the [AMP] industry is poised to take a big leap forward. This high-quality [price] oil and gas reservoir will require a newer approach. We'll need higher intensity more complex services and we believe we are in good position to leverage these awards and become a key partner for the ministry in Bahrain during the execution phase.

In addition to these announced awards, we have had quite a bit of success in bidding for tenders across our different countries of operations. In north Iraq, we got awarded multiple contracts by various independent [MTNV] and integrated service contract, water treatment and (inaudible) service contract. In south Iraq, we further consolidated our position by deploying a [flair-less] testing package for one of our clients.

In addition, we renegotiated an extension to some of our well intervention work. In India, we won another coiled tubing contract. In Oman, we won the casing accessory contract and also did the first well-testing job for one of our clients. Here is a case of us taking the expertise of what the company is very good at outside Oman, which is casing services, to Oman. Also we are on heavyweight consuming in high-pressure, high-temperature well for our main client. This is a first for Oman and for the client and shows our technical capabilities to plan, then execute complex operations.

Also in Oman, as further to the initiative, we have started manufacturing casing accessories. This project has been in work for quite a while and I'm glad to see it getting off the ground. This is a very unique initiative, and we are one of the first service company to invest in manufacturing in Oman. The objective of this is to become the major supplier of these casing accessories to all our customers in Oman and then in the global region.

In most countries, we are actively engaged with our customers to qualify new services and products. This process can take up to 2 years. However, we are demonstrating our capability and moving on a much faster pace to get several of those business lines (inaudible). This will allow us to bid on different product lines and the faster growing unconventional gas projects across the region.

On the operating side in this quarter, we have been in full mobilization mode for several of our contract wins. These include cementing in Kuwait, coiled tubing in Chad. Both of them are start from scratch operation and the client is pleasantly surprised with the level of our preparation for both of these projects. We should start seeing revenue from both during Q3. We were also recognized as the best service quality provider for cementing services by one of our major customer.

I'm very proud with the effort the whole team has put in ensuring we continue to deliver stellar service quality to our customers. That is our backbone to remain their reliable partner. Last quarter I commented on the geopolitical turbulence in the region. Specifically for Libya, we are holding to our initial assessment and continue to work towards building our business. The ongoing issues have not affected the oilfield areas where we work, nor our cooperation. We are taking all the contingency measures where we mainly have local crews who understand the environment and deal properly with the situation in close coordination with our clients.

We met with NOC and ensured them of our commitment to build a solid base to support their ongoing operation. As previously mentioned, we are constantly looking for innovative technologies which will provide our customer solution as well as a step change in how they operate. And we will employ a flexible approach in how we partner with these companies. This may stand from just being an exclusive service provider, forming [HUV] or taking an equity stake and providing development capital to these innovative inventors or companies.

In this life, we make our first investment in probably the most innovative company in well control space, Kinetic Pressure Control. Kinetic is working on developing a path-breaking [VOP] which will go in the middle of a normal VOP stack, and its innovative sheer blade design activated by an explosive charge will pretty much sheer anything. It is like a guillotine built inside the VOP and will have 100% guarantee that in the event of a well control, we'll be able to shut and isolate the work.

The company has already several marking investors, and NESR would be taking a nominal minority position as part of investment ground. We are very excited to partner with them and we already introduced them to our clients in the MENA region. As I previously discussed, this is classified into an opportunistic category as today we don't do much to the wellhead or VOP states. We do have a very small offering in Oman, but this technology provides us with an opening to do something special for our clients and we can build on this to expand into this business line.

We are always keenly looking out for such technology companies which will augment our product offering and allow us to solve key customer challenges. Once we have identified, we want the customer to buy into that vision as it adds significant value to them. In parallel, we continue towards working on qualifying more services to work with our clients, which will enable us to deploy this innovative technology as we are doing with Kinetic.

I hope with this brief summary all of you have a better understanding of where we are and how we are progressing throughout 2019.

With this, I will pass the call over to Chris to talk about the financial in details. As most of you know, Chris joined us recently, and I'm glad to say that he has hit the ground running. And I'm very happy he is part of the team. Chris?

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Christopher L. Boone, National Energy Services Reunited Corp. - CFO [4]

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Thanks, Sherif. I'm excited to be part of NESR and all the growth opportunity, as well as all of our highly motivated and professional employees.

Earlier today, we filed our earnings release reporting our results for the second quarter. Second quarter revenues were $160 million, an increase of 22% over the prior year quarter, primarily from continued growth from our Drilling and Evaluation segment.

Adjusted EBITDA was $46 million for the second quarter of 2019, an increase of 33% over the same period last year to the legacy company, driving incrementals of 40%. Our EBITDA growth demonstrates that we can continue to be able to profitably grow revenues that will yield future additional cash flows for both organic and inorganic growth opportunities. Year-to-date, our adjusted EBITDA was $86 million, which is 32% higher than the first 6 months of 2018. We anticipate continued growth in the second half of 2019, which is traditionally a more active time period for oilfield service companies as oil companies spend remaining capital budgets for the year.

EBITDA adjustments of $2.9 million for the quarter are primarily for integration, restructuring and new country and product line startup costs. Adjusted net income was $16.4 million or $0.19 per diluted shares. Prior year comparisons are not relevant due to predecessor accounting. In addition to previously mentioned EBITDA adjustments, we incurred adjustments to net income that primarily include exceptional interest and tax charges, which will be discussed later in my remarks.

Moving to our segments, our Drilling and Evaluation segment revenue for the second quarter was $65 million, growing more than 45% over the same period last year. We continue to expect D&E to grow during the second half of 2019, mainly enabled by the continued cross-selling of the drilling portfolio into our other operating locations from our leading position in Oman. Additionally, we are very pleased with the expansion of our evaluation business in Saudi Arabia, which has contributed significantly to our D&E segment growth in the second quarter of 2019 as compared to the prior year quarter.

D&E adjusted EBITDA was $16.3 million or 25.3% of revenue, an increase of 69% of the same period last year for legacy companies. As these product line expansion into new markets achieved scale and operating efficiency, we are able to realize improved profitability. This was a key driver in generating additional segment EBITDA in the second quarter of 2019.

Our Production segment revenue for the second quarter was $95 million, which grew 10% over the same period last year as we continued to gain market share in multiple regions. The previously discussed new contract awards will be drivers of future growth as well as other contracts awards we are hopeful of winning in the second half.

Adjusted EBITDA for this segment totaled $34 million, growing 30% over the same period last year. Improved product line mix and cost reduction projects helped drive the EBITDA improvement year-over-year. Depreciation increased sequentially by approximately $2 million as we continued to deploy new capital expenditures. We note that our net income both now and in future quarters will include amortization charges coming out of the purchase accounting of last year's business combination, totaling $3.8 million for the second quarter of 2019.

The year-to-date effective tax rate was approximately 19%, excluding the discrete reserve this quarter related to prior year taxes of approximately $500,000 and other pre-tax adjustments. This increase over the Q1 rate is primarily driven by change in the estimated mix of earnings to higher tax jurisdictions. The second quarter rate was impacted by a true-up to these new rate estimates. We continue to aggressively explore tax-restructuring activities and believe they will positively impact the tax rate in the future.

Looking at the balance sheet and cash flow, for the first 6 months of 2019, operating cash flow is approximately $24 million. Operating cash flow has been impacted by delayed collections in several markets, primarily related to slower invoice approvals and delayed retention repayments due to short-term contract extensions of approximately $35 million. We expect these delayed collections to be received during the second half of 2019.

Capital expenditures for the first half of 2019 was $56.5 million as we continued to invest in our growth opportunities. Most CapEx for the year was ordered in the first half and will be funded throughout 2019. As was discussed last quarter, we successfully refinanced our debt in the second quarter, which expanded the capacity, simplified the structure and improved the tax efficiency.

Cash and cash equivalents increased to $70 million as of June 30, 2019, while debt increased to $367 million, yielding a net debt increase of $20 million since December 31, 2018. Elevated cash levels drawn from our facilities were needed to transition certain bank guarantees temporarily from the prior credit facility to the new facility. The incremental net debt was used to finance the temporarily elevated level of receivables.

Interest expense was impacted by both the write-off of unamortized cost of the prior credit facilities as well as the debt to fund the guaranteed transition and higher receivables. As of June 30, 2019, our net debt to EBITDA ratio was 1.6x, but should reduce in the second half as working capital reduces.

We are optimistic as we enter the second half of 2019. We continue to aggressively pursue new market share of our existing service lines as well as explore opportunities to provide new service lines to our existing customers.

With this, I'd like to pass back to Sherif for his closing comments.

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Sherif Foda, National Energy Services Reunited Corp. - Executive Chairman & CEO [5]

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Thanks, Chris. Before I open for questions, I would like to discuss a very important topic, what NESR is doing on ESG, which was discussed extensively in our recently completed Board Meeting in London. We have stated from the beginning that we are committed to maximizing the social and economic value we bring to the communities we operate in, especially that we are the national champion of the MENA region. We are also committed to minimizing the negative impact of our operations on the environment.

In order to maximize our positive impact in the region and create share value, we developed a corporate ESG strategy that allows us to leverage our core strengths and capabilities, and the interest of our people to address the community needs of the MENA region. Our ESG initiative will focus on the economic empowerment of the communities in which we operate and on promoting equal opportunities for all. This is particularly important in the MENA region where gender diversity in the oil and gas industry is low, and employment opportunities for people with disabilities are limited.

We intend to address these problems through strategic initiative that empower women and people with disabilities at NESR and beyond. At the same time, we will leverage our HSE expertise to promote safe practices and environmental stewardship. We are also about to start building our R&D center in Saudi Arabia, where we will host the brightest minds to develop technologies that will help the communities of the region.

Finally, we are building a strong and healthy corporate environment in order to become the industry employer of choice in all the countries we operate in. We believe that we have a role to play in the development of the community of the MENA region and that in doing so, we will enhance the sustainability of our business.

We currently have many initiatives that are being undertaken in different countries to support our environmental and social commitment. However, we thought it best that we bring on a professional in this sphere who can then focus and expand our [EHE] efforts in a uniform manner and maximize the benefit for the communities we are part of. In that light, [Howasim Aziz] joined us recently as part of the corporate team to lead this function. She has extensive experience in this area and being a Saudi national, she understand the region very well. I am very happy she's sitting here with us as we speak during this call. We look forward to sharing with you more information about our ESG activity in the coming quarters.

In closing, Q2 was another great quarter, and I'm happy that we are on the path to deliver on our objectives this year and for the future. The international market is heading for strong recovery, MENA in particular will have a solid 2019. And I'm confident in our ability to at least double the growth rate of the region.

With this, I would like to take this opportunity to thank everybody for joining this earning call. And if there are any question, we'll be very happy to address them now. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Greg Colman with National Bank Financial.

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Greg R. Colman, National Bank Financial, Inc., Research Division - MD and Energy Services & Special Situations Analyst [2]

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Just got a couple of questions here. Wanted to start with margins. We saw margins, EBITDA specifically, expand 250 basis points year-over-year or 150 bps sequentially. Can you give us a little bit of color there? Is this seasonality and we should continue to expect to see those margins grow for the balance of the year? Was it synergies working through the system? Was it customer service, geography mix or something else? Just trying to understand how we should be thinking about margins for the balance of the year?

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Sherif Foda, National Energy Services Reunited Corp. - Executive Chairman & CEO [3]

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Yes, thanks Greg. As we discussed before, if you look at our D&E segment, and we did this various times, you have always the mix of the revenue between drilling and evaluation services. And once you have -- like this quarter you have more evaluation, and you'll have always a better margin. So the mix of those in terms of segments makes a difference on overall margins. The countries as well makes a difference, right? So some of these contract have a better margin in some countries than others. So overall, you would expect, as we said many times, this range of margins or the contracts we are having between the 25 to 35 and the more you have on the -- obviously, on the 35 or plus 30 gets you a overall better margin. So that range which we have today is what you expect us to be in for the foreseeable quarters.

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Greg R. Colman, National Bank Financial, Inc., Research Division - MD and Energy Services & Special Situations Analyst [4]

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Got it. And the mix of your activity in the countries you're operating in as we looked at the back part of 2019, is it comparable to what you saw in the back part of 2018? Or is it trending towards some of the higher margin activities?

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Sherif Foda, National Energy Services Reunited Corp. - Executive Chairman & CEO [5]

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I would say it's more or less what we're doing now.

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Greg R. Colman, National Bank Financial, Inc., Research Division - MD and Energy Services & Special Situations Analyst [6]

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Got it. Okay. On the capital spend here, in prior commentary you've guided towards about $100 million in CapEx for 2019. You're just past the halfway point there at $56 million at halfway through the year, so not too far the full spend. Is $100 million still the plan or has that number crept up at all with recent contract wins?

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Sherif Foda, National Energy Services Reunited Corp. - Executive Chairman & CEO [7]

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No, that's our plan. And we always had the mind that we're going to front load our CapEx for the year to be ready with the customer contract. As I mentioned, we have 2 countries where we started from scratch. We are ready, we are actually the only new company ready in this country. So -- and the customer is extremely happy with that and that's why we're starting operating. And everybody else basically that got a new award is not going to be ready for another 6 to 9 months. So this was the plan and we front-loaded and actually you would see even in the coming quarters this, the same kind of pace.

So we want to have all equipment ready shipping to the customer, be on location, we've got to start getting the revenue from Q3. And we are already now in August and we saw a regular result coming.

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Greg R. Colman, National Bank Financial, Inc., Research Division - MD and Energy Services & Special Situations Analyst [8]

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Got it. Okay. So still thinking about that $100 million?

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Sherif Foda, National Energy Services Reunited Corp. - Executive Chairman & CEO [9]

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Yes, absolutely.

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Greg R. Colman, National Bank Financial, Inc., Research Division - MD and Energy Services & Special Situations Analyst [10]

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The last one from me and then I'll pass it back. It's been an interesting reporting season from our chair with really good results from our international companies, yourself included in really challenging results for our North American-focused or centric companies. Is that dynamic creating any opportunities for you to deploy capital and source equipment from North America where it's struggling and then move it through to your growth opportunities in the Middle East? Are you seeing either asset or whole company acquisition opportunities rise because of this disparity globally?

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Sherif Foda, National Energy Services Reunited Corp. - Executive Chairman & CEO [11]

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Yes, obviously we are very -- we are in dialog with many of our I would say partners, other companies, looking at all the opportunistic opportunity for like equipment acquisition at much better rate. And we are always looking at these things. To give you a flavor, it's exactly what like we did last year when we bought the asset in Canada at a much lower $0.20 almost. We definitely looking at things of that nature.

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Greg R. Colman, National Bank Financial, Inc., Research Division - MD and Energy Services & Special Situations Analyst [12]

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But there's nothing near-term that we should be expecting or focusing on as -- steady as you go?

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Sherif Foda, National Energy Services Reunited Corp. - Executive Chairman & CEO [13]

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I mean nothing we can really talk about now.

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Greg R. Colman, National Bank Financial, Inc., Research Division - MD and Energy Services & Special Situations Analyst [14]

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Okay. Fine. No worries.

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Operator [15]

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Our next question comes from Igor Levi with BTIG.

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Igor Levi, BTIG, LLC, Research Division - Director and Energy & Shipping Analyst [16]

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So this year looks like you've entered 3 new markets, Kuwait and Chad earlier in the year and most recently Bahrain. Now you mentioned that the first 2 contracts will begin to generate revenue in the second half. Could you give us an idea of how large of an impact they will have in the second half or in 2020? And then also maybe touch on how the size of the contract in Bahrain and when that's expected to start up?

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Sherif Foda, National Energy Services Reunited Corp. - Executive Chairman & CEO [17]

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So Bahrain obviously because we did not get -- we will -- we cannot talk about the number exactly because we did not talk about this with the client. But you will not see -- it's not going to be significant for H2 because it's a preparation to start. We will have some -- we will have work this year, but the activity as such in Bahrain is going to increase from next year. So as you may know, this type reservoir will require a complete different scope of rigs, activities.

We are even talking -- the data is excellent, you're talking about a lot of new contract mechanism. You have obviously the local company [BEVCO] there. So there is a lot of other activity going on. There is a lot of discussion how they're going to develop that reservoir. So the expectation that obviously the revenue is going to increase, and then this is going to become one of our core countries as well. So today we just have -- I mean, we've got awarded like 3 contracts, very good. But you get the foothold and that you would see revenue as significant for your models, et cetera, I would say from next year.

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Igor Levi, BTIG, LLC, Research Division - Director and Energy & Shipping Analyst [18]

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Great. And then it looks like you've renewed 4 of the 5 main contracts in Saudi Arabia thus far and the last one remaining I believe was cased for Wireline. When could we expect to hear about it? And how large is it compared to the other contracts?

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Sherif Foda, National Energy Services Reunited Corp. - Executive Chairman & CEO [19]

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Okay. So I am not sure about the 5. We have much more than 5. We have a lot of contracts actually in Saudi Arabia. We -- today, the core contracts are owned, as you rightly said, extended or awarded. So the biggest one obviously is the one we just got now and that had a scope to even get much bigger, right? So this contract is for all the pumping, well services, coil tubing, cementing, stimulation, as well some -- even an avenue for fracturing.

So it's a much bigger scope than what we used to do before. And we -- as you know last year as well we, as you said, we extended couple -- another couple. But we have many other contracts. So we were awarded drilling business in last year, this -- beginning of this year we had as well 2 casing and running services et cetera. So we have multiple contracts in Saudi. If you talk now specifically about the -- what you call the Wireline or cased hole, we are -- we have a contract today and it is valid for some time.

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Igor Levi, BTIG, LLC, Research Division - Director and Energy & Shipping Analyst [20]

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Okay, great.

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Sherif Foda, National Energy Services Reunited Corp. - Executive Chairman & CEO [21]

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It's not for re-tendering for the coming couple of years.

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Igor Levi, BTIG, LLC, Research Division - Director and Energy & Shipping Analyst [22]

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Okay. And one more if I could.

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Sherif Foda, National Energy Services Reunited Corp. - Executive Chairman & CEO [23]

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Sure.

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Igor Levi, BTIG, LLC, Research Division - Director and Energy & Shipping Analyst [24]

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You talked a lot about new markets that you've entered. You've renewed the Saudi contracts. I mean, are there additional product lines that we could think about that could strategically fill the gaps and help you expand even faster?

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Sherif Foda, National Energy Services Reunited Corp. - Executive Chairman & CEO [25]

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Yes, I mean, it's absolutely right. I mean, as you saw we are a very strong production company today in all the countries, like we have a very strong presence in all the GCC, North Africa, in all the Production business line, right? And this Production business line or completion business line, it's -- you can talk about 8-9 product line in it, right? But there's couple obviously as well we don't do much in it, like artificial lift, we don't do much here.

If you look now on the other side on the D&E, as we always said, this is where we are very, very, very strong in Oman and very small in other countries, right? And this is what we are deploying, approving. And that's why you saw we have a 45% growth sequential on the D&E. The previous quarter looked like almost 69% year-over-year.

So this is growing at a much faster pace. And our aim is to actually double that, right? So for us it's like a startup, right? So if you want to now to go to specifics, definitely that's what we're doing. So you approving and qualifying a lot of like the directions winning, bigger portfolio of the Wireline because we are going through even new business line like we just mentioned about our investment in Kinetic, which is -- basically give us now a space of the well control, but in an innovative manner.

And we don't want to go to something that is -- like it is very commoditized, very low pricing, we don't want to be there. We want to do something when there is a differentiation. And where we have a strong presence, we enlarge that footprint exactly like we're doing now with all the fishing, the midyear downhole tools, et cetera where we are like designated pioneer in Oman. I mean, some of this business in Oman, we almost hold 80% market share, right? So we have a huge room to grow in the other countries for all this segment.

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Igor Levi, BTIG, LLC, Research Division - Director and Energy & Shipping Analyst [26]

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Perfect. That is extremely detailed and helpful. I'll turn it back.

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Operator [27]

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Our next question comes from the line of Sean Meakim with JPMorgan.

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Sean Christopher Meakim, JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst [28]

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So I was hoping if you could dial in a little more on the margin performance. The expansion in D&E was impressive. So I was hoping we could maybe just go into the moving pieces there. Could you give us a sense of how we should think about the influence of operating leverage, pricing for new contracts, the impact of our mix of cost-plus work that's adjacent to the core contracts? You already mentioned the influence of country mix. Just where do we come out on normalized margins for D&E as the segment scales? Can it get a free handle like production -- sorry, free handle margin like production? Or is mid-20s the right level, somewhere in between? How do we think about all those influencing factors towards a normalized margin profile for D&E over time?

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Sherif Foda, National Energy Services Reunited Corp. - Executive Chairman & CEO [29]

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Thanks, Sean. So just to -- okay, if I go one by one to your question, if you look at the activity and the tendering, similar to what I said last quarter, you see some company with disciplined approach in tendering, very glad to see that, and some unfortunately do not. So the customer is still going after looking at bigger scope in some of those tenders. And when they go to a huge scope, and they add lot of other stuff on it like LSTK obviously you see 0 discipline from the international player.

If you look at the service per product line, it's a mix -- it's a mixed bag. And again, when the contract is huge, people obviously tend to be like worried understandably to lose that footprint because there is a lot of newcomers or the clients are inviting new people. But so far it's manageable. I think the margins when -- if you're small like us, and you can choose where you want to be, definitely our aim is to maintain this type of margins in both Production and D&E.

Now if I move to D&E and say why the mix goes back and forth between quarter, unfortunately, it's the nature of the business if you want to -- because this is a lot of segments and a lot of a mix between the countries. So in some places -- and as we obviously get bigger, you will tend to do more of the -- the client will give you more of this cost plus stuff to do, right? So -- and you cannot say no because you are -- if you become top 3 provider of that segment in the whole country, you will be providing camp and road, et cetera. Again, it does not dilute the overall, but dollar value it's in addition, right? So I would say it's going to be all those in there, maybe 10% of our business can be in that cost line.

So the margin of the D&E, I'm sorry I did not give you a good answer, or crisp number to put it in your model. But it's -- I cannot tell you, yes, I mean obviously what we are aiming for is to be in that mid-20s -- mid to lower 20s I would say. It will not go to the margin of the Production for the foreseeable future because all this fishing remedy and downhole tools, rental stuff is not operated that much.

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Sean Christopher Meakim, JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst [30]

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Right. That's exactly what I'm looking for. I've been trying to get that gauge relative to the Production segment is helpful. So then as you're working towards this crosspollination strategy between the 2 segments, D&E is really the key in terms of the growth. So as you think about -- where would you say you are in that strategy? So in other words, obviously the business should continue to grow with D&E growing faster than Production, but over time, what's the optimal business mix you'd like to see between the two?

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Sherif Foda, National Energy Services Reunited Corp. - Executive Chairman & CEO [31]

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I think we're going to grow both, or D&E is going to grow obviously on a faster pace. The key is to maintain the mix between -- within D&E between evaluation and drilling, to not to dilute obviously the overall margins. But I think the Production is going to get another kick on growth because of the larger scope of contracts we are working on and as well adding couple of product line in 2-3 countries. So the mix will end up the same.

So despite the fact that the D&E is going to grow faster pace, but because of the baseline of the Production is bigger and it's going to get big contracts in the coming quarters, so you will see that the mix between both will not change much between our company between what we're doing in completion and what we're doing in Drilling & Evaluation. Definitely we will -- might be pleasantly surprised that our drilling if we go to more of the I would say direction drilling, bigger scope might actually become a bigger pie. But for now, I think the mix will be -- as a percentage between both would be more or less similar.

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Sean Christopher Meakim, JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst [32]

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That's very helpful. And then just to clean up a little more detail on the CapEx discussion, so as you think about the balance of CapEx that you have committed to for the year, you should have better EBITDA at the back end of the year along with improved collection seasonally. How does that set you up for free cash flow for full year 2019?

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Christopher L. Boone, National Energy Services Reunited Corp. - CFO [33]

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Sean, this is Chris. So again, that $35 million should hopefully flip back, again a little bit less CapEx. So with that, and as you said an improved EBITDA, our expectation is we keep active free cash flow positive in the second half. It's hard to be as specific because again we're -- it's hard to be exact on all the collections.

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Sean Christopher Meakim, JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst [34]

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Okay.

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Sherif Foda, National Energy Services Reunited Corp. - Executive Chairman & CEO [35]

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So if you -- if I comment more on this, if you look at the collection in H1 or in this quarter, and I'm sure you heard it from all the other commentaries from the big guys, it's -- it was a challenged quarter because we had -- the client basically delayed some of the payment, but this is like the -- these are the best clients in the world. So we have absolutely no issue. It just -- they delayed a lot of the payments for the quarter. So -- which is fine, right? I mean, as long as you manage obviously the payables and everything, but this is -- as Chris mentioned, we had in a couple of countries some delayed collection like everybody else.

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Sean Christopher Meakim, JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst [36]

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Understood, yes, more of a timing issue. Okay.

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Operator [37]

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Our next question comes from the line of Byron Pope with Tudor, Pickering, Holt & Co.

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Byron Keith Pope, Tudor, Pickering, Holt & Co. Securities, Inc., Research Division - MD of Oil Service Research [38]

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As you guys pointed out in the press releases you've recently celebrated National's 1-year anniversary and so, Sherif, my question is qualitative in nature. Could you just provide some context around where you feel the company is today with regard to the integration plan everything from the tier market structure? Just where are you relative to where you need to be? And what's left to be done with regard to how you think about the integration plan?

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Sherif Foda, National Energy Services Reunited Corp. - Executive Chairman & CEO [39]

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Yes, very good question. So, look, I mean, we put a very detailed plan on the integration mentioned the last couple of quarters of collocating, adding obviously because the 2 companies again, they were not overlapping, it's complementary. So the only thing we really made sure that when they had their small footprint, we made sure that they are in the same place. But then we enlarged, enhanced dramatically the infrastructure so to show the client that we can take such a big role in some of this business.

So as we have just developed in Saudi, we did the same thing in Algeria, we did the same thing in UAE, was basically we made sure that we have a very strong and a proper setup, so when the clients come and say are you serious you can do D&E in that scale? We said please come and visit us. It's not only what we have in Oman, which is a state-of-the-art facility. No, please come and see what we have in those countries. And both -- or the 3 countries, the client -- especially in Saudi and Algeria, the clients are extremely, extremely pleasantly surprised with our setup now, right?

So we have a full-blown infrastructure. I mean, I don't want to go through much, the technical detail, but like all the overhead crane, certification DNV, et cetera, et cetera. So ISO, we got an ISO, we get an API too. So we have all the structure and the infrastructure to take now bigger role and to be very professional in what we do in D&E. And we maintain this discipline that we do not take a job when we are not ready. So even if the client want us -- to push us, let's take that you can do the -- this (inaudible) we maintain, no, we want to do the job when we do it absolutely perfect.

So in that end I think we are done. We are almost there with the infrastructure. We have a country director on each one that is very visible. The client knows that -- the person in the VP or the GM of NESR in all its segment in that country, very well respected. The last piece that we are working on, and we said this will take time and we are working on it diligently, is the back-office ERP system. So this is what we want to make sure we get it right. And obviously from our experience between Chris and myself, we know that this was wrong in so many countries and so many times.

So we need to make sure which software we're going to use, how we make sure that everybody is happy with it, how to make sure it's a [SOX] compliant, et cetera, et cetera. And that's what we are working on. It's going to be work-in-progress. And today we have 2 system running, but we want to make sure that we have 1 system that everybody is happy with and it's at the right level of growth of the company because obviously our expectation that this company is going to be so much bigger than where it is today, right? So we have to have a system that is expandable to this type or size of segment, of number of head count, et cetera. I mean, we are already today at 4,000 people, right? So we need to make sure that we are at that level and that is the work in progress. Everything else I would say, customer branding, image, infrastructure is taken care of.

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Christopher L. Boone, National Energy Services Reunited Corp. - CFO [40]

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I'd like to add one additional, Byron, to that after that list is for example, we just rolled out a common equipment utilization platform across both company platforms so that we now see equipment across all countries and really see the utilization so that as we see new opportunities, we can move things more easily between countries and optimize our CapEx and equipment utilization. So just small -- lots of small things like that that we continue to work on to optimize.

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Byron Keith Pope, Tudor, Pickering, Holt & Co. Securities, Inc., Research Division - MD of Oil Service Research [41]

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Very helpful.

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Operator [42]

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Our next question comes from the line of Blake Gendron with Wolfe Research.

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Blake Geelhoed Gendron, Wolfe Research, LLC - SVP of Equity Research [43]

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Just honing in on the technology partnerships for a second, just wondering what the ideal equity versus cash split would be from your perspective, and maybe what you're sensing as far as appetite on the part of these technology startups? And then I noticed that Kinetic Pressure Control recently signed a partnership with Transocean. Just wondering how you think about exclusivity when you enter into these agreements? Is it regional exclusivity that you're striving for a country level? Or are you just trying to be an open platform for whatever technology provider wants to get in, in with a large upscale service provider in the MENA region?

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Sherif Foda, National Energy Services Reunited Corp. - Executive Chairman & CEO [44]

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Thanks, Blake. So it's very specific to every technology and it's very specific to the country or what exactly we want to do. And we said we have so many options where we do. So today we have more than a dozen almost agreement. So we have on chemicals, we have a chemical agreement with 2 suppliers and we provide -- we have exclusivity on some of the products we did together. And we supply this to the customer, to the country and we have an infrastructure obviously facility that we -- that they use our facility, we import the chemicals we provided to the customer.

So there is a lot of models. And increasing -- it's an open platform for innovation. And once we have something that is -- adds value and we are credible in front of the customer, we go and say we think this is very good for you because we developed [AVCV], right? So we just -- we are not an agent and we are not here just to facilitate them getting there. We are just making sure that technology-wise this is something that adds value to the customer.

Now the business model is obviously depending on the company, depending on the size of the company, depending on the investment. So now if I talk about -- specific about Kinetic, which as we announced, because we had an agreement with them, we decided -- we think it's extremely innovative, so we wanted to put money in it as well. So we invested in, so we're now a shareholder like all the other shareholder obviously on a much smaller scale. As much we think -- specifically we have specifically with the customer for our business in that region.

We are not here -- we want them -- obviously they're going to grow everywhere. Some of the stock is all due, so we are not going to -- they can do this -- we are not in deepwater, we are not going offshore, they can do this definitely without leaving us, right? So what we facilitate and what we help and what you have the facility with is this -- is the MENA region and what interest us. And definitely when we talk about VOP, you're talking here about 3 types, right? You have the Wireline, Slickline, you have the coiled tubing and then you have offshore and you have the land and you have the deepwater, right?

So there is a lot of scope within that when you say -- when you define exactly what exclusivity you are operating at in those countries, right? So we are again open platform because that -- our whole philosophy we're not building our own R&D, we have an R&D facility that is going to integrated in Saudi where we're going to have a lot of companies already that booked space that's going to deal with us in that facility and we're going to have joint research team between us, them, the client and the university to develop those technology for -- specific for the reservoir of the MENA region.

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Blake Geelhoed Gendron, Wolfe Research, LLC - SVP of Equity Research [45]

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That's really helpful color. Then if you look into the pipeline of both technology JV and M&A opportunities, any chance you can give us somewhat of a size of that and maybe a timeline? Are they a lot of smaller deals or should we expect a couple of bear deals here in the near to medium term? And then just in the interest of share liquidity, what is your sense for the appetite as you enter into these conversations of your partners taking equity when you do enter a JV or something like that?

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Sherif Foda, National Energy Services Reunited Corp. - Executive Chairman & CEO [46]

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Yes, look, again, very mix, it's obviously very generic and I don't want to give you a lot of grey answer, but if you look at the technology, we are working on 3 or 4 very unique I would say very highly IT type of technology that it goes to the second level of innovation in some of those technology. We're obviously going to mention them. The second part is the well-established technology companies we are working mainly on no equity and no financing because obviously this companies -- or these companies are very well established, very big. They're -- purely it's going to be a model of deploying in that region with exclusivity contract. So there is no financial part here in that [pool].

The key obviously is we are working on all this on consignments, right? So it's very good for our cash flow, it's very good for our working capital because all these agreements we make with big companies, they are all on consignment basis, so we do not buy anything, we do not pay for anything, we do not keep inventory. They -- we ship everything to that country and then once we operate we get paid, we pay ourselves and we pay them, right? So on the M&A front, we are working on couple. I don't know the timing, I cannot give you the timing, but it is something that we definitely want to re-conclude on them.

It's always going to be a regional type of companies to add to the portfolio, to add to the geographical and to add to the strong footprint. Obviously we're going to be very opportunistic on the timing and on the stock price, right? So -- and today definitely we will never issue equity or give equity to anybody at this level. So -- and we have the capability and the capacity to do any transaction we want to do with cash, right? So at the right time we will be able to issue equity at -- when obviously the share price is at the correct level, right? And these companies are extremely happy to take either that we are the one obviously driving what can they take and what they cannot take.

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Blake Geelhoed Gendron, Wolfe Research, LLC - SVP of Equity Research [47]

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Yes, understood. That makes sense. And then just one more if I can put it in quickly. You mentioned ESG. Is this basically interwoven with your in-country value initiatives that you have with some of the larger countries that you operate in? Or is it driven by specific companies and countries and what kind of resources are out there so we can get a better understanding for the thresholds for an ESG I guess qualified company in that region? And maybe some of the identifiable steps you're going to take over the next several years to achieve the goals?

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Sherif Foda, National Energy Services Reunited Corp. - Executive Chairman & CEO [48]

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Yes, it's a huge -- obviously, it's a very extremely important topic in the sense more of the -- and obviously from a business sense. So it is in line with in-country value and all the initiative each country have. So if you look at each one of them, Saudi Arabia, Qatar, UAE, Oman, Algeria, everyone has very specific program, very detailed and we are working always on that with them to make sure that if you are the economies of the national champion, you've got to be sure that you are the forefront or the leader of that.

But in addition, if you wanted to make sure that we understand and all our team understand and all our people because our commitment to the environment, social and [governance]. So what are we doing as an exact concrete steps in each to impact the communities where we operate, it doesn't have to be only the client, it just has to be what are we doing for example for gender diversity? What is our employment rate? What is the -- how among of ladies in a leading position in the company in the countries? And as we are working in the Middle East, gender diversity in the oilfield is not the best, right?

So this is what's all where we are proving and showing ourselves by taking a leading role in that space. We're looking at the impact of our employees, their families. Today when you look at our health safety environment; look at our driving records; our recycling et cetera, we are leader of that, but we want to make sure as well that our employees, we get that to their families, impacting their communities and then we have a sustainable impact to where we work. And that's why obviously we make sure that we have a professional doing that and that's why Howasim joined the team and she actually had a unique presentation to our Board to make sure that they understand exactly the steps and the long-term vision we are taking, 1 year, 2 years, 5 years, 10 years, what exactly we're going to achieve, but with a step, with a milestone, with a deliverable. And it's just not talking. That's exactly what we're going to do, budget within place and people to be able to execute on that vision.

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Operator [49]

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Our next question comes from the line of Jeff Fetterly with Peters & Company.

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Jeffrey Eric Fetterly, Peters & Co. Limited, Research Division - Principal and Oilfield Services Analyst [50]

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Follow-up to that ESG, are you seeing contract tenders or opportunities require this type of ESG structure in place or a policy? Or is this something that you're doing in advance or in anticipation of some of these things coming in?

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Sherif Foda, National Energy Services Reunited Corp. - Executive Chairman & CEO [51]

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No, so far there is no contracts or any -- that requires a specific like score or what you're doing in ESG. It's not framed like this, today all the contracts the companies, the clients are basically asking or the tenders is required based on what they have as [intrinsic value] score for that business. And today this is here in ownership structure, it's either a month of national increase you have, it's a local content basically. It's very similar to Norwegian, to the Brazilian, the Petronas, the Malaysian, all these companies have done.

Today there is more like specific oil sector ESG. What we did this is an initiative from us and I think we should take a leadership role of being with the communities without being specific to any customer or any country. We should be in the leadership role in that. So -- and I'm sure it's going to -- but if you look at the specific -- just to make sure I'm clear, if you look at the specific program of those countries for their in-country value, it's already touched on all these aspects of environments which it governs et cetera, right? So it touched that, but we are -- so we're taking care of that, but we want to as well to have a very concrete plan for our company at our corporate, what exactly we are doing for ESG.

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Jeffrey Eric Fetterly, Peters & Co. Limited, Research Division - Principal and Oilfield Services Analyst [52]

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On the Saudi side, with the contract renewals you announced last week and your comment earlier about allowing you to make additional investment in the region, what types of things would that additional investment entail and scope-wise?

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Sherif Foda, National Energy Services Reunited Corp. - Executive Chairman & CEO [53]

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Yes, what we planned already, so -- I don't want to say that we look at the figures, but what we planned already since last year, we planned very clearly that we're going to be very aggressive because we are going to get awarded multiple contracts. And our ambition is not what we want, our ambition is bigger, right? So we have bigger ambitions and bigger contract we are working on. So you have to build the infrastructure to make sure that when it comes you deliver. You cannot say, oh, I got the contract, I want 2 years to deliver.

I want to -- I get the contract, I get 3 months to deliver, right? So we are building the infrastructure in the sense of the space, the employment, the training, the R&D, the -- and that's why the CapEx that you're using, right? So we order a lot of stock to be there on time and we're going to build -- besides the fact that we have the Techno Valley which we are building, as you saw we made an announcement last year we were one of the core partner of the SPARK, the King Salman Energy Park, and we will have state-of-the-art facility in that space.

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Jeffrey Eric Fetterly, Peters & Co. Limited, Research Division - Principal and Oilfield Services Analyst [54]

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And so the investments that you're making either on a CapEx basis or infrastructure basis, is that to support the contract renewals and expansions? Or is that entirely for future opportunities?

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Sherif Foda, National Energy Services Reunited Corp. - Executive Chairman & CEO [55]

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For both.

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Jeffrey Eric Fetterly, Peters & Co. Limited, Research Division - Principal and Oilfield Services Analyst [56]

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Okay.

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Sherif Foda, National Energy Services Reunited Corp. - Executive Chairman & CEO [57]

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If we more than double the size of the company in a year, so you have to make sure that you continue to do that to hit your plan is to continue to do this growth profiling for the coming years.

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Jeffrey Eric Fetterly, Peters & Co. Limited, Research Division - Principal and Oilfield Services Analyst [58]

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The $100 million CapEx target for '19, how much of that would be committed and allocated to these contract renewals or call it deployments in the second half of '19?

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Sherif Foda, National Energy Services Reunited Corp. - Executive Chairman & CEO [59]

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They are all committed. I mean the $100 million will be all -- if you look at a month of contracts we have, we won and not announced yet, but we are aiming to win, those will be for all these contracts.

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Jeffrey Eric Fetterly, Peters & Co. Limited, Research Division - Principal and Oilfield Services Analyst [60]

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Because that's what I'm trying to understand.

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Sherif Foda, National Energy Services Reunited Corp. - Executive Chairman & CEO [61]

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Not everybody -- not everything was announced basically.

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Jeffrey Eric Fetterly, Peters & Co. Limited, Research Division - Principal and Oilfield Services Analyst [62]

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So as you announce additional contract awards, is that encompassed within or incorporated within the $100 million target spend this year? Or would those come from incremental capital?

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Sherif Foda, National Energy Services Reunited Corp. - Executive Chairman & CEO [63]

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For this -- yes. No, it's already in the plan.

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Jeffrey Eric Fetterly, Peters & Co. Limited, Research Division - Principal and Oilfield Services Analyst [64]

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Okay. And so for you to increase the capital spending for this year, would it be derived predominantly off of M&A?

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Sherif Foda, National Energy Services Reunited Corp. - Executive Chairman & CEO [65]

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No, I mean, as I said we have the CapEx for -- planned $100 million is for all the contracts we are awarded and all the contracts we will be awarded. And we do not need an incremental CapEx to deliver on both. If we need something else, it's going to -- I mean, cash, we -- that's what we're going to use for M&A. If at the right time we would see how is the mix of equity and cash. At this level of equity we will never issue equity above I mean a debt number.

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Jeffrey Eric Fetterly, Peters & Co. Limited, Research Division - Principal and Oilfield Services Analyst [66]

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And on the M&A side, your comments earlier, is your focus more on acquiring assets in North America similar to what you've done in moving them into the region and in the contracts? Or would be buying standalone businesses that either expand your scope or scale from a business side standpoint?

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Sherif Foda, National Energy Services Reunited Corp. - Executive Chairman & CEO [67]

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No, the M&A, it's -- yes, it's a twofold basically. I mean obviously when I talk about M&A, for me I'm talking mainly M&A as you buy a company in that space in the region or buying something like we did in Canada where we have lot of assets. But if you just buy assets at a lower price, I think this is [tropics].

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Jeffrey Eric Fetterly, Peters & Co. Limited, Research Division - Principal and Oilfield Services Analyst [68]

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Great.

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Operator [69]

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Our final question comes from the line of Greg Colman with National Bank Financial.

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Greg R. Colman, National Bank Financial, Inc., Research Division - MD and Energy Services & Special Situations Analyst [70]

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I know it's dragging on a bit here. Just really quickly on the [AR] side, the $35 million, can you tell us is that a single customer or a handful of customers? And then related, Chris, can you give us an idea on the working capital side based on your view on the second half, do you have an idea of how big the working capital release could be in dollar terms? And that's it from me.

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Christopher L. Boone, National Energy Services Reunited Corp. - CFO [71]

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Sure. It's more a issue of it is spread among several customers and countries, but it's probably more the mix of what's tied up with contract retention and releases versus just like on a slow pay, it's probably about 50-50 of the number I provided. So the contract retention releases are more lumpy, rather than incremental level C, hopefully out of some improved processes that we're working on with our customers to expedite payment processes. That's about the best I can tell you.

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Greg R. Colman, National Bank Financial, Inc., Research Division - MD and Energy Services & Special Situations Analyst [72]

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And then the quantify...

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Christopher L. Boone, National Energy Services Reunited Corp. - CFO [73]

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Our target is to be -- we have pretty good line of sights on the released the largest retention releases that's probably more like Q4 and the payments we're hoping will be -- I can't claim they're all going to come in magically into Q3, but we think they'll -- we'll get that other part of it back into the second half, probably across Q4.

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Greg R. Colman, National Bank Financial, Inc., Research Division - MD and Energy Services & Special Situations Analyst [74]

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And then a shot at quantifying the magnitude of that release?

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Christopher L. Boone, National Energy Services Reunited Corp. - CFO [75]

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Well, I said we think we are -- as I said on the call there is about $35 million that we said was certainly very identifiable that we know where it's -- we had to lay it in and so that's about the number. Like I said, some of that's retention, it will be more lumpy, but half of it's retention. Probably that's more of a Q4 and then the other half's slower pay and that will probably get caught up pretty evenly across Q3 and Q4.

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Greg R. Colman, National Bank Financial, Inc., Research Division - MD and Energy Services & Special Situations Analyst [76]

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Okay.

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Operator [77]

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Ladies and gentlemen, this concludes today's question-and-answer session. And now I would like to turn the call back over to Sherif Foda for closing remarks.

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Sherif Foda, National Energy Services Reunited Corp. - Executive Chairman & CEO [78]

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Thank you very much, and thanks to all of you. I know it's getting late, so we look forward to updating you on the progress next quarter. Thank you so much.

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Operator [79]

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

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Sherif Foda, National Energy Services Reunited Corp. - Executive Chairman & CEO [80]

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Thank you.