Q1 2021 Dril-Quip Inc Earnings Call

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Okay.

Yeah.

Good morning, everyone and thanks for joining my name is Luke Lemoine with capital one securities and I'm joined with <unk>, CEO, Blake Deberry, and CFO Raj Kumar Blake and Raj. Thanks for taking the time to.

Chatterbox real quick on the quarter today.

Well, thank you Luc and thanks for hosting US Thanks, Nick Yeah, you bet.

Blake could you maybe start off with just some opening remarks about the quarter and some things.

Accomplished and some highlights there.

Sure Luca you know first off on just really proud of the men and women of drill quipped that are executed.

For the quarter was a really good quarter from my view.

And we're seeing and our strategic growth pillars are helping to drive our bookings so bookings were up.

We had really strong downhole tools growth, which we've been working on that business are pretty strongly over the last year and.

And you know, we're starting to see the impact of the cost reductions we did in 2020 show up and the results. So all in all I'm very happy with the result.

Okay, maybe just to start with the orders there that were very strong and <unk> 57 million you had guided kind of 40 to 60, so at the top end and that range what's.

What's the outlook for the remainder of the year as far as quarterly orders and do you see a pathway of getting back to that $80 million to $100 million range per quarter at some point next year.

So yeah with respect to Q1, we were pleased to have the two horizontal tree and that was booked for an operator and the Gulf of Mexico, and you know, we did that and collaboration with pro serve on the controls and that's you know that's one of our strategies is a is a peer to peer collaboration and and you know we call it.

Consolidation by collaboration so that was a that was a big win.

And you know going forward, we still believe that our orders will be and that 40 to 60 range for 2020, one, but we see.

Some strength to happening and the back half of the year. So we're hopeful that we'll be at the top end of that range.

And as the economy continues to recover from the pandemic you know if that if that pace continues.

And we would expect to see orders to continue to prove and into 2022, and and B and a potentially higher.

Range of bookings.

Maybe turning to your downhole tools that you mentioned in your opening remarks, as well and the highest quarterly revenue essentially to the acquisition and <unk> 16, and ramps double quarter on quarter.

Can you give us and outlook on how you expect this to trend the rest of the year.

Yeah, and you said and I think we're likely to see some lumpiness during the year Q1 was really strong and in Saudi Arabia, because we had some carryover orders.

And Mexico was also very strong, but downhole tools is one of our key growth pillars and with the recent a stocking program, we initiated last year, and we expect to see meaningful growth year over year and that business and.

Particular, and Saudi Arabia, Latin America, and deep water and that's where we that's where we see our strength and that's where that particular product line.

Okay.

Subsea little lighter than we expected in the quarter kind of got off to a rough bracket starts you had some delivery project delays.

How should we think about the progression here for the remainder of the year.

Yeah, that's from you know what.

Well proceed and some significant improvement in the U S and terms of COVID-19 restrictions and and demand coming back, but the demand is still slower to recover and parts of Europe and Asia and that's that's somewhat muting on our subsea business.

And you know we're starting to really what we're seeing is the impact of the challenging bookings numbers that we had in 2020. So it's not really surprising that the revenue is going to be a bit challenging through.

Through the year, but Q1 was a good bookings quarter and it's a good indicator of our future revenue and you know as the vaccines become more widely distributed and economies open up we expect to see that that part of our business pick up accordingly.

So even with the.

Subsea routes declining song and <unk> gross margins were very strong and showed a nice increase quarter on quarter can.

Can you talk a little bit about the margin cadence for the balance of the year with your projected mix and the cost savings you've outlined.

Yes, sure Raj is probably best to talk about that on the hand that over to Hans.

Yes, thanks for thanks, allowing us to talk a lot on margins. We are we are extremely pleased with our margin performance in Q1.

We made good progress.

As you recall last year, we had some structural cost takeouts debt was about $20 million weighted.

And the benefit of that play into this year and beyond.

Also at.

And a very good position in terms of this year's productivity gains.

We started off this year with $2 5 million of productivity gains.

And as you recall, we were targeting about $10 million and productivity savings this year.

From this we expect supply chain savings from our downhole tools business to hit and the later part of the year. So if you think about it on the cost side I think we've got a tailwind in terms of helping us from a margin perspective.

If I shift to the mix side of things.

This quarter, we saw help from the downhole tools revenue that we talked about that they talked about as well as our after market service revenue was strong.

This quarter.

Going forward I expect to see some lumpiness and the near term, whereas we're seeing higher mix on fab joints and tumulus, it's essentially a good sign for us if we see our customers go back to work.

So I.

And I expect that as we progress through the year and go into the back half of the year margins will hold on.

And.

Mix will become more favorable and with the productivity gains are module sales will start to fill them up and as we exit the year.

Okay very good.

I'm not sure what you can say at this point, but has there been and your resolution with the litigation involving FMC with the trade secrets.

It's a pretty timely question Luke.

Actually you know we've just been through about a three week a jury trial the jury did reach a verdict yesterday.

And we received a verdict in our favor, which we are obviously very pleased with that outcome and I have to say, we are grateful to the judge and the jury for their work on this case, you know because it really validates.

The tremendous work of our team to develop this technology and it was done solely on our own.

You know with broke with the resources.

And so we were just glad to have that that behind us now.

Okay, Congratulations and congratulations on that that's really good to hear.

Maybe turning to some operational and strategic items, you've mentioned in recent quarters to your efforts to broaden your customer base, including looking at from your peers as customers.

How are these conversations have been progressing how.

Our peers, responding and kind of what's the value proposition for everybody involved.

Yeah. So so we're.

We're pleased with the initial discussions that we've had with it with a couple of our peers are primarily focusing on our subsea wellhead products.

And and really the value proposition as is and my view.

Relatively simple we've done some independent work on.

On on Wellheads and end market providers and that we.

We are considered a tier one provider and quite honestly one of the only tier one providers and subsea wellheads and this space.

And and so that gives us the ability to provide.

And well head system to one of our peers that debt. It gets the latest technology to <unk> to the end user and and and that's why I always find this it's one of those rare circumstances, where you have a win win win scenario you know it's a win for Droke with if we if we followed this model because we get more volume through our manufacturing facility.

Reducer manufacturing overhead, it's a win for our peer and.

And they get the latest technology can offer to the customer and end user but they can also choose to exit that that market. If they if that's something they choose to do and reduce their cost and it's definitely a win for the end user because they're not tied to.

One specific set of equipment through some EPC contract, that's all bundled together and they get they get the best of breed and and multiple classes of equipment and so I think I think it's gonna be a positive outcome and and the conversations are continuing.

And you know we're hopeful the debt that.

And that we make some progress on that this year.

Okay.

We talked about the the downhole tool business a little bit earlier.

On your good quarter here and making a lot of progress. This is the legacy <unk> Corporation that you acquired in late 2016.

<unk> talked about it could be lumpy this year just quarter to quarter, but when you look longer term kind of multi year. How have you modified your operations and business strategy and what are your expectations kind of over a multiyear period for this.

Hey, Raj you on are you wanted to say, yes, I'll take that Blake. Thanks.

So you know first Luca we brought in and unused leader to that business and and this individual has experience and in the downhole tools business.

And.

He led a strategic review of what needs to meet on and this business to grow it.

And from that.

We've made some inroads into standardizing on our product offering.

And that allows us to stock more easily if you look at this business.

Quick.

A quick execution customer once a customer pays a high level of importance on service quality and execution and you know us and real quick customer satisfaction is number one priority for US you saw the results on the energy point surveyed and pointing to that.

So that's that's how we've approached it we have closed down some locations that we deemed and not performing and.

And I think I'm more focused on the markets, where we are leader and the markets, where we expect that's going to be growth. So if you think about the middle East Latin America, and the deepwater space. That's the way, we're gonna be focusing the downhole tools business and as you can see from the Q from Q1 results setting aside the lumpiness over the year I think we are well on our way.

To make a good year over year of progress and this segment.

Gotcha.

On the past year, you've been highlighting the E series product line. How are you progressing gaining acceptance for these products with your customers and what are the challenges you're seeing in terms of adoption and what are your goals for these technologies and the future.

So yeah. It was actually a good quarter for our E series products. You know these all of these products are.

So we've developed over the last several years are bundled together with the with one one primary goal, which is to structurally change how our customers drill wells to provide them permanent cost savings.

And in Q1, we ran our first big bore T V, which was a success and and it's always good to get that first one done and you talk about what are the impediments. That's usually the largest one is has somebody done it first and so the first big bore to ease and the ground and also in Q1 and ran our first ex packed day, so that that's been done as well and so those are all.

Positive signs and you know we've been speaking with our customers about how all of these products work together to reduce time and mitigate risk and.

And and lower the carbon footprint for our customers and and I think this is a very attractive.

Proposition for them and and we're continuing to invest in technology and.

We've applied for another Spotlight award, we'll see what OTC does for a new E series product coming out and and hopefully we will see more of that in the coming months.

That's a that's accepted and and we you know.

We're going to market that that whole series pretty heavily here coming up.

Yeah.

The DXP, it's been a product that you've shown enthusiasm for during the past year and even received some attention from your peers.

Or any update you can provide in terms of how the marketing and this product is going and when you could see some of these trees booked and possibly the first <unk> installed.

Yeah. So yeah I M. That's a fair statement I am very bullish on VX T. I think it is.

On one of the most disruptive piece of technology and the subsea development space.

But in all honesty that the lawsuit did put a damper on some of our marketing efforts and.

Put that on pause you know we had customers that said, hey, I like the product, but I don't want to get tangled up in the middle of a lawsuit so I'm going to put it on pause until the law suits resolved. So they were just waiting to see what happened before fully engaged and so now we believe these discussions are going to pick back up.

Trials behind Us and I think that'll that'll lead to more bookings and installations and the future.

Our first VX D.

It has been sold.

And that tree is and final assembly, it's ER should be done here and the next month or so and so we look forward to getting that in the hands of our customers and and this particular customer.

He uses the full value of what the XD allows you to do which he has the tree and stock and.

And they they drill the well and if it is a keeper and commercial they go ahead and just do the completion right, there and and land the tree. So it's really a matter of when they're going to have the next opportunity to run it.

And once we get that will run like everyone else. Every every all of these other new products that'll be serial number one behind us and I think I think that's when we will see acceleration of that product into the market.

Okay.

Raj, we kind of touched on it earlier, but real quick set productivity targets for 2021, you made some progress towards these from the first quarter.

How do you expect these progressive and the remainder of the year and any challenges involved and reaching these targets.

And maybe if you could just kind of quantify how much of these costs do you think will be fixed versus variable with the market recovery.

So look you are on the productivity gains right.

I'm very happy with the progress we made in Q1 as I mentioned.

We got $2 $5 million of savings most of that was fixed in nature.

We will likely see the biggest productivity gains coming in late Q2 into Q3, as we transition the downhole tools.

From an in house manufacturing to our supply chain more third party supply chain model and.

And that's probably going to be more.

And in nature, and given its direct costs related to selling our product. So if I. If I would if I were to sum. It up you know fixed versus variable I would say early games vizio and more fixed and as we move and progress through the back half of the year, it's probably going to be more favorable coming from the downhole tools segment outsourcing initiatives.

Yes.

And maybe just turning to kind of on the market outlook.

Market for subsea spin very subdued since 2014.

And as we begin to see some improvement and commodity price and activity post COVID-19 period.

Give a view as to when you could see pricing improve and have you seen competitors react in terms of pricing on fewer available projects.

So yeah, it's a it's interesting to look at what's going on and the market. What we're really seeing is on on large major.

What we call Mega tenders, you know pretty high value.

A large quantity tenders the pricing seems to be extremely aggressive.

It's probably intuitive and what you would expect.

And we are seeing a few competitors that are being aggressive and order just to keep their manufacturing facilities open that's never been our strategy on them.

And I'm always have to say I'm happy to win the second order at good margins rather than than cut and the margins just to secure the work.

On the positive side, but we are seeing some push outs and delivery, particularly on subsea trees and that and as you well know Lukas is kind of often the precursor to two.

To better pricing for us. So I think there is there is starting to come some scarcity and and that that is always a positive for pricing.

Okay.

A lot of talk and investment from your customers on energy sources outside of traditional oil and gas.

How is it real quick preparing for the shift and spending and how do you see and impacting the demand for your products and.

And maybe just a tack on to that how are you looking at ways to potential and mitigate any negative impact on its transition over the medium and long term.

Right so.

Our view is it's it's a it's really more of a three pronged approach.

You know firstly oil and gas is still the cheapest form of energy that's going to help improve the lives of 1 billion people around the world. That's just a reality.

But.

There are things that we can do to help our customers reduce their carbon footprint and and that's why we've rolled out and marketing campaign for our E series products, just called Green by design and.

<unk> for example, and you know.

Eliminates 40 tons worth of hardware, that's 70 tons worth of C. O. Two that doesn't go and the atmosphere just to make steel and then you have to look at the whole transportation manufacturing cycle.

Have any carbon induced from that and but more importantly, when you go into the offshore spread.

All of that E series products working together shaved about five days of installation time should we think of all the vessels out there running diesel engines for propulsion and power and all that you take five days of that carbon footprint out for our customers and.

And you know I I believe I think we strongly believe go on the board that the carbon footprint is going to be another element on our bid review just like price delivery quality and reliability, it's gonna be carbon footprint. So that's that's prong number one for us.

Right now there are things that we can do with our existing products that allow us to participate in geothermal and carbon capture are our carbon mitigation and that's just within our existing product lines. So we are doing that right.

Right now and participating in that right now and.

The longer term you know the strategic view as we're going on we're going to follow our customers and maybe look for new customers and that space and and we've recently dedicated resources really to focus on energy transition and what other opportunities there are or technologies that need to be able.

For us to use and that really fit with our R&D prowess and strengths.

And if we could just circle back to three par and approached you just went over the geothermal and carbon capture you know some of your products you can point to that could you just give us a few examples here.

Yeah. So there's a lot of carbon capture and sequestration that are talking.

Talking about injecting and.

Putting carbon into a slurry and then injecting that into an existing reservoir. So that's effectively like a water injection free theres, some different materials and things that we have to do.

And in that environment, but.

It's it's wholly like drilling a well and it's much like drilling the water injection well to a waterflood on field.

Development and geothermal is really just a more high temperature, so a little bit lower pressure, but we've spent a lot of the R&D energies and efforts and our H ph D effort and Singapore. So we have developed seals for high temperature environments and that's that's something that we can do so that's pretty easy for us to.

Flip into.

Yeah.

Maybe on M&A side, you've been exploring ways to consolidate through collaboration on subsea equipment supply.

How does drill quite a few inorganic M&A or expansion and new products versus adult things as capabilities in house.

Raj you want on you want to take that yes. Thanks Blake.

Luke.

Well, we're always looking at technology accelerate our R&D roadmap, we lead with technology, I think you're well aware of that but.

We have said before.

We know that consolidation needs to take place and the industry.

But.

Right now, we're not just going to pursue consolidation just flow consolidations safe growth. We have set we have a set of guidelines.

And we look at this from a market share scale.

And what are the leverage levels and the free cash flow generation. So all of this.

So we focus on them and we look at and.

And the potential.

I must I must admit the bid ask spread is still light. So we'll have to see how things develop.

Over the course of this year and going into next year.

But in terms of.

Technology Tuck ins that sometimes that's something that we constantly review and.

And it's active and ongoing.

Okay.

Turning to your balance sheet has always been a strength for general quick how.

How are you guys looking at the allocation of excess free cash flow and what scenarios are circumstances would you need to see considering and resuming our repurchase of shares.

So.

We are comfortable we are comfortable with the excess liquidity, we prefer a simple capital structure. It offers us maximum flexibility and when I say that if you think about.

And the potential for a recovery going into later half of this year and into <unk>.

Early next year.

And given the project nature of our business that will be a timing build up working capital debt, we will need to fund I talked earlier about the technology investments. This is both organic and inorganic moving cash to fund that we.

We also use our balance sheet strength.

A strength when we go out to bid for work right we.

Typically the smaller player when it comes to bidding for work.

And we need to be able to show our customers that we have the wherewithal and we're gonna be around and we have the balance sheet to support that.

If I go back to my earlier comment about a simple capital structure.

With this sort of when I say simple.

It's not complicated there isn't any refinancing risk, we don't have a debt or convertible and hybrid type of security that's on our balance sheet and given the environment. We're in right now where liquidity and credit is challenged in this sector.

We believe that having a balance sheet like ours is kind of like a fortress strong balance sheet.

To help us.

Drive our business forward.

So you've talked about your cash flow and working capital improvements and <unk>.

Cheating that 5% free cash flow margin.

As far as revenue you exceeded that and <unk> with a working capital benefit how are things progressing and these areas and what's the outlook for these targets for 2021, and any challenges or from a risk and beating this free cash flow margin.

So Luke.

And we're progressing to plan and I'm very encouraged by Q1 performance right, we had close to $11 million of free cash flow.

If I think about what we've done.

We've been working on implementing all billing and turnaround times and we are looking at milestone payments we are pushing.

Some of them.

No inventory risks to our suppliers.

And what we're basically doing a controlling what we can control on the of course on the inventories side.

And this won't be immediate we will need to wait for the inventories to convert before we start seeing the working capital and pick up.

When I think about challenges.

You know and auditor and reduce inventory and we've made great efforts and looking at substitutions.

Using current inventories to substitute.

For current sales, but at the end of the day, we need to have bookings to facilitate and inventory reductions we are off to a good start but.

We have to see the strength continue.

While I say, we've collected we have stepped up our efforts with collections.

From customers.

We have seen in prior quarters.

Our customers have held and collections and that's caused us to have a detrimental free cash flow number I am encouraged that we've <unk>.

Interactions with our customers has picked up.

We are in constant communication with them and I think especially with our larger customers debt and appreciation that meeting payments debt meeting payment obligations is something that's critical for us and real quick.

And we saw good performance in Q1 and <unk>.

I'm hopeful and I expect this strength to continue.

In 2020 one.

Okay, maybe if we could just kind of step back from a high level view and look at how things are playing out on the four first four months of the year relative to your expectations for 2021.

Where are you seeing more opportunity, which areas do you think might be further behind and resuming activity.

What factors do you think most contribute to seeing improvement across all geographies and customers and the back half of the year.

So.

Yes.

With respect to regional level activities, and Norway has been strong theres been some governmental regulation there that's incentivizing exploration for oil and gas. So that's been strong.

South America, or Latin America is strong and Mexico is a bit uncertain, because there's there's some dynamics there, but but certainly in the Caribbean D&O insurance and then Brazil.

Think is going to be strong.

I think with the improved commodity price I think we're gonna see West Africa pick up.

I think Asia will be strong on the gas side down in Australia. So that's that's a positive and then and then a lot of the.

Six that are in countries that are not net exporters of oil and gas debt that is strong.

And because they are there.

They are developing the oil and gas reserves for internal consumption and so their business continues.

The Gulf of Mexico has been a little bit weak I think that's something to do with uncertainty around around the regulatory environment and the U S. My hope that that mitigates that certainly a a world class resource out there.

But look I like our position.

And were.

We're not scrambling to figure out how we.

Reduce our carbon footprint for our customers, which is becoming more and more important that's something we've done as a business since its inception back in 1981 was how do we help our customers do things faster and safer and smarter and by doing things faster and safer and less costly you also have the benefit of reducing the carbon footprint. So.

Think we have the right suite of products that can help our customers and.

Incredibly excited about <unk> I think it's gonna be.

<unk> changing it's just so much simpler than what's been done and the past and.

And I think the outlook for <unk> quip is a positive once once that demand for oil and gas starts the recovery.

Okay. Good.

Well, we kind of breathe through all the questions and.

And you kind of hit a lot of the high points and that last question, but any closing remarks, you wanted to make Blake.

Really just in closing I, just want to say to the employees of broke with the 2020 was tough 2021, and you know, we're starting to see recovery and and I. Appreciate all the efforts of our employees globally.

We're in the U S where we.

And we're back into the office and mid May and I'm looking forward to that and so we will we will in the work from home there.

And.

I think <unk>.

Thousand 22.

Vaccines continue to roll out and the economy starts to open up people start to travel I think you know the futures futures looking pretty good for drove quit.

Good Blake Raj really appreciate you all taking the time to chat about your real quick and I Hope you all have a great weekend.

Thank you Luke I appreciate it and take care.

Okay.

Okay.

Okay.

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