Q4 2022 Dril-Quip Inc Earnings Call

Speaker 1: Doug Hong

Speaker 2: Good day and thank you for standing by. Welcome to the Drill Quip Q4 full year 2022 earnings conference call. To ask a question during this session, you'll need to press star 1-1 on your telephone. You'll then hear an automated message advising your hand is raised.

Speaker 2: To withdraw your question, press star 111 again. Please be advised that today's conference call is being recorded. I'd now like to hand the conference call over to your speaker today, Aaron Fasio, Director of Corporate Finance. Please go ahead. Thank you.

Speaker 3: Thank you and good morning. Welcome to Drill Club's full year 2022 conference call. An updated investor presentation has been posted under the Investors tab on the company's website along with the earnings release.

Speaker 3: This call is being recorded and replayed we made available on the company's website following the call. Before we begin, I will let you remind you that Drillcups' comments may include four looking statements and discuss non- GAAP financial measures. It should be noted that a variety of factors could cause Drillcups' actual results to differ materially from the anticipated results.

Speaker 3: or expectations expressed in these four looking statements.

Speaker 3: Please do further the fourth quarter, 2022 financial and operational results announcement we released yesterday for a full disclosure on four looking statements and reconciliation of non-GOT measures.

Speaker 3: President and Chief Executive Officer and Kyle McClure, Vice President and Chief Financial Officer. I will now turn the call over to Jeff Bord. Thank you, Aaron, and thank you all for joining us today. You will put delivered an incredibly strong fourth quarter.

Speaker 4: in an important year where we met or exceeded most of our targets and made significant progress along our longer term financial, operational, and strategic objectives.

Speaker 4: Total revenue grew double digits year over year and our fourth quarter revenue was the highest quarter achieved since pre-fandemic.

Speaker 4: This was partly driven by several factors such as aggressive investments from Brazil, offshore investments across multiple markets from large, EMP customers, and price increases to offset inflationary pressures.

Speaker 4: Fourth quarter, gross margin grew by over 15 percent, and our overall profitability improved with the justity of it out reaching almost 11 percent in Q4 and improving 350 basis points year over year.

Speaker 4: Our improved margin profile, combined with our ongoing initiatives across the organization to drive operational efficiency.

Speaker 4: such as our investment in improved well-head manufacturing and footprint optimization.

Speaker 4: We'll continue to support our performance moving forward.

Speaker 4: Cash flow fell short of our break even target for the year.

Speaker 4: However, our cash position remains strong, and allows us to just strategically invest in a growing market.

Speaker 4: additional detail in this matter shortly.

Speaker 4: Bookings in the quarter were particularly strong at $94 million with no notable cancellations.

Speaker 4: This is the highest quarterly mark since Q4 2019, reflecting the ongoing upcycle in the offshore market, but also incrementally higher and in line with our typical Q4 seasonality.

Speaker 4: As strong as bookings were to end the year, it's worth noting that bookings do not include the entirety of any master service agreements or MSAs signed during the year.

Speaker 4: As customers call off from an MSA, we'll then include those units in the bookings.

Speaker 4: For example, we signed a new MSA with a customer for a West Africa project in the fourth quarter for 30 subsea wellhead systems. But in the fourth quarter, only 10 were included in the bookings.

Speaker 4: During 2022, we signed over $122 million in new MSAs.

Speaker 4: And as of year in, we have approximately 70 open MSAs.

Speaker 4: We believe this model will continue to evolve as our customers are more thoughtful in managing their supply chains.

Speaker 4: We ended the year with a very strong and growing backlog of over $241 million.

Speaker 4: representing double-digit sequential and year-over-year growth as product bookings increased due to improving market conditions.

Speaker 4: A significant portion of this backlog will be filled in fiscal 2023 and we feel confident the underlying market dynamics are constructive for continued growth in 2023.

Speaker 4: In total, it was a strong financial year and a pivotal year as we set the stage for the future.

Speaker 4: These include key investments in terms of both footprint and boots on the ground. We entered 2023 with some very positive trends in our key markets.

Speaker 4: For example, our ongoing investment in Brazil, Saudi Arabia, Norway, and Latin America.

Speaker 4: up swinging activity in the region to drive subsidy products and downhole schools growth in 2023 and beyond.

Speaker 4: Part of our investments in the region includes the targeting of a new manufacturing facility in Saudi Arabia, as well as efforts to expand our qualified products.

Speaker 4: in Brazil, where we currently have a leading market position with our well-head offering.

Speaker 4: We're also excited about our emerging downhull tools business growth potential.

Speaker 4: Brazil has announced plans to drill approximately 350 wells over the next five years, which calls into focus the importance of our strong relationship with Patrick Ross.

Speaker 4: In support of the expected demand, we're ramping up our stocking programs.

Speaker 4: Latin America has broadly been very constructive.

Speaker 4: Our downhole tools business has grown five times over the past few years.

Speaker 4: In 2022, we also had our first down hold to order, Angayana, with expected fall on orders and coming quarters.

Speaker 4: Norway, Norse, is also picking up from a traditional oil and gas perspective due to the Ukraine, Russia, conflict.

Speaker 4: We are well positioned with a service center in region to capture opportunities and serve our customers. Lastly, West Africa, a previously dormant region, is starting to come alive with strong signs of growth. We are now in the region to capture opportunities and serve our customers.

Speaker 4: We signed an MSA for well heads there in the fourth quarter and will be actively pursuing other opportunities as a region reinvigorates.

Speaker 4: In addition to the financial successes and promising market trends, I want to touch on the fantastic progress the team has made on some key organic initiatives that now have a very well-positioned to continue to drive profitable growth. As I step back and look at the year in full, what has been my first year at CEO and Kyle's first year as part of drill-quip?

Speaker 4: We have a lot to be proud of as an organization, and most importantly, we have made great strides in standing up the new product-winding focused organization and setting the stage to ensure dual-quip is positioned to capitalize on what is clearly a constructive, offshore market with increasing tender volume.

Speaker 4: and average quote value remaining above pre-pandemic levels.

Speaker 4: A dynamic we believe will continue to accelerate into 2023.

Speaker 4: to our operational excellence initiatives and realignment efforts during the year.

Speaker 4: We have established the foundation of strong product line focused themes and we began forming in early 2022. This organizational structure change is a multi-year journey but is already bearing fruit by streamlining leadership, operations, and customer focus.

Speaker 4: while also eliminating excess costs and improving efficiency. We continue to progress our footprint optimization plan to improve efficiency and reduce excess capacity.

Speaker 4: During the third quarter, we closed the cell to forge facilities at our Houston, Texas campus for roughly $17 million.

Speaker 4: In addition, in the fourth quarter, we reached agreement to sell the two remaining Houston properties as previously discussed, and we anticipate closing in the first six months of 2023.

Speaker 4: For these two transactions we expect the combined net proceeds to be in the 20 to $25 million range.

Speaker 4: This will conclude the current phase of our footprint rationalization that we outlined 12 months ago.

Speaker 4: These proceeds are airmarked to offset the previously announced $22 million investment in well-head manufacturing.

Speaker 4: As a reminder, this investment will lower costs and improve productivity in the coming years.

Speaker 4: delivering approximately $10 million in annualized EBITDA by the back half of 2024. We feel confident in our ability to further advance our market position due to the significant progress we've consistently made along our growth strategy.

Speaker 4: For example, our peer-to-peer collaboration.

Speaker 4: We believe our industry and our company are stronger when we work closely with our friends in the industry

Speaker 4: These collaboration agreements deliver superior value to our customers and ultimately to our shareholders over time.

Speaker 4: Another critical element of our growth strategies are downhole tools business.

Speaker 4: As Drill Cook's first acquisition, we swiftly implemented a targeted growth strategy, exiting unprofitable geographies, bolstering our commercial teams, streamlining our integrated supply chain, and enabling a new leadership team. These actions paid almost immediate dividends.

Speaker 4: resulting in the business growing over 35% year-over-year in 2021 and growing again by 7% in 2022.

Speaker 4: More recently, we were awarded a contract to deliver up to 21 of our OTC award-winning Expect the E-liner hangers for Projects in Brazil through 2024.

Speaker 4: We see this growth trend continuing in 2023 and expect another 10% plus growth from 2022 levels.

Speaker 4: As we previously discussed, we're targeting this business to expand to $100 million in annualized revenue run rate by the end of 2023. Finally, I want to highlight growth prospects in our e-Series suite of products.

Speaker 4: All of which are OTC Spotlight Award winners. These products are green by design, and as we see an increasing interest from our customers around improving their carbon footprint, we believe these products will become an integral solution to helping our customers meet their carbon footprint reduction goals. The most successful and best example of this.

Speaker 4: sweet of products thus far is our big board 2E well-hit system.

Speaker 4: We believe this system is setting a new industry standard. In 2022, we expected this system would represent approximately 50% of all well-head orders.

Speaker 4: And we've speeded in achieving that level.

Speaker 4: The most significant opportunity in this area is through our MSA with Petrobras, which includes up to 87 systems.

Speaker 4: through 2025.

Speaker 4: We are optimistic that as these installations gain traction and performance notoriety.

Speaker 4: We will see similar contract awards for other e-series products.

Speaker 4: We continue to build on our E-Series of Products. An example of this is the SBTE sub-C tree that is in the final rounds of test feet.

Speaker 4: This innovative product dramatically lightens our tree offering to be able to serve customers in both the traditional shallow water market and the CCUS market in late 2023 and beyond.

Speaker 4: All of these efforts to stand up the organization and improve our competitive position combined with a strengthening macro environment gives us great confidence in our strength and foundation and our abilities to drive profitable growth at real quick.

Speaker 4: With that, I'll turn it over to Kyle for some color on the financial results.

Speaker 5: Thank you, Jeff, and good morning everyone. As Jeff mentioned, the company delivered strong fourth quarter and four years results. As we continue to make progress along our initiatives for the business, and we believe we are well-positioned to execute on opportunities in this constructive market. Thank you.

Speaker 5: Looking at our results, fourth quarter revenue was 96.8 million and increased 24% year-over-year. Driven primarily by higher product and service revenues across all regions, reflecting the ongoing upcycle in the offshore market.

Speaker 5: For the full year 2022 revenue was 362.1 million and was up 12 percent year over year. The year over year increased with primarily driven by higher product revenues across all region.

Speaker 5: Partially offset by lower-service revenues in Asia Pacific. Gross margins during the fourth quarter were 31.2% plus 979 basis points a year over year.

Speaker 5: This improvement in gross margin is largely due to leverage on higher revenues, product mix, gains in pricing, and our ongoing initiatives across the organization to drive operational efficiency.

Speaker 5: SGNA expenses decreased by 18% to 94.2 million in 2022 from 115 million in 2021 due to lower legal expenses in connection with FMC lawsuit.

Speaker 5: excluding those legal charges in 2021, S-GNA was roughly flat year on year.

Speaker 5: Additionally, engineering expenses also decreased by 23% to 11.7 million from 15.1 million in 2021, as a result of the completion of certain strategic projects.

Speaker 5: So overall we are continuing to manage the overall SDA and E cost base despite expected back to back years of double-digit revenue growth. Our overall profitability also improved during the quarter with adjusted EBITDA coming in at 10.4 million, an increase of 9.8 million from one year ago. For the full year, adjusted EBITDA was approximately $30 million. $30 million.

Speaker 5: an increase of 98% year over year. The improvement in the GESCB, but it was driven by improved macro trends, strong performances in all of our businesses with subsidy product revenue, up 15%, subsidy services revenue, up 10%, and downhold tools revenue, up 6%. Turning out of booking, we are continuing to see an uptick in demand in the offshore drilling market, especially in Brazil, the Middle East.

Speaker 5: Latin America and some reemerging markets such as West Africa. Bookings for the fourth quarter were 93.8 million of 18% year-over-year and 52% sequentially. Our fourth quarter bookings marked the highest level we've experienced in three full years. For the full year 2022...

Speaker 5: America and some reemerging markets such as West Africa. Bookings for the fourth quarter were 93.8 million of 18% year-over-year and 52% sequentially. Our fourth quarter bookings marked the highest level we've experienced in three four years. For the four year 2022, bookings.

Speaker 5: For 271.3 million, a 19 percent increase from 2021 levels. As we look toward the first quarter of 2023, we do expect to see a bit of a gap in both things for the first quarter sequentially, likely in the $60 to $80 million range. Due to the fact the fourth quarter tends to be seasonally very strong as customers to review the lies, the remaining capex budgets.

Speaker 5: That said, we're in very strong position and as Jeff noted, as of the end of the fiscal year, we have around 70 open MSAs and feel good about our prospect of drive growth in the year ahead. We also, in the year with our backlog, up 15 percent, 241 million has off-shore drilling markets continue to improve. For 2023, we expect to fill approximately 70 to 80 percent of our current product backlogs with remaining amount consisting of longer-term projects which are being designed and manufactured to customer specifications requiring longer lead times.

Speaker 5: Turning down to free cash flow. Free cash flow in the fourth quarter came in at negative 23 million and fell short of our break even target for the year. As we think about the Delta's far full year forecast, there really are three drivers.

Speaker 5: First, as we are continuing to grow, more of our subsea revenues are weighted towards longer-term project work, which tend to have limited milestone payments. During 2022, this portion of our revenue grew faster than we have anticipated.

Speaker 5: This type of revenue makes up roughly 60% of the sub-T product total revenue. The highest it has been up from 30% just a few years ago. You can see that on the balance sheet and then the unbilled revenue balance, which increased 43 million year over year. So I guess we were anticipating a large tax receivable from the IRS that was unfortunately held up. And last we had about 10 million cash used relating to our previously mentioned investment and manufacturing in Houston. Real estate moves relating to our campus in Houston and the stand up of our new business unit structure.

Speaker 5: all of which were unforecasted a year ago. Cash flow will remain challenging as we continue to grow our backlog and revenues throughout 2023. Our incoming orders are expected to be weighted towards longer-term projects with limited mild unemployment. Finally, we do anticipate bringing on 20 to 25 million to letting to those additional real estate fields.

Speaker 5: sales to health supplements ending cash next year. Our balance sheet continues to be extremely strong, one that allows us financial flexibility to continue to invest in our core business while managing the longer-term cash conversion cycle of the subsidy product sales. Before I turn the call back over Jeff, I will offer high-level 2023 outlook.

Speaker 5: In 2023, we expect revenue to increase approximately 10% over 2022. This, of course, is dependent on two main drivers, sub-C bookings, and our downhOLD tools A judge that EBITDA has to improve at 40% to 50% incremental margins, which will depend on bookings mixed during 2023, the timing and execution of our previously discussed productivity initiatives. Bookings are expected to grow in the 10% to 20% range due to a large number of outstanding tree tenders and customer timing for upcoming projects.

Speaker 4: CAPEX is expected to increase to 25 to 30 million in 2023. CAPEX is expected to primarily consist of $11 million towards our well-head manufacturing investment, facilities in Saudi Arabia and Mexico, and rental tool supporting downhull tools business growth in Brazil. With that, I will turn the call back over to Jeff. Thanks, Kyle. While much has been accomplished, we know we still can do more to position our company for long-term success, advancing market share and overall profitability. We are well positioned to participate in strong market fundamentals and an upswing in the offshore market.

Speaker 4: The underinvestment over recent years across the industry has made for tightness today with long lead times for new and replacement equipment and thus a constructive environment for continued investment given the commodity price output. We are keeping a pulse on customer behaviors and confidence.

Speaker 4: And we expect border trends and spending to accelerate in 2023. As I touched on earlier, we're seeing significant signs of progress in key markets in Saudi Arabia, Brazil, and Latin America.

Speaker 4: As we enter 2023, capital allocation will be a critical area focus for drill quip as we support our organic and inorganic growth opportunities. We remain disciplined in our approach with a keen focus on driving attractive long-term returns on capital deployment.

Speaker 4: Our strong, clean, balance sheet allows the flexibility to consider multiple investment paths. These opportunities include organic initiatives and include the evaluation of potential inorganic opportunities that allow a line with our vision for the future. The M&A pipeline is rather strong and as you would expect, we're consistently evaluating the M&A landscape with a wide aperture of opportunities.

Speaker 4: Any M&A opportunity, large or small, would hear to our discipline approach to capital allocation, and any target will need to fit strategic and financial criteria that will ultimately provide accretion to our shareholders. In conclusion, 2022 was a pivotal year for DROP-WIP, with significant progress being made along our long-term objectives. Furthermore, as you may have seen, we published our first corporate sustainability report in 2022. At DROP-WIP, we believe technology will...

Speaker 4: Innovation is key to improving our energy efficiency and providing people around the world with universal access for reliable, affordable, clean energy. I want to thank our extremely talented and committed team here at Drill Quip for their efforts in pursuit of our vision for the company, their commitment to safety, and ongoing dedication.

Speaker 4: to all our valued stakeholders. With that, we'd like to open the line for any questions. Operator. Thank you. Thank you. At this time, we'll conduct a question answer.

Speaker 2: As a reminder to ask a question, you'll need to press star 1-1 on your telephone and wait for your name to be announced. To withdraw your question, press star 1-1 again. Please stand by while we compile our Q&A roster.

Speaker 2: Our first question comes from the line of Eddie Kim of Barclays. Your line is open. Thank you.

Speaker 5: Hi, good morning. Could you just update us on your well-head MSA with Petra Brost? It just seems like the activity level and an urgency from them has almost reached a fever pitch in just the last three months here and be on the offshore rig side. But as it relates to the drill flip, I know you got the MSA early last year for 87, well-head.

Speaker 4: have nearly all of those been called off at this point and any update on the additional tenders you'd been expecting from them. Yeah, good morning, Eddie. Thanks for the question. Yeah, that 87 well heads, I think about 50% of that has been called off. Today, we would expect the balance of that to be called off in 23, maybe early 24. There is a new tender that's already out there for the next tranche of well head systems. We would expect at least one tender.

Speaker 4: In the script, we do have 21 of our XPAC DE systems that are also under MSA. Today, only one or two of those have been called off. We would expect that to start to accelerate in 23 and into early 24 as well.

Speaker 5: Okay, understood. And then just separately shifting to your EBITDA guide, a pretty impressive guide on EBITDA incremental margins, 40 to 60 percent this year. Approximately how much of that EBITDA increase, would you estimate it is from kind of cost out and footprint rationalization versus higher pricing? I have to imagine you're seeing higher pricing right now, but you sort of have to get through lower price backlog this year before really seeing that benefit in 2024. Yeah, I'll let Kyle walk through the details, but I think if I could divide our business between the subsidy products and the downhole tool side.

Downhold tools does get pricing much quicker than the sub-C side. The sub-C side is definitely a backlog business. So when you look at our $240 million in backlog as an example, the vast majority of that is sub-C products. And you're right to say that's a lot slower to come through with that downhold tool business turns.

about every six to 12 weeks, so the pricing is really quick. They're all like call walk through those details. Yeah, I think on the productivity, if you will, or operational efficiency. We've got about five to 10 on a run rate base. Once we've got our property rationalization completed, obviously Jeff talked about to sail the Ford facility last year. We expect the closing. Other two facilities.

before the end of Q2. That on an annualized basis is about five defense. We'll get some of that this year, but I think the majority of sort of the year on year, even though the increase is gonna be through better mix and just volumes and then sort of legacy pricing coming back from Jeff mentioned downhole tools and then we've got, obviously some stuff that's in backlog that's got that we've taken to account. Now.

pricing as it relates to inflation. So we'll see all those, the benefit all those kind of flow through coming out of backlog and then as Jeff mentioned, the bookenship nature of downhill tools.

Got it, got it, understood. Thanks for all that color. I'll turn it back. I've had a good Saturday. Thank you. Thank you. As a reminder, in order to ask a question, you'll need to press star 11 on your telephone.

Since there are no further questions, we'd like to thank you for participation in today's conference. This does conclude the program and you may now disconnect.

I have you.

qu.