Q1 2023 Dril-Quip Inc Earnings Call
Good morning, and welcome to drove group's first quarter 2023 Fireside chat.
At this time all participants are in a listen only mode and there'll be no question and answer opportunity at the end of this call.
As a reminder, this call is being recorded.
At this time I'd like to turn the conference over to Erin Fazio Finance director for dual Quip. Please go ahead.
Thank you Matthew and welcome to drill our first quarter 2023, a fireside chat and updated investor presentation has been posted under the investors tab on the company's on site along with the earnings release.
This call is being recorded and a replay will be made available on the company's website. Following the call before we begin I would like to remind you that Joseph comments may include forward looking statements and discuss non-GAAP financials measures it.
It should be noted that a variety of factors could cause actual results to differ materially from the anticipated results or expectations expressed in these forward looking statements.
Please refer to the first quarter 2023 financial and operational results announcement, we released yesterday for a full disclosure on forward looking statements and reconciliations of non-GAAP measures.
Speaking on the call today from drop we have Jeff Bird, President and Chief Executive Officer and Mike.
Hi on the Clark, Vice President and Chief Financial Officer, and David Smith from Pickering Energy Partners I would now like to call the turn the call over to David Smith.
Thank you Erin and good morning, My name is Dave Smith I'm, the lead oilfield service analyst at Pickering Energy partners.
Wanted to say thank you for this opportunity to host Joe Quips first quarter Fireside chat.
And Kyle I look forward to our discussion after Jeff's prepared remarks, and with that I'll turn it over to Jeff.
Thank you David and thank you for joining us today, just as a quick <unk>.
Reminder, for those in Houston, we're experiencing pretty bad weather today. So if you hear Rainer Thunder in the background. It is not sound effects. It is actually rain and Thunder in the background. So with that we'll go ahead and proceed.
As you may have seen in our earnings release, we've changed our reporting segments from geography to subsea products subsea services and well construction. This decision was to change our reportable segments as part of our streamlined organization that we believe will give us our stakeholders better visibility to our business and more closely in line with our internal opera.
<unk> structure as.
As for first quarter results, we delivered strong year over year revenue results that were up 9% with revenue in our well construction segment growing 38% year over year in subsea services growing 10% year over year, reflecting the growing demand in key markets, such as Brazil, The Middle East Latin America, and some re emerging.
Markets, such as West Africa bookings for the quarter, reflecting the typical Q1 seasonality and we continue to expect bookings growth throughout the remainder of 2023. However, it should be noted that our targets to include a number of subsea trees, where <unk> will.
He will play a crucial role in order timing throughout the year.
We've also continued to make progress on our footprint optimization plan to improve efficiency and reduced excess capacity during the first quarter. We closed the sale of our aftermarket facility here in Houston. In addition, we continue to remain on track with the sale of a third Houston property. Later this year once completed the disposal of these for three properties will.
Contributed over $40 million in cash flow, allowing us to best in other areas of the business free cash flow did come in below our expectations. This was primarily driven by working capital timing related to accounts receivable, we expect working capital to normalize over the next two quarters and specifically day sales outstanding is expected to return.
To levels closer to Q4 of 2022 by the third quarter, which we believe will generate approximately $40 million in cash.
Finally, I wanted to reiterate that capital allocation continues to be a critical area of focus for drill clip 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.
Our strong clean balance sheet allows us the flexibility to consider multiple investment pass. These opportunities include organic initiatives and the evaluation of potential inorganic opportunities that align with our vision for the future with that I'll turn the call back over to David.
Thank you Jeff.
I guess starting out I'm curious when it comes to the current global economic environment. What are you hearing from customers or are you seeing any project deferrals or other signs of hesitation related to recent oil price volatility.
Yeah. Thanks, David that's a good question. So you really have to segment our different customer types.
To get a good read on that so let me just walk through this first of all what I believe is the most.
Responses to oil price volatility as the lower 48, and we essentially have no lower 48 exposure. So.
A change in oil price is not going to dramatically affect in a short term our revenue or our bookings as it relates to that and then if I think about our three other customer segments I've got the large Iot I'll talk about the <unk> I'll talk about and then kind of the small mid sized customers that I'll talk about so if I think about.
The ioc's well they've got very very long term plan. The most theyre going to do is move something to the right a little bit or move something to the left a little bit. We just don't see that right now in fact, as we're talking to those large IOC if anything what we're seeing is then accelerating plans, so where we might have thought they would have a reorder point in <unk>.
<unk> 2020 for some time, we're now seeing that that reorder point to be as early as late 2023. As an example, so we don't really see that in Iot, but once again, they're looking at oil prices out. The next five to 10 years not the next five or 10 months so to speak.
I think about Noc's.
So think about well construction.
And on that well construction side, we've got a fairly significant amount of exposure to NOC, So think Brazil.
The middle East.
Mexico Ecuador.
They're drilling for a whole number of reasons that don't include the current oil price and we're just not seeing any slowdown there in fact, we've talked about Brazil being a great market for us we've talked about Mexico remaining strong we've talked about salary range associate changes there either and that really.
Well construction for us and to some degree wellheads as well as it relates to Brazil, So nothing there.
The area, where we do see some customers probably more susceptible to short term price changes is really the small medium sized customers and thats really related to our <unk> franchise. So think Sps that's part of our subsea products segment and we've got about 10 trees. This year.
<unk> that we've got targeted as potential bookings and higher inflation rig rates.
Oil prices.
We'll all affect those customers well.
Necessarily cancel a project, but it might cause.
<unk> to be deferred so that's really the only space right now, where we're seeing really a responsiveness to short term oil price volatility.
No that makes perfect sense I would imagine even rig availability at this point it could cause some some projects for the mid size.
Independents to get deferred.
Yes.
Yes, that's exactly right.
And that's what affects our bookings quarter to quarter and I talk a lot about lumpiness quarter to quarter, it's really around those three those territories that we talk about with each trading kind of $3 million to $5 million it doesn't take a lot.
To move that traded arrived in effect, our overall bookings number.
Yes, absolutely.
Jeff you've mentioned over the past few quarters.
There are a few key markets, where youre seeing strong growth is there a specific market, where youre seeing the most growth and does that answer change if we talk near term versus long term.
Yes, so the two markets that we're most excited about right now are Latin America, and specifically, Brazil as you'll be aware, we filed that MSA about 18 months ago for 87 wellhead systems. We would have thought that was going to last for three years plus on they've already come out with another.
Their tender that will be awarded later this year. So that just gives you a sense of how quickly that Brazil market is accelerating we've got 21 ex Tac ves on an MSA as well as those start really getting installed. This year. So we're really excited about that Brazil market. If I move to Mexico, Mexico has been a really strong market for us as well specifically.
A well around well construction that markets are that.
That business there has grown fivefold over the last call. It three years, plus so Latin America, largely we're excited about the other area. We're excited about is really around middle east and specifically, Saudi we've seen a lot of growth in our well construction business in Saudi but even looking out broader middle east we're seeing growth.
There as well and then kind of a nascent area, where we're really starting to see pickup right. Now is Africa and it is not the usual suspects in Africa, It's really Namibia, we're seeing.
A lot of.
Exploratory right now a lot of orders dropping in there and really when you look at those fine that's got the opportunity to be a major major major field.
Kind of the next 357 years, so we're really excited about that as well.
Okay.
Yes, absolutely.
Circling back to the Middle East certainly a big driver of growth in the offshore market, but yeah.
On the shallow water side.
Could you provide a little more insight into your views of that market over the next couple of years and how drill quip is participating.
Yes so.
First of all if thats been a very strong if you go back to the <unk> acquisition that we made in late 2016. It was a strong market for <unk>. It continues to be a strong market for what is now our well construction business. It continues to grow we have exposure based on current qualifications to probably 30% 40% of that market.
From a well construction standpoint, we're actually working on qualifications that would expand.
That exposure to that market, so well construction is very.
Is well positioned.
To capitalize on that market.
We're making investments there we're looking at facilities right now in fact, probably in the next 30 days I'll be going over to review a facility that we're likely to invest in so we're going to put local manufacturing on the ground. There. We've already got local service tax we've already got local test and assembly. This will move out of our supply chain in kingdom as well so thats.
On the well construction side, if I turn to the subsea products side of the house, we participated more opportunistically in that market and largely thats because of qualifications and we are working now on qualification for a number of subsea products.
That market as well, we're taking that into account when we look at our manufacturing and supply chain in Kingdom. As you probably are aware of those qualifications are sometimes arduous.
And so we're probably 12 to 18 months away from formal qualification in kingdom on the subsea products side, but you should expect more to come on subsea products of well construction nice growth probably over the next 12 to 18 months subsea products starting to kick in probably 12 months out and we've already added.
<unk> start to.
We've already had a strong start to this quarter, we've already got a nice drop in bookings on the on the well construction side. In addition to signing an MSA in region as well already in the second quarter. So you don't see that press in our Q1 results, but when we release Q2, youre going to see a nice MSA from our well construction business and a nice drop in order there from <unk>.
As well.
Looking forward to that.
I guess.
Just circling back to <unk>.
The offshore bigger picture pace of offshore rig contracting is certainly improved over the past year, having watched this market for a long time I can't tell you how refreshing it is to be back firmly in and an offshore Oss upcycle I'm curious on your perspective is there anything about the upswing.
Wing.
We're seeing in the offshore market.
That you think is different from prior up cycles, and maybe assuming oil prices were to hold steady.
How would you be thinking about the next.
A few years.
Yes.
So a couple of things I mean, I think it's unquestionable that over the last five to seven years Theres been underinvestment offshore right. So I think those inside the industry.
Kind of always knew that investment had to come back.
So I don't think anybody thats inside of the hand, the history candidly at any LFS company or at any.
Operator is surprised that coming back I think the two things that are different. This time is that it's probably coming back in a more thoughtful capital disciplined.
Way as opposed to the sudden spurts and stops that we have because of over investment and under investment I think it's a nice slow March up as opposed to the.
The tops and bottoms that were experienced in the past and I think the other thing that really plays a role as you can't underestimate the role of energy security and if you think about some of the world events that we've seen really over the last 12 to 18 months I think people woken up to the fact that energy security matters and we can be very reliant on a few.
New players in the market it doesn't take much to move the needle from an energy security standpoint, So I think a combination of probably more disciplined approach to investment and energy security is really probably different this time than what you would have seen in the past the days of.
Of drill baby drill or probably.
Probably over based on the capital discipline that we're seeing today.
Yes that makes perfect sense.
So I don't know if this is Jeff question, Eric IL question, but I was hoping if you could share a little more color around the reasoning behind changing the reporting structure to subsea products subsea services and well construction.
Yes so.
I'll kick it off and then I'll, let Carl jump in.
As I came in to roll it over a year ago. One of my observation was that as a business. We were geographically focus but as an organization. We were really siloed and we didn't have the right strategies for each of our products and in each of our products is a very different strategic approach whether that would be well.
Or option or even if you look within subsea products or subsea services. There is elements in there that have very different strategy. So what we wanted to do is we wanted to align more from a strategic standpoint around these segments and products even underneath these segments. So that the organizations inside those products could be more clear about what.
What they were doing and where there are margin and that means that the days in the past where there'll be a gap between sales and sales admin and sales admin and engineer and engineering and manufacturing and so on we're breaking down.
Those silos from a responsibility standpoint, so that people have more clear accountability and if youre inside one of those organizations now you know what your strategy is you know what your margin too and when you'll see a right and your left those are people that are marching to that same strategy. Yes. The revenue was obviously very clear inside the organization and really became a lot of costs that is kind of shared amongst.
The organization that we've clearly defined now people have obviously P&L.
Jeff being a former CFO very returns focused individuals' wells and now we can start looking at things like return on invested capital for each of the new segments and really driving that behavior setting targets.
So I think we announced probably a while ago internally. This reorganization will just sort of went live with the back of the January now we're sort of operating with it here in January through through March for the first time in Q1, and obviously are reporting that way externally. So we'll give the market a little bit of a deeper look into the organization and the newly branded well construction organization.
Subsea services and in subsea products, and we will have a fourth one for the corporate segment, which is where the cost of running a public company. If you will but really about driving accountability driving returns inside the organization. We've got a number of investments we've got ongoing right now theyre going to help boost that longer term.
But it's really about sort of accountability, making sure people understand who's got what costs and ultimately being a returns focused organization.
So there's a lot of good color.
Sticking on one of those segments, the well construction business. So I think formerly referred to as downhole tools.
It's had.
Some some pretty solid growth.
Could you give us some color behind your confidence that this growth continues and do you still expect to reach the $100 million annualized revenue run rate by the end of 'twenty three.
Yes so.
If you look nice nice strong start by the way to the year.
With a little over $20 million in revenue for that well construction business.
If you.
We see strong growth there in salaries. So if I think about the two areas of growth. We expect continued growth in salary this year from that business and we're excited about that as I mentioned already in Q2, we have already seen some nice wins around that.
So we're excited about that the real area of growth beyond the normal markets, which is Saudi Mexico, Ecuador, I'm really comes in the deepwater. So if you go back to when we made the original acquisition back in 2016, and obviously this has developed slower than we would've expected as we believe there was an opportunity to go deep water with the X factor.
<unk>.
We've now taken that offshore we've got a qualified at a number of key customers that business was essentially zero call. It six to 12 months ago, We believe that business can grow to $20 million over the next really 12 to 18 months and we're starting to see real acceleration now in that product line specifically.
And it really adds real value to our customers I mean with each time you run the <unk> and these are customer number is not our numbers you save $1 million each time you run it so.
So the savings are substantial substantial enough that it's almost an immediate why wouldn't I do this and that's really the acceleration. We're starting to see now is that deepwater business. So if I think about that growth as the AG. This year, it's going to be Mexico is going to be a key contributor Saudi will continue to be a big contributor and growing and then the.
The last segment is really around deepwater and thats the growth that we're just starting to see now and we're just starting to the tip of the iceberg on that.
That's great to hear I have to admit I hadn't factored in deepwater growth for the downhole tools business I mean, the well construction business.
Sure.
By the way my goal today is not to call it downhole tools David.
Yes.
Segment, formerly known I knew I knew that was going to be a challenge throughout throughout the call for me.
We'd like to circle back to the MSA is maybe give some color on how draw Corp's MSA list has evolved how we should think about msas as it pertains to <unk>.
Our revenue outlook, this year, and maybe a little bit bigger picture.
What more orders coming through Msas might mean, if anything for reducing the historical cycle time between orders and backlog conversion.
Yeah sure so.
If you think about our product lines in subsea services I'm going to take.
Take off the table, because theres, not really any backlog per se or or de minimis for subsea services right. So if you think about msas are msas.
Really come in through subsea products until very lesser degree through well construction as well. So if you go back in the past if I go back to kind of the heyday call. It 2011 to 2014 people would equate these huge purchase orders.
The operators enabled a bit on the hook for those huge purchase orders that things turned down there. We're on the hook for weather things turned down or not and I think if you think about capital discipline.
I think part of that capital discipline is under a contract differently with <unk> suppliers and instead of placing these huge purchase orders on products that have lead times of 12% to 26 weeks I'm going to set up an MSA.
And I'm going to call off against that MSA and have a minimum quantity and that's what we're seeing today I mean, we saw that in Brazil, we see that with a lot of the large <unk> as well. So that's kind of an evolution I think it is actually healthier for the industry as a whole.
And I think it is healthy because candidly you don't end up with a lot of access.
Equipment in the chain of things turn one direction or the other right. So if you think about our subsea wellhead today. The lead time is 26 weeks in that.
We're going to reduce that the 13 weeks why would you place a three year purchase order for something that has a 13 week lead time, if you think about downhole tools.
12 weeks maximum lease out 12 weeks why would you place a three year purchase order for something as a 12 week lead that just doesn't make a lot of sense. So at least as it relates to subsea wellheads.
And as it relates to <unk>.
Well construction those are more MSA on the <unk> side, you might get those large purchase orders because the lead times are significantly longer. So the way I think about it is if you've got 18 months plus lead time youre likely to have large purchase orders if you've got a sub one year lead time youre likely to have msas and a lot of our products tend to be sub one year lead times.
Yes.
Perfect sense actually.
Kevin backwards with hoping if you can.
Could provide us an update.
On the ongoing operational excellence initiatives and cost specifically the footprint rationalization and then the manufacturing investments.
Whereas each stream relative to <unk>.
Additional investment required additional investment.
Yes.
Or are we on the timeline can you quantify the related investments.
And maybe are there any charges relative to.
Relative to this.
So let me just back up and talk up operational excellence as a whole.
The big initiatives that you've mentioned are very important but I think what's more important is we're starting to ingrain operational excellence in the DNA of the company and what that means is when I go to a manufacturing facility.
<unk> got real gambler walks of rewards and theyre solving problems everyday with our operational excellence tools. When I go to a service center they've got boards Theyre reviewing Kpis every day and Theyre solving real time problems with operational excellence tools.
That has happened in each of our facilities in each of our service centers around the world.
That probably is the most important part of operational excellence, because we are not waiting until the end of the week. The end of the month the end of the quarter to solve a problem. We're solving the problem real time and breaking down barriers that having been said youre right. We do have a lot of a couple of large things in stream right now of one of those is the footprint I mentioned that in the opening remarks, we had to.
Hundred 18 acres in Houston by the end of the year will be down to 130 acres and then we will have completed most of the work that we need to do in Houston, and we'll hit pause on that as it relates to footprint rationalization.
We are making investments.
So we had talked about a $25 million investment in subsea wellhead manufacturing that.
The first piece of equipment.
Equipment actually arrives this month that.
That will largely be done kind of early to mid next year and we'll start to get the real benefit of that early to mid next year that $25 million investment just just to put that investment perspective that goes from needing a 117 machines today that arent operating efficiently down to I think it's 12 machines.
Operating efficiently so you get a lot more footprint.
Opportunity out of that and then it really takes that lead time from call. It 26 weeks today down to 13 week. So it's really a game changer for us internally, but from a lead time standpoint is a game changer for our customers as well and that will drive gross margin expansion I think in our deck, we talked about getting to a 35% gross <unk>.
Arjun expansion that will drive gross margin expansion to 35% and so we really believe that we've got the right things in tow.
Around subsea wellhead and then we start to look at areas of the world, where we need to make investment I talked a little bit earlier about Saudi and the fact that we're going to look at investment in Saudi we're going to look at expanding our facility in Mexico as well as that business grows we're going to look at what are the right investments we need to make in South Africa West Africa as well so we're looking at those <unk>.
I don't see a charge specifically for any of those because candidly those are.
Greenfield investments, yes, just to clarify at 35% gross margin on products, specifically and as Jeff mentioned, there. We do have some smaller restructuring if you will.
Throughout the last call it five quarters or so related to property moves on campus some of those auto lending to them to the wellhead manufacturing investment.
And the last piece this moves kind of beyond operational excellence commercial excellence as we feel like we're very close to having the operational side running smoothly. So we can service our customers and the best way possible now moves through commercial excellence and how do we make sure that front facing side of the house.
<unk> is as good as the operational side of the house and more to come on that but what we're really starting to turn our effort now towards that.
Great I, just wanted to make sure I heard correctly.
Regarding the equipment investment.
Did you say it goes from kind of needing a 117 machines down to 12.
Yes.
Alright.
And some of those probably data would have always been excess machines.
Okay. Thanks to all of it is just machines that arent operating in the most efficient way or we've got too much downtime between those machines.
So.
On that topic of investment could you provide an update on your inorganic growth opportunities that.
You've touched on in the past.
And maybe is the company willing to take on some debt to help get.
That deal done I know, you've got a great cash balance.
Kind of thinking about the potential sizing.
Yes, so I'll kick it off and then I'll, let Carl talk a little bit on the financial side.
I think about the new reporting segments. We have got it actually has really helped us align around what's the right inorganic strategy for each of those right. So as you can imagine having an eight well construction is a lot more inclusive.
We have named downhole tool so as we start looking at inorganic opportunities theres plenty of inorganic opportunities around well construction. There is plenty of inorganic opportunities around subsea services theres plenty of inorganic opportunities around subsea products. Each of those we're looking closely at as we as we move along there.
We are looking at things that are adjacency, but.
But right now we're more focused on those three those three segments. Yes, I think if you look at the last couple of quarters towards the quarters. It feels like we're seeing a lot more deal traffic come through we've had a lot of folks have had a good 22 expecting any better 'twenty three I think the difference I would say versus any other point in the last nine years or so is that the sellers are much more realistic about valuations.
Starting to see the bid ask spread coming together, a little bit more which.
Which is nice to see I think as it relates to that I think we're still a little bit adverse to that from a capital structure standpoint, if it's purely an asset due to the cyclicality as well the debt markets really aren't what they used to be if you will the last 10 to 15 years, we are working through that as well.
I think for the time being we will continue to target carrying a debt free balance sheet unless as just kind of call that we find more of a unicorn deal with maybe it's a little bit more.
Different exposure to end markets with an ofa stub, but absent that I think we would still say, we're going to target a debt free balance sheet.
I appreciate the color.
So.
Looking at the quarter free cash flow missed missed our expectation.
Sensus and I get the working capital build.
You addressed it early on.
But can you talk about some of the specific steps that are being taken to help improve free cash flow and maybe not just getting getting dsos down in.
In the third quarter, but is there anything structural beyond that.
There is plenty of initiatives underway at any given time in the organization right now we've kicked off a number of order to cash initiatives here, probably the last couple of months.
Various initiatives that we're looking into to get down billing times collection times and so forth Q1 is always a tough free cash flow quarter for the company with the payment of our annual bonus we've got our annual property tax payment quarter.
Timing this quarter on AAR was just a little bit more than we anticipated and as we mentioned will probably catch up in Q2 Q3.
We will see a more normalized DSO exiting Q3 and with the caveat being that we are expecting growth to accelerate in the back half of the year, so assuming that bookings growth consistent with our full year guide for Q3 Q4 might require some more working capital.
But embedded in the next few quarters should be roughly that $40 million reduction we decided in the.
In the press release, all else equal if you will around working capital. We continue to obviously to have pretty good financial flexibility supporting our growth plans outlined at our full year guidance, which we reiterated in the press release.
And I do appreciate that.
The full year guidance, if I step back looking at last year.
<unk> 22 was a really strong quarter for drill pipe on revenue and EBITDA.
So for kind of my last question I'll, just be direct and ask.
How do you see <unk> 23, playing out and could we expect year over year growth.
I think we look at Q2 in general where the bookings came out of Q1, we would expect Q2 to look largely slimmer similar to Q1, we just finished with regard to revenue and EBITDA. So maybe slightly behind last year's Q2, there'll be some puts and takes obviously with the segments of course, but we would expect a flattish to Q1 of this year from a bookings viewpoint.
We expect to be in the 55% to $75 million range again, as Jeff mentioned some of those projects new head FIV liquidity ourselves at the top end of that range based upon some of those digital three orders and free cash flow should be improved versus Q1, as we catch up on timing.
As I just mentioned, so probably slightly down from last Q2, but flattish to what we've seen is Q2 look like this Q1.
Great I appreciate it.
Yes.
Yeah.
Given us a lot of information.
I am I am thinking I should have written down some more questions but.
That's all I got.
Got a lot of notes here to digest it.
Jeff and call. It was a pleasure to host the call with you all and I will turn it back to you.
Great. Thanks.
Thanks for hosting today, David It looks like we actually got through this without losing power here in Houston look we're pretty confident as we go into the balance of the year.
We're happy with the revenue, we're happy with the EBITDA from from Q1.
We continue to be optimistic around bookings the balance of the year and we will see the.
We will see the cash flow a bounce back kind of Q2 Q3 so.
More to come but pretty excited about the balance of the year. So thanks David.
Before the next time.
Thanks, David.
Thank you. This concludes today's conference call.
Thank you for participating you may now disconnect.