Q2 2023 Dril-Quip Inc Earnings Call

Good morning and welcome to Drogqip's second quarter 2023 earnings and Great North acquisition update call.

At this time all participants are in a listen only mode and there will be a question-and-answer session opportunity at the end of this call.

As a reminder, this cold is being recorded.

At this time, I would like to turn the call over to Aaron Fazio, Corporate Finance Director for Drove Quick. Please go ahead.

Thank you and good morning. We appreciate you joining us on today's call. An updated investor presentation has been posted under the investors tab on the company's website along with the earnings release and press release announcing the Great North acquisition. We have also posted an investor deck with additional details on the Great North acquisition that may be referenced during today's call.

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 drillcope's comments may include four looking statements and discuss non-GAAP financial measures. It should be noted that a variety of factors could cause drillcope's actual results to differ materially from the anticipated results or expectations expressed in these four looking statements.

on forlooking statements and reconciliation of non-GOT measures.

Speaking on the call today from Drolphos, we have Jeff Byrd, President and Chief Executive Officer and Kyle Messer, Vice President and Chief Financial Officer.

I would now like to turn the call over to Deathbird.

Thank you, Aaron, and thank you all for joining us today. As you saw in yesterday's releases, we announced our Q2 2020 reunions as well as the acquisition of Great North. We are excited to welcome Great North to the drill quick team.

And this acquisition is a significant step in our strategic effort to expand our well-construction portfolio.

We've been discussing our inorganic capital allocation strategy for about a year now and are very excited that we found the right opportunity to put our cash to work, creating shareholder value.

Great North is a perfect example of a high-quality asset purchased at the right terms.

Before we dive deeper into the acquisition details, both Kyle and I will first touch on our financial and operational results for the second quarter.

During the second quarter, we delivered strong results supported by the ongoing upcycle in key offshore markets. We produced revenue of $89.6 million, which is in line with the expectations we communicated to the market coming out of Q1. Our second quarter gross margin...

26.7 percent remains healthy and we continue to execute on our organic initiatives across the organization to drive operational efficiency.

Adjusted EBITDA for the second quarter with $8.8 million, flat sequentially, and down $600,000 year over year.

Notably, however, we generated positive free cash flow during the quarter, showing strong year-over-year and sequential improvements.

Kyle will go into greater detail on the free cash flow movements. Spillings in the quarter were $72.7 million, an increase of 36% sequentially, and in line with our prior guidance.

They should be noted that with the acquisition of Great North.

More than 50% of our revenue is now booked, shipped, and billed within our subsea product segment as our primary backlog business.

The Q2 book to bill ratio for our subsea product segment was 1.2 times.

During the second quarter, we saw 49 wellheads called off from existing MSAs. And as of quarter end, we had approximately 70 open MSAs.

Strength of our backlog, combined with our confidence in the underlying market backdrop, confirms that we are well positioned for a strong second half of 2023. We also had several significant operational milestones in the second quarter. Our customer-first mindset when it comes to innovation is driving incredible success stories and fueling some of the second half growth outlook. These anecdotes include passing the new wellhead qualification testing requirements for the Petrobras exploratory project in Brazil. We are the only wellhead provider who has met Petrobras' stringent requirements.

and I'm very excited about the level of excellence we continue to provide our customers in key growing markets such as Brazil. Additionally, there was a call off of an MSA in the quarter of 33 wellhead systems.

17 of which were directly attributable to the qualifications success.

In our well construction segment, we were awarded the first of five big bore X-back DE liner hangers in Namibia from a major operator. We are very optimistic this is the first tranche of growth related to this previously dormant region. The well construction team also successfully installed the floating

of over 5.5 miles.

The ability to install a liner hanger in that length allowed the operator to reduce its carbon footprint and overall cost of production by minimizing its surface grilling location.

Our equipment was used in the second quarter to inject CO2 for purposes of permanent storage for a project in Denmark. We spoke in a bit over the past year about our investment in an energy transition team. We are very excited to be contributing to these important early projects. With that, I'll turn the call over to Kyle for some color on our financial results. Kyle. Thank you, Jeff, and good morning to everyone joining us on the call. 2nd quarter revenue was 89.6M, a decrease of 5% year over year.

Sequentially, revenue was down slightly at 1%. As a reminder, we guided flattish revenue coming out of Q1, which is what we achieved. Taking a look at the segment results, Subsea Products revenue declined 10% compared to the prior year and 3% sequentially, which was driven by the timing of certain customer milestones within the quarter, shifting into Q3.

Subsea services decreased 7% year-over-year and was flat sequentially, which was tied to the timing of Subsea product delivery.

Finally, the well-construction segment grew 11% year-over-year and 3% sequentially.

selecting activity increases in Latin America, market share advances in deepwater, and strategic pricing impacts over the past year.

Gross margin during the second quarter was 26.7%, up 79 basis points year over year. This improvement in gross margin is largely due to favorable product mix, gains in pricing, and our ongoing initiatives across the organization.

That income for the quarter was $3.5 million, an increase of $9.1 million year over year. Adjusted EBITDA for the quarter was $8.8 million, a decrease of $600,000 from one year ago. The driver was the reduction in subsidy product revenue year over year due to timing of customer delivery.

versus Q1 adjusted even if it was flat, which is what we guided coming out of last quarter. Turning now to bookings, we are continuing to see an uptick in demand for the offshore drilling market, especially in Brazil, the Middle East, Latin America, and some re-emerging markets such as Namibia.

Bookings for the second quarter were $72.7 million, a 47% year-over-year and 36% versus prior quarter. Cash provided by operations was $11.3 million in the second quarter, a significant improvement of $64.2 million sequentially.

Pre-cash flow for the second quarter came in at a positive 1.1 million. This was driven by the normalization of working capital related to receivables through a reduction in DSL.

Inventory was a net use of cash in the period as we staged finished goods in anticipation of growth in the second half of the year. CapEx in the second quarter was $10.2 million, the majority of which was related to our previously mentioned wellhead manufacturing investments.

We were in that use of cash in the period as we staged finished goods and anticipation of growth a second half of the year. Half X in the second quarter was 10.2 million, the majority of which was related to our previously mentioned well head manufacturing investments and rental tools bound for work already secured.

Additionally, we received a long-awaited IRS refund of approximately $17 million during early July , which will only add to our strong balance sheet post-closing of Great North. Turn it back over to Jeff now to talk through the Great North acquisition in more detail.

Additionally, we received a long-awaited IRS refund of approximately $17 million during early July , which will only add to our strong balance sheet post-closing of Great North. Turn it back over to Jeff now to talk through the Great North acquisition in more detail. Jeff? Thanks, Kyle. Thanks, Kyle.

There are five key reasons why we've decided to acquire Great North. I'll go into each of these in more detail. First, this is an expansion of our land-based wellhead addressable market.

Second, it is immediately accreted to all financial metrics.

Third, there are identifiable and achievable revenue, cost, and working capital synergies.

Fourth, we retain financial flexibility with an industry-leading balance sheet. And finally, the reputation of Great North and their uncompromising client-first mentality matches drill-put. Great North is a leading provider of mission-critical, highly engineered, and highly-built, and highly-built and highly engineered.

customized weld heads, and proprietary completion solutions. Great North brings a wealth of expertise with a talented employee base and a solid reputation for delivering differentiated products to a diverse base of blue chip customers. Great North's products and services, which include conventional and thermal land-based applications.

will be integrated within DrillQuip's existing well construction segment, as I mentioned earlier. Great North's solutions include products, rental offerings, and field services, a very similar model to our existing well construction segment, which is focused on delivering highly engineered products on time while maintaining an excellent level of service quality.

Approximately 70% of the revenue comes from sales surface, well-hit products, and services, which include customized and engineered applications. Another 30% of the revenue is related to rental solutions, which are a comprehensive suite of products design to improve operational efficiency and safety during hydrology practice.

This acquisition expands our exposure to the shorter cycle onshore North America markets and expands Thirlpwips geographic presence. Great North provides us access through its service locations throughout Canada, which is the fourth largest market in production globally.

This technology portfolio also enhances our position to further service the emerging land-based carbon capture, utilization, and storage market.

drill coast extensive global footprint will serve to accelerate Great North international expansion

This, combined with DrillQuip's high pressure, high temperature, and metal-to-metal sealing technology will allow Great North to further expand their higher-end product offerings.

extending enhanced products and services to existing and new customers.

Not only will this transaction enhance our international opportunities and ability to meet our customers' global needs, it will significantly expand our total addressable market for land-based welding.

We anticipate total annual revenues energies in the $20 to $30 million range.

Additionally, annual cost energies are estimated to be approximately $10 million through the combined best-cost regional supply chains of both Great North and Droglith.

As we work through integration,

We also expect to gain working capital efficiencies in both organizations.

The combined company has a debt-free balance sheet, and we anticipate that the transaction will be accretive to all key financial measures in the first year.

I mentioned in the introduction that this acquisition highlights the merit of finding a high quality asset at the right terms.

We expect the return on invested capital to be approximately 20% the first year.

The free cash flow this combined transaction will offer adds additional flexibility to continue our organic and inorganic capital allocation strategy.

With the addition of Great North, we've taken a significant step in our strategic effort to expand our well construction portfolio.

This is an exciting opportunity for GrillQuip and we are confident that the acquisition of Great North will benefit both our customers and shareholders through a differentiated product offer. We are confident that the acquisition of Great North will benefit both our customers and

Improved Return on Invested Capital, Adjusted EBITDA, and Pre-Cash Flow.

Finally, before I turn the call back over to Kyle to review the terms of the transaction and our updated full year outlook, I would like to welcome our new team members once again from Great North to DrillClip. We look forward to updating all stakeholders on the progress of the integration and the team's early wins. Kyle?

Thanks Jeff. As for the terms of the deal, we are acquiring Great North on a cash-free, debt-free basis for a total upfront consideration of approximately $80 million.

which is subject to customary purchase price adjustment.

In addition to the upfront consideration, there are potential earn-out payments of approximately $23 million to be paid over the course of 2024 and 2025 as certain revenue growth targets are met by Great Lakes. In addition to the current revenue growth targets, there are potential earnings payments of approximately $23 million to be paid over the course of 2024 and 2025 as certain revenue growth targets are met by Great Lakes.

Continue to have ample liquidity to fund our operations and to evaluate incremental high return capital allocation upturn.

As mentioned earlier, day one, great nor it will be a creative on an adjusted EBITDA, free cash flow, and return on invested capital-based.

With that said, I would like to note some changes to our outlook for 2023.

We are raising our 2023 revenue target to 20% growth, up from 10% in our previous guidance, counts for the 2023 contribution of the acquisition of Great North in the remaining 5 months.

Expect second half revenue to be in the range of $240 million to $250 million.

We are maintaining 10% to 20% product bookings growth over 2020.

We expect second half adjusted EBITDA margins to be 14 to 16 percent.

We now expect approximately $30 million in CAPEX for full year 2023.

As a reminder, overall CAPEX is elevated this year as we close out our previously mentioned $20 million investment in subsidy wellhead manufacturing in Houston.

Going forward, we should expect to see overall cathecs need, including Great North, to run around 3-5% of revenues.

We expect pre-cash flow to be positive in the third quarter.

For the full year 2023, we continue to anticipate being in a net use of free cash load. As growth and on subsea products business will require a working capital bill and the majority of the $20 million well-head manufacturing investment will be paid out this year.

Our capital allocation priorities remain the same.

We are first prioritizing high return organic initiatives such as our investment in wellhead manufacturing.

Second, we will continue to evaluate incremental acquisition opportunities that expand our well construction portfolio and deliver significant accretion.

Finally, we will continue to evaluate returning cash to shareholders via stock buybacks in line with our free cash flow

Okay, that concludes our prepared commentary. At this point, we'd like to open the line for any questions.

Operator?

Thank you. At this time, we will be conducting a question and answer session.

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One moment please while we pause for questions.

Okay

As we have no questions at this time, this will conclude today's conference. You may disconnect your lines at this time. We thank you for your participation.