Q3 2023 Dril-Quip Inc Earnings Call

Good morning, and welcome to the real quips third quarter 'twenty twenty-three earnings call. At this time, all participants are in a listen only mode and there will be a question and answer opportunity at the end of this call. As a reminder, this call is being recorded at this time I would like to.

I turn the call over to Erin Fazio corporate Finance director Frigerator Quip. Please go ahead.

Thank you and good morning, we appreciate you joining us on today's call and updated investor presentation have been posted under the investors tab on the Companys website, 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 you. All could comment may include forward looking statements and discuss non-GAAP financial measures.

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 third quarter 2023 financial and operational results announcement, we released yesterday for all the pleasure on forward looking statements and reconciliations of non-GAAP measures.

On the call today from jobs that we have Jeff Bird, President and Chief Executive Officer, and Kyle Mcclure, Vice President and Chief Financial Officer, I would now like to turn the call original correct.

Thank you Erin and thank you for joining us today.

Third quarter, we delivered strong top line results that were up 31% sequentially and 33% year over year.

In addition to the revenues from Great North we saw continued strength in key end markets, specifically Latin America, the middle East and a further strengthening African market.

While revenue was consistent with our guidance, we did see some customer specific headwinds as a result of both rig availability and a very tight rig market and CSO delivery time.

This directly impacts our ability to service certain customers and as a result, our higher margin service segment delivered lower revenue than expected.

We do expect our service segment to rebound in Q4.

The availability also directly impact the timing of certain bookings, specifically MSA call offs in Latin America, and the middle East as well as the timing of certain subsea tree orders.

Accordingly, we are adjusting our outlook slightly for the fourth quarter of 2023, which Kyle will go into more details later.

Bookings in the quarter were $46 5 million a decrease of $26 million sequentially as a result of the rig and Fps overtime.

During the third quarter. We were also notified of the award of the Petrobras tender valued at up to $28 million of which most is not included in bookings for the quarter.

This is an incremental master service agreement supporting Petrobras and their pre Salt development Wells project.

And we expect the first call offs against the agreement to occur as soon as the next couple of months.

We have over 70 open msas and ended the quarter with approximately $200 million impact.

The strength of our backlog combined with our confidence in the underlying market backdrop.

Our long term growth outlook.

As a reminder, approximately 80% of our current business is caller or book and ship against Msas as we have different standardization across many product lines and reduce lead times.

Our second quarter gross margin of 27% remains healthy and we continue to execute on our organic initiatives across the organization to drive operational efficiency.

Adjusted EBITDA for the second quarter was $12 4 million up $3 $6 million sequentially and up $5 3 million year over year.

As we enter the final quarter of 2023 I believe the team has made excellent progress in terms of both operational and service excellence.

A good example of this is our recently awarded number one service quality position with Aramco in Saudi Arabia.

Grabs the team for their continued improvements in service quality excellence.

Strategically we completed our first acquisition since 2016 with the addition of great nor at this quarter.

Adding great North portfolio has not only been financially accretive with a great north team producing excellent results since close but also as exposed to a top producing region.

The integration team has done a great job with the back office work now largely complete and supply chain optimization plan is well underway.

First purchase orders and our liner hanger business utilizing great more supply chain have been created with initial deliveries occurring early next year.

We continue to expect total supply chain to drive annual synergies of approximately $10 million.

Which will be recognized starting in late 2024.

The team has also been working diligently on establishing a framework for cross selling great North Andrew I'll quit products, given the white space across our customer sets.

The excitement about the great North technology coming from our customers and country managers globally has surpassed our expectations.

And we look forward to seeing incremental revenue opportunities as a result.

The footprint optimization initiatives has continued to progress with the sale of a third building in Houston expected to close in the fourth quarter of the year.

Total cash proceeds from this initiative for the year are expected to be approximately $25 million, while simultaneously, reducing operating expenses to run our Houston campus.

These proceeds more than pay for the investment manufacturing equipment, we announced late last year.

I am excited to announce the first one she was delivered this quarter and we are currently testing that machine alongside our existing production lines.

The final machine deliveries are anticipated to occur in late spring next year, which will drive both cost and delivery time improvements for our subsea wellhead product.

Simultaneously, we have also been investing in key markets, where growth is underway and this quarter. It recognized several key wins.

We signed a new commercial agreement and the Ivory Coast of Africa, and subsequently recognize the first delivery of our products and rental tools in country.

Supported by our new service base there.

In Brazil, we sold our first offshore big bore liner hangers to two different customers, making a notable entrants to this market by our well construction team to complement our leading wellhead technology and region.

In Canada, the multi well Frac connector line with great nor had a record two month total revenue as customers increasingly adopt this time and cost saving equipment.

Finally, our equipment was used in the third quarter and a geothermal energy project in New Zealand.

While these type of projects are still in their very early stages. We are excited about the potential growth and the steady commercial successes of our energy transition team has achieved.

These systematic deliberate adjustments and investments.

That drove up to enter 2024 with a strengthened foundation and ability to capitalize on the growth of our continuing up cycle.

While there may be some near term product mix challenges that we will navigate as our customers refine their drilling schedules. We are confident in our ability to provide long term profitable return on capital.

With that said I'll now turn the call over to Kyle for some more color our financial results.

Thank you, Jeff and good morning, everyone.

As Jeff mentioned third quarter revenue was $117 2 million, an increase of 33% year over year.

And 31% sequentially driven.

Driven by strong organic growth of 11% sequentially led by subsea products and with the addition of great North which added another 17% or $15 5 million in Q on Q.

Taking a look at the segment results subsea products revenue increased 15% compared to the prior year and 25%.

Which was driven by the delivery of certain customer milestone this quarter in Europe.

Subsea services' revenue increased 6% year over year and was up 3% sequentially.

This segment was expected to grow double digit sequentially, but as Jeff mentioned rig availability for certain customers had moved drilling schedule for the REIT.

Increased activity in Brazil, offset some weather and customer schedule delays in the Gulf of Mexico and Asia Pacific.

Finally, the well construction segment grew 117% year over year and 76% sequentially.

The addition of great North and activity increases in Latin America, Saudi Arabia, Brazil, and West Africa.

As Jeff mentioned, we installed our first big bore liner hanger down in Brazil, or deepwater customer, which we think is going to be a great platform for future growth.

Gross margins during the second quarter was 27% of the <unk>.

150 basis point year over year.

The improvement in gross margin is largely due to the addition of great north and our ongoing initiatives across the organization to drive operational efficiency.

Selling general and administrative expenses increased 22% sequentially $27 million, which was driven by the addition of great note expenses and an increase in our bad debt reserve due to higher activity.

Engineering expenses were roughly flat sequentially and up slightly compared to the prior year at $3 1 million.

Adjusted EBITDA for the quarter was $12 4 million, an increase of $5 3 million, one year ago, and up $3 6 million sequentially.

During the quarter, we incurred a few discrete expenses related to bad debt inventory excess and obsolescence and liquidated damages all three.

These totaled approximately $3 million of Corp, which we will not expect to recur.

Cash provided by operations was $26 8 million in first quarter, an improvement of $15 5 million sequentially and $26 million in the prior year.

Free cash flow for the third quarter came in at a positive $21 4 million, which is our second consecutive quarter of positive free cash flow.

The highest figures since 2017.

This was driven by the normalization of working capital related to receivables threat reduction in DSO and an IRS refund we received in the quarter for approximately $17 million.

Inventory was a net use of cash in the period as we continue to stage materials in anticipation of upcoming growth.

Capex in the third quarter was $5 4 million largely driven by rental tools bound for work already secured.

We utilized approximately 86 million in the quarter completed the acquisition of great Northern inclusive of normal working capital adjustment.

Ending cash cash equivalents and investments were $190 million at quarter end and.

And we continue to have ample liquidity to fund our operations and to evaluate incremental high return capital allocation.

With that said I would like to note our outlook for the fourth quarter of 2023.

We expect fourth quarter revenue to be in the range of $117 million to a $125 million.

We expect fourth quarter bookings to be in the range of $75 million to $100 million.

The top end of that range includes six subsea trees that as Jeff mentioned and be significant in size comprising over $50 million in potential bookings in the fourth quarter.

We expect fourth quarter, adjusted EBITDA margins to be 14% to 16%.

And we expect approximately $10 million in Capex in the fourth quarter 2023, as we wrap up our previously announced investment in our Houston manufacturing equipment, which will come online next year.

We expect free cash flow to be positive in the fourth quarter and for the full year 2023, we continue to anticipate a slight net use of free cash flow.

In summary, Q3 results were below our expectations largely due to rig delays, which had a direct impact on our revenue mix, which impacted profitability.

Heading into Q4, we expect a strong revenue ramp with a full quarter of reservoir and sequential growth in our higher margin subsea services business.

In addition, we anticipate another solid free cash flow quarter to close out the year as we added to our clean balance sheet.

With that we'd like to open the line for any questions.

Operator.

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

I would like to ask a question. Please press star one on your telephone keypad.

Information Tom will indicate your line is in the question queue. You May Press Star two if you would like to remove your question from the queue for participants using speaker equipment. It may be necessary to pick up your handset before pressing Mr. Keith Please hold just a moment, while we poll for questions.

Your first question is coming from Eddie Kim with Barclays. Please pose your question your line is live.

Hi, good morning.

Just wanted to touch on the light orders this quarter, you mentioned rig availability and peso delivery timing, but the the first one makes sense I mean, if the customer can't get the rig there's no. There's no drilling that's going to take place, but could you expand upon the S. DSO comment I would've thought drilling and.

<unk> would be a bit independent of each other.

And just curious if it's.

I guess, which regions.

This applied to this S DSO delivery timing.

The experience.

Yes, good morning, Eddie Yeah, So so just a little bit.

<unk> order trend in general so the rig availability is specifically around the middle East where were seeing some challenges there and also around some of our smaller customers that might be fighting for rig availability. So we see that specifically on tree orders and things like that the DSO would be more related to Brazil, where we're seeing.

Some delays there in cost as a result of.

Of that but if I step back and just look at the broader order trend.

With the addition of great North right now at about 80% of our business.

Is book and Bill <unk> call off against MSA. So you think about that well construction business in the well construction business.

As almost all book and Bill I'll call off from MSA.

Services is obviously book and Bill.

Maybe a little bit of a call off from MSA and that really leaves subsea products as our as our one business now that really is a backlog or an order business and even inside of that the wellhead and that we have now are largely call off as well. So you think about the mention of Petrobras.

Yes.

And the and the recent award that we got on Patrick Ross up to $28 million of that 28 million only about four or $5 million of the $28 million actually goes into bookings and goes into backlog traditionally that would have been all $28 million would have gone in our bookings or would have gone into <unk>.

Gone into backlog. So this is a very different model now than we might have seen before from an order standpoint, obviously <unk> talked a little bit earlier about the $75 million to $100 million in the fourth quarter as it relates to order trends.

Are largely six trees trees.

<unk> can be anywhere from $3 million to $5 million depends on the size and scope of the tree and the size and scope of the project, but you know those are those are large orders and then at the small end and well construction you do get us something as small as $100000 call off so just a pretty diverse set of products now for us than you might've remember.

510 years ago even.

Got it thanks for that color.

And just just on that fourth quarter bookings guidance of $75 million to $100 million.

Big step up from third quarter levels, what gives you the confidence.

Kind of in that.

And that bookings range and.

That separately.

Any kind of preliminary thoughts on bookings for 2024, I would think that as rigs become.

More available in the Sps those get delivered.

Sir your book.

Wood with increased year over year, just any preliminary thoughts on 'twenty for bookings.

Yes, yes.

That ramp in Q4.

We've got good visibility to the ramp it'll it'll largely be dependent on timing for a number of customers. That's what the <unk> are based on as you know Eddie or Sps customers tend to be the smaller customers that.

Are probably more reliant on rig availability and and fighting for a rig probably a little tougher in a higher interest rate high rig rate environment. So whether it's Q4 Q1, we have confidence in the inbound orders it'll just be a timing question in Q4 really around the <unk> and that will kind of dictate where we end up in that.

Range in the quarter, if I look out to next year.

See a pretty constructive market next year pretty optimistic just getting early gauge is right now from a number of our customers there and their budgeting cycles right now, but all early indications are a another strong year next year also if you go back and look I don't know five to 10 years, we looked at this as well the Q3 to Q4 step up is.

Always there for us and almost doubling that we've got coming out of Q3. So we would expect pretty pretty decent order flow for Q4, but if you go back we have a seasonality to it effectively is what we typically see we went back and link among seven or eight years back and that's always been the case.

Okay got it got it great. Thanks for all that color.

I'll turn it back.

This does conclude our question and answer session.

Concludes today's conference you may disconnect your lines at this time, thank you for your participation.