Dril-Quip, Inc. (NYSE:DRQ) Q2 2023 Earnings Call Transcript

Dril-Quip, Inc. (NYSE:DRQ) Q2 2023 Earnings Call Transcript August 1, 2023

Operator: Good morning, and welcome to Dril-Quip’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 call is being recorded. At this time, I would like to turn the call over to Erin Fazio, Corporate Finance Director for Dril-Quip. Please go ahead.

Erin Fazio: Thank you, and good morning. We appreciate you joining us on today’s call. An updated investor presentation have 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 Dril-Quip’s comments may include forward-looking statements and discuss non-GAAP financial measures. It should be noted that a variety of factors could cause Dril-Quip’s actual results to differ materially from the anticipated results or expectations expressed in these forward-looking statements.

Please refer to the second quarter 2023 financial and operational results announcement that we released yesterday for a full disclosure on forward-looking statements and reconciliations of non-GAAP measures. Speaking on the call today from Dril-Quip, 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 over to Jeff Bird.

Jeff Bird: Thank you, Erin, and thank you all for joining us today. As you saw in yesterday’s releases, we announced our Q2 2023 earnings as well as the acquisition of Great North. We are excited to welcome Great North to the Dril-Quip 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 of 26.7% 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 $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. Bookings in the quarter were $72.7 million, an increase of 36% sequentially and in line with our prior guidance.

It 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 Products segment as our primary backlog business. The Q2 book-to-bill ratio for our Subsea Products 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. We ended the quarter with approximately $252 million in backlog, representing growth of 7% sequential. 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 a 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 qualification success. In our Well Construction segment, we were awarded the first of 5 Big Bore XPak 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 a floating liner hanger for a major operator in Alaska.

The well is one of the longest extended reach wells in the world with a lateral length of over 5.5 miles, the ability to install a liner hangers and that link allowed the operator to reduce its carbon footprint and overall cost of production by minimizing its surface drilling locations. Finally, our equipment was used in the second quarter to inject CO2 for purposes of permanent storage for a project in Denmark. We’ve spoken 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?

Kyle McClure: Thank you, Jeff, and good morning, everyone joining us on the call. Second quarter revenue was $89.6 million, 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, reflecting 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. Net 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 1 year ago. The driver was the reduction in Subsea Products revenue year-over-year due to timing of customer delivery. Versus Q1 adjusted EBITDA was flat, which was 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, up 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. Free 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 DSO. 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 and rental tools down 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.

I’ll turn it back over to Jeff now to talk through the Great North acquisition in more detail. Jeff?

Jeff Bird: Thanks, Kyle. There are five key reasons why we have 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 accretive to all financial metrics. Third, through our 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 Dril-Quip. Great North is a leading provider of mission-critical, highly engineered customized wellheads 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 Dril-Quip’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 sale of surface wellhead 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 designed to improve operational efficiency and safety during hydraulic fracking.

This acquisition expands our exposure to the shorter cycle onshore North America markets and expand Dril-Quip’s 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. Dril-Quip’s extensive global footprint will serve to accelerate Great North’s international expansion. This combined with Dril-Quip’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 need, it will significantly expand our total addressable market for land-based wellhead. We anticipate total annual revenue synergies in the $20 million to $30 million range. Additionally, annual cost synergies are estimated to be approximately $10 million through the combined best cost regional supply chains of both Great North and Dril-Quip. 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 merits of finding a high-quality asset at the right terms.

We expect a return on invested capital to be approximately 20% in the first year. The free cash flow this combined transactional 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 Dril-Quip, and we are confident that the acquisition of Great North will benefit both our customers and shareholders through a differentiated product offering, improved return on invested capital, adjusted EBITDA and free cash flow. Finally, before I turn the call back over to Kyle to review the terms of the transaction, our updated full year outlook, I would like to welcome our new team members once again from Great North to Dril-Quip.

We look forward to updating all stakeholders on the progress of the integration and the team’s early win. Kyle?

Q&A Session

Kyle McClure: Thanks, Jeff. As for the terms of the deal, we are acquiring Great North on a cash-free debt-free basis for total upfront consideration of approximately $80 million, which is subject to customary purchase price adjustments. In addition to the upfront consideration, there are potential earnout payments of approximately $23 million to be paid over the course of 2024 and 2025 as certain revenue growth targets are met by Great North. We continue to have ample liquidity to fund our operations and to evaluate incremental high return capital allocation upturn. As mentioned earlier, day 1, Great North will be accretive on an adjusted EBITDA, free cash flow and return on invested capital base. 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, account [ph] to the 2023 contribution of the acquisition of Great North in the remaining five months. We 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 2022 [ph] We expect second half adjusted EBITDA margins to be 14% to 16%. 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 Subsea wellhead manufacturing in Houston. Going forward, we should expect to see overall CapEx needs, including Great North to run around 3% to 5% of revenues.

We expect free 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 flow as growth in our Subsea Products business will require a working capital build and the majority of the $20 million wellhead manufacturing investments 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?

Operator:

Operator: As we have no questions at this time, this will conclude today’s conference, and you may disconnect your lines at this time. And we thank you for your participation.