Dril-Quip, Inc. (DRQ) on Q4 2021 Results - Earnings Call Transcript
Operator: Welcome to the Dril-Quip Q4 and Full Year 2021 Earnings Call. My name is Daryl and I will be your operator for today’s call. I will now turn the call over to Director, Investor Relations and Corporate Planning, Blake Holcomb. Blake, you may begin.
Blake Holcomb: Thank you and welcome to Dril-Quip’s full year 2021 conference call. An updated investor presentation has been posted under the Investors tab on the company’s website along with the earnings release and will 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 fourth quarter 2021 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 Dril-Quip, we have Jeff Bird, President and Chief Executive Officer; and Kyle McClure, Vice President and Chief Financial Officer. I would like to now turn the call over to Jeff Bird.
Jeff Bird: Thanks, Blake. First, I’d like to say that I am both humbled and excited to take over as CEO following Blake’s 11 years as CEO. I’d like to personally thank Blake for his many years of service to Dril-Quip. His contributions have been enormous and he will be missed. I am pleased to introduce Kyle McClure as our new CFO effective January 1. Kyle brings a wealth of both private and public company CFO experience, and has worked in a variety of industries, and is already just starting to bring his fresh perspective to the business. Welcome aboard, Kyle. You will hear more from him later in the presentation. I’d also like to congratulate our employees around the world. We closed 2021 with the best safety record in the last 20 years for Dril-Quip. This is a direct result of the hard work and dedication of all of our employees, but specifically those that are on our manufacturing facilities and on rigs around the world. Thank you for your efforts. With that, we will turn to Page 3 to review some of the highlights for 2021. We’ve consistently communicated a three-pronged growth strategy. And I am pleased to announce we have made significant progress on all three pillars. Beginning with peer-to-peer collaboration, we believe our industry and our company are stronger when we work closely with our friends in the industry. These collaboration agreements deliver superior value to our customers and ultimately to our shareholders over time. In 2020, we signed our first collaboration agreement with Proserv. We saw this start to bear fruit in 2021 as tree wins increase and expect that to accelerate into 2022 as we expect to more than double our tree awards from 2021. I am excited about the two additional collaboration agreements signed in the last 12 months. First, we signed a collaboration agreement with OneSubsea to provide wellheads, liner hangers and other tubular goods and services. This is an important collaboration agreement for Dril-Quip as it gives us broader exposure to customers that sometimes prefer bundled EPCI offerings. In addition to this broader exposure, it continues to allow us to serve customers that tender subsea, both separately and bundled. This specifically relates to the development market that today is about 60% of the overall subsea wellhead market. The subsea wellhead lead time means we will begin to see the benefits of this collaboration agreement later in 2022. We’ve already seen collaboration agreements pay dividend in our downhole tool business across multiple geographies, and we expect these benefits to only accelerate in 2022. This will be an important element of the 20%-plus growth we expect in that business in 2022. Second, earlier this week, we announced another collaboration, this one with Aker Solutions. This agreement opens the door for us to participate in a best-in-class carbon capture, utilization and storage offering with our customized injection wellheads and subsea trees. The agreement focuses on the strengths of both organizations to deliver an optimum solution for carbon capture and storage, and is in line with each party’s strategic goals of collaboration and partnership to unlock value for customers. Under this agreement, the parties have agreed to work together to target the Northern Endurance Partnership in the United Kingdom, which will be a priority project to secure offshore carbon dioxide storage in the North Sea. This represents a significant step forward in our energy transition efforts, and we are pleased and excited to be entering that market with a great company like Aker Solutions. Each of the companies we’ve entered into collaboration agreements with over the last 2 years as a leader in its respective markets. We appreciate that they recognize the strength of Dril-Quip’s product offerings, and are excited to see what the future holds for these agreements. We believe these agreements will allow us to outpace the market recovery over the coming years. Our second growth pillar is downhole tools. As Dril-Quip’s first acquisition, we struggled early with the integration of this business. However, in 2020, we implemented a strategy that I believe righted the ship. We exited unprofitable geographies, bolstered our commercial teams, streamlined our integrated supply chain and brought in a new leadership team. These actions paid dividends in 2021, resulting in the business growing over 35% year-over-year. Further, we were recently awarded a contract to deliver up to 21 of our OTC award-winning XPak De liner hangers for projects in Brazil through 2024. We see this growth trend continuing in 2022, and expect another 20% plus growth from 2021 levels. And ultimately, we expect this business to expand to $100 million in annualized revenue by the end of 2023. Finally, over the last couple of years, we’ve introduced our e-Series suite of products, 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 their carbon footprint, we believe they will become an integral solution to helping our customers meet their carbon reduction goals. The most successful and best example of this suite of products thus far is our Big Bore IIe wellhead system. This system is rapidly becoming the industry standard, and we believe will likely represent 60% plus of all wellhead orders, sometime in 2022. The most significant of these wins are the recent contracts with Petrobras that include up to 87 systems through 2025. In 2021, we also saw first installations of several other e-Series products, including our DXe wellhead connector in the North Sea and Badger high-fatigue casing connector in the U.S. Gulf of Mexico. We are optimistic that as these installations gain traction, we will see similar contract awards for other e-Series products. Moving on to Page 4, I want to highlight the progress we have made along our ESG journey. In February 2021, we became a participant in the United Nations Global Compact, supporting the organization’s principles on human rights, labor, environment and anticorruption. While Dril-Quip has always focused on maintaining a culture of integrity through ethical behavior, being socially responsible in driving sustainability through technology innovation, joining the UN compact and launching our ESG website was our opportunity to increase public visibility of these efforts. On the environmental front, we are focused on lowering emissions through developing green by design technologies that limit environmental and operational risk. From a social standpoint, we want to continue our strong workforce, health and safety record, while ensuring our workforce is representative of the diverse communities we engage and serve. Finally, from a governance standpoint, we’ve added additional members to the Board who bring outside perspectives and engage with our vendors to ensure that they are aligned with our ESG goals and objectives. I spoke a little on our product suite that is green by design. We believe Dril-Quip can play an important role for our customers in the reduction of greenhouse gases. However, we are not stopping there. Page 5 shows our progress on greenhouse gas emissions. During 2021, we completed our Scope 1, 2 and 3 emission assessment. We have spent considerable time both internally and with our vendors, establishing the baseline we believe appropriate to measure ourselves against. We will then establish targets we believe will make a significant difference over the coming years. We are aiming to release these targets later in Q1, and are excited to begin sharing those with all of our stakeholders, including our customers and investors that are increasingly interested in understanding how Dril-Quip is contributing to decarbonization. I will now turn it over to Kyle to walk you through the financials.
Kyle McClure: Thank you, Jeff and good day to everyone on the call. It’s great to be with the company and look forward to partnering with the management team and broader organization going forward. I will begin on Page 6, which highlights the financial results for Q4 and full year 2021. Q4 revenue came in at $78 million, which was down $5 million sequentially, driven mostly by lower product volumes in the Western Hemisphere and downhole tools activity after a record Q3 for that business. Full year 2021 revenue was $323 million, which was down $42 million year-over-year. The year-over-year decline is mostly tied to lower product revenues, driven by the impacts of the pandemic on overall oil and gas demand that led to lower orders in 2020 and the majority of 2021. Gross margins also saw some contraction during 2021, about roughly 100 basis points. However, much of this decline can be attributed to the cancellation of the forge lease agreement with AFGlobal, partially offset by our downhole tools contribution. Adjusted EBITDA for Q4 was roughly $1 million in the quarter, which was down roughly $3 million Q-on-Q due to lower revenue and unfavorable mix. The full year decline in adjusted EBITDA from $32 million to $15 million can be largely attributed to the decline in the subsea product revenues, partially offset by downhole tools revenue growth, lower research and development spend, and contribution from productivity improvements. Cost actions and productivity improvements in both 2020 and 2021 helped mitigate some of this impact to the decline in revenues, leading to 39% incremental margins. Turning to Page 7, Q4 bookings came in at $80 million, which was significantly above our expectations of $40 million to $60 million, which is where we have been running in the past six quarters. The fourth quarter was boosted by two horizontal tree orders in the Gulf of Mexico. The strong orders in Q4 helped take overall bookings for the full year to $228 million or a 25% increase from 2020 levels. We also ended the year with our backlog up 7% to $210 million after seeing a steep decline in bookings and backlog in 2020 due to the pandemic. The strong Q4 bookings number looks to be holding up in the first quarter of 2022, and we are expecting bookings somewhere in the range of $60 million to $80 million depending on timing of some of the tree orders expected in March. Overall, 2022, we expected to see bookings climb another 20% from 2021 levels on the strength of an estimated 17 to 19 tree orders, which would be more than twice the amount we saw in 2020 or 2021. Turning to free cash flow on Page 8, as many of you are aware, free cash flow is a key metric and focus for our company in 2021, following a challenging free cash flow year in 2020. In 2021, we targeted 3 main areas for improvement: inventory reduction, order-to-cash improvement and lower costs through lean productivity initiatives. The combination of these efforts resulted in free cash flow of $28 million in 2021, an improvement of more than $60 million compared to 2020. This represented a roughly 9% free cash flow margin, which exceeded our target of 5% free cash flow margin for 2021. Additionally, in Q4, we stepped up our share buyback, purchasing roughly $23 million in stock at an average price of $21.65, and this has continued into Q1 of 2022, buying another $6 million worth of shares in January. As announced in the press release last night, our Board earlier this week authorized another $100 million under our existing 2019 program, which leaves us with roughly $118 million worth of capacity to perform buybacks. Moving on to Page 9, I want to provide some background on the restructuring charges taken in 2021, and how they tie in with our broader strategy. The first half of 2021 restructuring expenses were connected to the final pieces of our 2018 transformation. This was roughly $26 million of charges related to exiting underperforming markets and outsourcing of certain manufacturing operations both tied to our downhole tools business. Of the $53 million in restructuring expenses taken in Q4, roughly $48 million of these charges are related to inventory write-downs associated with the discontinuation of certain product categories as part of a product and service line realignment that Jeff will elaborate on later in the call. The remaining restructuring was related to severance and facility rationalization. Turning to Page 10, this offers a look at our 2022 productivity improvement initiatives. Following up on our initiatives in 2021, we are now targeting approximately $15 million in productivity improvements for ‘22. Many of these are underway or have been actioned in Q1. These productivity initiatives are a combination of headcount, manufacturing and logistics improvements. While these productivity initiatives are typical of any annual planning cycle, the execution of these savings will be critical to offset inflationary pressures we are anticipating in 2022. We are expected to see some increases in most raw materials and freight in 2022 versus 2021. Our subsea business will be less impacted due to existing inventories, but our downhole tools business, which is shorter cycle, will see higher raw material costs. We will be passing along these increases to our customers where it makes sense, but execution on our cost-out productivity will be equally critical. To wrap up things on the financial side, I will offer a high level outlook for what we expect to see in 2022. From a revenue perspective, we would expect to see revenues increase almost 10% from 2021. This, of course, is dependent on the two main drivers: subsea bookings and downhole tools growth. I mentioned earlier that our outlook for bookings is looking to be up around 20%, but the realization and timing of those bookings will determine whether or not we are able to achieve our revenue objectives for the year. For context, 45% to 50% of our current year revenues come from current year bookings. This used to not be the case. We now see customers still awarding projects, but they more often do that through a contract with call-offs from that contract. This means that bookings do not enter our backlog until they are called off. We would expect to see adjusted EBITDA increase with revenues at a 40% to 50% incremental margin, depending on the timing and execution of our previously discussed productivity initiatives, and how we see inflationary pressures play out through the course of the year. From a CapEx standpoint, we’re expecting to see an increase of $15 million to $17 million total spend in ‘22. The majority, about $9 million to $10 million, is tied to delivering on our growth pillar initiatives, including downhole tools growth and recent contract wins in Brazil. Finally, we would expect the overall results to generate somewhere between a 3% to 5% free cash flow margin on revenue. Some of this will come in the form of a tax refund we expect to receive during the year and continued cash from collections and inventory management. I will note that for the first quarter of ‘22, we would expect to see free cash flow come in negative. In general, Q1 is a quarter we see large cash outflows in the form of property taxes and employee short-term incentive compensation, but we would expect to see the remainder of the year in positive territory as we strive toward our free cash flow target. With that, I will turn the call back over to Jeff.
Jeff Bird: Thanks, Kyle. It’s great to have you on board. Turning to the macro environment on Page 12, there are two key indicators that one should watch when thinking about our growth, specifically in our subsea products. Those are tree awards and deepwater wells. The first clearly impacts our order levels and is tied to our SPS franchise. We are expecting that to grow at an 8% CAGR through 2026 with a nice pop in 2022. As always, the direct correlation can be challenging due to specific customer drilling patterns. However, as I stated earlier in the presentation, we would expect our tree awards to more than double year-on-year to 17 to 19 trees in 2022. The second metric we look at is wells drilled. This is a direct indicator of number of wellheads and connectors used each year. Due to customer inventory and lead time, orders can often lag actual wells drilled. However, we do expect a 5% CAGR through 2026. As I discussed earlier in the presentation, we are already starting to see wellhead awards pick up with the largest and most recent award being the recent Petrobras contract for up to 87 exploration and development wellheads through 2025. I would restate that Dril-Quip will begin to participate in a larger share of development wellheads than we might historically have via our collaboration agreements with OneSubsea. Slide 13 shows our 2022 strategic focus areas. First, we will continue to build on the great work we’ve already done with our strategic growth pillars. We’ve laid a strong foundation, but there is more to be done. While these pillars will help us continue to grow top line revenue in our core business, we must also go further in our strategic focus in order to best position ourselves for the years ahead. As Kyle likes to say, we must walk and chew gum. To that end, we will be transitioning to a new, leaner, more streamlined operation. This will yield benefits not only in the short-term but also in the medium and longer term, and will structurally change our approach. Second, in terms of our organizational alignment laid out on Page 14, we will be streamlining our leadership and subsequently our operations around more focused and integrated business units, our mantra, when considering this reorganization, with small, self-contained teams that share a common strategy and control their own destiny. I’ll now provide an overview of these business lines and their leadership. Subsea product is led by Don Underwood. Don brings over 30 years of Subsea experience, both inside and outside of Dril-Quip and previously led our overall sales, marketing and product strategy efforts. Second, Subsea services led by Bruce Witwer, Bruce has been with the company almost 20 years, coming up to our engineering team and ultimately running operations in Singapore, Aberdeen and the U.S. And third, downhole tools led by Steve Chauffe. Steve brings over 25 years of OFS experience, both inside and outside of Dril-Quip. He has been instrumental in our turnaround of that business for Dril-Quip. These businesses will each have leaders on either a product level, as in the case of subsea products or a geomarket like subsea services and downhole tools. As I reiterated earlier, we did this because they all have unique strategies as well as operating models. This will break the barriers that come with a functionally run organization. Eliminating these barriers will enhance our customer focus, on delivering best-in-class products and services. It will also allow us to improve our lead times, reduce working capital and expand operating margins as we eliminate the waste inherent in our previous functional organization. Further, it will provide transparency within our businesses and allow us to make more thoughtful investment decisions that offer the highest return on capital employed. We would expect our energy transition business to grow into a fourth business in the coming years. Though still in the early stages, we have a well-qualified leader for this business in John Mossop, who spent over 20 years in a variety of engineering and R&D leadership positions at General Electric and Baker Hughes. In the coming weeks, we will be more closely aligning our R&D efforts to support John and the energy transition team. Third, we will further optimize our footprint as outlined on Page 15. Today, we simply find ourselves with too much roof line and a footprint not fit for purpose, even when considering the market recovery. We have made strides in becoming a leaner organization over the last few years, not only as a result of the downturn, but as a result of our lean efforts we began implementing in 2018. However, there are still steps we need to take. This will be a multi-phased approach that we expect to implement over the next couple of years. It will involve combining some operations in the shared facilities and divesting of the remaining excess property and buildings. Some of the proceeds of these property sales, which, based on our early evaluation, we would estimate to yield $40 million to over $60 million, will fund investment in new manufacturing machinery. These consolidation efforts and updated machinery are expected to result in an additional $15 million to $20 million in annualized savings by 2024 from a reduction in maintenance and fixed overhead expenses. Finally, Page 16 offers insight into our forward-looking capital allocation framework. We are one of the few OFS companies with balance sheet optionality. We find ourselves with no debt, and a strong cash position due to our prudent management of the commodity cycles and cost reduction execution. We must leverage this balance sheet strength to deliver superior returns as the market recovers. With just over $350 million on the balance sheet at year end and an estimated $100 million to $150 million needed to support daily operations and working capital needs, we have approximately $200 million to $250 million in excess cash we plan to deploy in three primary ways. First, we will invest internally by funding our highest return projects across our business lines. This will mean investments in the research and development of new technologies as well as manufacturing and information technology systems that will expand our market share in growth areas and help us to become more cost efficient and productive. Second, we will look to find attractive acquisitions that will help drive size and scale. This will include evaluating select opportunities in both energy and energy adjacent industries through the lens of a rigorous screening process. Targets under consideration will offer stable revenue streams, intellectual property and that compete in attractive long-term growth markets. We believe inorganic expansion will be a key driver for us in the future to maximize shareholder value and remain competitive. As Kyle mentioned, we have been buying shares over the past few quarters, and we will continue to be evaluating share repurchases and under the Board’s recent authorization of an additional $100 million to the existing share repurchase plan. In closing, I’d like to summarize the key takeaways from today’s call on Page 17. First, market conditions are improving. We are seeing an upward trend in orders and interest and services. We will participate in this improving market through execution of our commercial strategy. Our collaborations, service quality and technology will continue to bear fruit in terms of growing revenue and the market share. We will progress down the path of structurally changing our business with clearly aligned businesses under an experienced leadership team that will execute customized commercial strategies and drive efficiency and accountability. We will simultaneously begin our multiyear roadmap to improve profitability through a structural transformation of our footprint and investment in our manufacturing operations. And finally, we plan to leverage our strong balance sheet to look outside our company to inorganic growth that will complement our strong underlying business. I will now turn the call over to the operator to open the line for questions.
Operator: And our first question comes from Taylor Zurcher. Go ahead, Taylor.
Taylor Zurcher: Hey, Jeff and Kyle, thanks for taking my question and good morning. First one, just sort of a high level, one on the market outlook, one of your largest subsea peers this morning was basically making the point that the tone of customer conversations has reached an intensity point that they haven’t seen in a number of years. And as I just look at Q4 orders for you guys and the Q1 outlook as well as the 2022 outlook, I mean, clearly, there is momentum building. So just curious if you could kind of characterize for us the tone and tenor of some of the discussions you’re having with customers today? And if you think 2022 might be an inflection point or a leaping point for more healthy growth to come as we get into 2023 and beyond?
Jeff Bird: Yes. Thanks for the question. I’d echo the comments that you heard there that we are seeing a lot of customer conversations now that candidly, we haven’t seen from – candidly, before the pandemic. This is obviously the highest order quarter that we’ve had probably in six or seven quarters. We’re seeing strong Latin America conversations right now. Norway is extremely strong right now. Gulf of Mexico is extremely strong, so much so that probably rate constraints are the problem in Gulf of Mexico, and even starting to see early conversations in West Africa as well around some of the smaller independents, and things like that there. That’s mainly the subsea business. On the downhole tool side, it’s really a story of Latin America and the Middle East there. So we see Ecuador strong. We see Mexico strong. We see Saudi strong as well. We talked a little bit, I think, two quarters ago, probably around the 21 systems that were awarded in Brazil around our XPak DE. So a lot of great conversations right now. I think as we went into the pandemic, we probably aired to be – to miss the number. I think on the way out, it will probably be just the opposite of that. So we’re pretty optimistic about 2022.
Taylor Zurcher: Alright. Good to hear, Jeff. And just a follow-up on sort of the refocus strategy moving forward, I mean there is a lot of different buckets to parse through, but maybe I’ll just ask on the capital allocation bucket. On the – in the prepared remarks today, you talked about $200 million to $250 million of excess cash on the balance sheet. And you also talked about inorganic growth as being a key driver for Dril-Quip in the coming year. So I guess my question is, when it comes to capital allocation, how might the strategy notably differ, if at all, from the strategy Dril-Quip’s maintained over the past 2 or 3 years? I mean share repurchases have been part of the story. Inorganic growth has been part of the story. So just curious how you think about the capital allocation strategy potentially changing moving forward?
Jeff Bird: Yes. I’ll let Kyle answer that question. He’s spent a lot of time on that in the first couple of months he’s been here, so...
Kyle McClure: Yes. I think we look at inorganic as sort of a newer arrow in our quiver, if you will. I think internal investments will continue to be sort of priority one. Those are the best returns on our capital, if you will. We know kind of what we are – rental tools other things like that tend to be a pretty good use of our funds. Share buyback will continue to be part of the capital allocation policy going forward as well. That doesn’t change. You saw what we did in ‘21. I think our premise there is we generated $28 million of free cash. We bought back about that amount of shares. We make – as we look out in the future, obviously, free cash is going to be a little bit challenging into ‘22. We use the opportunity in the marketplace, seeing where we were trading in Q4 to kind of be opportunistic there. I think we’d probably still be opportunistic as well as look at free cash trends and kind of how we’re going to deploy that out into the marketplace. But inorganic is a little bit a newer one there. As Jeff laid out, we’re kind of early innings, if you will, on putting our framework together kind of where we want to take that. But we do look at – we do have excess cash on the balance sheet. We do need to grow inorganically, but we are sort of early days on putting that thesis together on how that’s going to play out.
Taylor Zurcher: Alright, makes sense. Thanks for the answers.
Jeff Bird: Yes, thanks.
Operator: And it doesn’t look like we have any questions. I’ll pass it back to the speakers for closing comments.
Jeff Bird: Okay. I’d like to thank everyone for their participation today on the call. I’m excited about the future of Dril-Quip, and the action plans and strategies that we’ve put in place to make us a better organization for all our stakeholders. And I look forward to providing updates on our progress in the coming quarters. Thanks, everyone.
Operator: And thank you, ladies and gentlemen. This concludes today’s conference. Thank you for participating. You may now disconnect.
