Good morning, and welcome to the Dril-Quip First Quarter 2023 Fireside Chat. At this time all participants are on a listen-only mode and there will 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 call over to Erin Fazio, Finance Director for Dril-Quip. Please go ahead.

Thank you, Mathew. Welcome to Dril-Quip's first quarter 2023 fireside chat. An updated investor presentation has been posted under the Investors tab on the company's 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 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 first quarter 20223financial 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 and David Smith from Pickering Energy Partners. I would now like to 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. I want to say thank you for this opportunity to host Dril-Quip's first quarter fireside chat. Jeff 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 reminder for those in Houston, we're experiencing pretty bad weather today. So if you hear rain or 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 have changed our reporting segments from geography to Subsea Products, Subsea Services and Well Construction. This decision was to change our reportable segments is a part of our streamlined organization that we believe will give our stakeholders better visibility to our business and more closely align with our internal operating structure. 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 and Subsea Services growing 10% year-over-year reflecting the growing demand in key markets, such as Brazil, the Middle East, Latin America and some reemerging markets such as West Africa. Bookings for the quarter reflected a typical Q1 seasonality and we continue to expect bookings growth throughout the remainder of 2023. However, it should be noted that our targets do include a number of Subsea Trees, where FID will play a crucial role in order timings throughout the year. We've also continued to make progress on our footprint optimization plan to improve efficiency and reduce excess capacity. During the first quarter, we closed the sale of our aftermarket facility here in Houston and in addition we continue to remain on track for the sale of a third Houston property later this year. Once completed, the disposal of these three properties will have contributed over $40 million in cash flow, allowing us to invest 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 days sales outstanding is expected to return to levels closer to Q4, 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 Dril-Quip 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 paths. 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? Are you seeing any project deferrals or other signs of hesitation related to recent oil price volatility?

Yes, 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 responsive to oil price volatility is 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 IOCs I'll talk about; the NOCs I'll talk about and then kind of the small mid-sized customers that I'll talk about. So if I think about the IOCs, look, they've got very, very long-term plans. The most they're 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 IOCs, if anything, what we're seeing is them accelerating plans. So where we might have thought they would have a reorder point in 2024 sometime, we're now seeing that that reorder point could be as early as late 2023 as an example. So we don't really see that in IOCs, but once again, they are looking at oil prices out the next five, 10 years, not the next five or 10 months so to speak. If I think about NOCs, so think about well construction and on that well construction side we've got a fairly significant amount of exposure to NOCs. So think Brazil, think Middle East, think Mexico, think Ecuador, they are 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 talked about Brazil being a great market for us; we've talked about Mexico remaining strong; we've talked about Saudi remaining strong, we just don't see any changes there either and that really affects well construction for us, and to some degree wellhead 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 those small, medium-sized customers, and that's really related to our tree franchise. So think SPS, that's part of our Subsea Products segment. And we've got about 10 trees this year that we've got targeted as potential bookings, and higher inflation, rig rates, oil prices will all affect those customers, and it won't necessarily cancel a project, but it might cause FID 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 could cause some projects for the midsized independents to get deferred.

Yes, no 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 tree – those 10 trees that we talk about. With each tree being kind of $3 million to $5 million, it doesn't take a lot to move that tree to the right and affect our overall bookings number.

Absolutely. Jeff, you mentioned over the past few quarters, there are a few key markets where you're seeing strong growth. Is there a specific market where you're 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 signed an MSA about 18 months ago for 87 wellhead systems. We would have thought that was going to last them three years plus and they've already come out with another 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 XPak Des on an MSA as well. 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 around well construction. That market's or that business there has grown five-fold 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 at broader Middle East, we're seeing growth there as well. And then kind of the nascent area, where we're really starting to see pick up right now is Africa and it's 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 finds, that's got the opportunity to be a major, major, major field in kind of the next three, five, seven years, so we're really excited about that as well.

Yes, absolutely. Circling back to the Middle East, certainly a big driver of growth in the offshore market, but entirely 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 Dril-Quip is participating?

Yes. So first, look that's been a very strong – if you go back to the TIW acquisition that we made in late 2016, it was a strong market for TIW. It's continued 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 well positioned to capitalize in 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 techs; we've already got local test and assembly. This will move a lot of our supply chain in Kingdom [ph] as well. So that's on the well construction side. If I turn to the Subsea Product side of the house, we participated more opportunistically in that market, and largely that's because of qualifications. And we are working now on qualification for a number of subsea products in 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, those qualifications are sometimes arduous and so we're probably 12 to 18 months away from formal qualification in Kingdom on the Subsea Product side, but you should expect more to come on Subsea Products. So well construction, nice growth probably over the next 12 to 18 months. Subsea Products starting in probably 12 months out and we've already had a strong start to this quarter. We've already got a nice drop in booking on the well construction side, in addition to signing an MSA in the region as well, already in the second quarter. So you don't see that press in our Q1 results, but when we release Q2, you're going to see a nice MSA from our well construction business and a nice drop in order there from Saudi as well.

Looking forward to that. I guess just circling back to the offshore bigger picture. The pace of offshore rig contracting has 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 an offshore, OFS up-cycle. I'm curious on your perspective. Is there anything about the upswing 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 few years?

Yes, so a couple of things. I mean I think it's unquestionable that over the last five to seven years there's 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 that's inside the industry, candidly, at any OFS company or at any operator is surprised that's 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 these sudden spurts and stops that we have because of overinvestment and underinvestment. I think it's a nice, slow march up, as opposed to the tops and bottoms that we've experienced in the past. And I think the other thing that really plays a role is 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 have woken up to the fact that energy security matters and we can be very reliant on a few players in the market, and 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 drill-baby-drill are 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 a Jeff question or a Kyle 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 Kyle jump in. As I came into the role a little over a year ago, I mean one of my observations was that as a business we were geographically focused, but as an organization we were really siloed and we didn't have the right strategies for each of our products, and each of our products has a very different strategic approach, whether that be well construction or even if you look within Subsea Products or Subsea Services. There's elements in there that have very different strategies. 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 they were doing and where they were marching, and that means that the days in the past where there'd be a gap between sales and sales admin, and sales admin and engineering, and engineering and manufacturing and so on, we were breaking down those silos from a responsibility standpoint, so that people have more clear accountability. And if you are inside one of those organizations now you know what your strategy is, you know what you're marching to, and when you look to your right and your left, those are people that are marching to that same strategy.

Yes, and revenue was obviously very clear inside the organization and really became a lot of costs that was kind of shared amongst the organization that we've clearly defined now. People have obviously P&Ls. Jeff being a former CFO, a very returns focused individual as well, so 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 as we announced probably a while ago internally of this reorganization, we just sort of went live with it back in January. Now we're sort of operating with it here in January through March for the first time in Q1, and obviously reporting it that way externally. So we'll give the market a little bit of a deeper look into the organization from the newly branded well construction organization, Subsea Services and then Subsea Products, and then we'll have a fourth one for the corporate segment, which is for the cost of running a public company if you will. But really it’s about driving accountability, driving returns inside the organization. We've got a number of investments we've got ongoing right now that are 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.

That's a lot of good color. Sticking on one of those segments, the Well Construction business, so I think formerly you referred to as downhole tool has had 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 '23?

Yes. So if you look, nice strong start by the way to the year with a little over $20 million in revenue for that well construction business. You know if you – we see strong growth there in Saudi. So if I think about the two areas of growth, we expect continued growth in Saudi this year from that business and we're excited about that. As I mentioned already, in Q2 we've 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, 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 have expected, is we believe there was an opportunity to go deepwater with the XPak De. We've now taken that offshore. We've got to qualify it. There’s a number of key customers. That business was essentially zero, call it six to 12 months ago. We believe that business could 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 XPak De, and these are customer numbers, not our numbers, you save $1 million each time you run it. 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 in that deepwater business. So if I think about that growth as I exit this year, it's going to be Mexico who's going to be a key contributor; Saudi will continue to be a big contributor and growing; and then the last segment is really around deepwater, and that's the growth that we're just starting to see now, and we're just starting to see 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.

By the way, my goal today is not to call it downhole tools, David.

Yes, yes.

The segment was formerly known as… [Cross Talk]

I knew that was going to be a challenge throughout the call for me.

I would like to circle back to the MSAs. Maybe give some color on how Dril-Quip's MSA list has evolved. You know how we should think about MSAs as it pertains to your 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.

Yes, sure. So if you think about our product line, in Subsea Services, I'm going to take off the table, because there's not really any backlog per se or de minimis for Subsea Services, right. So if you think about MSAs, our MSAs really come in through Subsea Products and to a 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 have placed these huge purchase orders, the operators, and they would have been on the hook for those huge purchase orders. And if things turn down, they were on the hook for whether things turned down or not. And I think if you think about capital discipline, I think part of that capital discipline is, I'm going to contract differently with my OFS 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 IOCs as well, so that's kind of an evolution. I think it's actually healthier for the industry as a whole and I think it's healthier because candidly you don't end up with a lot of excess equipment in the chain if 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 to 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 lead time 12 weeks. Why would you place a three year purchase order for something that has a 12 week lead time? It just doesn't make a lot of sense. So at least as it relates to subsea wellheads and as it relates to well construction, those are more MSA. On the tree 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 an 18 month plus lead time, you're likely to have large purchase orders. If you've got a sub one year lead time, you're likely to have MSAs and a lot of our products tend to be sub one year lead times.

No, that makes perfect sense actually. Stepping back, I was hoping if you could provide us an update on the ongoing operational excellence initiatives and kind of specifically the footprint rationalization and then the manufacturing investment. You know where is each stream relative to needed additional investment, the required additional investment? Where are we on the time line? Can you quantify the related investments and maybe are there any charges relative to these?

Yes, so let me just back up and talk operational excellence as a whole. I mean the big initiative that you've mentioned are very important, but I think what's more important is we're starting to engrain operational excellence in the DNA of the company. What that means is, when I go to a manufacturing facility, they've got real gemba walks with real boards and they are solving problems every day with our operational excellence tools. When I go to a service center, they've got boards, they're reviewing KPIs every day, and they are solving real-time problems with operational excellence tools. That happened in each of our facilities and each of our service centers around the world. That probably is the most important part of operational excellence, because we're not waiting till the end of a week, the end of a month, the end of a quarter to solve a problem. We're solving a problem real time and breaking down barriers. That having been said, you're right, we do have a lot of – a couple of large things in the stream right now and one of those is the footprint. I mentioned that in the opening remarks. We had 218 acres in Houston. By the end of the year we'll 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 first piece of equipment actually arrived this month. 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…

Yes, just to clarify, it's 35% gross margin on products specifically 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 are relating to them, to the wellhead manufacturing investment.

And the last piece you know, and this moves kind of beyond operational excellence to commercial excellence, is we feel like we're very close to having the operational side running smoothly, so we can service our customers in the best way possible. Now it moves to commercial excellence and how do we make sure that front facing side of the house is as good as the operational side of the house, and more to come on that, but we're really starting to turn our efforts now towards that.

Great! I just want to make sure I heard correctly. Regarding the equipment investment, did you say it goes from kind of needing 117 machines down to 12?

Yes.

Just want to make sure I wrote that down right.

Yes, it did. And some of those probably David would have always been excess machines. Some of it is just machines that aren't operating in the most efficient way or we've got too much downtime between those machines.

So sticking on the topic of investment, could you provide an update on your inorganic growth opportunity set that you've touched on in the past, and maybe is the company willing to the on some debt to help get a deal done? I know you've got a great cash balance, but kind of thinking about the potential sizing.

Yes. So I'll kick it off and then I'll let Kyle talk a little bit on the financial side. You know if I think about the new reporting segments we've 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 it named well construction is a lot more inclusive, than having it name downhole tool. So as we start looking at inorganic opportunities, there's plenty of inorganic opportunities around Well Construction, there's plenty of inorganic opportunities around Subsea Services, there's plenty of inorganic opportunities around Subsea Products. Each of those, we're looking closely at as we move along there. We are looking at things that are adjacency, but right now we're more focused on those three segments.

Yes, I think if you look the last couple of quarters, two or three quarters, it feels like we're seeing a lot more deal traffic come through. We've had a lot of folks who had a good '22, expecting an even better '23. 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. You're starting to see the bid ask spread coming together a little bit more, which is nice to see. I think as it relates to debt, I think we're still a little bit adverse to that from a capital structure standpoint. If it's purely an OFE asset due to the cyclicality, as well as the debt markets really aren't what they used to be if you will in the last 10 to 15 years, we're working through that as well. I think for the time being we'll continue to target here a debt free balance sheet, unless as Jeff kind of called out, we find more of a unicorn deal with – maybe it's a little bit more different exposures to end markets with an OFS stub, but absent that I think we'd still say we're going to target a debt free balance sheet.

I appreciate that color. So looking at the quarter, free cash flow missed our expectation, missed consensus and I get the working capital build. You addressed it early on, but what – can you talk about some of the specific steps that are being taken to help improve free cash flow and maybe not just getting DSOs down in the third quarter, but is there anything structural beyond that?

There's 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 in 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 in the quarter. The timing this quarter on AR was just a little bit more than we anticipated and as we mentioned, we'll probably catch up in Q2 and Q3. We'll see more normalized DSO exiting Q3. I mean the caveat being that we are expecting growth to accelerate in the back half of the year. So assuming that bookings growth is consistent with our full year guide, for Q3, Q4 we might require some more working capital, but embedded in the next few quarters should be roughly that $40 million reduction in AR we cited in the press release, all else equal if you will around working capital. We continue obviously to have pretty good financial flexibility, supporting our growth plans, outlined in our full year guidance, which we reiterated in the press release.

And I do appreciate the full year guidance. If I step back, you now looking at last year, 2Q ‘22 was a really strong quarter for Dril-Quip on revenue and EBITDA. So for kind of my last question, I'll just be direct and ask you know, how do you see 2Q ‘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 similar to the 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 would expect a flattish to Q1 of this year. From a bookings viewpoint we expect to be in the $55 million to $75 million range. Again, as Jeff mentioned, some of those projects do hit FID. We could see ourselves at the top end of that range based upon some of those digital tree orders, and free cash flow should be improved versus Q1 as we catch up on timing of AR as I just mentioned. So probably slightly down from last Q2, but flattish to what we see this Q2 looking like or this Q1 like.

Great, I appreciate it. You've given us a lot of information. I am thinking I should have written down some more questions, but that's all I got and I've got a lot of notes here to digest. Jeff and Kyle, it was a pleasure to host the call with you all and I will turn it back to you.

Okay, thanks for hosting today David and 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 Q1. We continue to be optimistic around bookings the balance of the year, and we'll see the cash flow bounce back kind of Q2, Q3. So more to come, but pretty excited about the balance of the year, so thanks David.

Look forward to next time.

Thanks, David.

Thank you. This concludes today's conference call. Thank you for participating. You may now disconnect.