Innovex International Inc (INVX) 2022 Q2 法說會逐字稿

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Dril-Quip Second Quarter 2022 Fireside Chat. (Operator Instructions) At this time, I would like to turn the call over to Ms. Erin Fazio, Director Corporate Development, Investor Relations and FP&A. Ma'am, please begin.

Thank you, Howard. Good morning. Welcome to: Dril-Quip's Second Quarter 2022 Fireside Chat. Our news release and financial statements issued yesterday can be found on our website. As a reminder, during the course of this conference call, we will provide forward-looking statements. These statements are not guarantees of future performance and involve a number of risks and assumptions.

Please review our SEC filings and website for a discussion of the factors that could cause actual results to differ materially. As you know, reconciliations of operating income and other GAAP to non-GAAP measures can be found in our earnings release. With that, I'll turn the call over to Dave Anderson.

Great. Thanks, Erin, and good morning. My name is Dave Anderson. I head up on Energy Services Research at Barclays. I'd like to thank Jeff for the opportunity to host this quarter's earnings fireside chat. So maybe we should call something a little bit different considering the middle of the hot summer, maybe it should we fireside pit, I'm not sure. Jeff is going to provide a brief recap of the second quarter, after which I'm going to have a series of topics and questions to discuss for the remainder of the hour. We're not going to be taking any questions but (technical difficulty).

Thanks, Dave. Thanks for hosting the fireside chat. I appreciate it, and you're absolutely right, probably something more appropriate than fireside chat as we sit here in Houston, Texas, in the middle of an awfully hot summer.

First, I'd like to thank the employees for a strong quarter and hard work that went into delivering the results. I really appreciate it myself, the management team and our customers appreciate the quality and safe manner in which we conduct our business in the second quarter. And this is probably one of our best quarters since the beginning of the pandemic.

So we're pleased with that also. From a revenue and adjusted EBITDA standpoint, we beat both our expectations and consensus. It was really broad-based growth among a number of our products. I'll just go through each of those. If I think about subsea services, we're most encouraged by subsea services. It was up a little over 20% sequentially.

We really like the growth in (inaudible) specifically as a result of the fact that that's often a leading indicator of our customers and activity levels coming back to work. So if you think about that, our customers have a customer property that they're bringing back to work.

They have rigs that they're bringing back online, so we start to see recertification and rework happening. So that's often an early indicator and probably our shortest turnaround and shorter cycle business of our 3.

The next is downhole tool, also a short cycle business. We've talked a lot about downhole tools over the last few quarters and the growth that we expect to see there. We had a nice sequential increase Q-on-Q there as well. That's really broad-based.

Latin America was strong, both in Mexico and Ecuador, Middle East was strong, specifically Saudi, and we're starting to see our deepwater business emerge there as a real growth opportunity there.

And last but certainly not least on the Subsea product side, a solid 7% Q-on-Q increase. We like the increase there. That's largely on the fact that we started to see orders pick up Back half of last year, the orders were up about 10% to 15% over the first half, that trend really maintained the first half of this year, and we're seeing that start to translate now into revenue.

So overall, a solid quarter. We're pleased with it and once again I'd like to thank our employees. With that, I'll turn it back over to you, Dave, for a robust conversation.

Great. Thanks, Jeff. So one of the things we've been seeing this quarter has been this growing expectation in offshore inflection. But I think it's also pretty clear, it doesn't hit everybody at the same time.

So we're seeing a lot of tenders out there for both deepwater and jack-up rigs. So maybe let's just start with what you're hearing from your customers, kind of what you're hearing from that current economic environment obviously, people are talking about a recession.

I'm wondering if they're talking about that at all or if your customers are instead looking the other way and really thinking about this energy -- global energy crisis we're facing and how they see kind of playing into?

Yes. So I think first and foremost, we're seeing our customers maintain capital discipline, and that's really across the board regardless of size of the customers, regardless whether it's an IOC or NOC, there's just a lot of capital discipline in the market right now.

I do think that there's some folks that have gone back -- some of our customers have gone back and are really reevaluating and sharpening their pencils on projects, looking at what do we believe the demand will actually be.

We're in a high inflationary environment. What does the project economics look like? So we see a lot of projects that are pushing to the back half of the year, and they're pushing the back half of the year as they just reevaluate what the economics look like.

And what we're hearing from our customers, it's very easy to look at today's environment and say, hey, it's $100 oil or $90 oil, everybody is getting back to work, but they're looking at much, much lower breakevens when they're doing that analysis.

So we're hearing numbers anywhere from $35 to $40 is what they're thinking about, so that they can be resilient if and when things turn back the other direction again. So I think it's very much an environment where cautious optimism is what I'd say.

So if I look at your orders this quarter, you did around $50 million. I was just kind of running some really quick silly math here, but I just looked at the last 10 quarters, you've averaged right around $50 million a quarter.

So how do you think about that and how that could potentially change with based on what you're seeing out there and obviously, I'm sort of thinking about '23 and kind of how these numbers could trend. So what sort of your, I guess, your 12, 18-month view on how the orders could trend?

Yes. So if I -- we'll talk about this year, and then I'll talk just more general environment for next year. I mean, this year, we still expect orders to be up year-on-year around 20%.

Obviously, you could do the math and figure out that that's a little back-end loaded right now. It doesn't surprise us that it's back-end loaded. We would have originally thought that at the beginning of the year. I think we might have gotten a little optimistic early in the year when oil prices were good and the inflationary environment wasn't there.

As we saw inflation start to creep in, some of those products are just a little slower to come online. So we would expect -- we talked earlier about 16 to 19 tree bookings this year. We expect about 11 of those in the back half of the year now. We've got that reflected in kind of our 20% up year-on-year.

The other trend that we're seeing, and this is across the board, is we're seeing far more MSAs now. And we're not seeing those purchase orders that automatically convert to bookings. So think about -- let's use Petrobras as an example.

They placed an MSA for 11 exploratory wellheads and, I want to say 76 development wellheads for a total of 87 wellheads. Those don't automatically go into bookings until they're called off. So if you go back 5, 6, 7 years ago, they would have just placed a purchase order for it.

So we are seeing a lot of good activity. It's just translated into MSA as opposed to bookings. If I think about 2023, look, it's a constructive environment, oil prices, we expect will remain high. We believe that the subsea services growth that we saw in the second quarter is indicative of customers coming back to work. And we would expect a strong bookings number again next year and likely up from '22 to '23 again.

So I was curious, you had just mentioned before on -- you talked about some of the short-cycle business running through. And I don't -- do subsea services, that doesn't run through backlog, I'm assuming, that goes right through revenue?

But maybe just kind of talk about your overall mix in terms of some of the short cycle versus longer cycle opportunities? And how that compares to maybe a few years ago, which I would have thought probably most of your business would have been more in kind of the longer cycle category?

Yes. So just to clarify, you're right to say most of the services don't go through backlog. There are situations where it's contracted a certain way where they might go through backlog. Petrobras will be an example of that. But outside of Petrobras, you're right, most of that service just goes straight to revenue.

So that's obviously short cycle customer could buy a wellhead. They could purchase a tree. They can purchase a connector, and it may be months or even years before we actually service that and see the service come through on that.

So those are longer cycles. So think about a wellhead is anywhere from 26 to 52 weeks depending on the specs of the wellhead, where it's going in the world. Think about a tree as anywhere from 12 to 18 months probably on the higher side right now, given supply chain constraints, and think about downhole tools is really very -- we've got stocking programs for downhole tools.

So that's very much a customer shows up, asks for the equipment and immediately goes to work. The lead times on that are almost to pick it up and at the longest maybe 12 weeks or something like that from a deepwater standpoint.

So when we say we're seeing the short-cycle business has pick up, that's really downhole tools that we didn't even own back in 2016. And it's really that services that as customers come back to work, they start to work through their inventory.

So I guess if I just think about coming on your wellheads and your trees in that, for the most part, are your orders coming from more short cycle work, meaning step-outs and field extensions, along those lines versus some of (inaudible) new fields?

I guess we're seeing it kind of generally speaking, but is that how your bookings also look?

Yes, it's more brownfield than greenfield, yes.

Yes. So I guess that's probably (inaudible) we see FTI ordered a whole bunch of -- they're talking about their subsea tree bookings and you're basically what you're saying that 12 to 18 months in front -- so basically, the wellheads and the rest of your business should therefore be more of a '23 event?

It just takes a little bit -- you're more of a shorter cycle in a longer cycle environment, I guess, is the way to put it?

Yes, that's exactly right. If you're comparing wellheads, which is kind of our core product line, if you compare wellheads to trees, yes, it would come on later in the cycle.

The other thing I think you often see with wellheads is you might see customers holding a little more inventory, you don't typically hold a lot of trees in inventory, whereas you might hold some wellheads inventory. So often as the cycle starts to rebound, we'll work through some of that inventory first before they start reordering.

So speaking of inventory and sort of the cost and inflation that we're navigating through right now, any concerns you have in terms of your realized margins in terms of that?

Or is it the stuff ordered, so I guess, kind of almost just in time to an extent that you can really capture any of those inflationary issues?

Yes, so you have to -- this is Kyle. You kind of have to split it into 2 pieces, the downhole tools business, as Jeff mentioned, a little bit shorter cycle. They're out on the forefront, getting price in addition (inaudible) seeing cost inflation happening.

Their margins have been relatively stable in the last, call it, 3, 4 quarters. They were out sort of late last year, raising prices sort of across the board from service and product. On the subsea product side of the house, a little bit longer, as Jeff mentioned in the cycle.

So we're pulling -- it's spinning on when you're purchasing inventory when that goes into the cost -- the folks in that business are out there right now, identifying where they're seeing inflation happening on a part-by-part basis and trying to get that pricing along to the customer as well, even though that may not come back out of inventory until much later.

So we're being very aggressive on the pricing side of the house. You're seeing that, I think, in the margin side, specifically on the downhole tools, you're seeing them stabilize margin and in fact, growing their other product margin.

Okay. That's good to hear. Maybe we could just kind of take a bigger picture to kind of look globally, kind of all the different markets where you've been active over the last few decades.

Where are you seeing activity kind of at the margin starting to increase a little bit more than others? I know kind of everywhere is starting to at least percolate, but what's kind of happening on the leading edge there? What's got you most excited as you think about the next 6 to 12?

Yes. I think if you step back and look at it, I mean, obviously, Brazil is very, very, very strong right now. I talked about the 87 wellhead orders, the MSA that we got earlier in the year, that's calling off much faster than we would have anticipated.

In fact, we expect them to probably go out for tender again later or early next year sometime. So that's much earlier than we would have expected. If I turn from there to the Middle East, Saudi remains strong. I was there 4 or 5 weeks ago, and our downhole tools business is humming along and expect to grow in the back half of the year in Saudi, both as it relates to that.

And even on some of our connector and service equipment business, we've had some diverter revenue there as well. So we think that's doing well. Norway remains strong. There's an economic scheme there that's actually encouraging drilling, so that's good as well.

Asia Pac is probably the slowest to come back. Although that having been said, if we think about our Subsea services, we did start to see an increase in recertification and rework as rigs start to come back online there. So that's kind of the overall.

I think if you think about GOM, they're really looking and I'll be curious to see how the new legislation that's working through right now plays out. I think in GOM, they're really looking for what I would say is regulatory certainty taking back the work.

And that's what I most often hear from our customers there is they want that regulatory certainty so they know the environment they're going to be operating in over the next 5, 10 years. And perhaps that will come out of the legislation working stuff out right now.

Let's not hold our breath. Could you kind of circle back to Brazil? And talk about the MSA you mentioned -- this is a big business for you. I guess if we think about last cycle. Can you talk a little bit about how different it is in sort of the contract structure?

You touched on it before, but I'd love to dig in a little bit more about the MSAs today versus really kind of what the business was before as it relates to those 87 wellheads, those are not in fact.

Just help me understand how those kind of flow through backlog and as you work through -- it's a little different than before, I think it would be helpful if you break that down for us, please?

Yes. Thanks, Dave. It's really a lot different than before. I think if you go back to the last big upswing, they placed purchase orders, they placed very, very, very large purchase orders and then we delivered against those purchase orders.

So the minute that they placed those purchase orders, those purchase orders went into backlog. In the environment we're in today, they typically have an MSA for up to a certain amount of wellheads.

Often is a minimum in there as well, but it's a kind of a min-max contract that you're thinking about, and that includes both the equipment and the service and then they call off against that contract.

So what we'll do from a recognition standpoint is when we sign a contract like that, we'll recognize the minimum to the extent there's a minimum. But anything above that minimum, we don't recognize until the call-off actually happens.

So when you see an announcement from us about 87 wellheads with Petrobras, that doesn't immediately go into backlog, the minimum would go in the backlog, but the balance of it would only go into backlog as it's called off. That helps clarify that?

It does. So then you -- so essentially, all 87 of those wellheads will have gone through backlog essentially by early next year? Is that how I should read your commentary about another MSA on the horizon?

Yes. I think about 30% of them will -- are already through -- are already through backlog. The remaining 70% will probably happen over the next 12 to 18 months.

They may not get all the way through it before they do their tender, right? So I would expect that when they're 80% of the way through or 70% of the way through that contract, that's when they probably want to go (inaudible) out the tender again, right? So it won't be just a -- it won't be a digital event quite that easily, right? There will be some cutover.

So when we think of Middle East and Saudi, Dril-Quip is not typically the first name that comes to mind. In fact, could you sort of talk about that opportunity in that market? We know there's -- I'm assuming this is for the offshore, all the jack-ups that are being tendered out there.

Could you talk a little bit about that market as you see that opportunity and kind of -- like I said, I don't remember this being a part of your story and (inaudible) at the same time, of course, jack-ups was really a big part of Saudi so fairly recently.

Could you talk about the evolution of that market and kind of where you guys sit in Italy?

Yes. Well, the reason you wouldn't have thought of it as a Dril-Quip market is because that really -- we really got a fairly large presence with that when we bought TIW. So that's really that downhole tools market.

TIW has always had a very strong presence in that Saudi market. So we're one of the key liner hanger players in that market, serving Aramco there. We do so -- we will sell from time to time, sub mudline, we will sell surface connectors. We will sell diverters from time to time. It's a smaller market, by far, the Liner Hanger business is our largest business in Saudi. But we are looking at opportunities.

And as you mentioned, a significant ramp up there. And as we had conversations with Aramco, they're really looking to add more vendors in that market just because of the ramp-up, and I think they're concerned about supply chain.

So what is that -- so are you -- on the wellhead side, you're not qualifying, I'm assuming for Aramco? Is that something you're trying to get accomplished? How does that work? Historically, it's not been very easy to get qualified, but things are very different in Saudi today -- these days.

I'm assuming -- maybe there's a little bit more flexibility there.

Yes, you're right that it's not easy to get qualified. So we're qualified on diverters. I think we're through some qualification on sub mudline. And on the surface wellhead side, we're not qualified yet.

Primarily for us, the Liner Hanger market. We're working on quotation of wellhead -- surface wellhead as well. We are working on that, but we're not qualified yet.

Okay. One market you did mention was West Africa. Is that -- I know it's always been sort of fits and starts. I'm assuming Nigeria and Angola, those markets have taken a little bit longer to get going.

Are you seeing any kind of signs, green shoots or anything like that happening in that market?

Yes, it's very early -- it's very early days, but we are seeing activity where we hadn't seen activity in a while there, but not really anything that would be material in the next 6 to 12 months.

Okay. And then maybe could you just discuss the competitive dynamics that you're seeing out there today, particularly wellhead is a sort of a two-horse race for a while. Just wondering if competitor behavior has changed at all?

Maybe kind of what's kind of compared to -- I know we're such an early part of the recovery here, but I don't know if there's anything (inaudible) from this recovery versus the prior recovery -- but just in terms of the competitive outlook out there would be helpful.

Yes. So if I think about it in that regard, you're right to say it's kind of a two-horse race. I mean, don't forget from a competitive standpoint, we've got a collaboration agreement with OneSubsea, where we'll work with them on wellheads.

We're actively tendering there. Obviously, we're relying on OneSubsea to win that business in order for us to tag along with them, but that's a situation. It's probably different than the last up cycle. We also did what I call (inaudible) collaboration agreements where we'll bid from time to time with Aker as well.

And those are really our 2 partners. So if you think about an EPCI bid, we typically on EPCI would go in with either OneSubsea or Aker to the extent that, that makes sense. And then, look, there are still plenty of large customers, Petrobras included that tender their wellheads completely separately from trees and the rest of the bundle.

And obviously, we're very competitive there.

So if I just kind of slide over to kind of talking about the kind of financial, maybe capital allocation (inaudible), but I guess it's probably more (inaudible).

I was wondering maybe if you could talk about how you see the second quarter playing out. You're talking about top line growth and kind of incremental margin targets. Could you help us kind of narrow down, kind of where you're hoping to land the plane by year-end, what the setup is for next year and kind of where our starting point will be for '23?

Yes. As I think about the back half, I think about Q3 and Q4, probably being somewhat similar to what we had in Q2 more or less. I think Jeff talked about the tree orders that will be pretty important for us to get those and start booking revenue and margin as it relates to those particular tree orders are so lumpy that they're very critical in the bookings process.

But I would expect Q3, Q4 to kind of be more or less because the numbers are sort of where they are in terms of size, $1 million here or there can make a big difference to hitting on the bottom line side of the house. But I expect Q3, Q4 to be more or less in line with Q2.

As we turn to Page 23, a little bit too early for us to probably touch on that at this point in time as we're starting to roll up budgets here in the next couple of months and getting CapEx plans from our customers and so forth. So I'd be a little bit hesitant to jump into '23 at this point.

Okay. And then in terms of the free cash flow expectations, you talked some pretty good confidence about building up that cash from the second half. One of the things that's come up quite a bit during earnings has been working capital builds and people kind of building that up.

So maybe talk about those 2 things together and kind of how free cash flow looks in the second half.

I would expect a pretty strong second half in terms of free cash. We had negative $25 million, I think, year-to-date, if you will, we would expect probably to come back on that front and have a pretty positive second half.

AR has been a bit of a drag in Q2 as we've been growing nicely Q-on-Q, we've seen a sequential decline in AR. We'd expect that working capital to pick up as revenues flatten out in Q3, Q4 to come back in. A couple of one-off items here and there in Q4, we expect to kind of drive our free cash into that.

We talked about 3% to 5% yield for the year. We're still sticking to all 5 pieces of guidance we stuck back out in February with bookings up 20%, revenue up 10%, incremental margins $40 million to $50, free cash at 3% to 5% yield and then CapEx for that $15 million to $17 million numbers.

I think we're ticking all of those as we hit the back half of the year. As we think about '23, I think it's just a little too early to talk about that.

Sounds good. Sounds good. Some of the recent commentary you've been talking about kind of M&A, you've done a few things over the last couple of years. Help me understand what makes most sense for your business? Sort of -- do you have a little bit different business than most? And on the wellheads and the trees and you've been pretty offshore-driven capital equipment, consumable type of business?

So is that the direction you continue to go? I would imagine there's a lot of opportunities in that market. So does that the direction we go or are you think in other places to take this business?

Yes. I think, David, it's a little bit of thinking about the Dril-Quip DNA and the expertise we have, right? So you think about that as high pressure, high temperature. Think about that as highly engineered manufacturing capability, something we can build on our footprint and it doesn't necessarily need to be to the right or left of a wellhead for a tree.

It could be energy or energy adjacent markets that we'd be looking at. We've actually spent a fair -- I mean, obviously, we're focused on the organic side. But over the last quarter, we've actually engaged a third party. We've gone through that in a fair amount of detail now. We've got it narrowed down to kind of a final 2, 3 areas that we're thinking about, and we'll be working on that really over the next, I'd call it, more 9 to 12 months. You should expect the balance of this year.

We're going to do an awful lot of work on, as we've talked about, making sure we get our roofline right, making sure we get our manufacturing investment right, standing up the new organization. But I think as we exit this year, you'll start to hear more around M&A. I'll let Kyle talk a little bit about capital structure.

We're going to put a pin in this M&A strategy probably here in the next couple of months, as Jeff mentioned, we've got to get with our board here in the next couple of weeks and talk them through what we're thinking about there and then how we want to communicate that and when and if we do to the market here.

But I think Jeff touched on it, it's going to be stepping out of Dril-Quip's DNA, it could be energy, it could be energy adjacent. We've got guiding principles we're gathering together. They're going to help take us through this process here. But we do think the inorganic side of the house is going to have to be a pretty big pillar of our growth going forward.

We're well positioned in our organic space here, as Jeff touched on earlier. We are pretty -- we've got enough work streams going on internally from a reorganization, property sales, footprint rationalization. We touched on the manufacturing investment in the release this morning -- those 3 items, those 3 work strings are plenty for us probably for the next 6 months.

We're going to be standing up that inorganic capability inside the organization. And where we point that ship, if you will, is still a little bit TBD, but it's going to have very much a connection to the Dril-Quip DNA and highly engineered, highly specified. And taking what we do well and being able to step that out and bring value to, as Jeff mentioned, the energy and energy adjacent spaces.

So it's a long-winded answer, basically saying, it's still TBD at this point in time, but we're spending a lot of effort on it because we know it's a critical path for our growth going forward beyond just what we see in the organic market.

So as long as I've known Dril-Quip, I think I've covered (inaudible) 20 years. There's never been any debt on this balance sheet. So all of the things that you're talking about, and my first thought is does this change that strategy?

Are you willing to take on debt to finance some of these potential new areas of growth?

Yes, we view our balance sheet as a very critical asset, obviously. We would not anticipate taking on debt in any one of these scenarios here. We want to continue to maintain a very healthy cash balance from an M&A standpoint, we'll probably be very programmatic about it.

Thinking through a string of pearls over time that help develop that capability inside the company. It probably wouldn't be a big bang type of deal. And we need our organic business, quite honestly, to generate a little bit more free cash right now than it is -- but I don't think that would be something we would entertain at this juncture.

I think our balance sheet, we want to continue to hold a pretty healthy cash balance on there (inaudible) options around making sure we've got -- we've done $21 million today on share buyback, right?

That's been a good thematic for us this year as we're pushing free cash back to our shareholders in that methodology. But I think as it relates to that, that's probably something that we would not entertain at least at this juncture.

All right. (inaudible). I tried. On the subsea tree side, I'm interested in something as we're talking about M&A and kind of moving to other areas, it would seem that subsea trees might be an interesting area right now.

I mean, one of your big competitors is essentially throwing in the towel, they said that essentially, they can't make the business work. I mean I know you talked about OneSubsea, but geez, I can't remember last time (inaudible) talked about this market. It seems like it's a pretty big opportunity on the tree side.

Is that an area where you see sort of some competitive dynamics shifting and maybe a little bit of an opportunity on that? I mean trees have sort of always been sort of, I guess, I would should say, opportunistic, it feels like over the years. So this is (inaudible) more opportunistic to more of a steadier part of the business going forward?

Yes. We're really looking at that from a tree. Think about trees from 2 aspects: 1 in shallow water. We've got a decent share in the shallow water trees. We'll continue to do that.

We've got a new tree that we're bringing online, called the SBTe that leverages some of our technology. We think we get first win on SBTe sometime early next year. That same tree is the tree that we'll use then in carbon capture.

So think of that as ultimately becoming our CCUS tree. So we look at it that way. Obviously, we sell deepwater trees, and you're right to say that we're optimistic or opportunistic, those tend to be smaller to midsized players versus the large projects. When the project gets to a certain size, that's when we'll team up with the likes of Aker or the likes of OneSubsea on an EPCI on the deepwater.

But on the shallow water, we've got a tree offering that we believe is competitive. We're developing a new tree there, and that tree also will become our carbon capture tree as well.

That makes sense. That makes sense. I'm going to shift here a little bit to move on to some of the growth pillars that are potential over the next several years.

I think it's just 3 in particular. One would be some of the collaboration approaches you're taking; two will be the downhole business; and three, that would be the e-Series product line, which you're building out. So maybe just start with the collaboration side here.

Can you talk about -- maybe the Aker collaboration is a great place to start (inaudible) announced this earlier this year is a great way to increase your exposure to energy transition.

Could you maybe talk about that collaboration, how it came about, the opportunities you see there? And then I guess, separately, what other areas you talk contemplating? Are there other collaborations like it's out there? And would it be in the energy transition bucket?

Yes. So specifically, as it relates to Aker, I mean, we've had ongoing conversations with Aker for a period of time. I think as they looked at both the shallow water tree that we've got and the wellhead they got, they thought that was a good match with the offering that they were going to bring to the market from an overall CCUS standpoint.

We signed that agreement, as you're aware, earlier this year. Almost immediately upon signing that agreement, we had a number of customers approach us afterwards, saying, hey, we didn't realize you guys were going to play in CCUS. So it's really presented some nice opportunities for both ourselves and Aker and for us separately from that.

In fact, next week, next Friday, we'll deliver a very small feed, but we'll deliver our first CCUS feed next week. We wouldn't expect to see on the large projects that we're talking about with Aker, the Northern Endurance Project.

We've ramped up there. We're probably spending $2 million to $3 million annualized now. We've hired folks. We're jointly located and working closely with Aker on that. We wouldn't expect that FID though, on that project until sometime next year.

And first order really wouldn't hit until late next year. We are working with a number of other companies -- we haven't gone public at those, so we're a little cautious about throwing the names out there, Dave.

But there are 2 or 3 other companies that on the energy transition side we will go to market with and hopefully, more to come on those.

So when would you expect some of those first Christmas trees and wellheads to be installed on CCUS? I'm just trying to understand the time and, obviously, we've been talking about these different projects, just trying to put a something on the ground here. When should we expect sort of the first one in the -- on the seabed, or I guess, however, they're design, I guess I'm not fully -- I don't know the full design here.

I'm assuming maybe there are surface wellheads, I'm not entirely sure...

It depends on the project. It depends on the project. We wouldn't expect first order until, I think, conservatively, we expect first orders late '23 and probably first revenue on that sometime in '24. So first install probably sometime in '24.

Okay. And then from there, hopefully, we'd start getting more of that and perhaps we'll even get a full carbon market. I'm sure that's kind of what you're planning on.

What other kind of markets are you targeting here? Is it just -- is this the only kind of area that you see potential for collaboration? Are there other areas that you see potential here?

Yes. I mean obviously, CCUS is by far the most immediate. I think as we look at something like hydrogen, as example, there's a number of areas where we could play from a high pressure, high temperature standpoint, but that's much more nascent than the CCUS market.

So I'd almost characterize CCUS as product development because it's an extension of things that we already do as opposed to hydrogen example, which is much more R&D and in its infancy right now.

Any other areas like geothermal, would there be an opportunity for geothermal for (inaudible)?

Yes. We looked at geothermal. What I'd said is we're accidentally selling the geothermal through connectors and pipe. But the geothermal market is a very, very commoditized market and we find it pretty challenging.

So we'll participate there, but it's going to be much more opportunistic versus something that we'll aggressively pursue and build out a whole product line around. I think our investment would be pretty small there.

Okay. Shifting over to the downhole tools. You had talked about some pretty good growth this quarter in there. Maybe just talk about -- I think it's got a little bit on the shorter cycle here on these tools because you're saying kind of that happens, you get a -- you get a -- you kind of come out the right as these things are happening.

Could you talk about how that business is developing and downhole tools is something that Dril-Quip has always been involved in pretty heavily. So is there something different about this cycle that you see going forward to see a better opportunity?

Is there something that's changed about the business that you think, maybe downhole tools will have a little bit more growth (inaudible)?

Yes. So if you go back in time, and this is obviously predates me, but if you go back to 2016 and before, clearly, Dril-Quip had a downhole tool business. But as I understand it, it was pretty immaterial to the overall business.

Obviously, the acquisition of TIW really was the beginning of what would be a more substantial downhole tool business. I think the thing that's materially different now than what might have been in the past is we now have very specific stocking programs around the world.

So if you go and talk to our business, they've got a stocking program in Saudi. So when I was out there, you can actually see (inaudible). We've got a stocking program in Ecuador. We've got a stocking program in Mexico. In key markets, we've got stocking programs where in the past, we just tried to respond with quick-turn manufacturing.

And candidly, that's not very effective and especially not very effective in what's a challenging logistics market today, right? So I think with that inventory on the ground around the world, there's real opportunity there.

The other thing is you pointed out some of the issues in salary around qualification. We worked very hard to get a number of sizes and a lot of our kit qualified in Saudi. So from a Liner Hanger standpoint, we're well positioned right now in Saudi.

We're working through a lot of the inventory in Saudi. We would expect a fair amount of restocking back half of this year in Saudi and going into next year. So the company is just -- I think we understand the short-cycle nature of it. And perhaps when we bought that company in 2017, we didn't fully appreciate how quick the turnaround really needed to be on those liner hangers.

When you say stocking programs, are you saying essentially you have the capacity of the downhole tools to meet those markets and you're basically kind of building out that capacity in advance of potential activity? Is that what you mean by that?

Yes. You've got to have inventory on the ground, right? So think about it as -- if I go back to my industrial days, think about it (inaudible) where you've got to have inventory on the ground.

And then as that customer pulls the inventory, the signal goes back to our manufacturing and our supply chain to restock those for. You've got to have certain sizes and certain kit on the ground in a (inaudible) that you can then hope that your customers can pull on immediately. If you don't have that kit, they're going to figure out a different solution.

I was just about to say, if you don't have it -- if you're not ready, you don't get to work, so the next thing I'm thinking about is what have (inaudible)? Do you see an opportunity because your competitors in that business have not done that? I mean is that what you're seeing out there?

There is a little bit of that. What shouldn't be lost by the way, is we supply a number of our competitors with liner hangers. So Schlumberger will buy a liner hangers from us, Halliburton will buy liner hangers from us. It really depends on the market.

So yes, I think the -- 2 things matter in that business, service quality, making sure you're servicing the customer in the right way and having that inventory on the ground. And we've dramatically improved our service quality, and that gives us a lot more at bats with customers, and we've got the inventory on the ground.

So Schlumberger had a big -- just speaking of Schlumberger, they had a big pickup in Gulf of Mexico activity and kind of more and more work offshore. I'm assuming that downhole tools sort of go hand-in-hand with just activity levels offshore?

Well, keep in mind, by the way, our downhole tool business is not nearly the deepwater business that you'd expect from wellheads and trees, right? There's a fair -- there's a healthy amount of what I call international land, not Lower 48, but there's a healthy amount of international land within that downhole tool business.

International land. Well, I wouldn't have thought that. Okay. That's interesting. Are there any kind of particular markets that you think you're ideally suited for? Or you have positioning, as you just said, sort of stocking, I guess you kind of rattled off a number of the countries. Are those sort of the countries that you see the biggest opportunity presumably?

Really, I think the good thing about it as Ecuador, Mexico, Saudi, Brazil with Petrobras is starting to emerge in an MSA for the XPak De with them. I think it's 27 systems is what's on that MSA, so think about it as those are the core markets.

We certainly supply other markets -- but when we supply those markets, that's where you'll typically see us (inaudible) -- we'll sell the equipment to some of that you might view as a competitor and then they'll install it for us.

Okay. So in 2021, you had 35% growth in this business. I don't -- correct me if I'm wrong, have you put out a number for your expectations this year? And just curious, should we -- I'm presuming you should be expecting double-digit growth in this business for next year?

Yes, we would expect double-digit growth on the business for sure this year and obviously coming out of 20. We had a nice year in '21. And this is an area where they've seen some really tremendous growth. As Jeff mentioned, the markets they're operating in.

And Saudi has been a key market for us in the last few years. So we would expect a nice growth in this business, and it's a really good service, same product business too. It's got nice margins across the board. As I mentioned earlier, they've done a really good job of fighting off the inflation beast here in the last 6 to 9 months or so.

If you go back pre-acquisition, Dave, that was $130 million business. So we've talked about that as over the next couple of years getting back to -- may not get back to 130 because those are the glory days, if you will, of the industry, but you can easily see that getting back to $100 million.

Next year, $100 million?

Over the next couple of years -- maybe. Yes, maybe exit, right? I suspect my downhole tool leaders (inaudible).

Well, the longer I keep talking, the more guidance for me to get out of you. So -- and make you guys (inaudible) a little bit faster. Now let's move on to the third part of that leg of growth here.

The e-Series technology expansion (inaudible). Can you talk about what exactly this product line is and where it fits in the market? Is this sort of a -- do you see a niche out there that you're kind of filling in the gap? Or how are you thinking about sort of the longer -- the prospects (inaudible)?

Yes. So the e-Series is just a number of products that we brought to market really over the last 4 or 5 years. It's really all about reducing costs for our customers.

How are you thinking about sort of (inaudible)?

Yes. So the e-Series is just a number of products that we brought to market really over the last 4 or 5 years. It's really all about reducing costs for our customers, reducing carbon footprint for our customers. They can certainly use the entire suite of products or they can use them individually.

So right now, we're more often than not see them used individually. So think about that as -- if you think about that from a wellhead standpoint, -- we've got e-Series wellheads and increasingly, we see all of our customers gravitating towards those e-series wellheads. I think we've already quoted numbers. We'll probably exit this year with probably 70% of the orders in wellheads all being e-Series, which is helpful for us in a number of ways, inventory included by the way.

The DXe connector is a high-fatigue connector. We've seen traction on that in Norway. We've seen traction on that in Gulf of Mexico. It's early days, but we're pretty happy about the adoption there.

I talked about the XPak De, and I talked about Petrobras and I talked about the MSA there. We're pretty happy with that. We have one actually (inaudible) right now, as a matter of fact. So that's very early days, but we're starting to see an uptick on that as well.

And then I talked a little bit about SBTe, which is the shallow water tree that will just be one more extension of that e-Series of products.

So Jeff, what's the pitch to the customer on this e-Series? Why would they want to (inaudible) DXe wellhead, connector or relying on e-Series? What is it -- I think you said it's more efficient, but what's sort of the selling point that you're offering?

Yes, it's really 3 things. One is just time, depending on the product that we're talking about. It's fewer trips, so fewer trips means less cost. And it's also a carbon footprint reduction as well. So depending if you get less trips and you start doing that math on fewer trips, less equipment, then that makes a (inaudible).

And increasingly, we're seeing our customers start to build into their tendering process questions around carbon footprint and what we can do to help them reduce their carbon footprint. And this series of products just helps them reduce that carbon footprint as well.

It's difficult to see where that goes in the calculation and the math, but I think you can expect it to get more and more competitive over the next couple of years.

So last section here. Just want to talk about some of the operational footprint from your organization. Probably my favorite subject, frankly, I know Jeff, we've talked about this quite a bit in terms of the changes you've made there operationally, the business itself Dril-Quip would sort of set up -- I don't know, the way I always view is sort of just kind of built on the fly to a certain extent. You've come in there last few years, you've really kind of changed that around.

Could you just kind of bring us up to date in terms of where you are in terms of adjusting your operational structure, maybe some of the changes you made, are they done? What are you working on today in terms of -- where are you in your sort of path to, I guess, optimal efficiency, if there is such a thing?

Well, let's start with the changes that we announced earlier in the year when I became CEO. We're getting much more product-focused now. In the past, we used to be very, very functional. And what my observation was you made those handoffs from salesperson to sales admin engineering to manufacturing, something got lost in between every step there in time and added time candidly.

It added a lot of time. And as you know, time is money -- time is expense, time is inventory. And so we're in the process of really reorganizing into those product groups. We've got leaders for those product groups. We're in the process of co-locating people.

You've been on our campus days. So you know how large the campus is and how spread out people can be -- we're in the process of co-locating into the different product groups.

We believe that will make those improved communication, obviously, between those functions and make us more efficient. As we relocate on the campus, we've got 218 acres on campus today. We've identified at least 100 of that candidly we can (inaudible).

So I think we said in our release already. We expect one of those is under contract right now. Our forge facility is under contract right now. We'd expect that to close this year. And 2 of the other properties, we'd expect to at least be under contract this year, if not close this year as well.

And we've talked about really the benefit of that. I mean we're probably unique in that we actually own a lot of our properties. So when we actually reduce roofline, not only are we reducing the expense that goes with having that roofline, but we're also able to get cash proceeds from it.

So we've narrowed that a little bit. It was a $40 million to $60 million range given higher interest rates. And the market we're in, it's tightened up a little bit. It's more $40 million to $50 million right now.

But we're pretty confident about that $40 million to $50 million of incoming cash. We're going to take some of that cash and invest it in manufacturing, clearly, not all of it, but we would expect to take about $20 million of that cash and reinvest it in our manufacturing.

The other thing I'd tack on there, when Jeff talked about the product line, organization is getting income statements by product line to understand true profitability across the portfolio here. And so we're in the process of doing that.

And that's kind of helping understand, as Jeff mentioned, as we're going through footprint rationalization, roofline rationalization, just who's doing well and who's not and where we need to focus our energy.

Yes, and where we need to make investments.

So Jeff, you brought up the forging. It's been sort of a -- so I've been talking about, gosh, and go back to my (inaudible) days, I never fully grasped the integrated model on the forging side. It sounds like you finally have a way to a seller there.

So how does this work going forward? Will you still be getting your forgings from whoever the new buyer there? Or do you get it from somewhere else? Can you talk about how this sort of changes your business going from sort of the fully -- I know it did just happen, but shifting from, say, what was 10 years ago, essentially a fully integrated model to what it is today.

So can you just talk about the differences between them and how you're sourcing those forgings because, of course, the next thing I want to think about is, man, (inaudible)? I'm sure that's probably not so easy. I know a lot of it comes from Europe or at least for a lot of people, but I'd love to understand how you're thinking about that?

Yes. So to be honest, Dave, we have -- we moved that supply chain for forgings outside of our on-site forge probably about 18 months ago, if not 24 months ago. We've got forging sources in North America.

We've got forging sources in Italy. Obviously, we're always looking at the cost of those forgings (inaudible) looking at the lead time of those forgings. But we do have forging suppliers really candidly around the world, but Italy, North America being the 2 largest of those.

So the forge that we've got on campus today when we make that sale, it will not operate as a forge. There's another strategic buyer that's interested in the property they're buying it and it won't operate as a forge today, as a matter of fact.

Yes.

The interesting thing about that, and I probably quoted these numbers before is in our peak, we were operating -- we probably had 35 million pounds a year going through there. At the low point, we had 7 million pounds going through there.

As we bought potential forged buyers in to look at that facility, their estimate is that they had to have 50 million pounds a year going through there to make that work from an economic standpoint for them.

So -- and look, these guys are professional forge suppliers, right? So presumably even at 35 million pounds. Now you could contend it's worth the -- as a lot of companies are experiencing now, it's worth the continuity of supply to have that. But when you get down to 7 million pounds, it's awfully hard to make that work. And I think we quoted a few years ago when we shut down the forge, I think we quoted $8 million to $10 million annualized savings, if I remember that correctly.

I mean, something like that might have made sense in '12, '13, '14, but pretty hard to see how that makes sense going forward (inaudible).

Yes. It's not fair to the people that made those decisions in '12, '13 and '14 to say it was a bad decision then because it was a very tight supply chain then, right? But you're right, now and going forward, it just doesn't make sense.

Great. So taking all of this into account and the efficiencies that you're thinking about and you're targeting. So -- how are you thinking about sort of where gross margins can normalize end of the day?

When everything is sort of done, settled down (inaudible) fast forward, 12 months, 18 months whatever normalized means, and I know that's not such an easy concept. But what's sort of your target here? What kind of operational margin expansion do you think you can squeeze out of this business?

Yes. As we sit here today kind of in the mid-20s, we would expect, call it, I'm going to say, 18 to 24 months down the road once these investments are made, roofline has shrunk, manufacturing investments made, we would expect to kind of be in the mid-30s is what our expectation is, and that's the math we're kind of working off of over time to kind of get us in that ballpark here.

Between the reorganization, Jeff mentioned, the property footprint rationalization, manufacturing investments, in addition to other work streams that we've got going on internally, we would expect that gross margin line to kind of be in the mid-30s.

Okay. That's good. That's a good target. So kind of last question here kind of on a (inaudible). What are some of your ambitions on kind of decarbonization targets, maybe just kind of expand some of your recent efforts on the ESG side, Jeff.

We don't think about service companies don't necessarily have the highest Scope 1 and Scope 2 targets, and Scope 3 is another question altogether. But just talk about maybe kind of some of the things that you're doing along those lines on your own footprint and other ESG efforts that you're trying -- that you're working on?

Yes. So look, we've gone out and identified our Scope 1 and Scope 2 greenhouse gas emissions. We've got a fairly good handle even on Scope 3 as well. We've got specific targets around that Scope 1 and 2 reduction, we've implemented some renewable strategy here in Houston as it relates to electricity and gas.

We have a solar installed. If you went out to our Singapore facility right now, you'd see that they're putting solar panels on top of a number of our buildings in Singapore. Obviously, this footprint optimization is probably one of the larger opportunities, if you think about almost cutting the size of our roofline in half here in Houston and consolidating all of our efforts into the other half is significant reduction. So we've done a lot of work to both understand and set very clear targets around Scope 1 and Scope 2.

That makes a lot of sense. Well, that's all the questions I had, gentlemen. Jeff, Kyle, thank you very much for the opportunity for hosting this.

I think we kind of touched on all of the subjects. We'll probably see a lot happening (inaudible) in just about every market. I think people are just trying to get a handle on kind of how things are playing out, different markets obviously happen at different times.

So clearly, there's a lot of things percolating just below the surface on the Dril-Quip's story. So thank you very much, gentlemen, for giving the opportunity today.

Yes. Thanks a lot, Dave. And I think we'll see you in a little over a month in New York.

That's right. Looking forward to that.

Okay. Thanks, Dave.

Thanks.

Okay, guys. Thank you.

Well, thank you for participating in today's conference. This concludes the program. You may now disconnect. Everyone, have a wonderful day.