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spk04: Good day and thank you for standing by. We'll begin our call in two minutes.
spk02: Good day and thank you for standing by. Welcome to the DrillQuip Q4 Full Year 2022 Earnings Conference Call. To ask a question during this session, you'll need to press star 1 1 on your telephone. You'll then hear an automated message advising your hand is raised. To withdraw your question, press star 1 1 again. Please be advised that today's conference call is being recorded. I'd now like to hand the conference call over to your speaker today, Erin Fazio, Director of Corporate Finance. Please go ahead.
spk04: Thank you, and good morning.
spk00: Welcome to DrillClip's full year 2022 conference call. An updated investor presentation has been posted under the Investors tab on the company's website, along with the earnings released. 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 DrillCup's comments may include forward-looking statements and discuss non-GAAP financial measures. It should be noted that a variety of factors could cause DrillCup's actual results to differ materially from the anticipated results or expectations expressed in these forward-looking statements. Please refer to the fourth quarter 2022 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 Joelco, we have Jeff Bird, President and Chief Executive Officer, and Kyle McClure, Vice President and Chief Financial Officer. I will now turn the call over to Jeff Bird.
spk07: Thank you, Erin, and thank you all for joining us today. DrillClip delivered an incredibly strong fourth quarter, capping an important year where we met or exceeded most of our targets and made significant progress along our longer-term financial, operational, and strategic objectives. Total revenue grew double digits year over year, and our fourth quarter revenue was the highest quarter achieved since pre-pandemic. This was partly driven by several factors, such as aggressive investments from Brazil, offshore investments across multiple markets from large EMP customers and price increases to offset inflationary pressures. Fourth quarter gross margin grew by over 15% and our overall profitability improved with adjusted EBITDA reaching almost 11% in Q4 and improving 350 basis points year over year. Our improved margin profile, combined with our ongoing initiatives across the organization to drive operational efficiency, such as our investment in improved wellhead manufacturing and footprint optimization, will continue to support our performance moving forward. Cash flow fell short of our break-even target for the year. However, our cash position remains strong and allows us to strategically invest in a growing market. Kyle will provide some additional detail in this matter shortly. Bookings in the quarter were particularly strong at $94 million with no notable cancellations. This is the highest quarterly mark since Q4 2019, reflecting the ongoing up cycle in the offshore market, but also incrementally higher and in line with our typical Q4 seasonality. As strong as bookings were to end the year, it's worth noting that bookings do not include the entirety of any master service agreements or MSAs signed during the year. As customers call off from an MSA, we will then include those units in the bookings. For example, we signed a new MSA with a customer for a West Africa project in the fourth quarter for 30 subsea wellhead systems. But in the fourth quarter, only 10 were included in the bookings. During 2022, We signed over $122 million in new MSAs, and as of year-end, we have approximately 70 open MSAs. We believe this model will continue to evolve as our customers are more thoughtful in managing their supply chains. We ended the year with a very strong and growing backlog of over $241 million, representing double-digit sequential and year-over-year growth as product bookings increased due to improving market conditions. A significant portion of this backlog will be filled in fiscal 2023, and we feel confident the underlying market dynamics are constructive for continued growth in 2023. In total, it was a strong financial year and a pivotal year as we set the stage for the future. These include key investments in terms of both footprint and boots on the ground. We entered 2023 with some very positive trends in our key markets. For example, our ongoing investment in Brazil, Saudi Arabia, Norway, and Latin America. In Saudi Arabia, we are continuing to make investments. We expected the upswing in activity in the region to drive subsea products and downhole tools growth in 2023 and beyond. Part of our investments in the region include the targeting of a new manufacturing facility in Saudi Arabia, as well as efforts to expand our qualified products In Brazil, where we currently have a leading market position with our wellhead offering, we're also excited about our emerging downhill tools business growth potential. Brazil has announced plans to drill approximately 350 wells over the next five years, which calls into focus the importance of our strong relationship with Petrobras. In support of the expected demand, we're ramping up our stocking programs. Latin America has broadly been very constructive. Our downhole tools business has grown five times over the past few years. In 2022, we also had our first downhole tool order in Guyana with expected follow-on orders in coming quarters. Norway North Sea is also picking up from a traditional oil and gas perspective due to the Ukraine-Russia conflict. We are well positioned with a service center in region to capture opportunities and serve our customers. Lastly, West Africa, a previously dormant region, is starting to come alive with strong signs of growth. We signed an MSA for wellheads there in the fourth quarter and will be actively pursuing other opportunities as the region reinvigorates. In addition to the financial successes and promising market trends, I want to touch on the fantastic progress the team has made on some key organic initiatives that now have us very well positioned to continue to drive profitable growth. As I step back and look at the year in full and what has been my first year as CEO and Kyle's first year as part of Drillquip, we have a lot to be proud of as an organization. And most importantly, we have made great strides in standing up the new product line focused organization and setting the stage to ensure Drillquip is positioned to capitalize on what is clearly a constructive offshore market with increasing tender volume and average quote value remaining above pre-pandemic levels. a dynamic we believe will continue to accelerate into 2023. Through our operational excellence initiatives and realignment efforts during the year, we have established the foundation of strong product line focused teams, and we began forming in early 2022. This organizational structure change is a multi-year journey, but is already bearing fruit by streamlining leadership, operations, and customer focus while also eliminating excess costs and improving efficiency. We continue to progress our footprint optimization plan to improve efficiency and reduce excess capacity. During the third quarter, we closed sale to Forge facilities at our Houston, Texas campus for roughly $17 million. In addition, in the fourth quarter, we reached agreements to sell the two remaining Houston properties, as previously discussed, and we anticipate closing in the first six months of 2023. For these two transactions, we expect the combined net proceeds to be in the $20 to $25 million range. This will conclude the current phase of our footprint rationalization that we outlined 12 months ago. These proceeds are earmarked to offset the previously announced $22 million investment in wellhead manufacturing. As a reminder, This investment will lower costs and improve productivity in the coming years, delivering approximately $10 million in annualized EBITDA by the back half of 2024. We feel confident in our ability to further advance our market position due to the significant progress we've consistently made along our growth strategy. For example, our 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. Another critical element of our growth strategy is our downhole tools business. As DrillQuip's first acquisition, we swiftly implemented a targeted growth strategy, exiting unprofitable geographies, bolstering our commercial teams, streamlining our integrated supply chain, and enabling a new leadership team. These actions paid almost immediate dividends resulting in the business growing over 35% year-over-year in 2021 and growing again by 7% in 2022. More recently, we were awarded a contract to deliver up to 21 of our OTC award-winning EXPAC DE liner hangers for projects in Brazil through 2024. We see this growth trend continuing in 2023 and expect another 10% plus growth from 2022 levels. As we've previously discussed, we're targeting this business to expand to $100 million in annualized revenue run rate by the end of 2023. Finally, I want to highlight growth prospects in 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 improving their carbon footprint, we believe these products will become an integral solution to helping our customers meet their carbon footprint reduction goals. The most successful and best example of this suite of products thus far is our Big Board II-E wellhead system. We believe this system is setting a new industry standard. In 2022, we expect that this system would represent approximately 50% of all wellhead orders, and we exceeded in achieving that level. The most significant opportunity in this area is through our MSA with Petrobras, which includes up to 87 systems through 2025. We are optimistic that as these installations gain traction and performance notoriety, we will see similar contract awards for other E-Series products. We continue to build on our E-Series of products. An example of this is the SBTE sub-C tree that is in the final rounds of testing. This innovative product dramatically lightens our tree offering to be able to serve customers in both the traditional shallow water market and the CCUS market in late 2023 and beyond. All of these efforts to stand up the organization and improve our competitive position, combined with a strengthening macro environment, gives us great confidence in our strength and foundation and our ability to drive profitable growth at DrillQuip. With that, I'll turn it over to Kyle for some color on the financial results. Kyle?
spk08: Thank you, Jeff, and good morning, everyone. As Jeff mentioned, the company delivered strong fourth quarter and four-year results as we continue to make progress along our initiatives for the business, and we believe we are well-positioned to execute on opportunities in this constructive market. Looking at our results, fourth quarter revenue was $96.8 million, an increase of 24% year over year. driven primarily by higher product and service revenues across all regions, reflecting the ongoing upcycle in the offshore market. For the full year 2022, revenue was $362.1 million and was up 12% year-over-year. The year-over-year increase was primarily driven by higher product revenues across all regions, partially offset by lower service revenues in Asia Pacific. Gross margins during the fourth quarter were 31.2%, up 979 basis points year-over-year. This improvement in gross margin is largely due to leverage on higher revenues, product mix, gains in pricing, and our ongoing initiatives across the organization to drive operational efficiency. SG&A expenses decreased by 18% to $94.2 million in 2022 from $115 million in 2021 due to lower legal expenses in connection with the FMC lawsuit. Excluding those legal charges in 2021, SG&A was roughly flat year on year. Additionally, engineering expenses also decreased by 23% to $11.7 million from $15.1 million in 2021 as a result of the completion of certain strategic projects. So overall, we are continuing to manage the overall SGA&E cost base despite expected back-to-back years of double-digit revenue growth. Our overall profitability also improved during the quarter with adjusted EBITDA coming in at $10.4 million, an increase of $9.8 million from one year ago. For the full year, adjusted EBITDA was approximately $30 million, an increase of 98% year over year. The improvement in adjusted EBITDA was driven by improved macro trends, strong performances in all of our businesses with subsea product revenue up 15%, subsea services revenue up 10%, and downhole tools revenue up 6%. Turning now to bookings, we are continuing to see an uptick in demand in the offshore drilling market, especially in Brazil, the Middle East, Latin America, and some re-emerging markets such as West Africa. Bookings for the fourth quarter were 93.8 million, up 18% year-over-year and 52% sequentially. Our fourth quarter bookings marked the highest level we've experienced in three full years. For the full year 2022 bookings were 271.3 million, a 19% increase from 2021 As we look forward to the first quarter of 2023, we do expect to see a bit of a gap in bookings for the first quarter sequentially, likely in the $60 to $80 million range, due to the fact the fourth quarter tends to be seasonally very strong as customers utilize their remaining CapEx budgets. That said, we're in a very strong position, and as Jeff noted, as of the end of the fiscal year, we have around 70 open MSAs and feel good about our prospects to drive growth in the year ahead. We also ended the year with our backlog up 15% to $241 million as offshore drilling markets continue to improve. For 2023, we expect to fill approximately 70% to 80% of our current product backlog, with the remaining amount consisting of longer-term projects which are being designed and manufactured to customer specifications requiring longer lead times. Turning now to free cash flow. Free cash flow in the fourth quarter came in at negative $23 million and fell short of our break-even target for the year. As we think about the deltas for our full-year forecast, there really are three drivers. First, as we are continuing to grow, more of our subsea revenues are weighted towards longer-term project work, which tend to have limited milestone payments. During 2022, this portion of our revenue grew faster than we had anticipated, and this type of revenue makes up roughly 60% of the subsea product's total revenue, the highest it has been up from 30% just a few years ago. You can see that on the balance sheet and in the unbilled revenue balance, which increased $43 million year-over-year. Second, we were anticipating a large tax receivable from the IRS that was unfortunately held up. And lastly, we had about $10 million in cash used relating to our previously mentioned investment in manufacturing in Houston, real estate moves relating to our campus in Houston, and the stand-up of our new business unit structure, all of which were unforecasted a year ago. Cash flow will remain challenging as we continue to grow our backlog and revenues throughout 2023. Our incoming orders are expected to be weighted towards longer-term projects with limited milestone payments. Finally, we do anticipate bringing on $20 to $25 million relating to those additional real estate sales to help supplement ending cash next year. Our balance sheet continues to be extremely strong, one that allows us financial flexibility to continue to invest in our core business while managing the longer-term cash conversion cycle of the subsea products business. Before turning the call back over to Jeff, I will offer high-level 2023 outlook. In 2023, we expect revenue to increase approximately 10% over 2022. This, of course, is dependent on two main drivers, subsidy bookings and our downhill tools business growth. Adjusted EBITDA to improve at 40% to 60% incremental margins, which will depend on bookings mixed during 2023, the timing and execution of our previously discussed productivity initiatives. Bookings are expected to grow in the 10% to 20% range due to a large number of outstanding tree tenders and customer timing for upcoming projects. CapEx is expected to increase to 25 to 30 million in 2023. CapEx is expected to primarily consist of $11 million towards our wellhead manufacturing investment, facilities in Saudi Arabia and Mexico, and rental tools supporting downhole tools business growth in Brazil. With that, I will turn the call back over to Jeff.
spk07: Thanks, Kyle. While much has been accomplished, we know we still can do more to position our company for long-term success, advancing market share and overall profitability. We are well positioned to participate in strong market fundamentals and an upswing in the offshore market. The underinvestment over recent years across the industry has made for tightness today with long lead times for new and replacement equipment, and thus a constructive environment for continued investment given the commodity price outlook. We are keeping a pulse on customer behaviors and confidence, and we expect order trends and spending to accelerate in 2023. As I touched on earlier, we're seeing significant signs of progress in key markets in Saudi Arabia, Brazil, and Latin America. As we enter 2023, capital allocation will be a critical area of focus for Drillquip 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 include the evaluation of potential inorganic opportunities that align with our vision for the future. The M&A pipeline is rather strong, and as you would expect, we're consistently evaluating the M&A landscape with a wide aperture of opportunities. Any M&A opportunity, large or small, will adhere to our disciplined approach to capital allocation, and any target will need to fit strategic and financial criteria that will ultimately provide accretion to our shareholders. In conclusion, 2022 was a pivotal year for Drillquip, with significant progress being made along our long-term objectives. Furthermore, as you may have seen, we published our first corporate sustainability report in 2022. At Drillquip, we believe technology Innovation is key to improving our energy efficiency and providing people around the world with universal access to reliable, affordable, clean energy. I want to thank our extremely talented and committed team here at Drulequip for their efforts in pursuit of our vision for the company, their commitment to safety, and ongoing dedication to all our valued stakeholders.
spk05: With that, we'd like to open the line for any questions. Operator?
spk02: Thank you. Thank you. At this time, we'll conduct the question and answer. As a reminder, to ask a question, you'll need to press star 11 on your telephone and wait for your name to be announced. To withdraw your question, press star 11 again. Please stand by while we compile our Q&A roster. Our first question comes from the line of Eddie Kim of Barclays. Your line is open.
spk09: Hi, good morning. Could you just update us on your wellhead MSA with Petrobras? It just seems like the activity level and urgency from them has almost reached a fever pitch in just the last three months here, at least on the offshore rig side. But as it relates to drill equip, I know you got the MSA early last year for 87 wellheads. Have nearly all of those been called off at this point? And any update on the additional tenders you've been expecting from them?
spk07: Yeah, good morning, Eddie. Thanks for the question. Yeah, that 87 wellheads, I think about 50% of that has been called off today. We would expect the balance of that to be called off in 23, maybe early 24. There is a new tender that's already out there for the next tranche of wellhead systems. We would expect at least one tender. in 2023, probably about a year earlier than we would have expected. So to your point, things are definitely picking up a little quicker there than we would have expected. Team's doing a great job there of starting to ramp up from a manufacturing standpoint, from a service tech standpoint as well, and we're pretty excited about that. I also should comment on the Downhole Tools business, as we commented in the In the script, we do have 21 of our XPAC DE systems that are also under MSA. To date, only one or two of those have been called off. We would expect that to start to accelerate in 23 and into early 24 as well.
spk09: Okay, understood. And then just separately shifting to your EBITDA guide, a pretty impressive guide on EBITDA incremental margins. 40 to 60 percent this year. Approximately how much of that EBITDA increase would you estimate is from kind of cost out and footprint rationalization versus higher pricing? I have to imagine you're seeing higher pricing right now, but do you sort of have to get through lower price backlog this year before really seeing that benefit in 2024?
spk07: Yeah, I'll let Kyle walk through the details, but I think if I could divide our business between the subsea products and the downhole tool side, downhole tools does get pricing much quicker than the subsea side. The subsea side is definitely a backlog business. So when you look at our $240 million in backlog, as an example, the vast majority of that is subsea products. And you're right to say that's a lot slower to come through, but that downhole tool business turns
spk06: about every six to 12 weeks, so the pricing's really quick there, but I'll let Kyle walk through those details.
spk08: Yeah, I think on the productivity, if you will, or operational efficiency, we've got about five to 10 on a run rate basis once we've got our property rationalization completed. Obviously, Jeff talked about the sale of the Forge facility last year. We expect to close another two facilities before the end of Q2. That, on an annualized basis, is about five to 10. We'll get some of that this year, But I think the majority of sort of the year-on-year EBITDA increase is going to be through better mix and just volumes and then sort of legacy pricing coming back from, as Jeff mentioned, downhill tools. And then we've got obviously some stuff that's in backlog that we've taken into account pricing as it relates to inflation. So we'll see all the benefit, all of those kind of flow through coming out of backlog. And then, as Jeff mentioned, the book and ship nature of downhill tools.
spk09: Got it. Got it. Understood. Thanks for all that, Connor. I'll turn it back.
spk03: Thanks, Eddie.
spk02: Thank you. As a reminder, in order to ask a question, you'll need to press star 11 on your telephone. Since there are no further questions, we'd like to thank you for participation in today's conference. This does conclude the program, and you may now disconnect.
spk01: The conference will begin shortly. To raise and lower your hand during Q&A, you can dial star 1 1. you Thank you. Thank you. Thank you. Thank you. you
spk02: Good day, and thank you for standing by. Welcome to the DrillQuip Q4 Full Year 2022 Earnings Conference Call. To ask a question during this session, you'll need to press star 1-1 on your telephone. You'll then hear an automated message advising your hand is raised. To withdraw your question, press star 1-1 again. Please be advised that today's conference call is being recorded. I'd now like to hand the conference call over to your speaker today, Erin Fazio, Director of Corporate Finance. Please go ahead.
spk00: Thank you and good morning. Welcome to DrillClip's full year 2022 conference call. 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 DrillCup's comments may include forward-looking statements and discuss non-GAAP financial measures. It should be noted that a variety of factors could cause DrillCup's actual results to differ materially from the anticipated results or expectations expressed in these forward-looking statements. Please refer to the fourth quarter 2022 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 DrillClip, we have Jeff Bird, President and Chief Executive Officer, and Kyle McClure, Vice President and Chief Financial Officer. I will now turn the call over to Jeff Bird.
spk07: Thank you, Erin, and thank you all for joining us today. DrillClip delivered an incredibly strong fourth quarter, capping an important year where we met or exceeded most of our targets and made significant progress along our longer-term financial, operational, and strategic objectives. Total revenue grew double digits year over year, and our fourth quarter revenue was the highest quarter achieved since pre-pandemic. This was partly driven by several factors, such as aggressive investments from Brazil, offshore investments across multiple markets from large E&P customers, and price increases to offset inflationary pressures. Fourth quarter gross margin grew by over 15%. and our overall profitability improved with adjusted EBITDA reaching almost 11% in Q4 and improving 350 basis points year over year. Our improved margin profile, combined with our ongoing initiatives across the organization to drive operational efficiency, such as our investment in improved wellhead manufacturing and footprint optimization, will continue to support our performance moving forward. Cash flow fell short of our break-even target for the year. However, our cash position remains strong and allows us to strategically invest in a growing market. Kyle will provide some additional detail in this matter shortly. Bookings in the quarter were particularly strong at $94 million with no notable cancellations. This is the highest quarterly mark since Q4 2019 reflecting the ongoing up cycle in the offshore market, but also incrementally higher and in line with our typical Q4 seasonality. As strong as bookings were to end the year, it's worth noting that bookings do not include the entirety of any master service agreements or MSAs signed during the year. As customers call off from an MSA, we will then include those units in the bookings. For example, we signed a new MSA with a customer for a West Africa project in the fourth quarter for 30 subsea wellhead systems. But in the fourth quarter, only 10 were included in the bookings. During 2022, we signed over $122 million in new MSAs. And as of year end, we have approximately 70 open MSAs. We believe this model will continue to evolve as our customers are more thoughtful in managing their supply chains. We ended the year with a very strong and growing backlog of over $241 million, representing double-digit sequential and year-over-year growth as product bookings increased due to improving market conditions. A significant portion of this backlog will be filled in fiscal 2023 and we feel confident the underlying market dynamics are constructive for continued growth in 2023. In total, it was a strong financial year and a pivotal year as we set the stage for the future. These include key investments in terms of both footprint and boots on the ground. We entered 2023 with some very positive trends in our key markets. For example, our ongoing investment in Brazil, Saudi Arabia, Norway, and Latin America. In Saudi Arabia, we are continuing to make investments. We expected the upswing in activity in the region to drive subsea products and downhole tools growth in 2023 and beyond. Part of our investments in the region include the targeting of a new manufacturing facility in Saudi Arabia, as well as efforts to expand our qualified products. In Brazil, where we currently have a leading market position with our wellhead offering, we're also excited about our emerging downhole tools business growth potential. Brazil has announced plans to drill approximately 350 wells over the next five years, which calls into focus the importance of our strong relationship with Petrobras. In support of the expected demand, we're ramping up our stocking programs. Latin America has broadly been very constructive. Our downhole tools business has grown five times over the past few years. In 2022, we also had our first downhole tool order in Guyana, with expected follow-on orders in coming quarters. Norway North Sea is also picking up from a traditional oil and gas perspective due to the Ukraine-Russia conflict. We are well positioned with the service center in region to capture opportunities and serve our customers. Lastly, West Africa, a previously dormant region, is starting to come alive with strong signs of growth. We signed an MSA for wellheads there in the fourth quarter and will be actively pursuing other opportunities as the region reinvigorates. In addition to the financial successes and promising market trends, I want to touch on the fantastic progress the team has made on some key organic initiatives that now have us very well positioned to continue to drive profitable growth. As I step back and look at the year in full and what has been my first year as CEO and Kyle's first year as part of DrillQuip, We have a lot to be proud of as an organization. And most importantly, we have made great strides in standing up the new product line focused organization and setting the stage to ensure drillquip is positioned to capitalize on what is clearly a constructive offshore market with increasing tender volume and average quote value remaining above pre-pandemic levels. A dynamic we believe will continue to accelerate into 2023. Through our operational excellence initiatives and realignment efforts during the year, we have established the foundation of strong product line focused teams, and we began forming in early 2022. This organizational structure change is a multi-year journey, but is already bearing fruit by streamlining leadership, operations, and customer focus, while also eliminating excess costs and improving efficiency. We continue to progress our footprint optimization plan to improve efficiency and reduce excess capacity. During the third quarter, we closed the sale of the Forge facilities at our Houston, Texas campus for roughly $17 million. In addition, in the fourth quarter, we reached agreements to sell the two remaining Houston properties as previously discussed, and we anticipate closing in the first six months of 2023. For these two transactions, we expect the combined net proceeds to be in the $20 to $25 million range. This will conclude the current phase of our footprint rationalization that we outlined 12 months ago. These proceeds are earmarked to offset the previously announced $22 million investment in wellhead manufacturing. As a reminder, this investment will lower costs and improve productivity in the coming years. delivering approximately $10 million in annualized EBITDA by the back half of 2024. We feel confident in our ability to further advance our market position due to the significant progress we've consistently made along our growth strategy. For example, our 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. Another critical element of our growth strategy is our Downhole Tools business. As DrillClip's first acquisition, we swiftly implemented a targeted growth strategy, exiting unprofitable geographies, bolstering our commercial teams, streamlining our integrated supply chain, and enabling a new leadership team. These actions paid almost immediate dividends resulting in the business growing over 35% year-over-year in 2021 and growing again by 7% in 2022. More recently, we were awarded a contract to deliver up to 21 of our OTC award-winning EXPAC DE liner hangers for projects in Brazil through 2024. We see this growth trend continuing in 2023 and expect another 10% plus growth from 2022 levels. As we've previously discussed, we're targeting this business to expand to $100 million in annualized revenue run rate by the end of 2023. Finally, I want to highlight growth prospects in 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 improving their carbon footprint, we believe these products will become an integral solution to helping our customers meet their carbon footprint reduction goals. The most successful and best example of this suite of products thus far is our Big Board II-E wellhead system. We believe this system is setting a new industry standard. In 2022, we expect that this system would represent approximately 50% of all wellhead orders, and we exceeded in achieving that level. The most significant opportunity in this area is through our MSA with Petrobras which includes up to 87 systems through 2025. We are optimistic that as these installations gain traction and performance notoriety, we will see similar contract awards for other E-Series products. We continue to build on our E-Series of products. An example of this is the SBTE sub-C tree that is in the final rounds of testing. This innovative product dramatically lightens our tree offering to be able to serve customers in both the traditional shallow water market and the CCUS market in late 2023 and beyond. All of these efforts to stand up the organization and improve our competitive position, combined with a strengthening macro environment, gives us great confidence in our strength and foundation and our ability to drive profitable growth at DrillQuip. With that, I'll turn it over to Kyle for some color on the financial results. Kyle?
spk08: Thank you, Jeff, and good morning, everyone. As Jeff mentioned, the company delivered strong fourth quarter and four-year results as we continue to make progress along our initiatives for the business, and we believe we are well-positioned to execute on opportunities in this constructive market. Looking at our results, fourth quarter revenue was $96.8 million, an increase of 24% year-over-year, driven primarily by higher product and service revenues across all regions, reflecting the ongoing upcycle in the offshore markets. For the full year of 2022, revenue was $362.1 million and was up 12% year over year. The year over year increase was primarily driven by higher product revenues across all regions, partially offset by lower service revenues in Asia Pacific. Gross margins during the fourth quarter were 31.2%, up 979 basis points year over year. This improvement in gross margin is largely due to leverage on higher revenues, product mix, gains in pricing, and our ongoing initiatives across the organization to drive operational efficiency. SG&A expenses decreased by 18% to $94.2 million in 2022 from $115 million in 2021 due to lower legal expenses in connection with the FMC lawsuit. Excluding those legal charges in 2021, SG&A was roughly flat year-on-year. Additionally, engineering expenses also decreased by 23% to $11.7 million from $15.1 million in 2021 as a result of the completion of certain strategic projects. So overall, we are continuing to manage the overall SGA&E cost base despite expected back-to-back years of double-digit revenue growth. Our overall profitability also improved during the quarter with adjusted EBITDA coming in at $10.4 million, an increase of $9.8 million from one year ago. For the full year, adjusted EBITDA was approximately $30 million, an increase of 98% year-over-year. The improvement in adjusted EBITDA was driven by improved macro trends, strong performances in all of our businesses with subsidy product revenue up 15%, subsidy services revenue up 10%, and down-hold tools revenue up 6%. Turning now to bookings, we are continuing to see an uptick in demand in the offshore drilling market, especially in Brazil, the Middle East, Latin America, and some re-emerging markets such as West Africa. Bookings for the fourth quarter were 93.8 million, up 18% year-over-year and 52% sequentially. Our fourth quarter bookings marked the highest level we've experienced in three full years. For the full year 2022, bookings were 271.3 million, a 19% increase from 2021 last year. As we look forward to the first quarter of 2023, we do expect to see a bit of a gap in bookings for the first quarter sequentially, likely in the $60 to $80 million range, due to the fact the fourth quarter tends to be seasonally very strong as customers utilize their remaining CapEx budgets. That said, we're in a very strong position, and as Jeff noted, as of the end of the fiscal year, we have around 70 open MSAs and feel good about our prospects to drive growth in the year ahead. We also ended the year with our backlog up 15% to $241 million as offshore drilling markets continue to improve. For 2023, we expect to fill approximately 70% to 80% of our current product backlog, with the remaining amount consisting of longer-term projects which are being designed and manufactured to customer specifications requiring longer lead times. Turning now to free cash flow. Free cash flow in the fourth quarter came in at negative $23 million and fell short of our break-even target for the year. As we think about the deltas for our full-year forecast, there really are three drivers. First, as we are continuing to grow, more of our subsea revenues are weighted towards longer-term project work, which tend to have limited milestone payments. During 2022, this portion of our revenue grew faster than we had anticipated, and this type of revenue makes up roughly 60% of the subsea product's total revenue, the highest it has been up from 30% just a few years ago. You can see that on the balance sheet and in the unbilled revenue balance, which increased $43 million year-over-year. Second, we were anticipating a large tax receivable from the IRS that was unfortunately held up. And lastly, we had about $10 million in cash used relating to our previously mentioned investment in manufacturing in Houston, real estate moves relating to our campus in Houston, and the stand-up of our new business unit structure, all of which were unforecasted a year ago. Cash flow will remain challenging as we continue to grow our backlog and revenue throughout 2023. Our incoming orders are expected to be weighted towards longer-term projects with limited milestone payments. Finally, we do anticipate bringing on 20 to 25 million relating to those additional real estate sales to help supplement ending cash next year. Our balance sheet continues to be extremely strong, one that allows us financial flexibility to continue to invest in our core business while managing the longer-term cash conversion cycle of the subsea products business. Before turning the call back over to Jeff, I will offer high-level 2023 outlook. In 2023, we expect revenue to increase approximately 10% over 2022. This, of course, is dependent on two main drivers, subsidy bookings and our downhill tools business growth. Adjusted EBITDA to improve at 40% to 60% incremental margins, which will depend on bookings mixed during 2023, the timing and execution of our previously discussed productivity initiatives. Bookings are expected to grow in the 10% to 20% range due to a large number of outstanding tree tenders and customer timing for upcoming projects. CapEx is expected to increase to 25 to 30 million in 2023. CapEx is expected to primarily consist of $11 million towards our wellhead manufacturing investment, facilities in Saudi Arabia and Mexico, and rental tools supporting downhole tools business growth in Brazil. With that, I will turn the call back over to Jeff.
spk07: Thanks, Kyle. While much has been accomplished, we know we still can do more to position our company for long-term success, advancing market share and overall profitability. We are well positioned to participate in strong market fundamentals and an upswing in the offshore market. The underinvestment over recent years across the industry has made for tightness today with long lead times for new and replacement equipment, and thus a constructive environment for continued investment given the commodity price outlook. We are keeping a pulse on customer behaviors and confidence, and we expect order trends and spending to accelerate in 2023. As I touched on earlier, we're seeing significant signs of progress in key markets in Saudi Arabia, Brazil, and Latin America. As we enter 2023, capital allocation will be a critical area of focus for Drillquip 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 the flexibility to consider multiple investment paths. These opportunities include organic initiatives and include the evaluation of potential inorganic opportunities that align with our vision for the future. The M&A pipeline is rather strong, and as you would expect, we're consistently evaluating the M&A landscape with a wide aperture of opportunities. Any M&A opportunity, large or small, will adhere to our disciplined approach to capital allocation, and any target will need to fit strategic and financial criteria that will ultimately provide accretion to our shareholders. In conclusion, 2022 was a pivotal year for Drillquip, with significant progress being made along our long-term objectives. Furthermore, as you may have seen, we published our first corporate sustainability report in 2022. At Drillquip, we believe technology innovation is key to improving our energy efficiency and providing people around the world with universal access to reliable, affordable, clean energy. I want to thank our extremely talented and committed team here at Droolquip for their efforts in pursuit of our vision for the company, their commitment to safety, and ongoing dedication to all our valued stakeholders.
spk05: With that, we'd like to open the line for any questions. Operator?
spk02: Thank you. Thank you. At this time, we'll conduct the question and answer. As a reminder, to ask a question, you'll need to press star 11 on your telephone and wait for your name to be announced. To withdraw your question, press star 11 again. Please stand by while we compile our Q&A roster. Our first question comes from the line of Eddie Kim of Barclays. Your line is open.
spk09: Hi, good morning. Could you just update us on your wellhead MSA with Petrobras? It just seems like the activity level and urgency from them has almost reached a fever pitch in just the last three months here, at least on the offshore rig side. But as it relates to drill equipment, I know you got the MSA early last year for 87 wellheads. Have nearly all of those been called off at this point? And any update on the additional tenders you've been expecting from them?
spk07: Yeah, good morning, Eddie. Thanks for the question. Yeah, that 87 wellheads, I think about 50% of that has been called off to date. We would expect the balance of that to be called off in 23, maybe early 24. There is a new tender that's already out there for the next tranche of wellhead systems. We would expect at least one tender. in 2023, probably about a year earlier than we would have expected. So to your point, things are definitely picking up a little quicker there than we would have expected. Team's doing a great job there of starting to ramp up from a manufacturing standpoint, from a service tech standpoint as well, and we're pretty excited about that. I also should comment on the Downhole Tools business, as we commented in the In the script, we do have 21 of our XPAC DE systems that are also under MSA. To date, only one or two of those have been called off. We would expect that to start to accelerate in 23 and into early 24 as well.
spk09: Okay, understood. And then just separately shifting to your EBITDA guide, a pretty impressive guide on EBITDA incremental margins. 40 to 60 percent this year. Approximately how much of that EBITDA increase would you estimate is from kind of cost out and footprint rationalization versus higher pricing? I have to imagine you're seeing higher pricing right now, but do you sort of have to get through lower price backlog this year before really seeing that benefit in 2024?
spk07: Yeah, I'll let Kyle walk through the details, but I think if I could divide our business between the subsea products and the downhole tools side, downhole tools does get pricing much quicker than the subsea side. The subsea side is definitely a backlog business. So when you look at our $240 million in backlog as an example, the vast majority of that is subsea products. And you're right to say that's a lot slower to come through, but that downhole tool business turns about every six to 12 weeks.
spk06: So the pricing is really quick there, but I'll let Kyle walk through those details.
spk08: Yeah, I think on the productivity, if you will, or operational, efficiency. We've got about 5 to 10 on a run rate basis once we've got our property rationalization completed. Obviously, Jeff talked about the sale of the Ford facility last year. We expect to close another two facilities before the end of Q2. That on an annualized basis is about 5 to 10. We'll get some of that this year, but I think the majority of sort of the year-on-year EBITDA increase is going to be through better mix and just volumes and then sort of legacy pricing coming back from, as Jeff mentioned, downhill tools. And then we've got Obviously, some stuff that's in backlog that we've taken into account, pricing as it relates to inflation. So we'll see all the benefit, all those kind of flow through coming out of backlog. And then as Jeff mentioned, the book and ship nature of downhill tools.
spk09: Got it. Got it. Understood. Thanks for all that, Connor. I'll turn it back.
spk03: Thanks, Eddie.
spk02: Thank you. As a reminder, In order to ask a question, you'll need to press star 11 on your telephone. Since there are no further questions, we'd like to thank you for participation in today's conference. This does conclude the program, and you may now disconnect.
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