Earnings Call: Q3 2023

Nov 13, 2023

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to Koil Energy's third quarter 2023 conference call. During the presentation, all participants will be in listen-only mode. After the speaker's remarks, you will be invited to participate in a question and answer session. As a reminder, this call is being recorded today, Monday, November 13th, 2023. A detailed disclaimer related to Koil Energy's forward-looking statements is included in the press release issued Thursday afternoon and filed with the SEC. It is also available on the company's website, koilenergy.com, or upon request. A reconciliation of non-GAAP financial measures used in the press release and on today's call is included in the press release and on the website. Listeners are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date made. Koil Energy Solutions also undertakes no obligation to revise any of its forward-looking statements to reflect events or circumstances after the date made. At this time, I'd like to turn the call over to CEO Charles Njuguna. Please go ahead. Thank you, Gary. Good morning, and thank you for joining us today. Our third quarter results reflect the prevailing climate that has been a feature of the offshore oil and gas industry over the past few years. The increase in revenue is characteristic of the recovery we are beginning to see, especially in the deepwater segments, hampered by continued effects of price pressures we faced during the recent downturn, which led us to strategically price some projects at lower than ideal margins. Yes, our cash balance at the end of the quarter was concerningly low. Having collected over $2.6 million since the end of the quarter, our current cash balance is roughly what it was at the beginning of the year. In a moment, Trevor will provide further details about our financials, but first we'll take a look at the broader business environment. Few industries are as impacted by geopolitical events as the oil and gas industry. The tragedies unfolding around the world have led to increased conversations about energy security. When these events are coupled with the underinvestment in offshore developments during the pandemic and its immediate aftermath, and a major focus on new energy sources for the past couple of years, there's a growing consensus about the need to rapidly replenish depleted offshore reserves. A viewpoint we are witnessing firsthand as we engage our customers. This changing offshore outlook provides cautious optimism for us to follow up recent project announcements with further announcements. For instance, we previously mentioned a couple of significant carousels opportunities which were supposed to have kicked off during the first half of last year, but were both delayed for different reasons. At the time, we talked about having gone through several rounds of clarifications with the customers, and in both cases, having commitment dates by which the customers expected to initiate the projects, before both projects were ultimately delayed. While the delays ended up being longer than initially expected, we have recently had conversations about both projects and remain cautiously optimistic about providing positive updates of at least one of them in coming months. Public commentary has also described an increase in project funding decisions, commonly referred to as final investment decisions, or FIDs, with one highly regarded organization estimating FIDs in 2023 to be 60% higher than the average over the past eight years. The amount of bidding activity we are engaging bears this out, with our year-to-date project awards almost totaling our full year 2022 project awards. If current conversations pan out as our customers have indicated, we could potentially announce a few million dollars worth of new orders before the end of the year, the revenue of which should be mostly realized in 2024. However, as we have repeatedly witnessed, things could shift to the right. Speaking of 2024 revenues, a good portion of the revenue from the projects we recently announced will also be realized next year, given the long cycle engineering that's required, as well as delays in the receipt of third-party components which are required for integration into the systems we're building. Despite the slower than ideal industry recovery, we have continued using this time to further our repositioning efforts, such as by advancing our product designs while simultaneously streamlining our engineering and manufacturing processes. A key initiative has been standardization of traditionally custom design products, including some assets which previously were thought not to be candidates for standardization. I recently sat through a demonstration of the improvements made to one of our core products, and while I acknowledge I may be biased, I was very impressed by the progress made by our engineering team. Speaking of product improvements, the new 20,000 PSI subsea connector we previously announced recently passed all third-party qualification testing, including some testing which, as far as we can tell, has never been performed on any competing product. While working on this project, our engineers were able to reduce the product's unique part count by about 50% over the previous design, while more than doubling its capacity. These efforts have not gone unnoticed by our customers, as evidenced by new requests following the qualification testing. What do these improvements mean for our shareholders? In addition to widening the technical breadth of our product offerings, these efforts enable quicker project execution, therefore speeding up revenue recognition and project cash flows, ultimately resulting in improved project profitability. Our revenues and profitability increase as we execute large quantity fixed price projects, where we design, engineer, and manufacture subsea equipment. These efforts are therefore directly tied to value generation. These efforts also directly correlate to our customers' value drivers, with a key driver being the ability to achieve fast oil as quickly as possible. Building on the company's historical reputation for creative solutions to one-off problems, we have been able to broaden our name beyond just getting our customers' existing fields back online faster than the competition, to also getting new fields online faster than our competitors, while meeting oil quality and documentation requirements. All factors being constant, and hoping the geopolitical issues do not broadly escalate, 2024 is shaping up to be the turnaround year we have all been waiting for. Our optimism for the future is further enhanced by the momentum we're seeing from our rebranding and relocation efforts, and the rekindling of former customer relationships, with $several million worth of recent project awards being directly attributable to these efforts. With the worst of the downtime appearing to be behind us, our focus is on our growth trajectory characterized by a four-pillar strategy. The first pillar is our value proposition of being the fastest enabler of our customers' ability to achieve fast oil or fast gas for new developments, or where we're working on remediation projects, getting them back online the fastest. With continued supply chain challenges being faced across the industry, timely project deliveries stands out to our customers. The second pillar is our relentless focus on funding our future, which is a function of a laser focus on our cash position, and a continuous focus on cost rationalization. The third pillar revolves around our products and service offerings through a renewed product improvement and innovation mindsets. Finally, we ensure we have the right team in place to serve our customers well, and we provide the tools and development necessary to ensure our team succeeds. This is through both development of homegrown talents, as well as augmentation with missing skill sets, and where necessary, making changes to ensure maximum cohesion. With our transformation efforts largely behind us, momentum building from the industry's positive reactions to these efforts, and market conditions appearing to trend in our favor, the foundations of the company have never been stronger, and we are optimistic that our shareholders will soon start realizing positive benefits from these efforts, even as we acknowledge the turnaround has taken longer than we'd have all wanted. With that overview, I will now turn the call over to our Vice President of Finance, Trevor Ashurst. Trevor? Thank you, Charles. Let's now take a minute to review our third quarter results. For the three months ended September 30, 2023, Koil Energy Solutions generated revenues of $4.1 million, which represents an 82% increase when compared to the revenues of $2.3 million for the three months ended September 30, 2022. This year-over-year improvement in revenues reflects a collective uplift in both service, project, and product-oriented fixed price project activity. Gross profit was $1.4 million, or 33% of revenues for the third quarter of 2023. This represents a 21% increase in gross margin when compared to the $269,000 or 12% of revenues we generated for the third quarter of 2022. This relative improvement in gross margin was mainly due to recognizing higher revenues I just mentioned, as well as lower rent expenses during the past quarter. Operating expenses were $1.6 million in Q3 of 2023, compared to $1.7 million in Q3 of 2022. The 7% decrease was primarily due to relocation costs incurred by the company in the third quarter of last year that were not repeated in the third quarter of this year. The decrease in operating expenses was partially offset by higher R&D costs for the development of our 20,000 PSI MQC plate. Turning to the bottom line, the company reported net loss of $143,000 for the third quarter, which translates to a $0.01 loss per diluted share. Our results for the quarter reflect the impact of a few projects we're working through that were strategically priced prior to this year's rise in bidding activity. This is compared to generating a net loss of $1.6 million, or $0.13 loss per share for Q3 of 2022. The comparative increase in earnings was driven by gross profit improvement associated with increase in both fixed price and service project activity. Moving to the balance sheet, our capital structure is composed of $3.4 million in working capital, which includes $1.1 million in cash and $5.5 million in receivables as of September thirtieth this year. This is compared to having $3.6 million of working capital as of December 31st of 2022, which includes $2.4 million in cash and $2.9 million in receivables. As Charles mentioned earlier, we deployed some funds towards building working capital in the third quarter, which led to a dip in our cash balance at quarter end. However, some of this working capital has since been converted to cash to bring our balances back to expected levels. We also had an outstanding $669,000 receivable at quarter end that was related to Employee Retention Credits claimed under the provisions of the CARES Act. Subsequent to the end of the quarter, we received a $344,000 refund related to these Employee Retention Credits. We unfortunately do not have visibility on when the remainder of this credit might be paid. This concludes the financial summary for the third quarter. Thank you for your time. I'll now turn the call back over to Charles. Thank you, Trevor. That concludes our prepared remarks today. I'll turn the call back to the operator to take investor questions. Gary? We will now begin the question and answer session. To ask a question, you may press star then one on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. Our first question today comes from Walter Schenker with MAZ Partners. Please go ahead. Hi, Charles. Hi, Walter. Two different subjects. One, I didn't have to ask you about carousels. You brought them up. Could you just give a little more color why, after lo these many years, you seem to be or hopefully are more confident that we're actually going to get some economic return from them in the not-too-distant future? First question. Yes. Thanks, Walter. The reason for the optimism, cautiously, is that there are some large projects which were put on hold. One, in particular, relates to. There have been a number of consolidations in the industry, and so in one case, an oil company was moving forward with a project, and then they got into an M&A situation. The projects were put on hold while they watched through all the governmental regulations of the transaction and approvals from different governments. All of that is now behind them, and they are ready to move forward from what they've told us. Okay. Realizing the future is hard to predict, you would hope to hear something within a quarter, 2 quarters? Now that it seems to be moving forward again. By year-end? At this point, they say within a quarter, but again, like I said previously, they even gave us a start date. Right now, yes, within the next, let's say three months, they've indicated we should hear something. This would be potentially a rental or sale? Right now, we're discussing a rental. The sale option is also on the table, so it depends on the timeline of how long they want it, but it's more for a storage application. It's a long-term storage, so once they determine the length of their project, at some point, the economics switch over to make it more palatable for them for a sale. It could go either way. Okay. Just in general, you express increasing optimism for meaningful orders and improving revenues as we look into next year. How much of that is a function of a generally better environment so that as you look out, there just seems to be more interest, and how much of it is specific to either your capabilities or projects you're already discussing with people, which hopefully have a higher likelihood of coming to fruition? It's a lot of the latter. We have a fair amount of very specific projects we're discussing with clients for larger quantities. For instance, over the past 2 or 3 years, we've probably had a handful of flying leads that we've built, and in many cases, been 1 or 2. Right now, this year alone, I think we're working probably on about 30 flying leads. We have some large quantity orders we are working on or that we're discussing, and that's what gives us optimism that things are looking up, in addition to the general environment. Given the improved outlook, pricing going forward will be at better margins, so that the projects all should be hopefully profitable to meaningfully profitable if we get increased revenues? Yes, sir. In addition to us also evaluating our cost structure internally. Okay. Looking forward, I would expect a $4 million-$5 million quarter in revenues to be a profitable quarter, all other things being equal? That is our target, yes, sir. Okay. Well, good luck on the carousels, especially. Thank you, Charles. Thank you, Walter. Again, if you have a question, please press star then one. Please stand by as we poll for questions. Our next question is from Frank Wisniewski, a private investor. Please go ahead. Hey, good morning, Charles. Morning, Frank. The 20,000 PSI project. Is the R&D for that completed now? Yes, it's substantially done. We are still working through some final paperwork and clarifications with the regulatory agency, but it's substantially done now. All right. I know it's not a huge number, but would we expect it to decline, or are there other things you're working on that will keep that R&D number higher? It probably would stay potentially relatively flat. We have a couple of other things we are thinking of for next year, but as a percentage of revenues, it would go down, because we've been very strategic with our R&D. As a percentage of it now, because revenues are going up, hopefully, right? Yes, exactly. Revenues are going up, R&D as a percentage. Yeah. What kind of markets, you mentioned that there had been a lot of interest in it. What kind of markets does that get you into? What kind of customer? Does it broaden your market at all, or does it just make you stronger in the areas you are already competing in? This particular product makes us stronger in the deepwater oil and gas markets because it's 20,000 PSI is the next frontier. However, the efforts that have been done in some of the features that have been used to come up with this product. We've identified some new markets we may be able to extend those features into, and that's where additional R&D could occur in 2024. What kind of We could build on that platform. Sorry, go ahead. Do you have much competition in the 20,000 PSI area? There's a handful of the big billion-dollar companies in the industry that have 20,000 PSI similar connectors, but there's some testing we've done that they haven't done. It's more of a function of now going to the market and selling it. What it does is, with all the consolidations happening with the bigger companies, for a company of our size, able to get it to market a lot quicker than some of the other ones, it does open up the market for us. As recently as last week, I was in Asia speaking about some developments in that part of the world, and they were very open to conversations about it because we can get it to market quicker. Yeah. Interesting. Switching to the balance sheet for a minute. The receivables, obviously, Trevor has said that a lot of the receivables have come in. You've got a little bit of the employee retention cash coming in. I noticed you've used your factoring facility to a very modest degree. Would you see you having to use that factoring more now that your cash position is so good, or are you in that much need of working capital that you'd be factoring out some of the other receivables? Yeah. The factoring is more of a backstop. We did factor one invoice. Yep. Part of that was really, the bank is heavily incentivized for us to use it, and they really asked us a lot about why aren't we using it, and we got it. We really have factored one invoice just to- Yeah. It was tiny, too. It was only about a quarter of a million bucks or something. Yeah. Just to make sure that when the time comes, if we need it, how would the process work? Yeah. At this point, we are managing just using our cash and expect to continue doing the same. Okay, good. Thank you. Happy with the improved prospects, and wish you good luck going forward. Thank you, Frank. Always good talking to you. This concludes our question and answer session. I would like to turn the conference back over to Charles Njuguna for any closing remarks. Thank you, Gary, and thank you to everyone for your continued interest in the company. We look forward to providing further updates in coming months. With that, let's conclude today's call. Thank you. The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.