ChampionX Q3 2023 Earnings Call Transcript

Quartr
Provided by Quartr
October 25, 2023

There are 11 speakers on the call.

Operator

Good morning. Welcome to Champion X Corporation's Third Quarter 2023 Earnings Conference Call. Your host for this morning's call is Byron Pope. I will now turn the call over to Mr. Pope.

Operator

You may begin.

Speaker 1

Thank you. Good morning, everyone. With me today are Thomas Somasundaram, President and CEO of Champion X and Ken Fisher, our Executive Vice President and CFO. During today's call, Soma will share some of our company's highlights. Ken will then discuss our Q3 results and the Q4 outlook Before turning the call back to Soma for some summary thoughts, we will then open the call for Q and A.

Speaker 1

During today's call, we will be referring to the slides posted on our website. Let me remind all participants that some of the statements we will be making today are forward looking. These matters involve risks and uncertainties that could cause material difference in our results from those projected in these statements. Therefore, I refer you to our latest same day filing and our other SEC filings for a discussion of some of the factors that could cause actual results to differ materially. Our comments today may also include non GAAP financial measures.

Speaker 1

Additional details on reconciliations to the most Directly comparable GAAP financial measures can be found in our Q3 press release, which is available on our website. I will now turn the call over to Soma.

Speaker 2

Thank you, Byron. Good morning, everyone. I would like to welcome our shareholders, employees and analysts geographically diversified portfolio in the 3rd quarter as we delivered adjusted EBITDA growth and margin expansion Despite some near term crosscurrents in our short cycle U. S. Land businesses, we once again delivered robust free cash flow generation and returned excess capital to our shareholders.

Speaker 2

I am appreciative of all our employees for their focus and tireless dedication to delivering value to our customers day in and day out. On Slide number 4, we begin our earnings call with our corporate vision, Purpose and operating philosophy because we wake up every day committed to improving the lives of our customers, our employees, our shareholders and our communities. On Slide number 5, we share one example of the many types of Champion X Innovation, With the Emerge from being relentless advocates for our customers and delivering technology with impact, Our SOPI Continuous Emission Monitoring System, which was designed from the ground up to be an effective and accessible solution Our continuous monitoring of on-site methane emission detection and this case study illustrates However, our SOPY system helped one of our customers detect and avoid a catastrophic leak at one of its production facilities in real time, resulting in environmental and financial savings. Our AURA Optical Gas Imaging or OGI camera is a natural complement to our 2Q system and is designed to help our customers meet current and future emissions monitoring needs by accurately detecting and documenting even small methane leak. Now turning to 3rd quarter performance.

Speaker 2

Our 3rd quarter revenue increased 1% sequentially As strong international growth in our Production Chemical Technologies and Production and Automation Technologies businesses were largely offset by lower activity in U. S. Land driven by lower drilling and completions activity. In Q3, U. S.

Speaker 2

Rigs declined almost 10% sequentially and U. S. Completions activity declined over 9% sequentially, impacting revenues in our Drilling Technologies and PAT segments. Our digital revenues increased 17% year over year. We remain highly encouraged by the continued strong adoption of our fit for purpose digital solutions, including our emissions management technologies that drive tangible productivity and sustainability benefits for our customers.

Speaker 2

Our continuous emissions monitoring technology installations We continue to deliver strong EBITDA performance. During the 1st 9 months of 2023, Our adjusted EBITDA grew 28% year over year and our adjusted EBITDA margin expanded 4 37 basis points compared to the 1st 9 months of 2022. Ken will take you through the details of our Q3 financial results shortly, But let me first touch on 3 key business highlights, which are shown on Slide number 6. First, EBITDA margin expansion. Despite experiencing $7,000,000 of foreign exchange losses related to Argentina currency devaluation, We delivered an adjusted EBITDA margin of 20.2% in the 3rd quarter, which represents our This is the consecutive quarter of sequential adjusted EBITDA margin improvement.

Speaker 2

Based on the midpoint of our Q4 guidance, For full year 2023, we will deliver an adjusted EBITDA margin expansion of 3 70 basis points compared to 2022. We remain confident in our ability to further expand our adjusted EBITDA margin as we step through 2024. 2nd, free cash flow. We delivered another strong free cash flow quarter, having generated free cash flow of $115,000,000 which represented 60% of adjusted EBITDA. This further demonstrates the best in class Free cash flow generating capability of our capital light portfolio of businesses and illustrates our high degree of confidence In converting at least 50% of EBITDA to free cash flow in 2023 and delivering between 50% to 60% conversion of EBITDA to free cash flow through the cycle.

Speaker 2

We expect our free cash flow to continue to grow in the coming years, driven by EBITDA growth and margin expansion. 3rd, returning capital to shareholders. Our disciplined capital allocation framework It's designed to create value for our shareholders. And in the Q3, we once again delivered on our commitment to return excess cash to our shareholders. In the Q3, between our regular cash dividend of $17,000,000 $68,000,000 of share repurchases, We returned 74% of our free cash flow to shareholders.

Speaker 2

Since we began our capital return program in the Q2 of 2022, We have returned $434,000,000 of capital to shareholders through dividends and stock repurchases. This represents 66% of the free cash flow generated during the same period. We expect our capital returns to grow disappear and through the cycle. Let me now turn the call over to Ken to discuss our Q3 results and our Q4 outlook.

Speaker 3

Thank you, Soma. Good morning and thank you for joining us today. I will be commenting on adjusted EBITDA for Sequential and year over year comparisons. We believe this metric best reflects the business performance of continuing operations. Our Q3 2023 revenue was $940,000,000 up 1% versus our Q2 2020 Revenues, while 8% lower than Q3 of 2022.

Speaker 3

On a geographic basis, Sequentially, North America and International revenues were up 1% and 2%, respectively. Drilling down, overall U. S. Revenues were flat quarter over quarter with PCT up 6% And PAT and DT down 3% 7%, respectively. Meanwhile, The rest of the world revenues were up 3% sequentially driven by solid growth in PCT and PAT.

Speaker 3

Year over year, North American revenues declined 2%, while international revenues were 17% lower. In the Q3, our largest business, Production Chemical Technologies, generated solid sequential revenue growth of 5% with both North America and international contributing positively. With declining U. S. Rig count and lower new well Leasing activities are shorter cycle U.

Speaker 3

S. Land businesses were impacted in the quarter with Production and Automation Technology Revenues up slightly at 1% and Drilling Technologies down 4% versus the Q2 of 2023. As previously communicated, sales to Ecolab under the cross sales agreement ended with the passing of the 3rd Anniversary of our merger date. As such, any sales to Ecolab are now reported in the Production Chemical Technologies segment and no longer reported in corporate and other. 3rd quarter GAAP net income for the company was $78,000,000 or 0.39 dollars per diluted share versus $96,000,000 in the 2nd quarter $23,000,000 in the Q3 of 2022.

Speaker 3

As seen on Slide 10, ChampionX consolidated adjusted EBITDA in the 3rd quarter was 190,000,000 up 2% versus the previous quarter and a 14% increase year over year. 3rd quarter adjusted EBITDA Included the impact of approximately $7,000,000 of foreign exchange loss related to devaluation of our peso exposure in Argentina during the period. In the Q3, ChampionX delivered a strong consolidated adjusted EBITDA margin of 20.2%. This was up 7 points sequentially and up 3.91 basis Our 3rd quarter free cash flow of $115,000,000 reflected Strong cash flow from operations and our continued focus on working capital management. The $115,000,000 represented 60 And capital investment was $48,000,000 net of proceeds from asset sales.

Speaker 3

Production Chemical Technologies generated 3rd quarter revenue of $604,000,000 up 5% from the 2nd quarter and 6% lower year over year. Sales were strong in North America and internationally where respective revenues were up 5% and 6 Segment adjusted EBITDA was $125,000,000 up 7% sequentially and 22% higher than the Q3 of 2022. The 3rd quarter segment adjusted EBITDA was Conversely impacted by the aforementioned $7,000,000,000 Argentina foreign exchange loss during the period. Sequentially, we saw a positive impact from higher volumes and productivity projects. Volume growth, increased selling price And productivity projects drove the strong year over year improvement.

Speaker 3

Segment adjusted EBITDA margin was 20 point 7%, up 37 basis points sequentially and up 4 72 basis points from the prior year's period, driven again by the higher volume selling prices and the productivity initiatives previously noted. Production and Automation Technologies 3rd quarter segment revenue of 256,000,000 Increased 1% sequentially. Year over year, PAT revenue was up 3%. Geographically, international revenue increased 9% sequentially, while North America revenue was down 1%. Digital revenues, which can exhibit some lumpiness quarter to quarter, were down 4% sequentially, while increasing 17% year over year.

Speaker 3

We continue to see increased customer focus on implementing digital and emissions technologies To reduce emissions and drive operational and cost improvements, we remain very excited about expected future revenue growth from digital, including our emissions offering. TAC 3rd quarter segment adjusted EBITDA was 59,000,000 Lower 2% sequentially, while up 14% year over year. Segment adjusted EBITDA margin was 23.2%, down 73 basis points versus the 2nd quarter and up 213 basis points from the prior year Due to higher volumes and selling prices, Drilling Technologies segment revenue was $55,000,000 in the 3rd quarter, down 4% sequentially and down 10% year over year with both declines driven by lower U. S. Land rig count activity.

Speaker 3

Drilling Technologies delivered segment adjusted EBITDA of $14,000,000 during the 3rd quarter, flat sequentially and down $3,000,000 compared to the Q3 of 2022. Segment adjusted EBITDA margin was 20 5.1% in the quarter, flat sequentially. Reservoir Chemical Technologies revenue For the Q3, it was $25,000,000 up 5% sequentially and a 29% decrease year over year. As previously discussed, the year over year revenue decline was driven by the exit of certain low margin RTP product lines last year. This exit resulted in lower revenues, but a significant improvement in the margin profile of this business.

Speaker 3

The segment posted Adjusted EBITDA of $4,000,000 during the 3rd quarter, flat with 2nd quarter and up $1,500,000 versus the corresponding prior year period. Segment adjusted EBITDA margin was 16.6% in the quarter, a 110 basis point sequential decline. Year over year, the segment margin increased 9 14 basis points driven by the product line exit and related restructuring actions. Moving to our balance sheet. As shown on Slide 11, we again ended the 3rd quarter in very strong position With liquidity of $954,000,000 including $285,000,000 of cash on hand and our available revolver capacity.

Speaker 3

At September 30, our net leverage ratio was 0.4x net debt to trailing 12 month adjusted EBITDA. In alignment with our capital allocation framework, we remain committed to the return of surplus capital to our shareholders. During the Q3, we returned approximately 70 4 percent of quarterly free cash flow to shareholders, $17,000,000 in regular quarterly dividends $68,000,000 of share repurchases. Year to date, we have returned 76% of Moving forward, expect us to continue our disciplined capital allocation process and are focused on delivery of operating and free cash flow along with continued improvement in working capital management. We will also focus on maintaining our robust liquidity level and a strong financial position enabled to Continue returning at least 60% of free cash flow to shareholders.

Speaker 3

As we continue to drive Disciplined capital allocation and continuous improvement in productivity, as you can see on slide 12, we continue to improve our return on invested capital or ROIC. We are making good progress toward our targeted 20% plus ROIC. Our trailing 12 month ROIC has improved to 17%, up approximately 400 basis points over the 2022 full year actual rate. Now turning to Slide 13 and our forward outlook for 4th quarter, we expect revenue in the range of 9.30 to $970,000,000 The projected 4th quarter revenue sequential change is primarily driven by Continued positive momentum in our international businesses, offset by expected seasonal slowdowns in our North American businesses As they move into the year end holiday, we expect our Drilling Technologies business to experience a sequential revenue decline Similar to that of the Q4 of 2022 as some of our customers act to manage their working capital and free cash flow in the year end. For adjusted EBITDA, we expect a range of $187,000,000 to $197,000,000 which at the midpoint represents a 7% increase over the Q4 of 2022.

Speaker 3

At the midpoint, this represents an approximate EBITDA guidance does not anticipate any further significant devaluation in the Argentine peso during the period. Moving forward, we remain confident in our 50% to 60% free cash flow to adjusted EBITDA conversion ratio guidance And we expect a free cash flow ratio of at least 50% for Q4 and the full year of 2023. Thank you. And now back to Zohr.

Speaker 2

Thank you, Ken. Before we open the call to questions, let me share a few thoughts with you. As a leading global provider of production optimization solutions for the energy industry, we are particularly well positioned to help our upstream and midstream customers In our short cycle U. S. Land businesses, we expect U.

Speaker 2

S. Activity to start growing in early 2024 As customer budgets reset, we remain confident in the favorable demand tailwinds for our businesses in 2024 and beyond. We are laser focused on delivering solid bottom line growth, adjusted EBITDA margin expansion and strong cash generation, And we remain fully committed to creating value for our shareholders through our disciplined capital allocation framework with crystal clear priorities for capital deployment, which includes high return investment and returning excess cash to our shareholders. With that, I would like to thank all of our 7,300 ChampionX employees around the world for their tireless and inspiring commitment To our purpose of improving the lives of our customers, our employees, our shareholders and our communities, I'm honored and humbled to lead such a purpose driven team. With that, I would like to open the call for questions.

Operator

Thank you. Ladies and gentlemen, we will now begin the question and answer Your first question comes from the line of Stephen Gennaro from Stifel. Please go ahead.

Speaker 4

Thanks and good morning everybody. Can you help us maybe understand your 4th quarter expectations a bit? I'm sort of thinking about Well, it's normally a margin improvement in Production Chemicals and I understand the North American softness in some of the other areas. But can you kind of help us understand a little bit maybe on a segment basis the margin progression you're looking at?

Speaker 2

Yes. Good morning, Stephen. So when you look at the Q3 to Q4 margin progression, We expect PCT, given the resilience of PCT and seasonal Improvement in the international business in PCT, We expect PCT margins to perform well in Q4 compared to Q3. You should see It had a strong performance in Q3. You should see similar performance or even slightly better in Q4.

Speaker 2

And I think, Stephen, this will be an important time also to talk about this Argentina devaluation. And so I'll as I finish my comment, I'll ask Ken to talk about that. Because that impacted the Q3 margin for us. When they come to PAT and Drilling Technologies, when you look at PAT, we do expect sequentially the Business to be softer in U. S.

Speaker 2

Land and we saw as we exited September. So when we entered Q3 and how we exited September, we could see in September The weakness getting more pronounced in the U. S. Land activity in September. And so we do expect That as we go into the Q4, the normal seasonal slowdown Will be fully present.

Speaker 2

We saw some signs of that already starting to happen in September. So And so and it is also the mix in PAT, as you know, the completion side It's primarily ESP is driven more by the completion side. So tends to be a higher margin in the PAT side. So that along with some slowdown In the hardware digital purchases in Q4, I think so that mix will impact PAT. So which means we will see Q3 to Q4 PAT margin to be somewhat down.

Speaker 2

And then when you look at the DT, DT is where we are going to see bigger impact and this is going to be very similar Because the conversations with customers are very similar to the type of conversation that happened last year. So it's very clear that particularly our for the customers of Drilling Technologies We are starting to get very focused on Q4 Working Capital Management. And we have already received calls to Push out deliveries and those type of conversations are already happening. So that's why we expect Our Billing Technologies business to be impacted, if it is similar to last year, you can Imagine it could be sequentially down as much as 11%, 12%. So as you know, that business decrements Higher, so you should expect the Drilling Technologies business to be down.

Speaker 2

Now having said all this, Stephen, I would say, we see lot of this The type of seasonal slowdown and customers managing working capital towards Q4 to be very temporary issues. If you look at the quality of the businesses, are still very strong. We still deliver Year over year, strong exit margin improvement and you will still see strong cash generation. You'll still see strong capital returns. So these we see these as temporary U.

Speaker 2

S. Land weaknesses, which we are experiencing, which started towards the end of the third quarter And then now we see it playing out in the Q4. So we expect 2024 as we enter into early 2024, we expect The budgets to reset and we are confident it will be another year of positive growth in U. S. Land as well as globally.

Speaker 2

So with that, I do want Ken to talk about Argentina devaluation Just to because since it impacted our Q3 margin. So Ken?

Speaker 3

Yes. Hi, Stephen. The PCT business historically has done business in Argentina profitably. We have roughly about $100,000,000 of annual sales there. We had some questions around the devaluation impacts, so I wanted to be clear about that.

Speaker 3

It's not really a revenue issue in that we're U. S. Dollar functional accounting there and we have Many contracts are essentially indexed to the dollar, so that when we invoice, we invoice at the current rate then. But the issue was that historically we've been as a primarily a product supplier, we've been able to repatriate monies to the U. S.

Speaker 3

Out of Argentina regularly. And so It had never been an issue before, but late last year and then through this year, we've seen the government make a series of changes to both regulation and That's delayed repayments to us and delayed our ability to repatriate. And so we had built up A balance with the peso exposure in the country that then right after the election, they changed the exchange rate And we were hit with the loss that we noted. So in the meantime, we've been working to mitigate that through Try to minimize that balance as much as possible. We have curtailed a little business And then we're negotiating and in fact have some customers agreed to start to pay us outside of the country in U.

Speaker 3

S. Dollars. So We'll continue to work that exposure down here over the next couple of quarters. As of This week it's about a $15,000,000 exposure. So should there be another significant devaluation, we would have an issue, but we're working hard To minimize it.

Speaker 2

And I think, Stephen, as you know, some of the companies have approached this to do a blue chip swap, Which results in a major write downs.

Speaker 3

Yes, maybe that's a good point. A lot of the peers in the group Our primarily providing services, so historically they were less able to repatriate and so they built even bigger balances And they accessed a parallel market called the blue chip swap and Took big losses. They excluded those losses from their EBITDA. We Treat FX today as part of normal adjusted EBITDA. So you get some small gains and losses each period, But we don't exclude it.

Speaker 3

But some of the peers took some pretty substantial Write downs on the blue chip swaps at late last year early this year because they build up even more significant balances. So Because we're a product provider, we are able to repatriate normally. The government actions Recently have been adverse and not very appreciated, I guess, I'd say. So Hopefully that helps give some color.

Speaker 4

Yes, that does. Thank you. And just one quick follow-up for me and that is the When I think about the sequential PCT margin performance in 4Q, is that after Taking into account the $7,000,000 so I. E. A cleaner number being flat to maybe slightly up in the 4th quarter?

Speaker 2

Yes. So I think the PCT margin in Q4 does not You know contemplate another devaluation and under that scenario it should be closer to the 21%.

Speaker 4

Got you. Great. Thank you for the details.

Speaker 2

Thanks, Stephen.

Operator

Your next question comes from the line of Marc Bianchi from TD Cowen. Please go ahead.

Speaker 5

Hi, thanks. I wanted to ask another one on this Argentina situation because it seems like if you're going to have 21% margins here in PCT in 4th quarter, there really isn't any operating leverage in the business because you're just sort of recapturing the absence of the $7,000,000 hit in the Q3. Are there some other Crosscurrents that are worth pointing out or maybe I'm not reading that right?

Speaker 6

No, I don't

Speaker 2

think there's anything significant I mean, there's always some mix issues that happens within the businesses. So outside of that, I would say, Mark, there is nothing other than the normal Variations due to mix, there is no major any other issues.

Speaker 5

Okay. And then, Soumya, you had mentioned an expectation for growth in entering 2024, but I know Typically, there's some seasonality that occurs in the Q1 with PCT falling off. Can you just sort of walk us through The typical progression and if you have any particular insight about early 2024?

Speaker 2

Yes. Mark, Great observation because we always see this Q4 to Q1 seasonality. And in the past, we have provided some color around historically how that has worked in our PCT business. So on a if you look at over the last 7 or 8 years, the PCT business on an average or at a mean, Q4 to Q1 revenues have declined about 5%. That is a pure seasonality.

Speaker 2

And some quarters, it's much worse. Some quarters, it's better depending on how Q4 is. So there will be a Q4 to Q1 decline In our PCT revenue, which is seasonally driven. And historically, like I said, it could be 5%. And then but when you look at DT Drilling Technologies, we do expect the drilling technologies business to rebound In Q1, and again, we have shown historically when Q4s tend to be the type of Q4 we are expecting, Q1 will rebound.

Speaker 2

Typically, in some years, it's a sharper rebound, but we do expect Q1 to be a Good rebound in our Drilling Technologies business. We expect PAT business Q4 to Q1 to be sequentially better as well Because the budgets typically reset in the early part of Q1. So normally, what we'll see in the PAT businesses, It will start a little slow in January, but as the budget starts getting into place in February, we will exit the Q1 quarter With a much stronger run rate than when we entered Q1. So in summary, we'll expect PCT to be seasonally down Q4 We expect PA to be Q4 to Q1 up. We expect DT to be up Q4 to Q1.

Speaker 2

And then as we look in the quarter as we look in the rest of the year in 2024, Q1 tends to be The lower quarter and Q2, Q3 tend to sequentially improve from there. And Q4, as you know, Mark, that like we are seeing this year, sometimes we run into these type of issues, but that's Too early to predict what Q4 of 2024 may look like, but we are confident Q4 to Q1 there will be growth And we'll see growth Q1 to Q2 and Q2 to Q3.

Speaker 5

Great. That's very helpful summary. Thank you.

Speaker 2

Thanks, Mark.

Operator

Your next question comes from the line of David Anderson from Barclays. Please go ahead.

Speaker 7

Hey, good morning, Soma. I have a few questions on the North America side of PCT. So the U. S. Rig count contracted 20% this But if I look on the EIA numbers, onshore production appears to actually increase at least through July.

Speaker 7

Now you said Lower PCT revenue was through the rig count falling, but I thought there was a little bit of a longer term longer cycle relationship there. Isn't production related the driver here? Am I missing something in terms of that side? I'm surprised there was that much of a relationship.

Speaker 2

Yes, Dave, I think let me make sure that we clarify. I think in the slide deck, we had a slide which showed The sequential by segment, U. S. Versus non U. S, so if you look at that, The PCT business actually grew sequentially 6%, where we had the real issues were in PAT and DT in the U.

Speaker 2

S. Land. So this goes to show the long term relationship and the resilience of our PCT business. So PCT U. S.

Speaker 2

Business grew 6% Q2 to Q3.

Speaker 8

Okay.

Speaker 7

So that held up there, that better. So it's the PAT side and the relationship there is the completions with the ESPs. Okay. That makes sense. So if we think about kind of longer term drivers in NAM for PCT, so U.

Speaker 7

S. Onshore is sort of in manufacturing mode. We're not going to see a whole lot of production growth over the next several years. So how should we think about the drivers in DAM for PCT from here? Is there an underlying Kind of increasing chemicals intensity story here, how should we think about kind of growth in this business relative to production over time?

Speaker 2

Yes. Dave, I think that's exactly right. And even if you look at our continued growth in the U. S. Business in PCT, It's a combination of 2 things.

Speaker 2

1 is definitely the growth in the intensity. And then the second aspect is Gulf of Mexico continues to grow as well. If you look at our offshore growth Q2 to Q3, We grew 13 12% sequentially in the offshore markets globally and Gulf of Mexico was an important part of that as well. So as we go into 2024, we continue to expect the intensity improvements as well as The Gulf of Mexico growth as well.

Speaker 7

So even in a flat low, let's just say hypothetically U. S. Onshore production is flat, Should PCT still continue to grow with higher basically chemicals to production over time? Is that a trend you're expecting to see? Okay.

Speaker 7

And then secondly, and then sticking on U. S. Onshore, E and P consolidation is obviously a big theme with Exxon and Chevron. Can you talk about what that means to your business? And I guess I'm curious just how fragment we know the offshore business is sort of very mote Around that, but how about U.

Speaker 7

S. Onshore? Is that more fragmented? And does this potentially create more market share opportunity for you onshore?

Speaker 2

Yes. I think when you look at this consolidation, so the positive Aspect for us is, we have stronger relationships, as you know, with the IOCs. And you saw with Exxon, we won the supplier of the year award. So as the consolidation is driven by the IOCs, Our presence and our long term relationship with our IOCs should help us Continue to maintain and gain positions in the in this consolidation. Now the thing we have to really be watching for is to make sure obviously as they consolidate The P and Ps will also look for efficiencies and savings along the way.

Speaker 2

So but we do feel given our long term relationship and given the global The way we support our customers in this area, I think we will see it will be a net positive for us.

Speaker 7

Okay. So aside from any U. S. Onshore production growth, the 2 main drivers of NAM here are going to be increasing revenue Sorry, increasing chemical intensity and market share on top of kind of any other inherent growth. So okay, that makes a lot of sense.

Speaker 7

All right. Thank you very much, Soma.

Speaker 2

Thanks, Dave.

Operator

Your next question comes from the line of Scott Gruber from Citigroup. Please go ahead.

Speaker 9

Yes, good morning. Good Good morning, Scott. So, Soma, it does look like your EBITDA margin is going to stagnate here in 4Q given this North American weakness. But if I heard you correctly, I think you mentioned margin expansion in 2024. Can you walk through some of the major drivers For continued margin expansion and do you think getting back to that 21% level Later next year is a realistic goal.

Speaker 9

Do you think you'd do better?

Speaker 2

Yes. Scott, if you look at For the last 2 to 3 years, we have consistently expanded margins every year. And clearly, there is a bit of a calendarization in our margin performances quarter to quarter. Given Q1 tends to be a softer quarter. It tends to Q4 to Q1, typically we'll see a bit of a margin drop And then we'll pick up our expansion efforts from there.

Speaker 2

So when we look at 2023 or when you look at 2022 And versus 2023, at the midpoint of our guidance, we will expand margins Close to 3 a little over 300 basis points, right? So you will see us as we go into 2023, continued expansion of that. And that will be driven by A couple of things. Number 1, we do expect a positive growth for full year in 2024. So that incremental will help.

Speaker 2

The second is our continued productivity efforts and continued growth in higher margin businesses, I. E. Our digital business and our emissions business. So we do think that the mix of our businesses And the growth will also help. So to answer your question, we do expect continued margin expansion in 2024.

Speaker 9

Got it. And looking specifically at drilling, that business used to close margins Closer to 30%, it was closer to 25%, and I realize that's going to take a hit here in 4Q. But just thinking about the medium term, Is 25% the new normal or should we be expecting something better than that High 20s, 30%. Where can that business get back to?

Speaker 2

Yes. Scott, it's a great question. I think there is a structural element around The continued drilling efficiencies that are driving the volume growth challenges in that business over a period of time. So the business is definitely a 25% business. That's no question in our mind.

Speaker 2

Can it get to a closer to 30% margin business It's going to very much depend on volume. But what I would say is, it's definitely a 25% margin business at this date.

Speaker 10

Got you. Appreciate the color.

Speaker 2

It will take a hit in Q4, as I mentioned.

Speaker 9

Right. Got it.

Speaker 8

Thank you so much.

Speaker 2

Thanks, Scott.

Operator

Your next question comes from the line of Saurabh Pant from Bank of America. Please go ahead. And his line has just got disconnected. Moving over to the next question from Ati Madak from Goldman Sachs. Please go ahead.

Speaker 10

Hi, good morning team. Can you mention that the Argentina revenue exposure doesn't really exist, it's more in the margins? And it sounds like there were activity expectations that drove the delta versus expectations for 3Q around guidance, versus expectations for 3Q around guidance, especially some but I'm wondering if there were any other things, maybe Destocking and Drilling Technologies, any other factors you can provide any color on? And how do you see those going forward?

Speaker 2

Yes. If you look at our Shortfall to first of all, we are disappointed with it, right? Our shortfall to our own Midpoint guidance is about $35,000,000 in top line, right? And I would say, Adi, Half of that is related to the U. S.

Speaker 2

Land and particularly in PAT. Again, this is with respect to our And PAT and Drilling Technologies. So roughly $16,000,000 $17,000,000 of that 35,000,000 Yes. Shortfall is in U. S.

Speaker 2

Land, in PAT as well as in Drilling Technologies. The remaining $16,000,000 $17,000,000 is a combination of 2 things. 1 is a shortfall in Argentina, And that is primarily driven by a delay in import certifications. And I'll ask Ken to comment on that. Again, this is all related to this devaluation issue.

Speaker 2

And then the remaining, The another country which where we had a shortfall compared to expectation is in Mexico. So Argentina and Mexico together contributed another about $15,000,000 $16,000,000 to the shortfall. So there are 3 Primary areas where we had shortfall to our expectation, U. S. Land, Argentina and Mexico.

Speaker 3

Yes. And Argentina was about 5,000,000 Of that revenue and that what drove that was we saw the government slowdown or stop giving import certificates During the course of the quarter and we weren't the only ones that experienced that. We actually engaged with the U. S. Commerce Department and heard that A lot of imports were being similarly treated across a lot of sectors.

Speaker 3

And then the Commerce guys have actually been helpful in trying to Get us those certificates and they started to flow a little bit better recently.

Speaker 10

Got it. Thank you. Just as a follow-up, Is there a way for us to gauge what the segment exposure is in Argentina? Is it evenly spread out? Is there a higher exposure in

Speaker 6

any segment?

Speaker 2

It's essentially it's all PCT. Largely PCT. There's not

Speaker 3

a lot of PAT exposure there.

Speaker 10

Got it. And the other question I had is, you mentioned free cash flow growth over time, a lot of that from EBITDA growth and some margin expansion. I'm just wondering if there is Any kind of color you can provide? You have a bunch of productivity projects ongoing. Is that the main driver?

Speaker 10

Are there other operating leverage drivers here As you think about hitting that 21% target and beyond?

Speaker 2

Yes. I think the 21% target for us is, As I mentioned, it's a combination of productivity and incremental revenue growth. That's what I would say. And I think the free cash flow conversion of that 50% to 60% for us is very much intact. And I think you will see our business continues to be a capital light business and will continue To generate that 50% to 60% free cash flow conversion.

Speaker 10

Great. Thank you. I'll turn it over.

Speaker 2

Thanks, Aarti.

Operator

Your next question comes from the line of Saurabh Pant from Bank of America. Please go ahead.

Speaker 6

Hi, good morning, Soma, Ken. I'm sorry, the line got disconnected for some reason right when you called my name. Sorry about that, but Thanks for getting me back on.

Speaker 2

Good morning, Saurabh. Go ahead.

Speaker 6

Yes. Soma, I think Basically, I'm thinking of how should we think about the level setting expectation for revenue growth from a 2024 perspective? North America has, like you said, has some crosscurrent activity would be improving on a leading edge basis. But on a full year basis, maybe you can expand on that. Do you see North America behaving in 2024?

Speaker 6

And then international and offshore should be doing well, right? So how should we think about top line as a whole For 2024 versus 2023?

Speaker 2

Yes. Saurabh, let me start by saying, we do expect Positive growth both in North America as well as internationally in 2024. Now given What we have seen in terms of the Q3 slowdown and now the Q4 slowdown, A seasonal slowdown. I think the base in Q3, particularly for U. S.

Speaker 2

Land, that's kind of Lowered a bit, right, from what we had assumed. So as we go into Q4, Like I said, I think we will see in as we go into next year, you will see in North America the Q1 Revenue to be sequentially better Q4 to Q1 and then it will progressively get better into Q2 and Q3. So from me, it's again, Q4 of next year is too early to predict right now, but I do expect a positive growth In North America, so what we are seeing right now is a temporary situation Nothing in our customer conversations is telling us that 2024 is going to be It's not going to be a growth year in North America.

Speaker 6

Okay, perfect. That was so much. That's helpful. And then just one quick follow-up on the PAT side of things, because there's obviously a seasonal element, year end slowdown, budget issues, all of that stuff. But I'm just thinking, is there also an element and how important is it?

Speaker 6

If you are thinking about the lag effect of Lower D and C activity, right, lower completion activity on production. There's obviously a little bit of a lag, especially on the ESP side of things. How should we think about just lag effect versus seasonality because that would tell us how quickly things recover in 2024. That's the reason I'm asking.

Speaker 2

Yes. Saurabh, I think intellectually and logically, we definitely We see there should be a lag effect, right? But we have tried correlating this multiple times, Whether it is a 3 month lag, 6 month lag, 9 month lag, and we have tried doing that. And it's a little harder to Pinned down how much is the lag effect because of couple of things. Number 1 is, as you know, the ESP, which is the primary business that tend to get impacted by completion slowdown.

Speaker 2

Customers It tends to run ESPs 2 times and 3 times into the same well nowadays. So sometimes it's very hard to kind of It's not one to 1. So it's always been a bit harder to really quantify Exactly how the lag effect works. But I do agree with you that there is a lag effect, but it's just hard to Quantify and predict. And we saw that in because as we got into September, we clearly could see our ESP Install rate starting how we entered the quarter in Q3 and how we exited the quarter in Q3 was lower.

Speaker 6

Okay, okay, okay. Now, Soumya, I know you've talked about the secondary, tertiary installations in the past, so that obviously offsets it to some extent. But no, that's helpful. Okay, Sumay, thank you. I'll turn it back.

Speaker 2

Sure, Saurabh. Thank you.

Operator

Your next question comes from the line of Doug Beka from Capital One. Please go ahead.

Speaker 8

Thank you. So continuing with PAT, the company received top marks in the Kimberlite artificial lift survey,

Speaker 1

But the growth in PAQ has

Speaker 8

been a little bit slower than I would have thought even factoring in the U. S. Activity dip, Given that some others have talked and pointed to Lyft as an area of strength, so really just wanted to get your thoughts on the competitive landscape within Lyft And if there's any market share shifts taking place there?

Speaker 2

Yes. So I think, Doug, the From a competitive landscape standpoint, I think if you look at the market Kind of differentiated in if you look at the 2 major forms of lift in artificial lift, which is the ESP And Rod left. So when you look at the ESP market landscape, I think our competitive position remains Strong there and we feel the activity is the major driver behind any type of Now when it comes to rod lift, there is a lot of players in rod lift, Especially when you go to the lower end of it, particularly in components and repair shops and so on and so forth. So sometimes in rod lift, you will see some pricing pressures and issues in the fringes you will see. But the way we focus on rod lift is in terms of the type of value we provide.

Speaker 2

So when I look at Our own data, I don't see a lot of market share loss per se. There are some in the fringes, but I wouldn't call that as the biggest driver for the any type of slowdown In growth, it's largely an activity driven. And we have today in the U. S, As you know, Doug, we have a pretty good market share position in all forms of Lyft. And in some of the Lyft Categories, we are the leading share position.

Speaker 2

But if you look at across all Lyft positions, we have Really good market share position. So I think I would say that the growth issue which we are experiencing In the second half year, it's largely an activity issue.

Speaker 9

And that's helpful context.

Speaker 8

One last one, just curious if there's been any nuance or change to the revenue cadence you talked about 21 to 25 at the Analyst Day, high single digits, still plenty of time, but wondering if this year This may be shaded or may be at the high end less likely.

Speaker 2

Yes. So Doug, If you look at 2023, if you normalize for The various elements such as Russia exit, the cross sales terminating As well as some of the product line exit we did as part of our RCT restructuring, If we normalize for all of that and at the midpoint of our guidance, it's somewhere in the 4% In 2023, 4% are slightly better. So when you look at that, obviously, when we gave our High single digit CAGR, we weren't expecting the second half this level of Activity weakness than what we expected, right? So it makes it harder, right, because We are starting with the lower year than we anticipated, so it makes it harder. But we are not giving up on That but I will acknowledge that it makes it harder given that we start with 4% as the 1st year.

Speaker 8

Yes, makes sense. Thank you so much.

Speaker 2

Thanks, Doug.

Operator

There are no further questions at this time. I'd now like to turn the call back over to Mr. Sundaram for any closing remarks.

Speaker 2

Well, thanks everyone for joining today's call and we look forward to talking to you in our next quarter's earnings call. Thank you and have a great day.

Operator

Thank you, sir. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines. Have a lovely day.

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Earnings Conference Call
ChampionX Q3 2023
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