Koil Energy Solutions, Inc. (KLNG) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to Deep Down's Third Quarter 2021 Conference Call. [Operator Instructions] As a reminder, this call is being recorded today, Friday, November 12, 2021. A detailed disclaimer related to Deep Down's forward-looking statements is included in the press release issued this Friday morning and filed with the SEC. It is also available on the company's website, deepdowninc.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 on the website. Listeners are cautioned to not place undue reliance on these forward-looking statements, which speak only as of the date made. Deep Down 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 would like to turn the call over to your Chief Executive Officer, Charles Njuguna. Please begin.

Thank you, Norma. Good morning, and thank you for joining us today. When we last got together, we mentioned the $60 per barrel oil price as a positive sign for the industry, and the industry having largely adapted to managing projects at that price point. At the time, there was cautious optimism for that price level to hold for the longer term, but not too many people are making plans with $80 per barrel in mind. 3 months later, here we are, and there are increasing projections about prices getting to levels not seen since the early to mid part of the last decade. However, the last 18 to 24 months have taught us all to be cautious in light of the inherent uncertainties of the future. It is against this backdrop that we view our increased revenues for the past 9 months of this year compared to the same period last year as a positive sign, though our margins are depressed by various unfavorable factors. In addition to pricing pressure from increased raw material costs, our customers are still exhibiting some signs of hesitancy on some of their projects, leading to limits on their budgets and, likewise, limits to what we're able to charge for our products and services. To help them streamline their projects, we have also been willing to subcontract certain aspects of their projects, opening us up to a higher proportion of third-party pass-through costs at minimal margin on a number of our projects, which in turn has led to lower than ideal margins. Despite these lower margins, this strategy is beginning to bear fruit as we have received invitations to bid on projects others would not have participated on, and even recently received a contract for a new product for us from a customer who has appreciated being able to procure a different product through us. What began as a $46,000 scope of work has now turned into hundreds of thousands of dollars' worth of work from an oil company we hadn't worked with in several years. Speaking of rekindled customer relationships, we recently announced another carousel project where we are utilizing the second of our 2 large carousels after using the first one earlier this year. These projects are continuing to support new conversations around the use of our carousels, further validating our [ expression ] that the market will continue to require these kind of equipment, often preferring a rental option rather than a purchase. Ironically, taking an impairment on the carousels at the heights of the COVID-19 pandemic has been a blessing in disguise for us as this has enabled us to offer the carousels for relatively low prices and benefit from the additional services we're able to perform. We couldn't speak on the carousels without mentioning our foray into the offshore wind markets. During our last call, we mentioned [ a decision our schedules ] to be made in October on a project we had bid on. Unfortunately, we are learning that the sense of urgency we're used in the oil and gas industry that is not directly translate to the emerging wind market. A few weeks ago, we informed that the customer would make a decision by Friday, November 12. But earlier this morning, we were informed the decision has been further delayed. Based on our engagements to date, a further delay was not a surprise. While we wait for that decision, we were recently approached to discuss the possibility of providing equipment and personnel for a totally different wind projects beginning in 2023. While this is still some time in the future, we view the fact that we were approached as further validation of our efforts to raise our hand and be identified as a viable option for the developing offshore wind industry. We will provide further updates as and when they do come available. Further to our efforts to participate in the offshore wind industry, this past Wednesday, we hosted a team from a subsea power company who have provided prototype products and services to customers in other parts of the world and are now looking to do the same here in the U.S. Our discussions with them have revolved around complementing their technology with our offshore environment expertise, particularly around strengthening their products for the subsea environment, then providing installation equipment and personnel for the final product. This is a different company from the one we described during our last call, which is another indication of our expansionary efforts beginning to bear fruit, and once again, further validation of our previously disclosed strategy of expanding our focus beyond just our core products and services to focusing on our core competencies, which are transferable to renewable energy applications. Again, at this point, we have no clear indication of when we will begin generating cash flows from these initiatives. Speaking of the future, business growth remains a key focus for us. So [ much though ] that we are enhancing our business development efforts while watching on a number of initiatives to reposition the company for the inevitable recovery we foresee. Our optimism for a recovery is influenced by a significant increase in bidding activity during the last several months, which could be partially attributed to some organizational changes we made in the way we engage our customers. We expect to make further announcements in coming months about these repositioning initiatives. And speaking of announcements, we do appreciate those of you who have reached out to discuss the possibility of a stock buyback program. While we continue to view this as a good way to return value to our shareholders, we have discussed it at the Board level and determined that at this point, and in light of some operational cash needs, we foresee in the not-too-distant future we will hold off on instituting a buyback product for now -- buyback program for now, sorry. We will revisit these topics during future meetings and communicate accordingly. With that overview, let me now turn the call over briefly to our Vice President of Finance, Trevor Ashurst, for a quick review of our financials. Trevor?

Thank you, Charles. For the 3 months ending September 30, 2021, Deep Down generated revenues of $3.6 million. This represents a 13% increase when compared to revenues of $3.1 million for the 3 months ended September 30, 2020. The growth in revenues can be attributed to the progressive increase in demand for our subsea equipment, support services and rental solutions. Gross profit as a percentage of revenues was 24% in the third quarter this year, which represents a 14% decrease in gross margin compared to 37% we generated in Q3 of last year. The decline in gross margin was mainly driven by increases in labor and service costs in conjunction with the pricing pressure from -- with pricing pressure from customers. Additionally, we received rent abatements during the third quarter last year that were not received this year. Selling and general and administrative expenses of $1.3 million for the third quarter of 2021 remained relatively consistent with last year's $1.4 million for Q3 of 2020. Turning to net income. The company recorded net income of $332,000 or $0.03 per diluted share for the third quarter this year compared to a net loss of $250,000 or a loss of $0.02 per share for the third quarter of 2020. The improvement in net income was mainly driven by recording the full forgiveness of the second PPP loan we obtained in March 2021 as well as maintaining a disciplined operating cost structure. Moving to the balance sheet. Our capital structure includes $3.7 million in cash and $5.8 million in working capital as of September 30, 2021. This is compared to having $3.7 million in cash and $4.1 million in working capital at the same time last year. Also, we received full forgiveness of the entire balance sheet -- of the second PPP loan we obtained earlier this year. And as a result, we no longer have any outstanding PPP loan balances on our balance sheet. In summary, we have witnessed increased levels of project activity throughout the first 9 months of this year when compared to the same period last year. Our top line success can be directly linked to the dedicated efforts of our highly-skilled team. I am certain that this level of devotion remains unmatched in our industry, which provides me with confidence that this trend will continue throughout the rest of the year. Finally, our balance sheet positions us well to pursue strategic growth opportunities and make investments that will increase our capital efficiency. With that said, thank you for your time, and I will now turn the call back over to Charles.

Thank you, Trevor. That concludes our prepared remarks today. So I'll now turn the call back to the operator to take investor questions. Norma?

[Operator Instructions] Our first question comes from Walter Schenker with MAZ Partners.

In looking at the quarter, obviously, the real issue is margin compression. Revenues were sort of consistently roughly where they've been. Was that an issue that you took on business which you knew was going to be marginal at best? Was there overruns on the first carousel project? Was it a single program? I'm trying to understand why margins were as poor as they were in the quarter. Hopefully, you know the answer.

Walter, thanks for the questions. The margins we took on -- it's a combination of factors. As we took on some of the projects we've recently taken on, I touched on it briefly where we've had customers ask us to pass-through certain costs for them, costs which we were not able to attach lots of margin where we essentially help them manage some of their contracts. This year alone, different from other years, we probably had about over $600,000 worth of pass-through costs, some of it at no margin and some at very little margin. If you took that and factored it in at our regular -- our target margins of 40%, as you previously disclosed, that would be an additional $300,000 to $400,000 worth of top line. Additionally, to your question about the carousel, we did not have cost overruns like we've had in past projects. However, we are limited in what we could charge on certain activities, which, in a normal business environment, we could easily have charged at least another $300,000 to $400,000 worth. That was a business that we took on either at a lower price than we would have or not getting it at all. And so strategically, we felt it was worthy to take it at lower margins, get the work, and that has actually opened the door to a lot of other business in the future, which we are cautiously optimistic about.

And those -- that business, which was at low or no margin, is largely completed in the third quarter or will continue into the fourth quarter?

That's largely completed in the third quarter. The aspect of pass-through costs, we do have a couple of customers who are continuing to -- especially international customers who are continuing to ask us to take on certain subcontracts at fairly low margin, but we do not, at this point, expect to take it on to the extent we've done it to date. So it will be smaller amounts.

Going back a few years, maybe more than a few years, there were substantial potential contracts which the company was buying for. We had a substantial backlog. Those type of projects are not just not being done or you are not participating in them?

We -- that's a very good question. So we -- if you go back to probably around the 2014, 2015, 2016 time frame, we had a fairly large proportion of products -- projects as opposed to service work. A lot of that had to do with greenfield projects, which is basically new fields and new developments essentially. Over the past couple of years, there has not been much of that. So a lot of our revenue this year has been very heavily service. However, we still maintain a cost structure, a facility geared towards those kind of projects where there's lots of products. And those do come with good margins on the products. As we look towards 2022 and beyond, we are in discussions about those kind of projects again. There is some loosening or opening up of greenfield projects coming up. And so we are actively discussing our customers about growing our product portfolio as we look towards the future. So we do see signs of that -- positive signs.

Albeit your types of projects are in the -- are not in the exploration phase, they are in the development phase where people are drilling for production and need to interconnect the production product equipment at the sea floor and run it up to a platform or something. So it should have a pretty good lead time. I realize they don't have to proceed to see whether or not -- I mean, again, this isn't just finding a new field and starting to do exploratory drilling, you're later in the cycle. So I'm just trying to get a better feel for whether or not people are announcing building out production in some of these fields.

So yes, good point. We are -- the equipment we provide is used on the production side. There are a number of previously announced projects -- previously announced discoveries, where we are talking to customers about the equipment which is -- like you rightfully say, long lead item projects and products. There are a number of them where we are discussing with them where they, in some cases, have not yet publicly announced the final investment decisions, and they're trying to work through their budgets. So we are working with them on that. But short answer is previously approved projects are beginning to move forward, especially with oil now in the $80 a barrel range. And so there's a lot of ongoing discussion. Again, unfortunately, there is pricing pressures because of raw materials. We are now getting into a situation where there are some labor constraints or talent competition. And so, we are walking through all of that and engaging our customers differently and cautiously optimistic that, that will bear fruit.

And lastly, before we see a significant step-up in financial performance, I will have to see some announcements of meaningful contracts. I'm just trying to understand if -- given the nature of what you've been doing for the last -- for 2021, I'll just use the whole year, it can get somewhat better, but we need big contracts to really drive revenues and margins.

Yes. That would -- yes, because a lot of the contracts we've executed this year [ even on ] projects have not been -- they've been smaller ones, $100,000, $200,000. So yes, we are looking to make some announcements. We are hoping we'll be able to make some announcements next year. But we are also looking -- we'll continue to look at just efficiency and other ways we can improve the bottom line and further optimize our operations.

[Operator Instructions] And sir, I'm showing no further questions at this time. I'll turn the call back over to you for any closing comments.

Thank you, Norma. And once again, thanks to all of you who joined our call today. We appreciate your interest and support of Deep Down, and we look forward to speaking with you about our progress on the next earnings calls. In the meantime, we hope everyone has a happy Thanksgiving and a merry Christmas on a happy New Year. And so let's conclude today's call. Thank you.

Thank you. This concludes today's conference call. Thank you for your participation. You may now disconnect. Everyone, have a wonderful day.