Superior Drilling Products, Inc. (AMEX:SDPI) Q1 2023 Earnings Call Transcript

Superior Drilling Products, Inc. (AMEX:SDPI) Q1 2023 Earnings Call Transcript May 11, 2023

Operator: Good morning ladies and gentlemen, and welcome to Superior Drilling Products First Quarter 2023 Financial Results. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation As a reminder, this conference is being recorded. It is now my pleasure to introduce your host Craig Mychajluk. Thank you. Please go ahead sir.

Craig Mychajluk: Yes. Thank you, and welcome everyone to our first quarter 2023 earnings conference call. We certainly appreciate you joining us today. Joining me are Troy Meier, our Chairman and Chief Executive Officer; and Chris Cashion, our Chief Financial Officer. Chris will first review our results in detail and then Troy will provide an update on the company’s strategic progress, after which we will open up for Q&A. You should have a copy of the financial results that were released before the market this morning. You should have also copies of slides that accompany our conversation today. If not, both documents can be found on our website at sdpi.com. Turning to Slide 2, I’ll point out that we may make some forward-looking statements during the formal discussion, as well as during the Q&A session.

These statements apply to future events and are subject to risks and uncertainties, as well as other factors that could cause actual results to differ materially from what is stated here today. These risks and uncertainties are provided in the earnings release, the slides and other documents filed by the company with the Securities and Exchange Commission. These documents can also be found on our website or at sec.gov. I want to also point out that during today’s call, we will discuss some non-GAAP financial measures, which we believe will be useful in evaluating our performance. You should not consider the presentation of this additional information in isolation or as a substitute for results prepared in accordance with GAAP. We have provided reconciliations of non-GAAP with comparable GAAP measures in the tables accompanying the earnings release, as well as in the slide deck.

So, with that, please turn to Slide 3 and I’ll turn it over to Chris to begin. Chris?

Chris Cashion: Thank you, Craig, and thanks everyone for joining us today. We kicked off the year on a strong note as our team continued to execute well to meet increasing demand. This slide highlights several of our accomplishments, which include the highest quarterly revenue and net income since the company went public in 2014. Our top-line growth for the quarter was driven by strong Drill-N-Ream tool sales from our U.S. channel partner, hire, contract services work, and the improved market conditions internationally. We expect a continued improvement in the international market throughout 2023. The operating leverage that we gained from hire Drill-N-Ream tool sales resulted in measurably improved operating income and net income and very strong EBITDA performance.

We put our strong cash generation to use in making capital investments to expand capacity to accommodate our increased work and in support of anticipated demand growth most domestically and on the international front. As we mentioned in our earnings press release, the company’s Board of Directors is finalizing a process to engage a financial advisor to assist the company in the evaluation of potential strategic transactions in order to maximize shareholder value. As part of the process, the Board will consider a full range of strategic alternatives, including acquisitions, sales, mergers, divestiture of assets, or other strategic initiatives. There’s no assurances regarding the outcome or timing of this evaluation, and we do not intend to make further announcements until such a time further disclosure is appropriate or necessary.

Now, turning Slide 4, provides an overview of our revenue growth. Q1 revenue was up 52% to a record $6.3 million reflecting the recovery of the oil and gas industry in North America, which resulted in increased tool revenue and strong growth in contract services. We also saw improving marketing conditions in the Middle East where we continue to gain traction, while not back to pre-pandemic levels, we have benefited from an increasing rig count when looking at our results on a year-over-year basis, as the average U.S. rig count was 761 in the first quarter up 128 rigs from the average in the first quarter of last year. However, as expected, the domestic rig count flattened and when comparing with the sequential fourth quarter was actually down 14 rigs.

Over the near term, it is our expectation that the North American rig count will stabilize around these levels. On the international front revenue doubled year-over-year, which reflected improved market conditions and our strengthened technical sales and marketing team. Our team continues to make further inroads, opening doors, and driving greater awareness of the Drill-N-Ream value proposition. Our international sales mix was approximately 13% of total revenue fourth quarter up roughly from 10% from last year. We continue to be encouraged by the many opportunities in the Mid East region and expect that mix change to continue to trend upwards. Now let’s move on to Slide 5 in review our tool and contract services. Fourth quarter contract services revenue was $2 million up 49% over last year.

This was due to continued expansion of the volume and products we refurbished and manufactured for our longtime legacy customer. Tool revenue grew 54% during the quarter, given our improved market penetration in the Middle East, and as our channel partner in the U.S. continues to drive new tool sales. In addition, activity on more rigs has led to increased royalty and repair revenue. Now, as you can see on Slide 6, we have continued to invest in people to address demand while still fighting inflationary headwinds for payroll, raw materials and other costs. Importantly though, we continue to demonstrate the significant inherent leverage in our operations as we leverage these costs with higher sales volume, which resulted in significantly improved operating margin performance.

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SG&A expenses were 32 – or 37.2% of revenue, down 270 basis points year-over-year, and down 200 basis points sequentially. SG&A expenses in the first quarter of 2023 included $360,000 of legal expenses pertaining to our patent infringement lawsuit. Currently, we’re preparing for a trial and expect a jury trial during the fall or early winter of 2023. Our strong offering leverage can be seen as we turn to Slide 7, which highlights our bottom line and adjusted EBITDA results. We delivered net income of $1.5 million or $0.05 per diluted share in the quarter. Now included was $350,000 of recovery of related party note receivable, whereas the comparable 2022 period did not have such a benefit. To put that $1.5 million into perspective that is more than what we achieved all of last year, which was our first year of positive bottom line performance.

Even backing out the recovery of the related party note, our Q1 2023 net income still outperformed all of calendar year 2022. Adjusted EBITDA nearly doubled year-over-year to $2 million with the EBITDA margin expanding 760 basis points to 32.1% our highest level in recent history. Moving on to Slide 8, we highlight our balance sheet, which has continued to strengthen. Cash generated from operations for the quarter was $1 million. Strong EBITDA growth in the current period was offset by an increase in working capital as the company continues to grow. Total debt for the quarter was $1.6 million down slightly from year end 2022, but down significantly 45% from the end of 2020. We are currently in discussions with a commercial bank regarding a credit facility with the use of proceeds to refinance our existing debt and to provide increased liquidity.

In addition, we expected an improvement in our cost of capital. First quarter CapEx was $1.6 million and was related to the completion of our new domestic machining centers, an increase in the Middle East Drill-N-Ream tool fleet, our new service and technology center in the Middle East and the expansion of PDC bit refurbishment capacity in Vernal. We ended the quarter with $2 million in cash down slightly from year end 2022. Now on to Slide 9, which provides our guidance. We continue to expect 2023 revenue will be in the range of $24 million to $27 million, which implies top-line growth of 34% at the midpoint. SG&A expenses are projected to be $9 million to $10 million. This is a step up from where we end in 2022, largely reflecting the litigation costs of approximately $1 million related to our ongoing patent infringement lawsuit that I mentioned earlier.

The SG&A expectations also take into account the investments we’re continuing to make in our international team to drive future Middle East growth. With these added international costs and our expectation that the new Drill-N-Ream tool sales will not be repeated at the same level we saw in Q1, we are maintaining our adjusted EBITDA guidance of $6.5 million to $7.5 million, which implies an EBITDA margin of 27.5% at the midpoint. That level is nearly 300 basis points higher than our 2022 results. Lastly, we have revised our expected capital spending for fiscal 2022 to range between $3.5 million and $4 million from the previous expected range of $3 million to $3.5 million. The added spending is in support of our Middle East expansion. So with that, I’m going to turn the presentation to Troy to wrap up with the review of our outlook and opportunities both in North America and internationally.

Troy?

Troy Meier: Thanks, Chris, and thanks everybody for joining us. Excuse me. So as we look at our outlook and opportunities, first of all, as we look at North America like Chris had mentioned, we’ve spent the money on new machining centers. We’ve also taken our Drill-N-Ream facility. We’ve moved that off campus into its own building, which has allowed us to now entertain a larger customer as we look at our legacy operations. We can double what we’ve been doing and our team’s working diligently to get that done. I want to talk about our team just for a minute. One of the things that we’ve been able to do is hire really well, the people that are attracting, been attracted to our company, a world class both domestically and internationally.

We’ve been able to bring on top individuals that they have a lot of get up and go, and they’re excited to see the growth of this company and to take this company to the next level. And we’re seeing that throughout the company. It’s very – it’s very refreshing and rewarding to work with these individuals. When you look at the North America again, when we look at our machining capacity Chris had mentioned, the spend that we have there those machines are now, we’ve got them fitted, we’ve got them tooled, and we’re looking at those opportunities to start filling that capacity. There’s a lot of opportunity out there for this type of machine, and it’s a lot of opportunity in the oil and gas business, and that’s where we really focus even though we still talk about diversification, there’s a big need for what we do in the oil and gas market.

Even though we talk about a flat rig count, there’s a tremendous opportunity within that flat rig count in North America for us to gain more business and we’re going to do that. When you look at our international opportunity, again the team there is really doing a good job. They’re – we’ve just been working in a few countries and we’re expanding that now as our team members get aboard and they understand what our products does and how it benefits the customers and the runs that we’re getting. We’re able to show offset data that really, really shows these NOCs the benefit of our wellbore conditioning tool. But with that, we’re also finding the need to duplicate what we do here in North America over there when we talk about, the bit repair service, we’ve got a tremendous opportunity over there and we get – we get asked a lot when, when are we going to start doing that in the MENA region.

And so the team’s looking at that, we’ve got the equipment that we’re putting into place to service the drilling rains. That facility will be up and going here by the end of this quarter. And there’s a – the next look from there is going to be to also look at enhancing our offering in the Mid East to do the bit refurbishment which is greatly needed in that part of the world. So the international market is got some tremendous opportunity for growth, not just Drill-N-Ream, but also our legacy business that we have to offer that part of the world. And like I say, we’ve essentially been duplicating the facility we have in Vernal. We’ve designed and created some new braising stations that are working out very, very well. We’ve got teams now trained that will be going in and out of the MENA region training our team members over there.

And our first team is heading over there within the next two weeks. So, but there’s some tremendous opportunity in our customers now are starting to see a big value that they’re receiving from running the Drill-N-Ream and there’s a lot of excitement on getting that into more of the wellbore as you – when you look at North America Drill-N-Ream fits really good into the curve, when we drill a horizontal well, we got customers that run it in the curve. We got customers that run it in the lateral. But what we see over in the MENA region is a need for much larger tools in the vertical section of the wellbore, as well as the curve and the lateral. Lateral is just now starting to become a way of drilling over there, if you will. They’re starting now to duplicate what we do here in the U.S. as we build a curve, and then go out horizontal directionally in a lateral.

And so we’re really excited about that happening now in the Mid East, what the tool was designed and built for. We’re now being able to just come right in there and say, yes, that’s – this is what Drill-N-Ream does, is to help you out in the lateral on top of benefiting them greatly that they’re seeing right now in the vertical section of the wellbore. Wellbore quality is getting is the new buzzword. When you talk to operators, they want to know, they’re all talking now about wellbore quality. What’s the quality of the wellbore on drilling and Drill-N-Ream that fits right, right in place. That’s what it does, is it – it helps to create a quality wellbore. So, we’re excited for the opportunities on both the domestic and the international markets, and we’re excited to capture those opportunities as the year goes on.

With that being said I’m going to turn it over to some Q&A.

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Q&A Session

Operator: Thank you, sir. The first question we have is from Dick Ryan from Oak Ridge Financial. Please go ahead.

Dick Ryan: Thank you. And congratulations guys, on a very strong performance. So Troy, just on the macro side, if you listen to what the drillers are saying, with gas prices being what they are, you’re seeing rigs being laid down and the gas fields and kind of moving over into the oil rich basins like the Permian. So there is a shift, and it sounds like gas is going to stay pretty challenging for the next several quarters at least. Is that changing your outlook of Drill-N-Ream opportunities and maybe a tag along? Can you talk a little more on how DTI is, kind of expanding the opportunities in North America?

Troy Meier: Yes, what we see is DTI is, when you look at the top operators in just say, the Permian, DTI has got tools on the top five operators, and they’re penetrating those operators deeper every day. So again, the buzz out there of wellbore quality is starting to, I was at a seminar it’s been probably four weeks ago now, down in Houston, and it was a seminar that the operators put on and asked the PDC suppliers to attend. And I was asked to come down and participate in this seminar, and almost every topic went to wellbore quality. So in the past they would drill a well and the completion team would come on, so you’d drill it really fast and whatever condition it was in, the condition team, that the completion team had to deal with.

And what we’re seeing now, is an awareness of, wait a minute, what kind of condition is this well, that you’re leaving me to complete? And so I think that’s been very beneficial for DTI is as customers now within their customers are saying, maybe a pioneer or an Oxy was using it on, 40%, 50% of their rigs. I think they’re getting a lot higher numbers now. So, we will see the gas basins slowing down. But I think what we’re going to see is the oil basins needing more rigs and also needing to do a better and better job at the wells they’re drilling. And I think, they’ll rely on Drill-N-Ream to help them with that. So, I think the Drill-N-Ream activity is going to stay busy. At least, the indications of the new tool sales and how busy, I mean, we’re setting records in our new facility, a new Drill-N-Ream facility.

It’s amazing, what the team is doing there, and the record number of tools that’s leaving that facility every week being repaired and put back out in the field. So, I think we’re still going to continue to see strong activity and strong use of the Drill-N-Ream.

Dick Ryan: Good, appreciate that. With the capacity now in place for the contract services side of things, can you kind of handicap, when does the marketing start to reach out to a potential another customer? Or how far along are we in that path?

Troy Meier: We already have, and we’ve already been doing a few products for other customers. We think that we’ve got a contract in place with one, and I think that it’s going to we’re now at the point where we can start soliciting work from them and so we should start to see that happening this quarter .

Dick Ryan: Okay. I appreciate that. Thank you Troy and Chris, and good luck and congratulations again and strong performance.

Troy Meier: Thank you.

Chris Cashion: Thanks, Dick.

Operator: The next question we have is from Ignacio Bernaldez from EF Hutton. Please go ahead.

Ignacio Bernaldez: Hey, good morning, and congratulations on the great quarter. Great to see the business doing really well. When you think about the international opportunity, what are some kind of headwinds you might be seeing or you are seeing in that expansion?

Troy Meier: Mostly logistics. It’s even though, the countries that we deal with in the MENA region are all very close to one another, it’s not like shipping a tool from Colorado to Texas. It’s every country’s got its own documentation that needs to be filled in, filled out. You’ve got restrictions on if you send a tool in there, how long can it stay there? And so we’re trying to understand the logistics portion of the business over there, and we’re getting much, much better at understanding that. But that’s probably been our biggest headwinds. And the operators they, now, what they’ve been doing that’s been really need is they’ve been looking at runs without the Drill-N-Reams and runs with the Drill-N-Reams – with the Drill-N-Ream and the comparison and what the Drill-N-Ream is doing is phenomenal.

And so it’s nice that, that they’re taking the time and looking at it and saying, okay, you’ve got something to sell here. You tell us it’s, it’s going to help us. We’re going to prove it to ourselves. And now that they’re doing that, the reports that we’re getting from the operators are phenomenal. We’re very impressed with all of the benefits that the Drill-N-Ream gives them, excuse me, and not just a quality wellbore, but you see a lot less damage to the bottom whole assembly, what we call the BHA bits last longer. Motors are lasting longer. We seem to take a lot of the shock and vibration that’s inherent with the drill string rotating and flopping around that Drill-N-Ream. And the fact that it is, conditioning that wellbore, it’s in constant contact with the wellbore, it seems to act as a shock absorber and really benefit.

And it lessens all of that vibration and shock that would be going right down to the BHA. So that’s another great benefit that the tool is giving the operators.

Ignacio Bernaldez: That’s really helpful. And thank you for the additional color on the benefit of the Drill-N-Ream from the operator perspective. Thank you so much.

Troy Meier: Thank you.

Operator: Thank you. The next question we have is from John Sturges from Oppenheimer and Company. Please go ahead.

John Sturges: Thank you for taking my call. Very nice execution. I really appreciate the results. Two questions. One is the drilling activity least from the Baker Hughes data appears to be flat to down from December. Was there a change in your go-to-market strategy? Because it looks like you’ve had a surge in penetration. And the second question is how long from now do you expect to go forward before you have to add additional capacity?

Troy Meier: So when we look at the market being flat and the change and why we’re seeing the increased revenue in a flat market, again, I think it’s the awareness that the operators are receiving in regards to the wellbore and the wellbore quality. It’s a big deal, when you look at all the tortuosity and, the dog legs and when you can smooth that out and, you can put in casing, whether it’s your, surface your intermediate or your lateral, and that you’ve got better cement job because you don’t have your casing leaning up against part of your wellbore that the Drill-N-Ream has now taken out. So you get a better cement job. I just think there is a much higher awareness of wellbore, it’s not just about how quick can we drill a hole anymore, which it’s amazing, how fast they’re drilling these wells, but the awareness of saying, what kind of wellbore did you leave us to complete, I think is really, okay, let’s do this quick and efficient, but let’s make sure we do it right.

And I think that’s been a big plus for the Drill-N-Ream tool.

John Sturges: So this, if I may, so this sounds more like a market driven response?

Troy Meier: It really is. I think it really is. And of course, DTI has done a fantastic job. They’ve also built a team and they’ve now got experts in the – with the Drill-N-Ream that, they’re getting out and they’re getting deeper into their customers to explain these benefits that are now obvious. And so I think that’s helping out a bunch too. And what was your second question? I’m sorry.

John Sturges: Well, with the current pace, how long will the current capacity last?

Troy Meier: We’ve got, we now have a lot of capacity. I mean, we were starting to get really tight in our facility, but moving the Drill-N-Ream operations off campus and into its own facility has added a ton of capacity. We’re – we could easily double what we’re doing now. So, I think it’s going to, I think it’s going to be a while before we’ve got to expand more capacity. I’m looking, I mean, it’s, we’ve got a couple of years.

John Sturges: Okay. It just looks at the current pace. It looked like it might be a shorter timeframe. Thank you for adding all that color. Appreciate it.

Troy Meier: Thank you.

Operator: Thank you. The next question we have is from Paul from as a Private Investor. Please go ahead.

Unidentified Analyst: Good morning, gentlemen, and congratulations on your first quarter report.

Troy Meier: Thank you.

Unidentified Analyst: I have three questions for you, trying to get an idea of where you’re at. Can you describe to me what percentage of your business is primarily making new drill bits versus refurbishments and repairs?

Troy Meier: New drill bits? When we – if we just talked drill bits and not throw Drill-N-Ream in there. You’re talking refurbishment is, yes, that’s a third of it.

Unidentified Analyst: Okay. That refurbishment is a third then, right?

Chris Cashion: That’s correct.

Unidentified Analyst: And the Drill-N-Ream is the rest?

Troy Meier: Yep.

Unidentified Analyst: Okay. And with your current growth, it’s taking place industry wise, can you describe to me your current position in the business? Is – are you considered now at the mid-tier manufacturing level? Are you a major producer? Where are you at on the scale?

Troy Meier: If we look at the scale of what we’re doing, we’re still very small, very small in our industry. We’ve got a long way to go to be what I’d consider mid-tier. So, we’re still very small.

Unidentified Analyst: Thank you. And with regard to the patent infringement lawsuit, are you the plaintiff or the defendant in that suit?

Troy Meier: We are the plaintiff.

Unidentified Analyst: That’s all I got for you guys. I sure appreciate you answering my questions.

Troy Meier: Thank you.

Chris Cashion: Thank you.

Operator: Thank you, sir. Ladies and gentlemen, at this stage there are no further questions. I will now hand back to management for closing remarks.

Troy Meier: Yes, again, we want to thank everybody for joining us and, we look forward to continuing growth throughout this year. The team that’s in place now, we’ve spent the resources to bring on some quality people and to get these people trained and our team is really starting to feel comfortable with their roles in the company. So look forward to our next earnings call and sharing some new highlights with you then. But thanks again everybody for joining us and have a wonderful day.

Operator: Thank you, sir. Ladies and gentlemen, that then concludes today’s conference. Thank you for joining us. You may now disconnect your lines.