Superior Drilling Products, Inc. (AMEX:SDPI) Q2 2023 Earnings Call Transcript

Superior Drilling Products, Inc. (AMEX:SDPI) Q2 2023 Earnings Call Transcript August 14, 2023

Superior Drilling Products, Inc. misses on earnings expectations. Reported EPS is $0.01103 EPS, expectations were $0.03.

Operator: Greeting. Welcome to the Superior Drilling Products Second Quarter 2023 Financial Results. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions]. Please note, this conference is being recorded. I will now turn the conference over to your host [Michael Petrillo]. You may begin.

Unidentified Company Representative: Thank you, and welcome, everyone, to our second quarter 2023 earnings conference. 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 review our results in detail, and then Troy will provide an update on the company’s outlook and opportunities, after which we’ll open up for Q&A. You should have a copy of the financial results that were released before the market this morning. You should also have a copy of the slides that accompany our conversation today. If not, both can be found on our website sdpi.com. Turning to Slide 2. I’ll point out that we have — 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 held by the company with the Securities and Exchange Commission. These documents can also be found on our website at or at sec.gov. I want to also point out that during today’s call, we’ll discuss some non-GAAP financial measures, which we believe will be useful in evaluating our performance, 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?

Christopher Cashion : Thank you, Mike, and thanks, everyone, for joining us today. We had another strong quarter as our team continued to execute well to meet the demand for our tools and Contract Services. Now this slide highlights several of our accomplishments, which includes very impressive year-over-year top line growth with increased Contract Services work domestically and continued growth in our international Drill-N-Ream business, which we expect to continue throughout 2023. The leverage that we gained this higher revenue volume has led to measurably improved operating income and net income as well as solid EBITDA performance. As we have discussed on previous calls, we have been making significant investments and manufacturing service capacity to accommodate our increased work and in support of anticipated demand in our international business.

I’m pleased to report that those investments are starting to pay off. As during this quarter, we completed our new service and technology center in Dubai and have begun repairing tools in that facility. And given the completion of our capacity expansion in Vernal, Utah, we have begun to refurbish a second customer’s PDC bits as part of our contract services work. Now if you’ll turn with me to Slide 4, you can see an overview of our top line performance. International, our quarterly revenue doubled year-over-year to $1 million as we continue to gain traction in the Middle East market. Our international sales mix was nearly 20% of total revenue during the quarter, our highest level to date and up from roughly 11% last year. We continue to be encouraged by the many opportunities in the Middle East, and expect that revenue mix change to continue to trend toward the international side of our business.

In North America, we saw revenue growth year-over-year. The sequential dip you see reflects two impacts. The first was that we had an exceptionally strong quarter of Tool sales for our U.S. channel partner during the first quarter of 2023 and that was due primarily to the timing of replacement tool purchases. The other factor to note is that the average rig count, which while up marginally since last year’s Q2 average, was down 39 rigs since the sequential first quarter of this year. And we have seen further declines in the U.S. rig count, and it reached 654 rigs this past Friday. Over the near term, it is our expectation that the North American rig count should stabilize around these current levels. Now from an international market activity perspective, the outlook is somewhat different.

During the first half of calendar year 2023, the international rig count steadily increased. And unlike here in the U.S., we expect this increase to continue in the second half of 2023. Now let’s move on to Slide 5 and take a little closer look at our Tool and Contract Services revenue. Second quarter Contract Services revenue was up $1.8 million, roughly 10% over last year with increased demand for the refurbishment of drill bits for our long-time legacy customer. And as noted above, this year-over-year average U.S. rig count was flat during this period of increased demand for our services. And as I mentioned earlier, we expanded our capacity to provide PDC bit refurbishment services to a second customer, and we began providing those services in Q2 of this year.

Tool revenue grew 23% for the quarter, given our improved market penetration in the Middle East and our U.S. channel partner continuing to drive year-over-year market share gains for our Drill-N-Ream tool. We also implemented a price increase in midyear last year. Now as we go on to Slide 6, you’ll see that we’ve continued to invest in people to address this demand for our services, especially in the Middle East region, where we’ve added over the last year 4 people in technical sales and business development, including a new team leader. Now SG&A expenses were up 45.8% of revenue, which is up over year-over-year, and sequentially. This reflects these investments in our human resources and also increased legal costs. Included in Q2 2023 was $450,000 of expenses related to the continuing litigation for patent infringement lawsuit violations of our Drill-N-Ream tool.

This was higher than expected. And currently, we are now preparing this case to go to trial — maturity trial, and we expect that during the early spring of 2024. But despite these added expenses, we still delivered operating income of $546,000 in the quarter, which is an increase of more than 4x over the prior year period. Now if we go to Slide 7, we can see the highlights of our bottom line and adjusted EBITDA results. In this quarter, we achieved net income of $323,000 or $0.01 per diluted share. And then that compares year-over-year to a slight loss in the previous year. We also have adjusted EBITDA of $1.2 million and an EBITDA margin expansion of 430 basis points up to 22.6%. And the sequential change reflects my earlier comments regarding exceptionally strong Q1 2023 Drill-N-Ream tool sales, along with those higher litigation expenses, pertaining to our lawsuit, our patent infringement lawsuit.

Now let’s move on to Slide 8, where we highlight our balance sheet. Cash generated from operations was $921,000 for the year-to-date period, down from the comparable period last year, largely due to working capital changes driven by a 50% increase in inventory, and this inventory increase is to buy raw materials, and we have work in process for tools in anticipation of greater demand for the Drill-N-Ream in the Middle East. So once again, this is internationally driven investment in inventory. We also had a significant receipt of $750,000 on some delayed accounts receivable. And now you also see that the company continues to invest in CapEx. And we reviewed those in the past. They’re largely related to the completion of our new domestic machining centers, an increase in the Middle East Drill-N-Ream tool fleet, the expansion of our infrastructure that I referred to a little bit earlier to accommodate a second PDC bit customer and the new service and technology center in the Middle East, which, as I mentioned, is up and running.

And we’re now repairing bits — excuse me, Drill-N-Ream, not bits. We’re preparing Drill-N-Ream tools in that facility in the Middle East. And when you look at our total debt at the end of the quarter, it was $1.9 million. And that we are happy to report that in late July of this year, we executed a new credit agreement with Vast Bank, and it includes a 5-year term loan of $1.7 million at 2-years $750,000 revolving credit line and a program whereby the bank can purchase certain accounts receivable. The proceeds from the receivables program was used to repay in full the amount of our outstanding indebtedness under our existing credit facility, a facility that existed as of June 30. The funds available through the term loan and the revolving line of credit can be used for working capital and growth capital purposes.

This new credit agreement provides additional financial flexibility and liquidity. Extends our maturity dates and, importantly, includes more favorable financing terms than our previous debt arrangements. The interest rate on the revolving line will be the greater of prime plus 1 or 7.5%, while the interest rate on the term loans fixed at 8.18%. This compares with 13.85% that we were paying under our old credit facility. Now let’s go to Slide 9, where we take a look at our guidance. We have updated our expected 2023 revenue to account for the decline in the U.S. rig count from what we were looking at in the previous quarter. Our revenue range is now between $22 million and $24 million, which implies a top line midpoint 20% growth. SG&A expectations have been tightened to between $9 million and $9.5 million.

And this includes those litigation costs, which are now projected to be approximately $1.2 million for calendar year 2023. And as I mentioned previously, we expect a jury trial in the spring Q1 2024. Our adjusted EBITDA guidance is $5.5 million to $6.5 million, which implies an EBITDA margin of around 26% at the midpoint. This level is about 130 basis points higher than our 2022 results. And then lastly, we’ve maintained our expected capital spending guidance for fiscal 2023 in the range of between $3.5 million and $4 million. So with that, I’m going to turn the presentation to Troy to wrap up with a review of our outlook and opportunities both in North America and the Middle East region. Troy?

Troy Meier: Thanks. Thanks, Chris. And I just want to take quick shout out — give a quick shout out to the Uinta Basin. And for those of you that haven’t been here that are on this call, you really need to come visit. The summers and fall here are just incredible. I just have say that looking outside it’s just beautiful out here. Anyway, let’s get into our North America. If we look at the opportunities that we have in North America, like Chris said, we spent the CapEx and we expanded our facilities here. We’ve got all of the Drill-N-Ream bracing and manufacturing is now in its own facility, which allowed us to clear out one of our buildings so that we could segregate a new customer that’s come in that we can have their bit line totally segregated from our legacy customers, and that’s gone really, really well.

The team is doing a fabulous job there. We’ve also, as you know, from prior calls, we’ve talked about bringing our quality, making it world class, and the team has done a fantastic job there as we look at our QS&E team and doing what they’ve done here in our headquarters and watching the team take hold of that whole management system and what’s going on there is really proud to be part of that. As we’ve expanded our capacity with the large machining centers that you’ve heard us talk about, the large manufac CNC machining center, the new addition of another 750. We’ve got a well-trained team and we’ve got capacity that — to start getting that additional work in here. We’ve got some highly qualified programmers and machinists and we’re going to start filling up that capacity and bringing in some additional work.

We also — as we look at our international opportunity — well, before I go there, I want to also give — our channel partners here in the U.S. are doing a great job, penetrating the market with the Drill-N-Ream. Even though we’re seeing a softening of rig count, they’re still strong out there and getting the tools and all. And one of the things that we like seeing is the fact that their fleet is now aging and those tools have got to be replaced. And so we know that we’re going to continue to get new tool orders as those tools are replaced. So looking at our international opportunity, and that’s where a lot of excitement for me comes from because we’ve been over there now for a while as we’ve proven up our tool. We’ve proven up the Drill-N-Ream in Kuwait, Oman, Saudi, the UAE.

The tool works very, very well. But the one thing that we were always lacking was the ability to run a tool, get it in from the field, get it turned around in a timely manner and get it right back out. And it’s really held us back from pushing hard, especially with all the disruptions in the sea container business. We just — it was too troublesome to try to put tools in a sea-can, put them on a ship and having no idea when that ship would get the cargo here to our Vernal facility. So now that we’ve got this repair ability in the MENA region in our Dubai facility, we’re excited to put an extremely strong push into that marketplace. We’ve — as Chris mentioned, we brought in a technical expert Mohamed Belhouchet, if you guys get an opportunity to read some of the white papers that this gentleman has put out, he’s world-class, and he’s joined our team.

And before he even joined our team, he did a couple of papers on the Drill-N-Ream that were very impressive, and we’re extremely excited that he’s now joined, and we’re ready to take our technical sales to another level. We look at what else can we do as we set up the repair center for the Drill-N-Reams in the MENA region, well, that also — that same skill set, not so much the same equipment, some of the same equipment, but the same skill set is needed for the bit repair. And we’ve been asked for many years to get bit repair up and going in the MENA region. The first trip I ever made over there was to look at a request from ADNOC to do that many years ago, but at the time, the volume just couldn’t justify it. So we now have a lot of that equipment.

It’s already made part of the CapEx spend that we’ve done this year. It’s in place. It’s being loaded into sea-cans and it’s going to be heading over to our large center, and we’ll be setting up and repairing not just Drill-N-Reams throughout the rest of the year, but starting in Q4, we’ll also be showing bit repair in there as well. So we’re extremely excited about the additional revenue that that’s going to bring. Another area that we’ve put a lot of emphasis on has been our ISO. When we look at the ISO requirements that we’ve had for this — for the international, the MENA region, the team has been pushing really hard to get that done so that — as we’ve now put a technical team in place, we now have the repair ability and capacity in place, and we’re going through our audit right now as we speak, as we’ve had the ISO 9001, like you all know, but we’re also adding the ISO 14001 and 45001.

All of that, we expect to have in place here — qualified and certified and in place so that as we now start knocking on doors in the MENA region that we can’t be tripped up by the lack of the ISO qualifications. So I want to tell our team and brag on them because they’ve done a tremendous job there. So when you look at our opportunities, and we’re in the MENA reach, I’m — that’s something that — we’re seeing rig counts increase over there, unlike here where we’re seeing rig counts decrease. They’re getting very aggressive. Saudi is picking up rigs, UAE is picking up rigs, Kuwait is picking up rigs. We feel that us being over there and doing what we’ve done to put us in a position for this day has been very, very important to the growth of this company and what it means to us going forward.

We still have a lot of opportunity here in North America. But I think what you’re going to see happen with us and our team in the MENA region over the next one year, 1.5 years is going to be very impressive. So with that, I’m going to turn the time to Q&A session. And again, thanks for joining us.

Q&A Session

Operator: [Operator Instructions] Our first question comes from the line of Dick Ryan with Oak Ridge Financial.

Richard Ryan : Chris, I just want to look at the litigation expense. You increased it for all of ’23, and then you say the trial is spring of next year. So we have some follow through litigation expense in the first quarter of ’24?

Christopher Cashion : Yes, we do. And that’s roughly $300,000 is what we’re kind of thinking that’s going to look like, Dick.

Richard Ryan : Okay. Okay. Say, Troy, a couple on the drill bit refurbishing. You got a second customer. Can you look down the road a couple of years, is that — would that customer be on par with the legacy customer, what they generate? Is it more or less? And then the second question is the bit refurbishing over in the Middle East, is that going to be a third customer? Or would that be either when you’re first two?

Troy Meier: So in regards to the first question, yes, every bit is as big as our legacy customer for sure. It’s somebody that we’ve looked at and targeted. And yes, it’s got tons of potential, very large in scale. When we look at the Mid East or the MENA — Mid East, North African opportunities, over there it’s different because that part of the world — some of the E&Ps, which are all pretty much NOCs, they still buy this, and they still own large inventories of bits that they own, like Kuwaiti oil and gas, they own thousands of bits. And I do know that you’re starting to see the rental market get very vibrant over there. I think anybody wants to buy a product that’s growing obsolete from the day you buy it. So — but there’s a tremendous opportunity for not just the ServCos, but also, like I mentioned, my first trip over there years ago was at the request of ADNOC to come look at the tools that they owned and how could we set up over there and repair.

Back then, it was quite a smaller operation. But yes, we’ve had a request from our legacy customers, we’ve had requests from all the major ServCos that have meaningful market share with drill bits. So I’m not quite sure how the regulations are with moving stuff in and out of countries. There’s a lot of — if you own a bit, let’s say, in Kuwait, what’s the regulations on moving that out into Dubai and having it repaired and then shipped back. We haven’t got to that in depth yet. I know there are some regulations, maybe they can be shipped out on temporary permits or something. But yes, I think there’s a huge opportunity there as far as bit repair goes.

Richard Ryan : Okay. So, on the channel partner, in the slide deck, you talk about further penetration in the U.S. market. Is that in the existing base that they’ve been working with you on? Are you expanding to any of the other basins?

Troy Meier : No, we’ve pretty much been running Drill-N-Reams in about every basin there is. But no, we’re seeing larger tools being ordered, which tells us they’re going into different portion of the wellbore into the vertical, if you will. We’re seeing tools run in the curve. We’re seeing tools run in the lateral. And if you look at the Drill-N-Ream, when we first brought that out, it was put in the lateral. And now it’s used all the time in the curve. And then I think that what we found when we went over to the Mid East was they weren’t drilling the curves and laterals, but they had complications in the vertical section of the wellbore. And so we’ve been able to really enhance wellbores in the vertical. And now the Mid East is now starting to do turbine laterals.

I think I mentioned — maybe it was on our last call that the Drill-N-Ream was on the two longest laterals ever drilled in Oman, and that’s been fairly recent. And so they’re now starting to build curves and go sideways and they understand the benefit of the tool in the vertical. And I think what we’ll see here in the U.S. is we’ll see more of a realization that what Drill-N-Ream does in the vertical is also good for the operators and the casing that they’re going to put in and the cementing they’re going to be doing. So…

Richard Ryan : Okay. Good. I appreciate it. To the extent that you can, is there any comments you can talk about on your strategic review process?

Troy Meier : We’re building the data room as we speak. We’re a small company, as you’re well aware. And we brought on a banker at the top of the game, and they’re expecting a lot from us and our team is responding. So we’re putting the data room together, and I think it’s moving forward very well.

Operator: And our next question comes from the line of John Bair with Ascend Wealth Advisors.

John Bair : I’ve got a couple of questions for both of you. Let me start off with a quick one on page seven, there’s a reference to right-of-use assets for about $559,000. Can you kind of explain what that is?

Christopher Cashion : Yes. That’s a result of some GAAP — fairly recent GAAP changes around what we used to call operating leases. In the olden days, we would expense — we’ve expensed those monthly lease payments. This — the new GAAP that came out, I guess, it’s been out 1.5 years or so now, requires you to capitalize those operating leases and amortize them over the term of the lease. And that’s what I call right-of-use assets. It’s not — they’re not technically capital leases. There’s no buyout option or anything like that. They are once again operating leases that now have to capitalize because we have the right to use the facility that we’re leasing.

John Bair : Okay. So that’s probably the sale leaseback involved with that?

Christopher Cashion : No. The sale leaseback is different, that’s a different animal. Yes, this doesn’t have anything to do with the Vernal facility. For instance, we’ve leased a facility there in Vernal, that’s not a part of our campus. It was our campus that we did the sale and leaseback. And I guess, last fall, as we were looking and developing the plan to increase our infrastructure to take on the second bit refurb customer, we leased a facility in Vernal, and it’s just a buy-in joint operating lease. That would be an example of a lease that would be in this right-of-use calculation as well as a leased facility that we have in Dubai. We don’t own that facility that the service and technology center is in. We leased that and there’s no options to buy. So it’s not capital in any sense, but it’s an example of another facility that we have the right to use. That’s a part of this right to use calculation. So it’s separate from the sale leaseback.

John Bair : Okay. Very good. And then you mentioned in the press release and your comments about receiving $750,000 of accounts receivable that were delayed. Do you have any additional delayed ARs out there? And secondly, I guess then you would — if you’re looking at the 6/30 — June 30th numbers, you would knock your ARs down by that comparable amount and add to $750,000 your cash on hand. Is that the way to look at it?

Christopher Cashion : That’s the way to think about that, it’s exactly right, John. That’s — it’s — we have a couple of large customers, to answer your first question, that a number of issues, systems kind of things, I would say on their side that caused some delay in us receiving remittances on outstanding AR and they — our DSO was elevated as of June 30 because of those delays, one customer here in the U.S. and one customer in the Middle East. And so yes, we collected not only the $750,000 that we alluded to, but we’ve also collected a bit more, another $150,000 or so and we’re expecting another $300,000 roughly that we’ll be getting over the next week or two. So these issues seem to be worked out. But yes, it led to an elevated AR number, and we’re seeing that come down.

John Bair : Yes, that kind of seeps into my other question is whether or not you see more of a delay in receiving your AR billings from domestic versus international and kind of how that plays out?

Christopher Cashion : Where we’ve always seen a significant delay, i.e., a higher DSO internationally than domestically. And with this domestic customer kind of getting their systems issues worked out, we fully expect receipts to look like they’ve historically been. And then historically, they’ve been very good. It’s — in the oil field, 45 to 60 days is a pretty good number to expect on DSO. Internationally, it’s not like the same, and it never has been. It’s — it easily can be 100 days plus internationally. And so we really haven’t seen any deterioration in either the domestic or the international market. Other than that’s the systems issue I mentioned, it’s hanging in there at that kind of level. So when you’re thinking domestically, you can think 50 days roughly. You’re thinking internationally, it can be 100 to 110. It can be double that. And that’s just the way international is.

John Bair : Well, with your emphasis on expanding internationally, then that’s kind of the reason for the question, I guess. So yes, another question was addressed about market penetration in the U.S. earlier. And with the inventory up in anticipation of increased activity, what do you think your conversion rate might be on sales over the next quarter or two of that inventory level? Do you have any feel for that?

Christopher Cashion : Yes, it’s going to be — it’s Q4 for sure. That’s kind of the way I’m looking at it right now, by the time we get that. And then maybe even late Q4 because once again, that inventory is going into tools, that’s going into the Middle East and converting AR into cash. It’s a long — it’s a big DSO. So if you are referring to cash conversion, taking inventory and burden to cash, then yes, it’s going to be late Q4, might even start running early Q1.

John Bair : Okay. Okay. Very good. So as far as — Troy, you spoke about expanding into bit repair over in the Mid East. Will that require additional CapEx build out of your facilities over there?

Troy Meier : Very little. We’ve got most of the equipment already built. We’ve got to increase our air pressure, our air line capacity. We’ve got to increase that. So another little bit there. We’ve got some electrical to do as we bring in our brace stations, but it’s not going to be nothing like you’ve seen in Q1. Most of the heavy lifting has been done.

John Bair : Okay. So really not any anticipation of an increased level of CapEx say going into 2024 then?

Troy Meier : No, no.

Operator: And we have reached the end of the question-and-answer session. I’ll now turn the call back over to Troy Meier for closing remarks.

Troy Meier : Again, I just want to thank everybody for joining the call. Looking forward to seeing you all and talking to you all again in November, and we’ll keep forging ahead and putting forward our best effort. So stay with us and look forward to seeing you and talking to you in November. Thanks again.

Christopher Cashion : Thanks, everyone.

Operator: And this concludes today’s conference, and you may disconnect your lines at this time. Thank you for your participation.