Superior Drilling Products, Inc.
Q2 2020 Earnings Call Transcript

Published: 7 Aug 2020

[Operator:]

Greetings, and welcome to Superior Drilling Products, Inc. Second Quarter 2020 Financial Results Conference Call. [Operator Instructions] Please note this conference is being recorded. I would now like to turn the conference over to your host, Deborah Pawlowski, Investor Relations for Superior Drilling Products. Thank you. You may begin.

[Deborah Pawlowski:]

Thanks, Devin, and hello, everyone. We appreciate your time today and your interest in Superior Drilling Products, Inc. On the call with me are Troy Meier, our Chairman and CEO; and Chris Cashion, our Chief Financial Officer. They are going to provide you with some prepared remarks discussing the current situation of the company, the results of the quarter and a little bit on where we see things going, then we’ll open the call for questions. You should have a copy of the financial results that we released before the market this morning, and you should also have the slides that will accompany our conversation today. You can find both of those documents on our website at www.sdpi.com. As you are aware, we may make some forward-looking statements during the formal discussion as well as during the Q&A session on today’s call. These statements apply to future events that are subject to risks and uncertainties as well as other factors that could cause the 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. All of these documents can 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, I’m going to turn it over to Troy to begin. Troy?

[Troy Meier:]

Thanks, Deb, and thanks, everybody, for joining us. Let’s go ahead and turn to Slide 4 in the slide deck. Diversifying revenue and cost reductions. I – as we go into this today, I’m going to tell you just a little bit. I’ve been in this business for 39.5 years and been through a number of ups and downs in this energy industry. And it’s – I’ve never seen anything like this. It’s crazy times. It’s rig count, just since March, is down 67%. This whole COVID has really, really changed the landscape and what we’re doing and how we manage this business. But you know we’ve got a great team. We’re survivors. I look at some of the things that we’re doing to replace our foundational business. We can no longer rely on the oil and gas sector to be that business that gives us that strong footing. And we do have some good programs in place. We’ll talk about them as we go through the presentation today, what we’re doing. Not losing focus at our opportunities in the oil and gas industry, which there are still a lot. We look at what we’re doing over in the Mid East and the expansion of our tools and how our tools are performing? How our team is doing over there? They’re doing a great job. And as we look at our tools and as we’re now leaving just the Kuwaiti market, we’re going in. We’ve got tools that are in the UAE and performing very well. We got tools now in the Ukraine. We’ve got tools in Saudi, and we’ve got tools in Qatar. Our tools get – gained a lot of recognition. We’re getting a lot of requests. We’re working with the major service companies. When you look at what’s going on in the international markets, you’ve got a lot of what we call IPM projects, they’re integrated. They’re turnkey projects. They’re – when these NOCs want to essentially set a new benchmark for how drilling should be done within their countries, they roll over to these IPM projects. And then these groups like Schlumberger or Halliburton or Baker Hughes come in, and they turnkey these projects. And it’s really interesting to see how these companies turn to Drill-N-Ream to help them turnkey their projects more efficiently. And so there’s a lot of excitement with our team around that and the things that we’re doing there. We’re getting some agreements in place. We’ve got to be very cautious on how we go from country to country to country. We’re an extremely small company that that’s – maybe we don’t have logistics exports like a lot of big companies do, but we’ve got some people that are learning very, very fast. And so when we look at going into and entertaining opportunities in other countries, we’re very cognizant of shipping requirements and costs and tariffs and duties, and we’re getting much better at that. And I think that’s going to show as we go throughout this year. As you all know, we’re relying very heavily on our international opportunities. We don’t see a rebound in the drilling market here in the U.S. anytime soon, and we’re focused on servicing our customers here. We’re building those relationships that we have here in the U.S. stronger and stronger and seeing if there’s anything else that we can do for them. But at the same time, we know that the real opportunity lies in the international market when we talk about the oil and gas sector. And we’re doing a lot of good things to strengthen our business and start bringing in that revenue that we need. And so as we look at diversification, we’re not losing sight of our tools and our talents that we can give to the energy industry. But we just do not want to get – we do not want to get burned with this energy environment anymore. Like I say, it’s been 39.5 years. We’ve got to get something stronger in place so that we don’t get tripped up so bad every so many years. Some of the things that we’re doing along those lines is, there’s certifications that we’ve got to have as we start to, one, if we want to take and start delivering products ourselves to the end users, there’s an ISO certification that we’ve got to get in place. That certification will be in place by year-end, and that allows us to go directly to the end users with our products. As you’re all aware, we’ve – there are some products that we don’t introduce to the market and we haven’t for 24 years, but are very in tuned with what the latest and greatest tools, design, theory, cutter types in these products. I’m talking about drill bits, of course. We know how to make those better than anybody in the world, and we know how to service those better than anybody in the world. And it’s time that we get out there and start doing that. And so one of the things we’re looking at as we go into international scene is, what is the opportunity there for something like a bit refurbication? How can we enhance our sales with Drill-N-Ream by also throwing a very high end drill bit to go out with that product. So there’s a lot of energy here. There’s a lot of excitement here on the things we can do. We’ve got an incredible workforce here that’s very, very talented. If you look at the ISO certification, it also allows us to start looking at DoD contracts, Department of Defense contracts. For many years, we’ve had companies the likes of Boeing and McDonnell Douglas and come here and ask us to do things for their industry. Like you all know, aerospace industry isn’t really doing well right now. But the Department of Defense, what’s going on there is very exciting. And we think that we can get the certifications that we need there. That’s the AS9100 certification, we’re working on that, and we really believe that we can take and start bringing in additional baseline revenues that will strengthen the foundation of this company that – so we’re not so relied on the oil and gas industry and the ups and downs that we go through. So we’ve got a team that’s working on these certifications, and they’re moving forward very rapidly and doing a very good job. So we’re excited about what we’re going to be able to bring in as far as diversifications. When we talk right now over in our fabrication facility, we’re – we’ve got parts going through there that are for some sort of weaponry. And it’s really neat what these guys can do and how they can – how creative they are. And the talents that they bring to that industry is going to be really fun to see. Keep in mind that, like I said earlier, we’re not losing focus of the companies like Baker Hughes that we have – still have a great relationship with, and we’re going to strengthen that even more. DTI, we’ve got a great relationship there. They’re doing a wonderful job with even penetrating the markets even better in this downtime. There’s some things we can do better with them, and we’re on it. We’re going to get it done. But this era that we’re in right now that I hear people calling it a black swan or a double black swan, I’m not even sure if I know what that means. But there’s a – it’s a tough time, but we’re survivors, and we will get through this, and we’ll be a better company when we do. So you look at – Chris will talk about the cash burn and what it is per month that we’ve got at $900,000, we’re doing things to bring that down. We’re looking at additional stages to bring our cost structure down. As you all know, we’ve already gone through two. We may possibly need to do a third one. But like I say, diversification is key to our survival and we’ll continue to move forward with our opportunities in the Mid East, and I’m proud of what the team is doing over there. And we’ve got a great team, and we just need to make sure that we continue to produce high-quality drilling tools. With that, I’m going to turn it over to Chris. Chris?

[Chris Cashion:]

Okay. Thank you, Troy, and welcome, everyone. Let’s continue our discussion by turning to Slide 6. If you look at the trend in quarterly revenue from Q2 2019 to Q1 2020, this shows that our growth strategy, even in a weakening oil and gas market, was working. Q1 of this year was our second-best revenue quarter since our IPO in 2014. We have successfully grown our international presence and expanded market share in Contract Services. That market share of Contract Services is referenced in that dark blue part of those bars. That – that’s the part of the business that’s all U.S. That’s driven 100% on the U.S. rig count. And so you can see we’re down slightly in that Q2 last year, Q1 time frame with the rig count down 28% during that time frame. We’ll move into Q2 of this year, and we’ll talk about the rig count going down again as we all know. But we don’t want to lose sight of the fact that even 2019 and the first quarter 2020, we were holding our own in a U.S. market environment that was down almost 30%. And so sometimes that gets kind of lost in looking at the decline in Q2 of this year, roughly another 64% on top of that. So it’s – that’s important to remember that for us as we think about our growth opportunities coming out of the COVID-19 environment, as markets begin to improve, we believe we can get back on that growth plan that we had – we demonstrated through Q1 of this year. Year-over-year international revenue for the quarter, Q2 quarter, up 66%. It now represents 17% of our total revenue. So now as we move into Q2 2020, whether we compare revenue in this quarter to last year’s second quarter or this year’s first quarter, it was clearly impacted by COVID-19. Rigs around the world were dropping. In the U.S., the rig count dropped another 64% during the quarter. The end of Q1 this year, 728 rigs dropping to 265 by the end of the quarter. So another 64% decline. And not only in the U.S., rigs declining internationally as operators were not working because of stay-at-home requirements. Global demand for oil dropped significantly while production, which cannot be turned off as quickly, created a surplus of supply. And all of you on this call understand all that. What we want to emphasize is despite all of that going on in the marketplace, the usage of the Drill-N-Ream relative to the market continued to expand as our U.S. distributor gained market share and as we penetrated the international market. The value of the Drill-N-Ream is critical to a market in these types of conditions. So bottom line, we want to emphasize the growth track that we were on through Q1 of this year. The same value proposition this company provides is still here today, and we’re going to expand those opportunities as Troy just mentioned and intend to get back on that growth curve. I might add that international revenue for the first half of 2020 was up 175% over the first half of last year. So with that, let’s go to Slide 7 and take a little deeper look at the tool revenue. On this slide, international revenue is included in the light blue part of those bar graphs called Tool Sales/Rental. That $335,000 of international Drill-N-Ream rental helped to offset a lack of tool sales in the U.S. Given the size of our distributor’s fleet, they did not need to add additional Drill-N-Ream tools to that rental tool fleet due to the significant drop in rig activity in Q2 of this year. We do, of course, continue to repair their tools as they continue to put those in service. The maintenance and repair fees are part of the dark blue part of these bars, and that’s labeled the Other Related Tool Revenue. So I want to emphasize that, that when we think in terms of maintenance and repair fees on the Drill-N-Ream domestically, that revenue stream together with our royalty fees makes up what we call Other Related Tool Revenue. And sometimes, you may hear us refer to that as recurring revenue. I should note that at this point that we have provided a discount to our U.S. distributor. We passed that discount along to them in April of this year, and they’re passing it along to their customers and, of course, doing these – those kinds of things because of the depressed state that this industry is in. So just to back up and put into perspective, that total rig count decline from the beginning of Q2 2019 to the end of Q2 2020, that five-quarter period of time, the rig count declined in the U.S. from 1,006 to 265. That’s roughly a 74% decline over those five quarters. As I mentioned earlier, quarter-over-quarter average rig counts are down 60%. And once again, that recurring revenue stream that we talked about was down only 38%. And you can see that when you look at those five quarters, you look at Q2 2019 $1.6 million of other related tool revenue/recurring revenue down to $1 million, $600,000 drop from Q2 last year to Q2 this year, 38% down in revenue, average rig count down 60%. So we talk in terms of averages when we’re trying to talk about revenue. And then point-to-point rig count declines, we believe that’s a relevant way to look at just what’s happened in this marketplace. So with that, let’s go to Slide 8 and look at our operating expenses. We completed Phase 1 of our cost-reduction plans. That was effective in the second quarter. These savings are reflected in these reduction in operating expenses that you see here on this chart. Cost of revenue decreased 45% due to lower variable costs on lower volume, the closure of our Abilene facility, reduction in headcount, reduction in salaries and reductions in other fixed costs. That’s what we call our Phase 1 of cost reductions and those got implemented in early Q2. As a percentage of revenue, cost of sales was 54% compared to 44% for the prior year period. The increase as a percent of revenue reflects lower absorption of overhead costs and reduced volumes. So while we took cost out of the fixed cost base, we couldn’t take enough fixed cost out. It did lead to a drop in the cost of goods sold percent. The decline of 26% in SG&A is reflecting headcount that came out of the SG&A departments as well as salary reductions and the deferral of new product development projects. As you may recall, R&D is a part of our SG&A line. Now taking a look at depreciation and amortization. You can see that it is down from almost $1 million to $680,000, a 27% decrease. This decline is due to the lower amortization expense as a result of fully amortizing a portion of our intangible assets in May of 2019. It is important to note that we have taken a significant amount of cost out. And in addition, we completed Phase 2 of our cost-reduction plan in early July of this year. So those benefits will start rolling through in Q3. So we’ve dropped our monthly operating cash requirements from $1.1 million in Q2 to around $900,000 currently. And we are now evaluating other cost reductions in a Phase 3. Now let’s go to Slide 9. Net loss was $1.2 million for the quarter, $0.05 per share; adjusted net loss, about $861,000 or $0.03 per share; adjusted EBITDA, which we use to measure operational performance, was negative $222,000. For the trailing 12 months, the EBITDA was $2.7 million or 16% of revenue. These metrics reflect the fall in our revenue in Q2 related to the impacts COVID-19 has had on our business and our industry. Now let’s turn to Slide 10. The cash balance at the end of the quarter was $2.5 million, and that was up from $1.2 million at the end of 2019 but down from $3.3 million at the end of the first quarter of 2020. Over the first half of the year, very positive working capital was driven by strong U.S. accounts receivable collections. Total debt at the end of the second quarter was $6.9 million, down $700,000 in the quarter and down $1.2 million since the end of 2019. The remaining principal balance on the Hard Rock note at the end of June $1.5 million, as you may recall, we’ve revised that agreement, spread out those remaining two principal payments

[Operator:]

[Operator Instructions] Our first question comes from the line of John Bair with Ascend Wealth Advisors. Please state your question.

[John Bair:]

Thank you. TGIF, right. A couple of questions here. The $900,000 a month cash burn, does that incorporate your anticipated expenses for your – getting your certifications that you’re hoping to have in place by the end of the year?

[Troy Meier:]

Yes, it does.

[John Bair:]

Okay. And then, as a follow-up, how long do you anticipate it might be or will take for the diversification effort to result in any kind of meaningful either contracts, business, basically generation of revenues? And can you do anything in the meantime while you’re trying to get those certifications?

[Troy Meier:]

We are doing stuff in the meantime, John. We’re – like I said, we’re – we now have parts going through our facility that are not oilfield-related at all. If you look at when we’ll start seeing a meaningful impact, I would say, about six months down the road. We’ve got to – we’re dealing with them. And we’ve been talking with some phenomenal companies that are very big in the DoD area that’s – there’s incentives for people – big companies to send work to what they call a rural zone. It’s called a hub. And so it gives us a competitive advantage when we start looking at competing against high-end machining facilities, say, in Houston or in Salt Lake. The fact that we’re rural is a good thing. And – but I really – even though we’re talking to a lot of companies and they’re excited about us getting lined up so we can start doing their work, it’s still going to take us a little time. There’s, like I said, the whole ISO certification that we’ve got to go through. It’s a big, big deal. And so we’ll be bringing on work, and we do work for prototyping in some of these industries. There’s some work that we can get by going underneath another company’s umbrella that they give us work that they bid on, and we do the work and it goes under their ISO certification. But for us to truly say when we’re going to see an impact? It’s going to be six months.

[John Bair:]

Okay. And like would some of the industries outside of defense, I know where that’s coming from, but areas like the EV market, perhaps auto-related or medical instrumentation, are those applicable areas that you could provide services to?

[Troy Meier:]

They are. We’ve got a really good ally. My old boss it’s Christensen many years ago, he went off and started a – he’s got a phenomenal business down in Salt Lake, and he deals with the medical industry with the type of high-end machining that we have. And we’ve been in negotiations and talks with them about how can we support their efforts. And yes, there are some industries out there that we don’t have the contacts in, but we’re working on them, but we know people that are doing work in there that we’ve got good relationships with.

[John Bair:]

Okay. And one last question, and then I’ll get out. Where – okay, you’re talking about going into a Phase 3 of cost reductions. Got to be getting into the muscle right now, maybe even the bone. So just wondering where other – what other areas you might be able to cut further while still trying to develop these other projects as well as expand your efforts internationally?

[Troy Meier:]

Well, when you look at the – we actually were cutting into the muscle in round 1. We’re just starting to stand up from a ugly downturn in the market that we had in 2015 and 2016. So it’s not like we had – if you can look back and say, okay, in 2014, and we built up and we end up with like 120 employees or something like that, and that last crash that we had, we end up cutting way back. And we never really built heavy. I mean everybody that we had was wearing multiple hats. And so yes, I mean, round one, we were cutting into the muscle. And round two, it was the bone. Round three, you’re going to be looking at executive salaries and stuff like that, that we’ve got to do to keep this if we need to pull that trigger. We’re not saying that we have to pull that yet, but we need to see some – a meaningful increase in our revenue or else we will have to go to that round three. But we’re not looking to let individuals go, that’s not going to be productive for us at all.

[John Bair:]

Okay, well. Good luck to you all. I have been down that path and AD’s as you know from our previously discussions privately. So best luck to you all and we looking forward to hearing your progress.

[Operator:]

[Operator Instructions] Since there are no further questions at this time, I would like to turn the floor back over to management for any closing remarks.

[Troy Meier:]

Well, I just want to say thanks, everyone, for joining us, and we appreciate you following us and supporting us. Again, this is an ugly, ugly time, but we’re not out and got a lot of fight left in us, and we’ve got some good things going. And I’m excited to get this time behind us. So again, appreciate you all, and thank you, and have a wonderful weekend. Bye.

[Operator:]

This concludes today’s teleconference. You may now disconnect your lines at this time. Thank you for your participation, and have a wonderful day.