Superior Drilling Products, Inc.
Q1 2019 Earnings Call Transcript

Published: 13 May 2019

[Operator:]

Welcome to Superior Drilling Products Incorporated First Quarter 2019 Financial Results. [Operator Instructions]. I will now turn the conference over to your host, Deb Pawlowski, Investor Relations. Ms. Pawlowski you may begin.

[Deborah Pawlowski:]

Thanks, Jeremy. Good afternoon, everybody. We certainly appreciate your time today, and your interest in Superior Drilling Products. Joining me on the call are Troy Meier, our Chairman and CEO, and Chris Cashion, our Chief Financial Officer. You should have a copy of the financial results that were released before the markets opened 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. If you are aware, 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 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 and other factors are provided in the earnings release the slides and other documents filed by the company with Securities and Exchange Commission. These documents can be found on our website or at sec.gov. I'd like to also point out that during today's call, we will discuss some non-GAAP measures which we believe will be useful in evaluating our performance. You should not consider the presentation of this additional information in isolation or the 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. Thanks everyone for joining us for our first quarter 2019 financial results call. Let's turn to slide four in the deck presentation and as you'll see this is slides going to be talking about the opportunities the company has and the opportunities that we're following through on. If we look at our the opportunity that we have with the enhanced contract service part of our business that's moving forward very well as we strengthen our relationship with our legacy partners, customers and go inside of their products and their product lines and seeing how we can help them with additional fleet maintenance that we're doing it's not just bits anymore, we're maintaining another product line for them and as we look at these product lines, that needs the same type of fleet maintenance that we've been doing for years on the bits, we also recognize an opportunity to manufacture these parts. So there's some good upside going forward as we look at the various product lines that some of these major service companies need additional support in the manufacturing and also the fleet maintenance of those products. We look at the opportunity that we have with the performance that our initial commercialization fleet has given us over the Mideast, the Drill-N-Ream, what we've seen over there is most all the majors have now run it within certain countries and with very good results and they're calling back and asking for some slight modifications to a thread just so that they don't have to use what they call crossover subs or something that gives it more customized to their needs but the team that's being built for the Mideast operation is doing a fantastic job. We're beefing up our technical staff for the Mideast and also the technical team that gets out there and is presenting this and we're very, very pleased with the results of the run so far of our initial fleet. We were looking forward to some great opportunity there, if you look at what we've learned over there is when we broke the Drill-N-Ream out here in the U.S., it was for the horizontal section of the well bore and when the tool broke out over in the Mideast, they were actually using it in the curve to help get some rotary steerable systems through the curve and what we found out here in the U.S. is we went from the horizontal into the curve and up into the vertical and over the Mideast, we've gone from the curve up into the vertical and now going into the horizontal. So there's some tremendous opportunity in the Mideast with the Drill-N-Ream and we're very pleased with the tools performance today. Strider, we look at the opportunity that we have there. One of the things that we've been able to do as of late is we've put together and completed a mathematical model of the Strider tool and although that may not sound like much, it is a big deal for our company, we've never had this opportunity before where we could actually model out a tool and run down whole parameters across this tool and make good decisions on change to design challenges within the tool itself. So the small tool, even in the open hole application is performing very well, we're very pleased with the results of it. As you know, we don't go out there we're not - we haven't been marketing or selling this tool, we just need to get approved up first and now the team is just strictly focused on this larger tool size, we run a test last week at Catoosa. We weren't in the hole very long, but we were able to come out, look at the breakdown of the tool, get together as a team and put this into our new model of this tool, make changes, run those changes through the model and make sure the changes we make just don't break down another part of the tool. The challenge with the current Strider that were the size, the last size that we're looking to develop is all based on the challenge there is the amount of flow, the gallons per minute the, GPM that these tools see and we're shooting the 700 to 800 GPM, which is would have been extremely high a few years ago but that's becoming more normal today. So there's some tremendous opportunity there. Like I said, the progress that we're making, it's been a long time coming, but we've got a, we've put together an incredible team that's supporting the development of that product and it's going to be, it's going to be a wonderful tool. When we look at the opportunity in our domestically with the Drill-N-Ream product, we feel that there's a need for additional support with our existing channel partner. We want to do what we need to do to, to get that market saturation of that Drill-N-Ream tool. It's a tool that needs to be out there and it shows its value and we believe that we can help our channel partner to saturate this market. So with that being said, I'm going to turn it over to Chris to go over some financial results. Chris?

[Chris Cashion:]

Thank you, Troy. Welcome, everyone. Let's continue our discussion by looking at slide six and you'll see on that slide that we have some significant revenue growth, almost 10% over the prior period with a declining rig count. So in Q1 of 2019 between the beginning of the quarter and currently rigs are razor down roughly 8% - 8.5% and in the face of that decline we have we manage to come in with a 10% increase year over year and a 45% increase from the prior quarter. Now the driver behind this is our contract services business and as you see there on the chart, it's up nicely from Q1, 2018. $0.5 million and that's roughly 45% and that's the result of what Troy alluded to some enhancements to our contract that we executed April, 1, 2018 with our legacy partner on the bit refurbishment side and we picked up another product to repair and get some pricing improvements and a little bit higher bit volume and some good strong mix. You know some of the parts we make a little more money than others and so we got some good mix shift showed up in Q1. So we're really excited about how that grew year over year and once again, in spite of a rig count decline. As you say, from the tool revenue perspective, that's the light blue part of those bar graphs and pretty flat when you look at Q1 this year over the prior quarter, and kind of choppy as you go throughout the year. That's, that's a function of the new tool, sales that we make on a quarterly basis and so it's kind of like a capital goods marketed that kind of moves around on a quarterly basis but if you just kind of step back and look kind of overall on an annual basis, it's pretty, pretty flat, pretty choppy is what we've seen over the last year. So if we go to Slide 7, we dig in a little bit more into those Drill-N-Ream revenues. On this slide, you've seen this one before we break down the new tool sales, the light blue portion of these bars versus what we call the recurring revenue coming from repair and royalty with regard to the Drill-N-Ream and you can see there that we got a strong increase from Q4 to Q1, but Q4 was a really low quarter for us and so we're just pleased to see that we reverse that trend that was tracking down in the last three quarters of 2018 and managed to bring that up in Q1 of '19. But then when you look at Q1, '19 versus Q1, '18 it's still a flattish kind of a number, good sustained growth on the dark blue portion of those bar charts and that's the repair and the royalty. So over time, when you look at it on an annual basis, the three bars on the right hand side, you see that dark blue continuing to grow and improve with the light blue, which is a new tool sales, staying pretty flat in the you know, roughly 6.5 million or so per year. So that's up the market share roughly that our distributor has is between 14% and 15% of the market and that's resulting in this more flattish kind of a performance that we see here and so we're looking at options on how we can broaden the penetration of the North American market to get more market share. So that's an opportunity for us and as Troy mentioned, working with our existing channel partner, we're going to try to figure out ways to get that market share moving up from where it is. Our channel partner has a good strong position in the Permian basis, we think somewhere around 25% and so we believe that's the potential for this tool throughout all the basins. So we got an opportunity to try to penetrate these other basins like the Permian has been penetrated. On the international side, as you recall, last year, we had what we call a test fleet of tools in the Middle East, just a small number of tools spread across three different countries and as we move throughout the year, we began to see that Kuwait was the early adopter, tremendous demand for the tool in Kuwait so we begin to focus our attention in Kuwait and then as you may recall in November of last year, we put out a press release where we were tripling our fleet of tools and we targeted Q1 this year to accomplish that and we did that. So we've expanded from just a test fleet of assets in the Middle East now we have a, we kind of call our Phase 1 of our commercial fleet and we achieved that we got that done and beginning to generate us some revenue, a couple of hundred thousand dollars in Q1 and versus all of last year and that's a nice significant increase of 350,000, roughly for the entire 2018. Once again, we didn't have the asset base in place to really generate commercial revenue and so with those assets in place, we're starting to see that revenue line start to move up. We expect some good solid growth throughout the rest of this year, as we continue to respond to demand by building more tools for that marketplace and as Troy said, we've got large service companies using the tool in the Middle East and they're making some requests for some specific spread special threads. They're running the tool in the [indiscernible] assembly which is a little different from how the Drill-N-Ream typically run. So a lot of good market intelligence, understanding how the markets demanding the tool. We've got the attention of the large service company. So we're really pleased about where we're going in the Middle East. Let's go to slide 8, where we look at operating expenses and current quarter versus prior quarter year quarter SG&A is up $400,000 and that's where we've been guiding the market over the last couple of quarters, that's international expansion is driving that and then also as you may remember, we've got engineering expenses as part of SG&A and so our engineering and development of the Strider and in that math modeling and the third party group helping us do that and the way we're really changing how we look at new product development with some good strong consultants have come on board is really starting to pay some dividends for us. That spending is in SG&A so that's a part of the spending increase and so once again, we're all on track to for that SG&A to fall between our guidance range of 8 million to 9 million for the year and we're right on track for that to happen. When you look down at the bottom, you see three bars, annual numbers, I want to use this to kind of move into the next slide, but when you look at Q1, 2019 on a trailing 12 month basis for D&A that's the lightest of the blue in that bar of $3.8 million and you see that's been pretty consistent over the last three years. Well, the trailing 12 months versus '18 and '17. $2.4 million of that is amortization and that's intangible asset amortization. So, I'd like to move to slide 9 and just focus on the impact that the amortization expense has on our bottom line. On slide 9, you see on the left hand side GAAP and adjusted GAAP net income and we show this every time. We haven't really, really focused a lot on it, but we're focusing on it now because this amortization expense on a quarterly basis is $600,000 and so when you look at our reconciliation of GAAP to adjusted GAAP or adjusted net income from a GAAP basis, that is the big reconciling item or the difference or the adjustment if you will, $600,000 a quarter and amortization expense, we will have these intangible assets fully amortized in another five quarters. So effective June 30, 2020 we will finish amortizing the intangible assets that we put on the books when we move off the Drill-N-Ream in 2014. So if you look at on the left hand side, Q1, 2019, trailing 12 months net income, slightly negative on a trailing 12 month basis, that's the navy blue, but when you factor out $2.4 million on an annual basis of amortization expense, our net income improves to just under $3 million. Now that's 16% of revenue on a trailing 12 month basis and so that's sometimes that kind of gets lost, we think as far as looking at the bottom line. But the message here is another five quarters will be finished with that that amortization expense. On EBITDA perspective, we're continuing to hang in there between 25% - 30% of EBITDA to revenue. Once again, kind of choppy on a quarterly basis and that choppiness is a function of drilling rig tool sales on a quarterly basis, but when you look at the annual numbers at the bottom, on the right hand side, you see it staying just under that $5 million of EBITDA and that's working out between 25% and 30%, of revenue and that is with our investments and engineering in R&D and our investments the geographic expansion of the Drill-N-Ream. So we continue to generate good strong EBITDA as we invest in the business. Let's go to slide 10 now and look at the balance sheet, and the balance sheet continues to get stronger, we generate a million dollars in cash from operations in Q1 and with that million dollars, we were able to fund our capital expenditures rental tool fleet in the Middle East and we also financed the paid down of debt, you can say we paid total debt down another $600,000 from 12/31/18 to the end of the first quarter. We continue to amortize the principal on our hard rock note and we did some refinancing of our the mortgage on our Vernal facility, we paid a $1 million down on that principle and extended the rest of that which is $3 million for a couple of years. We put a credit facility in place. So now we have a revolver, $3.5 million and so as we grow revenue, we've got a way to finance the working capital. So bottom line, cash is staying strong at $4.3 million with funding CapEx and funding debt service. Now let's go to slide 11 and look at the guidance. We've narrowed our guidance on the revenue side a bit from 21 million to 24 million to 21 million to 23 million. We brought it down on the top end just looking at the recount and the softness in the rig count, we think it's prudent to probably think in terms of a little softer growth over the rest of the year just because of the uncertainty in the marketplace, but still feel strongly about gross margins, SG&A that's the same guidance range we gave last time, we don't seen surprises their D&A, that's roughly $600,000 to $700,000 higher in our guidance for 2019 verses 2018 and that's depreciation expense on those tools in the Middle East and capital expenditures $2.8 million that's what it was in our last guidance and the majority of that as we mentioned, is continuing to build that Middle East rental fleet. So basically guidance is in-line with what we did the last time. So with that, I'm going to turn this back over to Troy.

[Troy Meier:]

Thanks, Chris. So when we look at the opportunities that we have going forward, we feel very strongly about what we're doing and the progress of our R&D department and the team, I really want to stress that the team that we've now built, as we've gathered, we've got a new firm that's dealing with our entire patent portfolio, we feel it's one of the nation's best, we've got a manager of this patent portfolio that is making sure our current patents and our patents going forward are very, very tight. And you know that's all starting to show, we've got an engineering team that we're using on the mathematical modeling, that is world class and so where we we're currently at with Strider is where we will be starting our next product at we will you know this mathematical modern, like I say, it may not sound like a big deal, it really is to have that ability to take your tools and to run them in a simulation that is very precise and it becomes more precise with the additional information that we give it every time that we test the tool and be able to make intelligent decisions on where the weak point is in the design. So this gathering of information is just incredible. With that, we're going to turn it over to some Q&A.

[Operator:]

[Operator Instructions]. Our first question comes from line of Jason Wangler from Imperial Capital. Please proceed with your question.

[Jason Wangler:]

Troy I wanted to ask I mean, obviously the Permian Basin market share at 25% I mean, if you're going to have 20% market share it's probably the best place to be. But you know, with the call it 15% market share at the end of the quarter, are there certain basins that you see specifically that, either you just are not is obviously as high as you'd like to be in or that maybe are the kind of the growth areas as you look forward in kind of getting the tool into more basins or I guess more expanded in those basins.

[Troy Meier:]

Yes, we know there's basins. Jason, if you look at the Bakken I mean that's where the tool is broken out, right. So we think that there can be some good opportunity in the Bakken and we think the Powder River, what's going on there, when you look at the rigs that are starting to stand up in the Powder River that's in our backyard and we think there's some great opportunity there and yes, you're right the Permian Basin is definitely the granddaddy of them all and we think that our channel partners have done a great job in the Permian, we just want to know, if we can we believe there's opportunity out there where we can address markets, basins, that we know the tool will perform very well and because they have in the past.

[Jason Wangler:]

Okay, and then you talked a little bit about Strider at the end. I guess as you think about it what are the milestones that we should look at or things that we should be kind of thinking of and the timing of whether it's, you know, getting it a field test or things like that, that we should be thinking about as we look forward to that being rolled out?

[Troy Meier:]

So the rollout of Strider, as you well know, this has taken us a lot longer than what I ever dreamed it would. It's a very complicated, complex system, when you're drilling with hydraulics, which wasn't my expertise and nor was it our teams but we've learned a lot with Strider. So when you look at the milestones for Strider, it's going to be getting this big tool proven out. And once we do that, we have a package that we can then offer to a channel partner that we say yes this tool, we cover all sizes, it doesn't matter if it's a completion, you're drilling out frac plugs, it doesn't matter if it's an open hole, well that you're drilling, this tool performs, and it performs very, very well. We're very close to having that done. We're going to be testing again, based off for the first time, mind you, based off of the evaluation of what we got from [indiscernible], when we just run that test. taking that information into what now is our mathematical model that the team got around over the last couple of weeks, we're able to make intelligent decisions on how the tool broke down works, we make those changes in the model and then run it in time in the model so that we're just in the past we've always said we believe this is where it's broke down. Let's toughen that up but not knowing what's going to happen when that's no longer the weak link and now we understand that if we toughen up the bearing system in this tool does it put an overload on our driveshaft and then we can toughen up that driveshaft before we ever test it. We've never had that opportunity in the past. So I believe that the test results that we get in July on our large tool are going to be good ones and it's supported by this model and until we've got nothing in our forecast with Strider but our goal is to have it completely commercialized ready to rock this year.

[Operator:]

Our next question come from the line of John Sturges from Oppenheimer & Co. Please proceed with your question.

[John Sturges:]

Really two questions. One is the Mideast R&D, are you doing some R&D in the Middle East? Or does everything have to be shipped back to the U.S. modified and then shipped back to where it's being deployed?

[Troy Meier:]

No R&D at all, the tools that we have over there is strictly the Drill-N-Ream and the tools are performing well, what we do need to get finalized over there is the repair of the tools. So as you know, we've got contracts with companies that allow us to get this repair service done. And to be honest with you, we thought we would have tools that would be ready to repair this last month but again, our tools are lasting longer than what we had anticipated. So the team is doing a very good job and the designs and the type of cutters that they're putting in the tools, tools are performing well. They're lasting well and we believe when we look at this going forward. It's a tremendous opportunity over there but there is no R&D efforts going on in the Middle East. That all of our R&D efforts right now are in regards to Strider and it all happens here in the U.S.

[John Sturges:]

Having a product last longer than expected is actually the nice problem to add.

[Troy Meier:]

Yes, it is.

[John Sturges:]

You mentioned very briefly or hinted at a next product based on some of the mathematical models that you're developing with Strider, could you add some color to that as to where you think you're next direction maybe?

[Troy Meier:]

Well I don't know, I've got so many rope burns around my neck from Strider that I don't dare mention anything else? So yes, the big takeaway there, John, is the fact that what we've done, what we learned through the whole R&D process with Strider, you know, we really had to [indiscernible] the process as we went through a horrible time in our industry and for the first time we've been able to look at something much differently, spend some money, get the modeling in place and so the next product which we've identified we believe will be ready for market much quicker than what the Strider has taken us and that's about as much color as I can put on that.

[John Sturges:]

Okay, and then let me let me ask you if the current Strider modeling, does that in fact improve anything with the Drill-N-Ream? Have you gone backwards with that?

[Troy Meier:]

You know the Drill-N-Ream is that tool that it performs well. We've seen, you know, the Drill-N-Ream has gone through a couple of design stages since its beginning and the current version of Drill-N-Ream we believe is giving our channel partner good value, and we're getting good value out of the tool but we have not gone back and modeled it, for a small company like this, it's quite a process when you engage in a mathematical model. It's something that has been way out of our reach up until now but it's quite a process to get this done.

[John Sturges:]

Okay then, I'm just jumping back to Strider briefly just on the logistics of the product, will you be in making a major announcement that is entering the market, because it sounds like there's still some customization occurring?

[Troy Meier:]

There is. We still got, I believe we've got a long way to go on this big tool but the long way to go, we can take in very large steps. So I don't think the timing is going to be all that long but there's still a lot to learn what you know, we're pumping. The big issue with that with the last one that we've got to finalize on this large tool is the 700 to 800 gallons per minute that they're pumping through these tools. Really, really is a test to get something that works efficient but also gives you - we could introduce a tool that would run well, but going to be very expensive to repair and Chris is constantly beating on us saying no, no, no, it's - our manufacturing costs has got to be in place, our repair costs has got to be in place. So we know what it is that we've got to do and we know where the weak point is in our current design. As far as announcing something this year, I firmly believe that we'll have it ready but then it's going to be lining up. How do we take it to market? What's the best way to do that? So we've got an agreement that we signed a couple years back with Baker Hughes on this tool and I believe they're still very interested in it, but that's going to be a whole another discussion once we can offer Strider across all size, the whole five range.

[Operator:]

[Operator Instructions]. There are no more questions at this time and I'd like to turn the call back to management for closing remark.

[Troy Meier:]

Well again, thanks everybody for joining us and we're excited about what's going on, we're excited about the opportunity and we look forward to talking with you all again in our next earnings call.

[Operator:]

This concludes today's conference and you may disconnect your lines at this time. Thank you for your participation. Thank you.