Superior Drilling Products, Inc.
Q1 2018 Earnings Call Transcript

Published: 10 May 2018

[Operator:]

Greetings and welcome to the Superior Drilling Products, Inc. First Quarter 2018 Financial Results Conference Call. [Operator Instructions]. I would now like to turn the conference over to your host Deborah Pawlowski with Investor Relations. Please go ahead.

[Deborah Pawlowski:]

Thank you, Hector and hello everyone. We certainly appreciate your time today and your interest in Superior Drilling Products. I have on the call today 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 also should have the slides that will accompany our conversation today. You can find both 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. These statements apply to future events that 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 and other factors are provided in the earnings release, as well as in other documents filed by the Company with the Securities and Exchange Commission. You can find these documents 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 as a substitute for results prepared in accordance with GAAP. We have provided reconciliations of non-GAAP to comparable GAAP measures in the tables accompanying the earnings release, as well as in the slide deck. So with that let me turn it over to Troy to begin. Troy?

[Troy Meier:]

Thanks, Deb. Thanks everybody for joining us this morning. As we go through the Q1 highlights for 2018, but I bet you'll notice that we've got - we are following a good trend that started last year when we look at the revenue growth as you can see its up 37% and Chris can talk of a lot more about that what's going on there but with that please note that the operating leverage that comes from that strong growth I think it's something you really want to highlight. If you look at the revenue growth and where a large part of this is coming from and the relationship that we have with DTI who is our North American distributor with the drill and ring tool and they've done a fantastic job as they build their fleet and that fleet got to be maintained and repaired you know that's a good - that's what we talk about when we talk about the legs growing in this relationship. And you also notice is that fleet gets bigger, there's more and more tools that have got to be maintained and repaired on top of the royalty revenue that comes from that. So again Chris will go over those numbers with you. I want to talk about the new contract that we've got signed with Baker Hughes, again it's the legacy business that we've been doing with them. One of our goals this year is to strengthen the relationships that we have you know with DTI and BHI. We value these customers and we're going to really put our best foot forward and see if we can do more for them and help them in other ways and just what we're doing right now. So as we look at the new four year agreement with Baker Hughes the boundaries that were in our previous contracts have been removed. We feel that we can service other areas effectively for them and so we're really looking forward to that opportunity and we also have other product lines that we're looking at bringing in that we can support them with not just the manufacturing or the repair of the PDC cutters but also the entire tool and tool assembly. So all the parts within product line. So we're excited what we can do there. We're also looking at joining a couple of teams with them to start looking at ways to strengthen their market share in the product lines they have, we are going to support their engineering staff and their manufacturing staff. So that will be a good opportunity for us there. One of the things that we've talked about was the expansion of the Drill-N-Ream into the Middle East. We do have tools over there, tools are in the hole. We've run tools over there. We're liking what we see. There's going to be a training, a bit of a training curve over there. Some things a little different than what we do here in North America but we're happy with what we're seeing and we're happy with the feedback we're getting from the NOCs and we're excited for the opportunity there. So we'll keep moving that and next quarter you'll hear a lot more about what we're doing there. Right now we're working on the agreement with DTI and we feel good about where we're at with them, the relationship we have with them is very strong we're very pleased with what they're doing. They're well run organization and they're doing a fantastic job and we're working with them on renegotiating the contract that we had and I'm sure we'll get that done in the next few months and be ready to keep on moving forward with them. Commercialization of the strider tool, what we have there is we actually just had this week we deployed our first tools with a major operator and we're excited for the opportunity we have there with them. We've got companies such as Weatherford that are now choosing our tool over - what has been perceived as the number one product out in the marketplace. They're now grabbing our tool instead of theirs and keep in mind that's just in a small area of the Rockies we're just - it's still a slow rollout. We don't have sales team so we need to keep that in mind but with what we are doing is we're getting that data that we need so that when we go to put this tool into the hands of a channel partner we can actually say here's the basins that's running, here's the offset wells, here's the quality of this tool now let's rock and roll. So we're excited about what's going on with our strider tool. We would like it to be a little quicker. I know it's been a long time coming but it is a good tool and we're happy with the results that we're seeing with the field runs. So with that I'm going to turn it over to Chris and he can go over the financials. Chris?

[Christopher Cashion:]

Thank you, Troy and welcome everyone. Let's continue our review turning to slide number six and look at some details around the revenue growth that Troy referred to. You can see by quarter how the top-line has grown and Q1 2018 $4.6 million that's the best quarter that we've had in a couple years and you can see there that's driving that is what we call the tool revenue that's a light blue part of that bar is the tool revenue and that's the Drill-N-Ream is driving that number and then the contract services revenue that's the bit refurbishment business with Baker Hughes and also the third party manufacturing work that we do. So you can see real some nice percentage increases for prior quarter compared to this quarter, prior quarter previous year and then the trailing quarter. Record sales of the Drill-N-Ream we'll look at them a bit more on page seven so that's came in real nice in the quarter and then as Troy referred we did renew Baker Hughes agreement and Troy mentioned we expanded our geographic footprint with that agreement. As you may remember historically we had our exclusivity in the Rockies, California and Alaska. It has now been expanded for the entire U.S. and Canada so we're pleased with that and we also got minimum volume commitments and so that gives us a nice consistent guaranteed flow of work and so we're really pleased with that as well. Let's go to page 7 and take a little deeper look at the tool revenue, that too we saw in the previous page $3.5 million in Q1 2018 and you see that broken down in the table at the bottom part of this page between tool sales and other related revenue and the other related revenue as you know is the royalty and maintenance repair fees just shy of $2 million in tool sales in the current quarter and then a nice increase as you see there 2.5 times increase current quarter compared to the prior year quarter Q1 2017 and so that continues to grow nicely and that's a function of the continued expansion of the Drill-N-Ream fleet in the hands of DTI and as Troy mentioned DTI continues to pick up market share. They were just a little bit shy of their goal of 12/31/17 of 12.5% but they are also - we make a point they are also chasing an increasing rig count with the Canadian rig count and so overall we're really pleased with how they continue to penetrate the market and as Troy mentioned we're in the process of renegotiating this agreement in ways this can be beneficial for both companies. So really, really pleased with the market penetration that we see here in the U.S. and Canada. Now going to page eight taking a look at operating expenses you can see that in 2017 pretty flat around 3.5 million or 4 million or so per quarter in total operating expenses and SG&A come in about 1.3 million roughly per quarter of spending and as we guided the market a couple of months ago we have a step up in our cost base and you should see that pretty clearly in Q1 2018 and that step up in spending is a function of the prototype spending that we're doing right now with the strider .We've got several sizes of strider that we're building and in the Middle East expansion as we continue to invest in rolling out the Drill-N-Ream to the Middle East and so you see that our SG&A we looked in at in total for the year $7 million roughly in SG&A for 2018 and you can see $1.7 million in Q1, so you can annualize that number and you get just under $7 million so that once again that increased spending is just as we planned it as we roll out the strider and as we roll out the Drill-N-Ream in the Middle East. Page 9, taken up look at the operating income and we're really pleased to see positive operating income Q1, 2018 a couple of $100,000 and I'll just reiterate that that is with the investments that we're making in R&D and in geographic expansion so with that spending we still have a positive income and we're really pleased about that. Our operating leverage continues to be strong even with incremental spending that we're looking at and so when you look at on trailing 12 month basis looking at Q1, $600,000 and if adjust that for an unusual expenditure in Q4 of 2017 that we talked about last time it's a little over a $1 million on a trailing 12 month basis positive operating income. In page 10, we continue the same story. Net income and we look at net income and adjusted EBITDA and we are just net income for amortization expense as you probably know when you look at our financials we have $600,000 per quarter of amortization expense and so that's a big number for us, non-cash number and when we look at net income adjusted for that at 600,000 per quarter we have 14.5% net income to revenue in Q1 once we adjust for the non-cash nature of amortization expense. $2.4 million for the whole year and so you can see Q1 trailing 12 months, $2.5 million of adjusted net income and once again the adjustment is just backing out amortization expense and $2.5 million on a training 12 month basis where we are really pleased with how the bottom line starting to take shape here. EBITDA same story, the EBITDA as a percent of revenue in Q1 27% and that is once again with the increased spending in R&D and business development or expansion into the Middle East, 27% just under 30% of EBITDA as a percent of revenue with our step up in our operating expense line. So we're really pleased with how the EBITDA continues to hold and the good leverage that we're seeing in this business. Page 11, taking a look at the balance sheets, couple of $100,000 decrease in net cash from the end of calendar year 2017, that's made up of reducing debt $600,000. CapEx was just under $100,000 so between those two items negative $700,000 and operating cash was positive $500,000 so there's your net cash decrease of a couple $100,000, so just to reiterate a $0.5 million positive on operating cash reduced debt another $600,000 would continue to take that down and that's continuing to service the what we call the hard rock note and so we made another $0.5 million principal payments and in Q1 and we've already made our May payments or our Q2 payment on that hard rock note we made that last week and so we have one more $0.5 million principal payment left this year on that hard rock note. After we make that payment that note will be down to $6 million that $6 million is served $4 million next year 2019 and $2 million in January 2020. I think as most everyone knows the other large part of our debt pertains to our vernal campus and the mortgage we have on that campus and that's roughly $4.5 million. We will now go to page 12, take a look at our guidance and so we're basically reiterating the same guidance that we gave a couple of months ago. We expect revenue in 2018 to be between 18 million and 22 million. At the midpoint of that guidance range that's 28% increase off 2017's revenue though roughly 15.6 million so we continue to see good growth. Our operating margin continues to improve. We expect that to come in anywhere between 5% and 10% and at the midpoint we expect that rig to reach about $1.5 million of operating income and once again that's on a GAAP basis and once again that includes that amortization expense and that's up from a couple hundred thousand in 2017. Interest expense continue to bring that down $750,000 in 2018 down from a little over 900,000 in 2017 and of course that's as we continue to pay down the hard rock note and continuing the monthly amortization of that mortgage. Our debt levels continues to decrease and then CapEx approximately $1 million which is about what CapEx was in 2017. So we're not having to spend a lot in CapEx and we expect to see that continue to improve for the remainder of 2018. So with that that ends our formal review of the financials and we'll turn over now for Q&A.

[Operator:]

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

[Jason Wangler:]

On Drill-N-Ream with the domestic contract, I believe that 12.5% number was for exclusivity to them I mean is there something else you guys are looking at negotiating or should we think of that as you are looking to bring other partners in or just how should we think about what you're looking to do the domestic side of it as we go forward?

[Troy Meier:]

We like what they've been doing Jason, DTI has performed very, very well and when we look at the exclusivity clause in there we think that they've earned that, they've done a phenomenal job. When we look at our contract and you look at how you get exclusivity was based off of a number of breaks in the horizontal realm and so when we look at what DTI has done is they've got more tools per hole per well if you will that they got no credit for. So we're negotiating, we understand that there are some things that they would like different and get credit for those tools but there's also some things that we need in there that keeps driving the purchase tools and the building of the fleet but we don't have any plans on at this point in time on having them share that with anybody.

[Jason Wangler:]

Okay, so maybe the way to think about it or amending the contract with all the knowledge you have now over the relationship versus simply stopping this one and starting new or starting the whole new process over there.

[Troy Meier:]

That's fair.

[Jason Wangler:]

Okay. And then Chris you mentioned with the drill remanufacturing contract, you have a minimum volume commitment but you also open up to basically exposed to all the U.S. So you have that NBC but how does it work on outside of that, is it simply just they kind of ship you guys business as they are doing their operation and there's obvious minimum but that can fluctuate on a higher end, now you have more exposure to all the areas versus what you have or how does that differ I guess just simply have the contract in the west coast.

[Troy Meier:]

You know from a practical perspective it's not a lot different. I mean as you know Jason, we got work at what we call non-contracted areas with Baker Hughes and that's been going on over the last four years of this previous contract. So they were shipping us product out of areas outside of the Rockies, California and Alaska. They just didn't contractually there wasn't an obligation to do that but they were doing it because they recognize our quality and our service and we turnaround bits quickly and their top notch quality refurbished bits and so we've just now have the contract more representative of exactly the way we've been working basically over the last four years.

[Jason Wangler:]

Okay. So it's just basically constantly now we have the whole U.S. versus whenever they do ship that work probe or whatever, okay.

[Troy Meier:]

Absolutely.

[Operator:]

Our next question comes from the line of Mr. John White with ROTH Capital. Please proceed with your question.

[John White:]

Is there any particular basin or region that you saw more increases in than other areas?

[Troy Meier:]

No, it's been steady growth throughout all of them to be honest with you. When you look at the Texas, Oklahoma if we are just talking about you know the Drill-N-Ream itself, that's the area that is strong but Northeast to still growing, opportunities in the Rockies is growing but I mean if you were to say just one basin it really stood out I can't say one.

[John White:]

Well that's good to have a diversified growth there geographically.

[Troy Meier:]

Yes.

[John White:]

What a lot of companies in the industry are talking about experiencing bottlenecks in terms of labor shortages, skilled labor shortages or shortages with trucks or problems with rail deliveries or you experience - is that affecting your business?

[Troy Meier:]

No it's not affecting us you know I mean where we are at we sit behind you know in the Rocky Mountains, in our area. The energy industry hasn't come roaring back, believe it or not it's actually kind of a good thing for us because it helps us retain quality employees and so it's nice going kind of been in Utah and not competing against you know the labor force that would be competing against in other places like Midland. So we're not seeing that.

[Operator:]

Our next question comes from the line of Mr. John Sturges with Oppenheimer and Company. Please proceed with your question.

[John Sturges:]

I'm curious on your refinancing whether it's possible to roll everything into some corporate debt and the mortgage and the Hard Rock note if there are any plans on doing that or if there are perhaps maybe disadvantage some of that I know was asset backed and I was just curious about that.

[Troy Meier:]

We do have conversations with regard to doing just that, they're very kind embryonic I would say at this point. Our major focus John is kind of twofold with the mortgage [indiscernible] the campus there. We were looking at selling leaseback opportunity with the investor group and we're quite ways down that discussion. We're kind of zeroing in on some terms and we're not quite there with that deal and we're going spend about another 30 day and see if we can get that done, if we cannot get that down then we will just do a pretty basic debt refinance on that facility but in the meantime we are talking to some groups about kind of rolling those two pieces of debt together the thing that we're finding most of the feedback we're getting today if they are talking some sort of debt instrument its some sort of just got a conversion feature to it. We're trying to find straight debt solutions at interest rates a reasonable and so we are not really - we are going to pursue instruments where we're going to look at issuing more stock to be quite frank. So our first effort is trying to find straight debt solutions but we do have a few folks who are interested in doing just what you said roll both of them together so we're pursuing both avenues.

[John Sturges:]

You just mentioned that Drill-N-Ream is lasting longer than anticipated. I would assume that it's improving the return on invested capital for the device?

[Troy Meier:]

Yes. Absolutely. We are - you may recall that we modeled first modeled this tool it was reusing strictly kind of rocky mountain kind of metrics and kind of a 12 run life is what we saw up in the Rockies and so moving outside the Rockies, looking at the number of runs is increasing and some of that is the application the way that tool the length of the laterals are somewhat shorter outside - so a run of 7000 feet versus a run of 10,000 that change the number of runs over the life of the tool so that's few variables that we are looking at but overall it does seem that the tool is holding up better so that's 12 run life, may be a little shorter than we thought it was going to be and so yes the tool its more durable, robust and doing good very well.

[John Sturges:]

Okay. Revenue from the mid-east, do you've - can you give some color when we might anticipate some revenue showing up in any particular quarter?

[Troy Meier:]

The process right now of extending our the term on our Middle East agreement with Weatherford, the testing agreement that you may recall that terms June 30 of this year and we're looking at extending that to 12/31 in order to get additional data, it's very important under this agreement that we understand the value add to the operators in the Middle East before we sit down and try to develop price points around selling tools and royalty rates and those kinds of things. And so it is sort of meaningful sense, it would be late this year I would say before we start seeing any measurable revenue. We do get - we do have a revenue split agreement in this testing period and we are finding where the operators are paying for these test runs and so as you may recall we split that revenue with Weatherford on a 60

[John Sturges:]

Okay. Also could you provide some color on how the strider - strider is going to be applied in the marketplace?

[Troy Meier:]

Yes, right now the quality of strider the one that we have been talking about, we have been some very good success with what we like to look at is calling them just strider because both tools now are built the same before they're used to be called - they are tubing tool - had no problem with the water that was typically used to drill out plugs and reentered wells but it couldn't handle the abrasive silica muds to be pumped through our [indiscernible] valve and now that tool is one and the same. So going forward you will hear us talk to him a strider and there's large strider tools and there are smaller strider tools, but what we have traditionally have called the coil tubing strider that tool has been performing very well and again we don't have a sales organization so we rely on our team and Algin [ph] who is you know been instrumental in the development of the tool, testing the tool and setting up the repair of the tool is the one that's been going out and using his contacts locally in the rockies and getting this in the hole and getting it - to get some great offset data and that data now has shown us like I said there's been an operator, Weatherford in this case and that has chosen to say you know across basin. We're now using strider because of performance and outperforming brand-x. So we're happy with the results and we're now building that complete strider line we're mimicking these tools both large and small you've heard us talk about the high tech materials that we put in there. We've got a big issue with the development of this tool was trying to get a material that would hold up to closed event in our closure can that's what creates the pulse in the system and essentially we turn it into a water jet and we finally have got a material that we're very, very happy with that's been shown us some phenomenal results and we're getting those manufacturers of that material on-board to start supplying us as we build the fleet. So we're happy with the performance of the tool, definitely not happy with how long it's taken us to get this tool developed and get it out there but now we're in the stages of finding the channel partnership to take that to the next level.

[John Sturges:]

Okay. I am just curious if you've any plans to break out DNR from strider in terms of revenue streams or are they - it's not yet meaningful enough to do that.

[Troy Meier:]

No, it's not meaningful enough at this point.

[Operator:]

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

[John Bair:]

One of my questions was addressed about international revenue recognition, but my other question is whether or not you're seeing much in the way of raw material cost pressures and if so is it very significant and affecting your margins at all?

[Troy Meier:]

No we're not seeing any pressures in a material cost. We've got a really good supply chain in our and still purchasing contacts we've made over the years that we're able to you know purchase both domestic and abroad at the mill prices at mill levels even though the volume that we buy is much smaller than, the contacts we have allow us to essentially piggyback on two large production runs of very high quality steel and so we're pleased with what we're seeing and we haven't seen any pressure as of yet in material pricing.

[John Bair:]

That's good. How far out in advance can you go I mean is this on a month to month kind of deal or run or how does that work?

[Troy Meier:]

As far as the pricing the material?

[John Bair:]

Yes I mean how often do you get notification let's say of any kind of price fluctuations on your major components?

[Troy Meier:]

It's usually - what we're seeing is we place an order and it's usually anywhere from 90 to 120 days out. And we get notification, our ally in Michigan will call and say you know they're talking about an increase in steel price here at this facility but we can purchase just as good quality from this facility. So we're able to - we're not locked into just one mill. We have a good name with quite a few mills around the world we're able to tap into.

[John Bair:]

Okay, very good and good luck and hope you have some accelerated results in the Middle Eastern effort there and things start to perk up. Certainly the price rising, commodity should be all help to you overall. So very good. Thanks very much.

[Troy Meier:]

Thank you.

[Operator:]

Our next question comes from the line of [indiscernible]. Please proceed with your question.

[Unidentified Analyst:]

The question I had is when you announced the Middle East deal in December you talked about [indiscernible] program of 16 DNR2, how many tools do you have actually working over there now and how many do you have lined up to be delivered over there?

[Troy Meier:]

Right now we've got 18 tools. We've got two more sitting here in the states that large tools that will be shipping over once we get the essentially iron out some details with Weatherford on those tools but the fleet will be 20. We have some request for some larger tools, some very large tools, some 16 inch tools. They think that there is great opportunity there. We've never built one that large so we got the design done, engineering is all done, but we're just identifying the market and how many tools does that mean, but right now the test cycle is 20 tools.

[Operator:]

Our next question comes from the line of Reid Walker with Hardcore [ph] Holding. Please proceed with your question.

[Unidentified Analyst:]

Just one follow-up question on the Strider as you talk about you're not differentiating between the kind of vent hole versus the agitator alike from NOP [ph]. Where do we stand on the testing as you're talking about building inventory, is that for the completion tool strider or--?

[Troy Meier:]

It's for both Reid, its - when I talk about duplicating both large and small tool in the past we've always had the coil tubing tool was designed and built a little bit differently it was our old design of our big tool and we've now got that to where it's both designed and matched, they are using the same material, same mechanics on both systems and we have an old inventory and old let me say when I say old it's not that old it's but our old style of tool we still have an inventory of those tools that we're running but as we do new jobs high profile jobs like the one we just did from one of the majors we sent out two tools with all the new high tech materials in our closer, closer can and that whole fleet will be rolling over to that.

[Unidentified Analyst:]

Okay, but my question is do you feel you're past the point of testing phase of the bigger gauge Strider that has a bigger revenue opportunity?

[Troy Meier:]

For sure.

[Unidentified Analyst:]

And you feel like you've got - I may have missed this but do you feel like you've got a high profile run with the quality customer done, do you feel like that's operating tool?

[Troy Meier:]

Well I feel like that what we've seen Reid, the runs that we have had when I say high profile they are in the hole for just a few hours. I mean these holes they are drilled very, very rapidly where we've been running these. So I feel comfortable saying that we can introduce this tool say to West Texas and we feel very good about the performance.

[Unidentified Analyst:]

Okay. Is the agitator the tool - I mean is the agitator on the whole bat short [indiscernible] I thought the agitator was on all the way junior vertical?

[Troy Meier:]

It just depends, if you look at the Wattenberg [ph] you know they'll have those holes drilled in three to four days and so put the agitation tool on and its sensing the hole for a day, day and half no matter if its NOB or anybody else.

[Unidentified Analyst:]

Okay. Well I'm glad to hear that you know [indiscernible] and nice quarter and good luck renegotiating with that important part at DTI and hopefully it's a win-win for everybody. Have a great day.

[Troy Meier:]

Thanks, Reid.

[Operator:]

Ladies and gentlemen we have reached the end of the question and answer session and I would like to turn the call back to Mr. Troy Meier for closing remarks.

[Troy Meier:]

Well again thanks everybody for joining us. We will continue to push and follow the trend that's been set early on last year. We are excited about the second half of the year. We have got some great opportunities here domestically in front of us with some you know great partners, that we're going to develop those relationships. We also have some great opportunity overseas internationally so we look forward to presenting Q2 results in August and again we thank you for participating and following. With that I want to say thank you very much and have a wonderful day and a wonderful weekend.

[Operator:]

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