Superior Drilling Products, Inc.
Q4 2017 Earnings Call Transcript

Published: 9 Mar 2018

[Operator:]

Deborah, your line is live.

[Deborah Pawlowski:]

Good morning, everyone. This is Deborah Pawlowski, Investor Relations for Superior Drilling Products, Inc. I apologize for this delay. This is an extremely unusual situation where the speakers are still caught in traffic. So, I am going to ask Daryl from our office to read the statements and then we are going to be putting you back on hold as soon as we can get the speakers in the room to start the formal part of the conference call. Daryl [ph]?

[Unidentified Company Representative:]

Thanks Deb. Hello, everyone. We appreciate your time and again we apologize for the delay here. Pretty soon Troy Meier, our Chairman and CEO; and Chris Cashion, our Chief Financial Officer; along with Deb, Investor Relations will be joining the call to review the results of the fourth quarter and the full-year 2017, as well as the outlook for 2018. 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 access 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. With that, we will go in hold for a few more moments while Troy and Chris get set up. Thank you.

[Operator:]

Greetings and welcome to today’s Superior Drilling Products Fourth Quarter and Full-Year 2017 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] As a reminder, this conference is being recorded. I would now like to turn the conference over to Troy Meier. Thank you. You may begin.

[Troy Meier:]

Thank you, and thanks everybody for joining us. Apologize for being a little bit later. Still not used to this Houston traffic I guess. Okay, let’s get right into it. As we look at the highlights for 2017 and for Q4 on 2017, the numbers that we will be showing you today, this morning we are going to show a revenue increase and I would like to talk about how this is really starting to prove out our business model that we talked about a year and a half ago as we build this strong relationship with our channel partners and the tools that we’re getting out into their fleet and what this does is these tools now need to be repaired and the royalty revenue which comes off of that, you’re going to be able to see that and the numbers that Chris show you and keep that in mind as we start talking about 2018 as we go along, what that’s going to do for this year as well. That will be that reoccurring revenue that we talked about as you start to see the fleets build herein the U.S and Canada and then keep in mind it’s a program that we are looking to do international as well. The contract services, you can see what’s happened there, you know we’ve got our legacy customer there that we are working on a contract right now that we feel very good about. 2017 was an improvement better than what the rig count was and we think going forward we will talk about little bit later on, how that’s going to - we are going to strengthen that relationship and enhance that with more offerings of our services too in our contracted service area. We have, the DnR, like we told you that we expanded into the Middle East. We got those tools built in Q4 and got them shipped. We’ll talk about those at the end of this. However, those are now deployed over in three countries in the Middle East, but that was a fleet that we built in Q4. So, keep in mind when you look at these numbers that takes into account the building of our, this test fleet in the mid-east. We have got 18 tools over there. The Strider technology, we are very happy with what’s happened there. We continue to prove that technology out. We have been getting some very good runs with some very strong potential channel partners. What we call the coil tubing as we go forward, we will be talking about that all as one, because the two tools we are finding out is that there is an opportunity there in Open Hole using coil tubing. So, even though our Open Hole project is moving along very well and we are happy with what we are seeing there, we will be rolling that out in the first half of this year. The coil tubing side of things, we are going to blend it together because the two tools are really the same anymore. The design they work the same and now we actually have a great partner that’s using coil tubing to drill Open Hole. So, to make it easier on us and how we look at things in our manufacturing and we are just going to - you are going to hear us talk just in regards to Strider and not separating the two. We will talk a little bit more about that at the end. I am going to turn it over to Chris. Chris if you want to go over the financial highlights.

[Chris Cashion:]

Okay. Let’s continue our discussion on Slide 6, where we take a look at how the revenue grew year-over-year. First thing to emphasis is, as you know 60% growth, this quarter Q4 versus Q4 of last year, very pleased with that. And as we guided in November, we were anticipating little softness in Q4. The year-end slowdowns that we see with some customers and so we weren’t surprised about that. It came in about what we thought we had. As you might recall, we had a guidance for revenue, top end was $15.5 million and we came in just a tad above that, a 15.6 million. So, we achieved our guidance. When you look at year-over-year, you see more than doubling of revenue as Troy mentioned a little bit ago rig count certainly helps, but it was more than just rig count than what we saw in 2017. We saw a significant increase in market share with our drill and main product, our flagship product, so we are really pleased with how that product has been rolled out into the U.S. and Canadian marketplace, our channel partner DTI has been doing an excellent job and so we're really pleased to have that worked out and you can see it in the numbers. In addition to that, we continue to support Baker Hughes with bit refurbishment outside our contracted areas and we are looking forward to working with Baker Hughes and supporting in some other areas that Troy will get into a little bit later on. If we now slip to Slide number 7 and we look at, kind of zero in on that tool revenue pace of our revenue stream, we see that in Q4 a little softness as we mentioned in tool sales if you look at that chart at the bottom of the page, but the other related revenue that’s - we call that our recurring revenue and it continues to increase nicely as you see there from Q4 2016 at roughly $300,000 to little bit over $1.2 million at Q4 2017. So that’s a nice trend as our channel partner continues to build a fleet of tools and this is drilling a ream, once again, drilling ream U.S. and Canada as Troy mentioned, and as our partner continues to purchase tools and build their fleet, penetrate the market, we continue to see good growth in that recurring revenue. You look at 2016 versus 2017 year-over-year and it’s nice 7X improvement. So, we're really pleased with that. Our channel partner as you understand - I think most everyone knows the goal at the end of 12/31/2017 is 12.5% market share. We are still evaluating that with our channel partner. We can tell that they did improve from the 10% goal that they achieved in June 30. So, we see continued improvement. We are just nailing down the details around the calculation of that share. So, if you would now just turn to Slide 8 and look at expenses, the first thing that we want to point out as you saw in the press release as Troy alluded to a little earlier, we had an unusual bonus that was paid, it was actually in lieu of equity restricted stock units, and as you will see we - that the net proceeds of that was used to pay down on our Tronco note. So that was a non-cash event for the company and the expense that we incurred in Q4 was roughly $600,000 as we describe here bonus in lieu of stock. And if you adjust that out then you see that for Q4 2017 we were at $3.8 million of operating expenses and slightly above what we’ve been running at between 3.6 and 3.7. We did have some incremental cash costs in Q4, around the Strider tool building prototype tools to get those tools in the field and tested and then our Middle East expansion. So that did lead to roughly $100,000 increase in operating expenses, Q4 versus the previous quarters. Now we are guiding in 2018, an increase in SG&A and just to remind everyone in that SG&A is our engineering expense as well, and so we’re looking at $6.5 million for the year, roughly $1.6 million per quarter and that’s up to roughly 300,000 versus 2017 roughly $1.3 million a quarter going up to $1.6 million and that’s reflecting a full quarter of increased R&D around the Strider, and as I mentioned those are prototypes that we’re building. We are gaining those prototypes into the field and they are being tested. And also, the Middle East expansion. Full-quarter of those cost as we rolled into 2018. So just want to highlight that we do expect SG&A to drift on up to $6.5 million for the year. If we now go to Slide number 9. You can see our adjusted operating income both on a GAAP basis and an adjusted basis. The charts are little busy looking at the dark blue versus light blue colors, but the bottom line is on an adjusted basis and in the adjustments for that $600,000 bonus, if we adjust that and once again like I mentioned it was a cash, non-cash bonus than for Q4 we’re breakeven, down slightly from where we were in Q3 and Q2. Once again that’s driven by the seasonality that we mentioned in the business in Q4 and some increased spending in R&D and the Middle East expansion. What we were really pleased with here is that that Q4 we approached that breakeven even with that seasonal downturn and even with some increased costs. So that’s - we're really pleased with the way that we keep the Charleston expenses monitored and maintained and you can see that year-over-year, a dramatic improvement from 2016 to 2017, and on a GAAP basis, a couple of hundred thousand dollars of operating income, and then of course adjusted $800,000. If we now go to Page 10, EBITDA on the net income, the top chart on the left, same story that net income if you adjust out $600,000 on a net basis where we’re close to breakeven and the thing that we’re really, really pleased with is the bottom right corner of this page for the year just under $5 million of EBITDA and that’s 32% EBITDA for 2017 and you can see that has quite a turnaround from a negative EBITDA of $ 1.5 million in 2016. So, the revenue increase taken control of costs, all the things we’ve been talking about for the year, it gives a 32% EBITDA for the company in 2017. Now we will go to Page 11 and take a look at the balance sheet. During 2017, we generated almost $2.5 million of cash. We reduced debt, debt down another almost $4 million in 2017 versus the end of 2016. One of the things that we did do in Q4 is we paid one of our $0.5 million principal payments to Hard Rock. We pulled that payment forward from January into November. We don't hold a lot of money on our cash sitting in the bank, and while we’ve got a great rate on that Hard Rock note, 5.75% saves us the money to pay that a little bit early. So, we did and you see the impact of that. We also made another $0.5 m million payment to Hard Rock in January this quarter and so we’ve got $1 million left to pay to Hard Rock on that note. So, you might recall the plan was to pay 2 million this year. We paid $0.5 million in 2017. $0.5 million of the $1.5 left we paid in January and so there is 1 million left. That’s payable on May 15 of this year, and July 15 of this year, a $0.5 million each. Refinancing our mortgage that’s a big focus for us right now. We have got on our vernal campus, we’ve got about a $4 million mortgage on that property and that term is August 2018. We’re talking to several finance companies to do a straight debt refinancing and we also have another option that we’re pursuing and that’s a sale on a leaseback. We’re talking to a group right now who is interested to buy the property. If we get the deal that we like, we could sell the property lease it back and just take the debt completely off our books instead of a refinance it, just pay it off. So those are the options that we’re looking at right now. We're really excited about the sale and leaseback option. And if we don't get the deal, once again, if we don't get the deal that we like then we will just refinance that and we will deal with that on that basis. So, you see $12.8 million debt outstanding at the end of 2017, and down nicely from where we were two years ago at the end of 2015. So, now if we go to Page 12, looked at the 2018 guidance regarding revenue lines between $18 million and $22 million, we are really excited about the things we’ve got going on this year. The geographic expansion into the Middle East. We are planning those seeds right now. We expect latter half of the year to start seeing some - a good return on that. You know about the field testing of the Strider technology and that’s coming along really well. So, we’re looking at a nice increase from 15.5 million roughly in revenue for 2017, up to a low of $18 million and as much as $22 million. Operating margin is somewhere between 5% and 10%, and of course it’s GAAP and so just to keep everyone, just remind everyone we’ve got $2.4 million of amortization expense every year that run through our P&L, and so that covers that expenses well. And we’re looking at 5% to 10% operating margin, interest expense $0.75 million D&A, slightly under $4 million, and CapEx roughly $1 million going forward. That’s about what we did in 2017. We’ve got some repair facilities we’re looking at, repair facility in the Middle East, repair facility in West Texas, few other CapEx items and so basically CapEx next year about what it was in 2017, $1 million. Okay. With that, I’m going to turn it back over to Troy and he can - he will walk you through our opportunities.

[Troy Meier:]

Thanks Chris. So, as we look forward into this year, we see a great opportunity with the drilling ream. When we talk about the market share that our channel partner is going after here in the U.S. and Canada, keep in mind that when we structured this model it was based up of one tool per well. One of the neat things that we're seeing is as the drilling ream is just not for laterals anymore. This tool has found a great home in the Carb, this tool has found a great home in the vertical, operators are seeing the value-add this is giving and their projects and it’s just, if you’re drilling a well it pays off to have a good well bore, and the industry is really starting to recognize that. So, when we look at that, I think of tool size, you know when this tool - when we first brought this tool out in the Rockies it was all 6-inch series tools. Well, now we’ve got 13-inch, we have got 12-inch as you think about the Mideast, the stuff that we’re looking at over there, I mean it is - average tool size over there is going to probably end up being quite a bit larger than the average tools size here in the U.S. So, we’ve got the design finished up for 16-inch tool, 14 and quarter inch tool. So, there’s lot of opportunity with drilling rig as we move forward into 2018. As we look at our channel partners, we're going to really make a hard push, it strengthens relationship and supporting, getting these tools out in the marketplace. We talked about our channel partner with the drilling ream and we feel we can do much more to support them and help them just essentially side-by-side let’s get this tool out there and let’s get it out, try to get it on every rig. We look at our legacy business. We’ve had teams working really close with BHI. I guess BHGE. For last few months we’ve had a team down here this week, we're looking at all the ways that we can help them and they can help us, and we’re really impressed right now with the talks and where we are at with supporting one another as we move forward into 2018. Talk about Strider, I know it’s something we’ve talked about for a few years now, but we’re really, really happy with what we’re seeing there. We’re getting our tool, if we talk about our small Strider tool, we are being compared side-by-side with the top tool in industry and we're beating it hands down. We’re seeing operators say, this is going to be our tool of choice. We have been working on getting manufacturing costs in-line getting repair costs in-line, how do we take this tool to market. That’s all stuff that we’re working on. We’ve put together a great business development team that was identifying potential channel partners and we're very pleased with where that’s going. Larger tool, we’ve been getting some test on that. We think that’s going to be the best tool in the marketplace. We're very happy with what we're seeing. We’ve got some very high-tech material in there that we’re able to get at a very reasonable price and that tool is really looking strong. So, we’re excited for the Strider in 2018. And we're going to continue to work on the next product. We still got to stay focused with Strider. Still take in a lot of our efforts in the R&D side to get that out there and get the manufacturing of that tool, down and get the turnaround times quick, but we have to start now looking at that next tool and we’re doing that again through our work business development group as we start talking to customers and looking at potential, the potential size of the market for our next tool. And we’re excited with what we’ve got, the list of opportunities we have and now we’re just, we’re going to start working on the top potential tool that we’ve got coming out and we’re going to stay on top of our next innovative project. So, with that being said, I'm going to turn it back over for Q&A section.

[Operator:]

Thank you. [Operator Instructions] And our first question is from Andrew Hanson with Redwood Investment Management. Please proceed with your question.

[Andrew Hanson:]

Congratulations on a great quarter, a great year. I really appreciate it. I think you said something earlier about Strider being used, can be used in an Open Hole using coil tubing and you also said something about Strider and drilling ream being, I think you said, the same tool, if you are using coil tubing for drilling, could you comment on that? I'm not sure I had that right.

[Troy Meier:]

Okay. So, in regards to the first question, the Open Hole for the coiled tubing, what we're seeing is there is, we have got a great customer that we’ve been with a long time that’s now looking at drilling Open Hole wells with coil tubing units instead of the big stand-up rigs.

[Deborah Pawlowski:]

I am sorry to interrupt. But I just want to make sure to start off right off that the Strider Technology is very different from the drilling ream technology. Those are really two different tools, two different technologies. So, let’s start there and talk to the Strider Technology, which is a new technology.

[Troy Meier:]

Okay. So, the Strider technology is the drill string enhancement technology that we’re just now rolling out. The drilling ream is the well bore conditioning tool that we’ve had out into the market now for going on five years and it’s the proven tool. We’ve gotten or were 3500 runs that is the well bore conditioning tool. The confusing part when I was talking about Strider was looking at coil tubing Strider, which was a market for completion of wells and Open Hole Strider which is a market, which are drilling the wells. Both of them need a - what’s called an extended reach tool, and so what we’re doing is, we're blending the two together because our designs are no longer different. We have the design that we’ve merged that works really well on both Open Hole and coil tubing and so we just call it Strider. And you can look at the Strider in the smaller sizes. We will be a what we were calling coiled tubing, and the larger size as when we start talking the 5.25, 6-inch that’s your Open Hole Strider. So, sorry for the confusion, but that’s two different product lines and Strider is just what’s called an extended reach tool or an ERT.

[Andrew Hanson:]

Got you. And just to go back for a second to Deborah’s point, both of those the extended reach and the Open Hole both use that hydraulic pulsing or oscillation-technology, right?

[Troy Meier:]

Correct. It’s - you are exactly right. I mean that’s what we’re doing. We are utilizing the hydraulic flow through the ID to create thrust.

[Andrew Hanson:]

Thank you.

[Troy Meier:]

And that’s just on the Strider tool. Just let me be clear, that’s Strider tool, the drilling ream as, there is no moving parts, the drill stream rotates, it then conditions the well bore.

[Andrew Hanson:]

Got you. Thank you.

[Operator:]

Our next question is from John White with ROTH Capital. Please proceed.

[John White:]

Good morning and thank you for taking my question. Excellent results. Really nice improvement. Now we are all glad to see the rig count climbing back up. You had mentioned coil tubing Strider being used for Open Hole drilling, you want to give us, can you say what basin that’s in, and give us an idea of the depth of the well?

[Troy Meier:]

Sure. When we look at that we’re talking about Alaska as they are starting to look at drilling some wells up there with efficiently with coil tubing. So that’s the market, the depth of those wells it varies. I mean they go anywhere from 3,000 feet down to 16,000 feet. It’s just, they are looking at very efficient way of drilling wells and without happen to have a big rig on locations.

[John White:]

Okay. That’s very interesting. Thanks for taking my questions.

[Chris Cashion:]

You bet.

[Troy Meier:]

You bet John.

[Operator:]

Our next question is from John Stoltzfus [ph] with Oppenheimer and Company. Please proceed.

[Unidentified Analyst:]

Thank you for taking my question. Again, congratulations on another good year. At what point do you think you’d had to add some capacity to manufacturing? And the second question I have is, will you be breaking out the international revenue as it begins to become meaningful?

[Troy Meier:]

Well, I’ll let Chris talk about breaking out the revenue. I’ll talk towards capacity. Right now, John, we're running about depending on the week, but we’re running about 45% capacity right now. I mean we’ve got great opportunity to go, what we call lights out operation, when we talk about the machining of parts it’s all done on some very high-tech CNC five access machining centers and we’ve got those programs down. I mean, our team has really done a great job on that, and we can actually go two and three shifts on that. What is - the unknown is on the larger tool sizes, it depends on how much we are starting getting up these larger tool sizes, you know you look at 12.25-inch drilling rig versus 6-inch drilling ream. It’s double, the amount of the time on the machine. So, as this tool fleet gets larger, we're going to have more time per tool on a machine, but we're still looking maybe mid-year to the end of the third quarter before we add another machine, which our team has identified, we are not looking at five axis machining that are in the neighborhood of about $1.2 million apiece. We're looking at a turning center to complement the five access machines we already have. So, this turning center can do all the, what we call dirty work, and all the rubbing and then we can take and put them into our high-end machines that do all the real fine machining to the microns.

[Chris Cashion:]

Yes. And with regard to breaking out international revenue, John, we really haven't decided how we are going to do that at this point, as we’ve indicated we are in a testing mode right now joint market development agreement with Weatherford in the Middle East. There is a revenue sharing, 60/40. 60% of whatever we get in this testing environment and this is with the end-user, a 60% comes to us, 40% to Weatherford, but we don't expect a whole lot that’s going to happen in the first half of the year in the testing program. Second half of the year where you could start seeing we get kind of optimistic about what we might see in the second half of the year. So, we’ve got a few months share to kind of figure out what is the right reporting. How to break that out? If we break it out, we will be taking talking with the investor relations about that. We will be talking with our auditors about that that will have an opinion of course. We will start looking at those kinds of revenue breakdowns, but as we sit here today we really haven't made any decisions on how we're going to show that.

[Troy Meier:]

And just to update everybody on the Mideast, we’ve got two tools that of TD’d [ph] dwells over there, just in the last couple of days, and we’ve got two tools in the whole right now. So, it’s moving forward, we’ve got 18 tools deployed over there in three different countries. It’s moving forward.

[Chris Cashion:]

We don't have the test results yet. We are doing post well analysis on those wells that have TD’d and so it is really [indiscernible] things are moving and we are going to be learning a lot.

[Unidentified Analyst:]

I have one follow-up and that’s on the coil tubing market versus the directional market and I was just curious, do you have a sense of the importance of Strider in the coil tubing market versus the size of the market in that area that requires directional control?

[Troy Meier:]

Yes, so if we look at what we recall in coiled tubing market think of your ducks, you know your drilled and uncompleted. That’s the market right, is when we go into the production, but also these wells that all get cleaned out, people go in there and they clean up the wells and get them producing again. That’s the coiled tubing market. And the longer these wells get, the more they’ve got to have a tool that can get their wait on bit out, you know at the 20,000 feet. And that’s what our tool does very, very well.

[Unidentified Analyst:]

That’s a large market.

[Troy Meier:]

It’s not as large as the Open Hole, but it’s going to be a good market.

[Unidentified Analyst:]

But it also sounds like it is a rework market as well.

[Troy Meier:]

Yes. I mean these wells got to be reworked. I mean they produce for so many years and then they’ve got to go in there and clean them up and get the sand out and rig work coming. So, as we keep drilling in these long lateral wells, those all got to be cleaned up here in a few years down the road.

[Unidentified Analyst:]

Interesting product. Thank you.

[Operator:]

Our next question is from Jason Wangler with Imperial Capital. Please proceed.

[Jason Wangler:]

Hi good morning guys. I was curious, you kind of talk about the Middle East and you just kind of addressed with 18 tools out there, how do you see that moving throughout the year, is there a plan to put more tools overseas or is it more as you mentioned as you get some test results back and getting to the second half of the year you will kind of assess what the demand and what Weatherford things as you go forward?

[Troy Meier:]

Well first of all we have a testing period, an introductory of our tool to the Mideast. It’s an increment that goes till the end of June, and so it’s really going over there, same with the value add is to our customer base over there. And then setting down with Weatherford and looking at how this moves forward.

[Jason Wangler:]

So, the way to think of it more is that - like you said is, through June is kind of the test phase and then like, I guess we are saying the same thing, that when you can sit down and assess the size of the addressable market, who the guys that are interested would be and then you can kind of start to design what you guys need to supply and then what they need to do on their brand to kind of move that forward?

[Chris Cashion:]

And that’s exactly how we would proceed going forward, but just to give you an [indiscernible] of kind of how it started, and this is very embryonic right, but it’s - we started with the 16-tool fleet and we’ve been requested to increase that to 18 tools and we’ve recently got a request that we jump it up another couple of tools. So, even in the testing mode, as we are getting out there, as our product champion and the Weatherford product champion are getting in front of KLC and Aramco and the operators in Oman, we're getting some pretty interesting feedback, but don't have test results yet, but based on the marketing that we’re doing there’s been demand for few more tools over and above, what we started with. So, we could see a few more tools added to the fleet before we get to June 30, and that’s - we are okay with that. We want to get this tool in the hole as many times as we can and in many places as we can and get as much test results back. So, we have got a good database to evaluate exactly the value-add that this tool is offering. So, yes, it started out with the sorted fleet size and it’s kind of creeping up a little bit.

[Jason Wangler:]

Okay. And maybe just to ask on that because that is pretty interesting, the different tools, are they different sizes or is there something that they are looking at saying can you do this for us or that for us because maybe that’s more specialized in where they are at or just may be the reasoning for the different tools as you're kind of going through this filling out period?

[Troy Meier:]

So, there is different sizes we have 6-inch series, we have 8-inch series, and we have 12-inch series is what we started with and we put so many throughout three countries and from that, what we're learning is the need for much larger tools. So, one of the things to think about is when you’re designing and fabricating these tools to go up over 8-inch series as you’ve got to have some real unique equipment and some special talents that not everybody in the market has. So, as we look at that large hole size over that we’re excited about, we weren't excited about all of it. The 6-inch, the 8-inch, the 12-inch, but we can do large tools and we can do them well and that really, really start setting us apart from what you all might call competition.

[Jason Wangler:]

I appreciate and I’ll turn it back.

[Operator:]

Our next question is from [indiscernible]. Please proceed.

[Unidentified Analyst:]

Hi, guys. How are you? The first question I had was on the manufacturing efficiencies you were talking about on Strider. Is there something, I mean if we talk about it right now, how much upside or how much improvement do you need in the manufacturing efficiencies to prove, to get to like an industry average operating margins or I should say company average operating margins?

[Troy Meier:]

So, Chris and his team have identified the margins that they’d like to see us get to. And so, we challenge our team to - you know when such prototype it is really difficult for us to be efficient making once use and two’s use. But when you start making 10 at that time and 20 at a time, our efficiencies just scream. And that’s really where we shine. So, as we’re taking this from prototype with the goal of hitting the margins that Chris and his team has identified, our team is on it. They love the challenge and they are getting that tool there and part of those, and those margins is what are your repair costs on that tool. So, when the tool comes back to us, what do we have to change? What’s going to be our cost on that repair. And so, identifying the right material, that’s what, one of the things that we struggled with on the larger tool was we had a tool that works very well, but it would just - since it is a waterjet with what we do with the fluid when we restrain it. And so that water jet, it didn't matter what we were putting on there, we were cutting through the coding’s that we knew where very good, and so we headed to identify this high-tech material that and then also get it to where our vendor on that material to come in at a price that was going to be beneficial for us to get into our tool, really cut down our repair cost and they’ve worked with us and they’ve done a great job and our team has done a great job and now we have got a tool that we have got a unique material on that allows us to chase down those margins, that Chris has set up their and the next team is doing the job and getting them there.

[Unidentified Analyst:]

And are the margins and that you’ve set, are they specific reach tool or is there a desired margin you want just companywide on a product?

[Troy Meier:]

Well if you look at each tool, you obviously know that when we report we have got margins we like to hit, but we try to get the best out of each and every part of our operation. So, when we talked about the Strider, maybe we get deemed a little bit when we - and I'm not saying this is what happens, but when we make the deal, but then after we get that tool in for repair a few times we get it back. So, there is methods to get those margins on that product line where we need them to be.

[Chris Cashion:]

That’s a good way to think about it. We have companywide goals, but we have got different products within the company and so sometimes you tweak the margin to fit the products like for instance as we have said before, Troy was explaining the Strider technology versus the drilling ream, the drilling ream has no moving parts. It’s a tool for steel with PDC covers. It is more complex than that, but basically, it’s PDC cutters and steel. Strider has got some moving parts fluid flows through the middle of that tool across those parts. And yes, as Troy said, we had difficult time finding material, steel, coating steel that would hold up with those kind of flow rates, but we believe we’ve got that solved now, but they have different tool, different repair profile when you bring it in. So, over the life of the product line, we expect very similar margins, but how you get there, is a little different sometimes, but yeah, I mean we have margins that we expect this business to achieve and then we would drop that down to the product line level.

[Unidentified Analyst:]

Okay and just one more thing on margins there. So, last year I guess on an adjusted basis it was just over 5% or was it 5.2% in 2017? I mean we have seen that credit on the slides. And so in 2018 with what looks like anywhere from almost 20% to 15% to 40% potential revenue growth, you would think you would get a little more level rates, you're kind of operating margin guidance was 5% to 10%, you did 5% this year on a lower number, I was thinking that seemed a little conservative or is that something un anticipated in the ramp up that’s may be causing you to be a little conservative on that range?

[Chris Cashion:]

We’re putting in place, I think on - there is a step in our fixed cost base. We ran at about 3.6 [ph], 3.7 [ph] million in operating expenses per quarter throughout 2017, and with the R&D that we’re going to be, we’re spending and with the expansion into the Middle East we’re stepping up that operating expense base, roughly $300,000 a quarter. And so that’s why you don't like to see the margins going from that 5.2% in 2017 in any higher operating leverage. We talked a lot about the operating leverage we got in 2017, we did, but we’re becoming a very different company now, and it’s requiring some investments particularly in the first half of 2018, and before we start seeing the revenue. So that’s part of the reason Matt that you don't require to see the operating leveraging our guidance that we saw in 2017.

[Unidentified Analyst:]

Okay, great. Thank you. That’s all I have.

[Troy Meier:]

Thank you.

[Operator:]

Our next question is from John Bair with Ascend Wealth Advisors. Please proceed with your question.

[John Bair:]

Thank you for taking my call and congratulations on a good year. You had mentioned that you have quite a bit of capacity, spare capacity, I was just wondering if you were manufacturing, and I'm just wondering how much of that increase in your SG&A is a function of headcount expansion, is there much of that in that mix?

[Troy Meier:]

No, and keep in mind when you look at our capacity think of our third-party machine services that we do, right now we’re machining parts for other companies that we would slow down on in order to put our parts through the facility. So, kind of think of that when we think about capacity. We have that ability to quit doing the third-party machine work as we bring in more and more of our work.

[John Bair:]

And that would assume obviously that your margin profitability or whatever is much higher on your own internal stuff then I guess? Correct?

[Troy Meier:]

Correct. I mean third party machine shops there’s not a lot of margin there.

[John Bair:]

So, you really don't, are not looking at needing to expand your headcount that dramatically then as you ramp up overseas and even expand here domestically?

[Troy Meier:]

It’s a little bit. We’re going to be needing some expansion with headcount, but not a lot. It will be in the repair side of the business, I mean, we’re going to need to train folks to repair our equipment internationally, and so there’s some investment in training that goes along with that and the headcount increase itself, but it’s not a significant number, I mean that’s what we're seeing in 2018 is going to really be the headcount increase, it’s going to be around the expansion geographically. We’ve got the capacity in place as Troy just described. We just need to shift what that capacity is doing, and so, but we don't need extra people. We just shift what they’re doing. So, yes, I mean there is some headcount, but it is associated with the geographic expansion.

[John Bair:]

Okay. That’s great. That’s what I was thinking. Appreciate it and good luck going forward.

[Troy Meier:]

Thank you.

[Chris Cashion:]

Thanks a lot.

[Operator:]

Ladies and gentlemen, we have reached the end of our question-and-answer session. I would like to turn the call back over to management for closing remarks.

[Troy Meier:]

Well, we would like to thank everybody for joining us today and appreciate your patience and we look forward to talking to you again, I guess it would be in May, and we’re excited about what 2018 is looking like. So, thank you again.

[Chris Cashion:]

Thank you very much.

[Operator:]

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