Superior Drilling Products, Inc.
Q2 2016 Earnings Call Transcript

Published: 12 Aug 2016

[Operator:]

Greetings and welcome to Superior Drilling Products Second Quarter 2016 Financial Results. At this time, all participants are in a listen-only mode. An interactive 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 your host Ms. Deborah Pawlowski. Thank you. You may begin.

[Deborah Pawlowski:]

Thanks, Matt. Good day, everyone. We appreciate you are taking the time to join us and your interest in Superior Drilling Products. Four our second quarter conference call here today joining me are Troy Meier, our Chairman and CEO; Annette Meier, our President and COO; and Chris Cashion, our Chief Financial Officer. Troy and Chris are going to review the results for the quarter as well as provide an update on the Company's strategic process. You should have a copy of the financial results that was released before the market opened this morning, as well as the slide will accompany our conversation today. You can access both on our website at www.sdpi.com. On Slide 2 of the slide deck, you will see the Safe Harbor statement. As you are aware, we may make some forward-looking statements during the formal discussion as well as during the Q&A. 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 from what is stated here today. These risks and uncertainties and other factors are provided in the earnings release as well as with documents filed by the Company with the Securities and Exchange Commission. You can find the documents on our website or at sec.gov. I also want to point out that during call today, 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 today's earnings release as well as on the slide deck. So with that, let me turn it over to Troy to begin. Troy?

[Troy Meier:]

Thanks Deb. Welcome everybody and thanks for joining us on this earnings call. Let's go ahead and turn to slide 4 in your slide deck, and get right into changing markets. As we look at this we believe what we are seeing here is the bottom of the market that we witnessed throughout the second quarter. You can see the decrease but also look at the year-over-year rigs count decline. And again we've been heavily concentrated in the Bakken that's been extremely hit hard. And as you all know our contracted services mainly the bit refurbishment, the contract that we have is for the Rocky, Alaska, California and we were also getting all that over flow work from other facility. That's all been hit very, very hard. So you can see that in the numbers. But we also want you to look at on this slide is -- we want to talk about moment that we are starting to see an improving market condition that we are seeing. As we look at this the rig counts and the activity start to improve and we are seeing this uptick in rigs count week over week. The momentum that we are going to talk about later on in this presentation we believe will carry us through any installing this upward tick of rig counts or any stumble that this upward trend may see. Let's go to the next slide on a slide deck on a number 5. You heard us talk lot about our channel partners that we are going to develop, the partnerships we are going to develop with drill fast companies. You are familiar with the one we had for a very long time and we are looking at expanding on those opportunities. We are in early stage talk with them and enhancing our services to them. But one thing that we are seeing is as we look at this partnership to be able to tap into the legacy relationships that we talked about in our last earnings call that we were hoping to be able tap into is really starting to show. As our sales team, we used to use their sales team that we support at the high levels in this companies this E&P companies is really need to see the strong relationships that these companies have. And it has been great to work with in the early stages here to be able to work with a well experienced and well funded sales team has been really exciting for us. One of the things that this also does for us is it reduces our cost in the sales infrastructure that we have. So we've been able to eliminate most of that cost. And it allows us to focus on our strength. We are a design engineering and fabricating company, and we are able to now really, really focusing on what we do well. So one of the things that we are excited about these partners as well is to see they accelerating pace that our tools are now been adopted in some very high profile areas. So we are excited about what this is going to look like as the year continues to roll forward. Let's go to our slide 6 in our slide deck. This tool here Drill-N-Ream, this was our flagship tool. This is the tool that we've been telling about, it save time and money and this is a need product. There was frustration of us not been out there to convince customers about because maybe our relationships weren't good enough, or maybe we just couldn't break through that. But what we are getting now is the Drill-N-Ream is more and more validation of the capabilities of this tool. And it's really exciting to watch this happen and some again high profile varies, as we look at Texas and the different basins in Texas. And what's going on down there is really fun to see. I mean operators are really, really seeing a major benefit when they run this quality tool. Its need to watch. So as we go through and we look at the tools that we have sold in to DTIs as we look at the sales in May, we look at sales in June and July, those sales now, those tools are starting to find their way into wellbore and is more and more these tools are being utilized we are seeing more and more repairs coming in and stimulate other operators to start calling and find out what these people are using, and what is saving in this time and money so if it's really exciting what we are starting to see. We got good steady adoption of our tool from major operator. These guys -- this operator we are talking about they are good. They are at the top of their game and they now understand the cost savings the Drill-N-Ream gives them. And that's just other people have to pay attention and when they do that it just leads to more and more sales. So we are very excited about Drill-N-Ream deal our flagship tool and we are pumped about what that's going to look like here going forward. The other thing about Drill-N-Ream is we are also seeing larger size -- we started that -- tha tool started its life out in 6 inch dial tool and we are now doing tools all the way up to 13.25 inch, so pretty need. Let's go to slide number 7 and let's talk about Strider. I know you've all heard me talk a lot about this in the past and this tool perfecting this hydraulic taming technology has been a challenge. It's kicked our butt several times. We've learned a lot. We've learned a lot about hydraulics and gears and pressures and fluid flow. And just drilling practices in general. And we now believe we are getting on top of that Strider and we had the tool that was working good but it just work good in brine. And if we take that tool into places that had different mud system, silica sands based mud, we found that our gearbox would get breached by this harsh environment and would cause a start stopping mode of the trusting that our tool create. We gotten with world class sealed, designers of sealed and figured out how do we sealed our drive system. And we believe we are on top of that. Now if we are testing our mono-bore system next week it's going to be out here in our test lube and we believe that that's going to show that we can drill in all different types of fluid environments and not just brine. So we are excited about what the future looks like for that. So one of the things that we've learned with Strider is it's the mechanic that Strider is sound and as we took that tool and we downsize that tool and we introduced into a market that is a whole different market for us. You look at the drilling side of the E&P companies and you look at the production side and this true to being Strider is now we are going into the production side of this company and we just introduced this tool a month or so ago and this tool is having phenomenal success. It's the thrusting action that Strider trait is allowing operators to drill the plug in this production wells, and the production side of the process, you are able to drill all of the plugs and they are able to keep an expensive rig change out when you look at -- you look at the coal tubing unit, mobilize and coal tubing unit, it's a lot more efficient, and that's what these operators choose to do. But typically close tubing units can only get you down so far. And then they've got back that unit often bring in what we call a work over or stick rig. Well, early indications with our tool is as we've been able to do the entire section drill all the plugs keep that operator from asking to bring on that stick rig and it's really neat, so we are looking as we go forward we are looking for some big things for our thru tubing Strider. It's got everything that we learned in our original Strider and good and bad and we were able to design this Strider with some awesome functionality when you start looking at the rotational drive coupling that we've designed. It is some intellectual property that we are getting out there. We are looking big things from this, for thru tubing Strider as we also introducing get our open hole Strider out and moving into the markets. So that being said I am going to turn this over to Chris to give you the financial results and talk about that.

[Chris Cashion:]

Okay. Thank you, Troy. And good morning everyone. Let's continue our review by going to page 9 in the slide deck. And on this page you are see operating expenses Q2, 2015 going to Q2, 2016, and the first thing I want to highlight is the asset impairment charge that we took in Q2. That charge pertain to that Strider product that Troy alluded to the one that is applicable only in brine operating environments. And so we made the decision to broaden that market application for that tool. And decided to write-off the assets that we had invested in that brine only tool. That's the tool that as you all know we commercialize last year in the Bakken with writing. And has been generating revenue but as the Bakken is going down as the activity has declined significantly like you saw earlier, we made the decision to focus our time and attention on a Strider that now have a broader market appeal. So as you look at Q2, 2016, if you can take a middle note to adjust that $4.1 million and adjusted down $400,000, we would have $3.7 million but that's unusual charge, and then if you adjust it down for the D&A expenses in that quarter, we are down 26% year-over-year in cash spending. So cash cost are down 26%, that's not the same percentage as our revenue decline. And the reason for that is we maintained costs and infrastructure to support our expansion specifically technical sales cost we maintained to support our channel partners and our manufacturing capacity, as Troy mentioned earlier going forward from Q2 we are seeing consistency in our manufacturing and so being able to utilize that capacity is very important to us. And we also had investments in new tool development. That's the referencing to Strider. That's both the mono-bore Strider as well as Thru Tubing Strider. And so that's picked up in our financials as R&D spending. We view that as investments in new tool. And then the other thing that we are begin the process doing is as we talked last time, this business model are going from rental tool business to tool sales business is allowing us to reduce our field sales and distribution personnel. So we are beginning to make those changes as well. Now let's turn to page 10 and look at our cash flow specifically EBITDA and you can see going from Q1, 2016 to Q2, 2016 we doubled the negative EBITDA due to the reduced sales and then the investments in infrastructure and new tools. The combination of those two led to $1.2 million EBITDA, negative EBITDA in Q2. One of the things that Troy alluded to was not only are we selling new tools but we are also selling used tools, used Striders and so we have $134,000 in Q2 of used tools that we accounted for as a gain on disposition of assets since we had book those in power on balance sheet as rental tools. So we did not flow through the P&L on the revenue line $134,000 of revenue. But we did achieve that sale, all cash, no cost for sales associated with that, just the net book value of those assets. And that resulted in a $72,000 gain in the disposition of those used tools. We are focusing now going forward operational efficiency and manufacturing processes. We are beginning to see more consistency in our plan with our tool sales model beginning to gain traction. And that's a very good thing for us. We are able to go out and look at purchasing material on more cost effective basis. We are basically developing a backlog and that's really going to help us with our manufacturing processes. Our revenue breakeven, this is the net cash breakeven is under $1 million now. And so we continue to lower that breakeven point. If you turn to the next page, now page 11, and look at the balance sheet. You can see from a CapEx perspective we really cut back CapEx in Q2, $26,000, not being in the Drill-N-Ream rental business has allowed us to not only to cut back CapEx in building that fleet but also as I just mentioned it opens up an opportunity to sell some of those used tools. So we've got our CapEx coming down real strongly. And going forward $180,000 you see for the second half of the year, that's for Strider, that's for that mono-bore new tool Strider, the larger tool and then also the Thru Tubing Strider. We renegotiated Hard Rock Note effective just yesterday as a matter of fact and in then renegotiation there was $1.5 million of principal payment due in July and the holder of that note is agreed to take stock of $1 million. And they will pay that $500,000 in October, 2016. And then we also are able to renegotiate 2017's debt service of $2 million that's been extended to 2020. So bottom line it was $3.5 million due in the second half of this year and the first half of next year. And just to summarize $1 million converted to equity, $500,000 to be paid in Q4 and then $2 million extended to 2020. So we are really pleased with the way that renegotiation had worked out for us. And I might add we are able to do that in maintaining the same interest rate on that debt 5.75%. We also are able this month to secure $1 million bridge loan to the private placement that allows us the flexibility to meet some obligations and so we are really pleased about that. And then we've established terms for forbearance agreement on our bank debt. We are at compliance on financial covenants and the bank has agreed to terms and we will be working toward getting that forbearance agreement in place. We are continuing to function under our existing facility. So we have once again the terms are negotiated we just need to get through the legal documents. So with that I want to turn the review back over to Troy. And he can walk us through the outlook.

[Troy Meier:]

Thanks, Chris. As we've talked about used tool sales, keep in mind that all those used tools that we are talking about are the Drill-N-Ream and not Strider in anyway. So as we look -- as we go forward and we start looking at our market, we are looking at improving conditions in the market. Now that really a good, good thing to hear and to see. But one of things that we are seeing with our technical sales support team is we look at all of the calls that they have gone to support a sales staff with DTI or shale as we gone out there, we've had more interest and more sales call and more presentation in the last two months than we've had in the previous two years. So that's really need to see it this things are moving in the right direction. And as we start to introduce to the marketplace our two different types of Strider now as we go into the open hole Strider that we are focusing on a big, big way. That's going to be very beneficial for us going forward and like I said I think we are on top of that. And we are excited to start getting that tool in the right hand. Thru Tubing Strider it is working well. We are getting some incredible runs with it and so lot of interest on that and we are looking at our manufacturing and a number of tools that we can put and we standardize as that product become standardized. Now we are taking and implementing good manufacturing practices around sales technology that allows us to look at our team and say, this is our Thru Tubing Strider team and sees how efficient we can become as we make those tools. One of the things we got to get really focused in on is our intellectual property. As we move forward into this year we got some innovation that is working very, very well. And we've got to get in there and we've got to make sure that we protect our intellectual property. I got a list yesterday from our R&D team on the top six items that we need to get filed and get in there and some impressive stuff going on here. So as we look to bring more and more technology to these companies that can distribute and get this out here, out into the hands of the operators. We are now building our company based of that philosophy and I think it's going to be very, very beneficial as we go forward. So with that being said, I am going to go ahead turn over to any questions-and-answers we may have.

[Operator:]

[Operator Instructions] Our first question comes from John Stoltzfus from Oppenheimer and Co. Please go ahead.

[John Stoltzfus:]

Yes. Thank you, gentlemen. I am curious about the current source of the bridge loan financing. So that was the private transaction, could you -- is the better description to where that the source.

[Annette Meier:]

His name will be in the 8-K filing with the bridge loan itself, John.

[John Stoltzfus:]

Okay, terrific. The other is in terms of the pre announced this share offering that was announced on the 12th of July, is that still in effect or have or does this refinancing that you done at the moment basically removed that from that table.

[Annette Meier:]

John, the S1 is still in process with the SEC

[John Stoltzfus:]

Okay. Another item is you said breakeven less than $1 million, I see that is I believe on the slightly less than a $1 million month so that would be breakeven of under $3 million of revenue a quarter. Is that correct?

[Chris Cashion:]

Yes. That's correct.

[John Stoltzfus:]

Okay. And the other I am just curious how much of the shift of personnel to your partner, now your marketing partner because you shifted your sales personnel. Do you have a breakout what that cost of previous cost was to you and how that would -- versus the $4.1 million of operating expenses? Just to give me a sense --

[Chris Cashion:]

Yes. Roughly it is about 65%-70% of our existing sales and marketing team, we've been able to shift. So that's -- in the past I think we've said that roughly a $100,000 a year in comp expense for a field sales individual. And so we've also disclosed in the past that roughly a team of 10 is kind of was best size of our team. And so we are able to decrease that. Like I said 65% to 70%.

[John Stoltzfus:]

Okay. The other item I think is interesting that you gone from a year ago you were about 62% of your own of the Drill-N-Ream your own tool as opposed to from what I can tell. And now you move that up to about 82% with the bit refurbishing obviously being fairly small amount. What can you project forward what likely mix is they are going to be? Because obviously you are more in control with Drill-N-Ream than you are in the bit refurbishing business.

[Troy Meier:]

John, let me say a few things here in regards to the bit refurbishing business that has been reflecting that rig count drop very heavily. We've looked at that and we've been in negotiations with -- and working on getting more and more products into our shop. And we are starting to see that in this third quarter. But we are also looking at other ways to and start relationship. We are in early negotiations talking about other things we can do in regards to their drilling product lines to test the talents in the equipment that we have here and utilize it more effectively.

[John Stoltzfus:]

So that would be more custom work as opposed to the refurbishing?

[Troy Meier:]

There is more custom work involved. There is also some looking at representation that's involved and getting more of these bits we look at the quality and the efficiency that happen here in this facility. And they are very familiar with it. And so as we go down there and talk them into shedding those costs in their facility and allowing us to do it here where we are lot more efficient that starting to get some attention.

[John Stoltzfus:]

Okay, good. I appreciate you are giving the color. It has been very helpful. Lots of information and I'll get out of the queue.

[Operator:]

[Operator Instructions] And our next question is from Hilary Shane from ODS Capital. Please go ahead.

[Hilary Shane:]

Hi, Hilary Shane. How are you guys? You made a comment that it's still with the SEC. I assume right by now the SEC is approved it. I mean there are not changes except for maybe the updated quarterly information because you don't have any financial accounting issues whatsoever. So I assume that all we are looking for now is sort of the quarterly numbers accurate, quarterly numbers, is that correct at this point?

[Troy Meier:]

Yes, go ahead.

[Chris Cashion:]

Yes. We are updating our S1 with an amendment to include as you just said the Q2 numbers.

[Hilary Shane:]

Yes, okay. And then I'll approved, do you still need to go forward with this offering now that you -- because of the stock I mean I don't want to get diluted at this level and the stock is so low. Aren't you going to hold off little bit? Because now you have a little bit of grace period with this bridge loan.

[Annette Meier:]

At this time, we really can't comment on timing or anything else like that. The S1 is in the review process with SEC.

[Hilary Shane:]

Okay. Because I really would prefer to try to get cash flow positive as opposed to raising money at this level. All right.

[Annette Meier:]

Appreciate your thought.

[Hilary Shane:]

And with this -- and how much is the S1 for how many dollar, what's the dollar amount of the S1? Do you remember?

[Chris Cashion:]

Yes. $5 million.

[Hilary Shane:]

$5 million, okay, great. Good luck with it.

[Operator:]

Thank you. I'd now like to turn the floor back over to management for any closing comments.

[Troy Meier:]

Thanks Matt. So we are looking forward and we are encouraged by the activity right now that we are seeing going into Q3. And the growing demand that we have for our unique drilling tools. We are excited about the direction we are headed in and we are glad to see an industry stabilizing. And I want to thank you all again for taking the time today to join us and we will be talking to you again in November. And giving you a third quarter teleconference update. Thank you.

[Operator:]

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