Q2 2023 Superior Drilling Products Inc Earnings Call

Greetings and welcome to the superior drilling products second quarter 2023 financial results. At this time all participants are in listen only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance. During the conference. Please press star zero on your telephone keypad. Please note. This conference is being recorded I would now.

Turn the conference over to your host Michael Patricia you may begin.

Thank you and welcome everyone to our second quarter 2023 earnings call.

We certainly appreciate you joining us today.

Me are Troy Meier, our chairman and Chief Executive Officer.

Chris Cashman, our Chief Financial Officer Christopher.

Crystal We'll review our results in detail and then Troy will provide an update on the company's outlook and opportunity.

After which we'll open up for Q&A.

She has a copy of the financial results that were released before the market. This morning.

I also have a copy of the slides that accompany our conversation today.

It's not all can be found in our website.

Hi, Tom.

Turning to slide two I'll point out that we have.

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.

And subject to risks and uncertainties as well as other factors that could cause actual results to differ materially from what is today.

These risks and uncertainties are provided in the earnings release.

Right.

Other documents filed by the company with the Securities and Exchange Commission.

These documents can also be found on our website.

Or you see Scott Scott.

I want to also point out that during today's call, we'll discuss some non-GAAP financial measures, which we believe will be useful in evaluating our performance.

Did not consider the presentation of this additional information in isolation or.

Or is it substitute for results prepared in accordance with GAAP.

We have provided reconciliation of non-GAAP comparable GAAP measures.

The tables accompanying the earnings release as well as in the slide deck.

So with that please turn to slide three and I'll turn it over to Chris to begin.

Yeah.

Thank you, Mike and thanks, everyone for joining us today.

We had another strong quarter as our team continued to execute well.

The demand for our tools and contract services.

This slide highlights several of our accomplishments.

Which includes very breath impressive year over year top line growth.

With increased contract services work domestically.

And continued growth in our international drilling rig business, which we expect to continue throughout 2023.

The leverage that we gain from this higher revenue volume has led to measurably improved operating income and net income.

As well as solid EBITDA performance.

And as we have discussed on previous calls we have been making significant investments in manufacturing and service capacity.

So accommodate our increased work and in support of anticipated demand.

Our international business.

I'm pleased to report that those investments are starting to pay off.

During this quarter, we completed our new service and Technology Center in Dubai.

And have begun repairing tools in that facility.

And given the completion of our capacity expansion in vernal, Utah.

We have begun to refurbish a second customers PDC bits as.

As part of our contract services work.

Yeah.

Now if you'll turn with me to slide four you can see an overview of our topline performance.

Internationally, our quarterly revenue doubled year over year to $1 million.

And as we continue to gain traction in the middle East market.

Our international sales mix was nearly 20% of total revenue during the quarter.

Our highest level to date and up from roughly 11%.

Last year.

We continue to be encouraged by the many opportunities in the middle East and.

And expect that revenue mix change to continue to trend towards the international side of our business.

In North America, we saw revenue growth year over year.

The sequential dip you say reflects two impacts.

The first was that we had an exceptionally strong quarter of.

A tool sales.

Our U S channel partners during the first quarter of 2023.

And that was due primarily to just timing of replacement tool purchases.

The other factor to note is that the average rig counts.

Which while up marginally since last year's Q2 average.

Was down 39 rigs.

Since the sequential first quarter of this year.

And we have seen further declines in the U S rig counts and it reached 654 rigs this past Friday.

Over the near term.

It is our expectation that the north American rig count should stabilize around these current levels.

Now from an international market activity perspective, the outlook is somewhat different.

During the first half of calendar year 2023, the international rig count steadily increased.

And unlike here in the U S. We expect this increase to continue in the second half of 2023.

Now, let's move on to slide five.

And take a little closer look at our tool and contract services revenue.

Second quarter.

Contract services revenue was up $1.8 million roughly 10%.

Over last year.

With increased demand for the refurbishment of drill bits for a long time legacy customer.

And as noted above this year over year average U S rig count was flat during this period of increased demand for our services.

And as I mentioned earlier, we expanded our capacity to provide PDC bit refurbishment services to a second customer.

And we began.

Providing those services in Q2 of this year.

Total revenue grew 23% for the quarter.

Given our improved market penetration in the middle East.

And our U.

U S channel partner continuing to drive year over year market share gains for our drill N ream tool.

We also implemented a price increase in mid year last year.

Now as we go on to slide six you'll.

You'll see that we've continued to invest in people.

To address this demand.

Well, our services, especially in the Middle East region.

Well, we've added over the last year for people in technical sales and business development.

Including our new team later.

SG&A expenses were up.

45, 8% of revenue.

Which is up.

Over a year to year and sequentially.

This reflects these investments in our human resources.

And also increased legal costs.

Included in Q2 2023 was $450000.

Of expenses related to the continuing litigation.

For patent infringement lawsuit violations of our drill N ream tool.

This was higher than expected.

And currently we are now preparing this case to go to trial.

Mercury trial, and we expect that during the early spring of 2024.

But despite these added expenses, we still delivered operating income of $546000 in the quarter.

Which is an increase of more than four times over the prior year period.

Now if we go to slide seven we can see the highlights of our bottom line and adjusted EBITDA results.

And this quarter, we achieved net income of $323000, a one cent per diluted share.

And how that compares year over year to a slight loss in the previous year.

We also have adjusted EBITDA of $1.2 million.

And EBITDA margin expansion of 430 basis points up to 22, 6%.

And the sequential change reflects my earlier comments regarding exceptionally strong Q1, 2023 drill N ream tool sales.

Along with those higher litigation expenses.

Turning to our law suit that infringement lawsuit.

Now, let's move on to slide eight we highlight our balance sheet.

Cash generated from operations was $921000 for the year to date period.

Down from the comparable period last year.

Largely due to working capital changes driven by a 50% increase in inventory.

And this inventory increases to buy raw materials.

And we have work in process for tools and.

In anticipation of greater demand for the drilling right in the middle East.

So once again this is internationally driven investment in inventory.

We also had a.

Significant receipts of $750000 on some delayed accounts receivable.

And now you also see that the company continues to invest in Capex.

We review those in the past they're.

Largely related to the completion of our new domestic.

Domestic machining centers and increase in the middle East drilling rig to our fleet.

The expansion of our infrastructure that I referred to a little bit earlier to accommodate a second PDC bit customer.

And the new service and Technology Center in the Middle East with job as I mentioned is up and running.

We're now repairing bits.

Excuse me drilling rig not best repairing drilling rig tools in that facility in the middle East.

Now when you look at our total debt at the end of the quarter. It was $1 9 billion.

And then we're happy to report that in late July of this year we.

We executed a new credit agreement with vast bank.

And it includes a five year term loan of $1 $7 million.

Two year 750000 dollar revolving credit line.

And a program whereby.

The banking purchased certain accounts receivable.

The proceeds from the receivables program was used to repay in full the amount of our outstanding indebtedness under our existing credit facility. The facility that existed as of June 30th.

The funds available through the term loan and the revolving line of credit can be used for working capital and growth capital purposes.

This new credit agreement provides additional financial flexibility and liquidity.

Extends our maturity dates and importantly includes more favorable financing terms than our previous debt arrangements.

The interest rate on our revolving line.

Will be the greater of prime plus one or seven 5%.

While the interest rate on the term loan is fixed at.

At 818%.

This compares with 13.8 stops for sense that we were paying under our old credit facility.

Now, let's go to slide nine, but we take a look at our guidance.

We have updated our expected 2023 revenue to account for the decline in the U S rig counts.

From what we were looking at in the previous quarter.

Our revenue range is now between 22 and $24 million, which implies a topline midpoint, 20% growth.

SG&A expectations have been tightened to between 90 and $95 million.

And this includes those litigation costs.

Which are now projected to be approximately $1 $2 million for calendar year 2023.

And as I mentioned previously we expect.

A jury trial in the spring.

Q1 2024.

Our adjusted EBITDA guidance is five and a half to $6 5 million.

Which implies implies an EBITDA margin of around 26% at the midpoint.

This level is about 130 basis points higher.

And then our 2022 results.

And then lastly, we've maintained our expected capital spending guidance for fiscal 2023 in the range of between three and a half and $4 million.

So with that I'm going to turn the presentation Detroit.

Wrap up with a review of our outlook and opportunities both in North America, and the Middle East region.

Sure Thanks, Chris Yeah.

I just want to take a quick shout out and give a quick shout out to.

The Uinta basin.

For those of you that haven't been here.

That are on this call you really need to come visit us.

Our summer and fall here are just incredible.

I have to say that looking outside it's just beautiful out here.

Anyway, let's get into our North America, if we look at.

And the opportunities that we have in North America like Chris said it spent.

Spent the Capex and we expanded our facility here, we've got all of the drill N ream.

<unk> seen in manufacturing is now in its own facility.

Which allowed us to come.

Clear out one of our buildings, so that we could segregate the a new customer that's come in that we can have there they're bit line totally segregated from the from.

Our legacy customers and so that's gone really really well.

Team is doing a fabulous job there.

We've also as you know from prior calls we've talked about.

Bringing our.

Our quality, making it world class and the team has done a fantastic job there as we look at our.

A key lesson 18, and doing what they've done here in <unk>.

At our headquarters in <unk>.

Watching the team take hold it for.

That whole manage that system and what's going on there, it's really proud to be part of that.

As we've expanded our.

Capacity, but the large machining centers that that you've heard us talk about the large <unk> CNC machining center the new.

Addition of another 750.

We've got a we've got a well trained team and we've got capacity to it.

Let's start getting that additional work in here, we've got some highly qualified.

Programmers and machinist and.

We're gonna start filling up that capacity and bringing in some additional work.

We also as Lee we look at our international opportunity well before I go there I'm wondering when you also get the.

Our channel partners here in the U S are doing a great job penetrating the market with the drill N ream, even though we're seeing a softening of rig count there, they're still strong out there and getting the tools and all.

And.

One of the things that we like seeing is the fact that their fleet is.

Now aging and those tools have got to be replaced.

And so we know that.

We're going to we're going to continue to get new tool orders as those tools are replaced.

So looking at our international opportunity and that's that's where a lot of excitement for me comes from because we have.

Then over there now for.

So while as we've proven up our tool we've proven up the drill N ream in Kuwait, Oman, Saudi the U a E.

The tool works very very well.

But the one thing that we were always lacking was the ability to run it tool get it in from the field get it turned around in a timely manner and get it right back out.

And it's truly it's really held us back from pushing hard.

Especially with all of the.

She disruptions in the sea container business.

No. We just we just it was too troublesome to try to put.

Tools and as he can put them on a ship and have no idea when that ship would get.

Cargo here too our Butler facility so.

Now that we've got this.

Repair ability in.

In the Mena region in our Dubai facility.

We're excited to put a.

Streaming strong push into that marketplace.

We've as Chris mentioned, we brought in a technical experts.

Muhammad Belichick, if you guys get an opportunity to read some of the white papers that this gentleman has put out he is world class and he's he's joined our team in <unk>.

For even joined our team he did a couple of papers on the drilling ream that were that were very impressive and we're we're extremely excited that he has now joined in.

Ready to take our technical sales to another level.

When we look at.

What else can we do as we set up.

The repair center for the drilling dreams in.

In the Mena region, well that also that same skill set not not so much the same equipment.

Some of the same equivalent but the same skill set.

As needed for the bit repair.

And we've been asked for many years to to get bit repair up and going in the Mena region. The first trip I ever made over there was to look at our request from add not to do that many years ago, but at the time the volume just couldn't justify it so.

So we now have a lot of that equipment and its already made or the capex spend that.

We we've done this year, it's in it's in place, it's being loaded into see cans and it's gonna be heading over.

Two our center and we'll be we'll be setting up and repairing not just drilling dreams throughout the rest of the year, but starting in Q4 will also be showing bit repair in there as well.

So we're extremely excited about.

The additional revenue that that's going to bring.

Yeah.

Another area that we've put a lot of emphasis on it has been our ICL.

When we look at the.

The ISO requirements that we've had for this for the international the Mina <unk>.

Region.

The team has been pushing really hard to get that done so that as we've now put a technical team in place. We now have the repair ability and capacity in place and we're going through our audit right now as we speak.

We've had the ISO 9001 like you all know, but we're also adding the ISO 14001 and 45.

And in one all of that we expect to have in place here are qualified and certified and in place. So that as we now start knocking on doors and in the Mena region that we can't be tripped up by the lack of the ISO qualifications.

So I'm going to I'm going to tell our team and brag on them because they've done a tremendous job there.

So when you look at our opportunities and we're in the Mena region.

That that's something that we're seeing rig counts increase over there. Unlike here, what we're seeing rig counts decrease.

They're getting very aggressive Saudi is picking up rigs you as picking up rigs kuwait's picking up rigs.

We feel that.

US being over there and doing what we've done to put us in a position for this day has been.

Very very important to the growth of this company and what it means to us going forward.

We still have lots of opportunity here in North America, but I think what you're going to see happen.

With us and our team in the Mena region over the next year year, and a half is going to be very impressive.

So.

With that I'm going to turn the time to.

The Q&A session.

And again, thanks for joining us.

At this time, we will be conducting a question and answer session. If you would like to ask a question. Please press star one on your telephone keypad, a confirmation tone will indicate your line is in the question queue.

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Our first question comes from the line of <expletive> Ryan with Oak Ridge financial.

Please proceed with your question.

Thank you good morning, guys.

Okay.

Chris just wanted to look at the litigation expansion increased it for all of 'twenty three and then you say that trial is spring of next year. So we have some you know.

Follow through litigation expense in the first quarter of 'twenty four.

Oh, yes, we do.

Yeah. That's that's that's roughly 300000 is what we're kind of thinking that's going to look like.

Okay.

Okay. Thank you.

A couple on the drill bit refurbishing. He got a second customer can you look down the road a couple of years is that.

Would that customer be on par with the legacy customer what they generate is it more or less and then the second question is the bit refurbishing over in the middle East is that going to be a third customer or would that be either one of your first two.

So regarding the first question, yeah every bit as big as our legacy customer.

It for sure.

It's it's somebody that we've looked at and targeted and yeah. It's it's it's it's got tons of potential very large in scale when.

When we look at when we look at our the.

The mid east are the Mena, our mid East North African.

Opportunities over there, it's it's different because that part of the world some of the some of the E&ps.

Which are all pretty much N O sees.

They still buy bits and they still own large inventories of bits that are the day, one like Kuwaiti oil and gas they own.

Thousands of beds and ER.

I do know that youre, starting to see the rental markets get very vibrant over there.

Don't think anybody wants to buy a product that's growing obsolete from the day you buy it.

So, but there's a there's a tremendous opportunity for us.

Not yes, the surf COSE, but also like I mentioned in my first trip over there years ago was at the request of add not to come look at you know the the tools that they own and how can we set up over there and repair.

Back then it was quite a smaller operation, but yeah, we've had requests from.

Our legacy customers, we've had requests from all the major serve codes that have you know meaningful market share with drill bits.

So I'm not quite sure how the.

Regulations are with moving stuff in and out of countries. There's a lot of you know if you if you own a bit let's say to wait what's the regulations on moving that out into Dubai, and having it repaired and then shipped back we havent got to that.

In depth, yet I know there are some regulations, maybe they can be be shipped out on temporary permits or something but.

Yeah, I think there's a there's a there's a huge opportunity there and as far as that repair goes.

Okay. Thank you say on the channel partner.

And the slide deck, you talk about further penetration in the U S market is that in the existing basins that they've had been working with you one of you expanding any of the other basins.

No we pretty much ran they've been running drilling ream, we send about every basin there is.

But no. We're seeing you know larger tools being ordered which tells us they're going into a different portion of the wellbore and into the vertical if you will.

We're seeing tool a friend in the curve, we're seeing tools running the lateral.

And you know if you look at.

The drilling ream on when.

We first brought that out it was it was put in the lateral.

And now it's at choose all the time in the curve.

And then I think that what we found in the when we went over to the mid east, whereas they weren't drilling the curbs and laterals.

But they had complications in the vertical section of the Wellbore and so we've been able to really enhance well bores in the vertical and now the mid east is now starting to do.

Urban laterals I think I mentioned.

Maybe it was on our last call.

The drill N ream was Luzon the.

The two longest laterals ever drilled.

You know in Oman, and that's been fairly recent.

And so they're now starting to to build terms and go sideways and they understand the benefit of the tool in the vertical and I think what we'll see here in the U S. As we will see more of the.

Realization that what drill N Ream does know vertical was also.

You know good for the operators in the casing that theyre going to put in and the cementing they're going to be doing.

So okay.

Okay. Good I appreciate it yeah to the extent that you can is there any comments you can talk about on your strategic review process.

You know, where we're building a data room as we speak you know were very bad.

We're a small company as you're well aware and and we've brought on a.

A banker at the top of the game and they are expecting a lot from us and our teams responding so well.

We're putting the data room together and I think it's it's moving forward very well.

Okay. Great. Thanks, Thanks, guys for the update T J congratulations on the strong quarter.

I appreciate it. Thank you thank you Doug.

And our next question comes from the line of John Bair with ascend wealth Advisors. Please proceed with your question.

Thank you good morning Christian Troy.

Good morning, John .

Are you all doing.

Good good good good good I've got a couple of questions for both of you.

Let me start off a quick one on <unk>.

Kevin there's a.

A reference to right of use assets or about 559000 could you.

Kind of explain what that is.

Yeah. That's a that's a result of some gaps are fairly.

GAAP changes around well.

Well, we used to call operating leases.

Indeed in the olden days, we would expense we.

We will expense shows monthly lease payments.

This is the new GAAP that came out of I guess, it's been out a year and a half or so now.

Wires, you to capitalize those operating leases and amortize them over the term of the lease.

And that's why they're called right of use assets, it's not they're not technically capital leases are there's no buyout option or anything like that there. Once again operating leases that are not capitalized because we have the right to use.

The facility that we're leasing.

Okay. So that's probably the the sale leaseback.

Well with that.

No the sale leasebacks are different that's a different animal.

Yeah. This is this doesn't have anything to do with the vernal facility for instance, we recently read.

At least a facility there and Bernal, that's not a part of our campus. It was our campus that we did the sale leaseback and I guess last fall as we were looking and developing the plan to do.

Increase our infrastructure to take on the second bit refurb customer we leased.

Our facility in Burnell.

And it's you know it's just.

Plain Jane operating lease that would be an example of a of.

Police that would be in this route of abuse calculation as well as a leased facility that we have in Dubai, we don't.

We don't own that facility that the servicing technology centers, and we release that and Theres no options to buy it so it's not capital eight cents.

But that's an example of another facility.

That that we have the right to use that as a part of this right to use.

Calculation, so it's separate from the sale leaseback.

Okay very good and then you mentioned in the press release and in your comments about receiving 750000 of accounts receivable that were.

<unk> delayed do you have any additional delayed a ours out there and secondly, I guess than you would if youre looking at the 630.

June 30th number she would knock here, a ars down by that comparable amount.

And I do know that the sudden death.

Cash on hand is that a way to look at it that's the way to think about that is exactly right. Jon. That's it's yeah. We had a couple of large customers to answer your first question that.

A number of issues systems kind of things I would say on their side.

That caused some delay in us receiving.

Remittances on outstanding a are in.

They are.

Our DSO was was elevated as of June 30th because of those delays one customer here in the U S and one customer and are in the middle East.

And so and so yeah, we collected.

Not only in the 750 that we alluded to but we've also collected a bit more another 150000, or so and we are expecting another 300000, roughly that will be getting over the next week or two so these.

Issues seem to be worked out.

But yeah, it led to an elevated number.

Okay.

We're seeing that come down.

Good.

Yeah that kind of Segues into my other question is whether or not.

You see more of a delay in receiving receiving your a our billings from domestic versus international and kind of how that plays out.

Well, we've always seen it a significant delay.

I E a higher DSO internationally than domestically.

And with this domestic customer kind of getting their systems issues worked out we fully expect receipts to to look like they've historically been and then historically then.

They've been very good as it sits in the oil field.

45 to 60 days is a pretty good pretty good number.

To expect on DSO.

Internationally, it's not quite the same and it never has been it's.

It's so it easily can be 100 days plus.

Internationally.

And so we really haven't seen any deterioration in either domestic or international market.

Other than that other than the systems issue I mentioned it's.

Hanging in there at that kind of level. So when you're thinking domestically you can think 50.

50 days, roughly you're thinking internationally.

It can be 100 to 110 and it can be double that.

That's just the way that's just the way international is right well with your <unk>.

<unk> expanding internationally then that.

Kind of a reason for the question I guess.

So another one another quick yeah. Another question.

It was addressed about market penetration in the U S earlier.

Earlier and.

With the inventory up in anticipation of increased activity. What do you think your conversion rate might be on sales over the next quarter or two.

That inventory level.

Do you have any feel for that.

Yeah, it's going to be.

Q4 for sure.

Yeah.

That's that's kind of the way I think I'm looking at right now by the time, we get that and.

And then maybe even late Q4, because once again that that inventories going into tools, that's going into the middle East.

And converting you know converting into cash.

It's a long it's such a big DSO so.

And if you're referring to cash conversion, taking inventory and converting it to cash then yeah. It's gonna be like Q4 might even start running into early Q1.

Okay.

Yeah.

Okay very good.

I think here.

So as far as Troy you spoke about.

Spanning into bit repair over.

And the mid east.

Will that require additional capex build out of your facilities over there.

Very little we've got most of the equipment is already built.

We've got to increase our.

You know air pressure, our airline capacity, we've got to increase that so another another little.

A little bit there, we've got some electrical to do as we bring in our base stations, but it's it's not going to be nothing like as you've seen in.

In Q1, most of most of the heavy lifting has been done.

Okay. So that should really not have any anticipate.

In anticipation of an increased level of Capex say going into 2024, then no no.

Okay.

Great. Thanks for answering my questions.

I appreciate it John .

Thanks, John Yeah, you all take care.

And we have reached the end of the question and answer session now I'll turn the call back over to Troy Meier for closing remarks.

And again I just want to thank everybody for joining the call.

Looking forward to seeing you all and talking to you all again in November .

And.

We'll keep we'll keep forging ahead and then.

Yeah.

Putting forward our R.

Our best effort so.

Stay with us and look forward to seeing you in talking to you in November thanks again.

Thanks, everyone.

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

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