Superior Drilling Products, Inc. (NYSE:SDPI ) Q4 2021 Earnings Conference Call March 11, 2022 12:00 PM ET

Craig Mychajluk - Kei Advisors LLC

Troy Meier - Chairman, Chief Executive Officer

Chris Cashion - Chief Financial Officer

Richard Ryan - Colliers Securities

John Bair - Ascend Wealth Advisors

Greetings. Welcome to the Superior Drilling Products, Inc. Fourth Quarter 2021 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]. And please note that this conference is being recorded.

I will now turn the conference over to your host, Craig Mychajluk. Thank you. You may begin.

Yes, thanks, Dan. And welcome, everyone, to our fourth quarter 2021 earnings call. We certainly appreciate you joining us today. I have joining me Troy Meier, our Chairman and CEO; and Chris Cashion, our Chief Financial Officer. You should have a copy of the financial results that were released before the market this morning. You should also have the slides that will accompany our conversation today. If you do not, both can be found on our website at sdpi.com.

Turning to Slide 2. I'll point out that we'll 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 are provided in the earnings release, the slides and other documents filed by the company with the Securities and Exchange Commission. These documents can also be found on our website or at sec.gov.

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. 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 with comparable GAAP measures in the tables accompanying the earnings release as well as in the slide deck.

With that, I'll turn it to Slide 3, and I'll turn it over to Troy to begin. Troy?

Thanks, Craig, and thanks, everyone, for joining us for today's call. You're on Slide 3, let's get into it and start right off with talking about strong execution. As we look back at 2021, one of the things that I'd like to emphasize is the fact that we spent the second half of last year really strengthening our foundation. When you look at what talent we've been able to bring into our company, I'd really like to tell our HR group what a wonderful job they've done. They've strengthened our team with bringing in some world-class fabricators.

When you look at the programs that they've put into place as they've talked and convinced people and shown them the benefits of rural Utah and coming here and all of it has to offer. We've really hired well. We've been able to bring in some tremendous talent in the fabrication side of things in every department. And you look at our management teams have been really, really strengthened with some world-class managers. I'm really, really looking forward to -- as we go forward into 2022 and beyond, I think we've really strengthened the foundation here, and we've put together a fabulous team.

Looking at the quality management team and what they've been able to do there, turning the -- our quality program into a real TQM, a total quality management system. They've done a fabulous job there, working with the local university to get testing -- get a testing and a certification structure here in place so that as we bring on new team members and qualify them in processes that we can do it locally here and not have to send sample coupons out to other parts of the country to be tested and the time lag that, that takes. They've done a fantastic job.

When we look at our business, as far as the tools that we build and design, you look at our flagship Drill-N-Ream product, our channel to market partner there, DTI, has done a really good job penetrating the market. They continue to bring new customers on. Some of the things that we're seeing there is -- we're starting to see tools that go to California, go to Alaska. So they're doing a good job, and they're selling deeper into their existing customer base. So that's -- they're doing a good job, and we appreciate that relationship.

When you look at our PDC activity, we continue to find ways to strengthen that for our legacy customer. We take on new product lines. We now have turnkey processes going on with that PDC. And it's not just refurbishment when we talk about PDC. We also -- we have an opportunity, and we'll talk about this a little bit more as we get into the slides, we've -- anything that has a PDC cutter and a diamond cutter, we're very good at building and repairing. And we've been able to identify product lines within our customers' products that we can then start looking at turnkey operations, and we'll talk about that here when we get down to looking forward.

As you noticed, the strong cash position. We continue to strengthen our balance sheet. But as we go forward, I want to spend a little more time today as we talk about future opportunities. But I'm going to turn the time over to Chris, so he can go over the numbers with you, and then we'll catch back up on opportunities. Chris?

Okay. Thank you, Troy, and welcome, everyone. Now please turn to Slide 4, where we provide an overview of our very impressive revenue growth for the year. Q4 2021 revenue increased to $4 million, up 11% sequentially and 156% year-over-year. Our North America market continues to see growth in drilling tool demand, higher royalty and tool fee repairs and robust bit refurbishment demand. For the full year 2021, revenue increased 27% to $13.3 million due to increasing orders for our Drill-N-Ream tool, and a significant recovery in oil and gas production in North America.

As oil and gas production ramps up, we're benefiting from an increasing rig count. We ended the quarter with an average U.S. rig count of 559 rigs, up 62 rigs from the third quarter of 2021 and up 248 rigs from the average in the fourth quarter of last year. We continue to be confident that the improvement, particularly in North America, as we've seen throughout 2021, will continue at a steady pace well into 2022, even as we deal with and go through various global headwinds impacting our industry.

On the international revenue side, it's been consistent, though remains dampened somewhat by the pandemic and Middle East COVID-driven containment restrictions. Despite the pressure, fourth quarter 2021 revenues, which now represent about 10% of our total revenue, still increased roughly 30% from last year's fourth quarter. The loss in international revenue for the full year was offset by a 35% increase in North American revenue.

Now let's move on to Slide 5 and review our Tool and Contract Services revenue. Contract Services revenue for the fourth quarter was $1 million, up 54% from the same period in 2020 and for the year, up roughly 20% to $4.1 million. The improvement in Contract Services reflects expanded volume and product refurbishment and manufacturing for our long-term legacy customer. As we mentioned, we are seeing a recovery in tool sales and Contract Services as tool fleet replacement is ramping up. Full year Tool revenue was measurably higher at $9.2 million, up 31% or $2.2 million from the prior year period, propelled by the Drill-N-Ream. We're seeing both new tool orders as well as an increasing repair and royalty revenue as we enter into 2022.

Now on Slide 6, you can see that we are continuing to be very focused on cost discipline even as we strive to -- in building our team, as Troy referred to. We're investing in the company growth with this team, and we see increasing demand for our products and services. Operating expenses in 2021 were down roughly $400,000 or roughly 3%, primarily as a result of lower amortization expense and the reorganization of the company's international business to improve profitability. Our cost control efforts and the higher demand in the market has allowed us to generate operating income of $90,000 in the quarter.

And I would just like to point out that this is the third straight quarterly positive operating income for us, and it's further validating the progress we are making. Like many companies, inflationary pressures persist and are keeping expenses elevated but our teams are working hard to improve processes and controls, as Troy spoke about. These are to address these pressures and support and hiring and training efforts. Staffing will continue to be a focus area as we move forward.

Now on Slide 7, you can see that our bottom line net income and our adjusted EBITDA results have improved considerably in Q4 2021 and for the full year. Quarterly net income was $645,000 or $0.02 of -- per share compared to a loss of $655,000 or $0.03 per share in the prior year period. For the year, we reported a loss of $500,000 roughly, close to breakeven and up significantly from a loss of $3.4 million in calendar year 2020. That's an approximately $3 million bottom line turnaround with a revenue increase of $3 million. Adjusted EBITDA for Q4 2021, $827,000, roughly or up to 21% of revenue. And that's $2.6 million for the full year, which is a $2.7 million turnaround in EBITDA. This performance continues to demonstrate the strong operating leverage of our business.

Now let's move on to Slide 8, where we highlight our balance sheet. You'll see that the balance sheet continues to strengthen as we continue to lower our debt levels. Cash at the end of the year was $2.8 million, up roughly $800,000 from the end of 2020 and up $400,000 sequentially. Cash provided by operations for the year, roughly $0.5 million. Long-term debt, including the current portion, at year-end was $2.5 million. And we've got one more $750,000 principal payment due on our Hard Rock note, and that's due on October 5, 2022. So our net debt to cash -- net cash to debt ratio is actually negative now. We've got more cash than debt on our balance sheet.

Finally, during the fourth quarter of 2021, the company completed an equity offering of 1.7 million shares priced to $1.15, and that resulted in net proceeds of approximately $1.7 million. We will be strategically directing a portion of our capital into raw material inventory to address supply chain inconsistency that we're seeing, and constraints moving out the delivery times so that we can ensure that we can successfully meet the increasing demands of our customers.

Lastly, I would like to report that our book equity balance at 12/31/21 is $6.1 million, which puts us back into the New York Stock Exchange continuing listing requirements.

So with that, I'm going to turn the presentation back over to Troy to wrap up with a review of our outlook and opportunities. Troy?

Thanks, Chris. So as we look at -- we look forward into 2022 and a lot of the things that we were working on throughout 2021 was agreements and structure to get signed early on this year and get into place. And I think as we go throughout the year, you'll all be pleased with what we come out with. But you look at our North America opportunity, we continue to work closely with our channel partner and also our legacy partners, as we look for more opportunities within those companies. We have an opportunity as we look at our manufacturing and we say, what is it that we do well and how do we get more of that?

And it's not looking at just being a third-party machine shop building some high-end products. We're looking at turn keen. We're looking at saying, not only let us manufacture that body, but let us complete that body. And as -- we've got a process in place that we call product line adoption, that we're currently setting up our first sale. We're spending $1 million on a machining center that's been identified for this particular product line, and we'll do that complete product line within the cell around this machining center.

And we think that's going to -- once we prove that up, we're going to be able to do that over and over again. When we look at our international opportunities, we're doing some things there. When you look at Oman, Saudi Arabia, Qatar, UAE, we've really strengthened our opportunities there with -- we're working with a very large servco in some of these countries. We're working with the E&Ps in these countries. It was -- it's been a very slow process. And like Chris mentioned earlier, the whole COVID thing hasn't helped. You look at Kuwait and it's still an issue to get expats in there and to get in there to sell, but that's going to open up.

And when it does, that's where we broke out into the MENA region, in the Mid-East area, and we expect the rig count there to come back up and -- but we're really looking forward. The team that we've got in place is doing a wonderful job, and we're working with some very high-end E&P opportunities there. So we're excited about what could happen there this year. You look at -- we've talked about M&A opportunities. We're still going down that road, and we're still talking to companies. That's very much alive. So we like what we're doing there. We -- obviously, we don't have a big staff to pay a lot of attention to that, but we're working it and we're moving that ball down the court.

So one of the things that we're excited about, we've always -- for the last couple of years, we've been talking about diversification. So we don't get beat up on the next downturn in this cycle that -- it's been very vicious to us, for everybody in the oil and gas industry, and we're diversifying. We're -- currently, we're working with electric vehicle technology, a company that's doing some very exciting stuff. We're helping them with design support and manufacturing support on a very small scale right now, but they want us to engage in a big way. And so we're excited about the opportunity that has.

We've feel that we can support their efforts as they grow this business in a big way. They've got some really unique technology that's fun to see. So as we look into 2022, I think it's going to be a wonderful year for us. We've got a lot going on. We've got a lot of things right close to the finish line to be signed. We've been working on agreements. And I think you'll all be happy with how this year rolls along and how it turns out.

So with that being said, I'm going to go ahead and turn it over to Q&A.

[Operator Instructions]. Our first question comes from the line of John Sturges with Oppenheimer.

Nice end of the year, gentlemen. My congratulations. The -- 2 questions. One is the -- you have the flexibility and you've done this in the past where you've made an early payment on Hard Rock. You have one more left, but you have a lot of optionality. I was just curious whether you're likely to make the early payment and just get that off the books?

John, that is an option, we look at it. We talk about it, but we'll evaluate that here. As we go forward, we've -- as we look at this product line adoption and spending $1 million to bring this machine in, it's not going to be $1 million cash. But there is going to be a good down payment that goes with it and the structure that goes around that machine. So we're watching it and just -- I wouldn't -- it's very possible that we could pay that off early, it would be beneficial when you look at the interest that we pay on it.

Okay. So -- but do you have the option not to as well, obviously, depending on the conditions business demand. The other question I have is I see the drilling that's gone up and has really not boosted production anywhere. Everyone is being cautious domestically and internationally. In fact, it looks, last couple of weeks possible -- a possible stalling of the rig count, it's too early to tell. Could you comment on just the general -- the color of the geopolitical stuff that's going on? And if you see any of that easing up near term?

When we meet with our team over in the MENA region, and we meet with them 3, 4 times a week. And like I mentioned earlier, what we see on the international market, if you look at Kuwait, there's still some issues there getting in. I mean we -- to travel in and out of those areas are difficult. I think what they're seeing over there is like we're seeing here. When you -- when we had this whole shutdown from COVID, your expats that were very comfortable going in and out of these countries that in some instances, got stuck in some of these places for 3, 4, 5, 6 months.

There's, one, a shortage of these workers. A lot of people have retired from oil and gas that were doing these expats programs, but we need them domestically here as well. So I think as we're starting to come back here, growing stronger here in North America, and it's still not an easy travel scene out there going in and out of these countries. I think that they're going to struggle to bring up production. I don't think it's going -- on the international markets, I don't think you're going to see a quick -- a large increase in production.

My personal view of that is they're not finding the people to do that. They're not finding the hands to be able to drill these wells. So when you see the rig count there, it's tough for them to bring on more rigs. They really rely heavy on the expat market. And it's just not a friendly environment for travel right now and going into these countries. So if you look at where we're at and not looking at internationally -- international rig count globally, but just looking at it in the region that we're in, I don't think you're going to see a lot of rigs standing up there.

But the opportunity there for us is tremendous because the rigs that are up, for the most part, we haven't done much, if any, on those rigs. So as far as -- the same in the Mid-East, we feel good about what we got going on in places like the UAE, places like Saudi Arabia, places like Oman. We've got a lot going on as far as opportunities coming forward. We've had to build an inventory to get over there, and we've done that. And we've got tools in place and we've got a team in place. We still struggle with identifying an area where we actually want to set up a refurb facility there just because of all the restrictions that are placed on those countries over there in the way of doing business, it's incredible.

But we're working on it. We feel we're going to get one up and running here. I would say, late Q2, early Q3, we should have something up and running. When you look at the North American market share, our domestic market, I think what we're going to see is a lot of small E&P companies popping up. We've got the bigger companies that have said they're going to have just -- it doesn't matter if it goes to $200 a barrel. They're going to have real restrained growth. They're going to not just start putting rigs up.

But I think what you're going to see is a lot of small E&P companies that come up and pick up a rig, 2 rigs, 3 rigs. And as those pop up and develop producing fields, then I think these larger E&Ps will buy up those fields. And that still allows them to keep their agreement with the market saying we're not going to go after standing rigs up. But they'll still be able to achieve bringing on more production by gathering up the smaller, newer fields that small E&P companies develop. That's how I look at it anyway.

Do you think they're going to be able to bring back the labor pool?

You know what, that's been really, really a strange deal. We've been hiring a lot, and we've been looking -- you need pumpers, drillers, location builders, all of this stuff that you need just to put up one location that's going to have 28 wells on it. John, to answer that question, you're seeing rigs come up and it's slow and steady, which I actually like. But I do think they'll bring back -- they'll entice people to come back into this market, but it's not going to be rapid. It's not going to be a rapid growth. It's going to be slow, steady. I don't think the labor pool is there just to go to 1,000 rigs by year-end. But I definitely think that we'll get to 700, 725, somewhere in there.

Okay. The other item, you had referenced sometime in 2021 that you were getting greater penetration of market share. Could you make a rough guess as to where you are currently?

As far as the drilling technology and what we have here in the domestic market, if you look at the areas where most of the drilling is going on, down in, let's just say, West Texas, for instance. I would dare say the market share is 30-plus percent. And then if you look on just the North American market in general, it's probably high 20s.

Right. And do you have a sense of the trend line on that? It sounds like it's growing.

It is growing. It is. More and more people are finding out what the benefits of the conditioned well bore.

Our next question comes from the line of Dick Ryan with Colliers.

Troy, to stay on that theme, you talked about DTI, bringing on new customers, increasing penetration. Is that in West Texas? Are you getting into other fields? Or can you give us a little more color as to what DTI is hearing from their customers?

Sure. It's everywhere. It's -- looking at what's happening with setting up, like I said, the smaller E&Ps in the Oklahoma area. It's getting some new customers in West Texas. It's now getting customers in California and Alaska. So yes, they're doing a good job.

If the market growth expands in the smaller E&P, is that a better environment for you? Or do you still need the larger ones to kick into really kind of benefits your business model?

No, it's good for us. It creates -- in this current environment we're in with the whole -- when you look at the supply chain and you look at steel and cutters and sorters and all the materials that we work with, and you can look at existing customers, existing opportunities out there, and you can monitor that and say this is how much of these items that we need. And as you all know, we're built -- we have to hold larger inventories, and we'd like to just because of the inconsistency in the supply chain today.

And when you have a new customer come on that may require different connections, different threads for their drill streams, then it just throw some complications into, okay, that size of steel, that different ID diameter, that different thread that goes on there, that's the stuff that you don't see that you can't plan for because you don't know where it is or what it is. And when it pops up, it's like everybody else, they need it right now. And so we have to kind of look forward and say how much more of these different sizes and different quantities of still blanks and cutters and sorters and fluxes that you really have a strong feeling is going to pop up, but you just don't know how much and when.

Sure. On the Contract Services side, is that still largely with the legacy customer? I thought you had some optionality to move to other larger customers on that front. Is that an option? Is that -- or are you expanding opportunities with your legacy customers that, that's the focus still?

No, it's an option. It's a very good option, and we've have been working it as very large customers move very, very slow. And -- but they do things very well. And it's -- we've been working on getting some qualified. And we've done step 1, step 2, I think we're getting close to the final stages of an agreement to bring on another high-end customer. But at this point in time, we haven't done it, but we've been -- that's an opportunity, and I think it's something that we can get done.

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

Kind of -- I'll ask this question regarding the market penetration in a little different way. the statistics that I've seen indicates that a lot of the rig increase, rig count increase is coming from independent or privately owned companies whereas the majors and the intermediate sized public companies have remained pretty steady in their overall rig count. So the question then is, have you seen a new business coming from that end of the market?

And given that the DUC count is -- has dropped rather significantly. At some point, the independent and majors are going to have to start picking up their activity not only to replace their production, but -- so I'm wondering if that happens in conjunction with your -- maybe these smaller companies adopting your Drill-N-Ream, if you could see a meaningful pickup in order activity.

One of the things, John, when we have a channel to market, like we do here in North America, we -- when we put that program in place, one of the things that we lost was that direct line of communication to that end user. If we do those programs going forward on the international basis, we'll keep -- we'll make sure that we keep aligned to that end user. But when you look here in North America, who's running the tools and who the new customers are, we really -- I really can't answer that when I look at that and say, well, there's 3 new small E&Ps that each got 2 rigs down in South Texas.

We break communications with DTI, and we see that when we invoice or when we get new connections or new tools request. So I don't know how many small E&P operators have come on or -- to be honest with you, I don't even know who they are. I just know that in communications with the DTI team, they'll tell me they've got a new company here or a new company there. And -- but we don't have that direct access to that end user.

Yes. That's kind of unfortunate, but in my mind, I think that at some point -- I think, yes, you got to split the problem with the labor force to be able to bring on any significant new amount of rigs. But that being said, hopefully, more people are adopting your tools. Are you seeing any meaningful improvement in, say, Canada?

I don't -- I haven't seen much in the way of Canada. I think they'll actually be laying down right now because of the -- they go through that freeze and thaw period where they can't have their drilling activity going on. And right now, we'll be going into the thaw period. So you'll probably see rigs laying down and then picking up again in a couple of months and going heavy once the thaw's gone.

Okay. One last thing. In the press release, you said there was a related party note receivable that was cleared up $707,000. Can you elaborate on that at all?

Yes, that's -- what that is, is that Tronco. You may recall that, John, when we fully reserved that receivable back in 2019, so we set up a 100% valuation allowance against that. And so as we settle that with Troy and Annette on an annual basis, the interest piece of that, then we can recapture a portion of that note that was fully reserved. So it's like collecting a fully reserved receivable that you would have written down. We can take that back as other income when we settle it. And so that's what that is.

Okay. Great. And then since you're now compliant with NYSE listing, what's kind of the time line before you have to submit something to them and then they review it and then say that's great? And then what's kind of the time line on that?

Yes. We typically have to submit a quarterly report to them, and we do that about 3 weeks or so after this earnings call. So I'm -- we'll be setting that date with them probably in early April, maybe the first week of April, we'll submit the report for Q4. And then they typically take all 3 weeks or so and come back to us and with a thumbs up that they accept our report. That's been the pattern that we've seen over the last 3 quarters.

Our next question comes from the line of Matthew Reiner with Adirondack Funds.

First question is, I know when you first started out, your tool life was -- in the Drill-N-Ream was like longer than you had anticipated, good quality tool. It was lasting, I guess, longer than you expected. And now that you've had more experience with it, do you have like a better feel for what the tool life is versus your...

Yes, we do. We've got a better feel for that. And it's -- go ahead.

Yes. That's -- what can you tell me about it? Is it -- have you kind of solidified it? And is it -- a ballpark of what it was?

When you look at the model that we originally modeled out, it was 12 runs, and it's up closer to 18. That's going from -- the only thing we had to model when we started was just the basin that we were in pretty much when we looked at the -- in the Bakken. And it was really the 6-inch class of tools. So we didn't have a lot to model from. But now we do. And so as we look at opportunities in the international markets, although what we see in the drilling environments in those markets, we see like in Oman, it's really, really the tools, the wear, the usage on the tool is really similar to what we see here in most areas in North America.

But then you see Kuwait. I mean, Kuwait, they just beat tools up. And so we think we've got a lot -- we're a lot smarter with modeling this out. I know we are. But when you look at Kuwait versus Oman, 2 totally different environments. So if you're going to model runs and try to predict that, it's going to be a lot less than when we model it out in Oman.

Got it. Okay. And then I just have a kind of a housekeeping one for Chris. And on the D&A, so I've seen it's been declining in the last few years going from like $3.4 million to $2.8 million like $2.1 million this year. But it sounds like maybe you're making some investments. So I don't know if maybe depreciation starts. I mean if I have it right, it was roughly $1.5 million this year and then amortization was just under $600,000 is -- can you kind of give me a ballpark is that -- and I think next year, your amortization of the intangible is supposed to drop to like $167 million. So I was just curious if depreciation should model still like that $1.5 million range? Or are you going to have some investments where that creeps up a bit?

Yes, that's going to creep up a bit. We are expanding. We've got some near-term opportunities that Troy talked about in the Middle East. We're getting some good revenue coming out of Oman now. So yes, the depreciation is going to inch up a bit. What drove the D&A down 2021 versus '20 was we fully amortized a bucket of intellectual property. And so that led to -- and that bucket was fully amortized at -- in May of last year. So we've got one more bucket of intangibles that we're amortizing. And so in 2023, that third and last bucket of intangibles would be fully amortized.

And so yes, we'll see it drop again. But yes, so that's -- it's -- the amortization expense has been going down. And yes, depreciation is going up a bit. But you're in the ballpark with the $1.5 million kind of number that you've got. But do expect it to go up slightly over 2022.

At this time, we have reached the end of the question-and-answer session. And I will now turn the call back over to management for any closing remarks.

Thanks again, everybody, for joining us and we're very excited about what we've -- the opportunities we have in '22 and '23, and we're going to continue to move forward and do what we -- the best we can do on this. We're -- like I said, there's a lot of opportunities. And I think -- the thing that excites me the most is when I look at our management team that we now have in place, I look at our employee base that we continue to grow on. And I look at the need that our customers have for our products, not just the Drill-N-Ream, but for the things that we do well. We're evaluating those, and we're going to capture some great opportunities. But thanks for joining us, and we look forward to seeing you on our next call.

This concludes today's conference call, and you may disconnect your lines at this time. Thank you for your participation and have a great day.