Superior Drilling Products, Inc. (AMEX:SDPI) Q3 2023 Earnings Call Transcript
Superior Drilling Products, Inc. (AMEX:SDPI) Q3 2023 Earnings Call Transcript November 11, 2023
Operator: Ladies and gentlemen, greetings, and welcome to the Superior Drilling Products Third Quarter 2023 Financial Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Craig Mychajluk, Investor Relations for Superior Drilling. Please go ahead.
Craig Mychajluk: Yes. Thank you, and welcome, everyone, to our third quarter 2023 earnings conference call. Certainly appreciate you joining us today. Joining me are Troy Meier, our Chairman and Chief Executive Officer; and Chris Cashion, our Chief Financial Officer. Chris will first review our results in detail, and then Troy will provide an update on the company's outlook and opportunities, after which we'll open up for Q&A. You should have a copy of the financial results that were released before the market this morning. You should also have a copy of the slides that accompany our conversation today. If not, both can be found at 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 and 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 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.
So with that, please turn to Slide 3, and I'll turn it over to Chris to begin. Chris?
Christopher Cashion: Thank you, Craig, and thanks, everyone, for joining us today. The third quarter presented some challenges given the persistent decrease in the domestic rig count which led to lower demand for our tools and Contract Service businesses. However, helping offset the slowdown in the domestic market was modest growth in our international business where we have made investments in our technical sales support team as we look to accelerate the Drill-N-Ream market penetration and capture greater opportunities moving forward. The overall top line softness impacted margins given the under absorption of fixed costs together with unfavorable product mix during the period. Also contributing were additional costs that I will speak to later in the presentation.
Despite these challenges, we generated significant cash from operations, driving our year-to-date total to $4.1 million. Also, during the quarter, we finalized our new credit facility which provides additional financial flexibility and liquidity, and we have begun to utilize the accounts receivable purchase program as part of that facility. Now if you turn with me to Slide 4, you can see an overview of our top line, which I mentioned, felt the impact of the lower U.S. rig count. International revenue, however, increased 6% over last year, but sequentially, we were down. And as we mentioned on our last call, at the end of Q2, we brought in a new team lead for our international business, and he has made tremendous progress during the quarter, getting up to speed regarding our business, evaluating staff and determining priorities.
As a result, we made further headcount changes within the business development, technical sales support group. This team lead has a highly technical approach in approaching the customer and represents a significant upgrade in our Middle East business development efforts. Our U.S. base executive management team spent significant time on the ground in the Middle East in guiding this reorganization. We see incredible opportunities for growth and are looking forward to leveraging our new team's capabilities and skills and significantly adding to that team as we move into 2024. In North America, we saw a slight revenue decline year-over-year. The change reflects the impact of a lower rig count in the U.S. as the current quarter average count was 650, down 111 rigs or 15% year-over-year.
The lower rig count impacted both Drill-N-Ream tool sales and Contract Services work. Despite this significant decline in the rig count, our revenue was only impacted by 3%. We were able to hold our own against these headwinds and gain a larger share of the tool and contract services market. Now unfortunately, the U.S. rig count story hasn't gotten any better as the count has further declined to 618 rigs as of last week. We haven't seen those kinds of numbers since the end of 2021 and beginning 2022 just as we were coming out of the pandemic. We believe we have reached the bottom of the U.S. rig count decline and expect the domestic count to begin to improve as we move into calendar 2024. On the international front, the rig count has trended very differently versus the U.S., steadily improving throughout calendar year 2023 from 900 at the beginning of the year to 962 as of the end of October.
Now let's move on to Slide 5 and take a little closer look at our tool and Contract Services revenue. Third quarter Contract Services of $1.8 million was down slightly from the sequential period and last year's third quarter. Likewise, tool revenue for the Drill-N-Ream was down slightly, which reflected the impact of that decline in the U.S. rig count, that 15% decline that we just referenced. Once again, we want to emphasize that our revenue decline was at a much lower rate than the overall 15% decline in the market. Now let's go to Slide 6 and take a look at SG&A expenses. As you can see, year-over-year, expenses were up roughly 50%, a significant portion of this was due to our international human resource reorganization that I mentioned earlier.
We had people that were not aligned with our new technical approach to business development and they are no longer with the organization. As well, with our U.S.-based management team spending a significant amount of time in the Middle East, we incurred increased travel-related costs. In addition, we continue to spend heavily in our patent infringement lawsuit. During the quarter, we incurred $260,000 in litigation legal expenses. Year-to-date, we have incurred just over $1 million, which is in line with our 2023 guidance. As well in the quarter, we modified our small diameter Strider tool to be run in the Middle East. And lastly, we had incremental costs related to our previously announced initiative to evaluate strategic merger and acquisition options.
Moving forward, we believe the majority of our litigation costs are behind us. And as of now, we expect a jury trial in the spring of 2024. We will continue to incur litigation-related costs as we move forward, but we expect those costs to be at a lower level compared to what we have spent this year. In addition, the reorganization of the Middle East technical team is complete and we don't expect a repeat of those travel-related transition costs nor do we expect additional Strider-related modification costs. Now if we go to Slide 7, we can see our bottom line and adjusted EBITDA results. Our business has significant operating leverage when volumes increase. But with lower volume, you can see the reverse of that is true with those unabsorbed fixed costs.
And layering on the additional costs, as I just mentioned previously, and the unfavorable product mix, they all contributed to the margin pressure that we saw during the period. We did have a reduction in force in the first week of October in order to rightsize our manufacturing organization for what we continue to see as a soft near-term market in the U.S. As I mentioned, we do expect, going into 2024, the market to begin to increase, but as we sit here today, it's still a soft market. That we've completed our investments in our Middle East repair facility and Drill-N-Ream rental tool fleet, this reduction in force will not impact our ability to respond to additional Drill-N-Ream tool demand as we move into 2024. Two other items also impacted adjusted EBITDA.
We received roughly $200,000 from a non-management shareholder due to short swing SEC profit rules. And these funds were recognized as other income in the quarter. Partially offsetting was a $43,000 expense due to an early redemption fee as part of the company's debt refinancing during the quarter. Now let's move on to Slide 8 where we will highlight our balance sheet, which has strengthened significantly. We have previously discussed our new credit agreement that we closed in late July. And beyond the additional financial flexibility and liquidity, it extends our maturity dates and, importantly, includes more favorable financing terms than our previous debt arrangements. Total debt at the end of the quarter was a modest $2.5 million, and we continue to be in a negative net debt position where cash exceeds debt.
Year-to-date, as I mentioned, we generated from operations $4 million compared to $1.3 million in the year-ago period. Cash at the end of the quarter was $4 million, double the balance from year-end 2022, reflecting improved working capital management and the timing of receiving customer remittances under the new credit facility purchase program and the result in transferring of those remittances to the bank. At quarter end, in October, we made a $1.2 million payment to our lender as part of that program. Now going forward, we do not expect to see timing issues such as these with the lockbox system now in place. With the lockbox, we will no longer be a customer remittance pass-through, thus payments will go directly to the customer, to the bank, to settle AR purchases.
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Capital spending of $3 million year-to-date was largely in support of our Middle East operations, which included the Drill-N-Ream rental tool fleet and the new service and technology center that we opened in the second quarter. Now let's go to Slide 9. We are maintaining our guidance for 2023. Our revenue range is $22 million to $24 million. SG&A is expected to be between $9 million and $9.5 million, and this includes those litigation costs which, projected through Q4, would be approximately $1.2 million. So as I mentioned previously, through nine months, it's just over $1 million. So we expect another couple of hundred thousand of spending in Q4. And as I also mentioned previously, we expect a jury trial in the spring of 2024. Our adjusted EBITDA guidance is $5.5 million to $6.5 million.
And lastly, our expected capital spending guidance for 2023 is in the range of $3.5 million to $4 million. So you can see that the vast majority of our CapEx has already been incurred. So with that, I'm going to turn the presentation to Troy to wrap up with the review of our outlook and opportunities both in North America and the Middle East region. Troy?
Troy Meier: Thanks, Chris, and thanks again, everyone, for joining us. Before I get started on my comments on the Q, I want to make sure that everybody on this call is aware. As mentioned earlier this year, the company's Board of Directors has engaged a financial adviser to assist the company with the evaluation of a potential strategic partner alternatives. This process is ongoing, and we are committed as ever to maximizing our shareholder value. As part of the process, the company has received and is actively evaluating unsolicited interest in the company from prospective strategic transaction counterparts. Keep in mind, there's no assurances regarding the outcome or timing of this evaluation, and we do not intend to make further announcements until such a time further the disclosure is appropriate or necessary.
So let's go to Slide 10. And let's look at North America, our comments towards North America. As Chris has mentioned, year-over-year, the rig count was down 15%, but we were able to support this downturn by bringing on some additional hot work. We've got some additional products going through our shop other than bits that we're seeing an uptick in. And so that's been a plus. The fact that we've been working with a second very large ServCo to start doing their work as far as the PDC bit refurb, that's coming along good. We think that that's really going to pick up and will be a big plus as we go into Q1 of next year. We're building that relationship. We've proven our services that we've done for them, and we expect to see that volume increase throughout Q4 and then really get strong as we go into Q1.
And we rationalized our domestic operations, and there will be some savings there, as noted. Let's look at the international. When we look at the MENA, the rig count, what we're seeing over there is totally opposite of what we're seeing here on the domestic front. It doesn't matter what country we're going to, whether it's Kuwait, the UAE with Abu Dhabi, the Kingdom of Saudi Arabia, Oman, they're all picking up rigs and they're doing it in a rapid fashion. We've proven our tool out very well in these countries. We haven't been able to do work in K.S.A. nor have we been able to do work in Abu Dhabi due to the fact that we didn't have our ISO requirements. Those are all complete now. So we're excited for the opportunity that that's bringing us.
As we look into next year and through the remainder of this year, we're excited to be able to, first of all, start doing work in with ADNOC in Abu Dhabi. We've made those visits. We've got some good history with some tools that we run there through a large ServCo that had very good performance. But again, we needed to get those ISO qualifications that we now have in place. So as our tech team, as we've been building that -- we've mentioned on previous calls, we don't consider ourselves a sales and marketing company. We're heavily weighted towards tech and operations and fabrication. And we have been building a team now that's been building a very strong database. As we look at the tool runs that we've had in Oman, in Kuwait, and even the tool runs that we've had in Saudi Arabia and Abu Dhabi prior to being essentially penalized for not having our ISO requirements, the Drill-N-Ream product line performs very, very well in the MENA region, just like it does here in the U.S. But I think the big opportunity there is the fact that when you look at the MENA region, the Drill-N-Ream was introduced into the vertical section of the wellbore.
So we introduced that tool in larger sizes. And so if you can envision a well, a typical well here in the U.S., we drill a vertical, we drill a curve and then we drill a lateral or a horizontal, if you will. And the Drill-N-Ream was designed and built for the laterals that have now turned into extremely long laterals here in the U.S. But when you look at the MENA region, the issues that they have in the upper section of the wellbore is where we've introduced the Drill-N-Ream room to really help out. Now saying that, we've also drilled the two longest laterals in Oman with the Drill-N-Ream. Sorry, the two longest, yes, laterals, horizontals again in Oman. So they are starting to make these curves and starting to lay down and go sideways, and that's where the real benefit of Drill-N-Ream comes in.
So the fact that we started out in the upper section of the wellbore and have proven this tool out in the MENA region with the larger sizes, the 16-inch sizes, the 12-inch sizes, and working our way down to the 8s and the 6s that are so popular here in North America, it's going to be really neat to see how this matures over time in the MENA region. We've mentioned earlier, Chris mentioned about our technology team. We're very pleased with what's going on there. And like I said, the database they're building and the runs that we're being able to now put in there, post run reports and show offsets of before and after our product, is really neat to see. And we're excited to start getting that out there in front of the customers. We have the new service, like our legacy service here, that's going to be happening.
We're looking to kick that off. When we talk about that, it's of course, the bit repair service. We're currently working with some large ServCos on contracts. As we look to kick this off in January, all of the equipment needed for that is in sea cans heading over there, looking to land in the Jebel Ali Port on the 29th of November. So that equipment has been built. We've got a couple of items left to go that will be in another sea can that leaves Vernal, hopefully, next week, and we've got some media blast units that will be going in there and another OD grinder. So the equipment CapEx has been spent. We have a highly-trained team that is really good at this service that will be overlooking and working and living in the MENA region as we kick this off in January.
So we're really excited to see that now start to mature as well. Again, the ISO certifications that the team got into place, it was a big task. And we now have the 45001, the 9001 and the 14001. So all of these things are in place along with a new, large Drill-N-Ream inventory. So we're looking to start seeing the benefits of all of this as we finish out Q4 and roll into Q1. But with that being said, I'm going to turn it over to some Q&A.
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