Superior Drilling Products, Inc.

Thanks, Stacy, and hello, everyone. We certainly appreciate your time today and your interest in Superior Drilling Products.

On the call with me are Troy Meier, our Chairman and CEO; and Chris Cashion, our Chief Financial Officer. They're going to review our prepared remarks, discussing the quarter, the third quarter, and a little bit of our outlook and then open the call for questions.

You should have a copy of the financial results that we released before the market this morning, and you should also have the slides that will accompany our conversation today. You can find both of those documents on our website at www.sdpi.com.

As you are aware, we may make some forward-looking statements during the formal discussion as well as during the Q&A session on today's call. These statements apply to future events that are subject to risks and uncertainties as well as other factors that could cause the 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 Securities and Exchange Commission. All of these documents can be found on our website or at sec.gov.

I want to also point out that during today's call, we will 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, I'm going to turn it over to Troy to begin. Troy?

Thanks, Deb. Thanks, everybody, for joining us today.

Let's go ahead and turn to Slide 4 in your slide deck. There are 3 things that I would like everybody to take away from today's call: And number one, I like to talk about our international growth and how that's going, how that's expanding and how our tools are performing there.

It's very, very encouraging; and two is the diversification in what we're doing here to essentially create a stronger foundation in the core business; and then number three, the managing of our costs. I think that's very important in these times, and our team is doing a very good job at that.

So let's start off with what we're doing and the traction we're getting internationally. The Drill-N-Ream, as you all know, we introduced it over in the Mid-East a couple of years ago, and we're really seeing it now where the operators see the benefit and the value that the tool gives.

And as we look at what's going on internationally and how we're being pulled into new opportunities into new countries, we're being pulled in there by large servcos that run the tool in countries like Kuwait and the UAE. And they recognize the value, and they recognize how much that tool is helping their performance and requesting these tools in places like Iraq and Ukraine, Qatar, Oman.

So we're very excited about that.

We have challenges with logistics that we're being educated on and working through as you all know when we -- these tools run, they've got to be dull graded, they've got to be serviced. And we've got a good team working on it, and they're doing a great job.

So you look at 5 different countries right now, the expansion after North America, and it's going very, very well. We're also seeing opportunities with a slim hole product line that is allowing operators to exit existing wellbores, cutting a window and exiting those wellbores and going through that window with the Drill-N-Ream tool.

As they go with smaller-sized bottom hole assemblies, this Drill-N-Ream is now allowing large operators that are well known to get in and out of these wellbores that, as they deepen existing wells, are sidetracked out of existing wells. It's a good opportunity for us going forward.

When we look at the diversification that we'll be talking about, as you all know, we've been -- our team has been working on getting ISO 9001 certified as well as AS9100 certificates, and we are going through audits as we speak. We actually have them in our facility today, and we're looking to wrap all of that up by year-end and I really think that we can probably have it done probably before December.

And what that allows us to do is go after some work that really fits into the wheelhouse of our machines.

As you all know, we have some large CNC machining centers here, and right now they're very busy making small parts, and we'd like to get them very busy making large parts and this certification is going to help us do that. So we're excited about being able to look at the defense industry and some of these other industries that require large parts to be machined, and this ISO certification and the AS certification will really help us get that done.

When you look at how we're managing our cost, I want you to be aware that we've reduced our monthly cash burn to $700,000. It's down dramatically from where we started the year.

We've gone into a Phase 3 of our cost containment, and it's going to be year-end. Going into 2021, we believe that, that cash burn will be gone.

So we're looking for a cash breakeven going into 2021, and I feel very good that we're going to achieve that.

But with that being said, I'm going to go ahead and turn it over to Chris. Chris?

Okay. Well thank you, Troy, and welcome everyone.

Let's continue our discussion by turning to Slide 6. If you look at the trend in our annual revenue, this slide shows that the value of our Drill-N-Ream wellbore conditioning tool has been gaining traction internationally, and that's what Troy just kind of walked you through, the various initiatives that we have and how that traction is really starting -- is really picking up.

You can see from this chart that we reached a pre-COVID high of $800,000 in Q1 International revenue. Our revenue went down in Q2 driven by the impact of COVID.

But what we are seeing in Q3 and continue to see in Q4 is the beginning of recovery internationally, and so we're very excited about that. We are now operating in 5 countries outside of North America partnering with global oil field service companies and serving the world's largest production companies.

Year-over-year, our international revenue for the quarter is up $141,000 or 49% up to $429,000 for the quarter, which represents about 28% of our total revenue. So we are rapidly becoming diversified geographically, U.S.

and internationally.

For the first 9 months, our international revenue increased 121%, and this was with a 20% decline in international rigs. In the U.S., revenue is down 47% with the overall U.S.

rig count down 52%. So the thing that we're really excited about is that in both markets, U.S.

and international, our tools continues to gain traction and share.

The decline in total revenue was about 24% sequentially or $500,000 compared with year-over-year decline of $3.5 million or 70%. Now this is demonstrating improving conditions since the initial impact of COVID-19 on our industry and the geopolitically driven imbalance of supply and demand in the global oil markets.

Now let's turn to slide 7, and we can take a little deeper look at our tool revenue. On this slide, the light blue, which is tool sales and rentals, includes our international revenue that we just spoke about on the previous slide.

That $429,000 is contained in that light blue part of the bar, and you can see that, with that revenue, it helped mitigate the decline. The overall decline in the revenue was only 11.4% sequentially, which is much lower rate than the overall market.

Once again, just another indication how the Drill-N-Ream is gaining share. Given the decrease in this market activity, our distributors' additions to their tool fleet were minimal in the quarter.

Now the navy-blue part of this bar contains what we call our repair revenue and our royalty revenue, and we repaired tools as they're placed into operation by our distributor. And so we're still seeing activity with the tool, good activity as a matter of fact.

As we just said, it's better than what the market is doing, and we can see that on this slide. We can see that year-over-year revenue for the recurring revenue stream that we have here, that's the navy-blue bar, down 65%, which is less than the decrease in the market of 72%.

So significant decreases in the market, but the theme is the same, it's a recurring theme. Our tools continue to outperform the market.

Now I want to continue to just to mention, keep everyone understanding that, in April this year, we did provide our distributor a discount for regular maintenance and repair work, and they often provide that on to their clients, and we do this in consideration of the depressed state of the industry. During the quarter, we saw the U.S.

rig count hit its low point in August with a total rig count of 244, and we're excited to see that since then the number of drilling rigs has been increasing, reaching 296 by the end of October. That's a 21% increase in approximately 2 months.

Now let's go to Slide 8 and look at our operating expenses. Through Q3 of this year, we have implemented 2 cost-saving initiatives comprised of headcount reduction, salary reduction, deferral of R&D projects and closing of our West Texas facility.

These actions have resulted in a 58% decline in cost revenue. As a percent of revenue, cost of revenue was 56% compared to 41% for the prior year period.

Now that increase as a percent of revenue reflects lower absorption of overhead cost and reduced volumes. SG&A, a good strong decline in that spending, down 39%, and that's a function of these cost reduction measures that we've implemented.

And of course, we implement these as a reaction to what COVID has done to our revenue line, significant reductions in our revenue related to the market conditions driven by COVID-19.

Now in October 2020, the company implemented a third round of cost containment measures, as Troy mentioned, through additional payroll reductions, which has reduced our monthly cash burn to approximately $700,000. This is down approximately $200,000 per month from previously reported cash breakeven.

The company expects that, at this rate and given expected improvements in multi-revenue, it will enter 2021 at a cash breakeven.

Now let's go to Slide 9. Net loss for the quarter $1.7 million, adjusted net loss $1.4 million, $0.07 cents and 5% per share, respectively.

Adjusted EBITDA, which is a measure we use for operational performance, was negative $600,000. For the trailing 12 months, EBITDA was $1 million or 8% of revenue.

These metrics reflect the decline in our revenue and that decline in our revenue is resulted -- is a result of COVID, the impact it's had on our industry.

Now at -- I think it's important to remember what our business looked like pre-COVID and so the bars in the right-hand part of this chart, you see 2018 EBITDA as a percent of revenue and 2019 EBITDA percent of revenue, healthy 21% and 28%. And remember that we were able to generate those kind of margins while investing in R&D and financing our geographic expansion.

So this is what the company will look like as we continue to turn the corner and get back to where we were pre-COVID.

Now let's go to Slide 10 and look at the cash balance that we ended the quarter, $1.4 million. Now that was up from $1.2 million at the end of 2019, but it was down from $2.5 million at the end of the second quarter 2020.

Total debt at the end of the second quarter was $6.7 million, down $200,000. We continue to pay down our debt, down $1.3 million for the year.

And just as a reminder, in that debt number is the remaining 2 principal payments totaling $1.5 million on our Hard Rock note. Once again, as a reminder, that first payment is due July 2021, second one in October 2022.

We are applying for forgiveness on our $900,000 loan from SBA payroll protection program. Regarding our mortgage, which matures in February 2021, we've been in active discussions regarding extending this with our current lender, and we received email confirmations that they will extend it.

And as another option, we are actively pursuing a potential sale and leaseback of our Vernal campus. Additionally, the company recognized $41,000 in other income related to a machine tool lease that was under an SBA loan that we had and that was forgiven as part of the CARES Act.

Now let's go to Slide 11 and just summarize our outlook and opportunities. Once again, regarding liquidity, with the latest round of fixed cost reductions, we expect to be net cash flow breakeven entering into 2021.

We expect our international revenue to continue to grow, driven by the demand we see globally for the Drill-N-Ream. And as Troy mentioned, we are working with all the major oilfield service companies that have acknowledged the value of the Drill-N-Ream.

We have opportunities in our bit remanufacturing business internationally in 2021. And as Troy mentioned, we are still working on ISO 9001, and we are close to having that accomplished.

As Troy said, auditors are looking over what we've done as we speak. So we expect to have those certifications done by the end of 2020, and that will open up more business to provide precision machining services to the defense industry and for other critical industrial applications.

So with that, operator, I would like to open up the call for questions.

Got a couple of questions here for you. Do you have any potential expansion of your product line in the Hard Rock markets?

For example, precious metals, base metal activity. I know in their exploratory work they kind of do diamond core, but very often they do reverse circulation drilling.

So I'm just wondering if perhaps you could have any application of your tools or the drill bits and particularly in refurbishment in those markets if that would -- if that's a possibility or if you've even looked into that and the level of...

John, we've done some custom design and manufacturing work for some of the mining industry. If you look at Kennecott and you look at some of the stuff over in Nevada, we haven't pursued that market with the Drill-N-Ream product line.

There is some opportunity there with a economic drill bit, if you will, that we've looked at. But no, we have not looked to deploy the Drill-N-Ream into that market.

I'm just thinking with particularly precious metal or even base metal prices on the rise here, more activity probably in that market and being domestic might be helpful, so that's interesting. Well, I hope you might consider looking into that if there's application.

And the follow-up question on that, totally unrelated, but you said you're active in 5 international countries right now. Does that mean that you have 5 tool assemblies at work right now or kind of how does that work?

And then if you can mention anything about Canada and Mexico activities and North America in general.

Okay. So if you look at our international activity, we've got a fleet -- our inventory sits in Dubai and also Kuwait, and that fleet is servicing the UAE, Kuwait obviously, it'll go over and then touch into Oman, it goes into Qatar.

And now we also have a small inventory, the slim hole opportunities that are in the Ukraine. And so when you talk about what does that look like, they're individual tools that are sent out to do a job and then they come back where they're into a shop where we have a service agreement with a company that will take and clean these tools and then do a dull grade and decide the level of service.

This goes through a -- it's all a web-based system that the team here created, so when we dull grade these tools with this service provider, we're sitting right down with them looking at the tool and identifying what part of that tool needs to be serviced.

So it's a very efficient way. I will say, however, the inefficiencies are that we don't have a full-blown Level 3 service center in the Mid-East, which we're looking to do the first part of 2021.

We'd like to get that done no later than Q2 because right now we have sea cans that are loaded with tools coming back to Vernal where we'll service these tools and put them back into a sea can and send them over.

So -- but you talked a little bit about the opportunities. What we're finding is as we are -- like in the slim hole application, as we're sitting down with the engineers of these projects and helping them get their tool assemblies in and out of the wellbore, that they've cut a window out of the existing well and gone deeper or gone sideways, we're also able to help them and start to identify opportunities for us by looking at what tools they're using downhole and can we design and build them a better tool, and we believe we can.

So as Drill-N-Ream opens the door for us to these large servcos on some unique projects, we're also identifying some opportunity within the wheelhouse, if you will, the equipment we have, the expertise we have to identify additional product lines that we feel that we can get out there and get to them.

So on these projects that you're working on, are they multi-well projects then? I'm trying to understand.

Are they one by one -- one well at a time type thing or is it a -- like if you're drilling off of a pad in the U.S., you're doing very often multi-well, so trying to understand a correlation between the type of what they're doing over there versus U.S.

So what we're seeing is these are what we call turnkey projects. It's where a servco has been asked -- they've put the bid in to directly be responsible for drilling wells either, in this case, Iraq or Kuwait.

And so they're in charge of doing this thing very efficiently. That's how they make -- that's how they're going to make their money on it, is this well typically takes 60 days to drill and that's how they bid that job, and they can come in there and do it for 45, it's a big win for them.

And so they ask -- that's where the excitement around our tool is really, really being generated, is the fact that this tool, as they use it maybe in Kuwait or UAE and they understand how it's helping them is one thing, but when they go to a turnkey project, they really want the tool, and so it's a testimony to the efficiencies the tool is creating, but yes, it's the -- I can say, with the exception of the logistics, we still struggle there because we're such a small company trying to figure out how to get stuff in and out of countries like Iraq or -- and the Ukraine. But other than that, when we get tools in place, the tools are performing well.

A very important note is every Tuesday, we get together with our international team and we go over the past week's performance reports. We go in and we do a post-run report for our customers, and we show them the savings that we're creating for them, and without any exception, when you look at our post-run performance reports, our KPIs are all checked off.

What that customer wanted our tool to do for them is check, and it's typically 3 to 4 different KPIs out of 10 that we offer them, they'll pick 3 or 4 for us to help them with, and those are always checked.

And so it's -- I'm excited about what we're seeing as these servcos are now pulling us into other locations and being able to benefit from the Drill-N -Ream technology in those locations, and it's really exciting for us to start teaming up with these companies that also have the ability to help us with logistics to get tools to them.

I would think your big service companies would be the main help in that regard. Am I not right on that?

You are right on that. We get the tools to Houston, and then they can take it from there, and so it's very, very beneficial for us to team up with them.

And they also give us places -- there's opportunities to store tools and to have qualified people dull grade these tools, and it just opens up. Every time we start talking and dealing with these companies, we see more and more opportunity all the time, and it's exciting road to go down.

All right. That's good.

What about -- what's the outlook right now with, say, Canada, Mexico, and say, maybe up in the Northeast up in -- with the gas market. Gas prices have firmed up a little bit, so are you seeing any increased activity, say, in the Marcellus/Utica trends up.

We're not forecasting a big increase in activity in North America next year. We have some, but our channel partner, Drilling Tools International, they've done a fantastic job.

They've got a great team that has held their own and actually been able to increase their market share during this downtime, and they're the ones that service Canada and the U.S. And so we figured there -- we look at that and they're doing a good job, and so we've been able to turn our attention to these other markets and other opportunities, but we haven't put a bunch in our forecast for 2021 for North America next year.

Right. One more and then I'll get out of the way for anybody else that might want to ask a question, that is, with some of the recent mergers announced here, particularly in the Permian and so forth, companies that are heavily involved there, is there -- are there any of those companies that are being, say, acquired that have not been using your tools that might now be prospective clients, given the acquiring company has been using your tools?

Yes. I mean that happens.

I mean there's times we hear about a company that's going to merge and essentially be managing a new company that has been -- or a company that's been running our tools, and so sometimes there is that worry. Will this new co -- this new management team accept the Drill-N-Ream?

And we're finding out that they do, but you still got to go back in there and tell a new team on what the product does, so yes, there's opportunities as M&As happen. There's good opportunities there.

Actually, a pretty decent quarter considering you had this uphill. I'm just curious about the slim hole product line.

It sounds like a new product line. Is it used in conjunction with perhaps Strider or some other tool that you offer?

No, but it's -- if you remember, right, we started with the slim hole Strider line before everything went south this year. We were doing some really neat stuff up in Alaska with the slim hole Strider with a very large servco, and so I think there's opportunity, John, when we look at this slim hole application because what we were doing up in Alaska with Strider is really similar to what we're doing in the Ukraine, other -- 2 different tools, a Strider is an extended reach tool.

It's used to get further out in the lateral, where the Drill-N-Ream of course is a bore-hole conditioning tool.

But when we look at what we're doing with the Drill-N-Ream in the Ukraine in the slim hole -- and when we say slim hole, we're typically talking the stuff that -- the 4- and 5-inch tool size and so the 2 tool sizes that we've got over there are the 4.5 and the 5.5, so they're new tool sizes for us, and we're identifying other parts of this operation that we're very familiar with, and we've made them parts and we've made them tools in the past, and we really think there is some good opportunity there.

Okay. This is a broader question.

It has to do with basically condition of the industry. I've seen the U.S.

production, oil production drop about 30% from where it was earlier in the year, but think now we have rig count down 70% so -- and a slight pickup beginning to show itself, and we all know that frac wells tend to drop in production profile a lot more quickly. Yet on the same -- on the other hand, we're seeing U.S.

consumption rise. So is this a forced -- what can I say, a need to meet the projected consumption demand?

Is that what's forcing up the rig count or are people just finding it more advantageous? Have they found other efficiencies and -- I'm just trying to get my arms around what's driving up the rig count.

When we first started looking at the rig count this year when we were trying to forecast what this looked like in the second quarter, we -- in this industry, we never see an increase in rig count in Q4. It's always the opposite.

The efficiencies that they've created today, they budget to drill X amount of wells starting in January, and the efficiencies, those programs usually end sometime in October or November and those rigs are laid down until January again. So this is something that's new to us, and I mean, we looked at it in Q3 and thought these companies are going to have to start drilling some of these leases and start replacing some of this production that these shale wells are famous for the decline curbs on them.

So you've got these wells that come in like gangbusters, but 12, 18 months out, that production falls off a cliff.

So we think that some of this is -- it has to replace that production that is definitely going to fall off that cliff, but we also know that a lot of the older wells were shut in. So the wells that had smaller amounts of production, those were the first ones to get shut in, in Q2 and going into Q3.

And the economics aren't there to bring those back on. So that -- all those wells that got closed in that had -- were developing small amounts of production every day that got closed up, they're not going to bring that back on at these prices, and they're going to have to chase the rapid decline of their production that comes out of these shale wells.

So we believe that we're starting to see and why this rig count has got to come up and so we're -- we'd like to see that going up obviously, and we're excited about it.

So then that begs the question, is this going to be up in fourth quarter for rig count going against the grain? Do you anticipate...

Yes. I mean you look at the rig count, it's been moving up every week couple more rigs.

I don't know if something recently is going to stall that out or if this whole COVID forecast lasting longer makes people more leery about bringing these rigs on, but I would think that there has got to be contracts that are in place for production demands and that the people have to supply. So again, I think that, that sharp decline of these shale wells, they're going to have to drill to fulfill their contractual needs.

Okay. That was my impression.

I just wanted to see -- get a sense of it from you. You're more -- you're closer to the ground on all this.

So anyway, thanks again for joining us. We've got a lot of opportunities in this down market.

It's obviously a tough market as you know. I mean it's brutal, but the team here is doing a great job.

There are some tremendous opportunities. We're going to protect our balance sheet.

We're going to continue to work on service agreements that we're putting into place with these large servcos, and we're excited about the uptick in some of our legacy business that we've had for a long time. We're seeing that start to pick up in Q4.

So we're excited and we're looking forward to getting 2020 behind us and getting down to some good business in 2021. And with that being said, thanks, everybody, for joining us, and we'll look forward to talking to you in March.